ETF Update: Is There Really Strength In Coal?

An important strength of a trading system is that it forces you to think. Humans form opinions and stick to them. The blinders of selective perception and confirmation bias lead everyone's fundamental analysis to conclusions that are difficult to budge.

We find that a regular review of the market, sector by sector, helps to avoid these biases. Our own approach looks at Trend, sector Cycles, and adds a touch of Anticipation. Since we do this with a universe of 57 ETF's representing a range of sectors, we call it the TCA-ETF model. (For new readers, there is a more complete description of our methods and ratings at the end of the article.)

This week's ETF update provides two good illustrations.

The Market

The S&P 500 gained almost 1% for the week. That is a great return, but to most it does not feel that way. Why not? Extreme volatility makes a 1% gain seem trivial. The market was up almost 5% on Tuesday, and declined the rest of the week. Most of the media and punditry are completely focused on bearish economic news.

The system rankings force us to keep an open mind. Fifty of the 57 ETF's have positive ratings. Since three members of the universe are inverse funds, we can never achieve more than 54 in the "buy" range. In addition, most of the ratings are quite strong, indicating better than average stock performance over the next month.

The market action, captured by the model, suggests that we look past the bearish fundamental news.

Strength in Coal

This week's featured sector is the Market Vectors Coal ETF (KOL). The ETF is based upon the Stowe Coal Index, which is down over 56% YTD. 40% of the exposure is outside the US. The top five holdings make up nearly half of the fund. The P/E ratio is under 11 and the price-to-book is just under 4.

During the last week, KOL made a big move in our rankings, from #12 in last week's report to #2 this week. We added the position on December 12th. Let us take a look at the price and volume history as shown in the chart below (click to enlarge).

Our model is like a wise advisor, providing recommendations and ratings without commentary. From experience, we know that a basing pattern like this is a positive factor.

We are pretty much alone in spotting the KOL potential. Charles Kirk, who misses very little, noted the ETF as a big mover without further comment. Tom Lydon did a feature last week on clean coal and coal gasification, mentioning KOL.

Coal Fundamentals

We are surprised at the KOL forecast from the model. We have three concerns:

1. Oil prices have been falling despite OPEC production cuts. There is always some ability to substitute one form of energy for another, so this is a negative for coal;
2. Chinese imports have been lower, with the Baltic Dry Freight Index hovering near historic lows; and
3. Obama energy policy does not favor coal. In fact, it is pretty much the opposite of the Tom Lydon position. At our sister site, ElectionStocks.com, we continue to monitor the impact of the Presidential transition on specific stocks and sectors. There is a good article on Obama's plan for auctioning emission rights and also breaking news on his science advisory appointments, the clean team.

Our Conclusion?

Trading has different time frames. While we expect the Obama energy policy to be relevant in the long run, we respect the market signal on coal. Our best guess is that there is something positive with Chinese demand. Meanwhile, we follow our system.

Weekly TCA-ETF Rankings

The ratings reflect prices and signals as of Thursday night, December 18th (click on chart to enlarge).

In our daily trading program (for accredited and institutional investors) we buy the top eight sectors. In our weekly program for individual investors (free report available upon request) we stick with the top six sectors.

There was not much turnover at the top. One of the new additions, RSX, did not perform well. While we were up about 2% on the week, this was the major limiting factor.

Based upon the current ratings, we continued our bullish stance in the Ticker Sense Blogger Sentiment poll.

Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETF's and Sector Rotation. Before turning to the current rankings, let us undertake a review for readers new to this series.

Our Method. In this past article, we described our basic methodology and why we believe the rankings are useful for fundamental traders and technical traders alike. While we urge readers to check out the entire article, the key point is that ETF's pose challenges and opportunities different from investment in individual stocks. The fundamentals may be more difficult to assess. Even with a good grasp on fundamental trends, there is a lot of technically-based trading in ETF's. This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves. Here is an article on that point.

The system synopsis. We look at Trending sectors, Cyclical Sectors, and build in an element of Anticipation for both entry and exit -- thus the name of the model, TCA-ETF. While we do not reveal the exact methodology for spotting trends and cycles, the system is not a "black box." The basic elements are used by many, and widely reported. We even discuss the need for human analysis as opposed to black box trading.

We do not buy a sector that is in the "penalty box." One can think of this as similar to a trading stop. It means that trading in the ETF has violated certain technical criteria. To assist readers in following this, we have added a field showing which sectors are in the penalty box. The overall number of sectors in the penalty box is also an important read on the overall market, influencing our overall posture.

We report the rankings each week, now on the weekend with a one-day delay, using the Thursday output from the model. We monitor and trade this daily, and offer a free report (request via the email address on the top left of the site) for those interested in our weekly trading program.

Comments

[Steve Erickson:]

Five quick things:

1. Re "The blinders of selective perception and confirmation bias lead everyone's fundamental analysis to conclusions that are difficult to budge."... very well said.

2. I agree that, on an end-of-week basis, KOL is a buy. It threw that signal on Friday, 11/28, on my weekly model. However, it's about the same price today as it was then.

3. On a daily basis, per my model, KOL threw a 'caution' on 11/18, and a 'sell' on 11/19 (an UP day).

4. Is there some reason, in addition to the three inverse funds, that you don't include at least three bond ETFs? They've been screaming lately, over everything else.

5. I couldn't help but notice that both of you're two "closed trades since last update" were losers... if you buy/sell at the open.

Regards,

Steve
TheEricksonReport@gmai...

2008 Dec 22 01:55 PM

[Steve Erickson:]

Five quick things:

1. Re "The blinders of selective perception and confirmation bias lead everyone's fundamental analysis to conclusions that are difficult to budge."... very well said.

2. I agree that, on an end-of-week basis, KOL is a buy. It threw that signal on Friday, 11/28, on my weekly model. However, it's about the same price today as it was then.

3. On a daily basis, per my model, KOL threw a 'caution' on 11/18, and a 'sell' on 11/19 (an UP day).

4. Is there some reason, in addition to the three inverse funds, that you don't include at least three bond ETFs? They've been screaming lately, over everything else.

5. I couldn't help but notice that both of you're two "closed trades since last update" were losers... if you buy/sell at the open.

Regards,

Steve
TheEricksonReport@gmai...

2008 Dec 22 01:57 PM