Seeking Alpha
Paulo Santos, Think Finance (377 clicks)
Long/short equity, arbitrage, event-driven, research analyst
Profile| Send Message| ()  

Ordinarily the substantial move on natural gas, which was rather predictable, would be a large positive for coal stocks (KOL). Based on such a move I've called a few coal rallies in the past. However, this time I think there's reason for a slight delay. In this article I will explain why.

Coal in the U.S.

Coal in the U.S. is used massively to make electricity. For instance, in 2012 up until September, 92.7% of the consumed coal by weight was used to make power. In this regard, coal competes with natural gas. This is so even though natural gas has many other uses, from heating to industrial applications.

Natural gas is usually the fuel setting power prices in the margin, and due to the shale boom in production, it actually got cheap enough to directly compete with coal and sometimes substitute it as the fuel of choice for producing power. This relationship between natural gas and coal means that if natural gas sees higher prices, as it has been seeing lately, coal too can see higher prices.

Coal's other use

The other use for coal is for making steel. Here, prices depend essentially on what is happening in China, since China controls almost half of the world's steelmaking capacity. And here, unfortunately, things aren't so bright as with natural gas. At this point and after a slight recovery, steel prices are again falling in China, which should be enough to pressure met coal prices lower as well.

Another factor

There's yet another factor for coal shares which must be taken into account. Coal shares are sometimes seen as cyclical in what regards the economy. If one gets a growth scare, then these stocks get dumped "en masse". This is particularly true for the Chinese economy and, at this point, there are signs a growth scare in China might take place in the short term (over and beyond what's happening to steel prices).

With this in mind, along with the huge leverage in the stock market and its overbought nature, it would seem that even if one was thinking of going long coal shares, it would be wiser to see this scare produce its effects in both the stock market in general, and coal stocks in particular.

Conclusion

Taking into account all the variables, it would seem better to wait for a growth scare in the stock market and in coal stocks. Then, when the small panic takes place in coal, one can consider buying stocks which might gain more from natural gas moving up.

Among these, Cloud Peak Energy (CLD) and Arch Coal (ACI) will seem like good candidates. I'm less fond of Alpha Natural Resources (ANR) due to the recent study on its risk I published in my previous article. I also think James River Coal (JRCC) is too risky - even riskier than Alpha Natural Resources - again due to my recent study on its risk.

In short, it's not yet time to go long these stocks, but there's a chance that such an opportunity might present itself in the near future, say, in the next few weeks. However, the opportunity should come in the form of yet another scare in the sector.

Source: Timing The Next Move In Coal