Stocks to Watch if Crude Oil Heats Up

Historically, when we begin to enter the spring/summer months, the price of crude oil heats up. As crude starts to heat up, some chemical stocks immediately come to mind. Yes, chemical stocks, not your average oil stocks like Exxon (XOM), Chevron (CVX), Conoco (COP), BP (BP), and Sunoco (SUN), as these stocks track crude well, but don't explode like these chemical stocks have in the past when crude trades higher.

The stocks that hit MY RADAR are: Sociedad Quimica y Minera (SQM), Terra Industries (TRA), Agrium (AGU), and Potash (POT). Looking at a chart of the United States Oil Fund (USO) versus each of these companies, it looks as if SQM is the strongest one to have in case crude rises. Two major parts of SQM's business are Lithium and Fertilizer. Parts of the company's profile are taken directly from Reuters.

Lithium

The Company produces lithium carbonate, which is used in a variety of applications It includes batteries, frits for the ceramic and enamel industries, heat resistant glass (ceramic glass), primary aluminum, lithium bromine for air conditioner equipment, continuous casting powder for steel extrusion, pharmaceuticals, and lithium derivatives. SQM also supplies lithium hydroxide, which is used primarily as a raw material in the lubricating grease industry.

Other Products

The Company produces and markets granular potassium chloride, which is distributed through its subsidiary, Soquimich Comercial S.A. in Chile. In addition, it imports fertilizers that are distributed through Soquimich Comercial S.A. in Chile, offering fertilization services to its customers.

Both demand for lithium and fertilizer increase when crude oil begins to rise, causing the price of stocks in the fertilizer/lithium industry to increase as well. When the price of crude goes up so does the demand for alternate energy. One major reason agriculture (fertilizer) stocks have boomed in recent years is because of ethanol. If more people want to grow corn faster they will use more fertilizers. On the other hand they are involved with lithium for batteries. When the price of oil increases so does the demand for hybrid type cars, which means the demand for batteries increases.

The chart below shows COP, CVX, SUN, and XOM correlated with USO over the last 18 months. As you can see from the chart, three of the four oil names have outperformed the USO, all with greater than 25% losses (click to enlarge).

The chart below shows AGU, POT, SQM, and TRA correlated with USO over the last 18 months. As you can see from the chart all of the chemical stocks have outperformed the USO, all with less than 25% losses, with SQM being the best performer and the only one which is positive over the last 18 months.

click to enlarge images

As you can see all of these companies are correlated quite well with USO. Overall when the price of USO gets hot, the price of SQM gets even hotter. The reason behind this is obvious especially since the birth of ethanol.

However recently from the charts you can see that they have disconnected a bit, with the greatest disconnect being when crude bottomed in February (amazingly the same time SQM was setting short term highs). SQM looks as if it has stabilized hitting its 52 week low in October, and I believe we have seen a bottom for the price of crude oil.

Assuming the correlation between the two will get stronger at some point, based on last year's activity, as the price of crude oil rises SQM should also rise. SQM has a nice head start so we may see SQM hit levels similar to last year assuming crude gets back into the 60-70 per barrel range. The current Bull to Bear ratio on SQM is 10:0 compared to more bearish statistics on the other chemical companies. To see a detailed definition of each component in the Option Maestro Bull to Bear ratio, click here.

Technical Analysis:

The chart above shows a clear double top set in February near $33 per share, and later in mid April at a higher high near $34 per share. The chart indicates that if we can break through resistance at $34 we could easily get to the next resistance which comes in near $37, and if we can fill in the gap down set in early September at $38, we could get above $40 a share on a short term basis.

All of these chemical companies are great, but I think SQM is the strongest company, with the greatest potential, not to mention they pay a decent dividend for the longer term investor. SQM has the highest rating for EPS growth, and RSI among the group of chemical companies in this analysis.

Disclosure: Long SQM

Comments

[Gravity404:]

Very interesting correlation. Thanks for putting this together.

I’ve been watching SQM for a while, as well as POT as they own 38 percent . It helps me make a decision on pulling the trigger.

I've been trying to time it, but we all know its time in the market not timing the market...

May 07 09:56 AM

[letsroll:]

Zacks has a STRONG SELL and 5-rank with target of $26

May 07 10:22 AM

[T. Marc Sch...:]

I agree with a lot of this. POT might be due for a rise. Nice article

May 07 10:46 AM

[TraderRob:]

Tickets are cheap on the "buy commodities bus" with all of the chatter about hard and soft resources, yet we've seen a historic run up in these recently. While crude is correlated to SQM I think the correlation is less signifcant than the correlation of fertilizer stocks to soft commodities. The inflation play isn't out of the gates yet as deleveraging is still the trend, so I'd pay close attention to the tethered relationship that all commodities are exhibiting with respect to global equity prices. Take a step back and wait for a pull back.

May 07 03:28 PM

[notsosmart:]

not yet.be patient.it may be hard to do but it may pay off.

May 07 04:04 PM

[einstein p ...:]

Built a position in the low 20s on SQM and it seems to be stuck in the low 30s. Lithium is key to the company's future, but it may also be holding down the price in the short term due to the ongoing problems in the car industry. AGU looks more interesting right here, after having reported a fair quarter --- to be kind --- and holding it's ground.

May 10 06:43 PM