There has been an abundance of commentary around Bernanke’s “green shoots” comment some weeks ago. Some economists have embraced what Bernanke said yet others are claiming that the green shoots are no more than perennial weeds!
So fact or fiction – are there “green shoots” or is the world continuing to fall into the abyss?
We suspect that there are “green shoots” or very positive signs that industrial activity is picking up. This suspicion is not from preconceived ideas or based on the opinions of others rather it comes from observing the behaviour of the market.
Many would have you believe that the most important commodity in the world is oil. There is no denying that crude is vitally important to understanding what is happening in the world economy.
However, we believe that the volatility caused by speculative capital (even more so over the last few years with the ease of access to trade oil), manipulation that is prevalent (or such that we are led to believe) and “shocks” associated with the disturbances to production due to natural disasters (like hurricanes in the Gulf of Mexico) and “political” events.
These “imperfections” serve to alter the price of crude over the short to medium term such that the price movements have little to do with changes in economic fundamentals.
The commodity that we believe is more representative of pure changes in economic fundamentals is coal. It is difficult to manipulate, its supply is not so affected by political or natural events and it is comparatively difficult and expensive to store, which effectively weeds out speculators.
Moreover, coal is a genuine industrial commodity with over half of the world’s electricity generation being powered by coal fired power stations. It is integral in the production of steel and can be converted to produce crude and other industrial chemicals.
In order to analyse the behaviour of coal we look at the movement of coal stocks relative to major market stock indices. This eliminates the impact of stock market movements so we can ascertain the movement due to changing expectations of coal demand and supply. In essence, outperformance of coal stocks suggests global economic expansion.
Yes this is a rather simplistic way of looking at things but it has proved to be a very accurate indicator of growth over the last 50 years and we see no reason why this indicator of world growth will break down over the next few years.
We look at the performance of the ETF KOL relative to the Dow World Index. KOL tracks the STOWE Global Coal index and is essentially comprised of coal companies globally not just US based companies. It suggests that on a global scale expansion is underway rather than contraction:
Just for a cross reference we also look at the performance of the Dow US Coal Index relative to the Dow Industrial. If also confirms the behaviour of the chart above.
Another confirming indicator is the performance of the global steel ETF SLX relative to the Dow World Index. If coal stocks are outperforming it should be accompanied by outperformance in steel stocks since without coal (albeit coke) steel would be very difficult and expensive to produce. It appears that steel stocks are also outperforming which adds weight to the behaviour of the two charts above.
We think that the outperformance of coal stocks has just begun and we see considerable upside in the likes of Massey Energy, Alpha Natural, Patriot, Peabody, and Consol Energy not to mention the ETF KOL and steel stocks. Valuation wise it appears that coal producers are still being priced as if the recession will continue at least another couple of years.
Of course there is something else that may well prove to have a bigger impact on coal stocks than economic growth and that is inflation. Coal is a currency just like copper, nickel, crude, silver and gold.
We have a reasonably large weighting to coal stocks in our global wealth accumulator portfolio (Earnslaw). We discuss the individual counters, weightings, and trade history with our subscribers.