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Several articles convince me that commodities, especially coal, should be close to the bottom. Here are the links to these articles. (That's the reason why you want to read economic news - to take advantage of any new opportunity.)

1. The coming rebound of coal and coal stocks.

2. A credit analysis of coal mining companies.

Is the bottom near for commodities?

For the last three years, the bottoms of coal stocks have been predicted several times. Nevertheless the coal stocks went up temporarily and then continued its bearish trend. Many coal companies could go bankrupt. I bet most of them will not offer one of the best appreciation potential, but I do not go that far to proclaim it is one of the best deals in our generation.

Many experts believe natural gas would replace coal to generate electricity. The impact of natural gas will be even clearer by 2016. That may be true in the USA, but not in China and many countries. Even with all the nuclear generators on-line in ten years (2023), China will still depend on coal to generate more than 60% of its electricity.

The stocks

I include 15 stocks and one ETF for analysis. After the initial analysis, I classify them into the following groups.

Coal

Gold miner ETF

General Mining

Steel

Petroleum

w Nat Gas

No.

11

1

1

1

2

Stocks

ACI,ANR,ARLP,BTU,CLD,CNX,JRCC,NRP,WLB,WLT, YZC

GDX

RIO

SID

CHK,DVN

Value

These stocks have very high potential for appreciation. However, they are risky. Nothing risked, nothing gained. Most have high debts (the average debt/equity is 129% in this group) and their survival depends on many factors such as the prices of the commodities. The following table concentrates on their values.

Stock

Price (11/7/03)

Forward

Yield

Cash

Flow

P/B

Debt/

Equity

P-

Score

ACI

4.38

-35%

Worst

.4

276%

-4

ANR

7.86

-75%

Worst

.4

90%

-6

ARLP

75.78

10%

Average

3.6

133%

8

BTU

20.19

3%

Worst

1.2

194%

-4

CHK

26.23

5%

Worst

1.3

77%

1

CLD

16.09

5%

Worst

1.0

100%

-2

CNX

26.23

10%

Worst

2.0

132%

-3

DVN

61.40

5%

Worst

1.2

101%

-2

JRCC

1.91

-80%

Worst

.3

74%

-5

NRP

19.93

10%

Average

3.4

84%

3

RIO

53.52

10%

Average

2.2

51%

0

SID

5.71

15%

Worst

2.1

329%

2

WLB

14.11

5%

Best

-1

WLT

18.11

-35%

Worst

1.3

287%

-3

YZC

10.08

15%

Best

.8

92%

2

Peabody Energy (BTU) has coal mines in Australia, which is closer to its primary customer, China. Rio Tinto ADR (RIO) has mines of different ores all over the world. Alliance Resource (ARLP) and Natural Resource (NRP) are partnerships.

If you do not want to deal with extra effort in filing the tax returns, buy partnerships in a non-taxable account. I have not checked out the requirements for filing tax returns for ARLP and NRP.

GDX, an ETF for gold miners, is not included in the above table. It has a huge non-correlation between GLD, the ETF for gold, so I believe there is good value in gold miners. GDXJ (not included in this article) is a similar one for junior miners, which is too risky for me.

Most data are obtained from finviz.com except Forward Yield. Forward yield is my estimate and it is defined as forward E/P. Cash Flow is based on the free site Blue Chip Growth. Cash Flow and Debt / Equity measure whether the company will survive. The table does not include all the metrics. P-Score is based on my book Scoring Stocks and 3 is the passing grade.

When the commodities are in the market bottom, the scores for these stocks would not be good. Actually most of them do not pass (the passing grade is 3).

Yanzhou Coal Mining (YZC) scores quite high with the coal stocks with a high dividend yield.

Arch Coal (ACI) and Alpha Natural (ANR) though risky have the most upside potential and both prices are about 40% of their book values.

Risk levels

The following table summarizes how safe are the stocks.

Safer

Middle

Risky

No.

3

6

7

Stocks

ARLP, NRP, YZC

CHK, BTU, GDX, RIO, SID, WLB

ACI, ANR, CLD, CNX, DVN, JRCC, WLT

My contradiction

I contradict myself in the following statements.

1. I do not trust the financial sheet of emerging countries including China. However, when many miners are foreign companies, I do not have a good option.

2. Mining is a sector I try to avoid.

It is extremely difficult to estimate how much ores (sometimes a miner owns several different ores of different grades in same or different mines) the company has; complicated by the complexities to extract and transport them. When those costs are greater than its production price, the company will not be profitable. Understanding the market for ore futures is another discipline.

One potential problem of mining companies from many emerging countries is nationalization.

Timing and Analysis

I would skip the worst scored stocks, which are too risky for me but they may have the highest appreciation. ACI and ANR are very tempting though.

Most of these stocks have been down for the year and there is more pressure to sell them for window dressing for fund managers in Nov. (even earlier) and for tax write-offs for retail investors in Dec.

Technical analysis will not detect the bottom, but the trend. When the trend is up, the risk is less but the opportunity to buy at the bottom is gone. Today, the trends of most of these stocks are down. I will explore whether there is a correlation of the bottom with the percentage from the last peak.

Timing is a suggestion and you buy the stocks at your own risk and risk tolerance.

My plunge into commodities

This article was originally written in 7/2/2013 (this article has been updated today) and it was included in my book Debunk the Myths in Investing. I recommended to buy commodities especially companies in coal in 11/2013 for the timing issues described above. Today I updated the performance of what I bought.

Most authors reveal a statement first and then illustrate with examples to substantiate that statement. Hence, such writers are always right. I am doing something just the opposite in this article. In analyzing what coal stocks to buy (the example) and you help me to verify the bottom for coal stocks (the statement).

This process has its risks, as I try to emphasize that investing is a prediction, which will not be 100% certain. However, the better educated the guesses are, the better chances the predictions will be materialized. Even if that prediction is wrong, there is nothing wrong with the logic here.

The following analysis was done in 7/2/13. In general, most prices have been up and most fundamental metrics such as P/B should be depressed further. My scoring system (P-Score) shows that evidence. Debt / Equity is an exception.

Stock

Price (7/2/13)

Forward

Yield

Cash

Flow

P/B

Debt/

Equity

P-

Score

ACI

3.69

-35%

Worst

.3

184%

-4

ANR

5.33

-75%

Worst

.2

70%

-6

ARLP

71.06

10%

Average

3.6

109%

8

BTU

14.86

3%

Worst

.8

126%

-2

CHK

20.92

5%

Worst

1.1

106%

1

CLD

16.19

5%

Worst

1.0

83%

-2

CNX

27.12

10%

Worst

1.6

81%

-1

DVN

53.05

5%

Worst

1.1

82%

-2

JRCC

1.82

-80%

Worst

.3

255%

-5

NRP

20.48

10%

Average

3.4

172%

3

RIO

40.69

10%

Average

1.6

57%

0

SID

2.61

15%

Worst

5.6

329%

2

WLB

11.4

5%

Best

-1

WLT

10.79

-35%

Worst

.5

276%

-2

YZC

7.03

15%

Best

.5

90%

4

If you bought all the stocks in July 2, 2013 (when the book was published), you should have the following return on 11/6/2013.

Average Return

S&P Return

Beat S&P by

Annualized return

20%

5%

300%

87%

I could not resist and bought two stocks from the above list. As of 11/5/2013, the performances are quite good but I did not beat the 20% average of the entire portfolio. DBC and NGD have been up more than 10% at one time.

Stocks

Buy Date

Return

BTU

06/24/13

33%

GDX

07/15/13

6%

FCX

07/31/13

29%

DBC

08/08/13

0%

NGD

09/12/13

-6%

FCX is too good a price to pass and the insiders bought many shares.

The above are actual and verifiable trades from my largest account.

Conclusion

The coal stocks have the highest potential for appreciation, but they are also the riskiest. By spreading out the risk with having more than one coal stock and stay with the first group or by purchasing an ETF on coal stocks such as KOL. The ETF included here is for gold miners.

Catching the bottom of a sector is risky but could be very profitable. I believe it will take at least two years for the market to recognize the potential upside values of coal stocks. Several of these stocks may not survive. That also depends on the impact from the shale energy and the recovery of the economy.

Repeatedly, we the retail investors never learn the following lessons:

1. Buy in fears and sell in greed instead of the other way round.

2. All inflated sector (and deflated sector in this case) will return to the average value with only one or two exceptions. Gold in 2011 is not really an exception but the USD had been depreciated.

These two lessons are the cornerstones on how bubbles are formed / burst and how we can profit from the bottoms of these sectors.

Source: Commodities: Bottom Or Mirage?