On 'Bunker Fuel', Coal Producers and Railroads

by: Jim Delaney

All too often over the past two and a half years there have been days and even some weeks where the correlation across all of the sectors of the equity markets has pinned itself at 1.0. There have been slightly less, but still too many days when that correlation stretched across all asset classes. In a healthy market bonds have a tendency to move opposite stocks with commodities moving independently of each of those. The relationships are always somewhat fluid with the result that while tending towards a positive or negative relationship, a shot gun wedding it is usually not.

“We haven’t seen the independence [in commodities returns] that you’d hope for in a diversified portfolio,” was how Jay Feuerstein, CEO of the CTA Xenon Group, put it. That sentiment was shared by Nadia Papagiannis, alternative asset strategist at Morningstar, when she observed, “We found out last year that they [stocks and commodities] were very highly correlated.”

This relationship is also borne by looking at the numbers as the S&P was up ~26% last year while commodities funds were up ~22% according to Lipper. Over the past three years those numbers are approximately -6.6% for the equity index and -7.3% for commodities funds.

The CEC Strategy uses the relationship between credit spread and equity price movement to generate buy and sell signals in stocks. As such looking across asset classes is not something unusual for Market Strategies Mgmt., Inc. With that in mind I thought it might be interesting to take a quick look at what is going on in some of the commodity markets to see if there are hints to be gleaned.

“Bunker fuel”, also known as residual oil is the cheapest liquid fuel and is what is used to power the freighters plying the world’s waters. It is priced at a discount to Brent Crude, the North Sea extract. That spread, recently quoted at $3.50 is the narrowest it has been in the last three years.

Diesel oil too has seen a rise in demand by China, India and Japan in recent months. ‘“The arrival of the first concerted signs of a distillate recovery' bodes well for global oil demand," according to analysts from Barclays Capital.

The price of coal has also recently rebounded with the Physical Fixed 1 Month Index reaching 59 on Jan 7th of this year a level not seen since February 9th of last year. Coal is also one of the commodities shipped by rail which makes rail traffic worth a look. Dahlman Rose & Company, a natural resource focused investment bank, recently reported that North American rail traffic was up 4.6% in December, the first year-on-year growth in a year.

The CEC Strategy tracks three coal stocks; Arch Coal, (ACI), Peabody Energy Corp. (BTU) and Massey Energy Co. (NYSE:MEE). All three of these are trading very close to their most recent highs while the associated CDS spreads hover near their lows. The Strategy is long all three names.

Of the railroad companies, Burlington Northern (BNI), CSX Corp. (NYSE:CSX) and Norfolk Southern (NYSE:NSC) are in the CEC Portfolio. The CEC Strategy is currently long CSX and NSC but these are being watched carefully as profit stops are within sight.