What Does Friday's Surge For Arch Coal And Alpha Natural Resources Tell Us?

| About: Arch Coal (ARCH)

Arch Coal and Alpha Natural Resources Surged Higher on Friday.

On Friday the stocks of Arch Coal, (ACI) and Alpha Natural Resources, (ANR) were up 29% and 20%, respectively. Clearly short covering played a prominent role. Despite being a hot summer Friday, trading volume was extremely high in Arch and more than double normal levels for Alpha. What are some possible takeaways from these robust moves?

The heavy volume and sharp moves suggest that some shorts were in a panic to cover. However, since Arch and Alpha closed near their respective highs of the day, investors believed there was a decent chance the stocks would move higher on Monday. Technicals aside, what were the catalysts for Friday's move?

Short Covering or Something More?

A few things drove the shares higher. First and foremost, Arch released earnings Friday before the open that were less bad than feared. Also before the open, Alliance Resource Partners (NASDAQ:ARLP) delivered strong earnings and cautiously optimistic commentary. Later, Doyle Trading Consultants reported that May month-end coal inventories were down modestly to about 202 million tons. This was deemed significant as typically inventories rise in May.

Do market participants suspect that most of the bad news is out and that tentative signs of coal market stabilization mark a good time to jump back into coal stocks? I think buying on Monday after Friday's surge is a risky bet. Mitigating the upbeat inventory news and Arch's less bad quarter are lower spot coking coal prices and a real possibility that U.S. exports, (a savior in first half 2012) will falter in second half 2012. I'm not trying to rain on anyone's parade, and I don't know if Friday's rally has legs, but I'm confident that we're not out of the woods on the underlying fundamentals.

Some Positive Takeaways

Still, a positive takeaway from Friday's rally might be that deep down investors think coal stocks are oversold and ripe for a significant rally. Some might think that it's likely that last week's low ticks mark a bottom. Further, some might believe that a rebound in thermal coal fundamentals MIGHT have already begun. Personally, I think it's too soon to make that determination, but I can understand why longer-term investors might be willing to stick their toes back in.

Another takeaway might be that investors are looking for the worst performing stocks to buy to ride, a "risk-on" market rally. Like Arch's earnings, some think the news from Europe is starting to get less bad and there are signs that China is getting more serious about stimulating its economy. A thought that I had last week was that coal fundamentals are so bad now that a new wave of production cuts will put markets back into balance sooner than some think.

This week will certainly be an interesting one. I continue to play the coal stocks through options. At last count, I've lost far more in option premiums this year than I've earned as a paid contributor to SA. Hopefully the tide will turn, but I'm not willing to bet that the tide came in last week.

Disclosure: I am long ANR, WLT, CNX, ARLP, NRP.