Coal Stocks: Where to From Here?

It didn't really matter what sector you were if this past week. If you were long, you probably got a little bloodied. But that was then, and this is now. What's next?

I'm sure a lot of you are wondering, "is the correction in coal over?" Well, I don't know. But I can tell you what I think and how I plan out a strategy in reaction to what has and may happen.

First of all, it is not about the correction being over, or not over. It's more a question about magnitude and probability. Let me be more specific and relate this to the current situation in coal stocks.

If the current decline is indeed over, then I would also believe that a move up from the current price would immediately be capped by overhead resistance (the green hypothetical price path). A break of the recent highs would be of low probability. Thus, I must conclude that the magnitude of an upward move would be small. At best, there would be a period of resistance near the recent highs.

What if the current decline is not over? Given how severe the recent selling has been, I also cannot be overly short term bearish. More likely, over that next week (if the correction is not over), we see some type of consolidation (the blue hypothetical price path) before another downward thrust.

That being said, I think it's equally likely that the sector moves up or consolidates and continues down. What about the magnitude of this move? I've already stated that an upward move would receive a lot of resistance. On the other hand, a downward move would probably trigger additional selling. Corrections in the past have generally retraced 50% of their gains from low to high.

For Arch Coal (ACI), this would suggest a move back down to the 150-day exponential moving average [EMA]. And the stock has also had a history of correcting back to that level. (I've selected ACI, as it is a fairly typical looking metallurgical coal stock. Others I like include MEE, CLF (also has iron), ANR and MTL (also has iron and steel milling).)

So, we have what I believe to be equal probabilities of moving up or consolidating and continuing down, but with the magnitude of a downward move being greater.

And finally, one more indicator I use to try to determine the end of a decline, is the concept of decline duration. Typically, large declines take several weeks to ultimately flush out all of the weak hands in the stock (and I'm also under the assumption that there are still a lot of these weak hands in the sector). So far, this correction has been all of two days. The last decline persisted for about two weeks. Add in the fact that the daily indicators still are in oversold, bearish (downward pointing) states and this lends some credence to the decline duration persisting for at least a few more days (see the blue lines on the bottom indicator, which suggests how long a correction might persist).

Ultimately, I believe that this sector retraces to the 150-day exponential moving average. Fundamentally, there have been very strong drivers (in the form of contracts signed at significantly higher prices) in the past few months which support the thesis that this is a correction and not an ultimate top. However, the speed in which the stocks have moved, in combination with a weak market (which, in my opinion, caused momentum traders and retail investors fleeing into this relatively niche sector - think tech bubble burst, and the formation of the real estate bubble afterwards) ultimately created a short term mini bubble.

Disclaimer: Long ACI, MEE, CLF and MTL; looking to add at the 150-day EMA.

Comments

[pachanguero:]

Wow and not one word about earnings. That drives the price not the chart! Come on what is up with that? Earnings will be fantastic!

2008 Jul 07 09:24 AM

[Urbane Gori...:]

Odd isn't it that China has stopped their factories and mills during the Olympic period (to last until late August) to reduce polution for the gaijin and coincidentally energy stocks have tanked... Hmmmmm ...

Thx jegan ;-)

2008 Jul 07 03:01 PM

[Mal:]

Fear and greed drive the stock market. Fear is driven by emotion. The fear of loss is greater than the hope of gain. Fear is short term and causes almost instant selling. The hope for gain is more long term and causes would-be buyers to think over their would-be purchase decisions. That is why good stocks with wonderful earnings are thrown out with the bath water. When a correction is underway and you own a good company with long-term, bright prospects, don't panic. Look forward to adding to your positions at lower prices. Sometimes looking at previous price action by looking at the chart and moving averages is just as valuable as looking at earnings. When emotion is at play, it can be more important. I think the article hit on some important concepts.

2008 Jul 07 03:06 PM

[risk manage...:]

Thanks Mal. Yes, these companies will have great earnings. But my comments here, were more based in trying to understand the short term movements. Say, a few weeks. The market is an expectations game. It doesn't really matter what the earnings are in the short term. As long as the market operates under the "global growth is dead" scenario, these stocks won't perform.

2008 Jul 08 12:01 AM

[schminkie:]

global growth is not dead. rather it is the big story of the 21st century thus far. 'players' in coal iron ore shipping steel etc are expanding and accelerating operations. ore revenues will be calculated retroactively to april first. associated revenues will likely reflect this during this quarter or the next. watching each tremor in the baltic index or the daily machinations of the nyse are good for trading. anr went up then way down then way back into the black all in one day, today. in the long run however, unless you see the building of industry, trade and infrastructure in china and india [3 billion people or so?] plus vietnam, indonesia... are going to flame out soon, hang in with these shares. is that what you think?

what i can gather is that there are complications and misinterpretations among analysts; you know, those guys working for the companies that are crashing with 10s of billions of debt. out and out lying and posturing and pissing contests seem to be pretty typical. meanwhile the heavy players are taking advantage of this growth and of the weak dollar buying companies as fast as my mother at a bergdorf goodman 2 for 1 sale.

i own anr sid rio, for examples, and will buy more on dips holding on through sector swings. watch the naysayers and then look at what's going on via objective sources. fyi. be careful about 'big news scoops' on coal. it is often old news; info i knew months ago.

2008 Jul 08 12:57 AM

[Jake2:]

It doesn't pay to be a true believer in any one religion here, or to look at the world through any one pair of rose-colored glasses. Sometimes it's better to be an agnostic or a person who looks at the world with a jaundiced eye.

2008 Jul 08 01:36 AM

[btmdwlr:]

Short term traders/ are looking for the best sector. Metals, coal, energy have been extremely hot and just about the only thing working recently. you know the story, the correction at the top of the bull run when the late-comers get burned believing this sector will continue to bull to new highs. the positions that got in early at lower prices are pulling profits off the table in millions to place their bets elsewhere. I have MTL and added more to my position, f-great earnings and it will get better. I will add again in high $38 range where I think it will have corrected more than enough then expect it to double again because its a good stock with great reserves in a sector thats HOTT until the market stabilizes (2yrs?)

2008 Jul 08 11:45 PM

[phdinsuntan...:]

G8 and climate change, carbon tax + China year of the rat means
a break for coal, sell in may and go away

2008 Jul 09 03:07 PM

[User 227003:]

Good clear-eyed piece, Jeff. Pachanguero, great add-on comment.

Schminkie, what 'you knew' is probably only what everybody else on this board also already knew. The media is always the last to report what investors, analysts, and insiders knew for months.

Your thesis is correct-- coal will remain the world's fuel of choice for the short term, earnings will shoot up, and the stocks will perform solidly enough for the next year or 2 in this fearful equities environment (but with big, rough daily ups and downs in price). I've been holding and adding on dips for a year. Global growth is undeniably in slowdown mode right now, but the consumerism & standard of living we created & the rest of the world is now copying will see to that.

2008 Jul 16 08:34 AM