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By: Costas Bocelli — April 13, 2011

Don't Overlook the Other "Black Gold"

WHILE ALL THE ATTENTION IN THE COMMODITY SECTOR HAS BEEN ON THE WILD VOLATILITY IN CRUDE OIL PRICES, DON'T OVERLOOK THE OPPORTUNITIES IN THE COAL SPACE.

Trading oil related products has reached the pinnacle of pure speculation, as the momentum traders have pushed oil prices to the outer limits of fundamental valuation.  Don't get me wrong -- there's definitely a small place in our portfolios for taking shots at riding a parabolic move, but most of my trading and investing centers around higher probability and more predictable outcomes.

The Coal sector has been strong, and is setting up very nice trading opportunities in the short to intermediate term.  The commodity is in the center of a prolonged super cycle, and it appears it should continue for quite some time.  The coal stocks have been drawing plenty of investor attention, and the volume has been robust, making this sector very liquid and attractive to position trading.

The fundamental story for coal has a solid foundation, and the intermediate and long term picture looks pretty black and dirty. 

Mainly, Coal accounts for 40 percent of the world's electricity generation.  What is really shocking is that, over the next 20 years, coal will continue to be the second fastest growing source of electricity, and still account for almost half of the entire world's electrical generation output.  Even with all the focus on renewable energy and promoting a greener environment with alternatives such as wind, solar and biofuel, the reality is that coal will remain the primary resource for electricity into the distant future. 

The chart below shows the breakdown by fuel source for worldwide electricity generation projections out to year 2035.  The source is the U.S. Energy Information Administration.

 
2035?  Yeah I know, trading on 20 year projections is not exactly my style or strategy.  But the point here is the relevance of the fundamental story behind this commodity.  Since the global economy has exited the recession, coal has been on a super cycle bull run and continues to maintain its trend.

The short term picture looks even more compelling for this space.  There are many catalysts out there that are driving coal prices and demand, thereby moving the stocks around and setting up great trading opportunities.

Earlier this year, Australia suffered one of the most devastating rainy seasons in history, causing massive flooding across Queensland.  The damage was widespread and caused major disruptions in the coal industry, taking precious supply off the market.  The Australian miners are still trying to catch up from all the damage, and it continues to affect production.

Another devastating catalyst that is driving the bullish coal sector is the aftermath from the earthquake and tsunami that hit Japan, the third largest economy in the world. 

The impact spans many variables, and is having a profound effect on the demand for coal in the short to intermediate term.

The damage to the Japanese nuclear plants, which account for a significant portion of electrical generation, has increased demand for natural gas and coal, and thus has firmed up prices.

Japan will also be engaged in a major reconstruction effort to rebuild their infrastructure.  Metallurgical coal is a key ingredient in the production of commercial grade steel, which Japan will need in abundance.

Countries such as Germany are reviewing their nuclear energy policies in the aftermath of the complications, taking a closer look at the risks that nuclear reactor disasters may pose.  As a result, the German Energy Agency has taken off-line and shut down roughly 7 megawatts of nuclear power that were deemed a potential threat due to age and design.  This lost electrical generation will be directly substituted with increased thermal coal, demanding an additional 3-11 million tons this year alone.

The best way to get exposure to the coal space is through the equity markets.  You can trade the Market Vectors Coal ETF (KOL), which is essentially a basket of stocks that are of significant size that engage in the mining of coal.

Here is a daily chart of KOL ...
 

You can see the bullish trend in the major coal miners, and increased interest (in the form of daily volume).  The recent sell off in commodities this week has pulled back the coal names as well.  If you believe in the space, there's nothing better than buying on the dip of a bullish pattern, especially when fundamentals back your thesis.

You can also play the single stock names if you a more savvy stock picker.  Three major names that stand out in the space are:  Peabody Energy (BTU), Alpha Natural Resources (ANR) and Arch Coal (ACI).

Daily Chart of Peabody Energy (BTU) ...
 

So roll your sleeves up, dig in, and get dirty!

Disclosure:  Author has a long (bullish) interest in the Coal Sector

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