Bullish on Coal Stocks- Thermal to Lead the Way

We believe that coal stocks are offer investors a unique value opportunity, that is if you can sleep at night and hold on through the volatility. Short-term, many of the coal stocks appear to be setting up for another run upwards. See the below charts.

The stocks of these companies and the coal stock ETF (ticker KOL) show an improving MACD and RSI, with the trend in both measures diverging from the price trend in June. In addition, the money flow in these names is improving, suggesting increased investor interest. Lastly, the downside volume over the last two days has been below the upside volume seen in late June, which in our opinion is a setup for further price increases.

Why the improvement in the pricing? It is our opinion that thermal coal pricing in the U.S. is set to improve. First, the price of the natural gas has increased significantly off the lows, making the economics of switching to gas from coal less appealing for utilities. Second, the expectation for further hot weather in U.S. has increased the likelihood of greater energy production in the weeks ahead. Another positive indicator is that the World is turning more towards cheaper coal imports to supply their energy needs- remember that natural gas trades at significantly higher prices in Europe and Asia thus making coal use more economic.

Lastly, we show the last three charts for illustrative purposes.

The top chart shows the stock price for Cloud Peak Energy (ticker CLD), the producer of thermal coal from the Powder River Basin, a large coal producing region in the U.S. There are many types of coal based on criteria including heat content, hardness, and impurities. Two broad types of coal are thermal coal and metallurgical coal. The former is used in the production of electricity while metallurgical coal is used in steel production. CLD is an exclusive producer of thermal coal and you will notice the stock's relative strength in recent months not only to the other coal stocks but also to the market as a whole (second chart). To us, this suggests the growing interest in thermal coal.

The bottom chart in the deck shows the stock price of CLD relative to the stock price of Walter Energy (ticker WLT), a large producer of metallurgical coal. We think this relative chart further shows that investors are betting that thermal coal pricing is set to improve. The bottom chart also shows the price trend of natural gas. Although some of called for the price of natural gas to pull back after its recent run, we find it hard to believe that investors will double down on a trend that would be short lived.

Investors should consider, or at least begin looking at, an equity stake or purchase of convertible debt in coal companies.