Below is an extract from a commentary originally posted at www.speculative-investor.com on 10th February 2008.
The following weekly price chart from http://www.fullermoney.com/ shows that the coal market has 'gone vertical'. As we've discussed in previous commentaries, the price explosion has been caused by the collision of long-term bullish fundamentals and short-term supply shocks.
Large vertical price rises are always bearish beyond the very short-term because they only ever happen towards the ends of rallies. The coal market will clearly reach some sort of top over the coming weeks, but there is no way of knowing whether it will be a short-term or an intermediate-term peak (it will almost certainly NOT be a long-term peak).
The main point we want to make in today's report is that even if the coal price is within a few weeks of an intermediate-term peak, the intermediate-term outlook for coal-related equities should remain bullish. This is because the coal price is likely to remain at a very high level relative to historical norms even as it 'corrects' its vertical ascent, thus convincing stock-market participants that a relatively high coal price is here to stay and prompting a further upward re-rating of coal stocks.
The performance of coal stocks relative to coal during 2004-2006 might be a reasonable indication of what's to come. To be specific, the weekly chart of the Dow Jones US Coal Index (DJUSCL) displayed below shows that coal-related equities continued to trend relentlessly upward for almost two years following the mid-2004 intermediate-term peak in the coal price.
We continue to believe that the stocks of coal-producing companies should be accumulated on pullbacks. And as previously advised, we think Patriot Coal (NYSE: PCX), a US-based coal miner with annual production of around 24M tonnes, has an attractive risk/reward ratio.
A few weeks ago we noted that the short-term outlook for copper had become bullish. In particular, the market had moved into "backwardation", indicating a short-term tightening of the supply/demand situation, and the price appeared to be basing.
Subsequently, the prices of copper and some of the other base metals have been given hefty boosts by the severe snowstorms that crimped metal production in China (as well as being the major consumer of industrial metals, China is a major producer of some metals). The result has been the upside breakout clearly evident on the following daily chart of March copper futures.
It is likely, however, that the severe weather that has given the prices of base metals a short-term boost by disrupting China's production and transportation will result in longer-term downward pressure on prices. The recent snowstorms are just the latest in a sequence of weather-related catastrophes experienced by China over the past year, the cumulative effect of which will very likely be slower Chinese economic growth and reduced demand for industrial metals. Perhaps we are being overly pessimistic, but we fail to see how a country with insufficient power, insufficient water, insufficient food, high inflation, a largely impoverished and poorly educated population, and a communist government will continue to be a world leader in terms of economic growth.
We suspect that copper's upside will be limited by resistance at around $3.75 and that its rebound will end within the coming month or so. We remain intermediate-term bearish on the base metals in anticipation of slower growth in China, slower global economic growth, and US$ strength.