While most stocks that underperformed during the August-September correction have enjoyed tremendous rebounds during the past five months, coal stocks have missed the party in a big way. Even as the S&P 500 and other major indices have moved out to new highs, the leading coal names are in jeopardy of breaking down to new lows.
The one-year chart of the Market Vectors-Coal ETF (NYSEARC:KOL), helps illustrate the extent of the sector’s recent underperformance:
What’s Gone Wrong for Coal
Coal stocks have come under pressure on several fronts. First is the collapse in the price of natural gas. Since electric utilities can replace coal-fired plants with natural gas-fired plants to take advantage of lower prices, the low price of natural gas has a negative substitution effect on the price of thermal coal (the type of coal used in power generation).
Using the United States Natural Gas ETF (NYSEARCA:UNG) as a proxy, it’s possible to see the correlation between coal stocks and nat gas prices during the past 12 months:
The news flow on coal has been a steady water torture in recent months. Power demand for coal came in lower than expected this winter due to mild weather, utilities already hold a high level of inventories and export demand is sluggish.
Coal companies offered a generally negative tone to their commentary in the most recent round of earnings reports, and a number of major U.S. companies have responded by cutting production. While a longer-term positive for prices, these actions have not yet had a favorable impact in the market because coal prices have continued to fall.
The result is collapsing earnings estimates throughout the industry. The table below shows the current 2012 estimates for the largest North American producers compared with 90 days ago, as calculated by Yahoo! Finance (all trade on the NYSE, except James River on Nasdaq):
|Company||Ticker||90 Days Ago||Current||Decline|
|Alpha Natural Resources*||ANR||$2.84||$0.75||-74%|
|James River Coal||JRCC||-$0.44||-$2.01||-350%|
|* Estimates for 2013|
These trends are reflected in the U.S. Energy Information Administration’s (EIA) recent outlook for coal, which it summarized as follows: “Electric power sector coal consumption is forecast to decline by an additional 2 percent in 2012 as generation from natural gas, nuclear, and wind increases and electricity consumption grows by less than 1 percent. EIA expects electric power sector coal consumption to continue declining in 2013 as increased output from other generation sources meets growing demand for electricity.” It didn’t help matters that China lowered its growth forecast to 7.5% overnight before Monday’s session.
What the Charts Are Saying
Right now, no shortage of commentators say coal stocks are an excellent buy because there’s so much upside from current valuation levels if coal prices begin to rise. And there’s certainly a case to be made: The stocks are trading at substantial discounts to their 52-week highs, and valuations are well below the five-year averages, which means positive news will undoubtedly have a favorable impact on prices. As a result, it’s safe to say there will be an excellent trade in coal stocks before this year is out.
But right now, let the charts be your guide. Of the seven stocks mentioned above, four are right at support, and one — Arch Coal, Patriot Coal and James River Coal — broke down to new lows on Monday. The fact that these stocks are so depressed at a time of strong market performance is a warning sign that all are vulnerable to a final breakdown if the broader market begins to weaken.
Watch these levels carefully, and use them as a guide before considering a trade. The breakdown levels and Monday’s closing prices are as follows:
|Company||Monday Close||2010 Closing Low||Difference||Intraday 52-Week Low|
|Alpha Natural Resouces||$16.35||$16.04||1.9%||$15.49|
|Arch Coal||$12.20||$13.22||-7.8%||$12.15 (3/5)|
|Patriot Coal||$6.36||$7.17||-11.3%||$6.24 (3/5)|
|James River Coal||$5.36||$5.54||-3.2%||$5.58 (3/5)|
The Bottom Line
Coal stocks have been beaten down so much that on the surface they’re starting to look like a buy. But until coal prices improve and/or estimates begin to stabilize, the sector continues to face major headwinds. Take your cue from the charts in the meantime because a breakdown to new 52-week lows will put these stocks in dangerous technical territory.