Don’t Expect Any Growth to Come in Coal Stocks

Today’s Markets and Money begins with one sector to avoid. Then we’ll follow on with a few worth further investigation. But there’s no prize for guessing the first one because I’ve said it before: coal stocks. Resource investors take note!

Here’s what Bloomberg reported during the week:

Beijing, where pollution averaged more than twice China’s national standard last year, will close the last of its four major coal-fired power plants next year…

The closures are part of a broader trend in China, which is the world’s biggest carbon emitter… Beijing plans to cut annual coal consumption by 13 million metric tons by 2017 from the 2012 level in a bid to slash the concentration of pollutants.’

You’ve probably heard the saying that when the US sneezes, the rest of the world catches a cold. China’s like that when it comes to commodities. When the world’s biggest buyer of coal stops spending, you need to take notice. This could get even uglier than it already is.

Of course, I’ve no doubt that a resource veteran like Rick Rule could make exactly the opposite case. When a sector looks as bad as coal does right now, guys like him get interested. That kind of play is based on the idea that you buy in dirt cheap in the hope of a big payoff should coal stocks make a cyclical comeback.

It’s not the way I buy stocks. And whether or not the fossil fuel divestment trend happening around the world will allow for a cyclical comeback in coal is actually the bigger point.

There’s no doubt that emerging markets want the cheap energy coal can bring. But it’s no good getting a bargain on coal if your citizens start showing up with skyrocketing rates of lung and stomach cancer, as they are in China, and you pay out all the energy savings for hospitals and coffins. That’s not to mention a generation of city school kids who can’t go outside to play because the air is toxic.

Anyway, I like to trade with the trend. As Jason McIntosh likes to tell subscribers of his trading service Quant Trader, ‘The trend is your friend.’ And the trend in coal stocks is down. It has been for years. There’re a lot more compelling industries and trades right now. If you’re going to risk your money in stocks, let’s look for tailwinds, not headwinds.

You could say the US home construction sector has the wind at its back. It’s worth a look if your timeframe is a couple of years and you can ride out the volatility that will show up in US stocks as the Fed shifts interest rates. You might be surprised to hear me say that is a sector worth looking at.

But The Wall Street Journal reported early in the week that one of the things to note about the US recovery since 2009 is the subdued role housing has played (so far) this time around compared to its historical role.

In fact, the paper pegs the relatively modest growth in the US of around 2% in recent years to that very fact. WSJ drew on a study an associated trade group did to say, ‘The industry still isn’t where it ought to be in a healthy economy. Overall, Mr. Markstein said construction should account for 4.5% to 5.5% of GDP, compared with the more tepid 3.7% in 2013.’

That is to say, there’s plenty of room for US growth to lift off this base. Anyone waiting for the US economy to fall back into recession might like to take note of that.

And if that doesn’t get your attention, the news from Bloombergrams the point home. Purchases of new homes in the US rose in February to a seven year high. Sales climbed 7.8% and, according to the report, exceeded even the most optimistic economists’ forecasts.

As a rule, mainstream economists are worse than useless. So in one sense, the fact that sales exceeded their expectations is nothing to crow about. The market knew well enough, which is why the US Home Construction ETF has been hitting 52 week highs lately.

The key quote from the Bloombergreport is this: ‘Acceleration in property values is limiting participation among would-be home buyers, while a lack of inventory is giving Americans fewer properties from which to choose.’

That’s showing up in another way. Lennar Corporation, a Fortune 500 US homebuilder, reported results last week, and you can see in the graph below the downward trend that it’s showing in the incentives it offers to buyers…

Source: nabtrade
Click to enlarge

That suggests strong demand. Remember the background here. The 2008 recession knocked out the homebuilders and left the US construction industry in the dumps. Supply of course doesn’t move. But the US population keeps growing and the recovery in time starts to raise existing property values. That equals higher rents for existing buildings.

The market then sees the higher rents, which are a signal to bring in supply to take advantage of this. Enter the construction industry.

This is why we keep pointing to our property clock in Cycles, Trends and Forecasts. It tells you what’s coming next. Then you just watch the stock market to see the related stocks start moving to confirm what’s happening.

I can tell you from personal experience, it’s a lot easier to make money this way than picking through a dozen penny coal stocks and gambling on a comeback in the dirtiest fossil fuel of them all.


Callum Newman

P.S. Watch your inbox at 1pm this afternoon for a very special presentation by The Daily Reckoning’s income specialist, Matt Hibbard. Matt’s going to show you how ‘forgetting’ about the stock market could be the key to making a sound income for the rest of your life.


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Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect.

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