Thermal Coal
Let’s compare the Newcastle Coal Futures to various thermal coal equities since May 1, 2021:
I’m using May 1st since that date approximately coincides with the last major coal equity pullback, so it gives them all about the same starting point. We could also use the last low in Newcastle Coal futures, say around Sept. 1st, but this is more art than science and the results are approximately the same.
What I find interesting is that US listed companies, particularly Peabody (BTU) and Consol (CEIX) are outperforming the Australian companies Whitehaven (WHC) and New Hope (NHC) by a wide margin. The US listed companies don’t really have much exposure to the seaborne markets, so one would have expected the Australian names to outperform instead.
Could the US names be responding more to higher domestic natural gas prices? Let’s check by comparing to the Henry Hub front month continuous contract, see below. The correlation is there but it really doesn’t explain the vast outperformance. I’m assuming the relative strength is simply because the US companies were MUCH cheaper when this rally began, and now they’re simply playing catch-up.
I think the Australian names are more steady and make for better investment vehicles, with a buy and hold approach, for example. It’s not easy holding on to BTU with daily swings up and down sometimes as high as 12-15%. I am personally accumulating the Australian companies (and CEIX) in the longer-term buy and hold bucket of my account using common shares while I trade in and out of BTU and others using call options.
Trade Idea
An interesting trade idea is an ARLP long paired with HNRG short. Both companies are in the Illinois Basin, and I’ve written extensively (here & here) about the relative competitive advantages of each, with the nod definitely going to ARLP. Since earnings, HNRG has been sold off relentlessly whereas ARLP has traded favorably, at least until today, see below. I think this trend continues as ARLP generates better financial results and HNRG disappoints newer investors expecting a quick turnaround. Paired trades are cool because you can really size them up and/or leverage them up since you’re neutralizing market risk. Take a day like today, for example, when all the coal equities are down; ARLP is down 2.8% while HNRG is down 6.5%. The paired trade would be up 3.7% even though both were down, something to consider.
Metallurgical Coal
Let’s compare the Australian Coking futures to the met equities, also using May 1, 2021:
The vast outperformance by Alpha Met (AMR) points to how bombed out the stock was. You could say it’s the same scenario with BTU on the thermal side but with one big difference, AMR has been on a fairly stable march upwards without the hair-raising pullbacks we’ve seen in BTU. AMR could be due for a pullback and I’ve covered my entire call position as of yesterday. However, I still own the common shares in my long term bucket and I’d say that you definitely want to be long AMR during next quarters earnings results, just like I recommended last quarter.
Ramaco Resources (METC) reacted very well to earnings this past quarter but I think we should wait and see how far it pulls back during this latest reversal before accumulating the shares again. ARCH has been consistent like AMR, but it simply wasn’t as beat down as much on a relative basis. I still think AMR plays catch-up going forward, but probably not to the same extent we’ve seen over the past three months. Warrior Met (HCC) is still stuck in it’s strike range, waiting on the good news that it’s been resolved. Once that news comes out I expect it to massively outperform it’s peers.
Summary
Now that we’re getting a bout of weakness, it’s time to reassess these intermarket relationships in order to understand and better handicap which pony we want to bet on going forward. I feel comfortable accumulating names like WHC and CEIX during these weak periods because I’m not afraid of “catching a falling knife” in these names. In other words, I’m not going to wake up one morning with these down 20% overnight. For those riskier high flyers, it’s probably better to wait for the pullback to exhaust itself, and then wait for even more for evidence that the bounce is real before getting back in.
I’m watching the S&P 500 Index and the S&P 500 Equal Weighted Index to see if there’s real strength when each dip is bought, as opposed to it just being the mega-cap names like AMZN and AAPL moving the cap indexes around. Once we see that the dip has been bought and the coast is clear, I’ll be checking these charts again to see what kind of relative damage was done. The goal is to own the names that go up consistently and don’t go down as much as the others during pullbacks. This is classic risk vs. reward trading in a nutshell. Good luck out there and please let me know if you have any questions.
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Thank you! Why not Coronado?
Thanks! Love the coverage and the US vs. Australia commentary.