Energy Remains a Leader with Opportunities

The fun  of investing is finding ideas and opportunities to put your money to work. Every since my grandfather taught me about stocks and the opportunity to own part of what you believe in, I’ve been hooked. I spend more time today looking at market sectors and how the rotation of wealth moves where it is treated the best, than individual stocks, but the opportunity and excitement is the same. There have been some interesting developments this week in the rotation process among some sectors as investors look for the next sector of choice.

The energy sector over the last three weeks has taken a leadership role as crude pushed higher and brought the stocks to life. The major mover of crude and the stocks has been speculation. The speculation has come in conjunction with the stimulus talk in Europe. The assumption is push more money supply to stimulate the economy, and the demand for oil will rise. Logical, but still speculative. This logic has been applied in many ways to stocks in general since the June 4th lows. Thus, the play or move in energy (XLE) has been a trade on the momentum and nothing more. If the speculation is validated by the data improving and demand rising then we look at the long term picture. For now the money is being treated well in the energy sector based on the speculation things will improve economically globally. Thus, take the gains, protect the downside risk and look for the validation if it ever comes.

The refiners are the one sub-sector of energy that has been moving based on a solid fundamental premise. If has been the ability of US refineries to produce the end product of gasoline and export it globally at a profit simply put. Due to the demand being lower in the US the refineries have the capacity to execute this process. So far it has been validated by earnings and growth in revenue, two keys to long term trends holding and moving higher. However, we have to be concerned about the refinery story working going forward with crude oil prices moving higher. The refineries make money on the crack spread between the cost of goods (crude oil) and the end price of the product (gasoline, heating oil, jet fuel, etc.). With crude rising the question is will the spread be enough as the ability to pass on the higher price of the end product meets resistance. In favor of the US refineries is the spread between light sweet crude prices in the US and Brent crude prices globally. Thus, we continue to hold our positions, but raise our stops and monitor the progress moving forward.

The last six or seven week we have been watching the price of natural gas rise again from the ashes. The price fell more than 60% from June 2011 to June 2012. The rise off the lows was nearly 40% since June. The question now begs too much, too soon? Or, is there still plenty of upside opportunity in the sector? The analyst are saying too much and time for a pullback in price. Thus, the initial selling has taken place this week with a drop of nearly 6%. Thus, volatility is back along with questions. The inventory data on Thursday didn’t help as the number was higher than expected, supporting the analyst chatter. However, it is only one week of data. Stops have to be in place on the commodity if you still own it looking forward. The bigger question lies in the stocks. How do they respond to the volatility in price? We know or assume the first reaction will be lower. But, if natural gas holds in the $2.65 – 2.70 range versus the $2.20 level it was at… won’t profits rise? Again it is speculation and it is worth watching the trend. FCG is the ETF to track for the outcome, and if UNG breaks below $19.50 support a short on the commodity as a hedge would make sense.

If money is leaving natural gas where is it going? Remember money goes where it is treated the best. If we look within the energy sector, coal would be my answer. Analyst have been talking favorably the last couple of weeks relative to the low price of coal. And you know if it is in the media there are those who will buy on the speculation. Coal stocks (KOL) has moved off the new low of July 25th, clearing resistance at $23.30, and moving up to $25.30, near the next resistance point, poised to move higher. Thus, watch KOL as the next opportunity to run in the energy sector on speculation. That makes it a trade and should be treated as such until it validates fundamentally any truth to the speculation.

Money likes speed, and migrates to where it is treated the best. For now the energy sector is one of the leaders in the move off the June 4th low that has offered investors and traders both opportunities to make money. As with any investment you have to define your strategy and manage the risk of the strategy failing. Stay focused, this remains a challenging market for investors with elevated risk.