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Coal Could Soon Be Portfolio Fuel

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One of the potential beneficiaries of this huge multi-month rally in natural gas prices may be a sector that’s been largely left for dead, and that sector is coal.

Now, we all are familiar with the negative thesis on coal. First, there’s the “war on coal” from a political policy standpoint, which comes to us largely from the environmentalists. Second, the previously low natural gas prices offered a cheaper and cleaner alternative to coal. These two factors teamed up to reduce demand and send coal stocks to multi-year lows.

But now, things may be changing.

First, the high natural gas prices we’ve seen of late have made switching to coal a more-attractive alternative, and that’s definitely could result in increased demand. Second, thermal coal inventories have been depleted thanks to the absurdly cold winter, and coal prices now are on the rise. For example, Powder River Basin coal has rallied from $11.73 per short ton to $12.15 as of last week, while Central Appalachian Coal has risen from $57.44 to $60.27. Third, coal stocks, after putting together a stealth rally throughout early 2014 on these improving fundamentals, have gotten killed of late due to the China-based selloff in the basic materials segment.

So, what we have now is a sector that is 1) unloved, 2) seeing improving fundamentals and 3) trading at an artificially discounted price.

Sure, coal stocks are down on China concerns because of reduced demand for metallurgical coal (which is used to turn iron ore into steel). However, keep in mind that this has nothing to do with demand for thermal coal, and that is where the opportunity is (specifically, thermal coal is used in domestic power plants).

I’m not a coal analyst, but I do know that companies such as Arch Coal (ACI) and Peabody Energy (BTU) are two of the more thermal coal-oriented producers. Both these companies, as well as many other coal producers, can be found in the Market Vectors Coal ETF (KOL). While KOL doesn’t represent a pure thermal coal play, if I am correct about coal’s upside potential, then KOL is going to rally.

From a trading standpoint, things definitely look attractive. The 52-week low in KOL is $17.16, roughly 1.5% below current levels. The recent high is near $20.50, almost 18% from here. So, risking one to make nine or 10 is a pretty good setup.

Finally, like gold miners, coal is one of the sectors that many wrote off and left for dead at the end of 2013. Yet this huge natural gas rally has breathed some life into the sector, and though the sector certainly remains risky, I do think it’s worth serious consideration.

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Tom Essaye is Founder and Editor, of The 7:00’s Report, a daily investment research note that provides need-to-know analysis of markets, economics, and geopolitics—all delivered by 7:00 AM, and readable in 7 minutes or less. At the time of publication, the authors held a long position in DXJ.