Sunday, April 6, 2008

On the strength of the transports, and commodity weakness..

From the video interview of Barry Ritholtz, came across this interesting comment:

Coal is a huge story. Strength of the transports does not mean economy is getting better. Thanks to a weaker dollar, we are exporting a lot more fertilizer and coal. North America is the Saudi Arabia of coal. (Likes ACI)

The basic point is that the transports reflect the underlying strength of the agricultural(commodities) and the energy sector, which the industrials don't. Dow theory as practised in the past may not be a relevant barometer of domestic stock market strength in a globalized world. Though this is an interesting point, I'm not completely convinced, yet! The Dow industrials are composed of companies who predominantly sell outside the US, alongwith commodity names like Caterpillar. Are the higher commodity(fertilizers) and energy(coal) demand a result of a weaker dollar, or the secular demand from the engines of India and China? I would argue for the latter.

The commodities and energy sectors are going through a speculative blow-off. They are cyclical sectors disguised in a 'secular term' trend. While I don't dispute the 'secular' uptick in demand due to consumption in the emerging markets, to expect the commodities sector to be impervious to a global slowdown is baloney.

Here's the punchline and a prediction (for what it's worth!): The current correction in the commodities space is not a multi-week phenomena. I'd argue that this time next year the commodities sector will be lower than where it is today. Given the cyclicality of the commodities sector, I would expect the transports to roll over and join the industrials.

The positive divergence we have seen in the transports is at best a short to an intermediate term bullish signal. The Dow theory sell signal of 2007 is still very much valid, and the rollover in the commodities space is only a confirmation of that.

Secondary point: While I'm positive on coal, I'm even more positive on natural gas and LNG(and would prefer holding CHK to ACI) . Carbon trading and emissions control(whenever that happens in the next 5-10 years) will make these more profitable and desirable energy sources, when compared to coal. (But maybe they'll come up with a way to make 'clean coal', and this point would then be no longer valid. )

Ah! The joys of investing and identifying secular term trends!