It’s Time To Sell Coal Stocks

Trading is, by nature, short-term. It involves rapid reaction to news and anticipating what that will mean for whatever you are trading in the next few minutes, hours, days, or sometimes weeks. At times though, it pays to take a step back and consider the bigger picture. That is the case right now, as coal stocks have reacted positively to good short-term news but the long-term negative narrative persists.

The good news that caused the recent strong rally came, as all news these days seems to, came from Donald Trump. Reports circulated earlier this week that he had instructed Energy Secretary Rick Perry to forestall the closure of coal and nuclear powered electric plants by forcing utilities to buy from them, even at uncompetitive rates.

This is the administration's second attempt to protect the domestic coal industry. The first was a proposal by Perry that compensation should be paid to the ailing plants for the "stability" they give to the power grid. That was unanimously rejected by regulators. The proposed use of an executive order this time around circumvents the need for regulators' approval but looks just as doomed to failure.

America is a country built on free markets, and government attempts to regulate away reality, no matter how well-intentioned, usually fail as they butt up against unintended consequences. In this case the downside is glaringly obvious. Forcing providers of electricity to buy at inflated prices will force up the price they charge to their customers. It will, in effect, be a tax on every person and corporation in America to support a very small group of workers and drag out the demise of uncompetitive businesses.

That is the long-term point here. The demise of coal as a fuel is not "unfair" or avoidable, nor is it just a U.S. phenomenon. The coal industry in America is dependent on these dying domestic plants because globally, coal is being phased out. It is seen as a dirty and efficient fuel source when compared to the alternatives of natural gas and sustainable generation methods such as solar and wind power. By actions such as we heard about this week, Trump may be able to keep the coal industry on life support for a bit longer but cannot change the eventual prognosis.

This matters because while traders tend to focus on the short-term in their immediate reaction to news, markets are essentially forward looking. The pop in coal stocks is therefore understandable but pressure from longer-term focused investors including the big funds that really move markets will make it short-lived. The question, then, as always, is how best to play the expected reversal.

The answer isn't all that complicated. The bigger the gains over the last few weeks, the bigger the potential drop. That brings us to Peabody Energy (BTU). That stock is up an incredible twenty percent or so over the last two weeks but has stalled and looks set to reverse direction.

That stall sets up a trade with limited risk and enormous upside. It is possible that the current bullish narrative will continue for a little longer, so if you short the stock either directly or via a bearish option play you would want to allow some room for another upward move. The high of 47.84 may appear to be a logical point off which to base a stop but the proximity to the $50 psychological level makes somewhere around $51 a safer choice. As you can see from the chart, the downside for the stock, and therefore the upside to a short position, is substantial when the long-term narrative takes over so the risk reward ratio is favorable.

President Trump's actions may look like a boon for the coal industry, and in the short-term that could be the case but, far from addressing the underlying problem, they will probably make it worse. Regulations designed to allow domestic producers to sell an uncompetitive product discourages the changes that need to be made if coal is to have any future and can only give a temporary boost to the stocks. Selling into this rally, therefore, looks like a good trade.