Coal Stocks: Don’t Try to Catch This Falling Knife

market sectorOne of the basic problems for investors who aren’t successful over the long term is that they are trying to catch a falling knife. This means trying to pick the bottom of a market sector decline, hoping that future corporate earnings will turn around. I’ve been asked several times if I would recommend the coal industry, as it’s trading at such cheap levels. Yes, the prices of stocks in this market sector have fallen, but “cheap” is a relative word. They are cheap compared to their recent past, but the stock market looks forward and there are signs that this market sector will have substantial headwinds for the companies and their corporate earnings.

The first and most obvious problem is the low price of natural gas. The market sector of natural gas is trading at decade lows. Many of the power plants that generate electricity do have the facilities to use either gas or coal as an input. However, an electricity-generating pant would certainly choose the cheaper option of natural gas right now. With new technologies to extract natural gas in the U.S.booming, most analysts expect a ton of new supply to hit the market over the next decade, keeping prices low. More pain for coal producers and their corporate earnings, as they will have a tough time competing with a cheaper substitute.

Natural gas isn’t only cheaper, but also emits less pollution. The second major headwind is government regulation. President Obama is close to issuing new rules that may halt the production of new coal-fired plants. There are reports that the Environmental Protection Agency might set tougher emission standards for coal fire plants, which on average emit twice as much pollution as natural gas plants do. A market sector that has a cheaper alternative and more government regulation will be tough for company’s corporate earnings to grow into the near future.

One option for the coal market sector is for coal plants to use carbon-capture technology. This technology is very expensive and would be a big hit to corporate earnings in that market sector. There are few alternatives for coal producers in North America and this market sector will, most likely, face very high hurdles for any kind of growth here.

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Arch Coal, Inc. (NYSE/ACI) is a popular coal name in this market sector. It is certainly clear that this stock has fallen off a cliff and appears cheap. From a technical viewpoint, as long as the stock continues to make new lows, I don’t want to own this stock, or any in this market sector. I would wait for a basing pattern, when enough buyers step in to support the price in this and other stocks in the coal market sector. This would indicate that the smart money is seeing value and wants to put its money where its mouth is. Talk is cheap, after all.

Could there be a turnaround in the coal industry? Possibly; anything could happen. I would look for three big changes to signal renewed interest in the coal market sector. Firstly, if regulations aren’t enacted, or if the policies are a watered down and allow for the growth of the industry, this would a good first step. Secondly, if natural gas prices rise off the floor, then we will see coal come back into favor with existing plants that can save money and boost their corporate profits. And finally, a big pick-up in sales overseas or new markets that are developed for the coal market sector would be an important sign. Until one of these occurs and it coincides with buyers stepping in to buy shares in the coal market sector, I would stay on the sidelines and wait patiently.