Utilities Rising & Transporters Sinking - Sector Rotation Is Providing Clues

Historically, investors gravitate toward more defensive and commodity focused sectors, such as precious metals, energy, commodities, and utilities, in late cycle bull markets. Recently, the stock market is beginning to show us signs that the bull market may be coming to an end. 

Commodities such as energy, grains, and precious metals have all experienced nice rallies. Price action also confirms money flow coming out of transports and into utilities....Continue Reading Here.

Utilities Continues To Rally – Is It Sending A Warning Signal Yet?

We have experienced an incredible rally in many sectors over the past 5+ months. My research team has been pouring over the charts trying to identify how the next few weeks and months may play out in terms of continued trending or risks of some price volatility setting up. We believe the Utilities Sector may hold the key to understanding how and when the US markets will reach some level of stronger resistance as many sector ETFs are trading in new all time high price ranges.

Utilities Sector Resistance at $71.10 Should Not Be Ignored

The Utilities Sector has continued to rally since setting up a unique bottom in late February 2021. A recent double top setup, near $68, suggests resistance exists just above current trading levels. Any continuation of this uptrend over the next few weeks, targeting the $70 Fibonacci 100% Measured Move, would place the XLU price just below the previous pre COVID19 highs near $71.10 (the MAGENTA Line).

My research suggests the momentum up this recent uptrend may continue to push prices higher into early May, quite possibly setting up the Utilities ETF for a rally above $70. Yet, we believe the resistance near $71.10 will likely act as a strong barrier for price and may prompt a downward price correction after the completion of the Fibonacci 100% Measured Price Move. In other words, the recent rally across many sectors will likely continue for a bit longer before key resistance levels begin to push many sectors into some sideways trading ranges....Continue Reading Here.

Get Positioned Now for the Next Great Natural Gas Switch

The Energy Report: Ron, welcome. You are making a presentation at the Money Show conference in Orlando in late January. What is the gist of your presentation?

Ron Muhlenkamp: The gist of my presentation is that natural gas has become an energy game changer in the U.S. We are cutting the cost of energy in half. This has already happened for homeowners like me who heat their homes with natural gas. We think the next up to benefit is probably the transportation sector.

TER: What is behind this game change?

"Natural gas has become an energy game changer in the U.S."

RM: The combination of horizontal drilling and fracking has made an awful lot of gas available cheaply. There's a whole lot of gas that's now available at $5/thousand cubic feet ($5/Mcf) or less. I live in Western Pennsylvania, and 30 years ago, Ray Mansfield was in the oil and gas drilling business, having retired from the Steelers. He said, Ron, we know where all the gas is in Pennsylvania; it's just a matter of price. If the price runs up, we will drill more. If the price runs down, we will drill less. Any way you slice it, we are just sitting on an awful lot of it.

Two years ago, we had a warm winter, and the price of gas actually got down to $2/Mcf. You saw an awful lot of electric utilities switch from coal to gas. Literally in a year, what had been 50% of electricity produced by coal went to 35%. The difference was made up with natural gas.

In transportation, the infrastructure to make the switch to natural gas has not been in place. We didn't have the filling stations or the trucks. Now, the trucks are just becoming available. You can buy pickup trucks from Ford Motor Co. (F:NYSE) and General Motors Co. (GM:NYSE) that run on natural gas. Furthermore, Clean Energy Fuels Corp. (CLNE:NASDAQ) has established natural gas filling stations coast to coast, every 250 miles on five different interstate highways.

Westport Innovations Inc. (WPRT:NASDAQ) has been producing 9 liter (9L) natural gas engines. Waste Management (WM:NYSE) uses 9L engines on garbage trucks and expects 8590% of its new trucks to be natural gas fueled. Westport has just come out with 12L engines, which are used for over-the-road trucks. I don't expect those engines to get adopted as fast as the utility industry made the switch to natural gas, but there has been a fairly rapid adoption in the waste management industry. I think we're on the cusp of a major trend.

TER: That fuel switching in the power industry has been going on since 2008. Is it still progressing at the same rate or is it picking up?

"The big switch is over in utilities. But we've barely begun the transition with transportation fuel."

RM: It's pretty much leveled off. In fact, there's probably a little bit less gas used than when gas was below $3/Mcf. The latest numbers I've seen show that we're running about 37% coal and about 3334% gas. Going forward, I think coal use will continue to decline, and natural gas use will continue to rise. The big switch is over in utilities, and it will be gradual from here. But we've barely begun the transition with transportation fuel.

TER: So the game has changed for the power industry, and the transportation industry is next. What other changes do you foresee in the future?

RM: We will continue to use more natural gas and less crude. Right now, for equal amounts of power, crude oil is priced at about three times the natural gas price in the U.S. That is too wide a spread to ignore, economically.

The Natural Gas - Crude Oil Spread

source: Bloomberg

Incidentally, in Europe, natural gas is still at $12/Mcf. It's on a par with crude. Most European chemical plants use a crude oil base to make chemicals. U.S. plants use a natural gas base. Natural gas becomes ethane, then ethylene, then polyethylene and then plastic. So producers of plastics or the feedstocks for plastic in the U.S. now have an advantage they didn't have before.

"The natural gas price advantage will be with us in North America for quite a long time. It's huge."

In Japan, the natural gas price jumped from $12 to $16/Mcf just after the tsunami wiped out the Fukushima nuclear power plant. To ship gas from the U.S. to Japan, the cost of compression, liquefying and decompression is about $6/Mcf. Executives at U.S.-based companies like Dow Chemical Co.

(DOW:NYSE) are saying they don't want the U.S. to export gas because that would drive the price up. But domestic gas consumers already have that $6/Mcf advantage. Meanwhile, in Williston, N.D., the natural gas price is effectively zero. Producers still flare it because they don't have the pipelines to take it out of the area. So this price advantage will be with us in North America for quite a long time. It's huge. That's why we call it a game changer.

TER: So how can investors take advantage of these changes?

RM: Well, any number of ways. We hold some fracking services companies, like Halliburton Co. (HAL:NYSE). We own a couple of drillers, including Rex Energy Corp. (REXX:NASDAQ). And we invest in the people who build natural gas export facilities, such as Fluor Corp. (FLR:NYSE), KBR Inc. (KBR:NYSE) and Chicago Bridge Iron Co. N.V. (CBI:NYSE).

I already mentioned companies building natural gas-fired engines, including Westport, which makes a kit to modify a common diesel engine. And because natural gas will require new, larger fuel tanks, investing in companies that build natural gas tanks is another way to play it. One of the disadvantages of natural gas versus gasoline or diesel is compressed natural gas takes about three to four times the volume to get the same range. Liquefied natural gas (LNG) takes about two times the volume.

Of course, compressed natural gas is stored in pressure tanks, so it takes a pressure tank of larger size. Fuel tank conversions have been almost as expensive as the engine conversions. 3M Co. (MMM:NYSE) has gotten in that business, as has General Electric Co. (GE:NYSE). There's another outfit called Chart Industries Inc. (GTLS:NGS; GTLS:BSX), which has already run a good bit.

"We want a foot in each of these camps because we're not quite sure who the ultimate winners will turn out to be, but we know what the product lines will have to be."

We want a foot in each of these camps because we're not quite sure who the ultimate winners will turn out to be, but we know what the product lines will have to be. Don't forget about the companies that own the LNG export facilitiesCheniere Energy Inc.'s (LNG:NYSE.MKT) facility should be up and running in probably 2015, but, again, that stock has run up a good bit, too.

Pipelines will benefit from the switch. One of the biggest pipelines in the country is Kinder Morgan Energy Partners L.P.'s (KMP:NYSE) Rockies Express Pipeline, which stretches from Northern Colorado to Eastern Ohio and ships gas east. Kinder Morgan recently filed to reverse the flow on part of the line. Right now, in Western Pennsylvania, we have a glut of gas. A few months ago, they reversed the flow of the pipeline from the Gulf Coast that used to come up to Western Pennsylvania. There's a whole lot going on.

TER: After some serious oil train derailments in recent months, pressure is building now to increase pipeline capacity, but there is also pressure on producers to reduce flaring, which is happening on a huge scale in the Bakken Shale. How will the economics and the operations of Bakken producers be affected if they can't flare and pipeline capacity is not increased?

RM: The Bakken is primarily an oilfield; the gas is a byproduct. We hear a lot about the Keystone XL Pipeline, which is meant to carry oil from the Bakken south. I can't speak specifically, but if you're going to lay an oil pipeline from the Bakken, you should lay a gas pipeline alongside it. You can ship oil by rail, but it's not economic to ship gas by rail. One way or another, the oil will be shipped.

TER: Bill Powers, the independent analyst and author of "Cold, Hungry and in the Dark: Exploding the Natural Gas Supply Myth," says gas prices are going to rise steadily to as much as $6/million British thermal units ($6/MMBtu) because U.S. gas production has peaked and now is now flat or declining. Do you agree with that?

RM: Our production of gas has not peaked and is not declining. We are using fewer rigs drilling for gas, but each well, particularly if you drill horizontally instead of just vertically, is producing so much more gas. Production is not declining and isn't likely to for at least a decade. At current rates, we can drill in Pennsylvania for another 50 years. Yes, you drill the best wells first but also, over time, you get a little bit better at timing this stuff. I'd be very surprised if the price in the next decade gets over $5/Mcf for any extended period of time because there's an awful lot of gas that's very profitable at that price. I'm willing to make that bet with Bill Powers. But even $6/Mcf gas would equate to $55/bbl crude, which is still a huge spread and wouldn't negate my general argument.

TER: What's your forecast for gas prices in 2014?

RM: My forecast is $4/Mcf, give or take $1. We just had a big cold snap on the East Coast. What used to happen is any time you had a cold winter, the price of gas jumped. For instance, in 2005, when crude was selling about $50/barrel ($50/bbl), gas began the year at about $7/Mcf, which was on par with crude, but in the wintertime, it doubled and ran up to $14/Mcf. The recent cold snap took gas all the way up to ~$4.20/Mcf. Gas is going to be in that range for a long time.

TER: Your advice to investors in natural gas is to get exposure to exploration and production companies, service companies and even LNG plant constructors. What about the LNG plant owners, the pipelines and the railroads?

RM: The pipelines will do well. They've already been bid up. The railroads will benefit from oil and gas, but they're getting hurt because coal tonnage is way down, CSX Corp. (CSX:NYSE) just reported. So for the railroads, it's going to be a wash. They'll haul less coal and more oil. The railroads won't haul gas. How much oil they haul is an open question. We're about to tighten restrictions on how tank cars are built.

TER: What did well in the Muhlenkamp Fund last year?

RM: The fund was up 34.4%. We did very well in biotech stocks. We did very well in financial stocks. We also did well in some energy stocks. Airlines did well for us. Incidentally, airlines benefit big time from cheaper energy, as you know. So it's fairly diverse.

TER: How are you adjusting your portfolio this year?

RM: Not too much has changed. We're no longer finding many good companies that are cheap. So we're monitoring and adjusting a little bit around the edges. We do think banks have further to go. We think the economy will grow somewhere between 2.53% this year. We've owned no bonds for the past couple of years, but with the Treasuries now, the interest rates on the longer end are high enough so that savers can get a little bit of return.

TER: I was surprised to see a really sharp drop in November for Fuel Systems Solutions Inc. (FSYS:NYSE). Why did that happen?

RM: Fuel Systems makes conversion kits for cars to burn compressed natural gas. In places like Pakistan, 40% of the cars run on natural gas; this is not new technology. A number of its customers decided to make these kits in-house. Fuel Systems is a small position of ours, but, yes, it got hit in Q4/13 when it announced that a number of its customers decided to produce their own kits. One of the nice things about this is there's no new technology involved. We've been using natural gas as a power source for generations. What has changed is the amount that's available reliably at a cheap price.

TER: There was another sharp drop in Clean Energy Fuels in October. What happened there?
RM: Clean Energy, so far, doesn't make a profit because it has been shelling out all the money to build all these filling stations. It's just taking a little longer than people expected. The stock is compelling at these levels. A number of these companies ran. Westport doubled, and we took some profits. It's now back down, and we should do a Buy rerating. There is volatility in this stuff, but the economics are undeniable. We still managed a 34.4% gain this year, which isn't bad.

"Royal Dutch Shell Plc is building natural gas fueling stations in concert with another truck stop operator."

Clean Energy has signed a joint venture with Pilot Flying J to build natural gas fueling stations at Flying J truck stops coast to coast. Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) is doing a similar thing in concert with another truck stop operator. For instance, the Port of Long Beach, Calif., passed a rule several years ago that the trucks on the port need to burn natural gas. The Port of Hamburg, Germany, has contracted to put a natural gas-fired power unit on a barge so that when cruise ships come into the harbor, instead of running their own power off their diesel engines and generators, they'll use this barge to supply power to the cruise ship because natural gas exhaust is cleaner than diesel exhaust.

TER: A couple of other companies had surprising drops Rex Energy and Westport Innovations. Rex rose all year until October or November, when it suddenly dropped. Westport also dropped suddenly. You had a wild ride in your portfolio, didn't you?

RM: We bought Rex at $13/share, and it went to $22 or $23, and it's now $19. I can live with that. The dips give you a chance to load up again. That volatility is why we have a diversified portfolio. That's why you don't just bet on three stocks.

As an investor, most of the time what you're looking for is to find a difference between perception and reality. Today, we have two realities: One is the price of crude oil, and the other is the price of natural gas. So it's literally an arbitrage if you can buy energy either at the equivalent of $100/bbl or at a third of that.

Four dollar gas is equivalent in energy content to about $35/bbl crude. So I can buy my energy either at $100/bbl or $35/bbl. Economics says that spread is too wide. It won't necessarily close, but it sure as heck will narrow a good bit. For instance, I own no conventional oil companies. I think the price of oil will be coming down.

TER: So what companies in your portfolio look most promising?

RM: If you really want to get me excited, we can talk about natural gas, which we've been talking about. We could talk about biotechnology, which is exciting but I don't understand it as well. We can talk about U.S. manufacturing, but that's basically based on cheaper energy. I just bought more Rex. At these prices, I'm buying Westport. I just bought Chicago Bridge. I just bought KBR.

TER: What is your main motivation in buying these companies? Is it just the stock price or is there something about the management of the company or the technology?

"I want to buy Pontiacs and Buicks when they go on sale. I don't want a Yugo at any price. I would like to buy Cadillacs, but they don't go on sale very often."

RM: We're in the investment business. What we rely on is good companies, and we look to buy them when they're selling cheaply. Our first measure of how well a company is run is we start with return on shareholder equity. So we like companies that are at least above average in return on shareholder equity. I cannot yet say that about Clean Energy, but we do think Clean Energy is at the forefront of something that's needed for this transition. We're always looking for good companies. Then the question is whether you can buy them at a decent price.

My phrase is: I want to buy Pontiacs and Buicks when they go on sale. I don't want a Yugo at any price. I would like to buy Cadillacs, but they don't go on sale very often. But if I can get Buicks when they're on sale, I'll make good money for my clientele. We think that the companies we have are at least Buicks. If we can get them at Chevy prices, that's when we buy them. I will not pay an unlimited amount for any company.

I've never seen a company that was so good it didn't matter what you paid for the stock. To us, value is a good company at a cheap price. Some people bottom fish. They look to see when they can steal companies, and there are times when you can make money that way. But at that point it's not often a very good business, and there aren't too many well run companies at bargain basement prices. So it's very unusual for us to buy a weak company or a weak industry.

TER: Ron, this has been a good conversation. I appreciate your time, and good luck with your Money Show presentation.

RM: Thanks; it'll be fun.

Ron Muhlenkamp is the founder and portfolio manager of Muhlenkamp Co. Inc., 


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Why Investors Must Be Cautious At These Prices

Last week on October 8th the financial market experienced a broad based sell off. Every sector was down with utilities being the only exception.

The individual leadership stocks, which are typically small to mid-cap companies (IWM – Russell 2K) that have a strong history and outlook of earnings growth, were hit hard as well.

Whenever the broad market experiences a price correction, one of the most important factors I analyze is how well leading stocks hold up and show relative strength to the broad market.

So, where does this leave us going forward?

When stocks that have been leading the market higher and only pausing during market corrections in the S&P500, Dow, and NASDAQ, it’s a positive sign. This tells us investors and big money continues to flow into the risk on assets (stocks).

Conversely, when these leading stocks/sectors begin succumbing to the selling pressure of the broad market, it quickly grabs my attention and tells us it’s time to be aware that a major top may be forming.

It looks as though the broad market rally is just barely hanging on. If the leading stocks and sectors begin breaking below their 50 day moving averages, my proprietary SP500 Market Timing & Trading System will shift to sell mode and things could get ugly for those who do not know how to trade a bear market.

Here's our chart work including videos for "Why Investors Must Be Cautious At These Prices"



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How to Spot & Time Stock Market Tops

Since the middle of April everyone and including their grandmother seems to have been building a short position in the equities market and we know picking tops or bottoms fighting the major underlying trend is risky business but most individuals cannot resist.

The rush one gets trying to pick a major top or bottom is flat out exciting and that is what makes it so darn addicting and irresistible. If you have ever nailed a market top or bottom then you know just how much money can be made. That one big win naturally draws you back to keep doing it much like how a casino works. The chemicals released in the brain during these extremely exciting times are strong enough that even the most focused traders fall victim to breaking rules and trying these type of bets/trades.

So if are going to try to pick a top you better be sure the charts and odds are leaning in your favor as much as possible before starting to build a position.

Below are a few charts with my analysis and thoughts overlaid showing you some of the things I look at when thinking about a counter trend trade like picking a top within a bull market.

Utility Stocks vs SP500 Index Daily Performance Chart:

The SPY and XLU performance chart below clearly shows how the majority of traders move out of the slow moving defensive stocks (utilities – XLU) and starts to put their money into more risky stocks. This helps boost the broad market. I see the same thing in bonds and gold this month which is a sign that a market top is nearing.

That being said when a market tops it is generally a process which takes time. Most traders think tops area one day event but most of the times it takes weeks to unfold as the upward momentum slows and the big smart money players slowly hand off their long positions to the greedy emotion drove traders.

Look at the chart below and notice the first red box during September and October. As you can see it took nearly 6 weeks for that top to form before actually falling off. That same thing could easily happen again this time, though I do feel it will be more violent this time around.



SPY ETF Trading Chart Shows Instability and Resistance:

Using simple trend line analysis we see the equities market is trading at resistance and sideways or lower prices are more likely in the next week or two.



Stocks Trading Above 150 Day Moving Average Chart:

This chart because it’s based on a very long term moving average (150sma) is a slow mover and does not work well for timing traded. But with that said it does clearly warn you when stocks are getting a little overpriced and sellers could start at any time.

General rule is not to invest money on the long side when this chart is above the 75% level. Rather wait for a pullback below it.



Stocks Trading Above 20 Day Moving Average Chart:

This chart is based on the 20 day moving average which moves quickly. Because it reacts quicker to recent price action it can be a great help in timing an entry point for a market top or bottom. It does not pin point the day/top it does give you a one or two week window of when price should start to correct.



How to Spot and Time Stock Market Tops Conclusion:

As we all know or will soon find out, trading is one of the toughest businesses or and one of the most expensive hobbies that one will try to master. Hence the 95-99% failure rate of individuals who try to understand how the market functions, position management, how to control their own emotions and to create/follow a winning strategy.

With over 8000 public traded stocks, exchange traded funds, options, bonds, commodities, futures, forex, currencies etc… to pick from its easy to get overwhelmed and just start doing more or less random trades without a proven, documented rule based strategy. This type of trading results in frustration, loss of money and the eventual closure of a trading account. During this process most individuals will also lose friends, family and in many cased self-confidence.

So the next time you think about betting against the trend to pick a top or a bottom you better make darn sure you have waited well beyond the first day you feel like the market is topping out. Stocks trading over the 150 and 20 day moving averages should be in the upper reversal zones and money should be flowing out of bonds and other safe haven/defensive stocks to fuel the last rally/surge higher in the broad market.

Also I would like to note that I do follow the index futures and volume very closely on both the intraday and daily charts. This is where the big money does a lot of trading. Knowing when futures contracts are being sold or bought with heavy volume is very important data in helping time tops and bottoms more accurately. And the more experience you have in trading also plays a large part in your success in trading tops and bottoms.

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So Much For One Hundred Dollars Per Barrel

Much was made of WTI crude oil passing the $100.00 mark and many thought that if we closed above $100 a barrel we would be in some type of new era for oil. Well that era is now over and lasted only a day as European debt fears, as well as the realization that the reversal of the seaway pipeline ultimately is more bearish then bullish. A terrible Italian and now Spanish debt auction stirred fears that the Euro zone credit woes are expanding.

Lack of confidence in the EU is causing buyers of Eurozone debt to command post EU record highs. Fear of a EU meltdown is overshadowing the fact that in the US our economy is starting to recover. More evidence yesterday came with a strong jobless claims number, retail sales, housing starts as well as other data that seems to suggest we are starting to move. The dollar and bond rallied in a safe haven bid and commodities started to tumble.

Get ready to party! Natural Gas supply hit a record high! The Energy Information Agency reported working gas in storage was 3,850 Bcf as of Friday, November 11, 2011. This represents a net increase of 19 bcf from the previous week. Stocks were 14 bcf higher than last year at this time and 224 bcf above the 5 year average of 3,626 bcf. In the East region, stocks were 58 bcf above the 5 year average following net injections of 9 bcf.

Stocks in the producing region were 148 bcf above the 5 year average of 1,098 bcf after a net injection of 11 bcf. Stocks in the West region were 18 bcf above the 5 year average after a net drawdown of 1 bcf. At 3,850 bcf, total working gas is above the 5 year historical range. Now the question is whether or not we will end the winter at a record.

Reuters News reports, "U.S. natural gas inventories should end winter at a 21 year peak after starting the heating season at an all time high for a third straight year, creating a buffer for consumers over the summer, according to a Reuters poll of traders and analysts. Without winter temperatures that come close to matching last year's severe cold, brimming inventories next spring could spell more trouble for prices, which hit a two year low this week of $3.11 per mm Btu despite the fast approaching peak heating demand season.

The Reuters storage poll put the consensus forecast for end winter inventories at 1.864 trillion cubic feet, nearly 300 billion cubic feet, or 19 percent, above average and the highest since 1991 when stocks in late March stood at 1.912 tcf. Such high inventories at the start of the spring and summer stock building season give utilities more bargaining power when rebuilding supplies for next winter, and can help lower power costs for consumers during summer when prices can go up as air conditioners come on."

Phil Flynn

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