Don't Invest Like a Pirate

If you only watch the stocks you own, then you may as well dress up like a pirate. At least then you can get some comedic value out of that patch over one eye.

Focusing excessively on your own favorite stock in a sector is easy to do, and I dare say most of us have done it at one time or another. But if you do, you're basically burying your head in the sand and hoping it hits a treasure chest.

To illustrate the importance of looking beyond just our favorite stocks in a sector, let's dive into the burning hot coal sector for a closer look.

The overarching structure of coal
Arch Coal (NYSE: ACI  ) may be the second largest producer of coal in the U.S., but as a prospective long-term investment vehicle for coal exposure, it didn't even make my top five list. Peabody Energy (NYSE: BTU  ) and CONSOL Energy (NYSE: CNX  ) look better in my view, having had more impressive earnings in past quarters.

But tuning out potential market insights from this major operator just because you favor its competitors from an investment perspective would be a mistake. Utility stockpiles of coals in the Powder River Basin (PRB) should normalize as more bloated stockpiles of Appalachian coals further east diminish. Given Arch's strong operating position in the PRB, a swift return to profitability could conceivably propel the miner back into favor with investors.

For the time being, however, profit remains elusive for Arch Coal. The miner kicked off coal-sector earnings this week with a loss of $1.8 million for the first quarter. Despite a 4.5% increase in revenue, Arch's results were dogged by non-cash charges and a loss incurred by the company's trading unit.

Despite having missed analysts' expectations by a wide margin, Arch's improved guidance for the full-year 2010 (along with an increasingly bullish long-term outlook) helped push shares higher. What is Arch Coal so excited about?

Try these numbers on for size
In May 2009, the Energy Information Administration (EIA) estimated that global coal production would increase by 515 million tons (or 7%) between 2010 and 2015. Coal investors can well hope that forecast holds true, since Arch Coal expects 220 gigawatts of new coal-fired electrical generation capacity to come online over that same period, which it estimates will represent about 750 million tons of fresh demand annually for steam coal alone. Of course, miners the world over are likely to ramp up production capacity aggressively over the period to address this robust demand growth, but the almost 50% gap in that supply demand equation certainly suggests future constraints in global supply. Industry forecasts through 2030 suggest a similar story of persistent growth in demand dominated by China and India.

There's another powerful component of the bullish saga unfolding in coal. Foreign demand for seaborne coking coal, which is used in steelmaking, has reached a critical mass, carrying prices to a level that makes even the long journey for Appalachian coals from the eastern U.S. to Asia an economical endeavor. Reflecting the recent uptick in reported direct export shipments from producers including CONSOL Energy and Patriot Coal (NYSE: PCX  ) , Arch Coal increased its prior expectation for total growth in U.S. exports in 2010 from 10 million tons to 15 million tons.

Arch Coal also announced it will mirror several fellow Appalachian producers in diverting high-quality coals from the steam coal market into the coking coal market to take advantage of higher profit margins. Arch is now targeting an abrupt tripling of its met coal production in 2010 to between 6 million and 7 million tons. This will serve to further hasten the decline in domestic steam coal stockpiles, which are already down some 35 million tons from their late 2009 peak. So far in 2010, an industrywide steam-coal production decline of 5.2% has coincided with a 2.6% increase in electricity demand. Those are the kinds of numbers needed to bring the domestic market back into balance.

Pirate's parlay
Simply stated, the long-term investment landscape for coal could scarcely look any stronger, and I believe it's high time that investors take notice of this opportunity regardless of their stock selection. For Fools who may not have a decisive selection in mind, the Market Vectors Coal ETF (NYSE: KOL  ) offers a compelling mix of domestic and global sector holdings, including not only producers but also the companies that build mining equipment, such as Bucyrus (Nasdaq: BUCY  ) and Joy Global (Nasdaq: JOYG  ) . Both of those companies are red-hot right now, as overall global mining activity has recovered quickly from the recession.

However you structure your own coal sector exposure, remember not to ignore other companies in the sector. If you do, then you could easily find yourself saying "Arrrr" if you're late in catching the next big industry trend.

The "Coal" tag within the Motley Fool CAPS community lists 29 coal companies. Find out what other investors are saying about the stocks you're watching, or share your Foolish thoughts with us. CAPS is free and fun!

Fool contributor Christopher Barker hopes that the global atmosphere won't one day resemble a volcanic ash cloud. He can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Arch Coal and Peabody Energy. The Motley Fool scrubs its disclosure policy before releasing it into the atmosphere.


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