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Weekly Newsletter, Saturday, 07/19/2008

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Table of Contents

  1. Commentary
  2. Changes in Portfolio
  3. Portfolio Listing & Top Picks
  4. New Plays
  5. Existing Plays
  6. Watch List

Leaps Trader Commentary

Corrections Happen

Corrections happen in every market, sector and stock and most of the time without warning. One week everyone is talking about the new highs and a short time later there is nothing but devastation. Traders and analysts scramble to pin the blame on the cause but in doing so many turn themselves into donkeys. Assigning blame after the fact can take many directions and normally most are wrong. It was a correction, plain and simple. The rally simply became extended and the underlying fundamentals were no longer able to support the price. Profits were taken, stops were hit, panic appeared and the selling quickly became overdone.

The correction in oil last week was the worst on record. Crude prices fell from just below $147 on Tuesday to close just under $129 on Friday. From the commentary in the press you would have thought a 250 million U.S. consumers had suddenly traded in their cars for bicycles and there was going to be an instant glut of oil that our great grandkids would be forced to deal with.

It was a correction, not a global catastrophe. It was a 12% drop not 50%. I wish I had counted the number of talking heads on TV over the last week claiming we were headed back for $80 oil. Never have so many been so wrong about any one thing and rushed to the airwaves to proclaim their stupidity. Even Donald Trump got into the act and went on a several minute tirade about how much oil there was in the world. "We are awash in it, there are tankers floating around fully loaded with no place to go. There is so much oil ports are turning them away. I know this to be a fact because I keep up with these things. The press has covered up this glut because the big oil companies don't want us to know, etc, etc." Donald you are one of the biggest jackasses I know and you could not tell an oil tanker from the Queen Mary. Stick to your overpriced real estate and bad hair.

I could pick out a couple reasons for the price drop and write a few paragraphs but I believe it was just time for a correction and all the reasons were just excuses helping to speed it on its way. Oil profits are not profits until sold. I will list a few in what I consider the order of importance but that is just my view.

1. Cooling Iran tensions. The U.S. and five other nations are meeting with Iran this weekend in Geneva to discuss bribes to get Iran to quit enriching Uranium. It will be the first meeting with a U.S. envoy since the hostage crisis in 1979.
2. The U.S. even said it might be interested in opening a diplomatic mission in Tehran. (I couldn't believe it either)
3. Options on August Crude Futures expired on Thursday.
4. August crude futures expire next Tuesday.
5. Oil was overly extended from its +$57 gain since February. $147 appeared to be a double top failure after the Morgan Stanley $150 by July 4th prediction passed.
6. A +3 million barrel build in crude inventories on the weekly report. -31 mb over the last 8 weeks, +3 mb last week. I somehow doubt that was the cause of an $18 drop.
7. The API said oil demand for the first six months of 2008 fell -3% to the lowest level in five years. Gasoline demand was down -1.7%. It was the first significant decline in gasoline consumption 17 years.
8. MasterCard's Spending Pulse report for the week said gasoline demand fell more than 5% in the prior week. Mastercard said the normal post July 4th holiday uptick in driving had not appeared.
9. CIBC World Markets predicted there would be 10 million fewer cars on U.S. roads by 2012.
10. President Bush ended the executive order preventing offshore drilling on the continental shelf.

Pick your choice of reason but it won't ease the pain in our portfolio. We were stopped out on seven plays when stock prices imploded along with oil prices.

They say you should buy stocks when nobody wants them. Buy when there blood in the streets. For energy stocks that would be now. I am adding two of our stopped positions back into the portfolio today. I am putting two back on the watch list and I am adding a long play on the XLE as a sector play. I was going to add a USO long but the potential for a continued drop to $122 convinced me to put it on the watch list instead.

Personally I believe Iran was stalling at the weekend meeting because they feel they can get more concessions from the next U.S. president. They are just stalling for time until the election. Iran made it clear as they entered the meeting this weekend that suspension of enrichment was "out of the question." After the six hours of talks on Saturday meeting EU foreign Policy chief Javier Solana said Iran gave "no clear answer" to the U.N. proposal offering economic bribes in exchange for a suspension. U.S. State Dept spokesman Sean McCormack said Iran had two weeks to "give a clear answer" or face further sanctions. Evidently the term "clear answer" had a specific meaning to what was said in the meeting. Diplomats described the talks later as a "final attempt to persuade Iran that it must halt its nuclear program."

After the meeting another member of the Iranian delegation repeated the "no chance" of a suspension mantra. Other than that simple statement Iran was silent about the outcome of the meeting. That suggests the government is planning a big announcement by the Ayatollah or President Ahmadinejad and they want to grab the stage rather than have a lower level aide get the sound bite. There is always the possibility that the meeting participants told Iran specifically that some demand better be met ASAP or they were going to get slapped down hard. Iran may have decided it was better to be quiet and consider the options before making a speech.

There are actually some signs the U.S.-Iran cold war stance may be thawing but it is too soon to tell if it is just a delaying tactic by Iran or the sudden realization that time is running short with Bush and maybe they would be better off to do something now rather than wait. Either way there was no decisive agreement reached at the meeting and that could be neutral for oil prices on Monday. If Iran makes headlines between now and then that could change quickly.

On the storm front there is a strong tropical wave in the western Caribbean that has better than a 50% chance of storm formation. If this turns into a hurricane this weekend then oil prices will quickly rebound.

Hurricane Chart

I believe that oil is extremely oversold as a result of all the conditions I listed above and from the asset allocation swap back into equities. If the equity market begins to roll over we could quickly see oil come back into favor.

Jim Brown


Readers Write:

Jim, I have been a devoted reader of your columns for over 5 years. Now I find myself trying to understand the recent market movements as they relate to energy investments. I will use by example, my comfort stock, XTO, which I have owned for years.

Underestimating the potential for fat tails is a major risk for all investors. I have always planned for the day when XTO would fall 15% in two days as the momentum traders moved out. Your column correctly points out what is likely to be the proper destination for oil stocks, but uses stop losses along the journey.

Now the question: XTO fell by 30%, or double my expectation. My conclusion is that the heat was too great for the arbs that bought energy and sold the financials. The loss on the short financials position was so great, that dumping the matching energy trade at any price was a necessary act.

Is this explanation too simple? If not, would this mean we have a few more weeks/months before the trades are all unwound? LC

Reply:

I think you may have hit the nail right on the head. Nearly every hedge fund worth its fee has been short financials and long commodities for the last six months. When the picture suddenly changed those same funds had to cover shorts instantly and pull money out of commodities. It makes perfect sense to me and the only question now is what will they do once the short squeeze is over. Go back into energy or stick with equities? If you figure out that part of the puzzle let me know and I will share it with the readers.

As far as XTO it was whacked because it is primarily a natural gas play and gas was crushed. XTO broke support at the 200-day on Thursday and fell to next level support at $55. I would be a buyer of XTO at this level. Maybe it is time to average into some more?

Jim

(I am going to try and make this a weekly feature. Send me your email questions and I will try to answer. Jim @ OptionInvestor.com)


August Crude Futures Chart - Daily

August Natural Gas Futures Chart - Daily

August Gasoline Futures Chart - RBOB Daily

 


Changes in Portfolio

New Plays
XLE $76.75 Energy Select SPDR

Dropped Plays

New Watch List Plays Triggered
FWLT $57.95 Foster Wheeler
HP $60.22 Helmerich Payne

Portfolio Listing & Top Picks

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Top Picks
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If you are looking to add another position these are my top picks for this week. The target prices listed would be the ideal entry points for these stocks today. There is no assurance any stock will ever return to these support levels and you will need to make your own decision about an entry point above these levels. I believe these stocks have the best potential this week. The list will change from week to week based on technicals, fundamentals, crude prices and market action. The list is not sorted in any particular order.


 


New Plays

Most Recent Plays

XLE $76.75 - Energy Select SPDR

The XLE is a group of 36 companies in the energy sector. Exxon is the largest component and Tesoro the smallest. See the complete list here.

The XLE has corrected from just over $90 to dip below $75 on Thursday. With a couple dozen service companies reporting earnings next week it should get a lift.

ETF Info:

Energy Select Sector SPDR Fund (the Fund) seeks to provide investment results that correspond to the price and yield performance of the Energy Select Sector of the S&P 500 Index (the Index). The Index includes companies that primarily develop and produce crude oil and natural gas, and provide drilling and other energy-related services. The Fund utilizes a passive or indexing investment approach to invest in a portfolio of stocks that seek to replicate the Index. The Funds investment advisor is SSgA Funds Management, Inc.

Buy Dec $80 Call XTG-LB currently $6.10

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New Watch List Plays Triggered
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FWLT $57.95 - Foster Wheeler

Foster is approaching converging support at $54 and higher. With oil service companies reporting next week I am hoping good results lifts the entire sector.

Earnings are Aug-5th

Company Info:

Foster Wheeler Limited operates through two business groups, the Global Engineering & Construction Group (Global E&C Group) and the Global Power Group. The Global E&C Group, which operates globally, designs, engineers and constructs onshore and offshore upstream oil and gas processing facilities, natural gas liquefaction facilities and receiving terminals, gas-to-liquids facilities, oil refining, chemical and petrochemical, pharmaceutical and biotechnology facilities and related infrastructure, including power generation and distribution facilities, and gasification facilities. The Global Power Group designs, manufactures and erects steam generating and auxiliary equipment for electric power generating stations and industrial facilities globally. In February 2008, the Company completed the acquisition of Biokinetics. On April 7, 2006, the Company completed the purchase of the remaining 51% interest in MF Power.

Breakdown trigger: $60 hit 7/166

Position: 2010 $70 LEAP Call LWM-AN @ $12.80

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HP $60.22 - Helmerich Payne

HP hit our breakdown trigger on Thursday and with just a week to go before earnings this would be a good place for a bounce. HP builds the best rigs in the business and they have a huge backlog.

Earnings July 31st

Company Info:

Helmerich & Payne, Inc. is primarily engaged in contract drilling of oil and gas wells for others. The contract drilling business accounts for almost all of the Company's operating revenues. It is also engaged in the ownership, development and operation of commercial real estate. It is organized into two separate operating entities: contract drilling and real estate. The Company's contract drilling business consists of three business segments: U.S. land drilling, offshore platform drilling and international drilling. The Company's U.S. land drilling is conducted primarily in Oklahoma, California, Texas, Wyoming, Colorado, Louisiana, Mississippi, Alabama, Arkansas, New Mexico, and North Dakota, and offshore from platforms in the Gulf of Mexico, California, Trinidad and Equatorial Guinea. During the fiscal year ended September 30, 2007, the Company's international land segment operated in seven international locations: Venezuela, Ecuador, Colombia, Argentina, Bolivia, Tunisia and Chile.

Breakdown trigger: $62 hit 7/17

Position: 2010 $70 LEAP Call LQB-AN $11.40


 


Play Updates

Existing Plays

SD $51.58 -9.88 - SandRidge Energy *** Stopped/reentered ***

The $20 drop over the last two weeks is extremely overdone as is the monster drop in natural gas itself. I think both will reverse any day now. We were stopped out of SD at $54 but after looking at the chart again I want to reenter SD here at the $51 level. I am going to put a tight stop on it at $46.

Company info:

SandRidge Energy, Inc. (SandRidge) is an independent natural gas and oil company with its principal focus on exploration, development and production activities. The Company also owns and operates drilling rigs and a related oil field services company operating under the name Lariat Services, Inc.; gas gathering, marketing and processing facilities, and, through its wholly owned subsidiary PetroSource Energy Company, carbon dioxide (CO2) treating and transportation facilities and tertiary oil recovery operations. The Company is focused on exploration and exploitation of its significant holdings in West Texas that it refers to as the West Texas Overthrust (WTO), a natural gas prone geological region that includes the Pinon Field, and its South Sabino and Big Canyon prospects. SandRidge operates in four segments: exploration and production, drilling and oil field services, midstream gas services and other.

New position: 7/20
Buy 2010 $60 LEAP LWE-AL currently $13.40

Old Position:
Breakdown trigger: $60 Hit 7/07
2010 $70 LEAP LWE-AN @ $13.00, exit $11.70 7/16

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MOS $127.13 -14.68 - Mosaic Industries

That drop was painful but at least we are still in the play. It was reported on Friday that the price of potash has risen +21% in recent weeks and the exporter for MOS, POT and AGU has told customers that all further sales in 2008 will be at the new price or higher. There is simply not enough product and too many people increasing their food consumption. As the world moves towards 7 billion people in 2012 this problem is only going to get worse. There were only 6 billion in 1999. Adding a billion mouths to feed every 12 years will require a lot more fertilizer.

Mosaic also initiated a quarterly dividend of 5-cents on Thursday.

Earnings July 28th

Breakdown trigger: $125 hit 7/08

Position: 2010 $160 LEAP Call KCA-AL @ $27.45

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FLR $84.25 -3.12 - Fluor

It is always a shock to wake up and see a stock trading for half the price of just the day before. Fluor split 2:1 on Thursday. I went back to see how I missed this event and the closest mention of it was on June 9th in an article about stock splits. The company itself announced it on May 7th. That was a week before their last earnings report. You would think this kind of event would get more press. Now we have two $100 leaps instead of one $200 leap.

Earnings August 11th

Breakdown trigger: $175 hit 7/07 (2:1 Split = $87.50)

Position: 2010 $200 LEAP Call LLF-AZ @ $35
Converted to (2) 2010 $100 LEAP Call LLF-AT @ $17.50

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ANR $94.27 -$2.53 - Alpha Natural Resources *** Dropped ***

Just a week after our entry Alpha Natural announced it was being acquired by Cleveland-Cliffs (CLF) for $8.3 billion. The deal calls for 0.95 shares of CLF plus a cash payment of $22.23 for every share of ANR. When the deal was announced that equated to $128.12 per share of ANR. We have a $100 LEAP. Unfortunately it is not that simple. As CLF declines on acquisition worries so does the value of the deal. As of Friday it had declined to $118.03. If you stay in this deal your LEAP will convert to some combination form of CLF LEAP and cash. I would prefer just to take our beating now and exit the play with a minor profit. It will be up to you to chose your game plan.

Earnings July 29th before the open

Breakdown trigger: $80 hit 7/08

Position: 2010 $100 LEAP Call WDB-AT @ $23.40, exit 25.40, 7/20

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TS $60.48 -$7.52 - Tenaris *** Stopped ***

This is crazy. The $17 drop in oil prices will not impact the need for oil pipe. There is currently a shortage of pipe and prices are going up. Unfortunately a bear market and the oil implosion knocked us out of Tenaris at our stop of $63. I would make a good case for $60 being strong support for TS but we are also getting news about inflation in Latin America depressing the stock exchanges and TS is the biggest stock on the Argentine exchange.

Breakdown trigger: $65 Hit 7/08

Position: Dec $70 Call TSW-LN @ $6.00, exit $5.90 7/17

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COP $83.91 -$4.22 - ConocoPhillips *** Stopped/Reentered ***

COP pre announced the week before that production had declined by 60,000 bpd. This week Lukoil, which COP owns 20% said production would decline by 3% this year. Oil dropped $17. It was the perfect storm for Conoco but it looks like they are trying to hold on to support at $82. We were stopped out at $87 but I am going to put them back in at today's numbers with a tight stop at $76.

Earnings are July 23rd

Buy 2010 $90 LEAP YRO-AR currently $11.35

Old Position: Entered at $90, stopped at $87
2010 $100 LEAP Call YRO-AT @ $11.70, exit $9.40, 7/15

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TRN $35.30 +3.97 - Trinity Industries *** Stopped ***

Highly frustrating here! Trinity rebounded +$4 for the week but not before stopping us out on an intraday dip to $29.73 (Stop was $30) on Tuesday.

Breakdown trigger: $35 Hit 6/26

Position: 2010 $40 LEAP Call YJS-AH @ $6.90, exit $4.40 7/15

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GDP $59.12 -15.06 Goodrich Petroleum *** Stopped ***

Big drop in gas prices knocked -$25 off GDP over the last 3 weeks. Stopped out at $58 on no news.

Good article on Goodrich here

Breakout trigger: $66 Hit 6/23

Position: 2010 $80 LEAP Call LP-AP @ $21.00, exit $14.90 7/17

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HK $39.70 -8.20 Petrohawk Energy

Petrohawk took a sizeable hit but remains in the same range as we saw three weeks ago. Support is holding at $37, stop is $34.

Prior commentary:

Chesapeake said it had sold 110,000 acres of its Haynesville Shale acreage to Plains Exploration for $25,600 an acre plus development concessions of $1.65 billion. This price tag on land means HK's current holdings are worth more than $7.4 billion in this play. HK only has a market cap of $9 billion meaning all the other assets are seriously undervalued. It may take several weeks for the news on HK to sink in but it should be going a lot higher even at its current valuation. Revenues are exploding.

Breakout trigger: $40.75 Hit 6/23

Position: DEC $50 Call HK-LJ @ $4.50

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CHK $54.33 -9.19 Chesapeake Energy *** Stopped ***

CHK was crushed by the sell off in gas but the CEO stepped up to the plate and bought another 750,000 shares at $57 each. We were stopped out at $56 but I am putting them back on the watch list with an entry at $51.

Previous commentary:

This is another stock that refuses to pull back but the news is too good to let it continue to run away from us. As I mentioned in the GDP lead CHK paid $178 million to Goodrich for a 50% working interest in some Haynesville Shale acreage. As I read further CHK said the Haynesville Shale could end up being the biggest asset they own and produce more gas than any other CHK property. That is a huge statement given CHK's massive footprint in places like the Barnett Shale in the DFW area. Encana (ECA) is the largest gas producer in North America and they said the Haynesville Shale could be the biggest deposit in North America.

Breakout trigger: $67 Hit 6/23

Position: 2010 $80 LEAP Call WZY-AP @ $8.60, exit $7.00 7/16

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ENER - $67.02 -0.20 Energy Conversion Devices

Definitely no complaints here. Trend is still up and ENER resisted the market drop.

Breakout trigger: $68.50 hit 6/16

Position: 2010 $80 LEAP Call KYU-AP @ 23.10

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BTU $64.10 -12.75 - Peabody Energy *** Stopped ***

Nat gas and coal trade in tandem and the collapse of gas prices crushed coal stocks. It did not make any difference that two different coal companies were on TV last week saying all 2008 production had already been sold and they were already pre-selling 2009 coal at much higher prices.

I am putting BTU back on the watch list with an entry at $61.

Earnings July 23rd

Breakout target: $81 Hit 6/09

Position: 2010 $90 LEAP Call LLW-AR @ $19.92, exit $13.64 7/17

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CRR $52.84 -.95 - Carbo Ceramics

CRR announced a +21% increase in the dividend and resisted the drop in the energy sector. No complaints!

Breakout trigger: $48 Hit 5/12

Position: Dec $50 Call CRR-LJ @ $5.80


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Non-Energy Positions
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None
 


Leaps Trader Watch List

Dropped Entries
FXI Shanghai ETF Drop stalled at $125 and rally began

New Watch List Entries
BTU
Peabody Energy
CHK Chesapeake Energy
USO United States Oil Fund

Current Watch List

CHK - Chesapeake Energy

CHK was stopped out as a play on the recent implosion in nat gas prices. $51 is a strong support level and a reentry point. The CEO stepped up to the plate on June 16th and bought another 750,000 shares at $57.

Company Info:

Chesapeake Energy Corporation is a producer of natural gas in the United States (first among independents). It owns interests in approximately 38,500 producing oil and natural gas wells that are producing approximately 2.2 billion cubic feet equivalent (bcfe), per day, 92% of which is natural gas. Its operations are located in the Mid-Continent region, which includes Oklahoma, Arkansas, southwestern Kansas and the Texas Panhandle; the Forth Worth Basin in north-central Texas; the Appalachian Basin, principally in West Virginia, eastern Kentucky, eastern Ohio and southern New York; the Permian and Delaware Basins of West Texas and eastern New Mexico; the Ark-La-Tex area of East Texas and northern Louisiana, and the South Texas and Texas Gulf Coast regions. In July 2007, the Company announced the acquisition of Kerr-McGee Tower from Anadarko Petroleum Corporation and subsequent sale of the tower to SandRidge Energy, Inc.

Breakdown trigger: $51

Buy 2010 $60 LEAP Call WZY-AL

Breakout trigger: $58

Buy 2010 $70 LEAP Call WZY-AN

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BTU - Peabody Energy

Stopped out on the prior position due to the crash in Nat Gas prices. Coal and gas trade in tandem despite all 2008 production and most of 2009 coal production being presold. I believe this was way overdone and we should look to reenter.

Earnings July 23rd

Company Info:

Peabody Energy Corporation (Peabody) is a coal company. During the year ended December 31, 2007, the Company sold 237.8 million tons of coal. It sells coal to over 340 electricity generating and industrial plants in 19 countries. At December 31, 2007, the Company had 9.3 billion tons of proven and probable coal reserves. The Company owns majority interests in 31 coal operations located throughout all the United States coal producing regions and in Australia. In addition, it owns a minority interest in one Venezuelan mine, through a joint venture arrangement. Most of the production in the western United States is low-sulfur coal from the Powder River Basin. Peabody owns and operates six mines in Queensland, Australia, and five mines in New South Wales, Australia. During 2007, the Company generated 89% of its production from non-union mines. On October 31, 2007, Peabody spun-off portions of its Eastern United States Mining operations business segment to form Patriot Coal Corporation.

Breakout trigger: $68

Buy 2010 $80 LEAP Call LLW-AP

Breakdown trigger: $61

Buy 2010 $70 LEAP Call LLW-AN

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USO - US Oil Fund

The oil sell off may be overdone and I believe we will move higher but not necessarily immediately.

Company Info:

United States Oil Fund, LP (USOF) is a commodity pool that issues limited partnership interests or units that may be purchased and sold on the American Stock Exchange (the AMEX). The Company invests in futures contracts for light, sweet crude oil and other types of crude oil, heating oil, gasoline, natural gas and other petroleum-based fuels that are traded on the New York Mercantile Exchange (NYMEX), International Currency Exchange (ICE) Futures or other United States and foreign exchanges (collectively, Oil Futures Contracts). It holds interests in other oil-related investments such as cash-settled options on Oil Futures Contracts, forward oil contracts, and oil-based over-the-counter transactions. As of December 31, 2007, USOF held 4,754 Oil Futures Contracts traded on the NYMEX and 300 Oil Futures Contracts traded on the ICE Futures. The Company operates under full management control of its sole General Partner, Victoria Bay Asset Management, LLC (the General Partner).

I am not using LEAPS because I view this as a short-term trade.

Breakdown trigger: $101

Buy OCT $110 Call IYS-JF
 


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