Commodity Correction Is Coming

 | May 04, 2017 | 5:10 PM EDT
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Stock quotes in this article:

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amzn

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aapl

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It's hard to tell from today's coverage on CNBC -- Trump, Trump, Trump, Congress, Trump -- but there has been a sharp correction in commodity prices. Actually, today's action represents the continuation of a trend seen in the past 2½ weeks. 

Oil prices fell a full 5% at one point today and, as the equity market trading day came to a close, were still trading below $45.50 per barrel of West Texas Intermediate crude and $48.50 per barrel of Brent. Copper prices hit a 17-month low yesterday and did not improve today and the always-volatile spot market for iron ore showed extreme weakness, with prices dropping 9.3% in Thursday's trading session. 

So, what gives? Pundits often dismiss day-to-day moves in commodities as "normal volatility," but as the pullback extends into its third week, one has to ask, "Is there any there there?" 

I don't think so, and I have been aggressively buying shares in smaller E&Ps, especially Gastar Exploration (GST) , which I featured -- along with Evolution Petroleum (EMP) and Torchlight Energy (TRCH) -- in a recent Real Money column. GST was actually the subject of my first RM column in 2014 -- I focused on GST's preferreds -- and I have been doing quite a bit of research on the company in recent days. 

It's always good to stay informed and have a personal coverage universe to be ready for a buy-on-the-dip play. You might be waiting in vain if you are putting in limit orders for Amazon (AMZN) at $600 or Apple (AAPL) at $100 or other such fantastical ideas, but from years of experience batting around small E&P stocks, I can say one thing for certain. That correction you are wishing for will happen, and you need to be prepared to buy low when commodity prices go into the tank. 

That's what I was doing today with Gastar, and I hope to get a chance to add some Torchlight and Evolution in the next few trading days as well. 

Inventories have been the focus of the bearish commodity trade in recent days, with words such as "stockpiles" and "glut" being casually thrown around again. It's a flashback to the first quarter of 2016. The pullback and rebound of the securities I was buying then at depressed levels -- the preferreds of Navios Maritime (NM-G) (my Real Money Best Idea) and Gastar among them -- taught me a valuable lesson. 

The key driver for valuation of commodity stocks -- longer-term, not in any particular trading day -- is demand for that underlying commodity, not supply. Knowing that Chinese demand for iron ore was not abating gave me the confidence to buy a dry-bulk shipper when that industry was extraordinarily out of favor, and looking at Chinese demand for oil is allowing me to buy E&P stocks today, even as their stock price charts paint a depressing picture. 

One must occasionally talk oneself off the ledge when dealing with commodity stocks, and I find it reassuring to deal with facts, not opinion or the "voodoo economics" of technical analysis. 

So here, from industry source Platt's, are the most recent figures for Chinese energy imports: 

  • China imported a monthly record amount of oil -- 9.21 million barrels a day in March. This level represented a 19.4% increase from March 2016's level and a 10.7% increase from February's level. 
  • Chinese domestic crude oil production fell 46% to 3.92 million barrels of oil equivalent per day in March. 
  • Chinese refineries ran at 64.6% of capacity in March. This is a recent high, but well below the about 90% refinery utilization rates seen in the Western world. 
  • China imported 2.7 million metric tons of refined oil products in March, a 10.2% year-on-year increase. 

So the Chinese demand picture is still quite bullish for the oil industry. Those data points gave me the intestinal fortitude to buy Gastar shares today when the market was dumping them. GST reports earnings Wednesday, and I'll write more on the company then. 

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