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LongShort with the Big Steel Rail

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An old friend who worked as a salesman in a store that sold musical instruments once told me a great story.

A fellow called one day and asked if the store stocked 12 inch Zildjian splash cymbals.

My friend, himself is a drummer, checked the stock and returned to the phone,

“Sorry, sir. We’re out of stock. We should have it by week’s end. Can I take your number and give you a call?”

“So you don’t have any 12 inch Zildjian splashes?” the fellow repeated.

“No, sir. Like I said, at the end of the week.”

“Oh yeah?” said the caller cryptically, “we’ll see…”

The story is apropos of a note we received on the talkback section of the website a few weeks ago, when a regular reader informed us of his opinion on the transports.

Regarding our own bullish call on the sector, the gentleman had the following to say:

Regarding the Transports…

Not a Breakout… this is known as a…………

FALSE BREAKOUT

You will see……….

 

Well, if the good reader intended this as poetry, perhaps we’ll acknowledge he has some potential. Even as prophesy (“You will see…”) he shows some promise. But as analysis, let’s agree that there’s something fundamentally flawed here.

The transports have been riding high of late, and doubters have been eating crow of the rankest order.

Here’s a chart of the trannies since last summer.

 

 

Certainly there exist any number of indexes that purport to be the ‘official’ read on transport stocks, and hard core enthusiasts can even construct one of their own. Common household items like quality construction paper and Elmer’s Safety Glue should do the trick.

But the venerable old Dow Transports will do just fine for us. And they say we have a breakout.

Even the Russian judges admit.

The technicals also indicate –

1) That we’ve reached a new milestone. Yes, pop the corks; the Dow Transports have now surpassed their all-time highs. On Friday last they scaled to their best ever intraday and closing levels. EVER. A three and a half percent climb from here would also put the Dow Industrials in new, all-time high territory, thereby confirming the transport move and giving us a full-on Dow Theory bull signal.

2) Current RSI readings are perilously high (blue box), indicating that the asymptotic 18% rise that we’ve had over the last two months is very near its end.

 

But will the Dow confirm? – Will there be a bull market?

 

We’ve no doubt about it. The only question is when.

That is, will we have a pullback here to shake out the weaker hands before we progress, or will there be a further rise that surprises even the bulls in its intensity before we get a consolidation?

For those of us who believe in the bull thesis, it’s all academic. And for those who want to play the interim pullback, we’ll have more to say below.

Coal’s the Goal

 

Let’s continue with a quick look at an open trade, initiated back in the middle of October in Mind the Doors Please, The Doors are Closing.

Coming off the heels of a very successful covered CALL trade in the summer using shares of Arch Coal (NYSE:ACI), we rewrote the selfsame trade using the November expiry. Those options promptly expired worthless, and we rewrote the CALLS using the January expiry.

As of last week, ACI shares were moving strongly, but they did not reach our January strike at eight dollars, closing instead at $7.65 on Friday afternoon. They therefore expired worthless, giving us the full measure of premium written and reducing our cost base for the shares to $6.76.

Part of our move this week will be to continue with the trade, lower our adjusted cost base and watch ACI continue on its merry way.

We’re recommending selling the April 8 CALLS, now going for $0.67, thereby reducing our cost for the shares to just $6.09. At ACI’s current price, we’ll then be ahead 25.6% for the trade, and if the shares are called away the third week of April, we’ll have pocketed over 31%.

We’ll keep you posted, of course, on all developments, but meanwhile, here’s a quick look at the chart for ACI. Note specifically last Friday’s action on the far right.

 

The skinny on ACI is as follows –

Technically, she just flew higher by almost 8% on three times her average daily trade (in red), while her moving averages continue their ‘scoop’ of price (in blue).

The spike could be attributable to any number of factors, but we agree with those who suggest that the recent rise in natural gas prices is behind coal’s push higher.

How’s that?

Natural gas prices are now discounting the prospect of a very cold winter, confirmed this past Thursday by official reports of diminishing supplies.

Objectively, gas has been on a tear, up roughly 15% in price over the last eight trading sessions and now sitting above the $3.50 price level – the point at which coal starts to look like a better alternative for the nation’s power plants.

Our Trade for the Week

We’re combining what we know about coal, transports, China (where coal demand is picking up) and the weather to bring you a trade on the railroads, which we believe will have a better go in the coming months than the market as a whole – despite the fact they’ve already been stellar performers of late.

And within the group, we’re focused on Canadian based CN Rail (NYSE:CPI), whose stock has made consistent gains for four straight years, rising an impressive 200% over that period amid the company’s determined push to improve operating efficiency. To boot, the stock has not looked as stretched as many of her peers recently, and for that reason we believe she’ll weather any short term pullback better than the rest – and better than the transports as a whole.

Wall Street Elite recommends 1) selling the ACI April 8 CALLS – as discussed above, and 2) a simple long/short play – buying CNI at $95.36 and selling the iShares Dow Jones Transportation ETF (NYSE:IYT), currently at $101.39, for a credit to you of $603 for every 100 shares paired.

The trade will profit as the spread between the two narrows.

With kind regards,

Hugh L. O’Haynew

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Comments

6 Comments on "LongShort with the Big Steel Rail"

  1. Brian Clark on Mon, 21st Jan 2013 11:33 PM 

    “Wall Street Elite recommends a simple long/short play – buying CNI at $95.36 and selling the iShares Dow Jones Transportation ETF (NYSE:IYT), currently at $101.39, for a credit to you of $6.03 for every 100 shares paired.”

    I suggest this generates a credit of $603 (not $6.03) for every 100 shares paired. What am I missing?

  2. Dan Brown on Tue, 22nd Jan 2013 9:40 AM 

    Hugh,
    Assuming you are correct, then explain all the momentum and volume divergences on daily and weekly charts of the major indices. We’ve seen several days this past year with volume levels that are normally only seen on Dec 24! You can’t ignore the decreasing average volume with increasing prices. As far as the rally in the $DJT since Mar 2009, on a monthly chart going back 30 years the rise looks like a text-book B-wave of an expanded flat. That implies wave C down is next. At any rate, I either have to believe my technical indicators, which are giving me serious pause on going long, or I have to throw them aside and go on emotion. I have not found the latter to be very profitable!
    Dan

  3. Hugh L. O'Haynew on Tue, 22nd Jan 2013 1:09 PM 

    Thank you, Brian. And right you are.
    Decimals flying about with no concern for the truth. It’s abominable!
    Please forgive.

    Danny boy – we’re with you – next wave is down, as short as it may be.
    And our trade says CNI will hold up better than the transports as a whole.
    The trade’s good to go.

    All the best,

    Hugh

  4. mike conway on Tue, 22nd Jan 2013 3:24 PM 

    short feb 95 IYT puts
    long march 101 IYT puts
    short march 103 IYT calls
    long march 111 IYT calls

    credit 0.15
    is what i did with your information
    rsi = 84
    thanks
    we shall see

  5. rob on Sat, 26th Jan 2013 11:10 PM 

    As I mentioned before a “false breakout” … I will now give greater detail. Yes, we had the breakout move. This looks to me to be a blowoff top based on recent volume patterns. You may get some further churning at these levels for awhile, but not for long. In any case, the next major move is down, and I believe it is substantially more than you have projected as a smaller 3rd wave. VIX patterns confirm the next move is down, and it will be big. Not a crash mind you, just a 10-12% correction.

  6. tom on Tue, 12th Feb 2013 11:53 PM 

    uncle matty,

    you called the breakout on the third doji in the blue circle, BEFORE the long candle which follows the 3 failed dojis. now you conveniently have those 4 candles and the next all inside the the instant blue breakout circle. very intellectually dishonest, uncle. as they say, let’s go to the videotape. see what you wrote, and when. and while we are at it, upon what did you base the breakout prediction at the time of the third doji?


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