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Saturday, March 7, 2009

A Play if Crude Oil Heats up

Historically when we begin to enter the spring months the price of crude oil heats up. As crude goes higher a stock on my radar is SQM or Sociedad Quimica y Minera (American Depository Receipt). Two major parts of SQM's business are Lithium and Fertilizer- parts of the company's profile are taken directly from Reuters:

Lithium

The Company produces lithium carbonate, which is used in a variety of applications It includes batteries, frits for the ceramic and enamel industries, heat resistant glass (ceramic glass), primary aluminum, lithium bromine for air conditioner equipment, continuous casting powder for steel extrusion, pharmaceuticals, and lithium derivatives. SQM also supplies lithium hydroxide, which is used primarily as a raw material in the lubricating grease industry.

Other Products

The Company produces and markets granular potassium chloride, which is distributed through its subsidiary, Soquimich Comercial S.A. in Chile. In addition, it imports fertilizers that are distributed through Soquimich Comercial S.A. in Chile, offering fertilization services to its customers.

Both demand for lithium and fertilizer increase when crude oil begins to rise, causing the price of stocks in the fertilizer/lithium industry to increase as well. When the price of crude goes up so does the demand for alternate energy. One major reason agriculture (fertilizer) stocks have boomed in recent years is because of ethanol. If more people want to grow corn faster they will use more fertilizers. On the other hand they are involved with lithium for batteries. When the price of oil increases so does the demand for hybrid type cars, which means the demand for batteries increases.

The chart below shows SQM correlated with USO. SQM is the blue line and USO is the red line (click on image to see larger more clear picture).



As you can see they are correlated quite well, minus a few earnings reports and downgrades to SQM last summer. Overall when the price of USO (pure crude oil ETF) rises, the price of SQM also rises. However recently from the charts you can see that they have disconnected a bit. SQM has stabilized hitting its 52 week low in October, and I believe we have seen a bottom for the price of crude oil. Assuming the correlation between the two will return at some point, based on last year's activity, as the price of crude oil rises SQM should also rise. SQM has a nice head start so we may see SQM hit levels similar to last year assuming crude gets back into the 60-70 per barrel range.


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