OnWednesday, Wunderlich Securities issued a trading call on solar stocksciting a correlation with oil prices. First Solar (FSLR) was the primebeneficiary of this research. Eric Rosenbaum from TheStreet.com beat meto the punch critiquing this call in “Should Solar Stocks Trade on Rising Oil?“, but I will add my two solar panels anyway.
Bottom-line – do not buy solar stocks as a play on higher oil prices. In fact, just buy oil-related stocks to play higher oil prices. Solar’s main contribution to energy generation is electricity. So, solar’s main competitors are the fuels primarily responsible for electricitygeneration. Coal and natural gas are the twin powers in electricitygeneration in the United States and across the globe. According to theInternational Energy Agency (IEA), oil is only 5.5% of all electricitygeneration. Coal and natural gas combined are 62%.
Oil’s contribution to electricity generation has fallen dramatically over the past 35 years
The U.S. Energy Information Administration’s Annual Energy Review 2009 shows oil is a mere 1% of the mix in the United States.
Wunderlich is focused on the recent strong correlation of First Solar to WTI (West Texas Intermediate) oil. However, the real story may bethat oil has had an unusually strong, positive correlation to the stockmarket. Given solar stocks have benefited from a stronger stock market,the correlation between oil and solar is more of a fortuantecoincidence. From Rosenbaum’s article:
“Pavel Molchanov, analyst at Raymond James, who coversboth traditional and alternative energy stocks, said that, historically, oil has traded in an inverse relationship to the equities market. Inthe past few years, that has not been the case, as rising oil priceshave coincided with rising equities prices. This correlation explainsthe rise of the price of a solar stock like First Solar amid a generalequities market and oil price upswing.”
So, over the past year or so, FSLR and oil have tended to go in thesame direction when looking at current prices. (Do not forget that FSLRis also part of the S&P 500 index). However, the day-to-day movesshow that this relationship is hardly tradable. In other words, if youhave a bullish outlook on oil, stick to bets on oil. The actualcorrelations using a daily time series show that First Solar has had aslightly negative correlation to oil (using XOIL, theAmex oil index) since April 1, 2009, right after the March, 2009 lows,and only a 0.48 correlation since the beginning of 2010. Theseunderwhelming correlations mean that there will be significant periodsof time where the First Solar vs oil trade has performed very poorly,and you could easily get stopped out of the trade. I expect these weakrelationships to continue.
I created a correlation matrix across my list of solar stocks andoil. For any two stocks with a correlation of 0.80 or higher, Ihighlighted the related cell in green. Click on the images for a largerview.
FSLR has had a negative correlation with oil since April, 2009
Even just over the past year, FSLR only has a weak correlation to oil
Note that since the stock market bottomed in March, 2009, only TrinaSolar (TSL) has had a strong correlation to oil (0.80 or higher). Thisoccurred given TSL’s extremely strong year in 2009 while oil was alsorecovering at a fast pace. Many solar stocks languished throughout 2009. Limiting the time window to correlations since 2010 drops even TSL from the list of strongly correlated.
Note also that given the size of the matrix of stocks in relatedindustries, we should expect to find at least two stocks, and likely afew more, strongly correlated to another just at random, so I am notmaking any general conclusions for trading. It could be interesting tospeculate on some of these relationships, but I will restrain myself for now.
Regardless, First Solar (FSLR) has done well with all the analyst attention it has received lately. It is now trading just above my $160 upper limit for the presumed trading range. Shorts are as bearish as ever with 31% of FSLR’s float traded short as of Jan 14, 2011. The total shares short have remained around 16M since the end of November. I highly suspect the next round of data will show shorts closing outpositions in the wake of this rally. If not, particularly if shorts have decided to double down, I suspect FSLR will retain extra fuel to powerhigher on this momentum.
Be careful out there!
Full disclosure: long TSL, SPWRA, WFR, JKS, ESLR, USO (with a covered call), and SSO