The market saw its strongest rallies in months this week, soaring more than 11 percent in just three days. Even better, volume has been heavy on the big up-days and breadth has been solid. These facts suggest broad participation and institutional support for the move.

This rally could continue for some time longer, perhaps extending well into April. After all, the market was, and is, extremely oversold after weeks of seemingly endless selling. But I'm far from convinced that this is the beginning of a new bull market, and I suspect we'll retest recent lows later on this year.

The main reason for my suspicion is the leadership of the recent rally. Check out my chart below for a closer look.


Source: Bloomberg

This chart shows the performance of all 10 S&P 500 economic sectors over the past five days. As you can see, the biggest leaders of the recent move are financials and industrials, the two groups that have been hit hardest this year. The S&P 500 Financials Index is up by nearly a third in just one week.

The proximate cause for the rally in financials is some positive comments out of both Citigroup (NYSE: C) and Bank of America (NYSE: BAC); both companies claim to be generating operating profits so far this year. But two months' worth of profits doesn't mean these banks have sufficient capital to return to a healthy state. More likely, traders simply seized on this tidbit of positive news as a catalyst for a short-term pop off deeply oversold levels.

Much the same can be said for the industrials. One of the biggest movers in the group is General Electric (NYSE: GE); the stock saw its credit rating downgraded this week from AAA to a still healthy AA+. But this move was widely expected; in fact, some analysts expected an even deeper cut. The market's reaction was a classic case of the old Wall Street axiom Buy the rumor, sell the news in reverse--in other words, the market tends to price in news long before it actually comes to pass.

The market also seized on a few bits of decent economic data this week. Retail sales released this week came in higher than expected, suggesting at least temporary stabilization in US consumer spending habits. And continued strong growth in Chinese lending activity suggests that Chinese banks are actively supporting the government's efforts to stimulate the economy. Our in-house Asia expert, Yiannis Mostrous, and I discussed he trends for the Chinese economy at some depth during a video available on At These Levels.

But two pieces of data don't make a trend; as regular readers of PMW know, I'm watching the US Index of Leading Economic Indicators for signs of a more meaningful trend. As I pointed out in the Feb. 20, 2009 issue, It's Still the Economy, the only indicators showing any signs of strength are money supply and interest rate spreads. And the weakened credit market continues to blunt the efficacy of monetary policy.

I'm encouraged, however, by the fact that despite the S&P's weak start to the year, far fewer stocks on the New York Stock Exchange (NYSE) broke down to new 52-week lows. I've been writing about this indicator on an ongoing basis over on At These Levels. See the chart below for a closer look.



Note that only around 800 stocks on the NYSE hit 52-week lows during the heart of the early March selling compared to more than 1,400 in November and well over 2,400 in October. This indicates that there remain some pockets of strength, or at least relative strength, in an otherwise lackluster market.

In Personal Finance, I continue to recommend the same basic strategy: Own a diversified mix of recession-resistant growth stocks and beaten-down names in more cyclical industries that stand to benefit handsomely in the early stages of any economic recovery. My favorite groups remain consumer staples, health care and for-profit education stocks as defensive plays and energy and technology stocks as plays on the coming turn.

A Refinery Tour

I made a trip to the San Francisco Bay Area this week for a talk with a local chapter of the American Association of Individual Investors (AAII) and a detailed tour of Chevron's (NYSE: CVX) refining facility in Richmond, Calif., led by one of the company's project engineers.

The refinery, located roughly 25 miles outside San Francisco, covers nearly 3,000 acres. In fact, Richmond is the largest refinery in the San Francisco Bay Area, with total throughput capacity of 240,000 barrels of oil per day and is Chevron's third-largest wholly owned facility. It's also among the oldest in the country--it opened more than a century ago, in 1902. My tour guide patiently and enthusiastically explained the complex web of pipelines and equipment.

Although I'm familiar with the basic refining process, I'd never toured a refinery of that size; the sheer scale of the operation is awe inspiring. It's a city unto itself, complete with its own fire department, water and sewage treatment facilities and a natural gas-fired power plant.

These aren't small facilities. Chevron's fire department is set up to aid the local Richmond department with handling fires throughout the city. And I found the water treatment facility particularly fascinating. Waste water collected from all over the refinery and surrounding lands is treated in several different ponds. One pond is equipped with bacteria that eat harmful chemicals that might remain in the water; the bacteria are kept active by constantly bubbling oxygen into the water.

And before any water is released into the environment, it's thoroughly tested. Interestingly, the company even passes the water through a pond filled with trout; as all trout fisherman know, these fish aren't particularly tolerant of poor water quality. The trout are frequently tested to ascertain if they're building up any contaminants in their systems.

The company's existing gas-fired power facility is capable of generating about 100 megawatts (MW) of power, not quite enough to make the refinery totally independent from the grid. But a new plant under construction as I toured the facility has a total output capacity of 150 MW. Even during periods of peak demand, Chevron should be totally independent from the grid. In fact, the company will have the ability to actually sell power from the plant for use outside the refinery. And the new power plant is a cogeneration facility that produces both power and steam used in a large number of refining operations.

The Refining Process

Refining is perhaps the most poorly understood segment of the energy business among investors. I've highlighted the basics of the business and some of the major factors that determine profitability on several occasions, including the Oct. 12, 2007 issue of The Energy Letter.

But getting out in the field always give you a better idea of exactly how these processes work and the type of machinery involved. As you might expect, for competitive reasons I wasn't able to take photographs while on the refinery tour; however, Chevron has provided me with some photos of their facilities, and I'll post some to At These Levels next week to better illustrate what some of the refinery equipment looks like.

Refining is basically the business of converting raw crude oil into useful refined products such as gasoline, jet and diesel fuel. Crude oil is essentially a soup of different types of hydrocarbon molecules, strings of hydrogen and carbon atoms. Much of the refining process consists of heating and cooling these molecules in a variety of processes.

The first step in the refining process is called distillation. Distillation towers are tall, cylindrical metal units located adjacent to furnaces. These furnaces are used to heat crude oil to extreme temperatures so the crude separates into molecules of different weights. Lighter molecules tend to rise up the distillation tower toward the top; lighter products might include butane and gasoline. Heavier molecules sink toward the bottom of the tower.

Distillation towers have trays located at different levels on the column. These trays collect molecules of a similar weight as they condense in the tower. This allows refiners to perform the basic separation of crude oil into useful products.

Simple distillation isn't enough--only about 40 percent of a typical barrel of oil can be directly converted into fuels using this process. Refiners want to boost the production of useful light molecules like gasoline and jet fuel, as these are the products in high demand. Many of the heavier molecules separated during distillation aren't suitable for use as fuel directly, but it's possible to convert them into lighter products using other processes.

Most involve heating heavier hydrocarbons in the presence of catalysts to break up those molecules into lighter products. Examples include catalytic cat cracking and hydrocracking.

Further processing of products is necessary to remove sulphur and nitrogen from the resulting crude oil. One of the biggest upgrades underway at the Chevron refinery was the installation of a massive new plant that will allow Chevron to remove sulphur from fuels more efficiently.

A Facelift

Perhaps the most interesting aspect of the tour was the massive construction project underway at the Richmond facility. Chevron is spending about $1 billion on the plant.

These projects will likely take three years to complete. Many of the refineries' basic processes are automated, and my tour guide told me that folks in my position often comment about how few people are visible working on equipment at the facility.

But, thanks to this multi-year construction project, the Richmond facility was abuzz with activity last week. Most of these upgrades involve the replacement of older, less efficient equipment that's been in service for decades.

I already mentioned the company's new gas-powered cogeneration plant and its new facility for managing the separation of sulphur from refined products. In addition, Praxair (NYSE: PX) is building a large new hydrogen production plant at the refinery.

The big industrial gas manufacturing firms typically own the plants they construct at refineries and sell the hydrogen they produce under long-term contracts. This is exactly the case at the Richmond facility: Praxair owns the plant in the middle of Chevron's refinery. This arrangement makes sense because hydrogen is a key part of several refining processes.

And the complexity of these upgrades is stunning. Since many of these new projects are connected to existing facilities, workers must find ways of installing new pipelines amid the existing spaghetti soup of 8,000 miles of pipe. The capital intensive nature of the refining business is apparent the second you set eyes on these facilities.

These upgrades can yield real benefits for profit margins. Not all crude oils are the same. Some, known as light crudes, contain a larger amount of light hydrocarbon molecules and are, therefore, easier to refine. Other crudes, known as sour crudes, contain high amounts of sulphur that must be removed during the refining process.

More advanced facilities for removing sulphur from crude oil can allow refiners to process crude oils that hold a higher sulphur content. Such crudes often trade at a lower price and are more readily available than light, sweet crudes. Refiners like Chevron, with the capability to refine higher-sulphur crudes, have the advantage of added flexibility in the sorts of feedstock used for their operations.

And refining is an energy-intensive business--refiners burn copious quantities of natural gas to produce the power and steam needed to refine oil. By replacing older, inefficient plants with more modern cogeneration facilities, refiners can cut their energy costs meaningfully.

From an investor's perspective, a few points are worth noting. First, the refining business is cyclical. Profit margins can change rapidly depending on the relative prices of crude oil and refined products. In recent months, thanks to weakened demand for gasoline, jet fuel and other refined products, margins have been relatively compressed. Most refineries are scaling back on their activity levels to avoid overproducing and creating a glut of products.

But this is a temporary demand phenomenon. Some refiners have put off or delayed planned upgrades due to weak market conditions; these improvements represent a massive up-front capital investment. And Chevron's plans to upgrade its Richmond facility were delayed due to some vocal local opposition and delays in getting permits for necessary construction projects. The company first proposed these upgrades more than three years ago.

Ultimately, US refiners will need to upgrade their facilities to meet demand and handle the processing of more complex heavy, sour grades of crude; easy-to-refine light, sweet crude is becoming increasingly scarce globally. To encourage the investment of massive up-front capital, refining margins will need to remain relatively high in coming years. The longer-term outlook for the industry is attractive.

Another investment angle to consider is the companies that supply services and equipment to the refiners. For example, industrial gas producers like Praxair and Air Products & Chemicals (NYSE: APD) should benefit from growing demand for hydrogen gas. Hydrogen is key to refining more complex grades of crude. In addition, their business model is relatively stable. As I noted earlier, these firms often construct and own facilities on or adjacent to their customer's operations, selling gas under long-term contracts.

Another group would be engineering and construction firms like Fluor (NYSE: FLR) and Shaw Group (NYSE: SGR). These companies are involved in building out key infrastructure and equipment used at oil refineries.

Keep an eye on At These Levels for photos of the Chevron refinery, and be sure to check on a regular basis for ongoing, up-to-the-minute commentary concerning the fast-moving markets, political developments and economic data; readers can also post comments and ask questions. Last week, for example, I explained one of my favorite strategies for making money and generating income in volatile markets, writing covered calls.

I'm also now on Twitter, a free service that's experienced a rapid growth in popularity over the past year. Twitter allows users to post short, quick commentaries on the fly. To hear my latest thoughts, go to, sign up for a free account and follow me--my Twitter username is Elliott_KCI.

Speaking Engagements

I'd like to extend a special invitation to Pay Me Weekly readers to attend the Atlanta Wealth Conference, hosted in a beautiful mountain setting in northern Georgia. This conference has always been a personal favorite of mine, as it's smaller than most with only 175 attendees.

Even better, proceeds from the conference all benefit a worthy cause, Friends for Autism. The conference lasts from Thursday, April 23, through Saturday, April 25. Meals are included for the special discounted price of $459 for a single and $599 per couple.

For more information, please visit or call 770-952-7861 and let them know I sent you.

And there are few better places to combine work and play than Sin City: Join Roger Conrad, editor of Utility Forecaster, Canadian Edge and New World 3.0, and me for The Money Show Las Vegas, May 11-14, 2009, at The Mandalay Bay Resort & Casino.

I'll provide significant insight into my approach to stock selection and portfolio management. Roger, a steady hand through many market events such as the one we're dealing with now, will talk about his new service focused on exploiting the greatest spending boom in history, New World 3.0.

This is one trip to Vegas that won't make a wreck out of you.

To attend as my guest, click here or call 800-970-4355 and refer to promotion code 012647.