In many ways, it’s hard to imagine a less friendly economic environment for firms in the transportation industry. The Dow Jones Transportation Index consists primarily of stocks in four industry groups: truckers, airlines, railroads and package/freight companies.

Energy is a major cost center for all four industries; you can’t run trucks, trains and airplanes without diesel or jet fuel. Historically, periods of rising oil prices are negative for transport stocks.

And then there’s the US economy. Longtime The Energy Strategist readers know that I believe the US economy is in recession. Others may argue that we’ll narrowly avoid going into recession. Either way, however, it’s clear that the US economy has slowed considerably since mid-2007, and consumer spending has weakened because of a barrage of negative trends: Higher energy prices, falling home values, rising credit costs and job market uncertainty have all hit consumers where it hurts.

But in the midst of that depressing backdrop, transports have been on fire this year. The Dow Jones Transportation Index is up 15 percent so far in 2008, compared to a 3.5 percent drop for the S&P 500. And transports are also up just less than 5 percent over the past year, compared to a decline of 5 percent for the S&P 500. Clearly, the conventional playbook for the transports is out the window.

There are some valid reasons for transports’ outstanding performance. First, the main driver of those gains is the railroads. Railroads firms move consumer goods and autos; this business has definitely slowed as the economy has weakened.

However, a big chunk of revenues for most railroads comes from moving commodities. The most important commodity is, of course, coal; more than half the US electric grid is coal, and railroads move that coal from mines to plants. To make a long story short, the coal business is on fire.

The same is true for agricultural commodities. Railroads are the key players when it comes to moving products such as wheat and corn. Even better, because ethanol can’t be transported by pipeline, the rails are also the most important players in ethanol transport. These businesses are also hot.

By and large, weakness in the rails’ consumer-levered businesses has been offset by strength in coal and agricultural commodities. And these companies have tremendous pricing power; not only have the rails managed to raise transport rates, but they also levy fuel surcharges to offset any increases in diesel fuel prices.

Of course, although the rails have been on a roll, truckers and airline stocks have been hit. These companies are more exposed to consumer spending and fuel prices.

Trucks are far less fuel efficient than trains. The airlines have been slammed this year; at least two carriers have been forced into Chapter 11.

But as I explained at some length in the March 19 issue of TES, crude oil prices could pull back from current lofty levels if the US dollar continues its recent rally. Longer term, it’s hard to be bullish on the greenback. But no trend moves in a straight line; the dollar is long overdue for a bounce. It’s likely that the Federal Reserve’s less-dovish statement this weak marked a short-term low for the dollar.

Crude oil has been primarily a weak dollar trade this year. Fundamentally, oil prices aren’t well supported; inventories of crude and refined products in storage look bloated across most developed countries.

Meanwhile, recent monthly statistical releases from the Energy Information Administration (EIA) indicate a real softening in US oil demand. Bottom line: In a strengthening dollar environment, crude could easily pull back into the $90s.

Such a correction would be good news for the truckers and airlines. At the same time, there are other catalysts for both groups.

For the airlines, there’s ongoing talk of mergers, alliances and other tie-ups. Some believe that overseas carriers are interested in deals. Further news on that front would send the airline group higher.

There are also some encouraging signs for truckers. According to statistics released by the American Truck Association, tonnage of goods transported has actually been on the rise over the past few months. Historically, truck tonnage turns higher just as the economy enters a recession; trucks are a classic early cycle play.

Bottom line: I like the transports. I see the group as both a play on further strengthening in the coal market and a natural hedge against a short-term pullback in oil prices.

To play this trend, I’m adding the iShares Dow Jones Transportation Average (NYSE: IYT) to the aggressive growth Gushers Portfolio. This is an exchange traded fund (ETF) designed to track the performance of the Dow Jones Transportation Index; the iShares offer diversified exposure to railroads, truckers and airlines. Buy the iShares Dow Jones Transportation Average under 97 with a stop at 77.50.