As Coal Prices Remain Steady, Are KOL's Gains Sustainable?

Commodities ETFs can be separated into two categories: those that track the spot price of the underlying commodity and those that track the value of companies that are involved with the processing, transporting and producing of a particular commodity. While ETFs based on spot prices tend to move directly with the commodity, the relationship of company-comprised ETFs to the spot price of the commodity they produce is more complex. The market value of Market Vectors Coal (KOL) has risen more than 20% in the last month, as coal companies have released upbeat news and investors estimate the future of China’s unflagging demand. The price of coal, however, has remained relatively steady, leading some investors to question whether KOL’s huge upswing is sustainable.

KOL tracks the Stowe Coal Index, which includes a globally diversified pool of coal companies. The companies in the index engage in coal transport, equipment manufacturing and the production of clean coal. In order to be included in the index, the coal companies must be principally engaged in the coal industry, derive 50% of revenues from the coal industry, have a market cap exceeding $200 million and have a three-month average daily turnover greater than $1 million. Currently, there are 32 companies included in KOL’s index. The largest sector in the index is Coal Mining & Production, at 73.1%, followed by Coal Mining Equipment and Coal Power Generation, which make up 12.6% and 8.7% of the index, respectively. As of April 30, the largest country allocation was the U.S., with 48.4% of the index. The second- and third-largest country allocations in KOL’s index are China and Indonesia, at 23.5% and 14.9%, respectively.

While Market Vectors was the first mover in the global coal ETF space, it no longer corners the market on this particular investment. On September 18, 2008, PowerShares debuted PKOL, the PowerShares Global Coal Portfolio. KOL and PKOL currently share six of their top 10 components, and the most noticeable composition difference between the two seems to be in their country allocations. While both funds have the U.S. as their top country allocation, PKOL has just 32% of the fund invested in U.S.-based companies, compared to KOL’s 48.4%. KOL has a lower expense ratio than PKOL, 0.62% versus 0.75%, and a significantly higher average daily trading volume, as is to be expected from a more seasoned fund.

The past year has been a tough one for coal investors. When the energy bubble burst last summer and the demand for coal fell worldwide, the price of KOL fell precipitously. For the one-year period ending May 15, KOL’s market return fell more than 59%, underperforming the S&P 500 by nearly 25%. Both KOL and PKOL have jumped markedly in recent trading, however, reflecting the surge in the coal companies that make up the funds’ indexes.

While KOL is tied to coal, the commodity, its price reflects the strength of the coal companies that compose the fund—not the spot prices of the actual commodity itself. Reports from the U.S. Energy Information Administration in April indicated that coal exports nearly doubled in 2008 versus 2007. The reports also showed that stocks of coal at distributors and power plants had not spiked like oil did in 2008. KOL and PKOL investors have also received good news from Asia. The price of coal for delivery is up in recent weeks, and China has been stockpiling large quantities. China has been completing coal firing plants at a rapid pace, suggesting that coal demand may continue to increase into the future.

Positive earnings news and expectations of a coal price hike helped to push shares of KOL’s top component, China Coal Energy, higher. On April 29, 2009, China Coal Energy announced a net profit of 1.86 billion yuan in the first quarter of this year, a year-over-year decline of 3.62%, according to a statement filed with the Shanghai Stock Exchange. In early May, Swiss investment bank UBS AG raised its stake in China Coal Energy to 7.08% from 6.94%, reflecting a surge of interest in the company on the part of investment banks. Since late April the investment banking community has been scooping up shares of Chinese blue-chip stocks, with the Hong Kong Stock Exchange releasing more than 15 applications from overseas investment banks for buying increased stakes in large companies like China Coal.

KOL is a large, liquid ETF that can give investors exposure to much of the good news emerging from global coal companies. When the global economy gains traction once more, China will grow its demand for energy sources, including coal, which could help to boost prices. Some traders, however, feel that prospective coal investors may have already missed the upswing and that the good news from coal companies may be overestimated. Prospective KOL investors should continue to keep KOL in perspective—volatility, company news and coal prices could all dramatically impact the price of this ETF on a day-to-day basis.

Comments

[inflation:]

So not quite clear whether you as an investor would prefer KOL over PKOL or vice cersa?

May 21 11:47 AM