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Exchange traded funds that invest in alternative energy sectors such as solar and natural gas were among the worst ETF performers in 2011. Agriculture funds also had a tough year as economic uncertainty, decreased demand, falling production costs and a strong U.S. dollar were among the biggest factors affecting the prices of these commodities.

Corn, wheat, and soybeans performed poorly this year due to decreased demand, overproduction and a stronger U.S. dollar. ELEMENTS Rogers International Commodity Agriculture ETN (NYSEARCA:RJA) and iPath Dow Jones AIG-Agriculture ETN (NYSEARCA:JJA), which track corn, wheat and soybeans, are both down about 21% this year.

While production forecasts released by the USDA show these commodity prices continuing to fall in 2012, a recent report from Bloomberg Businessweek stated below normal rainfall combined with hot and dry conditions in South America are threatening corn and soybean production output.

Though this should lead to a rise in prices, the effects may be overshadowed by other economic factors such as Europe’s debt troubles, which have led to a decline in the value of the euro. As the value of the euro falls the dollar strengthens, and because commodities are priced in dollars, a strong dollar leads to more expensive commodities for foreign countries thus driving demand downwards.

As Kingsview Financial analyst Matt Zeman said, “The dollar strength is obviously having a dramatic effect on commodities across the board.” Until significant progress is made in easing the debt logjam in Europe, agriculture commodity prices will likely remain highly volatile.

Coal prices also faced steady declines this year due to the cheap price of natural gas, which has coaxed many power plants to switch their fuel source to the cheaper alternative. Additionally, demand for metallurgical coal, which is used in the process of making steel, fell as demand for steel declined. Market Vectors Coal ETF (NYSEARCA:KOL) and PowerShares Global Coal (NASDAQ:PKOL), which both track roughly 30 companies involved in the coal industry, are down 31% and 34%, respectively.

With cheaper natural gas prices and the Environmental Protection Agency’s recent passing of a bill to reduce mercury emissions from the burning of coal, domestic use of this energy source will steadily decline over the coming years. Despite this, demand for the black rock remains strong overseas. About 90% of generated electricity comes from coal in both China and India, and in India alone coal use is expected to increase 41% by 2016.

To capitalize on the growing international need, U.S. coal companies have initiated a proposal to build two new coal-shipping terminals and expand existing terminals on the West coast to facilitate shipping. Whether or not coal will be a long-term energy solution for foreign countries remains uncertain, as both China and India have already begun to aggressively pursue alternative energy sources to fuel their growing economies.

With regards to renewable energy, lower solar panel prices, price competition with China, and excess supply resulted in significant losses for solar companies and ETFs that track the solar industry. The Guggenheim Solar ETF (NYSEARCA:TAN) and Market Vectors Solar Energy ETF (NYSEARCA:KWT), which both track companies in the solar industry, are among the leaders in worst performing solar ETFs as both are down about 65% this year.

The solar industry is expanding at a record pace as shown by investments such as the 1,000-megawatt Blythe Solar Power project in California and the acquisition of the Topaz Solar Farm project by Warren Buffet’s company. However, massive solar industry growth in both the U.S. and China has resulted in an excess supply for this energy source and sent prices tumbling this year.

With the looming expiration of the government subsidization of renewable energy projects, which provided $3.5 billion for private investments, record domestic growth remains questionable. If the subsidization program is extended, which is highly uncertain given the political gridlock in Washington, the industry growth may continue to expand. If the subsidization program is not extended, domestic solar projects will become much more expensive and are likely to face sharp declines. With China accounting for almost half of U.S. solar panel imports, a slowdown in the U.S will affect China as well. However, a decrease in output could allow solar prices to recover, as the current excess supply will fall.

What should investors take away from this? Expect commodities to remain volatile going into 2012 as there are many factors influencing their prices. Those looking to avoid volatility may want to seek safer investments in less volatile ETFs. However, when commodities do rebound, ETFs provide investors with an excellent opportunity to capitalize on the large growth they can achieve.

Market Vectors Solar Energy ETF

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August Koster contributed to this article.

Disclosure: None

Source: Alt Energy ETFs Get Trounced in 2011