KOL: Richly Valued but Still Worth a Look

Van Eck, the company that brought us narrow-based ETFs targeting various sub-sectors like gold mining and environmental services, has just launched a new fund dedicated exclusively to coal. While Market Vectors Coal (NYSE: KOL) is hardly suitable as a core holding, aggressive investors may still want to reserve a spot for it.

First, the basics. The fund will track the Stowe Coal Index, a modified, market-cap weighted benchmark of 60 companies engaged in various coal activities, ranging from mining and production to power generation and transportation. Like many sector funds, this one is rather top-heavy, as the top 25 names account for nearly 90% of the fund's assets.

According to Van Eck's website, expenses will be capped at 0.65% through April 2008, but could potentially increase thereafter. However, the ride has been well worth the price of admission thus far. According to backtested data, shareholders would have seen annualized returns of around +44% over the past three years ended December 2007 -- capped off by a sizzling gain of +103% in 2007.

Domestic U.S. coal giants like Peabody (NYSE: BTU) occupy about 40% of the portfolio, while most of the remainder is involved in Pacific Rim nations such as China and Australia. This diversification should continue paying off down the line. China is a growth driver for many different industries -- and coal is no exception.

Thanks to torrid economic expansion, China has an almost insatiable demand for electricity. To meet that demand, new power plants with the capacity to serve a city the size of Denver are popping up at the rate of one per week. With one of the highest consumption rates in the world, the country also has a ravenous appetite for steel. And both power plants and steel mills are typically dependent on one critical raw material -- coal.

According to the World Coal Institute, coal is used to produce roughly 40% of the world's electricity and 70% of its steel. And given the rapid industrialization taking place in China, the country now uses more coal than Japan, the U.S. and the European Union combined. All of this has translated into tremendous profits for companies like Yanzhou Coal (NYSE: YZC), one of the fund's largest holdings -- which delivered a whopping gain of +144% last year.

On the downside, coal has come under fire from environmental groups and others for its damaging greenhouse gas emissions, and a transition to greener energy has begun.

But, that transition could take decades to play out, particularly in emerging markets like China where environmental controls are still lax. In the meantime, coal-fired plants account for roughly 75% of China's power production, and that figure could climb over the next few years. Furthermore, many companies are adopting cleaner-burning coal technologies to stay in compliance with stricter regulations.

As you can see from an average P/E of 47, coal stocks are richly valued at the moment. That will only add to the volatility that typically comes with investing in such a narrow slice of the market -- particularly one that is heavily influenced by unpredictable commodity prices.

However, global energy consumption is going nowhere but up in the years ahead. And with oil prices surging to record highs, worldwide demand for coal should remain strong -- particularly in emerging markets.

Against that backdrop, aggressive investors might want to keep KOL in mind.

Disclosure: None

Comments

[tenqulong:]

KOL is highly correlated to XME and BHP ... so, it is just a new clone.

2008 Mar 14 06:36 AM