Black Days Ahead for Coal ETFs?

Material firms have been struggling over the past few months as sluggish demand from key markets, a strengthening dollar, and a boom in the stock markets have dampened the appeal for commodities. While this trend has been especially prevalent in agricultural commodities, industrial resources, in particular coal, have also been impacted by the trend.

The black diamond has been out of investors’ favor this year on the thriving alternative energy space. This is because the depletion of fossil fuel reserves, global warming and high fuel emission issues, new and advanced technologies as well as more efficient applications are making clean power more feasible. In fact, solar power is gradually replacing dirty coal in electricity generation in the U.S. while natural gas is becoming a more popular fuel input for power plants (read: 3 Clean Energy ETFs for a Green Portfolio).

All these factors kept coal prices at check, making coal miners difficult to sustain their profitability and margins. As a result, most of the coal miners – Peabody Energy (BTU), Alpha Natural Resources (ANR), SunCoke Energy (SXC) and Consol Energy (CNX) – have seen their stock prices tumble over the past month. The bearish trend is likely to continue in the coming months given the unfavorable industry demand/supply dynamics as well as some weak company-specific fundamentals.

Current Trends

China, the world's largest coal producer as well as consumer, is the main driver of the global coal market. Though coal production in China dropped 1.4% annually in the first eight months of the year, it has risen 40% since 2000 and thus still facing a supply glut given the declining demand.

This is especially true as China is on track to decrease its consumption of coal gradually from 69% in 2011 to 65% in 2017, 63% in 2020 and 55% in 2040, as per the U.S. Energy Information Administration. In addition, the Chinese government has put a ban on the sales or import of coal with 40% or more of ash content and 3% or more of sulfur content effective next year. Since China accounts for about one-fourth of Australia's coal exports, the move will hit most Australian miners, pushing down the prices of coal further.

Further, rising export volumes from Indonesia, Columbia, Russia and other coal producing countries are exerting downward pressure on prices and making the coal export market highly competitive (read: Indonesia ETFs Set to Climb Higher).

Apart from weak global industry fundamentals, the negative outlook is confirmed by a sluggish outlook for Peabody – the largest U.S. coal producer and a bellwether for the space. This is especially true as Goldman Sachs (GS) downgraded Peabody to ‘Sell’ from ‘Neutral’ last week, citing persistent pressure on the global coal markets.

According to the investment bank, weak Chinese demand and high Australian supply of coal will continue to weigh on the prices of coal throughout the year. These trends suggest that more pain is in store for the coal stocks and Market Vectors Coal ETF (KOL).

Coal ETF in Focus

This product offers global exposure to the coal industry by tracking the Market Vectors Global Coal Index. Holding 36 securities in the basket, the fund is a bit concentrated on the top 10 holdings with no single company making up more than 8% of the portfolio (read: Coal Stocks Post Mixed-Bag Q2, KOL ETF in Focus).

The ETF is widely diversified across each market cap with 36% going to large caps, 33% to mid caps and the rest to small caps. It definitely has a U.S. focus as roughly 39% of the fund goes to the American stocks. Beyond that, the Asia-Pacific region dominates with holdings in China (21.7%), Australia (10.7%), Thailand (7.6%) and Indonesia (7.1%).

The fund has amassed $173.7 million in its asset base and trades in average daily volume of 142,000 shares. Expense ratio came in at 0.59%. KOL has been the biggest laggard in the energy space this year, losing about 7% year to date, and has a Zacks ETF Rank of 4 or’ Sell’ rating with a High risk outlook. This suggests continued underperformance in the coming months (see: all the Energy ETFs here).

Technical Look

From a technical perspective, KOL is poised for further weakness. The fund is currently hovering around its 52-week low of $17.27 and its short-term moving average (9-day EMA) is comfortably below the mid and long terms (50 and 200-day EMA), suggesting continued bearishness for this ETF.

However, the coal ETF has already entered into the oversold position as depicted by its RSI of 27.36, which might suggest some upward push if any good news creeps into the picture or improved fundamentals in the space.

Bottom Line

Given some technical indication, the recent slump in the coal ETF might suggest a solid entry point for risk-tolerant long-term investors, should they have the patience for extreme volatility. However, near-term fundamentals remain muted at present with waning demand and slowdown in the Chinese economy. As a result, investors may want to stay on the sidelines unless the coal price bottoms out or some positive trends in the space start to build up.

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