A Lump of Coal Could Be Nice for Your Portfolio

TheStreet.com

NEW YORK (TheStreet) -- Investing in coal has yielded lousy results for the last two and a half years. Since peaking in April 2011 the Market Vectors Coal ETF is down 59% while the energy sector as measured by the Energy Select Sector SPDR is up 7.5%. Things have been so rough that PowerShares closed its Global Coal Portfolio fund in February, which had only $10 million in assets.

As difficult as it has been for the coal industry it stands to become even more difficult because of new legislation on emissions for new coal-fired plants.

New plants will now have to meet the standard of only 1,100 pounds of carbon per megawatt hour produced, compared to about 1,600 pounds for existing plants. In the next year the market should expect new regulations for existing power plants.

Energy production, just like any industry, will have its share of regulation and technological innovation. There is a technological solution to the new regulations. It's called carbon capture. In layman's terms, this process filters carbon out of power-plant emissions and diverts it it underground storage facilities. Then the carbon can be sold for other uses. Unfortunately, carbon capture isn't necessarily economically viable yet, so the innovation hasn't quite caught up to the new regulations.

Despite the concerns about pollution that are the catalyst for these changes, the U.S. still relies heavily on coal, the coal industry employs 550,000 Americans and regulation that is too aggressive potentially threatens some of those jobs.

This would appear to be a terrible time to invest in coal, but coal stocks clearly have slumped from their April 2011 peak, and the way coal is processed and consumed eventually may change.

For an investor with a high tolerance for volatility, the Market Vectors Coal ETF offers access to a contrarian trade without taking on the risk of investing in individual stocks.

KOL is a global fund with 45% of its holdings in U.S. companies; 16% in China, the world's largest consumer of coal; 10% in Indonesia; and 7% in Australia which exports much of its production to China.

Consol Energy and China Shenhua Energy OTC are the two largest holdings in the fund, each accounting for slightly more than 8%.

Since its inception in June 2008, KOL has become something of a yield play. It pays dividends annually. Its first dividend in 2008 was 9 cents, and its 2012 dividend was 42 cents, although the 2011 dividend was 48 cents.

The Market Vectors Web site reports KOL's 30-day yield according to the Securities and Exchange Commission's formula is 4.09%. This is not an accurate reflection of what fundholders should expect. The trailing yield based on last December's payout and the current price is 2.1%.

As is the case with all exchange-traded products, any future dividends could be more or less than past payouts. The trailing yield is merely an indication.

Any investor considering this fund needs to study the volatility. KOL's beta is 1.80, which means that for every percentage point that the S&P 500 moves, KOL can be expected to move 1.8%. That's a big number for a fund.

The bullish argument for coal involves Chinese consumption. Coal accounts for 67% of China's energy needs, and the downturn in the price of coal stocks can be partially attributed to fears of a slowdown in China's growth.

A turnaround in the China growth story, perhaps evident in Monday's report that manufacturing activity hit a six-month high, could put a bid under the group.

It is worth noting that China's government would like to reduce coal's use to "less than" 65% of the nation's needs by 2017 in favor of natural gas due to pollution concerns.

If coal fails to work out as an investment theme in the next couple of years, it will not be because China goes from 67% usage to 65%.

At the time of publication, Nusbaum had no positions in securities mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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