Is Now The Time To Buy The Coal ETFs?

Zacks

Investing in the basic materials and energy sectors have been solid choices for investors over the long haul. However, recent trends in these segments, in addition to slumping global economies, have pushed many stocks in these corners sharply lower during 2012.

In fact, only a handful of energy focused ETFs are up on the year while the vast majority—literally dozens of funds—are posting modest losses in the time period. Besides the continually beaten down clean energy sector, one of the biggest losers has been in the coal sector as the industry has also been extremely weak from both a year-to-date and a one year look, suggesting the power source has faced some very tough times in months past.

Currently, investors have the choice between two coal ETFs, the Market Vectors Coal ETF (KOL) and the PowerShares Global Coal Portfolio (PKOL). Both of these funds are currently testing their 52 week lows, having sank by more than 40% over the past one year period (read Two Energy ETFs Holding Their Ground).

Coal Power Trend

Unfortunately, the trends behind this phenomenon seem likely to continue for investors in the coal space. The incredible fall of natural gas over the past few years has been the competing fuel cheap and abundant, making it a perfect power plant input that also has fewer emissions.

Beyond this, the Chinese slowdown is also starting to impact the broad coal sector as well. China is far and away the biggest user of the fuel, using more than three times what the U.S. economy does on a yearly basis. Given that China is slowing down and is demanding less in fuel to power its economy, this trend could also have a large effect on coal prices and stocks over the rest of 2012.

Thanks to these factors, it has been a very rough time to get into the coal industry despite the favorable metrics that many products in the space are currently showing. In fact, both PKOL and KOL have a PE below 13 while their dividend yields are both approaching 2.6%. Given these trends, a short-term play on the coal could be an interesting move for some risk tolerant investors (see Inside The Forgotten Energy ETFs).

This could be especially true if China can avoid a hard landing and if coal prices can rise out of their doldrums on the futures markets. Additionally, a continued gain for natural gas prices could also help coal, especially if futures prices for this vital power plant fuel can once again hit the $3 mark.

However, while these trends might be encouraging to some value investors, it appears as those coal ETFs may have further to fall in the near term. In fact, investors recently saw Patriot Coal (:PCX) plunge by over 50% in a single day—although it did bounce back to ‘just’ a 35% loss in afternoon trading-- as the company sought out plans from restructuring advisers if it can’t meet near-term debt needs.

This helped to push many firms in the coal space lower with some of the bigger names in the space sliding by over 3% on the day. The plunge also represents a disastrous stretch for PCX as the company had a $25 stock about nine months ago while the firm is now teetering around the $2.20 level after its latest plunge.

With this kind of volatility in the marketplace, an ETF approach looks to be an incredibly good idea since risk can be spread around a variety of securities. Both PKOL and KOL allocate around 1% to PCX but hold about 30 other securities in their basket as well (see more in the Zacks ETF Center).

Furthermore, both funds pay out a modest yield around the 1.6% level while they both provide impressive diversification benefits thanks to their global exposure. In fact, both funds put less than half of their assets in American securities with higher levels of exposure going to firms based in the Asia-Pacific region including China, Indonesia, and Australia (read Three ETFs for The Energy Efficiency Boom).

Nevertheless, given this recent bout of uncertainty in the market place and the clouded economic outlook in Europe and the U.S., it may still be prudent to avoid coal stocks and coal ETFs for the time being. The space may have further to fall on the disappointing news while some consolidation seems necessary as well. As a result,  look for a push below 52 week lows before considering scooping up this beaten down—but still incredibly important—industry with ETFs.

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