Coal ETF Rally In Danger On Waning Chinese Demand

For the most part, 2013 has been a glum year for coal stocks, but the Market Vectors Coal ETF (NYSE:KOL) has been a strong performer since early August.

That is when KOL found support around $17.50, making a double bottom formation in the process. KOL has gained 10.2 percent since August 1, which is great, but the $177.3 million ETF is still down 23 percent year-to-date, a decline that puts the fund firmly in bear market territory.

Ebullience surrounding KOL and its constituents has been fleeting at best over the past two years due to cheap natural gas and slumping emerging markets demand. Gas prices are still cheap, but it could be slack developing world demand that again hurts coal stocks in the near- to medium-term.

While China's economy, the world's second-largest, has been posting some solid economic numbers as of late, the country's once seemingly limitless appetite for coal is cooling. China is often referred to as the 800-pound gorilla in the room for an array of commodities, but that is particularly true of coal. All those rosy price assumptions for metallurgical and thermal coal that were made a few years ago, the very forecasts that compelled investors to buy KOL and its holdings, were based in large part on robust Chinese demand.

Due to one of the world's worst pollution problems, China is looking to shift away from coal to cleaner-burning fuels and that move comes at a time when KOL's holdings are grappling with a supply glut and some are dealing with tenuous financial situations.

Last month, Moody's Investors Service raised its coal sector outlook to stable from negative, saying it does not expect industry fundamentals to deteriorate further "over the next 12 to 18 months, though business conditions remain very weak."

Weak indeed. Goldman Sachs recently slashed its 2014 price forecast on thermal coal by 13 percent to $83 per ton, according to the Wall Street Journal. China, which accounts for 16.5 percent of KOL's weight making the ETF's second-largest country exposure behind the U.S., will probably keep paring its imports of thermal coal, the coal grade used to generate electric power.

That is because China has plenty of its own thermal coal, and as a result, UBS expects Chinese coal imports to decline steadily, the Journal reported.

Making matters more problematic for KOL is that earlier this month, BHP Billiton (NYSE:BHP), the world's largest mining company, said demand for metallurgical coal or coal used to produce steel, is tepid because of slack demand and supply overhangs.

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Disclosure: Author does not own any of the securities mentioned here.