Red Hot Coal ETF Returns Not A Trump Trade

For all the jawboning President Trump has done about coal miners, you might think it was a huge employer and powerhouse for the future. In fact, the U.S. coal industry has been in decline for decades. That is primarily due to slack demand as power plants rely more on natural gas, and steel is increasingly imported.

U.S. coal production hit its lowest level in 40 years in 2016, and the size of the coal mining work force has been cut nearly in half, to stand at just 77,000 workers (roughly the employee size of Delta Airlines or Whole Foods), spread out over a few dozen companies.

So why, then, has equity-based KOL returned 91.63% over the past year, versus 17.33% for the S&P 500, and 13.16% for the MSCI EAFE Index?

In short, because KOL isn’t really related to what’s going on with U.S. coal miners.

The Bad Times

It wasn’t always looking this good, but it depends a lot on how you think about it. The reality is that the price of coal hasn’t particularly collapsed—at least the kind of coal that goes into power plants:

This chart looks at the price of thermal coal in the U.S. (in orange), and the performance of KOL. You can see that in fact coal prices had a bit of a rally a few years ago, before easing off a bit, whereas KOL had just an awful few years until the beginning of 2016. In fact, in the four years ending 12/31/15, KOL was down a staggering 78%.

The reason for the debacle wasn’t so much the immediate price of coal, it was the decline in demand—prices stayed relatively stable because the industry produced less and less of it. This drove many U.S. coal companies into bankruptcy. It’s been ugly.

But you might notice that the actual performance of the VanEck fund has much less relation to the orange line as it does the white—the Australian Hard Coking Coal Index. That’s the super-high-quality coal that’s only used for making steel. It’s much more expensive, and very tiny proportion of the coal mined in the U.S. (hence Australia being the benchmark price). And lately?

The reason for the huge movements in coking coal has nothing to do with Trump, and everything to do with the weather. Cyclone Debbie just rolled through Queensland and completely disrupted the industry—a short-term hiccup that will likely come back down.

The previous ramp was mostly attributed to a surprise surge in demand from Chinese steel manufacturers last fall. But then, it doesn’t really look like these short-term spikes have had much impact on KOL either.

The Cow Problem

So what’s going on here? Well, KOL is the classic “buy the cow” commodity strategy, much like buying the VanEck Vectors Gold Miners ETF (GDX) to participate, sort of, in the price of gold.

The reality is that KOL, despite being the only real pure coal play on the U.S. ETF market, is “diverse.” Take its largest holding (at 9%, Teck Resources): While coal is an important part of its business, it actually only generates 44% of its revenue from coal. The rest comes from zinc, copper and other metals.

Or take KOL’s 8% holding of Aurizon, which is technically classified as a railroad company (although half its revenue is coal-related). And then the 7% holding United Tractor is a mix of manufacturer, leasing agent and contract player for the industry.

There’s no question these folks are all deeply involved with coal—that’s the point, after all. But their fortunes aren’t going to be swayed all that much by U.S. electric plants. They’re not very related to the U.S. at all.

Here’s the portfolio broken down by where the companies are domiciled:

North American companies are just 22% of the portfolio—and the U.S. is actually just 8%. Indonesia, on the other hand, is the largest country of exposure, at 22%, with Australia and China coming in just behind. By revenue, the diversity here is even more apparent.

This breaks down the revenue from each individual firm to its source using Bloomberg data. It’s not a perfect way of doing things, but it does tell a story. North America becomes a small player in this version, and Asia and Australia dominate.

Knowing Your Bets

KOL is a well-designed fund providing unique exposure to an interesting corner of the global market.

But importantly, it should not be considered a “Trump trade.” KOL will rise and fall primarily on the supply and demand for coal not in the U.S., but in broader Asia. That’s a hot-button region all its own.

China recently decided to no longer accept coal from North Korea, leaving an entire fleet of coal freighters looking for new buyers in the South China Sea. The U.S. has an aircraft carrier parked in the region. Australia is finally getting the coal moving again.

These are the headlines that are going to move KOL, not a rash of executive orders from the Trump administration.

At the time of writing, the author owned none of the securities mentioned. You can reach Dave Nadig at [email protected].