A Reason Not To Trust The Coal ETF's Rally

"Don't fight the tape." It is sound advice. So, with that in mind, the point here is not to tell readers to be quick to short the Market Vectors-Coal ETF KOL, but rather to be informed and make decisions accordingly based upon what is right for an individual's portfolio.

Calling KOL previously moribund is being kind. The lone exchange-traded fund dedicated to coal stocks is off nearly 65 percent over the past three years and has not closed higher on an annual basis since 2010. That three-year plunge includes recent data, which show KOL has surged nearly 25 percent over the past month and almost nine percent in just the past week.

Call it recency bias, but it is KOL's most recent showings that should caution anyone from betting the farm on shorting this ETF. However, there is good reason to believe upside for the ETF will be challenging as metallurgical prices remain slack with essentially no indication those prices will recover in the near term.

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Pay Attention To The Broader Environment

“Metallurgical (met) coal prices will likely remain weak over the near term, increasing only gradually in the coming years as market oversupply recedes,” said Fitch Ratings in a recent note.

“Met coal prices have continued to fall in early 2016 with benchmark hard coking coal contracts settling at $81/tonne for the first quarter. This represents an over 30 percent decline from the $117/tonne price negotiated for the first quarter of 2015 and a drop of more than 75 percent from the peak at $330/tonne in mid-2011. Indications for the second quarter of 2016 are roughly flat and Fitch expects the year to average $85/tonne, down from the average of $102/tonne in 2015.”

Metallurgical, or “met” coal as it is referred to in the coal business, is a key component in the production of steel. So, a nearly 28 percent one-month gain for the Market Vectors Steel (ETF) SLX is potentially seductive. However, much of the recent gains for SLX and its holdings are attributable to the U.S. coming the defense of its steelmakers by unveiling punitive tariffs on foreign steelmakers that have been flooding the U.S. market with cheap supply.

Additionally, cheap or not, there is simply too much steel supply and not enough emerging markets demand to warrant higher metallurgical coal prices anytime soon.

“Fitch expects Chinese coal demand to remain weak for the next several years and forecasts that any increases in Chinese import demand will be met by Australian supply due in part to the cost advantages Australian producers enjoy as a result of the strong US dollar. Australian producers will also be advantaged by a June 2015 agreement exempting them from a tariff imposed by the Chinese government on met coal imports,” added the ratings agency.