The Other Black Gold

Published 7/21/2011 11:19 a.m. EDT

Although it's no longer widely used to power locomotives or heat homes, coal is a crucial component of steel production and is used to generate almost half of the electricity consumed annually in the U.S. In China, the world's largest consumer and importer of coal, more than two-thirds of power generation is coal-based.

As the world's developing economies add power-hungry industrial capacity, demand for relatively cheap and abundant coal should continue to rise. I've been long the Market Vectors Coal ETF ( KOL) for some time. This fund has recovered nicely from its 2008 lows, and our momentum model indicates it should continue to perform well in the near term. The PowerShares Global Coal Portfolio ( PKOL) is similar but carries a slightly higher expense ratio.

In a research note this morning, UBS wrote that China is considering reducing the value-added tax it levies on coal imports and that demand in Japan is growing briskly as that nation recovers from the March earthquake, tsunami and nuclear disasters.

While most of the coal mined annually is used for electricity production, there's another side to the coal story: its use in the manufacture of steel and other alloys. Heating low-sulfur bituminous coal at high temperatures in the absence of oxygen produces metallurgical coke, or "metcoke."

As it happens, the initial public offering of a company called SunCoke Energy ( SXC), which supplies metcoke to the steel manufacturing sector, took place this morning on the New York Stock Exchange. SunCoke's stock opened at $17 a share and quickly jumped 7%.

Demand for metcoke in India and China, which produces 50% of the world's steel, has been rising steadily, although SunCoke CEO Frederick "Fritz" Henderson, the former CEO of GM ( GM), acknowledged in an interview on CNBC this morning that the rate of demand in China is slowing. Nevertheless, Henderson said he believes that Chinese steel production and demand for his company's products would continue to expand there, just not at 9% to 10% per year.

At the time of publication, Dion Money Management was long KOL.

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