New Nuclear ETF Could Be Slightly Unstable

Nothing says "everyone into the bunker" like an old-fashioned uranium stock. In the last couple of years, investors have warmed up to the investment merits and possible use of uranium as potential limits to oil reserves increase the chance that nuclear power will come more into vogue.

Uranium stocks have been popular and done well the last couple of years. Van Eck just listed the Market Vectors Nuclear Energy (NLR - commentary - Cramer's Take) ETF as a way to capture the group without single-stock risk. An ETF will be appealing for some folks as even the "mature" stocks are quite volatile.

Despite the volatility, nuclear power as an investment theme appears to be compelling. According to an article from CNN, there are 434 nuclear plants in the world, another 30 currently under construction and another 200 in early-stage planning. The visibility for much more uranium demand is quite clear.

Splitting the Atom

The NLR fund is not quite what I was expecting. There are plenty of uranium miners, like the well-known Cameco (CCJ - commentary - Cramer's Take), as well as slightly lesser known Paladin Resources and Dennison Mines, and they get smaller from there.

Mining stocks make up 46% of the fund. While that may seem like a lot, I thought it would be closer to 100%, but the name of the fund is Nuclear Energy not uranium miners.

Plant infrastructure comprises 36% of the fund, and while this makes sense, the representation of this subsector is the biggest surprise in the fund's composition. The infrastructure components are mostly Japanese industrial conglomerates like Mitsubishi Heavy Industries, the largest holding at 9.7%, IHI Corp., weighted at 8.4%, and a couple of different Hitachis that add up to 10% of the fund.

NLR is heavy in foreign stocks, with Japan being the largest country weight by far at 41%. Canada, not surprisingly, is the second-largest country at 29%, followed by Australia at 13.7%. The U.S. only has a 3.4% weight.

Feast, Famine and Boredom

Any investment in uranium is clearly going to add volatility to your portfolio, and NLR is no exception; it has a beta (beta is a measure of volatility where the S&P 500 is 1.0; the higher the number, the more volatile the stock or fund) of 1.23, but I would expect periods where it is more volatile than that.

DAX Global Nuclear Energy Index

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The last few weeks (the chart above is of the underlying index) shows how wild the ride can be.

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Source:

The back test shows different points of leading and lagging broader energy indices and the S&P 500. The last couple of years have been the best in the life of the back test for uranium stocks as questions about peak oil have popped up and investors have had a new awareness of the group.

Expecting the last couple of years to repeat might be a tall order, but generally speaking, there will be more need for all things related to nuclear power. In addition to Japan's growing reliance on nuclear power, China and Vietnam are also moving toward nuclear.

Investors in this theme, regardless of how they access it, have to have the right expectation, time horizon and tolerance for volatility. I think the back test shows holders of NLR should expect feast, famine and boredom, and although I am not a huge fan of a lot of trading, this might be one that occasionally needs to be paired back and then added to as the theme matures.

I maintain a little uranium exposure for some clients who can withstand a little more volatility, but only allocate 2% of the portfolio for those clients. A common error investors make is to get infatuated with a compelling investment idea like this one and then allocate 20%, or more, to it. While the fundamentals of nuclear energy seem very obvious to me for the long term, many people will be uncomfortable with the ups and downs of this theme and any exposure should be moderate.

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At the time of publication, Nusbaum was long Cameco, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.