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Go Nuclear With A New ETF

Posted: Aug 20, 2007 14:37 PM by Matthew McCall

Tickers in this Article: NLR, CCJ, HIT, NMX

The global commodity boom that has been taking place for years has affected the metals, energy, agriculture and so on. One commodity that tends to be forgotten is uranium.

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In late June 2007, the price of uranium hit $135 per pound, up nearly 100% from January 1, 2007, and over six-times higher than its $20 price in January 2005. If a commodity experiences such a dramatic rally, there must be a reason and, more importantly, a strategy for investors to profit from the increase.

The No. 1 reason behind the surge may simply be supply and demand. The demand for uranium around the globe has increased and is expected to remain on an upward path for the near future. On the other hand, supplies are tight and the end result is higher prices.

Uranium Investments
Earlier this year the NYMEX (NYSE:NMX) began offering uranium futures contracts for investors who would like to gain exposure directly through the mineral. The majority of individual investors do not delve into the futures market, as that is not an option. There are a handful of uranium stocks that trade on U.S. exchanges, but the selection is small and diversity could not likely be met.

Canada is a different story. It is one of the largest producers of uranium in the world and home to the single largest uranium miner; there are a plethora of opportunities for investors. Along with the uranium stocks, investors wanting to take advantage of the demand for uranium should look to the mining equipment suppliers as well as the builders of the nuclear power plants.

New Nuclear Frontier
In mid-August 2007, Van Eck rolled out the Market Vectors Nuclear Energy ETF (NYSE:NLR), the first U.S.-listed exchange-traded fund focused on the nuclear energy market.

The ETF is based on the DAXglobal Nuclear Energy Index, which currently represents 38 companies engaged in uranium mining, enrichment and storage, nuclear plant infrastructure, fuel transportation and energy generation, and providing equipment for use in the provision of nuclear energy.

As of July 31, uranium mining stocks make up nearly half of the entire allocation, followed by plant infrastructure at 37%. Add in the nuclear equipment stocks and 95% of the ETF is focused on these three sectors. Because it is a global ETF and America is not a major player in nuclear, the No. 1 weighted country is Japan at 41%, followed by Canada at 29% and Australia with 14%. The U.S. makes up a paltry 3% of the entire allocation.

Top Holdings
The top three holding are large-cap Japanese companies that have exposure to the machinery and infrastructure needed for both mining and nuclear power plants. The No. 1 holding is Mitsubishi Heavy, a company that builds nuclear power plants along with many other large projects. The majority of its sales come from within Japan.

IHI Corp is the No. 2 holding and gives investors exposure to tunneling machines used in uranium mining along with other equipment. Hitachi Ltd (NYSE:HIT), which trades here in the U.S., is a major play in the construction machinery used in the nuclear industry.

The last two stocks in the top five have exposure to uranium mining: Uranium One and Cameco (NYSE:CCJ), both are Canadian companies. Uranium One explores and develops uranium mines in Canada and Australia, two uranium-rich countries. Cameco is the world's largest producer of uranium in the world and supplies one-fifth of all uranium available. (For greater insight, see An Inside Look At ETF Construction.)

Overall, the top five holdings offer investors a solid diversification within the niche nuclear sector. The one issue that should be brought to investors attention is the high concentration on Japan. If the Japanese yen continues to rise against the U.S. Dollar, it could lead to weakness in the Japanese stock market, which will result in a decline in NLR.

Did NLR Call the Top?
Often times when the "hot" investments become mainstream either through the media or ETFs, it can signal a short-term top. For example, the iShares FTSE NAREIT Mortgage REITS ETF (NYSE:REM) hit the market in May, and by August it was down nearly 50%, which was likely caused by the credit crisis. The two sectors are completely different; however, it does make for a great example of what could happen.

The price of uranium has already fallen over 20% in the last month, but remains much higher for the year. The questions are will demand remain high, and is supply really as tight as the analysts' report say? Because, at the end of the day, the supply/demand for the commodity will drive the price of many of the mining stocks. Also, if the demand is there for uranium, it suggests there will be new nuclear power plants throughout the world. I hope the U.S. begins granting approval for new nuclear power plants, which then could possibly cause a major spike in NLR.

This ETF is great for investors searching for a way to play both uranium and nuclear energy worldwide. The downside is the large exposure to Japan and the possibility the parabolic run in the price of uranium is over. The uranium bulls believe this is the middle of a long-term rally and that prices have just begun to rise - this is what makes a market. One suggestion is to do your homework before buying NLR or any other investment.

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By Matthew McCall

Matthew McCall is the president of Penn Financial Group, LLC, a registered investment advisor. He also publishes two newsletters, The ETF Bulletin and The PFG Letter as well as other educational material. As a registered investment advisor, he manages clients' investments based on their specific goals and objectives.

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