ICLN - ICLN: Wrong Place Wrong Time But Not Forever

2023-11-13 12:42:40 ET

Summary

• The outcome of upcoming elections in major countries will significantly impact clean energy policies and investments globally.
• The current electrical grid is insufficient to meet the demand for clean energy, and upgrading the infrastructure is hindered by regulatory issues.
• The ETF's holdings are under plenty of pressure right now, but I'm looking ahead to a market overreaction. That's why it makes my watchlist.

iShares Global Clean Energy ETF (ICLN) is the latest member of a little club I'm building. The members of this club are ETFs I'd be willing to own "at a price." I like the way they are structured, I'm following them and I believe the long-term outlook for the stocks they tend to own is above average to outstanding.

But there's only one problem: The stock market is not currently rewarding what's arguably cheap on a long-term basis. Instead, it's clinging to a very small number of stocks in a "number go up" fashion. I've seen this movie before, three times this decade. And I know how it ends. So rather than slap a bunch of buy ratings on ETFs that are solid but overpriced because the entire market is being treated that way, I'm "time stamping" my list of eligible ETFs. If it's like the year 2000, it will be 2-3 years before some of these are in prime position, though I might enter them in small size during that time.

But if this is 1987, they could be primed and ready to go next month or the month after. I'm not about speculating, but I know what I want when I want it, at least as an investor. When it comes to what to put on my pizza, that's a more perplexing issue!

That brings me to ICLN, which is a $2.6 billion ETF from fund giant iShares. ICLN is more than 15 years old, and over the past five years, its annualized standard deviation is 36%. That's about double that of the S&P 500 long term, and that tells me this is a feast or famine type of holding. I was questioned by a few readers recently about why I'd be researching something when it might not be right at a buy point. The bottom line for me is always price point, and ICLN sells at $13. I don't know that it will get to the $8 level where it has bottomed multiple times over the past decade, but I'd be much friendlier toward it following a crash toward that level.

ICLN has an 87% drawdown (price drop from top to bottom) on its resume. That raises the bar for how much of the old Benjamin Graham "margin of safety" I aim to have in an ETF like this. So it gets a Hold rating, as in I'm holding it on my watchlist.

In a market like this, I strongly discourage investors from reading too much into ETF "ratings" because they only scratch the surface, can change quickly and are those of the analyst, and don't say a thing about how someone else will use them. That's why it is "research and opinion" and not "advice."

Why ICLN makes my list

iShares Global Clean Energy ETF tracks the S&P Global Clean Energy Index with about 100 holdings. This is to be expected, given the current global social focus on climate change and including additional, cleaner energy sources alongside fossil fuel. There's a strong caveat here though. ICLN is strongly concentrated towards solar and wind companies (five out of the top 10) which are undergoing a significant amount of challenges due to grid capabilities.

A look at the chart above, comparing ICLN to the S&P 500 ( SPY ) clearly shows the volatility of this ETF. Currently, like most of the market, ICLN is not performing well when compared to the S&P, and this is illustrated in the chart below, a selection of six of the top 10 holdings. There's a lot of red here. These are the types of stocks that investors get very excited about for short periods of time, then the recoil and the prices plunge lower. There will be an environment (pardon the pun) where some of these companies are again "in vogue" and at that point, I'll determine if ICLN has the makings of a smaller long-term holding or just a fringe position in the portfolio.

What could crush my thesis?

Climate change, clean energy, and politics are a potent mix that's at the forefront of Global Clean Energy policies, investment, innovation, and future possibilities. The US, European Union, India, United Kingdom, and Russia are all big players on the world geopolitical stage that are facing elections during 2024.

The United States isn't the only country out of that handful that's becoming increasingly divided on the issue of climate change, and the direction each of these elections goes in will have a profound impact on the policies about and investment into clean energy across the globe, as the winners of these elections take the results of the election as confirmation of their outlook on climate change.

Another major potential disruption to clean energy investment is its concentration on solar and wind electrical energy. Electric cars, trucks, commercial fleets, home heating and/or cooling systems, industrial power supply… reports from around the globe are stating that our current electrical grid is insufficient to meet this demand.

Our current domestic power grids are woefully inept to integrate necessary renewable energy sources - plagued by aging, outdated technology and a regulatory structure that hampers the ability to upgrade the critical infrastructure required. In the US alone, the power grid operates at about 40% efficiency. - WE Forum

The other issue with a dependence on solar and wind is the inferred dependence on battery storage, so electricity can be stored for use when the sun doesn't shine and the wind doesn't blow. The top five minerals needed for batteries are lithium, cobalt, manganese, graphite, and nickel, and where the mineral mines are located, as well as where the minerals are refined has potential consequences for global supply. Currently, China sits at No. 1 with 80% of the world's refining capacity as well as 60% of the world's graphite supply (according to Bloomberg NEF's rankings). I'm sure we all remember the shortage of chips for cars because of shutdowns due to COVID that resulted in car manufacturers being unable to meet their quota for production.

The bottom line is that the Global Clean Energy sector is vulnerable to government policies and supply chain issues from raw materials, to manufacturing, to delivery to consumers. There are several paths forward, dependent on the policies of governments and the ability of companies within this sector to innovate technology to keep up with demand, transform the grid, and mitigate supply chain vulnerabilities.

Summary thoughts

ICLN has the ETF "fundamentals" in its size, liquidity, niche industry access, and well-constructed index. But the companies in solar, wind and other alternative energy industries are themselves not fundamentally sound enough right now. Neither is the technical picture, which is always the final buy signal for me.

It's not out of the question that we have already seen the best stock price performance these companies can offer, but the nice thing about markets is they tend to over-correct in both directions. If that happens on the downside and the broader market risk appetite picks up in an investor's time frame, not simply in a trader's time frame, ICLN could be a future portfolio holding. For now, it's a Hold, as in on the watch list, but not a current consideration for any of my model portfolios.

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