The solar industry is experiencing growing pains. Cheap polysilicon and lower-than-expected sales are hurting even the strongest companies. The long-term appeal of the industry is unmatched, but it's a dangerous time to buy individual stocks. The best way to play solar is to build a position using exchange traded funds.
The Claymore/MAC Global Solar Energy Index Fund and the Market Vectors Solar Energy ETF provide exposure to established players like First Solar and small-caps like Canadian Solar . These stocks could double or triple in value when the economy recovers.
This year, Claymore's TAN has gained 0.9% while Market Vectors' KWT has dropped 4.6%. The funds have eight of their top 10 holdings in common, but the Claymore fund benefited from its larger position in First Solar, the only U.S. solar firm to post a first-quarter profit.
In the past month, both funds have lost 19%, three times more than the S&P 500 Index. So what new woes are weighing on solar?
The industry's biggest problem is that polysilicon, a material that absorbs sunrays, has become absurdly cheap. The price has fallen to $65 a kilogram from a high of $450 in mid-2008. Analysts say prices could sink to $35 by year-end.
Low oil prices and weak demand for consumer electronics are adding to the polysilicon glut. Interest in alternative energy grew in the months before oil prices crested at $147 a barrel in July 2008. Now that oil goes for less than $70, people are less likely to buy expensive solar equipment.
Polysilicon is also used in semiconductors for phones and computers, and not too many people or companies are shelling out for new tech equipment these days.
Excess supply is forcing solar firms to slash prices and aggressively renegotiate polysilicon contracts. Solar power was dubbed "the next big thing" after the tech bubble burst in 2000, but now companies are in a race to the bottom. Last week, China-based LDK Solar provided a "business update," a.k.a. sales guidance massacre. The company cut its second-quarter sales forecast to a range of $215 million to $225 million, which sent a wave of pessimism through the market. Claymore's TAN and Market Vectors' KWT have fallen 11% since the announcement.
The funds' 10 biggest holdings have an average financial strength score of 4.7 out of 10, less than the 7.4 average of "buy"-rated companies. Investors of these ETFs must also pay 0.65% in fees, diluting the performance of the best-performing stocks.
Still, there is room for optimism. In May, we upgraded the funds to "hold" from "sell," suggesting better potential for gains.
Patience is critical for solar investors. If you can avoid economic myopia, consider investing in a solar ETF.