2009 was a record year for US wind installation, with 9.9GW of new wind farm capacity added to the grid compared to the previous peak of 8.4GW in 2008. On a global level, U$145 billion was invested in renewable energy infrastructure in 2009 which was in line with 2008. Interestingly, on a regional basis, Asia was the largest investor.

Despite the good news in this and other renewable themes, the alternative energy sector appears however, to be under siege short term. First, the UN Climate Change Conference in Copenhagen came and went without any formal agreements. Then the “Climate Gate” controversy gained broad media coverage, questioning the veracity of the conclusions of the scientific community relating to climate change after the exposure of two isolated instances where data was not reported accurately. In spite of the overwhelming evidence of the impact of industrialisation on climate, this has provided politicians and climate sceptics with an excuse for a period of longer inactivity in carbon abatement. In the US, there is also a growing disconnect between the expectations and confidence of developers and equipment manufacturers in wind. The US wind sector is also facing headwinds as access to project financing and the ability to secure purchase power agreements remains problematic. There has been a consecutive quarterly downward trend in 2009 for new projects entering construction. Only 1.6GW was registered as entering construction in 4Q 2009, a drop of 6% vs 3Q and 51% vs 2Q according to the American Wind Energy Association. These trends imply it will be tough for turbine manufacturers to meet guidance for 2010. We have shorted a European turbine maker, who is losing market share not just in Europe to Chinese manufacturers but also in the US and Asia, closing manufacturing sites and is projected to fall short of recent financial guidance.

Overall, January saw a significant sell off in the alternative energy and natural resource sectors. The S&P Global Renewable Energy Index fell by 12% during the month. Commodities like copper and crude oil also fell by 8.5% and 8.1% during the month with the MSCI World Energy and Materials Index falling 6.8%, as the outlook for a robust economic recovery moderated. Germany cut its solar feed-in tariff for roof-based and land based solar installations by 15% to 17%. Although this is not new news and was indicated to the market in 2009, it will create new challenges for an embattled sector, especially in Europe, since the proposal will start as early as April and be as much as 25% for farmland projects.

Despite a global credit crisis, overcapacity and declining margins, no solar firm has gone bankrupt yet. We believe there will be casualties with many smaller companies in particular in Europe and US suffering cashflow issues as the industry continues to undergo consolidation and rationalisation. We think that the low cost Chinese manufacturers like Yingli, Suntech and Trina will emerge as winners over the next 12 months. After the recent sell off, these stocks are trading at reasonable multiples of 13-15x projected 2010 earnings, have healthy balance sheets and are excellent values considering projected industry growth rates for the next 5-10 years in excess of 20%.

In our view nuclear power will be the new green power. Nuclear power is greener, cheaper and safer than most investors think and it is the only low carbon base load generation solution that is not restricted to specific locations. Global electricity demand is expected to increase by over 50% by 2030, while global carbon emissions require a 30% reduction. As a result, nuclear is the only viable option to meet the increase in electricity demand while simultaneously reducing CO2 emissions. There are 53 new nuclear reactors currently under construction, mainly located in Asia. Cameco and Silex are two companies will benefit robustly from this nuclear renaissance.

Cameco is the world’s leading uranium supplier and one of the fund’s largest positions. The company benefits from a strong and experienced management team and an excellent balance sheet. The stock trades at a forward PE of 17x and is leveraged to higher uranium prices. Although uranium is trading lower at $42-45 per pound on the spot market, long term contract are still being negotiated in the $60-70 range. Valuing Cameco using long term uranium prices conservatively provides 30-40% upside from current levels. In addition, we also get the option value of Cigar Lake, the world’s second highest grade uranium mine, for free as the market is not currently ascribing any value to it.

The risks for 2010 are beginning to accumulate. There is growing instability from rising unemployment, macroeconomic risks as stimulus measures fade and financial system risk spreading to sovereign debt in Greece and other countries. In addition to the European fiscal divergence, there is a growing perception of a diminished appeal of economic partnership between the US and China. Then there is the geopolitical issue of Iran and how to contain its nuclear ambitions. 2010 is shaping up as a volatile year for the markets. The world is a troubled place, and with that comes volatility reflected by markets. This is where equity long/short funds can serve a real purpose for investors, by protecting capital and reducing investment volatility.

Volatility has spiked upwards early this year and correlations have increased between sectors and stocks. The renewable energy, mining, oil and gas and emerging markets are all exhibiting unusually high correlations with each other. In addition, most risky assets are still displaying an elevated negative correlation with the US dollar. As a result, the risk metrics have amplified with the portfolio showing a higher value-at-risk and volatility recently. As a result, we have reduced net length to manage risk and as we go into February, the portfolio is expected to turn net short. Most of our sectors have seen sharp corrections and traded below their 100 or 200 day moving averages. Valuations are becoming increasingly attractive given share prices have fallen more aggressively than underlying commodity prices. In the mining sector a number of the major diversified mining companies are set to re-initiate share buy-back schemes or dividends which will provide some investor confidence. Volatility is likely to remain with us for a while yet. This does not eliminate investment opportunities either long or short. Overall, we intend to position the portfolio cautiously for the next several weeks, as this volatility plays out. Taking a medium term view, we believe markets will stabilise and the portfolio will be well positioned to exploit the opportunities when this occurs.

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