For the fifth consec-utive year, natural resources stocks have risen, thanks largely to a combination of strong demand from rapidly growing China and India and weak supply because of underinvestment in new mines and oil refineries. And while there may be bouts of market volatility along the way, fund managers are confident the sector will continue to deliver.

“I remain very bullish on the sector and still think peak oil [the theory attributed to U.S. geophysicist M. King Hubbert in 1956 that oil production has peaked and will soon decline] has created an environment for high energy prices for many years to come,” says Charles Oliver, co-manager of AGF Canadian Resources Fund and senior vice president at Toronto-based AGF Funds Inc.

“In the base metals, the huge demand from China and under-investment in new mines will create above-average prices and great profits for many of the companies we own,” he says.

Although the U.S. economy has slowed, the macroeconomic picture is strong elsewhere. Oliver notes that the latest increase in interest rates in Europe demonstrates that region is strengthening. Better still, Asia has emerged as the global driver of growth.

“We continue to see roughly 10% growth out of Asia — if we look at China and neighbouring countries,” he says. Many analysts expect China to grow by 10% in 2007 and slightly less in 2008. “The secular trend is what makes this such a powerful market,” Oliver adds.

Even if there is a temporary economic slowdown, it will present a buying opportunity, he says: “I continue to be very positive on the stocks today.”

Valuations remain attractive. Moreover, he would take the same action should crude oil prices decline significantly from the present US$65 a barrel: “OPEC is using a bottom of US$55. I would use any decline to those levels as a buying opportunity. But oil prices are not likely to go there at this time.”

A bottom-up growth inves-tor who works closely with Robert Farquharson, AGF’s vice chairman, Oliver is running a 180-name fund that is fully invested.

About 50% of the portfolio comprises energy names, 25% are metals and materials, 20% are precious metals and 5% are service firms. Over the past year, Oliver has gradually reduced the energy weighting and raised the metals and materials component.

A favourite name in the latter area is Inmet Mining Corp. A copper, gold and zinc producer with operations around the world, the firm is cash-rich and is expected to earn $10 a share in 2007. It also has a new mine coming onstream next year.

“It will make north of $10 a share in 2008 and it’s trading at $81 a share,” says Oliver. “If you strip out the cash, it’s trading at six or seven times earnings. That’s about half the multiple of the S&P/TSX composite index.”

A long-term investor, Oliver has owned Inmet stock since 2001, when it was trading around $8 a share. “Most people don’t believe in the secular growth in Asia,” he says. “At some point, though, there will be a re-rating in materials stocks.” He does not offer share price targets.

On the energy side, Oliver has long been keen on Suncor Energy Inc. “With peak oil, it’s becoming harder to find new production growth. But then you look at Canada: it has the potential to add millions of barrels a day,” says Oliver. He regards Suncor as “the most experienced oilsands company in the world” and expects it will double production from 250,000 barrels a day to 500,000 in the next five years. He says it has the potential to double that again five years out.

“But it trades at the same P/E ratio as the S&P/TSX index,” says Oliver. “This is a great company. It’s added value over time, and has done it in spades.”

Suncor stock is trading at $91.80 a share, up from $27 a share five years ago.



The market’s bull run is sustainable, maintains Scott Vali, vice president of Signature Advisors, a unit of Toronto-based CI Investments Inc. , and manager of CI Signature Canadian Resource Fund.

“A big part of this is the China and India story,” he says. “We are in the early stages of the infrastructure build-out. We’ve seen this type of thing historically, in Japan and the U.S., and it typically results in long-term demand cycles for resources such as copper and nickel — all the things required for infrastructure.

@page_break@“It’s not a short-term thing; it’s very sustainable,” says Vali. “But we haven’t seen this intensity of development for some time, so people are skeptical that it can continue.”

He notes that companies have been reluctant to make major capital investments because these did not pay off in the past. “We haven’t seen the investments needed to boost production capacity,” he says. “If demand stays strong, which we think it will, the supply response will be more muted than it would have been historically.”

Meanwhile, commodity prices are under pressure because new mines are located in countries such as the Democratic Republic of the Congo, which are riskier from a political and economic perspective.

“You need a higher rate of return to make those projects work,” Vali says, “which means longer-term prices at higher levels.”

Using a blend of top-down and bottom-up investment styles, Vali runs a 60-name fund. About 52% of the portfolio is invested in energy companies such as Petro-Canada, Suncor and Talisman Energy Inc. There is also 29% in metals and minerals, 11% in precious metals, small holdings in chemicals and fertilizers, and 5% in cash.

In the past few months, Vali has reduced the precious metals exposure, which was up to 16% of the fund, and correspondingly raised the base metals component because values were more attractive. This switch is largely based on the view that gold is “more a financial asset than anything else,” he says.

“Gold is unlike copper or nickel, which go into industrial products. Basically, it’s the equivalent of a currency,” he says. “Our view was that we had seen quite a bit of strength last year, but didn’t think it would be as strong this year.”

As a result, Vali reduced the fund’s holdings in Barrick Gold Corp., Agnico-Eagle Mines Ltd. and Yamana Gold Inc.

Among the fund’s largest holdings is Alcan Inc., acquired early this year. The aluminum giant’s shares had been depressed for some time.

“We felt the stock was under-valued, so we began to increase our weighting,” says Vali, adding that Alcan had been benefiting from the bottoming out of prices for alumina, an input in the manufacture of aluminum. As well, Chinese producers were less competitive because of domestic taxes on exports. Alcoa Corp.’s takeover bid in May was no great surprise, given Alcan’s favourable long-term assets, says Vali.

Alcan stock recently traded around $88.15 a share, about $8 more than Alcoa’s offer.



Equally bullish is Chris Beer, lead manager of RBC Global Resources Fund and vice president at Toronto-based RBC Asset Management Inc. He notes that between 1980 and 2000, the natural resources sector went through a bear market as supply exceeded demand — except in the U.S., the economy that leads the world. But 2000 was a turning point as China and India emerged as global drivers; the secular bull market was born.

“Commodity prices came off [in 2000], but they didn’t return to their former lows,” Beer notes. “Is it secular or is it cyclical? It’s both. The reality is that China’s industrialization and urbanization is driving demand. When you look at past events, these things are secular in nature, but they do have cyclical periods.”

As an example of where demand is heading, Beer points out that China consumes about two barrels of crude oil per capita a day, and India consumes only one barrel per capita a day. The U.S., by contrast, consumes 25 barrels per capita a day.

“What will happen if China goes from consuming two barrels per capita a day to seven barrels? We’ll need to find another 20 million barrels a day. Or will it become so energy-efficient that it will never move to some higher number?” Beer asks. “The same story applies to steel. Demand is quite strong, and supply is struggling to keep up.”

Beer argues that the commodity story has room to run, and that prices will stay at levels higher than most people have expected. “If you’re buying just a commodity, you may not make the same money as buying a growing copper company,” he says.

Running a 70-name fund, Beer blends top-down analysis with bottom-up stock-picking. In general, he favours companies with strong growth profiles that can expand their production and produce successively higher earnings. Beer also tends to shift between subsectors, increasing exposure as value becomes more compelling.

Currently, the fund is split roughly 50/50 between energy (such as Valero Energy Corp. and Murphy Oil Ltd.) and metals and mining stocks (such as Companhia Vale do Rio Doce and Mirabella Nickel Ltd.).

About 60% of the fund is in Canadian names, with the balance in the U.S., Australia, China and South Africa.

A favourite holding is XTO Energy Inc., a mid-sized independent player in the gas industry. The U.S.-based exploration and production firm is active primarily in the Rockies. “It is drilling unconventional units, such as shale. But it’s also more predictable,” says Beer. “Even though oil service costs have risen, its productivity is quite high.”

Although XTO trades at a premium to its peers, the stock has proven to be a winner. Bought about four years ago at around US$10 a share, the stock recently traded around US$60.90. Beer’s 12-month target is US$72 a share. IE