With resources prices low, some global money managers think now is the time to invest in energy and gold and, perhaps, metals.
The general view is that oil prices will move up once there are signs that the global economy is growing. As for gold, some money managers feel that the huge amounts of liquidity currently being pumped into the system will be inflationary, pushing up gold prices.
And there are money managers who think the big fiscal stimulus packages that governments are putting into place \u2014 many of which include spending on infrastructure \u2014 will boost metals prices.
As a result, this is a good time to re-examine your clients\u2019 resources exposure and discuss with them the possibility of increasing it.
Here\u2019s a look at the major resources subsectors:
> Energy. <\/b> Most global money managers think oil prices will rise quickly once it\u2019s clear that global economic growth has resumed, and stabilize around US$60-US$70 a barrel. There are outliers, however, who either expect the price to hop on a fast \u201cup\u201d escalator or think it will settle around US$35 a barrel.
The key questions are how quickly demand for oil and gas will recover, and to what extent supply will be constrained by the current dearth of exploration and development activity.
The fundamentals of demand growth are brutally simple. Highly populated countries such as China and India are developing quickly. The resulting huge increase in the number of middle-class income-earners is generating a healthy appetite for everything from higher-quality food and cellphones to cars and appliances. This demand for goods, in turn, requires energy.
Demand has slowed, however, in the face of the global recession. But that is a temporary phenomenon. Once the recession is over, emerging countries\u2019 fast pace of growth will resume and demand for energy will return. In the medium and longer terms, growth in demand may slow as emerging countries increase energy efficiency and the industrialized world uses less energy and moves toward alternative energy sources. But these changes will take time.
The supply side is less clear-cut. Some analysts adhere to the \u201cpeak oil\u201d theory, which holds that the supply of conventional light oil has peaked and prices will have to continue to climb to provide the incentive to develop increasingly expensive and hard-to-reach reserves. This group expects the return of US$150-a-barrel oil \u2014 even US$200 oil \u2014 and recommends buying oil and gas equities now to take advantage of the big run-up in prices when it comes.
But others doubt this will happen. John Arnold, chief investment officer and managing director of AGF International Investors Co. Ltd. <\/b>in Dublin, says a number of big producers can still justify new development at current oil prices.
Noting the conservation resulting from the current economic weakness and the memory of US$150-a-barrel oil, Arnold doesn\u2019t see a sharp increase in oil prices until 2011 or 2012, perhaps even later. In his view, US$35 is a \u201creasonable equilibrium price.\u201d As a result, he\u2019s underweighting energy.
Between these two extremes are the majority of money managers and analysts, who think oil prices will move up to US$60-US$70 a barrel once it\u2019s clear the global economy has resumed growing. And because they think the recovery could start in mid-2009, they recommend adding oil and gas stocks to portfolios now.
However, Lloyd Atkinson, an independent financial and economic consultant in Toronto, doesn\u2019t think you should add oil and gas stocks just yet. He doesn\u2019t think we\u2019ve seen the bottom in oil prices: \u201cWe could see it slip to US$30 or less.\u201d
Charles Burbeck, an independent global portfolio manager based in London, on the other hand, thinks the price is unlikely to move much in the next year.
Those managers adding to their energy positions this year say there are good Canadian companies in this sector, so there isn\u2019t a lot of reason for Canadian clients to go foreign. Beno\u00eet Gervais, manager of several resources funds with Toronto-based Mackenzie Financial Corp., <\/b>recommends Canadian Natural Resources Ltd. Gervais says the company will see growth this year and has hedged a large chunk of its 2009 production.
Scott Vali, vice president of portfolio management with Toronto-based Signature Global Advisors, a division of CI Investments Inc., <\/b>recommends EnCana Corp. It is low-cost, cash-rich and fast-growing.
Ross Healy, president of Strategic Analysis Corp. <\/b> in Toronto, suggests Petro-Canada. He likes its 3% dividend; not many energy companies pay dividends, Healy notes.
@page_break@Many money managers recommend avoiding companies producing in politically unstable regions \u2014 but there are exceptions, including Russia-based OAO Gazprom, the world\u2019s largest natural gas producer and a major supplier to both Russia and Western Europe. Gervais says Gazprom will see gas prices rise over the next three years as Russia moves toward deregulation.
There are also opportunities in ancilliary energy activities, such as energy services and pipelines. Gervais, for one, likes Copper Cameron International Corp., a U.S.-based company supplying equipment for deep-water oil production. CCI isn\u2019t affected by the slowdown because its clients are existing producers.
Gervais also likes some Canadian pipeline trusts that are yielding about 14%. But this could drop in a few years, he says, when income trusts become fully taxed. So, you have to select carefully. Some, he says, have U.S. assets or tax-loss carry-forwards, and there are some U.S. pipeline trusts whose tax position isn\u2019t changing.
In the longer term, there will be opportunities in alternative energy, says Dom Grestoni, senior vice president and portfolio manager with I.G. Investment Management Ltd. <\/b>in Winnipeg. In Canada, companies with wind-power operations include TransAlta Corp. and TransCanada Corp.. Although still insignificant in terms of earnings, these operations will grow in importance. In the U.S., General Electric Co. has a growing solar division.
> Base Metals. <\/b> Many of the same factors are at play in metals as are in oil and gas \u2014 but with differences. Oil and gas producers can slow production incrementally by stopping production at certain wells \u2014 and can increase supply just as quickly by drilling additional wells. But mining companies have to shut down whole mines. Because most companies don\u2019t have a large number of mines, that means a drastic cut in overall production.
As a result, many analysts expect less reduction in production in base metals than in oil and gas in the near term. Inventories, therefore, will be higher when global growth resumes, which will probably keep base metals prices low longer than energy prices.
Further, base metals are primarily used in consumer durables, construction, machinery and equipment \u2014 goods whose purchases tend to be delayed during recessions and until companies are convinced healthy economic growth has indeed returned.
The caveat here is that infrastructure spending is a key part of most governments\u2019 stimulus packages, and infrastructure requires lots of metals. So, demand for metals may increase more quickly than expected.
There are also differences among base metals, depending both on the use and the industry structure. Managers favour metals whose production is mostly in the hands of a few producers. Those companies can control how much is produced.
This group includes iron ore and copper, says Peter O\u2019Reilly, global money manager with I.G. Investment Management in Dublin. There hasn\u2019t been a big copper find in the past 15 years, O\u2019Reilly notes, and most of the small finds are in politically unstable or hard-to-reach areas. Iron is pretty scarce, too, he adds.
(In contrast, says Vali, there is major new production in nickel and zinc.)
The few major iron ore producers, Gervais notes, are reducing production by 10%-25% this year, which will help boost prices. Gervais likes Labrador Iron Ore Royalty Income Fund, which gets its income in the form of royalties, which are less volatile and drop by less than the price of the underlying commodity.
Another difference between base metals and oil and gas is that there is only one large Canadian mining company left: Teck Cominco Ltd. Few money managers like Teck because of the huge debt it took on when it acquired Fording Canadian Coal Trust at the end of October.
So, investors will need to go foreign to get exposure to base metals. Recommended companies tend to include conglomerates such as Brazil\u2019s Companhia Vale do Rio Doce, a major iron producer that also produces copper, nickel, coal, aluminum and potassium. CVRD also has lots of cash, O\u2019Reilly says, at a time when acquisitions can be made inexpensively.
Another recommendation is Australia\u2019s BHP Billiton Ltd. Bob Lyon, senior vice president and portfolio manager with AGF Funds Inc. <\/b>in Toronto, says BHP is the only mining conglomerate to have world-class, low-cost operations in all the areas in which it operates: copper, iron, coal, and oil and gas.
> Potash. <\/b> A number of money managers recommend potash. Stock prices have collapsed; they\u2019re priced, Grestoni says, as if fertilizer won\u2019t be needed for food production, when everyone knows demand for food is growing.
There may be some decline in fertilizer use with the global economic slowdown, but it won\u2019t last. Saskatoon-based Potash Corp. of Saskatchewan Inc., one of the few major producers in the world, isn\u2019t lowering prices because it doesn\u2019t believe that would increase sales. Gervais expects prices to rise as other producers cut production.
> Gold. <\/b>The price of gold tends to move with investor sentiment rather than demand for bullion. Some money managers think the price of gold will rise as inflationary concerns re-emerge; they recommend retail clients have about 5% of their portfolio in gold or gold stocks.
But others disagree. Atkinson, for example, believes central banks will mop up the excess liquidity once it\u2019s clear healthy economic growth is back, which would prevent an inflationary spiral.
Bill Sterling, chief investment officer with Trilogy Global Advisors LLC<\/b> in New York, which manages a number of funds for CI, thinks that in the wake of the credit crisis, there won\u2019t be money around to buy gold.
Grestoni prefers Goldcorp Inc. among the senior producers because it has production coming online or in late-stage development. Further, Lyon adds, the company has a clean balance sheet and the best growth profile.
Yamana Gold Inc. is Grestoni\u2019s pick among the Canadian mid-tier group.
Lyon\u2019s pick among the international producers is South Africa-based Red Back Mining Inc., a low-cost producer in West Africa that has a \u201cgreat\u201d balance sheet. Lyon notes it would make a great acquisition for one of the big players.\t IE<\/b>
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