It's time to invest in Canada
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Associate Editor
David Stevenson Oct 02, 2009
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Canada is having a good recession, and will do well from its natural resources. Here's how to grab a slice of the profits, says David Stevenson.
The world's worst economic slump since World War II may be easing up a little, but that's scant consolation to those joining the ever-lengthening global dole queue. Lose your job in the current climate and you could be out of work for a lot longer than during the last recession.
Except, that is, in Canada. Most Canadians being laid off are finding new work almost as quickly as those who became unemployed prior to the downturn, says Benjamin Tal at CIBC World Markets. "In Canada, average unemployment duration is currently 15 weeks, a modest increase from the pre-recession level of 14 weeks." During the 1991 recession, the average was 20 weeks. And the 'long-term' jobless rate – those out of work for over six months – is 30% below the level it was at during the same stage of the 1991 recession.
In short, "Canada had a better recession than most", says the FT's Lex. Despite the severity of the international financial crisis, none of Canada's major banks has failed, cut its dividend, or requested government help. Indeed, they're now in better shape than before the meltdown. As Robert Cyran of Breakingviews says, this was down to "a combination of regulatory restraint and conservative management". The total market value of the big five Canadian banks (Royal Bank of Canada, Toronto Dominion, Bank of Nova Scotia, Bank of Montreal and CIBC) has actually grown by 8% since the start of 2007. "By comparison the five biggest American commercial banks lost almost 40%, vaporising more than $350bn of market value."
Nor do Canada's banks look like they're about to trip up. In its 2008-2009 Global Competitiveness Report, the World Economic Forum ranked the country's lenders as the least likely in the world to need a government bail-out. US financial institutions languished in 40th place. And although interest rates are as low as in America, the Bank of Canada hasn't done much quantitative easing (ie, it hasn't minted lots more new money, unlike Britain and America), "meaning inflation isn't too much of a worry", says Martin Hutchinson of Moneymorning.com.
So private-sector finances are pretty healthy. But even more unusually for a Western economy these days, the public finances are in good shape too. Prior to last year's budget deficit – which even then was just C$5.8bn, only 0.5% of GDP – Canada had enjoyed a long run of budget surpluses. A two-year C$47bn (£27bn) government stimulus package (equal to just over 4% of GDP) will push up the annual deficit, with a 4.7% gap expected in the current fiscal year. Yet while the government isn't projecting a return to a budget surplus for five years, this shortfall still compares very favourably with the long-run, double-digit deficits currently being run up by both Britain and America.
Now, most of Canada's economic numbers are perking up too. June output grew month-on-month for the first time in almost a year, July new house sales set a new record, and 27,000 jobs were created in August. July's retail sales fell 0.5% from June after two good months, but that's less important in Canada, as private consumption accounts for just 56% of GDP, compared with two-thirds in Britain and 70% in America. The Conference Board of Canada's August consumer confidence index climbed for the sixth straight month. As Lex puts it, "Canada's economy seems to be righting itself quickly".
Of course, the general reaction from the rest of the world might well be, "who cares"? After all, Canada is "invisible on the world stage", as Carol Gear puts it in Thestar.com. A "bit player" in the United Nations, it may once have been seen "as a country that punched its weight globally", but "now it's barely in the ring". However, this lack of prominence is one of Canada's many attractions. It's often a good idea to focus on markets that aren't fully part of mainstream thinking. And smart investors are already starting to do that. Within the last 12 months, net foreign purchases of Canadian stocks and bonds rose sharply to hit a five-year high in July, according to the latest statistics from the Canadian Census bureau.
Canada is a play on emerging markets
One of the main reasons for this – and another key reason for investing in Canada – is that, unusually for a Northern hemisphere 'mature market', Canada's stock exchange is firmly geared towards commodity producers. Nearly 45% of the TSX Composite index comprises resource stocks, nearly triple the US market share. What's more, almost 60% of Canadian exports are linked to the commodity sector, roughly double the American position.
As David Rosenberg of Gluskin Sheff puts it, that makes Canada "a low-beta way to play the emerging markets via commodity exposure". In other words, while buying directly into emerging markets such as China and India exposes you to relatively high risk levels and greater volatility, Canadian stocks offer a lower risk, less volatile alternative. Rosenberg reckons that "if the history of long cycles is any indication, this period of Canadian market outperformance is barely halfway done".
And there's another key benefit (particularly for British investors) to be investing in Canada: its currency. The Canadian dollar is known as the Loonie because of the Common Loon bird inscription on the reverse of the dollar coin. It has a 65% correlation (as the chart above shows) with the Commodity Research Bureau (CRB) index, the world's longest-established commodity price barometer. So if commodity prices rise, the Loonie is likely to appreciate against most other major currencies.
What are the risks?
But there are risks. Firstly, there could well be a short-term correction in commodities and resource stocks. No bull market runs up in a straight line and if investors get the jitters about global recovery, as we suspect they will, then miners will fall along with everything else. As Richard Buxton at Schroders puts it: "Such setbacks are part and parcel of investing in mining stocks and you have to ride through them."
Secondly, with 75% of its exports bound for America, Canada's fortunes are quite closely tied to goings-on south of the border. So any signs that the US economic recovery is proving more sluggish than expected could hold Canadian stocks back to a degree. However, says Rosenberg, sell-offs based on weak US growth or corrections in commodity prices "are long-term buying opportunities. [Canada] ought to be bought on pullbacks." In the long run, it's not America but Asia that holds the key. "Emerging Asia is expanding again and growth forecasts for the region are still being revised higher." That's good for Canadian resource producers.
"And there's another reason to be bullish on commodities. It's called trade protectionism," Rosenberg continues. "First came US tariffs on Chinese-made tyres. Then we saw the EU impose anti-dumping duties of nearly 40% on imports of steel pipe from China. And now we hear out of Australia that its foreign investment regulator wantsto impose 15% caps for global purchases of the country's large companies." In other words, this means growing tensions in the resource markets. That's likely to be another longer-term positive for prices.
The third risky factor when it comes to Canada is a political one. The current minority Conservative government of Stephen Harper has done a good job, but the opposition Liberals have withdrawn parliamentary support, so there may be an election this autumn. However, "Canadian elections are a much smaller risk than you get in most countries", says Hutchinson. "A Liberal majority government would be no disaster. They might be a bit sticky about oil-drilling permits, but wouldn't otherwise rock the boat." In all, Canada is a low-risk way to play the biggest investment theme around right now – the shift of global power and wealth from West to East. We look at the best stocks below.
The best plays on Canada
The biggest stocks in Canada's TSX index are the banks. These may be about the best of the global bunch, but if you're looking to play Canada, you'll want some commodity exposure.
Canada's proven oil reserves are second only to Saudi Arabia in the world table, and below we look at the tar sands stocks. Elsewhere, Potash Corporation of Saskatchewan (TSX: POT) is the planet's biggest fertiliser producer. It's currently in contract talks with China, and has idled 70% of its production capacity this year. That's kept the share price suppressed while much of the rest of the stockmarket has been surging.
But boss Bill Doyle recently said he expects China to sign soon, probably in November, which will prompt countries such as Malaysia, Indonesia, Australia and New Zealand to follow up with orders. He reckons North American buyers will start rebuilding inventories in December in preparation for the early planting season in the southeast US.
It could all add up to a 50% year-on-year boost to potash sales volumes in 2010. At C$98, and on a forecast p/e of just over 12 times for next year, Potash Corp looks cheap. John Chu at Research Capital has a price target of C$124.
Sherritt International (TSX: S) is a diversified natural resource firm producing nickel, cobalt, thermal coal, oil and gas, and electricity. It's a world leader in nickel production (used for stainless steel, rechargeable batteries and coinage) from lateritic ore, with operations in Cuba and Canada, while a Madagascan project is under development.
With nine surface mines, Sherritt is the largest thermal coal producer in Canada, and is developing Canada's first coal gasification project. It also licenses its technologies to other metals firms. At C$7.53, Sherritt is on a forecast p/e of 10.8, with a yield just below 2%. Raymond Goldie of Salman Partners has a price target of C$10.50, around 40% above today's price.
If you're a less adventurous investor, but would still like a slice of Canada, you could plump for an exchange-traded fund (ETF), such as the iShares MSCI Canada Index (NYSE: EWC).
Top picks in the tar sands
Everyone works in the town of Fort McMurray, but nobody lives there. Ever since Great Canadian Oil Sands (now Suncor) pulled a barrel of oil out of the heavy tar sands that surround the town in 1967, Fort McMurray has been a temporary haven for Canada's oil workers. There were 27,000 of them living in makeshift camps around the area last year. And with an estimated 2.5 trillion barrels of petroleum to be mined from the Alberta tar sands, the locals should have a long time to get used to their temporary neighbours.
But it's been a lot quieter in the town's few bars of late. Only 23,000 oil workers have turned up for work this year, according to The Economist. Projects have been thin on the ground ever since oil fell below $80 a barrel. It's not that it's uneconomical for oil groups to work here – companies say they develop tar sands projects at an oil price of $50 to $60. It's just that there are far cheaper places to source oil. And oil groups are in retrenchment mode at the moment.
Between 2008 and 2010, developers were expected to spend C$128bn on tar sands projects. Now it looks like around C$80bn of that will go through, says the Oil Sands Developers Group. The Canadian Association of Petroleum Producers has scaled back its estimate of four million barrels a day by 2020 to 3.3 million. But all that is about to change. Last month, Chinese state-owned company PetroChina arrived in Alberta to buy a controlling share in Athabasca Oil Sands Corporation for $1.7bn. The investment gives China a 60% stake in two undeveloped oil sands projects in the north of the province.
That has really incensed the Americans, who are getting a bit sick and tired of the Chinese buying up all the things America needs to keep its economy afloat. This is the second major Canadian commodities investment the Chinese have made this year, having injected another $1.7bn into metal producer Teck Cominco in July.
How long before other energy groups stake their own claim to the tar sands? Not long. Canada's share of the American oil market could grow to 27% by 2035, from 19% last year, according to Cambridge Energy Research Associates. It won't be much fun for the Americans if they have to pay the Chinese to get at the oil.
So who might they buy? Oil Sands Quest (AMEX: BQI) looks a good candidate. The company has 731,000 acres along the Saskatchewan and Alberta Border and 488,000 acres in the Pasquia Hills oil shale, notes Investopedia's Aaron Levitt. It's a small company, with a market cap of $330m. And it's been hit pretty hard as oil collapsed – dropping from a peak of $6.24 last August to around a dollar today.
Just north of Fort McMurray, Canadian Natural Resources (NYSE: CNQ) is sitting on an estimated 16 billion barrels of bitumen along 115,000 acres of leased land. Around six billion to eight billion barrels of that stuff is reckoned to be recoverable. The company is an unlikely buyout candidate – weighing in at $30.5bn. But there are a lot of things working in its favour at the moment. With cheaper steel, cement and labour at its disposal following the events of the last year, it can justify new developments with oil at $60 a barrel. The low price of natural gas is also helping. Natural gas is one of the most cost intensive inputs in the production of oil sands. It takes 1,200 cubic feet of natural gas to produce just one barrel of bitumen, because it is burned off in the refining process. The company is beginning phase one of developing the project and trades on a forward p/e of 12.3.
• This article was originally published in MoneyWeek magazine issue number 455 on 2 October 2009, and was available exclusively to magazine subscribers. To ensure you don't miss a thing, and get instant access to all our premium content, subscribe to MoneyWeek magazine now and get your first three issues free.
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