Fund Manager
Craig Porter
The sub-prime crisis in the United States and the related tightening in the debt markets came to a head in the first quarter. We saw the near collapse and subsequent takeovers of Countrywide Financial and Bear Stearns due to a failing housing market and a lack of investor confidence. The consequences of the collapse of Bear Stearns on the entire financial market were deemed so great that the U.S. Federal Reserve took the unprecedented measure to aid JP Morgan in the takeover of the rival brokerage. These sentiments fed into the stock market when in January the TSX was off over 15% at one point, as trading volumes dried up in many sectors. Many small cap resource names were hit even harder and have yet to recover. The fear is that smaller companies that have to raise money to develop projects will find it difficult to secure financing. Senior stocks have vastly outperformed their smaller cap cousins in all areas of the resource market, year to date.
Although we’ve seen excessive volatility in resource equities so far in 2008, all of the themes that cause us to be bullish remain intact. Global demand still remains quite robust, particularly in developing nations. Supply problems will remain over the next few years, as companies are finding it increasingly difficult to build new projects with decent economic returns. The trend is that the higher commodities move, the more governments around the world are either expropriating projects, changing the terms of existing contracts, or increasing taxes. Companies are also seeing many costs being forced upon them that have nothing to do with the project that they are building. Social costs, such as roads, hospitals, and water plants are being forced on companies in many developing nations. Adding to this the cost creep in steel, chemicals, labour, and power makes us realize why many projects are being left on the shelf. This leads to continued consolidation in the sector, as companies would rather buy production now as opposed to going through the risks associated with exploration, permitting and development. We expect that during the second half of this year we will experience a flood of M&A activity, particularly with base-metal companies with assets approaching production. Management teams will be faced with the decision of how to deploy the massive cash flows that they can expect this year. Either they grow their companies through acquisitions, or they return the capital to shareholders.
The price of oil and natural gas were both very strong in the quarter. Oil closed near an all time high of $102 U.S. per barrel on the back of speculative demand and a weakening U.S. dollar. Although there continues to be strong demand for oil on a global basis, there does not appear to be a shortage of supply in the market. OPEC has steadfastly refused to increase production to bring prices down that it believes are caused by speculators. Although we are not predicting one, a deep recession in the U.S. would send prices sharply lower, as the U.S. still consumes 25% of the world’s oil. The price of natural gas rose 35% during the quarter as inventories of natural gas in North America have come down quite dramatically this past winter. We feel the outlook for the commodity remains bullish. Industrial use has picked up, particularly for power generation, as natural gas has become a much cheaper alternative than oil. As well, we didn’t see significant volumes of liquefied natural gas hitting the shores of North America, as higher prices were being paid elsewhere around the globe. Although gas producing companies have seen significant increases in their share prices, we still feel that many have compelling valuations when compared on a historical basis. The winners during the quarter were either gas-weighted stocks such as Duvernay and ProEx that operate outside of Alberta, as the province enacted higher royalties recently, or the drilling and service companies.
Weakness was felt by many companies operating in the oil sands of Alberta, which are facing higher capital costs and greater environmental scrutiny.
The price of gold rose quite dramatically during the quarter, trading at an all time high over $1000 U.S. per ounce, before closing out the quarter at $916. Investment in gold was spurred by fears of inflation and from buyers seeking a safe haven from the problems of the sub-prime debt crisis. Although jewelry demand has been fairly flat, investment demand from a number of sources has been quite strong. There has been significant demand for gold out of the Middle East, as many oil-producing nations are diversifying their massive holdings in U.S. dollars. Silver was also quite strong during the quarter with the price increasing 15%, to $17.31 U.S. per ounce. Again, it was the larger more liquid companies (such as Goldcorp and Agnico-Eagle) that outperformed the index.
A sector that we particularly like is the bulk commodity sector, primarily coal and iron ore. As opposed to trading on an exchange, the prices for these commodities are usually negotiated between the producers and consumers, and are contracted for the next year. This typically leads to greater predictability of earnings, as sharp swings in trading prices are eliminated during the year. Due to strong global demand and supply problems these commodities have seen their values skyrocket the last few years. Coking coal, used in the manufacturing of steel, has seen its price rise this year to over $300 per tonne, compared to around $100 last year, while thermal coal, used in electricity generation has risen close to 50%. Iron ore also saw a strong increase this year, with Asian steelmakers agreeing to a 70% increase in price.
One area that was punished during the quarter was the uranium sector. The price of uranium peaked in the middle of last year at $136 U.S. per pound before falling to close last quarter at around $72. Although the commodity was a little ahead of itself last year, we feel that the fundamentals point towards higher prices in the second half of this year. Problems affecting the sector include delays in the start-up of new mines, old mines seeing production declines, as well as legislation in different jurisdictions limiting new uranium exploration and production. These problems are the reasons that we invested in the sector. We still feel that tightness in supply as well as a significant number of new nuclear reactors coming on stream in the next five years will keep the uranium price buoyant.
Craig Porter - Q1 2008 Commentary
Date Published
Related Fund(s)
Fund Manager
The sub-prime crisis in the United States and the related tightening in the debt markets came to a head in the first quarter. We saw the near collapse and subsequent takeovers of Countrywide Financial and Bear Stearns due to a failing housing market and a lack of investor confidence. The consequences of the collapse of Bear Stearns on the entire financial market were deemed so great that the U.S. Federal Reserve took the unprecedented measure to aid JP Morgan in the takeover of the rival brokerage. These sentiments fed into the stock market when in January the TSX was off over 15% at one point, as trading volumes dried up in many sectors. Many small cap resource names were hit even harder and have yet to recover. The fear is that smaller companies that have to raise money to develop projects will find it difficult to secure financing. Senior stocks have vastly outperformed their smaller cap cousins in all areas of the resource market, year to date.
Although we’ve seen excessive volatility in resource equities so far in 2008, all of the themes that cause us to be bullish remain intact. Global demand still remains quite robust, particularly in developing nations. Supply problems will remain over the next few years, as companies are finding it increasingly difficult to build new projects with decent economic returns. The trend is that the higher commodities move, the more governments around the world are either expropriating projects, changing the terms of existing contracts, or increasing taxes. Companies are also seeing many costs being forced upon them that have nothing to do with the project that they are building. Social costs, such as roads, hospitals, and water plants are being forced on companies in many developing nations. Adding to this the cost creep in steel, chemicals, labour, and power makes us realize why many projects are being left on the shelf. This leads to continued consolidation in the sector, as companies would rather buy production now as opposed to going through the risks associated with exploration, permitting and development. We expect that during the second half of this year we will experience a flood of M&A activity, particularly with base-metal companies with assets approaching production. Management teams will be faced with the decision of how to deploy the massive cash flows that they can expect this year. Either they grow their companies through acquisitions, or they return the capital to shareholders.
The price of oil and natural gas were both very strong in the quarter. Oil closed near an all time high of $102 U.S. per barrel on the back of speculative demand and a weakening U.S. dollar. Although there continues to be strong demand for oil on a global basis, there does not appear to be a shortage of supply in the market. OPEC has steadfastly refused to increase production to bring prices down that it believes are caused by speculators. Although we are not predicting one, a deep recession in the U.S. would send prices sharply lower, as the U.S. still consumes 25% of the world’s oil. The price of natural gas rose 35% during the quarter as inventories of natural gas in North America have come down quite dramatically this past winter. We feel the outlook for the commodity remains bullish. Industrial use has picked up, particularly for power generation, as natural gas has become a much cheaper alternative than oil. As well, we didn’t see significant volumes of liquefied natural gas hitting the shores of North America, as higher prices were being paid elsewhere around the globe. Although gas producing companies have seen significant increases in their share prices, we still feel that many have compelling valuations when compared on a historical basis. The winners during the quarter were either gas-weighted stocks such as Duvernay and ProEx that operate outside of Alberta, as the province enacted higher royalties recently, or the drilling and service companies.
Weakness was felt by many companies operating in the oil sands of Alberta, which are facing higher capital costs and greater environmental scrutiny.
The price of gold rose quite dramatically during the quarter, trading at an all time high over $1000 U.S. per ounce, before closing out the quarter at $916. Investment in gold was spurred by fears of inflation and from buyers seeking a safe haven from the problems of the sub-prime debt crisis. Although jewelry demand has been fairly flat, investment demand from a number of sources has been quite strong. There has been significant demand for gold out of the Middle East, as many oil-producing nations are diversifying their massive holdings in U.S. dollars. Silver was also quite strong during the quarter with the price increasing 15%, to $17.31 U.S. per ounce. Again, it was the larger more liquid companies (such as Goldcorp and Agnico-Eagle) that outperformed the index.
A sector that we particularly like is the bulk commodity sector, primarily coal and iron ore. As opposed to trading on an exchange, the prices for these commodities are usually negotiated between the producers and consumers, and are contracted for the next year. This typically leads to greater predictability of earnings, as sharp swings in trading prices are eliminated during the year. Due to strong global demand and supply problems these commodities have seen their values skyrocket the last few years. Coking coal, used in the manufacturing of steel, has seen its price rise this year to over $300 per tonne, compared to around $100 last year, while thermal coal, used in electricity generation has risen close to 50%. Iron ore also saw a strong increase this year, with Asian steelmakers agreeing to a 70% increase in price.
One area that was punished during the quarter was the uranium sector. The price of uranium peaked in the middle of last year at $136 U.S. per pound before falling to close last quarter at around $72. Although the commodity was a little ahead of itself last year, we feel that the fundamentals point towards higher prices in the second half of this year. Problems affecting the sector include delays in the start-up of new mines, old mines seeing production declines, as well as legislation in different jurisdictions limiting new uranium exploration and production. These problems are the reasons that we invested in the sector. We still feel that tightness in supply as well as a significant number of new nuclear reactors coming on stream in the next five years will keep the uranium price buoyant.