Fund Manager
Craig Porter
Stock markets in North America continued to show the strength they exhibited last year in the first quarter of 2010. Gains were bolstered by a stabilizing housing market, stronger employment numbers and increasing consumer confidence. For 2010, the IMF is now predicting global growth of 3.9%, with China approaching 10%. This growth has led many commodities to continue their upward climb from last year. Although interest rate hikes are expected later this year off historic lows, it is typically rate increases much further into an economic cycle that cool down the resource sector.
The Canadian dollar was rapidly approaching parity with the US dollar this quarter. Strong commodity prices, and the thought that our interest rates may rise before theirs, led to this strength impacting resource companies. On the one hand, as most commodities are priced in US dollars, companies operating in Canada will receive less revenue for their products with a lower US dollar. On the other hand, commodities during the last few years have been inversely correlated to the US dollar. As the dollar weakens it becomes cheaper for foreigners to buy, so demand and prices go up. It can be difficult to determine the actual cost/benefit of these currency fluctuations on resource companies.
M&A activity picked up sharply in the first quarter. With the lack of spending during the last few years on exploration, resource companies are quickly coming to the realization that the only way they can show production growth is through acquisition. The typical company being taken out is one that has delineated a resource and completed an economic assessment. Larger companies feel that the construction and start-up stage is where they can extract the most value, as many smaller companies do not possess the expertise to carry out this critical phase. Throughout the depths of the recession in 2008 and early into 2009, the only acquirers of assets were Asian sovereign funds, typically from China. They were the only groups with the financial might to carry out transactions, often making very accretive deals with distressed sellers. In a sign that corporate lending has returned, we are now seeing large companies acquiring, often offering significant premiums to complete deals.
In the energy sector, the prices of oil and natural gas took two divergent paths. The price of oil rose 5% in the quarter, trading close to $84 per barrel, a 17-month high. Prices rose with signs of the economic recovery and with estimates from the International Energy Agency that demand would grow by 1.7 million barrels a day or 2%. We feel that the oil market is fairly well balanced. Although there will be some growth in supply from countries such as Russia and Canada, it appears that there is little spare capacity in OPEC nations. Natural gas on the other hand fell 30% in the first quarter. We had written previously about our surprise in the strength of gas prices in late 2009. There continues to be a large surplus of gas in inventory, weak industrial demand, and continued improvements in drilling technology, which are bringing down finding costs. We remain unconvinced of the short-term potential for natural gas, and tend to focus our investments to oil-producing names.
The price of gold traded in a fairly flat range around $1100 per ounce this quarter. Noise around inflation, higher interest rates and sovereign debt problems caused prices to bounce around. We believe that we are getting closer to the peak in gold for this rally. The majority of gold purchases the last few years have been safe-haven investments from those fearing a collapse in the global economy. As the world economy starts to recover, investors looking for higher returns will sell gold and buy equities. On the stock side, smaller caps vastly outperformed the larger companies on the back of a number of corporate takeouts of up and coming producers.
One of the strongest areas on the S&P/TSX was the metals and mining sub sector. Government stimulus spending on infrastructure, and a recovering global economy, has sharply increased demand for metals. For example, imports of copper into China reached all-time highs in March. Iron and coal prices also skyrocketed this year with an increase in steel production. The action in the iron ore markets gives a clear signal of an economic recovery. In a decadesold tradition, iron price was typically negotiated once a year between the producers and steel companies. The system appears to have broken down and large producers like BHP are now setting prices quarterly at levels more than double last yearʼs.
Overall, we see no reason to change our positive outlook on the natural resource sector for 2010. With stronger global growth will come greater demand for commodities, spread out among more countries than just China. We expect the markets to be choppy this year as concerns pop up regarding rising interest rates, sovereign debt issues such as Greece, and currency fluctuations. Outperformance may very well come from those who are able to benefit from increased M&A activity.
Craig Porter
Craig Porter - Q1 2010 Commentary
Date Published
Fund Manager
Stock markets in North America continued to show the strength they exhibited last year in the first quarter of 2010. Gains were bolstered by a stabilizing housing market, stronger employment numbers and increasing consumer confidence. For 2010, the IMF is now predicting global growth of 3.9%, with China approaching 10%. This growth has led many commodities to continue their upward climb from last year. Although interest rate hikes are expected later this year off historic lows, it is typically rate increases much further into an economic cycle that cool down the resource sector.
The Canadian dollar was rapidly approaching parity with the US dollar this quarter. Strong commodity prices, and the thought that our interest rates may rise before theirs, led to this strength impacting resource companies. On the one hand, as most commodities are priced in US dollars, companies operating in Canada will receive less revenue for their products with a lower US dollar. On the other hand, commodities during the last few years have been inversely correlated to the US dollar. As the dollar weakens it becomes cheaper for foreigners to buy, so demand and prices go up. It can be difficult to determine the actual cost/benefit of these currency fluctuations on resource companies.
M&A activity picked up sharply in the first quarter. With the lack of spending during the last few years on exploration, resource companies are quickly coming to the realization that the only way they can show production growth is through acquisition. The typical company being taken out is one that has delineated a resource and completed an economic assessment. Larger companies feel that the construction and start-up stage is where they can extract the most value, as many smaller companies do not possess the expertise to carry out this critical phase. Throughout the depths of the recession in 2008 and early into 2009, the only acquirers of assets were Asian sovereign funds, typically from China. They were the only groups with the financial might to carry out transactions, often making very accretive deals with distressed sellers. In a sign that corporate lending has returned, we are now seeing large companies acquiring, often offering significant premiums to complete deals.
In the energy sector, the prices of oil and natural gas took two divergent paths. The price of oil rose 5% in the quarter, trading close to $84 per barrel, a 17-month high. Prices rose with signs of the economic recovery and with estimates from the International Energy Agency that demand would grow by 1.7 million barrels a day or 2%. We feel that the oil market is fairly well balanced. Although there will be some growth in supply from countries such as Russia and Canada, it appears that there is little spare capacity in OPEC nations. Natural gas on the other hand fell 30% in the first quarter. We had written previously about our surprise in the strength of gas prices in late 2009. There continues to be a large surplus of gas in inventory, weak industrial demand, and continued improvements in drilling technology, which are bringing down finding costs. We remain unconvinced of the short-term potential for natural gas, and tend to focus our investments to oil-producing names.
The price of gold traded in a fairly flat range around $1100 per ounce this quarter. Noise around inflation, higher interest rates and sovereign debt problems caused prices to bounce around. We believe that we are getting closer to the peak in gold for this rally. The majority of gold purchases the last few years have been safe-haven investments from those fearing a collapse in the global economy. As the world economy starts to recover, investors looking for higher returns will sell gold and buy equities. On the stock side, smaller caps vastly outperformed the larger companies on the back of a number of corporate takeouts of up and coming producers.
One of the strongest areas on the S&P/TSX was the metals and mining sub sector. Government stimulus spending on infrastructure, and a recovering global economy, has sharply increased demand for metals. For example, imports of copper into China reached all-time highs in March. Iron and coal prices also skyrocketed this year with an increase in steel production. The action in the iron ore markets gives a clear signal of an economic recovery. In a decadesold tradition, iron price was typically negotiated once a year between the producers and steel companies. The system appears to have broken down and large producers like BHP are now setting prices quarterly at levels more than double last yearʼs.
Overall, we see no reason to change our positive outlook on the natural resource sector for 2010. With stronger global growth will come greater demand for commodities, spread out among more countries than just China. We expect the markets to be choppy this year as concerns pop up regarding rising interest rates, sovereign debt issues such as Greece, and currency fluctuations. Outperformance may very well come from those who are able to benefit from increased M&A activity.
Craig Porter