Fund Manager
Craig Porter
The fourth quarter of 2008 was a dreadful period for global equity returns. In North America the TSX was down 24% and the Dow was off 20% this quarter alone. Slowing economies, massive job cuts and government bailouts on a global basis all conspired to cause equity markets to drop and consumer confidence to plummet. Corporations have been very quick to respond to the economic downturn. With the ever tightening credit markets, producing companies have been quick to shut down unprofitable operations in an attempt to limit losses. Nickel, for example, saw about 9% of its global production shut down this year.
Even though we are in a recession, we feel that there are some positive factors in place for the resource area. The demand for commodities may remain robust due to the massive amounts of stimulus being pumped into global economies. To date we have tracked almost $2 trillion pledged by governments on a global basis attempting to boost their economies. China, for example, has pledged over $600 billion with a significant amount being spent on large infrastructure projects such as power generation, transportation infrastructure and water purification, which are all commodity intensive. The U.S. has pledge $50 billion to highway construction alone, which will consume massive amounts of concrete, steel and asphalt. Never before have we seen this colossal amount of money being spent in a relatively short period, which can only be positive for many commodity groups.
One of our long-term themes at Front Street has been that not enough money was being spent on building new mines, exploring for energy, and building new infrastructure. We often noted the bottlenecks in the energy sector, caused by a lack of pipelines and the fact that we haven’t had a new refinery built in North America in over thirty years. We noticed an interesting occurrence through the bull markets experienced over the last few years. Even though many commodities were trading at all-time highs, new projects were not being built because the capital costs to build them were rising just as fast or quicker than the commodity prices. We note that in the energy industry global production did not increase over the 2007/2008 period, even with oil trading well above $100 per barrel last year. The industry did not over build at the peak of this cycle, so it is felt that we shouldn’t have massive inventory builds this recession, which would have to be worked through before there is a recovery in commodity prices.
Crude oil and natural gas prices sold off dramatically in the second half of 2008 with the economic crisis. Although factors such as the credit crisis and housing breakdown frequently get mentioned, oil over $100 per barrel played a significant role in slowing the global economy. Oil prices fell by over $100 per barrel in just over four months. In an attempt to halt this slide, OPEC announced production cuts of close to four million barrels a day. How well they adhere to these cuts will play a role in oil’s recovery. The recovery in oil will also be boosted by a massive slowdown in exploration caused by the low price of crude. Most new projects on a global basis, including Canada’s oil sands, are uneconomic at crude prices in the $40’s. Suncor, for example, has slashed its capital budget by 70% this year to deal with the economic realities they are facing in the oil patch.
We remain positive on the outlook for gold out into 2009. Although we are in a short-term deflationary period, the massive amounts of liquidity being pumped into economies and the banking system on a global basis will eventually create inflationary pressures. Governments will be hesitant to raise interest rates to battle inflation, on fears of choking off economic growth. This will lead to a period of low to negative real interest rates, a scenario which gold always performs well as a store of value.
We see a lot of similarities in the resource sectors today with where they were a decade ago, in the 1998-99 period. Many commodities were trading at their cyclical lows and there was little demand for resource stocks. Today we see many mining stocks trading below the value of their cash holdings, and many oil producers are trading at two to three times this year’s cash flow, creating some compelling opportunities. Much like we saw at the beginning of this decade, these valuations won’t last forever. We feel that we are entering a period of significant consolidation as companies are finding it cheaper to buy growth on Bay and Wall Streets, as opposed to exploring and building it themselves. The winners coming out of this cycle will be the companies who maintained a strong balance sheet that are able to pick up quality assets that other companies were unable to finance.
Statistically, the U.S. entered a recession in late 2007. The first half of 2009 will probably remain very volatile, as bad news on the economy and further job losses will keep investors on the sidelines. However, as we get into the latter stages of 2009, we feel that equity valuations will start to improve, as investors start to look out into 2010 for a recovery and an improvement in earnings. In past recessions, stocks have typically bottomed and started their recovery six to nine months before the economy starts to improve. Those who wait to re-invest in the market, once good news on the economy starts to emerge, may find that they’ve missed out on a significant part of the next bull market.
Q4 2008 Commentary
Date Published
Related Fund(s)
Fund Manager
The fourth quarter of 2008 was a dreadful period for global equity returns. In North America the TSX was down 24% and the Dow was off 20% this quarter alone. Slowing economies, massive job cuts and government bailouts on a global basis all conspired to cause equity markets to drop and consumer confidence to plummet. Corporations have been very quick to respond to the economic downturn. With the ever tightening credit markets, producing companies have been quick to shut down unprofitable operations in an attempt to limit losses. Nickel, for example, saw about 9% of its global production shut down this year.
Even though we are in a recession, we feel that there are some positive factors in place for the resource area. The demand for commodities may remain robust due to the massive amounts of stimulus being pumped into global economies. To date we have tracked almost $2 trillion pledged by governments on a global basis attempting to boost their economies. China, for example, has pledged over $600 billion with a significant amount being spent on large infrastructure projects such as power generation, transportation infrastructure and water purification, which are all commodity intensive. The U.S. has pledge $50 billion to highway construction alone, which will consume massive amounts of concrete, steel and asphalt. Never before have we seen this colossal amount of money being spent in a relatively short period, which can only be positive for many commodity groups.
One of our long-term themes at Front Street has been that not enough money was being spent on building new mines, exploring for energy, and building new infrastructure. We often noted the bottlenecks in the energy sector, caused by a lack of pipelines and the fact that we haven’t had a new refinery built in North America in over thirty years. We noticed an interesting occurrence through the bull markets experienced over the last few years. Even though many commodities were trading at all-time highs, new projects were not being built because the capital costs to build them were rising just as fast or quicker than the commodity prices. We note that in the energy industry global production did not increase over the 2007/2008 period, even with oil trading well above $100 per barrel last year. The industry did not over build at the peak of this cycle, so it is felt that we shouldn’t have massive inventory builds this recession, which would have to be worked through before there is a recovery in commodity prices.
Crude oil and natural gas prices sold off dramatically in the second half of 2008 with the economic crisis. Although factors such as the credit crisis and housing breakdown frequently get mentioned, oil over $100 per barrel played a significant role in slowing the global economy. Oil prices fell by over $100 per barrel in just over four months. In an attempt to halt this slide, OPEC announced production cuts of close to four million barrels a day. How well they adhere to these cuts will play a role in oil’s recovery. The recovery in oil will also be boosted by a massive slowdown in exploration caused by the low price of crude. Most new projects on a global basis, including Canada’s oil sands, are uneconomic at crude prices in the $40’s. Suncor, for example, has slashed its capital budget by 70% this year to deal with the economic realities they are facing in the oil patch.
We remain positive on the outlook for gold out into 2009. Although we are in a short-term deflationary period, the massive amounts of liquidity being pumped into economies and the banking system on a global basis will eventually create inflationary pressures. Governments will be hesitant to raise interest rates to battle inflation, on fears of choking off economic growth. This will lead to a period of low to negative real interest rates, a scenario which gold always performs well as a store of value.
We see a lot of similarities in the resource sectors today with where they were a decade ago, in the 1998-99 period. Many commodities were trading at their cyclical lows and there was little demand for resource stocks. Today we see many mining stocks trading below the value of their cash holdings, and many oil producers are trading at two to three times this year’s cash flow, creating some compelling opportunities. Much like we saw at the beginning of this decade, these valuations won’t last forever. We feel that we are entering a period of significant consolidation as companies are finding it cheaper to buy growth on Bay and Wall Streets, as opposed to exploring and building it themselves. The winners coming out of this cycle will be the companies who maintained a strong balance sheet that are able to pick up quality assets that other companies were unable to finance.
Statistically, the U.S. entered a recession in late 2007. The first half of 2009 will probably remain very volatile, as bad news on the economy and further job losses will keep investors on the sidelines. However, as we get into the latter stages of 2009, we feel that equity valuations will start to improve, as investors start to look out into 2010 for a recovery and an improvement in earnings. In past recessions, stocks have typically bottomed and started their recovery six to nine months before the economy starts to improve. Those who wait to re-invest in the market, once good news on the economy starts to emerge, may find that they’ve missed out on a significant part of the next bull market.