We’ve been fielding a number of questions about the gold and precious metals sector recently, more specifically, why we are not buyers on gold? Let’s start there. The price of gold bullion has been exceptionally volatile recently, dropping $250/ounce over a two-day period in mid-April. Bullion has now given up $500/ounce from its highs in September, and is now, technically, in a bear market. Gold equity shares are down 40% year-to-date alone. So what’s up (or down) with gold lately? Gold bullion and precious metal shares have been in profit taking mode for much of 2012 and early 2013.
U.S. Stock market leadership remains defensive, suggesting weak economic growth, but a lack of inflation should keep bond yields low. Relative valuation (dividend yield 2.1% for S&P 500 and 3% for the S&P/TSX (TSX) vs U.S. 10-year bond of 1.9%) is still favourable for stocks. Markets peaked in April 2010, 2011, and 2012 followed by corrections of 16%, 18%, and 10%, respectively, on Eurozone flare-ups. However, with strong, widely-recognized recovery in U.S. housing, North American stocks are less likely to offshore exogenous shocks, in our opinion.
With continued headlines of record highs on U.S. stock exchanges in the first quarter, investors may have felt confident in their investments. However, the rally has been very sector specific. The Dow Jones 30 was up over 10% in the first quarter, while the Toronto Stock Exchange (TSX) rose only 2%. The major discrepancy can be explained by the large natural resource weighting on the TSX. Resources make up over 40% of the TSX. During this period, the energy sub-index was flat, golds were down 15%, and metals were down 14%.
“Life’s missed opportunities, at the end, may seem more poignant to us than those we embraced—because in our imagination they have a perfection that reality can never rival.”
Norm Lamarche: It is difficult to find a period of time when the Canadian resource sector has been so out of favor. The period post-Asian contagion, from 1998-2000 comes to mind. In that period, a western economy was healthy and growing, and had absorbed the emerging nations’ issues of 1997-1998. Commodity prices had recovered, reflecting worldwide economic fundamentals, but the resource stocks remained out of favor because investors were funneling money into sectors deemed more exciting. The technology sector at the time was taking cash flows away from the resource sector.
Current Asset Allocation (Feb 2013):
Equity 20%, Short 10%, Net Cash 20%, Privates 7%, Convertible Debentures 17%, Short-Term Bond 7%, Other Bond 14%, Cash Encumbered for Shorts 15%
We have been redeploying to cyclical equities on a hedged basis and to shorts in individual names that we deem to be expensive and, furthermore, we are allocating to convertible bonds as we see value in these securities. We are also building short positions in equity indices as one means to hedge equity exposure.
As we enter 2013, it appears as though the world economy is transitioning from deceleration to acceleration. The U.S. economy is the leader. U.S. growth has been very resilient, despite its own political, fiscal-cliff issues. U.S. economic growth is becoming qualitatively better, as it continues to broaden into other sectors of its economy, such as housing/construction, and consumption.
Economic Overview and Fund Positioning
A Dedicated and Experienced Team
OFI SteelPath focuses on energy infrastructure investment primarily through the Master Limited Partnership (MLP) asset class. OFI SteelPath has a market leading position and an eight-year track record in MLP investing, including an investment
team with over 50 years of combined energy infrastructure analysis and investment experience. The Investment Team is located in Dallas, Texas, in close proximity to the majority of MLP management teams and the country’s energy industry leaders.
After recent market performance, investors are questioning resource stocks, and the long-term prospects of equity investing, in general, while positioned in cash, or lowpaying, fixed-income products. We believe there is an opportunity to get back into equities, much like we saw in early 2009. At that time, extreme pessimism, similar to today, ruled the markets. However, as global economic growth returned, investors gained confidence, redeployed cash, and resource markets thrived as a result.
On the economic front, it is becoming evident to everyone that the United States is leading the charge out of the global economic slump. Industrial growth and manufacturing activity is also spreading to other sectors, such as real estate, construction, etc. This has been going on notwithstanding all the discussions (noise) about fiscal cliff and debt ceiling.
Estragon: I can’t go on like this.
Vladimir: That’s what you think.
-Samuel Beckett, Waiting for Godot
Extraordinarily low real-yields dominate the asset price structure as 2013 begins. As has been the case for several years, real fundamentals and market outcomes may continue to rest heavily on political decisions made in Washington, Brussels and Beijing. Although our core scenario calls for a still-challenging macro backdrop, we advocate overweights
in high-yield securities, securitized products, selected sovereign-debt and equities, with an underweight in safe sovereign-debt and cash.
Help me out on this one! Canada has 3% of the world’s capital in the energy universe,
but sits on 20% of the world’s natural gas reserves. (I’ve made these numbers up, but
the direction is correct). Canada has so much natural gas that it sits largely
Underdeveloped and unproduced.
After a rough start to 2012, equity and resource markets rebounded quite sharply in the third quarter. Many of the economic issues that caused investors concern, while not completely solved, had solutions devised to deal with the problems. Although it has yet to be fully implemented, Europe has devised a plan to buy bonds to support its weaker members. The ECB’s president stated that they would do whatever is necessary to preserve the Euro currency, and the European Union. We also had economic data out of the U.S.
In my view, the Quantitative Easing (“QE”)-inspired rallies are based on assumptions that may no longer hold true. Anecdotal evidence shows that low (zero?) interest rates and additional bond purchases by the Federal Reserve are not having their desired effects: M2 money supply velocity is low (and falling) while disposable, personal income growth
since the end of the “great recession” has been at a rate much lower than that of previous expansions during periods of quantitative easing.
After a difficult first half of 2012, Canadian stocks had a much stronger showing in Q3. There are a number of reasons for the performance, but one stood out: there was a growing sense of containment coming from Europe, as European government institutions, notably, the European Central Bank (ECB), convinced capital markets that they "were prepared to do whatever it takes to help end this crisis".
The completed quarter turned out to be much better than many had feared, a result of the gradual progress in Europe. Some of the dissipation of uncertainty was a result of assurances by policy makers in Europe to provide sufficient liquidity and statements that they will do whatever it takes to avert further erosion of confidence. Also during the quarter, other nations initiated further monetary stimuli to forestall additional economic weakness. The U.S. announced QE3, thus introducing open-ended support for the U.S.
Global stock markets weakened substantially in Q2 with the world index (excluding the U.S.) down 7%. In resource-heavy Canada/Australia, markets dropped 6.4% and 5.6%, respectively, as commodities pulled back on worries about the European woes, and a slowing world economy. Oil prices (WTI) dropped 17.5%, copper 9%. Needless to say, resource stocks were down significantly. The smaller stocks were down more markedly, with the Canadian Venture Exchange down a whopping 24% in the quarter.
“Everything we see hides another thing”
The quarter ended with continued economic uncertainty as the ever growing sovereign risk problems in Europe spread. After the Greek tragedy, Spain became the latest country asking for assistance, while concerns mount for Italy. We also saw both India and China experience a marked slowdown in activity. Pessimism and abject surrender has gripped the markets. As of this writing, German and French 1-year notes trade at a negative yield of nine basis points. The purchasers of these countries are willing to pay to own these treasuries.