Column

SUREFIRE INVESTMENTS

Buy Canadian commodity stocks for the rest of the decade—and hold ’em

DONALD COXE January 31 2005
Column

SUREFIRE INVESTMENTS

Buy Canadian commodity stocks for the rest of the decade—and hold ’em

DONALD COXE January 31 2005

SUREFIRE INVESTMENTS

Column

Buy Canadian commodity stocks for the rest of the decade—and hold ’em

DONALD COXE

BY NOW, READERS ARE SATED on stock market forecasts for 2005. The last thing you want now is somebody else’s view on the next 11 months. So, how about the next five years?

Since the birth rate decline accelerated in the industrial world in 1970, the key to investment strategies in the last half of each decade has been betting the winning asset classes of the decade’s first five years. Commodities, led by gold, base metals and oil, outperformed other asset classes in the 1970s; in the 1980s, Japanese stocks and bonds, along with financial

and consumer stocks everywhere, were the leading investments; in the 1990s, it was U.S. stocks, particularly technology stocks.

The current decade’s stars have been commodities, led by metals and oil, reliable dividend-paying stocks and Canadian stocks in general. Because Canada’s market has such heavy exposure to those attractive stock groups, and because of the strong loonie, Toronto has been the top-performing market in the industrial world since tech stocks

began their crash in March 2000, the plunge that knocked the U.S. off its economic leadership perch.

Here’s the formula for growing wealth for the rest of this decade: stick with the winners. The big stories now are:

(1) the technology crash; (2) the astounding demand for commodities, particularly oil and base metals, from the hundreds of millions of new middle-class

people in China and India; (3) the continuing problems of the industrial world arising from deteriorating demographic trends, which mean high costs for labour and for retirees—particularly their pensions and health care; (4) the War on Terror, whose financial cost is being financed almost exclusively by the already-overstretched U.S. and (5) the fall in the U.S. dollar.

Until the greenback reaches bottom, American stocks and bonds will underperform those of the rest of the industrial world, particularly Canada. Although an undervalued currency makes companies based in that country more competitive, global investors fear holding assets denominated in a weak currency, so the stock market of a falling currency country keeps losing relative value (as measured by the price-earnings ratio) compared with other markets. There’s nothing surer: the rich (holders of assets in strengthening currencies) get richer, while the poor (holders of assets in weakening currencies) get poorer.

The most attractive stocks are those Canadian (and Australian) companies with the longest-life reserves of oil and metals in politically secure areas of the world. Because, as the growing Chinese and Indian middle class obtain the basic ingredients of comfortable living—homes with indoor plumbing, electricity, basic appliances and, collectively, large-scale automobile ownership—the squeeze on global supplies of oil, steel and base metals will continue to intensify.

Meanwhile, the industrial world’s demand for raw materials rises only modestly each year, because most of us already have those basic ingredients of modern living. The 1950s mining boom that drove the Canadian dollar to US$1.06 came from the demands of the surging middle class in North America, Japan and Europe. But by 1970, most people in the industrial world had indoor plumbing, electricity and cars. Then came the baby bust, which meant that middle-class population growth began to decline. Those two factors combined to make industrial economies modest metal consumers. In 2003, U.S. GDP grew by three per cent, but copper demand fell by three per cent. Fifty years ago, such economic growth would have meant doubledigit growth in copper demand.

Oil demand grew rapidly after the Second World War as automobile ownership kept setting new records. Then came the oil shocks of the 1970s and the belated recognition of the need for greater energy efficiency. Thereafter, oil demand grew slowly, but output from the huge discoveries made around the world from 1950 to 1975 kept expanding the industry’s capacity, even when prices for crude collapsed.

If the Asians climbing the economic ladder had chosen to get along without computers, washing machines and, most importantly, cars, oil would still be cheap and metals would still be in oversupply. During the 1980s, many prominent latte liberals opined that the Chinese loved their bicycles too much to repeat the mistake we had made in our disastrous love affair with cars. It

didn’t turn out that way. Global oil production is barely able to keep up with rising demand, led by China, now the world’s second-largest oil importer and fourthlargest automobile market.

The oil giants, long feared as the mighty Seven Sisters, who could play off oil-producing countries against each other, are now desperate to maintain—let alone increase—

TORONTO’S stock

market has outperformed all other exchanges in the industrial world since tech stocks plunged in 2000

their output. Nor is OPEC the answer. Instead of reinvesting a reasonable proportion of their gigantic earnings in the oil industry, the scabrous sheikdoms and dictatorships that lead that cartel have squandered nearly all their revenues, so they are unable to expand output at a time of soaring demand.

Rapid Chinese and Indian economic progress, Big Oil’s problems and OPEC’s stupidity create opportunities for long-term investors. The most obvious shares to own are those of the Alberta oil sands producers, boasting the largest reserves of barrels of oil per share of any companies in the world.

Most serious students of longer term supply and demand believe that crude prices will be robust in coming years, not only in greenbacks, but in strong currencies as well.

Less obvious, but almost as attractive, are the great global mining companies (such as Rio Tinto, BHP Billiton, Phelps Dodge, Inco, Alcan, Teck Comineo and Potash Corp.) which produce the copper, iron ore, nickel, lead, zinc, aluminum and fertilizer that China and India must have. It is a measure of how cheap mining stocks have become after two decades of disappointment and decline that the market capitalization of the whole industry is only somewhat larger than that of Cisco Systems, a busted growth stock.

Also appealing are “short-duration” stocks such as income and royalty trusts, along with financial industry stocks. Their major attraction, in contrast with commodity stocks whose appeal is long-term reserves, is high, after-tax income now, rather than potential capital gains later. During the frothy 1990s, sleazy promoters convinced gullible investors to expect endless capital gains from stocks. During this decade, realism has returned and reliable returns from dividends are back in favour.

Long-duration commodity stocks, shortduration income stocks and a falling U.S. dollar: those are the key trends now. Savour the joys of investing in Canada. m

Chicago-based Donald Coxe is Global Portfolio Strategist, BMO Financial Group. dcoxe@macleans.ca