Canada – Page 20

What’s happening in Canadian energy?

I’m looking at the charts of several high-quality energy companies in Canada and their trajectory is down.

Looking at the raw commodity prices first:

Spot Natural Gas is down about 15% from December highs (recall that natural gas pricing is seasonal, for comparison the July futures are down less than 10% from the December highs):

West Texas Intermediate spot prices have not done anything over the past month and a half:

So why are the following down?

Peyto and Birchcliff (both very well managed natural gas producers) – Peyto appears to be down disproportionately in relation to natural gas prices:

However, despite that crude has gone nowhere, why are the oil producers starting to drop?

Crescent Point Energy:

Pengrowth (they have liquidity issues with an upcoming debt covenant that they may or may not blow in mid-2017) and Cenovus (another SAGD firm):

There are numerous other examples, but the only one unhurt to date appears to be Encana.

Makes me wonder what is going on. Something geopolitical coming with pipeline access to the USA?

President Donald J. Trump – Immediate implications for Canada

I have been saying here since January 2016 and repeating ever since that Donald Trump will become the next president. Friends of mine will know the words out of my mouth back in August 2015, where I said “not only will Donald Trump win the Republican nomination, but he will become the next president of the United States” – and everybody else started laughing. “No, I’m serious! You laugh today, but just wait and watch”.

Making these sorts of predictions looks easy in retrospect, but there is a lot of genetic psychology that makes it quite difficult to be the one to stand out in a crowd with a very unconventional viewpoint (especially in a country where basically 90% of the people supported Hillary). Either you are regarded as crazy (as my friends clearly did), or shunned, or both. The funny thing is even when you are proven correct, those attitudes generally don’t change much. The only solace on marketable pieces of information such as this (or a lot of what goes on in the financial marketplace) is that correctly contrarian viewpoints tend to make a lot of money.

The markets have basically V’ed since the election (and indeed, I kept a real-time chart of the S&P 500 futures on my desktop as the election results came through, and it was very impressive how trading took it down and up on the returns of various polling stations in key states like Florida).

But there are some macroeconomic parameters that need to be factored into a Donald Trump presidency. While the US system is designed to make sure that you can’t enact too much change with a stroke of the pen (the US Constitution is an amazing structure demonstrating separation of powers), it is pretty clear that companies dependent on Canadian trade with the USA are going to have a more difficult time if there is any perception of protectionism in that particular industry.

Energy policy in the USA will be fairly obvious – there will be more friendly regulations concerning fossil fuel extraction.

In particular, in the political climate of Canada, Justin Trudeau already has staked a bit of his political credibility on his future relationship with Hillary Clinton, and that has now gone to dust. It will indeed be very interesting to see what happens when Trump wants to renegotiate NAFTA – the impression I will be getting is one if I was in a boxing ring with Mike Tyson.

The other quick conclusion I can reach is that it is more probable than not that interest rates will rise quicker than most people generally realize. My hypothesis for this is that the institutions behind the US Government are quite Democratic-party dominated at present and they will want to hamper anything that will come out of the President’s office. And the easiest way to do this is to starve the nation by raising interest rates. Watch the Federal Reserve this December raise rates.

So in general, we have the following parameters:
1. Sell long-term bonds or anything with medium to lengthy durations.
2. Long US dollars.
3. Get rid of anything Canadian that is US trade-sensitive.
4. Get rid of anything strongly dependent on Democratic-related domestic subsidies in the USA.

One of Obama’s legacies is saddling the nation with another US$10 trillion dollars in fiscal debt in his 8 year tenure. Even for a nation as rich as the USA, this is a lot of money (about US$30k per capita). This clearly cannot be sustained and unlike other forms of political actions, the direct connection to the standard of life and the increase in the nation’s debt is diffuse and won’t be felt until later – but I suspect the impact of the huge increase in debt will happen over the next few years.

Canadian Preferred Share price appreciation nearly done

Preferred share spreads (in relation to government) have compressed significantly since last February and it appears that the macro side of the preferred share market has mostly normalized and accounted for the incredible drop of dividends on the 5-year rate reset shares due to the 5-year government bond rate plummeting (0.62% at present with short-term interest rate futures not projecting rate increases until at least 2018).

We are still seeing significant dividend decreases as rates continue to be reset.

I have looked at the universe of Canadian preferred shares (Scotiabank produces a relatively good automated screen) and further appreciation in capital is likely to be achieved through credit improvement (e.g. speculation that Bombardier will actually be able to generate cash indefinitely) concerns rather than overall compression in yields.

As such, one should most certainly not extrapolate the previous three months of performance into the future. Future returns are likely to primarily consist of yields as opposed to capital appreciation.

While investment in preferred shares, in most cases, is better than holding zero-yielding cash (in addition to dividends being tax-preferred), one can also speculate whether there will be some sort of credit crisis in the intermediate future that would cause yield spreads to widen again. If your financial crystal ball is able to give you such dates, you can continue picking up your quarterly dividends in front of the steamroller, but inevitably there will always be times where it is better to cash out and then re-invest when everything is trading at a (1%, 2%, 3%, etc.) higher yield.

I am also finding the same slim pickings in the Canadian debenture marketplace.

Valuations have turned into such that while I’m not rapidly hitting the sell button, I’m not adding anything either and will continue to collect cash yields until such a time one can re-deploy capital at a proper risk/reward ratio. If I do see continued compression on yields I will be much more prone to start raising significant fractions of cash again. Things are very different in 2016 compared to 2015 in this respect – in 2015 I averaged about 40% cash, while in 2016 I have deployed most of it.

Best places to park short-term, nearly-risk free Canadian cash

As a result of the Bank of Canada’s decision to hold the overnight interest rate target at 0.5%, options for Canadian dollar cash balances are bleak.

Cash can always be held at zero yield and would be immediately available for deployment.

There are also financial institutions that will allow you to lock your money in for a 1-year GIC and earn around a 1.25% risk-free return. However, the sacrifice in liquidity in the event that you would want to deploy such capital is unacceptable from an investment perspective. One can also purchase a cashable GIC (typically redeemable within 30 days after purchase) that earns slightly less yield – my local BC credit union offers such a product with a 0.85% yield.

I was curious as to the best exchange-traded products that would offer some yield at the lowest risk.

There are basically two options. They are (TSX: XSB) and (TSX: VSB). Both are short-term government bond funds. VSB is significantly cheaper on management expenses (0.11% vs. 0.28% for XSB), and both portfolios offer similar durations (roughly 2.8 years), and VSB has slightly better credit quality (55% weight to AAA instead of 50% for XSB). VSB should eventually have a better net yield after expenses (roughly 1.1%) due to the smaller MER. While the 1.1% net return is small, it is better than zero and is nearly risk free – there is anti-correlation between general market movement and the likely price movement of this fund – the capital gain on VSB should rise if there was some sort of crisis due to the heavy government bond exposure of the fund.

Another alternative which is deceptively cash-like but will not serve any purpose if you wish to save money for some sort of financial crisis is the high-quality corporate bond fund also offered by Vanguard (TSX: VSC). Although VSC will offer you another 80 basis points of yield, it has the disadvantage of likely having a liquidity premium in the event there was some adverse financial event – i.e. your cash-out price will likely be materially less than NAV.

All three ETFs trade at modest premiums to NAV.

Canadian interest rates

The Bank of Canada dropped their target interest rate from 0.75% to 0.5% today.

Canadian currency has taken a plunge in response. In addition the Federal Reserve Chair has pledged to start “normalizing” US interest rates by the end of this year which also puts downward pressure on all non-US currencies.

While I rarely have strong feelings on currencies, the “perfect storm” for the Canadian dollar is brewing (lowering interest rates, lowering GDP, lowering commodity prices, lowering external trade with China/USA, political uncertainty over the October 19 election) and it appears more likely than not that we’ll start approaching the point where we’ll see some sort of floor on Canadian currency (simply because the news could not get worse). I’m going to guess it will be around 72-74 cents, but we will see. I’d also expect this low to be reached around October and I may make a significant policy change on my CAD-USD holdings at this time given valuation levels.

My working theory is that the US economy is going to have extreme difficulties adjusting outside of a zero-rate environment and the process of deleveraging will be a painful business when hedge funds can no longer obtain money for free (Interactive Brokers, for example, will happily lend you USD at 0.63% for more than a million and 0.5% for more than $3 million). Paradoxically if the 30-year treasury bond decides to spike up from 3.2% to around 3.5% yield levels, I would suspect that purchasing long-term treasuries are going to be the winning play over the next period of time – not any equity fund. Debt levels incurred by the US government are hideously high and with every quarter point increase that they face will be a disproportionate amount of interest expense going out the door.

This also does not factor in other entitlement spending (e.g. social security, medicare, etc.) that serves to effectively ramp up the net expenditures for public debt purposes.

Right now I am mostly cash (or near-cash). Some of my efforts to find a place to park cash have mysteriously yielded results that are relatively low risk and I’ll be able to realize a modest single digit percentage at the cost of a little bit of liquidity, but in the event there are better investment opportunities on the horizon I will be in a very good position to pounce.