Canada – Page 30

Short term Bank of Canada rate snapshot

BAX futures suggest that the overnight target rate will be held at 1% for the December 7, 2010 Bank of Canada meeting:

Month / Strike	Bid Price	Ask Price	Settl. Price	Net Change	Vol.
+ 10 NO	0.000	0.000	98.690	0.000	0
+ 10 DE	98.710	98.715	98.710	0.000	4741
+ 11 JA	0.000	0.000	98.675	0.000	0
+ 11 MR	98.600	98.610	98.600	0.000	12558
+ 11 JN	98.460	98.470	98.460	0.000	15591
+ 11 SE	98.280	98.300	98.290	0.000	13157
+ 11 DE	98.140	98.150	98.140	0.010	7394
+ 12 MR	98.020	98.040	98.030	0.000	3483
+ 12 JN	97.930	97.970	97.950	0.010	274
+ 12 SE	97.850	97.930	97.910	0.010	108
+ 12 DE	97.780	97.830	97.830	0.010	7

The rates do suggest that by mid-year we might see another 0.5% increase in rates throughout 2011, but this is financially speculative noise peeking through the woodwork. 3-month corporate paper is yielding 1.17% at present, so there is not much of a divergence between existing rates and implied December 2010 rates.

In terms of long-term rates, Canadian 10-year bonds have crept up to 2.98% at the end of November 10th trading. While this is not anything significant in terms of the range over the past 12 months, it is up about a quarter point over the past month. The big scare for real estate gurus out there was likely in the early second quarter (April) when 10-year bond rates went to 3.7%. Still, this is nothing close to the past decade’s average of 4.3%, and the peak rate of roughly 5.96% back in the year 2001.

I am struggling to make what is a rather boring interest rate post interesting, so I will leave it here.

Potash Corporation takeover should be approved

The Canadian government has until November 3 to make a decision on whether they will allow the takeover of Potash Corporation (TSX: POT) to proceed.

I do not know what the decision will be politically – the only time that the Canadian government has exercised its right to refuse a foreign takeover of a Canadian company was in 2008 when Macdonald Deitweiller (TSX: MDA) was prevented from selling itself as Canada did not want its sole satellite manufacturer going into foreign hands.

As a matter of public policy the sale should proceed. First, the buying company is overpaying. Secondly, the media (and Saskatchewan government) is making it sound like that Potash Corp is the only potash producer in Canada – while they are large, it is not the only source of Potash production in the country.

If the Canadian government refuses this sale, you will likely see any built-in takeover premiums of large Canadian companies be reduced. This is also an increasing trend as of late – governments trying to protect their strategic interests in natural resources, including oil and gas, uranium, water, metals and other resources. One wouldn’t be shocked to see the ultimate resource – intelligent people – be a future (but hidden) consideration in the future.

Politically, however, the decision might be different.

Oil company valuation – general note

Most oil producing companies also produce natural gas. Since natural gas is an input to gasoline production, typically companies internalize their natural gas production to their operations. However, many oil and gas companies produce excess natural gas and this contributes to their income.

Watch out for some earnings disappointments due to lower natural gas prices. Cenovus (TSX: CVE), for example, announced less than consensus earnings this morning due to natural gas pricing. Another company that is due to report that has significant natural gas production is Arc Energy Trust (TSX: AET.UN).

I am just a passive observer of these two companies, in addition to many others in the sector. There are nuggets of value here and there, but all of those are in the non-dividend bearing category. Companies like Cenovus (and its sister entity, Encana) are good stores of value in energy, but are unlikely to triple in valuation if energy commodities increase. They should almost be treated like annuities, assuming fossil fuels are not supplanted by something with superior energy density in the future (not in my lifetime).

Toronto Money Show

I notice Susan Brunner has a good summary of some talks she attended at the Toronto Moneyshow. If she ever comes to Vancouver (or even if she is reading this), I will extend an invitation for coffee.

I know the Moneyshow (formerly Financial Forum) comes to Vancouver annually in February and I always make it a point to attend simply because if there are any dominant themes, I usually then yellow-flag them as a sign that the investment thesis has reached public saturation.

Just judging from Susan’s remarks, one can take the following as consensus:
– Negative on the US; all mentioned some form of a medium to long-term bear market with little equity returns;
– Government bonds over-valued (yields too low);
– Yield-bearing securities, including Canadian Banks, and various sorts of income trusts that will be converting to corporations, and in general anything with sustainable yields with a prevailing view of deflation;
– Some projected inflation. There seems to be a division of people in both camps;
– We are in the middle of a natural resource bull market for roughly the next decade;
– Most growth opportunities will be offshore in developing countries;

So these expectations are probably priced into the marketplace. It is a matter of determining whether things will actually occur as market participants are pricing, or whether the scenario will deviate.

Indeed, if the world believes that commodities are going up, there is a chance that demand could be even higher than expected. It is the equivalent of making a small-odds bet on a probable event – you will still be rewarded for getting it right, just not as well rewarded for betting on something very obscure and mis-priced that turns your way.

Bank of Canada leaves target rate at 1 percent

The Bank of Canada has left the overnight target rate at 1%. The announcement is here.

Key quotation:

The global economic recovery is entering a new phase. In advanced economies, temporary factors supporting growth in 2010 – such as the inventory cycle and pent-up demand – have largely run their course and fiscal stimulus will shift to fiscal consolidation over the projection horizon. While the Bank expects that private demand in advanced economies will become sufficiently entrenched to sustain the recovery, the combination of difficult labour market dynamics and ongoing deleveraging in many advanced economies is expected to moderate the pace of growth relative to prior expectations. These factors will contribute to a weaker-than-projected recovery in the United States in particular. Growth in emerging-market economies is expected to ease to a more sustainable pace as fiscal and monetary policies are tightened. Heightened tensions in currency markets and related risks associated with global imbalances could result in a more protracted and difficult global recovery.

To translate this into everyday English, the Bank of Canada believes that the growth in the economic recovery is now leveling, and that it is not entirely certain what the next stage will be. They are reading the same tea leaves that everybody else is reading.

Inflation in Canada has been slightly below the Bank’s July projection. The recent moderation in core inflation is consistent with the persistence of significant excess supply and a deceleration in the growth of unit labour costs. The Bank judges that the output gap is slightly larger and that the economy will return to full capacity by the end of 2012 rather than the beginning of that year, as had been anticipated in July. The inflation outlook has been revised down and both total CPI and core inflation are now expected to converge to 2 per cent by the end of 2012, as excess supply in the economy is gradually absorbed and inflation expectations remain well-anchored.

The Bank of Canada will be putting the brakes on further interest rate increases until 2011 at the earliest. I do not project a December rate increase.

Three month corporate paper is yielding 1.17%, and three-month treasury bills are yielding 0.89% yesterday. Today, this will decrease a little bit.

More important are the spread to longer term bonds, which 5 years will yield you 1.95% and 10 years will yield 2.76%.