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David Rosenberg (Fred Lum)
David Rosenberg (Fred Lum)

David Rosenberg

Making a case for Canada and commodities Add to ...

I stand accused of having missed the turn and that accusation comes from the throngs who believe that the only way to generate a positive return is through the equity market.

You see, for so many pundits, you are labelled a "bull" or a "bear" based on how you feel about the equity market. You turn on the various business shows on bubble-vision and it's all about equities; one would think that there is no other market on the planet.

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Equities continue to grab the imagination of the investment public even though they are now barely halfway through a secular bear market - a long-term, flat-to-down cycle - that is likely to last 18 years.

This does not mean that cyclical bull markets cannot occur in the meantime - they did even in the 1930s and in Japan in the 1990s. The S&P 500 has even managed to reach two historical price peaks (September, 2000, and October, 2007) during the current secular bear market phase.

But what is critical is that in secular bear markets, rallies are to be rented, not owned. Whereas in secular bull markets, selloffs are to be treated as opportunities to build long-term positions at better price levels.

My contention is that the commodity market entered a secular bull market right around the same time that the equity market entered its secular bear market - a tad later actually, in November, 2001.



...the price of virtually every commodity bottomed at a higher price [last year]than during any other recession in the past. David Rosenberg


Not surprisingly, the last secular bear market in equities, from the mid-1960s to the early 1980s, also took hold alongside a secular bull market in commodities; we are seeing something very similar take hold this time around but for very different reasons.

What really caught my eye this time was that during the vicious selloff in commodities last year, the price of virtually every commodity bottomed at a higher price than during any other recession in the past.

Oil, for example, if you look at the monthly averages, bottomed this cycle at $39.20 a barrel (U.S.). In the 2001 recession, the oil price bottomed at $19.33 a barrel; in 1990, it bottomed at $16.81; in 1982 at $28.48; and in 1975 at $10.11. We bottomed this cycle at levels that were peaks in prior cycles.

Take the entire Commodity Research Bureau (CRB) spot index and again it is plain to see: The bottom of this cycle was 307.4 versus 211.2 in 2001, 237.5 in 1992, 226.8 in 1982, 187.2 in 1975 and 107.1 in 1971. It's been an impressive show.

The fact that commodities bottomed at higher levels than ever before in the face of the most severe global recession in 70 years tells us what the floor is, at the very least.

I always cringe when I hear the words "it's different this time," but in fact, in the case of the resource sector, this indeed seems to be the case. Why? It's all about the shifts in the supply and demand curve.

On the supply side, we have a much more concentrated sector, with fewer players than in past cycles following the wave of global consolidation over the past decade, in particular. Moreover, the executives of these resource companies are business people, not geologists, and as such have been much more disciplined from a production standpoint.

On the demand side, an emerging Asia climbed out of its depression just over a decade ago with restructured economies, vastly improved balance sheets and changed political landscapes.

What we refer to as emerging markets once commanded more than half of global GDP before the industrial revolution, and are on track to regain that lost share in coming decades; likely sooner rather than later given China's critical mass and double-digit growth rates - its economy just surpassed Germany on the third rung of the world GDP ladder.

This is where Canadian strength relative to the United States comes into play - nearly 45 per cent of the TSX composite index is in resources; almost triple the share in the United States. Almost 60 per cent of Canada's exports are linked to the commodity sector, roughly double the U.S. exposure.

This explains how it is that the Canadian equity market has managed to outperform the S&P 500 this year by a cool 2,000 basis points (in this sense, Canada is basically a low-beta way to play the emerging markets via commodity exposure).

Moreover, considering that the Canadian dollar enjoys a 65-per-cent correlation with the CRB index, the added boost from the appreciation in the loonie means that an American investor putting money in Canada would have garnered a 28-per-cent gain on a currency-adjusted basis (versus a 4.0-per-cent gain from the S&P 500).

What we are witnessing is the reverse of the 1982-2000 secular bull market in U.S. equities and secular bear market in commodities, when the Canadian equity market underperformed by 87,000 basis points.

But, ever since the secular bear market in U.S. equities and bull market in commodities began in classic mean reversion nine years ago, Canadian equities have outperformed by 8,000 basis points.

If the history of long cycles is any indication, this period in which the Canadian market outperforms its southern peers is barely halfway done.

David Rosenberg is chief strategist for Gluskin Sheff + Associates Inc. and a guest columnist for Report on Business

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