Fabrice Taylor, CFA, publishes the President's Club investment letter. His letter and The Globe and Mail have a distribution agreement. You can get a free copy here.
Euphoria often dies hard. That means there's still time to get out of commodities, but the clock is running down quickly.
Resource stocks—ranging from big, dividend-paying names like Canadian Oil Sands and Teck Resources to fledgling exploration companies—have been very good to Canadian investors over the past decade. Although they were routed by the 2008-2009 financial crisis, many bounced back.
But commodities are, at the end of the day, a bet on global economic growth. Demand for the marginal unit—the next barrel of oil, pound of copper or whatever—ultimately sets the price for all sales. That means that a very small drop in demand, in the absence of a drop in supply, can really hammer prices.
The rout may already have started. Look around the world and major economies everywhere are on life support. The United States is stagnant, Europe is shrinking and the BRIC countries (Brazil, Russia, India and China) are slowing.
The slowdown has already squeezed the bottom lines of many global mining giants. Anglo-Australian behemoth Rio Tinto's profits declined by a third in the first half of this year. Vancouver-based Teck Resources' second-quarter profits fell by half, despite higher coal sales and record copper production. In other words, the company sold more stuff, yet it earned less.
Teck's share price has declined by about a third over the past year, yet the dividend yield is still just 3%. So, don't expect the income-seeking crowd to come to the rescue. If nothing changes, the stock is headed even lower.
What could change? Resurgent economic growth would boost commodity demand. But where would that surge come from? In Europe, politics—and hence economics—is still based on entitlements, and the morass will take years to fix. Japan's demographic problems are slowly killing its economy, which is also fraught with debt and political incompetence. The U.S. is creating few jobs and government debt is overwhelming.
That leaves the BRIC countries. In August, Citigroup cut its forecasts for GDP growth in India this year by a full percentage point. The IMF's forecast for Russian GDP growth is 4%, about half what it was before the financial crisis. The country is very vulnerable to any further drops in oil prices.
Economists are also ratcheting down growth forecasts for Brazil, despite repeated interest rate cuts by the central bank. One reason: China is slowing down and buying less Brazilian iron ore, steel, soybeans and whatnot.
Indeed, Chinese stock markets hit a three-year low in July. True, GDP growth is still in the high single digits, but the direction of the latest forecasts is down.
All of this is exceptionally bad news for commodity prices. Yet many investors and mining executives are complacent or in denial. The drop in Teck's share price over the past year has been full of sucker rallies, as punters who missed out on the big run-up saw opportunities to buy in— wrongly, as it turns out.
If you're sitting on paper losses in your commodity stocks—hoping forlornly for a turnaround—it's still not too late to get out. It's tough to take a loss, but it's worse to wait and then have to take a bigger one.
Loyalist Group Ltd.
Revenue increase in 2011: 428%
Everyone wants to learn English—Asians, Saudis, Russians, Brazilians and so on. And they want to learn it in English-speaking countries. Total ESL tuition revenue in Canada alone is about $700 million a year, most of it collected by mom-and-pop schools. Toronto-based Loyalist Group is consolidating the industry by buying up schools and wringing impressive synergies out of them. Insiders own lots of its stock, and billionaire investor Seymour Schulich recently bought a whack of it.
Armtec Infrastructure Inc.
Increase in EBITDA during the second quarter of 2012: 432%
Guelph, Ontario-based Armtec almost hit the debt wall last year. But the company is putting its house in order and looks poised to resume its former glory—well, to some degree. Armtec makes infrastructure products—pipes, precast concrete wall panels and the like. Those are the kinds of things governments like to buy when economies slow down.