Canadian Energy Trusts: The Best Long Term Income and Dollar Hedge?

by: Cliff Wachtel

The High Dividend Stock Investor's Collapsing Dollar Survival Guide, Part 7A


Before ever considering investing in stocks, we must always first look at the overall market, since almost all stocks follow the major indices. See Part 6A, Market Update: Warning: Do Not Feed (Yourself to) the Bears for full details. In short, we remain in a confirmed downtrend.

Treasury Secretary Geithner’s plan has revived the rally, but we’ve seen lots of short lived news driven rallies recently. Still, the idea of incentives to private investors to takeover questionable debts is a step in the right direction, since the government should not be in the financial services business any more than absolutely needed.

A. Ramifications for High Dividend Stock Investors

The overall trend continuing down, so use the current rally to unload unwanted stocks or pick up some partial short term hedges in the Ultrashorts at the following strong support levels, with sell stops about 10-15% below strong support in case the rally is prolonged, you’ll get out with small losses. Continue to invest only with funds allocated for longer term investment that you don’t need for the next six to eighteen months at least. What you buy now may well go lower.

  • UltraShort S & P 500 Proshares (NYSEARCA:SDS) – Buy under $75, Strong Buy under $65: GETTING VERY CLOSE
  • **UltraShort Financials ProShares (NYSEARCA:SKF) -- Buy Under $121; Strong Buy below $105: CURRENTLY AT STRONG SUPPORT! BEGIN TAKING POSITIONS
  • UltraShort QQQ ProShares (NYSEARCA:QID) – Buy Under $55, Strong Buy under $50
  • UltraShort Real Estate ProShares (NYSEARCA:SRS) – Buy Under $58, Strong Buy under $48
  • UltraShort Russell2000 ProShares (NYSEARCA:TWM) – Buy Under $75, Strong Buy under $65: CURRENTLY AROUND $73 BEGIN TAKING POSITIONS.

If you look at a chart for these, you’ll note my buys are very conservatively low. Before the current rally some readers suggested we would never see them. Guess what – many are already at or approaching these strong support levels. The SKF is already below and worth at least a small position, since there is renewed optimism regarding the financials, yet they’re far from resolved. USE SELL STOPS as noted above, since these can quickly cut against you.

1. Continue to Take Partial Positions at Our Recommended Strong Support Levels

Beyond the Ultrashort ETFs if you can earn reliable dividends from 8-12 percent or more while you wait for recovery, ongoing investment makes sense. As noted above, with a confirmed downtrend and likelihood for further declines, refer to our below recommended buy levels, which are at strong support levels.

2. Use Sell Stops?

While our emphasis is buy and hold as long as the distribution is safe and fundamentals hold steady, some may want to hedge their bets, especially if they may need the cash within the next year or so. It helps preserve capital, but only if you then buy back before the price exceeds your sell price. Most don’t time the market well.

Again, our focus is on getting high yields from healthy businesses whose price will recover while we earn outsized returns, and we don’t try to time the market too much.


See Part 1 and Part 2 of this series for the full story.

Recently China has openly called for replacing the dollar with a special newly created basket of currencies. Given the practical difficulties involved, this is unlikely to happen in the near future, and the Chinese know it. However, it must be noted by those with major USD holdings as a sign of things to come. There are lots of big players and governments holding mountains of dollar assets, and they can’t be happy about exploding supply of greenbacks.

It’s an ominous sign for the U.S. dollar. Unless the Obama administration does an extraordinary job in restoring stability and confidence in its currency, one of the long term ramifications of this U.S. – ignited world crisis will likely be a long term decline in demand for the USD as the large investors prudently seek to diversify out of the USD and limit their currency risk.


See Part 3 for the full details, but here’s the summary.

We’re seeking stocks of strong companies that mostly earn and distribute a high dividend in a non-USD currency and have a dominant position in a market for an essential product or service.

In this installment, we’ll begin exploring opportunities in the best single country in the world for stocks that combine high reliable dividends and USD hedge, Canada.


For those seeking to diversify out of the USD, the CAD is one of the best alternatives.

A. Grand Banks

Perhaps the most compelling reason to have a stake in the Loonie is the banking system behind it. Unlike most of the world, the Canadian banking system is a source of relative strength. Due to more effective regulation and conservative management, Canadian bank avoided subprime lending. They were not allowed to shift capital into more speculative businesses and endanger their overall health.

Thus the Canadian financial institutions will not be costing taxpayers trillions in bailouts. Loan default rates remain low, the banks’ finances and deposits are sound, and credit is available. Fourth quarter results far exceeded expectations on Wall Street and Bay Street. Most dividends were well covered or affirmed based on expected improving conditions later this year. Profits did suffer due to asset write downs, but the need for government assistance has been limited. The better Canadian real estate firms are actually performing relatively well.

Thus supply of CAD will not be expanding by orders of magnitude, unlike the USD, for massive bailout programs, and the CAD should retain its purchasing power far better.

Last year, a group of international banking experts was formed called The Group of Thirty. In January, this panel of former central bankers, finance ministers, and academics chaired by former US Federal Reserve Chairman Paul Volcker, issued a report with recommendations for repairing the world financial system and preventing a similar crisis in the future.

The report, Financial Reform: a Framework for Financial Stability, essentially recommended imitating much of the Canadian banking system. Its recommendations included:

  • Imposing capital limits on bank run trading operations.
  • Barring large commercial banks from running hedge funds and private-equity firms that mix bank and client funds.
  • Tightening government oversight of other kinds of financial institutions like insurance companies, investment banks, and broker-dealers.

In short, the report argued that because the financial services industry is so fundamentally essential to economic stability, it become more like the regulated utility industry – dominated by fewer, well capitalized players with more government supervision to preserve their health and continuity, albeit at the expense of avoiding more potentially profitable but speculative and risky businesses.

B. The Loonie Is a Commodity Based Currency

Because commodity exports are such a large part of the Canadian economy, the CAD tends to follow prices of energy, and other key commodities like grain and iron ore, etc. Thus they have all fallen together in the current slowdown.

However, as world populations continue to expand, even less than robust recovery will ultimately drive essential commodities higher, and so too support a rising Loonie.

Of course, there are other factors influencing how the CAD and USD fare against each other and other currencies, and the Australian Dollar shares much of the CAD’s USD hedge characteristics. Nonetheless, the CAD is a compelling hedge against the USD.

5. Canadian Oil and Gas Producer Income Trusts - The Big Picture

A. The Short Version

The best of these already have the price and dividend cuts behind them, still pay high yields at current prices, and probably will continue to do so even if there are further dividend cuts. They will likely double or triple both yields and prices as energy inevitably recovers. Thus for those who can wait 12-18 months, these stocks have the highest likely price appreciation potential of any high dividend stock.

However, the near term bears further downside risk.

B. The Longer Version

Except for those with some limited price hedging, however, revenues for energy producers everywhere have indeed deteriorated dramatically along with energy prices (oil from $150 to $40- $50 a barrel and lower, gas from $13 to $4 per MMBtu). Virtually all of the following recommendations have suffered stock price and dividend cuts of similar magnitudes, in order to preserve cash for survival and/or continued developing new supply sources and maintain/grow their reserves for future growth. All could cut further if energy temporarily dips much lower if there is a short-term supply glut.

Current prices for oil and gas are about USD 50 and USD 4. For perspective, these prices are well below global replacement costs for oil and gas (USD 80 and USD 8) and well below production costs for non conventional sources like tar sands, shale, and offshore drilling.

Thus we’re seeing unprecedented and continuing global supply destruction as much current and planned production is being reduced or halted.

The obvious good news is that this supply destruction makes future energy price recovery and new highs virtually inevitable as economies recover. When that happens, these energy trusts will recover their prior prices and dividends.

In Part B, we’ll look in detail at the following best selections for this group, and how the new tax regime coming in 2011 will likely affect them.

Note: All amounts quoted are in U.S. Dollars unless otherwise noted. All stock symbols are New York Stock Exchange unless otherwise noted. Yields are as of the day prior to publication.

C. Energy Income Trusts – Specific Recommendations

See Part B for full details on each and a look at how the new Canadian tax laws for 2011 will likely affect them.

The short version is that these are great long term income plays with some of the best appreciation potential of any income stock. However, short term risks include further new price lows (especially with the current rally) and dividend cuts if energy prices drop again.

Take only partial positions until energy prices appear to have stabilized, but be ready to load up on these as the market begins to show interest. Both prices and distributions will soar as energy recovers, giving you high yields and capital gains.

  • Advantage Energy Income Fund (NYSE:AAV). UPDATE: Has suspended dividends until further notice. It chose to use cash to continue development and not jeopardize present survival or future growth. The smart move, but income investors were not pleased. Its current price is at about a fifth of its reserves value. Hold if you can, or sell for loss but watch, it will be back.
  • ARC Energy Trust (OTCPK:AETUF): Buy under 13, Strong Buy under 10. Yield 19% prices in dividend cut, which with current payout ratio around 40% seems unlikely unless energy falls further. Reserves expanding, debt and costs falling.
  • Claymore/SWM Canadian Energy Income Fund (NYSEARCA:ENY): Buy under 10, Strong Buy under 8. Yield over 10%. For those that want to buy a basket that attempts to mimic this sector. Unfortunately, many good assets are not widely traded enough for this fund, which is why I prefer to cherry pick individual stocks.
  • Enerplus Resources Fund (NYSE:ERF): Buy under 20, Strong Buy under 16. Yield over 9%. One of the best choices of the group.
  • Provident Energy Trust (PVX): Buy under 4, Strong Buy under 3. Yield over 14% after the recent 33% dividend cut. Financially stable.
  • Vermillion Energy Trust (VETMF.PK): Buy under 19.25, Strong Buy under 18.25. Yield 9.7%. One of the best of the group.
  • Peyto Energy Trust (OTCPK:PEYUF): Buy under 7, Strong Buy under 6. Yield 17% after the recent 20%, dividend cut appear safe, barring further energy price drops. Expanded reserves to17 years, an industry best. Finances solid.

Disclosure: I have positions in most of the above mentioned investments.