Canada: The Industrialized Market for the Coming Decade

Though I will likely be ridiculed on the following prediction, it is hard to make a substantive argument to the contrary. But there are too many gems, overlooked stocks and strong fundamentals to dismiss the following country. Given my many articles about the inflation tsunami about to hit the western countries (with a few caveats of course), Canada, or more specifically the Toronto Stock Exchange and the Venture Exchange, could potentially perform in-line or outperform many BRIC countries.

What is the logic? I believe we are gearing up for the second leg of the commodity bull market, which will make the last ten years look like child's play. This has to do with the massive oil reserves that even many oil experts are ignorant of (more on that later) and the vast array of agricultural products that will be in demand by all the emerging and industrialized economies throughout the world. Finally, another industry I continuously promote is the mining industry. It is not that Canada is one of the top one or two mining countries, but rather the fact that the majority of the big and small players alike are incorporated here.

Oil: There is extreme value in the Canadian oil trusts, mainly because of the overreaction of the loss of the current tax-exempt status starting in 2011. Many of these companies have actual growth, which will either help or fully negate the impact of reduction to the group's bottom line. Some of the companies which come to mind are PennGrowth (PGH), Enerplus (ERP) and Canadian Oil Sands Unit Trusts.

The first two have cut their dividends to a measly 11%+. Should these prices remain for the next 5 years, I could see them yielding 20, 30 or 40% (I obviously don't expect that ). Canadian Oil Sands Unit Trust (COSWF.PK) has a substantial hand in the Synacrude project, which will pay off for years to come as the reserve base is quite large in addition to the current tapering off of cap-ex required. This leads me into my favorite aspect of Canada's oil the complex, the much hated oil sands (but that's just another reason to love it).

Yes, I know the arguments against the sands, including high cost of goods sold/manufactured, but that is hogwash. Many of them have extraction costs of $40-$45 dollars per barrel, while the less efficient producers still remain below $60. Even on a conservative estimate, with oil averaging $120 per barrel over the next decade, how can you argue a 50% operating margin is anything but great?

Oil companies aren't stupid and they understand the nuts and bolts of the industry, i.e Suncor (SU) buying Petro-Canada (PCZ) (one main reason was to dramatically increase exposure to the oil sands). Not to dwell on oil, but I've written previously about worldwide oil reserves, so that may be worth taking a gander at before the criticisms begin.

Agriculture: Wow, is this a misunderstood industry or what? Many important crops have seen very low single digit growth over the last decade while the population grows and emerging countries' demand for these products skyrockets as their standard of living has gone up. I could drag on for quite a while so I will first mention potash (which I have previously written about as well), whose mines of significant importance are found in Canada and Russia (though there are numerous mines around the world but no single country hold the quality and quantity that the aforementioned do.

One very telling sign of the increasing importance of this crop is BHP Billiton's (BHP) recent entry into the market. And of course they chose Canada. Potash is an amazing fertilizer of which many extracts can be used for a multitude of purposes. Broadly speaking, potash provides environmental protection and extremely high yields, just to name a few. To avoid all the other bi-products (see "what you should know about potash), I will add one more use that is widely used in the Asian countries and that is tobacco. Potash Corp. (POT) should be a core long term holding in every type of investors portfolio.

As I believe that wheat, corn, cotton and many others will see sharp price appreciation, the former has an amazing supply-demand disconnect and will be in high demand for the foreseeable future. This is because Australia experiences droughts like clockwork, making this market volatile. Canada also has the same problems (in terms of weather), while Europe has to grow enough for themselves and China's demand will go nowhere but up. This being said, wheat futures will likely be extremely lucrative (assuming you know the risks) and well as wheat-pooling companies such as Viterra (VTRAF.PK), who has recently purchased Australia's ABB Grain (the market share leader), thus negating the seasonality impact. Corn and cotton may be turned to as oil should oil goes back the stratosphere.

Again, I go back to the miners, though I will attempt not to ramble. Assuming a long term price of $1200 for gold (which is a lowball figure in my opinion) and $25/oz price of silver, the margins that will had by this industry will be a desired asset to have in many portfolios. Many miners have cash costs of $400/oz but assuming (for simplicity sake), the average cost is $600/oz. Like oil, a 50% operating margin will be easily achievable. The largest silver companies have cash costs now about $6-$7/oz, but assuming this number jumps to $10/oz, this will equate to a 60% operating margin; again, not to shabby.

Let's take the case of my favorite silver company, Silver Wheaton (SLW) - they have contractual agreements averaging 21 years with a 1% cap rate on cost increases to their average purchase price of $4/oz. Assuming this moves to $5, they will boast an 80% operating margin and about a 75% net margin (as they don't pay income tax) and have only a handful of employees.

All in all, I think the TSX is a place to have a portion in or significant exposure to going forward, especially if you invest via index funds.

Disclosure: Long COSWF.PK, PGH, ERP, SU, SLW, wheat futures, potash calls

Comments

[Brian O'Fla...:]

excellent article, agree completely - I'd add that the Canadian dollar is likely to substantially outperform the USD, which would further boost returns.

Sep 22 07:59 AM

[Andy1234:]

I bought heavily into the canadian REIT area.....as I also believe Canada will grow substationally in the future.

So why did I pick the reits. I do think the canadian dollar (loonie) will appreciate. But if you are mining the stuff and your operating costs are in loonies, and your selling product in US dollars.....you are now stuck with the scenario of....does the loonie appreciate faster than the commodity being sold in US dollars...or vice versa.

If the loonie appreciates more quickly....then the cost of production increases quickier than the cost of goods sold.....leading to a pinching of margins over time than an expansion....its a tough call what will appreciate more quickly.

The reits don't have this currency problem....as costs and revenue are both in the same currency.

One company that could get crushed if they don't hedge is nintendo...major sales in USD....costs in Yen.

Its just something to keep in mind.....but again....I own a lot in canadian oil sands and penn west energy, etc.....just because thats where the reserves reside.

Sep 22 09:00 AM

[Ferdinand E...:]

I'm prepared to believe anything good about the Canadian economy. Someone wrote the other day that Ontario Hydro is going on a capacity expansion binge, and if that is true - and some nuclear expansion is also possible in the near future - then that should just about give Canada the energy edge that they will need to deal with the next oil price upswing.

Sep 22 09:57 AM

[bindlepete:]

He missed one big Kahuna in the Oil Sands and that is PetroBank with their THAI process. Minimal cost , highest yelds, no water problems, minimal gas use,
minimal surface impact and huge reserves.

Add to this their Bakken investment/payoff and Columbian venture and it is a hard one to beat.

A small player but phenomenal potential.

Reserve your planeload of lovelies and buy a southern island.

Sep 22 10:03 AM

[Mistrofan:]

I am here and I can most certainly can tell you that our problems in the housing markets are almost as big as the US ones and that these problems have not been recognized, yet. For the intermediate term 2-3y CAD si Canada will be OK. But I won't bet my money after that.


On Sep 22 09:57 AM Ferdinand E. Banks wrote:

> I'm prepared to believe anything good about the Canadian economy.
> Someone wrote the other day that Ontario Hydro is going on a capacity
> expansion binge, and if that is true - and some nuclear expansion
> is also possible in the near future - then that should just about
> give Canada the energy edge that they will need to deal with the
> next oil price upswing.

Sep 22 10:07 AM

[Fred W:]

The "true" costs of extracting these "reserves" would be staggering to the Canadian wilderness. You seem to be missing the other side of the coin in this piece. Ignoring externalities and growth for growth's sake cannot be "the plan" moving forward, as it can only result in catastrophe in the end. Perhaps we can squeeze another couple of years of prosperity out of the U.S. taxpayer, but the end will be the same.
Quite simply, we are living in a zero sum world--WS has been and continues to lie to you. The U.S. taxpayer has temporarily delayed realization of this FACT with trillions of USDs. The party is coming to an end.

Sep 22 10:59 AM

[somecatchyp...:]

I don’t quite share the rosy of view of Canada held by the author and several commentators here.

Roughly three-quarters of Canadian exports go to the United States. There is growing recognition that this has to change, but significant progress will take years.

Given Canada’s over reliance on exports to the US, I’m pretty confident that the Canadian government will debase the loonie proportionally to any declines in the US dollar.

As commentator Mistrofan points out, Canada has problems brewing in the real estate sector comparable to what’s already happened in the US. In Canada, the real estate bubble is still inflating. There are still plenty that believe that “real estate is always the best investment” and “real estate never goes down.”

While Canada may be in a good position economically relative to the US, it’s hardly a rosy outlook. The old cliche up here is that “when America sneezes, Canada catches a cold.”

In the short term, Canada is very vulnerable to any downturn in the United States, until such time as the over dependence on US export markets is corrected. Over the longer term, the author identifies solid reasons to be bullish on Canada.

For more information on Canada’s housing bubble:

americacanada.blogspot...

greaterfool.ca

Sep 22 11:33 AM

[naidle:]

Canada exports about $500 billion a year. 79% of that to the US. (source: WolframAlpha)

I'm assuming you believe in the decoupling theory or do you think the US will continue to consume?

Sep 22 01:34 PM

[The Recusant:]

Better to look elsewhere for investing in a currency...Australia, perhaps? Although Canadian miners will shine regardless, due to the need for more silver, gold, and non-ferous minerals.

Sep 22 02:36 PM

[Uncle Pie:]

Let's see, USA: 2 wars, 46 million without healthcare, 12 million undocumented immigrants, scores of bank failures, imports 70% of its energy, petroleum production peaked in 1970, huge trade deficit.
Canada: no wars (except a few soldiers in Afghanistan), universal healthcare, very few undocumented immigrants, strong banking system, net exporter of energy, petroleum production not expected to peak until around 2035, trade surplus. Last month USA lost 260,000 jobs while Canada GAINED 27,000 jobs. In proportion to population, Canada gained about as many jobs as the USA lost.
In addition to the oil, mining and banking stocks, take a look at the financial conglomerate Power Corp. The US trading symbol is PWCDF. Interests in insurance, asset management, publishing, with investments in numerous other public and private companies. Low p/e ratio, good dividend yield. Long term total return to shareholders exceeds that of Warren Buffet's Berkshire Hathaway, according to a recent excellent article on the Bloomberg website. (you can retrieve this article if you go to the Bloomberg site and do a search for Desmarais Buffet). This is arguably Canada's Berkshire Hathaway (only with better performance and a generous dividend policy). This writer owns shares of Power Corp. and a number of other Canadian equities.

Sep 22 04:10 PM

[somecatchyp...:]

Naidle -

I’m not sure if your question was directed at me, but I’ll give it my two cents.

Some degree of decoupling seems virtually unavoidable. In fact, one of the key points I wanted to make is my earlier comment is that Canada urgently needs to decouple itself from the US as soon as possible.

Decoupling seems to be happening as we speak. (China stockpiling resources, urging citizens to buy precious metals, and advocating for an alternative reserve currency.)

I would venture to guess that the decline of the US will be long and slow process from this point forward. (Per Roubini) An abrupt, chaotic decline in the US dollar is in nobody’s best interest, least of all America’s creditors. Such a decline would destabilize the whole entire world. At the same time, we can’t rule out the possibility of a full blown currency crisis.

Sep 22 06:31 PM

[dsrtwriter:]

I do not see that it is in Canada's long term interest to decouple itself from the United States. Canada has absolutely no capacity to defend itself from military invasion and seizure of its assets. It takes a free ride on the shield of the U.S..

For Canada to decide that its economic interests are better served by moving under another sphere of influence such as China would ignore its long term interests in preserving democracy and freedom. Canadians and Americans would do well to spend some time reading the history of world conquests and the subjugation of peoples before they throw out strategic partnerships in favor of economics. The Chinese take a very long term view;they are not known as a merciful people to those they have subjugated.

Sep 22 07:30 PM

[realold:]

Excellent thoughts. The more that Canada provides to China, the more strategic it becomes. What would keep China from simply taking over Canada? China does not seem immune to problems and if their fantastic economic progress slows or reverses for awhile due to lack of demand or other outside factor, do the people just go back to the countryside? China will be the economic power of the century and all democracies should care a little more about what that means. Does "Poland" mean anything to you?


On Sep 22 07:30 PM dsrtwriter wrote:

> I do not see that it is in Canada's long term interest to decouple
> itself from the United States. Canada has absolutely no capacity
> to defend itself from military invasion and seizure of its assets.
> It takes a free ride on the shield of the U.S..
>
> For Canada to decide that its economic interests are better served
> by moving under another sphere of influence such as China would ignore
> its long term interests in preserving democracy and freedom. Canadians
> and Americans would do well to spend some time reading the history
> of world conquests and the subjugation of peoples before they throw
> out strategic partnerships in favor of economics. The Chinese take
> a very long term view;they are not known as a merciful people to
> those they have subjugated.

Sep 22 10:42 PM

[worriedwart:]

As the USa becomes more restrictive , more saddled down with debt, Canada will look even better

But even if America gets it together , Canadian firms as mentioned in the article and some I have picked up on like bridgewater appear to be headed in the correct direction

I also own suncor BQI on and off with GG
and i have shorted the USA banks but too much manipulation has kept that pps unrealistically high

good luck and take care

Sep 24 10:51 AM

[somecatchyp...:]

As I see it, America’s political and economic system is hopelessly dysfunctional. Without radical change, America’s military power will decline along with her economy. For these reasons, I’m not entirely certain that America will be able to function as a shield for Canada or herself going forward . In this type of nightmare scenario, amicable relations with the Chinese and other foreign powers could become much more important.

Further, I doubt the Chinese would ever militarily invade North America. This notion seems pretty far-fetched . Given the enormous cost of waging war, the Chinese would find it more economical to simply pay fair market value, rather than invade North America for her natural resources.

Rest assured, I would infinitely prefer to do business with Americans rather than Chinese. The common language, culture, history, geography, and values make this a no-brainer. Canada’s decoupling, if it occurs to any great extent, will be a matter of necessity rather than choice. Canada’s diversification of her trade relationships is simply a matter of sound economic policy and prudent contingency planning. When your best customer is going broke, utterly dependent on foreign lenders, finding new customers is not really a choice. The titanic is sinking, and, I fear my own country could drown in the vortex.

Sep 25 07:50 AM

[Hyperinflation:]

America IS broke, but the money they do have will spent on exactly the things Canada has enormous comparative advantages i.e Agriculture, Oil , and the Metals (which will be demanded by the masses once the inflation tsunami hits).

Sep 25 08:24 PM

[David Fischer:]

I disagree with much said in the article. Aside from the obvious commodities go up when USD goes down, but that is not to say these prices have to stay high due to this fact. Canada's western provinces from Manitoba to BC have not seen any downturn yet and have remained high, but not because of real demand, but rather delayed demand and a low USD. Many smart real estate investors in Canada are starting to sell their Canadian holdings and buying inexpensive foreclosures en masse in Florida, California and Arizona, 70 k for a 2000 square foot newer home, compared to 400 to 700 k in most of the western provinces. Hmm easy to do the math on this one. Most of the growth in Manitoba for instance was delayed growth from large investments, but those investments have fallen off a cliff this summer, and this will be noticed soon. Smart money will leave Canada for the US, of course the doom and gloom is still on the table, and many are not even looking in their own back yard for investments. These homes are cash flow positive, find me one cash flow positive real estate investment in western Canada, maybe in the repressed industrial areas in Ontario, but not in the west. And commodities demand will only continue to slow and supply will increase, real demand is dropping for energy in the US, and 120 oil? But I like the optimism none the less.

Sep 27 12:44 PM

[Albertarocks:]

Canada has an excellent defense mechanism that makes a military invasion by China, or the USA for that matter, a very unsavory proposition. It's called "winter". Quite literally, Canadian and Russian winters are killers.

But being realistic, if another country wanted to invade Canada, they would do so. They wouldn't survive the winter in tents, that's guaranteed, but come they might. The country is emerging as one of the world's brightest gems in a very dark Mordor-like, frightening world.

Although almost everybody seems to like Canada, kind of like a big funny cousin to everybody, it may be that what they really like is the gold in them thar hills. It's imperative that Canada broaden her field of exports, but that doesn't in any way mean an abandonment of support and continued friendly relations with the USA. But what's most troubling is the incredible speed with which outright fascism has overtaken the USA. What that portends for Canada's future may not be in her best interests, and indeed fascism's ugly head is even evident north of the 49th. The long greedy arms of the Rothschild cabal are even reaching into the vast wilderness. Hopefully they'll get chopped off in Canada, but don't bet on it. It would be best for all concerned that the USA doesn't start snarling at Canada, but rather continues to remain a good friend and trading partner.

In a perfect world, in the not too distant future, Canada might even be in a position to offer the USA some real assistance should it become necessary. I don't know exactly what form that might take, considering that Canada is still only 1 tenth the size of the USA generally speaking. But if the USA needs help, Canada will of course give it. Did I say "give"? I meant sell.

Oct 08 10:49 PM