Is Canada a Low-Beta Emerging Market Play?

Preface: for those not familiar with David Rosenberg, he is a very well known economist (some claim a relative perma bear) who made the move over from Merrill Lynch to a Canadian firm Gluskin Sheff earlier this year. While having mostly missed this rally, much of what he says deals more with the long-term structural issues we bring up rather than any tactical short to mid-term trading concepts.

Reader 'SKS' pointed us to this article from the Toronto Globe & Mail in which he makes the case for Canada as a "low beta way to play the emerging markets via commodity exposure". You will also notice the side by side "sector" weighting in the major indexes of the S&P 500 versus TSX.


Please note, from my general understanding, the Canadian banking system is dominated by 5 major banks (an argument against "too big to fail") but they are highly regulated (an argument for regulation).

• Banking in Canada is widely considered the most efficient and safest banking system in the world,^[1] ranking as the world's soundest banking system according to a 2008 World Economic Forum report.

But as the globe expands and modernizes the real juice will be in Canada's commodity exposure, very similar to the situation in Australia.

• 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.
• 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.
• 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.
• 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.
• 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.

Canada v US

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

No position

Comments

[coldcall:]

Okay being Canadian i may be biased but i believe Canada has a lot to offer right now. I agree that Canada is an excellent way to safely play the emerging economies because not only is Canada rich in natural resrouces of just about every variety, Chinese businessmen have strong connections with Canadian businesses. ie Husky Energy
Many Canadian companies are now dual Chinese such as:

Hangfeng Evergreen
Migao
Quadra Mining

and many others. These businesses because of the Chinese connections will have an advantage in emerging markets in Asia.

And of course as was mentioned Canadian banks are the safest in the world at the moment.

Go Canada!

Oct 05 07:50 AM

[John Galt:]

US Banks are highly regulated too. How good of a job the regulators do is a different question.

I do like Canada as an investment. They trade with the #1 economy on earth, they have the 2nd most real estate, they are probably top 3 in oil reserves, they have other commodities, an educated population, a more conservative (current) government than the US.

If you are going to talk up Canada, you also have to mention Australia but I agree Canada is right there and investors miss it.

I used to invest in a uranium producer CCJ back in the day and many of the smaller pink sheet juniors.

Oct 05 09:04 AM

[tripleblack:]

I have been making money with the Canadian oil patch trusts, though I have been out of that area for several months waiting for oil pricing to stabilize. Some of them have high yields, too, though I would watch some of those that don't (like PDS) to gauge the picture.

Oct 05 09:15 AM

[Uncle Pie:]

This retired baby boomer is heavily invested in Canada's oil sands. With the US currency being debased at an accelerating rate, I can't find any asset I'd rather own long term than a 40-50 year supply of oil, with NO appreciable production decline (unlike conventional oil production) and no exploration risk, sitting right next to the largest oil consumer in the world (the US). Yes there are environmental issues, cost overruns, disputes over royalties, etc., to contend with, but the long term picture is bright. The major names are Suncor, SU, Canadian Natural Resources, CNQ, and Canadian Oil Sands Trust, COSWF. This writer owns all three. Check out these companies' websites and view the investor presentations.

Oct 05 09:33 AM

[Graham and ...:]

Canada has the duel charms of emerging-markets like commodity exposure, and developed markets stability.

Oct 05 09:44 AM

[John Galt:]

I used to own CNQ back in the day and some big fund manager liked them too. I can't remember if it was Bruce Berkewitz, Heeber or somebody else. When oil prices go up these oil sands plays benefit, with lower prices or prices here they don't do as well.

I still wouldn't rule out the uranium plays longer term ( Canada, Australia, old Russian warheads, and actually Kazakstan borats home country) are the producers. If we do start to move towards nuke power like much of the rest of the world these places will benefit.

Oct 05 10:46 AM

[coldcall:]

I think CCO (Cameco on the TSX) and other Uranium plays are good for the longer term.

At some stage the world may decide that next generation nuclear plants are the lesser evil compared to oil, coal and perhaps even nat gas. Solar could unseat nuclear but it will take proper solar farms. Wind is really an inefficient joke.

In fact had the environmentalists of the 70s and 80s not made such a stink about nuclear plants we would have a far smaller carbon footprint today. So many of the folks going around moaning the loudest about global warming today were probably demonstrating against nuclear years ago. How ironic.

Oct 05 11:56 AM

[TraderMark:]

Australia is to China what Canada is to the U.S. - very similar profiles in terms of population, natural resources, land mass - difference is weather ;)


On Oct 05 09:04 AM John Galt wrote:

> US Banks are highly regulated too. How good of a job the regulators
> do is a different question.
>
> I do like Canada as an investment. They trade with the #1 economy
> on earth, they have the 2nd most real estate, they are probably top
> 3 in oil reserves, they have other commodities, an educated population,
> a more conservative (current) government than the US.
>
> If you are going to talk up Canada, you also have to mention Australia
> but I agree Canada is right there and investors miss it.
>
> I used to invest in a uranium producer CCJ back in the day and many
> of the smaller pink sheet juniors.

Oct 05 01:26 PM

[Mad Hedge F...:]

ins Hedge fund longs have been bunching up in the Canadian dollar for the past two months. Canada makes what everyone wants and doesn’t have enough people to consume it, making them a major exporter of everything hot. I bet you didn’t know that the frozen wasteland to the North is our largest foreign oil supplier. Most people guess Saudi Arabia. The Canadian supply is slated to double over the next 20 years, thanks to the environmental atrocity of oil sands. The land of Mike Myers, Jim Carey, and Pamela Anderson (note gratuitous photo below) is also a big supplier of gold, silver, lead, grain, uranium, wood, and other hard things. As for mosquitoes, they’ve got a lock on the market. Use dip to accumulate the loony. If you catch me singing “O Canada” in the shower, you’ll understand why.

Oct 05 01:38 PM

[bob adamson:]

TraderMark’s characterization of Canada for investment purposes as a ‘Low-Beta Emerging Market Play’ is very apt and I have nothing to add on that score. The comparison to Australia is also perceptive.

As a Canadian I share the opinion oft expressed of late that Canada, because of its sound fiscal and monetary policies, a well structured, capitalized and regulated banking industry, a sound real property sector etc., has avoided the full brunt of many of the current economic problems being experiences by other mature economies and that our long term future is bright because we combine the resource base of emerging countries like Brazil with the infrastructure, educated population and political sophistication and stability of a mature democracy like Sweden. A note of caution is in order however.

While we have faired very well during the first two years of the current recession and there are several concrete signs that we are emerging from it in good order, deep global recessions of longer than two years have historically impacted Canada especially hard. Because the Canadian economy is based so heavily on international trade (especially trade with the US), with a large primary and semi-processed products component, we tend to enter such recessions late but feel the full impact and emerge late as well. Canada would thus be negatively impacted in a big way by a double dip recession.

The CAN$ has appreciated about 40% relative to the US$ over the past four years. Many of our producers and manufacturers that depend on foreign trade have been negatively impacted because their production costs are paid in CAN$ and their products sell for US$. This is reaching the point where several sectors of the Canadian economy can not remain profitable if the CAN$ appreciates further. Those sectors and further CAN$ appreciation are therefore at risk. This serves to illustrate the fact that Canada’s is not a large self contained economy. While good economic management can shield us for some time and to some degree from the negative impacts of the global economy, we can not escape those impacts.

While Canada is enjoying a renaissance in its primary products extraction and semi-processing areas and in several niche fields (the entertainment industry and Research in Motion being two cases in point), Forestry and many traditional manufacturing fields are struggling. Much of the blue collar employment and industrial base is hollowing out. Other mature economies have similar problems but this trend is particularly marked in Canada over the past decade and the recession deepens this trend significantly.

The forgoing problems are more than balanced in my opinion by the positive factors mentioned by TraderMark and the others who have commented on the article. The problems are mentioned simply to give a fuller picture.

Oct 10 01:11 AM