O Canada: Investing in the World's Safest Economy

|
Includes: CCJ, EWC, SU, TCK, TD
by: Martin Hutchinson
I've said it once, and I'll doubtless say it a few dozen more times before the U.S. economy returns to health: Just because you have to endure recessionary conditions doesn't mean that your money has to.

That's the argument I make when I urge Americans to search for investments outside U.S. borders. Ironically, your money doesn't have to travel all that far: What's arguably the world's "safest economy" is actually located just north of the border. I'm talking, of course, about investing in Canada.
The United States vs. Canada

With the U.S. economy dragging along huge budget deficits and stuck in low gear, it's time to escape these problems by moving money away from this market.

I have written many times about the importance of escaping U.S. problems by investing abroad. But for those who don't wish to wade through Korean financial statements or Peruvian mining statistics, Canada represents a simple alternative.

In fact, it really has a lot in common with its neighbour just to the south - except for two major differences:

  • Canada's economy is backed by a rich cache of oil, gold and other in-demand natural resources.
  • And Canada's leaders didn't permit the outgrowth of an avaricious and out-of-control financial sector that then had to be bailed out with a series of budget-busting bailout/stimulus packages.

The annualized second-quarter-growth rate of 2.0% in Canada didn't much beat the 1.6% advance of its U.S. counterpart. But Canada's final demand growth - at 3.2% - was more than triple the tepid 1.0% move reported for the U.S. economy.

That's an indication that Canada's economy, though weighed down partly by its neighbor's weakness, is recovering more robustly.

As noted, Canada's banking system is more tightly regulated than its U.S. counterpart, so it indulged itself much less intently in the subprime-mortgage and financial-derivatives shenanigans that brought the U.S. system down. That means that the Canadian housing and mortgage markets are in better shape than those of the United States, because there are fewer foreclosures.

Canada's government was less self-indulgent in "fiscal stimulus" at the bottom of the recession, so its 2010 budget deficit projected by The Economist panel of forecasters is only 4.5% of gross domestic product (GDP) compared with 8.9% of GDP in the United States.

Canada's current account deficit, forecast by The Economist panel at 1.8% of GDP, is little more than half the projected U.S. deficit.

It doesn't hurt either that the Bank of Canada, instead of trying to figure out ways of lowering interest rates below zero, has begun to raise them instead; a 1% short-term rate doesn't encourage savings much, but it sure beats the U.S. target rate, which has been at 0.00% to 0.25% since December 2008.

As well as being better balanced fiscally and monetarily than the U.S. economy, the Canadian economy has a relatively larger resources sector, a big advantage when energy and commodity prices are being propelled higher by Asian demand.

Profit Plays North of the Border

There are a number of possible approaches to investing in Canada. One is to buy the market as a whole, investing in the Canadian market exchange-traded fund, the iShare MSCI Canada Index ETF (NYSE: EWC). This ETF has a Price/Earnings (P/E) ratio of 14 and a dividend yield of 1.6%, so the Canadian market overall is reasonably priced.

Back in October 2008, during the worst of the financial crisis, the World Economic Forum rated Canada's banking system as the safest in the world.

So it makes sense that a second possible approach is to buy one of the five large Canadian banks, where - because of better regulation - Canada has a clear competitive advantage over the United States. Of these five, I like the Toronto-Dominion Bank (NYSE: TD) the best. Toronto-Dominion shares are trading at 14 times earnings, with a nice dividend yield of 3.3%. Its Price/Book Value (P/BV) ratio is a reasonable 1.8, while its P/E actually drops to 10.6 on projected 2011 earnings.

Betting on the entire Canadian economy is a good bet, and will likely pay off nicely. The same is true of Canada's strongest banks. But if you really want to play to Canada's strengths - while also riding the most powerful long-term growth opportunities available to global investors today - then commodities and natural resources are the Canadian investment plays to make.

One resource whose importance is escalating is uranium, chiefly because of rising demand from reactor programs in China and elsewhere. As you know, one economical approach to battle global warming is to build more nuclear reactors, and those will require uranium to operate - thus the price of uranium is likely to be strong. While Australia's reserves of uranium are double those of Canada, Canada still has 9% of the world's known uranium reserves, meaning it will be a major producer for decades to come.

Indeed the world's largest uranium mine is the McArthur River mine, operated by Cameco Corp. (NYSE: CCJ), Canada's largest producer. Cameco shares are currently trading at 10.8 times trailing earnings, so it is reasonably valued, given the upside potential.

Canada's most important strategic relationship with the United States is in the supply of energy, both from conventional oil and gas and from the Athabasca tar sands deposits in Alberta.

Of the Canadian oil plays, I most favor Suncor Energy Inc. (NYSE: SU) because of its position as the most important producer of tar sands oil. This is only modestly profitable at current oil prices. But if prices run up, or if a global crisis restricts supplies, Suncor's tar-sands holdings can be expected to increase hugely in profitability. Suncor shares were recently trading at 19 times trailing earnings, but only 13 times expected 2011 earnings.

Finally, in Canada's very important minerals sector, I like Teck Resources Ltd. (NYSE: TCK), which is a major producer of coal, copper and other metals. And that's not all: Teck Resources has the Chinese government's China Investment Corp. sovereign wealth fund as a strategic 17% shareholder (one of CIC's few really profitable deals, up more than 100% since it bought in close to the bottom of the market).

Teck is trading at a remarkably reasonable 10.4 times earnings, and is due to benefit further from the inexorable rise in copper prices, and from completion of coal infrastructure enabling it to ship efficiently to the Chinese market from Canada's West Coast.

Through holding these or similar Canadian shares, you can diversify from the US economy, taking advantage of Canada's remarkable mineral and energy resources and its superior banking system. Truly, this trip north of the border - into what is arguably the world's safest economy, is well worthwhile.

Disclosure: None.

Original post