The Systematic Erosion Of The Retirement Savings Of Canadians

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Includes: BBRY, BDRBF, BXE, COSWF, LSTMF, PGH, PKKFF, PWE, RCI, TD, WFREF, ZPTAF
by: Edward Vranic, CFA

Summary

The low price of oil has badly hurt the Canadian economy and oil sands investors; global events outside of Canadians' control will continue to negatively weigh on this industry.

Canada's position as a low debt country is overstated, and its economic dependence on oil will only make it worse in the near term.

The TSX Venture Exchange has dropped nearly 80% in five years.

I suggest that all TSX Venture-listed firms listed with the Canadian Securities Exchange try to preserve themselves.

Canadians must take an active role in trying to protect their investments, and I believe I can help with this cause.

Job losses, a low dollar, high government and personal debt, a low oil price that has destroyed Canadian investment funds but somehow managed to keep the price of gas at the pumps relatively high and a poor regulatory system that has made Canada's once-envied junior stock market into the world's biggest joke. This is the economic reality for far too many Canadians as all of these issues have come together in the systematic dismantling of their wealth. Housing prices in the major cities have remained robust, which allow Canadians -- those who own properties at least -- to have a high net worth on paper. But every other economic factor is working to slowly erode net worth, and Canadians must act swiftly to defend their savings.

Oil prices are killing mid-tier Albertan producers, and it doesn't look like it'll be over any time soon.

I have written about the risk of continuing to hold stocks like Penn West Petroleum Ltd. (NYSE:PWE) and Lightstream Resources Ltd. (OTC:LSTMF), warning investors that these two companies were headed towards restructuring if the oil price remained low nearly a year ago. With oil at decade-long lows and still no bottom in sight, it looks more likely than ever that the price will not recover until these companies are gone. I have picked on PWE and LSTMF, but there is a whole list of these mid-tier producers subject to this dire situation like Pengrowth Energy Corporation (NYSE:PGH), Long Run Exploration Ltd. (OTCPK:WFREF), Bellatrix Exploration Ltd. (NYSE:BXE) and a bunch of others. One play I feel can survive is Canadian Oil Sands Limited (OTCQX:COSWF) because of the long life of its Syncrude asset, but I'm still not a buyer at current prices. I also like Surge Energy Inc. (OTCPK:ZPTAF) as it has a prudent management team. But even if it's undervalued versus its group of peers, that doesn't help much if I fear that those group of peers is all headed to zero.

I no longer short any of these names because it's not lucrative enough for me compared to other uses for my capital, but the following chart displaying the average operating cost per barrel of oil by country should demonstrate why Canada and Canadian investors in mid-tier oil stocks are going to be the biggest losers in any prolonged oil bear market:

Source

The United States, Russia and Saudi Arabia can all dance around and kiss each other when it comes to Iran, ISIS and various Middle Eastern political interests and tensions while the world runs out of space to store above-ground oil. With per barrel operating costs of $13.50, $7.60 and $5.00 respectively, they aren't going to be the ones suffering as they all flood the market with cheap oil. It's Canada and its $23.30 operating cost that is going to be the loser in this battle.

Worldwide oil production must continue to drop. It's not going to be from state-directed dirt cheap oil dug up in the Middle East. Some of it will come from the insolvency of the United States' highest-cost producers. But I believe that the bulk of the production decline will be forced upon the most expensive and highly indebted oil sands producers as they go bankrupt, along with a similar fate for producers in other high-cost countries.

Canadian investors should not hold mid-tier oil producers trading under $2 expecting a miraculous turn of fortunes. There is a reason why they have dropped around 90% in the past 18 months. What's worse is that I believe the job cuts seen in the oil industry and particularly in Alberta are nowhere near finished. The mid-tiers have scrubbed capex costs as much as they possibly can. The next step is the outright halt of production as companies either proactively enter into care and maintenance mode to conserve cash while they remain on life support until the oil price recovers or they just simply run out of cash and have to go into receivership.

When the global economy nearly had a meltdown in 2008, at least the price of gas declined to $0.60 to $0.80 CAD per liter in response. This provided some temporary cost relief at a time when it was desperately needed. The ultimate slap in the face to Canadians is that not only have their savings been ravaged from investing in commodity-focused investment funds, but they are still somehow paying around $1.00 per liter in gas. This is only about a 30% discount from 2014 highs of about $1.30 to $1.40 per liter.

The high price at the pumps is being blamed on the steep decline of the Canadian dollar (despite Canada being an oil exporter) from nearly par to the U.S. dollar to about $0.70 while oil has dropped. This has also caused the price of food that's imported to rise, and made it more expensive to travel or buy goods online from an international source. So a family that wanted to feed their kids a proper meal and provide them a good Christmas probably had to dip into their savings this past year more than what they would have liked.

The drop in the Canadian dollar is pointed out by some desperate bulls as a silver lining for the oil sands companies. Their operating costs decline as workers are paid in $CAD but the oil is sold in $USD. Yippee, that has really helped the situation! A stock like PWE has dropped 93% from $10 to $0.70 over the past year and a half, but Canadian investors can take solace that its Canadian dollar equivalent PWT.to has dropped only a mere 91% from $11 to $1 during the same timeframe. That extra 2% in avoided value erosion is really worth the extra 30% being paid at the pumps!

Canada's debt isn't as low as it appears and I believe the politicians don't realize it.

The Federal Liberal Party -- unlike its two closest competitors the Conservative Party and the New Democratic Party -- ran on a campaign that did not promise to balance the budget in an election that took place last fall. The rationale behind it was the long-held belief that Canada has the lowest net debt-to-GDP ratio of any G7 country and that it can afford to increase its debt in a low interest rate environment. A National Post report in 2013 uncovered certain flaws with this myth, showing that gross debt is actually 13th highest among the world's 30 most advanced countries when excluding public pension surpluses.

Net debt estimated by each province had Canada's two large eastern provinces Ontario and Quebec on the high end of the spectrum, with the national average being held down by Alberta's very strong position. With the oil price being in the gutter in the two years since then, Alberta's position as a low-debt province is in peril. The low Canadian dollar should help revive Ontario's struggling manufacturing sector, but who knows how long it will take to pick up Alberta's slack. Canada's legacy as a low debt country, particularly with such a low oil price for an extended period of time, no longer applies and the new government should govern with that in mind before going on too much of a spending spree.

Promises by the new Liberal government to keep deficits of no more than $10 billion a year and an income tax shift from the middle to higher class for a net neutral effect already appear in peril as they were made when oil was $20 higher. Canadians should expect the debt to increase substantially, which will only eat further into income and/or limit social programs in the future.

The pro-oil economic and environmental policies of the previous Conservative government encouraged a province like Alberta to focus on oil production instead of aggressively diversifying its economy while things were going well. It depended on the acceptance of the Keystone XL pipeline project, making Canada's economic future even more dependent on policies of the United States. The low oil price has resulted in severe job losses in Alberta and penny stock status for Penn West, Lightstream and many others. Investors and employees would have still lost nearly everything either way, so Canada might as well have loaded them up with carbon and income taxes, which would have added to the government's revenue stream and promoted more stringent environmental safety measures. I hope that in the next oil boom, government and industry will be more responsible so that the country is not subject to such an extreme boom and bust cycle.

The Conservatives created the Tax Free Savings Account [TFSA] in 2009 as a mechanism for Canadians to accumulate interest or dividend income or capital gains without being taxed on the profits. It was a great policy to implement, but the problem is there hasn't been an economic climate that would result in consistent investment gains for those who chose to took advantage of this great savings tool. The annual contribution limit to an individual's TFSA was raised to $10,000 from $5,500 last year (since reversed), but what good does that do if people invest it in a resource stock and promptly lose 50%?

Canada weathered the 2008 recession better than any other major country. However, Canada is taking the global economic slowdown of 2015-16 worse than any other major country. A slowdown that's not even a slowdown for the United States as it is finally in interest rate-raising mode.

The TSX Venture: The broken exchange that's down nearly 80% in five years.

The TSX Venture Exchange use to be a source of pride for Canadian investors. It use to be proudly described as an exchange for micro caps that's superior to the wild west of the OTC and a bastion for exploratory resource investment. It use to be home to more than half of the world's junior resource companies (it probably still is by default). But this chart tells you all you need to know about its recent struggles:

Click to enlarge

The Toronto Stock Exchange has by no means done well over the past five years, dropping over 10% from about 14,000 to about 12,350. This is especially true from the perspective of foreign investors who had to deal with an unhedged $CAD currency drop. But its junior cousin has done the seemingly impossible -- dropping 79% from 2,400 to 500 during that timeframe. Let that sink in for a moment -- an ENTIRE stock exchange that resides in a stable first world country has declined 79% in the past five years!

An investor exclusively in Canadian equities would have had to be an elite stock picker just to break even on the busted Canadian markets recently. Consider that some people have actually made money (not to toot my own horn, but I'm one of them) investing in Canada. Take those people out of the average and you're left with a bunch of investors who have lost 25%, 50% or possibly more of their savings. We're not talking about undiversified peak oil barons or gold bugs either, although they certainly belong in this category too. Someone who invested in a diversified portfolio of Canadian stocks that featured Penn West, Bombardier Inc. (OTCQX:BDRBF), BlackBerry Limited (NASDAQ:BBRY), Rogers Communications Inc. (NYSE:RCI) and The Toronto-Dominion Bank (NYSE:TD) lost around 50%, with the former three being absolute bombs and the latter two providing decent dividends while the stock prices remained flat. Now throw in some junior stocks from the exchange that lost 79% over five years into that mix.

Incredibly, there are actually people who celebrate the demise of the TSX Venture Exchange, believing it is nothing more than a home for scam artists or lazy CEOs of unprofitable firms to dilute, collect an easy pay check, reverse split the stock then dilute some more. Some necessary culling must take place, but just because there are a few bad eggs who know how to take advantage of the system doesn't mean that this should kill the speculative nature of the market.

The TSX Venture is supposed to house promising pre-revenue and unprofitable startups so that they can get the capital they need at a reasonable price to grow the business and eventually graduate to the TSX. If a company is spinning its wheels after five or more years, digging up nothing but dust or dirt as an explorer or unable to monetize its intellectual property or work through its business plan, then sure, perhaps investors need to turn off the taps and let the company expire. But stocks on the TSXV are being hammered down to small percentages of their original listing value just a few months or a year later. They aren't even given a chance to try to make their business plan work. And those who are advancing at a good pace still have a struggling stock price until they can demonstrate or close in on positive cash flow and no longer need to finance.

While some people view this as a conspiracy, there is very compelling evidence to suggest that banks and other large industry players are taking advantage of fragmented and insufficient regulatory oversight to short the junior exchange into oblivion. An article from Equedia titled, "Why the TSX Venture is Failing" dives into Canada's multiple parallel trading platforms, which makes it impossible to enforce the uptick rule on shorts. Trading bots owned by banks can take advantage of this and short cash-flow negative stocks at will, no matter how promising their prospects. The banks know these companies will eventually need to finance and they can force their hand at weak market prices in order to cover, if needed.

The Venture Capital Markets Association has also gone on to blame the Investment Industry Regulatory Organization of Canada [IIROC], which is controlled by the big banks in Canada and is designed to protect investors from deceitful trading and companies. The VMCA believes that the issue is that the banks have no interest in speculative juniors as they cannot provide short term profits. It also states that IIROC makes it difficult for older individuals to invest in private placements of Venture companies no matter how small of an investment they intend to make relative to their overall wealth, because high-risk, high-reward speculative plays aren't suitable for them. The final nail in the coffin is the high fees related to listing and other administrative duties, causing companies to use up a large portion of their funds in admin work instead of using it to, for instance, drill a few holes on a promising property.

I speak from personal experience when I say that there is merit to these arguments that the banks are trying to profit either by outright mercilessly shorting juniors or making it difficult for them to access capital because they decided it's too risky for certain investors to get involved. A stock that I have followed closely over the last two years is Peak Positioning Technologies Inc. (OTCPK:PKKFF) (PKK.C). Like many other Venture-listed stocks, it sat in purgatory on the TSXV, trading mostly at 1 or 2 pennies with occasional spikes on interesting news that lasted only a few days before the stock slid back down. In October, Peak decided to leave the Venture in favor of the Canadian Securities Exchange, an exchange known for its less strict and cheaper listing requirements with apparently no high frequency trader programs manipulating its stock listings.

Since Peak has joined the CSE, and in conjunction with positive business developments that were in part enabled by moving to the exchange, the stock has steadily increased from 2 to 5 cents. I watch the trading daily, and I can confirm that it looks honest, with no HFT bots or dark pools hammering retail investors. For instance, if someone was to buy 100,000 shares off of the ask at 5 cents, I would see the ask lots drop by that amount immediately. On the Venture, I often saw trades that were accompanied by simultaneous changes to the bid and ask, sometimes by multiple brokers. I believe that this is a sign that bots were controlling the price of the stock as opposed to real investors who actually take the time to understand the story of the stock in which they invested.

I suggest that every junior listing on the TSX Venture voluntarily de-list and re-list on the Canadian Securities Exchange and that every investor who reads this contact the management teams of their investments to encourage them to do so.

I know that investors, particularly institutional investors, would see this as a downgrade and may be encouraged to sell any company that made this move. I would suggest to those investors to reconsider as I strongly believe that the CSE better serves junior companies. Whatever perception of the CSE being an inferior exchange to the Venture will be short-lived as basically every broker (except Disnat) allows for online trading of CSE stocks. Investors can take a move to the CSE as a sign that management is willing to do what it takes to maximize long-term shareholder value, even if the perception may imply short-term pain. Peak did and look what has happened to it just three months after making the switch.

Politicians have very little incentive to stand up against the policies of IIROC and the big banks. I believe that the TSX Venture has been slow to act on its own deterioration and management teams of legitimate small cap businesses and retail traders must make a stand and threaten to leave in favor of the CSE, thereby possibly initiating more action by the exchange to protect its companies from manipultive trading or risk losing business.

How I have weathered this storm in the Canadian markets and economy and my final thoughts for Canadians.

As I mentioned above, I am one of the few investors who can claim to have made money investing in Canadian small cap stocks over the past several years. My TFSA, an account that I have contributed the maximum allowable $46,500 since 2009, stands at $136,000 as of January 10, a near triple. I believe I have a good handle on the Canadian junior markets as evidenced by my fairly decent success. If anyone wishes to follow my stock picks and analysis specific to Canada, please follow my newly created site at www.evranic.com. I wish to discuss with Canadian investors ways to preserve our wealth and how to protect the integrity of our markets.

For any Canadians who have struggled trying to build retirement savings as our stock market and economy have hit the dumps, I say take as active of a role as possible in your investments. Realize that many oil companies on the junior and highly-leveraged end of the spectrum are very likely doomed and there's not much we can do about it as the global market forces are having their way with the higher-cost oil sands. But I believe there are plenty of opportunities to make money, particularly on rising small cap tech stocks that have a clear path towards profitability and a strong balance sheet. There are also no shortage of miners and explorers with strong balance sheets and compelling properties that make cheap speculative investments with high upside if commodity prices recover.

What investors can't do is hold a stock and sit idly by, waiting and hoping. Demand more from your investments, more from the management teams that get paid so well to maximize shareholder value, more from the exchanges that house them and more from the regulators who are supposedly there to protect us. The term "activist investor" is gaining in popularity as billionaire hedge funds often seek membership to the boards of their investments, or at least seek to influence them. Canadian investors should strive to become activist investors to try to positively influence their small cap investments. Because if you don't defend your own investments, no one else will.

Disclosure: I am/we are long PKKFF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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