Sector Review: Gold, Railroads, Tech

by: Larry MacDonald

Stocks are influenced by variables at the company, industry, and macroeconomic levels. Here is a look at trends for selected industry groups, excerpted from a publication prepared by TD Newcrest analysts.

Base metals: Over the next 12 months, we believe that there are several reasons to be positive about the outlook for base metals and base metal equities, including: metal inventories are low throughout the supply chain; investors are increasingly looking to commodities as a hedge against inflationary pressures and a weaker U.S. dollar; and the credit crunch will continue to delay mine development, thereby muting a supply response from mining companies once demand does rebound. In 2010, we expect metal markets to be more settled as a new normalized level of supply and demand becomes apparent.

Gold: We continue to remain bullish on gold over the longer term, given its positive fundamentals, namely: flat mine supply, an inflationary environment, and negative U.S. real interest rates. Over the next 12–18 months, we expect the gold price to trade in a range of S$850–1,100/oz. We forecast that gold will average US$945/oz in 2009, US$1,000/oz in 2010, and US$950/oz in 2011. We project a long-term price of US$900/oz, based on our view that higher gold prices will be required to justify the development of the next generation of large gold mines.

Railroads: Notwithstanding recent industry volume weakness, North American railroads continue to enjoy relatively strong pricing power due to tight rail capacity, improved service levels, and the relatively competitive position of railroads over trucks. Fuel price and foreign exchange, which have presented substantial headwinds in the recent past, provided tailwinds for CN and CP in Q1/09 and Q2/09. Slower growth in the North American economy may continue to create some short-term pressures; however, our longer-term outlook on the sector remains positive.

Insurance: As well, we prefer the life insurance companies over the banks, primarily due to relative valuation discrepancies. In our view, we see attractive upside, with valuation discounts more than accounting for the risks associated with current macro conditions, uncertain equity market and credit outlook. Longer term, we like the Big Three (in Canada) insurers’ exposure to potentially higher growth markets like Asia and Europe. We also believe the group is well positioned to benefit from a demographic shift and increased demand for wealth transfer and payout versus accumulation type products.

Engineering and Construction: While forecasts are for a decline in business investment in non-residential construction, we believe the stimulus packages proposed in Canada and the U.S. may allow the public sector to offset most (if not all) of the pending decline on the private side. This bodes particularly well for the companies in our coverage universe, as several earn a majority of their revenues from the public sector. Interest rates, which have been and are largely expected to remain low for some time, are also positive as they create a more conducive environment for undertaking large projects.

Communications: Many other sectors seem to be shrugging off weak earnings as a lagging indicator, but for some reason investors have not given this same treatment to telecom and cable stocks. We believe this leaves our sector well positioned for positive earnings surprises over the next year if the recent green shoots evolve into a full blown recovery in the housing market and consumer spending. And if the macro environment takes another turn for the worse, we are confident that the downside in our names will be limited because the stocks have not enjoyed much of a rally, and because they still have strong balance sheets and high dividend yields.