Another sector where some opportunities may be emerging is in financials, particularly in the US.  Clearly the proposed Basel 2 rules for capital will not put any undue pressure on the banking system, even though those proposals may be used only as a ‘base case.’  Most banks will opt to hold substantially higher levels of capital than those mandated by Basel 2.  Despite this, banks will still have adequate capital and should be able to resume some level of loan growth again.  More importantly, though, is that mergers can still create value for the acquirors which means we should continue to see greater levels of activity going forward.  Canadian banks are more fully valued on the old parameters of earnings and/or book value, but they do have excess capital that could be used to increase dividends or look at acquisitions which could add to earnings.  Our top choices would be the major US banks, though, including JP Morgan, CitiBank and Bank of America (whose acquisitions of Country Wide Financial as well as Merrill Lynch could end up looking a lot smarter in the next upturn than they have so far).

One sector where we have taken some short-term profits though, is in the Gold sector.  If the US dollar rebounds at all in the fourth quarter on stronger US economic numbers then we could see some serious risk to the price of gold, perhaps back down into the US$1000-1100 range if a good portion of the speculators start to ‘cash in their chips’.  The gold stocks are a different story however.   Most of these stocks, outside of some of the more aggressive ‘junior’ plays, have failed to keep up with the move in gold bullion prices.  Some of this shortfall can be attributed to the miners themselves as their costs have gone up almost as fast as gold bullion due to dwindling supplies, higher finding costs for new deposits, bad decisions on hedging and some tough decisions going against them politically in some of the countries that they are mining in (i.e. changes in royalty payments to local governments and/or revenue sharing).  The net result is that the sector has badly lagged the move in gold itself and is therefore looking somewhat more under-valued than it has in some time.  This can be seen in the chart below which plots the ratio of the price of Gold to the value of the TSX Gold and Silver index over the past 20 years.  The ratio is currently about 2.6 times, well below the long-term average of 3.3 times.  Basically, investors don’t seem willing to factor a US$1350 price for gold into stocks.

The good news then is that the stocks should prove somewhat more resilient to a decline in the price of gold should it occur, although we know they wouldn’t be immune from any fall.  The longer-term play in our view would be to own these stocks.  Even if gold slips from current levels the stocks should have some protection.  If gold stays in the current range then there should still be upside in the stocks as the valuations start to reflect the current price as being more sustainable.  Moreover, the companies will most likely still find it cheaper to buy competitors than to spend the same amount of money developing new properties.  The more important thing will be to own the ‘acquirees’ rather than the ‘acquirors’, at least in the short term.  Ultimately, the acquirors should see their value increase as the growth from the mines that they buy should accrue to their valuation; at least that’s what the thinking has to be for a company like Kinross, which recently paid up a significant price to buy RedBack Mining for their prized ‘Tasiest’ mine in Africa.  Our top sector picks include Barrick Gold and Kinross Gold in the large cap group, and Iamgold, Eldorado and Yamana in the mid-sized miners.

The bottom line for us on the stock market overall is that we remain very bullish over the next 3-5 year period but have become a little more cautious in the very short term.  Stocks have had a tremendous move off the lows in late August driven by the potential for QE-2, strong third quarter earnings and extremely negative investor sentiment which provided lots of cash for the advance.  While most investors remain on the sidelines, still in shock from the events of 2008, sentiment has definitely gotten more bullish as the market has grinded higher.  The positive potential impact of QE-2 is already reflected in stocks, particularly the commodity stocks.  Third quarter earnings have once again beaten expectations but not in as astounding fashion as the prior few quarters.  Economic data should improve towards year end but that may not be enough to push stocks much higher from these levels, unless of course we see a correction in prices first!  The US Federal Reserve concludes its next 2-day meeting on November 3rd and it is almost universally expected at that point to announce specific details of its QE-2 program.  This announcement will come just one day after the US mid-term elections.  A lot of ‘rumour’ will have turned into ‘news’ by that time.  The next few weeks should continue to be very interesting!

1 2 3 4