Market Observations (Energy, Golds and Base Metals)
Energy E&Ps (OW): freeze or no-freeze? Who knows? What seems clear though is that many investors believe that whatever the outcome at the Doha meeting this week-end, this could be a typical “sell-on-the-news” event for oil prices. This is possible especially if crude keeps rallying this week. However, judging by the last production cut accord between OPEC and non-OPEC countries announced March 23, 1999, dips in oil prices should be shallow. Indeed, Figure 1 shows that crude fell slightly on March 24th but rose ~70% by year end. The TSX energy index rose 21% and the CDN$ 4.4%. Of course, a production freeze (rather than a cut) should lead to more muted results. Nevertheless, investors should focus on the medium-term outlook for oil prices. As we wrote in the April edition of the Quantitative Strategist, we believe the IEA underestimates 2016 world oil demand by ~0.4MMbbl/d and overestimates production by a similar quantity. If our calculations are right, we arrive at a global oil surplus of ~0.7 MMbbl/d in 2016 compared to 1.6MMbbl/d for the IEA. Therefore, dips in oil prices upon an OPEC-freeze announcement should be used as an opportunity to add exposure E&Ps. Investors can buy energy exposure through the XEG-T ETF. Otherwise, the top-5 rated Canadian E&Ps by the Quest® triAngle are GTE, RRX, VII, PSK and CNQ.
Golds (OW): Phase 1 of the bull market maturing. The TSX gold index is up nearly 60% YTD. Time to book profits and jump ship? Not yet if you are a long-term investor considering that secular bull markets in gold equities usually contain two distinct phases (Figure 2). Also, a secular bull market in golds has occurred at least once per decade since 1970. The gold cyclical rally that began last summer is Phase 1 of what should be this decade’s bull market. So far, this cyclical rally has returned 78% over 144 days. Should it stop here, the advance would be the smallest and shortest Phase 1 seen through the last four secular gold bull markets. Considering that this bull market began with the valuation of the Canadian gold mining index at 0.83x P/BV (an all-time low), we believe Phase 1 should extend beyond +100% before a multi-month consolidations occurs. Last, we want to repeat that our view on golds has little to do with a put option on risk assets. Gold(s) have become an inflation trade owing to the increase in headline CPI inflation and the Fed’s symmetric view on inflation — that is, allowing inflation to undershoot or overshoot the Fed’s 2% objective. Investors can buy gold exposure through the XGD-T ETF. Otherwise, the top-5 rated Canadian golds by the Quest® triAngle are OGC, BTO, CG, SMF and YRI.
Base metals (OW): copper inventories about to crest. The Chinese fundamental backdrop for copper is improving due to renewed spending on fixed investments and a cyclical upturn in housing market conditions. Despite the lack of a grand investment binge, the Chinese government recently approved a large set of infrastructure projects sooner than anticipated. Moreover, the reflationary efforts by the PBoC to unclog credit markets are bearing fruit with monetary aggregates (M1) rising briskly. As for the housing market, sales of real estate properties are up 15% YoY. Usually, a pick-up in Chinese real estate activity coincides with declining global visible copper inventories (Figure 3, second panel). Base metal stocks have handily outperformed the S&P/TSX YTD but falling copper inventories over the next few months should provide the next boost. Investors can buy copper exposure through the XBM-T ETF. Otherwise, the top-3 rated Canadian base metals by the Quest® triAngle are NSU, FM and TCK.B.
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