In This Issue

DOW SETS NEW HIGH

By Gordon Pape

The Dow hit an all-time high last week.

That’s great news, right? Then why does it may me so nervous?

On Tuesday morning, the Dow soared through its previous closing high of 14,164.53, set on Oct. 9, 2007. By the end of the day, it was sitting at 14,253.77, well above its previous historic intraday high of 14,198.10 reached on Oct. 11, 2007. And it just kept going from there, adding to its gains on Wednesday, Thursday, and Friday, albeit at a more modest pace. At the end of the week the index stood at 14,397.07 after having briefly cracked through 14,400 earlier on Friday.

It’s been a truly remarkable turnaround. The credit crash of 2008-09 knocked the DJIA down by almost 55% from its 2007 closing high, all the way to 6,443.27 on March 6, 2009. It has taken almost four years to get back to the October 2007 level but now we’re there, with an additional 233 points to spare.

Our own S&P/TSX Composite Index hasn’t fared anywhere near as well. It finished the week at 12,835.61, well below its all-time high of 15,073 reached in mid-June 2008. Over the two days following that high, the TSX dropped 492 points and has never come close to that level since. Now maybe you understand why record highs make me nervous.

The TSX has lagged mainly because of the on-going weakness in the commodity sector which, including energy, materials, and mining, accounts for more than 40% of the Composite Index. With a few exceptions, this has been a wasteland for investors over the past couple of years. Metals prices have been weak and there seems little prospect of a turnaround in the near future.

Our problems in the energy sector have been well-documented, with Alberta crude selling at deep discounts to the price for West Texas Intermediate and even deeper discounts to North Sea Brent. Meantime, natural gas prices remain in the doldrums due to a supply glut. The result has been a cash catastrophe for the Alberta government, as painfully shown in the budget tabled last week, and lower profits for the oil and gas companies, translating into stagnant share prices. Without a strong boost from the resources sector, the TSX is doomed to bob along in the wake of the high-speed Dow.

In the first issue of 2011, I advised IWB readers to start looking south for more robust returns. The Canadian market enjoyed a great run during the first decade of the century but it was clearly out of steam at that point. I have reiterated that advice on several occasions since, most recently in January of this year. There are certainly some good profit opportunities in the Canadian market and some of our recent picks have performed extremely well, such as Stella Jones (TSX: SJ, OTC: STLJF) which is up almost 90% since being recommended by contributing editor Tom Slee less than a year ago at $42.20.

But the real action in the developed markets has been on Wall Street and we’re likely to continue to see New York outperform Toronto for at least the next year. The TSX won’t see its own new record high until resource prices turn around and drive commodity stocks higher.

So what happens next on Wall Street? Some economists and traders quoted in the media after the Dow hit its new high suggested there is still significant upside remaining. There almost certainly is but don’t expect the rest of the year to be anywhere near as buoyant as what we’ve seen so far. As of the close of trading on Friday, the Dow was ahead 9.9% thus far in 2013. That pace is clearly unsustainable.

Often after an index hits a new high, there is a pull-back while the market consolidates its gains and prepares for the next upward leg. I would not be surprised to see that happen here. If it does, use it as an entry opportunity, especially if you have been slow to respond to the rebound in the U.S. market.

The best opportunities appear to be in higher-yielding dividend stocks. The rotation from bonds to equities is gaining momentum and many of the retail investors who are switching are looking for yield.

AT&T (NYSE: T) is an example of the kind of stock that is in favour right now. When I first recommended it in May 2012 it was priced at US$33.59 and paying a dividend of US$1.76 to yield 5.24%. The dividend has since been raised to $1.80 but the share price has jumped to US$36.68, dropping the yield to 4.91%. That’s not as attractive as last May but it’s likely to continue to attract income investors.

Here in Canada, the same thing has happened with BCE Inc. (TSX, NYSE: BCE). Not long ago, the shares were yielding 5.3%. Last week they moved through the C$47 mark before finishing the week at C$46.97. At that price, the yield is a tad below 5%.

Both BCE and AT&T remain Buys but if they continue to climb in price they will reach a point where they will no longer appear attractive to yield seekers. That is likely to occur when the yield drops to the 4% range.

Extending these examples to the broad market, I suggest a good strategy right now is to look for high-quality companies with yields of 4.5% and higher. These offer excellent potential for capital gains in the short to medium term. But don’t plan on holding them forever. When interest rates rise, as they will some day, the share prices will decline in many cases, pushing yields higher to keep them competitive with bonds on a risk/reward basis.

 

Gordon Pape’s new books are Money Savvy Kids and a revised and updated edition of his best-seller Tax-Free Savings Accounts. Both are available at 28% off the suggested retail price at http://astore.amazon.ca/buildicaquizm-20

Follow Gordon Pape’s latest updates on Twitter: http://twitter.com/GPUpdates

GOOD NEWS FOR THE ECONOMY IS BAD NEWS FOR GOLD

TOP

Contributing editor Gavin Graham is with us this week with some thoughts on the plight of the gold miners and updates on his stock picks. Gavin is the president of Graham Investment Strategy and is a frequent guest on radio and television business shows. Here is his report.

How quickly things change! Since the first of the year, we’ve experienced the strongest performance by major stock markets in almost 25 years, with the Dow hitting an all-time high. But just 10 weeks ago many investors were seriously worried about prospects for 2013.

Their concerns at the end of 2012 included the looming “fiscal cliff” in the U.S., China’s economic slowdown and leadership change, and the ongoing problems of the eurozone. Now, after the sharp rise in markets across the globe, these fears seem overdone – as Gordon, Tom Slee, and I all pointed out at the time. Even the failure of the U.S. administration and the Republican-controlled House of Representatives to reach a deal on spending cuts, leading to US$85 billion of across the board reductions in federal government spending, has not been enough to upset investors.

The Dow Jones Industrials has finally erased all of its losses from the financial crisis of 2008-09. Meantime, the S&P/TSX Composite is at 12,835, slightly off its 52-week high of 12, 895. The UK’s FTSE 100 closed at 6,483.58, its highest level since January 2008.

Through March 5, the MSCI World Index was up 10.8% for the year while the S&P 500 was ahead 8.3%. Japan’s Nikkei 225 had gained 6.6% and the MSCI EAFE (Europe, Australasia and Far East) Index was 3.6%. Here at home, S&P/TSX 60 (our blue-chip index) was up 3.3% (all in Canadian dollar terms).

Canada has been one of the weaker performers, which is in part due to the terrible performance of the gold mining stocks. As I write, bullion is down 6% so far this year. By contrast, the S&P/TSX Global Gold Index is off 19% and the BMO Junior Gold Miners ETF is down 24.6%. Materials stocks, of which gold miners are by far the largest component, comprise around 13% of the TSX market capitalization.

However, it’s not just gold producers that are suffering. The MSCI Emerging Markets Index (Free) is down 2.1% so far this year despite a lot of positive economic signs. U.S. fourth-quarter 2012 GDP growth is being revised up to slightly positive and U.S. GDP growth in 2013 is forecast at 2%-3%. China’s new leadership has set a target of 7.5% GDP growth for the world’s second largest economy for this year and various indicators such as several Chinese Purchasing Managers’ surveys are turning positive for the first time in 18 months,

In this context, to have both gold miners and emerging markets going down at the same time as developed markets stocks are on a roll seems counter-intuitive. If the economic outlook is improving worldwide, investors are right to feel they do not need disaster insurance in the form of gold. Conversely, if the situation is more fragile than investors believe, they are right to be nervous about exposure to the more economically sensitive and volatile emerging markets.

The enormous injections of liquidity by central banks continue to provide support for the equity markets. And what is good for developed markets should be even better for emerging markets. They were laggards last year and now look distinctly undervalued by comparison to developed markets. Therefore, my recommendation of the iShares Emerging Markets ETF (TSX: XEM) is reiterated and is now a Strong Buy. It closed on Friday at $25.66.

This is not the case for the other asset class that is down so far this year. Investment grade bonds, as represented by the DEX Long Term Bond Index, are off 1.2%. Perhaps the “Great Rotation” from bonds into stocks is actually happening. Or perhaps it’s merely that bond investors have finally noticed that all the money printing will eventually lead to inflation and that owning bonds yielding less than 2% provides little protection. The fact is that equities have beaten bonds not only this year but over the last 12 months as well, the first time this has occurred in four years.

Let’s get back to gold. The financial results of the gold mining recommendations that I have made over the last couple of years do not show anything bad enough to justify the steep declines in the share prices. Some pull-back was certainly in order, but not of this magnitude. My updates on the individual stocks follow.

In the next issue, I’ll review the performance of my other recommended companies. These will include such economically sensitive stocks as autoparts maker Linamar, drinks company Beam, and conglomerates Loews and Leucadia. We’ll see if strong operating performance is being reflected in share prices.

 

GAVIN GRAHAM’S GOLD UPDATES

TOP

Franco-Nevada Corp. (TSX, NYSE: FNV)

Originally recommended on July 26/10 (#20127) at C$31.69, US$30.45. Closed Friday at C$48, US$46.63.

Gold royalty play Franco-Nevada came in with an excellent set of numbers for the three quarters through Sept. 30 (year-end results are due March 19). Adjusted Earnings Before Interest, Tax, Depreciation & Amortization (EBITDA) was up from $233.1 million ($1.89 per share) to $254.1 million ($1.76 per share) year-over-year. Adjusted net income rose from $94.3 million ($0.76 per share) to $124 million ($0.87 per share). In both cases that excluded foreign exchange movements, gains or losses from investments, and impairments.

In November, the company announced the purchase of an 11.7% royalty interest in the Weyburn Oil Unit in Alberta and Saskatchewan for $400 million. Together with the $1 billion acquisition of an interest in Inmet’s Cobre Panama copper project, that makes $1.4 billion committed to long-life (30 year plus) assets.

Management raised the monthly dividend by 20% to $0.06 per share from $0.05, beginning in January. Despite this, the share price is off 12% over the last six months against an increase of 8% for the TSX Composite Index.

Franco-Nevada will see a number of its properties begin to generate royalties in 2013.

Action now: Buy.

Goldcorp (TSX: G, NYSE: GG)

Originally recommended on Jan. 16/12 (#21202) at C$46.45, US$45.42. Closed Friday at C$33.56, US$32.62.

Agnico-Eagle Mines (TSX, NYSE: AEM)

Originally recommended on Dec. 3/12 (#21242) at C$55.39, US$55.80. Closed Friday at C$40.41, US$39.22.

Goldcorp and Agnico-Eagle didn’t do badly at an operational level. Goldcorp reported record fourth-quarter gold production of 700,400 oz. vs. 687,900 oz. in 2011. Net income was up from $405 million ($0.50 per share) to $504 million ($0.62 per share) this year (note that both companies report in U.S. dollars). However, after adjusting for foreign exchange moves, investment gains and losses, and impairments, adjusted net income was down from $531 million ($0.66 per share) to $465 million ($0.57 per share).

For the full year, revenues increased to a record $5.4 billion on sales of 2.3 million oz. Operating cash flows before working capital moves totaled $2.47 billion ($2.97 per share) and adjusted net earnings were $1.6 billion ($2.03 per share). Proven and probable gold reserves increased for the ninth consecutive year. However, it was a modest 4% improvement to 67 million oz. The company raised the annual dividend by 11% to $0.60 per share. The market, however, chose to look at the revised cost of production per ounce that Goldcorp announced. That included the costs of depreciation rather than being on a cash basis. These came to $874 per oz. before by-product credits. The stock is down 20% over the last six months while the TSX Index is up 8%.

Agnico-Eagle delivered adjusted net income of $69.9 million ($0.41 per share) and $175 million of operating cash flow on gold production of 236,535 oz. This compared to a loss in 2011 of $601.4 million ($3.53 per share) largely due to a $907.7 million impairment charge for the Meadowbank mine in Nunavut.

For 2012 as a whole, the company had net income of $310.9 million ($1.81 per share) and operating cash flow of $737.9 million after working capital adjustments. AEM produced 1.043 million oz. of gold at a cash cost $640 per oz. and raised its dividend by 10% to $0.22 per quarter. Despite this, its shares are down 15% over the last six months.

Both Goldcorp (70%) and Agnico (20%) are anticipating substantial increases in gold production from new mines coming on stream over the next three years, and maintained production guidance for 2013. Both companies are delivering on production and profits but investors are choosing to ignore the fundamentals and focus instead on the lackluster performance of gold.

Action now: Both companies remain Buys and provide a reasonable dividend yield in addition to any upside in the share price.

Anglo Pacific Group (TSX: APY, LSE: APF)

Originally recommended on Nov. 14/11 (#21141) at C$4.20. Closed Friday at C$4.50,

Interestingly, my other minerals royalty play, base metals and coal company Anglo Pacific, has held up well. This is despite seeing its 2012 operating profit fall sharply to £9.3 million from £31.8 million as income from its major asset, a coking coal royalty on the RTZ-operated Kestrel mine in Queensland, Australia was affected by several negative factors. These included a changeover of the longwall mining machinery in the first half, disruption caused by flooding, and delays in commissioning a new coal processing plant. Meantime, coking coal prices fell from US$250 per tonne to US$170 per tonne during the year.

However, the Queensland government announced new higher royalty rates for coking coal to 12.5% per tonne between US$100 and US$150 and 15% above US$150 per tonne, effective last October. The Amapa iron ore royalty in Brazil continued to produce good income and the El Valle Boinas gold mine in Spain came on stream.

The company added two new royalties in iron ore and uranium to its portfolio of 22 royalty interests and the board raised the dividend 4.5%, giving it a yield of 3.3%. With net assets of £353 million and £24 million in cash, the balance sheet remains strong.

Action now: Buy.

Energold Drilling (TSX-V: EGD)

Originally recommended on March 12/12 (#21210) at $5.37. Closed Friday at $2.35,

Specialist gold and oil driller Energold Drilling has suffered from the depressing conditions for junior mining companies, historically its largest source of clients. With capital markets essentially closed for smaller mining companies, the problems became apparent in the latest financial results.

Energold conducts drilling programs in remote and difficult frontier markets for these companies. When their exploration capital dries up, so does Energold’s business. According to the third-quarter results, the number of metres drilled by its mineral division fell 46% to 92,300 and revenues fell 45% from $31.2 million to $17.3 million. Profit fell to only $600,000.

The company reported an increase in revenues per metre drilled to $192 from $174 previously. But this is expected to decline due to excess capacity and more drilling of brownfield sites for major mining companies.

The energy division, which gets the majority of its revenues from oil sands drilling during the winter months, recorded $9 million in revenues. Although it has received $45 million in multi-year drilling contracts beginning in 2013, it recorded a loss of $2.8 million in the quarter due to compensation payouts to the former owners.

Meanwhile, the U.K.-based drill manufacturing operation, which specializes in water drilling rigs for emerging countries as well as mineral and oil rigs, generated $3.6 million in revenues and posted a small loss.

Overall, the company reported a loss of $3.7 million ($0.08 per share) for the first nine months of 2012. That was disappointing, especially considering Energold had made a profit of $13.7 million ($0.34 per share) over the same period in 2011. A large amount of this reversal reflects the tight capital markets for junior miners and the revenue-linked compensation for the former owners of the energy division.

With $27.8 million in cash and its 6.98 million shares in Impact Silver, a profitable listed silver mining operating in Mexico, Energold’s balance sheet is still in good shape. Although the stock is down almost 50% over the last year and 35% in the last six months, Energold remains a Hold. The winter drilling season is always the strongest for its Bertram energy division and the increase in demand for some of its 132 mineral rigs from major mining companies may offset the lower demand from junior miners.

Action now: Hold.

– end Gavin Graham

 

THE LOONIE DIVES

TOP

Suddenly, cross-border shopping isn’t as much fun as before. Blame it on the diving loonie.

At the start of the year, our dollar was trading at about half a cent above parity. Now it is struggling to stay above US$0.97, closing on Friday at US$0.9717. That’s a drop of 3.3% in just 10 weeks. Since hitting its 2012 high of US$1.0371 on Sept. 14, the loonie has tumbled by US$0.065, a drop in value of 6.3%.

And there may be more downside to come. A report issued by National Bank Financial last week predicts the Canadian dollar will be trading in the US$0.95 range by the third quarter of this year and suggests it could possibly go even lower. The bank had previously predicted a slide in the loonie but now says it is happening faster than expected.

In the March issue of its Forex report, National Bank analysts Stéfane Marion and Krishen Rangasamy cite several reasons for the surge in the U.S. dollar, which is coming off its best month since last May, and the corresponding fall in our currency. These include new political turmoil in Europe as a result of the hung Italian election and renewed concerns for global growth following the failure of the U.S. Congress to head off sequestration, thus triggering US$85 billion in automatic spending cuts.

International investors are again turning to the greenback as a safe haven in the absence of any viable alternative. Japan’s new government and the Bank of Japan are pursuing policies that are devaluing the yen including an aggressive program of quantitative easing that National Bank predicts will drive the yen down to 100 per U.S. dollar by year-end. One American dollar currently buys about ¥95.

In Europe, the euro is once again under downward pressure as the continent deals with an economic contraction and unemployment levels that are dangerously high in many of the southern tier countries. -The path of least resistance for the euro is downwards,- the analysts write. They forecast a mid-year valuation of US$1.23, a decline of more than 5% from current levels.

As for the British pound, it has been in free-fall against the greenback. At the start of the year, it took almost US$1.63 to buy a single pound sterling, now the rate is down to about US$1.50 and still sliding.

No wonder global investors are piling into the greenback again. There’s nowhere else to go. Switzerland’s second-largest bank, Credit Suisse, announced in December it would impose negative interest rates on foreign investors holding balances in Swiss francs in a move to discourage capital inflows that have pushed the value of the franc to almost US$0.95. In other words, you have to pay them to hold your money.

So why not the loonie? Why isn’t our currency also benefitting from the safe haven mania? Our interest rates may be low but they are not negative, and in fact they’re higher than U.S. rates for short-term deposits. Plus we have one of the few national AAA ratings left.

Unfortunately (or fortunately if you are an advocate of a cheaper loonie) there are several factors working again us. For starters, the world continues to view the loonie as a petro-currency, rightly or wrongly. With our oil patch in a heap of trouble, that works against us. Our weak economic growth rate is another factor. Then there’s the Bank of Canada’s perceived new dovish position on interest rates which suggest that we won’t see any move off the current 1% overnight rate until at least the second half of 2014. Taking all this into account, the National Bank analysts do not see the loonie regaining parity for the foreseeable future.

Currency speculators can do what they want with these forecasts. That’s not a field that we advise our readers to get into because of the high risks involved. But one investment conclusion that we can draw from the National Bank outlook is that U.S. stocks look more attractive than ever.

Not only does Wall Street offer greater capital gains potential than the TSX under current conditions but there is also the possibility of enhancing your profits through currency gains. Any U.S. stocks that you own are already ahead 3.3% in Canadian dollar terms this year even if their market price has stayed flat, thanks to the rise of the greenback against the loonie. Any further decline in the Canadian dollar will only add to your gains.

For fund investors, this raises the question of whether to use ETFs and mutual funds that employ currency hedging. When the Canadian dollar is rising, such strategies work in your favour. Unhedged investments in U.S. securities lose value when the greenback depreciates, which partly is why American stocks performed so badly in Canadian dollar terms in the first decade of this century. But when the U.S. dollar rises, the converse is true. If you have significant assets in hedged U.S. funds, you may want to reconsider your position in the light of the National Bank forecast. – G.P.

 

GORDON PAPE’S UPDATES

TOP

Gibson Energy (TSX: GEI, OTC: GBNXF)

Originally recommended on Oct. 1/12 (#21234) at C$23.03, US$23.36. Closed Friday at C$25.74, US$24.61.

Gibson is a Calgary-based midstream energy company that I originally recommended last October at $23.03. Thus far it has worked out well for us, closing on Friday at $25.74 for a gain to date of 11.8%.

Last week, the company released fourth-quarter and year-end results that were better than expected and announced a dividend increase of 5.8%, more than analysts were looking for.

Revenue for the 2012 fiscal year was actually down slightly year-over-year but net income showed a significant improvement, coming in at $116.2 million ($1.10 a share, fully diluted) compared to a loss of $62.6 million ($0.88 a share) in 2011. Adjusted EBITDA increased by 31% to $302.1 million compared to $231.3 million in 2011. Cash from operations for the year was $308.9 million.

The company has received support from what it described as -a large oil sands producer- for the construction of a 300,000 barrel (bbl) oil storage tank at its Hardisty Terminal in eastern Alberta and announced plans to begin work on it immediately with a target commission date of mid-2014. This is in addition to the two 400,000 bbl oil storage tanks announced last September.

In an analysis published after the results were released, RBC Capital Markets praised Gibson’s -solid business outlook-. The brokerage firm said it sees -strong opportunities to build out crude oil infrastructure … with crude-by-rail being a potentially new service offering.-

The dividend increase brings the quarterly payment to $0.275 per share ($1.10 annually). The next payment is due on April 17 to shareholders of record at the close of business on March 29. Based on the increased dividend, the yield is 4.27%.

Action now: Gibson remains a Buy for income and growth for investors who are comfortable with the risk inherent in a midstream energy company.

Constellation Software (TSX: CSU, OTC: CNSWF)

Originally recommended on Oct. 9/12 (#21235) at C$104.50, US$105.92. Closed Friday at C$120.49, US$116.20 (March 7).

Constellation continues to perform well for us with the share price up more than $4 from our last update in late October.

Last week, the company announced fourth-quarter results that handily beat expectations as well as fiscal 2012 final figures. For the fourth quarter, the company reported revenue of $261 million, up 32% from $198 million in the same period of 2011 (Constellation reports in U.S. dollars). The company said the big jump in revenue was mainly due to acquisitions with organic growth accounting for 8% of the total. Fourth-quarter earnings were $40 million ($1.89 per share, fully diluted) compared to $19 million ($0.92 a share) in the prior year.

For the full year, Constellation reported revenue of $891 million compared to $773 million in 2011, an increase of 15%. Adjusted net income increased by $32 million (23%) to $172 million ($8.13 per share). The 2011 figures were $140 million ($6.63 per share). Cash flows from operations increased to $145 million from $138 million in 2011, a 5% rise. The company completed 35 acquisitions during the year at an aggregate cash cost of $141 million.

Good though the numbers were, analysts were disappointed by the company’s outlook for the first quarter of 2013. Management forecast gross revenue to be in the range of $245 million to $260 million with adjusted earnings per share to come in between $1.30 and $1.81, well below Street expectations of $1.97. The main reason for the lower profit guidance was reduced Adjusted EBITDA margins to the range of 14% to 18%. The Street was looking for 20%.

The stock pays a quarterly dividend of $1 per share with the next payment due on April 4 to shareholders of record as of March 18.

Action now: Buy, with a target of $130.

Trinidad Drilling (TSX: TDG, OTC: TDGCF)

Originally recommended on April 11/11 (#21114) at C$10, US$10.44. Closed Friday at C$7.11, US$6.80 (March 7).

Trinidad Drilling keeps posting decent results but investors don’t give a hoot. I said when I last reviewed this stock in January that it was stuck in a rut. It still is.

On March 6, the company released fourth-quarter and year-end numbers. While the final three months of 2012 were somewhat soft, full-year results showed a significant improvement over 2011. Revenue was up 5% year-over-year to $859.3 million, compared to $818.2 million in 2011. Adjusted net earnings were reported at $138.5 million ($1.15 a share, fully diluted). The 2011 figure was $87.4 million ($0.72 a share). The company said the improvement was due to -increased EBITDA, lower finance costs, lower income taxes and a larger gain on sale of assets-.

In its analysis, management noted a softening in overall demand in the fourth quarter as exploration and development was scaled back due to lower energy prices. However, the company said that demand for its modern, high-efficiency drills remained high, thus cushioning the impact of the slowdown.

For 2013, management expects that -conditions will remain relatively stable … with producers adjusting capital spending programs in relation to commodity price levels. The company expects that its modern, high performance equipment will continue to be in demand but that unless commodity prices increase there will be limited demand for lower specification equipment.-

The outlook did not include any forecasts for revenue and earnings. However, RBC Capital Markets is predicting free cash flow (post dividends) of about $72 million this year which the brokerage firm suggests could result in a dividend increase in the second half. The shares currently pay $0.05 per quarter ($0.20 annually) to yield 2.8%.

Action now: Continue to Hold. – G.P.

 

That’s all for this week. We will be back on March 18.

Best regards,

Gordon Pape

In This Issue

DOW SETS NEW HIGH

By Gordon Pape

The Dow hit an all-time high last week.

That’s great news, right? Then why does it may me so nervous?

On Tuesday morning, the Dow soared through its previous closing high of 14,164.53, set on Oct. 9, 2007. By the end of the day, it was sitting at 14,253.77, well above its previous historic intraday high of 14,198.10 reached on Oct. 11, 2007. And it just kept going from there, adding to its gains on Wednesday, Thursday, and Friday, albeit at a more modest pace. At the end of the week the index stood at 14,397.07 after having briefly cracked through 14,400 earlier on Friday.

It’s been a truly remarkable turnaround. The credit crash of 2008-09 knocked the DJIA down by almost 55% from its 2007 closing high, all the way to 6,443.27 on March 6, 2009. It has taken almost four years to get back to the October 2007 level but now we’re there, with an additional 233 points to spare.

Our own S&P/TSX Composite Index hasn’t fared anywhere near as well. It finished the week at 12,835.61, well below its all-time high of 15,073 reached in mid-June 2008. Over the two days following that high, the TSX dropped 492 points and has never come close to that level since. Now maybe you understand why record highs make me nervous.

The TSX has lagged mainly because of the on-going weakness in the commodity sector which, including energy, materials, and mining, accounts for more than 40% of the Composite Index. With a few exceptions, this has been a wasteland for investors over the past couple of years. Metals prices have been weak and there seems little prospect of a turnaround in the near future.

Our problems in the energy sector have been well-documented, with Alberta crude selling at deep discounts to the price for West Texas Intermediate and even deeper discounts to North Sea Brent. Meantime, natural gas prices remain in the doldrums due to a supply glut. The result has been a cash catastrophe for the Alberta government, as painfully shown in the budget tabled last week, and lower profits for the oil and gas companies, translating into stagnant share prices. Without a strong boost from the resources sector, the TSX is doomed to bob along in the wake of the high-speed Dow.

In the first issue of 2011, I advised IWB readers to start looking south for more robust returns. The Canadian market enjoyed a great run during the first decade of the century but it was clearly out of steam at that point. I have reiterated that advice on several occasions since, most recently in January of this year. There are certainly some good profit opportunities in the Canadian market and some of our recent picks have performed extremely well, such as Stella Jones (TSX: SJ, OTC: STLJF) which is up almost 90% since being recommended by contributing editor Tom Slee less than a year ago at $42.20.

But the real action in the developed markets has been on Wall Street and we’re likely to continue to see New York outperform Toronto for at least the next year. The TSX won’t see its own new record high until resource prices turn around and drive commodity stocks higher.

So what happens next on Wall Street? Some economists and traders quoted in the media after the Dow hit its new high suggested there is still significant upside remaining. There almost certainly is but don’t expect the rest of the year to be anywhere near as buoyant as what we’ve seen so far. As of the close of trading on Friday, the Dow was ahead 9.9% thus far in 2013. That pace is clearly unsustainable.

Often after an index hits a new high, there is a pull-back while the market consolidates its gains and prepares for the next upward leg. I would not be surprised to see that happen here. If it does, use it as an entry opportunity, especially if you have been slow to respond to the rebound in the U.S. market.

The best opportunities appear to be in higher-yielding dividend stocks. The rotation from bonds to equities is gaining momentum and many of the retail investors who are switching are looking for yield.

AT&T (NYSE: T) is an example of the kind of stock that is in favour right now. When I first recommended it in May 2012 it was priced at US$33.59 and paying a dividend of US$1.76 to yield 5.24%. The dividend has since been raised to $1.80 but the share price has jumped to US$36.68, dropping the yield to 4.91%. That’s not as attractive as last May but it’s likely to continue to attract income investors.

Here in Canada, the same thing has happened with BCE Inc. (TSX, NYSE: BCE). Not long ago, the shares were yielding 5.3%. Last week they moved through the C$47 mark before finishing the week at C$46.97. At that price, the yield is a tad below 5%.

Both BCE and AT&T remain Buys but if they continue to climb in price they will reach a point where they will no longer appear attractive to yield seekers. That is likely to occur when the yield drops to the 4% range.

Extending these examples to the broad market, I suggest a good strategy right now is to look for high-quality companies with yields of 4.5% and higher. These offer excellent potential for capital gains in the short to medium term. But don’t plan on holding them forever. When interest rates rise, as they will some day, the share prices will decline in many cases, pushing yields higher to keep them competitive with bonds on a risk/reward basis.

 

Gordon Pape’s new books are Money Savvy Kids and a revised and updated edition of his best-seller Tax-Free Savings Accounts. Both are available at 28% off the suggested retail price at http://astore.amazon.ca/buildicaquizm-20

Follow Gordon Pape’s latest updates on Twitter: http://twitter.com/GPUpdates

GOOD NEWS FOR THE ECONOMY IS BAD NEWS FOR GOLD

Contributing editor Gavin Graham is with us this week with some thoughts on the plight of the gold miners and updates on his stock picks. Gavin is the president of Graham Investment Strategy and is a frequent guest on radio and television business shows. Here is his report.

How quickly things change! Since the first of the year, we’ve experienced the strongest performance by major stock markets in almost 25 years, with the Dow hitting an all-time high. But just 10 weeks ago many investors were seriously worried about prospects for 2013.

Their concerns at the end of 2012 included the looming “fiscal cliff” in the U.S., China’s economic slowdown and leadership change, and the ongoing problems of the eurozone. Now, after the sharp rise in markets across the globe, these fears seem overdone – as Gordon, Tom Slee, and I all pointed out at the time. Even the failure of the U.S. administration and the Republican-controlled House of Representatives to reach a deal on spending cuts, leading to US$85 billion of across the board reductions in federal government spending, has not been enough to upset investors.

The Dow Jones Industrials has finally erased all of its losses from the financial crisis of 2008-09. Meantime, the S&P/TSX Composite is at 12,835, slightly off its 52-week high of 12, 895. The UK’s FTSE 100 closed at 6,483.58, its highest level since January 2008.

Through March 5, the MSCI World Index was up 10.8% for the year while the S&P 500 was ahead 8.3%. Japan’s Nikkei 225 had gained 6.6% and the MSCI EAFE (Europe, Australasia and Far East) Index was 3.6%. Here at home, S&P/TSX 60 (our blue-chip index) was up 3.3% (all in Canadian dollar terms).

Canada has been one of the weaker performers, which is in part due to the terrible performance of the gold mining stocks. As I write, bullion is down 6% so far this year. By contrast, the S&P/TSX Global Gold Index is off 19% and the BMO Junior Gold Miners ETF is down 24.6%. Materials stocks, of which gold miners are by far the largest component, comprise around 13% of the TSX market capitalization.

However, it’s not just gold producers that are suffering. The MSCI Emerging Markets Index (Free) is down 2.1% so far this year despite a lot of positive economic signs. U.S. fourth-quarter 2012 GDP growth is being revised up to slightly positive and U.S. GDP growth in 2013 is forecast at 2%-3%. China’s new leadership has set a target of 7.5% GDP growth for the world’s second largest economy for this year and various indicators such as several Chinese Purchasing Managers’ surveys are turning positive for the first time in 18 months,

In this context, to have both gold miners and emerging markets going down at the same time as developed markets stocks are on a roll seems counter-intuitive. If the economic outlook is improving worldwide, investors are right to feel they do not need disaster insurance in the form of gold. Conversely, if the situation is more fragile than investors believe, they are right to be nervous about exposure to the more economically sensitive and volatile emerging markets.

The enormous injections of liquidity by central banks continue to provide support for the equity markets. And what is good for developed markets should be even better for emerging markets. They were laggards last year and now look distinctly undervalued by comparison to developed markets. Therefore, my recommendation of the iShares Emerging Markets ETF (TSX: XEM) is reiterated and is now a Strong Buy. It closed on Friday at $25.66.

This is not the case for the other asset class that is down so far this year. Investment grade bonds, as represented by the DEX Long Term Bond Index, are off 1.2%. Perhaps the “Great Rotation” from bonds into stocks is actually happening. Or perhaps it’s merely that bond investors have finally noticed that all the money printing will eventually lead to inflation and that owning bonds yielding less than 2% provides little protection. The fact is that equities have beaten bonds not only this year but over the last 12 months as well, the first time this has occurred in four years.

Let’s get back to gold. The financial results of the gold mining recommendations that I have made over the last couple of years do not show anything bad enough to justify the steep declines in the share prices. Some pull-back was certainly in order, but not of this magnitude. My updates on the individual stocks follow.

In the next issue, I’ll review the performance of my other recommended companies. These will include such economically sensitive stocks as autoparts maker Linamar, drinks company Beam, and conglomerates Loews and Leucadia. We’ll see if strong operating performance is being reflected in share prices.

 

GAVIN GRAHAM’S GOLD UPDATES

Franco-Nevada Corp. (TSX, NYSE: FNV)

Originally recommended on July 26/10 (#20127) at C$31.69, US$30.45. Closed Friday at C$48, US$46.63.

Gold royalty play Franco-Nevada came in with an excellent set of numbers for the three quarters through Sept. 30 (year-end results are due March 19). Adjusted Earnings Before Interest, Tax, Depreciation & Amortization (EBITDA) was up from $233.1 million ($1.89 per share) to $254.1 million ($1.76 per share) year-over-year. Adjusted net income rose from $94.3 million ($0.76 per share) to $124 million ($0.87 per share). In both cases that excluded foreign exchange movements, gains or losses from investments, and impairments.

In November, the company announced the purchase of an 11.7% royalty interest in the Weyburn Oil Unit in Alberta and Saskatchewan for $400 million. Together with the $1 billion acquisition of an interest in Inmet’s Cobre Panama copper project, that makes $1.4 billion committed to long-life (30 year plus) assets.

Management raised the monthly dividend by 20% to $0.06 per share from $0.05, beginning in January. Despite this, the share price is off 12% over the last six months against an increase of 8% for the TSX Composite Index.

Franco-Nevada will see a number of its properties begin to generate royalties in 2013.

Action now: Buy.

Goldcorp (TSX: G, NYSE: GG)

Originally recommended on Jan. 16/12 (#21202) at C$46.45, US$45.42. Closed Friday at C$33.56, US$32.62.

Agnico-Eagle Mines (TSX, NYSE: AEM)

Originally recommended on Dec. 3/12 (#21242) at C$55.39, US$55.80. Closed Friday at C$40.41, US$39.22.

Goldcorp and Agnico-Eagle didn’t do badly at an operational level. Goldcorp reported record fourth-quarter gold production of 700,400 oz. vs. 687,900 oz. in 2011. Net income was up from $405 million ($0.50 per share) to $504 million ($0.62 per share) this year (note that both companies report in U.S. dollars). However, after adjusting for foreign exchange moves, investment gains and losses, and impairments, adjusted net income was down from $531 million ($0.66 per share) to $465 million ($0.57 per share).

For the full year, revenues increased to a record $5.4 billion on sales of 2.3 million oz. Operating cash flows before working capital moves totaled $2.47 billion ($2.97 per share) and adjusted net earnings were $1.6 billion ($2.03 per share). Proven and probable gold reserves increased for the ninth consecutive year. However, it was a modest 4% improvement to 67 million oz. The company raised the annual dividend by 11% to $0.60 per share. The market, however, chose to look at the revised cost of production per ounce that Goldcorp announced. That included the costs of depreciation rather than being on a cash basis. These came to $874 per oz. before by-product credits. The stock is down 20% over the last six months while the TSX Index is up 8%.

Agnico-Eagle delivered adjusted net income of $69.9 million ($0.41 per share) and $175 million of operating cash flow on gold production of 236,535 oz. This compared to a loss in 2011 of $601.4 million ($3.53 per share) largely due to a $907.7 million impairment charge for the Meadowbank mine in Nunavut.

For 2012 as a whole, the company had net income of $310.9 million ($1.81 per share) and operating cash flow of $737.9 million after working capital adjustments. AEM produced 1.043 million oz. of gold at a cash cost $640 per oz. and raised its dividend by 10% to $0.22 per quarter. Despite this, its shares are down 15% over the last six months.

Both Goldcorp (70%) and Agnico (20%) are anticipating substantial increases in gold production from new mines coming on stream over the next three years, and maintained production guidance for 2013. Both companies are delivering on production and profits but investors are choosing to ignore the fundamentals and focus instead on the lackluster performance of gold.

Action now: Both companies remain Buys and provide a reasonable dividend yield in addition to any upside in the share price.

Anglo Pacific Group (TSX: APY, LSE: APF)

Originally recommended on Nov. 14/11 (#21141) at C$4.20. Closed Friday at C$4.50,

Interestingly, my other minerals royalty play, base metals and coal company Anglo Pacific, has held up well. This is despite seeing its 2012 operating profit fall sharply to £9.3 million from £31.8 million as income from its major asset, a coking coal royalty on the RTZ-operated Kestrel mine in Queensland, Australia was affected by several negative factors. These included a changeover of the longwall mining machinery in the first half, disruption caused by flooding, and delays in commissioning a new coal processing plant. Meantime, coking coal prices fell from US$250 per tonne to US$170 per tonne during the year.

However, the Queensland government announced new higher royalty rates for coking coal to 12.5% per tonne between US$100 and US$150 and 15% above US$150 per tonne, effective last October. The Amapa iron ore royalty in Brazil continued to produce good income and the El Valle Boinas gold mine in Spain came on stream.

The company added two new royalties in iron ore and uranium to its portfolio of 22 royalty interests and the board raised the dividend 4.5%, giving it a yield of 3.3%. With net assets of £353 million and £24 million in cash, the balance sheet remains strong.

Action now: Buy.

Energold Drilling (TSX-V: EGD)

Originally recommended on March 12/12 (#21210) at $5.37. Closed Friday at $2.35,

Specialist gold and oil driller Energold Drilling has suffered from the depressing conditions for junior mining companies, historically its largest source of clients. With capital markets essentially closed for smaller mining companies, the problems became apparent in the latest financial results.

Energold conducts drilling programs in remote and difficult frontier markets for these companies. When their exploration capital dries up, so does Energold’s business. According to the third-quarter results, the number of metres drilled by its mineral division fell 46% to 92,300 and revenues fell 45% from $31.2 million to $17.3 million. Profit fell to only $600,000.

The company reported an increase in revenues per metre drilled to $192 from $174 previously. But this is expected to decline due to excess capacity and more drilling of brownfield sites for major mining companies.

The energy division, which gets the majority of its revenues from oil sands drilling during the winter months, recorded $9 million in revenues. Although it has received $45 million in multi-year drilling contracts beginning in 2013, it recorded a loss of $2.8 million in the quarter due to compensation payouts to the former owners.

Meanwhile, the U.K.-based drill manufacturing operation, which specializes in water drilling rigs for emerging countries as well as mineral and oil rigs, generated $3.6 million in revenues and posted a small loss.

Overall, the company reported a loss of $3.7 million ($0.08 per share) for the first nine months of 2012. That was disappointing, especially considering Energold had made a profit of $13.7 million ($0.34 per share) over the same period in 2011. A large amount of this reversal reflects the tight capital markets for junior miners and the revenue-linked compensation for the former owners of the energy division.

With $27.8 million in cash and its 6.98 million shares in Impact Silver, a profitable listed silver mining operating in Mexico, Energold’s balance sheet is still in good shape. Although the stock is down almost 50% over the last year and 35% in the last six months, Energold remains a Hold. The winter drilling season is always the strongest for its Bertram energy division and the increase in demand for some of its 132 mineral rigs from major mining companies may offset the lower demand from junior miners.

Action now: Hold.

– end Gavin Graham

 

THE LOONIE DIVES

Suddenly, cross-border shopping isn’t as much fun as before. Blame it on the diving loonie.

At the start of the year, our dollar was trading at about half a cent above parity. Now it is struggling to stay above US$0.97, closing on Friday at US$0.9717. That’s a drop of 3.3% in just 10 weeks. Since hitting its 2012 high of US$1.0371 on Sept. 14, the loonie has tumbled by US$0.065, a drop in value of 6.3%.

And there may be more downside to come. A report issued by National Bank Financial last week predicts the Canadian dollar will be trading in the US$0.95 range by the third quarter of this year and suggests it could possibly go even lower. The bank had previously predicted a slide in the loonie but now says it is happening faster than expected.

In the March issue of its Forex report, National Bank analysts Stéfane Marion and Krishen Rangasamy cite several reasons for the surge in the U.S. dollar, which is coming off its best month since last May, and the corresponding fall in our currency. These include new political turmoil in Europe as a result of the hung Italian election and renewed concerns for global growth following the failure of the U.S. Congress to head off sequestration, thus triggering US$85 billion in automatic spending cuts.

International investors are again turning to the greenback as a safe haven in the absence of any viable alternative. Japan’s new government and the Bank of Japan are pursuing policies that are devaluing the yen including an aggressive program of quantitative easing that National Bank predicts will drive the yen down to 100 per U.S. dollar by year-end. One American dollar currently buys about ¥95.

In Europe, the euro is once again under downward pressure as the continent deals with an economic contraction and unemployment levels that are dangerously high in many of the southern tier countries. -The path of least resistance for the euro is downwards,- the analysts write. They forecast a mid-year valuation of US$1.23, a decline of more than 5% from current levels.

As for the British pound, it has been in free-fall against the greenback. At the start of the year, it took almost US$1.63 to buy a single pound sterling, now the rate is down to about US$1.50 and still sliding.

No wonder global investors are piling into the greenback again. There’s nowhere else to go. Switzerland’s second-largest bank, Credit Suisse, announced in December it would impose negative interest rates on foreign investors holding balances in Swiss francs in a move to discourage capital inflows that have pushed the value of the franc to almost US$0.95. In other words, you have to pay them to hold your money.

So why not the loonie? Why isn’t our currency also benefitting from the safe haven mania? Our interest rates may be low but they are not negative, and in fact they’re higher than U.S. rates for short-term deposits. Plus we have one of the few national AAA ratings left.

Unfortunately (or fortunately if you are an advocate of a cheaper loonie) there are several factors working again us. For starters, the world continues to view the loonie as a petro-currency, rightly or wrongly. With our oil patch in a heap of trouble, that works against us. Our weak economic growth rate is another factor. Then there’s the Bank of Canada’s perceived new dovish position on interest rates which suggest that we won’t see any move off the current 1% overnight rate until at least the second half of 2014. Taking all this into account, the National Bank analysts do not see the loonie regaining parity for the foreseeable future.

Currency speculators can do what they want with these forecasts. That’s not a field that we advise our readers to get into because of the high risks involved. But one investment conclusion that we can draw from the National Bank outlook is that U.S. stocks look more attractive than ever.

Not only does Wall Street offer greater capital gains potential than the TSX under current conditions but there is also the possibility of enhancing your profits through currency gains. Any U.S. stocks that you own are already ahead 3.3% in Canadian dollar terms this year even if their market price has stayed flat, thanks to the rise of the greenback against the loonie. Any further decline in the Canadian dollar will only add to your gains.

For fund investors, this raises the question of whether to use ETFs and mutual funds that employ currency hedging. When the Canadian dollar is rising, such strategies work in your favour. Unhedged investments in U.S. securities lose value when the greenback depreciates, which partly is why American stocks performed so badly in Canadian dollar terms in the first decade of this century. But when the U.S. dollar rises, the converse is true. If you have significant assets in hedged U.S. funds, you may want to reconsider your position in the light of the National Bank forecast. – G.P.

 

GORDON PAPE’S UPDATES

Gibson Energy (TSX: GEI, OTC: GBNXF)

Originally recommended on Oct. 1/12 (#21234) at C$23.03, US$23.36. Closed Friday at C$25.74, US$24.61.

Gibson is a Calgary-based midstream energy company that I originally recommended last October at $23.03. Thus far it has worked out well for us, closing on Friday at $25.74 for a gain to date of 11.8%.

Last week, the company released fourth-quarter and year-end results that were better than expected and announced a dividend increase of 5.8%, more than analysts were looking for.

Revenue for the 2012 fiscal year was actually down slightly year-over-year but net income showed a significant improvement, coming in at $116.2 million ($1.10 a share, fully diluted) compared to a loss of $62.6 million ($0.88 a share) in 2011. Adjusted EBITDA increased by 31% to $302.1 million compared to $231.3 million in 2011. Cash from operations for the year was $308.9 million.

The company has received support from what it described as -a large oil sands producer- for the construction of a 300,000 barrel (bbl) oil storage tank at its Hardisty Terminal in eastern Alberta and announced plans to begin work on it immediately with a target commission date of mid-2014. This is in addition to the two 400,000 bbl oil storage tanks announced last September.

In an analysis published after the results were released, RBC Capital Markets praised Gibson’s -solid business outlook-. The brokerage firm said it sees -strong opportunities to build out crude oil infrastructure … with crude-by-rail being a potentially new service offering.-

The dividend increase brings the quarterly payment to $0.275 per share ($1.10 annually). The next payment is due on April 17 to shareholders of record at the close of business on March 29. Based on the increased dividend, the yield is 4.27%.

Action now: Gibson remains a Buy for income and growth for investors who are comfortable with the risk inherent in a midstream energy company.

Constellation Software (TSX: CSU, OTC: CNSWF)

Originally recommended on Oct. 9/12 (#21235) at C$104.50, US$105.92. Closed Friday at C$120.49, US$116.20 (March 7).

Constellation continues to perform well for us with the share price up more than $4 from our last update in late October.

Last week, the company announced fourth-quarter results that handily beat expectations as well as fiscal 2012 final figures. For the fourth quarter, the company reported revenue of $261 million, up 32% from $198 million in the same period of 2011 (Constellation reports in U.S. dollars). The company said the big jump in revenue was mainly due to acquisitions with organic growth accounting for 8% of the total. Fourth-quarter earnings were $40 million ($1.89 per share, fully diluted) compared to $19 million ($0.92 a share) in the prior year.

For the full year, Constellation reported revenue of $891 million compared to $773 million in 2011, an increase of 15%. Adjusted net income increased by $32 million (23%) to $172 million ($8.13 per share). The 2011 figures were $140 million ($6.63 per share). Cash flows from operations increased to $145 million from $138 million in 2011, a 5% rise. The company completed 35 acquisitions during the year at an aggregate cash cost of $141 million.

Good though the numbers were, analysts were disappointed by the company’s outlook for the first quarter of 2013. Management forecast gross revenue to be in the range of $245 million to $260 million with adjusted earnings per share to come in between $1.30 and $1.81, well below Street expectations of $1.97. The main reason for the lower profit guidance was reduced Adjusted EBITDA margins to the range of 14% to 18%. The Street was looking for 20%.

The stock pays a quarterly dividend of $1 per share with the next payment due on April 4 to shareholders of record as of March 18.

Action now: Buy, with a target of $130.

Trinidad Drilling (TSX: TDG, OTC: TDGCF)

Originally recommended on April 11/11 (#21114) at C$10, US$10.44. Closed Friday at C$7.11, US$6.80 (March 7).

Trinidad Drilling keeps posting decent results but investors don’t give a hoot. I said when I last reviewed this stock in January that it was stuck in a rut. It still is.

On March 6, the company released fourth-quarter and year-end numbers. While the final three months of 2012 were somewhat soft, full-year results showed a significant improvement over 2011. Revenue was up 5% year-over-year to $859.3 million, compared to $818.2 million in 2011. Adjusted net earnings were reported at $138.5 million ($1.15 a share, fully diluted). The 2011 figure was $87.4 million ($0.72 a share). The company said the improvement was due to -increased EBITDA, lower finance costs, lower income taxes and a larger gain on sale of assets-.

In its analysis, management noted a softening in overall demand in the fourth quarter as exploration and development was scaled back due to lower energy prices. However, the company said that demand for its modern, high-efficiency drills remained high, thus cushioning the impact of the slowdown.

For 2013, management expects that -conditions will remain relatively stable … with producers adjusting capital spending programs in relation to commodity price levels. The company expects that its modern, high performance equipment will continue to be in demand but that unless commodity prices increase there will be limited demand for lower specification equipment.-

The outlook did not include any forecasts for revenue and earnings. However, RBC Capital Markets is predicting free cash flow (post dividends) of about $72 million this year which the brokerage firm suggests could result in a dividend increase in the second half. The shares currently pay $0.05 per quarter ($0.20 annually) to yield 2.8%.

Action now: Continue to Hold. – G.P.

 

That’s all for this week. We will be back on March 18.

Best regards,

Gordon Pape