In This Issue

GOLD LOSES LUSTRE

By Gordon Pape

So Peter Munk is frustrated with the stock performance of Barrick Gold, the mining colossus that he created. Join the club! Hundreds of thousands of investors feel the same way.

Mr. Munk, the billionaire chairman of the world’s largest gold producer, praised the company at last week’s annual general meeting (AGM), lauding management for “exceptional performance” and citing Barrick’s “great fundamentals”.

“For God’s sake, the world should be at your feet,” he told the managerial team. “What more can you ask for?”

A higher share price, that’s what. On Wednesday, the same day that Mr. Munk was extolling Barrick’s results, the stock dropped $1.09. It followed that with a further pull-back of $1.28 on Thursday, reaching a new 52-week low in the process. After a weak rally on Friday, it finished the week at C$37.69, US$37.89. The stock is down 18.3% from $46.15, where it began the year. The shares trade in Toronto and New York under the symbol ABX.

On the surface, it’s difficult to understand what the market is thinking. The company released first-quarter results on the same day as the AGM and they came in close to expectations. Net earnings were $1.03 billion ($1.03 per share), a 3% increase from the year before (note that Barrick reports in U.S. dollars). Adjusted net earnings, with one-time items removed, were $1.09 billion ($1.09 per share), an 8% increase from same prior year period. EBITDA was up 9% to $2 billion however adjusted operating cash flow was off, coming in at $1.37 billion compared to $1.44 billion last year.

Barrick maintained its full year 2012 gold production guidance of 7.3-7.8 million ounces at total cash costs of $520-$560 per ounce and net cash costs of $400-$450 per ounce. The company expects copper production this year of 550-600 million pounds at cash costs of $1.90-$2.20 per pound.

In an effort to add to the attractiveness of the stock, the company raised its dividend by one-third to $0.20 per quarter ($0.80 annually). Based on what happened to the share price, investors were not impressed.

Barrick isn’t the only gold stock that being hammered. Goldcorp (TSX: G, NYSE: GG) also hit a new 52-week low last week, finishing on Friday at C$36.43, US$36.56. It’s off 19.4% since its 2012 opening price of C$45.21.

However, in Goldcorp’s case the sell-off is more understandable. The company’s first-quarter results, which were released on April 25, were disappointing. Net earnings were $479 million or $0.51 a share, fully diluted (Goldcorp also reports in U.S. currency) compared to $651 million ($0.81 per share) in the first quarter of 2011. Revenue increase by almost 11% to $1.35 billion but that was more than offset by a big increase in production costs.

CEO Chuck Jeannes blamed “adverse ground conditions” at the company’s Red Lake mine for delaying the development of new mining faces. “Taken together with lower grade in other areas of the mine, (this) led to our slow start to 2012,” he said. 

What is especially ironic about the plunge in the price of the two gold mining giants is that the metal itself is up 5% since the start of the year, when it was trading at US$1,566.80 per ounce. This disconnect isn’t new, but it seems to be gaining momentum. There have been many theories as to why this is happening but in the end it seems to come down to investor scepticism over the future direction of the price of bullion, which will directly impact the bottom lines of the producers.

And why this scepticism? I suggest it is because of the gradual (very gradual!) improvement in the U.S. economy. Although the correlation is not perfect by any means, there has been a tendency in the past few years for the price of gold to move inversely to the value of the U.S. dollar. When the greenback declines in international currency markets, gold gains ground. The reverse occurs, bullion drops. A stronger U.S. economy will tend to boost the value of the currency.

So far this year, the greenback has shown a very choppy pattern when measured against a basket of currencies that includes the euro, yen, pound sterling, Swiss franc, and Canadian dollar. But recently it has been in a rally mode and gold has been pulling back accordingly. (You can view a U.S. dollar chart at www.fxstreet.com/rates-charts/usdollar-index.) If that trend continues, we could see bullion pull back to below US$1,600, which would be bad news for the stocks.

It’s interesting to note that the gold price does not seem to react to crisis situations as it has in the past. The European situation appears to be deteriorating further. Elections in France and Greece threaten to create even more political uncertainty, unemployment is the highest it has ever been since the eurozone was created, and Germany, the continent’s economic engine, is teetering on the edge of recession. Yet gold doesn’t seem to care.

None of this bodes well for the near-term outlook for gold mining stocks. However, prices are now at levels where the strongest companies, such as Barrick, look increasingly attractive to those with a longer-term perspective. With the yield now up to 2.1% based on the enhanced dividend, the stock certainly merits a close look.

So does another of our gold picks, Franco-Nevada (TSX, NYSE: FNV). Originally recommended by contributing editor Gavin Graham in July 2010 at C$31.69, US$30.45, it has held up much better than either Barrick or Goldcorp. The stock topped C$46 during the winter before pulling back to finish last week at C$43.84, US$44.02. The company will report its first-quarter results on May 8. If they are good, take advantage of the opportunity to add to your holdings the price is down.

 

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ANOTHER BERKSHIRE HATHAWAY?

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Contributing editor Gavin Graham joins us today with a new recommendation. Gavin is President of Graham Investment Strategy, a popular speaker, and a frequent guest on radio and television business shows. Here is his report.

Gavin Graham writes:

Last year I recommended Loews (NYSE: L) to IWB readers, an insurance-focused conglomerate controlled by the Tisch family. While the stock has not done a great deal since then, down 6% before dividends, the book value has continued to increase. That is the measure that the Tisches, and indeed Warren Buffett, use to judge the progress of their companies, given the volatility of the insurance business.

Today I’d like to suggest another conglomerate with a long-term approach, which could regarded as another Berkshire Hathaway. In fact, it operates a joint venture with Berkshire for commercial mortgage servicing, a seal of approval for the management of Leucadia National (NYSE: LUK).

Leucadia is a diversified conglomerate with interests in mining companies, a stockbroker, property, timber, wine, gasification plants, plastics manufacturing, and gaming. It has been run by the duo of Ian Cumming and Joseph Steinberg since 1978. Over that period the book value has compounded at 18.5% per year, compared to 8% for the S&P 500 with dividends reinvested. Leucadia’s market price and shareholders’ equity have compounded at 19.8% and 19.1% respectively over that period.

But this excellent track record has not come without volatility. Although Leucadia’s stock was up eight out of past 10 years, it fell 58% in 2008, compared to a 37% decline in the S&P 500, and was down 22% last year while the index was up 2%.

Messrs. Cumming and Steinberg write a letter to shareholders which rivals Warren Buffett’s or Prem Watsa’s (Fairfax Financial) efforts in being both entertaining and informative. They have ruefully described the effects on book value of the recognition or removal of the “Deferred Tax Asset” (DTA). As they remind shareholders, DTA “is not cash but future taxes we hope not to pay.” They go on to remark for 2011 that “thankfully the accounting Pharaohs have been silent and we can almost skip a discussion of the appearing, disappearing, reappearing ‘Deferred Tax Asset'”.

In 2005 and 2007, the accountants decided the profits Leucadia was making meant $1.1 billion (all figures in U.S. dollars unless otherwise stated) and $542 million of deferred taxes could be added to the company’s book value. In 2008, $1.7 billion was subtracted, only for $1.2 billion to be added back in 2010!

However, volatility is not the same as risk. Warren Buffett has famously said he would much rather make a lumpy 15% than a smooth 12%, especially as the lumpiness of the return will deter investors who have a low tolerance for volatility. Messrs. Cumming and Steinberg fall into the same camp and an examination of their largest and single most successful investment reveals a great deal about the reasons for their success.

Believers in the long-term growth of Chinese demand, in August 2006 Leucadia invested $400 million, or almost 15% of its shareholders’ equity, in Australian start-up iron ore miner Fortescue Metals Group (ASX: FMG). For this they received 264 million shares and a $100 million worth of 13-year unsecured notes that receive 4% of the revenue from specific mines, net of government royalties. The following year the company bought an additional 14 million shares for $44.1 million.

With Leucadia’s equity investment, Fortescue managed to raise $2.1 billion of senior debt that allowed them to develop the iron ore mine, a 260 kilometre railway, and port facilities able to handle 40 million metric tonnes per annum (mtpa). Fortescue shipped its first ore in May 2008 and has since expanded its infrastructure to mine and ship 55 mtpa. It shipped 46.5 million mtpa last year for revenue of $6.2 billion and was shipping ore at a run rate of 57.7 mtpa in the fourth quarter of 2011. Fortescue has announced plans to expand further to 155 mtpa of which 90 mtpa will come from mines linked to Leucadia’s royalty note.

Obviously this investment has proven to be an enormous success, but Leucadia has taken the opportunity to crystallize profits. It sold 117.4 million shares last year for $732.2 million, as well as receiving $193 million in royalties net of withholding taxes. It sold another 100 million shares for $506 million in the first quarter of 2012, leaving it with 30.586 million shares worth $186 million and another seven years on the royalty note.

The Chairman’s letter notes that taking dividends, royalties, and stock sales into account, Leucadia has already harvested $1.8 billion and goes on to say “with more yet to come, this has already been a succulent investment.” This is despite a dispute with Fortescue working its way through the Australian courts over the latter’s attempt to issue additional royalty notes in August 2010, diluting Leucadia’s interest.

Leucadia has taken the same bold approach to several of its other investments. It swapped its interest in a Spanish copper project, Cobre Las Cruces, for a shareholding in Canadian miner Inmet (TSX: INM). That made it Inmet’s largest individual shareholder with 11 million shares, equivalent to 16% of the company. In the last year, Inmet announced and then terminated a merger with Lundin Mining; received a C$500 million investment from Temasek, the Singapore government’s Strategic Wealth Fund; brought Cobre Las Cruces production up to 80%-90% of its design capacity, and received environmental approval from the Panamanian government for its massive Cobre Panama copper-gold project. This in turn led a Korean group to buy a 20% stake in the project.

Leucadia’s other large quoted shareholding is a 29% stake in Jefferies (NYSE: JEF) which cost $980 million. Jefferies is a leading U.S. middle market full-service investment bank and broker, with 30 offices in 11 countries. Messrs. Cumming and Steinberg sit on its board of directors.

While Jefferies was valued at just under $800 million at the end of 2011, the Chairman’s letter notes: “in November, our investment in Jefferies almost disappeared! In the aftermath of the MF Global bankruptcy, Jefferies was falsely accused of having a similarly illiquid and risky balance sheet.” Coinciding with the European sovereign debt crisis, short-sellers took the opportunity to pound the stock. The Jefferies management responded with honesty and transparency, revealing all the details of their balance sheet. The bears were beaten back.

Leucadia increased its position in Jefferies in 2008-09, when investment banks were probably the least popular sector in the entire market. Its willingness to take large positions when it is convinced of the underlying soundness of the business has been a hallmark of its management.

For instance, in October 2007, just as the recession was beginning, it began buying stock in auto-finance company Americredit which provides car loans to customers with bad credit. The thinking was that the last payment the U.S. consumer would stop making was their car loan, given the importance of an automobile to enable them to get to work and do the shopping. Provided the interest rate charged was high enough to offset the inevitable defaults, a car finance company would still be profitable even in the depths of the recession. They proved to be right and Leucadia sold its Americredit stake to General Motors for cash in October 2010, receiving $830.6 million for shares that had cost $428.5 million to buy. That generated an internal rate of return of 29%, compounded.

The company’s Berkadia 50/50 joint venture with Berkshire Hathaway is another example of counter-cyclical thinking. It is one of the largest and lowest cost non-bank owned commercial mortgage servicers and originators in the U.S. The joint venture was established in December 2009 with $434 million in capital, of which half is Leucadia’s. Through the end of 2011, Leucadia has received $84.6 million in dividends. Both cash flow and dividends increased in 2011 from 2010.

While the commercial mortgage-backed market “remains in prolonged intensive care”, to quote the Chairman’s letter, and the pool of mortgages for which Berkadia receives fees (the Mortgage Servicing Rights or MSR) shrank from $214 billion to $190 billion between 2010 and 2011, Leucadia expected this and priced the deal accordingly while aiming to be the lowest cost servicer of MSRs.

Furthermore, Berkadia’s network of mortgage originators is beginning to refill the pipeline with deals. Some $5.2 billion of new multi-family and commercial mortgages were originated in 2011, up from $4.6 billion the year before. The majority of these loans were multi-family (condos and apartments) which were sold to federal agencies such as Fannie Mae and Freddie Mac while Berkadia retains the servicing rights.

Leucadia owns a number of other interesting smaller operations, such as the Hard Rock Hotel and Casino in Biloxi, Mississippi, which it bought out of bankruptcy following Hurricane Katrina. It also owns the Crimson Wine Group, producer of 230,000 cases of high quality California and west coast wines; oil and gas driller Keen Energy Services; valve and tube maker Mueller Industries (NDQ: MLI); manufacturers Idaho Timber and Conwed Plastics; and auto dealership joint venture Garcadia. But its most recent and largest investment is in beef!

The simplest way to explain Leucadia’s latest acquisition is to quote from the Chairman’s letter discussing the purchase of 79% of National Beef Packing for $868 million on Dec. 30. This also gives a good feel for the thought processes of its management.

“As our faithful investors know well, we have long watched and commented on global commodity consumption patterns. We continue to believe that as citizens of historically poor countries get richer they will demand higher quality items – and more of them. We believe this thesis is applicable to global protein consumption.

“While protein production and consumption in the U.S. is a mature market and is not growing, global protein consumption is growing at an astounding rate. U.S. beef exports were up over 22% in 2011 vs. 2010. This is an impressive number, made even more so by the fact that the U.S. is not allowed to export beef directly to China – not yet, anyway.

“For a variety of reasons, the U.S. grows the highest quality beef cattle in the world, especially of the Angus variety. People across the globe have an ever-growing desire to consume high quality U.S. beef and we will do all that we can to make that possible.”

National Beef holds a 14% share of the U.S.-fed beef market and processed 3.7 million head of cattle last year, equivalent to five million pounds of live cattle. It made $273.4 million of operating cash flow on revenues of $6.8 billion for the year ended Aug. 31, 2011. The previous owners of National Beef, U.S. Premium Beef and Northern Beef Packers (both of which are suppliers to National Beef), and the CEO, Tim Klein, are retaining 15%, 5% and 1% respectively.

National Beef has three beef processing facilities (two in Kansas, the other in California), a tanning operation, a trucking operation to move cattle, and two case ready facilities in Pennsylvania and Georgia to prepare meat in customer sized portions, removing the need for in-house butchers in supermarkets. It also owns 75% of Kansas City Steak Company which sells steaks direct to consumers through QVC, other online sites, and through catalogues

Worried about the outlook for credit markets, Leucadia paid cash for National Beef. It also reduced its total leverage by over 40% by calling $511 million of long-term debt in 2012 and buying back more of its debt in the market over the last three years. To quote the Chairman’s letter again: “Borrowing money at 7% without a clear path to make 15%+ is not attractive and we don’t see many opportunities to make at least that return.”

While both Messrs. Cumming and Steinberg are in their 70s, the board of Leucadia recently appointed Justin Wheeler as Chief Operating Officer. Mr. Wheeler has been with the company since 2000 and was largely responsible for the Americredit and National Beef deals.

Leucadia underperformed the S&P 500 in three of the last four years, despite realizing $2 billion in capital gains in the last two years and reducing its leverage. I believe it offers good value at current levels. I am recommending it for investors willing to undergo some volatility to gain exposure to a widely diversified and well-managed group of businesses run by two of the top investors of the last quarter-century.

Incidentally, Leucadia is one of the largest holdings of the top performing U.S. mutual fund of the last decade, the Fairholme Fund. It has even paid a small dividend from realized capital gains the last two years which will be treated as foreign income and taxed at an investor’s top marginal rate. These are the first dividends for a number of years.

Action now: Buy Leucadia at the market price. The stock closed on Friday at $24.61.

– end Gavin Graham

 

USEFUL WEBSITES

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Website: Christian Personal Finance

Link: http://christianpf.com/10-free-household-budget-spreadsheets/

Sponsored by: Bob Lotich

What it offers: A lot, but the specific focus of this link is 10 free budget Excel spreadsheets which you can download directly.

What’s good: All the spreadsheets are well-designed and intuitively easy to use. The Personal Budgeting Speadsheet, which I downloaded, contains 14 tabs. The master page contains three tables where you enter all your sources of income, your fixed spending commitments (e.g. mortgage payments), and your variable expenses such as food, clothes, recreation, and travel. By setting up a budget this way you can see immediately what percentage of your expenses are set in stone and where you have flexibility.

The next tab gives you a huge spreadsheet that shows all the expenses for the year by month, correlates that information with income, and calculates a bottom line surplus or deficit. After that, there are separate tabs for each month of the year.

There are several more useful spreadsheets on this site including other budget spreadsheet designs, a family budget planner, a wedding budget template, and a debt reduction spreadsheet.

What’s bad: Nothing that I could find, at least relating to the spreadsheets. The site covers a range of other topics including banking, insurance, and investing which I have not had time to investigate.

Rating: The budget spreadsheet section of this site gets a top $$$$ rating. – G.P.

 

UPDATES

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Philip Morris International (NYSE: PM)

Originally recommended by Tom Slee on March 28/08 as a spin-off from Altria at $52.66. Closed Friday at $89.13. (All figures in U.S. dollars.)

Philip Morris International closed on Friday at $89.13 after a very strong run since early November. That is well through our target of $80 and investors have made a 69% gain since our recommendation to keep the shares after they were spun off from Altria at $52.66 in March 2008. Dividends have been rising ever since and averaged $2.26 per annum, giving investors a total return of about 73%.

I think that while the stock may have more upside potential, it’s fully valued for the moment and investors should take their profits. I will provide more details next week.

Action now: Sell. – T.S.

Kinder Morgan (NYSE: KMI)

Originally recommended by Tom Slee on Sept. 6/11 (IWB #21132) at $25.19. Closed Friday at $35.25. (All figures in U.S. dollars.)

Kinder Morgan is also trading through our target price ($34) and we have a capital gain of 40% to this point. Plus we are receiving an excellent dividend of $1.28 annually for a yield of 3.6% based on the current price. Let’s hold on to this one for a while, with a new target of $38. If you don’t have a position, enter now.

Action now: Buy. – T.S.

Suncor Energy (TSX, NYSE: SU)

Originally recommended by Gordon Pape on June 12/06 (IWB #2622) at C$41.63, US$37.57 (split-adjusted). Closed Friday at C$30.19, US$30.35.

Elsewhere in this issue, there’s an article that discusses the fact that investors are dumping shares of Barrick Gold despite some very good financial results. Suncor is in a similar situation. The share price has been sliding ever since the company released its first-quarter results on April 30.

Suncor recorded net earnings of $1.46 billion ($0.93 per share) during the three months to March 31. That was up significantly from $1.03 billion ($0.65 per share) a year ago. Return on capital employed for the 12 months to March 31 was 14.8%, its highest level since the merger with Petro-Canada. The company cited “strong, reliable production and higher average price realizations” as the main reasons for the improvement.

On the negative side, operating earnings fell to $1.33 billion ($0.85 per share) in the quarter compared to $1.48 billion ($0.94 per share) the year before. The company said the decrease in operating earnings was due primarily to “lower upstream production volumes, higher royalties and higher depreciation in the Oil Sands segment, partially offset by higher average upstream price realizations”.

Upstream production was also down, averaging 562,300 barrels of oil equivalent per day (boe/d) compared to 601,300 boe/d during the first quarter of 2011. An unscheduled one-month shutdown of one of the company’s upgraders was a contributing factor.

This has not been a good period for energy stocks in general and for oil sands stocks in particular. However, I expect that patience will eventually pay off here.

Action now: Buy. – G.P.

Cameco Corp. (TSX: CCO, NYSE: CCJ)

Originally recommended by Gordon Pape on July 21/08 (IWB #2826) at C$38.77, US$38.73. Closed Friday at C$22.37, US$22.50.

The world’s biggest uranium producer reported first-quarter results on May 1 and they were encouraging across the board. Revenue was up 22% year-over-year to $563 million while net earnings rose by 45% to $132 million ($0.33 per share, fully diluted) from $91 million ($0.23 per share) in the same period of 2011. Cash from operations was up 54% to $409 million.

In an accompanying statement, the company described the near to medium term outlook as “uncertain” for the uranium market. This is an overhang from the Japanese nuclear accident which followed the earthquake and tsunami in March 2011.

“Much of the uranium market continues to be in a wait and see mode with limited long-term contracting occurring,” the statement said. “Concerns about possible excess German and Japanese inventories and U.S. Department of Energy materials being introduced into the market continue to cause uncertainty.”

Despite this, the company insists it sees “a very strong and promising growth profile for the nuclear industry in the long term. Countries around the world, with very few exceptions, have reconfirmed their commitment to nuclear energy. China, India, France, Russia, South Korea, the United Kingdom, Canada, the United States, and almost every other country with a nuclear program are maintaining nuclear as a part of their energy mix.”

For the current fiscal year, the company is projecting a revenue decline of as much as 5%. Meantime, administration and exploration costs are expected to rise, which suggests the bottom line is likely to be squeezed over the next few quarters. This could put downward pressure on the stock. Therefore, I do not recommend adding to positions at present.

Action now: Hold. – G.P.

BCE INC. (TSX, NYSE: BCE)

Originally recommended by Gordon Pape on Dec. 15/08 (IWB #2844) at C$21.30, US$17.06. Closed Friday at C$40.42, US$40.58.

BCE was one of the few companies to buck last week’s slide on the TSX, thanks in part to another strong earnings report. On Thursday, the company reported net profits attributable to common shareholders of $574 million ($0.74 per share), up 14.1% from $503 million ($0.67 per share) last year. Adjusted net earnings were $580 million ($0.75 per share), an increase of 6.8% compared to $543 million ($0.72 per share) in the first quarter of 2011. Operating revenue was up 9.9% to $4.91 billion, thanks to significant contributions from Bell Media, which owns CTV, and Bell Wireless.

Chief financial officer Siim Vanaselja reaffirmed all of BCE guidance targets for this year and said that the pending acquisition of Astral Media, which is expected to close in the second half of 2012, “will be EPS and cash flow accretive in 2013, positioning us well to continue executing on our dividend growth objective going forward.” The day before the release of the results, the Competition Bureau completed its examination of the takeover and said it does not intend to challenge it.

Earlier this year the company announced an increase in the quarterly dividend to $0.5425 per share ($2.17 per share). The stock yields 5.4% at the current price.

I advised taking half-profits in March when the shares were trading at C$41.55, US$41.93. They have come off a little since then but have not yet fallen enough to consider them a bargain buy.

Action now: Hold. – G.P.

 

CANADA FALLS FARTHER BEHIND

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It was the worst week the TSX has experienced in months. By the time the closing bell rang on Friday, the Composite Index had fallen 462 points or 3.7% in just three trading sessions. The Index finished on Tuesday at 12,333 and then recorded three triple-digit losses in a row to end the week at 11,871.

The slide wiped out all the remaining gains for 2012 at left the Composite Index down 0.7% for the year. That puts us close to the bottom among the world’s major stock markets so far in 2012. Even troubled Europe is doing better than we are. The German Dow is up 9.6% for the year, the U.K. Dow has gained 2.6%, and even the Paris Bourse is beating us with a small advance of 0.1%.

What’s going on? Canada is supposedly the strongest country in the G7 from a fiscal and economic perspective, but our stock market is being clobbered.

The answer goes back to the extremely narrow nature of our market. Once you get beyond natural resources and financials, there is not a lot left.

Financials have been pulling their weight this year with a gain to date of 5.4%. But the resource landscape resembles an abandoned open pit mine – blighted and barren. The S&P/TSX Capped Materials Index is down 10% so far in 2012, the Metals and Mining Index has lost 11%, the Global Gold Index has given back 16.9%, while the Energy Index is down 7.1%.

Consumer discretionary, consumer staples, health care, and real estate have all been strong but they don’t carry anywhere near enough weight to offset the losses being posted on the commodities side.

I hate to say it but it appears likely this pattern will continue for a while. Analysts and investors continue to watch the Chinese situation closely, wondering whether Beijing will be able to engineer a soft landing or, as seems increasingly likely, it’s going to be a hard one. Either way, China’s growth rate is slowing which means reduced demand for resources and a kick in the teeth for world prices.

While our market is floundering, Wall Street continues to do well. New York was off last week but the losses were nowhere near as bad as in Toronto and all the major U.S. indexes are still comfortably in the black year-to-date. Nasdaq continues to be the top performer with a gain of 13.5% for the year, thanks to a resurgence in the high-tech sector (with the notable exception of Research in Motion which fell to its lowest level in a decade last week). The Dow Jones Industrial Average is ahead 6.7% for the year while the more broadly-based S&P 500 has added 8.9%.

I expect the U.S. markets to continue to outperform the TSX for the rest of this year. Therefore, I reiterate the advice I have given on several previous occasions: add to your positions in U.S. securities. There are many choices on our Recommended List but I especially like the following at present. All prices are in U.S. dollars.

Coach Inc. (NYSE: COH). Originally recommended by Gordon Pape on March 26/12 (IWB #21212) at $77.09. Closed Friday at $72.53.

Kinder Morgan (NYSE: KMI). Originally recommended by Tom Slee on Sept. 6/11 (IWB #21132) at $25.19. Closed Friday at $35.25.

McDonald’s (NYSE: MCD). Originally recommended by Glenn Rogers on Sept. 19/11 (IWB #21134) at $88.29. Closed Friday at $95.87.

Norfolk Southern (NYSE: NSC). Originally recommended by Tom Slee on Dec. 14/09 (IWB #2944) at $52.22. Closed Friday at $71.63.

Southern Company (NYSE: SO). Originally recommended by Gordon Pape on Feb. 6/12 (IWB #21205) at $44.30. Closed Friday at $45.36.

SPDR S&P Dividend ETF (NYSE: SDY). Originally recommended by Gordon Pape on April 9/12 (IWB #21214) at $56.33. Closed Friday at $55.88.

Starbucks (NDQ: SBUX). Originally recommended by Glenn Rogers on Sept. 19/11 (IWB #21134) at $39.20. Closed Friday at $55.56.

Walt Disney (NYSE: DIS). Originally recommended by Glenn Rogers on Dec. 11/11 (IWB #21144) at $36.56. Closed Friday at $42.93.

Yum Brands (NYSE: YUM). Originally recommended by Glenn Rogers on Oct. 24/11 (IWB #21138) at $53.74. Closed Friday at $71.15. – G.P.

 

That’s it for this week. We’ll be back on May 14.

Best regards,

Gordon Pape
gordon.pape@buildingwealth.ca
Circulation matters: customer.service@buildingwealth.ca

All material in the Internet Wealth Builder is copyright Gordon Pape Enterprises Ltd. and may not be reproduced in whole or in part in any form without written consent. None of the content in this newsletter is intended to be, nor should be interpreted as, an invitation to buy or sell securities. All recommendations are based on information that is believed to be reliable. However, results are not guaranteed and the publishers, contributors, and distributors of the Internet Wealth Builder assume no liability whatsoever for any material losses that may occur. Readers are advised to consult a professional financial advisor before making any investment decisions. The staff of and contributors to the Internet Wealth Builder may hold positions in securities mentioned in this newsletter, either personally or through managed accounts. No compensation for recommending particular securities, services, or financial advisors is solicited or accepted.

In This Issue

GOLD LOSES LUSTRE

By Gordon Pape

So Peter Munk is frustrated with the stock performance of Barrick Gold, the mining colossus that he created. Join the club! Hundreds of thousands of investors feel the same way.

Mr. Munk, the billionaire chairman of the world’s largest gold producer, praised the company at last week’s annual general meeting (AGM), lauding management for “exceptional performance” and citing Barrick’s “great fundamentals”.

“For God’s sake, the world should be at your feet,” he told the managerial team. “What more can you ask for?”

A higher share price, that’s what. On Wednesday, the same day that Mr. Munk was extolling Barrick’s results, the stock dropped $1.09. It followed that with a further pull-back of $1.28 on Thursday, reaching a new 52-week low in the process. After a weak rally on Friday, it finished the week at C$37.69, US$37.89. The stock is down 18.3% from $46.15, where it began the year. The shares trade in Toronto and New York under the symbol ABX.

On the surface, it’s difficult to understand what the market is thinking. The company released first-quarter results on the same day as the AGM and they came in close to expectations. Net earnings were $1.03 billion ($1.03 per share), a 3% increase from the year before (note that Barrick reports in U.S. dollars). Adjusted net earnings, with one-time items removed, were $1.09 billion ($1.09 per share), an 8% increase from same prior year period. EBITDA was up 9% to $2 billion however adjusted operating cash flow was off, coming in at $1.37 billion compared to $1.44 billion last year.

Barrick maintained its full year 2012 gold production guidance of 7.3-7.8 million ounces at total cash costs of $520-$560 per ounce and net cash costs of $400-$450 per ounce. The company expects copper production this year of 550-600 million pounds at cash costs of $1.90-$2.20 per pound.

In an effort to add to the attractiveness of the stock, the company raised its dividend by one-third to $0.20 per quarter ($0.80 annually). Based on what happened to the share price, investors were not impressed.

Barrick isn’t the only gold stock that being hammered. Goldcorp (TSX: G, NYSE: GG) also hit a new 52-week low last week, finishing on Friday at C$36.43, US$36.56. It’s off 19.4% since its 2012 opening price of C$45.21.

However, in Goldcorp’s case the sell-off is more understandable. The company’s first-quarter results, which were released on April 25, were disappointing. Net earnings were $479 million or $0.51 a share, fully diluted (Goldcorp also reports in U.S. currency) compared to $651 million ($0.81 per share) in the first quarter of 2011. Revenue increase by almost 11% to $1.35 billion but that was more than offset by a big increase in production costs.

CEO Chuck Jeannes blamed “adverse ground conditions” at the company’s Red Lake mine for delaying the development of new mining faces. “Taken together with lower grade in other areas of the mine, (this) led to our slow start to 2012,” he said. 

What is especially ironic about the plunge in the price of the two gold mining giants is that the metal itself is up 5% since the start of the year, when it was trading at US$1,566.80 per ounce. This disconnect isn’t new, but it seems to be gaining momentum. There have been many theories as to why this is happening but in the end it seems to come down to investor scepticism over the future direction of the price of bullion, which will directly impact the bottom lines of the producers.

And why this scepticism? I suggest it is because of the gradual (very gradual!) improvement in the U.S. economy. Although the correlation is not perfect by any means, there has been a tendency in the past few years for the price of gold to move inversely to the value of the U.S. dollar. When the greenback declines in international currency markets, gold gains ground. The reverse occurs, bullion drops. A stronger U.S. economy will tend to boost the value of the currency.

So far this year, the greenback has shown a very choppy pattern when measured against a basket of currencies that includes the euro, yen, pound sterling, Swiss franc, and Canadian dollar. But recently it has been in a rally mode and gold has been pulling back accordingly. (You can view a U.S. dollar chart at www.fxstreet.com/rates-charts/usdollar-index.) If that trend continues, we could see bullion pull back to below US$1,600, which would be bad news for the stocks.

It’s interesting to note that the gold price does not seem to react to crisis situations as it has in the past. The European situation appears to be deteriorating further. Elections in France and Greece threaten to create even more political uncertainty, unemployment is the highest it has ever been since the eurozone was created, and Germany, the continent’s economic engine, is teetering on the edge of recession. Yet gold doesn’t seem to care.

None of this bodes well for the near-term outlook for gold mining stocks. However, prices are now at levels where the strongest companies, such as Barrick, look increasingly attractive to those with a longer-term perspective. With the yield now up to 2.1% based on the enhanced dividend, the stock certainly merits a close look.

So does another of our gold picks, Franco-Nevada (TSX, NYSE: FNV). Originally recommended by contributing editor Gavin Graham in July 2010 at C$31.69, US$30.45, it has held up much better than either Barrick or Goldcorp. The stock topped C$46 during the winter before pulling back to finish last week at C$43.84, US$44.02. The company will report its first-quarter results on May 8. If they are good, take advantage of the opportunity to add to your holdings the price is down.

 

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ANOTHER BERKSHIRE HATHAWAY?

Contributing editor Gavin Graham joins us today with a new recommendation. Gavin is President of Graham Investment Strategy, a popular speaker, and a frequent guest on radio and television business shows. Here is his report.

Gavin Graham writes:

Last year I recommended Loews (NYSE: L) to IWB readers, an insurance-focused conglomerate controlled by the Tisch family. While the stock has not done a great deal since then, down 6% before dividends, the book value has continued to increase. That is the measure that the Tisches, and indeed Warren Buffett, use to judge the progress of their companies, given the volatility of the insurance business.

Today I’d like to suggest another conglomerate with a long-term approach, which could regarded as another Berkshire Hathaway. In fact, it operates a joint venture with Berkshire for commercial mortgage servicing, a seal of approval for the management of Leucadia National (NYSE: LUK).

Leucadia is a diversified conglomerate with interests in mining companies, a stockbroker, property, timber, wine, gasification plants, plastics manufacturing, and gaming. It has been run by the duo of Ian Cumming and Joseph Steinberg since 1978. Over that period the book value has compounded at 18.5% per year, compared to 8% for the S&P 500 with dividends reinvested. Leucadia’s market price and shareholders’ equity have compounded at 19.8% and 19.1% respectively over that period.

But this excellent track record has not come without volatility. Although Leucadia’s stock was up eight out of past 10 years, it fell 58% in 2008, compared to a 37% decline in the S&P 500, and was down 22% last year while the index was up 2%.

Messrs. Cumming and Steinberg write a letter to shareholders which rivals Warren Buffett’s or Prem Watsa’s (Fairfax Financial) efforts in being both entertaining and informative. They have ruefully described the effects on book value of the recognition or removal of the “Deferred Tax Asset” (DTA). As they remind shareholders, DTA “is not cash but future taxes we hope not to pay.” They go on to remark for 2011 that “thankfully the accounting Pharaohs have been silent and we can almost skip a discussion of the appearing, disappearing, reappearing ‘Deferred Tax Asset'”.

In 2005 and 2007, the accountants decided the profits Leucadia was making meant $1.1 billion (all figures in U.S. dollars unless otherwise stated) and $542 million of deferred taxes could be added to the company’s book value. In 2008, $1.7 billion was subtracted, only for $1.2 billion to be added back in 2010!

However, volatility is not the same as risk. Warren Buffett has famously said he would much rather make a lumpy 15% than a smooth 12%, especially as the lumpiness of the return will deter investors who have a low tolerance for volatility. Messrs. Cumming and Steinberg fall into the same camp and an examination of their largest and single most successful investment reveals a great deal about the reasons for their success.

Believers in the long-term growth of Chinese demand, in August 2006 Leucadia invested $400 million, or almost 15% of its shareholders’ equity, in Australian start-up iron ore miner Fortescue Metals Group (ASX: FMG). For this they received 264 million shares and a $100 million worth of 13-year unsecured notes that receive 4% of the revenue from specific mines, net of government royalties. The following year the company bought an additional 14 million shares for $44.1 million.

With Leucadia’s equity investment, Fortescue managed to raise $2.1 billion of senior debt that allowed them to develop the iron ore mine, a 260 kilometre railway, and port facilities able to handle 40 million metric tonnes per annum (mtpa). Fortescue shipped its first ore in May 2008 and has since expanded its infrastructure to mine and ship 55 mtpa. It shipped 46.5 million mtpa last year for revenue of $6.2 billion and was shipping ore at a run rate of 57.7 mtpa in the fourth quarter of 2011. Fortescue has announced plans to expand further to 155 mtpa of which 90 mtpa will come from mines linked to Leucadia’s royalty note.

Obviously this investment has proven to be an enormous success, but Leucadia has taken the opportunity to crystallize profits. It sold 117.4 million shares last year for $732.2 million, as well as receiving $193 million in royalties net of withholding taxes. It sold another 100 million shares for $506 million in the first quarter of 2012, leaving it with 30.586 million shares worth $186 million and another seven years on the royalty note.

The Chairman’s letter notes that taking dividends, royalties, and stock sales into account, Leucadia has already harvested $1.8 billion and goes on to say “with more yet to come, this has already been a succulent investment.” This is despite a dispute with Fortescue working its way through the Australian courts over the latter’s attempt to issue additional royalty notes in August 2010, diluting Leucadia’s interest.

Leucadia has taken the same bold approach to several of its other investments. It swapped its interest in a Spanish copper project, Cobre Las Cruces, for a shareholding in Canadian miner Inmet (TSX: INM). That made it Inmet’s largest individual shareholder with 11 million shares, equivalent to 16% of the company. In the last year, Inmet announced and then terminated a merger with Lundin Mining; received a C$500 million investment from Temasek, the Singapore government’s Strategic Wealth Fund; brought Cobre Las Cruces production up to 80%-90% of its design capacity, and received environmental approval from the Panamanian government for its massive Cobre Panama copper-gold project. This in turn led a Korean group to buy a 20% stake in the project.

Leucadia’s other large quoted shareholding is a 29% stake in Jefferies (NYSE: JEF) which cost $980 million. Jefferies is a leading U.S. middle market full-service investment bank and broker, with 30 offices in 11 countries. Messrs. Cumming and Steinberg sit on its board of directors.

While Jefferies was valued at just under $800 million at the end of 2011, the Chairman’s letter notes: “in November, our investment in Jefferies almost disappeared! In the aftermath of the MF Global bankruptcy, Jefferies was falsely accused of having a similarly illiquid and risky balance sheet.” Coinciding with the European sovereign debt crisis, short-sellers took the opportunity to pound the stock. The Jefferies management responded with honesty and transparency, revealing all the details of their balance sheet. The bears were beaten back.

Leucadia increased its position in Jefferies in 2008-09, when investment banks were probably the least popular sector in the entire market. Its willingness to take large positions when it is convinced of the underlying soundness of the business has been a hallmark of its management.

For instance, in October 2007, just as the recession was beginning, it began buying stock in auto-finance company Americredit which provides car loans to customers with bad credit. The thinking was that the last payment the U.S. consumer would stop making was their car loan, given the importance of an automobile to enable them to get to work and do the shopping. Provided the interest rate charged was high enough to offset the inevitable defaults, a car finance company would still be profitable even in the depths of the recession. They proved to be right and Leucadia sold its Americredit stake to General Motors for cash in October 2010, receiving $830.6 million for shares that had cost $428.5 million to buy. That generated an internal rate of return of 29%, compounded.

The company’s Berkadia 50/50 joint venture with Berkshire Hathaway is another example of counter-cyclical thinking. It is one of the largest and lowest cost non-bank owned commercial mortgage servicers and originators in the U.S. The joint venture was established in December 2009 with $434 million in capital, of which half is Leucadia’s. Through the end of 2011, Leucadia has received $84.6 million in dividends. Both cash flow and dividends increased in 2011 from 2010.

While the commercial mortgage-backed market “remains in prolonged intensive care”, to quote the Chairman’s letter, and the pool of mortgages for which Berkadia receives fees (the Mortgage Servicing Rights or MSR) shrank from $214 billion to $190 billion between 2010 and 2011, Leucadia expected this and priced the deal accordingly while aiming to be the lowest cost servicer of MSRs.

Furthermore, Berkadia’s network of mortgage originators is beginning to refill the pipeline with deals. Some $5.2 billion of new multi-family and commercial mortgages were originated in 2011, up from $4.6 billion the year before. The majority of these loans were multi-family (condos and apartments) which were sold to federal agencies such as Fannie Mae and Freddie Mac while Berkadia retains the servicing rights.

Leucadia owns a number of other interesting smaller operations, such as the Hard Rock Hotel and Casino in Biloxi, Mississippi, which it bought out of bankruptcy following Hurricane Katrina. It also owns the Crimson Wine Group, producer of 230,000 cases of high quality California and west coast wines; oil and gas driller Keen Energy Services; valve and tube maker Mueller Industries (NDQ: MLI); manufacturers Idaho Timber and Conwed Plastics; and auto dealership joint venture Garcadia. But its most recent and largest investment is in beef!

The simplest way to explain Leucadia’s latest acquisition is to quote from the Chairman’s letter discussing the purchase of 79% of National Beef Packing for $868 million on Dec. 30. This also gives a good feel for the thought processes of its management.

“As our faithful investors know well, we have long watched and commented on global commodity consumption patterns. We continue to believe that as citizens of historically poor countries get richer they will demand higher quality items – and more of them. We believe this thesis is applicable to global protein consumption.

“While protein production and consumption in the U.S. is a mature market and is not growing, global protein consumption is growing at an astounding rate. U.S. beef exports were up over 22% in 2011 vs. 2010. This is an impressive number, made even more so by the fact that the U.S. is not allowed to export beef directly to China – not yet, anyway.

“For a variety of reasons, the U.S. grows the highest quality beef cattle in the world, especially of the Angus variety. People across the globe have an ever-growing desire to consume high quality U.S. beef and we will do all that we can to make that possible.”

National Beef holds a 14% share of the U.S.-fed beef market and processed 3.7 million head of cattle last year, equivalent to five million pounds of live cattle. It made $273.4 million of operating cash flow on revenues of $6.8 billion for the year ended Aug. 31, 2011. The previous owners of National Beef, U.S. Premium Beef and Northern Beef Packers (both of which are suppliers to National Beef), and the CEO, Tim Klein, are retaining 15%, 5% and 1% respectively.

National Beef has three beef processing facilities (two in Kansas, the other in California), a tanning operation, a trucking operation to move cattle, and two case ready facilities in Pennsylvania and Georgia to prepare meat in customer sized portions, removing the need for in-house butchers in supermarkets. It also owns 75% of Kansas City Steak Company which sells steaks direct to consumers through QVC, other online sites, and through catalogues

Worried about the outlook for credit markets, Leucadia paid cash for National Beef. It also reduced its total leverage by over 40% by calling $511 million of long-term debt in 2012 and buying back more of its debt in the market over the last three years. To quote the Chairman’s letter again: “Borrowing money at 7% without a clear path to make 15%+ is not attractive and we don’t see many opportunities to make at least that return.”

While both Messrs. Cumming and Steinberg are in their 70s, the board of Leucadia recently appointed Justin Wheeler as Chief Operating Officer. Mr. Wheeler has been with the company since 2000 and was largely responsible for the Americredit and National Beef deals.

Leucadia underperformed the S&P 500 in three of the last four years, despite realizing $2 billion in capital gains in the last two years and reducing its leverage. I believe it offers good value at current levels. I am recommending it for investors willing to undergo some volatility to gain exposure to a widely diversified and well-managed group of businesses run by two of the top investors of the last quarter-century.

Incidentally, Leucadia is one of the largest holdings of the top performing U.S. mutual fund of the last decade, the Fairholme Fund. It has even paid a small dividend from realized capital gains the last two years which will be treated as foreign income and taxed at an investor’s top marginal rate. These are the first dividends for a number of years.

Action now: Buy Leucadia at the market price. The stock closed on Friday at $24.61.

– end Gavin Graham

 

USEFUL WEBSITES

Website: Christian Personal Finance

Link: http://christianpf.com/10-free-household-budget-spreadsheets/

Sponsored by: Bob Lotich

What it offers: A lot, but the specific focus of this link is 10 free budget Excel spreadsheets which you can download directly.

What’s good: All the spreadsheets are well-designed and intuitively easy to use. The Personal Budgeting Speadsheet, which I downloaded, contains 14 tabs. The master page contains three tables where you enter all your sources of income, your fixed spending commitments (e.g. mortgage payments), and your variable expenses such as food, clothes, recreation, and travel. By setting up a budget this way you can see immediately what percentage of your expenses are set in stone and where you have flexibility.

The next tab gives you a huge spreadsheet that shows all the expenses for the year by month, correlates that information with income, and calculates a bottom line surplus or deficit. After that, there are separate tabs for each month of the year.

There are several more useful spreadsheets on this site including other budget spreadsheet designs, a family budget planner, a wedding budget template, and a debt reduction spreadsheet.

What’s bad: Nothing that I could find, at least relating to the spreadsheets. The site covers a range of other topics including banking, insurance, and investing which I have not had time to investigate.

Rating: The budget spreadsheet section of this site gets a top $$$$ rating. – G.P.

 

UPDATES

Philip Morris International (NYSE: PM)

Originally recommended by Tom Slee on March 28/08 as a spin-off from Altria at $52.66. Closed Friday at $89.13. (All figures in U.S. dollars.)

Philip Morris International closed on Friday at $89.13 after a very strong run since early November. That is well through our target of $80 and investors have made a 69% gain since our recommendation to keep the shares after they were spun off from Altria at $52.66 in March 2008. Dividends have been rising ever since and averaged $2.26 per annum, giving investors a total return of about 73%.

I think that while the stock may have more upside potential, it’s fully valued for the moment and investors should take their profits. I will provide more details next week.

Action now: Sell. – T.S.

Kinder Morgan (NYSE: KMI)

Originally recommended by Tom Slee on Sept. 6/11 (IWB #21132) at $25.19. Closed Friday at $35.25. (All figures in U.S. dollars.)

Kinder Morgan is also trading through our target price ($34) and we have a capital gain of 40% to this point. Plus we are receiving an excellent dividend of $1.28 annually for a yield of 3.6% based on the current price. Let’s hold on to this one for a while, with a new target of $38. If you don’t have a position, enter now.

Action now: Buy. – T.S.

Suncor Energy (TSX, NYSE: SU)

Originally recommended by Gordon Pape on June 12/06 (IWB #2622) at C$41.63, US$37.57 (split-adjusted). Closed Friday at C$30.19, US$30.35.

Elsewhere in this issue, there’s an article that discusses the fact that investors are dumping shares of Barrick Gold despite some very good financial results. Suncor is in a similar situation. The share price has been sliding ever since the company released its first-quarter results on April 30.

Suncor recorded net earnings of $1.46 billion ($0.93 per share) during the three months to March 31. That was up significantly from $1.03 billion ($0.65 per share) a year ago. Return on capital employed for the 12 months to March 31 was 14.8%, its highest level since the merger with Petro-Canada. The company cited “strong, reliable production and higher average price realizations” as the main reasons for the improvement.

On the negative side, operating earnings fell to $1.33 billion ($0.85 per share) in the quarter compared to $1.48 billion ($0.94 per share) the year before. The company said the decrease in operating earnings was due primarily to “lower upstream production volumes, higher royalties and higher depreciation in the Oil Sands segment, partially offset by higher average upstream price realizations”.

Upstream production was also down, averaging 562,300 barrels of oil equivalent per day (boe/d) compared to 601,300 boe/d during the first quarter of 2011. An unscheduled one-month shutdown of one of the company’s upgraders was a contributing factor.

This has not been a good period for energy stocks in general and for oil sands stocks in particular. However, I expect that patience will eventually pay off here.

Action now: Buy. – G.P.

Cameco Corp. (TSX: CCO, NYSE: CCJ)

Originally recommended by Gordon Pape on July 21/08 (IWB #2826) at C$38.77, US$38.73. Closed Friday at C$22.37, US$22.50.

The world’s biggest uranium producer reported first-quarter results on May 1 and they were encouraging across the board. Revenue was up 22% year-over-year to $563 million while net earnings rose by 45% to $132 million ($0.33 per share, fully diluted) from $91 million ($0.23 per share) in the same period of 2011. Cash from operations was up 54% to $409 million.

In an accompanying statement, the company described the near to medium term outlook as “uncertain” for the uranium market. This is an overhang from the Japanese nuclear accident which followed the earthquake and tsunami in March 2011.

“Much of the uranium market continues to be in a wait and see mode with limited long-term contracting occurring,” the statement said. “Concerns about possible excess German and Japanese inventories and U.S. Department of Energy materials being introduced into the market continue to cause uncertainty.”

Despite this, the company insists it sees “a very strong and promising growth profile for the nuclear industry in the long term. Countries around the world, with very few exceptions, have reconfirmed their commitment to nuclear energy. China, India, France, Russia, South Korea, the United Kingdom, Canada, the United States, and almost every other country with a nuclear program are maintaining nuclear as a part of their energy mix.”

For the current fiscal year, the company is projecting a revenue decline of as much as 5%. Meantime, administration and exploration costs are expected to rise, which suggests the bottom line is likely to be squeezed over the next few quarters. This could put downward pressure on the stock. Therefore, I do not recommend adding to positions at present.

Action now: Hold. – G.P.

BCE INC. (TSX, NYSE: BCE)

Originally recommended by Gordon Pape on Dec. 15/08 (IWB #2844) at C$21.30, US$17.06. Closed Friday at C$40.42, US$40.58.

BCE was one of the few companies to buck last week’s slide on the TSX, thanks in part to another strong earnings report. On Thursday, the company reported net profits attributable to common shareholders of $574 million ($0.74 per share), up 14.1% from $503 million ($0.67 per share) last year. Adjusted net earnings were $580 million ($0.75 per share), an increase of 6.8% compared to $543 million ($0.72 per share) in the first quarter of 2011. Operating revenue was up 9.9% to $4.91 billion, thanks to significant contributions from Bell Media, which owns CTV, and Bell Wireless.

Chief financial officer Siim Vanaselja reaffirmed all of BCE guidance targets for this year and said that the pending acquisition of Astral Media, which is expected to close in the second half of 2012, “will be EPS and cash flow accretive in 2013, positioning us well to continue executing on our dividend growth objective going forward.” The day before the release of the results, the Competition Bureau completed its examination of the takeover and said it does not intend to challenge it.

Earlier this year the company announced an increase in the quarterly dividend to $0.5425 per share ($2.17 per share). The stock yields 5.4% at the current price.

I advised taking half-profits in March when the shares were trading at C$41.55, US$41.93. They have come off a little since then but have not yet fallen enough to consider them a bargain buy.

Action now: Hold. – G.P.

 

CANADA FALLS FARTHER BEHIND

It was the worst week the TSX has experienced in months. By the time the closing bell rang on Friday, the Composite Index had fallen 462 points or 3.7% in just three trading sessions. The Index finished on Tuesday at 12,333 and then recorded three triple-digit losses in a row to end the week at 11,871.

The slide wiped out all the remaining gains for 2012 at left the Composite Index down 0.7% for the year. That puts us close to the bottom among the world’s major stock markets so far in 2012. Even troubled Europe is doing better than we are. The German Dow is up 9.6% for the year, the U.K. Dow has gained 2.6%, and even the Paris Bourse is beating us with a small advance of 0.1%.

What’s going on? Canada is supposedly the strongest country in the G7 from a fiscal and economic perspective, but our stock market is being clobbered.

The answer goes back to the extremely narrow nature of our market. Once you get beyond natural resources and financials, there is not a lot left.

Financials have been pulling their weight this year with a gain to date of 5.4%. But the resource landscape resembles an abandoned open pit mine – blighted and barren. The S&P/TSX Capped Materials Index is down 10% so far in 2012, the Metals and Mining Index has lost 11%, the Global Gold Index has given back 16.9%, while the Energy Index is down 7.1%.

Consumer discretionary, consumer staples, health care, and real estate have all been strong but they don’t carry anywhere near enough weight to offset the losses being posted on the commodities side.

I hate to say it but it appears likely this pattern will continue for a while. Analysts and investors continue to watch the Chinese situation closely, wondering whether Beijing will be able to engineer a soft landing or, as seems increasingly likely, it’s going to be a hard one. Either way, China’s growth rate is slowing which means reduced demand for resources and a kick in the teeth for world prices.

While our market is floundering, Wall Street continues to do well. New York was off last week but the losses were nowhere near as bad as in Toronto and all the major U.S. indexes are still comfortably in the black year-to-date. Nasdaq continues to be the top performer with a gain of 13.5% for the year, thanks to a resurgence in the high-tech sector (with the notable exception of Research in Motion which fell to its lowest level in a decade last week). The Dow Jones Industrial Average is ahead 6.7% for the year while the more broadly-based S&P 500 has added 8.9%.

I expect the U.S. markets to continue to outperform the TSX for the rest of this year. Therefore, I reiterate the advice I have given on several previous occasions: add to your positions in U.S. securities. There are many choices on our Recommended List but I especially like the following at present. All prices are in U.S. dollars.

Coach Inc. (NYSE: COH). Originally recommended by Gordon Pape on March 26/12 (IWB #21212) at $77.09. Closed Friday at $72.53.

Kinder Morgan (NYSE: KMI). Originally recommended by Tom Slee on Sept. 6/11 (IWB #21132) at $25.19. Closed Friday at $35.25.

McDonald’s (NYSE: MCD). Originally recommended by Glenn Rogers on Sept. 19/11 (IWB #21134) at $88.29. Closed Friday at $95.87.

Norfolk Southern (NYSE: NSC). Originally recommended by Tom Slee on Dec. 14/09 (IWB #2944) at $52.22. Closed Friday at $71.63.

Southern Company (NYSE: SO). Originally recommended by Gordon Pape on Feb. 6/12 (IWB #21205) at $44.30. Closed Friday at $45.36.

SPDR S&P Dividend ETF (NYSE: SDY). Originally recommended by Gordon Pape on April 9/12 (IWB #21214) at $56.33. Closed Friday at $55.88.

Starbucks (NDQ: SBUX). Originally recommended by Glenn Rogers on Sept. 19/11 (IWB #21134) at $39.20. Closed Friday at $55.56.

Walt Disney (NYSE: DIS). Originally recommended by Glenn Rogers on Dec. 11/11 (IWB #21144) at $36.56. Closed Friday at $42.93.

Yum Brands (NYSE: YUM). Originally recommended by Glenn Rogers on Oct. 24/11 (IWB #21138) at $53.74. Closed Friday at $71.15. – G.P.

 

That’s it for this week. We’ll be back on May 14.

Best regards,

Gordon Pape
gordon.pape@buildingwealth.ca
Circulation matters: customer.service@buildingwealth.ca

All material in the Internet Wealth Builder is copyright Gordon Pape Enterprises Ltd. and may not be reproduced in whole or in part in any form without written consent. None of the content in this newsletter is intended to be, nor should be interpreted as, an invitation to buy or sell securities. All recommendations are based on information that is believed to be reliable. However, results are not guaranteed and the publishers, contributors, and distributors of the Internet Wealth Builder assume no liability whatsoever for any material losses that may occur. Readers are advised to consult a professional financial advisor before making any investment decisions. The staff of and contributors to the Internet Wealth Builder may hold positions in securities mentioned in this newsletter, either personally or through managed accounts. No compensation for recommending particular securities, services, or financial advisors is solicited or accepted.