In This Issue

THE POTASH DECISION

By Gordon Pape

The state has no place in the boardrooms of the nation. – With apologies to Pierre Trudeau.

In 1967, Mr. Trudeau, who was minister of justice at the time, made clear his aversion to government attempts to control what consenting adults do behind closed doors during a debate over the decriminalization of homosexuality when he said “the state has no place in the bedrooms of the nation”.

Ideologically, you’d think that our current prime minister would be equally as opposed to the state dictating how directors should run their businesses and who should own them. But whatever his personal convictions, it appears they are about to be sacrificed on the alter of political expediency. If the buzz out of Ottawa is correct, the government will cave in to intense pressure from its Western Conservative brethren in Saskatchewan and Alberta and block the hostile takeover bid from BHP Billiton for Potash Corporation of Saskatchewan (TSX: NYSE: POT). Manitoba and Quebec also oppose the sale.

The message that a rejection would send to potential foreign investors in this country will be chilling. A Conservative government, supposedly a friend to business and a strong supporter of free enterprise and economic growth, will be widely castigated as unprincipled and unpredictable when it comes to foreign capital inflows. The decision could have negative implications for our long-term business and trade relations with the United States, Australia, the European Community, and rising economic powers such as India and China.

And to what end? There are no legitimate national security issues at stake. We’re talking about potash, not uranium. The would-be buyer is based in Australia, not Iran. We’re hearing a lot of noise about how the resource belongs to the people of Saskatchewan. Indeed it does, legally. All Potash Corp. owns is the right to extract it, and it pays the provincial government a hefty royalty for the privilege. What are we worried about? That BHP is going to cart off a 100-year supply of the stuff to Australia? Come on! The potash resources will stay in this country and will continue to be mined by Canadian workers.

When you strip away all the rhetoric, everything seems to boil down to money. The Saskatchewan government has come to the conclusion that it will lose billions of dollars in tax revenue if BHP succeeds. It’s an argument that carries little weight. Governments have it in their power to adjust the taxation system any time they want. If Premier Brad Wall and his cabinet don’t like what the outlook, they can change the rules. Giving BHP notice that they intend to do exactly that might make the company back off without the necessity of federal government intervention.

I have no love for BHP Billiton. It has become a colossus in the mining industry and throws its weight around accordingly. Its bid for Potash Corp. has been mismanaged from the outset and is a public relations disaster. The stingy, opportunistic offering price of US$130 a share was just the starting point. That has been followed by one gaffe after another, including the cavalier comment that as soon as the takeover was complete the company would opt out of its participation in Cantopex, the consortium that controls the marketing and distribution of Saskatchewan’s potash and provides Canada with international clout in pricing decisions.

Then there was the incredibly patronizing tone of Andrew Mackenzie’s Guest Opinion column in Friday’s Globe and Mail Report on Business. He’s the CEO of BHP Billiton’s non-ferrous unit and the point man for the takeover bid. In the first paragraph he tells us how he has “spent a lot of time in Canada”. He goes on: “I wouldn’t be the first Scot to have grown fond of Canada, and I have felt first-hand the many parallels between my homeland, and Saskatchewan and Canada.”

Does Mr. Mackenzie honestly think we’re still at the “He likes us, he really likes us!” stage? Or that we even care? Surely he, or more likely his PR writer, can’t be that naïve.

Not that any of this matters a hoot. All that seems to count is that Brad Wall has decided that he doesn’t like Mr. Mackenzie or the offer he has brought to the table and that he has somehow won over Stephen Harper to his position.

That didn’t look like the outcome a few days ago when Mr. Harper noted, correctly, that Potash Corp. is already majority-owned by U.S. investors and that CEO Bill Doyle spends most of his time in Chicago. An Australian company wants to buy a U.S. company. So what?

Now, thanks to Mr. Wall with support from fellow Conservative premier Ed Stelmach of Alberta, this has morphed into national identity issue. It is no such thing. It is hard ball politics, pure and simple, and Mr. Harper appears to fear that if he allows the deal to go ahead, the Western premiers will turn on him and cost him seats in next year’s expected federal election. Shades of Newfoundland’s Danny Williams!

The plain truth is that the BHP bid will fail even if the feds keep their hands off because the offered price is far too low. Events and the markets have passed BHP by. Unless the company is prepared to dramatically sweeten the offer – and it would probably take at least another US$30 a share to even tempt investors to tender – the bid will collapse. The cost of upping the ante by that amount would be almost US$9 billion, which would bring the total price tag for the acquisition to about US$47.6 billion. BHP could afford it but Potash Corp. starts to look pricey at that level and there’s no guarantee investors would tender even at US$160. The third-quarter profit of $402.7 million ($1.32 a share) was up 60% from a year ago and beat analysts’ expectations by a wide margin. The company expects to earn as much as $6 a share this year and between $8 and $8.75 in 2011. We’re starting to hear talk that the shares could be back above $200 within 18 months, based on fundamentals.

In these circumstances, my view is that Ottawa should stand back and let market forces play out. Investors aren’t stupid. It’s clear the BHP offer is woefully inadequate and the price tag for pushing it to an acceptable level may be too much for even this giant to swallow.

Let’s avoid the stigma that would come from closing the door to a multi-national corporation from a friendly country for no reason other than internal politics. Your initial reaction was right, Mr. Harper. Stick with it.

Footnote: Contributing editor Tom Slee advised selling Potash Corp. at C$157.06, US$149.67 right after the BHP bid was announced, saying that any price over US$130 amounted to pure speculation. The shares closed on Friday at C$147.50, US$145.09.


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

PENSION REFORM: THINK BIG, START SMALL

TOP

By Gordon Pape

Finance Minister Jim Flaherty says that improving our retirement savings system by overhauling the Canada Pension Plan won’t be easy and won’t happen any time soon.

“This is not something that will happen quickly,” he told The Globe and Mail recently. “We have to first of all agree on where we’re going and make sure everybody’s happy with that.”

It’s already clear that everybody at the political level is not happy. And working Canadians, the ones who foot the bill for any CPP enhancements, haven’t even been consulted yet. The odds are there will be a huge outcry against the changes once people realize what it will mean to their take-home pay.

Mr. Flaherty and some of his provincial counterparts are promoting “modest” changes to the CPP which would result in increased benefits for all future retirees. The catch, of course, is that they’ll have to be paid for by employees and employers, who are already being hit with high annual contributions.

For 2010, the maximum employee contribution is $2,163.15. Self-employed people pay twice that amount. Employers must match their employees’ contribution dollar for dollar. The maximum increases annually with inflation, making the CPP a burdensome payroll tax, especially for marginal businesses.

Moreover, there is no relief for employers in the event of overcontributions, which can happen when a person holds more than one job or changes employers during a year. Employees get a refund for overcontributions when they file their annual tax returns. For employers, that money simply disappears into the CPP maw. No wonder small businesses are skeptical about further adding to the CPP burden.

The government of Alberta has taken the lead in opposing efforts to fix the country’s retirement savings problems by tinkering with the CPP. They’re right. What we need are a number of targeted improvements rather than a universal overhaul that will catch everyone in the net, whether or not they want to be there. Moreover, many of the needed changes are relatively minor and could be implemented in the next federal budget without provincial approval.

A few days before Mr. Flaherty’s interview with The Globe, the Senate Committee on Banking, Trade and Commerce released its report on the study it conducted last spring into retirement savings. In doing so, the committee said it was specifically targeting the segments of Canadian society where it feels retirement savings reform is most needed: “middle-income Canadians, self-employed persons, and the employees of those small and medium-sized employers that may face barriers in sponsoring an occupational pension plan”. I was invited to testify before the committee in April and I was pleased to see that some of my suggestions have been adopted in one form or another.

Here are some of the committee’s recommendations that Mr. Flaherty can and should incorporate into his 2011 budget speech.

1. End discrimination against low-income retirees. One of the most abhorrent failings of the existing system is the penalty it imposes on low-income people for having saved a little money during their working years. Anyone who qualifies for the Guaranteed Income Supplement (GIS) will be shocked to discover that they lose 50c in benefits for every dollar that comes out of an RRSP or RRIF. The government treats these withdrawals as income and penalizes GIS recipients accordingly. (GIS payments are calculated based on net income.)

In my testimony to the committee, I pointed out that the logical result of this policy is that no one who might qualify for the GIS should contribute to an RRSP. It is one thing to treat withdrawals as taxable income – those in a low bracket won’t be hit very hard. It’s quite another to impose a 50% penalty on their pension benefits because they had the will and the discipline to save.

The committee agreed. Recommendation number two was that “the federal government make the necessary legislative amendments to ensure that, while remaining taxable, withdrawals from registered retirement savings plans have no impact on eligibility for, or the amount of, federal income-tested benefits and tax credits.”

2. Increase the RRSP contribution age. Why should people be forced to stop contributing to RRSPs and start making withdrawals when they reach age 71? It’s an impportant question at a time when mandatory retirement has become an outdated policy and an increasing number of people are working into their 70s, either by choice or necessity.

We also need to consider the fact that a significant percentage of baby boomers are approaching retirement age without a pension plan or adequate savings to sustain them for a life span that may extend into their 80s or beyond.

The only obvious reason for an age cut-off for RRSPs is to enable the government to start taxing these savings sooner rather than later. In other words, it’s a tax grab. My view is that people should be allowed to contribute to RRSPs for as long as they wish. The government will get its money sooner or later. Remember that at the death of the last surviving spouse, all money in an RRSP or RRIF is deemed to have been taken into income and is taxed accordingly.

The committee didn’t go so far as to endorse a lifetime RRSP but the proposal to increase the age limit to 75 is a good start. Their plan is to phase in the change over eight years (six months per year).

3. Review the minimum RRIF withdrawal rates. This one is a no-brainer. The current minimums are much too high in relation to the returns a prudent investor can earn in a RRIF. A 71-year-old has to take out 7.38% of the plan’s value and the percentage increases annually. With interest rates at record lows and income trusts a thing of the past, this means most people will have to begin dipping into capital immediately. This is folly, especially at a time when life expectancy is steadily increasing. The last thing we need is for retirees to start running out of money in their 80s because the government forced them to withdraw more cash than they needed when they were younger. My view is there should be no mandatory minimum, period. Let people take out what they need to live on and save the rest.

4. Increase TFSA contribution room. This was another issue I touched on in my presentation to the committee. I think Tax-Free Savings Accounts are a great idea but the low contribution limit of $5,000 a year works in favour of younger people and places older Canadians, with fewer years to contribute, at a disadvantage. The committee strongly agreed. Recommendation four proposes that a lifetime contribution limit of $100,000 be established for TFSAs, which would be in addition to the annual limit.

“Such a change could have several benefits,” the report said. “The lifetime contribution room could be used by individuals who experience a ‘financial windfall,’ including those we identified earlier as being our principal focus… Lifetime contribution room could also benefit those who are close to retirement and have had relatively less time to make TFSA contributions and to accumulate unused TFSA contribution room.”

The committee said that the Department of Finance estimates that such a plan would cost about $600 million initially, gradually rising to about $1.2 billion annually. But that assumes everyone would take advantage of the provision. Clearly, they won’t. The Finance estimate isn’t a worst-case scenario; it’s an impossible scenario. The committee dismisses the cost issue with the comment: “While we recognize the federal budgetary constraint that currently exists, we believe that the benefits of lifetime TFSA contribution room of $100,000 per individual, as adjusted for inflation – such as reduced public pension costs as well as higher levels of saving – would outweigh the cost.”

None of these changes is dramatic in and of itself. But taken together, they would provide meaningful improvements to a retirement savings system which, while not broken, can certainly be made better. Let’s hope that Mr. Flaherty won’t wait for national agreement on the CPP to introduce the necessary amendments.

 

A VOLUNTARY NATIONAL PLAN

TOP

One of the proposals I made to the Senate Committee on Banking, Trade and Commerce was the creation of a national RRSP to be run by a division of the Canada Pension Plan Investment Board (CPPIB) or a similar organization.

I see this as a logical option for several reasons. First, it would reduce costs. Right now, most people pay far too much in sales commissions, management expense fees, brokerage costs, etc. in their personal RRSPs. The costs of a national plan would be much lower because of efficiencies of scale and elimination of the profit factor. The annual management expense ratio would likely be no more than 0.5%.

Second, the CPPIB is able to invest in securities that are not eligible for ordinary RRSPs and/or are beyond the range of individual investors, such as infrastructure projects like the 407 toll road near Toronto and real estate. A national plan should be allowed the same latitude in choosing investments.

Third, the members of the CPPIB have proven themselves to be very capable money managers over the years. Just check out the returns compared to those generated by mutual funds and you’ll see what I mean.

In my testimony, I stressed that the national RRSP should be voluntary, just as RRSPs are now. People should be allowed to contribute if they wish to do so, with no compunction. Moreover, private plans should be allowed to operate side-by-side. You can bet they would become much more competitive in such an environment.

I also acknowledged in my testimony that the private sector would probably fight tooth-and-nail against the creation of a national RRSP. That’s only to be expected; financial services companies would stand to lose billions of dollars in assets under management if such a plan came into being.

The committee appears to have given a great deal of weight to this issue in formulating the final report. Recommendation six calls for the creation of a national voluntary plan that would enable Canadians “to benefit from the lower fees and shared risk that may result from membership in a group”. However, the committee advised keeping the plan within the private sector, backing away from a conflict with the financial services industry.

Specifically, the proposal contains these features:

1. A plan that incorporates a “limited number” of professionally managed retirement funds that offer a range of objectives, fees, and portfolios. This is similar to the structure now used for group RRSPs and defined-contribution pension plans.

2. The plan should be committed to “clarity, simplicity, efficiency, cost effectiveness, and low fees”. This is nice motherhood language but otherwise meaningless.

3. There should be a clear set of criteria for choosing fund managers which covers such potentially contentious areas as fees and conflicts of interest. Managers should be selected by a “competitive process”. This is more encouraging because it suggests that a rigid vetting program would be applied.

4. Everyone 18 years and older should be automatically enrolled in the plan, with an opt-out option. I don’t like this at all. It’s a variation on the much reviled negative option sales technique that has been widely condemned by consumer groups. In my view, this should be strictly an opt-in plan.

5. The ability to designate payments to the national plan as RRSP or TFSA contributions, within the legal limits.

6. Employers would be able to make matching contributions to the fund(s) of their employees’ choice.

7. A minimum notification period before making withdrawals. I would be cautious about that idea. People can access RRSP money at any time if needed for an emergency (except for locked-in GICs). Why should a national plan be any different?

8. “Impartial and professional guidance” about which funds to choose from the plan’s menu. Good luck with that. Simply providing plan participants with written information is woefully inadequate, a fact we have learned from experience with group RRSPs and defined contribution pension plans. A more interactive way of assisting people with their choices would have to be found. At this stage, I cannot begin to imagine what it might be.

The bottom line is that I think the committee has made this proposal much more complex than it needs to be. My idea of a voluntary plan managed by the CPPIB is much simpler, highly efficient, cheap, and easy to comprehend. I hope this isn’t the last word on this issue. – G.P.

 

THE FINANCIAL CRISIS: THE LOSERS

TOP

During the opening ceremonies of the 2010 Toronto World Money Show, editor and columnist Howard Gold presented his list of the top five winners and losers from the financial crisis. He’s the executive editor of MoneyShow.com and a former staff writer at Barron’s,

Last week I told you about the five top winners. Now here are Mr. Gold’s picks for the biggest losers.

Iceland. Talk about an economic disaster of the highest magnitude! Iceland wins the prize for the biggest loser, hands-down. No one else is even close. The tiny island nation (population 300,000) bet the house (literally) on a heavily leveraged banking system – debt ballooned to 6-7 times GDP. When it all came tumbling down, the country was left in shambles. The stock market lost 90%, GDP plummeted, and a massive devaluation of the krona hit every Icelander in the pocket book. The prime minister and other senior officials are now the subjects of criminal investigations.

Ireland. The economic rejuvenation of this historic financial backwater earned it the nickname “Celtic tiger”. The meltdown, says Mr. Gold, revealed it to actually be “a pussycat with a shamrock”. The main culprit was a real estate bubble that left Irish banks virtually insolvent after it burst (where have we heard that before?). Now the country’s debt to GDP ratio is worse than that of Greece.

“Ireland’s stock market is down 36.2% a year since Lehman’s fall and 23.5% annually over the past five years,” Mr. Gold said. That makes it the worst in Europe.

Greece. This country has become a case study for how not to run a nation. It has lived beyond its means for decades. The civil service is bloated and inefficient. The unions demand entitlements no one can afford. Tax evasion is a national pastime.

“When it comes to crises, Greece is clearly in a league of its own,” Mr. Gold commented. The stock market lost 35% a year from September 2008 to September 2010 and has dropped 15% annually over the past five years. Yet the Greeks seem to expect Europe and the rest of the world to keep bailing them out. “Really?” asks Mr. Gold, incredulously.

Club Med countries. “Spain, Portugal, and Italy are wonderful places to visit, but would you really want to live there?” asks Mr. Gold. Probably not. Too much debt, bloated real estate markets, and economic stagnation all add up to hard times for the people of these picturesque nations. “When was the last time you bought a Spanish-made smart phone or a Portuguese car?” he asked rhetorically.

Italy is the strongest in terms of industrialization but “the Italian stock market was the worst of these three over all periods we tracked – down more than 15% annually since Lehman’s collapse and nearly 9% a year since 2005. Its public debt to GDP ratio stands at about 120%.”

Austria and Hungary. How the mighty have fallen. Prior to World War I, the Austro-Hungarian empire was one of Europe’s superpowers. Now they are two of the biggest victims of the financial meltdown.

“Hungarian consumers borrowed big for loans that were then in cheap Swiss francs and euros,” Mr. Gold said. “When the Hungarian forint collapsed, their monthly payments became unaffordable…Austrian banks are now on the hook for tens of billions of dollars’ worth of those loans.”

The stock markets in both countries have plunged, with Hungary’s off 11.25% annually since Lehman Brothers went down while Austria has lost 24% a year.

“Obviously, goulash and wiener schnitzel don’t mix,” Mr. Gold said.

There are several lessons to be learned from these losers, Mr. Gold concluded.

1. No one is immune to “debt disease”.

2. “Leverage kills.”

3. Try to get China as a partner “and pray their real estate bubble doesn’t pop”.

You can read Mr. Gold’s columns at www.MoneyShow.com – G.P.

 

GORDON PAPE’S UPDATES

TOP

Agnico-Eagles Mines (TSX, NYSE: AEM)

Originally recommended on June 7/10 (IWB #20120) at C$61.06, US$57.69. Closed Friday at C$79.10, US$77.59.

Shares of Agnico-Eagle jumped by more than $4 on Thursday after the company reported record third-quarter earnings of $121.5 million (73c a share, figures in U.S. currency). That was a huge improvement over a loss of $17 million (11c a share) in the same period last year. The profit was driven by a 140% increase in gold production to 285,178 ounces as the company’s expansion program continues to take hold.

“The transformational phase at Agnico-Eagle is complete and has resulted in record earnings and cash flows per share,” said CEO Sean Boyd. “The next phase, one of optimization and expansion of our newly built mines, is underway. As a result, we expect gold production and cash flows to continue to grow. We look forward to reinvesting part of these growing cash flows to expand output, grow gold reserves, and increase our longstanding dividend.” 

The dividend reference comes as a bit of a surprise. Mining companies are notoriously stingy when it comes to paying out cash to investors. Agnico-Eagle has maintained its annual dividend at 18c a share since 2008 despite the big run-up in the gold price. However, the impressive increase in output clearly has management and the directors in a generous mood, although just how generous remains to be seen. The board of directors is expected to set the 2011 dividend when it meets in December.

For the first nine months of 2010, payable gold production was a record 731,138 ounces at a cash cost per ounce of $459. This compares with payable gold production of 329,628 ounces at a cost per ounce of $368 in the first nine months of 2009.

The company says the increase in gold production is due to the impact of two new mines that began operations in the past year. The increase in cash costs per ounce is mainly due to higher than expected expenses at Meadowbank ($682/oz) and Pinos Altos ($527), neither of which were operating in the first nine months of 2009.

The company said at the start of the year that it expected to double its production over 2009 and is right on target to meet that goal, reaffirming full year guidance at between 1.0 and 1.1 million ounces. The cash cost forecast for the full year remains unchanged from the second-quarter guidance of approximately $425 to $450 per ounce.

We have done very well with this stock and we have a capital gain of 29.5% (34.5% in U.S. dollar terms) in the five months since it was recommended. When I advised buying the stock in June, my original 12-month target was $72. I subsequently raised that to $76 but now we are through that level as well. If bullion prices continue to rise, this one could hit $90 or more within a year but let’s be conservative and set a new target of $85.

Action now: Buy.

Cenovus Energy (TSX, NYSE: CVE)

Originally recommended by Yola Edwards on Oct. 23/06 (IWB #2628) at C$25.93, US$23.06. Closed Friday at C$28.38, US$27.82.

One day, Cenovus will be an investor’s dream. Right now it’s just a great story with lots of promise but little pay-off.

The company released third-quarter results last week and they fell well short of analysts’ expectations. Operating earnings came in at $159 million (21c a share), down 63% from $427 million (57c a share) for the same period last year. The Street had been looking for 26c a share. Cash flow was also off dramatically, falling 45% to $509 million (68c a share) from $924 million ($1.23 a share) last year.

The problems were in the downstream part of the business. The company’s U.S. refining operations showed negative cash flow of $32 million, mainly due to higher per unit crude oil costs and lower utilization.

On the good news side of the ledger, production from the Foster Creek and Christina Lake oil sands projects increased 25% year-over-year and the company raised its overall production guidance for the year modestly to 252,000 barrels of oil equivalent per day (boe/d). As well, Cenovus reduced its operating cost projection for the year to a remarkable $8.92 per boe. That is far and away the lowest among oil sands producers.

The high quality and long life of the reserves plus the low operating costs are what make Cenovus such a compelling long-term story. But right now, the stock is fully priced based on output projections for the next couple of years and the share price appears to be stuck in the $27-$30 range.

The 2.9% dividend yield makes Cenovus worth holding on to, but I do not advise adding more at present.

Action now: Hold. – G.P.

 

YOUR QUESTIONS

TOP

International investing

Q – I read the last issue, as usual, with enthusiasm, particularly your reports on the Toronto World Money Show. Your summary of Mr. Howard Gold’s presentation was very interesting and leads to the question: What general investment would you recommend that would give us returns that reflect the fantastic annual returns of these stock markets?

I looked at your current recommendation list for international funds and couldn’t find anything there. Right now we do not own any international funds as we could not find any that were worthwhile. – Marcel L’H.

A – The problem is that no broadly diversified international fund could capture the returns generated by the small stock markets that topped Mr. Gold’s list of winners. You would have to invest directly in those markets.

The U.S. division of iShares offers several ETFs that enable you to do this. For example, Mr. Gold’s choice for the number one winner from the financial crisis was Singapore. You can take a position in that market by buying the iShares MSCI Singapore Index Fund (NYSE: EWS) which closed on Friday at $13.64 (figures in U.S. currency). It gained 25.8% in the year to Sept. 30 and shows a 10-year average annual compound rate of return of just under 10%. But remember, that’s in U.S. dollars. The fund’s four largest holdings, which account for more than 40% of the portfolio, are Singapore Telecommunications (10.9%), DBS Group Holdings (10.6%), United Overseas Bank (9.5%), and Oversea-Chinese Banking Corp. (9.2%). The ETF has total assets of about $2.1 billion and an MER of 0.55%.

Some other countries mentioned as winners by Mr. Gold that can be accessed through iShares ETFs include Chile (NYSE: ECH), Peru (NYSE: EPU), Indonesia (NYSE: EIDO), Malaysia (NYSE: EWM), Sweden (NYSE: EWD), and Australia (NYSE: EWA). – G.P.

U.S. REITs

Q – During your presentation at the recent Toronto World Money Show you mentioned that REITs are one of the better high-yield investment choices. In search of increasing my income, I have come across Annaly Capital Management (NYSE: NLY), a U.S. REIT, which yields about 15%. It has paid that rate for the last three years, and its housing liabilities are back-stopped by the U.S. government. The shares do not appreciate quickly, there is a currency risk, but I cannot determine what justifies such a high yield. What am I overlooking? – Jacob P.

A – You are right to be suspicious about such a high yield. Normally, it suggests a correspondingly high degree of risk. However, in this case it may have more to do with the downtrodden state of the American real estate market and investors’ reluctance to put any more money into it until things stabilize.

Annaly Capital Management was incorporated in 1996 and is based in New York City. Unlike most REITs, the company does not own any physical properties. Instead, its business is managing a portfolio of mortgage-backed securities, all of which are issued and guaranteed by U.S. Government Agencies and carry an actual or implied AAA rating. That may suggest the assets are safe and secure but before you put money here you should know that the guarantees are provided by the likes of Fannie Mae and Freddie Mac, both of which only exist today because of massive government bailouts. Perhaps that helps to explain why investors are nervous.

That said, analysts appear to like this REIT. Thomson/First Call reports that 12 of the 16 analysts who follow the stock rate it as Buy or Strong Buy, with the other four rating it as Hold. None see it as a Sell.

Keep in mind that because this is an American company you will not receive any of the tax advantages associated with Canadian REITs. You should assess the tax implications carefully before making a final decision. The shares closed in New York on Friday at $17.68.- G.P.

TFSA strategies

Q – Thank you for your interesting and insightful Internet Wealth Builder newsletter. I find it fascinating reading even though my investment funds are limited. I am writing to ask for your opinion on the topic of investments for TFSAs, especially pertaining to young investors.

I have three daughters, 24-29, who work very hard at saving. None is married, two are independent, and each is working hard at making a living. The youngest has put the allowed amount for two years into a TFSA though she has not invested it in any fund or equity. It seems reading your newsletter and two books on TFSAs, investing these monies in mutual funds is the preferred way to go. I have looked at your recommendations of the Dynamic Value Balanced Fund, Fidelity Canadian Balanced Fund, and Fidelity Canadian Disciplined Equity Fund. My question is out of the recommendations you make does any one fund have greater strengths for the particular savings vehicle and age of investor?

Would it be foolish for my daughter to invest the total amount in one fund, such as your recommended Beutel Goodman Income Fund? This was a low risk recommendation in June 2009. However, I note that this fund is no longer on your recommended list, though I am not sure why. If this is not the way to go, is it prudent to select one of the above funds or take a small position in a couple of blue chip stocks?

I appreciate your time and consideration of my queries. – Diana B., Vancouver

A – I doubt that your daughters want to devote a lot of time to managing an investment portfolio at this stage so I would suggest a simple approach for now. Given the amount of money in their TFSAs, one or two mutual funds would certainly be the most appropriate route. Generally, I recommend that younger people begin with a high-quality balanced fund. This runs counter to the general advice to go with an equity fund because they have long time horizons but my feeling is that young people should not take too much risk at an early stage of their investing experience. Big losses, such as we saw in 2008-2009, can sometimes spook novice investors for life.

If you want to choose from the funds recommended in the newsletter, one or both of the balanced funds you mention would be appropriate. Pure bond funds are likely to underperform over the next year or two so I would not advise putting a lot of money into one of those. A balanced fund offers both stock and bond exposure, which I believe is the best route for young investors at this time. – G.P.

 

That’s it for October. It didn’t turn out to be anywhere near as scary for the markets as in years past. See you again on Nov. 8.

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

THE POTASH DECISION

By Gordon Pape

The state has no place in the boardrooms of the nation. – With apologies to Pierre Trudeau.

In 1967, Mr. Trudeau, who was minister of justice at the time, made clear his aversion to government attempts to control what consenting adults do behind closed doors during a debate over the decriminalization of homosexuality when he said “the state has no place in the bedrooms of the nation”.

Ideologically, you’d think that our current prime minister would be equally as opposed to the state dictating how directors should run their businesses and who should own them. But whatever his personal convictions, it appears they are about to be sacrificed on the alter of political expediency. If the buzz out of Ottawa is correct, the government will cave in to intense pressure from its Western Conservative brethren in Saskatchewan and Alberta and block the hostile takeover bid from BHP Billiton for Potash Corporation of Saskatchewan (TSX: NYSE: POT). Manitoba and Quebec also oppose the sale.

The message that a rejection would send to potential foreign investors in this country will be chilling. A Conservative government, supposedly a friend to business and a strong supporter of free enterprise and economic growth, will be widely castigated as unprincipled and unpredictable when it comes to foreign capital inflows. The decision could have negative implications for our long-term business and trade relations with the United States, Australia, the European Community, and rising economic powers such as India and China.

And to what end? There are no legitimate national security issues at stake. We’re talking about potash, not uranium. The would-be buyer is based in Australia, not Iran. We’re hearing a lot of noise about how the resource belongs to the people of Saskatchewan. Indeed it does, legally. All Potash Corp. owns is the right to extract it, and it pays the provincial government a hefty royalty for the privilege. What are we worried about? That BHP is going to cart off a 100-year supply of the stuff to Australia? Come on! The potash resources will stay in this country and will continue to be mined by Canadian workers.

When you strip away all the rhetoric, everything seems to boil down to money. The Saskatchewan government has come to the conclusion that it will lose billions of dollars in tax revenue if BHP succeeds. It’s an argument that carries little weight. Governments have it in their power to adjust the taxation system any time they want. If Premier Brad Wall and his cabinet don’t like what the outlook, they can change the rules. Giving BHP notice that they intend to do exactly that might make the company back off without the necessity of federal government intervention.

I have no love for BHP Billiton. It has become a colossus in the mining industry and throws its weight around accordingly. Its bid for Potash Corp. has been mismanaged from the outset and is a public relations disaster. The stingy, opportunistic offering price of US$130 a share was just the starting point. That has been followed by one gaffe after another, including the cavalier comment that as soon as the takeover was complete the company would opt out of its participation in Cantopex, the consortium that controls the marketing and distribution of Saskatchewan’s potash and provides Canada with international clout in pricing decisions.

Then there was the incredibly patronizing tone of Andrew Mackenzie’s Guest Opinion column in Friday’s Globe and Mail Report on Business. He’s the CEO of BHP Billiton’s non-ferrous unit and the point man for the takeover bid. In the first paragraph he tells us how he has “spent a lot of time in Canada”. He goes on: “I wouldn’t be the first Scot to have grown fond of Canada, and I have felt first-hand the many parallels between my homeland, and Saskatchewan and Canada.”

Does Mr. Mackenzie honestly think we’re still at the “He likes us, he really likes us!” stage? Or that we even care? Surely he, or more likely his PR writer, can’t be that naïve.

Not that any of this matters a hoot. All that seems to count is that Brad Wall has decided that he doesn’t like Mr. Mackenzie or the offer he has brought to the table and that he has somehow won over Stephen Harper to his position.

That didn’t look like the outcome a few days ago when Mr. Harper noted, correctly, that Potash Corp. is already majority-owned by U.S. investors and that CEO Bill Doyle spends most of his time in Chicago. An Australian company wants to buy a U.S. company. So what?

Now, thanks to Mr. Wall with support from fellow Conservative premier Ed Stelmach of Alberta, this has morphed into national identity issue. It is no such thing. It is hard ball politics, pure and simple, and Mr. Harper appears to fear that if he allows the deal to go ahead, the Western premiers will turn on him and cost him seats in next year’s expected federal election. Shades of Newfoundland’s Danny Williams!

The plain truth is that the BHP bid will fail even if the feds keep their hands off because the offered price is far too low. Events and the markets have passed BHP by. Unless the company is prepared to dramatically sweeten the offer – and it would probably take at least another US$30 a share to even tempt investors to tender – the bid will collapse. The cost of upping the ante by that amount would be almost US$9 billion, which would bring the total price tag for the acquisition to about US$47.6 billion. BHP could afford it but Potash Corp. starts to look pricey at that level and there’s no guarantee investors would tender even at US$160. The third-quarter profit of $402.7 million ($1.32 a share) was up 60% from a year ago and beat analysts’ expectations by a wide margin. The company expects to earn as much as $6 a share this year and between $8 and $8.75 in 2011. We’re starting to hear talk that the shares could be back above $200 within 18 months, based on fundamentals.

In these circumstances, my view is that Ottawa should stand back and let market forces play out. Investors aren’t stupid. It’s clear the BHP offer is woefully inadequate and the price tag for pushing it to an acceptable level may be too much for even this giant to swallow.

Let’s avoid the stigma that would come from closing the door to a multi-national corporation from a friendly country for no reason other than internal politics. Your initial reaction was right, Mr. Harper. Stick with it.

Footnote: Contributing editor Tom Slee advised selling Potash Corp. at C$157.06, US$149.67 right after the BHP bid was announced, saying that any price over US$130 amounted to pure speculation. The shares closed on Friday at C$147.50, US$145.09.


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

PENSION REFORM: THINK BIG, START SMALL

By Gordon Pape

Finance Minister Jim Flaherty says that improving our retirement savings system by overhauling the Canada Pension Plan won’t be easy and won’t happen any time soon.

“This is not something that will happen quickly,” he told The Globe and Mail recently. “We have to first of all agree on where we’re going and make sure everybody’s happy with that.”

It’s already clear that everybody at the political level is not happy. And working Canadians, the ones who foot the bill for any CPP enhancements, haven’t even been consulted yet. The odds are there will be a huge outcry against the changes once people realize what it will mean to their take-home pay.

Mr. Flaherty and some of his provincial counterparts are promoting “modest” changes to the CPP which would result in increased benefits for all future retirees. The catch, of course, is that they’ll have to be paid for by employees and employers, who are already being hit with high annual contributions.

For 2010, the maximum employee contribution is $2,163.15. Self-employed people pay twice that amount. Employers must match their employees’ contribution dollar for dollar. The maximum increases annually with inflation, making the CPP a burdensome payroll tax, especially for marginal businesses.

Moreover, there is no relief for employers in the event of overcontributions, which can happen when a person holds more than one job or changes employers during a year. Employees get a refund for overcontributions when they file their annual tax returns. For employers, that money simply disappears into the CPP maw. No wonder small businesses are skeptical about further adding to the CPP burden.

The government of Alberta has taken the lead in opposing efforts to fix the country’s retirement savings problems by tinkering with the CPP. They’re right. What we need are a number of targeted improvements rather than a universal overhaul that will catch everyone in the net, whether or not they want to be there. Moreover, many of the needed changes are relatively minor and could be implemented in the next federal budget without provincial approval.

A few days before Mr. Flaherty’s interview with The Globe, the Senate Committee on Banking, Trade and Commerce released its report on the study it conducted last spring into retirement savings. In doing so, the committee said it was specifically targeting the segments of Canadian society where it feels retirement savings reform is most needed: “middle-income Canadians, self-employed persons, and the employees of those small and medium-sized employers that may face barriers in sponsoring an occupational pension plan”. I was invited to testify before the committee in April and I was pleased to see that some of my suggestions have been adopted in one form or another.

Here are some of the committee’s recommendations that Mr. Flaherty can and should incorporate into his 2011 budget speech.

1. End discrimination against low-income retirees. One of the most abhorrent failings of the existing system is the penalty it imposes on low-income people for having saved a little money during their working years. Anyone who qualifies for the Guaranteed Income Supplement (GIS) will be shocked to discover that they lose 50c in benefits for every dollar that comes out of an RRSP or RRIF. The government treats these withdrawals as income and penalizes GIS recipients accordingly. (GIS payments are calculated based on net income.)

In my testimony to the committee, I pointed out that the logical result of this policy is that no one who might qualify for the GIS should contribute to an RRSP. It is one thing to treat withdrawals as taxable income – those in a low bracket won’t be hit very hard. It’s quite another to impose a 50% penalty on their pension benefits because they had the will and the discipline to save.

The committee agreed. Recommendation number two was that “the federal government make the necessary legislative amendments to ensure that, while remaining taxable, withdrawals from registered retirement savings plans have no impact on eligibility for, or the amount of, federal income-tested benefits and tax credits.”

2. Increase the RRSP contribution age. Why should people be forced to stop contributing to RRSPs and start making withdrawals when they reach age 71? It’s an impportant question at a time when mandatory retirement has become an outdated policy and an increasing number of people are working into their 70s, either by choice or necessity.

We also need to consider the fact that a significant percentage of baby boomers are approaching retirement age without a pension plan or adequate savings to sustain them for a life span that may extend into their 80s or beyond.

The only obvious reason for an age cut-off for RRSPs is to enable the government to start taxing these savings sooner rather than later. In other words, it’s a tax grab. My view is that people should be allowed to contribute to RRSPs for as long as they wish. The government will get its money sooner or later. Remember that at the death of the last surviving spouse, all money in an RRSP or RRIF is deemed to have been taken into income and is taxed accordingly.

The committee didn’t go so far as to endorse a lifetime RRSP but the proposal to increase the age limit to 75 is a good start. Their plan is to phase in the change over eight years (six months per year).

3. Review the minimum RRIF withdrawal rates. This one is a no-brainer. The current minimums are much too high in relation to the returns a prudent investor can earn in a RRIF. A 71-year-old has to take out 7.38% of the plan’s value and the percentage increases annually. With interest rates at record lows and income trusts a thing of the past, this means most people will have to begin dipping into capital immediately. This is folly, especially at a time when life expectancy is steadily increasing. The last thing we need is for retirees to start running out of money in their 80s because the government forced them to withdraw more cash than they needed when they were younger. My view is there should be no mandatory minimum, period. Let people take out what they need to live on and save the rest.

4. Increase TFSA contribution room. This was another issue I touched on in my presentation to the committee. I think Tax-Free Savings Accounts are a great idea but the low contribution limit of $5,000 a year works in favour of younger people and places older Canadians, with fewer years to contribute, at a disadvantage. The committee strongly agreed. Recommendation four proposes that a lifetime contribution limit of $100,000 be established for TFSAs, which would be in addition to the annual limit.

“Such a change could have several benefits,” the report said. “The lifetime contribution room could be used by individuals who experience a ‘financial windfall,’ including those we identified earlier as being our principal focus… Lifetime contribution room could also benefit those who are close to retirement and have had relatively less time to make TFSA contributions and to accumulate unused TFSA contribution room.”

The committee said that the Department of Finance estimates that such a plan would cost about $600 million initially, gradually rising to about $1.2 billion annually. But that assumes everyone would take advantage of the provision. Clearly, they won’t. The Finance estimate isn’t a worst-case scenario; it’s an impossible scenario. The committee dismisses the cost issue with the comment: “While we recognize the federal budgetary constraint that currently exists, we believe that the benefits of lifetime TFSA contribution room of $100,000 per individual, as adjusted for inflation – such as reduced public pension costs as well as higher levels of saving – would outweigh the cost.”

None of these changes is dramatic in and of itself. But taken together, they would provide meaningful improvements to a retirement savings system which, while not broken, can certainly be made better. Let’s hope that Mr. Flaherty won’t wait for national agreement on the CPP to introduce the necessary amendments.

 

A VOLUNTARY NATIONAL PLAN

One of the proposals I made to the Senate Committee on Banking, Trade and Commerce was the creation of a national RRSP to be run by a division of the Canada Pension Plan Investment Board (CPPIB) or a similar organization.

I see this as a logical option for several reasons. First, it would reduce costs. Right now, most people pay far too much in sales commissions, management expense fees, brokerage costs, etc. in their personal RRSPs. The costs of a national plan would be much lower because of efficiencies of scale and elimination of the profit factor. The annual management expense ratio would likely be no more than 0.5%.

Second, the CPPIB is able to invest in securities that are not eligible for ordinary RRSPs and/or are beyond the range of individual investors, such as infrastructure projects like the 407 toll road near Toronto and real estate. A national plan should be allowed the same latitude in choosing investments.

Third, the members of the CPPIB have proven themselves to be very capable money managers over the years. Just check out the returns compared to those generated by mutual funds and you’ll see what I mean.

In my testimony, I stressed that the national RRSP should be voluntary, just as RRSPs are now. People should be allowed to contribute if they wish to do so, with no compunction. Moreover, private plans should be allowed to operate side-by-side. You can bet they would become much more competitive in such an environment.

I also acknowledged in my testimony that the private sector would probably fight tooth-and-nail against the creation of a national RRSP. That’s only to be expected; financial services companies would stand to lose billions of dollars in assets under management if such a plan came into being.

The committee appears to have given a great deal of weight to this issue in formulating the final report. Recommendation six calls for the creation of a national voluntary plan that would enable Canadians “to benefit from the lower fees and shared risk that may result from membership in a group”. However, the committee advised keeping the plan within the private sector, backing away from a conflict with the financial services industry.

Specifically, the proposal contains these features:

1. A plan that incorporates a “limited number” of professionally managed retirement funds that offer a range of objectives, fees, and portfolios. This is similar to the structure now used for group RRSPs and defined-contribution pension plans.

2. The plan should be committed to “clarity, simplicity, efficiency, cost effectiveness, and low fees”. This is nice motherhood language but otherwise meaningless.

3. There should be a clear set of criteria for choosing fund managers which covers such potentially contentious areas as fees and conflicts of interest. Managers should be selected by a “competitive process”. This is more encouraging because it suggests that a rigid vetting program would be applied.

4. Everyone 18 years and older should be automatically enrolled in the plan, with an opt-out option. I don’t like this at all. It’s a variation on the much reviled negative option sales technique that has been widely condemned by consumer groups. In my view, this should be strictly an opt-in plan.

5. The ability to designate payments to the national plan as RRSP or TFSA contributions, within the legal limits.

6. Employers would be able to make matching contributions to the fund(s) of their employees’ choice.

7. A minimum notification period before making withdrawals. I would be cautious about that idea. People can access RRSP money at any time if needed for an emergency (except for locked-in GICs). Why should a national plan be any different?

8. “Impartial and professional guidance” about which funds to choose from the plan’s menu. Good luck with that. Simply providing plan participants with written information is woefully inadequate, a fact we have learned from experience with group RRSPs and defined contribution pension plans. A more interactive way of assisting people with their choices would have to be found. At this stage, I cannot begin to imagine what it might be.

The bottom line is that I think the committee has made this proposal much more complex than it needs to be. My idea of a voluntary plan managed by the CPPIB is much simpler, highly efficient, cheap, and easy to comprehend. I hope this isn’t the last word on this issue. – G.P.

 

THE FINANCIAL CRISIS: THE LOSERS

During the opening ceremonies of the 2010 Toronto World Money Show, editor and columnist Howard Gold presented his list of the top five winners and losers from the financial crisis. He’s the executive editor of MoneyShow.com and a former staff writer at Barron’s,

Last week I told you about the five top winners. Now here are Mr. Gold’s picks for the biggest losers.

Iceland. Talk about an economic disaster of the highest magnitude! Iceland wins the prize for the biggest loser, hands-down. No one else is even close. The tiny island nation (population 300,000) bet the house (literally) on a heavily leveraged banking system – debt ballooned to 6-7 times GDP. When it all came tumbling down, the country was left in shambles. The stock market lost 90%, GDP plummeted, and a massive devaluation of the krona hit every Icelander in the pocket book. The prime minister and other senior officials are now the subjects of criminal investigations.

Ireland. The economic rejuvenation of this historic financial backwater earned it the nickname “Celtic tiger”. The meltdown, says Mr. Gold, revealed it to actually be “a pussycat with a shamrock”. The main culprit was a real estate bubble that left Irish banks virtually insolvent after it burst (where have we heard that before?). Now the country’s debt to GDP ratio is worse than that of Greece.

“Ireland’s stock market is down 36.2% a year since Lehman’s fall and 23.5% annually over the past five years,” Mr. Gold said. That makes it the worst in Europe.

Greece. This country has become a case study for how not to run a nation. It has lived beyond its means for decades. The civil service is bloated and inefficient. The unions demand entitlements no one can afford. Tax evasion is a national pastime.

“When it comes to crises, Greece is clearly in a league of its own,” Mr. Gold commented. The stock market lost 35% a year from September 2008 to September 2010 and has dropped 15% annually over the past five years. Yet the Greeks seem to expect Europe and the rest of the world to keep bailing them out. “Really?” asks Mr. Gold, incredulously.

Club Med countries. “Spain, Portugal, and Italy are wonderful places to visit, but would you really want to live there?” asks Mr. Gold. Probably not. Too much debt, bloated real estate markets, and economic stagnation all add up to hard times for the people of these picturesque nations. “When was the last time you bought a Spanish-made smart phone or a Portuguese car?” he asked rhetorically.

Italy is the strongest in terms of industrialization but “the Italian stock market was the worst of these three over all periods we tracked – down more than 15% annually since Lehman’s collapse and nearly 9% a year since 2005. Its public debt to GDP ratio stands at about 120%.”

Austria and Hungary. How the mighty have fallen. Prior to World War I, the Austro-Hungarian empire was one of Europe’s superpowers. Now they are two of the biggest victims of the financial meltdown.

“Hungarian consumers borrowed big for loans that were then in cheap Swiss francs and euros,” Mr. Gold said. “When the Hungarian forint collapsed, their monthly payments became unaffordable…Austrian banks are now on the hook for tens of billions of dollars’ worth of those loans.”

The stock markets in both countries have plunged, with Hungary’s off 11.25% annually since Lehman Brothers went down while Austria has lost 24% a year.

“Obviously, goulash and wiener schnitzel don’t mix,” Mr. Gold said.

There are several lessons to be learned from these losers, Mr. Gold concluded.

1. No one is immune to “debt disease”.

2. “Leverage kills.”

3. Try to get China as a partner “and pray their real estate bubble doesn’t pop”.

You can read Mr. Gold’s columns at www.MoneyShow.com – G.P.

 

GORDON PAPE’S UPDATES

Agnico-Eagles Mines (TSX, NYSE: AEM)

Originally recommended on June 7/10 (IWB #20120) at C$61.06, US$57.69. Closed Friday at C$79.10, US$77.59.

Shares of Agnico-Eagle jumped by more than $4 on Thursday after the company reported record third-quarter earnings of $121.5 million (73c a share, figures in U.S. currency). That was a huge improvement over a loss of $17 million (11c a share) in the same period last year. The profit was driven by a 140% increase in gold production to 285,178 ounces as the company’s expansion program continues to take hold.

“The transformational phase at Agnico-Eagle is complete and has resulted in record earnings and cash flows per share,” said CEO Sean Boyd. “The next phase, one of optimization and expansion of our newly built mines, is underway. As a result, we expect gold production and cash flows to continue to grow. We look forward to reinvesting part of these growing cash flows to expand output, grow gold reserves, and increase our longstanding dividend.” 

The dividend reference comes as a bit of a surprise. Mining companies are notoriously stingy when it comes to paying out cash to investors. Agnico-Eagle has maintained its annual dividend at 18c a share since 2008 despite the big run-up in the gold price. However, the impressive increase in output clearly has management and the directors in a generous mood, although just how generous remains to be seen. The board of directors is expected to set the 2011 dividend when it meets in December.

For the first nine months of 2010, payable gold production was a record 731,138 ounces at a cash cost per ounce of $459. This compares with payable gold production of 329,628 ounces at a cost per ounce of $368 in the first nine months of 2009.

The company says the increase in gold production is due to the impact of two new mines that began operations in the past year. The increase in cash costs per ounce is mainly due to higher than expected expenses at Meadowbank ($682/oz) and Pinos Altos ($527), neither of which were operating in the first nine months of 2009.

The company said at the start of the year that it expected to double its production over 2009 and is right on target to meet that goal, reaffirming full year guidance at between 1.0 and 1.1 million ounces. The cash cost forecast for the full year remains unchanged from the second-quarter guidance of approximately $425 to $450 per ounce.

We have done very well with this stock and we have a capital gain of 29.5% (34.5% in U.S. dollar terms) in the five months since it was recommended. When I advised buying the stock in June, my original 12-month target was $72. I subsequently raised that to $76 but now we are through that level as well. If bullion prices continue to rise, this one could hit $90 or more within a year but let’s be conservative and set a new target of $85.

Action now: Buy.

Cenovus Energy (TSX, NYSE: CVE)

Originally recommended by Yola Edwards on Oct. 23/06 (IWB #2628) at C$25.93, US$23.06. Closed Friday at C$28.38, US$27.82.

One day, Cenovus will be an investor’s dream. Right now it’s just a great story with lots of promise but little pay-off.

The company released third-quarter results last week and they fell well short of analysts’ expectations. Operating earnings came in at $159 million (21c a share), down 63% from $427 million (57c a share) for the same period last year. The Street had been looking for 26c a share. Cash flow was also off dramatically, falling 45% to $509 million (68c a share) from $924 million ($1.23 a share) last year.

The problems were in the downstream part of the business. The company’s U.S. refining operations showed negative cash flow of $32 million, mainly due to higher per unit crude oil costs and lower utilization.

On the good news side of the ledger, production from the Foster Creek and Christina Lake oil sands projects increased 25% year-over-year and the company raised its overall production guidance for the year modestly to 252,000 barrels of oil equivalent per day (boe/d). As well, Cenovus reduced its operating cost projection for the year to a remarkable $8.92 per boe. That is far and away the lowest among oil sands producers.

The high quality and long life of the reserves plus the low operating costs are what make Cenovus such a compelling long-term story. But right now, the stock is fully priced based on output projections for the next couple of years and the share price appears to be stuck in the $27-$30 range.

The 2.9% dividend yield makes Cenovus worth holding on to, but I do not advise adding more at present.

Action now: Hold. – G.P.

 

YOUR QUESTIONS

International investing

Q – I read the last issue, as usual, with enthusiasm, particularly your reports on the Toronto World Money Show. Your summary of Mr. Howard Gold’s presentation was very interesting and leads to the question: What general investment would you recommend that would give us returns that reflect the fantastic annual returns of these stock markets?

I looked at your current recommendation list for international funds and couldn’t find anything there. Right now we do not own any international funds as we could not find any that were worthwhile. – Marcel L’H.

A – The problem is that no broadly diversified international fund could capture the returns generated by the small stock markets that topped Mr. Gold’s list of winners. You would have to invest directly in those markets.

The U.S. division of iShares offers several ETFs that enable you to do this. For example, Mr. Gold’s choice for the number one winner from the financial crisis was Singapore. You can take a position in that market by buying the iShares MSCI Singapore Index Fund (NYSE: EWS) which closed on Friday at $13.64 (figures in U.S. currency). It gained 25.8% in the year to Sept. 30 and shows a 10-year average annual compound rate of return of just under 10%. But remember, that’s in U.S. dollars. The fund’s four largest holdings, which account for more than 40% of the portfolio, are Singapore Telecommunications (10.9%), DBS Group Holdings (10.6%), United Overseas Bank (9.5%), and Oversea-Chinese Banking Corp. (9.2%). The ETF has total assets of about $2.1 billion and an MER of 0.55%.

Some other countries mentioned as winners by Mr. Gold that can be accessed through iShares ETFs include Chile (NYSE: ECH), Peru (NYSE: EPU), Indonesia (NYSE: EIDO), Malaysia (NYSE: EWM), Sweden (NYSE: EWD), and Australia (NYSE: EWA). – G.P.

U.S. REITs

Q – During your presentation at the recent Toronto World Money Show you mentioned that REITs are one of the better high-yield investment choices. In search of increasing my income, I have come across Annaly Capital Management (NYSE: NLY), a U.S. REIT, which yields about 15%. It has paid that rate for the last three years, and its housing liabilities are back-stopped by the U.S. government. The shares do not appreciate quickly, there is a currency risk, but I cannot determine what justifies such a high yield. What am I overlooking? – Jacob P.

A – You are right to be suspicious about such a high yield. Normally, it suggests a correspondingly high degree of risk. However, in this case it may have more to do with the downtrodden state of the American real estate market and investors’ reluctance to put any more money into it until things stabilize.

Annaly Capital Management was incorporated in 1996 and is based in New York City. Unlike most REITs, the company does not own any physical properties. Instead, its business is managing a portfolio of mortgage-backed securities, all of which are issued and guaranteed by U.S. Government Agencies and carry an actual or implied AAA rating. That may suggest the assets are safe and secure but before you put money here you should know that the guarantees are provided by the likes of Fannie Mae and Freddie Mac, both of which only exist today because of massive government bailouts. Perhaps that helps to explain why investors are nervous.

That said, analysts appear to like this REIT. Thomson/First Call reports that 12 of the 16 analysts who follow the stock rate it as Buy or Strong Buy, with the other four rating it as Hold. None see it as a Sell.

Keep in mind that because this is an American company you will not receive any of the tax advantages associated with Canadian REITs. You should assess the tax implications carefully before making a final decision. The shares closed in New York on Friday at $17.68.- G.P.

TFSA strategies

Q – Thank you for your interesting and insightful Internet Wealth Builder newsletter. I find it fascinating reading even though my investment funds are limited. I am writing to ask for your opinion on the topic of investments for TFSAs, especially pertaining to young investors.

I have three daughters, 24-29, who work very hard at saving. None is married, two are independent, and each is working hard at making a living. The youngest has put the allowed amount for two years into a TFSA though she has not invested it in any fund or equity. It seems reading your newsletter and two books on TFSAs, investing these monies in mutual funds is the preferred way to go. I have looked at your recommendations of the Dynamic Value Balanced Fund, Fidelity Canadian Balanced Fund, and Fidelity Canadian Disciplined Equity Fund. My question is out of the recommendations you make does any one fund have greater strengths for the particular savings vehicle and age of investor?

Would it be foolish for my daughter to invest the total amount in one fund, such as your recommended Beutel Goodman Income Fund? This was a low risk recommendation in June 2009. However, I note that this fund is no longer on your recommended list, though I am not sure why. If this is not the way to go, is it prudent to select one of the above funds or take a small position in a couple of blue chip stocks?

I appreciate your time and consideration of my queries. – Diana B., Vancouver

A – I doubt that your daughters want to devote a lot of time to managing an investment portfolio at this stage so I would suggest a simple approach for now. Given the amount of money in their TFSAs, one or two mutual funds would certainly be the most appropriate route. Generally, I recommend that younger people begin with a high-quality balanced fund. This runs counter to the general advice to go with an equity fund because they have long time horizons but my feeling is that young people should not take too much risk at an early stage of their investing experience. Big losses, such as we saw in 2008-2009, can sometimes spook novice investors for life.

If you want to choose from the funds recommended in the newsletter, one or both of the balanced funds you mention would be appropriate. Pure bond funds are likely to underperform over the next year or two so I would not advise putting a lot of money into one of those. A balanced fund offers both stock and bond exposure, which I believe is the best route for young investors at this time. – G.P.

 

That’s it for October. It didn’t turn out to be anywhere near as scary for the markets as in years past. See you again on Nov. 8.

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.