With oil prices still below us$40 a barrel at the beginning of 2016 and base metal prices also very depressed, natural resources stocks may not seem attractive. Still, these sectors may hold opportunities.
Despite this pessimistic outlook, energy is overweighted by some portfolio managers, including Scott Vali, vice president and resources portfolio manager with CIBC Asset Management Inc. in Toronto. The thesis is simple: the plunge in oil prices was accompanied by an even deeper plunge in oil and gas stocks; thus, any sustained rise in oil prices is likely to push up stock prices.
However, the direction of price moves this year is uncertain. This uncertainty reflects the many unknown factors influencing the market – how much U.S. production will drop, what Saudi Arabia will do and how much oil supply will come from Iran and Libya.
The investing outlook for base metals is more negative. The main factor imposing a drag on these values is China, which is shifting from its emphasis on exports and rapid building of infrastructure to an economy driven by domestic consumer spending.
Here’s a look at the energy and base metals sectors in more detail.
– Energy. The big question is how long the Organization of Petroleum Exporting Countries (OPEC) can weather low oil prices. So far, OPEC has kept the price low to drive high-cost producers out of business.
Other key factors include U.S. shale-oil production. This source has been much more resilient against falling oil prices than expected and only now are there indications that shale-oil production is starting to drop. But downward price pressure may increase, with rising production from Iran and possibly Libya.
Given the interaction of all these factors, oil prices could drop further. However, some increase is more likely, perhaps leading to oil at US$45 a barrel by the end of this year.
Good-quality companies are recommended: companies with strong balance sheets, high-quality management, low costs and strong reserves. Possibilities include integrated firms, which explore, produce and distribute oil and gas, as well as exploration and production (E&P) companies.
Vali sees good value in the integrateds, which benefit from increased demand when prices are low. Investment possibilities include Suncor Inc., Chevron Corp. and Total SA.
Among E&P companies, favourites include Arc Resources Ltd., Canadian Natural Resources Ltd. Devon Energy Corp. and EOG Resources Inc. Notes Bob Lyon, senior vice president, portfolio management with the Signature Global Asset Management team at CI Financial Corp. in Toronto: “You can count on Arc and EOG because they are low-cost producers” with strong balance sheets.
Benoît Gervais, senior vice president, investments, and head of the resources portfolio team at Mackenzie Financial Corp. in Toronto, favours Seven Generations Energy Ltd., another low-cost producer with “exceptional” geological ability and expertise.
Joe Overdevest, portfolio manager at Fidelity Canada Asset Management ULC in Toronto, likes PrairieSky Royalty Ltd., which collects royalties from companies drilling on its land. He notes the firm has high return on equity, high cash flow, a dividend yield of 6% and an attractive valuation.
– Base metals. “If you have to have base metal stocks, own low-cost producers with good balance sheets,” advises Lyon. An example is London-based Rio Tinto PLC, a global producer of iron ore, with costs of around US$18-US$19 a ton, which is likely to rise to the high US$20s when transportation costs are added in. That provides a good profit, given the recent commodity price of around US$40.
Lyon favours copper in the long term, but notes that there is excess supply currently. Both he and Vali suggest Lundin Mining Corp., a low-cost producer with a strong balance sheet, that may be able to acquire assets that come up for sale.
Vali also likes HudBay Minerals Inc. As well, he notes, First Quantum Minerals Inc. still has some of the best copper assets, despite some balance sheet problems.
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