Few global fund port- folio managers and strategists are enthusiastic about resources stocks this year. Additional supplies of oil, natural gas and base metals are expected to offset the growth in demand for these commodities and put downward pressure on both commodity and stock prices.
Most portfolio managers think this is a temporary phenomenon, which probably will last no more than two years. It is anticipated that prices will resume their climb by 2015 as global economic growth increases and supplies tighten. For now, however, portfolio managers will tend to be underweighted in resources stocks.
Portfolio managers such as Bob Lyon, vice president and portfolio manager with Toronto-based AGF Management Ltd.; Joe Overdevest and Darren Lekkerkerker, portfolio managers with Pyramis Global Advisors, a unit of Boston-based FMR LLC; and Scott Vali, portfolio manager with Signature Global Advisors, a unit of Toronto-based CI Investments Inc., advise focusing on stock selection because of the challenging environment.
Prices of major commodities are expected to be flat or lower this year vs 2013. For example, oil prices closed at US$99 a barrel on Dec. 31, 2013, and are expected to slip a bit but remain above US$90 a barrel this year. This forecast assumes the market is not flooded by oil from the possible lifting of sanctions from Iran and the potential ending of the blockades of Libyan oil terminals.
Copper prices, which closed at US$3.35 a pound for 2013, also are likely to drift lower as new supply this year will put downward pressure on this commodity. But prices should stay above US$3 a pound, then start rising when supplies tighten again in another couple of years as production slows or ends at aging mines.
Although commodity prices are likely to be lacklustre in 2014 in general, portfolio managers do not believe the bottom will fall out of the various resources markets.
Benoît Gervais, vice president of investments with Mackenzie Financial Corp. in Toronto and portfolio manager of Mackenzie Universal Canadian Resource Fund, is one of the few portfolio managers who believe that 2014 could be a good year for resources stocks. He foresees an upside of 40%-50% for subsectors such as chemicals, forestry and base metals, a result of “re-rating when markets realize that the medium-term prospects are good.”
Although Gervais doesn’t foresee the same potential return for energy stocks, he notes that U.S. oil production is rising by 8%-10% a year, which should translate into a similar increase in earnings.
Gervais bases his predictions partly on global economic growth of 3%-3.5% this year, a range cited by many other analysts.
Stronger global economic growth would have a positive impact on the prices of resources equities. For instance, Jean-Guy Desjardins, chairman, CEO and chief investment officer with Fiera Capital Corp. in Montreal, is overweighted in resources equities because he thinks global economic growth will be 3.75%-4% or higher, which would push up commodity prices.
Here’s a look at some of the companies favoured by portfolio managers in various resources subsectors:
Next: Oil and gas
– Oil and gas. Lyon is focusing on two developments he doesn’t think markets have priced into stocks: the decline in exploration risk with shale production (“Companies such as Arc Resources Ltd. and EOG Resources Inc. have five to 15 years of visible earnings growth with virtually no exploration risk”) and higher margins for U.S. refiners, such as Valero Energy Corp., because oil in North America is priced cheaper than elsewhere.
Gervais’ picks include Advantage Oil & Gas Ltd., a Canadian company whose wells are now producing twice as much as two years ago, and Kodiak Oil & Gas Corp., whose costs are coming down as it gains experience in the U.S. Bakken shale oilfield.
Overdevest prefers services firms, such as Secure EnergyServices Inc., which performs waste disposal for the oil and gas industry. Another favourite is Pason Systems Corp., a software and hardware firm that determines what’s underground before drilling.
– Copper. Gervais, Lyon and Vali like Rio Tinto PLC. Lyon, for one, applauds the company’s new capital discipline and says its aggressive expansion of low-cost copper deposits makes it a “free cash flow machine.”
Lyon also considers Teck Resources Ltd., a large and growing copper producer, a “very good buy.” He adds that First Quantum Minerals Ltd.’s stock price is back to an attractive entry level following its takeover of Inmet Mining Corp. last March.
– Forestry. With the U.S. housing industry recovering and Canadian lumber exports continuing to flow to China, Lekkerkerker likes West Fraser Timber Co. Ltd., which is generating good cash flow.
– Chemicals. Methenex Corp. is one of Lekkerkerker’s largest investment positions. Methenex’s management team, he says, has been “the best allocator of capital in the resources space over the past 15 years.”
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