Sunday, July 22

Week 55 - Canadian Commodity Producers

Situation: Let’s say you visited Canada 10 yrs ago and converted $1,000 USD into Canadian dollars (CDN) at the airport but then had to cut your trip short and returned without exchanging those bills. You get around to exchanging that currency now 10 yrs later and you receive ~$1500 USD for your CDN$. Feels like there must be a mistake, eh? Well there isn’t. You’ve been holding a currency that was issued by a commodity producing country. (You’d have done even better had you gone to Australia.) Net of fees, your initial $1,000 USD bought you $1,519 CDN on July 1, 2002 , which grew in value and were worth $1,545 USD on July 2, 2012, representing a total return of  4.1%/yr. That was your “reward” but there was also a “risk”: CDNs fell 21% in value relative to USDs during the 18 month “bear market” from 10/07 to 4/09. Therefore, the notional “Finance Value” of your investment (risk minus reward) was 4.1 minus 21, or approximately minus 17. If you check out the Table accompanying this week’s blog, you will see that’s quite good, and in the range of a good hedge fund (Week 46). Congratulations! You’ve just received a grade of “A” in your first class on how to invest (not speculate) in commodities.

“But,” you say, “wouldn’t I have done better by investing in a high quality, no-load natural resource mutual fund with a low expense ratio?” Perhaps, but then you would be speculating. Think about it. That fund would likely have been T Rowe Price’s New Era Fund, with a 9.1%/yr total return over the past 10 yrs. However, it lost 46.3% between 10/07 and 4/09 leaving a notional Finance Value of -37.2%. You could have made more money than our currency example but only if you hadn’t been scared into selling at the bottom of the bear market. Let’s try to do better using another example and check out our “Gold Standard” for stock performance in a commodity-related economy--the diversified Fidelity Canada Fund (FICDX). Total return was 11.3%/yr over the past 10 yrs but it also lost 44.9% during that 18 month bear market, for a Finance Value of -33.5%. By comparison, the Vanguard Admiral S&P 500 Index Fund (VFIAX) had a total return of 5.6%/yr but lost 41.5% during the bear market, for a Finance Value of -35.9%. Well-run hedge funds lost only 64% as much as the S&P 500 Index during the bear market so their Finance Values were in the -10 to -20% range. Blackrock’s Global Allocation A Fund (MDLOX) is a full-load mutual fund run by a company that specializes in hedge funds. We use MDLOX in our tables as a benchmark for hedge funds.

This week we’ll look at Canadian commodity producers and railroads (see the attached Table). The major companies are analyzed by S&P and co-listed on the New York Stock Exchange. NOTE: Imperial Oil, the leading oil & gas producer, isn’t listed in our Table because ExxonMobil (XOM) holds 69.6% of its stock; XOM is listed instead. Alcan, the largest aluminum producer in the world, also isn’t listed because it is now a wholly-owned subsidiary of an Australian company, Rio Tinto (RIO); RIO is listed instead.

Bottom Line: Companies that extract, develop, and transport commodities for end-markets are risky endeavors because lead times are long and fixed costs are massive. But it remains a worthwhile endeavor because those same markets reflect population growth, infrastructure investment, and improvements in standards of living. Canada has a long history and much experience in extracting and developing commodities, which has been funded mainly by its banks. The Toronto Stock Exchange and Ottawa government have also played leading roles. Indeed, the entire Canadian economy is permeated with a deep understanding of risk management. That is why there was no subprime crisis in Canada.

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