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Jeff Saut Presents: Who Do You Trust?!


Manifestly, the world's insatiable demand for Canada's natural resources is unstoppable...


Editor's Note: The following article was written by Raymond James Chief Investment Strategist, Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

"Who Do You Trust"...except in this case I am not referring to the 1950s game show hosted by Groucho Marx, but rather the high yielding Canadian "trusts" that have entered the investment world in ever increasing numbers over the past few years. More specifically, I am referring to last year's "Halloween Surprise" when the Canadian government decided to tax those income trusts. Indeed, the "now you see now you don't" switcheroo on the tax status of the income trusts was a total surprise to the investment community and the concurrent "fall out" (read: decline) has been devastating for many investors. Plainly, I have returned from a week-long sojourn to Canada where my firm met with companies, portfolio managers, presented at the CFA forecasting dinner, and conducted seminars for our financial advisors. And just like the Canadian question du jour was, "What do you think about energy, as well as your so called stuff-stocks?"... the question back here in the States has been, "What's up with the Canadian income trusts?"

Regrettably, while I have seen many arguments like this inference from Reuters' Randall Palmer that the Canadian government might change its stance...

"OTTAWA (Reuters) - A committee of Canada's House of Commons will decide this week whether to reexamine the government's decision to tax income trusts, especially whether a four-year tax holiday for existing trusts is long enough..." well as the open letter to Canada's Finance Minister, James Flaherty (read it below), my firm believes the Harper/Flaherty tax decision stands as stated. All the attendant "noise" is just political posturing. If correct, this has ramifications for many of the Canadian income trusts. For example, last week a number of income trusts announced substantial dividend reductions, as well as one announcement that a trust was converting back to a corporation. Yet the news didn't stop there. U.S.-based Ventas (VTR) made a takeover bid for Canadian income trust Sunrise Senior Living (SZR.UN), which raised takeover speculation in Boralex Power Trust (BPT.UN). Clearly there is value in many of the income trusts, even under the new taxation schedule, but investors seeking income are advised to closely examine each trust on its own merits.

Nevertheless, I am pondering a much more macro question than income trusts. To wit, for years I have been steadfastly bullish on Canadian equities and the Canadian dollar. Since the "Halloween Surprise," however, my firm has been wondering if said "surprise" is/was a watershed event. I have seen a number of watershed events over the past four decades. My definition of a watershed event is, "An event marking a unique or important historical change of course or one on which important developments depend." Currently I am torn on the subject. Manifestly, the world's insatiable demand for Canada's natural resources is unstoppable, in my opinion. Still, such a major, and abrupt, policy change by the Harper government raises the question, "Will non-Canadian investors view such a change as 'unfriendly' and turn their investment intentions elsewhere?" If so, this would divert capital flows to Canada, at least at the margin, with negative implications for Canadian equities. Reinforcing the sense that this could be a watershed event has been the Canadian dollar's weakness, which began its "slide" concurrent with the "October Surprise." Unfortunately, as of yet I still have no answer and continue to ponder the Canadian question content in the knowledge that sometimes to decide not to decide is indeed a decision. Other watershed events under consideration are Thailand's alarming decision to implement "capital controls" and Sam Zell's surprising decision to sell his flagship Equity Office Properties (EOP) since I consider Mr. Zell the smartest real estate investor in this country.

Turning my attention to the U.S., I find most of the equity indexes I monitor little changed for the week with the outlier being the NASDAQ 100's (NDX) 2.60% loss. Things were not so tame in the commodity markets, however, where copper lost another 6.12%, zinc shed 8.71%, and tin rallied 10.23% (all basis the LME). Meanwhile, the grains remained firm with corn rising 2.70%, yet unleaded gasoline declined 3.50%, crude dipped below $50/brl. and natural gas climbed 9.25% as "things" continue to get curiouser and curiouser. Curiouser indeed, as my mailbox lit up questioning if crude's break below $50 was enough to bring about the "bottom" I spoke of in last week's letter? Hereto my firm is uncertain, but our sense remains that crude oil is close to a bottom despite rumors that Saudi Arabia is pressuring oil prices to bring Iran to its knees.

Bolstering this "bottoming" sense one need only to look at the crude oil chart at the end of this report from the good folks at "" who opine, "Once in a while, one needs to step back and look at the big picture, in this case the channel on the inflation-adjusted chart of spot crude. Nothing has been violated." I agree and have repeatedly noted that while warm weather has had a hand in pressuring energy prices, the real culprit has been Goldman Sach's (GS) mysterious reweighing of its much institutionally indexed commodity index (GSCI). Recall that in late July 2006 Goldman cut the gasoline weighting in the GSCI from 7.3% to 2.5% and staged those cuts incrementally right into the November elections. Again, just a few weeks ago, Goldman once more rejiggered the GSCI, cutting the energy component by 50%, causing one Wall Street wag to ask, "Why in an energy-centric economy does Goldman keep reducing the energy weighting in the GSCI?!"

As for the economic figures during my absence, the skein is still coming in stronger than expected. Admittedly there remains a "whiff" of the fox-trot economy (fast/fast followed by slow/slow) as last week's Empire State Manufacturing Index was reported much softer than estimated, which was in sharp contrast to December's much stronger than expected figures. Ditto the National Association of Homebuilders report came in two points higher than expected, the University of Michigan's consumer confidence "popped" by six points better than consensus (to 98), the Philly Fed shocked at 8.3 (five points higher than expected), and the PPI rose 0.4% more than anticipated to 0.9%. These events did not go unnoticed by the bond market, which saw the yield on the 10-year T'Note tag its highest level since October 2006 (4.78%). All of this continues to suggest that the 2007 surprise might just be that the economy reaccelerates and the Fed, rather than lowering interest rates, either holds them steady or actually raises them."

And speaking of "raising," it sure didn't take the Democrats long to try and raise taxes as they are proposing an energy package that would roll back billions of dollars worth of oil drilling incentives and raise billions more by boosting federal royalties paid by energy companies for offshore production. Nonetheless, as the astute Lowry's organization states, "Despite changes in the political winds, and stern warnings from our new Fed Chairman, the internal condition of the stock market remains strong." I agree, even though I don't understand it or trust it, which is why we continue to choose our investment ideas pretty carefully. Many of the names my firm has been using have a yield, like our recent recommendation on Strong Buy-rated Williams Partners L.P. (WPZ), where growth is pretty assured, driven by the parent company, and our fundamental analyst expects EBITDA to increase from $59 million to $217 million, in turn ramping its cash distribution from $1.73 to $2.41 per share. Other, higher beta names from Raymond James' research universe that we were asked about last week include: Covanta (CVA); American Medical Systems (AMMD); Verifone (PAY); and Syniverse (SVR).

The call for this week: I have learned over the years that when you see a headline, a picture and chart on the front page of a newspaper you are typically near an inflection point. Well while it's not exactly the FRONT page, Friday's Wall Street Journal, on the front page of Section C above the fold, there was a headline ("Who Is Hurt By Oil's Fall"), a picture, and a chart. My firm think oil stocks are bottoming, a sense confirmed by the action of various energy-centric indices (XLE, XOI, OSX, etc.). For more conservative investors, I have been using 5.6%-yielding Blackrock Global Energy (BGR), which despite its rally from the original recommendation still trades at a 5.6% discount to its net asset value. And yes, I still like the Canadian Oil Sands names mentioned in last week's report.

Editor's Note: This letter is from the National Post on 1/3/07.

Dear Mr. Flaherty:

Your first problem is that having lured hundreds of thousands of ordinary Canadians into
income trusts by promising not to raise taxes, you then cut them off at the knees. On the day after you broke your promise, some $25-billion of Canadians' savings went up in smoke. Since that black Wednesday, the income trust index has dropped a little more in relation to the total stock market.

Did any of your predecessors ever impose such a meltdown on their fellow citizens, or indulge in such confiscatory policy or bring Canadian capital markets into such global disrepute? I think not.

Your second problem is one of execution. For the sake of the tax base and tax fairness,
you didn't have to drop a nuclear bomb on the industry. You could have used a more surgical approach.

On the broken promise, the deed is done. The toothpaste is out of the tube. Canadians will make their judgment at the next election. On the incompetent execution, it's not too late to reduce the damage to decent, hard-working Canadians who made the mistake of taking Stephen Harper at his word.

Your press release of Dec. 21 sets out draft income trust legislation and gives Canadians until Jan. 31, 2007, to make technical submissions to your department.

This process is no substitute for democracy. Particularly when the action in question had such a disastrous effect on so many Canadians, it is incumbent on any government, and especially a minority government, to move quickly to subject its proposals to parliamentary scrutiny.

That is why I am seeking your department's co-operation in public hearings by the House of Commons Finance Committee early in the New Year. I will also be writing to the committee chair, Mr. Brian Pallister, MP, asking him to move forward with such hearings. The committee and the Canadian public need experts to answer key questions that you and your department have patently failed to answer.

-Why did the government choose a four year adjustment period, rather than the ten year period chosen by the United States, or some intermediate number of years? Had you chosen a longer period, Canadians' financial losses would have been reduced by many billions of dollars.

-You claim that a longer adjustment period would cost the government $500-million per year. Yet you refuse to divulge the basis for these calculations, and many experts claim that the revenue loss would be a much smaller amount, possibly nothing at all. Where does the truth lie?

-The energy infrastructure trusts argue that your action puts them at a crippling disadvantage compared with their counterparts. Is there merit to this claim?

-These are difficult questions, but billions of dollars of ordinary people's savings are at stake. That is why Canadians need expert public testimony as soon as possible. On the basis of that testimony, we and other opposition parties may urge the government to amend the draft legislation.

-John McCallum, PC, MP, Markham- Unionville, is the Liberal Finance Critic.

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