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Jeff Saut: Wrong About Canada?


Much of the upside profit "torque" has been removed from Alberta-centric energy companies. However, those companies' costs (labor, materials, etc.) continue to have plenty of upside torque, implying profit margins will likely come under pressure.


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.

"It is no disgrace to guess wrong, but it is a disgrace to stay wrong!"

Having been in the investment business for 37 years, and longer than that investing with my father, it becomes a pretty humbling business when "they" can measure you to the second decimal point every morning. If your "winners" outnumber your "losers," however, you should consider yourself fortunate. Count me in the fortunate camp, for my firm's "winners" indeed outnumber its "losers," which is one of the reasons my Canadian friends took such good care of me in Toronto last week. Unsurprisingly, I have been unabashedly bullish on Canada ever since 4Q'01, driven by my "stuff stock" theme. I love Canada, from one of the most beautiful cities in the world, namely Vancouver, to all of my French friends in Montreal. That said, I appeared on Business News Network (BNN; the CNBC/Fox Business of Canada) last week opining that the Albertan Ambush caught me by surprise.

For years I have been bullish on Canada's most business friendly province and the Canadian Tar Sands therein. Regrettably, those views changed last week with Alberta Premier Stelmach's decision to "shred" its previously agreed to covenants. Eerily, it was a year ago this week that I actually concurred with Canada's decision to change the tax status of its "royalty trusts" on the premise the country's corporations were embracing the trusts' favorable tax status and the result was a hollowing out of the country's tax base.

More recently, I agreed that the Abathasca's Tar Sands royalty régime needed a change to give the province's inhabitants more favorable "economic rents" for their oil sands resource. What I can't abide is the fact that the provinces' intelligencia reneged on its promise to a few companies, agreed to in contract form, by the way, and "grandfather" the royalty régime already in place for early tar sands investors like Canadian Oil Sands Trust (COSWF).

Ladies and gentlemen, when I was a "pup" in this business my mentors taught me that when you look someone in the eye, shake their hand, and agree to a contract, your word is your bond. Evidently, that is no longer the case in Alberta. For the record, I was on BNN when Premier Stelmach's decision was rendered, and despite what many Albertans heard, I am still bullish on Canada, as I am on most resource-based countries. I also stated that over the longer-term the tar sands will likely do fine because the world is near/at crude oil's "production peak" whereby the world will be consuming more oil than can be found. However, investment capital goes where it is best treated. And in the near-to intermediate term Alberta seems willing to ignore this fact.

Nevertheless, I was wrong in my assumption that many of the Alberta-centric energy stocks would decline last Friday. Clearly, $92.00 per barrel oil had something to do with that. Dennis Gartman, publisher of the Gartman Reports, even implied that Premier Stelmach's decision helped bolster the price of oil by noting (as reprised by Toronto's newspaper The Globe and Mail):

"Alberta's royalty plan contributed to a new record oil price because it could slow the growth of supply from the oil sands. Mr. Stelmach has sided with the populist farmers of rural Alberta who've long looked upon the oil industry with disdain, and has moved to increase the royalties upon much of the oil industry to what we consider to be onerous levels. This, in our opinion, is lunacy and it shall serve to make less oil available, not more available, from Alberta in the future."

Whether it was Mr. Gartman's insights, or various analysts' statements that the net asset value (NAV) for Alberta's energy companies would only decline a few dollars due to the régime change, the tar sands stocks did not sell-off as I had thought. Evidently the equity markets believe not much has changed. But here is what has indeed changed. Much of the upside profit "torque" has been removed from Alberta-centric energy companies. However, those companies' costs (labor, materials, etc.) continue to have plenty of upside torque, implying profit margins will likely come under pressure. In business, as well as economies, things tend to change at the margin, they don't change on a wholesale basis! And at the margin, at least on a short-to-intermediate term basis, I believe companies will move assets to other Canadian provinces where capital is better treated.

Consistent with these thoughts, I am going to be periodically "moving my capital" by selling partial positions in some of my Canadian Oil Sands positions of six years and redeploy those funds into other Canadian energy companies with less Alberta exposure. As often stated, one of my biggest worries has been centered on politicians and their increasing movement toward protectionism, intervention, and regulation. Plainly, these are some of the reasons a large number of Americans hold their own Congress in such low esteem. Another reason may be reflected in this video clip.

Speaking to the equity markets, my strategy of investing in "stuff," and countries rich in natural resources, continued to reap rewards last week as Australia iShares (EWA), Canada iShares (EWC), and Brazil iShares (EWZ) traded to new all-time highs. Similarly, the Gold and Silver Index (XAU) recorded new all-time highs, which clearly help my long-time holdings in precious metals.

Unfortunately, at least for me on a trading basis, two of the "things" driving the aforementioned action were a weaker U.S. dollar and stronger oil prices. Unfortunate because two weeks ago I went long the dollar, and short oil, on a trading basis, figuring that the dollar would firm after the G-7 meeting and if that happened crude oil should take a price-breather. Indeed, "It is no disgrace to guess wrong, but it is a disgrace to stay wrong," and I have been stopped-out of these trades with minimal losses.

Surprisingly, at least to me, the real star of last week was the financial complex, which jumped to the fore emboldened by remarks from Countrywide Financial's (CFC) CEO that the worst is over. To wit, "In no way did I expect what happened in August, where it was a complete collapse, a seizing up," Chief Executive Angelo Mozilo said on a conference call, "There has been, in my opinion, a significant structural change in the market, a permanent structural change." And with those comments the "financials" took off.

Alas, I am underweight the financials, save some special situations like Flagstar Bancorp (FBC), where hereto I have been just plain w-r-o-n-g. Still, I think FBC is an investable idea and am considering taking one, or two, more tranches (read: purchases) in this nearly 5%- yielding Michigan-based bank as we approach tax loss selling season.

To this tax loss point, it is worth considering that many institutional accounts will sell their "losers" into this week's fiscal year-end (October 2007) to offset their "winners." Following that will come retail investors' tax loss selling season, where for similar reasons select investable ideas will be sold to offset gains taken in this year's big "winners." Even I am considering "banking" partial positions in some of my capital gainers like Vistaprint (VPRT), which leapt more than six ponts on Friday and is up nearly 40% for the year, just to rebalance my portfolios. The implication is that many "good" stocks will be sold for tax reasons in the next few months and not because something is wrong with the fundamentals. This is one of the reasons I keep scaling into (read: tranching into) high-yielding big cap pharma names like Strong Buy-rated Johnson & Johnson (JNJ) and Pfizer (PFE). Verily, big cap pharma is cheap unto itself, cheap relative to the overall stock market, and cheap relative to the risk-free rate of return (T-bill). I continue to invest accordingly.

The call for this week: Last week I was in Toronto and tomorrow I leave for Europe for one of my biannual sojourns. Consequently, these will be the only strategy comments for the next three weeks barring some kind of extraordinary event. Worth considering is that the DJIA reversed its "sell signal" of a few weeks ago rendering a "point and figure" buy signal.

Also of note is a potential "double top" in the benchmark 10-year T'note (read: higher interest rates), as well as a new low in the Dollar Index. I will be spending the next few weeks seeing international portfolio managers and hopefully gleaning some investable ideas to enrich us all. In the interim, be careful out there!

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