A Comment -- General Comments From an Expert (A Commentary)

Portfolio diversification. How should the average investor decide on the appropriate degree of diversification, in terms of kinds of diversification and degree? Part of this depends on how large a portfolio is. If you have $50,000-$100,000, you could have as many as 25 stocks. Feels that 18 to 20 is a reasonable number. You may want a couple oil stocks, possibly 3 bank stocks, etc. You could also get into the US, but you have to realize the currency risk. You could also use Exchange Traded Funds where you can get diversification. This way, you can probably get away with 10 different holdings, because they are diversified themselves.

REITs. They got overpriced and the yields dropped. There are a lot competing against each other. He doesn’t have any significant amount in his portfolios. He likes specific areas in the residential, but feels the commercial side may be a little bit overbuilt in some segments. Until they get back to more competitive yields he would avoid REITs.

Economy. We have recovered and the markets are going well. A big part of it has to do with “money is easy”. The real question, if and when interest rates normalize, will be if the economy can handle it. Looking at car purchases in the US, for the last couple of months, they have been going gang busters with zero financing. They are selling cars, but if people have to pay 4%-6% for those loans, how many cars will sell? Feels we are in a liquidity trap where central banks are going to have to stay easy to fight the deflationary forces of all of us getting older and getting closer to retirement and having to make our money last. We don’t trust the stock market, and volumes are down massively in the last couple of years. At some point, a crisis comes, and we go through another shock. What are central banks going to do next time around? They have pretty much shot all their bullets, and the global debt is double what it was before the crisis.

Educational Segment. Sentiment surveys to see if there is an exuberance in the market or not. One of the best surveys for short-term trading, that correlates the best with the S&P 500, is the American Association of Individual Investors (AAII weekly bull/bear survey). When the percentage of bears is really low and the percentage of bulls is really high, the markets tend to make a peak. Within weeks, typically, you get some kind of a correction. The corrections over the last year have generally been 3%-5%, and the bigger one in February was just over 6%. On a reading a couple of weeks ago, the percentage of Bulls was up around 45%, and is currently at 37%. However, the percentage of Bears keeps going down. A lot of people are more neutral now and unclear, and not nearly as bullish as they were a couple of weeks ago. A recent Yardeni Expectations VS Reality chart (yardeni.com) shows the PE is continuing to rise, but we are getting more economic misses. The question is, is the market PE going to turn down giving us a pullback, or is the economy going to get better.

Markets. A 3-year comparison graph of the TSX versus the Dow shows both are trending higher. The spread between them widened in 2013, but is now narrowing, indicating the TSX is now threatening to outperform the Dow. A 1 year view indicates the TSX is basically a relatively outperform, but is also an established outperform.

TSX Financials VS TSX Composites. Financial Services sector has been the outperformer in 2014, so far. The 3 year chart shows that it has well-outperformed the TSX. In 2012-2013 the 2 lines scrambled, but in the latter part of 2012 the spread between the 2 started to get wider. On a 1-year chart, there was a wider spread from Nov to Feb, and then narrowed with the 2 running very closely together. This tells him that the large outperform is probably ending, and is now going to a “market perform”. What usually follows a market perform is the early stage of the “market under-perform”. The financials, as far as a relative performance, are probably getting tired.

Markets. It is interesting how much caution people are exercising, and how worried they are and how lingering the hangover is from the financial crisis of 2008-2009. We ultimately always have corrections, but we don’t know what is going to cause them. The good news is that we are seeing lots of signs that people are looking for a big correction, which is a good positive. Ultimately valuations on stocks are determined by earnings, and the good news is that earnings are actually driving at a fairly decent clip, irrespective of fairly sloppy activity in the 1^st quarter.

Oil. Fundamentals would suggest lower prices, but there have been a lot of disruptions and geopolitical risks that has been priced in. This makes it very difficult to predict. He envisions that prices could stay in this range for at least the next six months, and possibly as long as 12 months. His view longer-term is that as more supply becomes available, we’ll start to see the price come off.

Gold. Continues to be a believer. The floor has been relatively set at around $1100-$1200. For the types of companies that he is focused on, they could generate some very good margins and free cash flow. Doesn’t see a driver for it being much higher. Companies are living within the reality that they may have to work around $1200-$1400. There are 2 ways to play gold. Some people like leverage, i.e., higher cost operators, because their leverage plays to their advantage. E.G. They’re at $1200, and gold goes up $100, then margins go from $100 to $200. They double versus somebody who is at $1000 whose margins only go from $300 to $400, a 1/3 increase rather than a double. Prefers people that make money for him today, even if there is some downside risk to gold, and they have very sound focused operations.

Base Metals. Looking more constructive. Nickel is probably the one that people are paying more attention to because it has come off such a low, and had been trading as high as $9.50 from the $6’s because of the Indonesian iron ore export ban. In copper, there is some noise coming out of China in terms of collateralizing use of iron ore in copper. Thinks this dust will settle. People were settling for a surplus, and that is diminishing in terms of the size of the surplus.

Economy. Changes are accelerating. The problems in Iraq have all of a sudden become a bigger problem. People are not talking about the 35 year energy deal that Russia and China have just signed. He sees the puzzle changing in terms of the monetary shift that we are going through. This is a massively important deal. The monetary system we are in is changing, and to him that is the last piece of the puzzle. That deal is going to force Saudi Arabia and Germany to make a decision. China has been Saudi Arabia’s biggest buyer of energy, and have been telling them they don’t want to pay for energy in US$, so are going to buy it from the Russians. Germany is Russia’s biggest source of energy, and will have to decide whose geopolitical benefits they’re going to stand for. There is big friction starting to occur in Germany. We are seeing a creation of a Euro-Asian energy complex and trading environment. Because of that, they are going to start dictating the pricing. If Saudi Arabia decided they were not going to continue to trade their oil in US$, what is a country like Chile going to do? They are selling most of their copper to China, and China does not want to pay in US$. Because of this investors have to prepare for stagflation. Monetary instability within the global market means that a lot of the debt that the Western world and the US have, are going to have to be paid somehow, which is going to happen because of a US$ decline. Thinks these issues are accelerating exponentially. The rapidity of everything happening is accelerating.

Markets. We have already had some credit inflation a number of years ago and now credit markets are entering the fray. We are seeing some signs of price inflation. Core inflation is inching up, but you always exclude fuel from that. We are seeing some wage inflation pressures. Minimum wage discussions are taking place in the US as well as discussions about the working poor. It asks if economies are in sync. Margins vs. real wage growth shows major divergence. We may get some more wage and price inflation. Small caps do well in this environment because they can changes their cost structure quickly. He has had an exposure to commodities, but he does not make major bets. He owns component of Materials and Energy on the Canadian side. Sometimes you know too much and it creates Angst. Past GDP growth slowing was shown to be weather related. The economy rebounded after the winter.

Energy. This looks a bit stretched here because it is up 20% or so, but still has some potential to grow. Doesn’t think anything in the Middle East is going to solve itself anytime soon. In the long-term, in Canada especially, the gas market seems to be under a little bit of constraint, and there is some potential for growth in terms of the price, and that bullish market should continue. He wouldn’t be surprised that throughout the summer periods it should go higher. Inventory supplies are pretty low we could see a $5 handle on natural gas. Gold is also doing quite well this year. The only major sector that is lagging is the financials.

Markets. Thinks the Toronto market should continue to outperform to the end of the year, at least. His personal holdings are half energy and half small companies. Feels that with small companies there is a lot of potential growth. Canadian markets are going to be led by large companies, but you get the biggest bang for the buck from small companies and energy. Thinks it is possible that we’ll see a flatter, positive summer. Not anticipating big gains, but thinks there are positive elements in the US economy.

Energy Stocks. The timing of the relatively sudden drop in the Cdn$ versus the US$ tipped the money flows back into our Canadian energy market quite sharply. There was already a lot of good news building up. Some formations where we had been particularly efficient in using new technologies on, such as the cardium, Viking and now the Montney and the rates of returns attracted international attention. We’re going through a very large re-evaluation phase with the markets right now. We have lifting prices for natural gas which is quite nice. A lot of liquid rich natural gas plays have given some incredible rates of returns. Also, there are these manufacturing types of procedures that are taking place on unconventional formations. Some huge improvements on internal rates of return by lowering costs. Investors should focus on the right formations such as what is the rate of return for a typical well drilled into that formation with the average types of costs, such as the Bakken, Shaunavon, Cardium, Viking, and Montney.