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

Energy. There might be a pullback before there is a firm price on oil. Markets and commodities do not go in one direction. Given that we have had quite a bit of good news with oil in the last 4-6 weeks, it is just a matter of time before some bad news starts to creep back in. The good news is that we have consensus that we have reached a bottom in oil prices, but he wouldn’t translate that as stability in the share prices of oil companies.

Portfolio construction for a small investor? The biggest consideration is the amount of capital you have. With larger amounts of capital, you can properly diversify. Buying good quality stocks makes sense, however with that customization ability, comes risk that you are not diversified enough or that you start to become really excited about 1 or 2 companies putting more of your capital in that. A more conservative way is to have the broad market. This will not give you the customization ability, but if you are someone not managing on a daily basis, then a passive strategy like an ETF or a mutual fund would be a better way. You want exposure to the US and Canada, but don’t be too heavy in Canada because it is a small percentage of overall GDP growth.

Strategy for mitigating risks because of market fluctuations? This is something investors wrestle with on a daily basis. He generally never goes to more than 25% cash and doesn’t do it because he is making a big call on the market. If you are wrong, it is hard to recover. The idea of using cash is to add some insulation and reduce volatility. Anything more than 25% means you are making a call on the market. Over the summer we are going to have volatility, but is not expecting a major pullback.

Markets. A lot of companies in the resource sector have had to cut costs and now you are seeing more in the small cap resource sector. The small caps have underperformed for so long you could expect to see, from history, performances of 100-200 percent. If you see outperformance in the small caps for the remainder of the year then you will see more money move to small caps. You may see some IPOs in the small cap sector later this year.

Gold. Stocks and material stocks were oversold. The gold Resource Index was off 88% on a nominal basis, and more than that on a real basis. If you think gold is going up, you should own gold, as opposed to gold stocks. Gold should outrun gold stocks over time, because people take more risks to be involved in the gold stocks than they do in gold. The increase in the gold price itself increases margins of producers faster than the increase in the gold price. If you believe gold is going up, own the gold first. Gold is going higher for 3 reasons. 1.) The most important catalyst has been the zero interest rate policy. 2.) For 35 years, gold has traded inversely to the US$. US 10-year treasury has been in a 35-year bull market. If you believe it is closer to the end than to the beginning, then the gold bull market is closer to the beginning then to the end. 3.) Gold is treated as a safe haven, and has been for a millennium. The US Treasury no longer acts as a safe haven because of its current yield.

Market. Sometimes you have to listen to what the market is trying to tell you. Since early February, the US market has been moving up, despite 1^st quarter earnings of about -6%, and the 1^st quarter GDP also being pretty lousy. Thinks the market is looking forward to some earnings advance. We need earnings to grow in order for stocks to grow. For earnings to grow we need the economy to move forward. Consumers are in pretty good shape. They don’t have too much debt. Also, feels the US$ is going to go down which will help consumers outside of the US. Also, many emerging markets finance their dollar denominated debt, so when the dollar goes up, they have higher payments to make which is tough for emerging-market governments. Also, many commodities such as oil and natural gas are priced in US$s, and when the dollar goes up it makes those commodities more expensive than what they are in the US.

Pipelines. These are going down because of the fear that their customers are going to go bankrupt, and some of them are. If they go bankrupt, the contracts are potentially not going to be valid. Even if they have fixed-price contracts, they won’t be any good if the customer is bankrupt.

Gold mining stocks? Gold is very difficult to predict. Most gold mining stocks do not pay dividends, and have a lot of debt. If you are going to buy gold, he would do it now. The one thing that would predict whether gold was going to go up or go down is the US$. Gold is a place where central governments turn to when the dollar starts going down. When it goes down, US treasuries also go down, and governments start getting discouraged and start buying gold as an alternative for reserve assets. Doesn’t think either of the US presidential candidates are going to be good for the US$, which is why he would be bullish on gold right now.

Canadian Technology. For the most part technology is a smaller cap space in Canada versus the US. He is finding quite a bit of unloved value in this area. When you have an environment where you have a lot of money chasing after fewer deals, you are going to get a price mismatch. Some of the bigger funds started to buy these deals, which brings a fair amount of harder scrutiny to how the pricing happens. In the US, Fidelity was participating hugely, and then they were getting repriced, and this was followed by accounting. In Canada, every year we have to prove valuations of the private companies, their metrics and how they go about that. And they don’t correlate, they are going to jump up and down on valuations, so you have to be very disciplined when you are buying a private company through the scrutiny of your audit committee.

Energy. Previously OPEC had reduced the supply so that there was no inventory and that stoked the price up. However, there was always lots of oil around, lots of excess capacity. Now with Saudi Arabia saying that it was going to produce everything that it can, by definition that means there is no capacity, but it is all inventory which makes the market more volatile. The commodity can sit at $45, but the stock market will start discounting where the commodity can be 6 months from now. In connection with the Fort Mac situation, the first one that gets hit is the insurance company. $9-$10 billion of something has to get sold to pay for it. That money is being stored in assets, and assets have to be liquidated to cover bills. The one thing he is more concerned about is how much it would affect the smaller businesses, as opposed to the big Suncor (SU-T) and Canadian Natural Resources (CNQ-T).

Markets. Thinks financial markets are being supported by stimulus. Today was a great example because the market turned almost on a dime when China announced they were going to stimulate their economy. Earnings have been weak for two quarters in a row, and have actually declined. There were a lot of beats this time, but mostly on the back of diminished expectations on one hand, and what has essentially been record stock buybacks, particularly in the US. That has made earnings on a per share basis look probably better than they should be. Yet the market keeps going higher. He doesn’t see any justification for this except for the stimulus factors. Doesn’t think earnings are going to be there for another year at best, and if that is the case, one of 2 things has to happen. You have to have the price/earnings multiple expand keeping stock prices here, or you are going to have the market fall a bit which is going to bring the price/earnings multiple where it should be. The exception to that rule, are companies whose price/earnings are less significant, because they are in a disrupting part of the economy, such as Facebook (FB-Q) or Amazon (AMZN-Q). Those are the kinds of things where price/earnings are not going to matter as much, but you have a company that can grow in an economy that is not growing very fast. However, they are expensive and there is some downside risk. Single digit returns are the new norm right now. If so, he can do that with some covered option writing strategies on blue-chip stocks, and the stocks really don’t have to go anywhere in order to get that number. There is also less risk.

How do you know what to write covered calls on? He looks at a stock and what he feels is its trading range. Using the premise that the market is based on mean reversion, it is going to come back to the centre at some point. We know markets overshoot to the upside and overshoot to the downside. Nobody knows exactly where that number ends. You create something called a mean reversion, it will come back into the middle. Technicians look at moving averages to try to figure out what that is. The options market can give you some insight as well. By taking options on a particular security you can wrap a trade around what you perceive to be the mean reversion. If you believe it is worth a certain figure, you could sell a call option at the top end of the range, and if there is a reasonable price and you really get it right, you can actually reduce the cost of the stock down to the bottom end of the range. You can play that mean reversion game all day long. This strategy should always beat a “buy and hold”. If you apply this methodology across the board on indexes, it actually does work.

Energy. Feels we will find an alternative to oil, when we run out of oil. Technology will have figured it out at that point. Thinks oil is going to be a worthless asset 20 years from now. If so, then the long-term picture for oil is not good. Saudi Arabia is trying to get what they can get for oil today and build up a sovereign fund. They are putting their money where their mouth is because they are selling the main corporation, which they believe might be worth $1 trillion, which is based on the premise that at some point it will have no value. That means there will continue to be huge supplies coming out of the Middle East and around the world, and we will be sloshed in supply meaning oil prices will stay weak.

Markets. There will be some temporary disruptions to oil operations in Alberta because of the wild fires. There is a short term supply disruption, but this will not affect investing unless you are a day trader. Saudi Arabia is going to continue to be pedal to the metal with oil production. Summer driving will probably keep oil below $40. In September and October, we are at bigger risk for a pullback to $30. Global trade is slowing, including from China. This is a big challenge for the world. All the borrowing and spending is not working.

Markets. Since the financial crisis central banks have tried to do a lot in dabbling in uncommon monetary policies. This has had a lot of unintended consequences in the market places. No one knows what other unintended financial consequences will occur. The money available to borrow with low interest rates has not been invested in capital return. Investors are forced to go into risky assets. When you throw cheap money at people they do silly things. In 2005, crude oil was at $50. You go to the bank to explore your property, you don’t have a business. Now after the financial crisis, you have a business plan. Now you have a booming business. Now everyone is pumping oil. Everybody is over hedging and we have oversupply.