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

Gold and silver? These both had 2 ½-3 disappointing years. He doesn’t know if they will break out, but there is a lot of pent up energy in these trades right now. Doesn’t mean it is going to happen, but your risk/reward is pretty good. Looking at gold, it is in the $1160-$1180 range and is really positive. Silver tends to react a bit quicker, so you would get a pretty good cue on both of them based on how silver acts. They have been pretty constructive in the last couple of months. It doesn’t mean something is going to happen though.

Energy. Reading all the popular press, you conclude that there is somewhere between 1.5-2 million barrels of oil oversupply currently in the market, which has been enough to create the situation now where oil prices are falling dramatically. It really comes down to a game between the Saudi’s and the US shale industry. The oversupply issue is a concern with the Saudi’s because they want to protect market share, and really becomes a question of who is going to blink first. You have to wonder how much pain the Saudis can stand with this big haircut in the price of oil. They have a huge budget deficit even at higher oil prices. He thinks things are going to come to a rapid halt. For example, big players in the Bakken trimmed their budget by 50%. We are starting to see that across all the basins. It is just a matter of time before production follows the budget cuts.

Natural Gas. The story is one of oversupply, principally coming from shale gas plays. The biggest is the Marsalis in the Northeast US. This is a little more sensitive to weather issues, but you have to look a little deeper than that and convince yourself that there is some serious potential declines around the corner. The Marsalis is on the verge of producing 20 BCF a day, which would be not quite a third of the total US gas production. However, they have a serious problem in that they don’t have enough take away pipe capacity to get the gas to market. On December 31, gas in the Tennessee region was selling for just over $1 MCF. That is not sustainable, so why would a company drill if the best price they are going to get is $1. Gas production there will decline rapidly if the drilling stops or slows down. He expects this will show up in gas volumes. We need to see a big correction like this to get the fundamentals on side. Expects the gas season will probably finish back to normal.

Energy. It has been a very precipitous decline and he saw nothing that was predicting anything like this. Whatever the reasons, we are in a new paradigm as far as energy stocks are concerned. As a value investor and looking out over a five-year period, what you should be doing is very selectively initially taking some position in the companies that are likely going to benefit most from a very bad environment. A number of companies are likely not to survive and will soon be victims of M&A activity. Investors should initiate positions in the very high quality companies. Doesn’t know where the bottom of this is likely to be, but suspects that we are below the threshold where the new normal might end up. Don’t think we will see $100 for some time. In a situation where you have supply greater than demand, there is going to be a period where things run off and it will take a while for that supply to diminish. A lot of these companies, particularly those that are highly levered, are going to keep their wells going because they have to make debt payments and they need the cash. That can only last so long because banks are going to start to stop giving credit. This will initiate a whole new reorganization in the industry.

Markets. Canada is going to be hurt by the lack of participation in the energy sector, but he still thinks we are going to see more growth. The US economy seems to be firing on all cylinders, and for the moment they seem to be carrying the weight of the world on their shoulders. He believes Canada will benefit from that. Our lower Cdn$ will help to some extent. Ontario and Québec will be carrying most of the weight. Going forward, he believes we will see growth beginning to pick up again. Just not sure how long this process might take. China is still growing at 7%, and could well be bottoming out in terms of how low that will go. They are already becoming a much more major factor in global GDP.

Oil versus natural gas. Natural gas did not participate with oil when it was going up and has been a little bit stickier as oil declined. There has been an oversupply of inventory in natural gas. At current prices, the marginal cost of production of putting new production in place for natural gas is somewhat higher than what current prices would justify. Longer-term he expects we will see natural gas prices recover. We will not see the volatility in natural gas that we are seeing in oil. You have to watch the companies you are investing in, because a lot of companies are involved in both areas. Look for companies with the best balance sheet and best management that will take advantage of any opportunities.

Markets. Tax loss selling is where investors, who have losing stocks, will sell them in December. The sector is supposed to rebound in January-February. He did a scan on December 12 and picked stocks that had the highest deviation from the 200 day moving average. He widened the filters to 40%, so that anything below 40% would show. Ended up with about 55 names and everyone was an energy stock. Last Friday the group was up about 20%, but they all got murdered yesterday and are getting killed today. This is unusual. It is kind of alarming when you have tax loss selling in the sector, and it should rebound, but it gets killed again in the new year. Very worrisome.

Energy. A chart running from 2001 to 2014 inclusive showed a broad climb running up from 2000 with a manic peak in 2008 where the trend was broken. This was followed by a swing failure in 2011, where it failed to make a new high. It also failed to make a new high in 2014. Swing failures are very negative. If you are trying to bottom fish now, you should postpone it. It needs time to work itself out. The bottom in 2008 took almost 6 months to resolve. We are now only 3-4 weeks into this, so there are several more weeks to go. Let the crude build a base. Long-term support lines in crude show the first one as at $51, which is where the drop should stop. The ultimate low in crude is $38.

Energy versus TSX Composite. Basically looking at relative performance for 2014. Energy was a relative outperformer through the 1^st part of the year, and then in July-August, it began to decline when it started losing relative strength, followed by the absolute limit in November-January. We are still down in energy.

Gold versus TSX composite. Comparison chart was for 2014. Gold was underperforming from August to September, but things were starting to change in September, followed by a dramatic change in November-January. The gold sector is now starting to get relative outperformance. It is very early. There are certain levels that have to be broken through, but he would say that we are in the very early stages of a positive trend change in the gold sector.

Bond fund or bond ETF? When it comes to fixed income, there are several things to consider. You have to decide what percentage of your portfolio is going to be fixed. Depending on the size of your portfolio, sometimes there is an advantage to using a professional advisor that can buy bonds for you, instead of buying an ETF. Keep the duration down to 2-3 years in a bond portfolio.

Gold-Silver Bullion. Ratio is around 73%, versus the last 5-10 years where it has been around 60%. What would you buy and why? He has a comparison chart of the 2, which shows that the action was similar until around August when Silver started to underperform. Recently they have both started to turn up, so if silver is going to catch gold, it might be the better play, even though they both look favourable. He would probably play silver through one or 2 silver stocks and enjoy the ride.

Investors. Don’t sell out your entire portfolio. If you think the market is overpriced or toppy and you sell out, and if you are wrong, you never get back in. If you’re on margins reduce them. If fully invested, you might want to raise a little bit of cash. You also have to look for assets that are inverse or under-owned. Move away from crowded spaces. The REIT sector, not the individual ones but something like the iShares S&P/TSX Capped REIT (XRE-T). The Canadian utility sector looks safe. Japan has always been countercyclical, so get a Japan ETF such as the iShares MSCI JAPAN (EWJ-T).

Markets. Was surprised that OPEC decided not to cut production, like they have done over the past 20 years. In hindsight, perhaps he shouldn’t have been overly surprised because every 20-30 years or so they seem to do this to readjust the environment. He has definitely cut back, but at this stage this lower oil price environment will probably stabilize, but will stay low for the next 6 to 9 months. Meanwhile he will retrench to his best present ideas and best defensive names. The opportunity will come to pick away at these names over the next few months. All the geopolitical issues and risks are still here and still have the potential to get oil prices back up, but overall on oil per se, the supply/distribution needs a little while to catch up. The overall market will be uncertain for the 1^st half. He thinks it will be a mirror image of last year which started strong and ended weak, and this year might be just the opposite. He is constructive on the markets overall, and especially with the collapse of oil prices, expects to see great opportunities in the spring to buy these stocks.

US banks? From a relative valuation point of view, there is no question that the US money centred banks are a lot cheaper than the Canadian ones, probably because the business mix is quite different. Canadian banks are more of a super regional bank. Coming out of 2009, there has been a lot of regulatory change in the US and they are still up in the air as to how much ROE they can earn. They are cheap, and as long as the US economy can grow, there should be decent upside from them.