HIDDEN GEMS

Reasons to be bullish on Canadian commodities.

The performance of Canada’s economy, equity market and currency has lagged their U.S. counterparts for some time, which is why so many analysts are more bullish on companies down south.

But many U.S. companies are exporters that face headwinds due to the greenback’s strength, while the Canadian dollar’s weakness, despite its recent rally, is prompting some investors to turn more bullish on the commodity space and Canada by extension.

David Taylor, chief investment officer at Taylor Asset Management, fits into that category. He has increased his exposure to the Canadian equity market in the Taylor Partners Fund and other mandates including core mutual funds for IA Clarington.

“It’s harder to find great value in the U.S. without really paying up for quality,” Taylor said. “We’re looking for great opportunities and are tending to find them in Canada.”

Investors don’t need to make a currency call to see why this makes sense. Many Americans have seemingly given up on Canadian stocks, as evidenced by the market’s relative underperformance, so valuations alone make a pretty good case.

A lot of the lag in Canada has to do with oil prices. Taylor and senior analyst Michael Willemse were very bullish on oil when it was trading at US$42 per barrel, and continue to see opportunity, particularly in industries that are less directly tied to energy prices.

One such holding is SNC-Lavalin Group Inc., an engineering and construction company with a lot of exposure to infrastructure projects as well as the energy sector.

They’ve owned SNC’s stock for a while, but doubled up after the RCMP laid corruption and bribery charges in mid-February. SNC faces a ban on bidding for government contracts for 10 years if convicted, but Taylor thinks the stock is already reflecting this negative outcome, which may end up being softened anyway.

Several catalysts could turn the tide for SNC in the meantime, including two recent large contract wins, the expected sale of its stake in Ontario’s 407 toll road,

and conservative earnings estimates that pave the way for a positive surprise.

The managers are also playing the resource space more directly through iron ore, met coal, oil and even some copper companies.

Taylor thinks the best way to play the commodity cycle is to buy when prices are deep into the global cost curve, or when the average producer isn’t making money. That’s when supply responses typically happen, which is the case for many commodities these days.

His portfolios’ energy exposure dipped to about 10 per cent during the oil price correction, but it is now back up to more than 20 per cent. That’s proven to be a wise decision so far as oil prices rally.

The iron ore sector is no stranger to struggles either, but Willemse noted that Labrador Iron Ore Royalty Corp. (LIF/TSX) stands out.

It owns 15 per cent of Rio Tinto’s Iron Ore Co. of Canada and gets a royalty of seven per cent on sales from the mine, which arguably offers the highest-quality iron ore in the world.

The mine’s cost of production is higher than its Western Australian competitors, but after factoring in the quality and shipping costs to North American and European customers, Labrador Iron Ore is on solid ground.

“We think they compete very well and can be profitable throughout the cycle given that their royalty really protects us on the downside during a cycle like this,” Willemse said.

“It’s going to be one of the last mines standing,” Taylor added, noting that iron ore prices should stabilize this summer after a lot of de-stocking globally in the past nine months.

As for the market as a whole, there is good reason to be optimistic, particularly the extended nature of the current cycle.

Some sectors are certainly showing signs of froth and investors may be nervous that we’re in the sixth year of a cycle that typically averages eight. But cycles don’t end just because of age. They end when central banks and interest rates tell you its over, and none of the signs of a market rolling over are there just yet.

“Whether it’s inflation, leverage, bank lending, an inverted yield curve or higher interest rates, none of those things have occurred,” Taylor said.

PETER J. THOMPSON / NATIONAL POST David Taylor, CIO of Taylor Asset Management, says his company is tending to find greater opportunities in Canada as opposed to the United States.