• David Cockfield

The Dawn of a New Era


In our previous issue of the Artisan we outlined events we expected to have an impact during 2015. The past quarter has seen the further evolution of those events, trends and issues that will have both a significant political and economic impact, not only in 2015, but for years to come.

The sharp decline in the price of oil, while initially seen as a short term event, on further analysis may be with us for an extended period. This will have a huge impact on world economic growth and politics. One cannot over emphasize the economic importance of energy costs. Energy costs are reflected in the food we eat, the heating and cooling of our homes, transportation, manufacturing – the list is endless. A long term reduction in energy costs will provide a significant world economic stimulus. While Saudi Arabia and its preemptive price reduction can be blamed for the initial sharp decline in the price of oil, other factors are involved. The development of the U.S. oil shale deposits plus Canadian oil sands expansion is rapidly displacing U.S. oil imports. Nigeria had already been displaced and Saudi imports will likely be displaced in the next few years. Despite some slowing recently, North American oil production has continued to grow. Excess production has been going into storage to be available to meet future demand. North American oil producers have been cutting costs and focusing on projects with the best production prospects.

Take a look back at what happened in the North American natural gas industry in the last decade. Gas prices at $6.00 per MCF seemed likely to rise to $8.00 or even $10.00. Expensive natural gas from coal deposits was being developed. Then technology stepped in. Horizontal drilling, plus multiple fracking, combined with improved drilling techniques, opened vast tight geological formations loaded with gas. Gas prices fell under $3.00. The gas-producing industry adapted and reduced costs. It continued to improve extraction technology and is now operating profitably at gas prices under $3.00. Is the oil industry not facing the same fate?

A further factor that will influence future supply is the abundance of tight oil and gas geological formations throughout the world, as the technology is now available to bring those resources into production. The U.K. government is pushing hard against local opposition to proceed with horizontal drilling plus fracking. Europe is reluctant to follow but major energy users such as China will likely push ahead as fast as they can. In the interval North America is far ahead of other parts of the world in identifying, developing, producing and transporting both oil and gas products. Lower energy costs in North America will make local industries more competitive on an international basis.

Lower energy prices are not all good news for Canada. Oil production and exports are a significant part of Canada’s economy. Western Canada has achieved good growth from energy development that will be curtailed while adjustment is made to new lower price levels. While it is expected that oil prices will eventually move into the $60.00 to $70.00 price range, the timing of such a move is uncertain. In the meantime oil sands projects, now well underway, will proceed and add to future production over the next few years.

The Canadian economy has been helped by the decline in the Canadian dollar, which makes the price of Canadian exports more competitive. This downward trend in the value of the Canadian dollar against the U.S. dollar will likely continue with a rate of 70 cents Canadian to the U.S. dollar being quite possible. Looking ahead, given our view of prospects for energy prices, Canada will likely struggle over the next several years to achieve an annual 2% GDP growth rate.

Europe is in the process of beginning stimulation of their lagging economy – results are yet to come. In China slow growth has caused the government to promise a move to stimulate the economy. Japan`s economy continues to struggle. The bright spot, particularly for Canada, is the U.S. There are strong indications that the U.S. economy is in the process of finally gaining upward momentum. Employment and incomes are rising and housing is starting to show signs of returning to more normal growth. Encouraged by lower energy prices and continuing low interest rates, U.S. consumer confidence has risen and there is also some indication that the political gridlock may be easing. A strong U.S. recovery will have a spillover effect on Canada that will keep Canadian growth positive.

With a long expected increase in the Federal Reserve rate forecast this year, interest rates will likely edge up a small amount. Fixed income portfolios, particularly long duration portfolios, have recently shown spectacular returns based on capital gains. Interest rates rising even slightly would mean declining bond prices which could offset the coupons with the result being negative returns.

In order to take advantage of the current climate, our investment strategy has several themes: Reduced commodity exposure with a focus on high-quality North American dividend paying equities. A low volatility equity strategy when coupled (where appropriate) with exposure to alternatives such as absolute return strategies, real estate and private equity, can provide for increased portfolio diversification while generating cash flow. The objective is to be able to meet each client’s unique needs in a “best of class” manner.

#DavidCockfield

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