Market Overview
April has gotten off to a much better start. The S&P/TSX Index has gained 6.83%, a much-welcomed reprieve from what was a brutal March.
As we saw for the better part of 2019, when the markets turn bullish our Bull List and Top 20 tend to outperform.
Thus far, in April our Bull List has returned 13.53%, which is more than double that of the TSX Index.
Not to be the bearer of bad news, but don’t get too excited over the recent uptrend. The market is still volatile, and now is not the time to be making risky plays.
The March lows may prove to be the bottom, but there are still many calling for the markets to retest those lows in the coming months.
The truth of the matter is no one has a crystal ball. What we do know however is that the economy has all but come to a standstill, and the true impacts won’t be known for months. As such, we still recommend sticking to high-quality, defensive investments, and primarily ones that pay dividends.
Case in point, our most recent recommendation, Park Lawn (PLC). The company specializes in all things funerals, and we can expect revenue during an economic downturn to stay relatively stable.
The company hit highs of $29+ in 2019, and we thought the stock was simply too cheap at its $16.30 price point. The drop in price also made the company’s monthly dividend extremely lucrative.
Those who were members in 2019 saw us add Park Lawn back then as well, and we removed it from our Bull list after some healthy gains. We’re confident that the stock will do the same this time.
Will gold hit all time highs?
We are starting to get lots of questions about gold stocks. This is not surprising.
Even our foundational pick Franco Nevada (FNV) has gone up 19% since us releasing our 2020 foundational picks back in early March.
As of writing, gold is within ear-shot of $1,800 an ounce. It has not reached anywhere near these levels since the metal touched highs of $2,078 an ounce back in 2011.
Gold’s all-time high is around $2,250/oz which was achieved back in 1980.
There is a trend that investors should be aware of – both times it traded above $2,000/oz the price cratered, and a multi-year bear market ensued.
The amount of money the feds are pumping into the market is supporting the price of gold. It could for some time, and as a result gold stocks would benefit. However, be mindful of your approach.
For starters, we recommend everyone have exposure to gold for times such as these. Gold has proven to be a haven in times of volatility and is a good hedge against a recession. Unfortunately, investors tend to abandon gold when times are good, and only buy back in once the price has skyrocketed upwards.
It is counter intuitive to building wealth.
The good news is that COVID-19 has also impacted gold stocks. In the past week, they have outperformed in a big way, however that wasn’t the case at the peak of the market crash. Producers also crashed – this was a good thing. It means the recent run-up may not be done. There is still value to be had in the industry.
Don’t however, look for home runs. The easy money has already been made. Now, it is important to invest in high-quality stocks which have a strong track record and a bright future. Look for these qualities:
Historical earnings/revenue growth
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- There are some high-quality gold stocks that managed to perform quite well despite the prolonged bear market. This means they did not rely on a spike in gold prices to increase shareholder value.
Increasing production
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- How to you offset a potential dip in price? Increased production and long mine lives.
Low all-in sustaining costs (AISC)
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- The lower the AISCs, the better. Even those with a higher than average AISC may be worth a look if they have a proven track record of lowering AISCs.
Attractive debt-profile
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- Look for stocks which have a better than average debt/equity. We’re going to be adding debt/equity on our industry average page next week. When the price of gold crashed in 2013s, the highly leveraged producers suffered most. It led to big write-offs and dividends were essentially wiped out across the board.
- One way to limit this risk, is to invest in streamers. They have much lower capital requirements and leave all the costs of exploration, development and operations to the producers.
Safe mining jurisdictions
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- Those with high exposure to geologically volatile countries carry more risk. Case in point, Oceana Gold (TSX:OGC) has been the source of a few member requests. The company looks cheap, but its flagship mine is sitting idle. It is currently feuding with the Philippine Government and it has dragged on for longer than analysts have expected. There are still no signs of a resolution.
If you stick to these rules, your gold positions should do well regardless of market condition. It should also stand up well once the economy ramps back up and the price of gold weakens.
As for what stocks we like? We prefer streamers like our foundational stock pick Franco-Nevada (TSX:FNV), along with Osisko Gold Royalties (TSX:OR) and Sandstorm Gold (TSX:SSL) are worth a look.
We also have our eye on Kirkland Lake Gold (TSX:KL) which is trading at a big discount to its 52-week high. It paid a premium for Detour Gold and will result in higher AISCs. However, management has a solid track record of performance.
Regardless of what happens to the price of gold it is also important to remember that they are not immune to COVID-19 mitigation efforts. Gold mines in Ontario and Quebec and certain locations in South America have not been deemed essential services. As such, they’ve had to close.
As a result, several producers have pulled production guidance for 2020. A short-term headwind to be sure, but worth being aware of. (Note: since this was written, the Province of Quebec is allowing mines to re-open).
The outlook for oil and gas
While the oil and gas industry hasn’t been the hardest hit from all of this (think hospitality and tourism,) it’s definitely been among the worst.
WTI Crude has fallen from highs of $63 on January 6th 2020 to sub $20 levels as of this morning. This works out to be a 70% collapse in price in just over 3 months, the quickest we’ve witnessed.
As a result, oil stocks have cratered as well. Canadian Natural Resources (CNQ) was considered to be trading at a discount by many in the $42 range prior to the crash. Now the company trades in the high teens, and we’d expect them to stay in that range until the price of oil recovers.
Why the harsh drop?
Economic events in 2020, ones that no one could have seen coming until it was too late, created the perfect concoction to crater the price of oil.
The OPEC – Russia price war
On March 8th 2020, Saudi Arabia and Russia failed to strike a deal in terms of oil-production cuts in the middle of the COVID-19 pandemic. As a result, the OPEC+ alliance failed, and Saudi Arabia stated it had full plans to flood the markets.
On the same day, Saudi Arabia also said it has discounted its price per barrel by $8 a barrel to Asian, European and U.S. customers. As a result, the price of oil collapsed yet again, with Brent Crude posting its largest drop in a single day since the Gulf War of 30%.
A deal eventually came, which resulted in OPEC producers cutting production by nearly 10 million barrels a day. However, the current oversupply of the markets is in excess of 25 million barrels a day. We’re still waiting to see what comes in the form of cuts from non-OPEC producers, but with oil stockpiles still increasing at a rate of 10-15 million barrels per day, the OPEC cuts were too little, too late.
And to add salt to the wound, Saudi Arabia announced yesterday it would be discounted its price of oil, much like it did in early March. As a result, WTI Crude fell nearly 11%. Make no mistake, their primary intentions are still clear, and that is to try and bankrupt western oil companies.
Covid-19
The introduction of COVID-19 on a global scale is wreaking havoc on the price of oil in a multitude of ways. Primarily however, it is due to the literal shutdown of air travel around the world.
In the United States, air travel has reported to have dropped over 96% and airlines can be expected to lose hundreds of billions in revenue. In fact, the International Air Transport Association says airlines will use up close to $60 billion in cash just in this quarter alone.
Low oil prices are typically a good thing for airline producers, as fuel is cheaper to come buy. But, not at the extent of passenger travel which is what we’re witnessing right now at a scale that is simply unfathomable.
We’ve never witnessed a situation like this in terms of air travel in history, and the future remains impossible to predict.
We highly suggest avoiding the industry right now
There are a lot of contrarians looking to take advantage of a beat up oil sector. In fact, some already have. Oil stocks fell drastically and have since rebounded around 50% off their lows in the case of Imperial Oil (IMO) and Canadian Natural (CNQ).
But, there isn’t a single company in North America that can last on sub $20 crude prices. In order for these companies to profitably operate, we need COVID-19 to go away, airline travel to resume and the demand for oil to return to previous numbers. These are three pretty substantial conditions, and it’s fair to say that the first two need to be met in order for the third to come true.
Until then, only oil companies with lower costs per barrel and a strong balance sheet are in a strong position to survive this. Smaller, junior producers are currently shutting down rigs, halting production and at severe risk of bankruptcy. However, even companies in strong financial positions like Suncor and Canadian Natural may still see dividend cuts if prices don’t recover quickly.
In fact, there are even rumors of a major facility in Alberta, Teck and Suncor’s Fort Hills facility, outright shutting down.
As humans, we love to speculate, and we love the opportunity to make higher than average returns right now.
But, it’s very important to not speculate with money you can’t afford to lose.
There will be investors out there that take their shot at producers in the hopes that oil recovers. Just know that financially, the vast majority of companies cannot profitably operate at sub $20 WTI Crude and sub $7 Western Canadian Select prices.
**Daniel Kent is long CNQ.TO, SU.TO and PLC.TO. Mathieu Litalien is long SU.TO**
