Saturday, September 15, 2018

Your core portfolio should include commodity investments


A Portfolio may be subdivided into a Core and an Everything-else portion.  The Core should hold close to 80% of your paper investments and they should change as little as possible. Here you build up your large capital gains (basically interest free government loans) and you hold this part of you portfolio at your full-service brokerage.  Having your core portfolio in your full-service accounts makes you avoid trading frequently and thus minimizes capital gains taxes while reducing your commissions. Your full-service broker can also be your devils advocate to help avoid you making foolish mistakes.
The remaining 10 to 20%, are your none-core investments in your discount brokerage accounts. This is where you test your investment ideas and do, if you really must, your stock trading.  Also, this is where you can do your option trading. Ensure that you have enough cash to cover your option trades. Option trading is done here because your discount-brokerage commissions are low; your transaction costs are low. In a full-service brokerage, the commissions would eat up a lot of your option gains; these trades are horrendously expensive. Finally, since my Tax-Free Savings account is relatively small and I want to be able to move in it quickly, I tend to keep it under close control (in the discount brokerage) as well.

Commodity stocks, especially oil and gas are an exception – I keep most in the full brokerage account because they are longer term (for the length of the commodity cycle) kind of stocks. I don’t like to own the juniors, and most of my holdings are large companies such as CNRL and intermediates such as Peyto (which I kept too long) and Birchcliff (which I bought too early) or Whitecap. Others that I like are Baytex (first Raging River) and Spartan Energy (now Vermillion).  I also owe a bit in the U.S. 

Oil and gas stocks are heavily dependent on the energy cycle. These days both oil and gas prices seem to be decoupled and follow their own patterns – starting from around 2009.  Companies such as CNRL own a lot of gas, some conventional oil and a lot of heavy oil properties.  They also own upgraders and even refinery capacity. They hedge a significant amount of their production. This makes the company less dependant on the so-called discounted Canadian Select spot prices than many expect.  Overall, the best time to buy oil and gas stocks is when they are cheap and the best time to sell them is when oil or gas prices maxed out and everybody else would like to buy these producing companies. Typically, everyone sells in a panic when oil and gas prices collapse. The price build-up from trough to peak can last many years, up to a decade. Near the bottom, you’d think the producing companies are cheapest but that is not necessarily true. When you think that oil or gas prices hit rock bottom, you can open an initial position – (say a full position for a company is 5% of your stock portfolio – start by first buying a 1% position; preferably less). 

So many oil and gas speculators (who think they are investors) lost their shirt during the price crash. They do not want to get back in ‘ever’ or.. until they think they ‘cannot lose’ which is usually way too late and right before the cycle peaks.  Since those speculators are left holding the bag, they may keep on selling way past the commodity price bottoms. You see that happening today with oil prices recovered by over 100% but nobody is interested. This seems especially true with the current pipeline-issues and incompetent provincial and federal governments (the latter is the worst). This knee jerk reaction has resulted in extreme global underinvestment into oil and gas since 2014 or so. With very little drilling and exploration going on in the world (for over 4 years now) and with world demand growing by 1 to 2% each year, a hydrocarbon shortage is looming just over the horizon. 

The second stage of the recovery in the energy industry is coming. I don’t know what the trigger will be. A crash in FAANG and a market rotation into other industries including energy.  A price-shock due to a sudden recognition of tight oil supplies possibly as soon as late 2018 or early 2019. Resolution of the trade wars could provide such a trigger as well. Many possibilities.  The TSX energy sector is currently 19% of the S&P/TSX index – my stock portfolio exposure is only 7% or so.

Another commodity industry: (Gold) Mining counts 3% in my portfolio versus a TSX market weight of 10%.  Thus, although I am rooting for a recovery in those sectors, I feel that there is still plenty of time to get in. I am waiting for the ‘trigger’ and an opportunity to take profits in other sectors where I am overweight such as financials. Of course, I also own nearly 18% in market indexes: Canadian, U.S. and European indexes and I am looking for an opportunity to go back into China.

My career in the oil and gas industry provides me with lots of insights (wrong or right) in the energy sector and this is where I feel most at home. As such, I am likely to ramp up my holdings there once we’re getting closer to an oil & gas company boom, rather than an oil and gas commodity price boom. There is a clear distinction.  Thus, the oil and gas price and company cycles last around 15 to 20 years. We are currently in the early stage of the cycle(s) – three to four years from the bottom with a peak in early 2014. Gold peaked in 2011 and bottomed around mid-2015. In fact, it follows a very similar cycle as oil & gas with many of those stocks also in the doll drums. But there as well, I bought my initial stake and now I am waiting for the real boom to start.  Commodity style investing is not for the faint of heart and it takes a lot of patience until the boom.  The oil and gas boom is moving closer and with the pipelines and LNG in the making it may become a very exiting time.

Banks and insurance companies or investments such as Brookfield Asset Management and Onyx or Power Corp, are entirely different beasts from the buy and hold commodity style investments. These are nearly shoebox investments growing seemingly forever, but they have pitfalls as well. This seems to be more related to the hubris of their managements, which can be quite troublesome such as resulted in the 2008 financial crash in U.S. banks and in the ‘Third world debt’ crisis of the early 1980s which drove  Canadian Banks down dramatically. But mostly these investments are ‘stuff them in a shoebox’ and collect the dividends style. Both types (commodity and shoebox) belong in a core portfolio and require a lot of patience. But for the commodity stocks you also do need a contrarian spirit and a steel stomach.

Here is a final consideration:  The Liberal government has voted in favor of C-69. This may be yet another obstruction to invest in Canada's oil and gas industry. If you feel that way, you can still benefit from the new oil & gas boom by investing in the U.S. instead.  I am a proud Canadian but, these days, I find it more and more difficult to invest here at home.

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