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Energy stocks to outperform base metals in months ahead, says advisory firm

by Wayne Cheveldayoff, 2006-07-27

In the wake of the recent correction in commodities markets, investors may be wondering how they should be positioning their portfolios.

In a recent commentary, entitled “How to Play the Commodity Cycle,” the Montreal-based advisory firm BCA Research (, widely respected among institutional investors worldwide, counseled investors earlier this month “to position for the outperformance of oil versus base metals prices.

“Our view is that the overall commodity complex is in a secular bull market. However, with central banks tightening and global growth in a cooling phase, cyclical commodity demand is easing.

“Against this backdrop, the crude oil price is likely to outperform base metals.

“Chinese trends buttress the case. Chinese imports of base metals have already started to cool, and could moderate further as the authorities target a slowdown in select capital spending industries and real estate.

“Meanwhile, Chinese oil imports are still in an uptrend and should stay strong. Gasoline demand is a key driver of energy imports, and we expect sales to remain firm as the Chinese authorities encourage consumer spending.

“Finally, technical indicators highlight that there is more froth in the base metals market compared to crude oil.”

The bullish case for oil was also put forward by CIBC World Markets Chief Strategist Jeff Rubin in an early July Canadian Portfolio Strategy Outlook, which projected a 25-per-cent gain in energy stocks over the balance of 2006.

“We are only one Gulf of Mexico hurricane away from setting new record-high oil prices and record-high valuations in the energy sector while still-bristling global economic growth will keep base metals markets tight as a drum,” he states.

The Outlook (available at says the U.S. economy has not been the main driver of energy or base metals, as it accounted for a scant 15 per cent of global economic growth in the past three years.

“Instead, booming domestic economies in China and in the rest of developing Asia and the Middle East have driven over 60 per cent of recent global growth. Together with firming economies in both Japan and Europe, global GDP growth is a red-hot 5 per cent. An even larger rise in global industrial production will continue to support strong demand for both energy and base metals.”

Mr. Rubin is expecting the West Texas Intermediate oil price to average $76 (U.S.) per barrel in the July-September period and that soaring U.S. electricity demand during another record-hot summer to push natural gas prices back toward $8 (U.S.) per million btu.

“Similarly, global growth should continue to support higher valuations of metal stocks. Rapid industrialization of developing Asia (and the Middle East), not speculators, is the primary reason why base metals prices are at or near record highs. Although higher prices will eventually bring on new supply, global markets for copper, nickel and zinc are all expected to remain in (supply) deficit until at least 2008.

“Gold prices have historically shown an over-80-per-cent correlation with the trade-weighted U.S. dollar, and should thus benefit from renewed selling pressure against that currency when the Federal Reserve finally ends its tightening campaign.”

The CIBC World Markets Outlook is forecasting that the TSX/S&P Composite Index will gain more than 10 per cent to 13,600 by year-end 2006. It advocates investors increase their portfolio weighting in TSX stocks to 60 per cent from 50 per cent, and also increase their weighting of income trusts to 10 per cent from 5 per cent, while reducing their bond weighting from 38 to 30 per cent. A cash weighting of zero, down from 7 per cent, is also recommended.

“With the soaring Canadian dollar having already sent the Bank of Canada to the sidelines, we are expecting a strong second-half showing from the trust market, led by our significantly overweighted oil and gas royalty trusts.”

But at the same time, Mr. Rubin is advocating an underweight position in bonds because of the potential for another Federal Reserve rate hike to spill over into the Canadian bond market, causing bond yields here to rise (and bond prices to fall).

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at and he can be contacted at

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©2006 Wayne Cheveldayoff