2006 Q4 Newsletter December 31, 2006
In reviewing investments in 2006, I am reminded of the Clint Eastwood film, The Good, the Bad and the Ugly. The “Good” came from metal producers such as Hudbay (the top performer on the TSX) and Teck Cominco as well as, from our financial sector weighting and special situations such as Alliance Atlantis. The “Bad” came from the second warm winter in a row causing our natural gas investments such as Talisman and Canetic Resources to under perform. The “Ugly” came from the impact of the income trust tax policy reversal on Halloween night.
Minister Jim Flaherty on behalf of the Harper Government announced a tax on existing income trusts. This sudden policy change badly damaged the value of the income trust sector and our investments in income trusts. It changed what looked like a “great” year into a just good year for most of our clients.
Our overall LDIC performance was adversely affected by our approximately 30% weighting to income trust. Income trusts are not included in the S&P 500 or the DJIA; and make up only 10% of the S&P TSX index. Therefore, our weighting to income trusts negatively affected our relative performance.
As noted in the chart below of our top ten holding in the fourth quarter, results were mixed with seven up and three down. Our equity positions did extremely well with gains of 56.7% for Hudbay, 45.6% for Alliance Atlantis, 15.5% for TransCanada and 15.2% for Tim Horton’s. Our income trust positions were severely adversely affected by the income trust tax announcement with losses averaging 14% each on Canetic, Keyera and Pembina Pipeline.
Most of the Canadian economy and therefore many of our investments rest on commodities and their prices. The year 2006 saw a sharp increase in many commodity prices, particularly in base metals. The table below notes the increases in base metals and uranium as well as, the mixed changes for crude oil and natural gas. The 44% drop in natural gas prices is due in large part to the very high prices caused by Hurricane Katrina in 2005 and the warmer than normal winter in 2006. Crude oil has remained steady, trading in a range near $60 US per barrel.
Our view is that commodity prices are likely to remain strong in 2007 although not as strong as in 2006. It is likely copper prices will soften but still permit strong earnings for producers. Energy prices will be affected by the weather, the world political situation and the overall supply and demand position.
Political uncertainty and higher than anticipated share price lead us to realize the gains in Petrolifera. The Argentine government may introduce policies that will adversely affect oil revenues to Petrolifera.
We added several new positions in the fourth quarter. As well, we increased our holdings of several new equities during the quarter.
Axia Netmedia acts both as a technology integrator and market optimizer. The company has a ten year agreement to operate the Alberta SuperNet which is a broadband network service. Now it is utilizing its expertise to successfully bid on similar projects in France and Australia. This company is a great Canadian growth story for the next two to four years. The company’s early contract bids were successful in France and this is encouraging.
As a new uranium producer with production starting in the first quarter of 2007 their principal projects are in Africa and Australia. The uranium prices have sustainability at these levels in our view. There is more demand than supply in the uranium market. Recycled uranium from surplus weapons disposed of due to arms reduction temporarily met the gap although this supply is dwindling. Much higher prices are likely to persist and induce new production – the flooding of Cameco’s Cigar Lake.
Rally Energy is an oil and gas exploration, development and production company with rapidly growing activity in Canada, Egypt and Pakistan. A Canadian company, Rally is applying its expertise to two major projects; the Issaran Heavy Oilfield in Egypt and the Safed Koh Block Gas field in Pakistan.
Inmet Mining is a Canadian based mining company with solid reserves and production. The company produces copper, zinc and gold from global mining operations in Canada, Turkey and Finland. Inmet is a partner in a mining operation in New Guinea as well.
Solid growth prospects for one of Canada’s largest life insurance companies and the holding company of Manufacturers Life Insurance Company and John Hancock Financial Services. We like Manulife’s expansion in the United States and China. Well lead by a dynamic CEO, Dominic D’Alessandro, Manulife has shown an ability to successfully acquire competitors’ market share while simultaneously exhibiting solid internal growth. Manulife Financial also provides investment management services.
Brookfield Asset Management
Brookfield is an asset management company with four business units: property operations, power operations, timber and infrastructure operations, and fund operations in North America and the United Kingdom. It is one of the largest property owners and developers in North America with a portfolio of premium properties. Declining interest rates will help offset any business slowdown. Historically known as Brascan, Brookfield is shifting its capital from resources to infrastructure and property.
Royal Bank of Canada
Canada’s largest Bank has solid diversified financial services globally. In 2005, the company acquired operations in the British Isles and Continental Europe. In 2006, the company completed the acquisition of American Guaranty & Trust Company. Further increases in the dividend are also likely and a positive direction in an investment climate moving to safer investments.
The outlook for 2007 is mixed. Many economists forecast a slowdown in the Canadian and American economies from 3% – 4% to perhaps 2% or less. Overall, world economic growth is forecast at a robust 5% based on another strong year from China and India as well as the South American economies. This is a dawning of a new world economy in which the United States is not the only key economy. The challenge will be to carefully monitor developments and find suitable investments.
The Federal Reserve Bank and the Bank of Canada are likely to lower interest rates as the North American economy slows. Our challenge is to balance a defensive stance based on macroeconomic realities against company sectors where growth is anticipated.
We aim to lighten our energy holdings but hope for the onset of a brief period of winter in which to accomplish a shift to other sectors. So far, we have had no real winter this year again.
On behalf of all of us at LDIC we wish you a healthy and prosperous 2007.
Michael Decter President and CEO