Disclosure: The following represents my opinions only. I am long AAV.TO, ARX.TO, CRE.V, EOG.V, TAO.V, TNZ.TO, AOI.TO, SEI.V, NSE.V, and XYZ.V (Image credit to Markus Spiske on Unsplash)
A little over a year ago, I drew on the wisdom of Kenny Rogers with good results, but remember that The Gambler tells you that you need to know when to hold ’em… and when to fold ’em. If I’ve learned anything from my trips to Vegas over the years, it’s that the tables will always teach you about the importance of humility should you ever get too confident in your ability to predict random future events. To that end, I’ve played shoes of blackjack where it literally didn’t matter what I did; I just couldn’t lose. Likewise, I’ve played other shoes where, no matter how ‘skillfully’ I played, I just couldn’t win. Trust me when I say that coming to the end of the “can’t lose” shoes always has you thinking about how much more you should’ve/could’ve bet, while the “can’t win” shoes will make you wonder how it’s even possible that a stack of random cards could be so cruelly organized. To that end, ask any blackjack player about the concept of “streaks” and I guarantee you’ll get some stories. The fact that streaks happen doesn’t somehow fly in the face of statistics, but when they do happen, they definitely feel “unnaturally” good or bad… and they will evoke all of the emotions from glee to despair. I bring this all up because, from the 2020 lows, the market was one giant “can’t lose” shoe. It didn’t really matter what you owned coming out of those market lows from two years ago… a monkey could’ve made money throwing darts in that market. Heck, people were paying $300,000 for cartoon pictures of monkeys (not even real ones) before the streak broke. It went something like this… First, the meme stocks broke, then the SPACs and unicorns, then crypto, then just tech stocks in general, then the indexes — and now, the market malaise has finally caught up with energy and commodities. As a group, energy stocks are down around 25-30% from their June highs, while most metals stocks (copper, uranium, lithium, take your pick) have been nearly cut in half since their April highs. That’s likely an unfamiliar feeling for folks like me who have benefited from the resilience of commodities since the broader market peak six months ago, which brings me right back to where I started this paragraph — humility. Things had become pretty heated in the commodities square, and pullbacks are inevitable, but it seems like it’s probably a good time to take stock of where the market stands.
In hindsight, Dr. Copper started dropping well before energy stocks showed any signs of weakness — and copper did earn its nickname as a result of its predictive abilities when it comes to the state of the global economy. At this stage, I can’t even guess if oil or copper are going to go up 20%, or down 20%, or maybe both, in the coming months. Sure, I can make a lot of fundamental arguments for why oil should be “higher for longer” (and/or how Russia could squeeze it if they chose) and why copper will continue to be in high demand for the “green transition”, but that’s all in the market already, right? So when your market narrative doesn’t line up with what the tape is saying, it’s time to reevaluate your narrative, not to assume that the tape is wrong (even if you think it might be). The tape says that the market is worried about a recession… heck, I read an article over the weekend suggesting that the U.S. is already in recession. What that actually means in terms of the physical oil or copper markets is hard to say, but the impact of that worry on short term sentiment and money flow is akin to seeing a “check engine” light flashing on your dashboard… it puts you on edge — and you’ll probably be less likely to rev the engine too hard until you figure out why that caution light is flashing.
Despite trading at what I would consider “very cheap” multiples (even at lower commodity prices), the hard-asset appeal of energy and commodities (including gold) is tarnished in the face of a hawkish Fed, a strong U.S. dollar (check out the DXY chart), and now a feared recession. In addition to my “don’t fight the tape” comment from late May, I’d add, “never underestimate the ability of the market to overshoot to both the upside — and the downside — when it comes to its embedded herd mentality”. The 1970’s saw wild swings in commodity prices throughout the decade and I expect nothing less from the 2020’s. Arguably, a brief recession would set the stage for the next run in the “green-transition-linked” commodities, but that could be in two months, or two years. With the ECB and the Fed hellbent on getting inflation “under control”, they are likely to plow ahead until they break something, which would set the stage for them to slow down, pause, or even reverse course. To me, none of this changes the fundamental appeal of future-facing commodities, but it does mean that my loose (aka “beta”) bets are off the table. Generally speaking, I’ll play fewer hands, but will know them better, and I’ll keep a healthy stack of chips in my pocket waiting for a better narrative to emerge.
One of the nice things about running my own money is that I don’t have to be fully invested all of the time. Over time, I’ve found that my best returns have come from making bets that others aren’t making, which usually includes 1) small-cap “special situations” and 2) buying when everyone else has pretty much given up on a sector, company, or better yet, the market. A few days ago, a friend pointed me towards a Globe and Mail article that was titled something to the effect of, “Canadian energy stocks are a no-brainer”. Hmmmmm… that’s odd, I thought they were a “no brainer” when they were trading at fractions of current levels… so can they still be a no brainer? I’m not sure, but it makes me uncomfortable to read that in the Globe. Don’t get me wrong, the Canadian energy stocks do look really, really, really cheap. Too cheap. It’s spooky (**spooky enough that while I was in the process of writing this post, oil dropped $11/barrel!**) When it comes to be broader market, sure, some stocks really do look oversold to me, so I could envision a bounce, but then what? Does the market just keeping chugging along as cash keeps flowing into it on the back of higher liquidity and strong earnings growth? Where is that money/liquidity going to come from if everyone is worried about a recession? And does anyone really expect strong earnings growth in the stocks that make up the indexes? Would earnings growth be rewarded or would it just provide a chance to sell the rally? Hmmmm. A lot of investors have lost a lot of money in a lot of sectors at this point and the easy-money market appears to have left the building. This isn’t to say that money can’t be made in any market, but I think that at this point I’m more likely to get paid for “being right” as opposed to just “being there”. Bottoming is a process; and there’s a lot of damage to repair before people start thinking about how much money they can make again, especially while the losing part is still so fresh.
A year or two of market interest isn’t enough to fill the materials and energy holes that a decade of neglect has created, so I’m going to have positive bias towards those sectors until I see some evidence of a real supply response. The balance sheets of the miners and energy companies are as strong now as I’ve ever seen them and they are getting stronger by the day, even at current, or lower pricing. M&A has been fairly muted so far, but a lot of companies have a lot of cash and paper deals are a relative game, so just because stocks are down, it doesn’t mean that companies stop thinking about M&A to fill their development pipelines with high-return projects. Meanwhile, in Dividendland, more energy companies are likely to roll-out plans for getting money into their shareholders’ pockets and one of the best ways for them to do that is by increasing, or reinstating, dividends. Not too long ago, I laid out the case for Cardinal Energy (CJ.TO, last at $7.04) and gave some ranges for where the stock would settle at varying yields and that’s probably a reasonable way to look at most of the “mainstream” oils at this point. Find out what these companies are going to pay out in terms of sustainable dividends, at say, $70 oil, pick a yield that is high enough relative to the market’s blue-chip yields, and calculate the associated share price. When it comes to the smaller caps, I think that discovery and growth will still have the ability to attract market attention in names with good old-fashioned “catalysts” (drill bit discoveries, mergers, take-overs, asset acquisitions, operational milestones, etc.), but I’m fairly selective on those.
Tenaz Energy (TNZ.TO, last at $2.10) and Tag Oil (TAO.V, last at $0.32) both made the cut in terms of what I am willing to pack deep in my saddlebags, as I lead the stubborn mule that is my portfolio across a raging river, in the middle of a thunderstorm, at midnight. Both names have essentially no correlation to the market and, as would-be acquirers of assets, they should benefit from the negative price action in the energy square. Other less-travelled international energy stories that I will keep toes into include Africa Oil (AOI.TO, last at $2.03), Eco Atlantic (EOG.V, last at $0.51), Sintana Energy (SEI.V, last at $0.10), New Stratus (NSE.V, last at $0.68), and i3 Energy (ITE.TO, last at $0.365). All have catalysts expected in H2 2022, mostly drill-related, and I think that the catalysts are all big enough to attract attention in a tough market. I guess we’ll see. I’ve still got my Anacortes Mining (XYZ.V, last at $0.80) as I wait for the day that the market realizes that high-grade oxide gold projects with multi-million ounce underlying sulphide resources — in mining-friendly areas — don’t grow on trees. For now though, it’s a dormant houseplant. I’m still keeping a candle burning for Critical Elements (CRE.V, last at $1.29) and its high-quality Rose lithium-tantalum project in Quebec, but the flame is being buffeted a lot by market winds… and they are still waiting for provincial permits. Meanwhile, North American Nickel (NAN.V, halted, last at $0.58) has become a favourite joke in the office as “the best performing stock in the market”. That’s because it’s been halted since the middle of February as the company finalizes its merger/go-public deal with privately-held Premium Nickel. I know that base metals aren’t cool right now, but this nickel deposit is somewhat special and I think that it’s one that is worth keeping tabs on given its potential for both grade and scale. Nexgen Energy (NXE.TO, last at $4.50) is still the go-to for me when it comes to uranium, but it’s anyone’s guess as to when the market cares on that name again as the chart, like a lots of charts these days, is holding onto its lows by its fingernails. Lastly, Advantage Energy (AAV.TO, last at $8.04) is still an office favourite for its emerging CO2 capture prowess and gas-heavy production mix. Folks in our office prefer natural gas stocks over oil stocks heading into winter and my three favourites in Western Canada are AAV, ARX, and BIR.
So, for the most part, I’m in a waiting mode these days. Until I see signs that the resource stocks and sectors that I like have put in a bottom, retested that bottom, and are starting to exhibit signs of increased money flow/improved sentiment again, I’m in no hurry to deploy any of the cash that I’ve raised. The ECB and the Fed still have some rate hiking to do, there’s some economic/recession worry yet to roll through the market, and it’s not clear to me when this pain party will be over. Past market corrections like this have taught me that it’s best to just take a step back and give the market some time to find its footing again. There’s a reason why they say “don’t catch a falling knife” — it’s because you’re simply better off to stay clear and watch it hit the floor. At that point, you can just calmly pick it up, dust it off, and get back to work. To me, this idea that markets ebb and flow like runs of cards is a freeing thought, because it means that if you don’t like the market you’re in, all you have to do is wait for a different market…