By Martin Hutchinson
Director of Global Investing Research
The Canadian dollar – also known as "The Loonie" – moved above $1 last week, an extraordinary turnabout for a currency that was languishing down around $0.62 in January 2002. Americans are used to acting somewhat condescending toward their northern neighbor, but in this period of high commodity prices, the relative economic strength of the two countries is shifting. And it's Canada you should be investing in.
Much of the Canadian economy is indeed of a "branch-plant" nature – offshoots of U.S, companies that manufacture in Canada because of the slightly lower labor costs – although those low labor costs are accompanied by substantially higher welfare costs. Then there's the government; the Canadian Liberal Party, which has governed for most of the last century, is both slightly anti-American and mildly socialist. Famously, Canada has a national healthcare system, the likes of which Michael Moore would love to copy.
Overall, the Canadian government spends more than the U.S. government – about 40% of Gross Domestic Product for Canada, compared to 36% for the United States, including both countries' provincial, state and local governments – but the difference isn't extreme. And Canadian government spending would be considered wildly free-market in the EU, where of its 25 countries, only Ireland and Slovakia have lower spending. Canada has 1.6% per annum productivity growth over the last 10 years; that's lower than its U.S. rival, and is far below Asia, but would actually rank quite well in Europe. Overall, the Canadian economy grew at 2.8% in 2006, a bit below the U.S. rate. The Economist expects it to grow at 2.5% in 2007 and 2.7% in 2008, both slightly above the U.S. rate. However, unlike its southern neighbor, Canada runs a balance of payments surplus.
Doesn't sound terribly exciting, though, does it? And, indeed, for most manufacturing companies, it isn't. They enjoyed big cost advantages for decades with the loonie being so low against the dollar, and those cost advantages have disappeared – for certain against U.S. rivals, although the loonie has been more or less flat against the euro.
There's less high-tech in Canada than in the U.S. market, and what is there isn't all that exciting. JDS Uniphase (JDSU) made a splash in 2000, and was briefly worth well over $100 billion, with the share price peaking at $135. But that telecom equipment company is now selling at a more sober price of $14 – which still isn't as good as it sounds, since the company did a 1 for 8 reverse split last October; meaning just one of today's $14 shares would have traded for the princely sum of $1,080 back in the bull-market days of 2000.
Unless you've discovered the "flux capacitor," and have found a way to make time run backwards, that's not the investment performance we're seeking!
However Canada's true strength does not lie in manufacturing, or even really in agriculture – too bloody cold in winter! In today's world, where interest rates are low and commodity prices are high, Canada's in a very strong position indeed, and for two reasons:
- It has oil reserves – somewhat larger than the Middle East – in the form of the Athabasca tar sands.
- And it's the world's largest producer of uranium, with 25% of the world market. For purposes of comparison, Australia is second, with about 23%.
Let's take uranium first. Uranium prices, which were stagnant for decades, have zoomed up recently, from $20 a pound in December 2004 to a peak of $120 a pound in June 2007, though they have dropped back in the last few months and are currently around $85. With global warming the world's most fashionable concern, the best solution appears to be to build more nuclear reactors, and those will require uranium to operate – thus the price run-up.
While Australia's reserves of uranium are double Canada's, Canada still has 9% of the world's known uranium reserves, meaning it will be a major producer for decades to come.
The world's largest uranium mine is the McArthur River mine, operated by Cameco (NYSE:CCJ), Canada's largest producer, while Areva, the second largest producer, owned by the French Areva Group (OTC: ARVCF.PK) has two new mines opening shortly, and may surpass Cameco, once they are on stream.
Unfortunately, Cameco and Areva are trading at historic, nosebleed-level price-earnings (P/E) ratios of 42 and 50 times earnings. And Areva is only traded in New York on the dreaded "pink sheets," so may be illiquid. Nevertheless, you may want a modest flutter here – earnings growth in both companies currently appears stellar.
In oil, the Athabasca tar sands are estimated to have reserves of 1.7 trillion barrels, about four times the current proven reserves of Saudi Arabia. More important, Canada is a lot closer and friendlier than the Middle East, or even Venezuela, which has the other big tar sands reserves at Orinoco. Oil production from Athabasca is currently profitable at about $30 per barrel, which in times of low oil prices is not competitive with Middle East production costs of about $2 per barrel. However, oil prices have been soaring for several years, and at current oil prices of $82 per barrel, Athabasca is hugely profitable. If you think about that, market prices of $82 a barrel, minus breakeven costs of $30 a barrel (Market Price of $82 – Breakeven of $30 = Gross Margin of $50-plus a barrel gross margin) is a gross margin you can make money on. And there should be an extra kicker to come in Athabasca earnings, as oil prices have only recently risen from the $60 level.
Canada's oil resources aren't as expensive for investors as uranium. The best pure Athabasca play is Suncor (NYSE:SU), which is a positive bargain at 20 times earnings. Most of the oil majors are currently in Athabasca; Royal Dutch Shell (NYSE:RDS-B), in particular, has a big participation. However, it's still only a modest part of their overall operations and earnings – but at 9 times earnings the shares may be worth a look.
The Canadians call their dollar the loonie, after the loon bird that has graced their $1 coin since 1987. Americans have taken to using the term as something of an insult. They shouldn't; the loonie is a strong, friendly bird and there's money to be made from it.