When I wrote to you last year, I said that 2004 was the year for Canada to shine in world capital markets. Well, it seems that was only the dress rehearsal.
In 2005, the loonie rose in value against the US dollar for the fourth year in a row, closing at just under $0.86 US. Even more remarkable was the increase in value of the Canadian stock market. The S&P TSX composite index rose by 22 percent! In contrast, the comparable US stock market index barely eked out a 3% return for the year.
It’s all about oil
The current dynamic can be attributed to a number of factors in our favor. But, oil is the real story here. It is largely the energy stocks which now make-up 27% of the index that have been driving the growth in our stock market. As a group, energy increased in value in 2005 by a whopping 60% ! And it is the rising cost of oil which is expected to keep pushing up the value of the loonie.
In 2006, the cost of oil could climb to $70 US per barrel from the current price of $60 US. And if that happens, some forecasters are predicting that the loonie could be at par with the greenback in the next twelve months. Wow! That has not happened since the mid-seventies when the world was caught up in our first energy crisis. In fact, the current situation is largely reminiscent of that period, albeit with a few important differences.
The 1970’s oil crisis was brought on by the OPEC oil embargo and the world’s huge dependence on cheap Middle-Eastern oil. The high prices eventually came to an end once consumers and businesses alike began to adjust. We started driving smaller, more fuel efficient cars, insulated our homes and explored alternative sources of heat energy. Businesses found ways to reduce their consumption as well. For their part, the oil companies began to invest in new sources of supply. The quest for black gold went into full swing opening up areas of exploration that had been previously considered too expensive or too tricky to exploit.
By the early 1980’s, the demand for oil had slowed down considerably at the same time as world supplies were increasing. It was only a matter of time before prices were due to collapse, no matter what OPEC did. For the next 15 years or so, oil traded in a narrow range of $15-$20 US per barrel, down from a high in today’s dollars of $90 US per barrel.
Now at the start of 2006, oil is back up to $60 US per barrel and climbing. But, unlike the sudden spike in prices that characterized the ‘70’s, this current trend has been in the making for several years.
The explosive growth of developing nations such as China and India has greatly increased world demand for oil. The Chindia factor, as it has been called, is one to be reckoned with. But, even if the pace of this expansion were to slow down, easing demand in the short term, we are still faced in the longer term with something of a conundrum on the supply side.
Truth is the days of easy oil are behind us. Not only do oil companies have fewer and fewer prospects to go out and drill, they are reluctant to increase investment in new exploration in any significant manner – even at today’s prices. Not all that surprising when you consider the exorbitant cost of accessing some of the remaining sources of oil, not to mention the political and environmental risks involved.
Conclusion? It looks as though high oil prices are with us for the foreseeable future. If there is a silver lining here, it is that the market is now more motivated than ever to invest in the development of cost-effective renewable sources of energy – good thing too!
Time to go global
What does all this mean for the future of energy stocks? Given the sector’s 60% rise in value over the last 12 months, one can be forgiven for wondering if some stocks aren’t wildly over-priced, like Nortel and others in the heady days of the tech bubble. Interestingly enough, there is little consensus on this among professional money managers. That suggests we can expect energy stocks to continue to outperform for the near future. But, one never knows for sure. And that is why, as you learned from the tech experience, diversification is key. In fact, now may be just the time to re-consider the global component of your investment portfolio.
In 2005, the federal government eliminated restrictions on foreign content in the RSP making it easier than ever to invest globally. International stocks as a group have done very poorly over the last five years. But, the tide is changing on that front. Even the Japanese market is holding out some hope for a much-awaited turn around. If diversification is one key to successful investing, discipline is another. Selling Canadian “high” to buy international “low” is one way you can put that discipline into practice in 2006.
Economic outlook
How high can oil prices go before the negative impact translates into an economic slow-down or even a recession? Here too there is not a lot of consensus among the experts although no one seems too phased with the specter of $70 US per barrel. Whatever the breaking point may be, it appears we are not even close. In fact, the same economists who are predicting continued increases in the price of oil are also calling for another year of good economic growth in 2006.
In 2006
It seems there is every reason to expect a very prosperous year overall in 2006. May it also be one full of joy, peace and good health for all of you and your families!
