Last month's sudden surge in the resource sector, prompted by soaring oil and gas stocks, took even professional market watchers by surprise. But now investors have been left to wonder whether it was a flash in the pan or the beginning of a real recovery for resource funds.
Resource-fund managers say the scene may well be set for a long-awaited reversal in this sector some time this year. And although early positioning is key to catching sudden upward moves, investors who want to play the resource-fund card must be ready to exercise some patience, they caution.
"I think last month's rally was a sign that the conditions for a recovery are falling into place, but it's still very early and we can expect some short-term stalling and weakness to lull us all back to sleep again," says Fred Sturm, manager of the $178-million Universal Canadian Resource Fund and senior vice-president of Mackenzie Financial Corp. in Toronto, noting that many investors are eyeing "the March wake-up call" with some skepticism.
Gordon Zive, manager of the $165.7-million Royal Energy Fund and vice-president of Canadian equities at Toronto-based Royal Bank Investment Management, also expects the market to pause and catch its breath.
"The bulls say, 'More to come,' and I say, 'Yes, but nothing goes up in a straight line,' " he says. "There's the liftoff and then the consolidation. Be patient and see if crude prices settle back and then ride the next wave up."
Certainly, the past year was one of the most dismal periods for natural-resource funds. Dragged down by collapsing commodity prices, the average natural-resource fund lost 27.1 per cent in 1998 and continued to bleed losses for the first two months of this year.
But in March, the sector sprang to life. The Toronto Stock Exchange oil and gas index enjoyed a stunning one-month gain of 23.2 per cent, sparked by an announcement of planned production cuts from OPEC members.
After touching a 12-year low of under $11 (U.S.) in December, the price of crude jumped to almost $17 at the end of March.
Other resource sectors rallied in March, too, albeit less spectacularly. The forest products index rose by 10.7 per cent and the metals and minerals index was up 3.4 per cent.
This month, the oil and gas index has remained flat so far, but it's not unexpected, Mr. Sturm says. "Historically, when the reversal begins, there are three phases or waves. The first is typically a quick bounce off record lows, usually as a result of production cuts, and that's what we've just seen."
After an initial rally comes a period of waiting for the meaningful recovery in Stage 2, which he calls "the big, fat middle." It's characterized by strengthening demand, rising prices and volumes and the superior performance of resource stocks relative to the rest of the market, he says.
Phase 3, at the end of the cycle, sees commodity shortages and prices spiking above long-term realistic levels, says Mr. Sturm, whose fund gained 15.5 per cent last month, though it was down 25.2 per cent for one year, 7.2 per cent for three and 2.7 per cent for five. The compound figures mask some impressive returns, including 41 per cent in calendar 1996 and another 10.2 per cent in 1997, before the current slump set in.
Although the spotlight has been trained on OPEC's recently announced plans to cut oil production by about 2.5 million barrels a day, or around 8 per cent, Mr. Sturm says the steadily falling production of non-OPEC members is more important because they account for 60 per cent of total production, compared with OPEC's 40 per cent.
Terry Peters, partner and senior oil analyst with Toronto-based Griffiths McBurney & Partners, suggests there's actually a possibility that OPEC may be hitting the brakes too hard.
That's because, in addition to the OPEC cuts, non-OPEC production so far this year is about 8 per cent lower than in 1998, he says. But on the demand side, some Asian markets are recovering -- South Korea's energy consumption will rise by at least 5 per cent this year -- and in the United States, which consumes one-quarter of the world's oil, demand is expected to rise by 2.6 per cent.
Given the combination of OPEC and non-OPEC cuts, coupled with even this modest increase in worldwide demand, we could see inventories drying up and oil prices rising -- even spiking -- in the second half of this year, he says.
Mr. Sturm adds that he's encouraged by reviving stock markets in Hong Kong and Japan. "It looks like the beginning of a recovery over there, and that's the swing factor. The North American bloc, the European bloc and the Asian bloc each represents about 30 per cent of world demand and, obviously, it's the Asian demand that has been missing."
Mr. Sturm has about 50 per cent of his portfolio invested in oil and gas stocks, with another 20 per cent divided equally between pulp and paper and base metals, 13 per cent in platinum, silver and senior gold companies and 15 per cent in junior golds, diamond, uranium and coal companies.
Fifty stocks make up 85 per cent of the portfolio; another 25 represent small positions.
Some of his large oil and gas holdings include Talisman Energy Inc. and Penn West Petroleum Ltd., both based in Calgary. Other large holdings are Pacalta Resources Ltd. and AltaGas Services Inc., also both in Calgary. Major holdings in metals include U.S.-based Freeport-McMoRan Copper & Gold Inc. and Australia's Pasminco Ltd.
The fund's largest single position, about 5 per cent, is in Mississauga, Ont.-based Sino-Forest Corp., a highly profitable company that owns forests in China and sells lumber chips to Chinese pulp-making firms.
Investors who want to concentrate solely on oil and gas may consider the Royal Energy Fund, which zoomed ahead by 24.9 per cent in March. For the year ended March 31, it lost 26.2 per cent and has an average annual compound loss of 1.1 per cent over three years and a gain of 0.3 per cent over five.
Mr. Zive has about 77 per cent of his portfolio in oil and gas producers, which will rebound explosively in any recovery, he says. "Our large exposure to this segment of the oil patch means the fund is strongly positioned for a resurgence."
He agrees on the crucial importance of Asia. "Before their collapse, these countries accounted for about 60 per cent of the increase in the world demand for oil, so it's encouraging that the economies of South Korea, Thailand, Hong Kong and Indonesia now seem to be stabilizing and improving."
Mr. Zive holds large stakes in companies highly leveraged to gas as well as oil, such as Alberta Energy Co., Anderson Exploration Ltd., Poco Petroleum Ltd. and Rio Alto Exploration Ltd., all based in Calgary.
Gas drilling has been cut back because of low prices, and inventories are falling, which eventually will push prices upward, he says. In early February, the price of gas was $1.65 per million BTUs (British thermal units), which was the lowest in many years. It still hovers around $2.
In addition to oil and gas producers, Mr. Zive also has 14 per cent invested in integrated oils such as Toronto-based Imperial Oil Ltd. He also has about 9 per cent in large-cap oil and gas-servicing companies such as Houston-based Halliburton Co. and 3.5 per cent in cash.
More cautious investors who want to keep a window open on the energy and other resource markets may look at the $10-million AIM Global Natural Resources Class Fund.
Many of its investments are not what you'd expect to find in a resource fund. About 25 per cent is in steels and chemicals and another 20 per cent is in cement, gypsum and gravel companies, as well as in pipelines, propane distributors and uranium refiners.
Fund manager Derek Webb, a San Francisco-based portfolio manager with AIM Funds Management Inc. of Toronto, remains skeptical about a sustained resurgence in commodity prices and especially about trying to predict them.
"Trying to guess what commodity prices will do is a fool's game. I run a large-cap, blue-chip fund that's highly diversified among all resources and around the world to spread the risk."
At this point, he's still not bullish on the energy sector. The supply of oil and gas may be decreasing, but he says he's waiting to see more persuasive evidence of increased demand.
In spite of his skepticism, he has recently beefed up the fund's oil and gas component to 38 per cent of the fund, which holds about 80 stocks in all. His focus is on big, integrated multinationals such as Total SA and Elf Aquitaine, both based in France, and U.S.-based Mobil Corp.
"If there's going to be a breakout in the energy sector, I want to make sure I'm there and, since I'm not a roaring bull, this is the conservative way to do it," Mr. Webb explains.
The fund also owns every base metal, including Cominco Ltd. for zinc, Inco Ltd. for nickel, Cameco Corp. for uranium and Barrick Gold Corp. for precious metals, he says. It is also heavily invested in building materials, with large holdings in USG Corp. and Martin Marietta Materials Inc.
It gained 5.44 per cent in March and has average annual compound losses of 24.8 per cent for one year and 4.34 per cent for three years.
"Our goal now is to run a less volatile resource fund," Mr. Webb says. "About 18 months ago, we decided that trying to predict commodity prices was not the way to go and that we would broaden the mandate of the fund to include resource-related industries, such as pipelines, refineries, building materials and construction."