One sector where we have been reducing exposure very recently is in the Gold stocks. Golds have lead the market thus far in 2010 and we have, to now, been quite bullish.  But sentiment in the sector has become very bullish lately with speculative flows into the sector reaching record levels.  A faltering US dollar and record low interest rates have supported higher gold prices but those facts are now well known and their benefit could potentially be coming to a close, particularly since interest rates have almost no ability to go lower.  Another curiosity is that gold stocks have not followed gold prices higher at the same rate recently as they did earlier in this advance, suggesting that the rally may be ‘running of steam.’  Finally, gold stocks have benefited from the ‘risk aversion’ or ‘fear’ trade which had investors selling holdings in core sectors such as financial and technology and shifting money to gold instead.  If markets continue to act well, as we expect, then the ‘fear trade’ might become less important.  All these points together have prompted us to reduce our weight in the Gold Sector from overweight to about 50% of ‘index weight.’

One sector where we are particularly bullish on is Technology, particularly US technology stocks.  Technology shares are trading at their lowest level relative to the S&P 500 in nearly 20 years.  US tech stocks currently trade at 1.0 times the S&P 500 on a forward P/E (price/earnings) basis, the lowest level since March 1991, and well below the historical average of 1.3 times since 1977. This is despite the fact that the companies have net cash balance at or near record levels on both absolute terms and relative to the S&P 500.  Moreover, returns on invested capital have expanded in recent years as well.  There’s a perception that secular growth in tech has slowed.  The market appears to be “punishing” shares of tech bellwethers like Microsoft, IBM, Cisco and Google where growth is or appears to be decelerating.  Tech growth relative to the S&P 500 has declined from pre-2007 levels, but revenue and profits at tech companies have traditionally been stronger than other sectors coming out of any downturn and technology spending as a percentage of total capital spending continues to increase.  Much of this is related to the corporate need to improve worker productivity and overall profitability.  The global reach and branding of many of the key US companies such as IBM, Intel, Apple, HP and Cisco is also a key advantage for these companies a they expand and grow in new markets.

In Canadian technology it’s hard to believe that Research in Motion (RIM, manufacturer of the BlackBerry smart phones) is currently trading at only seven times earnings, despite the facts that the company is growing earnings at over 25%, has not debt on the balance sheet, has tremendous overseas growth and ‘crushed’ earnings expectations with their recent profit release.  Companies that are growing double digits, both top and bottom line, generally don’t trade at 7x earnings.  But, over the past six months, numerous reports that RIM’s competitive position is deteriorating due to new offerings from Apple’s iPhone and especially Android are gaining share while BlackBerry’s base of loyal customers is being eroded have lead to an exodus of investors, especially in the US.  As such, we believe it is fair to say that the market does not believe forward earnings consensus and think the stock is reflecting a 45% cut to forward earnings.  Are these concerns realistic?  The simple fact is that obsolescence is a greater risk in technology then in any other sector and RIM’s competitive positioning has clearly weakened.  But we believe that investors have over-reacted to the potential risk.  Last week RIM reported its second quarter results.  The numbers, which beat the street’s expectations significantly, appeared strong enough to quell a growing negativity that has hounded the company and sent its shares near three year lows. The number of smart phone units that RIM shipped increased by 45% year over year to 12.1 million. This meant top line numbers were also way up; the $4.62-billion dollar quarter was a record for the company, and a 31% increase, year over year.  Despite these accomplishments, investors chose to focus on an increasingly competitive smart phone landscape and the fact that net new subscribers missed the company’s forecast for the quarter.  Investors were also focused on a recent report from industry survey company, The Gartner Group, which forecast that RIM’s share of the smart-phone market will fall from almost 20% last year to 11.7% in 2014.

Gartner Forecast: Mobile Communications Device Sales (‘000 Units)

Operating System 2009 2010 2011 2014
Symbian (Nokia) 80,876.3 107,662.4 141,278.6 264,351.8
Market Share (%) 46.9 40.1 34.2 30.2
Android (Google) 6,798.4 47,462.1 91,937.7 259,306.4
Market Share (%) 3.9 17.7 22.2 29.6
Research In Motion (OS6) 34,346.8 46,922.9 62,198.2 102,579.5
Market Share (%) 19.9 17.5 15.0 11.7
iOS (Apple) 24,889.8 41,461.8 70,740.0 130,393.0
Market Share (%) 14.4 15.4 17.1 14.9
Other Operating Systems 10,431.9 12,588.1 26,017.3 84,452.9
Market Share (%) 14.8 9.4 11.5 13.5
Total Market 172,374.3 268,783.7 413,480.5 875,573.8

Source: Gartner (August 2010)

While we could go on ‘ad infinitum’ on why we think RIM and the Blackberry will do better than many analysts and investors believe, the simple reality is that, even if you accept the bearish view in the table above, RIM will still go from selling 34,346 devices in 2009 to over 100,000 units in 2014.  That’s a five-year growth rate in shipments of over 25%. It’s rare for most investors to find a company that will grow its core products sales at a rate of over 25% per annum for the next five years that is trading at only seven times earnings!  And that’s the bearish case.

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