Energy has shown good strength recently with WTI and Brent up over +4.0% in the quarter. Despite the positive move in the oil, the Canadian Energy sector was down -5.7%. Oil differentials blew out in the summer and fall, with heavy differentials increasing to $50/barrel recently. These spreads should narrow in the next six months, as refining capacity increases after the scheduled maintenance shutdown at Whiting, and crude by rail capacity expands. The portfolio is strongly weighted to light oil producers that can show growth and live within their cash flow. Stocks such as Yangarra, Tamarack Valley, Petroshale, Parex and Grand Tierra are such names. With Canada’s first LNG facility being recently announced, we anticipate stocks like Horizon North Logistics to continue to do well as they provide camps for migrant workers building the Kitimat LNG facility.

With the base metal sector, investors focus has been on global concerns. The commodities have all had significant pull backs through the summer, despite the continued decline in inventories. Copper inventories, for instance, have declined by 27.75% for the LME and 23.6% for the Shanghai over the last month alone. Mine supply growth over the next few years is muted; if demand continues at its current pace, there will be copper shortages. Names held in the portfolio include Ero Copper and Copper Mountain.

Gold stocks had a difficult third quarter, with the Canadian gold sector down -19.1%. Gold stocks were hit with US dollar strength and investor outflows. Last quarter, we saw heavy selling on the trading desks after the announcement of a manager change at one of the largest global gold funds in the world. The fund saw $1 billion move to a new manager with a minimal gold sector allocation. The new manager was in the market selling many Canadian gold stocks and was responsible for a significant portion of the sectors weakness. With the transition mostly behind us, seasonal strength, inflation accelerating and our forecast for a weakening US dollar, we anticipate a strong rally in gold stocks next quarter. The portfolio has been adding to its gold positions the last few weeks and increased its holdings in B2Gold, Golden Star, Alamos and Endeavour.

Another positive for resource stocks is the recent pickup in M&A activity. Senior resource companies have spent the last few years repairing their balance sheets but have poor growth prospects. In the last few months, we have finally seen M&A activity pick up in the small cap space. With South 32 buying Arizona Mining, Husky approaching MEG Energy, NorthStar Resources buying Pogo and Nevsun being purchased by Zijin, small cap resource companies are being purchased at significant premiums to where their underlying stocks are trading. Going forward we expect M&A activity to accelerate further and have seen several large cap companies increasing their equity interests in junior companies. Black Pearl, Tinka, Conerstone, Great Bear, and Sabina are stocks in the portfolio that are likely acquisition targets.

As the economy enters the later stages of the economic cycle, we anticipate investors will start allocating capital back into resource stocks. After the recent consolidation in Canadian small cap stocks, we look forward to a breakout after the recent consolidation, and believe the portfolio is positioned to very strong returns going forward.


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