In terms of the Financial sector in Canada, though, the key drivers of the gains so far this year have been the much-maligned life insurance stocks, not the banks.  Manulife Financial and SunLife Financial have each surged over 25% so far in 2012, leading not only the Financial sector but almost all other stocks in the index.  The gains came due to the reversal in bond yields and stock prices.  Profits of the life insurance companies are levered to rising interest rates and rising stock prices due to the structure of their assets and the accounting for their liabilities.  Weak stock markets and falling interest rates made them two of the worst performing large stocks in 2011.  That seems to be reversing this year though.  Given the sharp gains so far this year, though, and the need to support these recent gains with operational improvements and/or further favourable market moves, we have reduced our substantial overweight positions in both names to only ‘slightly’ overweight.

Uranium has been languishing in a commodities-price wasteland, trading at around $50 a pound on a spot market that’s in the doldrums.  Nuclear power still sports a black eye from the Fukushima Daiichi reactor meltdown, triggered last year by a massive earthquake and tsunami off Japan. A number of countries, including Germany and Japan, pulled the plug on reactors after the disaster, paring global demand for nuclear fuel.  But uranium prices are poised to steadily increase over the next few years. Supply is projected to decline just as developing economies turn to nuclear for their expanding electricity needs.  There are 61 reactors under construction globally, according to industry trade group the World Nuclear Association.  Of these, 26 are in China and 10 in Russia. The WNA adds that 162 reactors are on order or planned, with 51 in China, 17 in Russia and 16 in India slated to join about 435 operable reactors worldwide. At the same time, the supply of uranium is waning.  Beginning in 2013, secondary sources of uranium—mostly from the decommissioning of nuclear warheads—may dry up, as a U.S.-Russia accord to dismantle such warheads ends.  Mine output won’t rise fast enough to offset both higher demand and lower secondary supplies.  New production is required to meet forecast demand, yet financing of start-up uranium projects is likely to prove challenging in the current uranium price and investment environment.  Most analysts expect the price of uranium to rise from current levels of $51 to $70 a pound over the next two years.  Our favourite play in the sector is Uranium Participation.  Buying the stock around the current level of $6.70 is the same as buying Uranium at about US$42 per pound, almost 20% below the spot Uranium price and 30% below the long-term price.

Energy stocks have been one of the biggest laggards on the market this year, despite the fact that oil prices remain exceptionally high.  Low natural gas prices have hampered the profits of the Canadian companies though and worries that high gasoline prices could derail the recovery have also held back the stocks.  We view the sector as exceptionally undervalued at current levels and are overweight the group with a focus on the energy services (drilling) companies as well as the oil sands players due to their substantial reserves.  One of our favourites is Athabasca Oil Sands, which has assembled a concentrated, oil-focused resource opportunity that is without equal within the Western Canadian Basin.  In addition, the company was an early mover in acquiring tight oil acreage, establishing an enviable position at a relatively low cost.  In addition, Athabasca has added the necessary engineering, geological and geophysical talent required to bring their resources to production.  Cash and investments on hand, the proceeds from the exercise of the MacKay River Put and proceeds from the potential exercise of the Dover Put are more than sufficient to cover the Company’s communicated spending plans until 2015; upon which point we believe cash flow and prudent borrowing will be sufficient to further develop its assets.  We see the asset value of the company in excess of $25 per share, more than double the company’s current share price.

Overall we continue to be bullish on the outlook for stocks even though we are somewhat surprised that the cyclical stock markets, such as Canada, have lagged so many other markets so far in 2012, even though the global economic data continues to support expansion.  If China is the main worry for the global economy, we don’t think that the results will end up supporting those bearish views.   That economy will continue to lead global economic growth as their long-term expansion plans remain on target.   Given that the U.S. economy is showing positive signs as well and that our view is that  Europe have already seen its worst economic numbers in this cycle, the global economy could go back to ‘hitting on all cylinders’ over the next 12 months.  This should lend further support to stock prices and also prevent interest rates from falling any further, thereby taking the ‘wind out of the sails’ in the bond market.  While markets may see a short-term correction due to ‘overbought conditions’ and some shorter-term growth worries, we are not trying to time such a move and have instead rotated to the sectors where we see the best relative growth.   If there is a pullback in prices of great than 5%, then we would become active buyers again across our existing holdings.

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