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What to Do About Oil, CAD and Yields

This week, we wrestled with what to focus our Market Ethos on, given the many big moves we have seen in the markets including yields, the Canadian dollar (C$) and oil. Our problem stemmed from the fact that these three topics were covered in the previous three weeks of Market Ethos (see links above). We don’t want to write a ‘re-run’, but given the number of client inquiries on these three topics received over the past week, a revisit seems prudent. So here’s what we’re doing about oil, CAD and yields.

 

Oil – Supply is the Issue

Oil prices have retreated back down to below $45/barrel. What makes this more troubling is this has occurred with record demand, which continues to grow at a decent pace thanks to broadening global economic growth. Clearly the issue is on the supply side, with some faltering within OPEC on production cuts and rising U.S. production.

In May, according to IEA, the world consumed 96.9 mbpd, and yet produced 98.1 mbpd. This is the highest surplus, 1.2 mbpd, since before the announced OPEC production cuts. China oil imports were 15% higher in May of this year compared to a year ago. U.S. consumption is 4.2% higher. So clearly it is not a demand issue, which is a good thing.

Supply remains the issue. OPEC, after a number of months of contracting supply thanks largely to seasonality and cuts, has started to raise it again (blue line, top graph). At the same time U.S. production continues to climb, nearing its pace from when oil was much higher (orange line, same graph). Not a good combination for the commodity price. The number of drilling rigs in the U.S. has been rising for a year and is at two-year highs. DUCs are also back (DUCs = Drilled but uncompleted wells), 5,000 in the four major shale zones is a record high.

Even more troubling than just the commodity price is the underlying stock prices. During recent periods of commodity strength the sector just hasn’t risen as much as the commodity. And since 2017 started, the energy sector is the worst-performing sector for both the S&P 500 and TSX.

Our Portfolios Remain Underweight Oil

We remain significantly underweight energy and more defensively focused, mainly on integrateds and some pipes. This stance has not changed. However, with oil now below $45/barrel and prices starting to look more attractive, we are nearing a phase at which we would consider adding. But not yet.

One aspect that is starting to make oil perhaps nearing oversold levels is the rapidly declining number of net non-commercial futures contracts. If these tick much lower when the data is released on Tuesday and the stocks continue to slide, we may switch our fundamental hat for a contrarian hat and do some buying.

 

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Learn more about Redwood Tactical Asset Allocation Fund and Redwood Core Income Equity Fund (RDE).

Disclaimer

This material is provided for general information and is not to be construed as an offer or solicitation for the sale or purchase of securities mentioned herein. Past performance may not be repeated. Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please seek individual financial advice based on your personal circumstances. However, neither the author nor Richardson GMP Limited makes any representation or warranty, expressed or implied, in respect thereof, or takes any responsibility for any errors or omissions which may be contained herein or accepts any liability whatsoever for any loss arising from any use or reliance on this report or its contents. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend on or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” intend,” “plan,” “believe,” “estimate” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS.

FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained in this document are based upon what Redwood Asset Management [and the portfolio manager] believe to be reasonable assumptions, Redwood Asset Management [and the portfolio manager] cannot assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on the FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.

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