Equity Strategy May 23, 2008:      

The Canadian business press has been quite focused on all of the uncertainty surrounding the BCE take over deal. This situation should not surprise anyone as the writing has been on the wall since the beginning that the deal was flawed. The board of directors at BCE were so sure that they had the correct formula for achieving the maximum shareholder value that they neglected to include all of the participants in the process and this has caught up to them now.

The Board of Directors set way too many restrictions on who could bid that there was no possible way that shareholders were going to be well served. In addition to that they did not take in to account any of the objections from other stakeholders in the company and now the bond holders group have won their case in the Quebec Supreme Court which will push the closing date back and may offer the banking group an opportunity to opt out of their obligations and force the company to renegotiate the terms of the financing. All and all the shareholders have not been well served by the company’s Board and management, which is not a surprise as that has been the case for years. I do not have any sympathy for any one who continued to hold BCE shares as there was no reason to hold the shares once the price had moved up to the take over price there was only the risk that the deal would not complete.

The Supreme Court will be asked to review the Quebec court decision but that may not take place for months putting the entire deal in jeopardy in the mean time. The banking group will be relieved if the deal falls apart as they have been pushing hard to reopen negotiations in light of the changes in the credit markets, it is too bad this can happen.

I am surprised that the bankers are trying to renegotiate at this late date, if this were you or I trying to renegotiate a lending contract due to changing market conditions the bankers would just laugh at us, but it seems they are not willing to stand by the contracts they sign if it doesn’t suit them. All of this uncertainty is a major reason why the Canadian capital markets are never going to be viewed as world class and worthy of substantial long term investment by foreign investors, a national regulator of the capital markets would help to legitimize the capital markets here and add more certainty to the process.

The energy sector continues to lead the market in Canada the S&P/TSX reached an all time high this week which coincided with new all time highs in crude oil the same day. The price of crude has been forced higher by limited supply and strong growth in demand globally. The price may be a bit ahead of itself at the moment as speculators jump in to the trade, moving the price ahead a little too quickly and the move not driven by the fundamentals in the short term.

I would not be surprised to see a substantial correction develop in this sector as prices correct to more sustainable levels. As this correction develops investors should add to or initiate positions in the energy sector due to the potential for continued lack of supply growth over the long term. The imbalance of supply and demand will maintain higher prices in the future. We are never going to see oil trade back below $75 dollar a barrel again and most likely oil will consistently trade over $100 a barrel going forward. At these levels the Canadian energy sector will out perform other investment sectors over the longer term.

The next sector likely to make a sustained move higher is the gold sector which has been consolidating over the past few months. This consolidation phase is required in order to set the stage for another mover to new highs. Inflation is positioned to make a sustained move higher as the combined pressure of higher food and energy prices forces inflation up globally. Historically inflation has been one of the prime forces driving the price of gold up and after decades of decline inflation is coming back and will be here for some time yet.

Companies such as Barrick Gold (ABX-T), Kinross Gold (K-T) and Goldcorp (G-T) are all well positioned to benefit from higher gold prices and should be considered as core holdings in a well diversified growth portfolio.