The new reality

Back in the 1950s, GM president Charles Wilson pronounced that whatever was good for General Motors was good for the whole United States.

In the 1990s, we had our own version of that philosophy: what was good for Nortel was good for everyone. Of course, the inverse was also true so when Nortel stock tanked Canadian investors suffered accordingly.

Today, substitute “big oil” for Nortel and we’re back in the same situation. The price of crude directly affects us in dozens of ways, from the cost of running a car to the value of our pension plans. When oil prices fall, the loonie tumbles and our stock market does an imitation of Black Monday. Whether we like it or not, we’re increasingly seen as a petro-economy and that perception will only intensify going forward.

Consider the events of the first week of October. The price of crude took a dive (although it remained in the rarefied US$60+ range) and the S&P/TSX Composite Index fell more than 500 points in three trading sessions, from Tuesday to Thursday, a decline of 4.7 per cent. Energy stocks now make up between 25 per cent and 30 per cent of the Composite – not quite as much as Nortel in its heyday, butlose enough. So when they take a hit, the whole index gets bruised.

But it wasn’t only the stock market that got rocked that week. Our dollar, which ended on Sept. 30 at US86.13c, dropped all the way to US84.59c at the close on Oct. 6, a loss of 1.8 per cent. Then on Friday Oct. 7 the price of crude rebounded and, no surprise here, so did the loonie and the TSX. As oil goes, so goes Canada.

We’ve always been a resource-based economy but I can’t ever recall a time when our currency and stock markets were so closely tied to the fortunes of a single commodity. Obviously, this is not a healthy situation. Unfortunately, there doesn’t seem to be a lot we can do about it.

The Americans are suddenly awakening to the fact that they have a huge storehouse of fossil fuel sitting right on their northern border. We’re seeing more visits of high-profile U.S. politicians, more take-overs of our energy companies by giant American corporations, and more multi-billion dollar commitments to oil sands development. This is just the beginning.

Prime Minister Paul Martin has already started to use our oil as a lever to force Washington to pay more attention to our needs and concerns. He has made no overt threats – Mr. Martin isn’t the type – but some of his recent comments have implied that Canada would be prepared to consider sharing more of its oil riches with countries like China and India if the Bush Administration continues to play hardball on issues like softwood lumber. There’s nothing wrong with that. We have something the Americans have belatedly discovered they want in greater quantities. If we can use that to apply some leverage in other areas, we should do so.

Politics aside, how should investors deal with this situation? First, and most importantly, by understanding it. North America’s need for oil isn’t going to disappear in our lifetimes. Since we have a lot of it, thanks to the oil sands, that means energy stocks and trusts will play a major role in everyone’s investment strategy. But, like all commodities, oil is cyclical. It may seem hard to believe now but there will be a time when it is cheap again, in relative terms at least. There will be more recessions and when they come along the price of oil will drop as demand declines. Our stock markets and the loonie will follow.

That’s why I’ve periodically advised taking part-profits in the energy recommendations in my newsletters, thereby bringing portfolio weightings back into balance. A collapse in the energy sector similar to the one we saw with high tech in 2000-2002 is unlikely, but a sharp correction at some point is inevitable.

Of course, when the correction does occur it will offer a tremendous buying opportunity. You’ll be able to pick up high-quality energy stocks and trusts at a third to a half of today’s prices. But history tells us many people will pass, because of fear that prices will go even lower. Perhaps they will – but then we’ll see another big rebound as a new cycle begins.

Yes, it’s nerve-wracking. But it’s the new reality for Canadian investors. Get used to it.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that provides timely financial advice from some of Canada’s top money experts. For more information about becoming an Internet Wealth Builder member go to