Themes for the year ahead

I find it difficult to be optimistic about the prospects for the next 12-18 months. Although many economists continue to believe that another recession can be avoided, my gut instinct tells me a downturn is more likely than not. At the very best, we can expect a period of slow growth.

That’s why I have been advising caution on new equity purchases. There will always be investment opportunities, of course, but you have to be very selective and exercise price discipline.

In this context, I presented four broad investment themes for 2012 during my recent workshop at the Toronto World Money Show. They are gold, bonds, dividend-paying stocks, and income trusts/limited partnerships. Here is a summary of my comments.

Gold

Gold passed $1,900 an ounce and then retreated but I think it will crack through that level to stay before long (prices in U.S. dollars). I have never been a gold bug and I have always been skeptical about claims that it would climb to $5,000 or more. But we are living in extraordinary times. I have seen many crises over the years but I can’t recall the world being in quite such disarray during peacetime as we are experiencing now. Entire countries are teetering on the edge of bankruptcy, people have lost confidence in their leaders, radicals like the Tea Partiers are taking over the political debate, and corporations are stockpiling cash and hunkering down. It’s a mess.

It is in conditions like these that gold thrives. It’s the one universal store of value in a time when paper money is being degraded. It doesn’t matter where you are in the world, gold is accepted as a sound investment and a viable alternative when markets and economies are in trouble. I won’t try to predict how high it could go in the next year but suffice to say that there are still some good profits to be made.

You can buy gold or silver mining stocks, an equity-based mutual fund, a bullion-based fund or ETF, or the metal itself.

Bonds

As of the time of writing, the DEX Universe Bond Index was ahead 8 per cent for 2011. That is an astounding outperformance when compared to a loss of about 15 per cent for the S&P/TSX Composite Index. That result was totally unexpected; back in January hardly anyone predicted a strong year for bonds.

Some investors may be seduced into thinking there is more to come. There isn’t. Interest rates are so low now that there is hardly any upside potential left in bond prices. The yield on five-year Government of Canada bonds is only 1.41 per cent as I write. Comparable U.S. Treasuries are yielding an unbelievably low 0.87 per cent. Since yields can’t fall much further, there isn’t much capital gain potential for bond prices.

I think that at best we can expect a total return of 3 per cent to 4 per cent on bonds in 2012 and even that modest target will only be achievable by including a large portion of corporate issues in a portfolio. But the main reason for holding bonds right now is not to score big gains. It is to protect your capital. Bonds cushion your portfolio against the effect of stock market losses. The more bonds you own, the softer your cushion.

Dividend stocks

Many people are leery about the stock market and rightly so. But high-quality dividend paying stocks tend to be much more resistant to market downturns and you receive a monthly cash flow while you are waiting. Many of these stocks are in defensive sectors like pipelines and utilities so they tend to be much less volatile than the broad markets.

There are many good dividend stocks from which to choose, a large number of which have yields upwards of 3 per cent. I suggest that they you look closely at these in particular and discuss any that interest you with a financial advisor.

Enbridge (TSX, NYSE: ENB). Yield: 3.1 per cent.

BCE Inc. (TSX, NYSE: BCE). Yield: 5.4 per cent.

Fortis (TSX: FTS). Yield: 3.5 per cent.

Telus (TSX: T.A, NYSE: TU). Yield: 4.5 per cent.

Emera (TSX: EMA). Yield: 4.1 per cent.

Income trusts/limited partnerships

Many investors don’t realize that there are still a few income trusts and limited partnerships (LPs) on the market despite the imposition of the new trust tax on Jan. 1. Distributions from securities that are based in Canada now qualify for the dividend tax credit, so they are very attractive if held in a non-registered account. Here are three that I like. Again, talk to a financial advisor before making a purchase.

Inter Pipeline Fund (TSX: IPL.UN). Calgary-based Inter Pipeline is in the business of petroleum transportation, bulk liquid storage, and natural gas liquids extraction. The business is recession-resistant, so there is not a lot of downside here.

This LP has performed very well since I recommended it in my Income Investor newsletter in October 2009. We have a capital gain of about 60 per cent since then. It pays a monthly distribution of $0.08 per unit ($0.96 a year) and raised its payout by 6.7 per cent at the beginning of the year despite the new tax. It yields 5.9 per cent.

Brookfield Renewable Power Fund (TSX: BRC.UN). This is one of the largest power income funds in North America and it’s about to get even bigger with the addition of assets from parent company Brookfield Asset Management. The business is the production of electricity from environmentally friendly and renewable resources.

Right now, pending shareholder approval of the new proposal, the fund indirectly owns or holds interests in 42 hydroelectric generating stations and two wind farms in Quebec, Ontario, British Columbia, and New England. As with all the securities in this group, cash flow and relatively low risk are the main attractions. Any capital gains are a bonus.

I recommended this income trust in The Income Investor in July 2009 when it was known as Great Lakes Hydro. At the time it traded at $16.62. As of the time of writing it was paying on a monthly distribution of $0.10833 ($1.30 a year) for a yield of 5 per cent.

Brookfield Infrastructure Limited Partnership (TSX: BIP.UN). This is another Brookfield operation but it is based in Bermuda, not Canada. That means it is not subject to the new trust tax, nor do the distributions qualify for the dividend tax credit.

This LP has interests in such diverse areas as power generation and distribution, coal terminals, ports, timber, railroads, and more. It operates in Australia, Great Britain, the U.S., Canada, and South America.

The company pays out between 60 per cent and 70 per cent of cash flow as distributions and in August raised the payment rate by 13 per cent to US$0.35 per quarter (US$1.40 a year). Most of the distribution is treated as tax-deferred return of capital.

I recommended this LP in The Income Investor in September 2010. At the recent price of about $27 we have a capital gain of 30 per cent. The shares yield about 5 per cent.

Of course, none of these themes except the bonds is immune from a severe stock market downturn. But unless you put everything into cash you have to accept some degree of risk. I believe that a portfolio that is strong in these four areas will hold up well in the period ahead while throwing off some decent cash flow in the process.

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