A resourceful market

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World economic woes or no, demand for Canada’s commodities remains fired up, and poised to increase even further according to fund managers. Driving that growth are trends in emerging economies, where industrialization is unrelenting, and improved diets are fuelling demand for agricultural commodities.

On the energy front, increasing demand, declining supply and exploration cutbacks all bode well for oil prices. As usual, seemingly insatiable demand from China is the first driver they talk about when discussing their bullish outlook for the sector.

For Joe Overdevest and Darren Lekkerkerker, managers of the Fidelity Global Natural Resources Fund, top commodities on the material side include coking coal (used for making steel) and copper.

“China’s demand continues to be at record levels; it’s higher than it was pre-crisis,” says Lekkerkerker. “They’re in a very metal-intensive phase of their growth. You’ve got to build out your electricity grid and distribution, highways, railways. You’re constructing buildings. So we think copper – there’s big demand for it in the emerging markets.”

Alexander Lane, vice-president and portfolio manager of the Dynamic Power Small Cap and Dynamic Power Global Navigator Class funds, is also bullish on industrial materials, including forestry products.

“Canadians have educated the Chinese on the merits of framing houses using softwood,” he says. “In recent quarters exports of Canadian softwood to China have skyrocketed.” He also says there could be a supply shock in softwood stocks as the last pinewood beetle infested trees are harvested while the United States, China and Japan all compete for the product.

In addition to these areas, Lane also likes energy products and services and agricultural products. Like Overdevest and Lekkerkerker, he says agriculture stocks will do well, as demand for higher-protein diets increases.

“Demand for food is rising exponentially as diets move to cows, chickens and hogs, which are much more grain intensive (to produce),” he says.

According to the Fidelity managers, it takes roughly seven pounds of grain to produce one pound of beef or five pounds of grain to produce one pound of pork. Corn will also do well, they say, as U.S. ethanol programs consume large amounts of that country’s corn crop, driving prices higher.

In China and India, Lane adds that average crop yields are significantly lower than those produced by North American farms. “That needs to improve,” he says. “Better use of fertilizers, particularly potassium-based, would help alleviate this problem, as would increased use of technology like harvesters and genetically modified seeds.”

Finally, Lekkerkerker and Overdevest observe that China began to import large amounts of corn this year in response to flooding. “Security is top of mind when you don’t have a democratic country. What can make people revolt? Not having enough food,” says Lekkerkerker. “If China becomes a structural importer of corn – meaning they have to import every year to feed their population – that could really change the global equation for grains in terms of supply and demand. We could see structurally higher prices.”

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In energy, all three managers are comfortable with and bullish on the current supply-demand equation, saying the Canadian oilsands are a unique resource globally that will allow the country to substantially increase production over the next decade. Meanwhile the reserves of other nations are in permanent decline.

As far as U.S. demand and political rhetoric is concerned, all three managers agree that Canada is the most secure and significant source of U.S. energy and the oil sands are part of that supply, whether Americans like it or not.

“They’re in an interesting situation,” says Overdevest. “They may not like oil coming from the oil sands, but it’s going to be tough to see where they’ll get that oil if they don’t want it from the oil sands.”

Furthermore, Lane says demand and prices are impacted far more by buyers in Asia than those in the United States. “The world’s buyer of the next pound of copper or barrel of oil is more likely to be located in India or China than in the United States.”

Pricing, meanwhile, is helped by the fact that a lot of companies cut back financing and exploration in 2008 – a move that will likely begin to impact production and prices within a few years.

It’s a theme being repeated across other parts of the sector that rely on exploration as well. Unlike previous cycles where exploration was curtailed after a period of overbuilding, the last commodity boom was relatively short lived, according to Lane.

“We did not have a capacity-induced pullback. Demand has turned back up and so pricing has improved for most miners,” he says. “Major investments still need to occur to deal with a long-term supply problem for most commodities.”

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• Kate McCaffery is a Toronto-based financial journalist.

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