Choose exploration companies for tax breaks

Clients should invest in exploration companies for two main reasons.

These are not only tax advantages, but also compelling valuations, says Craig Porter, portfolio manager at Front Street Capital. He manages the Renaissance Global Resource Fund and co-manages the Renaissance Optimal Inflation Opportunities Portfolio.

The tax benefit comes in the form of flow-through shares, which allow companies that do exploration work in Canada—such as mining and oil and gas—to write off expenses. Investors can buy company shares and get a tax credit.

“The investor is allowed to write off 100% of what they put into that fund in year one, [which offsets] their income,” says Porter. He adds it’s one of the last few remaining tax benefits that has yet to be challenged.

Read: Charitable giving, flow-through shares strategies

“There’s a line for [this write off] in your tax form,” he explains. “It’s something that’s ingrained in the Canadian tax code.”

And because companies are beginning to trade down toward cash levels, he says valuations are becoming increasingly compelling.

He warns, however, these funds usually have a two-year time horizon. Clients should believe the resource market will improve over the following two years before deciding to invest.

Read: Low prices almost shutter oil sands

They also need to choose long-lasting companies that not only explore, but also produce, as they tend to have more cash flow.

Porter says market uncertainty has pushed investors to scale back, but he’s optimistic.

“We think we’ll be getting some better prices than if we had invested at the beginning of the year,” he says. “If you take that longer-term horizon, we think we should be getting some good bargains.”

He sees mass potential for returns on oil, as long as it stays between $85 and $95 per barrel.

“Companies can still explore and they’re still quite profitable. We’ll still see a lot of M&A activity.” If oil goes up to $115 or higher, it will slow down economic growth.

Read: Triple digit oil shackles growth: Rubin

And while he’s not bullish on natural gas—there’s too much supply—Porter notes low natural gas prices are good for the U.S. economy.

“Chemical companies and manufacturing companies are starting to bring business back to the U.S. because natural gas trades at a price about one-fifth to one-sixth of what it trades in Asia right now.”

Read: Is the commodity bull run over?

He adds, “It may not be good for the companies we’re investing in, but it’s a good sign for the overall North American economy.”