After a week in the sun, we'll be heading to LA for a quick visit with Liz, then home again. But not for long. We're heading to Nova Scotia and Newfoundland right after Stampede.

David and Kelly-Anne will be confirming their marriage at K-A's hometown of King's Cove, a village about 3 hours west of St. John's. We're looking forward to the parties, whale-watching and cod-jigging.

Golfers will know what it means to "shoot your age". In Phoenix, golfers try to "shoot the temperature". Since it reached 110F yesterday, even I was able to meet that standard!

Mortgage Insurance

The CBC Marketplace report is available for viewing at www.cbc.ca/marketplace/in_denial

Personal insurance - life, disability or critical illness - is more satisfactory, and may be cheaper, than the stuff that your friendly banker offered you while completing the mortgage application in a stress-filled office.

The table to the right is a comparison table as published on the CBC website.

Mortgage Referral

Please call me at 403-616-3434 if you need a new mortgage, or are about to renegotiate an existing mortgage. We may be able to save you a lot of money.

Where We Are

As I write this in May, it is now looking as if this crisis is under control through prompt action by the central bankers. Certainly the stock market believes this, as April and May were positive months, and we have mostly recovered from the early-year losses.

For the first 4 months of the year, natural resources was the top performer (+6.7%) followed by foreign and Canadian bonds (see table). Although gold was up 7.4%, gold stocks were down -7.2%!

The emerging markets tend to move in tandem with natural resources, but haven't this year. Emerging markets are down -3.1% this year. China has been hurt particularly hard; AGF China Focus, our top Chinese fund, is down -10.4% year-to-date. Within other sectors, real estate returned +1.3%, healthcare -6.5%, and financial services -6.0%. Tech brought up the rear, losing -8.4%.

As so often happens, the bond market operated contrary to the stock market. Interest rates plummeted in the first quarter, giving spectacular returns to bonds. The sense of recovery in April and May has resulted in a return to more normal interest rates, and we've lost some of those early-year gains.

Canadians haven't had to worry about currency exchange losses this year. The Bank of Canada is operating to keep the looney and the greenback roughly at parity. The Euro continues to be strong against both currencies.

Where We're Heading

Chart 1

By the way, gasoline here in Phoenix is $3.55/gal - roughly 94¢ per liter.

I recently read an interesting report (I'll be emailing it to clients when I get back to Calgary). The report argues that "this time it is different", and we're into a new world where food and energy will be the determinants to economic success. It makes me think of the days of gunboat diplomacy and the British Raj. Back to the Future!

There is only 1 OECD nation that is a large-scale exporter of both: Canada. In the developing world, only Russia and Kazakhstan currently fit the criteria. Brazil may soon join this select group. The author feels that Africa could be a future power, if it ever got its political act together.

The report particularly focused on south Asia. Asia (ex-Russia) is the only continent that is not self-sufficient in either food or energy. The author speculates that the current government cash reserves in China, India and the ASEAN countries will have to be spent on securing both food and energy for their population. China is looking to Africa (in particular) as their future storehouse of both.

The author concluded that one should be wary about investing in Asia, but Latin America, Russia and possibly Africa continue to present terrific opportunity.

"The winners are those who export oil, and the losers and those who import it. The ability to control where exports go and where they don't go transforms into political power. The ability to export in a seller's market not only increases wealth but also increases the ability to coerce, if that is desired".
                                                                                George Friedman - Stratfor, May 2008

As you probably know, I have some business interests in Central America. There's an interesting diplomatic battle going on there between Taiwan and China. Most Central American countries recognize Taiwan, and receive quite substantial foreign aid as a reward. Costa Rica recently switched sides, and joined the China camp. Their first goodie will be a new soccer stadium for San Jose. Complaints are now showing up in the press that the stadium will be smaller than wanted, and will be constructed using Chinese management, equipment and labour. Ticas won't be allowed on-site until the facility is finished.

Currency
The looney is a petro-currency. At oil prices above $100/bbl there's a very strong bias towards a strong looney. As I predicted in my last letter, the federal government and the Bank of Canada are working hard to contain the currency's rise and hold it at around par.

The federal government is using gloomy talk; the Bank of Canada is lowering interest rates. So far they are doing a good job. As you can see from Chart 2, the relationship between the oil price and looney has broken down, and is now flat-lining at roughly parity.

Chart 2

Interest Rates
Interest rates have bounced back to more normal numbers from their extreme lows early in the year (see the red and green lines in Chart 3).

Chart 3

Now we have to worry about a US recession, and the possibility that it may spread to the rest of the world. It is still true that if the US economy sneezes, then Canada catches a cold.

The yield curve (the difference between short term interest rates and long-term rates) is one of the best forecasting tools there is for future economic performance The yield curve is now sloping upwards quite nicely in the US (see Chart 4 for a comparison of today's curve vs. a year ago)..

Chart 4

Although the Bank of Canada is the institution charged with managing monetary policy, it isn't getting a lot of help from the Big Five chartered banks. While the Bank controls T-Bill rates, the Prime Rate is under the control of the chartered banks. The Prime Rate, of course, is the one that affects a multitude of consumer and commercial loans. As shown in Chart 5, the normal spread between T-Bills and Prime is 1.5 - 2%. The spread is currently 2¼%.

Chart 5

I mentioned in the previous section that the yield curve in the US is positive, indicating that good new lies ahead.

Here in Phoenix, the newspapers are talking about how to diversify the local economy away from growth-related construction and speculation. The business section has an article about unmanned aircraft as a growing and booming business sector.

Housing is never far below the surface. The front page of The Arizona Republic has a sticker for USHomeAuction.com: "over 450 homes must be sold!" The real estate section indicates that median house prices are down around 10% from this time last year. Despite this, there is optimism in the air if only because heavy rains and snowfall have replenished the reservoirs in the US southwest. Their 12-year drought may be at an end.

Canadians have been quick to take advantage of the US housing slump. According to International Living magazine, Canadians account for more than half of all new home purchases in California, Texas and Florida. Which brings up an interesting question: why are Canadians able to see weak real estate prices as an opportunity, while they see weak stock market prices as a threat?

"Canadians now account for more than half of all new home purchases in California, Texas, and Florida".
                                                                                               International Living May 2008

Stock Market
Last week, the Toronto stock market reached an all-time high. The most amazing part is that it has done so without the participation of the Big 5 banks. Instead, the TSX is being driven by stocks like Encana, Potash Corp, CN Rail, and Research in Motion.

Chart 6

Chart 6 shows that the situation isn't so rosy in the US. Earnings (green line) have definitely fallen from their peak. Despite this, the US stock market is doing very well. Investors seem to be looking past the current slowdown and seeing good times ahead.

I've mentioned several times before that the Canadian stock market out-performs the US when commodity prices are strong, and under-performs when commodities are weak. Chart 7 requires some explanation, but illustrates this.

Chart 7

The red line shows the relative performance of the Canadian stock market vs the US stock market. The red line is rising when Canada is out-performing; the red line is falling when the US is the stronger market.

First let's look at the unshaded portions of Chart 7. These mark times when commodity prices are weak. Note that in every case the red line falls - the US market outperforms Canada when commodity prices are weak.

Now let's look at the shaded areas on Chart 7. Here we see the opposite. The red line rises in the parts of the chart shaded in yellow: the Canadian stock market out-performs the US when commodity prices are strong. There is only 1 exception to this rule. Mr. Chrétien just about lost the whole country in the 1995 Quebec referendum. Do you think that this might have had a bearing on Canadian stock prices?

The blue line continues to head upwards. We remain in a commodity bull market. Canada remains the place to be invested.

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