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Harry Koza

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The next big thing

Harry Koza


Big cigars, diamond rings
Ridin' all around in a limousine
When you finally hit the top
Man you know what that means
Everybody's ready for the next big thing

Vince Gill, "The Next Big Thing"

The tiger springs in the new year. Us he devours.

— T.S. Eliot (1888-1965), Gerontion

TORONTO (GlobeinvestorGOLD) — I must confess I've been racking my brain trying to come up with the next big thing in investments for 2005, and I'd like to be able to say that I've come up with a six-pack of new ideas, but I keep gravitating back to the themes of 2004: resources, trusts, and power generators.

Despite a little central bank raising of interest rates in 2004, rates are still pretty attractive for borrowers, credit spreads continue to contract, and the U.S. economy, generally described these days as "sluggish," is still likely to post growth for all of 2004 in the 4.4 per cent range — better than just about any other developed nation. Everyone should be so sluggish.

China is still booming, although there are some concerns emerging that the soaring Chinese economy will slow down to sub-sonic speeds, maybe even come in for a hard landing. More likely is that the recent pace of growth in China will moderate slightly, with demand for what newsletter writer Dennis Gartman calls "things that hurt when you drop them on your foot" remaining strong. That bodes well for oil and gas and most mineral commodities.

Will commodity prices keep rising as fast as they did in 2004? Probably not, but so what? Oil and gas trusts were making money hand over fist with oil at $30 (U.S.). Sure, they were making even more enormous profits with oil pushing $50, but at $40 they won't be exactly hurting, either. Any decline in oil prices will just create buying opportunities, and I plan to add to my energy trust holdings on any decent pullbacks.

Another major plus for the trust sector is that for the first time, now that the Ontario government has legislated limited liability for trust holders, trusts will likely be added to stock indexes. That means that indexers will be buying trusts to match their weightings in the stock index, with salubrious effect on (especially) prices of the larger cap trusts.

The massive post-tsunami rebuilding job in South Asia will also help bolster the prospects of metal and timber and energy producers. Apart from the horrendous human cost of the disaster, there are hundreds of billions of dollars worth of infrastructure to rebuild and property damage that needs to be repaired.

Lawn bowling, anyone?

Here's another major theme for 2005: This year, for the first time in history, the number of North Americans over the age of 60 will be greater than the number of people under the age of 4. That is a major demographic tipping point, and the consequences for pensions, health care, and government tax revenues are going to be an increasing focus of markets in the years to come. That also points to a secular shift in investment philosophy, as aging investors switch their prime objective from capital gains to income-producing investments, like dividend-paying stocks, income trusts, and even — dare I say it — bonds.

The Bank of Canada, which was only recently widely touted as planning to raise interest rates by as much as another 250 basis points (a basis point is 1/100 of a percentage point) over 2005, now seems likely to remain on hold into the second half of the year. While that doesn't mean that bond yields will drop, it doesn't mean they will be rising any too quickly, either. In a way, that's too bad. I was hoping for rates to rise nicely by mid-2005, when I have several bond holdings maturing. I was hoping to be able to roll the principal into new bonds at yields higher than are currently available. Now that looks increasingly problematic. I have a feeling that sometime this year you may hear traders waxing nostalgic about the good old days of November 2004, when you could still buy ten-year Canadian government bonds to yield 4.5 per cent (they're about 4.3 per cent these days, by the way).

Last year, 2004, was the Year of the Monkey in Chinese astrology. Now, I'm not a believer in astrology or crystal power or lay lines or any of that other New Age mumbo-jumbo, but today, I happened to read a "think" piece in the main-stream press about how last week's tsunami and that big temblor in Iran early in 2004 are both examples of Monkey Year mischief; another claiming that the tsunami occurred because Earth Goddess Gaia is angry; and still another warning that the tsunami was caused by seismic testing for oil in offshore South Asia. Obviously there is no shortage of delusional people out there, and likely some of them are investors, too, so it is worth pointing out that 2005 will be the Year of the Rooster.

No cheeky monkey

The Chinese astrology sites on the Web say that this year, investors should "stick to practical and well-proven paths. Forget about that controversial best seller you were going to write. No get rich quick schemes this year, please! … Refrain from making speculative ventures. Disappointments and conflicts will result… This year we may have to expend maximum effort for minimum gain."

Wow, that sounds a lot like my investment strategy from the past few years! It also sounds just like my thinking for this year too. Oil and gas trusts, power trusts, monopoly business trusts (Yellow Pages, Water-heaters, etc), exchange-traded bond funds, stripped coupons and corporate bonds were my main investing focus in 2004. (Actually, they've been my focus since about 1999, and I must say, it has been a rewarding one). I really see little reason to change that bias, at least for the first half of 2005.

By the second half, we'll have a much better idea of where interest rates are going and whether the China story will continue to be driving markets. If yields are higher, I plan to load up on bonds. If not, I'll be looking to add quality income trusts and dividend paying stocks. As I progress into what someone recently described as "the back nine of my life," my prime investment directive increasingly becomes income generation and preservation of capital. Demographics will make that everyone's main thrust, too. Forget those double-digit stock gains of the bubble era: they were an aberration. I never had any Peter Lynch "ten-baggers" during the tech bubble, but then again, I didn't buy Nortel at $120, either. I'm thinking that 2005 may be the year that people finally start to realize that investing and speculating are not the same thing, even if that sea-change is driven by demographics rather than any sudden investor epiphanies.

Home sweet home

One major change for me this year is that I will enter 2005 mortgage-free. Yes, paying down my mortgage has been one of my biggest investments over the past several years, and a risk-free one to boot. Now, I'll have more disposable income left over to invest in things that will provide me with additional income over the coming years. If interest rates do go up, prepaying your mortgage will only become more and more attractive as an investment alternative. Don't forget it as part of your investing alternatives. (Did I mention it was risk-free?)

So, for 2005, I'm still looking at energy stocks and trusts, oil well service companies, and pipeline contractors. There will be several mega-pipeline projects started in the next year or two, and drillers will be sticking holes in Alberta, B.C., and Saskatchewan faster than government can jump on a bad idea. There are several wind-energy projects that will be financed during 2005, but, alas, they will likely be via private debt placements and it is unlikely any of the bonds will be available for retail investors. A couple of power trusts have been awarded long-term contracts to supply Ontario with wind-electric power, however, so part of some financings may well be with new trust units. There may even be a couple of new power trusts launched as part of Ontario's attempt to increase its electric supply.

(By the way, did you know that Ontario has the world's largest reserves of peat, a low-sulphur, clean-burning, renewable fuel used in electricity generating plants in Scandinavia and Ireland? )

I'm not planning on getting too much into stock markets in general until later in the year — bullish sentiment seems too high, 62.9 per cent last time I looked, bearish sentiment too low at 19.6 per cent, and only 17.5 per cent of those surveyed are calling for a correction. Since, as Finagle's Law states, the perversity of the Market tends towards a maximum, I'm expecting the most likely outcome will be the one that causes the most pain to investors. That means I'm staying mostly in income-generating, capital preservation mode, and looking for stocks that I like to buy when they get cheaper. I remain concerned about some largish bond maturities in my RRSP coming up in May and June, but still have time to decide what to do. Bonds may have more attractive yields by then.

From December 2003 to Dec. 30, 2004, net of new contributions, my RRSP is up 14.9 per cent year over year. The S&P/TSX composite is up about 13 per cent in the same period.

I can live with that.

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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