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Here's to you Uncle Horace

Paul Sullivan

Before we get started, I would like to take a moment to remember Uncle Horace. Who knew that rapacious old skinflint would leave me $25k? Uncle Horace, if you're out there, I take it all back, even knowing that you can't.

Growing this healthy little bequest over the next 12 months is going to be interesting, especially because there's a correction looming on the horizon.

I'm convinced it's going to get ugly after reading the latest letter from David LePoidevin, a very bright Vancouver-based advisor for National Bank Financial. LePoidevin has noticed that there's something disturbing going on in the bond market: it's called a "yield curve inversion." Basically that means short-term yields rates are higher than long-term rates, and it's not a harbinger of good news.

LePoidevin notes that yield curve inversions create tight money. Banks access capital at the shortest interest rates and lend out money long-term, and a rise in short term rates without a rise in long term rates cuts into their profits. They compensate by tightening their lending standards. Historically, there have been 11 yield curve inversions since 1950, the year I was born, and in 9 of the 11 occurrences, a recession followed, the only exceptions being 1966, when stocks lost 27 per cent, and 1994, when they inexplicably gained 25 percent. After the most recent yield curve inversion in 2000, the market declined 45 per cent. "Considering that record since 1950," he writes, "I don't like the odds of there being good times just ahead — since 82 per cent of yield curve inversions led to recessions and 91 per cent led to down markets."

"Quite frankly," he continues, "I'm surprised that there hasn't been much more media attention given the relationship between the yield curve and the economy." Consider the situation rectified. Right now, reports LePoidevin, the US yield curve is 45 basis points into an inversion, larger than 2000's, and a full-blown recession should follow in six months. This is not good news for a stock picker with extensive family obligations.

LePoidevin himself is fan of riding out the downturn in the market, holding cash, gold or gold stocks. He also advises that it's a good time to avoid investments that rely on consumer spending, and he also sees a decline in industrial commodities.

Meanwhile, I've already consulted with one member of the family, brother-in-law Greg, who's a Buffett buff and a big fan of exchange-traded bond funds, bonds because there's momentum in the bonds themselves, and exchange-traded to avoid management fees, which could eat up at least 20 per cent of the gains. The only problem — LePoidevin is discouraging on that front: "bonds today present little total return opportunity." OK, now what?

Well, once a growth investor, always a growth investor. The stock market may be in for a shellacking, but there's the stock market and there are stocks, and for some companies, at least, the next 12 months are going to go well. I'm a big fan of the price-to-earnings growth ratio, which is calculated by dividing a company's price-to-earnings ratio by the rate the Street expects the company to increase its earnings over the next three to five years. "It's the biggest metric we look at," Alec Young an equity strategist at Standard & Poor's Inc. told MarketWatch recently. "A company may have a high P/E, but, until you know what the earnings growth is, it's hard to ascertain whether the stock is attractive or not."

Admittedly, there's a fair amount of crystal-ball gazing in this approach, but at least we're narrowing the field to companies everyone likes, and with only 12 months to shine, we've got to take some risks. Basically we're looking for blue chip companies that have recently survived a hazardous patch, and are currently undervalued.

Now that we have a strategy it's time to start investing Uncle Horace's gift. Let's start with Goldcorp, Inc. For one thing, keeping an eye on this company is relatively simple — head office is just down the street from my office. The Vancouver business media record CEO Ian Telfer's every sneeze. I got it covered. Telfer is an acquisition enthusiast — his latest, a merger with Glamis, will create one of the world's largest gold companies with proven and probable reserves of 41.1 million ounces, all of it unhedged. Telfer's friendly $8.6 billion takeover of Glamis has incited his largest individual shareholder, Robert McEwen, the founder of Goldcorp, to take Telfer to court to force a shareholder vote on the merger. Telfer is fighting the action, and maintains that McEwen is the only shareholder who wants a vote. I'm betting that Telfer will prevail, because gold is about to go through the roof and Goldcorp/Glamis will own more of it than almost anyone else. Meanwhile, the controversy is keeping the Goldcorp share price artificially low — shares have dropped 25 per cent in the wake of the deal and McEwen's negative reaction. So let's follow David LePoidevin's advice and put 20 per cent of Uncle Charlie's money, $5,000, into Goldcorp. At today's price of $24.60, that gives us approximately 203 shares.

Let's not put all of our golden eggs in one basket, even a golden basket. If there's one commodity that's more precious than gold at this point, it's uranium. There are 100 new nuclear power plants are in the planning and development stages worldwide, and they all use uranium, which is in short supply. Chernobyl aside, nuclear power is still the main energy alternative to petroleum. And Canada is the world's largest exporter of uranium. This would have been a much nicer investment last year. Shares of Cameco Corp., the world's largest producer, rose 70 per cent last year. Share of Denison Mines Inc., another Canadian producer, increased 20 per cent, and the company is the source of takeover rumours.

The price of uranium has increased seven-fold since 2001 and is expected to reach $80 to $100 (U.S.) a pound in the coming months. And Cameco looks even better after it was one of only two Canadian companies ranked among the Boston Consulting Group's 2006 list of top value creators among global companies. Even better, it's trading at a 10-month low thanks to an adjustment following a speculative spike, although with a P/E of 33.50, it's still expensive. Still, sometimes you have to pay for growth, and we have to seize the day. So let's buy $10,000 (Canadian) worth of Cameco, and hope more countries follow Iran's lead and create nuclear power for peaceful purposes! That investment will buy us about 245 shares of Cameco.

So far, we've stayed in the metals/commodities sector, but now it's time to expand our horizons. If we haven't already, it's time to wake up and smell the coffee. Tim Hortons, that is. Talk about a hunch, but I have inside information. In the lobby of my building, there is a Starbuck's at one end and a Tim Hortons at the other. One of the world's foremost growth stocks versus a Canuck upstart. Yet, every single day, the lineup at Tim's is consistently twice as long as the lineup at Starbuck's - right here in the eipcentre of the Canadian birthplace of Starbuck's, urbane, sophisticated downtown Vancouver. Admittedly unscientific, but any coffee doughnut shop founded by a hockey player and a cop is built on solid foundations. And just ask all those Wendy's shareholders who tried to block the spinoff. So let's put down $10k, which at today's price is going to allow up to buy about 315 shares of THI and we have enough leftover for an extra large double double and a box of Timbits.

So there you have it: gold, uranium and coffee. It could all go so wrong. But if I win, the coffee's on me.

Paul Sullivan is a longtime Vancouver journalist and president of Sullivan Media. He also writes for The Globe and Mail.

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