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Yola Edwards

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Donít throw in the towel yet

Yola Edwards

Back to the future, it appears. Weren't we in the same position a year ago? Their handling of the income trust issue in November 2005 was one reason the Liberals fell from power on January 23, 2006 and by all accounts the same fate undoubtedly awaits the Conservative government at the next election when the investing public is in a position to effectively deal with Harper's arrogance and betrayal. Though Finance Minister Jim Flaherty's income trust legislation effectively becomes law by 2011, the public outcry over the government's handling of the issue isn't over yet. All of the bad political news has been priced into the income trust securities and since both major political parties are in favour of income trust tax reform we must accept the reality that a change of some sort is upon us. But, will that change stand as it is now proposed or will it take some other form? Now is not the time to be throwing in the towel, as public pressure may persuade the government to soften their stance, so there may be some good news yet.

Income trusts account for about 10 per cent of the Toronto Stock Exchange market value and their inclusion in the S&P/TSX Composite Index benchmark in December 2005 and the further inclusion of Canadian Oil Sands Trust and Yellow Pages Income Fund into the S&P/TSX 60 Index benchmark in August 2006 gave the investment vehicles clout as it meant that any financial institution which benchmarked the Canadian stock index had to load up on trusts. As a result of Finance Minister Flaherty's surprise announcement, the institutional portfolios along with smaller investors took a beating. Even Canadians who don't invest directly in the equity markets have been adversely affected by the Minister's decision as the Canada Pension Plan portfolio representing about 16 million Canadians was invested in income trusts to the tune of about $1.5-billion at year end March 31, 2006. Interestingly however, the CPP's portfolio was only half the weighting than those of other institutions that had invested in the sector.

If you elect to stay with income trust for the time being then, as with every investment, the key to making money is finding a business that's growing. As with stocks, trusts can reduce or eliminate their cash distributions if their businesses are weak. Added to the income trust risk is the proposed tax amendment which will further hinder distributions. The units will have to allow for a tax on distributions thus reducing cash flow to investors in the order of 31.5 per cent by 2011. However, this fact has been factored into the current price of the trusts.

Which income trusts then, appear to be poised to rally? A review of the commodity market suggests that although it is perhaps later in the game, the index is still in the midst of a major bull market and that may be an area of interest.

From a technical standpoint the commodity research bureau (CRB) index chart suggests that we are completing a fourth countertrend wave in a five-wave Elliott wave advance. The recent sharp decline in the index found support just above the 200-week support at 290 and the moving average convergence/divergence oscillator suggests the index is deeply oversold and at multi-year lows. Although we cannot rule out one more leg down, it appears further downside is limited to about 275 to 290. Since the fifth and final wave advance should approximate wave 1 the final target should be about 344 -360 giving us a truncated fifth over the next year. However, there may be an alternate possibility to be explored. It is possible that we are in a much larger cycle and that primary wave 1 completed at 365 and we are in fact completing the second corrective wave meaning that we are still in the early stages of the commodity boom. As such look for the next peak at about 403.

One income trust in the sector which bears consideration is Fording Canadian Coal Trust.

With the November 14 closing of 21.60, the stock has retraced 70.7 per cent of its gains extending back to May 2003 and as such should have found secondary support. The trust units currently offer distributions of $3.20 per annum which equates to a yield of 14.8 per cent. If we can expect a possible 31.5 per cent reduction due to the recent government announcement then we could expect the distribution to be cut to about $2.19, which at current stock price would generate a yield of 10 per cent.

Though company officials announced third quarter coal sales were down 8 per cent from the 2005 comparable quarter and coal prices were down $9 (U.S.) a tonne for the comparable quarter, coal prices on a year to-date basis were actually higher by 25 per cent or by $23 a tonne. As a result of the increased price for the commodity the $471-million available for distribution on a year-to-date basis was off marginally as it was down by about 1 per cent. However that didn't affect the stated distribution amount.

Based on a review of the technical charts for the Dow Jones US Coal Index it appears higher future coal prices are on the horizon. The index completed a bottom September 25 when it traded down to 205.23 where it formed a hammer bottom which signifies an end to the preceding trend. Since then a rally was stopped at overhead resistance at 273. Although a modest dip to 250 from current levels cannot be ruled out the index is forming a bullish saucer which should see a first rally to next resistance at the 200-day MA at 300 followed by a continued rally to about 345 over the next five months.

As for Fording Canadian Coal Trust, it appears a bottom is at hand. Before the announcement there was a case for the downside to have been limited to $27.50 as that was the downside target projected by the bearish head and shoulders pattern. However, the shock of the government's announcement saw investors drive the stock lower to support offered at the $23, which was a 1.618 retracement of wave A and it appeared that the support would hold as the stock turned and rallied on a dime once it reached that support. However it seems investor emotion is still in play and the stock is in a "throwing the baby out with the bath water" situation. However, even with the extreme sell off the MACD is still diverging positively. Further, the November 13 and 14 sessions ended with a harami cross being formed suggesting a trend reversal. At the same time the stock has retraced three-quarters of its multi-year gain and a bottom should be the expected result. As such, a rally from current levels back up to resistance offered by the falling window gap at $27.19- $28.14 with a further rally to $29.36 should be directly ahead. Although resistance along the way can be expected a continued rally to $37.50-$39.50 should be in the cards over the next five months. However, longer-term it appears that the stock is entering a new positive cycle, perhaps in more ways than one.

Yola Edwards is a contributing writer and technical analyst for Bell Globemedia Interactive, providing options and technical analysis research on a variety of North American equities.

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