B M O N E S B I T T B U R N S High Level Investment Report

Trusted Advice & Peace of Mind Issue #1 / January 2015

Ryan Cockburn, B.Mgt, CIM Vice President|Assistant Branch Manager

Associate Portfolio Manager & Investment Advisor

Westmount Branch – Calgary | Lethbridge | Red Deer | Medicine Hat

Tel: 403-382-3498 ryan.cockburn@nbpcd.com

Shelley Qually Investment Representative

Tel: 403-382-3693

Shauna Nevraumont Investment Representative

Tel: 403-331-2027

Introducing the “High Level Investment Report”

The “High Level Investment Report” is something that I am creating to be issued on a quarterly basis, as a collection of my ideas and views, as well as portfolio strategy reviews that go on “behind the scenes” that you are not aware of. I expect that these reports will help keep you in touch with the markets, your portfolio, and my thoughts in a more formal and regular fashion than in the past. It is important to stay in touch in between meetings and phone conversations, therefore I hope you enjoy the inaugural edition of my quarterly “High Level Investment Report” and the future editions to come.

I also expect to include other wealth topics and areas of interest that have been brought to my attention by my clients. If you have something you would like more information on and would like to see it highlighted in one of these reports, please send me an email!

New Year Resolutions – Exercise Caution in the Energy Sector Hindsight is 20/20. So if we look back, what caught so many by surprise and caused the energy sector to decline rapidly in the second half of 2014 with oil prices dropping over 40%? I believe the infuence that geopolitical forces had over the market during this time is important to consider in order to set expectations and investment strategy in 2015, particularly for energy and energy related industries in the portfolio. While there are various potential reasons for the price decline, including economic slowdown in Europe and China and high inventories of crude in storage, I fnd the drop in oil prices most correlated to geopolitical tensions.

The oil price shock is signifcant to the world of fnance. It has already caused governments, corporations and investors to evaluate the impact of lower oil prices on their budgets, their investments, and their debt repayments in 2015. Specifcally,

what will the impact be if oil prices stay depressed for a good part of 2015? When will lower prices be seen as an opportunity for some, and how long might it be considered a threat to others? As we have been accustom to oil prices averaging $100 for most of the last four years, it is hard for many people to discount lower prices for an extended period of time into 2015. As western Canadians, our confdence in the energy sectors assured recovery needs to be tempered when considering global geopolitical reasons for the weakness in prices.

Peak Oil Theory was making headlines almost daily as we exited the last decade. Higher oil prices were “here to stay” and we had seen oil prices recovering towards $100 after the 2008 price collapse. The oil price remained at elevated levels, even with unexpected production increases coming out of the USA due to the utilization of fracking technologies. Higher prices and

From Ryan Cockburn

fear of demand outstripping supply had created opportunity and technological motivation south of the border. What seemed like overnight, we no longer had a production decline problem in the U.S. and a transition in Sovereign energy fundamentals began.

Fast forward to summer 2014, and geopolitical tensions are running high because of Russia and Ukraine confict, amplifed by American driven sanctions on Russia, with Europe taking part in the sanctions to remain in-line with its Western Allies requests. Those sanctions are starting to hurt, with the European economy and the European Central Bank (ECB) recognizing this. In July 2014, open public discussion by the ECB on the need for their own version of Quantitative Easing (QE) by 2015 (to help offset their economic slump) immediately triggered a devaluation of the Euro and the US Dollar started a massive rally against global currencies (up 13% as of December 29th, measured by the US Dollar Index since July 1, 2014). This currency transition likely helped initiate the oil price weakness.

As commodities are priced in US Dollars, when we have massive movements in the US Dollar in a short period, we typically get dramatic price moves in commodities in the opposite direction (see chart – the Blue line is the US Dollar Index and Yellow is the price of Sweet Crude Oil for the past 5 years).

The strong upward move in the US Dollar beginning in July started to contribute to a weakening price of oil to below $100. Oil price trends accelerated downward and by mid-October, the price of Oil was $85 and the Toronto Stock exchange had declined over 10% in six weeks! Fast forward six more weeks and we saw a strong recovery in the market with a belief that the energy price decline would likely be short lived. The oil price was trying to stabilize awaiting the OPEC

meeting on November 27th. Even with many expecting no change from OPEC, when the news was released that there wouldn’t be a production cut, the oil price went into free-fall, and the energy share market followed.

In the past month, a lot of skepticism and speculation on the “real reasons” why OPEC didn’t cut production have been analyzed. Some say that the Saudis want to hurt the Russian economy because of their support for Iran, or that the Saudis want to squeeze the U.S. companies out of the oil business with prices of $60 per barrel. We can all speculate, but it is likely a real possibility that a little bit of all of these things are happening, as geopolitical and economic “warfare” have increased in recent months and the past year.

While most of the analysis on the decline in the oil price has been focused on geopolitical tension, this is not as easy to measure as economic numbers such as GDP rates of change. Therefore, trying to make an analysis on when the price of oil could recover is very diffcult, and is why I am cautious about an emerging oil price recovery in the early part of 2015.

I have found that there isn’t much concern about the potential fve year American recovery stalling out in 2015. General consensus wouldn’t say so. Europe is sluggish and acknowledged, but market sentiment is fairly strong in the fnancial world towards the U.S. Economy for the next year. GDP fgures show growth, but if time is spent sifting through the details, the growth in the statistics isn’t on the productivity side of the economy. If the recent strong U.S. economic fgures prove incorrect in 2015, we will then also have another unexpected reason for lower oil prices, which could keep a lid on the price recovery.

Source – Thompson One Smart

From Ryan Cockburn

The top strategy lately has been to keep investing in what works –and that has been America. Lower energy prices are a wonderful tailwind for the American consumer, a topic getting a lot of attention in the media. This could be positive for the economy for months to come, and help extend the recovery. I don’t disagree with this potential or even the power of this perception on market prices, but we might want to take caution and see if this sense of certainty becomes a reality after such a resilient run in the past few years in the U.S.

The strong move up in the US dollars’ value has been touted as a sign of economic strength as well. Or is it just currently the most attractive of the major currencies because Japan has started printing massive amounts of Yen, and the ECB is taunting the market with their own QE to offset a slowdown? Caution is warranted with these global events, especially as Canadian investors wanting to make additional investments in the energy market expecting quick gains, or in the U.S. market where currency swings in the CDN dollar from these low levels could reduce a large part of an expected equity return south of the border.

The intention of the summary above is to address some of the reasons for the energy decline, but also highlight that there are many other factors currently in the market that are less easy to measure, yet can control the direction of our markets, and as a result our portfolios. Even with hindsight, we still have enormous uncertainty as to what the price of Oil will do in 2015. When geopolitics is a major driver of price, oil could stay depressed for longer than most investors are willing to accept at this point in time. I believe that there certainly will be uncertainty in the oil market in 2015 and this will be a focus for portfolio positioning in the next year, as energy prices infuence many other sectors.

Investment Strategy As Western Canadians, we want to believe that oil and oil stocks will rebound swiftly and may be tempted to try to pick the bottom. Major recoveries in share prices in the sector in December should be treated with caution however. If history is a guide, going back to the mid 1980’s, we have needed at minimum 4-6 months of base-building before a bottom is found in crude after oil prices have fallen 40% or more.

From Ryan Cockburn

****In your Portfolio’s, we have had an underweight to energy investments, and so you haven’t experienced either of the sharp energy stock price declines since September. Resource allocations have been focused on the mining and minerals sector, rather than energy for the past couple of year, and while the recent decline in energy stocks (most down -20% to -50% in the past 6 months) looks attractive, it would be prudent to watch for better risk/reward levels to enter the sector from a longer-term investment objective.

To execute this strategy and to be active in the energy sector, a majority of my clients’ energy exposure in the last year had been allocated to Canoe Energy Income Fund.

The placement of this fund in portfolios was a strategic decision made prior to the energy sector decline, as the manager of the fund has proven to be very accurate at accessing the energy market fundamentals. He has been cautiously optimistic now for the past 18 months, but the recent sell-off in the sector has not been totally unexpected to him as he cautioned that energy share valuations were too high if prices declined from recent averages. In fact, heading into October, the fund had raised nearly 40% cash to step-aside heading into the uncertain months ahead. He continues to caution investors not to jump into the sector too early, as the current decline in price has shocked many companies, and caught a majority of them off guard. If prices stay low for longer, there will be a lot of companies with debt repayment issues, as well as capital budget reductions. Some clients with longer-term energy stock holdings have individual energy companies, but will be transitioned towards the Canoe Energy strategy soon.

Meanwhile there are plenty of other opportunities that arise from this decline in energy prices, such as consumer discretionary and staples companies (lower input costs), transportation sectors, and the materials sector (that use energy as an input cost). The technology sector is also trading at attractive valuations and is a key investment focus. These areas will consume more attention and focus in the early stages of 2015.

For those wondering if they should be buying into the energy sector now, I believe there will be excellent opportunity in the energy sector for those with a long time horizon, but realistically for most investors it is best to approach the sector with caution for now. After experiencing the long bottoming process in the Precious Metals Mining shares in the past year, after a sharp decline in 2013 (not unlike the energy sector this year), there will likely be many trading opportunities, but the time to commit longer-term money to the sector might be hard for most investors to sit through and be patient.

I hope that the information in this inaugural report provides insight into my views on the energy sector, specifcally how I am interpreting the complex infuences on the energy environment, and approaching it from an investment standpoint.

Wishing you all a very prosperous New Year and looking forward to working with you in 2015!

Take care,

Ryan Cockburn

BMO Nesbitt Burns Inc. and BMO Nesbitt Burns Ltée provide this commentary to clients for informational purposes only. The information contained herein is based on sources that we believe to be reliable, but is not guaranteed by us, may be incomplete or may change without notice. The comments included in this document are general in nature, and professional advice regarding an individual’s particular position should be obtained. BMO Nesbitt Burns Inc. and BMO Nesbitt Burns Ltée are indirect subsidiaries of Bank of Montreal and Member Canadian Investor Protection Fund. “BMO (M-bar Roundel symbol)” is a registered trademark of Bank of Montreal, used under license. “Nesbitt Burns” is a registered trademark of BMO Nesbitt Burns Corporation Limited, used under license.

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