Investment strategy in troubled markets

Can you have it both ways and limit risk?

With global pundits almost universal in projecting a 2023 recession, most sensible investors will plan on a recession taking place. With inflation verging on out of control rates and little doubt that interest rates will rise further, most investors will avoid long bonds and not try to “fight the Fed” which has pretty well always been a difficult task. With a global energy shortage, it seems likely that despite the risk of a material drop in oil & gas prices during a recession, post-recession the shortage of fossil fuels will keep commodity prices firm until there is an energy supply response, and there is little chance that either nuclear or renewables can scale up fast enough to make serious dent in fossil fuel usage for at least a decade or two.

So how should one manage their energy investments in these rocky waters and where else should the put money in the interim. I am old enough (actually, more than old enough) to have seen inflation in the high teens, interest rates on short term government bonds in the high teens, borrowing rates over 20% on mortgages and lots of people lose their investment savings, their homes and their livelihoods by getting it wrong and living in a fool’s paradise of hope.

Here is what I see as a sensible plan. First, an energy portfolio should have a reasonable weighting (say 40%) in debt free producers with free cash flow, low sustaining capital and a policy of paying dividends. When money is short, those dividends come in handy. Names I like are Birchcliff (BIR.TO), Pine Cliff (PNE.TO), Cardinal (CJ.TO), Gear Energy (GXE.TO) and Whitecap (WCP.TO) [which while not debt free is getting there fast]. I own large positions in all of these and they make up well over 50% of my energy portfolio. Many would say that is inconsistent with my strategy and it is, but I don’t make material changes to my portfolio frequently and it is the market, not me, that brought about the imbalance by bidding BIR up to more than 10 times my cost and Whitecap to more than five times. I am not crying the blues.

Another weighting (say 10%) might include companies that have long-live reserves, high torque to higher oil prices and manageable debt. These will be volatile and not for the faint of heart but can be sources of long term gains of consequence. Names I like are MEG Energy (MEG.TO), Athabasca (ATH.TO), Spartan Delta (SDE.TO), Baytex (BTE.TO) and ARC Resources (ARX.TO). Of these, I have sold all my holdings except my 80,000 shares of Spartan Delta. Why? I don’t like MEG’s buyback strategy (although it is popular with many investors), I don’t like Athabasca’s debt level (although it is rapidly improving), I don’t like Baytex’s management generally, and I don’t like ARC’s hedging practices. These companies all have solid assets and plenty of potential for gains, but you can’t dance with every girl at the party. Spartan Delta is more than 10% of my portfolio, again a result of a much higher share price than my cost. I don’t expect to sell Spartan Delta below $20 if ever.

A final stock weighting (say 20%) is well-managed and resilient majors which have survived many economic downturns and alwasy seem to emerge stronger. These include Canadian Natural Resources (CNQ.TO), Suncor (SU.TO), Tourmaline Oil (TOU.TO) and Cenovus (CVE.TO). Note I don’t hold U.S. entities not because there aren’t good ones but because the Biden Administration’s antithesis to energy troubles me. Not that Trudeau is any better, but my view is that Canadians will end his tenure at the next election. I have held all of these names but traded out of them profitably to bulk up my personal balance sheet. I may add them back early in the next market sell-off but that will depend on the alternatives at that time.

That adds up to 70% plus at this stage of the cycle, I think 30% cash will pay off handsomely if that recession does materialize and energy names tank. I would deploy that money if any of the following names hit the listed prices:

MEG - $6.00 a share
BTE - $4.00 a share
ARX - $14.00 a share
ATH - $1.75 a share

No one thought those prices were even a remote possibility in 2016 but in 2020 they all traded for less, in some cases a lot less. I bought MEG at $5.40; BTE at $0.35; ARX at $6.50; and, ATH for $0.10. I have sold all of these holdings now for substantial gains.

My strategy is personal to me and I don’t make recommendations to anyone about how to manage their money, just pass on my own thoughts about how I manage mine. Bookmark this article and 2 years from today I will post the sequel - how this approach worked out.