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Is Canada Too Dependent on Natural Resources?

By Ari Charney on September 23, 2015

To most investors, Canada’s investment story is all about its resource riches. That was certainly one of the main attractions for us when we launched Canadian Edge more than a decade ago.

But the other part of the investment story is that Canada has far greater respect for the dividend than the U.S.

The best example of the importance accorded the dividend up north is the fact that the S&P/TSX Composite Index yields a full percentage point more than the S&P 500–3.2% versus 2.2%.

That may not seem like much at first glance, but take a closer look: The yield on Canada’s benchmark index is nearly 50% higher than its U.S. counterpart. And a difference of a full percentage point quickly adds up thanks to the magic and power of compounding.

Beyond that, as the diverse industries represented by the nearly 30 names in our Dividend Champions Portfolio show, there’s far more to Canada than the resource sector. The same holds true when it comes to stocks with enticing yields and attractive dividend growth.

Even so, we can hardly dismiss what the oil shock has wrought. Canada’s economy has suffered two consecutive quarters of falling gross domestic product (GDP), while the collapse in crude oil has undercut support for the Canadian dollar.

That’s prompted some to wonder whether Canada is overly dependent on its abundance of resources. Although the resource sector, which encompasses key commodities ranging from crude oil to base metals, accounts for about 20% of the country’s economy, during boom times it was responsible for more than a third of business investment.

Now, of course, a significant portion of that capital spending–about 40%–has evaporated in the wake of companies’ dramatic cuts to capital expenditures.

While it’s too soon to tell the full extent of the damage from the oil shock–oil prices still have yet to stabilize–most economists believe the effect was front-loaded toward the first half of the year.

For instance, the consensus forecast calls for GDP to sharply rebound during the second half of the year, with growth averaging 2% annualized compared to the contraction that occurred during the first six months. With oil prices still near cycle lows, the growth drivers are demand from a resurgent U.S. economy further stoked by a falling Canadian dollar.

Meanwhile, Bank of Canada Governor Stephen Poloz recently observed that even when prices are falling Canada’s natural resources are an “endowment [representing] a store of value and a source of future riches.”

And thanks to the declining exchange rate, U.S. investors with an aggressive streak have an opportunity to buy a stake in that source of future riches at a sizable discount–lately around 25%, since the loonie is trading at USD0.75.

As for what the future holds, Poloz takes a constructive view, noting that, “Canada has seen this movie before–we’ve managed it well in the past, and I’m confident we’ll continue to manage it well in the future.”

He doesn’t lament the inevitable boom-and-bust modes of the commodities super cycle, acknowledging that, “… it’s far better for a country to have resources than not to have them.”

Poloz believes the central bank’s efforts toward maintaining “low, stable and predictable inflation” along with a lower exchange rate will make it easier for the economy to absorb the crash in commodities prices, while setting the stage for the eventual rebound.

And as anyone who’s followed the tumultuous commodities markets over the past 15 years can attest, there’s always a rebound.

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