Mailbag – Stock Picking in the Canadian Energy Sector

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*You all know the drill by now, we get a great question through our contact us page and allow everyone to benefit from it.  As always, these are real questions from real readers and identities are always protected.

I wanted to send a question about investments.  I can’t remember where I heard parts of this, CBC and other sources but I was wondering if there is some kind of investment in agriculture.  I have been hearing/thinking the following:

  • Water and food security worldwide seem to be getting worse.
  • Global warming is likely not stoppable/reversible, especially in the short term.
  • The Canadian growing season is getting longer.
  • Canadians are very hesitant to sell / export water.
  • We are not hesitant to export wheat, beef, and other crops which is essentially the same as exporting water.
  • Food production in areas that were traditionally high producing (California, etc) is getting difficult because of extreme heat/drought.  With our growing season extending we can grow different crops that we couldn’t before and with higher yields. 
  • Big investment groups are looking to Canadian agriculture –someone in the Middle East bought a large chunk of the wheat board?
  • Food prices are going up quickly so there will be changes to how / what people eat.  Consumers are either paying more or getting less for the same package but marketers only have so much ability to hide or gloss over that food is proportionally more expensive.

Stock Picking in the Canadian Energy SectorI’ll do more research but my impression is that Canada has fairly good water security and farmland that is going to have longer hotter growing seasons.  It seems like it makes sense that there will be an increase in value of agricultural land / agriculture products. There is also likely going to be a shift in how people eat, though it will probably take a long time in Canada – less meat will become the norm and high-water-requirement crops will also become more expensive.  I don’t think it will be an overnight thing, it would be more gradual over years.

This is just a thought, I have been seeing a lot of “reporting” on this over the years.  I think people are hesitant to acknowledge that there could be a change.   It’s very stressful to think that food / water are potentially at risk so most people avoid thinking about it.  Thoughts?  Are there investments that could take advantage of this?   REITs or stocks in big food production companies or something else?  Futures seem too short term/specific.

Evan

 

Hey Evan,

You have some interesting reasoning here and the potential future you see developing could indeed become a reality.  But I have two thoughts for you:

1) Starting ten years ago or so a supposedly “expert” economist named Jeff Rubin started talking about a concept called peak oil and how a lack of oil was going to quickly change the way we lived.  This man had access to almost any piece of relevant information you could think of as the Chief Economist over at CIBC – yet he was hugely wrong (even if he has yet to admit it).  What we instead saw was a classic case of incentives at work.  It became very profitable to figure out ways to get oil out of the ground, so what happened next?  We figured out new ways to get oil out of the ground of course!  Today we know that we won’t be seeing “peak oil” for several decades if ever.  Check out the Freakonomics books/podcast and think about how incentives might play out in this scenario you’ve created above.  I think it’s very hard to predict what direction consumption and supply patterns will take.

2) The trends you have predicted seem plausible, but admittedly you haven’t looked at much original research and tend to take generalities at face value (i.e. “Water and food security worldwide seem to be getting worse.” – are they?).  Now, consider that there are absolutely massive investment companies out there with whole teams and/or departments that study agriculture around the world exclusively.  They study consumption patterns of growing populations in depth, they know every major player in the agricultural arena, and they have essentially made their entire lives about predicting what agricultural production will look like next year, in five years, and beyond.  Knowing that these investment arms exist and that they have access to billions of dollars in capital, do you still think you can outsmart the market?

Related: Canadian Dividend Investing: Utility Stocks

I ask if you think you can outsmart the market because that is essentially the bet you’re placing here Evan.  A common mistake investors make is that they believe they are outsmarting other small retail investors like themselves by seeing long-term trends or short-term inefficiencies that no one else sees.  In reality, what you are saying is that you have identified a major factor that most people at massive companies designed to find these inefficiencies have not noticed.  A term financial talking heads like to use to describe this reality is “baked into the market”.  If we apply these thoughts to your ideas, the question is has much of the investing world looked at the same trends you have, identified the likelihood of the various scenarios you propose, and determined the best allocation of their capital on that basis already?  My answer would be that they have, and have likely done so in a much more efficient way than you or I ever could due to their massive advantage in tools, manpower, expertise, and insider knowledge.

If you agree with line of thought and the idea that these major trends are already “baked into the market” to a large degree, then the logical conclusion is that you stand a very small chance of beating the market, and that even if the events you have predicted will happen come to fruition (a risky bet), others have likely already priced those events into their current stock portfolios.  At that point, we arrive full circle back to the broad market ETFs we describe and recommend in our free ETF ebook.  The good news for you as a Canadian resident is that if events occur as you predict they will, the home country part of your portfolio (Canadian TSX ETF most likely) will do very well and you will benefit anyway.

Related: Dividend Investing vs Index Investing

To directly answer a couple of your other questions, there are funds out there that allow you to invest in agriculture products, but I would not recommend them at all for small retail investors.  Certainly stay away from any sort of commodity futures unless you want to make those markets your full time job!!!  Commodity markets are very volatile and notoriously difficult to predict.  If you are still bound and determined to try and outperform the broader market I would do a substantial amount of reading about picking stocks in general, and then substantially more reading on the agricultural world specifically.  Maybe at that point you will be able to identify some good long-term value plays versus their current stock valuation. Even after doing all of that work though, I don’t any single retail investor’s chances to be brutally honest.

Hopefully this helps and wasn’t too much of a downer!

Cheers,

Kyle

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Kyle is a high school humanities teacher by day, and freelance personal finance author by night. He has been published in academic journals, and has also co-authored the book "More Money for Beer and Textbooks". In his free time Kyle likes to limp up and down a basketball court and pretend to be a tough guy in a boxing ring.

13 Comments

  1. Roadmap2Retire on July 8, 2015 at 11:19 am

    Kyle,
    I have to disagree with your reasoning here. I think Evan is right on the money in his thoughts on investing and the reasoning. Just because there are “massive investment companies” that deal with the data and do this for a living and have billions of dollars at their disposal doesnt mean a retail investor should stop investing and simply give up. Like you pointed out, “experts” like Jeff Rubin get it wrong all the time. Yes, a retail investor will probably not make a “killing” by outsmarting the market – but there is an opportunity to get a piece of the pie, so to speak.

    Evan is also right in identifying the overall trends such as food, food production/agriculture, and water issues of the future. As a matter of fact, food and water security IS getting worse – and numerous studies have shown that already. Just look at the population growth and demographics – the rapid increase in births coupled with increased life expectancy due to peaceful conditions and better healthcare, the population is expected to grow to 8 billion (low est) to 10 billion (high est) according to UN. Feeding that size of global population will take a lot. We need to grow more food in the next 40 years than what we did in the last 10,000 years put together. See this article from Economist – www.economist.com/news/…-farm-gate

    Evan – I invite you to explore this idea – there are plenty of opportunities out there – and I am investing in ag companies myself, and also looking some water investment opportunities. Also, check this book out which I read last year – its a fantastic read and will give you some broad ideas on what to look at.
    roadmap2retire.com/2014/…ok-review/

    cheers
    R2R



  2. Kyle on July 8, 2015 at 8:43 pm

    The historical performance of stock pickers says that statistically I’m certain to be right at least 20x more often than I’m wrong R2R. There were plenty of studies that showed that oil was growing more scarce as well. Then the price produced an incentive that led to innovation in the field. Who knows when something like a more efficient de-salinzation will be produced if the incentives are right? The same idea goes for food. Malchus predicted centuries ago we’d run out of food long before this. What happened? Farmers responded to incentives and are more efficient now than ever before. The point is for one person who does not have access to insider information to try and bet against the overall market, it just doesn’t work out far far more often than it does no matter how many articles you have read. Just because you agree with Evan’s reasoning in this specific case (and I agree, it is sound logic) doesn’t mean advising to invest on these sentiments is a good idea. At the absolute riskiest Evan could maybe play with 10% of his overall portfolio in this manner, but I wouldn’t advise it unless he has done a lot of homework.



  3. Roadmap2Retire on July 9, 2015 at 9:35 am

    Kyle,
    I fail to see your point on how investing in anything equates to “betting against the overall market”, as you put it?! Investing in anything does not equate to betting against the market. Not by any measure. If we follow your logic and thought process, no one should invest whatsoever – even in index funds – since you dont have insider information anyway. One should have an open mind to invest in new ideas – that is how fortunes are made…but ideas should be approached objectively and both sides of the equation should be evaluated. Exploring an idea and researching the field before investing is not “investing on a sentiment”.

    Btw, advising someone to invest 10% of their portfolio in one idea is bad advise. Each investor is different.

    As for the point of desalination, yes its completely possible. A new technology could be just around the corner that uses less energy and cleaner than current solutions, that could transform the water industry – hopefully an investor looking at this field/idea has taken that into consideration.

    R2R



  4. Ferd on July 9, 2015 at 1:40 pm

    Also, while Evan is most probably right that a change in the food industry is likely to occur due to demographics and all, there is not much way of knowing HOW the changes will occur. The incentive which Kyle talks about could be seen by scientist who will push for in-vitro food which could render the investment in farming land worthless. So do you invest in biotechs or farms? That’s a pretty big difference. It all comes down to people looking for the big score.



  5. Kyle on July 9, 2015 at 4:12 pm

    I don’t know whether to go with Biotech or farmland Ferd, but I do know that Canada (and consequently the TSX 60) will win either way! Just keep buying the index and you’ll be just fine (even if you don’t get “the big score”).



  6. Kyle on July 9, 2015 at 4:55 pm

    I think we’re missing each other here due to misunderstanding certain terminology R2R. I’ll reply in a numbered response here just to make it easier in case anyone else wants to chime in with their thoughts.

    1) Investing in specific stocks or sectors definitely equates to “betting against the overall market.” If you decide to invest in one area or in one company instead of the broad index which that company is a part of, you are in effect saying that you believe that sector or market will outperform the average right? If not, then why would you want to choose a “below average” investment? By picking a specific company or a specific sector you are betting that you know better than the aggregate of the underlying market (aka the benchmark index).

    2) I think you misunderstand my logic to the point I’m not sure you’re aware of what an index fund actually consists of. By definition passive investing/couch potato portfolios/index investing (all different terms for essentially the same thing) cannot possibly be affected by insider knowledge – or any other kind of knowledge. You are basically saying, “I’ll let the sharks sort it all out and decide who can read balance sheets better, and then I’ll just take the average of the benchmark index.” Consequently, it doesn’t matter what you know or don’t know about certain companies or sectors, the performance of your portfolio is simply the average return no matter what.

    3) Investing large parts of your portfolio in new ideas can indeed be how “fortunes are made”, but far more often they are the case of fortunes that are lost. The math is in on this account. Please read our eBook and see the decades of statistical analysis by guys like John Bogle, Eugene Fama and other Nobel Prize winners that show that stock pickers almost NEVER beat passive investors. It is simply very very very hard to pick stocks better than the guys on Wall Street who can move markets by themselves and have incredible advantages over the average investor. This is especially true once you look at all the fees associated with being a stock picker.

    4) Please re-read my comment. I at no point advised Sean to invest 10% of his portfolio in one idea. I said that if he really really felt the need to speculate in the way you are advocating for (because that is what stock picking is – speculating you know more than the average of the other people in the market) I could never advise doing that with more than 10% of his portfolio. This is commonly referred to as the “core and explore” method of building a portfolio and is recommended to people who really feel a need to scratch the itch of speculating in the stock market without crippling their retirement savings like most stock pickers do.

    5) Re: Desalination: Yes that is exactly the point. It’s possible the whole rationale that Sean had for betting hard in the Canadian ag sector could be flipped on its head – just as Rubin’s oil bet was. I’m saying that it’s nearly impossible to predict what incentives and innovation will do going forward, and that it is even more unlikely that you will do this task better than professionals whose only job it is, is to determine what the ag market will do. I do know this much, I’d rather own the TSX 60 index and not worry about desalination one way or the other. If things break the way Sean thinks they will, then great, Canada’s economy will see a serious boost (and so will my portfolio – albeit not as high as if I had speculated more narrowly on the ag sector specifically). If things don’t break that way my portfolio is still diversified and ready to go where the overall market takes it.

    Advocating that amateur investors speculate that they know more than the guys who operate Wall Street and Bay Street is the definition of bad advice. Reading a few news articles that sum up trends that might or might not happen does not constitute doing research. Anything that is actually factual in those articles has long ago been “baked into” the stock prices in Canada’s ag sector.



  7. Roadmap2Retire on July 10, 2015 at 9:42 am

    Thanks for sharing your thoughts, Kyle.

    Reading your comment – I think it boils down to the difference in our philosophies. I belong to the camp where I believe if you dont take any risk, you will not reap any reward. So, each investor will need to evaluate according to his/her risk-reward spectrum and decide what he/she wants to do.

    I understand what index funds are – and also understand what the pitfalls are. Some issues I have with index fund investing:
    1. Index funds are heavily weighted in certain sectors – if you say you want to stick to averages, and pick TSX60 as your fund – you are in essence picking an index that you think will perform better than other indexes. Why are you picking TSX60 index instead of S&P500 index? Just because its home? Canada makes only 4% of the world’s market, and the global exposure is very limited, so in essence you are tying your boat to the Canadian economy.
    2. Somebody is still picking stocks for you in those indexes. Indexes change all the time. Just look at how many changes have gone into DJIA. Most recently – Apple was swapped into the spot for AT&T. So, someone is still stock picking for your index.
    3. Weightage is not balanced – The TSX60 has 32% in Financials, 25% in energy, 18% in Materials…and the rest is dividend amongst the other sectors. That is not a balanced fund by any measure. By picking just the TSX60, you are betting that these three sectors will outperform the rest of the market. We all know that diversification is the best way to cushion your portfolio from major breakdowns as the individual risk is reduced, but all investors have to live with systemic risk.

    All to say, taht simply picking an index fund does not solve all your problems. You still have to pick more than one index to avoid the risks mentioned above. So, simply assuming that your risk is mitigated because you are using an index fund is incorrect. Moreover, which index funds will you pick? There are so many markets, so many indexes – you still need to “pick” something.

    My beef with your earlier comment was the discouragement in researching to invest and advising 10% as speculative portion of portfolio. Evan – may as well be an amateur investor. I dont know him. But discouraging a budding investor from performing the research and making his mistakes and learning from the experience is not the way to make progress…all while being under the impression that your investments are safe just because you picked an index fund.

    cheers
    R2R



  8. Kyle on July 10, 2015 at 9:56 am

    Fair enough R2R, thanks for the detailed input!

    For anyone following the conversation, feel free to download my free eBook that explains in detail what a lot of this stuff means and what my portfolio looks like. R2R is correct, having 100% of your investments in the TSX 60 index would not be a good idea. Feel free to check out what I invest in and the accompanying explanations for just why I decided to do things that way.



  9. SST on July 23, 2015 at 8:04 am

    Article is probably a bit old in the tooth but…

    Also have to disagree with the pessimistic view. There are some public market vehicles which allow for agri investment but the best way would be a private market investment.

    I invested in a private farmland fund — very simple buy-and-hold business plan — which retuned 62% annually on money at risk. The Sharpe ratio of farmland is highly superior to stocks, so on a risk-adjusted basis, the farmland investment crushed stock returns (even though stocks have been in a mighty bull market).

    Liquid Independence over at the Freedom35 blog went a step further and bought actual farmland (as opposed to a fund etc.). Being an owner will always net you more profit than being an investor, and he is reaping the rewards, as you can see here:
    www.freedomthirtyfiveblog.com/2015/…more-15362

    Further more, the CPPIB has started to invest in Canadian and foreign farmland (with YOUR money!). They are a very smart group with a legal mandate to invest conservatively, thus their agri investment could be seen as a sign of quality. They are a huge fund, but it’s not a matter of “outsmarting” them, it’s a matter of going along for the ride. As well, I made my initial farm investment a few years prior to CPPIBs, so it is very plausible for a retail investor to beat the “massive companies” to the punch.

    I would, and do, choose farmland/agri over biotech as the latter will always be subject to a lot of politics and regulations…farmland is subject to one thing: human hunger.

    Intelligent investigative research is never a bad thing, I would highly suggest it before simply, and lazily, buying an index without any initial or further exploration of other opportunities.



  10. Kyle on July 23, 2015 at 10:14 pm

    Agreed that just buying the farmland straight up would be the way to go SST (I really like what LI has done). But the problem is creating enough of a portfolio where even a modest purchase of farmland didn’t dominate any attempt at diversification. I’m interested in learning more about this private farmland fund. What sort of entity is that and how did you access it if you don’t mind me asking? Is it basically a holding company that buys up land and then rents it out?



  11. SST on July 25, 2015 at 12:17 pm

    I did a lot of research and digging post-2008 and came up with a small private limited partnership. Business model was just as you said, buy to rent. It is now defunct as the majority vote was to sell the assets and exit.
    (That’s one of the major downsides to investing in a fund etc. rather than being an outright owner: you don’t control the sale/acquisition process. The other downside being at least one deviation removed from the centre of profit.)

    I recently put some money into the AgCapita farmland fund; I’m not expecting the same stellar returns but it’s more for a dual diversification play — farmland and private equity combined. I’m also ok with sacrificing some returns for not taking on the job of a landlord.

    As for an asset dominating a portfolio, I’d say the majority of investing Canadians already have their portfolio dominated by real estate in the form of their principal residence…and no one seems to have a problem with that.

    In relation to the general feel of the responses to this article, a great quote I read just today: “If you don’t want to work and think, buy a low cost index fund.” — Tren Griffin@25iq



  12. Kyle on July 26, 2015 at 7:54 pm

    It’s too bad the shareholders of your partnership didn’t hang on – ag land has been on a tear the last few years. I wonder if that sort of entity would work in SK as long as the majority shareholder was an SK resident. That would be a very interesting way to gain exposure…

    I agree on people tying up too much of their net worth in their house and feeling more secure on account of that. Personally I don’t advocate for looking at your house in that manner at all, so it doesn’t impact my “investment portfolio”.

    I don’t think your quote gives enough context to index funds at all. There are many many people that work and think very hard and badly underperform a portfolio of basic low cost index funds. Lots of really smart people just weren’t quite as smart as they thought they were, and lost a lot of money in the process of finding that painful lesson out.



  13. SST on July 27, 2015 at 9:00 am

    I believe Sask farmland is open to all Canadian investors for any acrage amount. The thing with Sask farmland is that it is currently in the mid/later stages of catching up with relative price levels of other farmland, so it’s much more of an opportunistic investment than a long-term play. I’d say reaping 62%/yr took advantage of the recent “tear” (including a 6% rental rate), how much longer and higher it will go is anyone’s guess. I still have exposure with AgCapita.

    With CCPIB buying Sask farmland last year for $1050/acre (I think), it kind of sets up a price floor. There might be another triple or quadruple available in the future.

    It’s not just about working hard and/or thinking a lot, it’s about working and thinking on the right stuff. Perhaps all those smart under-performers were diligently focused on the wrong things; it’s easy to get caught up in ones own biases and become blinded to other realities.

    An example, I’m a bit aware of farmland yet totally unaware of biotech. There might be advancements surfacing in that sector which could come to fruition in the next 5 years that could dwarf farmland price increases, but I am poorly positioned to take advantage should those arise; I would need to expand the scope of both my thinking and work to do so.
    (The NASDAQ biotech sector has also been on a tear the last few year — 32%/yr for the last 5 years. I didn’t capture any of that.)

    But if I choose not to, I can always invest in the return of the aggregate indexes (which, as R2R pointed out, has some intelligent hard working people doing the stock picking on your behalf). There are ag indexes available, e.g. MOO, but all have under-performed basic farmland, leading one to think that perhaps ag is a good investment, but ag companies are not.

    Best of luck in whichever ag investments you choose!
    (just don’t choose MOO)



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