A forecast for a continued decline in the greenback, outlined in the research booklet Focus 2004: Outperformers and Underperformers for 2004, underpins much of Scotia Capital’s predictions for the global economy.
Scotia Capital expects the U.S. dollar to continue its decline this year against the currencies of America’s major trading partners, including Canada, whose dollar is forecast to end 2004 modestly higher at US80.
The brokerage house believes the lower U.S. dollar, combined with stimulative fiscal and monetary policies south of the border, will support a relatively strong growth rate of 4.4% for the U.S. economy in 2004, with the manufacturing sector leading all others. Canada is expected to lag slightly, with a growth rate of 2.8% in its gross domestic product.
Furthermore, Scotia Capital reckons that inflation pressures will remain muted, with expectations of 1.8% and 1.6% in the U.S. and Canada, respectively.
Andrew Pyle, vice-president and senior financial-markets economist of Scotia Economics, states that while the U.S. is in a position to continue to lead the world in growth over the near term, China has “already taken over the real role of leader in growth, especially in terms of demand for commodities, to the point where that country is starting to show signs of overheating in credit demand, money supply, and inflation.”
Pyle predicts that the pressure on China to adjust its peg to the U.S. dollar will build as the year wears on, until authorities there finally capitulate. He says “such a development could in fact signal an end, perhaps temporary, to the U.S. dollar’s plight, which would be good news for Canada — the country that is now paying the heaviest price for the past and current U.S. growth.”
In the meantime, Scotia Capital points to three major beneficiaries of a weakening U.S. dollar: commodities, gold, and U.S. multinationals.
Commodity prices are generally driven by global industrial production, and Scotia Captial notes that prices have historically risen about 20% in the two years following a steep and stable yield curve — though this increase could be even greater over the next two years if the U.S. dollar is extremely weak, as was the case in 1971-1974 and 1986-1989.
“Copper is the metal best able to predict the rebound in global industrial production, as copper prices always increase once the U.S. yield curve becomes steep and stable,” states Scotia Capital, “and copper is also usually the leader.”
As well, zinc, copper, nickel, gold, and aluminum all show average increases of at least 70% during the 3.5-year period following a steep and stable yield curve, and more than 50% if statistical outliers are excluded.
Noting that there has already been a “huge stealth rally” in nickel (up 140% during the last 11 months), Scotia Capital sees more upside for zinc, copper, aluminum and gold producers, as these metals could still rise at least another 30% over the next 2.5 years based on past economic cycles.
Scotia Capital’s base metals analysts, John Redstone and John Hughes, believe that, in most cases, Western World metal demand should outstrip supply at an accelerating rate through 2004 and into 2005. For 2005, they forecast average prices of US$1.15 per lb. for copper, US75 per lb. for aluminum, and US50 per lb. zinc. On the downside, they forecast nickel sinking to an average of US$4.50 per lb. in 2005.
With respect to the stock prices of metal producers, Redstone and Hughes caution that the current levels of several of their covered stocks fully reflect their potential rise in earnings.
Of the large companies they follow, the analysts see stocks of aluminum producers (
Their two tops picks of the bunch are Alcan and Teck Cominco:
— For Alcan, they have a 1-year target of US$55.44 per share, which has been calculated by applying a 14-times multiple to forecast earnings for 2005. They describe the acquisition of Pechiney as an “excellent move by Alcan” that will allow for at least US$250 million worth of synergies in the next three years.
— The analysts love how Teck Cominco’s assets provide exposure to rises in zinc, copper, coal, and gold prices, and predict that “given that all of Teck Cominco’s commodities are strengthening simultaneously, the company will outperform the remainder of our coverage universe in 2004.” Their 1-year target price is $23.80 per share.
They stress that Teck’s earnings are highly sensitive to changes in the zinc price, and for every US1-per-lb. increase, they estimate earnings will jump by C7 per share.
They add that management succession remains a relevant topic, as deputy chairman and CEO David Thompson may retire at the end of 2004.
This year’s Focus edition is a major departure for Scotia Capital in that, for each sector, its analysts also select and dissect a top under-performer. James McLeod, managing director and head of equity research, says this change recognizes that Scotia Capital’s clients are “interested in a broader perspective than just our best long ideas.” The unstated message, of course, is that Scotia Capital is taking another step in rehabilitating the reputation of its analysts in the wake of the ethics scandals on Wall and Bay streets over the past few years.
For their top under-performer, Redstone and Hughes put nickel miner
“On balance, we believe the shares of Falconbridge are fully valued at present,” they state, emphasizing that the price of its principal commodity, nickel, will stabilize at US$4.50 per lb. in 2005, since current nickel prices are beginning to encourage significant substitution.
Right now, roughly 75% of the stainless steel being produced contains nickel, and every one-point drop will cause nickel consumption to fall by roughly 16,000 tonnes per year, compared with Western World consumption of 1.15 million tonnes per year.
The analysts expect that incremental nickel production at existing facilities worldwide will narrow the gap between supply and demand in the nickel market over the next two years.
They say that while Falconbridge should bring incremental production on stream through 2005 (for example, the 8,000 tonne-per-year Montcalm mine in Sudbury is due to open this year), any major new mine project for the company is several years away.
— Next week: Scotia Capital’s views on the gold market, and gold analyst David Mallalieu’s picks for 2004’s top out- and under-performers.
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