The recent action in JDS Uniphase reveals market distortions by the S&P 500, our contrarians say.

Benj Gallander and Ben Stadelmann
Saturday, March 18, 2000

While Alan Greenspan and Gordon Thiessen believe they are seeing the big picture, our bet is that a couple of years down the road, their persistent focus on inflation will be regarded as The Big Oops.

Remember 1989’s promised soft landing before the economy cratered? There is no need to raise interest rates as the dramatic escalation of oil prices will soon begin to throttle business activity.

Why isn’t inflation a threat? First, the oil price increase means that the average North American consumer will retarget more than $600 worth of spending a year on energy rather than other goods and services. Funds that might be available for that new TV or sofa are being pumped into the gas tank, which has a contractionary impact in the overall economy.

A large percentage of this money also leaves North America exacerbating this effect. Meanwhile the internet will lower costs by eliminating middlemen, lowering distribution costs and the necessity to pay rent for retail outlets. The ease with which consumers can comparison shop will make it more difficult for companies to raise prices.

The scenario of interest rate increases could have been avoided if government was visionary rather than reactionary. When oil prices careened to near $10 (US) a barrel, the time was optimal for governments to raise taxes on this commodity.

This increase would have discouraged the flagrant growth in energy consumption, epitomized by the SUV (sport-utility vehicle) generation. Additonally, money raised could have been utilized to reduce government debt, or for social and health programs. The public would hardly have felt the pinch of these taxes, as prices at the pump and in the home would still have been under the historical norm.

And now, with oil prices having skyrocketed, the tax increase could be rolled back, giving consumers and businesses a break on current prices. The whip-saw of oil prices hurts almost everyone in the long run, whereas stable prices would help ensure a healthier, less schizophrenic economy.

Higher oil prices are bringing relief to the oil patch and creating some buying opportunities. One of our favourites is Gulf Canada Resources, which is trading in the $5 (CDN) range. Under the stewardship of chief executive officer and president Richard Auchinkeck, Gulf has been moving from a debt-laden behemoth to a fiscally responsible corporation.

Mr. Auchinkeck’s background in accounting undoubtedly aided him in recognizing that Gulf’s financial position was spiralling out of control. Debt, which reached almost $2.7 billion in 1997, has been cut by about one-third. Operating costs fell 10 percent to $5.79 a barrel of oil equivalency on a year-to-year basis in the last quarter of 1999, with administration costs slashed 41 percent.

While the company lost $24 million in the fourth quarter, this was down from $116 million last year. At prices above $20 (US) a barrel, Gulf should start to put up some mighty respectable numbers. We purchased this firm way back in 1994 at $3.95 (CDN) and foolishly did not jettison it when our sell target of $13.50 was reached in 1997. Next time, we’ll be wiser.

A much smaller player on the scene is Kelman Technologies. Specializing in seismic processing and archiving data, this firm prospers when oil firms are busy exploring. Many petroleum companies have been reticent to expand their prospecting activities, questioning whether the oil price increase is sustainable.

But players in the patch are rapidly becoming believers and record industry cash flow means they have money to spend. Until its spending ramps up, Kelman can make money from its archiving division, which grew by 48 percent last year. A December deal with Apache Canada should add another 25 percent growth in revenue this year.

During the lean times, a primary reason Kelman suffered losses is that it chose to retain staff. Ultimately, this in-house experience will prove very beneficial. With more than $30 million in tax losses, the firm will recognize additional benefits, as turning this duck positive means more dollars will stay in the kitty, instead of being destined for government coffers.

A recent Contra purchase at 40 cents, our target price is $1.60. Given that the company traded at $3.25 in 1997, this goal seems amply reasonable. Kellman was trading at 54 cents this week.

For the vast majority of stocks to be successful in the next couple of years, it’s necessary for Mr. Greenspan and Mr. Thiessen to take their foot off the gas on interest rate increases. Fortunately, with a US election on the horizon, it behooves the powers not to raise them too far. In all likelihood, rates will be scaled back during the second half of the year.