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April flowers, May showers and growing resource stocks

Even though it may rain on the markets in May, this Canadian small-cap advisory says, you can look for some small stocks to grow.

April is the cruellest month of all, a poet said. But this year it was reasonably compassionate. In this part of the country, the last part of April felt like summer. And the stock market emerged from a dreary winter with a bit of a bullish run.

But there may be some cruelty ahead, say the editors of KeyStone’s Small-Cap Stock Report. “Father Market,” they say poetically, “delivered a rather flowery April, which could set the table for a showery May.”

But that downpour won’t drown all stocks, says this advisory, especially energy and resource companies. It recommends three investments in the resource area that it thinks will weather any downturn. One is an un-sexy agricultural income fund, another is literally explosive, and the other is digging in China.

But why are April and May reversing their usual roles?

The other side of the coin

“April was decidedly a positive month for Canadian markets,” says the advisory. Surging crude oil, solid metal prices and recovering financial stocks led the way.
What went up doesn’t necessarily have to come down but, in time-honoured fashion, we have to look to the south to see what may be in store for us.

The U.S. Federal Reserve Board has now made seven straight cuts in the federal funds rate since September, so that it is now down to a very thin 2 per cent. “There were signs the Fed may believe it has done enough to prevent a deep recession,” says the advisory.

But the other side of that coin is inflation. “Surging crude and food commodity prices have consumers worried about inflation as the price at the pump and weekly grocery bills are taking a significant bite out of disposable income.”

Consumer spending accounts for two-thirds of the U.S. economy these days, and the U.S. Conference Board recently announced that consumer confidence had fallen for the fourth month in a row.

“Broadly speaking,” says the advisory, “North American markets have been deceptively calm in recent weeks given the weakness of the economy and how consumers are struggling not only with a slumping housing and job market but also high prices.”

First-quarter confessionals

Four months into the year, investors appear to have bought into the notion that the Fed has staved off a wider calamity, “when in fact what they’ve done is allow the financial system to stay afloat as they work down and write off a tremendous amount of bad debt.”

Cutting the key rate time after time hasn’t really done the job. It has not trickled down to consumers’ borrowing rates — but it has kicked the U.S. dollar and sparked commodity runs. “It has translated to spikes in food and energy costs for the public at exactly the wrong time,” adds the advisory.

The advisory’s editors believe the U.S. economy is currently in a recession, and with the S&P/TSX Composite Index close to 500 points off its all-time high, their outlook on the Canadian market is neutral at best.

“First quarter confessionals are right around the corner,” adds the advisory, “and we will be watching with great interest for signs of weakness.”

In fact, corporate results are liable to be fairly sturdy for now, since most observers feel that the weak U.S. economy won’t really sideswipe Canadian results for another three to six months. In the shorter term, expect energy and commodity companies to be buoyant, while financial stocks will deliver some bad news.

Three small firms, the advisory believes, will ultimately deliver good news.

The Green Hornet

KeyStone’s Small-Cap Stock Report believes in finding the right sectors, then digging for the stocks with the best prospects. Food and agriculture is one of their favourite areas right now. And they have a company they like even though it isn’t “the sexiest story on the street.”

Alliance Grain Traders’ Income Fund (TSX-AGT.UN) has been in the advisory’s sights for the better part of a year, and they have upgraded it to a buy. Alliance is in the business of sourcing and processing — cleaning, splitting, sorting and bagging — specialty crops, mostly for export markets. Alliance handles the full range of pulses (edible seed legumes like peas, chickpeas, beans and lentils) through six processing plants.

An increasing world population is driving up growth in the world grain market. Also, the conversion of traditional protein crops like corn, wheat and soy to biofuels (“an ill-advised venture” in the advisory’s opinion) is playing into Alliance’s hands. The developing world is consuming more pulses as the traditional crops are priced out of the diets of subsistence consumers. “Enter the lentil or the ‘Green Hornet’ on the protein scene,” says the advisory.

It has been following this income fund since it traded at about $6.71 last year. It closed Friday at $11.56.

Then there’s a stock that actually straddles resources and another business the advisory likes very much — the rebuilding of the nation’s infrastructure. Nordex Explosives Ltd. (TSX-NXX) makes explosives for the mining, quarry and road construction industries. It posted strong results for 2007, the sixth year in a row its revenues have risen. It’s small and not very liquid, but the stock is starting to move. Trading at $0.65 when this report was issued last week, it is now at $0.75.

With offices in Toronto and Hong Kong and 10 kilometres of nickel and copper ore operations in northwestern China, GobiMin Inc. (TSX-GMN) was originally recommended by the advisory last September at $2.70 after “an unwarranted selloff” of the shares. They took short-term profits in October when the stocks shot up to $3.81.

Coming off a year in which its revenues rose by 98 per cent, the company is completing a thorough upgrade of its mining operations. Hold the stock for now, says the advisory, or buy on weakness. It entered the weekend at $2.81.

If May showers do come to the market, this advisory doesn’t believe the market will be totally swamped. You can still find sunshine with some small caps that have a long growing season ahead of them.