Falling oil, gold prices hit Canadian economy hard

Different dynamics at play behind drop in oil and gold prices

There’s no way to sugarcoat it: tanking oil and gold prices – two key commodities for the Canadian economy – are bad news times two, according to analysts.

Crude oil prices are at a three-year low, gold at a 4.5-year low (but for very different reasons). The resource-heavy Toronto stock market and TSX Venture exchanges are being pulled down as a result, and the Canadian dollar last week fell below US$0.88.

Crude oil prices spiked briefly to US$106 per barrel in June, after the Islamic State invaded Iraq, but fell below US$80 last week.

That might be good for consumers, who will pay less for gas at the pumps, but low commodity prices are generally bad for a resource-dependent economy, analysts say, although a low Canadian dollar could help offset those low prices for exporters.

“Canada is a very oil-dominant economy, with 25% of our net exports of all commodities from Canada being crude oil and refined petroleum products,” said Scotiabank commodities market specialist Patricia Mohr.

“So a small decline in prices is a net benefit, but if the price goes down significantly, I would say the Canadian economy is disadvantaged.”

She added that the low prices are unlikely to delay plans to build new pipelines from Alberta to B.C.

Oil prices have been dropping due to lower demand from a weak global economy and new sources of shale oil in the U.S., which might normally be offset by Saudi Arabia cutting production – something it has not done. Analysts believe the Saudis’ strategy is to keep oil prices so low that it will stall the U.S. shale oil boom.

Peter Tertzakian, chief energy economist with ARC Financial, recently wrote that Alberta oilsands producers are “battle-hardened” to withstand low oil prices.

They have sold oil for as low as US$70 per barrel while other producers were netting US$120 per barrel, he writes – this at a time when the Canadian dollar was strong (a negative for exports). According to Tertzakian, Canadian oil production grew in both the oilsands and light oil patch, despite the price discounts and stronger loonie.

“As a consequence of adapting to local circumstances, our oil output is likely on track to grow by another million barrels a day by 2020, regardless of this recent price drop,” he wrote.

One bit of good news for Canada was last week’s sweep of Congress by Republicans in the U.S., who are likely to approve the Keystone XL pipeline, which would give Alberta producers increased access to American refineries.

While Canada as a whole is affected by oil prices, B.C. is more directly affected by dropping gold prices because so many mining companies are headquartered here, and even non-gold producers are suffering from gold’s drag on mining stocks.

Mining in general has been in a bear market, the likes of which has not been seen for years, and the recent drop in gold prices – from an all-time high of US$1,920 per ounce in September 2011 to US$1,143.76 November 5 – adds weight to sinking mining stocks.

“Vancouver is one of the three or four worldwide hubs for mining finance, and in my 25-year career, this is by far the worst capital market that I’ve seen for junior exploration companies,” said Rob McLeod, CEO of IDM Mining Ltd. (TSX:IDM), which is proceeding with plans to develop a new underground gold mine project near Stewart, despite the current gold prices.

He said the break-even point for many operating gold mines is US$1,180 per ounce.

“As gold has broken down below it, you’re probably going to see some gold mines close around the world.”

Because IDM’s Red Mountain project is a high-grade deposit with low capital costs ($76 million), McLeod said the project can still be built at current prices.

“If gold dipped below US$1,000 per ounce, that’s probably when we’d have to put the development aspect on the shelf,” McLeod said.

Gold’s slide is largely a currency issue, analysts say. Gold is traded in U.S. dollars – both of which are safe-haven investments – and when the dollar is weak, gold is strong.

Quantitative easing in the U.S. devalued the greenback and increased gold’s value. But the U.S. plans to end that Federal Reserve economic stimulation policy this month, which will bolster the greenback’s value and lower gold’s.

The TSX Venture Exchange (TSX-V) is an accurate gauge of how the mining sector is doing, said mining analyst Mickey Fulp, who publishes the MercenaryGeologist.com. The S&P/TSX Venture index fell below 750 on November 5.

“That is approaching the all-time low for the Toronto venture exchange, which was set late in 2008 during the global economic crisis.”

Fulp added that 80% to 90% of the juniors on the TSX-V are companies with poor projects or management – “companies that are doomed to failure.”

He fears a continued drop in gold prices could hurt even the better companies, because they would be either operating at a loss or be unable to raise capital for new mining projects.

“The good companies have not exactly prospered, but they have maintained, and they have been able to raise money for good projects,” he said. “The fear that I have now is that will change and the baby will get thrown out with the bath water.”