Canada Plays China Card

Trade friction and energy leverage has led to an unprecedented Canadian policy of "speak loudly and carry a big piece of lumber" policy towards the United States.

The long-running dispute over American tariffs on Canadian wood escalated to the point last week that the Canadian Prime Minister Paul Martin indirectly linked settlement with continued U.S. access to Canadian energy supplies. Meanwhile, Canadian Natural Resources Minister John McCallum was off to China to meet with Chinese oil, mining and forestry officials.

This is serious business. Part of the 1994 NAFTA free trade agreement ensured that Canada would remain the preferred supplier to the U.S. It may surprise you to learn that Canada supplies 17% of U.S. oil imports, 16% of our natural gas and almost all of our hydropower. The Canadian government owns the majority of the country's energy and Canada exports more than 1.5 million barrels per day to the United States accounts for 8% of U.S. consumption.

China's Lengthening Reach 

Meanwhile, China's aggressive moves in Canada's energy sector are raising eyebrows in Washington. Chinese government has allocated $ 100 billion for overseas acquisitions of oil and gas. The Chinese are going to buy one to invest in Canadian energy companies spree and recently plunked down $ 2 billion a thousand mile pipeline from tar sands in Alberta to the port on the west coast and on to Beijing and Shanghai to build. While the oil reserve numbers for Saudi Arabia are under scrutiny, Canada has recoverable reserves of about 175 million barrels. Much of it is in the oil sands, that profit is processed at an oil price of $ 20 or higher and T. Boone Pickens thinks Canada's oil sands production could reach 6 million barrels per day

There are now about one million ethnic Chinese living in Canada and China is now Canada's second largest trading partner. Last month, Chinese President Hu Jintao visited Canada and stated that the two countries had upgraded their relations to a "strategic partnership".

The U.S. is Waning Grasp 

This Chinese-Canadian power play puts America in real jam. You can write a book about the long dormant conflict timber but a Nafta panel recently ordered the U.S. to return $ 5 billion collected tariffs to Canadian timber companies. Relations with Canada were also weakened earlier this year when Canada announced that it would not contribute to the American-led missile defense program even though 90% of the Canadian population lives within 100 miles of the border between the two countries and the Americans buy 85% of the total Canadian exports.

What's going on? Part of the answer is that the vast majority of Canadians against the policies of the Bush administration. The issue is sensitive in many areas in Canada that are highly dependent on the timber industry and Mr. Martin and his party are preparing for national elections expected early next year. It is always a vote getter to poke a stick in the eye of the elephant to the south.

How to play 

While the Canadian-American relations have seen better days, the energy boom has certainly been beneficial for investors in Canadian markets. The iShares Canada (EWC) follows the MSCI Canada Index which has 40% exposure to Canada's energy and materials sectors. While the S & P index is up only 3%, the Canada iShare is by 16.6% year-to-date and 28.8% over the past twelve months.

Speaking of wood, it is smart to get some exposure wood in your portfolio and I have timber REIT Plum Creek Timber (PCL) were at the core of our portfolio for more than two years. Here's why I like it. First, wood is a great inflation hedge and over the past 100 years has increased by 3% above the average annual inflation rate. Second, wood is not correlated with stocks or bonds and thus is a great "shock absorber" to catch when shares decrease your portfolio. During the 1970 bear market, timber rose in value while stocks fell. Thirdly, from 1973-2000 timber yielded an average annual return of 15%. Last but not least, timber valuations are attractive after several falls mainly in 2000-2002 compared to real estate prices. In 2004, Plum Creek was 23% and this year has traded between $ 34 and $ 39 last week end just over $ 35 with an attractive dividend yield of 4.3%.

It behooves to negotiate a settlement of the dispute, the U.S. ASAP wood and lock up Canadian energy for the Chinese get the jump on us. Investors can not do much about improving Canada-US relations, but they can be improved by adding exposure to wood as well as Canada as both an energy and China play their portfolio.