Stelco Holdings Inc STZHF

TD

[retiredcf]

Canadian Small Cap Model Portfolio Materials

We are removing our position in Ero Copper Corp. (ERO-T, portfolio weight 4.8%) from our small-cap model portfolio. As our only copper-producer holding, our copper portfolio weighting drops to 0%. Although we believe in the long-term upside, we are seeing too many negative signals that could pressure copper prices and, in turn, copper equities, over the near term.

An early catalyst for our initial position in Ero Copper last summer was the rise in the China 10-year bond yield. It was our view that a rising China 10-year bond yield indicated an improving Chinese economy, which would support higher copper prices. Although copper prices have nearly doubled since last year's Q1 low, the China 10-year bond yield has stalled (Exhibit 1). We believe this could be an indication of a slowing Chinese economy. This is further confirmed by the decline in the China Citigroup Economic Surprise Index below 0 (Exhibit 2). We are already seeing weakness in the materials sector in China, as tracked by the Global X MSCI China Materials ETF (CHIM-US), which has declined close to 20% from its mid-February high. The recent weakness in the Australian dollar (Exhibit 4) and the sharp rise in LME and China copper inventories (Exhibit 5) are not positive indicators of higher copper prices, in our view. Finally, the speculative net long position in copper, which had been at all-time highs, has fallen dramatically over the past two weeks (Exhibit 6). Canadian copper stocks have come under pressure during previous declines in the speculative net long position.

At present, we prefer steel to copper and hold a large overweight position in Stelco Holdings Inc. (STLC-T, small-cap portfolio weight 6.2%). Stelco continues to be supported by and is highly correlated to Hot Rolled Coil (HRC) steel pricing (Exhibit 7). Global steel stocks have also performed well since last year's COVID-19-low and momentum remains strong, with the VanEck Vectors Steel ETF (SLX-US) up close to 25% year-to-date. We believe that the relative strength in steel versus copper could also lead Stelco higher relative to Ero Copper. (Exhibit 8). However, we are not adding to our steel exposure, given our relatively high weight in Stelco.

Following the removal of Ero Copper, our small-cap model portfolio materials weighting declines to 12.4% versus 24.9% for the S&P/TSX Small Cap Index. However, this underweight is the result of our low portfolio exposure to the gold, silver, and precious metals & minerals sub-sectors through portfolio holding MAG SIlver Corp. (MAG-T, portfolio weight 1.5%) versus the index combined weighting of 15.2%. We would look to return to copper if we see a combination of the above indicators turn positive again.