Cash is the only way to completely avoid a down market. But you can dodge most of the pain—even in a specific sector—by avoiding the real landmines. And when things inevitably do turn, you’ll be very much in the game for the big gains to follow.

As the December issue shows, we’ve done that for the most part in the Canadian Edge portfolios. Most of our holdings have taken on some water, particularly in the wicked November selloff. But most also continue to post strong, growing, sustainable cash flows and even dividend growth.

High yields such as these trusts offer are to this decade what high tech was to the 1990s. Tech’s torrid rally was interrupted with a terrific fall during the credit crunch of 1998.

This year, we’ve seen high yielders across the board follow the same pattern. High tech recovered sharply in 1999 when investors lost their fear and returned their focus to making money. So should high yield in 2008, when a bottom for the US economy comes into focus.

Stress tested by well more than a year of difficult market conditions, our favorite Canadian income trusts should enjoy more than their fair share of gains. Coupled with high, growing yields, that should make for some very stunning total returns for those who hang on.

I have, however, hit two major landmines during the current trust stress test: natural gas and Boralex Power Income Fund (BPT.UN, BLXJF). I discussed both at length in the December issue. Here’s more on what I think of them now.

Let’s start with gas. The fuel’s inability to break out of a now two-year slump has hurt both gas-weighted producers and drillers. So it’s no surprise that Paramount Energy Trust (PMT.UN, PMGYF), recently sold Precision Drilling and Trinidad Energy Services Income Trust (TDG.UN, TDGNF) have taken whacks this year.

The good news for all three is they remain solid as businesses, despite some of the worst macro conditions any sector has ever had to face. In fact, because of a strategy that focuses on long-term contracts in the US deep drilling market, Trinidad’s cash flows have scarcely been dented.

Paramount is more exposed. But management’s recent release indicates it should be able to maintain a very sustainable 50 to 60 percent payout ratio, barring a dramatic further drop in gas prices from here. And with little debt, a commanding market share in Canada and expansion in the US, Precision’s cash flows should start to recover in 2008, even if gas stays relatively flat.

None of these trusts’ unit prices are likely to rally until investors can really see a bottom for the US economy, and there may be further downside in the meantime. But all three appear to be hunkered down to survive the turmoil that could result from a US recession. And once things do turn, they’re in great shape to recover their losses of the past year in short order.

As I pointed out in the December issue of Canadian Edge, now’s a good time to take a tax loss in Precision. But unless something really negative happens to fourth quarter results, I’ll likely add it back early next year as a recovery play. Meanwhile, I’m sticking with Paramount and Trinidad. Note the trio is only suitable for aggressive investors.

I’m equally convinced the recent crash in Boralex is also temporary. The power generation trust’s troubles began about a month ago, when it released third quarter earnings that reflected a sharp drop in water flows to its hydroelectric power plants. That stirred fears that a distribution cut is unavoidable at the same time worries about a US recession began to crest again.

The result has been a dramatic drop in the shares from the USD9-to-USD10-per-share range to less than USD6. The last part of the drop has been an especially disheartening slow drip, with every attempt to rally the shares met by relentless selling.

Again, this isn’t surprising. Investments perceived to have weakening fundamentals are always especially bashed during down markets. The key question is whether or not Boralex Power Income Fund is solid underneath. If it is, perceptions will inevitably change and we’re going to see the mother of all recoveries in the shares. If not, it could add a lot more to the losses we’ve already seen.

As the sudden collapse of Enron proved in 2001, the numbers you see don’t always tell the full story. Based on its official figures, Enron looked solid all the way to the bottom. In fact, it was rated investment grade by Moody’s and Standard & Poor the day before it filed Chapter 11, and only a handful of analysts advised selling before then as well.

I, for one, rode the stock all the way down the 20s before I concluded—incidentally, not based on any numbers—that I didn’t understand the situation. And by the time my sell recommendation reached readers of my advisory Utility Forecaster, it was already in the low teens.

The numbers, however, are all we have on which to base a rational decision. Obviously, it would have been better to unload Boralex last year, when it traded in the USD9 to USD10 range, or even a month or so ago. But it’s still in the Canadian Edge Portfolio. And my task now is to decide whether it should stay there and whether readers should continue to own it.

It’s fundamental that a trust’s cash flows must cover its distributions over time, or else a payout reduction is inevitable. And over the past year or so, we’ve seen scores of trusts forced to cut distributions, for reasons ranging from falling natural gas prices to an inability to raise capital to just running bad businesses.

None of those three reasons apply to Boralex Power Income Fund. The trust’s hydroelectric generators, cogeneration facility and biomass plant don’t depend on energy prices to make a profit. Rather, output is sold to creditworthy utilities and government entities under long-term contracts, most of which have a price escalator built in and little or no exposure to changing fuel costs.

Power generation is a proven business for successfully operating an income trust. In fact, another CE Portfolio trust Macquarie Power & Infrastructure Income Fund (MPT.UN, MCQPF) announced a modest 2 percent dividend increase this week. That was despite a third quarter payout ratio of 143 percent, and it demonstrates management’s confidence that the shortfall was seasonal and will be reversed in the current quarter and into 2008.

As for capital, Boralex Power Income Fund isn’t on its own. Rather, it’s a royalty stream drawn from a collection of cash-generating power plants owned by much larger Boralex. The parent owns 23 percent of the income fund’s shares—which provide a significant chunk of its overall income—and also manages the plants.

The income fund was formed by Boralex in February 2002 to hold five Quebec hydro stations, two US hydro stations, two Quebec biomass plants and the only natural gas-fired cogeneration station in Quebec. Since then, it’s routinely covered the distribution with cash flow, although the payout has basically been flat for the past couple years.

In 2006, there was a brief shortfall when hydro flows to the trust’s river-based plants temporarily sank. The income fund’s shares crashed from the USD9-to-USD10-per-share range to as low as USD7 before swiftly recovering as the rivers rose again.

That time around, of course, there was no accompanying recession threat from the US as there is now. But given that its plants sell output under long-term contracts to strong counterparties, it’s hard to see their vulnerability even if the economy here weakens dramatically, particularly given the recent strength in New England power prices.

As for the parent company itself, it’s coming off one of the stronger third quarters in memory. Despite weak hydro flows—not just to the income fund’s plants—revenue rose 29 percent and cash flow surged 8.2 percent. The biomass division thrived with a 43 percent jump in revenue, and the company was also able to sell renewable energy certificates in Connecticut at improved prices. Earnings per share more than doubled from year-earlier levels.

The bottom line: This company runs Boralex Power Income Fund, and it’s quite healthy. That point was further underscored by its recent purchase of a 50 percent stake in a Spanish company developing solar power systems.

As shareholders of Enron found out—many the hard way—that company’s management was running things to benefit themselves and not shareholders. That’s extremely unlikely in the case of Boralex, however.

First of all, Boralex has a vested interest in capturing the maximum in distributions from Boralex Power Income Fund, simply because they represent a significant amount of its overall earnings. In addition, the income fund has an independent board of trustees, a majority of which aren’t connected to the parent.

Finally, the assets here are quite straightforward, i.e., power plants, which gives me a great deal of confidence in the solid credit ratings awarded the income fund by both the Dominion Bond Ratings Service and S&P.

If water flows remain weak and the income fund suffers another soft quarter, it’s entirely possible the parent’s management will elect to chop the distribution a notch. There’s also an ongoing dispute regarding management of one of the biomass plants, though even a worst-case outcome here wouldn’t affect cash flow enough the threaten distributions on its own.

Arguably, however, the shares are already more than pricing in all this risk and a great deal more–namely a cut as large as 33 percent versus a far more likely reduction of 15 to 20 percent that would more than bring things back into balance even if water flows remain low. And the Canadian analysts that have published bearish opinions on the income fund have target prices in the CAD8-to-CAD9-per-share range.

That leaves us with two choices: Either something’s going on here that doesn’t meet the eye, or Boralex Power Income Fund is a solid bargain at these prices, with potential for massive upside in the next six months.

Based on the numbers, I’m still going with the latter but with a caveat: Boralex Power Income Fund is only a buy for those who can tolerate some downside risk if I’m wrong.

And above all, don’t double down on Boralex Power Income Fund, or any other loser, in a down market. Not only would you be exposing your portfolio to greater danger, but odds are increasing your position is only going to make you more emotionally invested.

In other words, if you already own Boralex Power Income Fund, keep what you have but don’t buy more. If this works out half as well as I still think it will, you’ll make plenty from here. And if it doesn’t, you won’t have blown out your portfolio on one of the real blowups in this trial by fire for Canadian income trusts.

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