Steve Palmer: change up your portfolio’s sector weightings to capture profits

Steve Palmer: Continued economic growth in China is considered to be one if the largest factors that can positively impact the mining sector in particular and resource commodity prices in general. Recent economic data points to an increase in Chinese growth in 2014. And strong growth in the European and North American economies is expected for 2014. Simply put, periods of accelerating global growth create higher demand for commodities, so commodity prices typically do well during a boom and this translates into higher expectations for stock prices. Industrial growth, of course, increases the demand for energy resources, in general, as does the increase in popular consumerism brought about by new wealth created by industrial growth. Oil and gas remain very good bets.

Resource commodities are looking stronger day by day. In recent weeks, the energy sub-index in the Toronto Stock Exchange (TSX) has broken out of its two-year trading range. {See chart below.] The TSX Composite index has broken out of its previous range. The major U.S. indices are hitting new highs. Canadian indices weighted toward resources have lagged over the last two years, but now they are starting to outperform. Typically, in a market cycle, resource stocks outperform during the second half of a bull market cycle, and that is what we should start to see.

TSX Energy Index One-Month Chart

TMR: Your AlphaNorth Partners Fund currently has about 3% of its funds in precious metals, 15% in metals, 11% in energy, 15% in life sciences and the bulk, 56%, in technology. How did you arrive at these weightings?

SP: These weightings are not set by top-down analysis. We do a lot of bottom-up work, and the relative weights are also a function of the opportunities presented to us from a risk-reward point of view. We do not totally disregard sector weightings, but we invest within a wide band in that regard. The AlphaNorth Partners Fund strives for a diversified portfolio in resources and technology and life science companies. The goal is to reduce the volatility and enhance returns over the long term. In 2011, for example, we reduced the weight in resources because the risk-reward at that time favored non-resource investments.

We have always had exposure to both technology and resource stocks, but we did increase our weight in technology names in lieu of resource names. Right now, our portfolio is skewed toward the non-resource names by 70%. Non-resource names, it must be said, are working out much better than the junior resource companies in the portfolio, year-to-date.

TMR: Why are the junior resource companies lagging the techs?

SP: Investor sentiment is still quite negative on junior resources. Gold has not been doing well this year. Retail investors are doing well with the big blue chip U.S. companies, which keep hitting new highs, and also with fixed income products. Investors have also turned to technology and life science companies, which have performed well in 2013. We think those areas and U.S. large caps will start to underperform going forward.

TMR: What is the outlook for uranium?

SP: Uranium should trend higher over the long term because, inevitably, Japan will have to restart its nuclear program. It is costing Japanese industry tens of millions of dollars a day to burn natural gas in lieu of using energy generated by nuclear reactors. In addition, a couple of new reactors will be built in the United Kingdom. And the Chinese government has aggressive plans to expand its nuclear program. Uranium is not nearly as volatile or as liquid a market as natural gas or oil. Investors are waiting for a catalyst before moving back into uranium stocks in a meaningful way, and, unfortunately, there is not much in the way of good news at the moment. Uranium needs either a strong price uptick or clear evidence that China or Japan is strongly committed to supporting the resurgence of nuclear energy before potential investors start buying.

TMR: What is the current outlook for graphite mining?

SP: A few graphite companies are doing extremely well in the market. Zenyatta Ventures Ltd. (ZEN: TSX.V) is the star performer. Its stock recently rocketed from $0.25 to $5. Zenyatta has discovered a unique graphite deposit in Ontario. It can refine the material to very high purity at very low cost. And it is now drilling to define the size of the resource. A preliminary economic assessment should be released within a few months.

TMR: What do you look for in a graphite mining firm?

SP: The size of a firm’s deposits is not the main element that makes any mining operation economic. There are a lot of deposits around the world, but many of them are not economic. Grade is the big factor, alongside the direction of the underlying commodity price. For instance, there is a graphite company calledCanada Carbon Inc. (CCB:TSX.V), located near Montreal. Its location is near infrastructure, the deposit is very high grade and the company has demonstrated that it can refine very pure graphite that it can potentially sell at a large premium. Because the mine is close to the surface and adjacent to infrastructure, it could prove to be a highly profitable venture.

Mason Graphite Inc. (LLG:TSX.V) has a good project in Quebec. Mason is run by a very experienced team that has been getting good drill results. It will release a new resource update shortly that should significantly increase the size of the resource.

TMR: What about alternative fuels, specifically solar, which is taking off right now?

SP: Solar makes more and more sense. In the early days of solar, it needed to be heavily subsidized to compete with other forms of energy, but technological advances have really brought down the cost. The price of oil is shooting up, while the cost of producing solar is declining. Solar energy is now very competitive with fossil fuel-based energy.

TMR: Can U.S. energy independence lead to a thriving gas exploration bull market?

SP: I doubt that there is really such a thing as U.S. energy independence in the near term. New technologies like horizontal drilling have boosted production significantly in North America, but, conversely, the traditional drilling sector there is tapping out. Typically, the fracked wells are experiencing high decline rates. The oil sands are the major source of new production for the future.

TMR: Are the oil sands going to give out at some point, too?

SP: There is a lot of reserve in the oil sands, but tapping them economically requires high price levels. I am not saying that we need significantly higher price levels than we have today, but the breakeven point for the oil sands is creeping higher. We need additional pipeline capacity. Clearly, the U.S. is not going to achieve energy independence if there aren’t enough pipelines to transport the oil.

TMR: What juniors do you like in oil and gas?

SP: I am not focusing on the domestic producers right now because most do not have significant upside. I look for companies with more growth potential, such as Mart Resources Inc. (MMT:TSX.V) in Nigeria. Mart is getting very significant results at the wellhead. Its stock is currently depressed, because it reached its pipeline capacity. But in 2014, the company plans to access a new pipeline constructed byRoyal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE).

TMR: Are there any other oil and gas juniors that you like?

SP: There are a couple of Canadian firms that we do like. Pinecrest Energy Inc. (PRY:TSX.V) has not moved as much as some of the other domestic names. It has a huge amount of tax pools that shelter it from paying any taxes during the foreseeable future. These tax pools could be a very valuable asset to the company that acquires Pinecrest. In the last few weeks, over 5 million shares have been purchased by Pinecrest insiders, which is always a sign of good things to come. Stay tuned.

TMR: Where is Pinecrest located?

SP: Its production is in Western Canada, which is, as I said, a mature basin. In order to ramp up production in a mature basin, a firm needs to innovate with new technology. Horizontal drilling and fracking technologies have allowed production to be sustained at reasonable levels. But in a mature basin where you have hundreds of companies punching thousands of wells every year, the marginal cost of production keeps rising.

TMR: Your private investment firm, AlphaNorth, has posted some remarkable annual returns and some not-so-remarkable annual returns since its inception in 2007. To what do you attribute this volatility?

SP: Investing in small caps and, particularly, investing in the junior resource asset space is a highly volatile practice by definition. But over the longer term, small-cap equities are the best-performing asset class. Our return for the AlphaNorth Partners Fund since inception is over 130%, and the TSX Venture has declined by 65% during that period of time. We tell our investors that the monthly returns may be volatile, but if you have a longer-term time horizon, as in five years or more, the returns should continue to be very strong.

The bulk of the Partners Fund’s return emanates from long-term investments, not from shorting stocks. Obviously, going long, a stock can go up 10 or 20 times from the purchase price. But with shorting, an investor can only make a maximum profit of 100%, while risking an unlimited loss. The risk-reward ratio for shorting is often not favorable. However, we do short company-specific names from time to time and we use exchange-traded funds to get short exposure when the market is overvalued or we believe it is due for a technical correction. During the past year, we have shorted minimally, because the risk-reward has been highly skewed to the upside, in our opinion.

TMR: It is good talking to you again, Steve.

SP: My pleasure.

Steve Palmer is a founding Partner, president and chief investment officer of AlphaNorth Asset Management and currently manages the AlphaNorth Partners Fund, AlphaNorth Growth Fund and the AlphaNorth Resource Fund. Prior to founding AlphaNorth in 2007, Palmer was employed as vice president at one of the world’s largest financial institutions, where he managed equity assets of approximately CA$350M. Palmer managed a pooled fund, which focused on Canadian small-capitalization companies, from its inception to August 2007, achieving returns that were ranked No. 1 in performance by a major fund ranking service in its small-cap, pooled-fund category. He also managed a large-cap fund, which ranked in the first quartile of performance among other Canadian equity pooled funds. Palmer earned a bachelor’s degree in economics from the University of Western Ontario and is a Chartered Financial Analyst.

Want to read more Mining Report interviews like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit The Mining Report.

Source: Peter Byrne of The Mining Report  

DISCLOSURE: 

1) Peter Byrne conducted this interview for The Mining Report and provides services to The Mining Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Mining Report: Mason Graphite Inc. and Mart Resources Inc. and Royal Dutch Shell Plc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Steve Palmer: I or my family may own shares of the companies mentioned in this interview. I personally am or my family is paid by the following companies mentioned in this interview: None. Funds managed by AlphaNorth may hold positions in the companies mentioned in this interview: Mart Resources Inc., Pinecrest Energy Inc., Zenyatta Ventures Ltd. and Mason Graphite Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

Streetwise – The Energy Report is Copyright © 2013 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.

Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.