Buy potash and sell gold

Date: Wednesday, September 21, 2011
Author: Jonathan Ratner, National Post

Manager: Steven Palmer, AlphaNorth Asset Management

Fund: AlphaNorth Growth Fund

Description: Diversified exposure to Canadian companies typically in the $100-million to $1-billion market cap range

Launch date: July 25, 2011

Firm’s AUM: +$150-million

While investors continue the multi-year trend of piling into anything that provides a yield, stocks present a more compelling option than bonds, according to Steven Palmer, president and chief investment officer at AlphaNorth Asset Management.

While falling yields recently caused the U.S. 10-year bond to dip below 2%, Palmer finds it hard to see why that is an attractive one-year return. After all, some small-cap stocks can provide 2% returns in just a couple of hours.

At the same time, the yield on the TSX 60 index has made a relatively rare ascent above Government of Canada 10-year bonds.

“On a relative basis, equities are very attractive,” Palmer says. “People have been quite panicked. In August, markets got a little scary and everybody thought we were going into another credit crisis situation.”

The manager doesn’t believe that is the case, noting that the market is no longer acting like it does either.

“The charts tell me that we made a bottom and the market is trading quite well in my opinion — setting higher lows and retesting the downside a couple of times,” he says. “I don’t think the market wants to go down anymore, so I’m quite optimistic for the balance of the year.”

However, Palmer says the TSX large caps have to stabilize before small caps can move up as people get more comfortable that the broader market is okay. So while TSX Venture stocks aren’t expected to lead the way out of this poor market, the manager also warns that the index will experience a bit of a lag given its large number of gold stocks.

“If the markets continue to improve and people get more comfortable with the economic outlook, gold is going to go down,” he says.

Palmer also runs the Alpha-North Partners Fund, a small-cap long-biased hedge fund launched in December 2007. It is only available to accredited investors with a $150,000 minimum and share purchases were limited to existing investors as of July 1, 2011. However, the recently-launched AlphaNorth Growth Fund is a mutual fund with daily liquidity and a minimum investment of $1,000.

While the top-down strategy of the two funds are similar, the growth fund aims to have broader sector exposure.

For example, it holds a couple of financial names — Canaccord Financial Inc. and Home Capital Group Inc. — and the sector makes up 6% of the fund.

Materials account for 51% of the portfolio, with potash and rare earths representing the largest weightings in the sector.

Palmer believes the macro picture is pretty strong for potash. “People need to eat — that’s critical,” he adds. “They don’t need to wear gold chains and hoard gold in their basement.”

Palmer is avoiding gold stocks when possible, but he does own some in the portfolio.

While the Partners fund targets more speculative rare earth explorers, the Growth fund looks for exposure to the sector though names like Neo Material Technologies Inc., which processes rare earths.

The energy sector makes up 21% of the fund, with a mix of oil, natural gas and coal exposure. However, Palmer prefers to look at situations that are not dependent on commodity prices. Instead, he focuses on companies with a good shot at a discovery or success with existing operations.

A 6% weighting in health care, 10% in information technology and 6% cash position round out the portfolio.

BUYS

CIC Energy Corp.
Ticker  ELC/TSX
Close  $1.66  P/E-
The position: Recently added to existing position.
Why do you like it? The company has spent approximately $170-million defining a 2.3 billion ton coal deposit in Botswana. A feasibility study for both mining the coal and a coal-fired power plant have been completed.
There has recently been some disappointment as a deal to sell the company has fallen through, which has contributed to a decline in the share price of more than 70% year-to-date. However, management is still actively working towards selling the company. “We believe this is a very attractive asset for a larger company and management will ultimately be successful,” Palmer says.
Biggest risk: The company is unsuccessful in negotiating a satisfactory price for the asset.

Neo Material Technologies Inc.
Ticker  NEM/TSX
Close  $8.28  P/E – 8.9x
The position: Adding on weakness after initiating position shortly after fund launched.
Why do you like it? Neo Material processes rare earth minerals, which are essential in the technology sector with uses ranging from batteries, motors and computers to solar products, optical devices and mobile phones.
“Recent earnings have surprised to the upside, beating analyst expectations by a wide margin,” Palmer says.
He notes that positive earnings revisions followed, but the shares currently trade at a modest 7x earnings.
“Strong earnings momentum is typically associated with strong share price gains. This is a lower risk way to play the surging demand for rare earth elements.”
Biggest risk: Declining prices for its products.

Trimel Pharmaceuticals Corp.
Ticker  TRL/TSX
Close  $1.09  P/E -
The position: Established position at substantial discount to IPO price.
Why do you like it? Trimel is developing several advanced stage products, including a testosterone therapy and a Viagra-type product for women. Both of these are potential multi-billion dollar markets, Palmer notes. “The IPO performed poorly out of the gate. At the current market value, the upside potential is quite significant if the products continue to be successful in clinical trials.”
Biggest risk: Funding and clinical trial risk are key hurdles for biotech companies, however Trimel recently raised $30-million.

SELL

Gold
The position: Adding new gold names is the last item on Palmer’s “to do” list.
Why don’t you like it? Palmer believes that gold is overbought in the near term after rising nearly US$400 per ounce in the past two months.
“We have been taking profits in this area recently,” he says. “We believe equity markets will stabilize and rally into year-end while gold declines.”
A potential positive? The risk to this thesis is that global growth and the resulting fear among investors continues to rise, causing gold to remain a safe haven.