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The Metals Resource Investment Story Is Not Over

Commodities / Metals & Mining Aug 25, 2009 - 07:59 PM GMT

By: The_Gold_Report


Best Financial Markets Analysis ArticleNot many investors anticipated the devastation 2008 would visit upon the markets. Nonetheless, shrewd advisors sought, as always, to limit risk by investing in a wide array of sectors. Looking to do just that, Malcolm Gissen and Marshall Berol started a no-load mutual fund—the Encompass Fund—in June 2006. Like others, the fund suffered a steep decline in Q408, but has since witnessed a pretty dramatic recovery. In this exclusive interview with The Gold Report, Malcolm and Marshall share why they believe "we're still in the early innings" of the resource investment game and foresee a bright future for the all-star junior miners.

The Gold Report: Malcolm and Marshall, you started the Encompass Fund in June of '06 with the intent of investing in a wide array of sectors, "to minimize or avoid sharp declines in the market," as it says on your site. However, according to your stock chart, you had a fairly dramatic decline in Q4 '08 with a pretty dramatic recovery since then. Tell us a bit about what happened there.

Malcolm Gissen: What happened was that prior to and in 2008 we emphasized resource companies in our portfolio, and we believed that these companies were performing well. We had confidence in management. In the case of the resource companies, many of them continued to expand their resources, in some cases, very substantially. So we felt we were pretty comfortable with holding these positions in our portfolio.

In the second half of 2008, a number of these companies experienced very sharp declines in their stock prices. We were alarmed, so we called the companies and asked if they knew what was going on. Their only explanation was that somebody was dumping a lot of their shares, which we, of course, could see in the market.

But it wasn't until very late in the year, when these companies spoke to and visited hedge funds, that the hedge funds would tell them that they had experienced a lot of liquidations and, as a result, were selling all of their resource company positions—and selling them as quickly as they could. In some cases, it was program trading. In other cases, they just dumped the stock. In the case of the junior mining companies, where the stock was generally thinly traded, it had a profound impact on stock prices when hundreds of thousands of shares or, in some cases, millions of shares, were unloaded in the marketplace, driving down the price of a number of these companies anywhere between 50% and 95%. When we saw that happen late in the year and realized the cause, as managers of the Encompass Fund, we decided we would buy more shares of some of the companies. We did that and that is one of the reasons the Encompass Fund has gained about 80% this year.

Marshall Berol: There were several things we did, but when we saw what was happening with the markets in the fourth quarter of 2008 and what was happening with the companies that the Fund was invested in, we went back and reviewed each of the companies for how well we thought they could survive (i.e., a good investment going forward), and sold several of the companies we felt were weaker because of finances or the projects, or the time involved in getting the projects moved along, and factors of that nature. So those companies we sold at that time, and as Malcolm said. We increased the positions in some of the companies that we did own and felt were strong companies with good management, finances and projects that we felt would be worth owning going forward. Fortunately, that has worked out this year.

MG: I would say I have not been surprised at how well many of the companies in the Encompass Fund have performed this year. Marshall may not agree with this—and we don't agree on some issues—but I expected that good companies that performed well from an operations standpoint would outperform. I felt that the resources companies that were continuing to expand their resources would excel since I didn't think the prices of the resources were going to decline much. I felt there would continue to be demand for the resources and so I've not been surprised by the performance and, in fact, think that there's more to come. I don't think the story is over yet.

MB: Yes, we're definitely of the view that the resource investment story is not over. We're still in the early innings. There are a lot of reasons we believe that the demand for resources will continue to expand. It's supply-demand in the case of gold and, to a lesser extent, silver. It's the storehouse of value. There's the inflation aspect. A lot of aspects come into the various resources—whether it's the metals or energy—that we feel has a very bright future going forward.

We're not of the camp that thinks deflation is here to stay, or that there's not going to be some decent growth globally. We're in a global economy. There's just no two ways about it. While the U.S. or Europe may be slower, at this time and going forward over the next few quarters, there's a lot of growth that's occurring in Asia and Latin America, and they need resources. And, to the extent that the populations are improving their quality of life, they're consumers and they want things that use resources of base metals, and they want gold. They want silver from a jewelry standpoint and a storehouse of value standpoint for gold. We just don't see where that doesn't continue, certainly with some volatility, with some ups and downs. But we just believe that it will continue and that there's a very bright future for resource companies.

TGR: Marshall, in an interview you did with Al Korelin you brought up the demand creation by the BRIC countries, particularly China and India. With the demand and also the time it takes to put new mines into production, you said there's going to be a shortfall for quite a while. Am I correct in thinking that those mines were taken offline during the recession? And, if so, wouldn't bringing these mines back up in the next couple of years soften the gap between the demand-supply?

MB: There have been some mines that were taken out of production. However, I don't think it's all that significant in the overall scheme of things. What has been more significant is the reduction in the expansion of existing mines that some of the majors have done, such as BHP, with various commodities. Some of the small producers have slowed down their expansion and, certainly, the juniors have slowed down getting into production. So it's more a factor that the expansions that were planned for '08, '09, ‘10 and ‘11 have been delayed or slowed down or maybe, in some cases, eliminated, rather than that existing production has been taken offline.

TGR: Do you see a possibility that the lack of base metals—copper, iron ore, etc.—could actually slow the growth of the emerging countries in China and India?

MB: Yes, I think to some degree that could happen. It should also be said that in the case of a good number of these metals, it's become more and more difficult to find major resources. As you know, the large gold companies have a demand that needs to be met for a certain number of ounces a year just to maintain their current levels. And over the last few years, we've seen them be increasingly aggressive in buying these smaller companies. The smaller companies are faster on their feet, they're more flexible, they move much more easily, and a number of them control very substantial resources.

One of the companies in our portfolio, Seabridge Gold (NYSE.A: SA), is a very good example of controlling substantial gold in the ground. So, we believe that at some point, one of the major gold mining companies is likely to acquire Seabridge, as well as a number of the other smaller gold and silver mining companies. We see that trend continuing as companies are being forced to spend more money, to be doing their exploration in more difficult environments, in some cases, hostile jurisdictions.

TGR: How do you decide where you're going to invest for your fund?

MB: The Encompass Fund is set up as a no-load general mutual fund. It's not a hedge fund. We're an SEC-registered no-load mutual fund. It was set up to invest in companies regardless of market cap size because we don't think a fund should be limited to investing in large or small companies, or any type of company. It was also set up to invest in any areas we believe offer good, long-term appreciation.

In the Encompass Fund we can invest in any sectors that we think look attractive. For the last several years and even before we started the Fund, with our private accounts, we've believed in resource companies—gold, silver, other commodities—so we were invested there. When we established the Fund, we invested in a number of resource companies. We do have other areas we like—healthcare, particularly, and some special situations that we invest in. From the standpoint of the Fund, we don't want to be necessarily a resource fund or a gold fund. We want to invest where we believe there are opportunities for long-term appreciation and that leads us to a variety of the resource sectors currently.

TGR: Can you clarify for me in terms of long-term appreciation are you looking at that as a sector play long-term appreciation or actually buying individual companies and holding them for long-term appreciation?

MG: I would say both. When Marshall and I got into this business, 'long term' meant 5 to 10 to 15 years. Nowadays, long term seems to mean two to four years. The definition of ‘long term’ has clearly changed as investors have gotten less and less patient. We want to have exposure to metals and we believe that once we make that decision and decide which metals may look more attractive now than others, we're going to find the companies that we think will provide us the most upside potential—taking into account the risk—for that particular metal.

TGR: Earlier on, you said that when the market was going down you went back and looked at your portfolio in the metals and said, 'who's really going to survive and why?', and then actually culled out part of it and increased another part of it.

MG: Correct. We will make calls from time to time. We think copper is undervalued at this particular time. It might be a good time to be invested in zinc. And then once we do that, we'll decide which copper and zinc companies we want to add to the portfolio. And, generally, those companies will be companies that have control of a very substantial resource, have excellent management, and have either the capital or access to capital that gives us the sense that the company will be able to develop the resource and realize its full potential. We will hold that company until we think the company has realized its potential. And that may take a few years.

We thought last year would be a very good year for a number of the companies in our portfolio. We expected that they would be acquired last year. For example, as gold was rising in the summer, we felt that a couple of gold companies in our portfolio had a reasonable chance of being taken out. Well, you know what happened last year; there weren't many companies being acquired. We didn't necessarily sell those companies when their stocks declined because we continued to believe they were particularly undervalued based on the resources they controlled, and the huge potential for expanding those resources. We want to hold on to those companies because we believe they have the potential to double or triple from where they are now and, in some cases, they've already doubled or tripled this year.

TGR: Can you share with us what some of those companies are?

MB: On Edgar ( you can see the annual report of the Encompass Fund showing the full holdings of the Fund as of May 30th. The Fund also had a substantial amount of cash, both because we have had some good inflow of new cash into the Fund over the last several months, as well as the fact that we have felt that there might be some small pullback in the market. Further, there may be some price consolidation with a number of the companies that we're interested in, so we're in no rush. We're looking for opportunities caused by the market to buy them at better prices. But some of the companies we're certainly more than pleased to share.

TGR: Give us some of your top picks in terms of what you expect them to do for the second half of the year.

MG: It's very difficult to predict whether it's going to be in the next 6 or 18 months, but somewhere in the next 24 months, we expect the resource companies to really break out, probably be acquired or expand the resource to the point where the market realizes there's an enormous resource there and they should be buying the stock. So a company that we like, for example, is Avalon Rare Metals (TSX:AVL). It's a rare earth metals company. This is a Canadian company that not only has substantial assets, but some of their properties have the heavier rare earths. There's been a lot of expansion of the applications of rare earth metals. We think that's likely to continue. The Chinese produce over 95% of the rare earth metals in the world. There's talk that the Chinese may restrict their exportation of those metals, so this is a company that we like.

We like the management; they've got the financing to do the drilling, to expand the knowledge of what they have. Coverage of rare earth metals and the rare earth elements has become more common in the last several months because several newsletter writers have written about the situation. China produces 97% of what's produced currently and it seems likely they will either restrict or eliminate exports. In a hybrid or an all-electric car, there are 40 to 60 pounds of various rare earth metals and elements. So if we're going to expand the usage of those automobiles, we're going to have to have the rare earth metals and it's a situation that has been brought to the fore. We knew that there was limited production in the world, that most of it was out of China, and that a company like Avalon, which has its resource in Canada, was likely to be very favorably looked upon by the investment community at some point in time. We're pleased that the point in time is sooner rather than later.

TGR: You two just came back from Mexico on a site visit and I think you were down there and you saw Great Panther Resources (TSX:GPR) and Endeavour Silver Corp. (TSX:EDR) (NYSE.A:EXK). Are those companies in your portfolio, or about to become members of your portfolio?

MG: Endeavour Silver has been in our portfolio; we've been impressed with the company for some time. We think they have good resources, very competent management, and we think that they're very smart acquirers of properties and that it is likely they will continue to find other mines and properties near where their existing mines are that have very substantial resources. We think that Endeavour is substantially undervalued right now, that there's lots of opportunity there.

MB: Great Panther and Endeavour Silver both have very impressive operations. They both are in the Guanajuato area and have other operations in Mexico. The mines we visited — and these are producing underground mines that both companies have in the Guanajuato area — they're both very impressive with their underground mines, with their mills, with what they're doing and how they're doing it, and how they have reopened and brought back into production these mines, as well as the concern for the local people and their employees that each company exhibits and their concern about mining safety.

We have not been invested in Great Panther in the past. We became familiar with them more recently and welcomed the opportunity to see their facilities, meet the management of the company and of the mines, and are taking a hard look at it as an addition to the portfolio. There is a disconnect from the historical ratio between gold and silver and what it is now. It's currently roughly 65-66:1. The ratio of the price of gold vs. silver has been as high as 70. In the past few years, it's been down to 45 or 50. We think that this disconnect is going to narrow and so we're interested in adding some additional companies involved in silver to the portfolio.

TGR: One of your major holdings in the portfolio is Exeter Resource Corp. (TSX.V:XRC) (NYSE.A:XRA), exploring for gold in Chile and Argentina. Can you speak a little bit about Exeter?

MB: Yes, another company that we've been invested in for some period of time. It has exploration and discovery operations, as you say, in Chile and Argentina. They have two main projects that they're working on currently. First, Caspiche in Chile, up in the Andes, roughly 14,000 feet. It's between Kinross Gold Corp. (K.TO; NYSE:KGC)' Refugio mine and the Kinross/ Barrick Gold Corp. (NYSE:ABX) Cerro Casale project, and they have been drilling on it the past couple of years and they're currently drilling on it. They have found a substantial quantity of gold and copper and we think there's great potential for that project and that Exeter has the management and the finances and the ability to carry forward on the expansion and exploration of the project.

The second project that they're actively working on is in Southern Argentina, the Patagonia area, and that is a gold project. That would be an open pit mine. It's very near Cerro Vanguardia, a project that has been producing gold with an open pit process for a good number of years. Exeter's drilling several of the veins in this Cerro Moro project and we think that it's up to 800,000 ounces and growing. We think that's another very economical project that will be brought into production sooner rather than later by Exeter, assuming nobody comes along to give Exeter an offer that they can't refuse. So we have analyzed the company and are invested in Exeter. I visited both projects and was very impressed with what the company's done and where they are and we think there's a bright future for the company.

MG: Also, an undervalued company that we think is going to markedly expand their resources.

TGR: Does your target potential for Exeter assume some type of buyout or going into production?

MB: Yes, one or both.

MG: If we had to bet, we would say that probably someone's going to acquire them because we think both projects will prove to have very, very substantial resources that will be very attractive to a number of companies, some of which are mining right near them.

MB: Particularly, with regard to the Caspiche project in the Andes, it is going to be a very capital-intensive project to build out. It's 14,000 feet up. It's a major project. The great likelihood, in our view, is that either that project gets acquired by a major gold mining company or a gold-copper company or maybe a copper-gold company and/or that some kind of joint venture or joint arrangement is worked out because it's probably beyond Exeter's capacity to do it in and of itself.

With regard to Cerro Moro, from the information we have, it appears very possible that Exeter can bring that into production itself, which we would anticipate it'll do, unless it gets an offer that is too attractive to turn down.

Talking about gold companies, Seabridge Gold has two major projects. The first is Courageous Lake, in the Northwest Territories, which has about 10 million ounces, and a 43-101 study. Seabridge also owns a valuable property in British Columbia, the Kerr Sulferets Mitchell Project, which has roughly 35 million ounces of gold and 8 billion pounds of copper. Seabridge expanded the resource greatly over the last several years with its successful drilling program. They're doing additional drilling and we anticipate that they'll be additional ounces of gold and pounds of copper added to their resources.

They're well funded and have good solid management in our view and we're very optimistic that that company will have one or both of the projects acquired by a major company, or that the company itself will be acquired. And we think it's undervalued. It's roughly $30 a share, which values its resources currently at probably $20 an ounce of gold, without any valuation put on the copper. That's definitely at the low end of the range of valuations of companies out there. They've got roughly 1.3 ounces of gold in the ground for each share and we think that is a very attractive situation. We have believed it for a number of years. We started investing in the company for our private accounts in 2002 and it's one of the companies that we put in the Encompass Fund portfolio when the Fund opened in June of 2006. Having said that, we have sold off some Seabridge shares from time to time, depending on valuations and our outlook, if the price of the stock had gotten ahead of itself.

MG: That was a case where a client account paid $3 to $4 per share and had ridden it up to over $30.

TGR: The only way you make money is when you finally sell.

MB: Exactly. Somebody has pointed that out to us and we've learned that over the years.

TGR: I appreciate the time you've taken with us today.

DISCLOSURE: Malcolm Gissen — I personally and/or my family own the following companies mentioned in this interview: Encompass Fund; Seabridge Gold; Endeavour Silver; Avalon Rare Metals; Exeter Resource

I personally and/or my family am paid by the following companies mentioned in this interview: I own a 50% interest in Brick Asset Management, the management company that manages Encompass Fund, and receives a management fee from the Fund. See for complete disclosure.

DISCLOSURE: Marshall Berol — I personally and/or my family own the following companies mentioned in this interview: Encompass Fund; Seabridge Gold; Endeavour Silver; Avalon Rare Metals; Exeter Resource

I personally and/or my family am paid by the following companies mentioned in this interview: I own a 50% interest in Brick Asset Management, the management company that manages Encompass Fund, and receives a management fee from the Fund. See for complete disclosure.

Malcolm Gissen founded Malcolm H. Gissen & Associates Inc., an investment advisory services firm, in 1985. He has been an investment advisor since 1985 and has managed separate accounts since 1999. Mr. Gissen’s management experience has focused primarily on investments in publicly traded companies, including real estate investment trusts. Mr. Gissen received a B.S. degree from Case Western Reserve University and a J.D. degree from the University of Wisconsin. Marshall Berol has been engaged since 1982 as an investment manager in San Francisco, CA. Since 2000, he has been the Chief Investment Officer of Malcolm H. Gissen & Associates, Inc. In addition, for more than 15 years, Mr. Berol has owned his own investment firm, BL/SH Financial. Mr. Berol’s investment management experience has focused primarily on investments in publicly traded companies. Mr. Berol did his undergraduate work at the University of California (Berkeley) and received a J.D. degree from the University of San Francisco School of Law.

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