Gold Investment "A Crowded Trade"...?

Gold Investment warning from a US fund manager...

IF YOU'RE LOOKING for a bullish gold outlook, don't expect it AlphaNorth Asset Management President and CEO Steve Palmer.

"If you just look at the supply/demand factors outside all the gold investment demand, it's not a pretty picture," he says. But he's still making money on junior gold equities. The AlphaNorth Partners Fund, about 10% of which is comprised of gold small caps, has averaged returns of 28.4% since it started in 2007.

In this Gold Report exclusive, Steve explains his position on Gold Investing, and shares his market insights.

The Gold Report: For our readers, who may not know much about AlphaNorth Asset Management, please give us an overview of your company, its funds and how you manage them.

Steve Palmer: My partner Joey Javier and I founded AlphaNorth in 2007. In December of that year, we launched the AlphaNorth Partners Fund, which is a long-biased, small cap-focused hedge fund. We focus on Canadian securities, primarily. The goal of the fund is to maximize returns over the longer term. I should also comment that it's a diversified fund, so it's not a strictly resource fund. Typically, it's half resource focused and half technology and special situations.

TGR: The fund has averaged annualized returns of about 28.4% since it launched in 2007. Congratulations!

Steve Palmer: Thank you...

TGR: You're welcome. In another interview, you said you select these companies based on what you call "inefficiencies" in the small-cap space. What constitutes inefficiencies?

Steve Palmer: In the Canadian micro-cap and small-cap spaces quite often there's a lack of general awareness of company fundamentals, especially if there's no research coverage or institutional ownership. Frequently, there are orphaned companies with some exciting prospects and nobody knows about them. So, we try to identify these early stage situations and get on board at a cheap price before they become widely known.

TGR: How do you find these companies? Is there a certain process you go through? Or, are your decisions influenced by what you hear on Bay Street?

Steve Palmer: Well, we have quite a large network of friends and people in the investment business who are giving us ideas all the time. We do some of our own screening, as well.

TGR: You started in the investment business back in the mid-1990s as a research associate, and then you became an analyst. I know from some previous interviews that you very much believe in technical analysis of companies. Are we talking discounted cash-flow models or charts? Are we looking for catalysts?

Steve Palmer: Technical analysis in terms of reading stock price charts to complement our fundamental research. Technical work has been very useful for us in the past, as it helps us time our buy and sell decisions.

TGR: What sort of charts?

Steve Palmer: I use candlestick charts exclusively. We overlay several other technical indicators on our candlestick charts. These charts were not very common in the mid-1990s but now they're used much more to identify patterns. We have found technical analysis particularly useful in instilling sell discipline; for instance, selling is the trickiest component of investing. A lot of people buy in at the same time, but timing when to sell is the hardest part.

TGR: What are some rules of thumb that you've managed to work out for selling?

Steve Palmer: One rule of thumb from your fundamental analysis is to have an idea of what a company is worth. When it gets into that range, you're looking for an opportunity to sell. We wait for the charts to confirm it's time. At other times, they help you say, "Well, I think this thing may go further still."

TGR: Both the TSX and TSX Venture Exchange were up last week and are at or near their highest points since the 2008 crash. In such markets, the bases for company valuations often cease to be only fundamentals and regularly get caught in the momentum of the market. How do the charts work when everything is up like that?

Steve Palmer: The market was up over a few days but it hasn't been particularly volatile lately. It's just been trending up nicely for the last three months. I don't think things are getting too crazy. The S&P 500 Index is trading at 13x forward earnings; this is particularly cheap in the context of a fixed income environment where yields are so low So, I don't think equity valuations are out of whack.

In Canada, the markets are largely resource focused. Our indexes have a much bigger component in resources and the primary driver of those share prices is what the underlying commodity prices are doing. Gold's been hitting new highs and oil has increased to the $88-range last week, so it shouldn't be surprising that the stocks are following.

TGR: As a percentage of your holdings, how many bought at the private-placement level?

Steve Palmer: Most of them. I like to buy as private placements because you get the additional leverage of the warrant, and there's no trading cost to get involved. You don't pay commission on the purchase and you can buy it at a discount quite often.

TGR: So, you don't go through a broker?

Steve Palmer: Sometimes it's directly with the company, but most of the time it's through a broker – or brokers – if it's a big deal.

TGR: You said in a recent interview with SmallCapPower that you're something of a gold bear and you're short Comex Gold Futures. Please explain the rationale behind that decision.

Steve Palmer: Well, it's a somewhat contrarian call. Gold is a very crowded trade. Investors are unanimously and wildly bullish on gold and they have this view regardless of the unfolding economic situation. In recent quarters, I think the gold market is being driven entirely by investors and exchange traded funds (ETFs). Many Gold ETFs have entered the market and there is much gold hoarding. If you just look at the supply/demand factors outside of all of the gold-investment demand, it's not a pretty picture. Another thing I don't like about gold is that it's not good for anything other than to wear around your neck. I much prefer buying a commodity that is useful to people, such as oil.

TGR: You have numerous positions in small junior gold companies, nonetheless, many of which are in the AlphaNorth 2010 Flow-Through Limited Partnership Fund. What tax advantages are there for being vested in a fund like that?

Steve Palmer: Our Flow-Through Fund provides investors a tax write-off of the purchase amount, so that has the effect of lowering the breakeven costs of the investment. It also has the capability to convert earned income into capital gains, which are taxed at half the rate.

TGR: To make this clearer, let's use a round number as an example. If an investor put $10,000 into your fund, how much of that investment would he or she receive as a tax refund?

Steve Palmer: If you're at the highest tax bracket, which is 46% in Ontario, a $10,000 investment will generate a $4,600 refund, a little more once you add in some of the other expenses relating to the investment. So, it's closer to 50%.

TGR: Let's get back to your other fund, the AlphaNorth Partners Fund, where you have had some success with rare earth element (REE) companies. What are you seeing in that sector?

Steve Palmer: The rare earths sector is quite small. I guess the biggest driver is all the press around China being the largest rare earth producer. The country produces more 90% of the world's REEs, but it has put some restrictions on exporting those materials and the prices of many of REEs have gone up significantly. So, there's a scramble to develop and find rare earth deposits outside of China.

In the summer, we were accumulating some of the rare earth names. We identified the trend fairly early and got in on several situations with which we've done quite well. We've really seen investors pile into that sector over the last two or three months; more recently, it seems a little overheated so we've taken some profits.

TGR: Do you have some parting thoughts on the overall mined resources sector?

Steve Palmer: Well, that whole space is highly dependent on growth in Asia – that's been driving the demand for these commodities. So, the biggest risk would be a slowdown in China. That's why we don't position the fund entirely as a resource play. We buy a lot of names that are less sensitive to Asian growth in non-resource sectors.

TGR: Thanks, Steve. We appreciate your insights.

Buy Gold at the lowest prices, and store it in the safest Zurich vaults for as little as $4 per month using world No.1 online, BullionVault...