Return of the Resource Story

The case for natural resource investing remade...

NOT MANY PROFESSIONAL investors anticipated the devastation 2008 would visit upon the markets, says The Gold Report.

But having done that, Malcolm Gissen and Marshall Berol started a no-load mutual fund – the Encompass Fund – in June 2006. Malcolm Gissen founded Malcolm H. Gissen & Associates Inc., an investment advisory services firm, in 1985. Marshall Berol has been engaged since 1982 as an investment manager in San Francisco, CA, joining Gissen in 2000.

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.

Malcolm Gissen: 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.

Marshall Berol: 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 US 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?

Marshall Berol: 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?

Marshall Berol: 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.

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

Marshall Berol: 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?

Malcolm Gissen: 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.

Malcolm Gissen: 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?

Marshall Berol: On Edgar (www.sec.gov) 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: I appreciate the time you've taken with us today.

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