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Bearish On Gold, Bullish On Gold Miners

Fund manager seeks "discovery stories"...

STEVE PALMER has served as president, CEO and a director of AlphaNorth Asset Management since founding the firm in the fall of 2007. Between August 1998 and August 2007 he managed a small-cap pooled fund, posting a return of 35.8% over the nine years, which Morningstar Canada ranked number one for performance.

Steve Palmer's investment strategy is simple: get in cheap while companies are relatively unknown and then pick up doubles, triples, or better when they hit the big time.

In this interview with The Gold Report, Steve shares some ideas for spotting big growth potential...

The Gold Report: At the end of March you had CAD$100 million under management. This gives you tremendous flexibility with small-cap companies. How much can you manage and still maintain your small-company focus?

Steve Palmer: Since inception of the fund, we have said we would limit new investments once we reached CAD$100M. As a result, we gave notice several weeks ago that the Class A and D shares will be closed to new investors after June 30.

TGR: Do you anticipate opening a new fund?

Steve Palmer: Yes, in early May we filed a preliminary prospectus for a new mutual fund — the AlphaNorth Growth Fund. This fund will have more of a mid-cap Canadian equity focus. 

TGR: You managed a large-cap fund for a major asset management firm. You never had any problem with liquidity of shares in that kind of situation. But is that your chief concern in the micro- and small-cap space today?

Steve Palmer: Yes, liquidity is always an issue when you're investing in small-cap companies. So, it's prudent to limit the size of the assets under management. Otherwise liquidity can detract from performance. Currently, our focus is small caps because they offer the best long-term returns. Our small-cap assets have reached a level now where I don't want to go too much beyond, or it will start negatively impacting the returns we can generate.

TGR: I know you're long-biased, but what makes you a hedge fund?

Steve Palmer: Well, the AlphaNorth Partners Fund structure also gives us the flexibility to use leverage and to short stocks, unlike the mutual fund structure. But most of the money is made from the long side. I've listened to other managers brag about making 50% on the short sale. But, if I only make 50% on a position, I'm disappointed. I'm trying to get into something that has lots of potential and make multiple times my invested capital. So, that's why we focus on the long side. 

We use the shorting to hedge our market risk, lock in gains in positions that are not freely trading or make outright negative bets on a company. So, that just helps limit the downside. But, the strategy of the fund is not to have every month be consistently positive. We're trying to maximize returns over the long term.

TGR: Your January performance was up 5% or 6%. February was an outstanding month when the fund was up 23%. March up about 1%. How did April shape up?

Steve Palmer: The fund returned 11.7% in April, so it has been a very strong month, especially in the context of the TSX and the TSX Venture, which were both negative during the month.

TGR: In your last interview in December, you had some short positions in Gold Mining equities. You were right at the time. By the end of January, Gold Prices had plunged by about $100/oz. from mid-December. I'm wondering if your outlook has changed. Do you think gold is overvalued today?

Steve Palmer: Well, the value of gold is very arbitrary. I've always used it as a play on the US Dollar. And, in recent weeks the US Dollar has gone down fairly significantly and as a result gold has rallied. We do still have a short position on COMEX gold, a small position. That helps to hedge some of the risk of our junior gold equities that we own. So, of all the commodities, it's probably my least favorite. The major reason for that is that I think investor sentiment remains unanimously bullish on gold, and that's bound to turn at some point. 

TGR: Steve, you're looking for equities that have a driver other than appreciation of the underlying asset. Isn't that right?

Steve Palmer: Right. For someone who is actually negative on the commodity, some would say I have a surprising number of junior gold investments. But as you say, they're more driven on stock-specific catalysts. They're more discovery stories versus the senior gold producers, which are cash-flow driven and where the price of gold directly impacts the value. The juniors are impacted to some degree by the gold price, but whether gold is plus or minus $50/oz. from where it is today is not going to materially change the outlook for a company that's on the verge of a big discovery, for example. 

TGR: One of your investment theories is finding value through inefficient markets. Can you still find hidden nuggets in these piles of small-cap resource companies?

Steve Palmer: Yes. A lot of opportunities exist in Canada. The TSX Venture Exchange alone has more than 1,600 listings. There is no shortage of good opportunities in Canada.

TGR: If there is no analyst coverage and people aren't writing about it, you really have to know a lot about the company. What's your main safeguard in the due diligence process?

Steve Palmer: Well, we usually meet management before investing in a company, and we assess the business plan and the current value of a company. At the end of the day, it depends on the risk compared to the reward opportunity. So, we try to get in on situations that have minimal downside risk; in other words, very cheap valuation and strong management. 

We also want to see strong backers who are going to make things work one way or another. If it doesn't work on one asset, they'll find another one and then make it work over the long term. And on the flip side, we want to have lots of upside potential. So, quite often we get involved in private placements where you can buy a unit that is a share-and-a-half or a full warrant, which provides you additional leverage to gains if things really work out.

TGR: Thank you, Steve.

Steve Palmer: Thank you as well.

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