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Gissen & Berol: Focusing on Capital Appreciation
Source: By Tim McLaughlin and Karen Roche of The Gold Report (4/21/10)
Many investors have become impatient with waiting for returns over the long term. Encompass Fund Founders Malcolm Gissen and Marshall Berol say they still invest for the long term, but acknowledge that the long term is now shorter than it used to be. In this exclusive interview with The Gold Report, they discuss how they choose companies for their fund and a new way to play the rare earths sector.
The Gold Report: First, congratulations on your Encompass Fund performance of 137% last year. Morningstar rated your fund very highly in 2009.
Marshall Berol: In their database of over 16,000 funds, Encompass Fund was number five for 2009, and number one in the World Stock Fund category.
Malcolm Gissen: For the three-year period, the Encompass Fund ranked in the top 1% in the World Stock Fund category. The fund is about three-and-a-half years old.
TGR: What did you see in the investment landscape last year that others apparently missed?
MG: I think it's a combination of things. We continued to emphasize resource companies and some healthcare companies, the sectors that we felt would perform well. The companies that we liked in those sectors did even better than the sector as a whole. For example, last year gold was up 24%. The gold companies that we liked, and also the silver companies for that matter, mostly doubled and tripled in value in 2009.
Early in 2009, Marshall and I discussed the fact that a number of these resource companies had been battered in 2008. We felt that they were performing well. They should not have declined in 2008 and they offered an even better opportunity. We had the courage of our convictions to add to our positions and to initiate new positions in some companies in these sectors. Our investors were well rewarded for our doing that.
TGR: What do you think was the difference between 2008 and 2009?
MG: In 2008, a lot of hedge funds had made money, as we had in prior years, by investing in resource companies, especially in the junior mining companies. We were pretty heavily invested in those areas in 2008. When the hedge funds had a lot of redemptions and had to come up with cash to pay their outgoing investors, the first thing they sold tended to be the companies in which they had large gains. In many cases these were the resource companies.
In the case of the junior mining companies, many of those companies' stocks are thinly traded. So when these hedge funds started simply dumping millions of shares of these thinly traded stocks in the market, a lot of the junior mining companies fell 50% to 95% in value during the second half of 2008. Marshall and I started calling these companies saying, "We don't understand. You just discovered 5 million more ounces of gold and your stock is down 15% or 20% in two days. This makes no sense."
The companies told us they didn't know what was going on, but somebody was clearly selling a lot of shares. It wasn't until about October that these companies were in New York visiting East Coast hedge funds, and learned that the hedge funds had simply dumped their stock in the marketplace. That had a very negative impact on these junior mining companies. It certainly hurt the Encompass Fund.
MB: At that time, it was not only the redemptions that the hedge funds were getting. The hedge funds were getting margin calls. Individual investors were getting margin calls. Individual investors and the professional investors were very nervous. They were shell shocked as the second half of 2008 and the beginning of 2009 wore on. There was a tremendous amount of liquidation.
A larger gold company such as a Newmont Mining Corp. (NYSE:NEM) or a Barrick Gold Corp. (NYSE:ABX;TSX:ABX) could take that liquidation and go down some. Some of the smaller companies, the junior companies, went down tremendously, as Malcolm has said. They went down 50% to 90%.
We went back and looked through the portfolio. We went through the companies we owned and assessed what the attributes were, pro and con, of those companies. We looked at their finances, their management, their projects. Then we decided to eliminate a few of the companies that we felt weren't as strong, weren't as solid. We added to existing positions in companies that we felt were solid and the prices were mismatched to what the company represented. Then when the markets started to recover in March of 2009, a number of these companies went on to perform spectacularly for the balance of 2009 and into 2010. That's what certainly contributed to the excellent performance of the fund, and what we think will continue to contribute to a positive performance of the fund going forward. Of course as we all know, and as the SEC requires us to say, past performance is no guarantee of future results.
Having said that, it is important to look at where a company has been and is and try and determine where you think it's going to go as a company and as a stock investment in the future.
TGR: Marshall, in our last interview, you said the resource investment story is not over. We're in the early innings. Where are we in the resource story today and what resources have the best investment story?
MB: Where we are in the continuum of the story is we feel it's still early on. It's not as early on as it was a year ago, or two, or three or five years ago. Gold has gone from $275 to $300 an ounce to currently, say $1,150. In the U.S., it's a little off from the high reached last year of $1,220.
If you're in Europe and you're looking at gold in the context of euros, gold has hit new highs. That's the same with various other currencies of the world. We feel that's going to continue. We feel there are various reasons why it will continue for gold and silver. Silver has some of the same attributes as gold in that it's a precious metal and it's looked at as a monetary metal. But silver also has its industrial uses. That's a major component with what happens with silver.
We continue to like copper and some of the other base metals. We continue to be very positive on some of the commodities involved in the energy complex, particularly uranium and coal and to a lesser degree oil and natural gas. Oil and natural gas march to their own drummer, if you will. These other commodities, the precious metals, the base metals, we feel certainly have further to go on the upside. If the next question is how far and how high, we wish we knew. We don't have a good enough crystal ball to say. We would say that we're still in the earlier innings of the ball game, if you want to use that sports metaphor.
TGR: Are you saying that's specifically about gold or do you see that across the entire resource sector?
MB: It's certainly gold, but basically along the entire resource sector. With regard to the commodities, the base metals, the industrial metals, it's also dependent, particularly in the shorter term, on the economies of the world. It's the U.S. economy. It's Europe. It's Asia. It's China. You're not going to have copper continuing to go up, as it has over the last number of months, unless the economies of the world continue to improve. We think that's going to happen. It doesn't happen in a straight line. There are fluctuations and there's volatility.
If you look out a period of time, and by that I'm talking about 6, 12, 18, 24 months, yes we remain positive. Our outlook is based on a longer-term investment. We are looking for capital appreciation. We are not traders as such. We are not looking for short-term movements. Although we are aware of them and conscious of them, what we're looking for, both for our individual client accounts and for the mutual fund, is long-term capital appreciation.
TGR: Haven't some investors gotten impatient waiting for the long term? In other words, is the long term shorter now than it used to be?
MG: The long term is definitely shorter that it used to be. The markets are far more volatile. You have far more information available. You have many more individuals with all the information at their computers who are day trading. You have hedge funds and private equity funds controlling enormous amounts of money that have a profound impact on the market. All of this has tended to force investors to shorten up their horizons. The long term used to be 5 to 10 years, now it's probably 3 to 5 years.
TGR: Has that changed the way you manage the fund in that case?
MG: Yes, it's changed the way we manage money both for the fund and for individual clients. We had to make that change because of the volatility in the marketplace. We have to respond to that. We have to be aware of it. It enters into the way we operate, the way we invest.
MB: Having said that, we're still looking to invest for the long term for capital appreciation. What it does change is that instead of having a 5- or 10-year horizon, as Malcolm said, you shorten that horizon to 2, 3 or 5 years. You also need to be more constantly aware of what the markets are doing and what's happening with a particular company and the stock of that company so you can react if you feel it's warranted.
Investors, particularly individual investors, but certainly professional investors as well, are human beings. Too many investors are acting too quickly because of the ease with which you can buy and sell equities these days. They're acting too quickly. They're pushing a button to buy or to sell before getting the full amount of information they probably should be utilizing. Having said that, that's the market we're in. You have to be aware of that and you try and take advantage of that.
TGR: Given that the long term has gotten shorter, how does that affect when you're investing in resource companies? In other words, do you steer clear of companies that are just in the exploration mode and stick only with producers?
MG: No, we don't. We invest in a good number of exploration companies. Some will not go into production without a joint venture or acquisition of the company.
MB: Because we anticipate that they may be bought out and somebody else will take it into production.
MG: Or they don't want to get into production. A change for us is that we may be more apt to take profits than 5 or 10 years ago. For example, a good number of the resource companies in which we are invested have soared 200% to 400% in one or two years. We may still like the company and believe it has further appreciation potential, but nowadays we might consider selling part of the position in order to realize the large profits we attained. In other words, we will be taking some money off the table even though we might think that company has a bright future and the stock could go higher. That's one of the ways in which our style, our methods, have changed as a result of the shorter-term focus and view that many investors have.
TGR: Now when you're looking at those companies, are you looking for ones that are likely acquisition targets, or is that just a hope that that's going to happen?
MG: That's a hope that it'll happen. We don't like to rely on the fact that this company is likely to be acquired because too many things can happen. That should not be a determining factor in our decision to invest. We're investing in companies that we think on their own will continue to increase shareholder value. A company that we think has excellent management and excellent prospects on its own. In the back of our minds, we're aware that this company would be a very attractive acquisition target for certain larger companies and that might happen. If it does, that's just a bonus. This would be in addition to the excellent returns we expect to get based on the fundamentals of that company itself.
TGR: That being said, what precious metals companies are you excited about right now?
MG: One of the companies that you're probably aware we've been invested in is Exeter Resource Corp. (NYSE.A:XRA;TSX:XRC; Fkft:EXB). Exeter recently spun off its Argentinean resources into Extorre Gold Mines Ltd. (TSX:XG). The investors in Exeter received shares in Extorre. We like Exeter. We like its resources. We think it has excellent management. We think its resources would eventually be attractive to an acquirer, but on its own we think that Exeter will continue to increase the value of the company through their organic growth, through the drilling that it is doing. They're doing substantial drilling at Caspiche, their Chilean operation in the Andes Mountains. We think that will continue and we think that the resources will continue to be expanded and upgraded.
As far as Extorre, we also like the projects it has in Argentina. It is continuing to drill at its Cerro Moro project in southern Argentina. We think they'll have good drilling results. They'll expand the resource. There's very good quality gold there, high-grade gold and also silver. We think that is a project that could get into production relatively quickly, which is a very attractive attribute, as you know.
TGR: Is Extorre a single resource company or do they have multiple projects?
MG: It has a primary project where it's drilling. It has other properties with substantial resources in Argentina. One has been held up for political reasons; the company is hopeful that it will be able to further explore and eventually mine. Extorre also has other exploration opportunities in Argentina.
MB: It has other exploration prospects that it anticipates working on down the road but currently the major activity is this Cerro Moro project (gold and silver)in southern Argentina.
TGR: Any indication of how large their resource is?
MB: Yes. Extorre has a 43-101 that's approximately 625,000 gold-equivalent ounces. They've reported some of the drilling results that have been going on over the past six months or so, but there's been no update on the 43-101 resource. That's anticipated to be out in the next 30 to 60 days. So we'll see. Some of the analysts are anticipating that there could be a doubling of the resource in the upcoming 43-101, but of course we don't know. We'll find out when it's published. (Subsequent to this interview, Extorre reported an updated 43-101 resource report indicating more than 1 million gold-equivalent ounces.)
Exeter has just updated their 43-101 for their Caspiche project. They have over 30 million ounces of gold and gold equivalents. Caspiche has substantial copper in the deposit in the project. Converting copper to gold-equivalent ounces, you end up with over 33 million ounces of gold equivalent at the Caspiche project, one of the largest undeveloped copper-gold projects in the world.
MG: We should add that Marshall and I visited both of these properties in November. The Caspiche property is about 14,500 feet up in the Andes Mountains.
TGR: Does that make it difficult to recover those resources?
MG: It's challenging. You have issues of infrastructure. One of the benefits with this particular property is that it's very close to the Cerro Casale property that Barrick and Kinross Gold Corp. (TSX:K;NYSE:KGC) own. That is also a very large resource. This has led to speculation that the Caspiche property will be very attractive, particularly to Barrick, which recently bought 25% of Kinross' interest in the Cerro Casale project to increase Barrick's interest to 75% (Kinross continues to own 25% of Cerro Casale).
MB: While mining at 14,500 feet is challenging, it's certainly doable these days. To the north of Exeter's Caspiche project, Kinross has their Maricunga operating mine, which is about 10 kilometers north of the Caspiche project. Exeter and Extorre are not in production. Extorre is hoping to be in production in the next 12 to 18 months.
A company that we're invested in that is in production, and has been increasing production, is Avion Resources Corp. (TSX.V:AVR). Avion is operating projects in Mali, West Africa. It acquired a project from Nevsun Resources Ltd. (TSX:NSU;NYSE.A:NSU) a couple of years ago at pennies on the dollar. Nevsun sold because it was concentrating on another project that Nevsun had in Eritrea. Avion has brought their project into production and is increasing production. It continues to drill and has acquired some additional land and additional projects. It's a company that we've been invested in for the past couple of years. It has done extremely well both as a company on their business plan and as a stock.
TGR: In terms of silver, are there specific companies that you got an eye on?
MG: We've been invested in Endeavour Silver Corp. (NYSE.A:EXK;DBF:EJD;TSX:EDR). Endeavour has two major facilities in Mexico that we visited in July.
MB: Facilities being producing mines?
MG: Yes, they're in production. Endeavour's stock more than tripled last year.
TGR: What do you like about them specifically?
MG: There are several things. We like their properties but we also like the management. Management has a history of getting great buys for properties that are very easy to get into production. They have a history of getting into production quickly. As you know, production means cash flow. So from the time they make an acquisition, if they can get into production and be producing revenues, it makes the company more attractive because the cash flow enables them to continue to expand both organically as well as through acquisition.
TGR: Are they planning any acquisitions that you know of?
MG: I recently had dinner with the chairman and he would only say that there are a couple of attractive candidates, but he would not say more than that.
MB: Another company in the silver space that we own in the portfolio that has a different business model and game plan that we feel is very attractive is Silver Wheaton Corp. (NYSE:SLW;TSX:SLW). Silver Wheaton does not explore for silver, or discover silver, or mine silver. Silver Wheaton is in the business of providing financing to silver miners. They provide financing on an upfront basis and will buy the production, the silver production from a company on a long-term contractual basis. So it does not directly have the risk of the mining operation. Instead they will benefit from an increase in production at the mine or mines of a company that they have an agreement with, as well as benefit from an increase in the price of silver. The model has been very successful.
TGR: The rare earths have been getting a lot of attention lately. What's your take on those?
MG: We got into the rare earth metals through a company called Avalon Rare Metals Inc. (TSX:AVL;OTCQX:AVARF). We did that about three-and-a-half or four years ago. We felt that the demand for rare earths would only increase. The Chinese are producing 95% of the world's rare earths and have continued to talk about keeping the rare earths at home and not exporting them to the rest of the world. Meanwhile, rare earth metal applications are increasing all the time. They are particularly relevant in certain industries involving green technology. If you look at hybrid or electric cars, there are more than 20 pounds of rare earth metals in every hybrid car. If you look at solar installations, if you look at wind power, they all use rare earth metals. The most valuable rare earths are the heavy ones. Avalon has more of the heavy rare earths than any other western company.
MB: A company that has a different game plan on the rare earth metals is Dacha Capital Inc. (TSX.V:DAC;OTCQX:DCHAF). Dacha is a Canadian company and trades in Canada. It has a business model of acquiring rare earth metals in China and warehousing them outside China. The inventory is available for sale to companies around the world. It's an unproven concept as far as it goes with rare earth elements. There are certainly other companies that have done similar things in other industries and other products. Dacha believes that it has the contacts and the sources to acquire the rare earth elements to store them and warehouse them and to be a seller of them at a profit over time. We think it's a very interesting concept.
TGR: Thank you both for your time today.
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 20 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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1) Tim McLaughlin of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) Of the companies mentioned in the interview, the following are sponsors of The Energy Report or The Gold Report: Avalon Rare Metals and Exeter Resources.
3) Marshal Berol: I personally and/or my family own shares of the following companies mentioned in this interview: Encompass Fund, Extorre, Exeter, Avalon, Avion and Dacha. I personally and/or my family are paid by the following companies: None.
Malcolm Gissen: I personally and/or my family own shares of the following companies mentioned in this interview: Encompass Fund, Extorre, Exeter, Avalon, Avion and Dacha. I personally and/or my family are paid by the following companies: None.