Steve Palmer, founder and chief executive of the Toronto-based investment manager AlphaNorth Asset Management, prefers metals that have uses beyond sitting in a basement safe or gift-giving. In this exclusive interview with The Gold Report, Palmer explains why he is looking closely at hardworking base metals that could take off with increasing global demand and a market rally he is forecasting through the end of the year.

The Gold Report: In August, you wrote that you did not believe the U.S economy was heading into another recession despite continued investor concerns about global growth. Do you still believe that?
Steve Palmer: Yes, there is nothing that has transpired that would cause me to change that view. The economic data has been quite good. The market was retesting the low that it hit on Aug. 9 and it briefly dipped below that level. But it had one of the largest rallies in the last 25 years to rise above that low. From a technical point of view, the retest was successful and we have continued to trade higher since Oct. 4. I believe the bottom is in and the stock market will rally significantly into the end of the year. The recent market action only further supports that view.

TGR: As we emerge from that bottom, how are you choosing between undervalued companies right now?

SP: I am trying to focus on the less speculative names. Even the companies that are well financed have been experiencing greatly depressed share prices, so there are strong gains to be made in those. You don’t have to go searching too far down the food chain into the really speculative stuff to generate strong returns.

TGR: You’ve written that equities remain extremely attractive relative to historical valuations and are particularly attractive relative to other asset classes, such as bonds. Do you believe equities are the best place for investors to be if the bottom falls out of the market, as it did in 2008?

SP: I don’t believe that the bottom is going to fall out. But if you were to believe that that’s the case, bonds are the place to be temporarily. If you remember back to 2008, the meltdown only lasted a few months and then the market started to move higher. Historically, it is clear that equities do outperform bonds over longer timeframes. Many investors do not realize that they can lose money in bonds. Investors can take a significant capital loss on bonds unless they hold them to maturity if yields go up. A 10-year bond that is yielding 2% is locking in a 2% return for 10 years and equities are likely to far exceed that.

TGR: Also, if inflation is higher than 2%, investors are losing money.

SP: Investors should also be mindful of the tax differences. In Canada, capital gains are taxed at half the rate as interest. If you’re earning 2%, by the time the taxman gets through with it, it turns into 1%. Then if you have inflation, you are losing money every year, or at least losing purchasing power.

Investors are hoarding cash and piling into fixed-income products. They will probably continue to do that until they start losing money or see others making a lot more than they are in the equity market. Then we will see a shift.

TGR: You forecast that the equity markets are going to rebound through the end of the year. So that shift could be about to occur.

SP: For many investors it is going to take longer. Most of them will probably miss at least the first half of the rally and then they will pile in right at the end.

TGR: Recently, the asset mix in the AlphaNorth Partners Fund was 37% technology, 25% energy, 27% metals and 11% precious metals. Why does the fund have more exposure to metals than precious metals?

SP: I am not a big fan of precious metals at the moment. The precious metal stocks are far more expensive than the metal names. Both in terms of a net asset value and, on a multiple basis, precious metals are typically double the price. Base metals are, as the commodities themselves are, something that gets consumed, something people actually need. Many of the products that we use today require them. Whereas precious metals have minimal uses other than sitting in your basement vault or wearing them around your neck, which is not very practical.

TGR: That’s certainly not the case with silver. Silver has a huge industrial demand component.

SP: The major uses for silver historically have been for industrial uses, jewelry and photography. The photography component has been declining rapidly with the increased use of digital cameras. If it were not for investment demand increasing in recent years, the total demand for silver would have declined. The silver price would not be anywhere close to where it is currently if it wasn’t for the investor demand through exchange-traded funds and people hoarding it.

TGR: What’s your thesis for investing in base metals?

SP: Base metals are tied to global economic growth. Global growth should reaccelerate shortly and continue to be driven by China. The results will be favorable for supply/demand fundamentals for the commodities.

TGR: What particular base metals are you most bullish on?

SP: I have no particular favorite. The companies that are represented in the fund are a mix of different base metals. Most base metals companies have a combination of metals. For example, I met with Canadian Zinc Corporation (CZN:TSX; CZICF:OTCQB) this morning, which has zinc, lead and silver.

TGR: Those are quite common in one deposit. Are there some other base metal companies that you believe have some upside?

SP: Orbite Aluminae Inc. (ORT:TSX) is a base metal name with a twist. It is not just a base metal name. The company actually works with alumina—aluminous clay, Orbite Aluminae calls it. It has a process for extracting alumina from the clay in Québec.

Québec is home to about 12 aluminum refineries because of cheap hydroelectric power. When you combine electricity with alumina you get aluminum. Basically, two tons of alumina plus some power creates one ton of aluminum. Companies have been shipping alumina in from South America and all over the world, whereas in the future, it is anticipated that Exploration Orbite will be able to supply aluminum locally for much lower cost.

TGR: That is an interesting name that might not come across the radar screen of most investors. What are some common themes in the precious metal companies that are part of the fund?

SP: They are relatively early-stage companies with favorable odds of a major discovery, or they have a very cheap valuation relative to the peer group. The holdings are skewed toward gold.

TGR: You figure out which are the best in class and then compare valuations?

SP: It is somewhat subjective. You have to assess what the odds are that the company will find something, how big the discovery could be, and weigh it against the current valuation. We try to get in situations that have cheap valuations relative to the potential of what they can find and that have high odds of actually finding something.

TGR: Do most of these companies have prefeasibility studies?

SP: These companies are across the spectrum. Some of them have a resource already. It is a question of how big the resource can get. Some of them are earlier stage where they don’t have any drilling yet, but they have some very attractive targets.

TGR: When The Gold Report spoke with you in May, you said, “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.” What are some positions that you have taken in the precious metals space that you believe have long-term potential for gains that are significant?

SP: One example would be Ryan Gold Corp. (RYG:TSX.V). The Yukon has had many significant discoveries in the last couple of years. It is a very hot area right now and many companies have been getting good drill results. Ryan Gold has a huge land area there. It has an abundance of soil samples and some other geotechnical work done, which indicate some very promising drill targets. The company has a market cap of about $80 million (M) versus $60M in cash as of June 30. I view it as very high odds that Ryan Gold will find a significant gold deposit on its property. It’s just a question of time. The initial drill results will be out in the next few weeks. The company is also well financed.

I do own a few other companies in the Yukon, but I have the most confidence in Ryan Gold being able to find something very significant and offering the best returns from current levels.

TGR: Are there any other stories that you really like?

SP: Majescor Resources Inc. (MJX:TSX.V) and Seafield Resources Ltd. (SFF:TSX.V:) are examples of a couple I have mentioned before.

For example, Seafield has a strong potential to add to its resource. Its valuation is less than most other Colombian junior gold explorers. I like that there has been insider buying recently in the stock.

Majescor has some similar attributes. It is in Haiti, so it’s a totally different area, but the company just recently raised money and has cash to proceed over the next year. Insiders participated in that raise as well. It’s a very low market cap.

TGR: Majescor also has a project in Madagascar, a volcanic massive sulfide project, which seems like something that you would be interested in because it has not only gold and silver, but also copper-zinc-gold-silver mineralization. What is your view on that project?

SP: The major reason that I own Majescor is for its Haiti project. But it is also good to invest in a company that has multiple projects. If one doesn’t work out then the hope is that the other one will.

TGR: What’s your outlook for gold and silver?

SP: My view of gold and silver is that they trade with the U.S. dollar. The U.S. dollar has rallied in recent weeks and gold has dropped $300. If the commodities all improve and appreciate over the next couple of quarters, gold will probably get dragged along. But they aren’t the preferred commodities that I like to invest in at the current time. I think there are other commodities that make more sense and that will perform better.

TGR: Namely?

SP: Copper, potash, oil, gas, zinc and coal.

TGR: Thank you very much for talking with us.

Steve Palmer is a founding partner and chief investment officer of AlphaNorth Asset Management. Prior to founding AlphaNorth in 2007, he was employed at Canadian Equities, one of the world’s largest financial institutions, as vice president where he managed the Canadian equity assets of approximately $350 million. Palmer managed a pooled fund, which focused on Canadian small-capitalization companies from its inception to August 2007 achieving returns that were ranked #1 in performance by a major fund ranking service in their small-cap, pooled-fund category. He also managed a large-cap fund, which ranked in the first quartile of performance among other Canadian equity pooled funds. From 1997–1998, Palmer was employed as a portfolio manager at a high-net-worth investment boutique. Palmer earned a B.A. in economics from the University of Western Ontario and is a Chartered Financial Analyst.