With high market volatility, running a small fund like the Magna Opportunity Fund, which seeks to deliver exceptional returns, requires nimble management. In this exclusive interview with The Gold Report, Bo Chew tells us how he does it and what criteria he uses to select his fund’s investments. In the process he drops quite a few names with good upside potential for investors to consider in the current market environment.

The Gold Report: The CBOE VIX Volatility Index was all over the map in 2011. Your Magna Opportunity Fund is capped at only $20 million (M) with a goal of producing exceptional returns by trying to be nimble within the market. Can you explain how you plan to achieve this when a lot of the larger and more diversified funds try to just stay even?

Bo Chew: With this particular fund we expect to deliver very high returns by being concentrated in about 30 holdings where each position has a realistic potential to increase 100% within 12 to 24 months. The basic premise is buying companies that are undervalued, have great people, offer huge upside and have important catalysts in the next 6 to 12 months. Unlike large funds, we can take advantage of really beaten down companies or less liquid opportunities. One example is Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE), which recently reached a three-year low at $33/share, down from a 52-week high of $78/share, due to closing Goldex and the challenges experienced at Meadowbank. With Agnico we bought $35 January 2014 call options for $6.90.

In 2012 Agnico-Eagle is expected to produce 1 million ounces (Moz) of gold at $750/oz cost, producing $950M of cash flow, and its market cap is only $6 billion (B). So, over the next two years we see a lot of potential catalysts, including possible resumption of operations at Goldex, lowering costs at Meadowbank, advances in Meliadine and La India, plus resumption of growth in 2013. If Agnico-Eagle gets back to $60/share, we’ve got a gain of 260%, not counting the value of the options.

TGR: So, you’re playing that one through the options and not through the stock itself.

BC: That’s right.

TGR: That certainly gives you plenty of upside leverage if you guess right. And, it limits your downside to the cost of your options.

BC: Exactly.

TGR: I’m assuming that in most cases you’re probably going to be buying the stocks rather than playing options. Right?

BC: Yes. We have two options currently. The other one is Kinross Gold Corp. (K:TSX; KGC:NYSE). We try and buy them when we see them, in this case at multi-year lows, where we believe that the company is strong and its share price will recover.

TGR: How far out are the options?

BC: Two years.

TGR: Are you also buying physical metals or just equities and options?

BC: Generally we stick with equities and options. We do try to maintain about 10% cash and also we have the ability to leverage 25%. That gives us a lot of room to take advantage of opportunities. From time to time, we’ll trade 10% in silver or gold exchange-traded funds.

TGR: Do you have a preference for how you weight your portfolio between the various sizes of companies?

BC: We tend to prefer the small caps and like the mid caps as well. The challenge with large caps is that in most cases I can’t realistically see a stock increasing 100% within 12 to 24 months unless it’s something that is really beaten down and misunderstood.

TGR: You can always play the options on the large caps if you can hit the right timing.

BC: Correct. For example, the other option that we’re looking at is on Cameco Corp. (CCO:TSX; CCJ:NYSE), two years out as well.

TGR: You’ve also made an investment in the Commodity Capital Midas Letter Opportunity Fund. What do you like about it?

BC: We like the people: James West and Tobias Tretter, whom we had the opportunity to talk to a number of times and to meet. This particular fund is unique because approximately 80% of it is in placements, of which 30% is in seed and pre-IPO. We also get access to some of the placements for our fund. A huge advantage is we get warrants. On the pre-IPOs, we’re getting in at significant discounts.

TGR: How long do you typically have to wait for a pre-IPO investment like that to turn liquid?

BC: Often on a pre-IPO you might have to wait two to six months. For example, there’s one we’re buying in at about $0.15/share and the discussion is that within three months the company will do the IPO at $0.35 to $0.40/share.

TGR: Turning to junior stocks, 2011 was a pretty dismal year. Are you expecting that 2012 will be a breakout year for them?

BC: That’s a good question. The juniors are definitely quite undervalued. We do expect 2012 to be a good year as merger and acquisition activity picks up. However, it doesn’t really need to be to help our performance because catalysts in the next 6 to 12 months with our stocks can push the prices up.

TGR: So, you’re looking for specific catalysts that are independent of what the general market is going to do?

BC: Yes. I’m looking at companies that are advancing projects through to prefeasibility or feasibility or derisking as they ramp up toward production. We try to buy at the point in the resource company cycle where there’s less risk. Often, that means buying early while the story is being formed and there isn’t a lot of exposure. We also buy after a company has largely derisked the project and it’s within one or two years of production. Sometimes we also buy when a company has disappointed but it’s still a good company with an intact story.

TGR: How do you decide when you want to sell?

BC: The sell decision is based on one of the four buying criteria—value, catalysts, great management and upside potential—breaking down. Often we’ll sell a stock when it’s run up because there’s no longer value, or when key people leave and we feel that materially impacts the ability for the company to move projects forward or when there’s an absence of near-term catalysts.

TGR: Just looking at the price chart will give you a good indication of how much longer you might want to hang on.

BC: That’s true. Often you have to give the markets time to tell you whether you’re right or wrong.

TGR: Can you tell us about some of the companies you particularly like at this point and what you’re expecting from them in the next couple of years?

BC: One of those would be Barkerville Gold Mines Ltd. (BGM:TSX.V). Barkerville is a $90M market-cap company with 117,000 hectares in the Cariboo Gold Belt in British Columbia that has produced 3.8 Moz of gold historically. It has seven past-producing mines; three gold deposits, including the QR Mine and a 900-ton-per-day (tpd) mill; and recently permitted the Bonanza Ledge Mine. I like this particular company because there’s been a lot of gold produced in this area. It has really beefed up its advisory team and insiders own about 10%.

In 2012, Barkerville intends to process ore from Bonanza Ledge to produce about 20–30,000 ounces (20–30 Koz). At $800/oz cash cost and $1,700/oz gold, operating cash flow will be between $18M and $27M. There is potential to develop additional mineable reserves at the QR Mine to boost that production to 50 Koz in 2012. It’s waiting for results on 33 more holes. One hole at Cow Mountain returned 52 meters of 14.2 grams/ton (g/t) gold. Within 24 months we would expect over 100 Koz of annual production. At a conservative $3,000/oz, we’ve got a $300M value to the company, which triples its $90M market cap.

TGR: Well, those are pretty substantial numbers.

BC: Scorpio Gold Corp. (SGN:TSX.V) is another one we like. Scorpio owns 70% of Mineral Ridge in Nevada, which has a history of gold mining dating back to the mid-1800s. There’ve been problems with this particular mine more recently. It sat dormant from 2005 to 2010 until Peter Hawley, founder of silver producer Scorpio Mining Corp. (SPM:TSX), took over in 2010. Insiders own 38%. Production started in May 2011 from the Drinkwater pit. Mining at the Mary Zone has just started increasing the production at Mineral Ridge to about 5 Koz per month. The ownership increases to 80% after four months of production above 3.5 Koz. The current resource is only 357 Koz, but it’s only from two pits. There are another eight pits that are defined and another three pits outlined. Drilling between the pit areas should expand the resource and define a possible super pit that could be 3–5 Moz. If cash costs decline and production increases to 80 Koz, and if a super pit is defined, we expect Scorpio Gold to do very well.

TGR: Definitely has some big upside there too. So, what else do you like?

BC: MAG Silver Corp. (MAG:TSX; MVG:NYSE) is a company focused on two large-scale projects within the Mexican silver belt. MAG has a 44% joint venture with Fresnillo on a 221 Moz silver project called Juanicipio. It’s one of the highest quality silver deposits in the world and borders the Fresnillo mine, which is the largest primary silver mine in the world. MAG has a significant land package in the area and we expect it to be taken over at some point.

TGR: That makes sense. Of course, all these companies that have something substantial going for them are potential takeover targets.

BC: For sure. We also like Pretium Resources Inc. (PVG:TSX; PVG:NYSE). Pretium is another one of our mid-cap takeover targets. It owns the advanced stage Brucejack and Snowfield projects in northern British Columbia with a combined 56 Moz of gold in all categories. Brucejack is one of the largest high-grade projects with 5 Moz at 16.9 g/t gold Measured and Indicated and 3.3 Moz at 25.6 g/t gold Inferred. So, the updated Brucejack preliminary economic assessment shows a net present value of $2.2B pretax.

TGR: On a per share basis what does that present value work out to?

BC: About $25. I like Pretium because that particular project has a lot of expansion potential with the large land package.

TGR: It’s always nice to have big upside to expand resources.

BC: Another company we like is South American Silver Corp. (SAC:TSX; SOHAF:OTCBB), which has traded at a significant discount given its 230 Moz Malku Khota silver deposit. There are two reasons: it’s low grade and it’s in Bolivia. South American Silver is given very little value for the new 3.8 billion pound copper deposit in Chile, which is 35 kilometers (km) from El Teniente, the world’s largest underground copper mine. The in-ground value of this deposit is roughly the same as the silver deposit. South American Silver is led by Greg Johnson, co-founder of NovaGold Resources Inc. (NG:TSX; NG:NYSE.A). Zamin Precious Minerals Ltd., a resource company with operations in South America, is 19% owner. It has a really strong relationship within the government of Bolivia, which has confirmed that private investments in mining, and South American Silver in particular, are welcome and will continue to be respected.

TGR: Apparently, the market hasn’t recognized that and is focused on the political risk more than on the upside potential of the resource.

BC: Yes. Malku Khota makes up for the low grade with its high indium and gallium value. The preliminary economic assessment (PEA) shows that at $18/oz silver, there’s $704M net present value (NPV) at 5%. And, the cost to produce net of byproduct is $2.94/oz. The catalysts for South American Silver are securing offtake agreements for the indium and gallium, completing prefeasibility and feasibility studies, and likely takeovers or joint ventures on both projects within 24 months.

TGR: So, that’s relatively short-term visibility for upside movement.

BC: That’s true. A little smaller company we like is called Metanor Resources Inc. (MTO:TSX.V; MEAOF:OTCPK). It is bringing its Bachelor Lake mine in Québec into production and has begun milling ore from a 5,000-ton bulk sample. Metanor is expected to produce 60 Koz of gold at a cash cost of $464/oz. Some 20% of the gold goes to Sandstorm Gold Ltd. (SSL:TSX.V) at $500/oz. Metanor has 1.6 Moz of resources with a fully permitted 1,200 tpd mill and the infrastructure replacement value is $150M. The huge upside comes from the 781 Koz Barry deposit, which has the potential to become a significant low-grade, high-tonnage deposit like Osisko Mining Corp.’s (OSK:TSX) Malartic mine. Osisko has a $4.5B market cap and will be producing about 610 Koz/year starting this year. Barry has only had 50km of drilling on a potential 13km strike, compared to the million meters of drilling at Malartic. If you multiply the drilling at Barry 20-fold, it could conceivably host a 14 Moz deposit.

TGR: That’s a lot of expensive drilling.

BC: Perhaps, but it should have cash flow to help with the drilling. Industrial Alliance recently put out an estimate that the 300 Koz resource at Bachelor Lake is estimated to be about 700 Koz, which can extend the mine life to 10 years. So, if we take Bachelor Lake at 60 Koz/year, Metanor’s 80% portion is 48 Koz. If we only assume $1,000 of operating cash flow per ounce, we’ve got $48M of cash flow. And, the company is trading at only about a $68M market cap.

TGR: Any others you’d like to talk about at this point?

BC: Avino Silver & Gold Mines Ltd. (ASM:TSX.V; ASM:NYSE.A; GV6:FSE), a re-emerging silver producer in Mexico, is expected to produce 1.1 Moz silver equivalent. Avino is in the process of stockpiling ore and will commence production once it has enough to operate at 250 tpd. It is targeting 3 Moz of silver production from three projects within three years. It does have a proven resource at San Gonzalo and the Avino vein as well as a tailings resource. Avino’s market cap is only $61M.

Another company we really like is Gran Colombia Gold Corp. (GCM:TSX.V) because it’s an extremely undervalued gold producer. It’s taking production from 90 Koz to 540 Koz by 2016. It has total gold resources of 13 Moz with a market cap of $220M. Its main operating mine, Segovia, has planned expansion in 2013 to increase production to 200 Koz per year with cash costs of less than $900/oz by the end of 2013.

Gran Colombia’s other project is Marmato, with 12.4 Moz gold and 75 Moz silver. A PEA done in 2011 shows a mine that’s projected to produce 540 Koz gold and 1.3 Moz silver at $524/oz costs. As it ramps up production and gets closer to putting Marmato into production, we expect it to be taken out as well.

Another company that has really been beaten up due to delays is Gryphon Gold Corp. (GGN:TSX; GYPH:OTCBB). It was supposed to be in production at 43 Koz gold per year this March. It has about a 2.1 Moz combined resource in Nevada; $1,000/oz of operating cash flow times 43 Koz is $43M on a market cap of $30M. In addition, there are three new anomalies that have been identified, each significantly larger and shallower than the main sulfide resource, which is about 1.1–1.2 Moz. So, there is potential for Gryphon to get into the 3–5 Moz size.

TGR: Sounds good.

BC: We also see upside in Geologix Explorations Inc. (GIX:TSX), which has a $44M market cap. Geologix’s Tepal project in Mexico shows a PEA with a $412M NPV at 5%. And, there’s a potential for this to continue growing. There’s a new resource estimate expected in March and a prefeasibility study in June. Depending on how the prefeasibility study goes, it could be in production in 2014.

TGR: Do you see any developing opportunities that are still in the early and more speculative stages that might be places for people to get into at this point?

BC: I think there are a couple of areas. One would be commodities that are less common or less mainstream, like graphite or tungsten. Also, companies that are less followed could be great opportunities, because with less news there’s very little hype and very little trading, leading to potentially depressed levels. There are many great opportunities, but you have to do your research.

In the category of companies that are less followed, one is Xtierra Inc. (XAG:TSX.V), which is a $26M market-cap company with about $8M in cash. It has $100M silver equivalent in Mexico and is advancing the Bilbao project, which is likely to produce 2 Moz silver in Q414. But, it also has a tailings project that could produce 2 Moz silver, which is likely to come onstream earlier than that.

TGR: So, is there anything else you’d like to talk about?

BC: I have one more company in a less mainstream region. This is Minco Gold Corporation (MSV:TSX), which has a $168M market cap with $70M in cash. It has a 101 Moz silver deposit in China with significant resource expansion potential and is very close to getting into production at 5.5 Moz/year at a $5.65/oz cost. There’s been very little news and it’s just waiting for the environmental impact assessment to start construction. It is fully funded to production, which is expected in Q114.

TGR: What would you like to leave with our readers as far as how they can best profit in the current investment environment?

BC: We have a volatile investment environment so it’s important to keep a certain amount of cash available to take advantage of opportunities. At the same time you have to take your profits when things do go up. Resource investing is inherently risky as only a small percentage of deposits ever become mines. But, you’ll have greater success focusing on high-quality projects with a lot of blue sky run by excellent people who have financed, built, joint ventured and sold mining operations. These companies can reward shareholders in today’s very difficult environment.

TGR: That’s a good investment philosophy with useful guidelines to follow. Thanks for giving us a nice list of creditable companies with some great upside potential.

BC: Thank you.

Bo Chew is the manager of the Magna Opportunity Fund and has been associate portfolio manager with Chartwell Asset Management since 2010. He is the principal of Legacies Financial Group and was formerly the trading director for Chartwell Financial Inc, a mutual fund dealer, from 1994 to 2006. He is a Canadian Investment Manager (CIM). Chew has successfully managed a stock account since November 2003 using a similar investment approach as the Fund. He seeks the highest returns without excess risk and has a significant amount of money in the Fund.

The precious metals equities selloff at the end of 2011 was overdone, says Stephen Taylor, portfolio manager of The Taylor Fund and founder of Taylor Asset Management, in this exclusive interview with The Gold Report. Taylor remains bullish on gold, silver and base metals and is looking to some names that were walloped in the selloff to prosper in the next three years.

The Gold Report: The Global and Mail reported that more than 50 private-equity mining deals were struck in Canada in 2011—more than in any other sector. Why is private equity pouring venture capital into junior mining plays faster than any other Canadian business sector?

Stephen Taylor: The important thing is that private equity funds have the patience and the experience to take the long-term view that’s required with development-stage mining companies. There’s been a growing dysfunction in the U.S. initial public offering market for small-cap companies and development-stage enterprises of any type. It has led to depressed valuations. It’s not surprising that managers of private equity funds have the patience and see some bargains and are jumping into the sector.

TGR: Most of the deals involved minority positions, not takeovers. Why?

ST: That is really the best way to do deals as a private equity investor. These firms are looking to partner with or back experienced management teams. Experienced management teams are increasingly reluctant to cede control to an outside firm that doesn’t have real expertise in the mining sector. Trying to seek majority control would be a mistake.

TGR: What was the performance of The Taylor Fund in 2011?

ST: The fund, which has about $45 million under management, had a rough year. It was down about 20% in 2011 after a gain of 21% in 2010 and 96% in 2009. Since inception, it’s averaged just more than 26% a year versus about 9% a year for the S&P 500.

TGR: What’s the current industry weighting of the fund?

ST: It’s about 40% invested in energy, which is mainly oil and gas. Mining comprises about 30%. About one-third of the companies are in China, another third are in the U.S. and the final third are in Canada. The Canadian component includes many companies that have substantial operations in other parts of the world.

TGR: You previously told The Gold Report that you saw some “overdone selloffs in the resource space.” Was the selloff that occurred in the latter half of 2011 overdone?

ST: It clearly was. It seemed that 2011 was particularly fierce in the junior resource space. Sharp selloffs have been followed by quick bounce-backs. Miranda Gold Corp. (MAD:TSX.V) sunk from $0.67/share to $0.24/share at year-end but has since recovered somewhat. Silvermex Resources Inc. (SLX:TSX; GGCRF:OTC) went from about $1/share to $0.36/share at year-end, but is back up to $0.46/share.

TGR: Did the Taylor Fund add to existing positions or new positions as other investors were exiting junior mining plays?

ST: We were indeed. We were selective buyers on our core positions like Lumina Copper Corp. (LCC:TSX). We participated in the recent Anfield Nickel Corp. (ANF:TSX.V) financing. We want to be selective in our new additions, but we’re always going to be looking to quality management teams as one of our first conditions.

TGR: How long on average do you hold a position in junior mining?

ST: Typically, two to three years. Last year, we did lighten up in some names where the results weren’t what we had hoped. We lightened a bit on Fire River Gold Corp. (FAU:TSX.V; FVGCF:OTCQX) after some disappointing results.

TGR: You remain bullish on precious metals in general?

ST: As long as central governments around the world continue to print money and to telegraph a low to negative real interest-rate policy, precious metals are the place to be quite frankly. The next two quarters may be flat to sideways, but over the next two to three years precious metals are going much higher.

TGR: News about the Greek debt deal pushed the gold price up recently. Was this just a short-term uptick?

ST: The Greek debt deal is the first of many as other countries around the world will ultimately be forced to restructure their obligations as well. All of these will contribute to rising demand for precious metals and will support higher prices. It could occur in the next quarter or the next year, but I won’t be so bold as to make that distinction. I do know I want to be long on precious metals and that they’re going to be much higher over the course of several years.

TGR: Anfield and Lumina are nickel and copper plays. Do you see value in base metals?

ST: I do. There’s a long-term secular rise in living standards that will continue for a huge portion of the world’s population in China, India and Brazil. As this process grinds forward over the next 10–30 years, regardless of short-term disruptions, there will be an inevitable increase in demand for base metals. Existing deposits also continue to be depleted. As owners of some of the largest undeveloped base metals projects in the world, Anfield and Lumina are going to be well positioned.

Lumina is one of many Ross Beaty–related companies with which we’ve been involved. He has a tremendous record at generating shareholder value. The company has done extensive drilling on the Taca Taca property in Argentina during the past couple of years. There has also been significant historic drilling done on the project. The deposit just gets bigger and bigger. It’s close to being the largest undeveloped copper deposit in the world, if it’s not already.

That’s going to be a very valuable resource to someone. The company has indicated that it’s going to put itself up for auction at some point in the next several months. Based on transaction prices for other undeveloped copper deposits, the ultimate sale price could be in the neighborhood of $1 billion, or about $20/share. I think Lumina will be acquired or bought out in 2012 at a price in excess of $20/share.

TGR: David Strang, who is president and CEO of Lumina, was also involved in the management teams of Global Copper, Northern Peru Copper, Lumina Resources and Regalito Copper, all of which were bought by bigger players. How long before Lumina gets a takeover bid?

ST: Within the next 6 to 12 months. It’s possible that an unsolicited, unexpected bid could emerge before then, but I believe the company will begin to actively solicit bids in the first half of 2012.

TGR: What does Lumina need to do before that happens?

ST: It just needs to continue to derisk the project. The largest elements have been done. Frankly, the deposit is so big at this point that I almost wish the company would explore creating a spin-off vehicle to hold a portion of it for further exploration and perhaps to sell down the road.

TGR: It’s an interesting story because it’s less than 100 kilometers from the Escondida Copper Mine owned and operated by BHP Billiton Ltd. (BHP: NYSE, BLT: LON, BHP:ASX) and Rio Tinto Plc (RIO:LSE). That certainly seems like a likely dance partner.

Anfield, which has essentially the same management group as Lumina, has a nickel laterite project in Guatemala. Anfield was assembled by Ross Beaty years ago and seems to work pretty well. Is Anfield a takeover target as well?

ST: I believe it is. This team has skin in the game. They have substantial personal investments in these companies. They also participated in the recent financing. As a side note, they also participated in the Lumina financing in November. I really respect that. It sends a very positive signal when management teams put up their own money and buy at prices that are close to what other investors paid.

TGR: What are some of the companies that you have positions in that are developing precious metals projects?

ST: We continue to be fans of Miranda. It has a number of irons in the fire and, ultimately, one or more of them are going to hit. It did a joint venture with Red Eagle Mining Corp. (RD:TSX.V) on the Pavo Real project in Colombia. I wouldn’t be surprised if Miranda continues to pick up projects in Colombia and elsewhere.

Red Eagle continues to drill Pavo Real. It has been able to attract some sophisticated, smart investors. I’ve heard that Ross Beaty and his group have a position slightly less than 10% in Red Eagle. That speaks volumes as to the quality of the group that Ken Cunningham, CEO of Miranda, and Ian Slater, CEO of Red Eagle, put together.

TGR: Red Eagle has two main projects, Pavo Real and Santa Rosa. Which one of those excites you more?

ST: The drill results from Santa Rosa were OK. Clearly, one hopes for a homerun. The potential for those in a place like Colombia always exists. However, I don’t play favorites. I will stand by the management team and not play geologist today.

TGR: You weren’t overwhelmed by the drill results from Santa Rosa?

ST: Don’t get me wrong. I was not disappointed by the Santa Rosa results. It’s just that I’d love to see a homerun and this was double.

TGR: Do you think it’s starting to look like a bulk tonnage target?

ST: It’s always a possibility. The company didn’t have any preconceptions. The point of the drilling program was to see what it had and which direction that would take it. It’s got some good potential there. Let’s see where the drill bit takes us.

TGR: Miranda has projects in Colombia, Nevada and Alaska. Which one is getting the lion’s share of the attention?

ST: It has good joint venture partners that are busy drilling away in Nevada, one of which is Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE). But the attention going forward in terms of new developments could be additional land in Colombia. CEO Cunningham clearly has his eyes and ears open. It wouldn’t surprise me to see the company pick up some additional property there.

TGR: You mentioned Silvermex earlier. What are your thoughts on it?

ST: Silvermex continues to do a good job ramping up production at La Guitarra. It’s slow and steady. Its stock got caught in the selloff that we talked about earlier, but it’s trudging along.

I’m very bullish on silver. I believe that could outperform gold on a percentage basis over the next two to three years. Silvermex is a great way to play that trend.

TGR: What’s the next catalyst for that stock?

ST: It’s going to be either the silver price and the macro developments that drive that or further delineation of its plans going forward at La Guitarra. Silvermex is getting some good drill results in some high-grade areas. Everyone’s waiting to see where it wants to go.

TGR: Does Pan American Silver Corp.’s (PAA:TSX; PAAS:NASDAQ) purchase of Minefinders Corp. (MFL:TSX; MFN:NYSE) bode well for a company like Silvermex?

ST: Clearly, Silvermex could be a good acquisition target at some point. It’s a process that will continue into the years ahead, however.

TGR: You also have a position in Largo Resources Ltd. (LGO:TSX.V)?

ST: We have a small position. We like CEO Mark Brennan, Largo and vanadium. It had to do a bit of a dilutive financing to get its mine under construction. We may invest more in that name at some point, but we’re largely on the sidelines at the moment.

TGR: Do you have any final thoughts on the space for investors?

ST: My biggest worry for a lot of these development-stage companies is governmental risk. Governments and jurisdictions around the world may get greedy when faced with the pressure to restructure their financial obligations and debt. They may attempt to take a bigger piece of the pie. That’s a risk that’s always been part of the mining business, but investors should be particularly attuned to that over the next two to three years.

Stephen Taylor is chairman and CEO of Taylor Asset Management, a Chicago-based investment management firm focusing on small-cap domestic equities and emerging markets. He also serves as a portfolio manager for the Taylor International Fund Ltd., a small-cap equity fund. In addition to emerging markets, Taylor’s area of expertise includes private equity, restructuring and turnaround situations and both small- and mid-cap companies. He has considerable experience in the natural resources and finance industries in Canada and China.

Opportunities abound across the spectrum of precious metal equities, which remain undervalued as bullion prices continue their upward trends. That’s the word according to Charles Oliver and Jamie Horvat, both senior portfolio managers at Sprott Asset Management. In this exclusive interview with The Gold Report, Oliver and Horvat express cautious optimism about the prospects for gold stocks in 2012.

The Gold Report: When we talked in the wake of the debt ceiling crisis last fall, Charles, you expected volatility to be good for gold and forecast a continuing long-term bull market for precious metals. These days, the scary stories pertain to the European Union (EU). Will negative headlines continue to play a role in the price of gold and silver?

Charles Oliver: Absolutely. The headlines about the European Central Bank (ECB) infusion of billions of euros into the banking system has been very good for the price of gold. Since the ECB announced it would be issuing €489 billion in December, gold has had a nice little rally off its lows. I expect in the next couple of weeks a further issuance of money will be quite supportive for gold.

Europe is still a mess. Greece seems to be heading to bankruptcy in slow motion. That problem has been going on for two years and we could find these issues still persisting a year from now. Ultimately, central banks around the world will continue to print and debase their currencies, which will be very good for the gold price.

TGR: Jamie, do you agree with that? Or might Greece strike a deal to pay off its debt, turning the price of gold down?

Jamie Horvat: I think the deal is based on the fact that the only tool governments have at their disposal is the continued monetization of debt and the continual printing of money, which is always good for gold. On the other hand, if Greece does not get the sought-after debt relief and restructuring or, if it is kicked out of the EU, it could result in the unwinding of the European banking system and could have larger implications globally. If that happens, we’ll see a short-term hiccup in the gold price as it is used as a source of liquidity and investors sell their future in an attempt to live and fight today. That may be the tail-risk event as we continue to see additional quantitative easing (QE) programs all over the world. From Japan to the UK, more than $1 trillion could be spent in the next few months to provide ongoing liquidity in Europe. That is why the longer term outlook for gold is still positive.

TGR: In a November television interview, Charles, you expressed concern about China’s growth. Has that changed? And what are the implications for precious metals?

CO: The China story affects the industrial metals more than the precious metals, but I’m still concerned that we see weakness in China. The volume of loans being done now and the contraction we’re seeing there both signal that weakness. A number of other economic statistics indicate that China is clearly slowing down; the only question is how big a slowdown it is. Ultimately I think it will impact the base and bulk metals more than gold and silver—copper, iron ore, steel, those types of things.

TGR: Your $644.5 million Sprott Gold and Precious Minerals Fund ended 2011 with a tough quarter, off 10.6% compared to an 8.7% loss on the benchmark S&P. Your quarterly report cited tax-loss selling as one of the reasons for thinly trading stocks performing poorly. Have you adjusted your portfolio since then?

CO: The portfolio is continuously being upgraded. We made a number of changes during the last quarter. We did some of our own tax-loss selling in the portfolio. When I sold some of those stocks, I tried to redeploy the proceeds into some of the other names that I wanted to own that were also experiencing tax-loss selling. A lot of companies in the junior space were down 70%. It wasn’t through any fault of their own; it was just because the market had no interest in small companies because it was risk averse last year.

TGR: Were the other names you were buying into mainly juniors?

CO: Yes, there were a fair number of juniors, but every segment of the gold stock market is very cheap today. I can find great valuations in small-, mid- and large-cap stocks. All of them are extremely cheap. That’s not always the case. You might think all segments would move together, but in reality one segment often does much better than the others during a particular year.

TGR: It appears as if about 30% of the fund is dedicated to the small-cap issuers, which have a little bit higher risk profile then the large caps. Do you see those small caps as the way to drive growth in the portfolio?

CO: If you look over the last decade, a lot of the alpha that’s being generated in the gold fund has been through small- and mid-cap names. That’s across the board. Whether in the gold space, the oil space or any other type of stock, generally speaking, small-cap stocks have better growth and long-term growth returns.

TGR: What are some of the juniors you picked up as you were redeploying at the end of the year?

CO: I can mention a few names from my most recent year-end report for investors. Canaco Resources Inc. (CAN:TSX.V) is a small cap with a project in Tanzania. It did a financing at around $5.40/share back in March 2011. It’s a good stock, but through tax-loss selling and an aversion to small-cap stocks, it has traded down to below $1.50/share. What a great opportunity.

I looked at Canaco several years ago. It was really interesting, but it was a little on the early-stage side and it got away from me. I’m not one who likes to chase stocks; I don’t run after them. And then last year, Canaco had a lot of cash on its balance sheet and suddenly came under severe selling pressure. I thought, “Great, I’m getting a second opportunity to buy something at a much better price.” Additionally, I expect its property in Tanzania will one day be a mine.

TGR: How many years away is that?

CO: Probably 5 to 10 years. The lifecycle in the mining industry is usually at least that long from a grassroots discovery through permitting, construction and ultimately getting into production. In the small-cap space, I’m always on the lookout for companies that I believe will have a mine at some point in the future. Canaco is a good example of that.

TGR: Any other examples of companies that could be big movers in 2012?

CO: Another company, Lake Shore Gold Corp. (LSG:TSX; LSG: NYSE) was down 70% in the last year. I actually owned it a couple of years ago, and thought it got expensive. It was trading north of $4.50/share not too long ago, and went down to almost $1/share. The company had a few hiccups in terms of its mine plan, but the stock has been overdone. I sold it up much higher and took this as an opportunity to get involved with it again.

TGR: How high could it go?

CO: There is no reason Lake Shore Gold can’t get back to the highs it made last year if it executes on its strategy. These things usually just take a bit of time.

TGR: Eric Sprott is probably one of the leading silver bulls in the world. In your view, what’s the ideal balance between gold and silver equities and bullion in an investors’ portfolio?

CO: I believe it makes a lot of sense to have a combination of both stocks and bullion. It really depends on the individuals in consultation with their financial advisors to get the appropriate allocation. Bullion is an asset that helps preserve capital. You’re not there to make a killing. You’re there to protect capital, especially in the context of the currency debasement that is going on. Gold stocks are more of an asset used to capture capital gains during the bull market we are in. Many studies have suggested that 5–10% on a long-term basis is a good allocation to precious metals. I’ve heard some numbers much higher at the Sprott organization, but again, I think it ultimately depends on an individual’s goals, propensity for risk and capital preservation requirements due to age and circumstances.

TGR: What are some of your favorite names among silver equities?

CO: I like the large caps. Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ), which is trading at about 9–10 times its price/earnings (PE) ratio, has potential to double production over the next five years as it builds its Navidad mine in Argentina. Pan American is fully funded to get that growth.

Coeur d’Alene Mines Corp. (CDM:TSX; CDE:NYSE) is another one trading at about 9–10 times its PE ratio. It has doubled production over the last four to five years. This company actually has done a great job; it’s one of the few over the last couple of years that have managed to do a pretty darn good job of keeping cash costs very low. If you look at almost all of the large-cap silver names, you’ll find most of them trading either at high single-digits to low double-digit PE ratios. They are extremely cheap.

TGR: What are some catalysts that could take Coeur d’Alene to the next level?

CO: I think it’s just a matter of time and execution. Ultimately these companies will make good earnings and cash flows at the current price. One of the things we’ve seen in the gold sector, and are certain to see a bit in the silver sector, is that a lot of these companies are starting to initiate dividends. Last year Hecla Mining Co. (HL:NYSE) announced a plan to pay a dividend linked to the silver price. In a recent presentation I attended, Coeur d’Alene suggested that it might start looking at paying a dividend sometime next year.

TGR: Could that have a big impact on the share price?

CO: We will have to wait and see, but I think investors look for good companies that pay nice yields.

TGR: What are some other promising silver names?

JH: On the development and exploration side, Tahoe Resources Inc. (THO:TSX) has great potential as it moves toward production on its flagship Escobal project in Guatemala. We like what we see in Tahoe’s exploration there—the whole development story. It may have a world-class asset with the resource and reserves it currently has on hand—plus significant exploration upside as well.

Scorpio Gold Corp. (SGN:TSX.V) is a junior that has come off the bottom. Scorpio has been viewed in the past primarily as a base metals company and a zinc producer, but most of its upside in terms of both exploration and production now comes from silver exposure. I continue to like Scorpio.

TGR: With so many companies in the small- and large-cap area beaten down, how do you determine which ones will deliver?

JH: As Charles mentioned, valuations are pretty depressed. Looking at the large caps broadly, you have to distinguish between those that are executing projects and those that aren’t. Among the companies reporting recently, Agnico-Eagle Mines Ltd. (AEM:TSX/NYSE) and Kinross Gold Corp. (K:TSX; KGC:NYSE) are two examples of companies that unfortunately lost some ground. Agnico enjoyed a premium thanks to its growth profile, but lost that premium because it didn’t execute on that growth profile. Kinross, too, has declined due to the lack of execution.

On the other hand, Barrick Gold Corp. (ABX:TSX; ABX:NYSE) was in line and Goldcorp Inc. (G:TSX; GG:NYSE) was above estimates. Both Barrick and Goldcorp have growth projected into 2016, but they’re trading at depressed multiples to the group. Goldcorp has 60% growth ahead of it.

Investors who have been going to the price participation of exchange-traded funds or gold bullion will slowly start coming back to the market if some of these companies continue to capture that cash-flow margin and continue to increase dividend payments. They will be attractive to investors if they show a willingness to return capital to shareholders. In terms of the market in general, investors seem to want to be paid to participate in the market, so they are looking for companies with yield.

TGR: What names fit the criteria you mentioned for companies that have upside ahead of them?

JH: Based on projects in development and assuming they continue to execute and move the projects forward, some of the names I like are Belo Sun Mining Corp. (BSX:TSX.V), Colossus Minerals Inc. (CSI:TSX), Continental Gold Ltd. (CNL:TSX), Premier Gold Mines Ltd. (PG:TSX) and Perseus Mining Ltd. (PRU:TSX; PRU:ASX). These are all things I continue to monitor and continue to like.

TGR: Belo Sun is sitting at about $1/share now. What do you like about it?

JH: Belo Sun’s 100% owned Volta Grande project in Brazil is located in an area with good infrastructure and the government is building the world’s third-largest hydro-damming facility just to the north. It’s a really good project with recent—and continuing—exploration success, in a good jurisdiction with good economics around the project. I believe that has the potential to be a mine one day.

Belo Sun also has added significantly to the resource and continues to move the project forward. I’ll continue to like those types of projects as long as they continue to execute. So far, though Belo Sun hasn’t been rewarded for its success. Small caps were down 38% on average in 2011.

TGR: Do you have favorite jurisdictions?

CO: When you look at the jurisdictions in our portfolio, about 80% of the companies are domiciled in Canada while 80% of the operations are international. We do have some big concerns about politics and country risk. A couple of years ago, when a lot was going on in Africa, we decided to cut back on some of our African names. Not eliminate them, but reduce the weighting and redeploy those funds into operations in North and South America. Now we are unfortunately experiencing some issues in South America, such as what is going on with the governments and some of the mining projects in Peru today. As with Africa earlier, last year we made an active decision to reduce exposure in Peru because of those concerns.

You can’t pick where the mines are—that’s geologically where the gold deposits are and it takes you to some challenging places. That is why we like to be in a lot of different countries, to diversify that risk. I have concerns about Peru but I’ve got a little bit of Peru. I don’t like Russia particularly, but I’ve got a little bit of Russia. Having a basket of these cases can minimize the risk. Having said that, I should be able to buy these companies in higher risk regions at cheaper valuations. Otherwise I certainly wouldn’t invest there.

TGR: Do you agree with that Jamie?

JH: Definitely. Taking a basket approach and diversifying the risk within the portfolio has been our practice for a long time. There have been a lot of discussions around people seeking more politically secure jurisdictions. But even in Canada, even in British Columbia, we have seen mines not get permitted based on native land rights issues, water usage issues and other local issues. So risk isn’t confined to places such as Africa or Peru. Using that basket approach definitely helps mitigate the jurisdictional risk.

TGR: You mentioned investors might start moving from bullion back into the stocks after a year when equities weren’t performing in line with the metals prices. The cliché is that investors are always wavering between greed and fear. What will give investors confidence to take a chance on some of these undervalued juniors?

JH: I think it all comes down to execution. Are you executing on that project? Are you moving it forward? Are you building per-share value by growing the resources and converting them into reserves? Are you advancing the project and doing the feasibility studies? Are you wrapping the economics around the feasibility of the project and the value and the leverage that you can obtain from putting that into production in the market? Companies that continue to execute and build their resources and reserves will get rewarded. Unfortunately, a lot of companies have made some missteps in the market.

TGR: Any other thoughts you would like to leave our readers with before we say goodbye?

CO: Gold equities didn’t do very well in 2011. It was a tough year. The last time we had equities perform so poorly was 2008. Then 2009 and 2010 were exceptionally good years for gold stocks. That pattern makes me cautiously optimistic that 2012 will be a very good year for gold stocks.

JH: I totally agree—2011 was a “lite” version of 2008. Small caps were down 78.5–79% in 2008, and last year they were down 38% on average. The U.S. banks and the mortgage-backed securities issue were at the heart of the 2008 liquidity crisis, and in 2011 the issues have rolled into a European bank and sovereign debt crisis—with the U.S. opening up the swap lines again, with unlimited U.S. dollar amounts to help with liquidity to European banks through to February 2013, I believe. Taking all of that into account, I’m cautiously optimistic. I’m hoping that as in the second half of 2009 into 2010, when we had a significant recovery in the precious metal space, we will see a similar type of recovery in 2012.

TGR: Thank you, gentlemen.

Bringing more than 21 years of experience in the investment industry, Charles Oliver joined Sprott Asset Management (SAM) in January 2008 as an investment strategist with focus on the Sprott Gold and Precious Minerals Fund (TSX:SPR300). Prior to joining SAM, he was at AGF Management Ltd., where he led the team that was awarded the Canadian Investment Awards Best Precious Metals Fund in 2004, 2006, 2007, and was a finalist for the best Canadian Small Cap Fund in 2007. At the 2007 Canadian Lipper Fund awards, the AGF Precious Metals Fund was awarded the best five-year return in the Precious Metals category, and the AGF Canadian Resources Fund was awarded the best 10-year return in the Natural Resources category. Oliver obtained his Honors Bachelor of Science degree in geology from the University of Western Ontario in 1987 and his Chartered Financial Analyst (CFA) designation in 1998.

Jamie Horvat joined SAM in January 2008. He is co-manager of the Sprott All Cap Fund, the Sprott Gold and Precious Minerals Fund, the Sprott Opportunities Hedge Fund LP and the Sprott Opportunities RSP Fund. He has more than 10 years of investment experience. Prior to joining SAM, Horvat was co-manager of the Canadian Small Cap, Global Resources, Canadian Resources and Precious Metals funds at AGF Management Ltd. He was also the associate portfolio manager of the AGF Canadian Growth Equity Fund, as well as an instrumental contributor to a number of structured products and institutional mandates while at AGF. He joined AGF in 2004 as a Canadian equity analyst with a special focus on Canadian and global resources, as well as Canadian small-cap companies. Horvat spent five years at another large Canadian mutual fund company as an investment analyst before joining AGF. He holds a diploma in mechanical engineering technology from Mohawk College and earned an Honors Bachelor’s of Commerce degree from McMaster University. He is a member of the International Research Association and a licensed international financial analyst. He is also a member of the Ontario Association of Certified Engineering Technicians & Technologists.