Paul Wong: First, it takes a lot of patience to be contrarian. You
also need to have a lot of discipline. Probably more important than anything
else, you need sticky investors. That's the hardest thing to get on the
planet right now, an investor willing to stick it out.
Contrarian investors have to have the stomach to buy when the market is in
the midst of a violent selloff, and they have to have the wherewithal to ride
the volatility of the storm. That's the patience and the discipline part.
Successful bottomfishing investors have to be able to discern the fine line
between a company that could rally hard after a down leg and one that is on
the verge of going bankrupt. You can throw luck into the requirements for
being a contrarian investor as well, but at the end of the day it is a
challenging way to approach building a portfolio so it is a good thing it
sometimes pays off so dramatically.
Mutual funds aren't traditionally built to be contrarian. I remember a
joke I learned when I was a junior portfolio manager. I mentioned to someone
that a stock could be a great investment in three or five years' time, and
the fellow shot back to me, "Yes, my successor will look quite brilliant
when that happens." That's the problem with long-term, contrarian-type
investments. It may be a great idea, but you may not have a job by the time
it pays off.
TGR: Does it take a lot more homework to be a contrarian investor
than following an index or a blue chip stock?
Maria Smirnova: Certainly, but that's what we do here. We stay in
touch with the companies in our universe all the time. We get to know the
management teams. So for us, it's par for the course.
TGR: That distaste for precious metals, particularly gold, seems to
be softening lately. What is your working estimate for gold prices through
the rest of 2015?
PW: We see gold prices range bound between $1,150 an ounce
($1,150/oz) and $1,300/oz. What's driving gold right now is the volatility in
the currency market. The U.S. dollar has been strengthening against every
currency on the planet based on monetary policy. The U.S. is just in a
different phase of its economic cycle than everyone else. The Federal Reserve
Board is now focused on increasing rates, possibly as soon as December of
this year. Conversely, Europe and Japan are still in quantitative easing
mode. They're looking aggressively to lower rates. Paired with attractive
bond yields and a domestic economy that is relatively stable, the U.S. dollar
will probably continue to be strong and that has an impact on gold prices.
TGR: Paul, you took the helm of the Sprott Gold and
Precious Minerals Fund (SPR300:TSX) in late January. Like the market,
it's had some challenging quarterly results. What adjustments have you made
and why?
PW: The main thing we did was increase the overall liquidity of the
fund. We break the fund into two parts, a trading part and a core portfolio
part. The trading part is mostly made up of the large-cap names because they
are more liquid. We are still very much in the long secular bear phase of the
market. We may be in the late innings of it, but we're still in the
retrenching game. That is why it is important to trade gold. It's one way to
add value. To protect the downside in the portfolio, we have to be actively
trading. That requires increasing the proportion of larger, more liquid names
in the portfolio.
TGR: On the trading side of the portfolio, has what makes a good
short-term trade changed as we've moved into this part of the cycle?
PW: No. It's typically the same. We always look for companies with
exceptional market negativity that get caught up in a selling frenzy, but
have the ability to rebound. That is a buying opportunity.
The converse is also true. A stock that had a tremendous run and is now
overvalued is an opportunity to sell calls to provide downside protection
while maintaining exposure in the name. Or it is a chance to just sell the
name outright. There are also companies that continue to execute and execute
well. They act more like a large-cap core than a trading name, but I throw it
in the trading bucket for simplicity's sake.
Another approach would be to buy the stock when sentiment bottoms or, if
it's liquid enough, sell puts. That way you pick up a premium, which you can
use to buy upside strikes (out of the money calls), which makes the trade
self-funding. So there are lots of things you can do in the trade portfolio
to add value to the fund.
TGR: What is the makeup of the core part of the portfolio?
PW: The core of the portfolio is about 50% of the value throughout
the full cycle. It can go as low as 30% and as high as 70%, depending on how
bullish or bearish the market gets. Typically, it is composed of 20–30 names.
This is the part of the portfolio where we really focus on the fundamentals,
the geotechnical and financial aspects of our stock selection process. This
is mostly the mid- to small-cap names and the area where over the full cycle
most of the alpha will be generated in the fund.
The trading part is mostly large-cap names, with some liquid mid-caps.
This section of the portfolio is driven more by macro data. It's more about
shifting beta exposure in gold equities as the market changes. Typically it's
about half the portfolio through the full cycle. In the past, there have been
about 20 names, so it's a bit more concentrated.
This is also the area where we keep our option exposure. We'll be using
options more in the fund to protect downside and provide some upside when
appropriate. It's also the part of the portfolio where if things go really
bad, we can short. Bear exchange-traded funds help with the liquidity and
maneuverability of the fund through various parts of the market phases.
TGR: What criteria do you use to pick core companies?
MS: We are not afraid to take longer-term positions. While trading
names usually have mines in production already, for the core portfolio, we
have a lot of developers or explorers. We look for quality deposits that we
think have a high chance of becoming mines.
The most important factor is that it has to have a good management team.
We always look for that. We look for size potential, world-class projects of
3–5 million ounces or more. In the last two decades, we have seen a
significant drop off in discoveries of these world-class deposits, but that
makes the ones we do find even more valuable. Then we look at a project's
economics. We have two in-house technical experts we rely on. These
geologists travel a lot to see projects in person. Size doesn't always lead
to a good economic project, so there has to be grade, workable metallurgy and
a favorable location in a stable jurisdiction. We look at a lot of criteria
when deciding on a core position because these are longer-term positions and
we have to be certain.
TGR: What are some of the core positions that you have strengthened
since you took over?
MS: Some of the names that we have added to are Dalradian
Resources Inc. (DNA:TSX), Lake Shore Gold Corp. (LSG:TSX) and Pretium
Resources Inc. (PVG:TSX; PVG:NYSE).
TGR: Dalradian recently released an update on progress at the
Curraghinalt gold project in Northern Ireland. What are the metrics you will
be watching when it releases the prefeasibility study?
MS: Dalradian has been advancing its project quite nicely. We're
expecting prefeasibility by the end of 2015, but before that, we're expecting
an update in its resource estimate in Q3/15. We are looking for conversion of
Inferred resources to Measured and Indicated resources. The company is doing
an infill program, so we are looking for a demonstration of continuity and a
demonstration of thickness and grades of the veins that it is exploring. Then
in the prefeasibility study, we're looking for any changes in capital,
operating expenses and recoveries based on metallurgical testing. The company
is considering changing the processing method so that instead of shipping
concentrate overseas, it will actually produce doré on site. That would be
quite interesting.
TGR: Is the next big step for Pretium going to be federal permits
or financing construction?
MS: The Brucejack project is a spectacular deposit. Pretium is
expecting both the start of construction and the federal environmental
decision in Q3/15. I expect the financing to come right after receiving the
federal permit. The company is well cashed at this moment. It has over $100
million in the bank. I don't see financing as a big risk frankly because this
is one of those world-class deposits with high grades. The company also has a
notable investor in Zijin Mining Group Ltd. (601899:SHA). So I'm not concerned
with financing. I am just looking for the federal decision to trigger that.
TGR: Lake Shore recently announced Q1/15 results. Did you like what
you heard about shifts in operating costs?
MS: Yes, Q1/15 was good. More importantly, the trend is improving.
Costs have come down. The company is generating free cash flow. The valuation
looks quite favorable. The company has had some very exciting exploration
results. We think it found a new deposit near its mine that can provide
longer mine life or more production in the future, but that is still being
explored.
TGR: What advice do you have for investors who are looking to tweak
their portfolios during a challenging time in the sector?
PW: Have a plan. State your objective and establish a very clear
buy and sell discipline. Don't get emotional; just stick with your plan.
That goes for any sector you care to invest in. As for gold, it comes back
to making the most of the late innings of a bear market and preparing to reap
the rewards of some pretty good rallies that could come off of that. So stick
with your discipline. At some point in the next couple of years, we expect to
see a pronounced bottoming in gold and that will probably be the stage for a
more sustainable bull market. But we're not quite there yet.
TGR: Thank you both for your time and your insights.
