Source: Brian Sylvester of The Gold Report (6/8/11)
Finding great values in precious metals, Freestone Capital Senior Analyst Jason Mann explains why roughly one-third of the firm’s $2.1B assets under management is invested in non-traditional assets in this Gold Report exclusive.
Companies Mentioned: Aberdeen International Inc. Goldgroup Mining Inc. Newmont Mining Corp. Simmer and Jack Mines Ltd. Sprott Resource Corp. Yukon-Nevada Gold Corp.
The Gold Report: In broad strokes, how would you define your investment strategy at Freestone?
Jason Mann: Freestone manages an array of proprietary and open architecture investment solutions for our high net worth clients. We have long used non-traditional asset classes to help manage portfolio risk, but even within our proprietary equity strategies, we are generally risk averse. In equities, I’d characterize us as “value with a catalyst” investors. We’re definitely looking for investments that are cheap, but if there’s not some sort of corporate action, some sort of catalyst to really drive a stock above its fair value, then we’re not really interested.
TGR: What have been some of your best ideas that fit those criteria?
JM: Two of our better ideas that I sourced were Aberdeen International Inc. (TSX:AAB) and Sprott Resource Corp. (TSX:SCP). These have been prototypical investments for us: they appeared cheap, they had clear catalysts that should drive the stock value higher, and they came with some sort of “free option” that could drive outsize returns. These two companies are good examples because they seemed cheap when we bought them; then some of the catalysts that we foresaw kicked in, and the stock price closed that gap. Of course, not every idea works out as planned, but these were two of my better ideas.
TGR: Aberdeen put out a statement in the first quarter that said that it had a net asset value (NAV) of $1.37 per share, but it’s trading at about $0.82 right now. What do you think is the reason behind the disconnect?
JM: Aberdeen is small and underfollowed, which usually creates a discount. Its liquidity is a bit lower than some larger funds can handle, so it’s stayed under the radar. I’m actually shocked it trades at a discount because the company is very transparent and you can see most of its individual positions. We can estimate the NAV daily.
TGR: David Stein, Aberdeen’s president and chief operating officer, does a good job with disclosures. There’s no doubt about that. Could the dispute with South African miner Simmer and Jack Mines Ltd. (JSE:SIM) have been holding the stock back? The good news is that Aberdeen entered a binding arbitration agreement over a $10 million loan that it provided to Simmer and Jack in 2006.
JM: There’s definitely a discount because of that issue. The company holds the $10 million on the books, but it’s not really there until the lawsuit is settled. That’s actually one of the catalysts that we anticipate will drive value.
We expect the lawsuit to get cleaned up in the near to medium term. Assuming Aberdeen settles the lawsuit, it will have that cash flow in, and the market can more easily value the company. The company also has a gold royalty that it can monetize once the lawsuit is cleaned up, which should serve as another catalyst to drive value.
TGR: Another tack that Aberdeen has taken is to buy back its shares. The company has bought back over 700,000 shares for about $0.90 each. Do you think that’s an effective use of capital?
JM: I believe that the shares are pretty attractive, so it makes sense for the company to also buy them in the open market. However, if it comes at the cost of not being able to invest in other great companies, then it’s not necessarily a good decision. But Aberdeen has done a great job of allocating its capital over time, and that is clear in its NAV performance. I’ll give management the benefit of the doubt because they’ve shown that they’re great capital allocators.
TGR: What’s your upside on that stock?
JM: It can easily trade to NAV and its NAV could continue to grow once some of its performance shares kick in and its warrant portfolio gets revalued upward. Some other holding companies, such as Sprott Resource, have traded above NAV at certain points. When gold really gets hot, junior miners take off and their warrant portfolio might go crazy. In this scenario, the stock could trade at 1.2 times NAV… that’s definitely possible.
TGR: Sprott holds a number of oil and gas companies. It also holds about 74,000 oz. of gold bullion. Was that what attracted you to it?
JM: When we first found Sprott, we couldn’t believe that we were able to buy the stock at a discount to its physical gold, physical silver and Canadian Treasuries, plus get all of its other unique business for free. We were very pleased to pick that up. We got interested because we liked the long-term prospects for gold and silver and we were able to buy that at a discount through Sprott Resource.
TGR: Where do you see that stock trading through the end of the year?
JM: If the company keeps doing what it’s doing, I wouldn’t be surprised to see it trade up to between $5 and $6. We are not concerned with where the stock price will be in one year because its underlying businesses are really going to mature over the next three to five years. The stock may be at $6 at the end of this year, but I wouldn’t be surprised to see it as high as $12 in three to four years.
TGR: It’s a long-term play.
JM: Definitely. Sprott is one of the top players in the commodity space and Sprott Resource’s collection of assets is truly unique. No company can replicate its farmland business. Its uranium business is a really unique asset. And we’re happy to have the Sprott team manage those for us.
TGR: Have you met Eric Sprott and his management team?
JM: I’ve met with the management team. I recently met with Steven Yuzpe, its chief financial officer, and received an update on the portfolio. He’s a pretty dynamic guy.
TGR: About one-quarter of the long-short strategy you manage are investments related to commodities, and you seem eager to add positions. There are not many asset management companies with that much exposure to commodities. Can you explain why Freestone’s proprietary managed strategies have so much exposure?
JM: Part of that is our macro view. We expect at least moderate inflation as the eventual result of the massive government stimulus and this will drive commodity prices higher. But our exposure is really driven from our bottom-up process of finding cheap stocks with catalysts—we just happen to find a lot in the commodity space. It helps that we have a constructive view on commodities in the long term.
TGR: Many large asset management companies and funds stay away from commodities because there can be so much inherent risk. How do you account for those kinds of risks?
JM: One way is by holding companies like Aberdeen and Sprott, which have a tremendous history of success in that space. We sort of ride their coattails, and that’s worked out well.
Another way is to make sure that the discount to our estimate of intrinsic value is so large that we’re compensated for taking that risk.
The third way is to limit the amount of risk that we take. One position we have, Yukon-Nevada Gold Corp. (TSX:YNG), is not a major producer, but it’s sitting on an asset that was a huge, high-producing mine. We believe that there are only temporary, fixable issues that need to be addressed in order to get it producing again. It’s not like Yukon-Nevada has to dig a bunch of holes and find the gold. We know that the gold is there. It’s been produced. It’s just a matter of jumping through the hoops to get that mine up and running.
In each of these three cases, we are gaining commodities exposure in a very different way than simply buying a basket of commodities.
TGR: Yukon-Nevada was involved in a class action suit brought by some former employees of its subsidiary. That action has been settled recently. Do you see that as a catalyst for growth?
JM: It’s certainly nice to have that out of the way. As with Aberdeen, a lawsuit can be an overhang on the stock. However, for Yukon-Nevada, the major goal is getting the mine running and producing at the levels that it’s capable of. At that point, the company should be revalued as a producing miner instead of a speculative exploration stock. That’s the major catalyst we’re looking for with Yukon-Nevada.
TGR: The company posted a profit of about $30 million in the first quarter. However, it wasn’t directly as a result from mining. It had to do with some derivative liabilities. When do you expect the company to post a profit from mining?
JM: Possibly by the end of the year, or 2012 at the latest. If it starts to get pushed out beyond that, it would really call our investment thesis into question. Given all the hurdles that the company has faced, we think that management is doing an OK job. By 2012, it should be producing at the rates we expect and get a proper valuation to push shares higher.
TGR: Yukon-Nevada recently closed a private placement that raised almost $60 million. Obviously, someone else believes in the long-term price appreciation of that stock. What’s the upside as far as you’re concerned?
JM: The stock was recently trading at $0.48. It could trade at over $1. We don’t have an exact price target. We just believe that it’s worth a lot more than it is trading at today.
TGR: This year, you’ve added positions in two silver companies and one gold company. Are you bullish in the long term on precious metals?
JM: I think a better way to state our view is: we’re bearish in the long term on paper currencies. We think gold is interesting as a hedge against currency devaluation. Silver can act in a similar way, but it has its own dynamic. We like exposure to silver and gold companies with an idea that it’s a proxy for our bearish bet on paper currencies.
One thing that’s making us cautious is that there seems to be a consensus in the investment community that gold is going up indefinitely. It’s like in 2007, when people thought that real estate was going up indefinitely. That made us cautious, too. But given our near-term outlook on money printing worldwide, we’re bullish on metals in the near term. We’re not sure how long they’ll continue to act as the proxy for our bearish bet on paper currencies, however.
TGR: A number of gold pundits are predicting a significant pullback before the ultimate high. It remains to be seen whether or not that’s going to be the case. Do you have some positions in other small-cap mining plays?
JM: Newmont Mining Corp. (NYSE:NEM) is an interesting trading vehicle. Other large miners tend to come into favor and spike just as gold is peaking. As gold sells off, they also sell off. We think that’s an interesting trading vehicle.
Another interesting small-cap miner is Goldgroup Mining Inc. (TSX:GGA). It’s sitting on a huge resource base. It has a decent management team. We think that it could become a producing mine with potential for a huge valuation change.
Its flagship project is the Caballo Blanco project in Mexico. We expect that mine to come on in the back half of 2012. Right now, that is not priced into its stock. But we believe that the company seems to be executing on time and that it should be able to get Caballo up and running.
TGR: There tends to be a bit of summer weakness, and a rally in the fall, for precious metals. Will your investment strategy change at all in the summer months?
JM: Our strategy is the same. If we can find companies trading below intrinsic value with catalysts to drive the stock prices higher, and a couple of free options, then we’ll buy them—whether it’s June or December. We’re aware of the seasonality of metals and mining, but we come to work every day looking for great values whether it’s summer or not.
Metals and mining are an interesting space. There are a lot of risks, but there are values out there if investors look hard enough. Aberdeen is a great example. The company published its NAV to tell investors exactly what it is worth, and it still trades at a discount. So, if you’re willing to do the work and find promising companies, you can be rewarded over time.
TGR: Thanks, Jason.
Jason Mann began his career with Freestone Capital Management in 2005 as an analyst with the alternative investments group. Using his knowledge of alternative investment strategies, Mann has provided analytical support and generated investment ideas for Freestone’s long-short equity and long-only equity strategies since 2007. Jason holds the Chartered Alternative Investment Analyst (CAIA) designation, and has a BS in economics and psychology from the University of Washington and a Masters degree in financial economics from the University of Toronto. He enjoys spending his free time with friends and family, traveling and surfing.
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1) Brian Sylvester 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) The following companies mentioned in the interview are sponsors of The Gold Report or The Energy Report: Aberdeen International.
3) Jason Mann: I personally and/or my family own shares of the following companies mentioned in this interview: Aberdeen International, Sprott Resource, Yukon-Nevada Gold, Newmont Mining and Goldgroup Mining. I personally and/or my family are paid by the following companies: None.