The Gold Report: Clear Harbor Asset Management actively invests in resource equities, and it's doing so during one of the most bearish periods ever for resource equities, particularly for small-cap resource equities. Some institutions are leaving the space altogether while others are reducing their exposure. What are your plans?
Aaron Kennon: While the resource benchmarks have all suffered significantly over the last several years, Clear Harbor's natural resources strategy has returned more than 58% since inception 27 months ago. This compares to an approximately 4% return by our benchmark, which is the Standard & Poor's Global Natural Resources Index. We're thrilled with this performance and believe that our team is well positioned to take advantage of investment opportunities in a more proactive fashion while the vast majority of investors remain either defensive or rattled. So our plan is to stick to our disciplined, value-oriented approach to the sector and continue to perform well for our clients.
We have also constructed a strategy where the majority of our securities are listed and operated outside the U.S., with approximately 50% of the positions representing small-cap companies. This contrasts with most of our competitors, who are forced into the mid-cap and large-cap segment of the market due to the size and scalability of their investment strategies. Clear Harbor has no intention of backing away from this sector, which has long been a specialty for us. There are too many attractive investments and too many compelling macro tailwinds. From the rise of the global middle class to the future population expectations to the undeniable fact that the world is embarking upon the most expansive monetary experiment of all time, resources are an essential component for any investor's portfolio.
TGR: You said most of the equities that you invest in are based outside the U.S. Do you have anything in China?
AK: Our position in Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) represents our only natural resources investment in China at the moment.
TGR: Are you employing new or different strategies to counteract or even take advantage of the risk-off sentiment in the resource space right now?
AK: Yes. Some companies in the sector possess more cyclical risk than others. The larger, more diversified resources companies capture the general cyclical trends in the market but do not have as much business-level risk imbedded in them, whereas many of the smaller-cap companies significantly outperform or underperform due to geological or operational success. We attempt to balance both of these risks in the portfolio and adjust our strategy based on shifts in company-level valuations and macro risks. Our strategy provides us with the flexibility to shift from resources equities into the actual commodity, which some other strategies do not have. In an environment where we believe that equities could experience significant stress, we have the ability to lighten up on our gold mining exposure and perhaps allocate that capital into bullion, or shift from the mining sector altogether to agriculture or oil and gas. Of course, we can also maintain cash when we deem appropriate.
TGR: Could you break down the asset allocation inside Clear Harbor's Natural Resources Strategy?
AK: One third of the portfolio is in the metals and materials sector, just under two thirds is in the energy sector and the remaining piece represents agriculture.
TGR: Has that changed over the last year?
AK: The allocation has remained relatively steady.
TGR: Many analysts will tell investors that they need to do their due diligence before investing in junior resource plays, but that's very easy to say and much harder to do.
AK: Due diligence is critical when analyzing the investment merits of a junior resource company. We always try to meet with management teams and determine their knowledge base and try to glean an understanding of their past successes and failures. We also seek to determine a company-level valuation based on existing and future resource potential. A drilling program at the junior exploration level can either kill a project or expand its resource potential and legitimize management's vision for the company. This speaks to the geologic risk and, therefore, the investment risk that is inherent in a junior company.
TGR: Are there some rules of thumb that you apply to your due diligence?
AK: There are several. A few that immediately come to mind are: quality and flexibility of management, appreciation of the capital markets and valuation of the stated and prospective resource assets. The ownership structure is also of interest to our due diligence. Does management own equity? If so, how much?
TGR: Do you have a geology background? Do you like to look at the core?
AK: I've looked at lots of core. I do not have a geology background in an academic sense, but I spend a good deal of time on the ground with geologists. For example, when I was in Argentina recently, we had an opportunity to travel with a geologist from one mining company to the other, and he was extraordinarily helpful in connecting geology to an investment thesis.
TGR: These days, geologists can put numbers into computer models to build preliminary economic assessments and NI 43-101 technical reports. But these models often don't take into account things like structural controls in terms of geology and other nuances of a deposit. As a result, are these mines not performing to the levels put out in prefeasibility and even feasibility studies?
AK: It varies. I make sure that there is a good deal of geology knowledge at the company level but also a respect for and an understanding that, at some point, an exploration program needs to go from being a science project to potentially a business model that can return value to shareholders. Part of my job as a portfolio manager is to find companies that have people at the top who can merge those critical components.
TGR: While you were in Argentina, the country's government nationalized Repsol YPF SA (REP:BMAD), a division of a Spanish oil company. What was your reaction to the news?
AK: While this was a significant event for the country and the capital markets, my initial reaction was not one of shock but of disappointment. The government's decision follows a pattern of contempt for foreign creditors. With that said, some of the largest companies in the world continue to wade into the country and accept the political risks. Apache Corp. (APA:NYSE) is increasing its capital expenditures in the country by 20% to $300 million (M). In my opinion, the Argentine government will find it challenging to seek out international partners to operate and expand the YPF resource in production. That will lead them to conclude that what occurred in this particular instance should not apply to other resources companies in the country in the future.
TGR: How does this compare to Venezuelan President Hugo Chávez seizing the assets of a number of oil contractors there as well as the Crystallex International Corp. (KRY:TSX) gold mine?
AK: Time will tell. YPF was once a publicly owned company, owned by the Argentine government before it was privatized and sold to Repsol in the 1990s, so the YPF nationalization was justified through several lenses: populism, colonial angst and national pride. The Argentine government recently aired a commercial that presented the history and identity of Argentina as firmly entwined with the history of YPF: former Argentine President Juan Perón, the Argentine flag, a crowd of children waving flags and a YPF gas station choreographed together in this television commercial. I'm not sure the government could pull off a similar ad displaying McEwen Mining Inc. (MUX:NYSE; MUX:TSX; MAQ:TSX) or Minera IRL Ltd. (IRL:TSX), for example.
TGR: While in Argentina, you spent time with Rob McEwen, the former CEO of Goldcorp Inc. (G:TSX; GG:NYSE). McEwen had remarkable success building Goldcorp into a top-tier gold producer, now the second largest gold company in the world. After he left Goldcorp, he started U.S. Gold Corp. (UXG:TSX; UXG:NYSE) and that performed remarkably well for shareholders as well. Then he took a large position in Minera Andes Inc. (MAI:TSX; MNEAF:OTCBB), and the two companies came together to form McEwen Mining. How did he react to the news of YPF being nationalized?
AK: He didn't panic. He is a seasoned mining executive who has had to assess political, geological and execution risk on many occasions in the past. I'm sure he was disappointed, but he continues to believe there is good reason to maintain a significant presence in the highly prospective Santa Cruz province of Argentina.
TGR: Apache is there, and it is going to up its investment by 20%. On the gold side, Goldcorp is there. McEwen is there. AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) is there as is Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ). For silver, Coeur d'Alene Mines Corp. (CDM:TSX; CDE:NYSE) is there. Does the presence of these companies provide you with a measure of security in some of your Argentine investments?
AK: Certainly. These global players see the rewards in this region while also recognizing the risks. A junior investor should welcome their activity in the region. Juniors may seek partnerships with the larger players that have significant cash reserves and a desire to grow production in the coming years. Approximately 10 companies are actively exploring, developing or producing in this province. It remains a largely untapped opportunity, and that always attracts me as an investor.
TGR: This is a growing theme in this space that countries, especially in South America, continue to nationalize resource-based assets. It seems like it's only going to get worse before it gets better. What makes it get better?
AK: We don't see the core natural-resources countries in the region moving in this direction. Chile, Peru and Colombia are the other South American countries that remain on our radar screen. These three governments and their respective jurisdictions all function in their own unique way, but we do not see a thesis that what has occurred with YPF, for example, applies to the entire mining sector.
TGR: But Peru withdrew a mining permit from Bear Creek Mining Corp. (BCM:TSX.V). And there's across-the-board resource nationalization via higher royalties and ownership stakes.
AK: Santa Cruz is a tundra, a desert-like environment with very few people and very little surface water. Peru has mountainous areas, ravines and the potential for mining activity to interfere in a negative way with the natural environment and local populations. We need to be careful not to confuse a removal of a permit for environmental purposes and local concerns with a true interference of government due to a desire to nationalize and retain capital within the country.
TGR: Apart from the Santa Cruz province being rather isolated and lightly populated, what else makes it a point of destination for mining companies seeking precious metals?
AK: Santa Cruz is vast but has significant infrastructure—roads, electricity—and also a meaningful level of collective mining knowledge on the ground there, both local and international. Most important, the geology appears exceptional by global standards. It was untouched by the mining industry until the mid-to-late 1990s. In other South American countries there are hundreds of years of artisanal mining. While San Juan has more history with mining and energy, Santa Cruz is in just the first years of what should be several decades of significant exploration and production success.
Larger producing mining companies with clean balance sheets and cash to put to work want to seek out mining companies in this capital markets environment that are on the verge of developing their mines, have already started to develop or are just in the process of producing. The geology is critical, but considering the stage of mine development may be an interesting strategy right now. A mid-stage or predevelopment-stage company is a multibillion-dollar company's acquisitions sweet spot right now. In this challenging capital markets environment for the junior space, there may exist very interesting opportunities for the majors.
TGR: Are you buying companies, with that thesis in mind?
AK: Yes. The geology is exceptional, similar to Nevada in the mid-1800s: outcroppings, very little activity. This is a geologist's and a gold miner's paradise. And we're not day traders in our strategy; we like to make investments, establish relationships with management and see a return on our capital over time.
TGR: You're saying buy-and-hold can still work in this space.
TGR: What is the typical hold time?
AK: It's significantly above the average holding period for a typical natural-resources strategy, particularly in the junior space. Greater than two years. Our strategy is only 27 months long, and many of the positions that were in the strategy on day one are still there today.
But we also look at every position objectively. We're not beholden to the notion that every position needs to be a long-term holding. If the facts change, if management changes and we do not like the direction of the investment, we will change course as well.
TGR: What are some of your positions in precious-metals equities in Argentina?
AK: The positions that we own at the firm level that have exposure to Argentina are Minera IRL and Argentex Mining Corporation (ATX:TSX.V; AGXMF:OTCBB), but we have several names on the radar screen that we're still doing work on: Extorre Gold Mines Ltd. (XG:TSX; XG:NYSE.A; E1R:FSE), Mariana Resources Ltd. (MRY:TSX; MARL:LSE) and McEwen Mining.
TGR: Why did you decide to take a position in Minera IRL, a small, precious metals–focused company?
AK: Minera IRL is an interesting company not only because it is a small cap that is under the radar screen of many investors, but it also represents the characteristics that an acquirer ought to look for in its business model: It has some existing production. It has a huge land resource. It has geographical diversification. It is active in Peru as well as in Argentina—it has production in Peru and is about to build an open-pit mine, Don Nicolas, in the Santa Cruz province. I am impressed with operational management, its geology knowledge base of the area and its willingness to be creative and nimble. The team is highly motivated and organized. It seems to communicate extraordinarily well and work well together across cultures, experiences and skill sets.
TGR: Argentex is developing its Pinguino silver-gold project in the Patagonia region of Santa Cruz province. What do you make of that deposit?
AK: The risk-reward profile of Argentex is different than that of Minera IRL, but I still think it's a compelling profile. It has a resource estimate coming out this quarter, which should prove up the highly prospective nature of its resource, which is a silver resource. This is an asset that is trading at $0.10–0.12/ounce. The company has a bit of cash. It is drawing down about $200,000/month. It has probably $9.5M cash on its balance sheet. I am particularly impressed with the chief geologist over there, Diego Guido. He is also a professor at University of Buenos Aires and has access to other interesting perspectives within the geology space.
TGR: That stock is down about 20% this year. Does that make you nervous, when you see a company sliding 20–25% in less than half a year?
AK: We bought it about 30% lower than current prices. So it's down on a year-to-date basis, but it's a recent acquisition for us. So we're actually quite pleased with where it is at this juncture. I think it speaks to who we are here at Clear Harbor Asset Management, which is a group of patient investors, and it also speaks to a little bit of luck.
TGR: Is that one of the things that you're doing right now, seeing a lot of value out there and cherry picking some of the low-hanging fruit?
AK: Yes. There is some exceptional low-hanging fruit in the mining space at the moment. If you look at any sort of multiple across the space, cash-flowing gold mining companies are trading at historically extraordinarily cheap multiples. There are lots of reasons for that. One is the general nature of capital markets at the moment. Another one is disbelief that we're going to see gold prices remain at current levels and perhaps go higher. Third is the historic transition of capital from the equity gold mining space to exchange-traded funds. There's a significant opportunity to take advantage of these prices and carefully allocate capital across companies that you've done your work on and companies that represent different risks: country risk, perhaps geology risk to some extent and the risk of some being development stage, others being exploration stage and others being operational stage. Having a diversified portfolio is also important at this juncture.
TGR: Eldorado Gold, with an asset in Brazil, tried very hard to buy Andean Resources Ltd. (AND:TSX; AND:ASX), but Goldcorp ultimately won that auction. Do you believe that Eldorado will attempt at some point to reenter Argentina?
AK: Perhaps. It now is integrating the European Goldfields Ltd. (EGU:TSX; EGU:AIM) acquisition. This is a very talented management team. This is a group of people that has outperformed expectations over the last several years. To the extent that it integrates and moves the Turkey plans in the right direction, it wouldn't surprise me if we see it dabbling in Argentina.
TGR: Are Argentex and Minera the only two in which you have positions in Argentina?
AK: Yes, but we are doing some additional work and believe that if someone is looking to allocate capital to the country based on the thesis that the YPF scare is overdone, you want to look not only at Minera IRL and Argentex but also look at Extorre, Mariana Resources, Mirasol Resources Ltd. (MRZ:TSX.V) and McEwen Mining.
TGR: Do you have some parting thoughts on the space at large?
AK: The capital markets are going to continue to challenge the juniors. This is an extraordinary time to be in the driver's seat with capital and to allocate selectively to compelling investments, not just in Argentina but around the world.
TGR: Thanks for your time.
Aaron Kennon serves as chief executive officer of Clear Harbor Asset Management and is a member of the firm's Investment Committee. Prior to co-founding Clear Harbor, he was a portfolio manager at Ingalls & Snyder LLC where he managed multi-asset class securities portfolios for institutions and high net worth individuals. Prior to joining Ingalls, Kennon worked at the Royal Bank of Canada and Citigroup Inc. Kennon is a graduate of Yale University.
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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: Goldcorp Inc., Argentex Mining Corp. and Extorre Gold Mines Ltd. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Aaron Kennon: I personally and/or my family own shares of the following companies mentioned in this interview: Eldorado Gold Corp., McEwen Mining Inc., Argentex Mining Corp. and Minera IRL Ltd. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this story.
4) Note that the natural resource strategy was launched as a separate portfolio at Clear Harbor on Feb. 1, but it has been a subcategory within the firm's larger "go-anywhere" strategy since February 2010. Performance figures are unaudited. This is not a solicitation to buy or sell any security.