-- Posted Thursday, 1 December 2011 | | Disqus

As the market sloshes around, gold is searching for its identity. It has played currency hedge and equity adeptly at different times this year. While other investors wade through the confusion, Brian Ostroff, managing director of Montreal-based Windermere Capital, is taking the opportunity to snatch up gold mining equities that have been quietly performing under the radar. In this exclusive interview with The Gold Report, he contemplates why the market isn't rewarding junior gold equities worthy of praise.

The Gold Report: There are unprecedented debt problems threatening the existence of the European Union. The U.S. government is exploring ways to cut more than $1 trillion from its annual budget, which could put the brakes on the U.S. economy. However, you don't forecast a market plunge like in 2008. Why?

Brian Ostroff: It's a tale of two cities. On the one hand, Europe has a lot of issues addressing sovereign debt and it has structural issues. The EU is a group of countries that has been put together, but it's difficult to get a consensus to deal with those issues. A domino effect started with Ireland, Greece and Portugal. Just today there was news about a poor bond auction in France.

Unlike the European economy, the U.S. economy doesn't seem to be stalled despite its debt issues. Economic indicators seem to be showing some improvement. Jobless claims in the U.S. were recently at a seven-month low and industrial production numbers are good. Even confidence numbers have been pretty good.

At this time, I don't expect that the U.S. will face a double-dip recession. The U.S. economy is starting from a lower level than it was at in 2008, so it can't fall that far again. Home prices aren't going to fall another 30% or 40% and job losses aren't going to triple from here.

In 2008, commercial lending completely dried up. The biggest and the best companies that relied on the commercial paper markets to get funding faced liquidity issues. However, over the last couple of years, there's been billions of dollars in bond issuances by those companies as they moved out of commercial paper and into longer-term debt. They wouldn't be subject to another liquidity crunch because they no longer have to rollover their paper every 30, 60, or 90 days.

The primary risk, which unfortunately is currently outweighing the statistics, is a psychological one. It takes a toll when you wake up every day and hear how bad things are and how inept the politicians seem to be at getting a consensus. To what degree is the U.S. economy impacted by Europe beyond psychology? That's the big question but U.S. banks don't appear to have huge exposure to European sovereign debt on their balance sheets and let's hope not too much counter-party risk.

TGR: But we really don't know.

BO: Fitch Ratings has raised concerns, but St. Louis Federal Reserve President James Bullard said recently that the European debt crisis is unlikely to impact the U.S. so I guess we will see but, realistically, the Europeans are not a big driver of the U.S. economy.

TGR: How will the global economic picture ultimately prove positive for precious metals?

BO: The reason to be bullish on gold is that there is most likely going to be more money printed. The European Central Bank will likely get the okay from its member nations to put together a bailout fund of $1 trillion euros or more—whatever is required. Although there are signs of an improving economy in the U.S., I don't see the Federal Reserve tightening any time soon. The last piece to this puzzle is China. It tightened up last year and early into this year. Some are now concerned that China is slowing down too much and with that the next move by the Chinese could actually be a loosening.

Our belief has always been that gold is a currency no different from the euro, dollar or yen. But gold can't just be printed. It's just a relative valuation. We see gold continuing to gain on the back of all this printing.

TGR: Some days gold trades like a reserve currency, but other days it trades like common stocks. When do you expect gold to find its identity in this Jekyll-and-Hyde situation?

BO: Gold seems to get caught up in the risk-on/risk-off trade. Historically, gold has been inversely correlated to markets as a whole. That was apparent this summer when things really started to deteriorate in Europe. With all asset classes dropping, gold rallied up to $1,900/ounce (oz). It really was starting to regain its luster as a safe-haven asset. Lately everyone is saying, "Where's gold, where's gold? Why isn't it doing its job?" But let's be realistic, the gold price is still $1,750/oz with all the headwinds it seems to be facing. I'm encouraged that gold is going to continue to be a good place to be.

TGR: What do you expect the trading range to be in 2012?

BO: I'm not much for prognostication on trading ranges. I do believe that the trend is going to continue to be higher.

TGR: Do you forecast a similar trend for silver?

BO: Silver is the poor man's gold. It might be difficult for people to pay $1,750/oz for gold, but $33/oz for silver is pretty attainable. As more people start to understand the benefit of precious metals as a hedge, silver will gain from that.

TGR: Windermere Capital currently manages two open-ended hedge funds with a natural resource focus, Breakaway Strategic Resource Fund and Navigator Fund, both domiciled in the Cayman Islands. How exposed are those funds to precious metals?

BO: Breakaway is exclusively mining and Navigator is across all natural resources. Both funds have moderate-size positions in precious metals, but our focus is on a micro level. We go company by company. Right now, there is great value in stocks and we anticipate taking our holdings up.

Gold stocks are also a tale of two cities. Are they gold or are they stocks? Lately, they have acted more like stocks. I like to look at the ratio of how much gold it would take to buy the Philadelphia Stock Exchange Gold and Silver Index (XAU). Over the last 30 years, on average it would take about 0.23 oz gold to buy that basket of stocks, whereas today it would be about 0.116 oz gold. That's about half of the historic norm. One could conclude that gold stocks are acting more like stocks than gold. Our anticipation is that the ratio will make its way back toward the norm.

One reason we have seen such a distortion is gold exchange-traded funds (ETFs). Before ETFs existed, anyone who wanted exposure to gold typically bought gold equities. Gold ETFs have definitely drawn in a lot of money that might have otherwise headed for the equities. Gold ETFs, however, really serve a different purpose than gold itself. People who buy gold ETFs lean more toward the speculative crowd looking to profit from gold's movement as opposed to people who buy physical gold seeing it as a hedge and aren't necessarily looking to profit from it.

If we were going to go through a period of a relatively narrow range on gold, the hot money would leave ETFs. The profit would have been made [or lost] and the trade would be over. Then that fast money would look for whatever other opportunities exist. With the gold price at these levels, gold companies are going to make a lot of money. The sector is going to start to pick up attention and money will flow to it. We think the ETF effect on the gold:stock ratio will dissipate over the next few months.

TGR: Silver ETFs have proven to be much more stable than gold ETFs. Do you have any explanation for why the averages are much different for the SPDR Gold Trust ETF compared to the iShares Silver Trust ETF?

BO: Silver is really just gold on steroids. Silver had a speculative spike last spring where it ran up to about $50/oz. It's since worked its way back into the low $30s. That's a pretty amazing collapse really—and it only took about a week. Silver is probably consolidating its gains. A lot of investors are licking their wounds, but silver will make another move.

TGR: Do your funds invest in ETFs at all?

BO: From time to time, however, the focus of our fund is mostly on the small- to mid-cap equities themselves. Our performance is driven by our ability to find some interesting, young companies much earlier than when other financial players would look at them. Our group has a strong technical bias to it. A lot of our guys are geologists, mining engineers or metallurgists. We're even comfortable with micro- and nano-cap stories where we feel there's the backing of good management on a good property that the market inevitably will start to recognize.

TGR: Haven't the juniors suffered an even more drastic underperformance than the seniors have?

BO: I call the juniors a one-way market because investors typically either want in or they want out; there's very rarely equilibrium. In August and September, there was a lot of wholesale liquidation in the sector. A lot of funds had come down to the juniors looking for beta. Then they found themselves in a situation where they had to get out, but they were in a market where there wasn't much liquidity. It has really created a lot of opportunity going forward for the juniors in particular.

TGR: Catalysts that once significantly moved share prices in the junior precious metal equity space are either not moving the share price or they're moving it only a negligible amount. How are you taking advantage of that?

BO: These markets run in cycles. Right now, investors are exiting this sector. Even if a company issues some good news investors see that as a liquidity event and use it as an opportunity to sell rather than buy. For us, it continues to be a matter of looking at the company and looking at its progress. It's a perfect environment because there are companies that have done a great job advancing their projects, but their share price has not responded. I'd go one step further—there are people that are looking to exit their position and providing us the liquidity we need to get into some of the stories that we find very attractive.

TGR: You seem to favor a lot of companies operating in Québec. Is it because you are in Montreal and this is the space and people you know?

BO: Foremost for us is making an investment in a sound jurisdiction. It's hard enough to find an ore body that's big enough to be economic and take it down the path to production. To layer on an additional wild card of whether or not a company may or may not own that mine tomorrow is just not where our appetite is. We tend to stay in stable, well-known jurisdictions. It's pretty tough to beat Canada. And within Canada, Québec is a wonderful place to do business. We do have a lot of investments outside of Québec, but Québec definitely plays an important role in our portfolios. The government is very pro-mining. It recently introduced the "Plan Nord," which will put billions of dollars toward infrastructure to assist mining companies.

TGR: Arianne sounds very compelling. That will certainly remain on our radar screens. Do you have any parting thoughts for us today, Brian?

BO: It's important for investors in the sector to understand the nature of this market—it's a very volatile sector. It's important to understand the company as an investor, so that when there are periods where the market doesn't give any appreciation for the assets, investors understand why they are holding it. If the company does a good job moving forward, inevitably investors will get a good return on their investments.

TGR: Do investors also need to have a defined exit strategy?

BO: It has to be a little bit more fluid. Investors definitely have to understand why they invested in a company. They should understand what that company's benchmarks are to see that it hits them. Then they'll understand why they should continue to hold a stock or, if a company has fallen short of those benchmarks, why it's time to exit.

TGR: Thanks for sharing your thoughts with us, Brian.

Brian Ostroff graduated from the University of Toronto in 1986 and joined RBC Dominion Securities in 1987 where his focus was on small-cap special situations and alternative investments. In 1999, Mr. Ostroff joined M&A advisory firm Goodrich Capital where he was the Canadian managing partner overseeing mandates across a spectrum of industries with a focus on display technologies and mining. In 2004, Mr. Ostroff moved over to the trading side of the business where he spent a year as a proprietary trader with a large Canadian bank and then subsequently on his own for four years before joining Windermere. His area of focus is the junior and mid-tier mining sector.

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-- Posted Thursday, 1 December 2011 | Digg This Article | Source: GoldSeek.com

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