Summary
- Accelerating global growth in 2016 will also increase demand for commodities and have a positive impact on prices.
- When the junior space is depressed, it is a good time to pick up shares.
- The U.S. dollar is poised to weaken, which should have a positive impact on commodity prices.
Steve Palmer's AlphaNorth funds have a history of making high returns from investments in Canadian commodity juniors, including gold and energy plays. With regard to the current commodity markets, however, Palmer pulls no punches: Profits are not easy to reel in. But the downturn does not signal the end of the world. In this interview with The Gold Report, Steve Palmer explains that commodity markets change cyclically, and there is money to be made buying undervalued precious metals and energy juniors.
The Gold Report: How do you account for falling commodity prices?
Steve Palmer: The strong U.S. dollar is driving commodity prices down. The dollar-based slide is magnified by the summer doldrums and the lack of liquidity in many of the junior names. There is also a widespread perception that the Chinese growth rate is slowing, which is negatively impacting the value of commodity stocks in general.
But the reality is that, even though the growth rate in China has declined to 7%, it is growing from a much higher base, and this still translates into strong demand for commodities.
TGR: Why does the strong dollar drive down commodity prices?
SP: Commodities are priced in U.S. dollars. As the U.S. dollar exchange rate goes up, commodities become more expensive for buyers and demand falls. There is an inverse correlation between the U.S. dollar and commodities, particularly gold, but also energy.
TGR: If the U.S. dollar keeps getting stronger, and producers cannot afford to buy industrial commodities, then the supply of these commodities is going to increase, which will also drive prices lower. Between the strong dollar effect and its consequent supply/demand responses, it sounds like the perfect storm is brewing. If the Federal Reserve uncaps interest rates, will that help the energy and gold markets weather the storm and recover?
SP: Historically, the Fed has always waited until commodity prices are rising before increasing interest rates. It raises rates to cool a strengthening economy, so that prices do not inflate. We are longer away from interest rates rising than most people think, in my view.
However, I do believe that the U.S. dollar is poised to weaken, which should have a positive impact on commodity prices. Accelerating global growth in 2016 will also increase demand for commodities and have a positive impact on prices.
TGR: What would be the main catalyst for a weakening dollar?
SP: The U.S. was among the hardest hit countries in the global financial crisis. The Fed provided a significant amount of stimulus to keep the battered economy from imploding. The super-stimulated U.S. economy has been leading the world since 2008. Investors have flocked into large-cap U.S. stocks and the perceived safe haven of the U.S. dollar. But as Europe and emerging markets around the world recover and growth strengthens in these regions, money will start to flow out of the U.S. and into the faster-growing economies. There will be less demand by investors looking for the safe haven of the U.S. dollar. This should be positive for commodity prices. Commodities are cyclical.
TGR: The AlphaNorth Resource Fund is stacked at about 17% energy and 33% precious metals. Why have you weighted your portfolio like that?
SP: There is no magical formula in the weighting. It's just how things have shaped up given the performance of our investments and the individual security selection from our bottom-up fundamental analysis work. However, we do like to keep the portfolio diversified across various commodities.
TGR: As an investor, how would you pick out the potential survivors?
SP: We identify projects with lower risk and/or higher impact projects. We like to back strong management teams. We stick with well-financed companies. When the junior space is depressed, it is a good time to pick up shares. Commodities are very cyclical, and when the markets turn back up again, the share price returns will be quite dramatic.
TGR: What is the story going forward for domestic energy juniors in Canada?
SP: There is no way to gloss over the issue: It is a tough environment. Many of the juniors have pulled back on capex and are acting conservatively for the near term. They just do not have the cash flow in this pricing environment to reinvest in exploration and development. Drilling activity has fallen significantly.
TGR: Thanks for your time, Steve.
This interview was conducted by Peter Byrne of The Gold Report and can be read in its entirety here.
Steve Palmer is a founding partner, President and Chief Investment Officer of AlphaNorth Asset Management and currently manages the award-winning AlphaNorth Partners Fund, AlphaNorth Growth Fund and AlphaNorth Resource Fund. Prior to founding AlphaNorth in 2007, Palmer was employed as vice president at one of the world's largest financial institutions, where he managed equity assets of approximately CA$350M. Palmer managed a pooled fund, which focused on Canadian small-capitalization companies, from its inception to August 2007, achieving returns of 35.8% annualized over a nine-year period, which ranked it No. 1 in performance by a major fund ranking service in its small-cap, pooled-fund category. Palmer earned a bachelor's degree in economics from the University of Western Ontario and is a Chartered Financial Analyst.