A Market Inefficiency: Uranium Demand = Higher Long Term Prices

Posted by Steve Palmer - The Energy Report

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Believe in Oil & Uranium

Steve Palmer, chief executive of Toronto investment firm AlphaNorth Asset Management, scans the market for inefficiencies. And it pays off in the long term. While comparable market benchmarks are down as much as 46%, his small-cap fund has returned nearly 200% since its launch in 2007. In this exclusive interview with The Energy Report,Palmer explains why his long-term vision makes him a continued believer in oil and uranium.

The Energy Report: About 30% of the AlphaNorth Partners Fund, which consists mostly of Canadian securities, was invested in tech stocks, with similar percentages in metals and energy the last time we spoke in May. What’s the asset mix now? 

Steve Palmer: Technology stocks comprise about 32%, metals 26% and energy 27%.

TER: Although the fund was down about 6.5% in August, it is up 23% for the year through August. It was down about 15% in September, but it’s still positive on the year. What edge does AlphaNorth have that allows you to make gains in an economic climate that’s as negative as this one?

SP: It’s very difficult to make money when markets drop more than 10% in a month. We don’t pretend to be able to make money in those kinds of months like we experienced recently and in the fall of 2008. However, since inception of the fund in December 2007, the fund has returned approximately 190% despite declines in the Canadian indices. 

The Canadian indices that I use as benchmarks are both negative. The S&P/TSX Venture Index, which is the closest benchmark to what we do, is down 46% over that timeframe and the S&P/TSE Composite is down 5%. Despite the poor markets, we’re still able to generate substantial returns over a long-term timeframe.

TER: What is your primary strategy for generating profits?

SP: Good stock picking. We’ve had some good calls on specific stocks. We’ve been able to sell them at the right time. We use technical analysis to help do that. We do some hedging in the Partners Fund at certain times when we think the market is vulnerable to a correction. That has helped cushion the downside and contribute to positive returns when the short positions work out.

TER: In the coming quarters, do you see yourself leaning more towards one of those sectors that you mentioned earlier, perhaps at the expense of another?

SP: No, not particularly. Given the correction, all of those sectors have been beaten down pretty good. There are a lot of bargains across the board now.

TER: Let’s take a closer look at the energy portion of the AlphaNorth Partners Fund. What’s the mix in terms of oil and gas, uranium, renewable and coal?

SP: It’s mainly oil-focused. Coal would be the next most significant component and then iron ore and uranium.

TER: Uranium’s off the radar for many investors given the events resulting from the tsunami in Japan earlier this year. Are you still a believer in uranium?

SP: Yes, I’m still a believer. Long term, the supply/demand should result in higher prices. China’s still moving forward with building many new nuclear plants. There’s a huge demand for power in many parts of the world. Uranium is, in many cases, the most practical way to add power. It’s unfortunate what happened in Japan. It’s created a negative investor sentiment in the short term, but the fundamentals are expected to be strong over the long term.

TER: Many uranium projects being developed need $50 uranium just to break even. The spot price for uranium is just above that now. Do you believe Chinese demand alone can bring uranium prices up enough to make smaller development projects sustainable?

SP: Chinese demand will account for probably more than half of total new demand over the next 10 or 20 years. We’ve been working through stockpiles from nuclear weapons, but that’s pretty much depleted now. We do need new supply, but there are not many new uranium projects coming on. 

TER: China’s Sichuan Hanlong Group is in takeover talks with Bannerman Resources Ltd. (BAN:TSX; BMN:ASX), which owns two uranium development projects in Namibia. Uranium titan Cameco Corp. (CCO:TSX; CCJ:NYSE) is in the midst of a hostile bid for Hathor Exploration Ltd. (HAT:TSX.V), which has a high-grade uranium project in the Athabasca Basin. These are clearly cases of larger companies preying on smaller uranium companies beset by low share prices. Could it be time to take positions in uranium companies with near-term development projects?

SP: It just demonstrates that larger companies need to increase production and economic uranium deposits are very difficult to find. They are more difficult to find than many other commodities. The good projects are going to be in high demand.

TER: What are some uranium stories in the fund?

SP: Athabasca Uranium Inc. (UAX:TSX.V; ATURF:OTCQX) is one. 

TER: It’s not all that far from Hathor. It’s about to begin a drilling program in the next few weeks. What are you expecting from that?

SP: I’m not expecting anything, but I’m hoping for good results. It’s in the right neighborhood and there’s obviously a lot of high-grade uranium and some very profitable mines close by. The company has a very small valuation; they have reasonable odds of success. I’m just hoping that the drills are kind.

TER: Do you have any holdings in Australia?

SP: We have a stake in Mega Uranium Ltd. (MGA:TSX) in one of our other funds.

TER: What do you like about that story?

SP: It’s cheap. It has defined deposit in Australia, which is a good jurisdiction. It’s not just a one-project company. 

TER: Some of those projects are in locations that need some political will in order to begin mining. Do you see that happening?

SP: Yes. I think there’s a decent chance that it will change. You need some political will in many areas for uranium. It’s not something that people typically welcome. The permitting process can be quite long regardless of where you are.

TER: What are some oil and gas stories that are undervalued right now?

SP: Canadian Overseas Petroleum Ltd. (XOP:TSX.V) has assets in the North Sea, which is a good jurisdiction. Management has drilled wells there before and been quite successful. They have multiple locations to drill. It has lots of cash to complete the job. If you risked their drill targets, you still get a net asset value (NAV) over $1 a share. It’s currently trading at $0.32.

I just saw some research yesterday from an analyst that has a risked NAV of $1.20. Assuming all of their drilling is successful, the potential NAV would be roughly $3.50. That’s unlikely to occur because they are not going to be 100% successful. The end result will be somewhere in between those two numbers.

TER: Is there another intriguing name?

SP: Primary Petroleum Corp. (PIE:TSX.V) is very cheap and it has a lot of potential. Primary is an emerging play in Montana for the Bakken. It’s a shale play that extends into Montana from Alberta. Several larger U.S. companies seem to be having some good success there. Rosetta Resources Inc. (ROSE:NASDAQ) and Newfield Exploration Corp. (NFX:NYSE) have been having a lot of success drilling in Montana. Primary has about 300,000 acres, which is quite large for a small company. It also recently signed a letter of intent with a U.S. major to farm in on the majority of their acreage where the partner will fund the exploration. Primary will have no requirement to spend any of its cash and it will benefit from the expertise and experience of its partner.

TER: What’s your outlook for the energy sector?

SP: Energy is one of the commodities I favor. It’s a resource that’s gone once you use it, so you constantly have to keep finding more. The demand continues to grow. 

TER: Thanks. 

Steven Palmer, CFA, serves as president, CEO and a director of AlphaNorth Asset Management since founding the firm in 2007. AlphaNorth currently manages a long-biased, small-cap hedge fund. As VP of Canadian equities at one of the world’s largest financial institutions, he managed assets of approximately $350M. He also previously managed a small-cap pooled fund, achieving returns ranked #1 by Morningstar Canada. He has a BA in economics from the University of Western Ontario.

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1) Brian Sylvester of The Energy 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 Energy Report: Athabasca Uranium Inc., Mega Uranium Ltd. and Bannerman Resources Ltd.
3) Steve Palmer: I personally and/or my family and/or AlphaNorth may own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.