At the end of the second quarter the portfolio’s energy weight was reduced in favor of gold. Towards end of August, the fund started taking profits on some gold stocks and reinvesting the proceeds in energy stocks. Given the current inventory of gas, and where we are in the gas cycle, we focused on companies with significant natural gas exposure like Crew, Kelt, Painted Pony and Paramount.

Within the gold sector, the portfolio has increased its exposure to the developers versus producers. Producer valuations are approaching 1.5 to 2.0 times their Net Asset Value (NAV), compared to many developers which are trading below 0.5 times NAV. With many of the developers able to raise capital, we expect their NAV to materially increase as they move their projects forward.

In September there was a massive rebalancing of the TSX Small Cap Index, with the weight in energy sector increasing and the gold sector decreasing (down approximately 10%). While the fund does not mirror the index, the magnitude of the change was significant enough that the portfolio was recalibrated accordingly.
The three names contributing most to the portfolio’s performance were Trevali Mining, Shopify Inc. and Klondex Mines. These three names added 2.9% to performance while the three names detracting most from the quarter performance were NexGen Energy, Oceanagold Corp and Petrowest Corp. These names subtracted -1.69% from performance this quarter.

Trevali is a Canadian zinc miner with two producing assets, the Santander Mine in Peru and the Caribou Mine in the Bathurst Mining camp of New Brunswick. It has two other assets also located in the Bathurst Mining camp which are currently undergoing a Preliminary Economic Assessment. Management of Trevali is very strong and can lean on Glencore for technical advice as they are a strategic partner with a 4.4% ownership and purchaser of all Trevali’s concentrate. The zinc market continues to look fundamentally strong with supply tight and the price of zinc up over 50% this year. The portfolio continues to hold its position in Trevali.

Shopify is a leading cloud based commerce platform designed for small and medium sized businesses. Merchants can use their software to design, setup and manage their business across multiple channels, including web, mobile, social media, as well as in their physical stores. The platform is sold via SAAS Model and currently the software powers over 300,000 businesses globally. Management is strong and entrepreneurial. The stock is no longer cheap but with a growth rate of +80% for monthly recurring revenue, the stock price is justified. We continue to hold the position and watch the quarterly results for any sign that their growth might weaken.

Klondex is a superb narrow vein underground gold producer located in a very safe jurisdiction. It has three producing properties. Two located in Nevada; the Fire Creek Mine and the Midas Mine, with the third mine, the True North Gold Mine, located in Manitoba. Klondex also recently purchased the Holister Mine and the Aurora Mines out of CCAA. The CEO Paul Andre Huet is fantastic and is a proven underground operator with a focus on profitability. In the last quarter we sold the position when we reduced the portfolio’s weight in gold. We intend on re-entering the position if the price of Klondex stock’s materially pulls back or the price of gold resumes its uptrend.

The NexGen positon detracted from performance this quarter. As mentioned in prior letters, the Arrow deposit located in the Southwest section of the Athabasca Basin in Saskatchewan is a discovery that puts it amongst the richest uranium deposits in the world. With a current inferred resource of 202 million pounds of U3 08 at a grade of 2.68%, the deposit is still open in all directions with significant room to grow. Last quarter this was one of the portfolio’s largest positions, but we have reduced the position due to the tremendous appreciation in the stock’s price in the first half of 2016. Given the quality of the asset, we continue to hold a reduced position.

OceanaGold is one of our perferred gold stocks. It has one of my favourite CEO’s Mike Wilken, who delivers consistently on his promises. The company is diversified geographically with mines in New Zealand, Philippines and the USA. The pipeline of growth is strong as they bring Haile into production and they are amongst the lowest cost producers in my universe. In September, the Philippines announced the results of their mining review and listed OceanaGold’s Dicippio mine as one of the mines with environmental infractions. This provided some uncertainty and the stock sold off significantly. We took this price weakness as an opportunity to increase the portfolio’s weight. Since then the news from the Philippines has softened and the company appears to be preparing to bring the deposit on stream.

Petrowest is an Alberta corporation involved in both industrial and civil infrastructure projects as well as energy pre-drilling and post-completion services. The stock was hit hard post the decline in energy prices last year, but had won a significant contract with the Site c Energy project (a $1.75 billion project which Petrowest is a 25% joint venture partner). On the back of this significant project the company was able to raise equity to fix its balance sheet and move forward on the project. Unfortunately, the project had suffered significant delays and Petrowest continues to burn cash without a clear timeline as to when the project will proceed. In the quarter, the fund sold its position.

Outlook

As mentioned earlier, the quarter and year has been good for Canadian small cap investors. To help explain why investors have done so well, one needs only to look at some of the price moves in commodities this year:

Δ Q3

Δ YTD
Aluminum

+1.3%

+11.8%
Copper

+0.0%

+2.8%
Lead

+18.6%

+17.1%
Nickel

+11.9%

+20.1%
Zinc

+13.7%

+50.0%
Iron Ore

+4.6%

+30.1%
Gold

+0.0%

+24.4%
Silver

+4.2%

+37.1%
Crude Oil (WTI)

-0.3%

+29.6%
Natural Gas

-2.1%

+22.9%

So has the commodity move run its course? I would argue that much of the move was off extremely depressed levels. Many commodity prices were so low that investment in the sector stopped, impacting the future ability for these resources to keep up with future demand. New supply will likely continue to be constrained until there is a proper resumption in the investment cycle for the sector. On the demand side, Central Banks in the emerging markets continue to press hard on the monetary reflation pedal to kick start growth. There efforts are finally starting to bear fruit. In September, the leading economic indicators for BRIC countries continued to push into expansion territory. While commodities appear to have moved off the bottom, the sector does not show much supply growth and should global demand start accelerating, commodity prices will move materially higher.

To date, the year is shaping up well despite all the uncertainties that exist (US Election, UK exit, and the negative interest rate experiment). Despite these risks, we continue to be optimistic that Canadian Small Cap stocks are still in the early phase of a bull market with plenty of room to run. We are in unprecedented times and we will remain watchful for any changes that might need to be taken with respect to the portfolio.

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