And so, the third quarter is in the books! In general, and in hindsight, the quarter was good. It was, however, not without its hiccups. The first few weeks of August and September tested the resiliency of the strategy, but we held the conviction and were rewarded in the end. For the quarter. The portfolio return was +11.1% and year to date is +20.4%. This compares favourably to the S&P TSX Small Cap benchmark which had a quarterly return of +10.5% and a year-to-date return of 18.0%. Markets in the US and globally also performed well in the third quarter.

The largest contribution to returns this quarter came from materials, with the gold sector breaking out. Although the gold price had been strong for much of the year, gold stocks were not keeping up with the move in the commodity. This dynamic changed in the quarter, potentially spurred on by some corporate M&A as well as companies showing good growth in future cash flow with costs remaining relatively under control.

The quarter also saw small cap equities performing well relative to the large cap index, a phenomenon we expect to continue through the remainder of the year as inflation appears to be under control and the Fed is on an interest rate easing cycle. Below shows the portfolio components and attribution for the quarter.

Although the returns of the quarter were enhanced by the significant overweight in materials, stock selection in multiple sectors provided the largest component of active returns (particularly in energy, industrials, materials and technology).

Company positions which detracted most from performance last quarter were Payfare Inc., Gran Tierra Energy and DLP Resources. Collectively these three positions cost the portfolio -1.7%.

Payfare is a global fintech company offering digital banking, instant payment and loyalty-reward solutions for the gig economy workforce. The company’s solution gives workers instant access to their earnings and relevant cash-back rewards. The risk to the company was its concentrated client base. At the time of purchasing the position, the company appeared undervalued given its growth and margin profile. Unfortunately, in late September a significant client, DoorDash did not renew its contract with the company. This was Payfare’s largest customer. Despite the company being well capitalized, the loss of its major customer puts future growth into question. We exited the position on this catastrophic announcement.

Gran Tierra Energy is an international exploration and production energy company in Colombia and Ecuador. The management teams have a long history of success in the sector. With energy prices continuing to be weak in the third quarter we shifted the portfolio towards more natural gas exposure and uranium exposure versus oil stocks. Gran Tierra was a casualty of this portfolio move, and we no longer hold the Gran Tierra position.

DLP Resources is a copper mineral exploration company. The focus for the company is their Aurora project which is a copper-molybdenum porphyry system. The company expects to provide a resource statement in 2025. The company is still very much under the radar screen of most investors. We like the prospectivity and the company is funded for further drilling. We continue to hold the position.

The three names which provided the highest returns for the quarter were Freegold Venture, Kraken Robotics and Crew Energy Inc. Collectivley these three names added +3.5% to quarterly performance.

Freegold Venture has been a long-term holding. Freegold is advancing one of North America’s largest undeveloped gold deposits, Golden Summit located just outside Fairbanks Alaska. In September, the company released its updated indicated and inferred mineral resource to over 22 million ounces. The company is optimistic about the potential for expansion of their 2024 drilling program, testing for potentially higher-grade material to the west of the deposit. Freegold stock was up over +200% last quarter.  The portfolio has trimmed the position in Freegold on price appreciation but continues to hold sizable positions in the stock and warrants.

Kraken Robotics is a technology service company providing imaging sensors, batteries and robots for underwater applications serving the defense and offshore energy industry. The company’s unmanned underwater vehicles are used for subsea data collection. Kraken continues to expand its customer base and backlog. Revenue growth has been strong and forecast to grow at 40%. With more than $150 million in announced contracts in the last 2 years, its customer pipeline stands at $900million. We continue to hold our Kraken position.

Crew Energy Inc was a position held by the portfolio because of its strategic land position in Montney Fairway. With Canada’s new LNG facility being brought on and the prospect of future LNG facilities, Crew held an enviable position of undeveloped Montney (liquid rich gas) locations. Tourmaline Oil Corp, Canada’s largest gas driller purchased Crew Energy. The announcement happened in August of 2024 and the premium offered was +72% over the previous days’ closing price. The portfolio tendered their shares and no longer owns the name.

WHAT NEXT!

As previously mentioned, the portfolio holds a significant overweight position in gold equities. The gold price has been doing well throughout the year despite real rates rising in the first half. The explanation for this could be twofold; global turmoil in the Middle East and strong central bank buying of bullion. Historically the strongest rallies in gold and gold equities occur when real rates are declining. We are moving into this part of the cycle now. Inflation appears to be under control with US inflation below the Fed’s target level giving the Fed a strong backdrop to lower rates to help stimulate the economy thus avoiding a recession. On September 24th, 2024, Fed Powell cut rates by 50 basis points, the first cut in four years.

The following chart shows gold equity price changes relative to the bullion price. Given the positive backdrop for gold bullion and the fact that gold equities are still lagging the initial move we continue to hold a high weighting in gold stocks.

The next chart shows that we are just breaking out on the gold index relative to the rest of the market. We are maintaining our overweight gold equities and have layered in a larger allocation to silver equities.

With future rate cuts on the horizon the question is, has the US averted a recession? The bond market is less sure but clearly the equity markets believe we have. Historically the bond markets have a more accurate track record for predicting such events. The portfolio’s healthy gold weight provides some defensive characteristics if a recession becomes a reality.

The current rate backdrop also favours a weak US dollar. We do think the table is set for the US$ to weaken relative to other global currencies. In general, the weaker dollar would be supportive of most commodities including our preferred metal, copper.

No big secret here, but copper is clearly our favourite commodity. The future demand for copper is strong. Areas of future strength include improvement in global GDP, industrialization of India, the electric vehicle adoption and new power for artificial intelligence. The supply of copper is not robust, years of underinvestment in exploration has left the cupboards bare. Exploration that is successful is happening in more remote areas of the world adding significantly to the capital cost as well as all in sustaining cost (AISC) driving the breakeven price of projects higher. The risk of holding an overweight position of copper is more short-term in nature (based on a recession or not). Clearly our current position is that a recession is avoided but we are monitoring the situation carefully for any sign that the economy is faltering. With the price of copper holding the $4.00/lb mark, the environment looks constructive for copper stocks, as illustrated in the chart below.

The market seems to be awarding small cap stocks with good returns for companies showing good growth and that are profitable. Names that are serving us well include Zedcor, Kraken, Blackline Safety and Savaria.

The area of the market that is somewhat confounding is energy. Clearly OPEC is holding back production and the uncertainty around the increase of quotas have kept a lid on oil recently. The market looks balanced but there is little confidence from investors that that will continue. Natural gas has had a tough summer with bloated inventories but as we move into the heating season and ramp up LNG Canada, we expect natural gas fundamentals to improve. While the stocks are inexpensive, the weak commodity prices have not driven investors to bottom pick. We maintain a market weight in natural gas stocks and anticipate adding to the sector in the next couple months.

Global and Canadian equity market continue to climb a” wall of worry” and drag more investors in. Will this continue into the year end? We certainly hope so but are prepared to change our minds if the economic data doesn’t support avoiding a recession. As usual, please reach out if there are any questions or concerns.