’ Tis season for small caps
FUND MANAGER SPOTS OPPORTUNITY IN GOLD, COBALT
Seasonality isn’t the only reason investors should be allocating more of their capital to Canadian small caps these days.
While monthly performance data going back to 1980 shows that December, January and February are by far the best-performing months of the year, Steven Palmer, chief executive officer at Toronto- based AlphaNorth Asset Management, sees other factors supporting the junior market in Canada.
After hitting an all- time low in January, the S&P/TSX Venture Composite Index had made a dramatic move higher, due primarily to gains in gold stocks, but also other pockets of strength like lithium and marijuana stocks.
“As we approached the U.S. election, there was a nervousness with investors as they didn’t really know what was going to unfold, so even large caps sold off,” Palmer said.
The S&P 500 declined for nine consecutive days prior to the election — the first losing streak of this length in 35 years.
That’s not unexpected, since markets don’t like uncertainty. But once the results were in, large caps staged a rally and some small caps pulled back.
Palmer believes that sets the stage for the traditional strength small caps see between December and February. The portfolio manager of the AlphaNorth Partners Fund, and two mutual funds, t he AlphaNorth Growth Fund and AlphaNorth Resource Fund, highlighted other drivers for small caps during this period.
One is the dissipation of tax- loss selling late in the year, and other is RRSP season, which brings new capital into the market.
Large caps outperformed their smaller peers in both October and November, but the weakness in Canadian juniors is largely related to the decline in precious metals prices.
“That’s why we’re looking at that sector,” Palmer said. “The decline in precious metals is providing a good buying opportunity.”
He’s focused on adding some gold exposure to AlphaNorth’s portfolios, as the precious metal appears to have reached a support level.
“Gold is a proxy for the U.S. dollar and I don’t foresee the currency continuing to strengthen,” Palmer said.
The portfolio manager also likes zinc and copper in particular these days, as most base metals have broken out of their trading ranges.
Another area Palmer has keyed in on is lithium, although he’s reduced his exposure because of how well several stocks have done this year.
“I think the sector was getting somewhat overheated, as a lot of junior lithium companies have popped up,” he said. “Many of them are promotional and most of them will fail, so we’ve transitioned the portfolio a bit from lithium to cobalt.”
Palmer has a position in Green Swan Capital Corp. (GSW/TSX-V), which recently started a small drilling program, and had some encouraging grab samples that included both cobalt and gold.
Another holding, Cruz Capital Corp. (CUZ/TSX-V), has accumulated quite a few properties that are prospective for cobalt, and will be initiating work programs on some of them shortly.
“The big issue with cobalt is that a lot of the production is out of the Democratic Republic of the Congo, but there are some issues there in terms of human rights,” Palmer said. “People are trying to avoid supporting that industry there, so the focus is on cobalt in legitimate jurisdictions like North America.”
The manager also noted that since cobalt is a byproduct of copper production, investors can opt for a larger miner for their exposure to the commodity. The problem is these large mining stocks are primarily driven by the copper price or other base metals, not cobalt.
Since cobalt, like lithium, is used in rechargeable batteries, the demand for these commodities is growing significantly along with electrical vehicle usage and energy storage facilities.
Another very hot sector in the junior resource space has been marijuana stocks. It’s an area Palmer has largely avoided, as he is quite negative on the sector as a whole.
“I think investors need to be very cautious because these stocks are trading at crazy valuations, and there is nothing proprietary about the majority of them,” he said. “I believe they are all going to 10 cents within a couple of years, and it may happen sooner rather than later, when people realize these companies are not going to be as profitable as they thought.”
Palmer likens it to growing tomatoes. Companies are simply growing a plant, and the margins are going to get squeezed.
At the same time, he believes there is a lot of misinformation in the marketplace that marijuana cures everything under the sun.
“There is no scientific evidence for the majority of the claims,” Palmer said. “There are probably lawsuits that are going to come out of it all too, so it’s just not a space I want to be in.”
The manager does have a position in Tinley Beverage Company Inc. ( TNY/ CSNX), which makes beverages with hemp, and the CBD and THC product from marijuana plants.
“It’ s unique because not many companies have a beverage, and they are targeting the U.S. market, which is far larger than the Canadian market,” Palmer said.
He also highlighted Tinley’s partnership with beverage maker Cott Corp. to formulate a proprietary mix that is actually appealing to consumers’ palettes, “because you can’t just throw marijuana oil into any food product and expect it to taste good.”