Gissen & Berol: Investing for the New "Long Term"

Source: The Energy Report  (8/27/09)

Encompass Fund managers Malcolm Gissen and Marshall Berol sat down with The Energy Report to share their views on energy investing and what they believe are the strongest subsectors in the mix. While bullish on coal and natural gas, both are strong advocates of uranium, citing a "definite supply-demand imbalance." Discover new opportunities for long-term appreciation in this exclusive interview.


Encompass Fund managers Malcolm Gissen and Marshall Berol sat down with The Energy Report to share their views on energy investing and what they believe are the strongest subsectors in the mix. While bullish on coal and natural gas, both are strong advocates of uranium, citing a "definite supply-demand imbalance." Discover new opportunities for long-term appreciation in this exclusive interview.

The Energy Report: Malcolm and Marshall, you started the Encompass Fund in June of '06 with the intent of investing in a wide array of sectors, "to minimize or avoid sharp declines in the market," as it says on your site. However, according to your stock chart, you had a fairly dramatic decline in Q4 '08 with a pretty dramatic recovery since then. Tell us a bit about what happened there.

Malcolm Gissen: What happened was that prior to and in 2008 we emphasized resource companies in our portfolio, and we believed that these companies were performing well. We had confidence in management. Many of the resource companies in the Fund’s portfolio met our expectations and continued to expand their resources, in some cases, very substantially. We were comfortable holding these positions in our portfolio and expected these stocks to outperform.

In the second half of 2008, a number of these companies experienced very sharp declines in their stock prices; we were alarmed, so we called the companies and asked if they knew what was going on. The only indication, they said, was that somebody was dumping a lot of their shares, which we, of course, could see in the market.

But it wasn't until very late in the year, when these companies spoke to and visited hedge funds, that the hedge funds would tell them that they had experienced a lot of liquidations and, as a result, were selling all of their resource company positions—and selling them as quickly as they could. In some cases, it was program trading. In other cases, they just dumped the stock. In the case of the junior mining companies, where the stock was thinly traded, it had a profound impact on stock prices when hundreds of thousands of shares or, in some cases, millions of shares, were unloaded in the marketplace, driving down the price of a number of these companies anywhere between 50% and 95%. When we saw that happen late in the year and realized the cause, as managers of the Encompass Fund, we decided we would buy more shares. We did that and that is one of the reasons the Encompass Fund has excelled this year.

Marshall Berol: There were several things we did, but when we saw what was happening with the markets in the fourth quarter of 2008 and what was happening with the companies that the Fund was invested in, we went back and reviewed each of the companies for how well we thought they could survive (i.e., a good investment going forward), and sold several of the companies we felt were weaker because of finances or the projects or the time involved in getting the projects moved along and factors of that nature. So those companies we sold at that time, and as Malcolm said, we increased our positions in some of the companies that we did own and felt were strong companies with the management, finances and projects that we felt would be worth owning going forward. Fortunately, that has worked out this year.

TER: Have you been surprised how the market has come back?

MG: I would say I have not been surprised at how well many companies in the Encompass Fund have performed this year. Marshall may not agree with this—and we don't agree on some issues—but I thought that this should happen. I felt that these companies were continuing to expand their resources. I didn't think the price of the resource was going to decline much. I felt there would continue to be demand for the resources and so I've not been surprised by the performance and, in fact, think that there's more to come. I don't think the story is over yet.

MB: Yes, we're definitely of the view that the resource investment story is not over. We're still in the early innings. There are a lot of reasons we believe that the demand for resources will continue to expand. There's the inflation aspect. A lot of aspects come into the various resources, whether it's the metals or energy that we feel have a very bright future going forward.

We're not of the camp that thinks deflation is here to stay, or that there's not going to be decent growth globally. We're in a global economy. There's just no two ways about it. While the U.S. or Europe may be slower, at this time and going forward over the next few quarters there's a lot of growth that's occurring in Asia and Latin America, and they need resources. And, to the extent that the populations are improving their quality of life, they're consumers and they want things that use resources of base metals, and they want gold. We just believe that it will continue and that there's a very bright future for resource companies.

TER: How do you decide where you're going to invest for your fund?

MB: The Encompass Fund was set up as a no load general mutual fund. It's not a hedge fund. We're an SEC-registered no-load mutual fund. It was set up to invest in companies regardless of market cap size because we don't think a fund should be limited to investing in large or small companies, or whatever. It was also set up to invest in whatever areas we believe offer good, long-term appreciation.

So, we can invest in any sectors that we think look attractive or are attractive. For the last several years—even before we started the Fund with our private client accounts—we've believed in resource companies—gold, silver, other commodities—so we were invested there. When we set up the Fund, we invested in a number of resource companies. We do have other areas we like—healthcare, particularly, and some special situations that we invest in. But when looking at it from the standpoint of the Fund, we don't want to be necessarily a resource company or a resource fund or a gold fund. We want to invest where we believe there are opportunities for long-term appreciation and that leads us to a variety of the resource sectors.

TER: Are you looking at long-term appreciation as a sector play or actually buying individual companies and holding them for long-term appreciation?

MG: I would say both. When Marshall and I got into this business, 'long term' meant 5 to 10 to 15 years. Nowadays, long term seems to mean two to four years. The definition of long term has clearly changed as investors have gotten less and less patient.

TER: Do you have real gems in the portfolio?

MB: We think they're all real gems, but some of them, from a catalyst standpoint or a near- to intermediate-term standpoint, stand out. An area that we like very much is uranium because of, again, supply and demand factors, production factors, production difficulties. There are 440 nuclear plants operating worldwide, 104 of them in the United States. There are approximately 100 or 120 that are on the drawing boards in various stages of planning or construction. Roughly 40 nuclear power plants are currently under construction worldwide. It takes uranium to operate those plants and generate the electricity that the plants are designed to generate.

Nuclear plants worldwide are currently utilizing approximately 180 million pounds of uranium; but there are only approximately 100 million pounds of new uranium being produced (mined on an annual basis). The balance over the past number of years has come from above-ground inventories or from decommissioning,primarily, of Soviet nuclear weapons. Both those sources are coming to an end. The Soviets have said that the agreements to reprocess their nuclear weapons, which are scheduled to expire in 2013, will expire then. They will not extend it. So that source of uranium is coming to an end. There's a definite supply-demand imbalance.

The United States' nuclear power expansion is slow, but it is progressing. The Obama administration is somewhat wishy-washy as to the extent to which they're going to support it or not. But the fact of the matter is the new plants or expansions are moving along in the U.S., and, more particularly, around the world in Asia, China, France, Japan and India—and it's going to require more uranium. When you talk about the recession and its effect on supply, that hasn't affected the uranium industry. Cameco Corp. (TSX:CCO), the world’s largest producer, which currently produces 20% of the uranium in the world, had a major mine that was scheduled to come into operation a couple of years ago, Cigar Lake. Cigar Lake has had major flooding problems and production from that project is now out two or three years. There are people that say it'll never come into production. So there are some production problems.

BHP Billiton Ltd. (NYSE:BHP) (ASX:BHP) (PK SHEETS:BHPLF) had a major uranium project in Australia which has been slowed down for expansion. It's to be considerably expanded and that has been slowed down for a variety of reasons, logistical and financial. One of the companies that we have in the portfolio and that we have been very positive on is an American company, Uranium Energy Corp. (NYSE.A:UEC). Uranium Energy has a number of uranium projects that they acquired over the last several years in the U.S.—in Colorado, Utah, Wyoming, Texas and New Mexico. Their primary project is in Texas and it is progressing, we believe, very, very nicely toward the objective of producing uranium in Q4 '10, 12 to 15 months from now.

We have been in Uranium Energy for some period of time. We’ve added to it and it has been an outstanding performer this year, as it went from under a dollar at the end of last year to currently roughly $2.50. It has been higher. They are expected to be the next uranium-producing company in the U.S., and there's no question that there will be a market for that uranium. They may or may not sell it before they start production. They may or may not be the company that takes it into production. It is possible that somebody will come along, a uranium user, and want to buy the project and/or the company. But regardless of whether it gets bought, we feel there's a very bright future for Uranium Energy and some other companies operating in the exploration and production of uranium.

TER: Do you think there's any risk that uranium will be deemed a strategic resource by various countries inhibiting the flow of uranium into what they call the general market pricing mechanisms?

MB: I think the answer is yes, and it's not just uranium—it's a number of commodities, such as the rare earth elements in China, and China saying 'well, we're not sure we're going to continue exporting. In any event, we're not going to export as much as we have.' We believe that's going to be the case with a number of commodities where countries that are producers are going to be restricting exports and expansion of production because they realize they have a valuable asset in the ground and they want to manage how that's monetized and for what period of time, whether it's monetized by them, their own country and their own companies, or elsewhere.

Certainly a major factor in the commodities arena these days is China and other emerging countries, but particularly the Chinese companies, many of which are state-owned and/or state-controlled, buying resources in other countries or buying portions of companies in other countries. And there's no indication that there's going to be any slowdown of that effort on China's part, or on the part of the host country to minimize the extent to which a foreign country is—whether it's China, Australia, Japan or Korea—acquiring assets. The South Koreans are interested in iron ore because they have a very, very large steel industry. The Japanese are interested in a wide variety of commodities to supply their industries. So it's a factor that's present and it's not going to go away, in our opinion.

TER: How has this potential of government intervention impacted your decision on which countries to invest in?

MB: For one thing, it's likely that prices will get higher for both the commodity and the value of the companies that are producing those commodities. A number of the companies that we talk to tell us that they've been approached by mostly Chinese and, in some cases, Japanese, both representatives of the government, as well as of companies in those countries that are interested in acquiring either the resource or the company itself. And that gets into a competitive situation, which should move prices higher.

One of the areas that we haven't talked about that we like is coal. The Chinese, as you know, are an enormous consumer of coal. They would prefer not to have to import the coal. So we looked at companies that are producing coal in China and we've invested in one just recently that we think has terrific potential, L&L International Holdings (LLFH:OB). We've invested in a coal company that's producing coal in Mongolia, about 20 miles from the Chinese border, that we also think has enormous potential. It's SouthGobi Energy Resources (TSX.V:SGQ), which is about 80% owned by Ivanhoe Mines Ltd. (TSX:IVN) (NYSE:IVN). Ivanhoe spun out SouthGobi and its coal deposits and is concentrating on copper and gold. So SouthGobi is in production, expanding production.

As Malcolm said, it operates about 20 miles from the Chinese border and they're running trucks 24/7 from the mine facility to the Chinese border, where they're loaded on rail cars to be taken into China to be utilized. We would anticipate that at some point in time there may be some business relationship activity between the 80% owner, Ivanhoe, and SouthGobi. But whether that happens or not, SouthGobi is doing extremely well, is well capitalized, well funded, is increasing their production, and we think has a very bright future as an investment.

TER: What other sectors of energy are you invested in?

MB: Well, certainly oil and gas. We invest in companies; we invest in equities. We don't do futures. We don't own the commodity itself for a variety of reasons. We're in oil companies. We, in the past, have been more heavily than we are now in the Canadian energy oil and gas trusts. There have been tax and other changes, so we have reduced our exposure to Canadian Energy Trusts, but we still have some exposure. We still think some of them are attractive. And an area that we have been investing in somewhat and will be increasing is natural gas. Natural gas prices have just been clobbered, and, again, its production has increased, and the demand has gone down.

Weather enters into it. Hurricanes enter into it. A lot of factors enter into it, but the bottom line is natural gas is selling at less than $3.25 per mcf. It's way, way off its high of $15 and way out of line with the historic relationships between natural gas pricing and oil pricing. We think because we're, at heart, value players — although value to us doesn't necessarily mean that it's some ratio of book value or some of the other metrics that you sometimes see about value players—value means it's undervalued, that there are things that are not being recognized by the market place and will result in a company stock going up in price. And we're also contrarians. There are very few people we talk to these days or that you hear on CNBC or that you read anywhere who have much good to say about natural gas. There's just a natural inclination for us to look closer at that kind of situation, which we have been doing and we have done some small investing in natural gas companies or the natural gas ETFs for the Fund. We anticipate we will be doing more of it because we think that there's a far greater likelihood that natural gas prices will go up and the stocks go up over the coming three, six, nine, twelve months than it going any lower.

TER: Are you looking just at North American natural gas or do you have a different view of international natural gas opportunities?

MG: We always look everywhere, not just necessarily North America, but we're very sensitive to the political realities of the world and prefer to be investing in safer jurisdictions. And I might be a little more cautious than Marshall in this area. We've also looked at alternative energy. We've had meetings with people who are proposing to produce energy from every agricultural resource imaginable and think that still is some distance away. It still is going to be on the edges, a small portion of energy production over the next several years. We have invested a little bit in solar and think there may be opportunities there, but we still think it's not mainstream yet. We've looked at hydro, we've looked at wind as well, but we don't think we're there yet. As Marshall has indicated, we are strong advocates of uranium and think that the American public doesn't understand the efficiencies, the improved technology, that safety improvements have been made. It's not a dangerous commodity anymore. And, also, it would provide a very considerable number of jobs in the United States and, as you know, there's substantial uranium in the United States. It would really reduce our reliance on foreign imports. So, for all these reasons, we are advocates of nuclear power.

TER: Malcolm and Marshall, this has been great. We appreciate the time you've taken with us today.


DISCLOSURE: Malcolm Gissen
I personally and/or my family own the following companies mentioned in this interview. Encompass Fund, Uranium Energy Corp., Ivanhoe Mines, SouthGobi and L&L International Holdings.
I personally and/or my family am paid by the following companies mentioned in this interview. I own a 50% interest in Brick Asset Management, the management company that the Encompass Fund pays a 1.45% management fee to manage the Fund.

DISCLOSURE: Marshall Berol
I personally and/or my family own the following companies mentioned in this interview. Encompass Fund, Uranium Energy Corp., and L&L International Holdings.
I personally and/or my family am paid by the following companies mentioned in this interview. I own a 50% interest in Brick Asset Management, the management company that the Encompass Fund pays a 1.45% management fee to manage the Fund.


Malcolm Gissen founded Malcolm H. Gissen & Associates Inc., an investment advisory services firm, in San Francisco, California in 1985. He has been a financial advisor since 1982 and he became a Certified Financial Planner in 1985. He converted his firm to a money management firm managing separate accounts in 1999. Mr. Gissen's management experience has focused primarily on investments in publicly traded companies, especially in the resource and real estate sectors. Mr. Gissen received a B.S. degree from Case Western Reserve University in Cleveland, Ohio and a J.D. degree from the University of Wisconsin.

Marshall Berol has been engaged since 1982 as an investment manager in San Francisco, CA. Since 2000, he has been the Chief Investment Officer of Malcolm H. Gissen & Associates, Inc. In addition, for more than 15 years, Mr. Berol has owned his own investment firm, BL/SH Financial. Mr. Berol's investment management experience has focused primarily on investments in publicly traded companies. Mr. Berol did his undergraduate work at the University of California (Berkeley) and received a J.D. degree from the University of San Francisco School of Law.


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