The bull market in commodities, which hit a major bump in 2008, could resume in another 18 months when conditions are favourable again, says resources specialist Dennis da Silva.
"We have to look at a four- to five-year period of adjustment in global economies -- and that includes emerging markets," says da Silva, manager of Middlefield Precious Metals Class and managing director of Toronto-based Middlefield Capital Corp. "Give it another year to 18 months of relatively flat markets, but (look forward to) strong commodity prices. Copper, gold and silver should be at strong levels, and there should no excuse for companies not to generate good margins. Even oil is at a very strong level."
Da Silva is particularly bullish on gold bullion and argues it could hit US$2,000 an ounce within about 18 months. Although the price has lately weakened at around US$1,700, he tries to ignore the short-term noise in the market and focuses on the cost cycle for producers. "When I look at gold, the cost cycle has risen to the point that the all-in cost to generate an ounce of gold is around US$1,200-$1,300," says da Silva, adding that all-in margins have not kept pace with gold bullion. "To generate an appropriate internal rate of return, the floor is US$1,600."
Yet da Silva is not relying on a rising gold price to choose stocks. Rather, he is a stock-picker who concentrates on a handful of companies that create value through growing net asset value, cash flow and earnings. Two-thirds of the precious-metals portfolio is in small-cap emerging producers. Single positions in the 26-name fund are limited to about 10%. In accordance with a volatile sector, turnover was fairly high in 2011, at 118.5%.
One representative small-cap holding is Premier Gold Mines Ltd. PG, which is developing a project in Northern Ontario that has a proven resource of 3.5 million ounces. "The backbone of the company is the Trans-Canada project. But the real reason for owning Premier is the Rahill-Bonanza joint venture, at Red Lake, Ont., which it co-owns with Goldcorp Inc. G," says da Silva.
"The market is excited about the next couple of years where you will see ongoing results from underground drilling at the site," says da Silva. "This is the sexy part of the story and could involve multi-million ounces. What could make this stock a double, or more, over the next couple of years, is any material success at Red Lake."
A Toronto native, da Silva is a 20-year industry veteran who graduated with a bachelor of business administration from York University in 1992. He worked for one year in the marketing group at fund managers United Financial Corp., and then spent about a year at Toronto-Dominion Bank, where he was in the asset-securitization division that assembled mortgage-backed securities.
Da Silva went back to York University and completed his MBA in 1995. That year, he was hired as an analyst at Middlefield Group when it was fairly small. "My initial work was on the resource side. But I never looked back," recalls da Silva, who became managing director in 2000.
Best known for specialized products, Middlefield has grown to about $3 billion in assets under management, held mainly in closed-end funds and flow-through funds. It's the latter area where da Silva has been particularly active.
In 2007, the firm launched the first of several specialized resource funds, starting with Middlefield Uranium Focused Metals, followed in 2008 by Middlefield Precious Metals Class. In 2009, it introduced Middlefield Global Agricultural Class and Middlefield Groppe Tactical Energy Class. While da Silva manages the first three funds, Rob Lauzon, managing director, Western Canada, oversees the energy fund.
The precious-metals fund lost 27% for the 12 months ended Nov. 30, versus the median fund in the Precious Metals Equity category, which sustained a 25.6% loss. On a three-year basis, the fund gained 0.9% while the median return in the category was 0.3%.
Da Silva admits performance has been volatile, as the fund did extremely well in 2010 when it returned 89.3%, compared to 59.6% for the median fund, and then began to report losses in 2011. Since then it has been tough sledding and, like its peers, the fund has been in negative territory.
"This is part of the disappointment with the sector," says da Silva. "We're in a year of transition in 2013. But you can't continue to see equities under-perform the underlying commodity. Producers have to address their under-performance, and it's starting to happen with companies re-evaluating their projects."
While that unfolds, da Silva looks to performance from large-cap names such as Franco-Nevada Corp. FNV, which collects revenues from holdings in other producers.
"The stock has a very good correlation to the gold price. But the kicker is that it gives me leverage to growth from the underlying operations from which they collect royalties," says da Silva, adding that the stock is trading at a premium multiple of 1.5 times net asset value. "Our expectation is that its revenue should double in the next five years -- whereas I don't see the bullion price doubling."
