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Mackenzie precious-metals fund outshines the pack

Rising gold prices and manager's three-pronged strategy put fund in lead

Special to The Globe and Mail

Unease over the collapse of Enron Corp. and other global economic jitters have helped fuel the Lazarus-like rise of gold stocks and gold bullion -- traditional safe havens in troubling times.

The benchmark Toronto Stock exchange gold and precious-minerals index rose an impressive 38.8 per cent in the 12 months ended Jan. 31, compared to the broad Canadian market's decline of 16.6 per cent.

Meanwhile, early this month, bullion itself broke through the critical $300 (U.S.) level for the first time in two years.

Precious-metals funds have benefitted from those moves. And the $65.2-million Mackenzie Universal Precious Metals Fund has outshone all the rest.

With a 65-per-cent return in the 12 months ended Jan. 31, the Mackenzie fund led the category, far outpacing the peer-group average return of 41.3 per cent.

The fund was also No. 1 over three and five years, averaging an annual 25.1 per cent over three years, versus 6.8 per cent for the category average, and 0.3 per cent over five, compared to an average 10-per-cent loss for its peers.

Credit goes to a three-fold strategy by manager Fred Sturm.

"Our first strategy was looking for companies that are growing through the drill bit," says Mr. Sturm, a senior vice-president at Toronto-based Mackenzie Financial Corp. and natural-resource specialist who has run the fund since its January, 1994, inception. These are well-managed companies, with good asset bases, strong balance sheets and are developing properties. It doesn't matter what the gold price is; if you poke a hole in the ground and find a bunch, you still make your investors wealthy."

Timing also helped in buying these stocks, he adds, as he'd typically move in six months before a company launched new production and before the market took an interest. Examples that proved to be highly profitable include Meridian Gold Inc., and Goldcorp Inc. The fund also benefitted from takeovers of junior exploration companies like Sutton Resources Inc.

The second part of his strategy is expressed by the notion "anchor with the world's best." Globally oriented, Mr. Sturm spent a lot of time investigating, and then investing in, South African and Australian gold, diamond and palladium producers.

The third leg was responding to commodity price trends. While gold and gold stocks were struggling a few years ago, Mr. Sturm invested up to 30 per cent of the portfolio in platinum and diamond stocks that saw share prices rise.

And two years ago, as he began to anticipate a rise in gold prices, he systematically shifted away from gold producers that hedge their production and upped his exposure to firms that would benefit.

For example, he favoured South Africa's Harmony Gold Mining Co. Ltd., a large, but cheaply priced producer, over Barrick Gold Corp., the industry giant that has long engaged in forward selling.

Going forward, Mr. Sturm remains upbeat, but he's also cautious about manoeuvring his way around a part of the market that is notoriously volatile.

Part of his positive outlook is based on a scenario seeing gold moving between a high of $350 and a low of $300, which depends on several factors.

For example, Mr. Sturm notes an ongoing supply-demand imbalance. While there is demand for 3,800 tonnes of gold a year, only 2,600 tonnes come from the ground, with the remainder made up by scrap recovery, forward-selling and central-bank selling.

"The latter two are two sources of extra supply that in a different environment could disappear," he says. "That argues at some point for higher prices."

Another key driver is consolidation. The three-way merger of Normandy Mining Corp., Franco-Nevada Mining Corp. Ltd., and Newmount Mining Corp. would rationalize the industry further.

Though it would also effectively lessen the choices for investors, it could put upward pressure on stock prices, he says.

A change in the world currency picture could also be beneficial. In particular, Mr. Sturm foresees a decline in the U.S. dollar in the next 12 to 18 months, largely due to very low domestic interest rates and investment flows going to other countries, which would make gold bullion more affordable in Asia and Europe.

"Any of these arguments, by themselves, are insufficient to argue for a stronger gold price. Put them all together, and you have a wave that supports a higher price," he says.

How is Mr. Sturm positioning the fund? Although he admits many stocks are expensive, he argues there are still many that deserve attention.

"It is more of a mixed bag. We don't have quite the opportunity we had a year ago. But we're not yet at a point where gold shares cannot rise any more because they are at silly prices," he says, adding that the typical warning signals that mark the "silly" stage are glaring headlines suggesting that gold is the place to be.

"Put it together, and we are in the middle of a move. If gold was too cheap at $250, and fair at $350, then at $300, we are in the middle."

Currently, Mr. Sturm has about 70 per cent of the 40-name portfolio in gold shares, with about 15 per cent in so-called polymetallic firms (that mine gold and copper) and 8 per cent in diamond plays.

With a propensity to mid- and small-cap producers, he has a large weighting in Repadre Capital Corp., a mid-cap firm that has a joint venture with South Africa's Gold Fields Ltd. in Ghana, as well as an interest in Aber Diamond Corp. "The company appears small, but the underlying assets are truly world-scale," he says.

Other favourite names include Gabriel Resources Ltd., a smaller firm developing a gold mine in Romania, Iamgold Corp., and Peru's leading gold producer, Compania Minas Buenaventura SA.

On a geographic basis, the producing assets of the companies in the fund are quite diversified. About 25 per cent are in Canada, 35 per cent in Africa, 15 per cent in South America, and the rest are in the United States, Asia and Europe.

Mr. Sturm admits that sustaining the fund's performance at the current rate is unrealistic. Yet he is convinced that as long as the commodity price keeps rising, the sector will outperform the broader market.

"Just as it is wrong to have too much exposure, it is too wrong to have none," he says, adding that having 5 per cent exposure in one's portfolio is not excessive.

Although analysts are impressed with the fund, some caution investors about the timing of their entry.

"Like most precious-metals funds, it was a laggard through most of the 1990s, but recently the whole sector has come to life and this one turned in a terrific gain," says Toronto-based fundbook author Gordon Pape, who gave the fund a $$$ sign in his latest buyer's guide.

"But this is not a buy-and-hold fund," warns Mr. Pape, noting that precious-metals funds have periods when they outperform, followed by those when they languish.

"If you think the gold rush will last, be our guest. Just remember the high level of risk," he says.

James Gauthier, mutual-fund research director at Toronto-based FundMonitor.com Corp., also urges prudence.

"The sector does provide good diversification and if you are concerned about continuing economic problems, this is a good place to be." he says. "But don't expect another 60-per-cent return from this fund."

He adds that Mr. Sturm "has proven himself to be an excellent manager and has done very well with other resource funds. Having a good manager is key in this area. And he's head and shoulders above the competition."

© 2007 The Globe and Mail. All rights reserved.

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