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TOPS in ROCKS

After riding the greatest commodities boom in half a century, suddenly, playing the mining sector is not so simple. Many of the related equities have run out of steam amid fears of dwindling metals demand in a global economic downturn. THESE DAYS, IT TAKES A TRUE ROCK STAR TO GET THE JOB DONE

This summer, before the minerals sector experienced a series of sudden, steep landslides, we conducted a straw poll of mining-sector professionals, including corporate executives, investment bankers and industry analysts, and asked them about their favourite fund managers who focus solely on mining. A few names kept coming up. We winnowed down the list to three stars: a big-bank fund manager with a sixth sense about winning management teams, a hedge fund manager who isn't afraid to suggest mergers and acquisitions to CEOs and a dynamic duo who've successfully moved against the crowd. Ian Telfer, chairman of Goldcorp, agrees that each of the fund managers we selected has been around long enough to intimately know the players, the ore bodies, the regional politics and the technical elements of the business, plus they have great influence when it comes to raising money. "If they decide to go into a financing, it certainly helps with other fund managers," he says.

Kinross Gold CEO Tye Burt offered perhaps the most ringing endorsement of our finalists: "I would have any one of these people manage my money."

MARGOT NAUDIE

Investment management is in Margot Naudie's blood. Her father was a fund manager, and Naudie soaked up plenty of stock market wisdom around the dinner table while she was growing up in Montreal. "I pretty much always knew I wanted to do it," she says of being a stock picker. Armed with a degree in political science and economics from McGill University, she followed her father into the business. But when she joined TD as a buy-side analyst in 1994 and was asked to cover the mining sector, she was far from being a rocks maven. "I knew absolutely nothing about mining," she says with a laugh.

After taking night school classes, Naudie engrossed herself in the world of prospectors, ore bodies and larger-than-life promoters, and developed an uncanny ability to distinguish who would deliver on their promises and who was spouting hot air. Canadian mining legend and Franco Nevada chairman Pierre Lassonde observes, "A big part of her success is the fact that she sized people up more than she sized up the technical aspect. That's how she's done so well."

As the lead manager of the TD Precious Metals Fund, her investing picks have demonstrated that she has an astute insight into what makes a mining firm work in high times and low. Naudie has experienced both ends of the spectrum over the course of her career. When she started at TD, there was plenty of deal-making, discoveries and client interest. "I think it was my fourth day on the job when Royal Oak bid for Lac Minerals," she recalls. By the time she began managing mining funds in 1998, however, the Bre-X scandal and the Asian financial crisis had taken the bloom off resource firms, and investors had switched to the high-flying technology sector. Nevertheless, since she took over the Precious Metals Fund 10 years ago, it has returned 13% annually. As of the end of July, the fund was down 4.5% over the previous year, but has averaged 23% over the past three years.

In an industry defined by risk, Naudie (who also co-manages the TD Energy and the TD Resource funds) has found plenty of ways to lessen the potential downside without sacrificing returns. Her fund tends to favour well-established names in the gold sector that own what she calls "trophy assets" and are likely to perform well regardless of the stage in the commodity cycle. For example, she fancies Goldcorp, with its flagship Red Lake mine in Ontario and its promising prospects at a new operation in Mexico. (It's the fund's biggest holding.) Barrick Gold, the world's largest bullion producer, with its prosperous Goldstrike mine in Nevada and a penchant for aggressive deal-making, is another top pick. "I tend to be a little more conservative in my investments because preservation of capital is extremely important," says Naudie. "Risk-adjusted returns are extremely important. Let's face it, these are high-risk businesses."

It's not that Naudie shuns junior miners, which can juice a fund's returns with their massive upside potential. But since they have a habit of running into financial, political or technical mining problems, she offsets investments in small firms with the more predictable performance of senior producers. "What distinguishes this fund from some other precious-metals funds is that we pay more attention to the benchmark," she says. She calls it a "barbell approach": A healthy weighting in the large caps gives the portfolio ballast.

If anything, the summer's vicious correction in mining equities has reinforced Naudie's propensity for the name brand mining firms. "It's been extremely acute in terms of the downdraft. I think it does highlight the benefits of the barbell ap--proach," she says. Naudie has also been adding to her position in beaten-up names like Freeport and Yamana. "We have not been in a position where we have had to sell securities. My sense is that there has been a fair amount of forced liquidation. Quite frankly, there has been some distressed selling and we've been in a position where we could take advantage of that."

Before buying a stock, Naudie always considers what she calls the "four Ps": property, people, politics and price. She's looking for quality deposits that don't need commodity prices to be at record levels to be profitable. And she wants a location conducive to development--Quebec, for example, with its mining-friendly regulations, is an ideal jurisdiction, she says. Naudie's small stake in Ecuador-focused Aurelian Resources, on the other hand, reflects the risk of that country's volatile political system.

Among her favourite juniors in the fund is Capstone Mining, which operates a copper mine in Mexico. She bought the stock for 80 cents, and it now trades at around $3 a share. She particularly likes the management team, which spun off the mine's silver production into Silverstone Resources.

So focused on people is Naudie that when she saw the press release announcing that industry veterans Ian Telfer and Frank Giustra had taken control of Wheaton River Minerals in 2002 and had appointed Pierre Lassonde as an adviser, she loaded up on the stock. It was, as she puts it, a "bet the jockeys" investment. Wheaton River became the success story of the cycle, eventually merging with Goldcorp to create a miner that's now the world's second-largest gold producer by market value.

With over a decade in the rocks and stocks business, Naudie is no rookie. But Kinross CEO Tye Burt says she continues to bring a fresh eye to the job. "She is perpetually young," he says. Yet she is shrewd enough to have seen the good and the bad ideas, and to know how to sort through them."

TERRY BELL

Terry Bell doesn't come off like your typical flashy hedge fund guy. His East Coast roots still show in his soft-spoken, measured tone and the casual garb of khakis and a golf shirt. Like many of his colleagues at Salida Capital--whose well-appointed midtown Toronto office greets visitors with a model of the Bluenose II--Bell is a product of the Atlantic provinces. "This firm has a Maritime bent," he says.

As the founder and chief strategist of Salida's Global Prospector Fund, Bell, 46, has been a major presence in the mining sector since the fund's inception in May, 2003. The fund takes sizable positions in small- and mid-sized mining exploration and development companies that have quality projects, often based on the belief that those stakes will attract premium bids from major producers. If things aren't moving in what Bell and his firm feel is the right direction, they're not shy about giving management a nudge, in hopes of spurring a deal.

As Bell points out during a chat over lunch, salida means "exit" in Spanish. "We think one of our best exits is to sell to the professionals. Rather than just trading stocks into the market, the ultimate end game--or salida--should be to sell to the ultimate buyer that is going to develop the project." A few years ago, Bell suggested to Yamana Gold and its deal-crazy head honcho, Peter Marrone, that they should have a look at Viceroy Exploration and its Gualcamayo project in Argentina. Salida owned both stocks. "I was haranguing them," Bell says with a sheepish grin. "I would sit them down for lunch and say, 'This is a good deal for you guys.' And the next thing you know, they did it." (Marrone won't say if the pitch was the catalyst for the deal, but notes that Bell "seems to understand the dynamics of mining companies better than a number of hedge funds out there.")

Though rocks have been his career-long passion, Bell took a circuitous road to the hedge fund world. He left Woodstock, New Brunswick, more than 20 years ago to earn a geology degree from McGill University, later supplementing it with a graduate degree in mineral economics. After a short stint in exploration in the mid-1980s, he switched to analyzing the industry. He spent three formative years covering small-cap base metals and gold stocks for Eric Sprott in the early 1990s. "Those three years really honed that idea of thinking like an investor," he says. He later spent half a decade at TD Securities before the industry downturn of the late '90s. But by 2002, the mining sector was turning around, and Bell was offered the chance to join some former colleagues at Salida. With his deep understanding of mining, he helped round out the skill sets at the upstart hedge fund, whose founders were primarily experts in oil and gas. Since then, Salida has grown into one of the biggest and most successful hedge funds in the country.

While it was fashionable during that latest cycle of the commodity boom to focus on mining management teams with deal-making prowess, Bell, the geologist, still believes it's all about the rocks. "A lot of people say they invest in people. Well, people are awesome. They are definitely important criteria. But geology is what counts."

The Salida Global Prospector Fund is looking for companies with deposits that have the scale to attract the big producers. Yet Bell also has a mantra when searching for resource plays: He wants projects that are "already found but not recognized." As a model, he points to Canico Resource, a Vancouver junior that acquired the Onca Puma nickel deposit in Brazil from Inco in 2003. Bell and Salida initially bought the stock at $1.40, and continued to add to the position as it grew increasingly clear that Onca Puma would become one of the 10 largest nickel mines in the world. In November, 2005, Brazilian giant Companhia Vale do Rio Doce struck a friendly deal to acquire Canico for $865 million, or $20.80 a share. "We made good money across the funds," says Bell, who, in addition to overseeing the Prospector fund, steers the bulk of mining investments peppered throughout Salida's other fund offerings.

With his strong technical background, Bell has seen the value of several other mining properties before their owners got takeover offers from the majors. Some of his big scores include Cumberland Resources (taken over by Agnico Eagle), Dynatec Corp. (by Sherritt International) and Arizona Star (Barrick Gold). "He must have done a thousand property visits" to deposits big and small, says Franco Nevada's Pierre Lassonde. "He's a guy who can differentiate the gold from the floss."

Of course, not every mining stock is going to attract a rich takeover bid or triple its production in a few years. To round out the portfolio, Bell stays busy by trading, shorting and hedging.

It has been a tough summer for Salida and Bell. With a high exposure to jun-iors, the Salida Global Prospector Fund has felt the summer sell-off even more than most. Bell's fund has roughly $100 million in it now (you need $1 million to invest in it) and was down 38% over the last year to the end of July. Fortunately, the fund was up 22.3% in 2007, 70% in 2006 and 25.7% in 2005, net of fees. It is still up 20% annually over the last five years. Bell says, however, that amid the drubbing, there are still encouraging signs.

"Even in the carnage of July, in some ways our target market was validated when we saw the pretty good premium takeover bids for Aurelian Resources [by Kinross] and Gold Eagle [by Goldcorp]," he says. "Our strategy hasn't changed. We still think the commodity markets are going to be robust and provide opportunities in base metals and precious metals. If anything, we're going to focus on our core holding names where the prices have brought them into deep value."

CHARLES OLIVER AND JAMES HORVAT

These two guys don't just work together, they think together. Business partners since 2004, Charles Oliver and Jamie Horvat are a hive of ideas, market theories and collected wisdom. Now running the precious metals fund at Sprott Asset Management, they share an office, feed off each other's opinions and finish each other's sentences.

"We've always had a like-minded approach in our analysis and in investing," says Horvat, a 36-year-old mechanical engineer by training who helped design auto parts and forestry equipment before switching to mutual funds. "We're always pushing each other to prove where we're wrong rather than where we are right." Armed with more than two decades of industry experience and a geology degree, Oliver, 45, doesn't mind sharing the decision-making or limelight with his younger colleague. The duo approach, he believes, leads to sharper stock-picking. "Two minds are better than one," he says.

Together, the pair hold deep convictions about the market, commodities and the prospects for resource stocks. For starters, they're vehemently opposed to corporate hedging (selling forward metal production at set prices) and share a faith in the fundamental value of gold rather than government-issued currencies, particularly in times of economic crisis and geopolitical turmoil. Last year, Oliver vowed to shave Horvat's head if the bullion price failed to reach $1,000 (U.S.) an ounce. While his partner's dark locks have so far escaped the clipper, Oliver has since upped the ante, promising to shave his own head, as well, if gold doesn't top $2,000 an ounce within four years.

Oliver and Horvat are also "peak oil" theorists, believing the world's crude production will soon reach its apex and shift into a permanent decline. Commodities, they say, are in an unprecedented boom that will last for years because of sustained strong demand from the rapidly industrializing economies of China and India, and years of underinvestment in mineral exploration.

Plenty of fund managers claim to have been early believers in the strength of the current commodities bonanza, says Yamana Gold CEO Peter Marrone, but he maintains that Oliver was the real deal, correctly predicting the so-called supercycle years ago. Oliver's unwavering conviction that things really were going to be different this time around even helped change Marrone's own views. "I became a convert, and Charles --would have been one of the people whose comments resonated with me," he says.

The comings and goings of mutual fund managers rarely make headlines. But when Oliver and Horvat defected from AGF Funds (where they had originally paired up) to join Sprott Asset Management in January, plenty of ink was spilled about Sprott's coup. After all, the duo were highly decorated stars of the industry: As co-managers of the AGF Precious Metals Fund, they won the Canadian Investment Award for the top precious metals fund in 2004, 2006 and 2007. The fund returned 104% in 2002 (under Oliver's management but before Horvat's arrival), 19% in 2005 and 64% in 2006.

Like their new boss, Oliver and Horvat take an unconventional approach to investing. Even in the generalist funds they managed at AGF, they eschewed financial-industry stocks and leaned heavily toward mining, energy and materials issues. At times, Horvat concedes, they faced plenty of skepticism from potential investors. "Everyone thought we were nuts," he says with a grin. The subprime mortgage crisis, the collapse of Bear Sterns and the sell-off in banking stocks soon after proved them right.

They have a kindred spirit in the investment company's founder, resource guru Eric Sprott, whom they've admired for years. "Eric used to come and talk to us at AGF as a strategist," Oliver says. "A lot of the stuff he was talking about wasn't the mainstream stuff you were hearing from economists. But I thought he was right."

Sprott tends to focus on small-cap resource stocks rather than established commodity producers. That suits Oliver and Horvat just fine. They're bullish on the beleaguered junior mining sector, which has struggled amid the credit crunch despite strong commodity prices.

As for the vicious sell-off that savaged nearly all resource-focused funds over the summer, Oliver concedes it's been tough. The duo's belief in bullion and the fundamentals, however, remain deeply etched. "The views are still all positive. Everything is in place. It's just a matter of getting the market to go along. Sometimes these markets don't follow through on what we deem to be the logical conclusion. Usually that's just time and patience," Oliver says. Horvat adds that if investors are brave enough, current conditions present a real buying opportunity.

"Now is the time to take that relatively strong Canadian dollar when there is maximum fear in the marketplace and buy some really good companies at depressed fear valuations," he says. Oliver boils down their investing formula to a few key maxims: "Not listening to everybody. Having independent views. Saying, 'I think resource stocks are cheap and bank stocks are risky,' and then acting upon those things rather than indexing." And, of course, ensuring their ideas pass muster with their biggest critics: each other.

© 2007 The Globe and Mail. All rights reserved.

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