January 2015 Edition - Financial Passage Maker

The Financial Passage Maker

January 2015 Edition

The Voyage

I have been involved with things other than investing in recent months, hence the abnormally long interval between issues of The Financial Passage Maker. However, with the advent of winter, I've started to focus more attention on research and background reading. You will see the results of that work in this and future issues.

1. The Financial Log Book

I took profits with many of the holdings. Why? Because I sense that the world's energy scene is changing – that while some stalwarts will remain as worthy components of my portfolios, the profits can be allocated to other sectors for better returns. As you will see, I am slowly moving my fleet to “more protected harbours” as I expect a fair degree of financial turmoil within the next few years. At the same time, I'll explore opportunities for gains, primarily in smaller companies which are overlooked by analysts and which are not within the sights of larger institutional investor for reasons of scale.

2. View From the Masthead

Sometimes, a “little event” can lead one to re-evaluate a long-held position ... in this case it was some research into recharging the batteries of my trawler.

3. View From the Gun Port

At present, I have a lot of cash on hand. Some of the stash will be reserved for exploiting opportunities once the market corrects (it could be months/years). A smaller portion will be allocated to small cap companies which are under the radar of most analysts. I ploughed a small amount into a tiny farm equipment developer.

4. Recommended Reading for the Moorings

Once in a long while, a good book will come along at the “right time” and galvanize one's thought processes. I was lucky indeed in that lightening struck twice: two books which should be on the bookshelves and in the minds of all investors.

5. In the Wake

Thoughts on slow travel.

1. The Financial Log Book

Entity	Initial Price/ Purchase Date	Price 2015-01-09	Gain/Loss since Jan 1/15 %	Gain/Loss Since Purchase %
Central Fund of Canada (CEF.A)	9.77 2007-09-04	14.37	not relevant at this time	47.1
Silver Wheaton (SLW)	12.37 2007-09-04	25.76		108.3
Polaris Materials Corporation (PLS)**	10.70 2007-06-01	2.24		-79.1
Cenovus (CVE)	32.39 2010-07-27	23.77		-26.6
Canadian National Railway (CN) *	48.88 2009-04-14	79.38		229
North West Company (NWF)	16.23 2009-05-07	25.45		56.8
Oceaneering International (OII-N)	52.95 2012-12-13	55.6		5
Deere & Company (DE)	88.07 2013-01-03	85.65		-2.8
Rocky Mountain Dealerships (RME)	11.89 2013-01-03	8.87		-25.4
HollyFrontier (HFC)	47.95 2013-01-28	35.7		-25.5
Titan Logix (TLA)	1.25 2013-09-11	2014-08-20 sold 1. 35
Kelso Technologies Inc. (KLS)	2.20 2013-09-11	2014-08-15 sold 6.32
U.S. Silica Holdings (SLCA)	25.15 2013-09-11	2014.10.08 sold 46.35
Oak Tree Capital Group (OAK)	56.45 2013-10-28	52.51		-7
High North Resources (HN)	0.62 2014-03-06	0.1		-83.3
Fairfax Financial Holdings (FFH)	477.98 2014-3-25	603.01		26.2
Clean Seed Capital (CSX)	.51 2015-01-07	0.55		7.8

*CN split 2 for 1 on 2013.12.02

** does not reflect impact of follow-on investment @ $.67 per share

Precious Metals

The “safe haven” value of gold and silver continues to have currency (pardon the pun) in these days of financial uncertainty and geopolitical upheaval. Even with depressed silver prices SLW continues to be profitable. On the other hand, marginal operations and junior companies are finding it difficult to secure financing for mine development. And the majors are now paying the price of unwise decision-making by testosterone addled executives who simply found themselves unable to imagine that the yellow brick road might lead over canyons spanned by rickety bridges. At some point, the cycle will repeat, hence my willingness to continue with a very high quality holding where operational risks have been minimized. (Curious readers might be interested in going to SLW's annual reports in order to check up on staffing levels – not much room for deadwood in this lean operation.)

Polaris Materials Corporation

Polaris Minerals Corporation was renamed as Polaris Materials Corporation effective January 1, 2015.

The company continues to make progress with its terminal facilities in California, a rather slow process which has taken several twists and turns over the past five years.

Investing in fledgling enterprises is not for the faint of heart. Polaris is a case in point. The precipitous crash in the share price was a reflection of nervousness in the market. Nevertheless, the fundamentals of the company remained:

• a fabulous resource with quality materials and large reserves
• a strategic ocean-side location whereby materials could be shipped at low cost to a variety of markets
• increased difficulty in permitting new quarries within a reasonable distance from major urban areas along the west coast of the U.S.
• good management which has the skills and mindset to negotiate the challenges of building a new company e.g. signing agreements with First Nations at a time when many resource companies ignored the wisdom of doing so; minimizing costs during economically challenging times; being resilient in the face of setbacks to the development of unloading facilities in California.

With this in mind, I doubled my stake in Polaris when the share price reached $.67. It was not a comfortable time but I saw no reason to change my view about the fundamentals of the company. I am now comfortably above water.

It is easy to review the periodic financial reports of Polaris. They are clearly written and management appears to be quite forthcoming. Looking forward, I see a few catalysts which could move the share prices upward:

• completion of the unloading facilities in California
• improvements to land-based transportation linkages in California as they are currently insufficient to cope with the movement of products in/out of the U.S.
• a resurgence in construction activity and a possible mega project or two along the coast

The balance sheet of the company is free of debt and it would appear that it is now profitable. In the future, there will likely be more turmoil, but the fundamentals of the company remain. I may yet add to my position.

Oil and Gas

I am not a market timer (usually) but I decided to take some profits with US Silica Holdings, Kelso Technologies and Titan Logix. That it took place before the decline in oil prices was pure luck. I will still keep an eye on these companies as they are well run and have nice balance sheets.

I was less prescient with High North Resources. Junior companies are risky at the best of times and I managed my risk by limiting the size of my position. Likely as not, the holding will be absorbed by a more well-heeled company. Unlike Polaris, there are many competitors in the field which have deeper pockets. Lesson learned: only hold companies with strong fundamentals (i.e. ability to secure financing during bad times) and a strong competitive position a la Polaris. Polaris is a company you could take home to see mother – High North ... not so much.

I decided to maintain my position with Oceaneering International as it is a well run company which is active in many geographic areas. In my search for services companies, I considered that marine operators would be somewhat more protected from land-based strife than their terrestrial cousins ... one of my strategies for addressing geopolitical uncertainty.

North West Company

While it's easy to get buried by quarterly/annual financial reports and the like, the “details” often confuse the reasons for investing in an enterprise. In the case of NWF, I was satisfied that its financials were quite fine. However, my reasons for investing in the company concerned the intrinsic qualitative attributes of the enterprise:

• it has a competitive “moat” in the remote communities which it serves
• time and time again, company management has demonstrated its ability to learn from its mistakes viz the recent improvements in its expanded operations in Alaska and the Caribbean.

It is a core holding. My reasons for continuing to hold it?

• an annual dividend in the vicinity of 4.5 percent
• a company which should survive better in economic hard times than other entities listed on the TSX

Contrarian Investors

The minds behind Fairfax Financial and Oak Tree are first rate. They look for opportunities and take risks (wisely) where others fear to tread. My sense is that they will perform well when the markets “correct”. In fact, I have added significantly to my positions in recent weeks for this reason. Both pay nice dividends, especially OAK. In the latter part of this newsletter, I will comment on a recent book by Howard Marks, the Chair of Oaktree Capital Group.

2. View From the Masthead

Sometimes a small “event” can lead one to reappraise a long-held view. In this case, it was a back-of-the-envelope calculation concerning various technologies for recharging the battery banks on my trawler. A few years ago, I purchased a portable gas-powered generator for this purpose at a cost of US$650. At the time, the $Canadian was above the $US so we decided to buy the unit in Chicago for less than 50% of the cost it would have been had we purchased it in Canada. (The savings paid for the trip and we discovered some wonderful art museums in Cleveland and Chicago ... also the houses of Frank Lloyd Wright in Oak Park ... abodes which are quite unlivable in my opinion ... but beautiful to look at ... trophy houses.)

Since we spend a lot of time at anchor in the reaches of northern Georgian Bay and the North Channel (the best freshwater cruising grounds in the world), I decided to review our options for power management. Normally, the on-board alternator will be sufficient for recharging battery while the boat is under way, provided that we travel for a minimum of three to four hours in a two day period. However, for longer stays at anchor, other power sources are necessary. In our case, we use a gas-powered generator and run it for a few hours each day. The noise and inconvenience were bothersome.

I explored a variety of options. I decided to reduce electrical power consumption through more energy efficient lighting and by using propane for things such as on-demand hot water for showers and cooking.

I also explored solar energy and found that costs have dropped very significantly over the past five years – to the point where I can install a solar-powered system capable of meeting our needs for electricity at less than the cost of a new generator. The benefits: greater reliability; negligible operating costs; no noise. The technology is robust and mature.

Given low oil and gas prices, there is not much incentive for consumers to switch to technologies such as solar power and geothermal energy. However, things change. “Alternative” technologies will become cost competitive and the technologies will gradually make inroads to the building industry, a beast which is notoriously conservative (slow moving regulations and risk adverse investors and builders contribute to slowing the rate of uptake of new technologies).

There will still be opportunities in the oil and gas sector but I am now looking for opportunities in other sectors. More on this in later editions.

3. View From the Gun Port

Agriculture

My holdings in Rocky Mountain and John Deere were established as long term positions. Agriculture is becoming even more mechanized and there is an imperative for farmers to be more efficient for a variety of reasons: securing a better return per unit area in order to maintain a competitive position in the marketplace, the high cost of labour, etc.

In recent weeks, I discovered an interesting venture, Clean Seed Capital (CSX) which is listed on the TSX Venture Exchange. I found it by reading trade magazines. I have established a position and will record it in the Financial Log Book.

In brief, a bright farmer has invested a tremendous amount of time, effort and money in developing a technology which was originated by his father. The CX6 Smart Seeder is a seed drill (introduces seeds into the soil) that can be controlled precisely to deliver nutrients and seeds to maximize returns by adjusting application rates in response to variations in field conditions. Farmers have voted with their pocketbooks by investing in the company. Field trials were completed successfully last year and a contract has been signed with an advanced equipment manufacturer to produce the machinery.

You can start your own research by visiting the following sites:

http://www.cleanseedcapital.com

http://howardgroupinc.com/clean-seed-capital-group-ltd/

While CSX has germinated and started to sprout, there are some hurdles to overcome before it can flower fully:

• More time will be required to verify the reliability of the machinery. While the equipment has been tested in a variety of field conditions, more time is needed to ascertain the reliability and performance of the drill in the hands of many operators whose levels of knowledge and skill will vary.
• While the company has made major strides in developing its technology, more money will be required for further technological improvements, manufacturing, distribution and servicing. The likely cost: a further dilution of shares as financiers will undoubtedly insist on a share of the action – a more profitable strategy than term payments for cash in the event that the company is successful.
• Distribution networks have to be established. The Board of the company has some expertise in this regard.
• Companies with larger resources will develop competing technologies and may have the wherewithal to undercut CSX's pricing structure.

The venture is speculative but I believe that it has “good bones”: skilled and dedicated management, a technology which has been well received at farm shows by people with mud on their boots, and an ability to secure funding consistently to meets the needs of the fledgling enterprise.

One other possible outcome: the company is absorbed by a larger entity. I am always mindful that ventures like this are risky and limit my investment accordingly. I am also prepared to accept that stock prices may fluctuate significantly with new enterprises like CSX.

4.      Readings for the Moorings 

In October, I decided to review the underpinnings of my approach to investing. By way of preparation, I started to practice on the piano in earnest – the English Suites by Bach – in order to tune up my mind. (The Suites are hard and demand a level of technique which is slightly beyond me at present ... but I persist as Bach's stuff is deeply satisfying.)

After I few weeks, I started to read and read ... many books and articles ... most too long for what they had to say ... most too narrowly focussed to be of much use to an investor like me.

I finally realized that I needed to broaden my perspective on investing – this as opposed to improving my knowledge of technique.

It is reasonably easy to learn the technical side of investing. That is where most analysts arrest their development ... and for that reason, I don't read 'em as most of them produce pro forma reports as required by their superiors. And as for most of the financial press ... streams of fluff to fill air time and pages.

It is much harder to develop a philosophical approach to investing and to acquire the wisdom to fully implement one's craft i.e. to develop a “style” and be able to employ technique from a range of possibilities in order to realize an intended result. That is what makes Herr Buffet so great: a master of approach ... and a technical virtuoso. So, now to the books.

The Most Important Thing Illuminated

I have mentioned the writing of Howard Marks on several occasions. Letters From the Chairman (of Oak Tree Capital Management) are treasures to be savoured. Now the essence of these missives has been consolidated into a wonderful book.

A slight diversion: I have learned never to adhere slavishly to methodologies promulgated by “gurus” who have been lucky enough to make money when circumstances favoured their method. Often as not, they crash and burn when luck turns against them. In my view, the essence of successful investing rests in a few things:

• how to think: how and when to select the most appropriate arrow from one's quiver of analytical tools to best fit the situation at hand; and, most important, how to think more deeply about the fundamentals which influence the trajectory of a company's future
• how to manage risk

Howard Marks addresses these issues in a masterful way. His prose is elegant and direct and accessible to most every reader. Further, his insights are based on the experience of almost 40 years as an investor. (He also received an excellent academic education many years ago.)

I'll not comment further on his plot line save to offer the following reviews of his book which have been penned by two “older” practitioners and a newbie:

http://investing501.com/2013/05/book-review-the-most-important-thing-by-howard-marks/

http://www.forbes.com/sites/moneybuilder/2013/05/28/book-review-billionaire-howard-marks-the-most-important-thing-illuminated/2/

https://www.scribd.com/fullscreen/53752933?access_key=key-2emcmt6rvuwd23i4vuzj&allow_share=true&escape=false&view_mode=scroll

In contrast to one of the reviewers, I really appreciated the “war stories” in the book. To my mind, story telling is one of the most effective ways to convey the full essence of an author's thesis.

Another noteworthy feature of the book are periodic commentaries on various paragraphs which are made by a few legends in the investing community. They are akin to marginal notes. Some agree or expand upon Marks' writing whereas others present divergent opinions.

This is a book to be savoured and revisited. It is one of four or five top reads on my investing bookshelf. Yes, I decided to buy the book after first borrowing it from our municipal library.

Another recent addition to the shelf is:

The Manual of Ideas: The Proven Framework for Finding the Best Value Investments

John Mihaljevic's book complements The Most Important Thing in that it presents a review of some highly successful investment methodologies e.g. the deep value approach (Graham style), investing in companies with excess or hidden values, under-followed small and micro cap stocks, etc. At the risk of simplifying things too much, most of the approaches are based on discovering unrealized value.

He discusses each approach in the following way:

• brief introduction to the method
• why it works
• uses and misuses
• beyond screening: application of the method in practice
• asking the right questions
• key takeaways

For more detail about the contents, click on the following link:

http://www.alphaarchitect.com/blog/2013/09/26/investing-book-review-the-manual-of-ideas-by-john-mihaljevic/#.VLLAt2TF9v8

I liken the book to a treatise on shot making on the golf course. No golfer with aspirations for a lower score would even consider venturing forth without a variety of clubs in the bag. While a putter can be used off the tee box, a driver is much preferred, especially when long yardages are required.

The same is true for investing. In my view, a one-size-fits-all approach may not yield the best results over time. The trick is to ascertain what method best fits the circumstances. The Manual of Ideas provides a good introduction to this way of thinking.

Summary

It is one thing to read these books. It is quite another to absorb the ideas and put them in practice. A thought in this regard: select a company you like and subject it to an analysis using a variety of techniques. In this way, you can save time by reworking the data you have collected for the purpose. Before doing so, however, write down your investment thesis (the reason for investing in the company). In so doing, you will inevitably incorporate your philosophical approach – the substance of Mr. Marks' book. I have done this with Polaris Materials and learned a lot. I have also applied it to the new holding of Clean Seed.

The Graham Investor: Intelligent Value Investing is a blog maintained by John Keown. I mentioned him in an earlier edition of The Financial Passage Maker. Mr. Keown thinks and writes very well and his periodic (short) missives are well worth reading. This said, the main value of the site, from my perspective, lies in the regularly updated stock screens. Take some time and browse the site's offerings.

http://www.grahaminvestor.com/

5.     In the Wake

Slow Travel

This fall, we rented a small house in a tiny hilltop village in Provence. Within a few days we settled into the rhythm of the village: a trip to the tabac for croissants and a baguette in the morning; a walk to the car which usually included a visit to the communal garbage facility; a tour to see the sights of the regions; a bottle of wine on the patio which overlooked miles of vineyards against the backdrop of some low mountains; a simple dinner; some reading. Over time, we tired of seeing the “must see” sights in places such as Avignon and Arles. And we soon gave up on the “natural attractions” which were so highly rated by the Guide Michelin. The French get quite excited by heights and any suggestion of “nature”. On more than a few occasions, our eyes rolled at the crowds and the rather mediocre surroundings of a few highly touted natural areas. We are indeed spoiled in Canada. The sound of wolves at night, the sight of a black bear or moose, geese and eagles overhead and the like ... these are precious.

We shelved the Guide Michelin and, instead, started to visit the local villages and towns on their market days. As a result, we saw and experienced far more. With travel, it's generally the details of place and the people you meet which leave the deepest and most lasting impressions. This was certainly the case with the markets of Provence: friendly and relaxed people in the pace of established routines; a tremendous variety of high quality foodstuffs and merchandise which is a feast for the eyes; the leisure to have a long and hearty lunch on a square in order to fuel up and people watch ...

If I were to revisit the region, I would stay in Saint-Remy-de-Provence about a dozen kilometres south of Avignon. It is a graceful place replete with a wide selection of restaurants and interesting shops. It also enjoys a very central location which provides quick and easy access to reaches of Provence. For more information, start with this link:

http://www.saintremy-de-provence.com/home.html

Some highlights of the trip:

• the friendliness of the inhabitants: everywhere and always
• the courteous drivers ... a real surprise
• the ready-to-eat foods in the markets: exceptional quality and reasonably priced
• the monasteries and vestiges of Roman civilization, plus “les borries”
• our inability to find a really good wine in the Luberon despite a dedicated effort
• a real appreciation for the cyclists in the Tour de France: the ascent of the dreaded Mont Ventoux is vertiginous and extended; however, the descent is what left me in wonderment: we never got over 45 kph in the car whereas on some stretches, the cyclists hit speeds in excess of 75 kph or more, a testament to their tremendous bike handling abilities and courage.

I wish everyone a prosperous and fulfilling New Year. “Follow your heart.”

Purpose of the Newsletter

The Financial Passage Maker provides ideas for people interested in building wealth. It is aimed at thinking people who have decided to take on personal responsibility for their financial well-being.

The newsletter is issued more or less quarterly, a reflection of the fact that good investment ideas are not all that plentiful ... certainly not sufficient to justify a monthly or bi-weekly report. All ideas presented in this newsletter are ones that I have invested in personally. I am not interested in filling space with observations on stocks I do not own. I eat my own cooking.

The Financial Passage Maker chronicles the messy process of building a financial portfolio. I hope that it will provide some useful insights and enable readers to think critically for themselves. As in all things, however, the path to financial well-being takes consistent effort coupled with humility and a knowledge of self. This can only be developed through practice over many years. My personal voyage to financial well-being has had unanticipated benefits that are worth far more than my balance sheets: new found friends, new perspectives on the world, and a greater knowledge of self. Further, I am now more able to help others.

The Financial Passage Maker chronicles my voyage in the investment world. In no way do I recommend that you base your personal investment decisions on the contents of the newsletter unless you are prepared either to consult a financial adviser qualified in your area of interest or undertake due diligence on the basis of your own research - or both. Remember, in the final analysis, you are responsible for your own financial well-being. Would you have it any other way?