Category: Weekly Commentary

02 Feb 2013

Issue 5

Canaccord Genuity Corp. and National Bank Financial Inc. are leading the initial public offering of American Hotel Income Properties (AHIP). Palos had a one-on-one meeting with management a few days ago. AHIP’s strategy is consistent with our view — you need to be creative in the REIT space for valuations on traditional REIT’S have crept up to uncomfortable levels according to Palos. However, AHIP’s business is original and definitely deserved consideration. Some of AHIP’s unique attributes are… View full commentary in PDF

25 Jan 2013

Issue 4 – Why We Love Uncle Sam

While we recognize that recent stock market performance has a lot to do with the application of easy money in terms of cost and availability, it remains that the US economy is doing fairly well when compared to other developed economies. Corporate profits are beating expectations, confidence about the future has improved and the housing sector is on a significant uptick. View full commentary in PDF

18 Jan 2013

Issue 3 – Pair Trade in the Pressure Pumpers

Pressure pumpers are companies that offer fracturing and chemical stimulation services to enhance oil and natural gas production. There are three Canadian publicly listed companies that provide these services: Trican Well Services (TSX: TCW), Canyon Services (TSX: FRC), and Calfrac Well Services (TSX: CFW). The three companies usually trade in tandem. However, a trading opportunity has occurred among two of them: long FRC versus short TCW. There are two reasons why Palos thinks this trade is very compelling… View full commentary in PDF

04 Jan 2013

Issue 1 – 2012 Report

Palos is pleased to announce that the Palos Income Fund was up 5.5% for 2012. This brings the Palos track record to 9 years of positive returns and 9 years of outperforming the TSX since its inception in 2002 and translates to a compound annual return of approximately 11.05% compared to 7.12% for the TSX. But what is most impressive is that the returns that the fund generated did not come by taking additional risk. In fact, the fund took less risk…. View Full Commentary in PDF

25 Jun 2012

Issue 14

  • Palos Income Fund

By Charles Marleau, Yarith Chhiv & Adam Smalley Scotia Plaza, in Toronto, has been in the news lately as Bank of Nova Scotia (BNS) said that it is exploring a sale of its trophy headquarters. A sale would be a positive for the bank and, as a shareholder in BNS, the Palos Income Fund should benefit. Dundee seems to be the likely buyer at a price of more than $1 billion implying a cap rate of 4.9%. Ultimately, we think the largest beneficiary of this transaction will be Brookfield Office Properties Canada (BOX-U), another Palos Income Fund holding. BOX-U owns a very large portfolio of “class A” office properties in the largest Canadian cities and is currently trading at an implied cap rate of 5.9%, a significant discount to the implied cap rate in the Scotia Plaza transaction. We believe that the contemplated Scotia Plaza transaction will cause high-end Canadian REITs – like BOX-U – to trade up as public market valuations approach those of private market valuations.

  • Palos Majestic Commodity Fund

Platinum and gold took a tumble, as minutes from a recent Federal Reserve meeting showed no hints of a QE3, leaving bullish participants souring on their bets. Pressure on wheat prices could increase, as harvests are coming in earlier then expected due to the unusually warm winter. Cocoa futures continue to edge lower, as there is less concern for crops in the Ivory Coast, coupled with lower demand.

  •  Palos Merchant Bank

By Noah Billick, Cameron McDonald, Brendan Dunn and George Kaneb There are excellent mining opportunities all over the globe. One of Palos Merchant Bank’s larger positions is in South Korea, where they are mining Tungsten. Tungsten was initially recognized as an element by Peter Woulfe in 1779. We presume that Woulfe Mining, one of our major mining positions takes its name from the scientist. Christopher Ecclestone of Hallgarten and Co. wrote an interesting piece in Knight’s Metals and Mining Research publication. The following are some of the highlights from his research on Woulfe Mining:

  • The South Korean mine was one of the largest Tungsten-Molybdenum producers in the world before closing due to low metals prices (not a lack of resources)
  • Recent scoping indicates 40 remaining years of life in the mine
  • Recent deal with International Metalworking Companies B.V. (IMC) both for a portion of the Tungsten mine and for a joint venture to process the Tungsten
  • IMC, subject to due diligence has agreed to pay $35M for 25% of the mine
  • The joint venture has agreed to an off-take agreement to acquire no less than 90% and up to 100%, guaranteed by IMC
  • IMC has then agreed to purchase a minimum of 90% of the processed Tungsten produced by the joint venture
  • Wolfe Mining has other assets, including a gold mine in South Korea

Woulfe Mining has been an effective Palos Merchant Bank position that has seen excellent growth as a company and has created value creator for investors, in one of our key vectors of interest.

  • Risks, Hedges and Opportunities

By Adam Smalley


Interest rates in Canada and the United States have risen over the past few weeks. The 10-year Government of Canada (GOC) bond is up about 25 bps since early March to 2.12% today. Similarly, the 10-year US Treasury (UST) is up about 25 bps to 2.18%. About 14% of the Palos Income Fund is currently invested in fixed income (straight corporate bonds, convertible bonds and preferred stock). Given the backup in rates, and the questions our investors have been asking, we thought we would describe in a little more detail how we use duration to manage our interest rate risk. Our preferred stock portfolio consists almost entirely of reset preferred stock and retractable preferred stock. Reset preferreds generally pay a fixed dividend rate for five years and then “reset” to a spread over a benchmark (often the GOC 5-year bond). A good example is Nexen Inc.’s 5% Series A preferred. The Nexen preferred pays a fixed 5% dividend until 2017; then, it “resets” to a yield equal to that of the 5-year GOC bond plus 359 bps. Five years later it resets again. Reset. Repeat. Resets take a lot of interest rate risk out of the portfolio as they behave, with a little bit of a lag, like a floating rate instrument. Retractable preferred stock is different. Retractables give the preferred holder the option to force redemption at preset “retractable” dates (“hard” retractables require redemption in cash while “soft” retractables give the company the option of paying in cash or common shares). In effect, retractables give holders a put option in the event interest rates rise. Brookfield Properties’ 5.2% Series G preferred is a “soft” retractable. It pays a fixed 5.2% dividend rate but is retractable beginning in 2015, meaning holders can force the company to redeem. There are only a handful of hard retractables left in the market and unfortunately we don’t expect new issuance to increase. Because of the resets and embedded put options in retractables, effective duration is significantly shorter than stated or final maturity. Our fixed income portfolio consists of straight corporate and convertible bonds. We manage interest rate risk in this part of the portfolio by owning only short or intermediate-term maturities, which we define as ten years or less. We further manage interest rate risk by owning bonds that trade, in our judgment, at credit spreads that are too wide. In other words, we own bonds in companies that have improving balance sheets and cash flows. We expect any deterioration in price that occurs from higher government bond yields will be more than offset by spread-tightening due to credit improvement. An example is Jo-Ann Stores 8.125% Senior Notes ’19. These bonds are trading at 100.5 which is a 7.97% yield and a spread of UST of +697 bps.

  • What is New on the Macro Level?

By Hubert Marleau A recent Bank of Canada report shows that the Canadian dollar may be overvalued for non-hydrocarbon Canadian exports. Our US dollar positions are unhedged to profit from the eventual strengthening of the US dollar compared to the loonie. Recommended article by the Bank of Canada: Canada’s Exports Need to Be Reoriented to the New Global Economy, Says Bank of Canada Governor Mark Carney The full speech can be read at:

14 Jun 2012

Issue 13 – Dividends

  • Palos Income Fund

By Charles Marleau, Yarith Chhiv & Adam Smalley The Palos Income Fund took advantage of difficult market conditions this week by tactically trading our portfolio. First, we covered some of our short positions at attractive levels. Second, as volatility on the TSX rose, option premiums rose as well. We sold call options – in order to take in additional income – on some of our core holdings at relatively high volatility levels. We chose positions on which to write calls based on three factors: implied volatility, time-to-expiration, and our own fundamental evaluation of those companies. Provided the implied volatility and time-to-expiration were reasonable and fairly priced, we wrote calls on stocks that were nearly fully valued. In the last few days we sold calls on Coca-Cola, Cineplex, Toronto Dominion, Telus and Johnson & Johnson.

  • Palos Majestic Commodity Fund

The Majestic Commodity Fund demonstrates how versatile its trading system is by capitalizing on both upwards and downwards trends. This week’s big mover is natural gas. Natural gas futures set a new 10 year low this week. The downward spiral could be seen as a result of poor production numbers, warm weather patterns and an abundance of supply from shale fields.

  • Risks, Hedges and Opportunities

By Adam Smalley


Over the past few years, dividend-paying stocks have been favored by investors. Even Apple, with the largest market cap on Earth, decided to pay a dividend in order to join the club. In the old days (1995 to 2000), dividends were considered a sign of weakness, an admission of failure, a signal that a company had such limited prospects that returning cash to shareholders was more attractive than investing in the business. Now, dividends are a sign of a strong company, sober management, and investor realization that growth-at-all-costs is so 2007. Dividends, however, are changing. The Bush tax cuts, which provide that qualified dividends are taxed at 15% instead of the taxpayer’s highest marginal rate, are set to expire at the end of 2012. There is no doubt that a re-elected Obama will push for expiration of the tax cuts. Doing so would be a political win for the Democrats as it would eliminate one of the few untarnished legacies of the Bush presidency and theoretically raise tax revenue. If a Republican wins, it is far from certain that the Republicans will have majorities in both houses to get behind a presidential push for extension of the tax cuts. A third option is that an Obama-led White House will push for a compromise that would maintain the Bush tax cuts for taxpayers making less than $200,000. We think that outcome is highly unlikely as it would require a democratic majority in both houses. Regardless of who wins the White House and Congress, doing nothing or getting nothing done (depending on your perspective) – and letting the Bush tax cuts expire – is the path of least resistance and the likely outcome in our view. The Palos Income Fund currently has limited exposure to US dividend-paying stocks. There are many reasons for this, expected tax increases being just one. However, we do expect a selloff in US dividend paying stocks if/when expiration of the Bush tax cuts becomes fait accompli. A selloff will likely be a buying opportunity. The bottom line is that these tax breaks will expire if nothing gets done in Washington. Doing nothing is something Washington is very good at. We think the days of favorable tax treatment of dividends are coming to an end.

  • What is New on the Macro Level?

By Hubert Marleau I was travelling all week on business and when I do so it is very difficult to write. However, I did a lot of reading and did come across a number of interesting subjects that I believe to be worthy of consideration. I shall brief you on some of them today for further elaboration in future weekly reports. 1) The CIRA Commodities Group, in collaboration with CITI, argues, in a very recent study named North America, the New Middle East, that North America could become the largest source of new supply of oil during the next decade.  The oil sands in Canada, deep-water production in the US and Mexico, oil from shale and tight sands, natural gas liquids and bio-fuels could add over 11 mb/d of liquids taking production from 15mb/d in 2010 to 26mb/d by 2020.  Energy sufficiency would certainly make America economically strong and give it geopolitical independence with huge and profound ramifications for US monetary policy, the US dollar as a reserve currency and re-industrialization. 2) Abundance by Steven Kotler and Peter H. Diamandis is a must read for serious investors. The book argues in exhaustive detail that exponential technologies, the DIY innovators, the Techno-philanthropists and the rising billions in few hands are conspiring to solve our biggest problems. If these four forces were properly laid out in a strategic road-map for governments, industry and entrepreneurs, our near-term future would look very good. This is indeed a contrarian view. Yet, there is a lot of empirical and theoretical evidence in the book to show that conventional wisdom may be wrong, as it often is. The rise of Robotics is upon us. 3) I also came across several seriously written articles on the US labour market that are disturbing. They claim that the rate of unemployment may be far more structural than cyclical.  It is generally accepted that the natural unemployment rate is around 5.5%.  However, many experts are convincingly pushing that number as high as 7.0% to 7.5%.  If this proves to be the case, inflationary pressure could emerge much faster than generally anticipated.

23 Mar 2012

Issue 12

Palos Weekly Commentary

  • Palos Income Fund

By Charles Marleau, Yarith Chhiv & Adam Smalley The Palos Income Fund added more Teck Resources Ltd (Teck) to its core holdings. Our thinking is that steel demand and prices in the US will pick up. Teck is one of the most important sources of coking coal in the world and a major supplier of steel mills. Teck has materially underperformed the steel companies which have rallied hard since October 2011. The price of coking coal should see an uptick in H2/2012 as demand for steel is a leading indicator to higher coking coal price. Rising coking coal prices should provide a lift to Teck stock, which has been trading more in line with coal producers than with global diversified miners. We also expect upward revision to Teck’s earnings estimates. Regarding valuation, Teck is trading at an EV/LTM EBITDA multiple of 4.45x, near the low end of its historical valuation range. The company has a strong balance sheet with investment grade ratings and net debt/EBITDA of 0.49x. As further upside, Teck’s oil sand assets are largely ignored by analysts and could be a meaningful source of value once production commences in 2016.

  • Palos Majestic Commodity Fund

Our commodity fund continues to capture profits from trends, such as sugar and cocoa. Sugar futures are on the rise, over news that production numbers have not met expected forecasts. Analysts believe that there may be a problem with the health of Brazil’s crops. Heavy rainfall in Africa has analysts reducing their projections for cocoa.

  • Risks, Hedges and Opportunities

By Adam Smalley NAL Energy Palos Income Fund bought NAL Energy’s 6.25% convertible bond ’17 in the new issue market at par last month. We did this despite a bleak chart for the underlying stock because we viewed NAE as very cheap on a flowing BOE basis. We preferred the convertible bond over the stock despite the stock’s 9%+ dividend – we weren’t convinced the dividend was “safe” and preferred to be in the convertible bond which paid a 6.25% coupon but still participated in the equity’s upside. The convertible bond traded between 102

01 Feb 2012

Issue 8

“This week, Palos Income Fund received positive news from two of its core holdings. Magna International (Magna) reported a strong quarter and raised its quarterly dividend…”