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Hedge fund Founder Steve Palmer invests in micro- and small-cap companies that might grow explosively through successful exploration or development of novel technologies. By maintaining his focus on ground-breaking companies rather than commodities, Steve's AlphaNorth Partners Fund has achieved an extraordinary annualized return of 57.3% for the three year period ending April 30, 2011. In this exclusive interview with The Energy Report, he shares his secrets for targeting growth companies.

Companies Mentioned: Athabasca Uranium Inc. ATURF.PK), Lithium Americas Corp. (OTCPK:LHMAF), Newfield Exploration Company (NYSE:NFX), Primary Petroleum (PETEF.PK), Rosetta Resources Inc. (NASDAQ:ROSE) and U3O8 Corp. (OTC:UTREF)

The Energy Report: You focus largely on Canadian companies. Why? Is this a long-term play on the Canadian dollar or against the U.S. dollar?

Steve Palmer: Well, I live in Canada and deal in Canadian dollars. Most of my investors are Canadian. So, that's the logical answer. There's no shortage here of opportunities to invest in small companies that offer very attractive returns. So, I don't need to start going out of my area of expertise and looking for ideas in other countries where I'm not as familiar with the people or how things work.

TER: Are you able to accept accredited U.S. investors in your fund?

SP: No. We can accept international investors from anywhere in the world except the U.S.

TER: Are you still roughly half technology?

SP: Not quite half. It's about 30% technology right now.

TER: And your tech sector is also mainly Canadian?

SP: Yes.

TER: I'm aware that you at times rely on technical analysis. I'm just thinking about your small- and micro-cap space here. Isn't technical analysis much less reliable in some of these very small companies?

SP: Yes, that's true, especially some of the companies that have a much shorter trading history. Some of the companies don't necessarily trade every day or don't have much volume. So, technical analysis is less meaningful in those situations. But, the primary benefit of our technical work is identifying the appropriate points to sell. I think that's what distinguishes managers when they sell investments. Historically our technical work has added significant value for us in getting out of situations at the right time.

TER: So, its primary value for you is in determining exit points?

SP: Yes. It also provides us a sell discipline. It's easy to marry the stock, but the technical work provides an unbiased viewpoint. So whenever the technical indicators on one of our positions tells me to sell, I take money off the table even if I still like the company's fundamentals. So, I'll sell some with the idea that if I still like it and the stock goes down a bit I'll just buy it back cheaper. If I'm wrong, it'll just force me to take some profits on the way up.

TER: You invest in special situations. Are there any you can talk about?

SP: There are a couple. They're quite small. There are several situations where companies have a special technology. One, for example, upgrades heavy oil more efficiently than the current process. Things like that — unique technologies that can be widely used and have significant value impacts for some larger companies. But these companies are not proven necessarily just yet. This one particular company I'm talking about is in the pilot plant stage. But, the special situations are just ideas like that — unique technologies that can have a big impact.

TER: Ok. You're not able to mention that company?

SP: No it's too early to mention.

TER: Do you have a theme or some underlying theory for looking at your energy plays?

SP: I tend to focus more on international companies with international assets because they often have much bigger upside potential rather than just a low-risk domestic company.

TER: How are you weighted in energy?

SP: More weighted toward oil. Although I know a lot of people are negative on gas, I like to be contrarian whenever I can so I'm not negative on it. I don't view it as having much downside from here. It's only a matter of time before it starts doing better.

TER: We're in a post-Japan tsunami/earthquake environment, and I'm wondering how you feel about uranium equities today?

SP: Well, I have been positive on uranium equities. It's quite unfortunate on many levels what happened in Japan. All of the uranium stocks took a bit of a hit after that event. But, I don't think the long-term market dynamics have changed. Short term there's been a setback. We've used the setback to add to some of our favorite positions in the uranium space.

TER: Could you describe this as a deep value industry now?

SP: I wouldn't think of it as a deep value.

TER: You think of it as a growth industry?

SP: I think it's a growth industry, yes. I don't think China's canceled all their plans for new reactors, or for those that they have in the planning stage to be built. They're still moving forward. There are also other countries expanding their use of nuclear energy especially with oil prices having gone up to $120/bbl now. That's a driver for uranium. It's a competing energy source, and that higher oil price is only going to benefit uranium.

TER: How are you playing uranium?

SP: We have a basket approach of just buying five or six juniors that we find offer good reward potential. U3O8 Corp. is one of our favorite names.

TER: Why do you like it?

SP: It has multiple assets around the world with discoveries already. It's a reasonably lower risk to see that those assets are going to be expanded. It's well financed, and it also has some rare earth element resources that add to the attractiveness of it.

Athabasca Uranium Inc. is another one that we like. It's focused in Saskatchewan. It's a very low market cap relative to the potential upside if it were to find a uranium asset. Its property is positioned very well right beside other known resources. It's more of an early stage company.

TER: Very early stage, your kind of play.

SP: Yes.

TER: What about other minerals? I think you've owned some lithium equities in the past, or you currently do.

SP: Yes. I'm not necessarily a huge fan of lithium as a commodity because there seems to be a lot of it around. However, there are a couple of situations that are very attractive. At the end of the day it appears that there is a strong demand, and we will need to increase the supply of lithium. It's always best to invest in the lowest cost producers.

One name I could mention is Lithium Americas Corp., which we like. It recently announced a preliminary economic assessment (PEA) that was better than analysts' expectations, with lower costs than expected. And the net present value (NPV) of the project is significantly higher than the market value of the company. It carries a pre-tax NPV of CAD$983M compared to a market cap of about CAD$150M. So, there's a big discrepancy there, and as the company continues to develop that asset you could expect that the divergence will contract.

TER: Steve, I know you've thought about this a lot, but if you can make a lithium-ion battery that is more energy dense, say with three to five times the capacity of a nickel-metal hydride battery, you've still got to charge that battery with electricity that has been generated from some other source of power. So how does this help us?

SP: Well, yes. People seem to think of these batteries as so environmentally friendly, but nobody is thinking about how you charge the batteries. Are you burning coal to produce electricity to charge the batteries? And, some of these battery technologies are very toxic, people throw the batteries in the garbage, and that's extremely bad for the environment. So, it's a little bit of smoke and mirrors. That's why I'm not super bullish on the whole macro-lithium battery theme.

TER: Were there any other energy companies you wanted to mention?

SP: Well, I think one I mentioned in my last interview was Primary Petroleum. That company is continuing to evolve and progress towards a discovery. Over the last couple months it has raised funds so now it can drill on its own rather than seeking a finance partner. It is continuing to acquire more land in Montana where it's targeting the Bakken oil formation. Several big companies, including Newfield Exploration Co. and Rosetta Resources Inc. are operating in the area and getting good results. They've been fairly quiet about what they've been doing, but if you connect all the dots you'll find that they've been having great success. Newfield, for example, just put a second horizontal well into production not too far from Primary's property. That is why I'm optimistic Primary will find something once it starts drilling later this year.

TER: I enjoyed talking with you. Thank you for your time.

SP: Thanks.

Steve Palmer has served as president, CEO and a director of AlphaNorth Asset Management since founding the firm in the fall of 2007. The company currently manages a long-biased, small-cap hedge fund. Prior to founding AlphaNorth, Mr. Palmer was employed at one of the world's largest financial institutions as VP of Canadian Equities, where he managed assets of approximately $350 million. He managed a small-cap pooled fund from its inception in August 1998 to August 2007, achieving returns that Morningstar Canada ranked #1 in performance (35.8% over nine years versus 10.0% for S&P/TSX Composite Index and 13.0% for the BMO Weighted Small-Cap Total Return Index) over the same period. Mr. Palmer also managed a large-cap fund that ranked in the first quartile of performance for years 1–5 and 10 at the time of his departure in August 2007. Prior to this, he worked as a portfolio manager at a high net-worth investment boutique. Starting his career as a research associate in January 1995, Mr. Palmer quickly progressed to research analyst. He has a BA in economics from the University of Western Ontario and is a CFA.

DISCLOSURE:

1) George Mack of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.

2) The following companies mentioned in the interview are sponsors of The Energy Report: Athabasca Uranium, Lithium Americas and Primary Petroleum.

3) Steven Palmer: I personally and /or my family or AlphaNorth funds may own shares of the companies mentioned in this interview. I and/or my family are not paid by any of the companies mention in this interview.

Source: Steve Palmer: Small Companies Poised for Big Growth