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  With Richmont, we hope to be more efficient than the market

BENJ GALLANDER and BEN STADELMANN

Friday, November 28, 2008

Golly gee, how many market axioms are dying out there? "Blue-chip" companies, which are supposed to be safe havens for investors, have filed Chapter 11. Others are now under government auspices or have been taken over by former rivals, which are now themselves teetering on the edge of the abyss.

Those who remained true to the "buy and hold" mantra have been left grasping worthless paper, or assets that are way down in value. Still, there are those who remain loyal to this gospel and suggest that, in the long run, everything will work out just fine.

Perhaps it will, at least for those employed by the mutual funds that take an average fee of 2.5 percent whether the portfolio is up, down or indifferent. They preach that if you're out of the market on the 10 biggest up days, your returns will suffer severely. Sure, but how come they never mention the advantage of being out of the market on the 10 worst-performing> days? Hmm...

Going back in time, one of us remembers arguing with a professor about the "efficient market hypothesis." This theory, based on the assumption that investors behave rationally, is considered economic canon at universities. The prof was a believer; the fledgling Contra Guy, not.

The theory posits that if information about companies is freely available, the prices of securities should mirror their intrinsic value at any given time. And, unless an investor has inside info, she cannot expect to outperform the market over the long term except by random chance.

It is the widespread belief in this theory that has led to the proliferation of passively managed index funds.

But it never made sense to us. Not simply because of our 21.8 percent annualized return over 15 years, but because we had seen other people do so very well in the market over a long period of time. That doesn't mean that great investors do not get trounced during market thrashings. Heck, even Warren Buffett is taking a beating these days.

In October, we decided to repurchase an old favourite of ours, Richmont Mines. We had bought it in 2000 at $1.81, then spun it out two years later at $4.60. It continued to climb, touching $6.90 in both 2003 and 2004. Hoping that lightning will strike twice, our purchase price was, once again, $1.81.

As there was no gold in the portfolio, Richmont was somewhat of a defensive play. While we are not of the conviction that gold will replace paper money, as some gold bugs are, the metal is a good place to tuck some funds as part of a diversification plan.

When our previous position was sold, the company's operations were humming. The bottom line reflected this: in 2003, the company made a solid 32 cents a share. However, as the profitable mines were depleted and large capital expenses were required to bring new ones on stream, Richmont suffered dramatically. In 2005, the firm lost $27.5 million, or $1.54 a share.

Things appear to be turning around. Cash costs at the Beaufor Mine have dropped from $642 an ounce a year ago to $485 today. The Island Gold mine is coming along slowly, and Richmont is paying $17 million in a combo of cash and shares to buy out the interest of partner Patricia Mining. This will still leave the enterprise with better than $20 million in cash and no debt, one of the cleanest balance sheets in the industry.

In the first three quarters of this year, Richmont repurchased 243,000 shares at an average cost of $2.57 for cancellation. This quarter, they bought more at under $2 a share. Additional repurchases are expected.

Unfortunately, the enterprise is not currently profitable, losing $894,000 in the most recent quarter. This was slightly more than half the loss of a year ago. The improvement is primarily due to the jump in third-quarter revenues by 245 percent year-over-year to almost $16.6 million. It is likely that Richmont will be profitable before 2009 is out.

Fortunately, we did not buy to hold in 2000, or we would be sitting pretty much where we were eight years ago. Instead, thinking as we do that we have some skill in the stock-picking arena, we bought, sold, and bought again. Of course, that could simply be our egos getting in the way; if so, the efficient market hypothesis might ultimately get the better of us.


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