Manager Commentary June 30, 2024

Whitney George

The following commentary covers the six-month period from January 1 - June 30, 2024, and is an excerpt from the Sprott Focus Trust 2024 Semi-Annual Report.

June 30, 2024

Dear Fellow Shareholders,

For the first six months of 2024, Sprott Focus Trust (FUND) declined 0.98% based on Net Asset Value (NAV). In terms of market price, FUND declined 3.29% due to the widening of the trading discount to NAV. This compared to a return of 13.56% for the Russell 3000 Total Return Index.

Unfortunately, this was the worst first-half performance for small companies on a relative basis in 25 years. One needs only to look back to the late 1990s, at the peak of the dot-com bubble, to find such a divergence. Fortunately, what followed that crisis was a decade of strong outperformance. One of our favorite technical analysts, Carter Worth, points out that the technology-heavy Nasdaq Composite Index has just recently recovered all its relative losses to the Russell 2000 Index associated with the dot-com bust 24 years ago. We own many small-capitalization stocks (FUND’s weighted average market capitalization was $3.36 billion as of June 30, 2024). James Furey of Furey Research, a small-cap specialist, points out that the total market cap of the Russell 2000 Index as a percentage of the total market cap of the S&P 500 Index, currently at 6%, has never been lower. This is about one-half of the historical average and one-third of its peak. Further, relative valuations and 10-year relative returns are at historic lows. While we are certainly disappointed in our short-term performance, we remain optimistic about what lies ahead.

Given our lackluster performance thus far in 2024, it should not be surprising that FUND continued to trade at a relatively wide discount to its NAV (12.31% at quarter-end versus 10.21% as of year-end 12/31/2023). During the first six months, we repurchased 606,870 shares at an average price of $7.79. We also carefully considered converting FUND to an actively managed ETF. As the largest shareholders, the short-term financial benefits are very clear to us. However, given our contrarian value discipline, the longer-term benefits of our closed-end structure outweigh the one-time gain we could achieve with a transition. We generally like to buy when others are selling, and we don’t wish to attract new partners after periods of strong performance. For now, we are happy with our existing structure and will continue to invest in our portfolio of quality discounted companies.

As we noted in our last letter, we expected inflation and, therefore, interest rates to remain higher for longer due to structural changes in global trade and increased geopolitical turmoil. Check! While expectations were for seven interest rate cuts at the beginning of the year, the consensus moved down to zero and is now back up to one or two later this year, despite a visibly softening economy. We also expected fiscal deficits to remain at record levels. Check! The Office of Management and Budget recently increased its projected deficit forecast by 27% for fiscal year 2024, up to $1.9 trillion from $1.5 trillion just last February. Finally, we believed that commodities, especially precious metals, would do better as long-term supply/demand fundamentals became better understood. Check! Gold prices broke out of their multi-year trading range, setting new highs this past spring. Interest in critical materials like uranium, copper and silver increased dramatically during the first half. And while they have traded off a bit recently, we expect they will likely perform positively for the remainder of 2024.

What did we miss in our year-end predictions for 2024? Simply put, it was artificial intelligence (AI). Just when we thought the markets could not continue to be dominated by a handful of mega-capitalization technology companies, the world woke up to the productivity dream of AI, concentrating even more capital into a handful of companies counting on significant future profit growth to meet current valuations. We don’t know when this speculative behavior will end, but our experience tells us it won’t be pretty when it does.

Positioning & Portfolio Activity

As of June 30, 2024, Sprott Focus Trust was invested in 34 equity positions (down from 36 at year-end 2023) and held 4.8% in cash and cash equivalents (up from 2.6% on 12/31/2023). Cash is a by-product of the opportunity set we perceive in markets today, and our increased cash position when compared to year-end 2023 reflects the elevated state of markets generally and the dearth of compelling new ideas available in markets today.

As shown in Figure 2, the Materials sector was FUND’s greatest exposure at 38.9%. We continue to believe in the secular mining upcycle in both precious and base metals. However, we are closely watching economic activity for signs of a significant slowdown that might delay or derail the benefit to miners and drilling contractors. The Energy sector, at 14.7%, was the second largest exposure and is comprised of very high-quality companies in both production (Exxon Mobil Corporation) and services (Pason Systems Inc., Helmerich & Payne, Inc.). Financial Services remains a significant exposure at 14.0% and is concentrated in asset managers. Six of the previous period’s 10 largest positions remain, with the current top 10 comprising 43.1% of FUND’s net assets, down slightly from 45% six months ago (see Figure 1).

Typical for the late stages of a bull market, as value investors we were better sellers of portfolio positions than buyers during the first half of 2024. Only one new position was initiated, while three positions were liquidated. FUND has long held a position in Hong Kong-listed Value Partners Group Limited but having much greater conviction in other asset managers in the portfolio, we decided it was time to move on. Value Partners Group has encountered significant challenges in recent years, but its recovery in the eyes of investors is exacerbated by the deterioration in Sino-U.S. relations. The escalating tensions between the two economic giants have increased market uncertainty, affecting investor confidence and asset valuations in China and the rest of Asia. As a result, global financial markets, including those in Hong Kong, have experienced heightened risk aversion and extremely poor investor sentiment. Moreover, the geopolitical tensions have prompted regulatory and policy changes, complicating business operations and strategic planning for firms like Value Partners Group and the companies they invest in. The company’s assets under management (AUM) have declined as its value-driven strategies have struggled against the tide of growth and momentum-driven investing. Value Partners’ specific focus on China and the Asia-Pacific region generally have been additional challenges as investors have shunned Chinese equities amid the deteriorating relationship with the United States. Geopolitics notwithstanding, the challenges to Value Partners’ business have been too great to overcome, and with Sino-U.S. relations likely to remain poor, Asian markets will likely continue to struggle.

We have written in the past about initiating starter positions in companies that seem to meet our test of quality and undervaluation but require a greater degree of understanding and analysis to become a full-sized position in FUND’s portfolio. Sometimes, however, during further research we occasionally conclude that the starter position should be liquidated for a variety of reasons. This was the case with Sims Limited, the Australian-listed metal recycling company. Further on in this letter, we describe the challenges that Sims’ competitor Radius Recycling, Inc. has faced as metal spreads compressed, severely impacting margins of both companies similarly. Although the scrap steel processed by Sims and Radius is a critical feedstock for steel production, neither company provides the type of direct exposure to structural drivers of steel demand in the U.S. that we desire. The recycling business at Sims is one large degree of separation away from the pricing and demand dynamics we believe will be most beneficial to investors in the steel sector. We have significant exposure to this via our participation in Nucor Corporation and Steel Dynamics, Inc. and consider our existing exposure to Radius Recycling as sufficient, thus deciding to liquidate the starter position in Sims during the period.

The third position that was sold (alongside the only purchase during the period) can be considered a switch within our basket of gold mining companies as we liquidated Barrick Gold Corporation and entered Alamos Gold Inc. Barrick Gold, while being one of the largest and most established gold mining companies in the world, has been facing challenges such as operational issues, geopolitical risks in certain regions where it operates and fluctuating production costs. These factors have impacted Barrick’s profitability and share price performance, even as it has benefited modestly from the recent strength in the spot price of gold. After missing its guidance for the last two years, there exist better opportunities among Barrick’s peer group, including Alamos Gold.

Alamos Gold has shown strong operational performance, lower geopolitical risk exposure and a robust pipeline of development projects. According to the company, 89% of its net asset value is derived from Canadian assets. As an intermediate gold producer in low-risk jurisdictions, Alamos has fully funded plans to grow gold production from ~500,000 ounces targeted in 2024 to ~900,000 ounces in the future. In addition, all-in sustaining costs (AISC) are forecast to fall from approximately $1,159 per ounce to approximately $1,025 as production scales. Alamos’ 2024 acquisition of Argonaut Gold Inc. is central to its plans to become one of Canada’s largest and lowest-cost gold producers. Alamos’ performance on environmental issues such as water efficiency and greenhouse gas emissions per ounce of gold produced is well ahead of industry averages, and the company has been recognized for superior health and safety management systems, earning the Silver Helmet Award. On balance, and when compared to Barrick Gold, Alamos’ focus on increasing production and reducing costs provides a more attractive growth profile, offering better potential returns with less perceived risk in the current market environment.

Figure 3

Portfolio Diagnostics

Performance Contributors and Detractors

Figure 4 shows which positions contributed and detracted the most from FUND’s aggregate performance so far in 2024.

Figure 4

Top Contributors to Performacne

Clarkson PLC shares returned 33% (in local currency), contributing 0.8% to FUND’s total return for the period. The company is the world’s largest shipbroker, acting as an intermediary in ship charter transactions and arranging purchases and sales of ships and other maritime assets. While Clarkson’s shipbroking business is the dominant driver, ancillary services, including project finance, investment banking and support services (such as stevedoring and logistics), are informed by proprietary research, making Clarkson PLC best-in-class in servicing the global shipping sector. Although charter shipping transactions are a key focus for investors and the typical driver of Clarkson’s share price in the short term, second-hand purchase and sale transaction activity has been the reason for the recent strength in company shares in 2024. Exxon Mobil Corporation shares advanced 17% year-to-date and contributed 0.7% to FUND’s overall performance despite disappointing Q1 earnings. The market appears more focused on Exxon Mobil’s longer-term value creation potential from upstream volume growth in the Permian basin, Guyana and Brazil; downstream volume expansion initiatives; its forecasted $5B in cost savings by 2027; low carbon investments in biofuels, hydrogen and lithium; and finally the potential for significant capital returns to shareholders as a result of its recently deleveraged balance sheet and solid free cash flow generation, even in a tepid oil price environment.

Agnico Eagle Mines Limited is a senior gold producer with assets and operations located in the politically safe jurisdictions of Canada, Australia, Mexico and Finland. The spot price of gold increased 12% in U.S. dollars (USD) during the first half of 2024, outpacing most major asset classes and the best six month start since 2020. Agnico Eagle shares advanced nearly 21% over the same time frame, exhibiting the expected operational leverage in such a pricing environment; it contributed 0.67% to FUND’s performance in the first half. Several factors explain gold’s rise this year including central bank buying, Asian investment flows, geopolitical uncertainty (safe haven buying) and evolving investor views on the timing and pace of U.S. Federal Reserve interest rate cuts as economic growth decelerates. We trust that gold will continue to provide ballast in FUND’s portfolio as markets continue to reflect the uncertainties present in the world today. Steel Dynamics also contributed to portfolio performance in 2024 as shares advanced 10% through June 30. Quarterly results exceeded investor expectations and the company remarked that the underlying demand environment for steel remains firm, especially in the non-residential end market. This resulted in near-record steel shipments and higher average realized prices as Steel Dynamics continue to pursue various growth initiatives that should drive higher through-cycle operating margins. Rounding out the top five contributors, Berkshire Hathaway Inc. shares advanced 14% in the first six months of 2024 as expectations for improving underwriting margins across Berkshire’s insurance businesses amid the favorable property/casualty insurance and reinsurance market environment. Earned rate increases, combined with lower claims frequency and lower claims severity are helping to bolster margins. In addition, Berkshire’s equity portfolio continued to benefit from appreciation in its largest position, Apple Inc., increasing book value per share.

Top Detractors to Performance

Recently renamed Radius Recycling (formerly Schnitzer Steel Industries, Inc.) led the top detractors during the period as its shares fell by nearly half through June 30, 2024, detracting 1.79% from FUND’s overall performance. The business of metal recycling captures the spread between the price Radius pays to acquire scrap steel (in the form of old automobiles, appliances and various other end-of-life steel products) and the price that scrap steel manufacturers pay Radius for processed recycled material, which they use as feedstock to melt and reformulate into new finished steel products using electric arc furnace (EAF) technology. Approximately 70% of steel production in the U.S. is of the EAF variety, which has a 40-60% lower carbon footprint, a significant positive for the environment in this hard-to-abate sector. Recycled steel plays a direct and critical role in the supply chain for EAF steel production. When there is a shortage of used automobiles and other scrap items, the prices Radius pays can remain high. And when demand for finished steel products stalls, selling prices for processed recycled material can decline, compressing the spread (akin to gross margin). This has been true for Radius recently but explains only part of its story this year. Increased Chinese exports of finished steel products have satiated global steel demand that otherwise might have been supplied by domestic U.S. scrap steel producers. This has exacerbated the price decline, as seen with hot rolled coil (HRC) pricing this year (approximately -40% according to industry sources). Demand for steel is expected to strengthen due to continued onshoring of manufacturing, fixed asset investment derived from public funding in infrastructure projects, as well as continued increased demand for non-residential construction such as data centers and other industrial construction needs.

Marcus & Millichap, Inc. (MMI) is the leader in the private-client market for commercial real estate brokerage, involving transactions between $1 million and $10 million. It will come as no surprise to readers that commercial real estate transaction volumes have been negatively affected by higher interest rates. 2023 revenues declined by 50% versus 2022 and resulted in an operating loss for the full year, driving shares 27% lower during the period under review and detracting 0.79% from FUND’s performance. With net cash comprising more than 20% of its market capitalization on June 30, 2024, we are happy the company continues to opportunistically repurchase its shares as we believe they trade at a material discount to fair value. Pent-up demand in the private-client market and a potential U.S. Federal Reserve shift in interest rates are catalysts for recovery in MMI’s business and share price.

Shares in specialty retailer The Buckle, Inc. detracted 0.75% from performance during the first half as declining sales of its high-quality, on-trend apparel, accessories and footwear negatively impacted margins and profitability. Although consumer spending has been trending down recently, The Buckle continues to open new stores and remodel others with the expectation that the current environment is not severe, and its unique retail offering will retain its consumer appeal through the current downturn. We are encouraged by its net cash balance sheet which should enable the company to withstand this garden-variety downturn in great shape, as it has done through several previous downturns.

AerSale Corporation shares declined 45% during the last six months as investors lost confidence in the commercial prospects of its revolutionary Enhanced Flight Vision System (EFVS) for the Boeing 737 product line. After finally getting FAA approval in December 2023, further FAA delays related to validating the company’s flight training program were revealed, inhibiting the ongoing sales process with key initial customers. We have little reason to doubt the efficacy of the technology, based upon flight test data and the FAA’s approval, but the constant delay in roll-out of the product is indeed a frustration. Given the low expectations embedded in the company’s valuation, it is likely to benefit from any shred of incremental progress toward the commerciality of AerAware or the success of its core businesses.

Finally, THOR Industries, Inc. shares detracted 0.52% from performance amidst the soft retail environment for its recreational vehicles (RVs). The company stated recently that it expects the softness to persist into 2025. THOR remains disciplined on price, as they have a history of doing, as well as focusing on matters within its control such as supply-chain efficiencies and cost-savings. THOR has successfully navigated many soft retail environments through the years and has emerged stronger from such periods. Despite losing modest market share to aggressive discounting by competitors, we believe THOR’s long-term drivers of product differentiation and its ability to scale up in a more normalized economic environment should preserve its strong competitive position. Demand for RVs in Europe has been a strength for THOR as both unit increases and price strength have partially offset weakness in North America.

Outlook

As of this writing, little has changed from the outlook we presented at the start of 2024. As expected, inflation remained a bit stickier than most had hoped in the first half. Short-term interest rates are unchanged although expectations have fluctuated wildly over the last six months, as mentioned earlier. Despite a strong economic environment, fiscal deficits remain severe, and federal debt as a percentage of GDP (gross domestic product) is nearing the historic peak seen just after World War II.

Fiscal deficits continue to grow to non-recessionary records as a percent of our GDP. Two wars continue with no feasible end in sight. And elections both here and abroad are characterized by highly unpopular choices and results that reflect a desire to throw the incumbents out.

Fortunately, gold prices responded favorable to these difficult fundamentals, setting new highs almost daily. Our investments in precious metals miners have started to respond to this but only recently and less dramatically than we would expect. This sector is virtually unowned. It will not take much of a re-allocation from mega-Cap technology and artificial intelligence stocks to create strong performance within this group. We can also look forward to the inevitable mean reversion that will benefit our investments in smaller companies. We continue to own a collection of conservatively capitalized businesses which earn high returns on its own capital and share those returns with its shareholders generously.

Once again, I would like to thank you all my colleagues at Sprott. I am very proud of the evolution of this organization and how we are positioned today. I would also like to thank Matt Haynes for his extensive contribution to this letter. And most importantly, thank you to our loyal and patient shareholder partners. Please feel free to call us anytime 1.203.656.2430.

Sincerely,

W. Whitney George,

Senior Portfolio Manager

The views expressed above reflect those of Mr. George as of the date stated above and do not necessarily represent the views of Sprott Asset Management USA, Inc. or any other person in the Sprott organization. Any such views are subject to change at any time based upon market or other conditions and Sprott disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for the Sprott Focus Trust are based on numerous factors, may not be relied on as an indication of trading intent on behalf of the Sprott Focus Trust.