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The Globe and Mail

Wall Street legend aims to strike pay dirt in Ontario

Seth Klarman is considered one of the world's money managing impresarios, a superb value investor whose record of outsized returns has given him cult status on Wall Street.

What interests him now might be a surprise: rocks and spuds in a rural Ontario backwater.

While typical hedge funds flip stocks, commodities, and complex financial derivatives, Mr. Klarman's Baupost Group has taken a position that is more down to earth, literally. It's invested in Highland Companies, Ontario's largest potato grower, which recently proposed developing a mega quarry on part of its sprawling spud lands.

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Potatoes and gravel seem like far-out investment ideas, even for a U.S. hedge fund, and Mr. Klarman's taking a shine to them suggests they may have upside potential currently not appreciated by the market.

The trade is likely to either cement Mr. Klarman's reputation for acumen, or be a big flop.

On the side of acumen are some intriguing numbers. Baupost was part of a group funding Highland's purchase of about $50-million worth of potato lands in Dufferin County in Southwestern Ontario, under which, at a relatively shallow depth of about six metres, lie an estimated one billion tonnes of limestone suitable for construction aggregate.

The rock could be worth up to $25-billion, depending on its quality.

To be sure, there is a big element of dice-rolling. To hit pay dirt, the quarry needs to be licensed, which means overcoming the fear and loathing among many in the local area toward the proposed development. It's a huge, hard-to-quantify risk.

And then there are the spuds. It's not clear whether hedge fund operators, typically the ultimate city slickers, have much expertise on the starchy tuber, the fallback position on the trade in case the quarry doesn't go ahead.

Mr. Klarman, who declined through a spokesperson to be interviewed, manages about $23-billion (U.S.) through his Boston-based Baupost.

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But in a written statement to The Globe and Mail, Baupost said the investment "is consistent with our long-term, value-oriented strategy. We take our role as a responsible investor seriously, and made this investment because we were confident that Highland would pursue this project in a thoughtful way that respected the local application process, as well as important community and environmental concerns."

'Highly Unusual'

Mr. Klarman's ideas are definitely worth tracking, if not emulating. Each $1 placed with Baupost when it opened up shop in the early 1980s has grown to about $165, or a compounded rise of 20 per cent a year, one of the best long-term records among hedge funds.

"Klarman looks for highly unusual items. He is in no way limited to just the stock market," observes John Reese, who wrote The Guru Investor, a book about highly successful fund operators.

Even so, Mr. Reese hasn't found top investors who've taken a shine to potatoes. "Potato farming, no, that strikes me as unique," he said.

Mr. Klarman has such a wide following that even the book he's written divulging his money-making secrets, Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor, has itself become a quirky investment, and an excellent one at that. It was originally published in 1991 for $25, but new copies of the out-of-print book are currently offered on for a stupendous $2,500, or a 100-fold increase.

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The book's basic thesis for extreme money making is to buy securities so underpriced by the market that huge profits are virtually assured, and chances of capital loss remote. The key to the concept is buying when prices are very low, relative to a security's real value, so that the investment has a comforting margin of safety against errors in judgment, poor timing, and adverse market moves.

For those interested in mimicking Mr. Klarman on this trade, be forewarned. It will be difficult.

There are no publicly traded spud growers in Canada. Commodity futures exist for potatoes, but that's a field or gamblers and speculators.

The few publicly traded quarries aren't guaranteed money makers either. One of the only ones on the TSX, Polaris Minerals Corp. , is a money-losing penny stock whose fortunes have been dimmed by the U.S. construction downturn.

If Mr. Klarman's operative principle is a margin of safety, he may come up short on this trade, according to back-of-the-envelope calculations. In order to assemble its huge, 26-square-kilometre land position, Highland paid about $8,000 (Canadian) an acre, or 30 per cent above market prices in the area, near Melancthon, Ont., and nearly three times the price of spud-growing land in New Brunswick.

On the plus side are supply-and-demand trends. Ontario quarries are mining more rock each year than they're replacing in new reserves, raising the possibility of shortages, observes Bill Galloway, senior vice-president of Holcim (Canada) Inc., a major aggregate supplier.

Still, the sheer size of the proposed development could overwhelm the market. Highland is asking the province for the right to mine unlimited quantities each year, possibly wishful thinking considering Ontario hasn't granted such requests for decades.

The proposed pit would ultimately be about seven square kilometres and as deep as a 15-storey building. Highland intends to truck dirt into the bottom to permit farming in areas once they're mined, but this will require pumping out in perpetuity to prevent the inflow of groundwater from creating a new lake.

It isn't clear whether pit farming is economically viable, given the high cost of electricity for the hundreds of millions of litres of water that will need to be pumped daily.

The biggest investment risk, though, is the human factor. People living near proposed quarries tend to hate them, what with the prospect of blasting, dust, and worries over groundwater disruption. This one is no different.

"Folks will fight this until the bitter end," predicts Carl Cosack, a cattle farmer who lives nearby.



Seth Klarman is an investor who likes a margin of safety on his investments and is mindful of "tail risks," or remote events that could devastate a portfolio if it isn't hedged for disaster.

Right now, he doesn't see much of value in the stock market. Only about 10 per cent of his Baupost Group's assets are stocks.

But among his top holdings are a pair of gold stocks. Gabriel Resources Ltd. , developer of a gold mine in Romania, is his No. 3 holding. Allied Nevada Gold Corp. is No. 6.

Mr. Klarman says he is interested in the yellow metal because he's worried about hyperinflation and the possibility of a plunge in the U.S. dollar. According to a rare media interview in The Wall Street Journal, he's also bought deep, out-of-the-money put options on U.S. bonds, a strategy that will pay off big time if interest rates soar.

Although he admitted that the odds of interest rates going through the roof are "way less" than 50-50 over the next five years, he said the trade represents cheap insurance against financial calamity. If rates get back to double digits, the purchase could return 10 or 15 times the original investment. If rates rise to 20 or 30 per cent, the return will be 50 to 100 times the original investment.

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