"There will have been three great inventions since the beginning of time: fire, the wheel and central banking." (Will Rogers)

A rollercoaster of a quarter! The resources index was down by 8% in August, but staged a strong recovery to end 12% up from last quarter. The market clearly believes in the curative powers of the world's central bankers, but it remains to be seen whether the fallout from the debt market crisis will have wider ranging effects.

For the quarter, the fund returned 13.6%. The best performing companies in the portfolio were Exxaro (31%), BHP Billiton (25%) and Anglogold (22%). Anglogold was the best performing gold share, driven by an 11% increase in the rand gold price. Platinum shares lagged, but Impala (11%) significantly outperformed Amplats (- 10%) and Northam (-12%).

International shares contributed significantly to performance. In US dollars, CVRD increased 52%, Petrobras 25% and Norilsk Nickel 22%.

For the 12 months to end September, the fund returned 64.7% relative to the 54.8% of the benchmark. The yearly compounded return over the last three years was 52.4% and 48% respectively. These are truly exceptional numbers and these levels of returns are unlikely to continue.

We ended last quarter's commentary with the following line: "We have started the third quarter with more new investment ideas than we have had in a while, and look forward to reporting back in 3 months." This has indeed proved to be the case. A number of new companies are represented in the fund for the first time.

We bought a significant position (8% of fund) in Mondi Limited. This company, spun out of Anglo American in July, produces paper and packaging and is one of the most unloved commodities around. Mondi has low cost assets and large shares of the markets in which they operate. Earnings are low after 3 years of declining earnings, and paper and packaging markets are improving. The market values Mondi significantly below the replacement value of their assets and we expect good returns from our investment.

Internationally, 4.5% of the fund was invested in Bermudan-listed Pallinghurst Resources. Due to a timing issue, this was unfortunately still reflected as international cash at the end of the quarter. Pallinghurst is a private equity vehicle investing in the natural resource sector. It is led by Brian Gilbertson who should need no introduction. True value creators are rare in this world, but in the South African market we've had more than our fair share. Surnames like Joffe, Lynch, Saad and Rupert spring to mind - I do not hesitate to add Mr Gilbertson to this list. All these individuals' track records stem from a visionary approach and astute decision making which has been achieved over many years and in a variety of different market conditions. When offered the opportunity to co-invest with any of these gentlemen at cost; it is one of the easiest investment decisions to make. A decision made even easier by the fact that two years of prior work by the Pallinghurst team has led to three very exciting opportunities having already added value to your investment.

The last new investment was slightly smaller - 1% of the fund in Russian gas giant Gazprom. While investing in Russia is not for the fain-hearted, Gazprom's investment case is very compelling. The current assets will deliver very strong earnings growth as the loss-making domestic gas sales (70% of total) are decreased in favour of high margin exports and Russian domestic gas prices increase. With the largest gas reserves in the world, investments in oil and power generation and the backing of the Russian government, Gazprom has incredible opportunities to add value to their current asset base which investors are getting for free.

Whether central banking turns out to be an invention akin to the wheel or not, we believe the companies represented in the fund will ensure continued good performance relative to our benchmark.

Henk Groenewald
Portfolio Manager

'Extreme Commodities' "Another thing I think should be avoided is extremely intense ideology because it cabbages up one's mind. You see it a lot with T.V. preachers (many have minds made of cabbage) but it can also happen with political ideology. …. I have what I call an iron prescription that helps me keep sane when I naturally drift toward preferring one ideology over another and that is: I say that I'm not entitled to have an opinion on this subject unless I can state the arguments against my position better than the people who support it. I think only when I've reached that state am I qualified to speak. This business of not drifting into extreme ideology is a very, very important thing in life." Charlie Munger

The quote above is from Charlie Munger,
Warren Buffet's lesser known, more idiosyncratic partner. It is common cause that extreme ideologies (or fanaticism) have done the world more harm than good. They have most often found an outlet in religions and politics, and it is most dangerous when the two are mixed. In financial markets, fanaticism has found a perfect partner in greed which has resulted in gold rushes, manias and bubbles throughout history.

The biggest problem with extremism is the inability to see the other side, to walk in another's shoes. It is in general not built on consideration and open-mindedness, but on judgement and intolerance. It seems a great pity that fanaticism does not find natural release in acts of 'extreme kindness' or 'extreme tolerance'.

In investment markets there are many extreme views. In the resources sector, eloquent speakers convince you that commodities are running out and prices will go up for ever, while others try to convince you of an imminent collapse in global demand. The share of voice for the different arguments is dependent upon recent performance. Today the snorts of the bulls are most audible, while they were difficult to detect amongst the roar of the bears in 1998 or even 2001.

In the fund, we prefer to take Mr. Munger's advice and stay away from extremes. When we value companies, we focus on all the factors driving valuations. For mining companies these are mainly prices, volumes and costs.

Based on our analysis we take strong actions in the fund, taking large positions in certain companies. These may sometimes be viewed as extreme. However, these extreme positions are never based on fanatical views about commodity prices, super cycles or on our guesses of the next 12 months relative performance. More often than not, the positions we take are based on factors that are under the control of the companies we invest in, and not solely on our forecasts of commodity prices.

We cannot ignore prices as they are a very important driver of the value of our companies. It is however one of the inputs where we have less certainty and it is particularly difficult to predict prices a year or two from now.

The circumstances that caused current prices were extreme. Supply could not keep up to very strong demand growth and this has lead to critically low metal inventories. For continued high metal prices, you need demand to continue to surprise and supply to continue to under perform. We don't expect this to last for ever and expect lower prices in the medium term.

With a very strong bull market behind us (and continuing since quarter end) worrying about the future certainly seems to have been silly in hindsight. We sometimes feel like Mark Twain when he said: "I'm an old man and I've known a great many troubles, but most of them never happened." We are however strengthened in our resolve to keep on worrying by a further quote from Charlie: "You can say, who wants to go through life anticipating trouble? Well I did. All my life I've gone through life anticipating trouble. And here I am, going along in my 84th year and like Epectitus, I've had a favoured life. It didn't make me unhappy to anticipate trouble all the time and be ready to perform adequately if trouble came. It didn't hurt me at all. In fact it helped me."

Over the quarter the fund delivered a 7.25% return. For the six months to June it returned 28.05% and 48.45% over the last 12 month period. This compares to the 26.3% and 41.2% produced by the benchmark over the same periods. We are happy with the companies represented in the portfolio currently, and believe that on a relative basis, this will continue to provide investors with a decent share of upside potential while providing adequate performance if trouble develops.

Very little changed amongst our top 10 holdings relative to last quarter. Our top three holdings are still BHP Billiton, Impala Platinum and Sasol. BHP Billiton (20%) and Sasol (9.9%) were positive contributors, and BHP again outperformed Anglo American (6.9%). Impala (-5.3%) was the worst performing platinum share over the quarter, and significantly underperformed junior platinum companies (even after a significant correction in their share prices). This makes us more excited about the outlook for this premium quality company. After continued good performance, we have reduced our holdings in Mvelaphanda Resources and Mittal Steel. We still see some value in these shares, but have found better opportunities elsewhere. We have started the third quarter with more new investment ideas than we have had in a while, and look forward to reporting back in three months time.

Henk Groenewald
Portfolio Manager

"When shortages exist, however, even commodity businesses flourish. One of the ironies of capitalism is that most managers in commodity industries abhor shortage conditions - even though those are the only circumstances permitting them good returns. Whenever shortages appear, the typical manager simply can't wait to expand capacity and thereby plug the hole through which money is showering upon him."
Warren Buffett

For the 2006 calendar year, the fund returned 50.14%, the second successive year of above 50% returns. That this has been an exceptional period goes without saying. More satisfying for us is the fact that 2006 marks the 5th year in a row where the fund has outperformed its benchmark.

The final quarter of 2006 was a very good quarter for the fund, driven mainly by the good performance of the platinum shares. The fund returned 13.22% versus the benchmark 4.48% return. Our picks amongst the junior platinum miners, Aquarius (+26%) and Eland Platinum (+83%), outperformed the majors Impala (+15%) and Anglo Platinum (+9%).

Amongst our big holdings Sasol (+1%) and BHP Billiton (-4%) detracted from performance this quarter, while Mittal Steel (+25%) had a good period.

During the quarter we purchased a significant stake in Mvelaphanda Resources which now makes up 5.46% of the fund. We were attracted to Mvelaphanda by the large discount to its underlying constituents (mainly Goldfields and Northam). Since our purchase, the announced deal with Afripalm will allow the business a much more solid platform for growth into the future. We believe this business is priced for the worst, and does not take any value creation from future deals into account. We like taking bets where the odds are in our favour!

Like many investment managers, we are guilty of quoting Warren Buffett too often and it seems almost sacrilege to put such a negative quote above when reporting on another excellent year for the fund's investors. Last year we warned that commodity prices were at high levels relative to their long-term averages and that in time they will adjust to more realistic levels. We were therefore surprised at the size of the continued increases in commodity prices through 2006.

While we have little faith in our ability to forecast short-term price moves, higher prices make us more cautious, not less. Whatever happens, 2007 is bound to be an interesting year. Recently, there have been signs of both supply and demand becoming more elastic, driven by higher prices. Supply in nickel, coal, zinc, iron ore and alumina is coming from unexpected sources and consumers are getting smarter about recycling and substituting one metal with another, or even with plastic. This should not come as a surprise to investors, as commodity prices far above the cost of producing them will lead to new production. Once again, capitalism does not disappoint. Counteracting this are still low stock levels and continued demand growth from primary applications.

In such an environment, we remain more defensively positioned. No doubt, we'll be surprised again next year at the exact path commodity prices and resource shares took in 2007. Instead of trying to predict short-term price moves, we shall continue to concentrate on determining the value of the businesses operating in our sector. This value is not determined by commodity prices today, but rather commodity prices tomorrow and for a long time into the future.

We continue to look for low risk opportunities, and invest in companies that we believe offer attractive long-term valuations. Hugo Nelson and Henk Groenewald Portfolio Managers