"The most interesting information comes from children. For they tell all they know and then stop."
Mark Twain

The last six months has seen better times for investors. The FTSE/JSE All Share and Resources indices rallied 37.5% and 30% respectively since March. The All Share (-25%) and Resources indices (-43%) are still below peak levels achieved in 2008.

Commodity prices also rallied from their lows, with the major Economist Metals Index up 70% from the low in February. All commodities are still significantly below the high prices achieved in 2007 and 2008. The rand strengthened by 25% in the same period, offsetting some of the benefit of higher prices to SA companies.

For the quarter, the fund delivered 14.0% relative to the 13.6% of our benchmark (the mean performance of competitor funds in the same sector). Over the last 12 months, the respective total returns were -4.3% and -2.5%.

In commodity markets, the debate currently centres around the sustainability of the demand we have seen from China in 2009 and the timing of a recovery in the Western World.

In China, a more resilient economy and the effectiveness of the massive stimulus package has enabled it to be one of the few countries where commodity demand and imports increased over last year. China, and a return of investment funds into commodity markets, has been the only support to commodity prices for much of this year. At current levels, Chinese demand now accounts for more than 50% of most commodities.

From the data we have available, it seems clear that some of the recent imports into China has gone into building inventories of commodities and does not necessarily reflect underlying demand. This would seem to indicate that we should expect at least a slowdown in the rate of imports into China.

In the face of slowing Chinese demand, the traditional consumer economies of the West have to make up for the difference. Western demand has been weak for most of this year, but has recently shown signs of recovery. Inventories are still low, and will need to undergo the same cycle of restocking as we have seen in China. The timing and strength of a recovery is uncertain, but it seems unlikely that mature economies will return to the debt-fuelled consumption rates of 2007 in the medium term.

We cannot predict commodity prices over a specific period with a reasonable amount of confidence. The world economy is a tremendously complex system with many non-linear feedback loops and unknowable events waiting in the future. Despite all the intelligence and analysis poured into forecasting, very few predicted the global economic crisis. Our view is that this poor forecasting performance will continue into the future. Nobody really knows.

In running your fund, we ignore the inevitable noise contained in forecasts and the debate of the day in the media. We focus on owning companies where the price paid compensates for the risk you take based on an uncertain future. We are confident that the fund will outperform its benchmark in most future scenarios. Over the last quarter, the market gave us opportunities to reduce our share in companies that performed to levels closer to our estimates of fair value (Impala, Anglogold, Merafe, Sappi), and increase our holdings in laggards that we like (Gazprom, Zimplats). We took advantage of the current strength of the rand to increase our international holdings. Overall, our positioning has not changed much with essentially the same large holdings.

Portfolio managers
Henk Groenewald and Duane Cable

Green Shoots, Moss or Yellow Weeds? The fund returned 14.64% for the quarter against 7.71% for the benchmark. For the year to June, the fund returned -42.35% against the benchmark's -42.65%.

The greatest contributors to quarterly performance were Mondi, Pallinghurst Resources, Metorex, Sappi and our preference for Anglo American over BHP Billiton. Our holdings in AngloGold and Sasol detracted from performance.

During the quarter, we took advantage of lower price levels to add to some of our existing holdings, primarily Sappi, Zimplats and the Palladium and Aluminium ETF's. As was indicated in the previous quarter's commentary, we believe that BHP Billiton is relatively expensive compared to Anglo American and during the quarter we further reduced our holding in BHP Billiton, while increasing our weighting in Anglo American.

We also initiated a position in Pan African Resources ("PAN"), a low cost, unhedged and debt-free gold producer. PAN has some interesting exploration projects, primarily Phoenix Platinum, which owns the rights to Platinum Group Metals (PGMs) contained in surface tailings dumps. At current prices one effectively gets the exploration assets for free, while the existing gold business is at a substantial discount to our assessment of intrinsic value.

The past quarter has indeed been a more cheerful one for investors following the bloodbath experienced in the second half of 2008. By the end of June, the FTSE/JSE Resources Index has rallied 42% from the November lows and most market commentators have been talking about 'green shoots'1 and some have even been brave enough to suggest that the commodity supercycle is alive and well. The term 'green shoots' has definitely become one of the most overused terms of the quarter and a recent Bloomberg article even highlighted some interesting comments from market commentators trying to pour cold water on any signs of a global recovery. One market commentator even coined the word moss. "It may be green shoots, but they are growing slowly. It's moss." Nouriel Roubini, or better known in the market as Dr Doom, believes he is seeing more yellow weeds than green shoots. The market appears to be obsessed with trying to time exactly when the economy will recover. It appears that economists are cooking up an alphabet soup in trying to explain the shape of the economic recovery with terms like 'V-shaped', 'W-shaped', 'Tick-shaped' or 'Square root-shaped' being some of the more commonly used phrases.

History has taught us that our ability to time the market successfully on a consistent basis is limited. As admirers of Warren Buffet, we have learnt that when you waste time worrying about questions that can't be answered, you spend less time on the few things that can be answered. We do not know exactly when the global economy will recover, but neither do we believe that this is a question that can be answered with any great certainty. Instead, we remain focused on long-term valuations and looking for opportunities that we believe have been mispriced by the market.

The fund remains fairly concentrated with our top 10 holdings accounting for 76% of the fund. The constituents of the top 10 have not changed since the previous quarter and we continue to believe that despite short-term market uncertainty, the fund should be able to deliver superior returns relative to the benchmark over the long term.

Portfolio managers
Henk Groenewald and Duane Cable

The fund returned -3.46% for the quarter, against -1.03% for the benchmark. For the past year, the fund returned -47% against -42% for the benchmark.

After a period of underperformance in a fund with a record of consistently outperforming the benchmark, investors have a right to start asking hard questions. After all, 2008 was the first calendar year since 2001 in which we have underperformed our benchmark. None of the questions from our investors, however, can be as tough as the questions we pose to ourselves.

Firstly, let us assure investors that nothing has changed in our investment philosophy or process and we still remain convinced of our ability to outperform the benchmark over longer-term periods. We would be very worried if recent underperformance was a result of us changing our philosophy or process, or if it causes us to abandon our proven philosophy. This was not the case.

A large part of our underperformance relates to not owning enough BHP Billiton, and our large Mondi position. We sold BHP too early but still believe this company is relatively expensive at the moment (notwithstanding the undeniable quality of assets and management). The fact that Mondi declined in price just makes us more excited for the future returns from this investment.

Did we make mistakes? Of course we did. Our largest mistake when faced with overvalued large companies was to buy too many of the smaller companies we thought offered better value. In hindsight, this unfortunately proved to be wrong as the inevitable weaker management teams, corporate governance and balance sheets accompanying the companies proved to be value destructive in a few cases. We have sold the companies where the investment cases have been permanently impaired and weren't reflected in reduced share prices.

Portfolio
When building your portfolio, we strive to ignore the constant noise in the market and identify undervalued and mispriced companies based on long-term valuations. We will take large positions based on fundamental research.

At the moment, the portfolio is quite concentrated, but with a diversification across sectors. Our top holdings are Impala Platinum, Sasol, Anglo American, Mondi and AngloGold.

We like the long-term fundamentals of the platinum and oil markets, hence the large Impala and Sasol positions. Both are low cost producers in their markets. AngloGold is our favourite (and only) gold share, with low cost, long-life operations and a new management willing to focus on cash flows.

In dollars, you can now buy Anglo American at the same price you could in 1994. There are reasons for the underperformance but this company still owns fantastic assets and is now very cheap. Mondi is similarly unloved and did not benefit from the commodity boom.

We are happy with the fund's positioning as it stands and look forward to outperforming the benchmark in future.

The future
"Invert, always invert" was the motto of one of the greatest mathematicians of all time, Carl Jacobi and also a favourite of Warren Buffet right-hand, Charlie Munger.

We are often asked for our outlook on the cyclical commodity sector - a nearly impossible question as it pertains to forecasting the essentially unknowable future. In this note, we will look at this question backwards. Instead of discussing what we think will happen, we will examine what you are paying for currently. This will lead us to determining our returns under a whole range of different scenarios.

At the moment, the resource sector clearly offers much greater value than it did nine months ago. On our calculations, based on long-term average real earnings and long-term PE multiples, the sector as a whole already prices:
· A 50% to 60% drop in earnings;
· Normal or "through-the-cycle average" earnings about 35% below current but 50% above the long-term real average.

Our conundrum is that share prices have not fallen as much as commodity prices. In other words, the market is looking through currently very low commodity spot prices and already discounting better earnings sometime in the future. This is a very rational assumption, as commodity prices have throughout history cycled from high to low values. Unfortunately this also means that now is not a once-in-20-year opportunity where the market is so pessimistic that it is priced for very bad conditions to endure far into the future.

Relative to the rest of the market, the sector again doesn't stand out as massively over- or undervalued.

Overall, we think the resources sector is priced rationally. It is not pricing in the worst outcome of a three to five-year recession and is pricing in at least something for continued Chinese growth in future. If this eventuates, an investor will make market related returns over a three to five-year period. If the outcome is much better (due to either very strong emerging market growth or a quicker recovery in developed economies) or worse, your actual returns will differ. The current PE on historic earnings is 8.8x versus a 20x of some nine months ago.

Unsurprisingly, your returns from investing in the resource sector, as always, are dependent on the actual economic outcomes in future. Investors have to come to their own conclusions but we don't think the valuation of the sector as a whole offers a compelling opportunity.

We are far more excited about future returns from the fund than for the sector as a whole. We see very specific opportunities and have positioned the fund as such. For example, the fund's current average PE is 5.4x versus the 8.8x of the sector. In the fund, you are currently only paying for a much more bearish outcome than described above and should do better than the sector no matter what the economic future actually holds.

"The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored."

"Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell.

" The Intelligent Investor, Benjamin Graham.

We started the previous quarter's commentary with the following line: "These are very trying times to be invested in the stock market, especially in the resource sector." In the third quarter, we experienced a severe correction, with a 33.1% decline in the benchmark, and encouraged investors not to panic. This advice proved to be useful for what lay ahead in the fourth quarter. During 2008 we saw the market swing between greed and fear. In the past quarter we saw a further decline in both commodity and companies share prices. "When you sell in desperation, you always sell cheap." This is the advice from one of the great investors of our time, Peter Lynch, who managed the Fidelity Magellan Fund between 1977 and 1990. The global liquidity crisis led to forced or panic selling in many instances and we used these opportunities to buy great companies at low prices. The financial crisis of 2008 will be one for the record books, with many market commentators believing that we are in the worst economic environment since the Great Depression of the 1930s. China's economy, one of the key contributors to the resource bull market, has not been strong enough to withstand the global weakening and we have seen a large decline in the demand for commodities. In the space of a few months, the price of copper, nickel and oil declined between 70% to 75%. When people stop buying cars, and they stop buying houses, it travels all the way back to the mine. We have not only experienced a decline in commodity prices but also declining volumes, with producers reporting pressure from customers to delay or cancel shipments. The period of super profits that commodity producing companies have enjoyed is over for now. Short-term profit forecasts are abysmal and companies have cut staff, reduced exploration spend and cancelled capital expansion projects in an attempt to reduce costs. As painful as it has been, the market was very quick to price in the bad news. With many commodity prices below the marginal cost of production, we are starting to see the supply response needed to improve the demand/supply balance. Although difficult to predict when global demand will recover, the decision to curtail investment in supply will most likely be the seeds for the next bull market. The return for the past quarter has been extremely disappointing with the fund declining by 24.2%, worse than the benchmark's decline of 19.5%. Regular readers of our quarterly commentaries and those familiar with our investment process will be aware of our emphasis on long-term valuations over short-term market movements, and the past quarter has not changed that focus. We are, however, disappointed with the poor returns for 2008, underperforming the benchmark by 4.6%. The past quarter's returns meant that for the first time since 2001, and only the third time since inception, the fund has not been able to outperform the benchmark for the calendar year. The greatest detractors of quarterly performance were Mvelaphanda Resources, Mondi, Metorex, Zimplats and Pallinghurst Resources. Our holdings in AngloGold and Harmony helped to offset some of this underperformance, as did our underweight positions in Anglo Platinum and ArcelorMittal. During the quarter, we took advantage of market declines and low price levels to add to some of our existing holdings. Some of the larger purchases included Sasol and Impala Platinum. We also took profits by reducing (e.g. AngloGold and Harmony) or selling (e.g. Keaton Energy) holdings which have performed well. Those proceeds were used to fund better opportunities with a larger margin of safety. During the quarter, we initiated a position in Sappi, a global coated fine paper and chemical cellulose producer. The paper industry is cyclical and one wants to buy a cyclical business when earnings are low, the newsflow is bad and expectations for a recovery in earnings are low. Unlike many resource companies, Sappi has not benefited from the resource boom and earnings are depressed. The market has been focusing on the extremely negative short-term demand outlook for the sector. The newsflow is indeed bad, with the global financial crisis having a negative impact on advertising spend; one of the primary uses for coated fine paper. After many years of poor returns for the sector, a number of Sappi's peers are currently not profitable and have weak balance sheets. This situation is not sustainable and industry profitability will need to improve, or many companies will go bankrupt. After years of irrational behavior, we are seeing signs of consolidation and more rational behavior from suppliers. While current prices are reflecting a very poor short-term outlook, the balance of probabilities for long-term rewards is in favour of a patient investor. As we start a new year, we are bombarded with predictions from numerous financial experts about what lies ahead in 2009. History has taught us that our ability to forecast the immediate future is limited. We will remain focused on long-term valuations and will seek to take advantage of whatever attractive opportunities 'Mr. Market' will present us in 2009 to generate long-term rewards for our investors.

Henk Groenewald & Duane Cable
Portfolio Managers