Stay the Course
It has been a few months since I last shared my perspective from my position at Sprott. Much has happened in the interim, most of it good — vaccines have allowed us to resume some sense of normalcy. Challenges including climate change, terrorism, racism and disease are being addressed, although wealth inequality has risen sharply and is driving a broad shift towards socialist governments.
Grateful for a Good Year
At Sprott, we have been very fortunate. Our team safely operated remotely and is now back together, and our culture has never been stronger. We launched Sprott Physical Uranium Trust ("SPUT"), spurred by our long-term belief in the resurgence of low-carbon nuclear power. After years of planning, SPUT became an overnight success as the improvements in its structure and marketing support generated immediate investor interest. Driven by close to $3 billion in inflows to our exchange-listed trusts, Sprott's client numbers and assets under management have soared to new highs. Our inbound traffic is growing, as a wider spectrum of investors appreciate the need for diversification from financial market assets, where valuations are stretched and increasingly dependent on artificially low interest rates. Our shareholders have been rewarded with steady and growing dividends, the highest share price in this cycle and a NYSE listing of Sprott Inc., which broadened our shareholder base.
Figure 1. Sprott Inc. AUM ($ Billions USD)
Source: Sprott Inc. as of 9/30/2021.
Our Positioning for 2022
We expect more of the same for a while. The U.S. Federal Reserve Board's (the "Fed") tapering plans as announced were widely anticipated. In the rate markets, there seems to be a balanced argument between cooling economic growth supporting a dovish low-rate regime and stubbornly-high inflation combined with the taper, which could drive rates higher. Meanwhile, significantly negative real rates continue to spur massive flows into the equity and risk markets — There Is No Alternative for investors. Momentum indicators tell us that this flow will likely build into year-end window dressing, providing more fuel for one of the best years ever for equity markets.
As I mentioned in my last report (Golden Anniversary Reflections, June 2021), we continue to believe that inflation will persist. The flood of global monetary stimulus has finally "breached the levee" to generate a positive demand shift, and China is no longer able or willing to supply deflation through its exports. Labor markets are tight and workers are ready to hold out, knowing that the government has their back now. We continue to puzzle over why the overwhelming focus is on the definition of "transitory." Major price increases have occurred which will not be reversed, and the likelihood is that this cycle will be repeated. Exactly when and by what quantum is of much less relevance than the global, constant and irreversible process of monetary debasement.
Figure 2. Inflation: Year-Over-Year Consumer Price Index (1982-2021)
Source: Bloomberg as of 11/30/2021. U.S. YoY CPI reflects the year-over-year change in the consumer price index, measured by CPI YOY Index. You cannot invest directly in an index. Included for illustrative purposes only.
Looking slightly further out, we do not believe that plans for tapering will materialize without being challenged by either weak markets or slow economic growth, the two of which are now joined at the hip. The track record of the dot-plots associated with the Fed's forward rate signaling is unblemished with success. It seems to us that a "fake taper" is the real game plan. To justify that statement, we point to a) the Congressional Budget Office's 10-year budget, which continues to rely on low nominal and negative real interest rates and b) the Fed's continued readiness to provide massive repo facilities in the event of market fluctuations (no different than printing money to buy government or mortgage debt). It appears that the game plan of the Fed and the U.S. Department of the Treasury, which is now a mathematical imperative, is for the continued financial repression of savers, plain and simple.
Figure 3. The U.S. 10 YR Treasury Bond Real Yield (2016-2021)
Source: Bloomberg as of 11/30/2021. U.S. 10 YR Treasury Bond Real Yield reflects U.S. 10 YR Treasury Bond Yield less Year-Over-Year Consumer Price Index, measured by USGG10YR Index less CPI YOY Index. You cannot invest directly in an index. Included for illustrative purposes only.
Which Canary Will it Be?
I am amazed at the resilience of this "go-go" stock market. It has bulldozed over the Evergrande and Chinese junk bond meltdowns, crisis and hyperinflation in several minor economies, major pandemic lifestyle and employment changes, inflation which is realistically running close to 10% annualized and a steady list of parabolic, nonsensical speculative asset bubbles. My brother, an experienced portfolio manager who runs a sustainable growth mutual fund, noted that a company making mundane shoes with recycled materials was 20 times oversubscribed on its expensively-valued IPO (initial public offering), which promptly doubled. At the time of writing, the Omicron variant of the COVID virus is causing some travel and market gyrations. I could list more examples, but there is no need to tone this holiday message negatively. In our mind, the question is when, not if, one of these "canaries in the coal mine" will mark the top of the easy money pendulum.
Update on Precious Metals
Gold and silver have churned through a relatively difficult year. More than anything else, gold has been held back by taper/rising rate fears along and their positive knock-on effect on the U.S. dollar. General confidence indicators are high and market volatility is low, which both suppress demand for gold. And yet, the fundamentals of the gold thesis continue to improve. We note that gold versus 1) the total amount of debt outstanding (Figure 4); 2) M3 money supply growth; and 3) gold to the size of the U.S. budget and trade deficits are all low or lagging. Sentiment indicators and technicals are slowly building the case for a resurgence in gold's long-term rally, as noted by the 100-year Dow/Gold ratio near all-time peaks (Figure 5) and with the potential for a sharp mean-reversion.
Figure 4. Gold versus Aggregated Central Bank Balance Sheets
Source: Murenbeeld, Reuters Eikon, Incrementum AG. Included for illustrative purposes only.
Figure 5. Dow/Gold Ratio: Past 100 Years (1921-2021)
Source: Bloomberg as of 11/30/2021. Dow reflects the Dow Jones Industrial Average index price level and is measured by INDU Index. Gold reflects the Gold Spot Price and is measured by GOLDS COMDTY. You cannot invest directly in an index. Included for illustrative purposes only.
Meanwhile, gold equities are trading at historically low valuation multiples, especially when compared to the S&P 500. Most generalist investors do not appreciate that gold producers are generating better revenue growth, profitability margins and return on capital but with lower valuations and higher dividend yields than the S&P 500, as shown in the following table.
Figure 6. Valuations and Fundamentals: Gold Miners versus S&P 500
Source: Bloomberg as of 11/30/2021. Gold Miners (GDM) reflects the NYSE Arca Gold Miners Index measured by GDM Index. The S&P 500 is measured by SPX Index. You cannot invest directly in an index. Included for illustrative purposes only.
And so, we reiterate our year-end 2020 recommendation that gold investors stay the course. 2022 will likely feature some catalysts for gold equity value improvement, even absent gold price rallies. Rising dividends are likely as are "beats" of earnings expectations due to suppressed analyst gold price inputs. The sector is rich with M&A (merger and acquisition) catalysts now that balance sheets are unlevered and many COVID restrictions are off. Based on my experience, this represents a once-in-a-cycle equity buying opportunity.
Sprott's Future Plans
Over the past year, Sprott's asset inflows and growing client engagement reinforced the strength of our brand and the positive investor experience with our products in the minerals sector. Using fund flows as an example, Sprott funds outperformed the competitive funds of most global asset management heavyweights.
At the same time, investor interest in minerals continues to increase. Minerals essential for de-carbonization have become a prime beneficiary of investor demand for sustainable investments. Based on total 2050 carbon-neutral goals and multiple projections of required investment in the minerals area, $500 billion of new investment capital in each specialty of base metals would not be a stretch, equaling the current size of the public minerals equities markets. This is akin to trying to fill a wine bottle with a fire hose, the overflow representing the lack of quality opportunities in the sector. We plan to focus on specialty minerals, which encompasses many targets that could benefit from new products designed to make quality investment options available and liquid to a wider range of investors.
Figure 7. More Than $1 Trillion of Investment is Needed in Key Energy Transition Metals by 2035
Source: Wood Mackenzie.
Our conviction is that now is an ideal time for us to continue to invest in the growth of Sprott's businesses by hiring more sales and marketing professionals, launching new strategies and products focused on specific mineral areas and exploring global tuck-ins acquisitions and partnerships. Sprott will have a busy 2022 managing these new product and growth initiatives. I have never been more confident that our investment professionals and operations platform is well-positioned to support this dynamic growth.
To all of our clients and shareholders, we appreciate your support and wish you a Happy Holiday and a Great New Year!
Peter Grosskopf, CEO
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