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Although "quantitative easing" (QE) may be
propping up the U.S. economy for the time being, it solves nothing. That's
how Eric Sprott, Chief Executive Officer &
Portfolio Manager of Sprott Asset Management and
Chairman of Sprott Money Ltd., sees it. It's not
just that QE shoves problems from the private sector into the public sector.
It's worse than that, because as Eric tells The Gold Report readers, QE is "just
debasing the currency which will eventually lead to hyperinflation." One
upside though: "You can just feel the momentum in gold—it's
picking up dramatically" and so too are prospects for a plethora of
little-known small and mid-cap gold stocks.
The
Gold Report: You have written quite a bit about the U.S. government's growing debt
and a whole bunch on unfunded liabilities leading to a default on obligations
or printing more money.
Eric Sprott: There aren't too many choices when
you're in debt to the level that the U.S. government is. As we've outlined in
some of our recent articles, one way of calculating it says there's $72
trillion of debt and other way suggests it is $100 trillion. It's almost
academic which calculation you use; it's just an overwhelmingly serious
problem.
Thank
goodness we have a zero interest rate policy. Otherwise, the cost of those
obligations would be unbearable. As we analyze where we are and look at all
the things that the administration is doing, it certainly seems that they're
going to try to spend their way out of it. Last week's announcement regarding
the extension of the homeowner credit, in addition to giving corporations
loss carry-backs while paying unemployment benefits for an additional 20
weeks—these are all signs of trying to spend their way out of it. It is
looking more and more like it will be an inflationary scenario. It could even
be hyperinflationary.
I find it
instructive that the U.K. has announced another quantitative easing program.
I really think that once the Fed has spent the $1.25 trillion buying the GSE
paper that we might yet see another level of quantitative easing in the
States.
TGR: Since there
clearly isn't enough tax revenue to support spending their way out of this,
are you looking at a situation in which the U.S. government is just going to
be printing more money?
ES: That's what I
would presume. I knew that net government revenues from taxes for '09 versus
'08 were pretty brutal, but I recently looked back to '07. In October'07 the
U.S. government received net $150 billion in taxes. In '08 it was something like
$133 billion and in '09 they got $110 billion. That's at least three years in
a row of contraction in tax revenues.
TGR: Do you see any
scenario in which the government will begin to contract itself—meaning
cut costs?
ES: I don't think
they are going to restrict anything. They have no choice. We are in such a
weak economy that any suggestion of tax increases or spending cuts would just
tip people over, so I do not see that happening. I think we will continue to
have a quantitative easing policy. It's funny. It's not a policy; it was an
absolute necessity because no one was going to buy the bonds. I do not know
why anyone would buy a U.S. government bond for 10 years, paying 3% or so
when the currency fluctuates as much as it does, the financial position being
what it is and the alternatives being what they are. You could buy stocks,
you could buy commodities, and you could buy foreign markets. Every one of
those has done better than the bond. Because I do not see who would likely
buy those bonds, I consider the government purchasing its own securities a
necessity, not a policy.
TGR: Given enough
quantitative easing, the dollar may no longer be the reserve currency. If
that happens, what's in store for the economy and for investors?
ES: As an investor I
am pretty sure what areas of the market will do well, but I truly cannot tell
you how things will function when the current fiat currency system fails. To
be brutally honest, I have no idea. It is hard to imagine what happens when
people turn their backs on currencies, but I would suggest that we are
already seeing it happen as we speak. You can feel in the market; people do
not want to own currencies today. Particularly U.S. currency.
I am not
saying that this is anything imminent, but people are questioning many global
currencies now, not just the U.S. dollar. I would question the U.K. pound
today; I would question the Japanese yen today. Many governments have
completely overdone it.
When the
Indian government purchased 200 tons of IMF gold, the finance minister said
that Europe and the U.S. had "collapsed." Those were his words.
They wanted to get those dollars out of their treasury; they would obviously
much rather own something physical.
TGR: Do you see the
potential of any currency becoming the new reserve currency?
ES: The only one
would be the Chinese yuan. However, I think
collectively the world would probably say, "Having one reserve currency
was a mistake the last time. We should probably use a basket to determine
values."
TGR: So what are the
options?
ES: Various members
of the G-20 talk about commodity backing and so on. You could create a
computer system where you could actually use commodities as currencies. It's
pretty easy to quantify all these units, so maybe we will go there. Hardly any
hard currency physically trades hands now, you could literally have
everything just trade in gold and silver on computers. Maybe it goes to that.
We will see.
TGR: If it had to be
gold and silver, could you expand it into oil?
ES: Yes. You could
include any number of commodities. As long as the units are backed by
something. You would have to be able to get the unit on demand.
TGR: You said
earlier that as an investor, you know which areas will do well. What are
they?
ES: We have been
seriously involved in precious metals for 10 years now. With some obvious ups
and downs, it has been 10 great years. I had purchased gold and silver
because I knew there would be more demand than supply, and I am sure that is
the case today. I could not have predicted quantitative easing in 2009, nor
could I have predicted that the financial world might actually buy into it. I
still almost pinch myself when I think about it.
I always
knew there would be a bonus thrown in by fiat currencies being damaged, and
with quantitative easing you know that the values of currencies are going
down. That makes the precious metals story just that much more compelling and
I am sure that is why India bought 200 tons of IMF gold and others will
follow suit. We are also seeing many hedge funds and pension funds moving
into gold. Whereas central banks used to sell gold, now they are buying it.
Then there are the ETFs. You can just feel the momentum in gold—it's
picking up dramatically.
TGR: With no
interest in buying bonds given such low returns, and with so many currencies
declining, is there really any upside in the market beyond precious metals?
ES: There is, but
as one who runs hedge funds and has a short side in my portfolio, my biggest
fear today is that we actually go into a hyperinflationary situation where
all asset prices go up. Of course some will go up way more than others. Hard
assets, including precious metals, would probably go up the most. Softer
things such as bank shares probably would not perform as well. However,
everything would go up in a hyperinflationary environment.
TGR: Do you see that
happening in the short term?
ES: You cannot rule
it out. It is shocking to think the Fed bought almost $2 trillion of
securities. If they have to announce another quantitative easing, it will not
take too many people too long to figure out what the net result of that has
to be. Looking at the price of gold makes me think a lot of people are
catching on.
Although
I think it is a distinct possibility, I have no idea when it would happen
because it's a function of whether they continue quantitative easing. That is
just debasing the currency which will eventually lead to hyperinflation.
TGR: Some people are
predicting a fairly substantial market correction. From your viewpoint, would
that just be a blip in light of the inflationary spiral you foresee?
ES: I think in many
ways the rally off the bottom has been a little phony and it is interesting
how it has coincided with quantitative easing. I am not so sure that we have
really solved any problems. We have just moved them from private company
statements onto public statements. We own GM, Fannie, Freddie, AIG, GMAC, whatever. We just moved the problem, but the problem
has not disappeared. It may yet happen that the weakness continues to beget
weakness. As people lose jobs, their homes are foreclosed upon, they declare
bankruptcy, it's a permeating negativism that has to
stop. You are never going to stop it until jobs are created and we still have
not created any jobs. I am shocked that with all the
stimulus and all the job creation that supposedly went with it, there has
been nothing, net. There have been no new jobs.
TGR: But they say
there's a delay between the market appreciating and when the jobs start, that
the market is the leading indicator. And then you get someone like Warren
Buffet, who just bought Burlington Northern. He's betting on America. What do
you see that Warren doesn't?
ES: I would never
criticize Warren Buffet. I am not criticizing him, but I do not think he saw
the extent of the financial problems that we encountered and he is not
perfectly right all the time. Yes, I think Warren has to bet on America. He
is a big part of it and he may yet be right because Burlington Northern is a
business that moves real things and real things will still have value in the
situation that we all imagine us maybe going to. So he can be right and I can
be right at the same time.
TGR: Your funds are
heavily invested in precious metals, basically as a hedge against devaluing
dollars. To what extent are you looking at physical metals versus equities in
these funds?
ES: Early this year
I began to move out of some of our physical gold and into mining stocks.
There have been a plethora of mining stocks that had incredible value if you
could buy into the companies' production forecasts and buy into the price of
the metal at the time. When gold was $850, we could buy stocks that in two
years' time would have been trading at two times cash flow. When we were
buying them at $950, we could still do that. There were some phenomenal
values and most in an agglomeration of names no one's ever heard of. Many of
them are new with things just starting up. Of course, they had financing
problems because of the decline in the market. But the opportunities were
overwhelming. So we bought a lot of stocks of that nature.
TGR: Can you share
with us some of the juniors that were relatively unknown that have given you
some good returns?
ES: Sure. Some of
the smaller producers are CGA Mining Limited (TSX:CGA;
ASX:CGX), Medusa Mining Limited (ASX:MML), Norton Gold Fields Limited
(ASX:NGF), Norseman Gold Plc (LSE:NOGO.L), and Yukon-Nevada Gold Corp. (TSX:YNG). These are all very small market cap companies, but
they can make significant amounts of money. You know, 100,000 ounces is $100
million in sales. It is a very simple thing to put the three zeros on the
end, right? If your costs are half the price of gold (i.e., $500), you have
$50 million of cash flow. With $50 million of cash flow in a stock trading at
$100 million, you have a cheap investment. There are lots of those names
around.
TGR: How about in
the exploration space?
ES: There have been lots of interesting exploration plays, some of
which are in the States. We own a little company called Romarco Minerals (TSX.V:R). We own San Gold Corporation (TSX-V:SGR), which has had some tremendous exploration. There
is one in Indonesia called East Asia Minerals Corporation
(TSX-V:EAS) that could be very exciting on the exploration
front. Galway Resources Ltd. (TSX-V:GWY); Galway picked up the gold property south of Ventana Gold Corp. (TSX:VEN). Ventana's been one of
the hottest gold stocks around and that's brought a lot of attention to
Galway.
TGR: Right now it
seems that the metal is outperforming the producers and the junior companies.
Do you see that changing?
ES: I would not
agree with that. I go back to 2000 when I started buying gold and gold shares
and the HUI Gold Index was 35 then. It is about 660 today, so it has gone up
about 1200% while the price of gold has gone up some 300%. Since the bottom
in October, the HUI has risen maybe 190% from the bottom. I do not know what
the bottom of gold was, but maybe it got as low as $650, but the HUI Index
has probably appreciated twice that.
A couple
of months ago I saw a list of the top 100 performing junior gold stocks since
the bottom. I don't have that list in front of me right now and cannot even
tell you who did it, but to make the list, a company had to be up 400%. The
average was 700%. It was shocking how much some of these stocks went up. You
would have to be deep into small mining stocks to recognize the names.
TGR: Does gold have
to increase for such stocks to see any more appreciable value or is there
more upside for them?
ES: I probably own
25 or more names on that list, and really have not sold many of them. When
this list was done, the price of gold might have been $900. Now we are
$1,100. I am finding lots of upside opportunities in these small to mid-size
gold companies. I have a tough time stomaching the incredible valuations in
some of the bigger ones, but I still think there is pretty good value in the
smaller names.
TGR: At The Gold
Report we don't get a sense that the average investor is buying gold. Is
that your sense as well?
ES: Yes, I agree
that very few people have gone there. In fact, one of the funny things about
the physical gold market and even mining stocks, for that matter, is that
there is not a lot of room for everybody. Almost everything is spoken for.
It's not as if gold is not owned by someone already. There is very little
produced each year.
When I
first got into gold, it was suggested there was a shortage of physical gold,
and the only reason the price did not go up substantially then was because
the central banks kept selling it. Now the central banks do not sell and you
have all these new buyers. I have no idea where this gold is physically
coming from. Even the array of gold stocks available to the world is not that
large. We are very lucky to be based in Toronto, sort of the gold mining
financing capital of the world. Everybody in the world of gold tends to come
through here. There is not a big sense of gold mining in the United States
for sure, but it's quite a topic in Toronto.
TGR: How likely are
we to get into a gold mania if indeed people in some countries aren't even
talking about it yet?
ES: You just have
to watch the gold price. We are probably at a very significant level right
now. Finance people looking at it have to be wondering what is going on. I do
not think it is a secret now. You can hardly pick up a financial newspaper
where they are not talking about the potential weakness of the U.S. dollar.
TGR: As you say
here, we're trading around $1,100 as of this interview. What catalyst is
going to come up? I clearly think that India stepping up to the plate, making
that buy—frankly, I expected China to do it before India.
ES: If the Chinese
come in now, we all have a story. I am sure they will, and/or somebody else
will. It is not a lot of money—$6 billion or $7 billion is a drop in
the bucket for the Chinese. That could happen. I have always believed there
could end up being some problems in the physical market some day, regarding
the settlement of contracts. We have these huge concentrated short positions
in both the silver and gold on the Comex. There was
a day when the price of gold went up $25; those shorts lost $1 billion
dollars that day—serious dough now. So there could be things happening
in the physical markets.
TGR: Speaking of
physical markets, where are premiums on coins these days?
ES: On gold coins
it's about 6.5% and around 20% above intrinsic on silver. Wafers and bars are
obviously less. If all of a sudden there is a run in coins, those premiums
can change pretty quickly. It does vary a lot. There have been times when the
U.S. mint is on-again, off-again in terms of output. Regardless we have had
significant interest in large quantities and we are lucky that we have always
had a substantial inventory of particularly gold Maple Leafs. We probably
have $50 million of them in inventory at all times, so we're not likely to
run out. Besides, we have great supply sources, and we are constantly
replenishing our inventory as we sell—regardless of how high the gold
price is.
TGR: And considering
your Sprott
Money Ltd. enterprise, you're clearly a believer in holding the physical metal.
ES: I am. People
should want to have their own physical gold and silver. A lot of them take
certificates, but I certainly would never advise doing that.
Eric Sprott has accumulated 35 years of experience in the
investment industry. After earning his designation as a chartered accountant,
he entered the investment industry as a research analyst at Merrill Lynch. In
1981, he founded Sprott Securities. After
establishing Sprott Asset Management Inc. in
December 2001 as a separate entity, Eric divested his entire ownership of Sprott Securities to its employees. In December 2004, the
Sprott Hedge Fund L.P. won the Opportunistic
Strategy Hedge Fund Award at the Canadian Investment Awards. The Sprott Offshore Fund, Ltd. won the 2006 Mar Hedge Annual
Performance Award under the Canada-Based Manager category. Eric received the
two Ernst & Young awards in 2006—Entrepreneur of the Year
(Financial Services) and the Entrepreneur of the Year for Ontario. In
December 2007, Investment Executive named Eric Fund Manager of
the Year. Last year, the Sprott Offshore Fund Ltd.
won the HFM Week's Best Long/Short Hedge Fund award globally. Sprott Money Ltd. is one of Eric's newest ventures. As
one of Canada's largest owners of gold and silver bullion, the company's goal
is to facilitate ownership of precious metals to the general public.
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