Ed Coyne

Hello and welcome to Season Two, Episode Three of Sprott Gold Talk Radio. I'm your host, Ed Coyne, Senior Managing Director at Sprott Asset Management. Today we've got two special guests joining us, and we're going to do our best to cover a lot of ground in a short period of time time. With us today is our very own John Hathaway, Senior Portfolio Manager of the Sprott Gold Equity Fund, along with a new guest, Fred Hickey. Fred is the editor of the High-Tech Strategist Investment Newsletter. In honor of the Masters, I'd like to start this by saying hello, friends, and welcome to Sprock Gold Talk Radio. Thank you both for joining the Macro Gold Roundtable. Now, Fred, I believe you and John have known each other for some time, but can you tell our listeners a bit more about yourself, your background and your publication?

Fred Hickey

I graduated from the University of Notre Dame. I was a financial guy. Accounting, didn't do a lot of accounting, eventually made my way into becoming a stock analyst for a broker term in a Boston, boutique in the technology world. I've been writing the newsletter since 1987, so that's 35 years published every month and the primary focus has been technology all these years. But in the early 2000s period, when I saw what the Fed was doing, which was getting increasingly out of control, I started to put a lot of my money into the precious metals at that time, which was a good decision. I also knew that at that time the tech bubble, which I had been shorting through put options, that we were likely to go through a long term decline in tech, and  we did. We had a lost decade in stocks in tech in the early 2000s for the whole decade. And I continued to be involved heavily in the precious metals, gold, silver and gold mining stocks and silver mining stocks throughout this period because the Fed had only gotten crazier and crazier. Couldn't ever imagine that we'd be talking about printing trillions and trillions of dollars as they have been doing. I have my feet are in both camps on both the precious metals and gold, although I would like some day to go back solely to tech.

Ed Coyne

John, many of our listeners are already familiar with you and your work at Sprott, but for some of our newer listeners, would you please highlight your general role at Sprott and your day to day?

John Hathaway

Sure. I joined Sprott a couple of years ago. Before that, I had been at Tocqueville Asset Management and founded and managed their gold fund, called, the Tocqueville Gold Fund, which has been renamed the Sprott Gold Equity Fund. And as far as my daily routine, every day we have a morning call, 11:30 Eastern, and there can be as many as ten or twelve on the call or as few as five or six. But it usually consists of our research team of six people and some of the other portfolio managers, and we talk about the news of the day, and we go into one or two of our holdings in depth, full immersion in the precious metal space. Sometimes we talk about macro, but mostly we talk about companies.

Ed Coyne

It's great to obviously have you now, you've been here with us for a couple of years at Sprott and obviously your track record and experience speaks for itself. Fred, I'd like to start with you, and it's a bit of a statement, and I will get to my question, but I think it's worth highlighting what's really going on today. We've got a number of macro-level things playing out simultaneously, including and hopefully the end of COVID. We've also got the Russian invasion of Ukraine. Because of that, we've got unprecedented sanctions on Russia. Inflation continues to be sort of a thorn in the side of both sides, whether it's on the consumer side or on the industrial side. The Fed policy is starting to rear its head and try to taper. We've got a wholesale reworking of the energy supply line and supply chain, and last but not least, midterm elections coming up in November. And I'm quite certain I've even left out a few things. So I guess my question is this. We're trying to understand the direction of both the economy and general markets, particularly when you look at things from a tech point of view, what guidance or tools you tend to lean on to help make sense of all the things going on today?

Fred Hickey

Well, the answer is I'm working all the time on the Internet. I use all sorts of resources, both tech and gold related. I also have substantial contacts that I've developed over the 35 years I've been writing the letter and everything from the Wall Street Journal to very detailed sites that are very specific to Asian technology information.

Ed Coyne

 I find it interesting that you focus on technology, yet you're also a believer in gold. Those are two completely opposite ends of the spectrum. And I think that's fascinating to think about, particularly as our listeners listen to this podcast and think about how can they leverage things like gold when they're building out their portfolios, because nothing can be farther from each other than technology and gold. One is a yellow rock and one is not. And I just think that's fascinating that you've applied both in the way you look at the world.

Fred Hickey

Well, I talk about it as if it's a Yin-Yang for me, because I think they're polar opposites. When the stock market is doing well and things are swell in the world, then gold usually is out of favor. And if you go through the decades, that's the way it's been. We had a great bull market in the 1970s for gold, and it was a very difficult market with a big crash in the mid 70s for stocks and then in the 80s through 2000s, we had the greatest tech bull market, and that was a 20 year bear market for gold. And then in 2000 timeframe, we went into the last decade for stocks, and then we had a massive gold bull market. And so that's the way it goes and it works out very well for me as long as I know where we are, right?

Ed Coyne

Well, it's amazing. Gold continues to do its job in times of stress. And John, I think this is a good time to get your view on that as well. How do you prioritize some of these things? You're constantly moving stuff to the front burner and the back burner when looking at it from constructing a portfolio. Walk our listeners through that from a portfolio manager's lens. How do you look at all these things going on and how does that apply to your portfolio?

John Hathaway

I focus on the macro. I spent a lot of time on that, and then it boils down to individual company analysis. Right now we're really on the cusp of breaking out to new highs. Gold, and this sort of echoes Fred's comments, is the inverse of the stock market. So I would say that the fact that gold is breaking out is probably bad news for mainstream investors who are relying on conventional investment strategy. When people ask me what has been the main headwind for gold, it's been really two things. One is the constant talk about the Fed getting more hawkish and rising interest rates are in theory very bad for gold. And then secondly, it's that the comfort level of 98% of all investors with the strategies that have done very well for them over the last ten years. I think we should talk about this and really want to hear from Fred on what he thinks about it. But I think the world has changed dramatically for a couple of reasons. Most people think it's the Ukraine. I wouldn't dismiss that as being a major factor, but I think without the Ukraine and the scary aspect of that, we were already in a new world because the Fed is basically out of bullets.

And I think the fact that more and more people are realizing it is really bad news for stocks. There's no middle ground. They cannot tame inflation without cratering the economy. And if they crater the economy, then whatever earnings people are expecting aren't going to happen. So the stock market has to go lower or they basically allow inflation to continue to run very high. And if that's the case, then that also has a negative effect on asset valuation. So I think that's where we are, and I think that's something we should really spend some time on.

Fred Hickey

Yeah, I agree completely. When tech stocks are going crazy, as they were, and you had a giant bubble, the greatest stock market bubble that I've ever seen in terms of valuations on a price to sales basis, the stock market went 35% above an all time records high, which was at the .com bubble, and I thought, I'd never see the .com bubble again. But here we are. And then also on a price to GDP basis, we were 30% to 50% above there, too. So this was the greatest bubble we've ever seen. In addition to that, there was also a bond bubble where real rates went to historic lows. And in a typical 60-40 portfolio, bonds are usually the ballast. It's the stable part of the market. Well, we've gone from what was historical bull market in bonds to this quarter year-to-date, the worst bond market decline ever. For a quarter, that's down five and a half percent, and it's since the peak last year, you're down 8%. Well, that's not your store of value that people go to in times of trouble. So we have a very dangerous market, still extremely overpriced, and the bond market is not a safe place to go.

So where do you go to? Well, I think we're starting to see institutions move into gold now. They had been avoiding it. You could see it in the major ETFS, where they've added 200 tons this year-to-date. And you've seen it in their interest in the large cap miners as well. But the largest miner in the world went to record highs recently as part of the S&P. So institutions have gotten very interested in this because they said there's no choice. There's an article today in the Wall Street Journal and it was talking about the possibility of a soft landing. Well, there's no possibility of a soft landing if you look what's happened. Anytime oil prices have spiked in history, you've had a recession and we've gone over that. Anytime you had an inverted yield curve in history, and we're close to that right now, you've had a recession. You have spiking oil prices, spiking food prices. The consumer is in great difficulty. Now you have with this Russian crisis, this Ukrainian crisis, you have the spike in oil prices and food prices and shortages of food likely. There's no way they're going to avoid when they're doing QT and raising interest rates.

Every time they tried to exit from their money printing episodes, it's always led to a market turmoil. And that's always been good for gold. So everything I mean, it's almost a perfect storm for gold where everything's coming together.

Ed Coyne

John, you've seen this in the past. We saw it as recent as 2016, when the Fed attempted to raise rates and gold, the first half of the year was up nicely and gold equities were up well over 100% entry year. And then they sold back up a little bit, but still were up a lot. As the Fed tries to press this and try to raise some of those rates like you talked about, they've definitely painted themselves in a corner. What do you anticipate is going to happen both in the gold trade as well as the gold equity trade, as they sort of get stubborn and try to continue to push this policy through of raising rates and tightening.

John Hathaway

The yield curve says that they can't raise rates so maybe they can raise them on the short end. But there's so much subprime debt that is financed on a floating rate basis that to me if they were to try to go to say 50 basis points and however many hikes are being priced in, they would create an enormous amount of delinquencies, bankruptcies and more and more people out of work as a result. Again, they simply cannot achieve the medicine which was applied under Paul Volcker in the late 1970s to stop inflation in its tracks. Because if they did, and given the fact that the economy is so more highly indebted than it was in the late 1970s, the repercussions would be really adverse and politically intolerable. And again, to add to Ed's earlier question, in an election year, it's just impossible to think that that would happen.

Ed Coyne

Well, you both have said it in different ways that we're sort of in the perfect storm for both gold and gold equities, frankly, to do quite well. And they certainly have had fits and starts. We broke through 2000 for a while and we've given a little bit of that back. It seems like the investors timeframe and their ability to pay attention to things is so short and so tight. John, I think you said it spot on the pivot. At some point that pivot reality will set in. What do you think that is going to cause that pivot? What do you think it's going to cause the investor to say, okay, really, the Fed is not going to bail us out. Buying the dips is no longer going to work. I keep doing that and the market keeps selling off. What will be the straw that sort of breaks the proverbial camels back? And when I talk to investors, they want to know, because last year, John, you heard this and Fred, you may have heard this as well, given everything going on, why hasn't gold done better? I heard that all the time. And I said, well, Gee, why wouldn't have gold done actually worse last year when you had the Fed just plowing capital into the market?

So what will be that pivot? What will wake people up and say we actually have an issue here and we should be thinking about more of a risk-off strategy right now and not just doubling down every time the market hiccups.

John Hathaway

Well, I'm waiting for the pivot. I bet Fred's in the same camp as that. Powell is super-embarrassed by his bad call on inflation starting last year. And Mohamed El-Erian was just in the press yesterday talking about what Powell really needs to do is explain to the world how he made such a bad call. I'm not holding my breath. I really feel like the Fed is out of bullets. And I've always thought that in one way gold was a put on confidence in the Fed. And if you start to sift through the various things -  I know Fred does it and would be interested in his take - I'm starting to see that confidence in the Fed start to ebb away pretty quickly. And I think that would be very closely connected to loss of confidence in the valuations that we have in the equity market.

Fred Hickey

I think you might be seeing that in the reaction in the 30-year bond here where it's been spiking up. That's an indicator of loss of confidence in the Fed right there. It's not something they wanted to see with only a 25-basis point increase. Now, I don't know if that's going to continue because I think we're going to head on to a recession, but I think it's really a strong sign that they're losing ground.

Ed Coyne

Historically, the late Marty Zweig would always say, don't fight the Fed. And I think, John, you said something interesting as well, which is gold is a put on the confidence of the Fed. And Fred, you just said it as well. I think that confidence is going to be shaken, that they're maybe not in as control as they would like us all to believe. And the first crack in the Foundation, I suspect, was when they said, "okay, inflation is not transitory. It's actually real." And these CPI index numbers -   I don't know how many people actually pay attention to that. I think a lot of the investors say - "well, if cash is going in the market, I have the fear of missing out. I'm going to keep buying the market" -  until they can't take the pain anymore. And the market, as you all know, will do as much as it can to inflict as much pain or as many people as possible for as long as possible. I always tell people gold is not here to replace your assets. Gold is here to allow you to stay invested in your assets. And I think that's what we're starting to see in the market today.

Ed Coyne

And I think both your comments have kind of hit that spot on. I'm reminded by this great quote from Mark Twain - "history does not repeat itself, but it often rhymes." We've seen this movie many times in the past. And Fred, I think you said it earlier. We've seen gold do its job multiple times when the market has sold off, gold has stepped up. The correlation or the lack of correlation to other assets is there. As investors walk into this room today, whether they're currently invested in the market or they're looking to put capital into the market, how should one think about gold as they build out a portfolio, whether it's - hey, I'm in retirement, I need to stay invested. What do I do to protect my assets? Or a younger investor or someone that maybe sold a business and says I have fresh capital, I need to put it in the market, but I'm worried about the market. How do I go about doing that? How do you either stay invested or how do you get invested in the market?

John Hathaway

I mean, I played golf with Pierre Lassonde this weekend and he was asking me the same question, how come gold isn't higher?

Fred Hickey

I was just going to say, people have no patience. Gold has doubled. I say this latest bull market, we were at $1050 in 2015 and beginning in 2016. Then we were 1180. And here we are, a couple of weeks ago and were at 2070. These things don't happen overnight. It's only been very recently. You talk about gold, it's only been very recently that the CPI numbers started to look high to people. It was a year ago at this time we were under 2% and now we're here with 8% CPI and 10% PPI. And those numbers are suppressed. It's really higher than that. So it's only in the last year we started to see inflation. Now if they start to pivot and start to print money again or lower rates or whatever they do or even just start talking about it, I think people are going to realize the Fed is out of control.

Ed Coyne

And John, from your point of view, particularly with the focus on the gold mining stocks, what would your view be or what would your I don't want to say advice, but guidance, be effectively on what an investor is to do? How are you going to stay in this market? Or again, more importantly, how do you put new capital to work in this market, knowing what we know and knowing what we're seeing out there?

John Hathaway

Well, first of all, I don't think investors should stay in this market. I think that the idea of buying the dip is like committing hari kari I remember Bob Farrell, the great market strategist for Merrill Lynch, and he's still delivering his pearls of wisdom, said that investment resolve is not as strong as fear. If you think it's going to work out in the long term, you're just going to go through tremendous pain and most likely significant declines that will really test your conviction.

Fred Hickey

Let me give you an example on that. The 2000 tech bubble, largest market cap stocks in the world were Intel, Cisco, Microsoft, EMC and Sun Microsystems were up there as well. Emc and Sun collapsed by 97% and never came back. I mean, they eventually got bought out by different companies, never came back. Cisco has never returned to those highs, ever. Here we are talking about 22 years later. Intel is half of the level it was 20 years later. You don't want to be buying stocks, tech stocks, or even there's a lot of areas in the market that are grossly overvalued. Value stocks of course, a better place, I think. But you don't want to be there in the greatest stock bubble in history. You won't recover, maybe forever, but certainly not for decades.

John Hathaway

I think we should spend a few minutes just talking about the value proposition represented by gold mining stocks. They are quite profitable today. They are financially healthy, and their earnings should rise with a higher gold price. And you're not paying demanding valuations to invest even today, even though those stocks are up year to date and maybe over the last couple of years,. To me, that would be my message. If I could get in front of anybody and pound the table, that's what I would say. But I know Fred will have a lot to say on that, too.

Fred Hickey

The cheapest sector I can find is the gold area. And some people heard about the higher cost in an inflationary environment. That's true. But if you look at what's been happening here, back in the 2000s, time frame, the highest margins, dollar margins the gold miners had was in 2012, and it was around $640. And that's the difference between the average realized gold price companies sold things for, and they're all-in sustaining costs. So the high was $640. Well, where is it today? Well, it's $840 with a $1,940 old price today and a little over $1,000 for the bigger miners, you're looking at over $800 in margins. And even with this increase in prices, we have, and I would say it's likely here in a recession which will come out of this tightening, that you will then have declines in some of these prices, like diesel, because there'll be destruction of demand. And there's a chance that you could have a declining cost base at the same time you have rising gold prices. And that did happen one of the time talking about history repeating or rhyming.

That happened in the 1930s when you had obviously the Great Depression. And there's a possibility that could happen again. But certainly, I think we'd see a severe recession if the Fed continues to tighten. And so you're likely to see declines or flattening out in cost yet the gold price is likely to go a lot higher. There's a ratio of Hui to gold ratio, and that's the gold stocks basically to gold. And back in the 2000s time frame, that average .46 Hui to gold ratio. Well, what does it tell you? It's .16. It would have to triple just to get to the same level. And it was even higher at certain points in the 2000s it was .65, where you have to go up four or five times to get to the same valuation now because the margins are so high.

You're seeing all the majors have been buying back shares, raising dividends, constantly raising dividends. One of the reasons why gold stocks have been so depressed is they had a very difficult time in past years where the management weren't so attuned to shareholders. And now they've learned from that. And so it's all about keeping their costs down. It's all about increasing shareholder returns and they're doing it. These things are really cheap. It's the cheapest area you could find. You talk about margin of safety. Well, if you're generating enormous amounts of cash flow and if you compare that to the overall stock market, I know that Sprott people have done that,? I've seen their numbers, you're looking at dividend yields and free cash flow and earnings. They're all from the miners, all 50, 60, 70% higher than what you get from the overall stock market. So what a great place to be.

Ed Coyne

I think John mentioned it earlier too. The institutions are starting to take notice. You're seeing it in the performance patterns. You're seeing it in the liquidity. The larger names that capital can flow to easier are starting to get some attention and talk about values. The juniors look incredible relative to the seniors within the gold mining space. So obviously we believe in this. This is what we do for a living. But I think for those investors that are looking for a place to find value, find opportunity, the gold miners certainly look interesting.

Well, gentlemen, we could probably spend another hour or two on this and I may hold you to this and have you guys come back at the end of the year to revisit what we've talked about to see what's happened. Certainly this year is going to be an interesting one. For our listeners who would have some interest in subscribing to Fred's newsletter, I encourage you to look up The High-Tech Strategist or to email Fred at [email protected] You can also follow Fred on Twitter. For those that want to learn more about what we're doing on the Sprott Gold Equity Fund, we encourage you to visit our website at sprott.com. And with that, once again, I'm your host, Ed Coyne, and thank you for listening to Sprott Gold Talk Radio.