2020 has been a very challenging year for everybody. You’ve been in the equities game for 46 years now, so when it comes to financial crises and market meltdowns, this isn’t your first rodeo. What would be your key piece of advice For investors as they survey the debris of 2020?
The correct way to react to a crisis is to prepare for it for a very long time. For most of my adult life, I have maintained higher cash balances than most people. That is to say, more liquidity than many people deemed prudent. The consequence of which is that when a liquidity crisis or a crash happens, I have both the means (the cash) and the courage to take advantage of it rather than being taken advantage of. So, one thing is to carry more liquidity than some people think is prudent. Although the purchasing power of your cash declines more rapidly than you think over time, the option value of cash is extraordinary when other people don’t have any.
The second thing is to know enough about your investments that you have the courage of your convictions. If a stock is priced at $10 and nothing fundamentally changes with the company, but the price declines to $5, it is arithmetically twice as attractive at the same time that you’re uncomfortable holding it. The more courage that you have in your conviction, the more knowledge that you have, the more likely you are to use that knowledge and to acquire more of a good asset cheaply, which has worked very, very well for me over time.
With specific regards to precious metals, understand that the big thinkers, the central bankers and the governments, their policy response to a crisis is always the same: to debase the currency. So currency-related crises, liquidity crises, things like that, have a policy response which is invariably good for precious metals. That is not to say that in the middle of the liquidity crisis, the price of precious metals doesn’t go lower, but the policy response from the big thinkers is always the same and always good for precious metals.
But the policies we have seen in recent years of low or negative interest rates go against people holding onto their cash and building up some savings. A lack of personal savings has specifically been highlighted as a major problem in this sort of period of lockdown where so many people have been out of work.
We can unpack each of these points. The first is that the nature of a democracy is a war on savers by spenders, spenders being more numerous than savers. There’s a great old libertarian bumper sticker in United States that democracy is four coyotes and a lamb voting over what’s for lunch. So one can count on fiscal policy that favours spenders over savers. That notwithstanding, you have to save. The fact that savings becomes less attractive as a consequence of low interest rates is of no matter, because the gradual depreciation of the purchasing power of your savings is more than made up for by the option value of having that cash available to deploy when other people are either unwilling or unable.
2008 turned out to be pretty good for me personally. This is not to say that it wasn’t uncomfortable at the time. The discomfort that we went through in March this year was less good for me because it did not last as long. The truth is that, irrespective of the fact that savings is relatively unattractive, given the extraordinarily low interest rates that one is paid, one needs to have liquidity, no ifs, ands, or buts. The fact that the big thinkers don’t want you to is all the more reason to do it.
Looking forward to the year ahead, we have some big political situations coming up, such as the u.S. election. What are your expectations and is another drop on the way?
I really don’t know. It amuses me that a country this great has managed to find four so spectacularly unsuitable candidates, but we can move on from editorializing. What your audience is probably interested in is how it might affect their markets. My suspicion is that no party is in favor of anything that would resemble sound economics. The Democrats and the Republicans will be involved in a race to debase your savings. They will both engage in quantitative easing.
Now, if you personally did quantitative easing, they would call it counterfeiting and they put you in prison. When the big thinkers do it, it’s policy and it’s popular and it gets them elected so it’ll continue. Both will continue debts and deficits. There is no difference between Tweedledum and Tweedledumber on debt and deficits. And that debases the currency too. Similarly, artificially low interest rates will continue under either administration. My suspicion is that if the Democrats are elected, the ruin will continue and precious metals will go higher. If the Republicans are re-elected, the game will continue, the ruin will continue and precious metals will go higher. My suspicion is that whichever ticket gets selected, that the wind is in the sails of precious metals and that the debasement of the US dollar will continue.
There is not much else in their toolbox really. What would you do if you were in that position?
I would do what Volcker did – I would take the bitter pill. It would not take very long to have a reset. If you let the market take control of interest rates, you would bring on a recession. You realize that we were in an economic recovery for 10 years until COVID-19 hit. That’s one of the longest economic recoveries of my career, however tepid that recovery might have been. The idea that somehow the big thinkers can outlaw a reset or a recession would be laughable if it weren’t so destructive. So what I would do is let markets take their course. Now that would be hugely unpopular because most people haven’t prepared for the market taking its course. I remember my own portfolio and my career’s response to Volcker, which was extraordinarily harsh. That notwithstanding, I learned the seminal lesson of my investing career, which is to say that occasionally the markets work. And more people need to learn that.
So it seems that you should be holding onto your cash even tighter. But you’re saying that it’s those times when you need to have the courage of your convictions and make some prudent investments.
One of my consistent flaws is that I am extremely linear and extremely rational. If I believe that A and B and C and D are true, the likely outcome is Y. Unfortunately I confuse two words in English. One is inevitable and we’re usually right. And the other is imminent and I’m usually wrong. So I’m always early on the buy side and I’m almost always early on the sell side. And it turns out over 45 years, that has worked out extremely well for me. Other people might have different points of view.
I do believe that in the near term, precious metals are probably 18 months into a real bull market, not a recovery from an oversold bottom. I understand that all markets are cyclical and volatile, but precious metals are extremely volatile and I believe that while we will see cyclical declines in a secular bull market, that this bull market has some reason to run, simply because of the debasement of other forms of savings. And I also believe that the response to the increase in precious metals prices has not been accurately reflected in equities prices, except ironically, at the very bottom of the quality pyramid. For the last four months, the juniors, particularly the nothing, nowhere juniors, the ones that have no net present value whatsoever, have been on a ridiculous tear. And the financing market has been truly insane. But if you come up the quality trail, I would say that some of the higher-quality companies are really cheap. Go ahead.
When it comes to rational investors, no one more than Warren Buffett, looks at a balance sheet and says, “This company is cheap or expensive,” and invests accordingly. Buffett recently made an investment into Barrick. What’s your take on that?
I think that’s very instructive. Many gold bugs are saying that, “Now Buffett is changing his tune.” I think that’s wrong. I think Buffett regards gold as a pet rock, an inert asset. What it says is much more important. What it says is that you have to look at the expected value of future cash flows. At stable gold prices if you look at that relative to the enterprise value, market cap plus cash minus debt, you are buying future earnings cheaply. That’s what Buffett looks at. He doesn’t care if it’s sugared water, meaning Coca-Cola, or credit cards, meaning American Express, or Barrick. He looks at the expected net present value of future cash flows relative to the enterprise value. And he looks at Barrick versus the S&P 500 and he says, “Despite the fact that I hate their product, I like the company.”
Buffett is always of two minds with regards to management. He has two famous quotes. One is that, “There’s millions of people in the world who can play basketball, but to win, you’ve got to have a couple of seven-footers.” Clearly Mark Bristow is a seven-footer. He also says that, “You ought to buy a business that’s so good that it could be run by a moron because sooner or later it will be.” I don’t think he feels that way about Barrick, and I don’t think that he feels like it’s a good business for all times. I just think that he thinks relative to the cash it will generate in the next 10 years, it’s cheap.
You have been talking about how a lot of the higher quality miners are undervalued. Why do you think that is?
This equities bull market began the way others do with the best of the best moving first. The gold bugs, having been spanked by an eight-year bear market, came back into this market in tepid fashion. So they bought the biggest and the best. The generalist investors, who are beginning to appear in droves, similarly bought the best of the best. What normally happens is that after the best of the best move, the relative values, the best of the rest, and the large single-asset producers move next. But that is not what has happened. Market leadership moved to the penny dreadfuls, and I mean dreadfuls. I’m not talking about the great juniors. I’m talking about the dross.
It really amuses me that all of the gold bugs, myself included, bemoan the central banks’ printing of worthless currency units. But the private sector is always more efficient than the public sector. And the Canadian dealer network, in particular, can print phony share certificates even faster than the Fed can print phony dollar bills. So we have a situation where the speculators in the junior sector, and I count myself among them, need to be very careful.
Coming further up the quality chain, if you believe that US$1,900 gold is going to hold, these companies may very well be historically cheap.
Many mining companies have continued to post fantastic results this year. Are people taking notice of this?
I do not want to comment on what will happen to general market securities because I am not a general market analyst. The truth is that stocks move up because they exceed expectations and in 2019, the expectation for the gold sector was so low that it was impossible not to exceed it. It would have been more difficult to get under the bar than over the bar, including the expectations of management teams. Gold is one of those odd industries where most management teams do not believe in their product, except that they know that it is easy. It lowers their cost of capital to be looking for it. The consequence is that the management teams have been extremely cautious with their gold price forecast and their budget. Guys who had a budget that was focused on US$1,250 have had a very pleasant surprise at $1,900.
The period from 2000 to 2010 featured farcical investment decisions on the part of mining companies: stupid acquisitions, ill-fated capital deployment, all that kind of stuff. The industry wrote off tens of billions of dollars. One consequence is that most management teams were allowed to pursue other employment opportunities, which is to say, the shareholders fired them.
That lesson is very fresh on the management teams now, and they have been extremely cautious with regards to acquisitions and to capital expenditures. They are making capital expenditures based on $1,300 or $1,400 gold. They are going to become more aggressive, which will put life through much of the sector, but it isn’t just about the income statements that are improving; the fact that they haven’t done anything stupid with that money means that those balance sheets are becoming absolutely impregnable. If you look at the balance sheet of a Barrick or a Kinross over the last 24 months, the renovation of those balance sheets has been astonishing.
Now if you look at both the balance sheet and the income statement in conjunction, you understand that in the absence of an acquisition or a big capital project, there are billions of dollars to be returned to shareholders by way of
dividends or buybacks, which is a very pretty situation from my point of view.
Are we already seeing some companies increase their dividends?
We’re seeing them increase their dividends as they should, in fairness, against the $1,250 gold price, with their balance sheets intact. They will need to either deploy their capital at competitive internal rates of return, which would also be a good thing, or return the capital to shareholders, which would be a good thing. They have two wonderful choices in front of them.
Are there any particular regions in the world where companies have an advantage in terms of the price of gold in their local currencies versus the cost of production?
Certainly almost everywhere. For all of my criticism, the US dollar seems to be the strongest major currency in the world. As Doug Casey is fond of saying, “The prettiest mare at the slaughterhouse.” Any country whose currency is depreciating against the US dollar has an inadvertent subsidy to the mining industry. The input costs are in depreciating currency while the products are sold in the stable currency. I’m fairly tolerant to perceived political risk, so for me the whole circumstance of cost versus sales price versus resource and reserve, probably favors Russia. But I realize that Russia is a pretty gamey pick for most of your listeners.
From an investor’s point of view, do travel bans and things like that make it harder to go and get some analysts’ boots on the ground to check out mines?
Yes, it absolutely does. There is no substitute for having one of our own geologists or engineers touch the rock or look at the plant. The only thing that I can say is that we are on an equal competitive footing with all our competitors because nobody is allowing their staff to travel.
For me, the travel ban has been a good thing. I feel better at age 67 than I felt at age 55 because I’m not flying through 10 times zones a month. I get to speak to your audience from my home in Anacortes as opposed to flying to Cape Town. While I dearly love Cape Town, as an example, it’s easier on the carcass to do it this way.
For me, the travel ban has been a good thing. I feel better at age 67 than I felt at age 55 because I’m not flying through 10 times zones a month. I get to speak to your audience from my home in Anacortes as opposed to flying to Cape Town. While I dearly love Cape Town, as an example, it’s easier on the carcass to do it this way.
our readers will be interested to get your take on where you think the gold price is going to go next.
I’m too old and too smart to give you a price target. I don’t know. First of all, because gold is priced in the US dollar, which is in itself a floating abstraction, I don’t know what the dollar is worth. If you know nothing about the denominator and you don’t have a numerator, it is very difficult to come up with a sum. Here’s what I can tell you: Gold does well when people are concerned about the diminution of the purchasing power of their savings in traditional savings instruments, in things like the US 10-Year Treasury. Anybody who isn’t concerned about the purchasing power of their savings in US 10-Year Treasuries has lost the plot.
I will rethink my precious metals thesis when we have positive, real interest rates on the US 10-Year Treasury. Traditionally, they have been north of nominal inflation by 200 basis points. I will revisit
my premise when the US federal government deficit is less than 1% of GDP, and/or I will review my premise when the market share of precious metals or precious metals related assets in the United States exceeds 3% of the total market for savings and investment products in the United States.
Right now, it’s less than one half of 1%. It is ironic, with the wind in the precious metal sails, that precious metals and precious metals market share of savings and investment assets in the United States is one-third to one-quarter of the three decade mean. It isn’t just that wind is in the sails, it’s that the asset class is under-owned, which is hilarious.
Why do you think that is? Is it because the stock markets have been on such a tear over the last 10 years?
People pay attention to recent evidence and recent pricing signals, rather than to history. The fact that gold hasn’t really performed as an asset for some period of time, while bonds have performed extraordinarily well for 38 years, makes people attracted to an asset class, which is to say bonds, where the market is arguably over. They haven’t discovered a market that is the antithesis of the bond bull market. But it’s good. That sort of attitude makes it easier for an old guy like me to compete.
If people want more help with investment, what should they do?
Any of your listeners or readers who care about our opinion can visit a web link, sprottusa.com/rankings, which has a web form where they can enter their natural resource portfolio. We will not give investment advice, but we will rank the companies by our own criteria, one to 10, with one being most attractive, 10 being least attractive. And I’ll add comments where I think my comments might have value.
In addition to that, I will send back, a 50-year Barron’s Gold Mining index chart, which is a wonderful visual aid to see where we are now in the market and valuations relative to other bull markets in precious metals over the last 50 years. I will also include a 100-year commodity chart, which is a wonderful visual aid to see the valuation of commodities relative to other investment classes, and frankly, other asset classes, over the last 100 years.
In terms of overall market turmoil, how does 2020 rank?
For every asset class, it started off in fairly rough form. The world economy shut down. The ability of the big thinkers to smooth things over by pouring in large dollops of cash has always surprised me. I’m surprised that the markets have been as benign as they have been. I can’t speak to markets like Great Britain, but my suspicion is that the first half of 2021 will be a little less generous. I think that you’re going to see the beginnings of foreclosure prices. There’s a forbearance on foreclosures right now. I think there is going to be an eviction crisis, and I think there’s going to be a bankruptcy crisis. I think the policy response to that social circumstance will be scary, and I think that people’s reaction to all of that will be scary.
I am not one of these guys who thinks that the United States is going to collapse, but I think that we have some trying times ahead of us, irrespective of who gets elected president. My suspicion is that people, being increasingly politicized, will continue to be hostile towards each other. I suspect, unfortunately, that you’re going to see violence on the right and violence on the left, and the vast majority of the population who sits in the middle will be rightly concerned about this escalation in social tension, much like what happened in the latter half of the ‘60s.
So as we look forward to the year ahead, I guess you will be saying, Stay liquid, stay sharp.
Stay liquid, stay sharp. If you can afford it, buy some physical precious metals, and look at the relative valuations of precious metal stocks. Prepare yourself for a truly spectacular rally, three, four, or five years from now, in industrial materials. Another two or three years of underinvestment in productive capacity in things like oil and copper means that we will have a rally in those commodities that resembles the rally that we saw in the first part of the last decade. Not now, but later.
