The Gold Report: Your Markets at a Glance commentary last November said it seemed unlikely that silver would stay under $30 for long. Four months later, the spot price is about $35. Are you surprised by how quickly your prediction came true?Eric Sprott: Not really. Based on fundamental evidence, technical evidence and other things going on in the markets, I thought silver would be explosive this year. I've probably fallen a little short of my targets, but I think it's going higher. Silver doesn't have to hit $50 for everyone who's involved with it to make outsized returns, but I thought it could reach $50 within the first half of this year. All the data supports the thesis that silver is undervalued.
TGR: Are you seeing $50 as a top price, or a new baseline?
ES: Lots of things may happen in the short term that have no bearing on the long term. Silver now trades at a price ratio of about 40:1 to gold. In other words, it takes 40 ounces of silver price to equal one ounce of gold. The historical ratio is more like 16:1. My view is that we will go back to 16:1 within two to five years. To put that in perspective, a $1,600 gold price would imply $100 for silver. I happen to believe that gold will go much higher than $1,600; therefore, given time and letting this ratio play out, I think we'll certainly see a three-digit price for silver.
TGR: So, $50 may even become the floor.
ES: It's a step on the way. It may come faster or it may take a little longer; but when it happens, silver will outperform gold 3:1. That's a shockingly large difference and good reason to get a little more involved in silver.
TGR: You've said that silver will be this decade's gold.
ES: We assembled the gold articles we wrote over the last decade into a compendium called Gold the Investment of the Decade and these are also archived and available on our website. Now that we're in the second year of another decade, I'd say silver will be the investment of this decade. Gold essentially blew everything away in the last decade. There was no contest whatsoever with any currency or stock market. I think we'll all look back 10 years from now and say silver was the investment of this decade, because it might triple the performance of gold—and I think gold will continue to outperform all other currencies and stock markets. So I think silver's really an area where people should focus very heavily.
TGR: This performance you're describing can't be based primarily on manufacturing demand. How much do you anticipate in the way of investment demand?
ES: There are two parts to the silver story. One is industrial demand and one is investment demand. Industrial demand has been quite strong, but the thing that's been very unusual in the last year or two has been the marked increase in investment demand. There are many ways of viewing investment demand, and it's obvious we're going to experience some serious growth here. Judging from the data points that we look at, and as Larisa would mention, when we look at our sales of gold and silver bullion, we're actually selling about five times more dollars of silver than we are dollars of gold. That means we're selling 200 times more silver bullion than gold bullion. The U.S. Mint is selling as many dollars of silver coins as dollars of gold coins. GoldMoney.com, an online precious metals bank, also has sales of silver and gold that are about equal.
I want to emphasize that we're dealing with the flow of money here. The price difference is 40:1; but with that kind of money flowing into this commodity versus that commodity, you also have to look at the availability of one versus the other. In this case, believe it or not, that's 1:87—there's $1 of silver available in the world for every $87 worth of gold. The number of coins is explosively larger than the dollar figure. Something has to give when you have the same amount of money going into two products that are priced 40:1.
TGR: Perhaps Larisa could tell us a little bit about what's happening with Sprott Money, including a comparison to other precious metal investment alternatives.
Larisa Sprott: Sprott Money buys and sells gold and silver bullion, which includes coins, bars and wafers. We either physically deliver it or store it. Our storage depository is located in the State of Delaware. Within the next 6–12 months, we will be opening a facility in Canada.
Precious metal investment alternatives include exchange traded funds (ETFs), certificates and trusts; for instance, iShares is listed on an exchange—you get a piece of paper saying you own the commodity, but you don't have access to it. As my father mentioned, GoldMoney offers gold holdings, whereas Sprott Money allows you product choice and physical delivery of the gold and silver.
TGR: If you choose to have it delivered.
LS: I'd venture to say that 90% of our clients have their gold and silver delivered to them. They store it in a bank vault or at home—they have the peace of mind of knowing where it is. And 10% of our clients choose to store it in our depository.
TGR: And you're thinking about adding a storage facility in Canada, so there would be a choice?
LS: There's been huge demand from both Canadian and American clients to store in Canada. The impression I get is that they fear that what happened back in 1933, when the U.S. government seized the gold in people's safe deposit boxes, could happen again. So, clients might feel safer or more confident storing in Canada.
TGR: Would an additional value to an American investor storing bullion in Canada be the ability to convert it into Canadian dollars?
LS: Yes, and that's a good point. Anything we sell to clients, we will buy back.
ES: We can deal in either Canadian or U.S. currency.
TGR: At this point, are your customers Americans or Canadians primarily?
LS: About 70% Canadian, 30% American. That's a good segue actually, because in the next six months, we're going to open Sprott Money USA with an office in New York City to break into the U.S. market a bit more.
TGR: Regardless of where these metals are stored, the common view is to hold them in your portfolio as insurance against economic or currency crisis. Eric, you've recommended that Sprott clients hold 60%–70% of their net worth in precious metals, whether in vehicles such as Sprott Money or another. Because that proportion seems higher than what's appropriate for insurance purposes, to what extent do you look at precious metals as investments versus insurance?
ES: It's a bit of a semantic argument in a way, but I guess I would start with the view that I have a large distrust of the financial system. I really worry that we could have some kind of collapse. It sounds extreme to say, but we nearly had one in '08 and we nearly had one Europe last year. We still live in a very over-levered financial system. The banking issues just don't seem to go away. We bail out Iceland or Ireland or Greece, and now we've got to bail out Egypt or Tunisia or wherever else is going to have some fiscal difficulties. Ultimately, I just don't think there's enough tangible support for these systems when people want to extricate themselves and take their money out of the banks.
Unfortunately, bankers can't get rid of the asset on the other side of their balance sheet. So I think people will realize sooner or later that having their assets in physical metal is better than a bank deposit. I say that on a universal basis. To get back to whether it's insurance or an investment, I certainly can look at it as insurance because it's the one asset that should maintain its purchasing power. In some kind of financial collapse, all assets other than real assets will go down in value, so in that sense it's insurance.
It's also relatively proven to be an aggressive investment. Gold's gone up for 11 years; I think it's 17% a year and silver's gone up even more. I think it's all due to the debasement of the currencies and it's relative to the currencies. So I think it's both. I don't have any trouble investing on behalf of our clients to the tune of 70% to 80% in precious metals. We've had a very high weighting in those areas for a long time. Of course, it has been the right place to be—and I think it will continue to be the right place to be.
TGR: The silver market is so small it lends itself to being held down artificially. What measures might free up the market movement?
ES: As you probably know, all sort of lawsuits accused HSBC and JP Morgan of manipulating the price of silver in 2008 when it went down. In that situation, quite frankly, I was the most surprised and disappointed person in the world to see that in the middle of a financial collapse, the price of silver—and even gold—didn't rally. It seemed so unlikely that that should've happened. In my mind, that consequentially suggested forces might have been at work that weren't normal in those markets. But the manipulation will end, if there was manipulation. I'll explain why.
On commodity exchanges, the majority of transactions never settle in physical delivery. Just as an example, of the 800 million ounces (Moz.) of silver produced in a year, there are days when the commodities markets will trade 500 Moz. Well, obviously, nobody is settling this stuff because you can't have an 800 Moz. annual market and trade 500 Moz./day. These are just people pressing buttons on computers—you know with their algorithms or whatever—but they're not taking physical delivery. Manipulation takes place when a person who has more money than another person can drive the price of a product up or down, and it's easy to manipulate a market wherein all you need is fiat currency.
Manipulation will end when enough people say, "You know what? I'll take delivery of that product." I think that's what's happening in silver. More and more people are taking delivery. The dealers who are short something like 400–500 Moz. have like 42 Moz. in storage. Our organization alone owns more than 42 million ounces. That's not a lot of silver to cover a short bet of 400–500 million ounces. With every delivery period, those inventories keep going down. They're going to go down to the point where everyone realizes there is no silver left. As a matter of fact, for all intents and purposes, I think there might be no silver available today, as some mints are no longer taking silver coin orders because they just can't provide them. So, it's obvious to me that this supposed silver inventory doesn't exist anymore and that ends the manipulation.
LS: Speaking of inventories, I'd like to rewind a bit and make a point. There are so many competitors out there, but what sets Sprott Money apart from all of them is that our business model is a lot different in that we don't sell what we don't have in stock. I've heard stories from clients who say they've placed orders with our competitors and had to wait six months for delivery. Sprott Money has reserves and a lot in stock.
TGR: Currently, the aboveground silver remaining is somewhere around one billion ounces. At $35/oz., that's $35 billion for the entire sector—and seven entities hold 50% of it at this time. That seems so concentrated that these entities could manipulate the price, as the Hunt Brothers did back in the '70s.
ES: Most of those entities represent an agglomeration of individuals' interests; for example, I don't know how many accounts GoldMoney has, but it would all be in individual accounts. In the case of our Silver Trust, Sprott Physical Silver Trust (NYSE.A:PSLV), it's whatever money we can raise from various sources that enable us to go and buy the 22 Moz. we bought. I don't know how many shareholders it has, but it trades millions and millions and millions of shares a day. So, really none of these entities are organizations doing anything—they are groups of investors acting through various vehicles. I don't think anybody's tried to corner the market here.
TGR: So, we have far more investors in the silver sector than in previous decades.
ES: Absolutely. I think the phrase that probably captures silver's behavior, to which it's always been referred, is "poor man's gold." I think those who haven't bought gold are, to some extent, seeking refuge in silver. But anybody who's been a student of the silver market, as I myself might qualify, realizes we have a very tight situation here. And as this momentum builds to participate in the silver market, the shorts are just going to get overrun and the price could get excessively explosive.
TGR: Explosive silver prices could bode well for companies in that space, too. Could we segue to the participation in the silver market through equities, mining companies that have silver assets?
ES: We do own a lot of silver shares, as well as gold mining shares. We must own 40 or so different silver stocks. For the purpose of this discussion, I'll focus in on bigger vehicles available to the public at large. They're way more liquid and we don't have a strategic position in them. Relative to gold, there aren't a lot of silver vehicles, but we continue to like stocks, such as Silver Wheaton Corp. (NYSE:SLW; TSX:SLW), First Majestic Silver Corp. (TSX:FR; NYSE:AG; Fkft:FMV; OTCQX:FRMSF) and Hecla Mining Co. (NYSE:HL). On a little lesser scale, Bear Creek Mining Corp. (TSX.V:BCM) and on a really lesser scale is Aurcana Corporation (TSX.V:AUN). With some of the smaller companies, we have strategic positions like 10% or 20% and I don't want to be pushing our own book here.
TGR: Most of the stocks you mentioned have assets located in either Mexico or Idaho—areas where Sprott portfolio managers seem comfortable in terms of the companies' ability to continue growing and performing.
ES: There's no doubt about a comfort level with operations in North or Central America, but we also have investments in Peru—where Bear Creek Mining is focused—and Argentina. We have no particular issues with those areas. The market, of course, always discounts whatever country it is—whether it be China, Russia, Kurdistan, the Congo or wherever—based on the political risk there. Typically, it's built into the stock price and sometimes at a deeper discount than the situation warrants. As a result, some opportunities to make investments in places away from North and Central America can pay off.
TGR: Suppose an investor wants to take $100,000 from his nest egg and put it into precious metals because he's nervous about currency markets. Would you recommend putting 70%–80% of that into bullion and the other 20%–25% in mining equities? Or, would you suggest diversifying outside of the precious metals arena?
ES: Just to clarify, I'm not recommending that people have 80% of their money in physical (though I can tell you I don't see any problem with that). When I say we have 80% invested in PMs, the physical component is 30%–35% and the stock component 45%–50%. That's the way we have played it.
As a portfolio manager, of course we want to get a little more action out of the shares than we can get out of precious metals because of the leverage factor. I'm personally invested at that rate, I invest for clients at that rate and I think it's the wise thing to do. I'm not a great believer in diversification for the sake of diversification. Make a stand on what you believe is going to happen and participate in it. Just trust that you're going to be right. If you're going to be right, you'll get an outsized return. So, that's our call and we're sticking with it. It's proven very rewarding over the last decade. And of course, it's been very rewarding to be in silver in this decade—it's been phenomenal. Maybe I should've had 100% of my money in silver.
TGR: Given that silver's the play of the decade, is your organization shifting from gold equities into silver equities more heavily?
ES: Since the end of '08, I've been selling gold bullion. Initially, it was to buy gold shares because the gold shares got absolutely massacred in '08. As the year wore on and into 2010, I got more and more fascinated by silver equities, so I've also been selling gold bullion to buy silver equities. I haven't yet sold silver bullion to buy silver equities, which may be the next thing I do—again, because the equities are a little more levered. Obviously, silver on its own has had superior performance, particularly in the last nine months. It's been a phenomenal performer. Mind you, the silver stocks have way outperformed it, so we'll see going forward.
TGR: It's great to understand your rationale. Thank both of you so much for your time and insights.
Eric Sprott is chairman of Sprott Inc., CEO, CIO and senior portfolio manager of Sprott Asset Management LP and chairman of Sprott Money Ltd. He has accumulated more than 40 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. as a separate entity in December 2001, Eric divested his entire ownership of Sprott Securities to its employees. Eric has been stunningly accurate in his predictions, including foreseeing the current financial crisis. He chronicled the dangers of excessive leverage and the bubbles the Fed was creating, while correctly forecasting the tragic collapse of the housing and financial markets in 2008. Eric's predictions on the state of the North American financial markets, as well as macroeconomic analysis have been presented in Markets at a Glance, a monthly investment strategy newsletter.
Larisa Sprott joined Sprott Money Ltd. in the role of president in December 2009. 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. Larisa has more than 15 years of experience in the financial industry, having worked at Sprott Securities Inc. (now Cormark Securities) first as an office administrator in the Vancouver office, followed by roles in both research and corporate finance at Toronto headquarters. Larisa then spent five years with Sprott Asset Management in the capacity of client services, sales and marketing. In November 2007, she became an investment advisor responsible for servicing and managing high net-worth clients.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.
DISCLOSURE:
1) Karen Roche and Sally Lowder of The Gold Report conducted this interview. They personally and/or their families own the following companies mentioned in this interview: None.
2) The following company mentioned in the interview is a sponsor of The Gold Report: None.
3) Eric Sprott: I personally and/or my family own shares of the following companies mentioned in this interview: Sprott Physical Silver Trust. I personally and/or my family am paid by the following companies mentioned in this interview: None.
4) Larisa Sprott: I personally and/or my family own shares of the following companies mentioned in this interview: Sprott Physical Silver Trust. I personally and/or my family am paid by the following companies mentioned in this interview: None.
