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October 6, 2020 | (62 mins 43 secs)
Sprott Market Strategist Paul Wong explains how technical analysis provides future guidance on the direction of gold markets and indicates that gold bullion and gold stocks have substantial room to move higher. He also explains why gold may be a more effective portfolio diversifier in this environment. Also explored:
Natalie Noel, RIA Database: Cover Slide
Hi everyone. Thank you for joining us for today's Webcast: Gold Rally Over, or Just Getting Started: A Technical Perspective, sponsored by Sprott Asset Management. Today's Webcast will be providing one CFP, one CIMA and one CFA CE credit. If you have any questions on credit, please don't hesitate to give us a call at 704-540-2657.
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So with that, I'd like to turn it over to today's First Speaker, Edward Coyne, Senior Managing Director, Global Sales for Sprott Asset Management. Edward?
Ed Coyne: Slides 2-6
Thank you, Natalie, and thank you all for joining us today. At the risk of repeating virtually every speaker this year, this has been certainly unprecedented and interesting times, and today we decided to take a more technical look at the gold trade and the gold allocation.
I'd like to introduce Paul Wong, who is the CFA and market strategist at Sprott Asset management. Paul Wong has more than 30 years of investment industry experience specializing in investment analysis for natural resource investments. Paul first joined Sprott Asset Management in 2011, and from 2012 to '17, Paul was a senior portfolio manager responsible for Sprott positions of the Sprott hedge funds.
From 2015 to '17, he was a lead portfolio manager of Sprott Precious Metals Equity Funds. Paul has experience in resource funds, asset allocation, quantitative funds, and was a proprietary trader for several years. Paul earned his Bachelor of Science and Geology from the University of Toronto and is a CFA charter holder.
Again, my name is Ed Coyne. I'm the senior managing director and the host of today's call, and I oversee global sales for the firm.
For those that aren't familiar with Sprott, Sprott is a global leader in precious metals investments. With over $17 billion in assets under management, Sprott is a publicly listed company and trades both on the New York Stock Exchange and the Toronto Stock Exchange under the ticker symbol SII.
What's unique about our firm is that we have a full suite of investment solutions: from our exchange-listed products that focus on physical bullion, as well as factor-based ETFs that look at both senior large-cap miners and junior small-cap miners to manage equity solutions, both with our Sprott gold equity fund with the ticker symbol SGDLX, which is an actively managed fund managed by John Hathaway and Doug Groh, as well as our flagship mutual funds and equity funds and closed-end securities.
In addition to both our physical products and our equity products, we also have unique solutions in the lending space, focusing on predominantly mid to smaller cap mining companies, as well as offer brokerage services in the precious metal markets.
Today's Webcast is really going to focus on the technical view of the gold market, talk a little bit about the economy, and look at ways you can leverage gold, both from a physical standpoint and an equity standpoint, to help diversify your portfolio.
Paul Wong, our Market Strategist, is going to talk about COVID's unprecedented impact on the global economic landscape, the macro variables that explain gold's move, more importantly, look at the technical chart patterns for gold over time, try to understand why gold may make sense over bonds, and frankly, over cash, and take a closer look at silver.
I will wrap up the call with some Q&A and also give you a general look at our suite of products and how gold can diversify your portfolio. With that, I'd like to start the call off with Paul Wong, our CFA and Market Strategist, taking a more technical look at what's going on in the broader market.
And the first chart really talks about the financial conditions and what's going on from a deterioration standpoint. Paul, if you could spend some time on page six and really start the conversation on what this chart is telling you and what are some of the important takeaways from this chart?
Paul Wong: Slides 6-7
Thanks, Ed. First thing is the red line. That's the US nominal GDP year over year. And what you'll notice is that in the last 50 years, it's had a succession of lower lowers, lower highs.
Typically, when the economy gets in trouble, the Fed has a standard response, they lower rates and inject liquidity or increase debt. But what you'll notice is that every cycle, you need more and more debt, basically to get the same effect you had in the prior cycle, and every cycle ends up with higher levels of debt than the prior cycle.
That's the black line, which is the Fed's debt as a percentage of GDP. That's an inverted chart. You can see every cycle, it just gets higher and higher and higher. And the Fed, they inject liquidity. It shows up in the money supply. That's the green line and since COVID hit, it's been accelerating even before COVID. But since COVID, it's gone exponential, and all that gets reflected in the price of gold in time.
Switching to slide number seven, that's our US M2 money supply. I focus on the US money supply because the data tends to be a lot fresher and it's hard to track down a lot of the global comp, the global measures.
This is a 50-year chart of the US M2 supply; the black line on top, log chart. The blue line is the 12-month rate of change on money supply, and I just marked some points. The point really is that the response to COVID is unprecedented. It's more than twice the growth we saw back for the great financial crisis back in 2008-09, which is around 10 percent. Today, we're realizing around a 22% growth rate. The reason being is that COVID, it was just a synchronized global demand shock.
It happened simultaneously. The response has been quite extraordinary. Globally, there's been $8 trillion of monetary policy added to the $13 trillion fiscal. The problem you had is that the zero-bound conventional monetary policy essentially stops working or stops working well, and you need to achieve the next level of stimulus, to create the kind of economic growth.
What we're seeing now is that almost all the countries are essentially moving towards MMT or MMT-like policy. In the meantime, you have the Fed announcing new policies. This is sort of the day-to-day tools they are using.
September, we have the outcome based for guidance and average inflation target. These are the new tools the Fed has added to their arsenal. We’ll talk about it a bit later, but the monetary response is what's driving the movement in pricing gold.
Just to reiterate that, I think that's a very important point that COVID has certainly had an impact on the market this year and it's had a shock factor and it has really accelerated gold's move in the short term. But to your point, I think it's really more about the stimulus and what that's going to mean longer term for the gold trade.
And I know we're going to go into those charts, but I thought that was a point that was worth reiterating, that it's really the response to COVID that's really driving the demand for gold longer term.
Right. It's again, that word again, unprecedented. But the thing is that it's not the end. If it was the end, every central bank would say right now that the crisis is over, the economy is returning back to normal. We don't need any more stimulus things. In fact, the opposites say that, every Fed speech you've heard since COVID is basically to keep emphasizing the need for more and more stimulus.
Ed Coyne: Slide 8
Right. Well, let's go to page eight and talk exactly about that QE lone resulting in money printing. Let's highlight data. I think this is a great chart to start to reiterate what's really happening in the market, and what do balance sheets and money supply really mean to the overall economy.
Paul Wong: Slide 8
The black line is the Fed balance sheet as a result of QE. Currently, right now, it's sitting around $7 trillion. We had a big move from COVID, went from roughly about three and a half to a doubling classes rate ever. The purple line is the excess reserves. The problem you have with QE is that it needs to go through the financial system, and when it goes through the financial system, a lot of gets stuck in the system. Typically banks, they aren't reserved constraints. The access reserve gets stuck in the system.
What you'll see is the green line, that's the velocity of M2 or the multiplier effect. Basic collapses. It's been steady heading lower and lower through time. Since COVID, it's absolutely collapsed. What it's really saying is that yes, the Fed is launching a lot of stimulus, but also a lot of that is also stuck in the balance sheet or stuck in the reserves in the financial system. It's not making its way into the real economy. Because it's stuck in the financial system, you can see the effect on the stock markets, on real estate.
That's the one part where it is working, and it explains the K recovery. That part explains the growing equities in the economy. The bottom line is at the zero bound. It's just not working. They're going to have to probably make some changes to this. Again, its changes are likely to be positive for gold.
What does this really mean for gold? This is really what brings you to the crux of today's call, is how does this translate to the gold trade, to the gold allocations?
Paul Wong: Slide 9
Right. If you think gold is a store of value, i.e., it's money, yeah then that's slide nine. The black line is the US dollar gold cross. The way to read is $1 buys currently right now .00053oz of gold. Back in 1970, before the US went off the gold standard, I think you bought like .028oz of gold.
It's really just reflected the expansion in M2, the green line. Again, that's another inverted chart. And just for clarity, fiat money, all it means it's money that's not backed by anything of value, like a commodity. Basic governments control the amount of money that's issued and flowing in the system.
Since COVID hit pretty much every developed country, the economy has expanded the money supply tremendously. US, Europe, China, Japan, everyone. That's happened, it's probably going to keep happening
What does it mean for gold? If you look at the long term correlation, the gold has roughly about an 80 percent R squared M2 over the last 50 years. Since the great financial crisis, since we hit the zero bound limit, if you take M2 and other important factors like currency yields credit, that R-squared goes up to about 88 percent.
if you take the last five years, that number actually goes up to around, last time I checked is around 95 percent. You can see the gold is really starting to track these variables, and the variables really do explain what's going on in gold right now.
Taking it back a little bit more, what does that mean for gold? If you apply rough math, and I think I use just the basic regression fit. Since the great financial crisis, roughly every $1 trillion in debt, about two thirds of that ends up in M2. Basically you get roughly about $666 billion increase in M2.
If you retro fit that back, again, these are very rough numbers, but that works out to about $120 an ounce in gold. And if you go back to the prior chart, M2 the growth rate roughly about seven percent, by that the current M2 levels, and you're looking roughly about $200 or more per ounce per year, if you assume M2 grows at historical long term rate, and I'm willing to bet it'd be much, much, much higher than that.
Paul, just touch on that for a minute. The long term patterns of gold, because I think a lot of investors, the investor circle is starting to expand on those that are interested in the gold allocation today. This is nothing new. Let's talk about gold bullion from a technical standpoint longer term.
We know what's happening shorter term. But I know on page ten, you address kind of longer term. What does this mean? What could this do to the overall gold price longer term? I know you have to finish another point as well, but can you touch on that as well to walk people through the longer term outlook for this allocation?
Paul Wong: Slides 10-12
Okay, sure. This is a long term secular chart log and the black line, that's a secular channel golds and variety. And since about the mid '70s, figure out where do you start the chart? I started right after the Bretton Woods system collapses pretty much by March of '73, and basically gold gets rerated because every currency is now starting to be valued.
It reached a high of $200, pulled back to $100, and that's why I marked the beginning of the secular channel. It's been riding inside this channel for almost 50 years. You'll see that tends to have sharp moves up by ways of consolidation, sharp moves up.
This latest move, the peak in 2011 to the breakout in August of this year, to me, that's a very clear cup and handle pattern. And breaking through the $1,900 level, you triggered a cup and handle breakout. You can do standard projection targets on this. But basically, the basic minimum target you get is roughly about $2,750 gold on just a pure cup and handle projection target.
Switching to slide eleven. Medium term chart, one thing you'll notice about gold is that in the last cycle, literally long term basis, it looks like it has a pretty straight line up. You look at it a little closer, what you'll see is that gold trades in what I call channel projections. Basically it runs through channels, with all dates, and it hits the next higher channel level.
You can layer that in with some Fibonacci retracement patterns, and you can get a pretty good estimate as to where gold will trade. I guess the hard part for most people, these news tends to be very gappy. That's the nature of gold, that tends to be gappy.
That red line in the chart, the 375 level, that's a big break base breakout pattern on gold. Typically, when you get one of these types of patterns, you tend to get a movement that's very, very dramatic. You have to think of like a coil spring type move. What you'll see is that gold will have very, very, very sharp gapping up moves. It will pull back and then consolidate a little bit, and then pop higher.
Again, you can see on the far left what the progression looked like in the prior cycle. That's not the complete move in gold. That's typically what you'll see. That makes trading gold difficult, because typically in the last cycle, what I remember everyone I'm speaking to is literally saying, "I'll buy gold when it pulls back. I'll buy the gold when it pulls back", probably hasn't, and it actually never really pulled back maturely enough for them to buy.
If we switch to slide 12, it's a short term pattern. And this pattern is exactly what you saw back from 2001 to 2011. You get these, I'm marking the circles, these consolidation patterns. Typically, there's two types of flatter looking one, and one that are a little bit more sharper down. Typically, after you get one of these, it consolidates entry day. You get these very sharp moves that scares people.
Psychology is always like what's going on, it's at the end of the end, and then pops higher, and people think, "I missed the move. I can't buy, it's too high". Literally, this is just how gold trades, and it's traded like that from 2011. The pattern seems to be repeating again. If I can offer one piece of advice, it's basically just follow the monetary policy, fiscal M2, dollar yield, and stick with the long term trend questions.
Paul, I think that's a great point, because so often people get caught up in the short term noise of all investments, not just gold, but in particular with gold. When you look at this chart on page 12, you can understand why people tend to either lose patience or get scared out of, or let fear dictate the way they allocate or invest in gold.
I think for our listeners today, that distinction between trading gold and investing gold is an important one, because longer term an investment at gold has continued to serve well in a portfolio, where trading, if you get it wrong, it's a great way to create a lot of frustration in your portfolio.
I think this is a great chart for people to sort of zero in on, and think about when they're considering an allocation to gold, is to have a longer term view on why you own it and how to own it. I think this is a great chart to address this. Thank you for that.
There's one thing about gold is, of all the asset classes out there it tends to be very emotional. And also most fund managers I work with all have had a hard time trying to understand gold. They don't understand it, they get caught in the day to day trading action. It happens, it's common. It happens quite a lot.
If there's one indicator that's starting to really help a lot, it's on Bloomberg. There's a function that tracks the total amount of known gold housing ETFs. I wrote a bit about it in the September commentary, but it's a good thing to track. It gives you a better picture as to what longer term money is doing with gold. Yesterday it made a new all-time high. That's a good one to track. It is reflected more of long term, more patient, less trading type money.
I think to that point; I can just speak from a sales standpoint. We are seeing that investors interest in circle expand from an unsolicited standpoint. We're getting more and more inbound calls and interest on how to think about the allocation, how to allocate to the space itself and so forth. I think we expect that to continue based off the call volume and activity we've been seeing really the last couple of years. It's really spiked this year in particular, to really bring it to light.
Paul, we spend a lot of time talking about what's caused the shock in the system. We've talked a bit about the value of a core allocation to physical gold. The natural progression, I think for this call, is gold equities. How should someone think about gold equities? Are they an allocation that's just too volatile to think about? Or is that something we should look at? And I know on page 13, you start to address the story behind gold equity. If you don't mind shifting gears and talking about that for a bit, I think that would be beneficial for the group.
Paul Wong: Slides 13-14
Okay, sure. Gold equities are more volatile. Historically, it has about twice the volatility of bullion. Let's go through some of the technicals. Black line is the GDM or the NYSE Arca Gold Miners index. Dashed line indicates the channel it's been sitting in, going back since the early 90s. Red line is the big breakup pattern similar to if you want to equate it back to gold bullion, this would be the rough equivalent of the $1,375 breakout level. It's on a chart to chart basis.
You can see that bullion is much further ahead than equities, but you can see the patterns for the most part are very similar, but it's just essentially been delayed, but it also falls again.
If you look at the last cycle from 2000 and 2011, again, it goes through the same process. It is a strong impulsive move up, it goes into a chopping consolidation and it shoots higher again. Again, big moves, very volatile, but it tends to be difficult for most people who try and trade. Again, you have to have a view of where you think gold is going.
On slide 14, I put two charts. Basically this is the gold miners. The top one is the gold miners to bullion ratio. And what you'll see is that you can see it's breaking out of this down channel that's been in place since about the mid 2000s. I marked the big overhead resistance level, and you see the green, it's shaping up. This is a bullish pattern.
This is important because what I mean is that once this breaks higher up, you get a relative flow of money from bullion to equities. Same thing with the chart below, this is the gold miners to S&P ratio. Again, the red line, big overhead resistance level.
And again, once the turn starts to happen, you get a relative flow of money into gold miners. It's very important because one thing about gold equities, it's the limited market cap. When I ran my first gold fund back in the mid-90s, one of the first thing I found out was that if you add up the market cap of every single North American traded equity, it was less than Coca Cola.
That means that when the flow funds turn towards gold equities, it really turns, because you go from pretty much no buying, to all incremental buying. It has a big implication on gold equities. Basically, it's the big gap. Today, the same thing. If you add up the market cap of every North American traded gold equities, I think it's roughly about the size of Proctor and Gamble.
Right now, only 10 stocks has a market cap north of $10 billion. When the flow turns, and again, this market is ideally shaped for this type of crowding effect that we've been seeing in a lot of different sectors. It hasn't happened yet. Will it happen? I'm not certain. If it does, it will be very quick and sudden. And we've seen it every single cycle. What you'll see is prices will start to gap up, pull backs become shallower, and it starts to really outperform.
Again, it's a limited flow.
Paul, to that point, do you think the last 10 years or so, with more and more ETFs and indexing out there, more quant funds, more technically driven type of investment strategies, hedge funds and so forth, I know this is pure speculation, but do you think as markets become more mature and more capital has found its way into those types of investment strategies, this kind of 'crowding effect', that if it does break above that red line, whether it's the S&P ratio or the gold bullion ratio. Again, speculation. But that severity could be really extreme, given there's so many more quantitative kind of electronic driven trading platforms that are effectively momentum type of processes out there. How do you think it's going to affect this type of move in the market?
The bottom line is that most strategies are momentum based, they tend to have a liquidity cut off. You're in this, I guess, this race. As liquidity gets higher and higher, and as the thought that gold stays higher for longer and eventually you get the turn. I mentioned it's the relative lack of liquidity. When the turn does happen, it'll happen very quickly, and it'll just take off like a rocket. I've seen it before numerous times in the past. But once the dynamic flows take control, it takes control.
Gold equities will move, and it forces this self-feeding crowding effect. We've seen it in other parts of the market this year, technology being probably the most extreme ever. But it's the same notional idea, but if you apply that to gold equities, it will happen. There's just not enough liquidity flow to satisfy all buyers.
Let's talk about that for a moment, because I think the general view on gold equities is that they are nothing more than a levered trade, or leverage allocation to the directional price of physical gold. Gold equities personalities and balance sheets have certainly changed in the last decade or so. I mean, you've got storied investors like Buffett buying large cap mining companies like Barrick Gold, because they could have gone for physical, but they chose equities, and valuations are changing, free cash flows are changing, margin expansions happening.
Talk about gold equities for a moment as a true stock with a real balance sheet and so forth and more than just a leverage trade to the price of gold. I know you start to address that it did on page 15. If you don't mind spending some time on that, because I think it's important for our listeners to understand that these are also stocks, that also have earnings, that also have balance sheets.
Yes, it's an investment relative to the price of physical gold, but it's much more than that as well. If you could spend some time on that. I think that would be beneficial for everybody today.
Paul Wong: Slides 14-16
Okay, sure. I guess gold equities in the last cycle is really driven by growth at any cost. Typically, when that happens, it doesn't end well. But as usual, the pendulum swings, and this cycle, it's radically different. You mentioned balance sheet. The last cycle, very leverage balance sheet today. Pretty much most companies were not carrying any debt. They were completely, almost unleveraged.
The return on capital last cycle was not a thought. Today every management company talks of return capital, and they run the business so there's a sustainable return on capital. As gold prices head higher, that return will head higher.
There's a focus on free cash flow this cycle. Free cash flow levels are high, and probably heading higher again as gold prices get better. Past cycle, there was very little thought given to free cash flow. You generate free cash flow, then yeah, you generate free cash flow, but no one made a big deal out of it.
M&A in the last cycle again, because growth at any cost, it was... Yeah. It was a little crazy. Today, M&A is very measured. It's very much more disciplined. Probably the biggest thing for the companies is the cost structure in industry in the last cycle.
In the last, we had the big China boom. There was big capex plans into iron ore met coal, copper mines. All that money equipment went up in cost, doubled, tripled. Mining engineers, doubled, tripled. Cost of anything and everything went insane the last cycle.
This cycle around, completely different. You're almost a deflationary type of environment. Oil prices peaked out at $120 in 2008. Today we're sub $40. Unemployment is a problem across the world, so you're not going to get a lot of labor pressures on gold companies. Your two biggest cost component in gold mines is power and labor.
All the other incidentals are coming down as well. The pendulum has swung now back the other way. You have management teams that are focused on return in capital, cost structures are well in place. Clean balance sheets focus on turning capital and capital discipline. Very, very different.
If you go to slide 15, you can see that the blue line is the gold miners index. This is the estimated EV/EBITDA. And one thing to point out is that for the miners, for the most part, they're still trading in the bear market ranges. The market peaked out in 2011, and since then, you're trading in that low range. You're basically trading with bear market valuation bans on an industry that's basically found religion, and it's now gone the other way.
I just highlighted the information technology group. It's more than twice. The thing to point out is that since the Powell Pivot, markets have been really been driven by lower real rates and a weaker US dollar. For technology, that means higher multiple expansion. For gold, it means store of value.
But the R squared between the GDX and the XLK, which is the tech ETF. It's staying at 81 percent, and of all the, I checked the other ETFs, just the big liquid ones, but it's by far away the highest correlation. Basically you think about gold equities, it really is on a macro level basis, driven by the same underlying macro factors, except that it's less than half the valuation.
All the price increases have been driven by earnings, there's very low multiple expansion, at most 20 percent from PE expansion maybe, that's it. Whereas technology is completely driven by multiple expansion. I showed that on slide 16.
Since 2018, earnings outlook has been flat. All movement we've seen is multiple expansion. Gold miners, that black line, I don't know if it's sustainable, but that earning's growth rate is running roughly about 80 percent growth rate right now. I think the closest analog, probably in terms of earnings power to gold companies, probably back to the '30s, where gold was all flat, but your cost components were crushed into a big deflationary cycle.
The margins kept expanding through the '30s. Today, I don't have the numbers from the '30s, but in the 30 years I've been doing this, I don't recall a time where gold companies have this type of structural advantage in terms of ability to grow margins, positive push on the revenue side and downward push on the cost side. Just haven't seen that before.
And right now, no one really cares. You can see there's not a lot inflow to gold equities. Lots of people are ignoring it. And to me, it's probably one of the best value plays out there. I mean, the whole market has been fixated on this. When will this rotation happen out of growth and to value? Because in the growth side, there's five stocks that make up 24 percent of the S&P 500.
Concentration levels are high as it's ever been, and every time we see in high concentrations in broad equity markets, it's always ended badly. Whether it's oil in the late '70s, technology in 2000, it all ended badly because the crowding effect is dangerous.
You have to keep justifying ever higher and higher multiple, but very little growth. If you have one area in value, again, I'm not a value expert, but to me, you have one area in value where the same macro forces are driving tech, it's driving gold. I just put that out there, but it is very different, and I don't recall ever seeing something like this.
Let's shift back real quick to gold, because I think that ultimately is where the story starts, right? You can't have margin expansion necessarily if the price of gold is going down. As we talked about the last four decades, it's been the slow march North with these periods of extreme moves when there's been volatility introduced into the market, or decoupling in some part of the market, whether it's economy related or tariffs related or whatever the case may be, whether it's a decoupling or dislocation in the market, gold continues to march forward.
Let's go back to gold for a moment from a portfolio holding standpoint, and what that looks like relative to U S Treasuries, what that looks like to the US Treasury Index ratio and so forth. Talk about that just for a moment before we wrap up the more formal part of the call today.
Paul Wong: Slide 17
Sure, alright. On slide 17, I have a chart top panel, US Treasury Index and Bullion. The blue panel below is the ratio of bullion to the US Treasury ratio index. Red line marks, again, a big breakup pattern. Gold has been outperforming since summer 2015.
It's outperformed by about 50 percent, or annualized about 8.5 percent probably on a compound basis, I guess the thing about gold and treasuries is that they both provide diversification. The bonds you have a problem with is that you're at the zero balance. You don't really have much more in terms of upside.
I guess you're protected on the downside. With gold, you have diversification plus you don't have any cap on the upside. Gold moves with M2, and pretty much you have there's virtually no cap on the upside. Another thing about bonds is that at this price level, you're buying bonds for capital appreciation. There's no yield on it. Lower the curve you go. You think of that way, then it becomes very difficult to hedge a portfolio with bonds by itself.
I think the negative correlation periods we saw from the end of the great financial crisis, up to about probably January, February this year, that deep negative correlation is probably gone. You're at the zero bound, you're going to have zero correlation. You lost a big portion of your downside protection in a multi asset portfolio.
And many fund managers are starting to replace it, and that's where gold comes in, because it does have unique features. I mean, I heard fund managers trying to replace bonds with high yielding equities. That makes some sense. But the end of the day, they're still equity. It's not going to give you the kind of diversification or non-correlation you need.
Going back to the blue line chart. That's a breakout chart, that chart's heading higher. Gold will continue to outperform bonds for the next while.
Well, that brings up a good point, too. I mean, historically, as an investor looked at gold, they looked at it predominantly to hedge their traditional equity portfolio. But to your point, lower for longer interest rates. Real rates flash to negative in many parts of the world, gold is starting to serve as a replacement in many cases to bonds, and even from a cash standpoint, particularly international investors, they're looking at gold now as an addition to or complement to even their cash positions in their portfolio.
The physical gold allocation is serving multiple roles right now in our traditional 60-40 portfolios. I mentioned this before, but we are seeing an investor circle start to expand. I think Paul, to your point about this sort of zero bound, limited upside to bonds, an investment into physical bullion makes a lot of sense as a core allocation.
Then for those that want some additional torque to the allocation, the gold equity story today looks more interesting than ever, given all the things you mentioned from a free cash flow and margin expansion and better balance sheet standpoint. I know the title has the word gold in it, does not have the word silver in it, but I've started to learn more about our audience, and invariably, people will start asking questions about silver.
We currently have 59 questions, for example, in the queue. And as I was scanning through them, there was a lot of questions on silver. We sort of wanted to get ahead of that, as it were. And on page 18, I'm going to ask you to focus a little bit on silver and what that means for a portfolio today and what's your view on it? I know you focus predominantly on gold, but talk a little bit about silver. How should investors think about that?
Paul Wong: Slide 18
Let's talk a bit about the chart first, and then we'll get into a little bit some of the nuance. I overlaid the gold and silver together on the same chart, and the prior peak and silver back in 2011, if you want to call it a blow off top bubble, what do we want to call it? I'm being conservative here.
If you do that, then with gold trading roughly around $1,900, if you rough fit it, the silver should be trading around the $30 to $35 area. That's roughly where it should be, and it's not. It's lagging. Why is it lagging? If you break down, what you'll see is it's the flow into ETFs.
There's another function on Bloomberg as well. I think the ticker is ETSI, ETLTL, it tracks the total known amount of silver in ETFs. Gold started off first because it's bigger, it's liquid. It has roughly 15 times the liquidity of silver. We saw the migration in large funds into gold, and we've been seeing it steadily since about just around the time of the Powell Pivot in 2018.
Silver just started moving more recently, gold silver ratio has been coming down in favor of silver. Now what really drives silver? It's kind of interesting. If you take the gold silver ratio, there's a Morgan Stanley cyclical index, if you take a cyclical divided by defensive index, they see measures, whether cyclicals are outperforming or not, the gold silver ratio has a 71 percent correlation to that, meaning that silver performs really well when the market has a pro cyclical bend to it, as it does now.
It does, and if you overlay that with when gold is bullish, that's the calling card for silver. You have two markers, bullish gold, check, and rotation towards cyclical from defensive. That's what we're seeing now. The whole exercise of the Fed is basically trying to get a cyclical recovery going. You can see we have a lot of V shaped recoveries in a lot of different parts in the market. You can see there's a rotation towards that.
For silver, what it means is that it has a really unique feature, one it has a store of value feature like bullion so long term, it still has a very strong correlation to M2. But it also has a strong correlation to procyclical factors. It's a very odd, very rare hybrid asset, but it is volatile right now. There's some little trading I mentioned in the September commentary. Looks like a lot of dealer gambles in play.
It will kick up volatility, but it will provide buying opportunity. If you understand the trading dynamics, and what's going on and how silver trades, it does set up better buying opportunity.
It's a higher volatility feature, twice the volatility, but twice the reward. But it also offers a very, like I said, a very unique feature. I don't know of any other commodity that has that store of value with a procyclical bias to it. Silver, again, it's lagging. But you'll see that if you pull up the amount of silver ounces held in ETFs compared to gold, it's actually rising faster than gold. That clip back level back in the summertime just before silver broke out of it’s $18 range.
You can see the accumulation happen prior to that. Since then, the last little while has been a bit of a pause, but it's a blip on a bigger picture. If you have a portfolio that can handle the volatility, it's very interesting to look at right now.
Ed Coyne: Slides 20-23
Thank you, Paul. That actually took care of about a third of our questions, which is great. Speaking of that, before we go into the questions, I do want to touch on a couple of things that I think are of interest. One of them is really the long term performance, as to what I like to call the super cycle of gold, because so many people are really focusing on what's happened, frankly in the last twelve months or so, but if you look at what gold has been able to do from a performance pattern standpoint for the last two plus decades on page 20, many investors are really surprised when they look at the overall returns of gold on page 20.
You have over two decades of return patterns, both up market cycles and down market cycles. I think it's interesting for people to note that gold has been one of the best performing assets out there, over and above the S&P, over and above bonds and cash, frankly, has been been slightly negative. The most recent cycle or current Bull market cycle that we saw begin in really the fourth quarter or 2015, when the Fed attempted to tighten, that cycle has really started to drive the current market moves, and COVID really just expanded that in a much faster rate.
If you look at the last four and a half plus years, both gold and the S&P have delivered very similar returns, and both of them have obviously put a huge shadow over bonds, which are only up about 20 plus percent over that time frame, and cash, which is, again, negative about 4 percent over the last four and a half plus years. I think it's really interesting to think about gold not as a trade, but as a long term core allocation.
Given the current narrative we're seeing in the market, both from an economic standpoint and from a geopolitical standpoint, we think the narrative continues to be supportive for the gold allocation, which also we think translates into a gold equity allocation. On page 21, I think it's important to note that not only has gold been an effective allocation to help dampen volatility, but it's also enhanced returns.
A relatively modest allocation of between 5 and 10 percent, into a traditional 60 40 portfolio, you find that gold has been an enhancer of returns, but it also has been a reducer in volatility. We're not here to say that you should sell everything and buy 100 percent gold. It's not an equation of gold versus the market, but it's really more an equation of gold and the market.
When you start to look at gold as a diversifier in a portfolio or a way to enhance a portfolio, when you go at gold with that lens, then it becomes a more effective, productive type of allocation. And on page 22, we like to talk a little bit about just really the different solutions Sprott has.
With over three decades worth of experience, we are one of the largest, most focused firms in the precious metals market, and we do offer a full suite of solutions whether you want to do a combination of gold and silver from a physical allocation in our Sprott Physical Gold and Silver Trust, which trades on the New York Stock Exchange under the ticker symbol CEF, or if you want to do a full pure play allocation into physical gold, with the ticker symbol PHYS, or pure silver, PSLV, those three specific trusts give you direct ownership of the physical metal, and for US investors they have a potential tax advantage as well, which we can certainly talk about offline.
Then we even offer a platinum and palladium trust which gives you exposure to those physical metals. In addition to that, we do have two factor based ETFs that give you exposure to the senior large cap, more established miners that have multiple mines and different phases of production, down to our junior small cap miners that are in many cases in late stage discovery or built out of early stage production.
We have two ETFs that are very interesting to look at as well, that have a factor based overlay that look at the underlying positions within that portfolio. Then we offer the seasoned portfolio, that is an active portfolio managed by John Hathaway and Doug Groh, called the Sprott Gold Equity Fund, which we acquired earlier this year from Tocqueville.
We have an active approach to the equity solutions, and we have two factor based ETF approaches to the solutions, and depending on where you are joining us today on this call within the country, I encourage you to reach out to our regional senior investment consultants. For those on the West Coast, you can reach out to Matt, the Midwest Central Region, Julia, and for those on the East Coast, Sergio.
I encourage you to reach out to our senior investment consultants on page 23, and allow them to work with you on how to think about the allocation, how to think about the waiting in the allocation, and help us deliver to you some unique solutions on how to participate in both the physical market and the equity market. With that, I'll take a pause and turn it back to Natalie to cover a few house cleaning issues before we go into some Q&A.
Great, and thank you both for such an informative presentation. As a reminder, a copy of today's presentation as well as additional material can be found in the Documents folder at the bottom of your screen. We appreciate your feedback. Please take a moment to fill out our brief survey also located at the bottom of your screen. Our speakers will be taking advisor questions. Please type your question in the box to the right of the slides, and we'll get to as many of your questions as possible.
In the event your question is not answered on today's webcast, a member of the Sprott Asset Management Team will get back to you directly. If you'd like to have a conversation to further discuss the ideas that were covered during today's event, please click the one on one folder at the bottom of your screen and confirm you request. With that, I'll hand it back to Ed to take our first question.
Question and Answer Section
Ed Coyne Q&A
Thank you, Natalie. As I mentioned, we knocked out a good chunk of questions when we addressed silver. I am looking at the inbox here at 71 questions currently. I will tell you this, we'll probably only have time for a few questions live, but between Matt, Sergio, and Julia, we will make every effort to respond to everyone's questions in the next couple of business days, depending on how you register, either by phone call and or email.
Rest assured, we will get back to everyone with questions and we'd be happy and we welcome the opportunity to have a more detailed call with everyone today, on how to think about the allocation. With that, I'd like to start with one of the questions that I think is one that's on a lot of people's minds, which is how important is the devaluation of the US dollar to the bullishness of the gold trade? And, Paul, I think that's a good question for you to address, because that seems to be what's happening a lot today.
There's an inverse correlation to the strength or weakness of the US dollar, how important is that longer term when thinking about gold?
Paul Wong Q&A
It's important, but you need to put it within context. A weaker US dollar, you should see that consistent with the outlook for monetary policy, real interest rates, credit conditions. It's part and parcel of all the other variables that are going on for gold.
Short term, sure. I mean, the market can trade day to day with fluctuations in the dollar pricing and impact gold that way. The longer term, what you should see is a weaker US dollar consistent with expansionary monetary policy, higher fiscal policy expected, real rates still negative, and still in a downtrend.
You should hear the Fed continue to talk about loosening money, financial conditions and a bunch of other indicators. It's important, but you should really look at it in conjunction with the other indicators to get a much clearer, consistent view on the direction of gold.
By the way, they want a weaker US dollar, period. Strong US dollar tightens financial conditions around the world like you wouldn't believe. The biggest short on the planet right now is a US dollar short.
The most conservative I've seen is there's roughly about a $13 trillion short in the US dollar, meaning that foreign countries issue debt, and US pay the nominee in US dollar. Back in March 2020, the reason why the Fed opened up all the swap lines was trying and get US dollars flowing.
One of the big pressure points in the overall market was, again, the squeeze on the US dollar. If you see a move up in US dollar, pretty certain the Fed will find a way to knock that thing back down again. You cannot have a stronger US dollar. Again, it's part of the Fed put, as I mentioned.
Ed Coyne Q&A
Thank you for that one, Paul. Here's another one that I think is one that's probably on a lot of people's minds. This relates to interest rates. We've all talked about lower for longer interest rates, whether we're talking about the Fed fund rate or real rates. But the question is, what's the history of gold and gold mining stocks during a rising interest rate environment. What's been your experience on that, Paul? If you can speak to that.
Paul Wong Q&A
Well, it's variable through time. The most consistent one is real interest rate. In the '70s, we actually had rising interest rates, but gold ripped through it because the real rates were collapsing because inflation was so high. It depends, is the answer. The real answer is, look at real rates. Don't look at nominal rates.
Right now, nominal rates are held flat. The Fed has a $120 a month QE program. Nominal rates aren't reacting. Look at where real rates are going. If you want, you look at break evens, and look at break evens where they're heading. Basically, as break evens head higher. If we get this reflationary push, the market breaking it higher, we'll expect the Fed to keep normal rates within a band. And that means real rates will collapse, head lower. Don't get too fixated on where nominal rates are going. It may create day to day trading noise, but the real picture is real rates.
Ed Coyne Q&A
All about the real rates. Perfect. I know we're coming up on the hour, and we can certainly address one or two more questions and as I mentioned, we will get back to everybody by phone and or email, but just looking at the questions, trying to consolidate them here, another question is obviously price targets, and I know you don't want to get into a particular price.
The questions range from as much as; can you justify a $4,000 per ounce price target? Another question that came in was specific to a little more modest, which is what is a realistic 2021 outlook or upside for gold?
Can you talk about that for a moment? I know you address it a bit in a presentation talking about the $2,400 range or so based off money supply, but what do you think the price target could look like? Let's say now through the end of next year, just to get a sense of what people can think about.
Paul Wong Q&A
If you use a combination of technical and model inputs, like macro model inputs, with a certain band, I just did that like last week. It's somewhere around call it $2,150 to $2,500. The problem you have is that there's so much uncertainty, right? I mean, I could paint a picture where, let's say Democrats sweep. All of a sudden, you get a $2 trillion to $3 trillion stimulus package rolled out right away. Again, back to math, that's $200 to $300 rough increase in the price of gold pretty quickly.
If they decide that okay yeah, the Fed keeps the swap line, US dollar swap line's going past March, then yeah, you're going to have a weaker US dollar. If you keep the nominal rates cap, you get a break even reflecting the stimulus and real rates are going to plunge even more, then you get your $2,500 price target pretty quick.
I mean, there's a lot of variables involved, and there's a lot of uncertainty, that's the problem. It's a wide range, but it's not too hard. Build a model. Start plugging numbers. Start plugging assumptions. You can see the range is quite wide. One thing you'll notice is that the upside is far greater than downside once you start playing with numbers. I do that a lot. Just what's my upside downside ratio? I try to put in different scenarios just to see where the possible range is.
The possible range, I think this is reasonable, but things could change the next day. The $2,150 to $2,500 to me seems reasonable.
Ed Coyne Q&A
Great. Thank you. We're at a little over an hour now so I think we'll stop there. What I would encourage everyone to do again is to reach out to respective senior investment consultants in the region. I'd also encourage you to join us for the monthly newsletter, our white paper, our research piece that Paul Wong puts out. He does talk a lot about some technical moves and so forth in the market and gives some pure reporting on what's going on in the overall gold allocation or gold trade. You may find that informative as well.
Thank you all for joining us today on this call. We will be reaching out to all those unanswered questions, and we look forward to working with you all going forward and helping you allocate to gold through Sprott Asset Management. Thank you for your time and interest today, and have a good rest of the week.
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