Macro Gold Roundtable
The Fed’s recent rate hike provides the backdrop for an insightful conversation with market veterans John Hathaway and Fred Hickey. They discuss Fed policy, inflation, investor sentiment and other supportive factors that have created an interesting setup for gold bullion and gold miners.
Ed Coyne: Hello and welcome to Season 2, Episode #3 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. With us today is our very own John Hathaway, Senior Portfolio Manager of 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 Sprott 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 more about yourself, your background and your publication?
Fred Hickey: I graduated from the University of Notre Dame. I was a financial guy. Accounting major, didn't do a lot of accounting, eventually made my way into becoming a stock analyst for a brokerage firm in Boston, a 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. But in the early 2000s period, when I saw what the Federal Reserve ("Fed") was doing, which was getting increasingly out of control, I started to put a lot of my money into 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. 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. I 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 in both camps, although I would like to go back solely to tech someday.
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: I joined Sprott a couple of years ago. Before that, I had been at Tocqueville Asset Management and founded and managed their gold fund, 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 metals space. Sometimes we talk about macro, but mostly we talk about companies.
Ed Coyne: You've been here with us for a couple of years at Sprott and your track record and experience speak for themselves. Fred, I'd like to start with you, it's a bit of a statement, and I will get to my question, but I think it's worth highlighting what's going on today. We've got many macro-level things playing out simultaneously, including 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 a thorn on both the consumer and industrial sides. 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 U.S. elections are coming up in November. And I'm quite certain I've even left out a few things. 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 do you tend to lean on to help make sense of all the things going on today?
Fred Hickey: 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 that I've been writing the letter and everything from The Wall Street Journal to very detailed sites 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 opposite ends of the spectrum. I think that's fascinating to think about, particularly as our listeners think about how 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 think it's fascinating that you've applied both in the way you look at the world.
Fred Hickey: I talk about it as if it's Yin-Yang for me because I think they're opposites. When the stock market is doing well and things are swell globally, then gold is usually out of favor. 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-1970s for stocks; then, in the 1980s through 2000s, we had the greatest tech bull market, and that was a 20-year bear market for gold. And then in the 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: It's amazing. Gold continues to do its job in times of stress. John, I think this is a good time to get your view on that. How do you prioritize some of these things? Walk our listeners through 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 spend a lot of time on that, and then it boils down to individual company analysis. Right now, we're 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. I would say that the fact that gold is breaking out is probably bad news for mainstream investors who are relying on conventional investment strategies. 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 as rising interest rates are, in theory, very bad for gold. 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. Let's talk about this and I want to hear from Fred about what he thinks. 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 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.
I think the fact that more and more people realize it is really bad news for stocks. There's no middle ground. The Fed 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 valuations. I think that's where we are, and I think that's something we should spend some time on.
Fred Hickey: Yes, I agree completely. When tech stocks were 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 records high, which was at the dot-com bubble, and I thought, I'd never see the dot-com bubble again. But here we are. And then also on a price to GDP basis, we were 30% to 50% above that, too. This has been 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. We've gone from a historic bull market in bonds to this past quarter year-to-date, which represented the worst bond market quarterly decline ever. For a quarter, that's down 5.5%, and from the peak last year, you're down 8%. Well, that's not the 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? 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. But the largest miner in the world went to record highs recently as part of the S&P 500. Institutions have gotten very interested because they said there's no choice. There's an article today in The Wall Street Journal talking about the possibility of a soft landing. There's no possibility of a soft landing if you look at 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. With the Russia-Ukraine crisis, you have a spike in oil prices and food prices and shortages of food likely. There's no way the Fed will avoid a recession when they're doing QT and raising interest rates. Every time the Fed has tried to exit from its money-printing episodes, it's always led to market turmoil. And that's always been good for gold. 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 but then sold back up a bit. As the Fed tries to press this and raise rates, as you talked about, they've painted themselves in a corner. What do you anticipate is going to happen both for the gold trade as well as the gold equity trade, as the Fed gets stubborn and tries to continue to push through 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 people out of work as a result. Again, the Fed simply cannot achieve the medicine applied under Paul Volcker in the late 1970s to stop inflation in its tracks. Because if they did, and given that the economy is so more highly indebted than it was in the late 1970s, the repercussions would be really adverse and politically intolerable. Again, to add to Ed's earlier question, it's just impossible to think that would happen in an election year.
Ed Coyne: Both of you have said it in different ways that we're in the perfect storm for both gold and gold equities to do quite well. And they certainly have had fits and starts. We broke through $2,000 for a while and we've given a little bit back. It seems like the investors' timeframe and ability to pay attention to things are so short and tight. At some point, that pivot reality will set in. What will be the straw that breaks the proverbial camel's back? When I talk to investors, they want to know why gold hasn't done better? I hear that all the time. And I respond that gold could have done worse last year given that the Fed was plowing capital into the market. What will wake people up and say we actually have an issue here and we should be thinking about a risk-off strategy and not just doubling down every time the market hiccups?
John Hathaway: I'm waiting for the pivot. I bet Fred's in the same camp. Powell is super-embarrassed by his bad call on inflation last year. And Mohamed El-Erian was just in the press yesterday talking about what Powell needs to do: explain to the world how he made such a bad call. I'm not holding my breath. I 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'm beginning to see that confidence in the Fed is starting to ebb away pretty quickly. And I think that would be very closely connected to the loss of confidence in the valuations that we have in the equity market.
Fred Hickey: I think you might see that in the reaction of the 30-year bond 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 will continue because I think we're going to head on to a recession, but it's a strong sign that they're losing ground.
Ed Coyne: Historically, the late Marty Zweig would always say, "don't fight the Fed." I think, John, you said something interesting as well, which is gold is a put on the confidence of the Fed. I believe that confidence will be shaken, that the Fed is not in as much control as they would like us all to believe. The first crack, I suspect, was when the Fed indicated, "okay, inflation is not transitory. It's real." I always tell people gold is not here to replace their 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.
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. Gold's lack of correlation to other assets is there. How should investors think about gold as they build out a portfolio, to protect my assets? Whether you are in retirement rying to protect income and wealth, 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 $1,050 in 2015 and the beginning in 2016. Then we were $1,180. And here we are, a couple of weeks ago and were at $2,070. 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. It's only in the last year we started to see inflation. Now, if the Fed starts to pivot and 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: John, from your point of view, particularly with the focus on gold mining stocks, what are your thoughts on what an investor should 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: 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. 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, but they never came back. Cisco has never returned to those highs, ever. We are talking about 22 years later. Intel is half of the level it was 20 years ago. You don't want to be buying stocks, tech stocks, and there are a lot of areas in the market that are grossly overvalued. Value stocks of course, may offer a better place, I think. But you don't want to be there during 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 mining area. And some people heard about the higher cost given the 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 (an ounce). And that's the difference between the average realized gold price companies sold things for, and they're all-in sustaining costs. The high was $640. Where is it today? Well, it's $840 with a $1,940 gold price today and a little over $1,000 for the bigger miners. You're looking at over $800 in margins. 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 during the Great Depression. 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, the HUI Index to gold price ratio, and that basically measures gold stocks to gold bullion prices. Back in the 2000s time frame, HUI-to-gold ratio averages 0.46. Today, it is 0.16, which means it would have to triple just to get to the same level. And it was even higher at certain points in the 2000s, like 0.65, 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 major gold mining companies are buying back shares, constantly raising dividends. One of the reasons why gold stocks have been so depressed is they had a very difficult time in past years when managements weren't so attuned to shareholders. Now they've learned from that, and 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, you're looking at dividend yields and free cash flow and earnings 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 opportunities, the gold miners certainly look interesting.
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@example.com. 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. And with that, once again, I'm your host, Ed Coyne, and thank you for listening to Sprott Gold Talk Radio.
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