Sprott vows to stay the course

Date: Friday, October 31, 2008
Author: Mark Noble, Advisor.ca

While the market has created a swath of destruction for everyone, it's been particularly cruel to Eric Sprott, superstar fund manager and CEO of Sprott Inc. On a particularly candid conference call with investors on Thursday, Sprott was adamant that his funds are sticking to the strategies that made him the most consistently successful Canadian fund manager of the last decade.

Sprott's retail funds, like his flagship Sprott Canadian equity, have dropped nearly 40% over the last three months as particularly the commodity and resource markets took a turn for the worse. His company's assets under management have declined to $5.6 billion, compared to $7.7 billion as of June 30, 2008.

The performance has had a cascading effect on the stock price of the recently launched public company, which is trading at roughly a third of its original offering price of $10.00 a share back in April.

On the call, in which he discussed the company's third quarter results, Sprott outlined that his company's funds have long anticipated the meltdown in the financial markets; what's perplexing him is that investors have not behaved thus far as he anticipated.

"We've had other times where we have had serious disagreements with the markets," he says. "We've haven't been wrong in being negative about the market; we haven't been wrong on the negative growth of the market. We have been wrong on the valuations people are attributing to resource stocks in a grossly illiquid stock market."

Sprott Inc nevertheless managed a healthy $122 million in net sales on the quarter. Part of this could be attributed to the strength of the company's hedge fund offerings, which have massive short positions on the market, and which the long-only retail funds are unable to carry. Sprott says the hedge funds are short roughly 65 cents on the dollar, with 25% of those positions being in the financial sector.

The long positions of the hedge funds are very similar to the long-only retail funds, which have had their positions in small/mid-cap resource stocks hammered.

"The short positions are everything. Our equity fund is down in the forties and we are roughly breaking even on the hedge funds," he says. "We've made our performance on the short side."

Nevertheless, Sprott says he's surprised the long positions on his mutual funds aren't panning out. Under no circumstances is he willing to abandon his core investment thesis that investors will eventually turn to hard assets like gold and resources, as the financial system continues to work out its leveraging problems.

Gold in particular Sprott remains very positive on. It's the single biggest holding of the company. He points out that while the prices have retreated of late, it still remains one of the few asset classes up on the year.

He expects confidence in the financial sector will continue to erode along with the value of paper currency. That will eventually put gold prices back on an upward trajectory. Early in the call, he noted that it's not outside the realm of possibility that gold prices could top $1,500 in the not-too-distant future.

"We are shocked at the reluctance of gold prices to recognize the financial crisis we are in and we are confident that day will come," he says. "We still expect, given the passage of time and given the ineffectiveness of some of the manoeuvres in the financial sectors, there will be a big role for gold going forward."

If his thesis doesn't agree with market direction for some time, Sprott says he's willing to wait and take the hit on performance — and potentially the redemptions that may follow.

"Gold was a wonderful investment in the bear market of '01-'02. It has not been so far, in the worst bear market of '08, which goes against conventional thinking. As portfolio managers, you've got to take a stand on something here. We believe in [gold]; we believe in the peak oil theory," he says. "If we continue to underperform, we should expect redemptions. I think the TSX is down something like 19% this month, and we're down 21% — not that I ever want to compare our performance to the TSX. I do not. I'd much rather compare myself to zero."

He adds, "I don't know if we will end up positive on the year. I think we would be more stressed out if we thought all the investment strategies we had weren't working. That would be a really big problem for us."

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com