Sprott questions logic of rally

Date: Friday, May 8, 2009
Author: Steven Lamb, Advisor.ca

Being a contrarian can hurt sometimes, especially when the markets are enjoying a broad upswing. For Canada's most vocal bear, the latest rally is doing little to change his mind.

Eric Sprott, president and CEO of Sprott Asset Management, acknowledges that his portfolios have taken a bit of a beating, especially among the short positions in his hedge funds.

"We've taken our hit and, hopefully, if we're right, we'll get a very large and immediate gain," he said. "That's what our investors want us to do; they want us to have an opinion and stick with it."

The markets have staged a significant rally so far this spring on the foundation of successive government interventions in the financial services sector. Sprott points out that each move failed to reassure investors, until the U.S. Federal Reserve and Bank of England embraced a policy of quantitative easing — a polite way of saying "printing more money."

Sprott questions the logic behind gains made on these announcements.

"We all know it's massively inappropriate, unless you're gaming the system. Something has got to give," Sprott says. "What should give here is the value of the underlying currencies. You just can't print $1 trillion and expect people to accept at face value the next day that the dollar is worth what it was before you printed the trillion."

"In the case of the U.S. government, I think it has guaranteed something like $11 to $12 trillion in securities."

To pay for this guarantee, he says that the U.S. Treasury is issuing an average of $10 billion in bonds every trading day.

"The bonds are breaking down. The treasury bond has risen 10 basis points today, which to a bond owner would be shocking," he said. "The bond auction that went off yesterday [May 6] was purchased at [a yield of] 316 or 317 [bps]; it's already 10 basis points higher. Whoever bought it and didn't off-load it, they're losers one day later. And now they're being asked to buy another big issue today."

He said he doesn't understand why anyone would take any comfort from the Fed's promise to print more money.

"We are still dyed in the wool bears. Yes, there is a gaming going on in the system, but we've seen this many times in the last 18 months. I don't think [the recovery] is going to last, and there may be a horrendous price to pay for it."

He does see hope for his favoured holdings — the companies that are involved in the energy, precious metals or materials sectors — as more investors are turning to "real" stocks. He will be shocked if the price of energy does not rise significantly over the next 12months.

"We've never given up on the peak oil thesis; I believe in it more strongly today than ever," he said. "You have this economic contraction that is going to bring about the recognition of peak oil even faster because we are drilling fewer and fewer wells every day, and depletion is becoming way more significant."

New gold funds coming to market will drive up the price of the precious metal.

Competing with advisors

On June 1, the company will divide into Sprott Asset Management, Sprott Private Wealth and Sprott Consulting.

He says Sprott wealth will allow the firm's sales staff to focus on catering to individual investors with a minimum investment of $250,000.

"Individual investors are the best type of investors to have because they don't suffer from the same emotional volatility that institutions tend to have," he said, pointing out that institutional money managers are paid to make decisions and often shift assets to demonstrate the value of their service.

"Whenever you get a new institutional account, you know it's massively unreliable," Sprott says. "The people are changing all the time."

Opening a private client shop will place the firm in direct competition with the same advisors that have faithfully delivered assets to the Sprott funds over the years. Yet the company does not expect a backlash.

"Generally, it hasn't been a problem; we've already got 2,000 private clients right now with a significant portion of the assets of the company in that division," said Peter Hodson, portfolio manager for Sprott Growth Fund. "Some don't like it, but it's part of the business and they understand it.

"We haven't advertised; we're not actively in their face. We do see a big opportunity, and we don't see a big pushback from the brokers that we deal with now."