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Sprott Bets on Mexico as Hedge Fund Boosts Bonds: Canada Credit

Date: Tuesday, February 25, 2014
Author: Cecile Gutscher and Eric Lam, Bloomberg

Sprott Asset Management LP is betting Canada’s bond market will be on the losing side of a deepening North American rivalry with Mexico for the fruits of a recovering U.S. economy.

Michael Craig, fixed income portfolio manager at Canadian hedge fund Sprott Inc., said he’s buying Mexican government debt because demand for Mexican oil is growing at Canada’s expense. The move comes as the firm, which made its fortune investing in gold and mining stocks, boosts its fixed-income allocation in balanced funds to 30 percent from 25 percent, according to co-chief investment officer John Wilson.

“Over time a U.S. recovery is going to benefit Mexico far more than Canada,” Craig said in a Feb. 19 interview in his office. “They don’t have the sensitivity to a slowing Chinese economy; they’re much more plugged into the United States.”

The C$7 billion hedge fund, founded by Canada gold bug Eric Sprott, started investing in bonds in July 2010, hiring Craig and Scott Colbourne, now co-chief investment officer. Gold’s 25 percent fall in the past two years has increased the allure of bonds. An index of emerging markets and high-yield company bonds favored by Craig gained 17 percent during the same period.

Higher Yield

Two-thirds of Sprott Asset’s C$350 million of bond investments are outside of Canada. Among the top five holdings of the C$150 million Diversified Yield Fund as of Dec. 31 were a Polish government bond due in 2023 and the junior-ranking debt of Irish insurer Beazley Group Ltd.

Sprott doesn’t hedge back to Canadian dollars purchases of Mexican government bonds in pesos, Craig said. Mexico’s 30-year benchmark note yields 7.46 percent while Canada’s 3.5 percent note due December 2045 yielded 3.02 percent at 1 p.m. in Toronto.

Foreign investors pulled C$10.3 billion out of the Canadian bond market last year in the first annual outflow since 2007 and the most since 2003, Statistics Canada reported Feb. 18, as they swapped the safety of Canada’s top rating in favor of higher yields in riskier sovereign markets.

Canadian energy exporters may lose at the expense of Mexican rivals following constitutional amendments that allow companies such as Exxon Mobil Corp. (XOM) and Chevron Corp. to obtain drilling licenses and other production contracts. The reforms may add $20 billion to foreign-direct investment in Mexico as soon as 2015, according to an estimate from Bank of America Merrill Lynch.

Once in a Generation

“It’s something you see once in a generation that’s going to open up their economy particularly in the energy sector,” Craig said. “My sense is a lot of the money that’s set aside for oil production, if it goes to Mexico it’s going to hurt other jurisdictions, and one of those is Canada, so you actually see less development of oil sands at the benefit of Mexico.”

Canada growth will stagnate in the meantime, Craig said. The risk of deflation and consumer debt means the Bank of Canada will have to hold its benchmark rate at 1 percent, where it’s been since September 2010, past 2016, he said.

“This is the aftermath of a recession that’s driven off a debt collapse, not an inventory collapse: the recovery is long, agonizing and pretty tepid,” Craig said. “You see interest rates moving a percent higher and I guarantee you have a housing problem. You want a recession? Raise rates.”

Sprott Inc. (SII) saw its investments fall by almost a third to C$7 billion from C$9.9 billion last year, according to a Jan. 20 statement, as a gold-price slump prompted investors to flee its metal-focused funds. Precious-metals investments -- physical metal and equities --- accounted for about 70 percent of the firm’s assets under management, Glen Williams, a company spokesman, said in November.

“Our assets under management declined in 2013 as the downturn in the natural resource sector took a toll on some of our larger strategies,” chief executive officer Peter Grosskopf said Jan. 20. “Looking ahead, our key priorities include continuing to diversify our Canadian platform, capitalizing on international opportunities and building scale in our institutional business.”