Gold's Value in the Post-COVID Recovery

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June 14, 2021 | (59 mins 05 secs)

Gold is on the rise again, as the market debates whether inflation will be transitory as economies recover post-COVID. Extreme volatility among cryptocurrencies like Bitcoin has also benefitted gold in Q2. Gold mining stocks are enjoying renewed activity as market participants recognize the free cash flow and profit potential this sector offers. In this webcast we discuss:

  • Although gold continues to be underrepresented in portfolios, we are seeing a growing interest among institutions looking to replace bonds
  • Gold is being supported by several macro tailwinds, including negative real rates, rising inflation and exploding government balance sheets
  • Bonds are at a dead end as a portfolio diversifier for 60/40 portfolios…with negative real rates, they offer minimal upside combined with substantial downside risk
  • Gold mining stocks continue to be inexpensive relative to gold bullion and cheap by any standard valuation metric

Featured Speakers

John Hathaway
John Hathaway
Senior Portfolio Manager
Sprott Asset Management
Doug Groh
Douglas Groh
Senior Portfolio Manager
Sprott Asset Management
Edward C. Coyne
Edward C. Coyne
Senior Managing Director, Global Sales
Sprott Asset Management

Webcast Transcript

Natalie Noel, RIA Database: Cover Slide

Hi, everyone. Thank you for joining us for today's webcast, Gold's Value in the Post-COVID Recovery, sponsored by Sprott Asset Management. In today's webcast, we'll 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.

We welcome any questions you may have at any point in time during today's webcast. You can type questions in the Q&A box to the right of the slides, and we'll do our best to get to as many of your questions as possible. If your question is not answered during today's event, a member of the Sprott Asset Management team will get back to you directly. We have many materials available for you to download in the Documents folder at the bottom of your screen. As always, we appreciate your feedback and strive to make these events the best they can be for your viewing satisfaction. At your convenience, please take a moment to take our survey which is located at the bottom of your console.We will cover quite a bit of information during today's webcast. If at any point in time you're interested in scheduling a one-on-one meeting with Sprott Asset Management, please click the one-on-one folder at the bottom of your screen and confirm the request. In the event you missed any part of today's webcast or simply like to watch it again, a replay will be made available to all registrants who will receive that information by email.

With that, I'd like to go ahead and turn it over to today's first speaker, Ed Coyne, Senior Managing Director, Global Sales for Sprott Asset Management. Ed, take it away.

Ed Coyne: Slides 1-3

Thank you, Natalie, and thank you all for joining us today for the webcast. With me today is both John Hathaway, CFA and Senior Portfolio Manager at Sprott, along with Doug Groh, Senior Portfolio Manager at Sprott. John joined Sprott Asset Management in January of 2020 with over 50 years of experience and as the Portfolio Manager of Sprott Hathaway Special Situations Strategy and Co-Portfolio Manager at the Sprott Gold Fund.

Previously, John was with Tocqueville Asset Management LP. Prior to joining Tocqueville, John co-founded and managed Hudson Capital Advisors and earned his BA from Harvard College and his MBA from the University of Virginia. John also holds a CFA designation.

Also with us is Doug Groh, Senior Portfolio Manager at Sprott. Doug joined Sprott Asset Management in January of 2020 with over 35 years of experience and as a co-manager of the Sprott Gold Equity Fund and other investment vehicles at Sprott. Previously, Doug was a Portfolio Manager at Tocqueville Asset Management LP since 2003. Doug earned his BS in Geology and Geophysics from the University of Wisconsin and his Masters from the University of Texas.

For those who are not familiar with Sprott, I thought I'd take a few minutes to explain who we are and what we do, and how we do it. Sprott is a global leader in precious metals investments, with over $17 billion in assets as of March 31, 2021. We're one of the largest publicly traded asset managers in the market today focused on precious metals. We trade both on the New York Stock Exchange and the Toronto Stock Exchange under the ticker symbol SII.

At Sprott, we offer a full suite of portfolio management solutions. With over $12 billion in physically listed products, we allow investors to own physical gold, silver, a combination of gold and silver, or platinum/palladium. We also have a suite of managed equities with close to $3 billion in assets, whether it's our flagship U.S. mutual fund, the Sprott Gold Equity Fund, with the ticker symbol SGDLX, or a suite of our factor-based ETFs that give you exposure to both senior and junior mining stocks. We also offer private lending and brokerage services in the precious metal space.

Ed Coyne: Slide 4

Today, I wanted to cover a few things in the webcast and I've asked John and Doug to join us. Doug will focus on the gold mining space and John will focus on the physical space. What we want to talk about is the way gold is largely underrepresented both by institutions and investors today, and we still believe there's plenty of room on the upside for both assets to do quite well.

We found that in the second quarter of this year, gold climbed back above 1,900 and is sitting in the 1,850 range today as inflation fears and historically low rates continue. We also believe that bonds are at a dead-end. They offer minimal upside in a typical 60/40 portfolio with close to zero interest rates, and we believe they offer substantial downside risk. Lastly, on the gold side, we encourage our investors to take advantage of the gold price weakness that we're finding and to establish and increase their long positions.

On the gold mining stocks, we're going to have Doug talk about how mining stocks are the least expensive relative to bullion in decades and cheap by any standard, whether you're talking about absolute or relative. We're also going to look at how companies are growing their free cash flow. We believe that over $10 billion of free cash flow can be had at current metal prices today. Doug will also explore that. We'll also look at the dividend hikes and buybacks that are becoming more and more frequent, and lastly, we will close with some of the M&A activity that we're seeing in the space today.

Ed Coyne: Slide 5

Before I turn it over to John Hathaway to talk about the gold side of the market, I'd like to read a quote to everyone, which I believe in the simplest terms, sums up why gold today, why the narrative, why you should be thinking about it, why you're on this webcast. The quote is quite simple. "It is dangerous to accept that government spending, no matter how much or what for, is the only solution and even more dangerous to believe that the shape of the recovery is only a function of the size of the stimulus package." Bottom line, "Central banks do not manage risk, they disguise it."

Ed Coyne: Slide 6

With that backdrop, I think it would be great to have John Hathaway join us and talk a bit about what's going on in the gold market today. John.

John Hathaway: Slide 7

Thank you, Ed. I love that quote, "Central banks do not manage risk, they disguise it." That's exactly what we're seeing today. Heather, if we can go to the first slide. Since 2000, which is why we have this chart to start with, gold has been the best performing asset in terms of large categories versus equities, bonds and the U.S. dollar.

Why 2000? 2000 was the beginning of radical monetary policy that was undertaken by the Fed under Greenspan, and then Bernanke, and then Yellen, and now we have Powell. They're all cut from the same cloth.

What astonishes me is how much faith investors seem to have in them. I will take some time on my last slide to talk about that. It's important to make the point here that even though gold has outperformed other asset classes for the last 21 years now, it's almost a well-kept secret. There are lots of reasons for it, but I think it means for those of us who are on the call that it is not on the tip of everybody's tongue. It's performed great, but it is not widely held. It is misunderstood. I think it's worth the time and trouble to understand what the dynamics are.

John Hathaway: Slides 8-10

If we could go to the next slide, please, Heather. What we see here is that we know that interest rates are abnormally low. They're definitely controlled, or at the very least, heavily influenced by Federal Reserve policy. When interest rates are as negative as they are now, and you can see the inflation adjustment, interest rates are negative 0.86 percent, just a few basis points from a record low for the last 20 years. That has been a very positive condition for gold.

Why is that? Because it means that bonds as Ed said in his introductory remarks are a dead end. People think of bonds as a way to diversify portfolio risk. But for what we see ahead here, our guess is that real interest rates will go into more deeply negative territory. As you can see from this chart, that that will be very positive for the gold price in the years ahead.

One of the things driving the gold price is the balance sheet expansion of the Federal Reserve and other central banks. The thought that the Fed is going to normalize interest rates and so that we would have a yield curve that's steeply sloped and reminiscent of what we saw in the 1990s when capital markets were much healthier than they are today, that, to me, is a fantasy that's never going to happen.

And the reason is the Fed is now buying $120 billion a month, $4.8 trillion a year. This talk about tapering, to me, is just a joke. It's just posturing by the Fed, because if interest rates were to go up with valuations in the stock market at these nosebleed levels, there would be a lot of collateral damage in terms of falling stock prices.

While they talk about tapering and while many investors think that they could and maybe will taper someday, I would say, and you can write this down, it's just not going to happen. They might try it, but if they do, we will have adverse consequences throughout the capital markets.

We're on a runaway train as far as government spending goes and as far as balance sheet expansion goes. That all leads to, without getting too complicated about it, an inflationary outcome. This is a long discussion. I'm not going to go through it today because we don't have time.

The more kinds of prints we see on the CPI, which last month was an annual increase of five percent as everybody knows, the more deeply negative real interest rates become and the greater the need for having gold exposure increases. I think this is worth thinking about. If anybody can tell me, figure out a way that central banks are going to pull back from this posture of super easy money, you have my email, my phone number. I'd love to know, because I just don't think it's going to happen.

The consensus is that the stimulus that is being applied to the economy and the ones that are being proposed, which may or may not take place, equate to a robust economic recovery, one that's sustainable and one where the economy returns to a healthy state of affairs. The recent action in bond prices gives the lie to that expectation. You had a very regular uptrend in the 10-year bond yield for just about a year.

The thesis of that was, first of all, a lot of robotic funds, artificial intelligence, and so forth were shorting the bond market on the expectation that the economic recovery would be robust and sustained, and therefore the bonds would be a bad debt. Here we see, this chart is from Cornerstone Macro, from their very good technician Carter Worth that you've broken down out of that channel.

I think this is a very strong signal that the economic recovery is in trouble. First of all, we know that China is already pulling in the reins. We know that employment statistics here in the U.S. have been disappointing, certainly below consensus expectations. If you look at manufacturing orders, they've been weak. I could go down a list of things where the economy's performance is not up to the very rosy expectations that you hear from the consensus.

Why is this important? Why it's important is that the political establishment in Washington will have no tolerance for an economic slowdown. That will lead to even more money printing than we saw on the previous page. And that, again, is very bullish for gold.

I would say that this is probably the most important chart in my section of the presentation. The economy is headed for a slowdown. A slowdown means tax receipts to the government start to weaken, deficits start to widen, and certainly a very good chance if this turns into a recession, that panic sets in in the political class in Washington, and we'll see all kinds of new initiatives to boost the economy.

If that scenario is correct, gold should make a new high, which, as you may recall, last year, touched $2,069. And my bet is if this scenario turns out to be correct and the macro consensus is as wrong as I think it is, gold will set new highs by maybe a significant amount. That, of course, will be very good for our investment strategy, which is to invest in gold mining stocks.

I'm going to turn it over now to Doug, who will talk about the whys and the wherefores of how attractive gold mining stocks are today in this current context. That's it for me. Take over, please, Doug.

Ed Coyne: Slide 11

Thank you, John. Doug, before you go into that. To John's point, I think you make some great points about the physical market. Doug, I think you've been around a long time looking at these individual companies, walk us through some of the charts that you like that really highlight what's really going on in the gold equity story today because it's been a part of the market that many investors have largely ignored.

With a lot of the points that John just made, the supportive narrative for the physical market, gold equities look more attractive than ever. Spend some time and walk the listeners through that, if you would.

Doug Groh: Slide 12

Okay, thank you. I hope you can all hear me well. What I thought I'd do today is just address a few points with regard to the gold mining sector. First, I'd like to discuss a bit of the structure of the gold mining industry and why that presents a very unique investment opportunity for investors that are looking for exposure to gold that is a little bit unique in that there's various opportunities for value creation.

I'd like to also discuss a little bit about the valuation that the market is currently assigning to the precious metal sector. If we look at the first slide here on page 12, gold supply factors, discovery, and production, you'll observe on the left-hand side there that over the last number of years, we have not seen a lot of gold discoveries. The supply is tight. Gold prices are high for a reason because gold is scarce. It's not easily realized.

Annual production, as much as it's increased over the last decade, is likely to plateau and decline over the next number of years because we have not seen that discovery activity in the sector. I think that's a very important aspect for investors to realize that there's really good support for the price of gold, because gold availability is somewhat limited.

As investors become more enthusiastic about having that exposure to gold, it becomes more challenging to meet that demand. Structurally, there's a very good outlook, I think, for gold over the long term, just from a supply and demand factor perspective.

Doug Groh: Slide 13

If we look at the next slide on page 13 or so, you'll see that the gold miners have really done quite well. Earnings estimates are up significantly over the last three or four years with the rising gold price while the S&P's earnings outlook has diminished, it's beginning to recover. As John just mentioned, it's somewhat of an uncertainty as to how well the economy will do going out into the latter part of this year and next year.

However, for the gold miners who have been very disciplined in the last five, six or seven years in terms of their cost structure and their financial position on their balance sheet, are in an excellent spot to make the most of this current gold price environment. I don't think that's something that investors have really fully recognized.

Doug Groh: Slides 14-15 

If we look at the valuation on page 14, which compares enterprise values EBITDA or the gold mining equities versus the S&P index, you'll see there's quite a gap between how the market values the gold mining sector. It's only applying about a multiple of 6 of enterprise value to EBITDA for the gold mining sector, which is less than half what's being applied to the S&P 500 index.

You can see then that the market is really ignoring and discounting the opportunities that are present in the gold mining space. Yet those opportunities are really not just about making cashflow and finding gold, but about a number of different things.

The sector is very deal-oriented. There's opportunity to create value through transactions, whether it's mergers and acquisitions or whether it's through property sales or some type of deal. Certainly, discovery can be a significant value creator when a company finds gold that can be a tremendous value enhancer for that company and for the industry.

There's a number of different elements here in the sector where there's value creation opportunities beyond just the gold price, whether that is, M&A or improving balance sheets, which we have seen over the last five or six years, or better cashflow, or better earnings, cost cutting initiatives, or expansions of operations where economies of scale can improve the cost profile for a company.

These can be really quite significant and meaningful to the bottom line for a company. If you think about the operational leverage here for the sector, it's really quite unique. If you look at the space and you recognize that the cost of production for an ounce of gold is approximately $1,100, that means right now, that the mining companies are making $750 to $800 an ounce in profit. If the gold price goes up by a hundred dollars from here, that's about a five or six percent move. But the improvement in the margin is a hundred dollars, and that expansion is about a twelve percent improvement in terms of their margin.

There's a unique aspect of leverage here that these companies can realize in a rising gold price environment. Yet the market has not really assigned a valuation that is appropriate for that type of leverage. In addition, I'll mention again, that when we do see profits expand with a higher gold price, we also see asset values improve, the marginal ores that companies have mined in the past become more valuable, and even some of the ores that are not profitable in a higher gold price become valuable and more productive.

There's a number of different aspects I think that investors should recognize from a gold mining stock that can create significant value, not just the move in the gold price, but the increase in the asset value for that company, the potential for economies of scale to improve the cost profile, the potential for deal-making from a better gold price environment, and then the M&A activity.

I mentioned a little bit that the structure of the industry is important earlier. I think it's important to recognize that there are quite a few companies that are very good at exploring and identifying gold deposits. Oftentimes, those companies aren't the best at producing gold. Then there's companies that are good at developing ore deposits, but maybe not good at finding them.

Yet what that presents for the sector is a situation where companies that are exploring and maybe finding gold deposits are getting undervalued relative to the potential of that deposit, where larger companies or developing companies can perhaps add value by acquiring those smaller companies and assuming those operations and creating value by developing the deposits or producing gold from those assets.

There's quite a there's quite an environment of M&A activity here in the space that is very ongoing. We have seen over the last year and a half or two years, some significant M&A transactions. If we go back two years ago or two plus years ago, we saw the combination of Barrick and Newmont to create the Nevada Gold Mines, which was a very significant transaction and merger in the gold mining space.

Then shortly thereafter, we saw Newmont acquire Goldcorp to become the largest gold producer. And since then, we've seen a number of very significant gold transactions through mergers or property deals, where companies have combined their assets to become more efficient in the marketplace, to become more recognized for the scale that they realize, to improve their balance sheet. We're really seeing quite a dynamic environment for deal making and value creation in the space.

Doug Groh: Slide 16

If we look at page 16, undervalued cash flows and inexpensive resource ounces, it recognized that the market is not really giving the valuation it used to give to the sector. That might be for a number of reasons.

If we think about the past 10 years, when the sector was growing and expanding, many of the miners got ahead of themselves in assumed projects that they really could not finance. Their balance sheets got into trouble. They weren't generating the cashflow to pay off that debt. They had to sell assets or they had to restructure accordingly. The market overly discounted the sector in a number of companies. That certainly presents opportunities for investors when there's an over discount.

We've seen somewhat of a disregard for discovery and the assets in the ground, where some years ago, we would recognize that companies would get very good value for their assets in the ground. But now, the market is really not giving a full valuation that is warranted for ore deposits.

I think it's important to recognize that once a discovery is made, it can take quite a while before that discovery is generating cash flow as a producing asset. There's a number of things that have to occur.

A company has to define the deposit. It has to develop the deposit. It has to get the permits and the social license to operate that deposit. It has to go through the engineering plans and scale up to an operation. This can take a number of years. It's not unusual to see a five to seven-year runway from discovery to development and production before cash flow is generated.

As much as that earlier slide showed discoveries are down, we can very much, with certainty, anticipate that production is not going to increase significantly in the years ahead. In fact, it's more likely to trend downward. That I think is a very fundamental and important element for investors to recognize that prices should be more stable than perhaps the market fears because not easy, as I say, to bring on a gold mine.

Doug Groh: Slides 17-18

Turning over to the valuation gap in senior versus junior gold miners, again, it emphasizes the opportunities in the space for realizing value. The senior producers get a much better valuation than the junior producers for a number of reasons. The larger cap companies are perhaps more recognized. There's more liquidity in the marketplace to gain exposure to the larger cap names. Their balance sheets might be more robust. They might have a number of different operations, so their risk profile is a little bit different.

Whereas the junior or smaller mining companies, perhaps their operations are smaller. Perhaps they don't really have as many alternatives to generate cash flow. They don't operate three or four mines. Maybe they operate only one or two mines. Their balance sheets may be a little bit more tentative because they only operate one or two mines.

The valuation gap that is presented certainly gives an opportunity for the seniors to acquire the juniors in order to build out their profile, the senior profile, in order to replace the resources that the seniors are realizing. I think that's an important element.

We see that on a constant basis, where a larger company with a better valuation is acquiring a smaller company or maybe an attractive company with a lower valuation. Very important for investors to recognize that dynamic. Oftentimes, people think you invest in gold mining stocks for the price leverage.

While that is certainly part of it, I think for us at Sprott, it's only really one aspect. Where we try to add value at Sprott, is to look at those companies that are not just creating value from the operating leverage, but that have other levers of value creation, whether that is discovery or whether that is an M&A transaction that's important or very attractive. Perhaps it's the balance sheet, where at this gold price, the debt levels on these companies' balance sheets are shrinking very quickly.

In fact, there's a number of companies that are in a net cash position relative to their debts, which is really unusual for our space. Whereas 10 years ago, as I mentioned earlier, these companies were struggling with their plans to provide enough capital to build out their operations. Now, there's a flood of capital that's coming in. Cash flow is really quite strong, where we see a different dynamic in the sector, which I think is also underappreciated by investors.

That is that these companies are issuing dividends and they're very attractive dividends. The yields on some of these companies are one and a half or two percent, three percent, or more. The free cash flow from these companies has been on the rise and should continue to rise as the debt levels come down, as profit margins continue to improve from the scale that these companies are realizing. We're really in a very intriguing dynamic for the sector.

In addition to the dividends that are being issued, a number of companies are buying back their stock, which again, for a capital intensive sector is very unique, and I think very much underappreciated. It's not unusual to see a company announce a share buyback program for a year or so.

I think that is something that should continue at these precious metal prices, which I think we're arguing are sustainable for some period of time. In fact, I think in the coming year, the gold mining sector could be looked at as really an important income and dividend-generating sector for the overall market. It's perhaps not out of the realm to think of these companies being similar to the South African producers of 25 or 30 years ago, 40 years ago that were noted for their dividend.

The sectors become much more disciplined, much more focused than it was 10 years ago in terms of allocating its capital and in terms of generating a return on the investors. We have been involved in the precious metal investing space for some time, and we have driven that message home to mining companies that they have to return something to shareholders if they want an attractive valuation. Mining companies are getting that message, and they are delivering with dividends, with share buybacks, with better balance sheets, with better capital allocation, which really is not appreciated at all by the marketplace.

I think in time that will be recognized. I think the current environment certainly presents a great opportunity as cashflows are rising, balance sheets are in good shape and valuations are compelling.

Ed Coyne: Slide 19

Thank you, Doug. I think one of the charts that I really like, and I think it's worth spending a few more minutes talking about, is what's different in 2010 and 2011 versus 2019 and 2020 on page 18, which we talk about the M&A cycles underway.

When the large-caps were merging the last couple of years, it was mostly at fair market value. As we see more opportunity in the junior miners, the potential premium for those to draw upon looks quite exciting or quite interesting. Could you spend a few minutes just talking about this page in a little more detail of what looks different today in the M&A cycle versus the last big M&A cycle we saw back in '10 and '11?

Doug Groh: Slide 18

Right. Well, I think 10 years ago, companies were trying to do buildouts or acquisitions for the sake of growth. That was the overarching theme. Companies just wanted to grow. Now they recognize that growth for growth's sake is not really well appreciated, that it has to be quality growth, that it has to be disciplined growth, that it has to be focused growth, that is going to add to the enterprise and to the corporate structure.

Part of that is a dynamic in the world, where there's greater geopolitical risk than 10 or 15 years ago. Companies are not just looking for gold wherever it is found, but they're looking for gold where they can mine it, where they can operate, where they can carry on business. There are parts of the world that have become more restrictive in terms of operations.

That might include either the laws, or royalties, or taxes, or infrastructure. Companies with better discipline with regard to their capital are recognizing that infrastructure is important. The tax regime is important. The royalties that might be payable can inhibit the value.


So there's a better approach to seeking out an attractive acquisition and not to do it just for the sake of growth, but also the values have to be compelling as well, and as demonstrated on one of the slides, there is quite a gap between the larger companies and the smaller companies. This is something we see on a regular basis, where the larger cap companies are adding value through an acquisition of an undervalued situation.

That undervalued situation might be for a number of reasons, perhaps because the acquired company doesn't have the development capital, or the expertise, or it's not recognized by the market because of the liquidity constraints that might be imposed on a company such as a small-cap company. But the larger cap company can benefit from that type of consolidation.

We see that on an ongoing basis. We've seen it in Western Africa. We see it in Latin America. We see it in Australia. It's really a very exciting dynamic. It makes covering this sector a lot of fun because there are a number of tweaks and twists and turns that do occur where value can present itself, and investors can capture that value if they're diligent and observant about the dynamics of the industry.

Ed Coyne: Slide 19

It seems like today, the gold equity space is like the ultimate value allocation, whether you're talking about increasing cash flow, or decreasing debt, or increasing dividends, or one-time dividends, or dividend payout policies. As a value investor out there looking to allocate capital, certainly gold miners shouldn't be overlooked, particularly as you talk about from an M&A standpoint.

Thank you for those comments, Doug. I think there are some very insightful points in there about not only the physical gold side from John, but a lot of the points you just made on the gold equity side. We encourage everyone on this call to reach out to us to learn more about how we can advise you on the gold equity space.

Before we go to Q&A, I do want to spend a few minutes talking about the allocation in general. So often, we do these calls, and then ultimately, people call us or investors call to say, "now what do I do? How do I actually allocate to this, or why should I bother allocating to it?" I hear what you're saying, but what's the point behind it?

Ed Coyne: Slide 20

Now on page 20, we just like to remind people first and foremost that gold can and has provided portfolio protection over multiple market cycles or multiple market disruptions. If you go back to the global financial crisis, even before that, you can go back to the tech bubble burst.

Multiple times, gold has stood the test of time, and it's zigged when the overall market has zagged. Even when the Fed attempted to tighten in 2015 and '16, as people explore the reasoning behind that tightening, gold did well in that environment. Then, obviously, we all remember this time last year, when no one knew what the future was going to look like with the pandemic, gold once again held its head quite high.

It's an important chart, that coupled with a chart that John Hathaway talked about at the start of the presentation of over two decades of strong performance and gold ability to protect the portfolio over time, it's not enough to think about gold as a way to grow wealth, but it's really there to protect your wealth. It's really about asset and capital preservation more than anything else. The gold equities, I think, are something that's opportunistic and we think today that environment looks very attractive.

Ed Coyne: Slide 21

On page 21, I think from a portfolio asset standpoint, the reason why gold has done so well over multiple market cycles is really pretty direct. It's low historic correlation to traditional investments, whether you're talking about U.S. equities, cash, real estate, even fixed income with rates as low as they are, it's really a bond surrogate to the current market today. In some parts of the world, it's a replacement or a complement to cash.

We're seeing gold on the physical side start to go into investors' portfolios in the way that we haven't seen in the past. From an opportunistic standpoint, we're finding the gold equity story to look more and more attractive.

Ed Coyne: Slide 22

On page 22, it just really speaks to the volatility component or the reduction of volatility. A simple allocation of five or ten percent not only enhances your overall total return of your portfolio, but it reduces your overall volatility, which is really the name of the game, staying invested over multiple market cycles.

Ed Coyne: Slides 23-24 

Gold and gold equities are not designed to replace your current assets. They're designed to allow you to stay invested in your current assets by owning a portion of the market that has a history of diversifying your portfolio over time. Simply put, on that allocation, that risk reduction drops by about 15 percent when you look on page 23 of a five to 10 percent allocation to gold in a traditional 60/40 portfolio.

The part of the market that I think we don't always talk about, but we're talking about very opportunistically today, is the gold equity allocation. We always say physical first and that goal is designed to protect your portfolio. But once you own that physical, how else can you take advantage of the space? We believe in this current environment, the equity story looks incredibly attractive.

In a simple balanced model of 50/50 of your allocation in gold, if half was in physical and half was in equity, you would have over found multiple market cycles, multiple rallies, gold has enhanced your overall return within the sector.

Ed Coyne: Slides 25-27

At Sprott, we do offer a full suite of solutions. And we encourage you to reach out to our sales desk. At the back of the presentation, we'll find our full map of national and regional coverage, whether it's Matt Harrison on the West Coast, Julia Hathaway in the Central Region, or Sergio Lujan on the East Coast. We offer full support within the marketplace, and we encourage you to reach out to our respective senior investment consultants on how to think about the gold equity trade today, whether it's physical, equity, or debt, or a combination of all three.

With that, I'd like to turn it back to Natalie and we will go through some of the questions that have been coming in during the call, as well as a few questions that came in during registration.

Natalie Noel: Slide 28

Great. Thank you all for such an informative presentation. Just 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 reach out 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 the request. With that, I'll turn it back to Ed for our first question.

Question and Answer Section

Ed Coyne: Slide 28

Thank you, Natalie. And thank you all for submitting questions either at the time of registration or we've seen quite a few come in during the call itself. The first question is, given 50 years of experience, John Hathaway, I think this is a perfect kickoff question for you in the audience, and it has to do with cryptocurrencies.

The question is: has the universe of buyers for gold been reduced by the presence of cryptocurrencies as an alternative to fiat currencies or just as an alternative in general? What's your view on that, John?

John Hathaway Q&A

Well, I started doing this when I was thirty years old. That's how I have 50 years of experience. Crypto. There's no question that it has taken the oxygen out of the room for gold. I've talked with a number of people about it. I would say that without crypto, maybe the gold price would be a hundred, $200 higher than it is right now. Crypto is a force to be reckoned with.

I would also say this about it, that governments hate it. I know El Salvador might be the exception, but China and the U.S. don't want cryptos like Bitcoin to gain wide usage because it undercuts tax revenue. The established governments don't like it and they will be offering digital currencies of their own. It's already happening in China. The Fed is talking about it, so we'll have digital currencies around the corner.

The reason for that is it gives governments greater control. I should just take this opportunity to compare what gold offers versus crypto. Gold is a real asset. It does not depend on the Internet to transact or to protect capital. It's much more anonymous than crypto, and it's real property. It's a tangible asset.

Gold has many aspects to it that are, to me, advantageous vis-à-vis crypto. The one thing the crypto crowd has gotten right is that paper currency is losing value, and they're totally right about that. I don't dispute the thesis. I just think that gold has advantages when one thinks about protecting wealth and anonymity of that wealth.

I could say a lot more. I'm probably upsetting a lot of people who are Crypto Zealots and I'm not against crypto. I think it has a lot of advantages, but I think gold, for all the reasons I mentioned, is a better way to protect capital than crypto.

Ed Coyne Q&A

Thank you. John. And I have found many of the investors we deal with, particularly the private families, in a lot of cases, they tend to own both. They see the crypto market more as a risk-on allocation and an investment in the future of what may or may not happen. The physical market is more of a risk-off protector of capital allocation.

Many of the private families that we deal with and the advisors that do own both, the reasoning behind them is very different than maybe, say, five or six years ago when the crypto market tried to compare itself to gold. They've really bifurcated as far as how people look at them today. I think that's going to continue.

Doug, this is a good one for you. This is something that I think you touched on quite a bit, but it might be worth repeating. That is you've been doing the gold equity space for quite a while now. When was the last time, if there was the last time, that you saw valuations in gold stocks, the level we're seeing them at today on whether it's a relative basis or an absolute basis. Is there another time that you could draw upon where the environment was similar?

Doug Groh Q&A

No, not at all. That's a good point. I'm glad you brought that up. I have never seen such a favorable environment for the gold mining sector in the 35 years I've been doing this. What's interesting, I think, is that the balance sheets are so much better now. The opportunities, perhaps, are a little bit limited because of the geopolitical risk in the world. I think the process to bring on a mine is so much more complicated than it was years ago.

The opportunity in terms of investing is really fantastic. If you think about the free cash flow yields of about six, seven, eight percent, that was really unheard of in the past. There's really a different environment here. I just go back to those balance sheets. They're so much more favorable than they were in the past.

These companies can now build out their assets from the cash flow they're generating. Years ago, they had to go out and issue equity or they had to raise debt. Today, they don't really have to do that. The valuations for the seniors are attractive enough for them to go out and make meaningful additive acquisitions, which wasn't always the case.

It's really a different world that presents itself. Thus they're able to issue dividends, where years ago, they could not build out their assets and issue dividends at the same time, and buy back stock as they're doing now. Buying back stock was unheard of. This sector has been known for issuing a lot of stock.

With this favorable gold price environment in the last year or two, we're seeing a different trend here. I think investors really haven't caught onto that. There's not a real positive response yet for those dividends and for the share buybacks.

The reason for that, I think, is because there's disbelief that that opportunity can continue. I think investors feel that it's a one-off situation. They're raising dividends now, but that's not going to last. I would beg to differ.

I think with these healthy margins where these companies are generating $800 or so an ounce in profit and their balance sheets are clear, there's no reason why they cannot continue to issue dividends and buy back stock and make acquisitions as well as build out their assets. They're in a very favorable environment right now. It's very Goldilocks for them.

Ed Coyne Q&A

It certainly seems like the investor circle is expanding. Just over the last year or two, even talking with our CEO, Peter Grosskopf, we're seeing more and more institutions unsolicited, frankly, come to us on the physical side. More recently, we're seeing it on even the equity side. I think in a lot of ways, it does feel like it's just getting started from an investor interest standpoint.

John, this is a fun one. I'm going through the questions. I can't help but bring this one up, which might be difficult to answer, but we're clearly pro-gold with three decades of experience in the precious metals space. But what could go wrong with our bullish prognosis right now for gold? In your mind, what would have to happen for us to change our tune on the gold story today?

John Hathaway Q&A

I would say that if we had robust, sustained economic growth, which is what the consensus expects, and if interest rates normalized and real interest rates rose to, let's say, for the sake of argument, two percent, or three percent, which we are nowhere near, I think that would be a big headwind for gold. 

Obviously, I have a different view of where we're headed. The history of government stimulus is that it has never lasted more than one or two quarters. It's basically a tourniquet and the return on investment from government spending is negative.

You could set me off on this. I could talk a long time about it, and I know I don't have that time, but it would be that thing, that something in the form of robust sustained economic growth, a reduction of the government deficit, a reduction of Fed intervention in the capital markets. All of those things, which would totally surprise me, would probably not be good for gold.

Ed Coyne Q&A

Thank you, John. I know we're coming up on the hour at two o'clock, but maybe we'll end with one question that I don't want to go down the conspiracy theory side of it, but this question, I think, is something that's been coming up more recently, particularly with the Reddit crowd, which is talking about physical ownership.

The question reads, what is the ratio, and this could be for John or Doug, and we may not actually know the exact number, but what is the ratio of paper ownership for each physical ounce of gold in existence presently? I think that's a question that we should address. Doug or John, feel free to take a stab at that. I don't think we have the hard number, but we certainly know it's greater than one for sure.

John Hathaway Q&A

Let me take that, Ed, and maybe I'll touch on Basel III while I'm at it.

Some of you may know, but maybe a lot of you don't know is that there are new regulations being imposed by Basel III, which I think behind that is the Bank for International Settlements that would require bullion banks to offset their unallocated gold exposure with very big haircuts to their balance sheet. To make a long story short, Basel III will make it increasingly difficult for bullion banks to trade in the synthetic paper market.

I think the question really originates from that perspective. We know over the years, we've seen huge amounts of so-called gold transact hundreds and hundreds of tons in a short space of time when the people transacting have no physical gold underneath that.

In those cases, the ratio is infinity. I did ask the chief executive of the World Gold Council in a recent phone call if he had any idea what the ratio of synthetic gold or the leverage in derivative transactions to underlying physical was. He didn't know. He said, I just don't know.

It is vast. It is significant. But Basel III,1 I think at the end of the day, it goes into effect in Europe in actually the beginning of July this year and in the UK in January of next year. I think the net effect will be to reduce the supply of paper gold. It's a little bit technical, but I do think it will be a positive for gold prices.

I think investors, to the extent they understand if they have an options position or a futures position or anything that's not physical gold a hundred percent allocated, and they understand that gold provides capital protection over long periods. They will shy away from the synthetic solutions, and they'll look at something like the Sprott Physical Gold Trust. Long with an answer, but I think it was worth spending some time on it.

Ed Coyne Q&A

That's perfect. Thank you, John. I know we're at two o'clock now, so I would just encourage those that have interest in what John and Doug have both said, whether it's the physical market or the equity market or a combination of both, to reach out to your respective senior investment consultant on the West Coast, Central, or Eastern region, and let us help advise you on how to think about the space.

We take great pride in the products we've created over time, and we're very conscientious about what we bring to market. We love to have the opportunity to advise you all on how to think about the trade. And we certainly appreciate your time and interest today. We hope to consider you all clients at some point down the road. Thank you for your interest.


1 Basel III is an internationally agreed set of measures developed by the Basel Committee on Banking Supervision in response to the financial crisis of 2007-09. The measures aim to strengthen the regulation, supervision and risk management of banks.

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