Canada’s biggest bear: Eric Sprott on why “Silver is the investment of this decade”

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Fear is once again gripping financial markets around the globe. When this last happened a mere three years ago, investors poured money into government bond markets to protect their assets from the risks of stocks and other investments.  This time it is precisely these same government bond markets that are at the root of the next crisis.

When European and American banks were on the brink of collapse in 2008, governments swooped in to inject capital into the banks to steady the system.

While saving the banks for the time being, what they ended up doing was effectively transferring the issue from the banking sector to the public sector. With these debts piling up and economic growth stuck at a standstill, investors are now pressuring these governments to get their financial house back in order as they fear these debts cannot be repaid. With stocks remaining volatile and government bonds now being perceived as more risky, investors are seeking safe havens for their capital that are immune from these issues.

Eric Sprott, Chairman, Founder and Senior Portfolio Manager at Sprott Asset Management, has been warning about these development for years, and has been strategically positioning his clients in precious metals, most recently silver. “The ultimate destiny for gold and silver is that people will prefer to own those investments rather than have money in the bank,” said Sprott on Financial Sense Newshour on October 19. “And there’s a lot of money in banks.  People don’t yet perceive that gold and silver are the superior investment, but in my mind they are.  Because when you have money in the bank, there is tremendous counterparty risk.”

Counterparty Risk

Counterparty risk refers to the inherent quality in most financial assets that one person’s asset is another person’s liability.  This concept is most easily understood when looking at a bond. To an investor, a bond is an asset, a right to receive a steady stream of payments followed by a lump-sum repayment of the initial principal. The other side of that coin, however, is that that same bond is a liability to the initial borrower. So the investor in a bond takes on counterparty risk, or the risk that the borrower will be unable to pay. While almost all financial assets require the investor to assume some type of counterparty risk, precious metals are unique in that they are no one’s liabilities—and this is a key aspect of why Sprott sees them as such an appealing investment.

In a stable economic environment, this counterparty risk is accepted and factored into asset prices.  The problem arises when investors fear wholesale issues with the financial system—and this is precisely what keeps Sprott awake at night.

Dominoes

When asked whether he fears a tipping point he replied candidly, “Totally. I worry about it happening. In fact I would expect it. Let’s make it more serious than that. I believe the whole financial system is at imminent risk of collapse. Imminent. And that is why [the authorities] always have to make sure nobody fails.

Recently there was a run on [Greek banks] and because they didn’t want a bank run to actually happen, the four other major Greek banks lent them $500 million. They didn’t want pictures of a bank run on the news. Most people forget that the financial system was within hours of collapsing in September of 2008.

It’s well documented. We have been close before and we just transferred the risk. The sovereigns’ have taken on the risks of the banking system.”

With such a dire view of the financial system, it is no wonder that Sprott invests in the traditional safe haven of precious metals. What is somewhat surprising is that he has focused lately on silver as opposed to the traditional precious metal investment, gold.

Sprott goes on to explain why he currently favours silver by using the following illustration.

“I use various proxies to show how people are thinking about silver—most obvious is the monthly data that comes out of the U.S. Mint,” says Sprott. “The most shocking part is for every dollar that goes into gold, there is a dollar that goes into silver. With the price ratio between gold and silver being over 50 to 1, that means 50 times more silver is being sold by the U.S. Mint than gold.”

“When we did our initial public offering (IPO) for the Sprott Physical Gold Trust (an exchange-traded fund   that invests exclusively in gold bullion, TSX symbol PHY.U), we raised $440 million; when we did the IPO for the Sprott Physical Silver Trust (an exchange-traded fund that invests exclusively in silver bullion, TSX symbol  PHS.U), we raised $550 million. This is the market talking and what it is saying is people are prepared to buy as many dollars of silver as they are gold. But the availability of silver to buy in the world in relationship to the availability of gold to buy is in a ratio of 1:100, but they are buying on an 1:1 basis, which would suggest that silver will be way more explosive than gold, unless of course that changes dramatically.”

What this tells us is that investment dollars are pouring into silver at a much faster pace, in terms of the investable supply, than they are in gold. This would suggest that the percentage increase in the price of silver should be greater than that of gold. “That is my reason for liking silver over gold. Any article you read, you read about the pent up demand for silver in China and India, you see it happening.”

Analysts have been waving the flag over silver for months now. To those who think it may be too late to get into, Sprott says that is a wrong conclusion. “The reason is that what has happened here in the last 11 years is that the market has decided that (precious metals) are now the reserve currency. The market has made that decision and it just gets manifested more every year and we keep forcing people to come to this conclusion by all the idiocy of central banks and governments.”

Sprott goes on to list the litany of unconventional policy actions that have been taken in recent time to keep the system running, “You have your TARPS, quantitative easing 1 (QE1) and  QE2, bailouts, conservatorships; the printing of money has become so extreme that the average guy is getting it. The amount of money in circulation is skyrocketing and the only thing standing behind a currency is the promise of governments which I find a very incongruous statement.

Between the debts that governments run up, the printing of paper that the central banks do, it becomes more and more obvious to a growing group of people that currencies are in trouble.

David Franklin, CEO of Sprott Private Wealth, works closely with Eric and also believes in the prospects for silver, though his views on the global economic situation are slightly less dire than his boss’.

“Precious metals are reacting as they should to the chaos around us,” says Franklin. He points out that negative real interest rates also creates a silver-friendly market. “We see that loudly today at the headline rate of inflation in Canada, most of the Canadian bond curve is negative, meaning you are losing money every time you buy a Canadian bond because you are not making enough interest to cover the cost of inflation.”

Negative real interest rates force people to go out and speculate and find other ways to preserve capital, and the go-to assets in a negative real interest rate environment are hard assets; gold and silver particularly. “So there is no better environment right now for gold and silver as ways to preserve capital. The U.S.

Federal Reserve has said we are not going to raise interest rates for the next two years which pretty much guarantees negative real interest rates for investors.

Gold is going to be the thing to own for the next couple of years, for no other reason than that.”

And what is good for gold is better for silver.

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