A Different World Coming for Monetary Policy, Gold and Silver - Monthly Wrap Up
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It’s been a doozy of a month: Gold went straight down the elevator shaft five weeks in a row after an Easter bounce, while silver continued its sideways ten-year run. Will things turn around in June? Host Craig Hemke sits down with Tavi Costa of Crescat Capital to break down the month’s gold and silver news.
In this edition of The Monthly Wrap-Up, you’ll hear:
- How to factor in inflation when considering mining companies
- Why maximum pain may come ahead of another Powell Pivot
- Plus: when will the worst be over for metals?
“As you said, it’s been kind of chaotic with what’s happening with the markets as a whole. I would say that there’s some sort of liquidation that happened in the markets, with even more of the unfolding of the problems that we’ve seen with long-duration assets and technology companies and really the capital outflows from things that have been crowded over the years to things that are really unloved, which are, in my view, tangible assets. And so that rotation continues to happen, but recently the steep decline in equity markets caused some liquidation in some folks and other portfolios, and I think there’s a lot going on under the hood in markets.” - Tavi Costa (May Monthly Wrap Up)
To hear Tavi’s full thoughts on this month’s gold and silver news, listen here:
Announcer: You're listening to "Sprott Money Monthly Wrap Up" with Craig Hemke.
Craig: Well, hello again, from Sprott Money News and sprottmoney.com. It's late May 2022, so it's time for your monthly wrap-up. I'm your host Craig Hemke and joining us this month is Tavi Costa. Tavi an old friend of ours who is a partner and portfolio manager with Crescat Capital in Denver. It's gonna be great to get his input and all that has taken place this month to begin to look ahead to June.
Before we get there, though, please remember that this content is brought to you by sprottmoney.com. Anytime you're in the market for physical precious metal or looking for a place to store it, sprottmoney.com needs to be your number one go-to site. All kinds of great deals, always competitive pricing, sprottmoney.com, or you can call them at 888-861-0775. Okay, let's get this underway. Tavi, thank you for spending a few minutes with me.
Tavi: Hey, Craig, thanks for having me again. Looking forward to this.
Craig: This has been a doozy though of a month Tavi. So, I gotta get your thoughts, first and foremost, on what we've dealt with over the last, oh really, five or six weeks now, I think it was the Monday after Easter, that gold briefly trade above 2,000 and silver traded up near 27, and then it was straight down the elevator shaft for about five weeks in a row. What do you make of that and you might just throw in about, you know, from a macro sense, what your firm makes of all that?
Tavi: Yeah, as you said, it's been kind of chaotic with what's happening with the markets as a whole. I would say that there's some sort of liquidation that happened in the markets with even more of the unfolding of these problems that we've seen with long-duration assets and technology companies, and really the capital outflows from things that have been crowded over the years to things that are really unloved, which are, in my view, tangible assets. And so that rotation continues to happen but recently, the steep decline in equity markets caused some liquidation in some folks and other portfolios, and I think there's a lot going on under the hood in markets.
Crypto assets have really plunged in the last week or so. We've had a few cryptocurrencies actually going to zero, which is a little bit of a reminder of risk in management in general for some folks. But, you know, it's a good reminder of when cost of capital rises, you know, folks have to do fundamental analysis. You know, we're back to that, which we saw that back in the 90s, maybe mid-2000s and I think most market participants have forgotten how to behave in this environment, but profitability is back.
And Craig, if you look at the markets right now, the sector that is really lagging is not even technology, we saw that technology lagging period, all the way back to 2021 February. And now I think what's really laggy is actually a consumer discretionary, guess why? Because the squeeze of margins is real, and those are the businesses to have some of the lowest margins in the whole overall market right now. And so, we're seeing profitability becoming a priority again as we thought it would. And so, therefore, we're seeing some of those companies with very lean margins heavy having issues now.
Craig: Well, let's talk about that as it relates to the mining sector Tavi, about margins getting squeezed with input costs for miners going up so much in diesel fuel, you know, energy and the rest. And a lot of the majors pointing that out with their last round of earnings results talking about, "Oh, man, all and sustaining costs are going up, and we're getting squeezed and all these different directions." You've been a big proponent of the shares and how they're finally spitting off free cash flow that sort of thing. How aggressively do you factor in inflation, that sort of thing, and how you guys evaluate mining companies that you want to invest in?
Tavi: Yeah, some of the producers certainly have been impacted negatively with their margins too, but I would say at least their products and what the underlying commodity that they sell is moving in the right direction, even though gold and silver may not be going up as much as we thought it would, at least, it's not going down like technology stocks are in the last few months and so. I think there's more of intellectual arbitrage when you think about what's happening in commodities just for the fact that there's a lack of knowledge in the space creating a lot of inefficiencies.
When you look at the free cash flow in aggregate for the miners, it's quite interesting. There is a little bit of divergence with where gold prices are versus where free cash flow is, meaning free cash flow is not following as strong as actually gold prices are when you look on a monthly basis or quarterly basis. However, it's not really as significant as you're seeing in other parts of the market. And so, that should still... I think the overall equity market will suffer including mining stocks when it comes to margins, but I think that the mining space is certainly should be favored considering the fact that we're holding tangible assets, and the issues on supply should continue to lead to higher prices of those businesses.
And so, you know, it's been a lot of negative... with pessimism in general for the industry. But I don't think things have really changed as far as the thesis remains as strong as it gets. And I think investors it's a time to get busy and accumulate assets as much as you can in the space, that's my view, at least. But I think fundamentals continue to look really strong, energy companies, free cash flow yields for energy companies, despite the recent appreciation in price of those stocks look really, really strong.
I mean, it's probably one of the strongest free cash flow yields we've seen in history. And so, commodities still look very attractive and I think that's a real trend. I posted a chart recently of commodities versus NASDAQ. And NASDAQ is now decoupling from commodities or commodities are decoupling from NASDAQ, where NASDAQ is starting to fall as commodities are up almost 180% all the way back to the pre-highs of the pandemic on February 19. And you're looking at NASDAQ now, you know, there's a separation of over 50 percentage points between the two asset classes. And so quite interesting what's going on.
Craig: Yeah, you mentioned commodities, Tavi and so many base metals have had such a strong 18 to 24 months. Silver really hasn't, you know, and I know that weighs on a lot of silver investors' minds because it's been a really sideways 10 years, I guess at this point. I did a thing, one of the features that we do every month here at Sprott Money is ask the expert, and the expert here in May from a couple of weeks ago was Frank Giustra.
And one of the questions somebody had sent in for Frank, I think... just maybe prompted this in my head that I'd asked you this too because the question that was for Frank was, you know, if silver can't keep up with inflation, then how can silver mining companies expect to perform long term? You know, if they're constantly getting squeezed on their margins, if their output... if what they produce isn't keeping up with inflation, then their costs are just going to keep rising faster than their product?
What do you think of that? I mean, do we need... obviously higher metal prices or is going to help? But is that particular in the commodity story that, you know, since silver's performed so poorly for years that maybe other more base metal mining or gold metal mining is a better place to look?
Tavi: Well, it's an interesting question, because it's a self-fulfilling prophecy at the same time, as monetary conditions tighten here, it should also hurt a lot of the producers to continue to produce. And so, at some point, it should lead to even lower supply and more constrained supply, that should increase the pressure towards the appreciation of those commodities. I mean, I've been also very surprised with the price of silver, but I should point out that the goal for an investor is to identify long-term trends and accumulate assets prior to the move.
And what I think it's interesting here is, we've had the same case for energy, let's say, you know, if you look at oil, for instance, back in 2020, the case for oil was just as strong as the case for silver is today. The thing is, there was a trigger at that time, many triggers, some of them, the Green Revolution started to really move forward and we had the election, which shifted leadership in the U.S.. And we had the oil prices going negative, and some companies went bankrupt during that time.
And so, there was some sort of trigger that caused the beginning of a bull market for oil. I don't know, you know, as an investor, it's just very, very difficult and challenging to have that crystal ball to figure out what the trigger is. I have some ideas what it could be, it could be yield curve control, it could be a reversal of the Fed policy, I mean, it could be so many things. Now, what I do think is, is it's going to look obvious when silver, in my view, gets up to, let's say $50 an ounce or so. I think a lot of people will look back and say, "Yeah, that was very obvious that this was a very strong case, and you should be buying it."
But unfortunately, markets don't behave that way. They stay rational for sometimes longer than it deserves. And perhaps, a lot of market participants end up not really finding those inefficiencies as opportunities. And so, you know, as I said, our goal is to get as close as we can to identifying those long-term trends. And I think we identified one here, maybe it's monetary asset at a time of inflation, when I think over history, certainly it's behaved very well. It's certainly serve as a hedge to inflation and perform better than gold during those times too. Gold to silver ratio looks extremely attractive for silver right now.
We know the supply side is very constrained and mostly comes from countries that have a lot of geopolitical issues. And so, it's historically undervalued relative to equities in gold, as I said before, the monetary base relative to other commodities, and so, the case is very, very strong. The Capex for the silver miners have been dismal over the years, you look at the discoveries of silver has been very low also. And so, we aggregate the whole thesis, it looks really attractive. Who knows what the trigger is going to be. But I think as an investor, you want to be a buyer not staying in the sidelines.
Craig: Do you think, I guess I do, that we're headed toward what I call Powell Pivot number two, being a Powell Pivot number one was when the equity markets crashed about 20% in the fourth quarter of '18, all of a sudden, they went from tightening to loosening. Will it take a kind of a Max Payne environment, again, for equity investors to get to Powell Pivot two?
Tavi: I think it's going to take a little more Payne. I think it's interesting what's going on because, you know, we're looking kind of backwards on things, particularly the Federal Reserve, and you think about just in terms of earnings, you know, earnings are at peak right now. But are they really, you know, realistically, in the next six months, I don't think you're going to be at peak at all, I think you're going to be much lower.
We're seeing margin squeezes everywhere as I was referred to before. Labor markets, now, what does it mean that technology companies are behaving very poorly in the last month or so? I mean, technology is a major part of the economy today, it's also a major part of labor. So, what does it mean to unemployment rates in the near future? So I think there are a lot of questions when it comes to the macro data that's going to be coming out in the next six to nine months, that we could be, you know, very well, in a recession already.
I'm in that camp, but you know, the Fed is always late to the party, it might tighten monetary conditions even further. Some folks are worried that this is going to hit the commodities market, if it does, what an opportunity. But in my view, the availability of capital is one of the most important themes here, and that is going away. That availability, the excessive liquidity that we've had in over the years.
And the lack of discipline, it's almost like we have to go a little bit to a more disciplined world, very different than we've seen, the progressively more aggressive monetary fiscal policy over the last 20 to 30 years. And so it's, you know, I personally think at some point, we'll see 10-year yields is starting to bother some of the Fed members, and we may see some sort of yield curve control, or at least an attempt to that, and I've been in that camp. But I think we're gonna see more Payne in equity markets before the Fed really reverses its policy.
Craig: Well, let's finish with that question. And I guess, Tavi, as we look ahead now to June, May obviously was a pretty challenging month, you had the May FOMC meeting about three weeks ago, that kind of laid out this course of 50 basis points for the next several meetings in a row. What will you look for do you think to sense that, "Okay, the worst is over at least for the metals or will it be a turn in the bond market, turn to the dollar index economic data?" What will you be watching here in the month of June to kind of give you a feel that things are turning for us?
Tavi: Well, look, the short answer is I don't have that clarity as much as I wish I had. But one thing I am looking at and I never stopped looking at is if the macro thesis continues to be strong and if I continue to identify the long-term trends are still as appealing as they were before. I think there's a lot of mining companies that kind of missed their window to raise capital. And so you've had companies now having to raise money at a much lower valuation, which in the market is not going to trade well in most of those companies.
And so, it's a great opportunity to find great assets. For a company that still hold great assets, they just missed the window to raise capital. And so, as an investor, I think you should be taking advantage of those opportunities going forward. As far as any market signal, look, some of the signals that I think are important is that we just had one of the largest tax revenues in history of the U.S. in the last 12 months. And mostly that has to do with what the government was handing out of cash to the population and basically, everything went up, and we saw debasement of the currency in 2021, relative to other assets, and then folks had to pay some of their share in terms of taxes.
So, majority of that came from individual taxes here. And so, I think you got to be watching for what's the next development, and the next development is going to be fiscal spending. And fiscal spending is really, really strong more than we've seen any other time outside of recessionary periods. Even adjusted for inflation, what we're spending when it comes to fiscal stimulus is absurd. And that to me, is that fiscal and monetary disorder is what leads to folks starting to buy monetary metals and over time, and so now, that's what I'm paying very close attention to.
I think that any reversal in policymaking, I think would start leading to a potential rising in metal prices. I think the 60, 40 portfolios, and the unwinding of those portfolios and starting to really look into other or new ways of hedging their portfolios, I think gold is going to play a role into that just like other commodities have done recently. And so, yeah, it's hard to pinpoint one or two or three things that can make the shift to a full-blown bull market for precious metals, but the long-term case is really strong. And so, I think investors should just lean on that part of it and really continue to accumulate as much as possible, at least as has been our approach towards this.
Craig: Right. So Tavi, before we go, tell us a little bit about Crescat Capital. I am a happy customer/client. But rather than me do the commercial, can you tell everybody what you guys do out there in Denver.
Tavi: And we are very appreciative of having you as a client, by the way. We manage a global macro hedge fund, which has been doing very well this year, I think we're up about 40%, year to date, loan short, as well as another fund that we manage. The Precious Metals Fund, we launched back in August of 2020. It's done very well since its inception. I believe up about maybe closer to 200% or so since inception. And our goal is really to invest in what we think it's going to be this exploration age, Craig.
I think we're gonna see the comeback of this exploration budget from the majors and other companies in order to replenish their reserves. And I think there's going to be an M&A cycle that we've never seen in the past. I mean, we've seen M&A cycles in the past, but I think this is going to be to a degree that we have not seen over the last few decades. And so, I'm extremely excited, I think you want to own high-quality assets in space and our goal is to lead investors of most of those deals that we believe are going to be at world-class discoveries. Yep.
Craig: All right, and one more thing before we go just the reminder I like to leave everybody with, of course, this content just doesn't appear out from anywhere someone has to sponsor it and your sponsor is Sprott Money. So, I do a couple of things for them, one, at least just give them a like or a subscribe on whatever channel you're listening to this [inaudible 00:19:13.842] or ask the expert segment or their Monthly Precious Metals Projections, all the other great content that Sprott Money puts out.
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But of course, you want to just pick up the phone and give them a call, they'll be happy to help you at 888-861-0775. We've been speaking with Tavi Costa, Portfolio Manager, and Partner at Crescat Capital. Great voice in the precious metals industry and great to get his perspective here in May. Tavi, thank you so much for your time.
Tavi: Thank you, Craig. I appreciate it.
Craig: From all of us here at sprottmoney.com, thank you for listening, we'll have more content for you next month.
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