"Ask The Expert" with Ned Naylor-Leyland

Craig: You're listening to "Ask the Expert" on Sprott Money News.

Craig: Well, greetings from Sprott Money News and sprottmoney.com. It is the month of April 2023. And it's time for your "Ask the Experts" segment. I'm your host Craig Hemke. Joining us this month is my old friend, Ned Naylor-Leyland. Ned runs a precious metals fund for Jupiter Asset Management in London. And I can think of no better expert to discuss the current situation here in April of 2023, than Ned. So, Ned, thank you so much for spending some time with me.

Ned: Always a pleasure. Always a pleasure to be with you, Craig.

Craig: Great to see you, my friend. Hey, and again, before we get started, the standard reminder, don't forget, it is Sprott Money that provides all this content for you through the course of the month. So there's two things you can do, you can like or subscribe to their channel on whichever channel you're watching this stuff or listening to it. You can also just keep them in mind, their business is bullion and bullion storage. So, anytime you're in the market looking to buy the dip, be sure to check their site, sprottmoney.com, or give them a call, 888-861-0775. Ned, I don't know if I butchered your actual title and job description. So, let's start there. Tell everybody a little bit about what you do on a daily basis.

Ned: Sure. So, I manage a fund investing in bullion and the miners, but in a more of a...we like to think a more qualitative way than versus being benchmarked. So it's kind of quite narrow in terms of what we will and we won't do. But having said that, like I say, we do work both gold miners and silver miners that bullion, which is a little different than other people. But I would say that a good proportion of my job is still education, trying to get other professional investors comfortable with the framing of an investment into monetary metals, and why it matters and what the relevance of it is, at the moment, probably we'll carry on having to do a lot of that. But, you know, as you know, I do enjoy that. So, it's fun to get out there and meet, you know, professionals and pitch.

Craig: Ned, I find that most interesting because basically what you do for a living is what I do in my investing life, and what probably many people that are watching us do, they own bullion, and they own the mining shares, you get to do that for a living. And so, since you're watching this every day, that's why I value your opinion, so much. And at a time like this, it's great to check in with you.

I wanna start... We've been collecting questions, and they've kind of fall into three categories. So, I wanna start with the first category today. And that's just kind of the broad monetary policy category. We're all expecting at some point the Fed to stop hiking rates, pause, but actually start cutting them as Fed Funds Futures are pricing in rate cuts before the end of the year, the Fed themselves has analysts that are predicting a recession. But metals prices have rallied, gold's up 7% or 8% year to date, but not yet breaking out. Where do you think we are in terms of that monetary policy cycle, and what will you be looking for for some type of breakout?

Ned: Well, look, I think that what of course is so interesting about where we are at the moment and why it won't be right to be quite excited about the rest of the year, is that normally financial conditions are tightened through guidance and policy, rather than through a banking crisis. Now, when they're tightened through guidance and policy, as you and I have discussed many times, what that creates is a positive real interest rate environment, and that drives our sector down.

So, generally what happens is you get the tightening through policy and guidance and real rates, and then they loosen and then we go back up again. What's happened this time, of course, is that we're near the all-time high. And financial conditions have tightened dramatically through the function of what's going on under the bonnet in the financial system. So, we haven't been whacked before conditions are loosened. Well, that leaves us in a very interesting position because we're very near that breakout zone. And what's more, actually, in addition to that we have no participation at all, so no one's interested or doing anything, which is incredible, really, and it's very, very good news, actually for all of us if that's the case because we're not facing an exhaustion of the trade, you know, we're not at a point where people have all done it and it's time for them to come out.

Now, as for what will pick us through that level, well, there are lots of different potential answers to it, but it's weird, we seem to be in a position now where before, whatever the data was and whatever the guidance was, and whatever the market condition was for 12, 18 months, it was considered to be hawkish, and so it was bad for gold and silver. It feels now it's flipped, no matter what is said, or what the data is now, the sense of the market is that it's dovish, the market wants to see everything as dovish now, the same way last year, it wanted to see everything as hawkish. And that of course, is good for us rather than bad for us from last year.

I don't know what the exact trigger will be to push us through this level, I do think we need one, because it's a 50-year technical pattern as you know, so in order to get through that, you would say that get the dollar gold price to 2100, which for me is the key level, you know, you can make the argument is 2070, or whatever, but, you know, you wanna get through it properly on a weekly close through 2100. And that will set up a whole different market environment, in my opinion.

I think we do need one more catalyst. And I think I would put those, as you said, three buckets, I'll put those into three buckets. One is data, the other is the real economy, and the third is the most important one, which I'll save up for a second. So, data, I just don't buy it, I've said for 12 months, I don't think the data will show up. We won't get a pivot by data, data has been managed optimistically for so long, that making it look bad, it's just seems so unlikely, you know, I just don't buy that we'll get bad enough data to drive a genuine pivot through Fed guidance and policy.

The real economy, you know, loosely if we describe that as being about, you know, bank and general corporate earnings, again, I'm dubious that we'll see sufficient weakness there to deliver them a greater pivot in the bond market to drive us through 2100. That leaves the third bucket, which is the plumbing. And that's where the whole thing has come from in the last two months, the plumbing of the financial system was always gonna be where the problem showed up on where the pivot appeared from. That has been the case so far this year. I tend to think it will probably be through that again. So, something the continuation of what really started with gilts, and then we saw swap lines, and then we saw SVB and Credit Suisse.

And, you know, all of this, i.e., just to explain what I mean, you know, you have the surface of the financial system, but then all the plumbing is the stuff underneath that you don't see, and much of that is to do with derivatives, of that mainly is to do with derivatives. And that shows up as news flow, you know, they're event-driven news flow through the plumbing. I think we probably will see something from there over the next quarter, which would push us through that key level. I am dubious we'll get through it until we see something like that, though, because it's such an important level.

Craig: And you work with a firm full of people that they're like normal people, right? They're not you and me, always enthusiastic about the precious metals. And, you know, I see stuff on Twitter, and granted, this is anecdotal, but people are trying to make the case that somehow gold is gonna go down now because all the gold investors are all excited and sentiment is frothy. But I'm sure you've noticed in your conversations with your co-workers, their sentiment toward gold probably is far from frothy. What will it take in your mind, to start getting that, I will loosely call them generalist, point of view to be more bullish on gold?

Ned: Well, it's interesting. So, I would say that the professional investors that I work alongside, they are way more invested in our sector than you realize. So, in other words, they do at the margin, not all of them, but a lot of them do get it and they have way bigger positions PA in their own account than you would see in the rest of the financial industry, so IE3 clients. So, you know, you speak to my peers, a lot of them do get it and we'll have reasonable allocations, and some of them quite big ones. So, a lot of them do see it, versus the overall capital pie that's a tiny, tiny, tiny, tiny amount. So, symptom-wise there I see a shift, and I think that they're definitely interested and excited.

But to get the generalists involved, and I've had a bunch of meetings lately where people are saying, "Look, we see this, but we've got people within our decision-making process who don't like the asset class, don't agree with it, they don't wanna do it, you know, how do I get them over the line?" And so I'd answer your question by saying what I said to them, which is, "I wouldn't bother. Just don't even try." Because the thing is, we're so close here to the breakout. And as soon as we break out, they're all gonna wanna know about it anyway.

So, you know, the problem is here is chicken and egg, and it's that phrase that, wasn't it Chris Powell or was it... I think it was, who price action creates market commentary. You know, the truth is, they're all getting excited and interested but they'll do it at $2,100 to $2,200. Because it will be very clear and obvious, and demonstrable that we are in a new price regime, it's running, CTAs have gone long, it's in the financial press, and then it becomes a self-fulfilling situation then.

So, I think at the moment, I'm kind of like, "I wouldn't even bother." Don't waste your bullets trying to convince anybody at this point. It's not worth it. Because right now they're gonna look at it and go, "Yeah, yeah, you know, heard it all before several times, mainly from you, you know, why am I gonna listen to you now?" Let it break out, and then they'll all turn around and everyone, including the people listening to this will be the experts that are asked by their friends and their colleagues. "Oh, you know about this, tell me about this."

So, I think it's kind of let the event-driven stuff happen that pushes the markets for you on real rates down a little bit further, sends us through that level, and then it will all just happen in and of itself. I'm not sure if that's an appropriate answer. But that's how I see it at the moment.

Craig: It is a perfectly fine answer, my friend. Let me ask you the second question, though, because I think it dovetails off of that. We've had several people write in noting that they have frustration with the mining sector, the gold miners, in reference for this question, you know, if you measure the gold price versus a proxy, like the GDX, the big gold mining ETF, the price of gold very near all-time highs, GDX, like, a half its all-time highs. Even if you just go back to last April, you know, gold's about this price level, GDX is more like 46 versus the current 34. As a fund manager, can you just take a second to explain to people, you know, outside of that flow of funds, why it is that the mining shares can't seem to keep up with price?

Ned: Well, I mean, flow of funds, as you just said, is vital, because mining equities behave a bit like open-ended options. And again, you and I, we've discussed this before, that while individually, they have almost total idiosyncratic downside risk on an individual basis, as a collective, they're a form of out-the-money option. And the less interest and flow of funds there is, the more, you know, option will drift lower. And now generally, they don't give us gold miners who have to do a pretty good job to go bust in a gold mine. I mean, it does happen, but it's very rare.

You know, really what they go to is 1 and 2 cents in the dollar, you know, in terms of an option. Now, you know, mainly that's flow. But there is, of course, this other important point, which has to do with cost structure and margins, which is that, you know, these... So, most investors, most investors need a healthy margin before they're gonna want to participate in an asset class, they don't want to be involved in stuff that's barely making money. Now, of course, I say that, and then I start thinking about tech, and I think, well, doesn't stop them there.

But, you know, as a general rule of a certainly diversified mining, what's the trend is about diversified miners is they have very large operating margins, and they pay big dividends based on the fact that they have usually sufficient reserve replacement, plus free cash flow dynamics to pay large dividends and that's brings investment in and investors become interested and wanna own the stocks. So, it's a combination of a lack of deliverable margin, or implied margin when you're not in production. And the flow of investment capital at the side of it is potentially more important because it's competing, you know, the capital has to compete versus other investment subsets.

So, you know, unfortunately, gold miners are definitely an alternative, and they're considered to be a pretty fringe alternative for a fringe group of individuals. Now, that means that they are competing with all sorts of other alternatives that might have positive momentum, growing margins, growing performance, growing... you know, all the things that people look for. And therefore, you just see this drift away from these options if you wanna call it that, and you just see the opportunity drift down. But of course, it also means if something's trading at 2 to 4 cents on the dollar as an option, and then it turns, you know, that can be very beneficial if you're in at the right moment.

So, it is frustrating, it is annoying, and it is difficult for me to pitch mining stocks for exactly the reason that you bring up and the listeners bring up, which is they suck, you know, look at them, they don't perform. Now, why would I buy that? And the answer is that unfortunately, until we reach the $2,100 and above regime, price regime, we're still in a bear market versus dollars. In truth, you know, you gotta remember the dollar has basically had gold in a risk-free headlock since 1980. Big periods where gold's tried to, you know, flip in on the dollar, you know, and roll the dollar in wrestling sort of format and take over. And each time, the last minute, the Fed intervenes and kind of pushes gold over again, they go, "No, no, no, back off, you know, we want the dollar on top."

But, you know, once we do reach that new regime, the flow dynamics surrounding these stocks as in the participation in them, plus, obviously, the operating margins will expand, they'll become more able to start paying dividends and, you know, looking like a proper investment. But having said that, of course, as you know, a lot of them have very big structural problem with reserves. So, you know, it's gonna be hard for them to get out of their own way initially, they're gonna have to show consistency in the new price regime, consistency of performance, before the wider part of the market accepts that this is a viable support.

Craig: And then as you know, they often then move quickly when they do, like, comparing it to an out-of-the-money option that suddenly starts to pick up, you know, those options can go from 4 cents to 8 cents to 12 cents pretty quick. And I think that's a great analogy, Ned. That leads me then to the final question, which is also dealing with the miners, but the silver miners, and whether there's an opportunity in the short-term, we've been discussing, on my side, the kind of dislocation, even just in the last 12 months between the ETF use it as a proxy, I guess, the SILJ, which is the junior silver miners, and the price of silver, they've been in lockstep really for a couple of years, but in the last 6 to 12 months quite a relative gap has opened. Is that, I guess, relatable to what we just discussed with the GDX, does it also represent an opportunity perhaps for someone like you to overweight the silver miners?

Ned: Yeah. I mean, look, I think the waiting is the important point, you know, that clearly just a spicier version of what we just discussed, you know, they have lower operating margins still. And in some cases, you know, non-existent operating margins, which means that they're highly sensitive, they're even deeper out the money. They also have a bit of an issue, which is in terms of the grade profile of a silver mine, versus the costs of mining, so in other words, you know, your operating margin is skinny, your great profile isn't that great, that leaves you what one might say, on the ragged edge somewhat in terms of the operating environment, and unless you have prices trending higher, and when price is trending higher, they look great, you know, and they and they can work very well.

But I think the truth of silver miners is they are sensible applied in the right quantum, everybody has a different tolerance for volatility and risk, of course, so it will depend on, you know, each person or entity's tolerance for the volatility. But what I think is certainly true is gold goes about 2100, silver's likely to enter an environment that went into a bit '09 to 2011, where of course it did whatever it was, 4X what the gold price did. So, it's very reasonable to expect a silver miner to deliver gapping performance when fresh capital comes in.

But this is the point, which is, if you look at a major gold mining company, they receive capital reasonably quickly after physical gold, so in other words, physical gold gets big and then the capital percolates down into the largest gold mining companies and the royalty companies. And guess what, SILJ, which you referred to is the last thing to receive investment capital. So, when you sell them it, you know, [inaudible 00:19:30.397] because the investment capital has not reached there, has never got there, you know, all you've seen is a little bit of hedge fund involvement in the largest gold miners long and short, but both long and short, mainly because they're being liquid and they're more usable by those very large hedge funds, they're willing to play in those very big pots of capital.

But there's been no fresh capital available to mining generally in a very long time. And so, until that arrives, you know, I wouldn't be anticipating any particular excitement from silver miners, you know, they will move and do move on a lag, and when they do move, they move. But, you know, it requires additional patience and additional tolerance for volatility. That would be my framing of it.

Craig: You mentioned $2,100 gold as catching everybody's eye, high 20s, maybe a silver price that starts with a 3, would that maybe get people excited?

Ned: So, I don't think it works like that. I think it's about gold, I think it's about gold, it's just that it's a function of gold. It's not really about silver on its own. I'm not saying there isn't the odd person who will, you know, get excited about silver on its own, I mean, you know, sure. But really they don't. You know, what happens is people get excited by gold and then they go, "Where's the beta?" Or beta, I think you call it. They go, "How do I... I want more, I don't want just that, I want more." And that takes the capital into junior miners silver and silver miners and it's not really about silver, it's about gold.

Now, of course, it's also true that there is one additional comment about silver which is as we know there isn't any. So, you know, you can get this accelerated excitement driven by a squeeze potential, like we saw with that moment two years ago where really a very small group of people buying a bit of SLV created a fundamental problem in the silver market. So, you know, that is also true, but it's all driven through gold. It's not driven through silver on its own, it's driven through gold.

Craig: Ned, you are based in London, you work for Jupiter Asset Management, what's the name of your fund?

Ned: It's called Jupiter Gold and Silver.

Craig: Jupiter Gold and Silver. Now, I in the U.S. cannot buy that fund, because as everyone knows, the British and the Americans are sworn enemies and we cannot cooperate on anything. Why the heck can't I buy it, Ned? That drives me crazy. However, people in Europe and can people in Canada buy your fund?

Ned: No, it's very much narrow jurisdiction in terms of who gets to use its rules, in North America and Europe, and never the twain shall meet, it's all very cordoned off, which is fine. You know, it's nice, we can just discuss the market in broad brush terms and not worry about, you know, the specifics. But look, you know, ultimately there are plenty of vehicles over there that people can access this asset class through, and that's good for all sorts of individuals within the industry. So, that's fine.

Craig: All right. So, those of you listening from the UK, check out Ned's fund. And Ned, thank you for your friendship over the years, but also for this latest podcast. This has just been terrific. And you've answered all the questions and I think given people some great answers and a lot to think about. So thank you for your time. It's been great fun.

Ned: It's a pleasure.

Craig: And please, everyone, keep sprottmoney.com in mind, for all of your bullion services, whether buying it or stacking it, or maybe storing it someplace, give them a call, 888-861-0775. We'll be back with more content later on this month that you're definitely gonna wanna hear as we get to the monthly wrap-up. But for now, it's time to sign off. Thanks again to Ned. Thanks again for sprottmoney.com. And we'll speak with all of you again soon.