Ask the Expert with Tavi Costa - June 2023
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An episode of "Ask the Expert" hosted by Craig Hemke with a special guest Tavi Costa!
This month, Tavi and Craig discuss the macroeconomic environment, the Federal Reserve's actions, market trends, and the precious metals market.
They touch on issues such as the AI euphoria in the stock market, passive investment vehicles, the debt ceiling, the Fed's balance sheet, interest rates, volatility, and the potential for a market downturn.
Watch or listen now to learn all the insights and opinions on the current state of the market and potential scenarios for the future:
Male Speaker: You're listening to "Ask The Expert," on Sprott Money News.
Craig: Well, greetings again from Sprott Money News at sprottmoney.com. It is now the month of June. Holy cow. Halfway through the year 2023. A guy told me once that the days drag, but the years fly as you get older. And man, oh man. I'm getting older, and the years are flying. Anyway, it is time for your "Ask The Expert" segment for June. I'm your host, Craig Hemke, and joining us this month is my old friend, Tavi Costa. Tavi, you'll, I'm sure, recognize him. He is a frequent guest on financial media, and blog sites, and YouTube. Just a sharp guy, who is in our corner for the precious metals. He's actually a partner and a portfolio manager with Crescat Capital in Denver, Colorado. And it is always fun to visit with him. Tavi, thank you for your time.
Tavi: Craig, I'm delighted to be here with you again. Looking forward to this conversation.
Craig: Well, it's always fun to visit with you. And before we get started, the usual note that, again, this stuff doesn't just come at you for free, so you want to thank the good people at Sprott Money for providing this content every month. You can go to sprottmoney.com, check them out for the deals that they have on bullion, and storing that bullion. But also, hey, if anything, if you're not in a buying mood right now, just give 'em a like, or a subscribe on whatever channel you're watching because that helps spread the word as well.
But again, give them a call if you are in the market. 888-861-0775. So, Tavi, let's talk about this market. As we have solicited questions from Sprott Money customers for you, they've kind of broken into three categories, and we'll try to get to all three here over the course of this podcast.
One, just this macro, you know. What's the market doing? What's Powell doing? And then we'll talk about the metals and then maybe get into the mining shares, because that's part of what you do at Crescat. Let's start with the macro. As we record this on the 22nd, heck, it was just a week ago, prior to the FOMC, that Fed Funds futures were pricing in a couple of rate cuts this year. The Fed was talking about, you know, holding things sideways. Now, all of a sudden, you know, the whole thing's turned upside down. The Fed's talking about hiking a couple times. Those rate cut expectations are gone. What do you think? As we look forward into the back half of this year, is it wise to think that that's all off the table now? Or is there too much uncertainty?
Tavi: No. Well, look, I'm gonna try to explain what I view, at least, as the most important aspects of this market and the macro environment. I think, first, we had the AI euphoria that changed the game in a large way. It created huge inflows into a part of the market that we continue to see issues, which is the mega-cap stock. Some of them are more justifiable in terms of the improvement of fundamentals, supposedly, on estimates, you know, like Nvidia is gonna quadruple their free cash flow if analysts are correct and so forth.
And the others, you're seeing major inflows in terms of capital, but we're not seeing any fundamental improvement whatsoever. Apple would be a great example. And this is sort of the product or reflection of passive investment vehicles that are driving the flows of those stocks.
Then we recently also had the debt ceiling issue. The debt ceiling was something important, and, because it sucks liquidity from the markets. We're living in a world where the deficit issue is compounding the debt problem in an alarming pace. The Fed is shrinking its balance sheet at its fastest pace in history. We're already one year into this fastest, also, pace in terms of the Fed hiking rates.
And when you look at volatility, it looks to be a completely different world, right? I mean, we're seeing the VIX at historically depressed or suppressed levels. You have the 10-year yield is starting to move higher again. This was the whole reason why the market declined in 2022, if you think about it. It wasn't really a reflection of fundamentals deteriorating. It was totally because of the duration risk. The 10-year yields are rising, and that caused markets to fall while 10-year yields are not falling. They're still holding their levels in a very significant way, and look like they could be potentially breaking out.
So, to me, it's almost irresponsible to not be long volatility today. I am, as a fund manager, looking for ways to be long volatility. I look at the XLF for instance, the ETF of financials, and I see that the volatility of that, the implicit volatility of those options, are extremely low relative to even...some of the banks are starting to move already. Some of the regional banks are moving, because treasuries are still having that pressure. Seasonality is playing an impact here. VIX is...seasonality tends to cause its suppression, all the way to the middle of the year.
The other part of the year tends to be a time when you see a rise in a significant way. And lastly...well, we can discuss gold in a minute here, but that's sort of, I think it's setting the stage for a volatility event, and you wanna be long volatility, in my opinion.
Craig: And so, as you look forward, you know, it seems to me at least that a lot of folks look at the market, almost seems like a day-by-day basis, without kind of a bigger picture. And, you know, the market relies on the Fed for this guidance, you know, as if it's set in stone. But, I mean, Tavi, it was on March the 7th that Powell himself was on Capitol Hill, like he's been this week, talking in his Humphrey Hawkins testimony, and he was talking about higher for longer. It was only four days later that Silicon Valley Bank collapsed.
So, would it seem that things come at them just as fast as everybody else, so they have to react too? Do you think that, I mean, whether it's commercial real estate or any of these other issues, would you put any stock on this notion that the fed's just gonna keep hiking through the end of the year? Or is it more like, well, we'll just wait and see about that?
Tavi: I have my money on that the Fed is probably gonna have to stop, but first, what we need to see, even if we're gonna see cuts or anything like that, again, we really need to see some deterioration in the markets, and we haven't seen that yet. And so, how can you make a case that the Fed is gonna pause, or cut interest rates, if the market continues to be, or volatility continues to be as suppressed as it is, and other things like especially the euphoria in some parts of the market?
So, it's hard to believe that that's gonna happen, especially when you have agricultural commodities starting to move in a large way. Recently, we've had a big divergence between agricultural commodities and food prices. Well, that's gonna suggest that food prices should be higher in a couple months as history shows. So, I'm in the camp that we need to see... I'm always thinking about the sequence of events. And to me, a volatility problem is likely underway.
And you have also junk bonds looking quite attractive when it comes to short positioning. So, that's, to me, where most of that is coming from. And remember, we've had a major yield curve inversion problem back in November. That tends to be the case where positioning should be in the gold-to-S&P 500 ratio, when you look at, historically, for the next two years after you get the signal, that is extremely bullish for precious metals relative to overall market.
Again, sometimes you see precious metals falling, but they don't fall as fast as the equity markets do. And so, I think we're kind of in that scenario. And if you look at historically, you also see that there are months where that ratio doesn't work. We had a two-month period now where that ratio actually declined. Equity markets went higher, gold prices went lower. Is that the end of that trend? No, I don't think so. I think this is just a normal pullback in an upper trajectory of this ratio. And so, I remain, you know, focused on the long-term trend.
Craig: And so, as we, I guess, round that corner, and then let's focus on that long-term trend, we're in the summer of, now, of 2023, halfway through the year, as I mentioned earlier. As we go into the back half of the year, it's easy to lose track of the fact gold is up $100 year-to-date, and tracking along, you know, its average annual gain since, you know, the century flipped 23 years ago. What do you think will drive gold prices if we can get them to turn here in the back half of the year? Is it that increase of volatility that kind of shakes the foundations of what the Fed is trying to accomplish? Or where do you think prices are headed?
Tavi: To me, ultimately what's going on is the treasury problem is a big issue. I mean, we've just had, since the debt ceiling problem, the government had to issue about $638 billion of U.S. debt since the agreement was reached. I mean, think about that. The whole expectation was that the debt limit was gonna be raised by, or the debt was gonna be raised by about $1.2 trillion. We already saw half of that in, what, a couple weeks? And so, you know, in my estimates, just looking at the log version of the debt problem, you can see that we're probably gonna see a $2.2 trillion of issuances in the following one to two years.
If that's the case, with the Fed actually doing what they have been doing, which is shrinking their balance sheet, allowing their treasury holdings to mature, and mortgage-backed securities, this is gonna create a pressure, at some point, that the Fed is gonna have to step in and be the buyer of last resort.
I firmly believe that that's gonna be the main reason, when gold starts really sniffing that around, and I think it has been recently, and we've seen a triple top, historical resistance, more recently. I think the whole world is looking at this whole situation. The 60/40 portfolios have really struggled over the last year. This year has been the complete opposite, pretty much, mostly on the equity side. The treasury side has not really worked very well.
At some point, I think people will start questioning, why do we own debt from another indebted economy, with the downside volatility being so high relative to gold? And the more we question those issues, I think the capital influx is gonna have to go towards the metal, that has the longest history of credibility, of being a defensive asset, of enhancing the quality of international reserves of central banks.
And that's all gonna be the long-term trends playing a role into forcing gold prices well above this triple-top kind of scenario. Once we break down from there, I think that's what brings, you know, the liquidity that we need from a starving industry, which is the mining industry. I mean, this is, you know, one of the longest business models we've seen in history, now, completely out of favor, unloved, almost like working in a scenario where valuations appear to be, with gold prices, you know, at a what, at a $1,600, $1,200 an ounce, looking at valuations today, while gold is close to breaking to new levels.
So, to me, this is, you know, an opportunity for a long-term investor. I will continue to be focused on this breakout. I'll continue to be focused on 60/40 portfolios switching their portfolio positioning towards the metal, central banks being largest buyers of the asset as well. I mean, I think everything is kind of coming along. But the skepticism remains the case here. So, I guess it's an opportunity. I will continue to be focused on this.
Craig: Yep. Me too. In our remaining time, let's talk a little bit about the mining shares, because that's much of what you do as portfolio manager at Crescat, is, you've got mining shares, junior mining shares, resource, explorer stocks. As do I. And actually, as everybody should know, I have a portfolio at Crescat, relying on your expertise and Dr. Hennigh's expertise, and the whole team.
The challenge is, I can look at that, and I'm sure a lot of people listening to us can look at that and go, "Oh, look at this. It's great. I mean, look at the resource they have there. It's beautiful," you know, and the grade, and the district, and all that kind of stuff. But as the sector is out of favor, it seems like none of that matters. And these companies burn through money, and then they've gotta come back to market and try to get some more. I guess, ultimately, my question is, from your expertise, and how you guys run things at Crescat, what words of wisdom would you pass along to mining share investors as we kind of wait this out, and wait for, you know, the breakout and the rally and the infusion of capital interest that will come with it?
Tavi: That's a good question, Craig. Look, if you think about the ways of investing, I'm a firm believer that the best way to really make money in the space, and identifying big macro trends, like gold prices, which I think will be higher, not lower, 10 years from now, is looking for what is the most asymmetric bet you can make in this space?
And to me, it continues to be in the exploration phase. I think some folks tend to be looking at the technical analysis a little too much in terms of hoping for a breakout in prices and that level of confirmation before you start getting invested and really accumulating assets in this industry. To me, it's the other way around. I think you want to be buying low, and this is as low as it gets.
I mean, the thesis remains very robust. We're seeing production for most of the major companies falling, which is the case that happens in, during the last two gold cycles, in the '70s, and in the early 2000s, all the majors have been ultra-conservative, which is also creating, you know, if you think about the commodity cycle itself is predicated on the CapEx cycle, and we have that confirmation already.
If you look at even the central bank purchases, it's something we didn't see in the 2000s, when we had that major bull market for the metal. And today that is the case. It's similar to the '70s in that sense. Inflation wasn't the case in the early 2000s. It was the case in the '70s. And so, you know, you think about the robustness of the thesis itself continues to be very strong. And when you look at the metals and mining industry, especially the exploration and development phase, again, most of those businesses are trading at multiples, or valuations, that are already set for failure.
And, in my opinion, that is certainly not the case. It's interesting that you're not seeing the differentiation of quality businesses and bad quality businesses inside of this very inefficient part of the market. And so, for an activist, and also a long-term, you know, mindset of an investor, this is a dream, to be allocating capital in this, at this time, you know, before the liquidity influx.
So, to me, this is really the case. I don't think this industry is going away. I think the need for gold is increasing. If you look at the debt problem, you know, a bet against gold is a bet against the debt imbalance getting worse. I don't think that's gonna be the case. I think the deficits will continue to make the debt problem continue to get worse. And so, putting it all together, in my opinion, it's the time to be deploying capital into an industry that's been starved for money, and also looking for ways of creating strategic partnerships, of creating the new major companies, or accumulating assets that are ultra-cheap and ultra...or, I should say, deep value opportunities, looking for jurisdictions that may play a role in the following 5 to 10 years.
I think there's so much to be busy here in this industry, and people that are just waiting for the breakout, that's not my strategy. It's certainly not what I'm trying to accomplish. I don't think, even, we're in the Sprott Money show here, if you think about it, I don't think Sprott's strategy was that either. You know, I don't think Sprott got where he got by waiting for a breakout. I think most of the billionaires in this industry accumulate assets when prices are low, and this is where we are.
Craig: Eric's old line he taught me was, you gotta be comfortable being in the party, at the party, but in a room by yourself, while everybody's off partying. And you gotta have the confidence that you're analyzing things correctly, and be willing to make a stand. And that's kind of what we all have to do at this point. You guys do a great job with that, Tavi. Please, as we wrap up, tell everybody a little bit about Crescat, and then where they can find you on Twitter, because you're a really good Twitter follow.
Tavi: Well, thank you very much, Craig, for having me. Well, Crescat is, you know, we created a portfolio of precious metals companies back in 2020. It's been performing very well. Our thesis is to work with Quinton Hennigh, which I think it's the smartest exploration geologist I know. I wanna create a portfolio of ideas in strategic as well, you know, jurisdictions that we think are gonna be in high demand for this new gold cycle that we're likely to enter.
And, to me, it's important to be diversified, but really, you know, almost like a hybrid venture capital approach. But rather than in an expensive technology space, I wanna do this in the mining industry, by owning what I think are gonna be the best discoveries of the next 5 to 10 years, owning a substantial amount of those businesses, and helping them to accomplish those goals, along with this activist approach with Quinton Hennigh.
I think we've proven, even in this kind of neutral market, what we can do in terms of performance. But, you know, I think, imagine what we could do in a bull market. So, that's my opinion, obviously, where I think the opportunity lies ahead. But, you know, we're trying to create a vehicle that will hopefully really capitalize in what we think is gonna be one of the most important historic moments for the metal. And not only gold, but really, electrification metals are also gonna be part of this overall thesis.
So, yeah. Thanks for having me again. It's always nice to talk to you, Craig.
Craig: And, Tavi, that Twitter handle, so people can follow you there?
Tavi: Oh. I forgot about that.
Craig: It's all right.
Tavi: @TaviCosta is my Twitter handle.
Craig: Well, that's easy enough.
Tavi: Yeah. Follow me there if you like macro-related topics. I always share my views there. So, you're welcome to follow that. Thank you.
Craig: T-A-V-I-C-O-S-T-A. That's pretty easy. Even I can spell that. Tavi, great stuff. Again, Tavi Costa of Crescat Capital in Denver. Great to visit with you. Thank you for your time.
Tavi: Thanks for having me, Craig.
Craig: ...of all of us here at Sprott Money, thanks for watching. We'll have another "Ask The Expert" segment for you in July.
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