Recorded: April 2, 2020
INTERVIEW TRANSCRIPT (EDITED)
Albert Lu: Welcome to Sprott Media. I’m Albert Lu, joined once again by Rick Rule, president and CEO of Sprott U.S. Holdings. Rick, thanks for joining me again. How are you doing?
Rick Rule: Albert, always a pleasure. I’m doing well considering the turmoil that the world is in. Like yourself, working from home, which I must say is not all bad.
AL: That’s right.
RR: I feel bad for billions of people around the world who are suffering. I must say other than thinking about them, I’m not one of them.
AL: We’re fortunate to be able to continue doing what we love and continue to be paid for doing it. That is for sure. Rick, we started earlier this week a series that is basically an investor’s primer in natural resource investing. We covered gold. I think we covered a lot of ground in that video. Anyone who wants to catch up on that can click the link here to go back to watch that video.
Today, we want to talk about silver, Rick, and I guess before you launch into the primer I want to say from my own standpoint I’ve learned over the years that investing in silver is very much different than investing in gold. So with that, why don’t you lead the investors through this topic.
RR: Well, I think that’s a great way to start and I think for anybody’s records we should note that today’s call is taking place on April 2, 2020. One of the things about these videos, Albert, is that they hang around on the web for years. People need to pay attention to when the information that they gather was presented, because things change, particularly, as you note, in silver.
Silver is extraordinarily volatile as a commodity and the stocks are even more volatile. Not surprisingly, our customers don’t seem to mind upside volatility but they don’t like downside volatility very much, which is why the primer is useful. It’s also useful because I think over time it’s fair to say that Sprott itself has become a brand name for silver investment in speculation. We manage billions of dollars in physical silver and lots and lots of silver stock on behalf of hundreds of thousands of investors worldwide. And this discussion is particularly topical for our customer base and for people who are thinking about becoming customers of Sprott as a consequence of our long familiarity with and identification with silver.
So let’s start. Silver at the beginning of the discussion is unusual in that it is both a precious metal and an industrial material. And the market for silver and silver’s utility to investors and speculators is a consequence of both of those phenomena. In terms of markets, precious metals markets are almost always led by gold. In my experience — in the last 45 years in the business, which we’ve discussed in the past — gold moves first because it moves based on fear. When the move, when the bull market is underway, silver moves later than gold. It’s more triggered, I would suspect, both by the momentum established by gold but also by virtue of the fact that the unit cost of silver is so much lower than gold. It’s been called, as an example, poor man’s gold. And particularly in South Asia, Bangladesh, Pakistan, India and Sri Lanka, silver has been regarded for centuries as both a medium of exchange into store of value — that is to say a real money. And in those economies, the fact that the small unit price relative to gold exists is one of the things that gives it utility.
We’re going to discuss a little bit more about silver’s function as a precious metal later. But I think it’s worth covering it as an industrial material, too, because the uses for silver — the industrial and fabrication uses for silver — are growing very rapidly, particularly [and] not surprisingly as a consequence of its low price.
Silver is useful right now as a germicide and there are increasing applications around the world that recognize silver’s efficaciousness as a germicide. It is increasingly being woven into cloth, so that its germicidal properties can be, in effect, worn. It is used as an ointment for wounds around the world, and it has increasing application in water pollution, control equipment in purifying water. The principal use of course used to be photography, but technology has changed all of that. And the principal use now, the principal industrial use for silver, is in electronics fabrication and in particular in solar panels.
Now, it’s worth noting that the extraordinary economic slowdown that we’re facing right this moment is impacting silver demand from industrial applications worldwide. As the fabrication of all types of consumer and industrial materials has slowed down dramatically, particularly in China, which is the world’s largest market as we know for solar panels. Considering silver, it is a hellishly difficult material to do market forecasting on, hellishly difficult for a couple of reasons.
On the supply side, importantly, most silver in the world doesn’t come from silver mines. It comes as a byproduct of mining other materials, including primarily gold, copper and lead and zinc. So having a sense of byproduct supply involves making forecasts, not so much about the silver market but also about the gold market, the copper market, the lead market and the zinc market.
The second thing is that a surprising amount, historically, of silver that was used in industrial applications is recycled, which is to say that scrap is often a very important source of supply. And then finally, investment supply, because so much of the above-ground supplies of silver are held by living, breathing retail individuals, particularly in South Asia. Circumstances like crop failures in India literally lead to dishoarding, where people who have stored their wealth in silver rather than in say rupiah used their silver to, as an example, feed their family. It’s been noted that good economic conditions in rural South Asia — which is to say good harvests, a lack of floods, a lack of drought — contribute substantially to silver demand. And poor economic conditions in South Asia, particularly currency devaluations, lead to dishoarding or silver supply. So, when you’re looking at silver, forecasting either supply or demand is notoriously tricky.
What we know is that the primary determinant of the silver price in the near term is investment demand. And as we said earlier, what we know with regards to investment demand is that silver historically has moved later than gold but has moved further.
AL: Rick, your description of silver’s moving later, gold moving earlier based on fear, it sort of paints the picture of maybe gold as a Wall Street monetary metal — whereas, silver is more of a Main Street monetary metal. When you look at the performance of silver over this last month, it did move rather drastically when the liquidity crunch hit. And I’m wondering does that suggest that silver was held rather prevalently in margined trading accounts? Or is this some other phenomenon we’re looking at?
RR: The Sprott metals desk reported to us with regards to gold that about $60B worth of gold was held in leveraged long commodity trading accounts. Some of that leveraged as much as 33:1. We don’t have the same figures for silver, but given the volatility inherent in silver, one can assume that the leverage long positions in commodity trading accounts for silver were as large or larger than they were for gold. So I think your points are very accurate. Now, that isn’t to say that some of those leverage long positions couldn’t be called in institutional positions. I’m sure they were in many cases institutional positions, but it isn’t the sort of traditional holder that one would have looked at. [For] people who owned either gold or silver as an investment position, this is a circumstance where leverage long retail institutional players in commodity trading accounts were looking at volatility and probably got more than they were looking for in the near term.
Certainly, the move that you described to the downside in silver, I think, can be largely attributable to two factors. One would be in leveraged long accounts when credit goes away, which is precisely what happened two or three weeks ago. Those accounts get liquidated, whether or not the holder wants to liquidate them or not. That’s what happens. When the credit goes away, the leverage long accounts go away. The second thing is that I suspect that there was some expectation of reduced industrial demand for silver, given the reduced level of economic activity that we’re facing around the world.
AL: Rick, when we talk about gold and recommending or suggesting what place it should hold in one’s portfolio people are comfortable at least I am saying 10 percent or even higher. With silver and the volatility, what approach do you take? Do you take sort of a risk parity approach, where you scale it to adjust for the volatility? What do you do?
RR: I would argue that there isn’t a one-size-fits-all answer, Albert. I would describe silver as much more speculative than gold. And I think that somebody who intends to have a position in either physical silver, but more particularly in the silver stock, needs to self-identify as a speculator. I would argue that the major silver producers worldwide and probably the metal itself don’t qualify as investment quality assets, but are much more speculative.
I would be the last one to criticize speculation. All of the money I now invest I made speculating, so there’s certainly room for silver in my portfolio, which is really where the conversation goes next. We’ve discussed that over the last 40, 45 years in recoveries from oversold bottoms in precious metals, like the ones that we’re in, gold moves first [and] silver moves later. But silver moves further. But the most volatile asset class is the silver stocks, because the outsize move in silver generates outsize margin gains in the silver stocks. And also because the silver stocks are so rare.
It’s arguable that there are 11 silver stocks globally worth considering. That isn’t to say that there are only 11 silver stocks. What I’m trying to say, there are probably only 11 legitimate silver stocks on a global basis. And historically what has happened is that after the precious metals thesis has been verified by movements, first in the gold price, then by the silver price. First of all, the precious metals money comes into the silver stocks but then later when the generalist money comes into the silver stocks. There simply isn’t the float of silver equities available to accommodate investor demand.
I remember myself very well in the 1970s, little shares like Coeur d’Alene going from 10 cents to $65. No, sadly, I wasn’t long. But I do remember also very well being part of the formation of both Silver Standard and Pan American Silver. Silver Standard, if my memory serves me correctly, we financed at 72 cents with a full warrant and it went above $40. Similarly, Pan American, we financed 50 cents and it went above $40 too. I’m not pointing this out merely to boast but rather to illustrate the astonishing upside that exists in silver equities and hence the fondness with which speculators regard them.
AL: Rick, one of the things our friend Steve Sjuggerand points out is that you want to buy something that is hated in the market. I think silver has been hated for some time. Would you say even more so than gold?
RR: Well, I think people have been punished for owning the silver stocks more than they have been punished for holding gold. So I guess all investment experience is personal and that would, I think, indicate that what you’re talking about is true.
One other note on silver that I forgot to mention, Albert, before we move on is that, currently, although most silver in the world is produced, as I say, as a byproduct of other materials, the most important primary silver producers in the world are Mexico and Peru. And in those countries currently right now a large part of their mining activity has been closed as a consequence of official sector response to the coronavirus. So we can expect a couple things in the near term. One would be reduced availability of silver, both from new mine production and to the mints. And the second would be a near-term constraints on cash flows among the major silver producers.
A further note that I think that we should talk about is the fact that people who want to participate in the silver market right now in retail basis for physical silver will experience some problems. The entire physical dealer market worldwide is effectively out of inventory of retail quantities. This doesn’t mean that large institutional quantity product isn’t available. What it means is that the 1 oz. product, the 10 oz. product and even the kilo product on a retail basis is sold out.
So it’s worthy to note that people who want to be involved in the physical silver market in the very near term will experience some difficulty with that. I’ve never before in my life seen a circumstance where the dealers are buying back retail physical silver product at a substantial premium to spot, so that they can resell it at an even higher premium to spot. This says something about the nervousness that people have with regards to the current economy, I think, and their increasing fondness for precious metals — both gold and silver — in the circumstance where faith in other investment in savings products is weak.
AL: So in valuating one’s own suitability for this, the first question you have to ask yourself is: Are you willing to speculate? That is, are you willing to lose the money that you lay out? What are the next questions that someone considering speculating in silver and silver stocks should ask themselves?
RR: I think the second question — and it’s different than risk — is: How prepared are you psychologically for volatility? Because the silver market is notoriously volatile, even notoriously volatile interday, and if you are the type of person who is emotionally unsuited to volatility, what will inevitably happen is that the market will take advantage of you. If, by contrast, you are both financially and psychologically capable of dealing with volatility or, in fact, are skilled enough to use volatility in your favor, silver is a perfect, perfect, perfect market.
AL: So an example of that, Rick, would be watching the price get cut in half and buying more?
RR: Absolutely, if you have the courage to do that. Or, as an example, if you wanted to be in the high quality silver stocks. If, as an example, the near term production shutdowns in Peru and Mexico constrained their free cash flow for a quarter and the quarters that came out were bad quarters and the market overreacted to that, a good speculator would use that volatility and that information, knowing that the shutdowns were other than permanent — in other words, were temporary — and used that price weakness to buy a bigger position rather than being shaken out of their existing position.
If you don’t have the psychological training and psychological strength to handle that volatility, I would suggest that you stay out of the silver market. I don’t want the takeaway from this to be out of the silver market because traditionally investors in precious metals equities over the course of a precious metals bull market do extraordinarily well in the high-quality silver stocks. But it’s also true that in every circumstance, in every circumstance, their patience and faith gets tested and that will happen this time for sure.
AL: You make an interesting point about these producers that may have their operations shut down for a while. I imagine, like other businesses, strength of balance sheet is going to be one of the considerations you’re looking at, Rick, when you’re evaluating whether or not the market has overreacted or not.
RR: Yes, absolutely. Balance sheet strength and simply the ability of the management team to make intelligent decisions over time. You’re looking for management teams that have been disciplined in terms of what they’ve put into production and management teams that have run solvent and low-cost operations, so during periods of time when there is an oversupply of silver, they maintain solvency. It’s important to note, Albert, that if, as I believe, we’re entering the period of reduced economic activity, ironically we should see increasing reduction in silver production. It makes certain sense to me that if demand for lead and demand for zinc and demand for copper, in particular, falters as a consequence of a global economic slowdown, the byproduct silver production, which is often over 70% of primary silver production, will in fact falter. It’s also worth noting in the very, very, near term that the shortage of physical silver in retail quantities will be impacted because the COVID virus has shut down almost all of the major refining capacity worldwide. The ability of the refining industry and the banking industry to deliver retail silver to the market is really constrained because precious metals refineries around the world are shut down as a consequence of government action around the COVID virus.
AL: Rick, I can’t help but looking at it this way from a global macro standpoint. If you look at the silver price now hovering around [$]14.50. That’s a price that was available in 2008. And part of what goes into the dollar price of silver gold and everything is the amount of money in circulation. And if you think of all of the nonsense that’s occurred between 2008 and now, the idea that you could go back and buy silver at a price that [it] was, I don’t know, [in] February 2008 is like almost like having a time machine.
So from that standpoint it certainly looks like a very good time to buy, considering we’re looking at possibly $10T or more increase in the balance sheet of the Federal Reserve. So before we conclude here, Rick, do you have any parting thoughts for the speculator?
RR: Well, the important parting thought is that the impetus for this call came about from grading well over 3,000 portfolios for speculators who submitted them to us and looking at portfolios from existing clients at Sprott. The truth is that there’s a very small population of silver stocks that are investible, and the most important part of speculating in silver companies is, in fact, stock selection. And what I would urge people who care about the sector to do is, first of all, examine how you have your physical position if you have one. And consider the alternatives that are available, particularly in today’s market where there is such an extraordinary markup on physical product, and where in fact counterfeit product is beginning to come on to the market.
And then, secondly, when you look at your silver stock portfolio, you really, really, really need to practice stock selection. Talk to your Global broker. We know the silver business inside out, the silver equities business. We’ve been in that business for 40 years. If you don’t have a Global broker, Sprott Global broker, I would suggest that you get one. The truth is if you believe that we’re in a precious metals bull market and if you believe that history repeats, one big beneficiary of the gold move will be silver. But the biggest benefits here it could very well be silver stocks. It’s important as a speculator to be positioned, but it’s more important to be positioned in the right names.