Maria Smirnova, Senior Portfolio Manager of Sprott Asset Management.
Fireside chat: The Silver Perspective. The Fireside Chat features Maria Smirnova, Senior Portfolio Manager & Chief Investment Officer, Sprott Asset Management,Tavi Costa, Partner & Portfolio Manager, Crescat Capital LL. and Peter Krauth, Author of "The Great Silver Bull" and Editor of the Silver Stock Investor Newsletter.
The following are Maria Smirnova's excerpted comments.
Taylor Combaluzier, Red Cloud Financial Services: Welcome back to Red Cloud Summer Silver Conference. I'm Taylor Combaluzier, a mining analyst at Red Cloud. Thank you to all our viewers for joining us today. During our Fireside chat, I hope to get some new perspectives on the silver sector.
We have Maria Smirnova, Chief Investment Officer and Senior Portfolio Manager from Sprott Asset Management. She has over 20 years of investment experience and joined Sprott Asset Management in 2005.
Taylor Combaluzier, Red Cloud: Let's jump into some macro. Maria, during the COVID pandemic, we saw unprecedented amounts of liquidity injected into the market and governments providing fiscal stimulus. U.S. debt has ballooned, and it's over $30 trillion now, 125% of GDP. Has this constrained the ability of central banks to use interest rates to fight inflation? And what does it mean for silver, ultimately?
Maria Smirnova, Sprott: That's a good leading question and a big subject of discussion. As you mentioned, the government debt of the U.S. is about $30 trillion, but the total debt in the U.S. is ~$67 trillion; more than double if you count other debt. Let's remind everyone that it was only $3.7 trillion in Paul Volcker's time. So it has grown 20 times. Today, total U.S. debt is about 274% of GDP [gross domestic product]. That's a very high number. We haven't seen such levels of debt since World War II. In addition, the U.S. does run twin deficits [i.e., fiscal/budget and current account/trade deficits]. The trade balance is currently close to $89 billion. The budget deficit is about $1 trillion, but it's been as negative as $4 trillion. This means that the U.S. debt load is continuing to grow. The consumer is also becoming distressed and racking up debt quite rapidly. Total consumer credit outstanding is close to $5 trillion.
As debt grows, so does the interest rate burden, and it becomes a vicious cycle. With interest rates increasing, the debt burden increases as well. So, I think the answer to your question is "yes". Central banks are becoming increasingly constrained in their ability to raise interest rates. Recently, the Fed and other central banks, including Canada, have been raising rates aggressively, compared to recent times, given the more benign environment prior to COVID. We can debate how far the U.S. Federal Reserve ("Fed") will go. The Fed is intent on taming inflation. We had another CPI [consumer price index] print for July and CPI has been moderating from a high of over 8-9%. It's a matter of how much pain the Fed and other central banks are willing to inflict on their respective economies. Inflation is still much higher than interest rates, so on a real basis, interest rates are still negative. This is positive for silver and positive for gold.
I'll leave it at that, but in my personal opinion, I don't think that the Fed can increase interest rates much higher without inflicting serious damage to the economy.
Taylor Combaluzier, Red Cloud: Maria, let's segue to the supply side of silver. Silver supply is expected to grow a bit in 2022, about 2.5%. But supply deficits are expected in 2022 and deepening deficits going forward. Do we have enough mines being developed to meet the growing demand for silver, and are mining companies spending enough to make discoveries?
Maria Smirnova, Sprott: It is always interesting discussing the physical fundamentals of silver because it is a beast with two heads. As Peter said, investment and industrial. Silver has been in surpluses; silver has been in deficits. And it also depends on how you look at the deficits and surpluses. We look at the market balance after ETF flows, after all the investment demand. To answer your specific question about supply, I agree that we should expect growing deficits. On the supply side, I've been looking at these stocks for over 10 years now, through thick and thin. Unfortunately, we launched the Nine Point Silver Equities Fund at the very top of the market in 2012. I've lived through the tough times. I've lived through times when companies could not raise money. And in the past two years, we have seen a resurgence of companies being able to raise financing for drilling, which has been fantastic. I have enjoyed the last several years because of this specific point.
But in terms of overall mine supply, this is what I can say without going into mine-by-mine specifics. Mine supply has always disappointed. Okay, we can have projections going forward and see if somebody's projecting 5% growth. Well, it won't come in. I'll give you an example. Last year Metals Focus was projecting, I believe, mine supply to be 848,000,000 ounces or so. Last year, supply came in at about 829 million, 20 million ounces or 2% below what they expected. That's not new. I have seen this year after year, but why does that happen? Because companies have hiccups and operational issues. There could be a flood, some political unrest and all kinds of events coming into play, so overall supply never comes in on budget.
At Sprott, we don't look at mines in terms of whether silver is the byproduct or the primary product. I believe most silver mines are byproduct. To me, a primary silver mine is a misnomer because silver is rarely mined on its own. I know only one or two mines in which silver is produced independently. We look at all kinds of mining companies and I would say the common sense for all types of metals. We just don't have enough mines coming into production in the near term. This reflects years of underinvestment when companies have been penalized for raising capital to explore for metals and build mines. This also involves longer permitting timelines, political unrest in various countries, etc. As you know, a large proportion of silver production comes from Latin America and Mexico. In many Latin American countries, we have seen changes in governments, politicians talking about more taxes and changing mining rules.
I may be going into the weeds here, but to answer your question, I don't see enough silver mines coming on board soon to address the growing deficits. I am talking about large silver mines, a 10 million ounce mine, which represents ~1% of the overall market.
To put it in context, how many of those mines do I see in the pipeline? Maybe two or three, and at the same time, we're seeing ore grades decline. The Silver Institute published data recently about how ore grades have been declining. We need to keep expanding production to keep up. At the same time, while I'm encouraged that we're seeing money flow into the industry and companies raising money to drill again, it's not fast enough to drill out the resource, finance it and put it into production.
Taylor Combaluzier, Red Cloud: Next, a two-part question. What are some important criteria that you apply when evaluating silver stocks? Any traits you tend to avoid and part two is what are some of your favorite jurisdictions?
Maria Smirnova, Sprott: The criteria we look at for mining stocks vary. Some of the criteria depend on the stage of the company, whether it is in the exploration, development or production stage. But overall, mine location is important and we've discussed that today. Management teams are very important. As you know, we've been doing this for at least 20 years and follow management teams closely. For me, when I speak to a management team and they tell me what their plans are, they need to follow up with me and demonstrate how they have delivered on their stated objectives. It doesn't mean that the results have to be extraordinary. It just means that management team needs to be true to its word. In terms of other criteria, geology is very important and you cannot change geology. Thinking in 3D helps thinking about what the deposit looks like. I always look and ask for significant amounts of data. The more data, the better. Drill results, visuals, sections, etc.
Capital structure is also important. Australians are famous for having billions of shares unissued. That doesn't necessarily matter, but having a tight capital structure sometimes helps, with not many warrants and options, etc. We're increasingly turning our lens to ESG [environmental, social and governance] issues. Specifically, I would start with governance issues. We're examining the strengths of boards and the rules surrounding that, compensation schemes, etc. That's always been the case. But E and S, environmental and social concerns, are coming more into play. These are the big areas where we look, without going into more detail.
Taylor Combaluzier, Red Cloud: Maria, what is Sprott's perspective on how silver can fit into an investment portfolio in the current environment?
Maria Smirnova, Sprott: At Sprott, we are big gold and silver bulls and involved in other commodities, including uranium. We've just launched an energy transitions fund to capitalize on other metals as well other materials. Some of the themes we discuss are related to silver. Generally, we have been advocating for a small proportion of an investor's portfolios to be in silver and gold. You can call it a hedge; you can call it a diversifier. We have done studies that demonstrate that having precious metals in your portfolio has the potential to increase returns and reduce risk over time, and I mean decades, not month to month. As Peter said, mining equities can be quite volatile, but they can potentially benefit portfolios over time. At Sprott, we believe in hard assets, gold and silver, specifically, especially in the current macroeconomic environment. We think the backdrop for silver is very positive from several perspectives.
Taylor Combaluzier, Red Cloud: I would like to thank our three panel members for joining us today and for having this great discussion.
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