Join Stephanie and Grant for a fascinating conversation with a true legend of the precious metals industry, John Hathaway.
The three discuss John’s storied career, what the gold market looked like twenty years ago, how John’s experience of multiple cycles has helped him deal with the volatility inherent in the precious metals space and what he expects to see going forward.
Gold’s role in a portfolio, how to identify potential investments and the importance of managing the psychological component of what can be a tempestuous ride all come under the microscope…
Grant Williams:
Before we get going, here’s the bit where I remind you that nothing we discussed during The Super Terrific Happy Hour should be considered as investment advice. This conversation is for informational and hopefully entertainment purposes only. So, while we hope you find it both informative and entertaining, to say nothing of super and terrific, of course, please do your own research or speak to a financial advisor before putting a dime of your money into these crazy markets. And now, on with the show.
Jerry Seinfeld:
People always tell me, you should have your money working for you. Because, you send your money out there working for you, a lot of times, it gets fired. You go back and what happened, I had my money, it was here, it was working for me. Yeah, I remember your money. We had to let him go.
Grant Williams:
Welcome, everybody, to another Super Terrific Happy Hour. The ingredient that makes it all feel those things, is my co-host, of course, the effervescent and luminous, Stephanie Pomboy.
Stephanie Pomboy:
That’s pressure, that’s real pressure.
Grant Williams:
This is pressure you’ve dealt with your whole life, don’t whine about it. How are you doing?
Stephanie Pomboy:
I’m doing great, how about you?
Grant Williams:
Well, I had something shoved up my nose this morning. And, hopefully, if it comes back all clear, they will cut the tracker bracelet off me and I will be allowed to-
Stephanie Pomboy:
Leave your house?
Grant Williams:
Fresh air. Yes, I know. After two weeks of climbing the walls, which will be, I have to say, a huge relief. I’m not going to deny that it sent me slightly batty.
Stephanie Pomboy:
You’re such a menace to society, they finally locked you down.
Grant Williams:
Yeah, if I keep getting positive COVID test coming back every few days, just to keep me in here, then I’ll know that it really was a case of menace to society.
Stephanie Pomboy:
Yeah.
Grant Williams:
So listen, we have a mutual friend of ours joining us today.
Stephanie Pomboy:
Sure, do.
Grant Williams:
The great John Hathaway, who, you and I, have both known for a long time. You probably better than me, seeing as your proximity to him out in the Wild West. Do people get offended if you call them a doyen? I’m not sure. I don’t think I would be. I think, if you’ve been around long enough to be achieve doyen status, that’s a good thing, isn’t it?
Stephanie Pomboy:
I would think so, but, as a female, maybe I have a different threshold on what appropriate to be called?
Grant Williams:
Yeah, true. You’ll be a doyette one day, I presume. Or, is it doyenne, two N’s and an E on the female… I’m not sure. But anyway, John Hathaway is, without question, one of the doyens of the gold market. John’s been around for a long time. His managed money in the gold space for 20-plus years. So, Steph, and I had a fantastic chat with him. The reason I’m telling you that we record this in the past is because we had all kinds of stuff going on today. We had dogs, we had poor internet connections, we had police sirens, it was really quite the experience.
Stephanie Pomboy:
I hate to pull this one again, but Mercury is in retrograde again.
Grant Williams:
Listen, what I need, I need somebody to tell me when it isn’t in retrograde, because it seems to be in retrograde all the damn time.
Stephanie Pomboy:
We have to schedule these a little better. We’re going to have to consult the astrologist before we record our podcast for now.
Grant Williams:
You’re right. We need an in-house astrologer. How very bull market is that, an in-house astrologer.
Stephanie Pomboy:
Right.
Grant Williams:
Perfect. Why don’t we just get to the important part where you and I chat to John, and then we can reconvene afterwards? What do you think?
Stephanie Pomboy:
That sounds splendid.
Grant Williams:
Here is our chat with the great John Hathaway. Well, John, welcome to the Super Terrific Happy Hour. I hope you’re feeling all three this morning.
John Hathaway:
Well, thank you. It’s a little early here for happy hour, but I guess it’s five o’clock somewhere.
Grant Williams:
Always. That’s the beauty of five o’clock. It’s always that somewhere.
Stephanie Pomboy:
And, it’s Friday, so you can start early.
Grant Williams:
Exactly, right. So, John, the subject at hand today, is one dear to all three of our hearts, and that’s gold. What I’d love to start off by doing if I can, because there will be people out there somehow, who are unfamiliar with your storied career, and so I’d love to go right the way back and give people a snapshot of what brought you into the gold space and what the kind of environment looked like at that time. Because, I suspect, when we get further on into this conversation, it’s going to be a really useful reference for people.
John Hathaway:
Sure. 1998, I had just joined forces with my old friend Robert Kleinschmidt, at Tocqueville Asset Management. As a contrarian firm, which we basically were value-oriented, we found ourselves very out of sorts with what was going on in the markets in those days. Obviously, dotcoms, telecoms, all the things that were very popular, were things that we couldn’t bring ourselves to. In a brainstorming session, I blurted out, “Well, maybe we should launch a gold fund, that would show our true colors.” We’re very small then, so we’re all sitting around on a small conference room table, and everybody started laughing when I mentioned it.
John Hathaway:
Then, our founder Francois Sicart, said, “You know, John, that’s not such a bad idea.” And, he said, We’ll seed it with some of our capital and a few clients. And, since you brought it up, you be the manager.” I said, “What have I gotten myself into it.”
Grant Williams:
You asked for it, you got it.
John Hathaway:
Exactly. So, be careful when you blurt out something off the top of your head. But, I haven’t really learned that lesson very well since. So, we launched the Tocqueville Gold Fund with $10 million. It was a mutual fund in June of 1998, and, at its peak, we grew to 3 billion. That was about 10 years later, maybe a little bit longer, 2011. So, it was a great run and I thought what was going to be a part-time job, basically took all of my time. I did it, at first, by myself, and then I hired Doug Groh, I think, it was probably ‘03 or so, and then we added a few more.
John Hathaway:
But, it became very important to the firm. And, frankly, for a guy who used to be a value investor, going back to my David J. Greene days, in the late 1970s, and as a generalist, and then before that, I was at Spencer Trask, where we believed that the higher, the better. We believed in desert island stocks, where you could go away to a desert island and come back and everything would be great. Or, one-decision stocks. Obviously, Spencer Trask, it was a long decision, because if you bought Avon or Polaroid or Kodak, and thought it was a desert island stock. [crosstalk 00:07:08] back to a very happy outcome.
Grant Williams:
You had a chance to get out of those Kodak last year, don’t forget, or earlier this year, finally.
John Hathaway:
That’s kind of, a quick survey of how many decades now, 1972 till now. So, a bunch of years, but basically just gold since 1998. And, it was great for 10 years, 11 years, then we went through the nuclear winter from 2012, really, until about 2018. A lot of the competition dropped by the wayside. I guess, at the end of ‘18, we were one of the few people standing. My partner, for various reasons, thought that Tocqueville should not be in the institutional business anymore. Clients weren’t sticky, etc. He saw the gold fund go from 3 billion down to about a billion.
John Hathaway:
He felt the same way about some of the other… We had a very good international fund or international value. We sold that. And, we’d started a process for the gold fund. There were a few biters, surprisingly, and one of them, the one that had the best terms and the best deal, was Sprott. So, as of January 2020, my team and myself, all of our clients are part of Sprott Asset Management. For anyone who might not know, Sprott is 100% devoted to the precious metal space. I have, at my disposal, now, something I didn’t have a Tocqueville, a number of very good analysts, so very good geologists. Sprott has investment banking capabilities in the space, they also have a lending capacity. They also have closed in funds that are backed by physical metal. So, we were kind of, soup to nuts, and the missing piece was active management of mining stocks, which is what we brought to the table.
John Hathaway:
So, that’s where we are today. You could credit Sprott for buying at the low, I think they did. In my case, it worked out very well. So, I’m looking forward to this next leg of the bull market.
Stephanie Pomboy:
It’s amazing how more than 20 years after you started the fund at Tocqueville, or you came up with the idea, it’s still being met with snickers of derision, even though it’s performed so well, relative to the conventional asset groups that people really focus on. It’s sort of, quietly, really done quite well. Do you feel, from your new vantage point at Sprott, you get a window into flows and whether there’s a real shift where you’re getting real money buyers in here who are interested in this space?
John Hathaway:
No, I point out that gold has outperformed every other asset class, or the other asset classes since 2000. So, back to your early observation, it often amuses me that there’s so little recognition of that. And, we can come back to that. But, the fact of the matter is that, having outperformed S&P and having outperformed bonds, and obviously it’s up in dollars, substantially, there’s very little interest in it, even now. We could talk about why that is, but that’s the fact, that it’s still considered to be a fringe strategy, maybe even lunatic fringe.
Grant Williams:
Yeah.
John Hathaway:
It’s definitely not mainstream. And, I’ve been trying to make the case, there have been others as well, some of our mutual friends, Dan Tapiero would be a good example, but there are others, that bonds basically can’t do the job anymore of diversifying conservative portfolios where you’re trying to balance equity and balance equity risk. We could talk about that, it’d be an interesting conversation, but the fact of the matter is that the bonds, because they’re at the zero bound now, basically, it’s return free risk. I see more people using that. I have to credit Jim Grant was coming up with.
Stephanie Pomboy:
Jim Grant, yeah.
John Hathaway:
Everybody uses it now. So, what’s going to fill the void, and gold, basically, has years of history, you could say, millennia, for 1000s of years. It’s been a very effective risk diversifier. I believe that gold will eventually and, maybe sooner rather than later, the way things are shaping up, fill some of that back that vacuum that bonds have vacated. If you do the math on it, and I just wrote this and sent both of you my latest article, the inflows into physically backed gold ETFs this year have exceeded… this is year-to-date, have exceeded any previous year. I believe that number is somewhere in the 900 billion, I think. It worked out to around 900 metric tons.
John Hathaway:
That sounds like a lot, but it’s a drop in the bucket. Because, I did some research on this. There’s around 100 trillion of assets under management by various kinds of managers, pension funds, banks, mutual funds, and so forth. If you just hypothesize that maybe 1% of that 100 trillion moves into gold because of the vacuum that bonds have created, well, that would require, at current prices, the next six years of annual global gold production, and the market simply can’t clear at that price. So, you don’t have to hypothesize inflation or deflation, all you have to say is, bonds are stuck at the zero bound. Maybe, they go to negative nominal yields, that’s a speculative bet, but they could. But, I think, most conservative investors, probably would shy away from that, but, gold, you look at the look at the record since 2000 and you say, well, that’s probably not a bad place to diversify equity risk.
John Hathaway:
In my mind, this is just back in the envelope kind of, numbers, the market can’t clear if you hypothesize 1% of 100 trillion moving into gold at $1900. It, more likely, clears 5 to 10,000. It depends on the timing, it depends on a lot of things. But, as long as bonds stay pinned to zero interest rates, which it seems to me to be a reasonable bet, it isn’t hard to imagine gold prices going up three to four, five-fold from where we are today, without, necessarily, end of the world scenarios.
Grant Williams:
John, there’s a bunch of things I want to come back to, and, particularly, this idea about bonds and being able to diversify portfolios anymore. But, before we get to that, I want to take you back again to that crazy idea you had to launch the Tocqueville gold fund. Just explain, for people listening, the conditions around you, because, at the time, it would have seemed like a crazy idea that perhaps you could just describe the state of the gold market, the mood, the condition of a lot of the companies, the balance sheets, a lot of the problems that there were around that time, because there were a lot. Even for gold guys, it would have been a crazy idea.
John Hathaway:
Yeah, first of all, two things, the market environment was very similar to what we have today.
Stephanie Pomboy:
Yeah.
John Hathaway:
That’s just the general euphoric mood of the financial markets. The gold business had come out of a long period of low profitability, many of the mining companies were being managed by financial engineers, Peter Munk comes to mind at Barrick, and I think others followed suit, that gold was just another commodity pretty much like aluminum or zinc or iron ore. So, a lot of the large producers thought it was very smart to sell gold forward. They had reserves in the ground that would be produced over the coming years, and it was just simply an arbitrage, you could play the yield curve, and get a forward price on gold that was higher than spot today, because, in those days, you had a yield curve that was more steeply sloped.
John Hathaway:
So, the forward price of gold look pretty attractive relative to spot. Then, the only issue was to produce it at costs that were held under control. That was the theory of the whole idea. But, what that did was, bring future supply of gold forward, and it effectively depressed the spot price. In addition to that, central banks also decided that gold was not worthy of their balance sheets, and was a non-yielding asset. I would say, this probably started in the mid-1990s, selling gold, leasing gold to get some return. And, the combination of those things, and the general opinion of gold at that time, was extremely negative.
John Hathaway:
So, I think that combination of factors, the supply of future gold that be produced plus existing gold, it was on the balance sheets of the central banks, essentially drove the gold price down to… I remember it very well, the UK was among those that wanted to sell and Gordon Brown was the Finance Minister, I believe, and UK dumped a couple 100 tons of gold on the market when it was trading around 250. That will forever be known as the Brown Bottom and the gold price. That led to the Washington Accord, in which the central bank’s agreed to sell only X amount of gold for a period of years. I believe it was five years.
John Hathaway:
That marked the turn in basically what was a 20-year bear market in gold. It had peaked out around 1980 at $800 US, when Volcker put the screws to inflation. So, some of us remember, not everybody listening what, what it was like then, and basically gold took it on the chin for 20 years. So, that was our start, I guess, what always helps, but we collectively agreed that gold was completely out of favor, it fit with our contrarian philosophy. And hence, the Tocqueville gold fund.
Stephanie Pomboy:
I guess, those forces that conspired to push gold lower, have now reversed in terms of, the central banks are no longer selling gold, they’re buying, right? The mining companies have also stopped this practice of wantonly selling forward production, haven’t they?
John Hathaway:
There’s no kind of gratuitous selling of gold forward, just to generate revenue for the balance sheet. You do see some selective forward selling. Typically, to bring a new gold mine into production, bankers might require some hedging. So, you see it that way. But, it’s not like just selling gold and hedging future gold. I believe there are some companies that were well over 50%, maybe even 70%, hedged at low prices. It’s kind of an interesting story, because what happened is that the price of producing gold went up, and the gold price went up.
John Hathaway:
So, companies that had to deliver into hedge books at prices that they had agreed to, maybe, three to four years before, were losing money on deliveries, and it led in the case of in one company, Ashanti, a bankruptcy. And, in the case of Barrick, again, going back to Peter Munk, a great financial engineer that he was, and he was in cahoots with Goldman and with bankers, it was like a frenzy of selling that left Barrick with a hedge fund that was losing money. I can’t remember the exact years, but four or five years later. They had to basically de-fees the hedge book by issuing debt to buy in and to restructure what essentially it was a bad debt to the Goldman Sachs’s and the JP Morgan’s of the world.
John Hathaway:
So, it’s a great lesson in financial engineering and group thinking. And again, Grant’s question goes back to the atmosphere that prevailed in those dark days, 1998, 1999. So, what we’ve seen since then, is, it started with dot com crisis, the dawn of radical monetary experimentation by central banks. That’s why I like to go back to 2000 when we show, because that, to me, was the thing that changed the market for financial assets, and also for gold. What I think we’re in now is a steady March hasn’t been steady, I’ll have to say. It was an unsteady March, because, after 2011, we had this nuclear winter, that’s five or six years.
John Hathaway:
I quoted Kevin Warsh, who’s a very smart guy who wrote a great op-ed in the journal, it was back in early September. He basically said that, once an institution embarks on a path that the Fed has embarked on, and, of course, all the other central banks of the world are doing the same thing… And, we could talk about fiscal policy in a second… there’s no turning back. Each iteration of QE has been bigger. The current one, I guess, it’s QE 5, is 120 billion a month, 1.4 trillion a year of balance sheet expansion. If anyone thinks that there’s not going to be another QE, they’re absolutely smoking pot, as we do here in Colorado.
Stephanie Pomboy:
Well, much less any unwind of this balance sheet. This notion that they had, that they were actually going to be able to unwind the balance sheet or be watching paint dry. It’s amazing that it seemed like the Fed actually believed that internally. I’m sure, Kevin Warsh, had he been there, would have said-
John Hathaway:
Yeah, Kevin, that’s probably why he didn’t get picked as Fed Chairman. Powell is basically the puppy dog for the treasurer, doing their bidding. Basically, what it has led to, is the emasculation of the Fed as an independent, institutional factor in determining interest rates and monetary policy. That has repercussions all over the place. It has repercussions in terms of valuation of financial assets, it has enabled fiscal spending of a magnitude that nobody would have dreamed of even five years ago. What I think the gold market is fishing out, sensing, is that there’s absolutely no way of turning back. Our mutual friend, Lacey Hunt, says, the only way out of this is extended period of austerity. And, lots of luck with that.
Stephanie Pomboy:
What’s that word?
John Hathaway:
Austerity, yeah. Belt tightening. You heard of belt tightening?
Stephanie Pomboy:
Oh, my gosh.
Grant Williams:
Yeah. Austerity is one thing, extended is a completely different factor.
John Hathaway:
Actually this year, we’ve seen austerity. Stephanie, you pointed that out in this last article. So, their savings are up, people have held back on spending. So, maybe, we do get a burst of inflation, that’s probably why the yield curve is steepening a little bit. But this is all picking up dimes before bulldozers. It doesn’t change the bigger picture, but probably, maybe, we do get a few months of higher inflation because of these supply chain interruptions and a number of things you could bring to bear. But ultimately, the Fed has to keep interest rates right there at the zero bound, 1.77%, is the average interest rate on 25 trillion.
Grant Williams:
Yeah.
Stephanie Pomboy:
Right.
John Hathaway:
If rates went up by 1%, think of what that would do to, not only this already crazy budget deficit, but what would be the repercussions in the job market or the-
Stephanie Pomboy:
Yeah, the corporate space, it would be annihilated, yeah.
John Hathaway:
So, again, it’s a matter of just watching this train wreck go down at a very slow speed, and yet the investment consensus still thinks they can bring it back under control. That’s the thing that absolutely drives them nuts.
Stephanie Pomboy:
That’s incredible. There’s facts that just came out and noted that, analysts expect a 12% increase in the S&P over the next 12 months. And, this is what we’re up against. I mean, when we talk about, and we should go into it, this trade-off between stocks, bonds, or gold as a new rival for bonds as the safe haven. Because, right now, no one’s really thinking about that as a long-term investment thesis, stocks are still the place to be and they’re going to go up 12%, and deficits going to go back down to 1 trillion a year, and the Feds going to shrink its bounty.
John Hathaway:
That would be great, yeah. Yeah, that’s like the prevailing wind, a guy across the street here unveiled, a potato patch, we call him… This shall not be recorded, I’m sure, but we call him Bloomberg Barry. He’s our Bloomberg about once every two weeks, and that’s his calling. You see, we have a cordially neighborly relationship.
Grant Williams:
So John, let’s talk a little bit about this, about the macro backdrop then for gold. We’ve talked a little bit around it, but you wrote a really good piece this week, I guess, just talking about the simple math of gold. So, as all that’s fresh in your mind, I’d love you to lay out that thesis, because this is the thing that struck me about gold over the years is, when you boil it down, it’s such a simple thing to understand, gold. If you can park the idea that it doesn’t produce a yield, it’s just a lump of metal. If you can just get past that first part of the jigsaw, the case becomes very compelling and actually very simple quite quickly. So, perhaps, you could walk us through that simple math equation of yours, so people can understand where you’re coming from.
John Hathaway:
Right, okay. First and foremost, gold has an outstanding record of being uncorrelated with financial assets. Off the top of my head, I can’t remember the numbers, but if you stack gold up against bonds, real estate, other commodities, equities, it has a very low correlation with them. Now, that also can mean that, during a bull market in financial assets that gold would underperform. But, certainly in periods of stress, and over long periods of time, as we’ve talked about, in this chat, a 20-year cycle, it performs very well. Bonds can no longer do the job, for reasons that we’ve talked about, but just to reiterate, it’s hard to imagine bonds, particularly at the short end, trading much more than the zero bound. Now, the longer end is a different discussion, but at the short end, bonds.
John Hathaway:
So, bonds which have traditionally been the diversifier of choice, to balance equity risk in conservative portfolios, no longer does the job. So, asset allocators must be thinking, what else can we do? Now, this is not to say that there are super smart investors, most of whom you’ve had on your podcast, haven’t been able to generate very good returns, but we’re talking about 100 trillion of AUM’s and growing at a pretty good clip, which can hire a Druckenmiller or a Dalio or Klarman. People like that, they’re just not available. So, they have to basically accept generic returns to meet pension fund obligations, beneficiary retirement obligations, that sort of thing. So, they’re stuck with the generic return that you get in asset classes. If you look forward, and say the bonds can’t do the job, and you’re going to own equities, which is generally where you get your alpha, they’re pretty risky these days.
John Hathaway:
I referred to the valuations of the market today versus 2000, and they’re very similar, in fact, in some cases, worse. So, I’m thinking, if I’m an asset allocator, and I’m aware of this and I’m not drinking too much of the Kool-Aid on Bloomberg and CNBC, got to do something. What is that something? Well, gold, front and center, is one of the answers. There may be other answers, but gold certainly is one of the answers. So, we’ve seen some of this. We saw-
Stephanie Pomboy:
Was it Ohio Pension, or one of them?
John Hathaway:
I’m sorry?
Grant Williams:
Yeah, Ohio.
Stephanie Pomboy:
Yes, it was Ohio Pension that started that.
John Hathaway:
It was the police and fireman’s pension plan, which is advised by Wilshire Associates, which, I’m guessing, advises trillions of dollars in pension fund assets in the public space, I’m guessing. Anyway, they said 5% is what it is. Now, how they implement that, we don’t know. But to me, that was like, boy, that’s the first, I hate to use the word, green shoot. That was certainly a sign of what I think is things to come. It’s not like everybody’s on board. In fact, nobody’s on board, I can tell you that, just being in Sprott, the kinds of flows into physical metal that exists. They, typically, almost can guarantee you that there isn’t a state pension fund among [crosstalk 00:31:08] allocations. They’re family offices, individual investors. People who can make quick decisions, don’t need consultants to do their thinking or to paper over decisions.
John Hathaway:
So, we’re just at the very beginning of seeing that shift take place. Then, just to go back to maybe reinforce the point, at the current price of 1900, the market cannot clear trillion dollars, which is 1% of global AUM’s, and that’s based on a Boston Consulting Group study. It’s probably not the most accurate number in the world. It’s kind of, a fuzzy number. But order of magnitude, it’s not a crazy number. So, 1% of 100 trillion, you can’t do it at today’s price. I said earlier, it works out to six years of global mine production. This other number that people toss around as though all the gold that’s ever been mined, is still above ground. So, the supply of gold is much greater than what you’re talking about, the annual global mine supply.
John Hathaway:
But, I think that’s a crock. The reason I think it’s a crock is because so much of that gold that’s ever been mined, is not in marketable form. It’s not in 100 ounce bars, or 400 ounce bars. It’s on temple rooms in India, it’s in high-end Tiffany jewelry, much of which my wife has. You just can’t bring it to market. So, I would say, that number’s maybe 20%. But, the only way you coax it out of other forms that has been shaped into, is by higher prices.
Grant Williams:
Yeah.
John Hathaway:
So, I’m pretty comfortable in this analogy that, as long as we have very low interest rates, and bonds are out of the picture, the goal is next up, and I just don’t think you need to hypothesize drastic scenarios. We could do that if we wanted to, but we don’t have to. You could approach a very conservative investment committee and saying, look, you got to allocate something to go because better bonds are going for it. That’s, to me, the most compelling thing you can say about why gold is headed higher, without even getting into some of the more macro extensions of that, the implications of big budget deficits and rapid money creation.
Stephanie Pomboy:
This brings you to the question then of the pushback I always get on the gold thesis from big institutions is, it’s too small to be investable. That’s what I hear routinely. It’s too small to be investable. Like, well, if you wait until it’s big enough to be investable-
John Hathaway:
That’s too late.
Stephanie Pomboy:
But, how do you answer that question?
John Hathaway:
It almost answers itself. If there’s not enough to go around, at these prices, well, gee, what does that mean?
Stephanie Pomboy:
Right.
John Hathaway:
Maybe, there will be enough to go around at something much higher. Bill Simon, who was the Treasury Secretary in the 70’s, said the same thing, that once they closed the gold window and inflation was high, they were trying to figure out what to do about it. I’m sure, people suggested that they back the dollar with gold once again. Simon’s answer was, well, there’s just not enough to go around. Yeah, ever since, there hasn’t been enough to go around.
Stephanie Pomboy:
Right.
John Hathaway:
So, the supply of physical metal, which grows, by the way, at 1% or 2% a year, those are pretty basic numbers.
Grant Williams:
Yeah.
John Hathaway:
It just doesn’t compare to the supply of financial assets, which has been ramped up because of what the Fed and other central banks are doing. So, frankly, as long as we have a market in which stocks can trade at 25 x earnings, good companies, and that we did an equal weight of the S&P EBITDA, we basically tried to reduce the influence of the 5 or 6 stocks that are just completely crazy. It still works out to 16 x enterprise value to EBITDA, whereas the gold miners, totally shunned, are trading around 8 x. So, if you’re a value buyer, which I’ve always been, then you can make a very compelling case right now that… we’ve been talking about gold mainly, but you could also talk about gold stocks, which are geared to the gold price.
John Hathaway:
If you believe, no, Merrill Lynch is saying $3,000 on the gold price. I’m not sure how they came up with it, but you hear Dalio talking about higher prices, not sure he’s put a number out there. But, you do hear respectable, highly-esteemed people talking about numbers, 3, 4, $5 000 now. If you really believe that, the upside in gold stocks is just dramatic. These companies, most of what we own, unless they’re in the developing side, where we’re just building a mine or in the export. But, the ones that are producing, trade the big cap guys, at free cash flow yields of 5 or 6%. I’m talking Newmont, Barrick. Barrick will generate something like current prices and expected costs, something like 30% of their enterprise value over the next four to five years in free cash. Newmont would be similar. Then, we have others that are down the totem pole in terms of recognition and smaller mid cap. We’re trading at 20% free cash flow yield.
Grant Williams:
Yeah. John, we talking about stocks, I wanted to get onto these. You had a chart in your piece this week, which I’ve used many times. It’s such a great illustration of this. That’s the ratio of the gold price to the Philadelphia Gold Bucks Index, the HUI, because I think a lot of people, they’ve seen gold, go to break that magical $2,000 announced barrier and it’s corrected and we’ve seen all the jarring, jawboning around that, which is to be expected in both directions, I guess.
Grant Williams:
But, we’ve had what you’ve so beautifully described as a nuclear winter. I think during that time, there was a hell of a lot of damage done to the psyche of people who either owned or tried to own gold stocks, because during that nuclear winter, these things were just taken out behind the woodshed and clubbed. It’s been horrendous to watch. There’s this feeling that either it’s going to happen again, which I suspect this time around, may not be the case. I’d love to get your thoughts on that. But, also, the fact that these companies are in much better shape now. And yet, if people perceive that they’ve had a good run already, you look at that ratio of the gold price to the mining stocks, and it’s still down at the kind of low level it’s been, I don’t know, [crosstalk 00:38:43] to start with your fund. Yeah.
Grant Williams:
So, just talk for a little bit if you can about that relative valuation of the gold mining stocks and how you think about those in terms of that leverage, you mentioned earlier as a proxy for the gold price itself.
John Hathaway:
Okay. I think that’s a good point because you’re right, the self-inflicted damage, that the mining company management’s inflicted on themselves when gold peaked out at 1900, 9 years ago, was considerable. Their balance sheets were compromised by debt, by badly thought out takeovers, and also costs of mining rose sharply, so the profitability of the margin, the spread, between the selling price and cost structure… in those days wasn’t even totally understood, because everybody looked at cash costs.
John Hathaway:
So, fast forward to today, I would say you have a completely new breed of management, that are more financially aware in terms of how to manage their balance sheets. They’ve been chastised for the mistakes that they made. And, if anything, I would say they’re being too conservative today because there are incredibly attractive acquisitions. You can buy an existing mine in the market at a 30 or 40% discount to what it would cost to build it from scratch. You just telescope the whole process. But anyway, so that’s where we are today. So, mining company managements are talking about raising dividends, which is a good thing, the payout ratios are very low. But, I think there’s room for them to increase. And, for the most part, you’re not seeing aggressive takeovers, you’re seeing mergers, but mergers of equals for synergies.
John Hathaway:
There’s rationale for it. I’m not 100% in favor of those kinds of mergers, but you’re seeing it, and the cost side of the equation, the global cost of mining an ounce of gold is roughly $1,000. An important component of that is energy. So, energy costs are attained. Foreign exchange is a big factor. So, if you’re operating in an emerging market, maybe, 30, or 40% of your costs are in local currency. So, at least now, I’m not saying that wouldn’t happen. But, we’re not seeing now and for maybe the next three or four years, the kind of cost blowouts that wreck margins.
John Hathaway:
So, when you think about the economics of mining, if it cost $1,000 to mine, and maybe two years ago, the average gold price was 14 or $1500. Today, this last quarter, the cost averaged $1900, and the costs are still $1,000, so their margins have doubled, but their stocks have not doubled. If you’re bullish on the gold price as I am and you think the gold price can go to 2500 or 3000 over the next two or three years, and those costs, they’ll surely rise, and that’s one thing you have to keep an eye on. The managements are still looking at life through the rear-view mirror, which is not a complaint, it’s just an observation. So, I don’t see them doing the stupid things for at least two or three more years that they did-
Grant Williams:
It’s just a matter of time.
Stephanie Pomboy:
We have a stupidity window, here.
John Hathaway:
Yes, we have a stupidity window. So, who knows what the world looks like, three years ago, in terms of inflation and that kind of thing. But anyway, right now, you’re in a terrific spot for these companies to show rising earnings, dividend increases, share buybacks, and they’re doing all that. And, as shareholders… And, we’re very vocal backseat drivers. We’re certainly letting our feelings be known that this is the right thing to do. The one thing that they’ve not done is not buying enough of our portfolio that they should be buying because the returns on capital. They’ll get there. Maybe, [inaudible 00:43:03] to be able to call it a day.
Stephanie Pomboy:
Well, I know you’re obviously bullishly positioned, both on the bullion in the minors, but if you were to take… let’s say, someone gave you $1,000, what would your allocation between the bullion versus the miners be right now? Would you be putting it all in the miners to get all the leverage? Or, do you think that you’d still focus on the bullion itself?
John Hathaway:
To me, the answer to that, it’s a little wishy washy, but I think it depends on who you are and what kind of investor you are. I think, for people who are trying to play it safe, then weight your exposure towards metal. It’s a super safe asset, own it the right way, own it in physical form, outside of the banking system, and there are ways to do that, or you can own GLD. Or, you can own something like a Sprott physical trust, which we know the gold is there and it’s backed 100%, so that’s okay. And, it’s exchange traded, so you have overnight liquidity.
John Hathaway:
But, if you’re more like me, and you would like to max out your returns, you would weight your exposure heavily towards mining shares. It’s inconceivable to me that they would not perform way better than the bullion price. If you think bullion price is going to even take the Merrill Lynch number, 3000. I just can’t imagine, even the most bid cap conservatively managed mining stocks, wouldn’t go up by a factor of 3 or 4X to that…
Stephanie Pomboy:
Don’t they need to up three times just at the current price to be trading at the ratios they were a decade ago, relative to gold?
John Hathaway:
Yeah, I’d have to go back and look at that. I don’t know the answer. Don’t forget, the mining share space is very small, it might be $250, $300 billion.
Stephanie Pomboy:
I think it’s the same size as Home Depot.
John Hathaway:
Okay. But, maybe, one of these new high tech start-ups.
Stephanie Pomboy:
Yeah.
John Hathaway:
Yeah. I’m just astonished at the valuation. But yeah, it’s a tiny space, so it wouldn’t take big capital inflows to drive these stocks way higher, and they’re still basically out of favor. So, to me, I’m trying to max returns. I’m going for the stocks versus the metal.
Grant Williams:
John, just expanding on that a little bit, because we’ve talked a little bit about how there’s a lot of new people coming into the space and how we’re starting to see endowments come in and I’ve been having a couple of conversations, which confirm that, for sure. This question is really, for people who haven’t invested in a mined gold mining space yet, but it’s going to be incredibly useful for people who have and are still sitting there with the hands over their eyes, looking at the charts every day. But, how do you go about identifying… what are the things you look for? Is it management, above all, and then asset? Or, how do you assess a company, assess a project, to figure out whether it’s investable?
John Hathaway:
Yeah, that’s a great question. But, you look at management, obviously, and I’ve been around in this space long enough that I know, pretty much, everybody.
Grant Williams:
Yeah.
John Hathaway:
At Sprott, we have some really good geologists, nitty-gritty analysts, so we scrub the assets very carefully, and that’s very important. Another consideration is political jurisdiction, asset safety. You feel better about Nevada, or Canada, in general, or Alaska than you do about Mali or Burkina Faso or Indonesia. But, it’s relative, because they’re all ultimately bad. When gold goes up, is, these companies will have a bull’s eye on their backs for higher taxation. It’s inevitable. Not to put any cold water on the thesis, but, I think, going in with your eyes open, you would have to expect that somewhere over the next three or four years, if gold does what I think it’s going to do. And, these companies produce the kinds of earnings and cash flow that I think they will, then you have to expect that there will have to be concessions made along the way to the local governments. So, it’s just something to think about. It’s nothing we watch all the time, we’re on top of the nitty-gritty of that. But, to me, that’s a small consideration compared to the change that will take place in terms of profitability, dividends, and all that sort of thing.
Stephanie Pomboy:
It seems like the primary obstacle to the miners is just this same psychology that we get into when we started talking about it at the very beginning, where, despite the fact that gold has performed since 2000, and has done phenomenally well, this year, in particular, I think gold’s up around 25%, the S&P’s up 8, you still can’t have a polite conversation with someone where you suggest that gold is a meaningful asset class that deserves to be looked at on a par with stocks and bonds.
John Hathaway:
Yeah, I think that’s right, and I think the reason is that it’s threatening to the consensus, and we haven’t even gone there yet. But, if you extrapolate the trends that we talked about, which is the emasculation of the Fed, populism, etc. It doesn’t work out well for mainstream investment banking. My neighbor just can’t go there.
Stephanie Pomboy:
Bloomberg Barry.
John Hathaway:
Bloomberg Barry. So-
Grant Williams:
Sorry, Steph mentioned psychology there, and I know that was something else I wanted to ask you, John, because one of the biggest obstacles to making money trading, or investing in the mining space is the psychological component because it’s such a difficult horse to ride. A lot of people are trying to time these things, which, to me, is a one way ticket to the nuthouse. But, for someone who’s managed to survive and keep himself relatively sane over doing this over a 20-year, bull, bear and nuclear winter cycle, how do you think about handling that psychological component? How do you try and minimize the damage that the volatility can do along the way?
John Hathaway:
Some people would say that I am in the nuthouse, or have been, rehabbing or whatever. It’s very difficult. I have to tell you that, believing this thesis when gold was doing badly and the stocks doing worse, was very difficult. And, frankly, whatever, asked about it, and a lot of what I wrote in 2013, 2014, basically, was the long-term view.
Grant Williams:
Yeah.
John Hathaway:
Keynes said, in the long term, you’re dead. I think a lot of people… There are investors that remain committed to it, that suffer through those difficult years. But, frankly, I think it’s the memory of that, and the awareness of that in the mainstream, that still keeps people away. So, I just feel like much more upside is there just because investors aren’t. As long as the mainstream stocks, and forms of investment are doing well, are doing okay, even if the S&P is only up 8%, it’s still up 8%. People aren’t going to look here. It will only be very opportunistic kinds of investors, which is not the Ohio Pension Fund, it’s, the smart money is starting to take notice.
John Hathaway:
So, the question, I guess, was on psychology, and I think the psychology is still on its back foot. There isn’t high conviction, other than if you look at someone like me, people are very tentative, when they bring this up. I can tell you conversations we have with potential investors, and we might find, in an institutional setting, an individual who’s highly convinced that this is the right thing, but he’s afraid to bring it up in his group, his peers, because if you buy Amazon, and it goes down, 30%, well, you’re okay. You’re right there with the rest of us. But, if you buy Newmont and it goes down 10%, you’re-
Stephanie Pomboy:
You’re unemployed, yeah.
John Hathaway:
That’s where we are.
Grant Williams:
Yeah.
John Hathaway:
Because, we have these conversations, I can just tell, there’s great… People buy into the thesis, individuals will, but then to bring it up in an institutional setting where there’s peer review, it’s really tough.
Grant Williams:
Yeah, it’s fascinating to me, because I think of guys like you who’ve been in this industry, and have the kind of tenure you have, who understand the thesis, and have actually lived through the complete cycle. And, you’re really trying to sell that story to investors. So, for you to check that thesis in moments of stress and moments of poor performance, it’s just a question of going back through your experience and reassuring yourself and reminding yourself of times when similar things have happened and how it ultimately played out. But, any investors that come into, either, the Sprott funds or put mining shares in their own portfolios, they don’t have that repository of experience to fall back on.
Grant Williams:
So, I just imagine you constantly having to talk people down from the roof who bought into the thesis, and then suddenly get gut checked at a given moment, like we saw when gold corrected from 2000, back to 1880. Now, those of us who’ve been in the market for a long time, recognize that for what it is, and sure enough, here we are, it’s back through 1900. And, you can see all kinds of signs that there’s real buying around those levels now. But, if you bought into the thesis that 2100, just shy of 2100, wow do you talk to those people and say, listen, this is actually perfectly normal, and this is what gold does, and the thesis is still intact?
John Hathaway:
Yeah. That’s a good question. It’s hard. Because of these little shake up’s. If the stock went from 21 to 18, well, that’d be kind of normal, but when gold goes from 2100 to 1800, it’s like the end of the world.
Grant Williams:
Right.
John Hathaway:
So, psychology is fragile and conviction is scarce. I guess, that is a way of saying, for me, as a contrarian, there’s a lot of upside. But, again, dealing with that in terms of hand-holding explanations, and so forth, that’s a real challenge. But again, I’m talking to Druckenmiller or somebody like that, they’re fine with that.
Grant Williams:
Right.
John Hathaway:
But, if you’re managing the state pension fund, and you come up for a quarterly review, you’ve had a bad quarter. It’s the first thing out the door that is being criticized. So, there’s a long way to go in terms of getting on the investment thesis here. I’m seeing signs that it’s taking place, but I think as long as people are comfortable with the consensus, that things are going to just be okay, it’s still a hard sell.
Stephanie Pomboy:
I think of this as the flip image of central banking, in terms of the psychology. Gold’s been outperforming since 2000, but people are terrified to take that bet. But, the central banks around the globe have managed to make one disaster after another since 2000. And yet, for some reason, the confidence in their ability to steer us through any economic outcome is resolute. It will not be shaken.
John Hathaway:
Absolutely, it’s Teflon, they can do no wrong. And, because, as Mike Solomon said, and I quoted him, he said, they bailed us out, time and again. But, there may come a time that they can’t, that they don’t bail us out, that they have lost their magic.
Stephanie Pomboy:
Aren’t we there? As you said, with bonds at zero, now, what are they doing?
John Hathaway:
No, we’ll find out because Powell said, we have tools.
Stephanie Pomboy:
Yeah.
John Hathaway:
We have the right tools. We have other tools.
Stephanie Pomboy:
Right.
John Hathaway:
Groucho Marx says, I’m a man of principle, if you don’t like my principles, I’ve got others.
Grant Williams:
Exactly, right.
Stephanie Pomboy:
Oh, God.
John Hathaway:
Have they got the right tools.
Stephanie Pomboy:
Yeah. Oh, man.
Grant Williams:
Well, I don’t think there’s any shortage of tools at the Federal Reserve that I can see. That’s the good news. Now, you’re talking to me or the dog, John, I’m not sure?
John Hathaway:
The dog is sitting in my favorite chair.
Stephanie Pomboy:
Oh, boy.
John Hathaway:
Oh, my God.
Grant Williams:
John, I’ve just seen the time, it’s flown by, so we’ve taken a lot of your time, but there’s one thing else I wanted to ask you if you’ve got time, and that’s just, when you’re putting a portfolio together now, and you think of the majors, you touched on Barrick and Newmont, the likes of those guys that are very easy for people to get comfortable with, just because of the size. But, talk about some of the mid-tiers, some of the exploration projects, some of the places that are a little bit further up the risk curve and down the knowledge curve, so people get an understanding of how you try and identify companies in that space that are worth investigating further?
John Hathaway:
You look at Barrick or Newmont or Agnico, they’re terrific companies that do really good at what they do. But, that’s also priced into the valuation.
Grant Williams:
Yeah.
John Hathaway:
Again, I think Barrick, or a Newmont or Agnico will go up multiples of the gold price, the delta will be substantial. For a lot of people, that’s enough, probably should be enough. But, there are dozens of companies that are well below the awareness of generalist investors, that have incredible metrics, good assets. For Newmont or Barrick to grow is really hard, they produce roughly 5 or 6 million ounces a year, it’s very hard to grow. It’s not a growth business. The growth comes from developing a mine, maybe making an intelligent acquisition bolt on that kind of, thing. You can only do that from a smaller base. And, the companies with a smaller base are basically very underrepresented in the passive vehicles like GDX.
John Hathaway:
So, that’s where we find the most interesting values because they are… I didn’t mention this, but the mine life of the industry is very low, it’s the lowest in 30 years. Now, that doesn’t mean the large guys can’t extend their mind lives by doing near mine exploration and that kind of thing. But, there are these very good mid cap, smaller cap companies that are generating accretive value for shareholders by either discovering more ounces, because they’re smart geo’s or by successfully taking a mine that has yet to be built into production. And, that’s a very value accretive process. It can also be harrowing, it can also be difficult. I wouldn’t recommend that for the typical investors, but if you’re steeped in it as we are, we feel comfortable doing that kind of thing.
John Hathaway:
That’s where we would expect, if Newmont can go up three or four times, these holdings that we have, we think can go up, twice or three times that. That’s been the history of this space, since I’ve been in it. When generalist money starts saying, well, gee, Newmont’s pretty fully valued, what else can we look at? They’ll look at things that we’re talking about.
Grant Williams:
Yeah. I’m trying to picture the gold industry being fully valued. I can’t even conceive of such a thing.
John Hathaway:
Right. These can be there for, at least, a few years, the next growth stocks, because they’re going to have a great year-over-year earnings. The smaller companies are on a path to produce rising earnings and cash flow, not independent of the gold price. So, I think they will get discovered. We need the wind at our backs in terms of the gold price, but, assuming that, that’s where I want to be.
Grant Williams:
Yeah.
Stephanie Pomboy:
Hopefully, though, it won’t be discovered by the Robin Hood crowd because I don’t need that rollercoaster ride.
John Hathaway:
Yeah, I think compared to things like Hertz and [crosstalk 01:01:29]-
Stephanie Pomboy:
These companies are entirely too sturdy.
Grant Williams:
Way more risky.
Stephanie Pomboy:
Oh, gosh.
Grant Williams:
John, look, it’s been a lot of fun chatting with you. Thank you, so much, for taking all this time.
John Hathaway:
I’ve enjoyed it.
Stephanie Pomboy:
Yeah, as so I.
John Hathaway:
I assume this will be heavily edited.
Grant Williams:
What we’ll do is, we’ll cut the three of us out and just leave the dogs in.
Stephanie Pomboy:
Leave the dogs, right, exactly.
Stephanie Pomboy:
Oh, man.
Grant Williams:
John, for people that want to find out more about the work you’re doing at Sprott, how can they get in touch and find out more about the fund and what you do?
John Hathaway:
Oh, my God.
Grant Williams:
Don’t worry, I’ll find it out, I’ll do it.
Stephanie Pomboy:
Don’t feel bad, John, I say the same thing when Grant poses that question to me, what’s your Twitter handle? I don’t know.
Grant Williams:
Every week.
John Hathaway:
Go to our website.
Grant Williams:
Yeah, don’t worry, I’ll do that. I’ll do that in the outro, I’ll find the website and I’ll do it myself.
John Hathaway:
Okay.
Stephanie Pomboy:
Thank you, John.
Grant Williams:
All right, John, thanks for spending this time with us. Hopefully, we will get to do this in-person soon.
Stephanie Pomboy:
Safe travels to the land of fruit nuts.
Grant Williams:
Take care, bye-bye.
John Hathaway:
Bye-bye.
Stephanie Pomboy:
Bye.
Grant Williams:
Well, Steph, there we go. Look, John has seen every cycle that there has been in the gold business, which is why it’s so fun to talk to him, because he really has lived this thing up, down, left and right, backwards and forth.
Stephanie Pomboy:
Yeah, absolutely. No, his perspective is really excellent, very helpful, particularly right now, with gold doing what it’s doing. As we continue down this road of unprecedented monetary and fiscal policy, I love this notion of gold, supplanting treasuries as sort of, the conservative category and an asset allocation strategy. I think it’s a really strong case he makes and, boy, it’ll probably happen at a glacial pace, but it’s got to be starting to chip away.
Grant Williams:
Well, I had a conversation a week ago with the head of a large public endowment in the US, and it was a fascinating conversation. He’s a lovely guy and very smart and very concerned about all this stuff. He’s taken his gold allocation to two and a half percent, and he’s on his way to five. He was doing it through futures, at the moment. At some point, they just want to get to that allocation, what they do with it, once they’ve got the position, is anybody’s guess.
Grant Williams:
But, it was interesting when you think about the damage that’s been done to that psychological component by some of these dive bombing runs in the futures market. Yeah, it’d be interesting to see what happens if we have a whole lot of endowments just sitting there waiting for the chance to buy gold futures to get themselves positioned, because two and a half percent of the endowment market is a hell of a lot of money two and a half trillion dollars, if John’s numbers are right, even if they’re close to being right.
Stephanie Pomboy:
Yeah.
Grant Williams:
This market cannot even close to accommodate that kind of inflood.
Stephanie Pomboy:
Yeah, absolutely. Well, fingers crossed for that.
Grant Williams:
Yeah, fingers crossed. Well, that’s it for us for another week. If you want to read more of John’s writing, and I cannot encourage you to do that strongly enough, you’ll find it at sprottusa.com. If you go there now, you’ll find, on the front page, under the heading insights, you’ll find John’s piece, Gold, The Simple Math. We didn’t get into single stocks, but if you get in touch with John, you can find out more about the portfolio, more about the kind of stocks that John buys, and, as we’ve said, and hopefully it’s become self-evident through the course of this conversation, this is a space that John knows as well or better than just about anybody in the space, which is why we’re so thrilled to have him join us. Steph, I guess we say farewell to each other for another week.
Stephanie Pomboy:
Yes, It’s been super and terrific.
Grant Williams:
And, you leave me happy as always. I’m going to put you on the spot though, how should people try to find you in the interim?
Stephanie Pomboy:
I just looked it up. My Twitter handle @spomboy.
Grant Williams:
It’s still the same.
Stephanie Pomboy:
It’s still the same, apparently.
Grant Williams:
And it’s the same challenge to remember it. Mine is, @ttmygh. We will say our goodbyes and we’ll see you next time. Thanks for listening.
Stephanie Pomboy:
Cheerio, pip pip and all that.
Grant Williams:
Nothing we discussed during the Super Terrific Happy Hour should be considered as investment advice. This conversation is for informational and, hopefully, entertainment purposes only. So, while we hope you find it, both, informative and entertaining, to say nothing of super and terrific, of course, please do your own research or speak to a financial advisor before putting a dime of your money into these crazy markets.
