Trading conditions in natural resource, and particular extractive industries continues to be very challenging. The dominant trend in industrial materials, (base metals, ag minerals, energy minerals and oil and gas) is very soft; the oft forecast “economic recovery" would appear to be nonexistent everywhere. Even the U.S. economy is only strong in comparison to our anemic competitors, real incomes in the U.S. are weak, as is labor market participation, constraining both demand and productivity gains.
Recovery from commodities “bear markets" occurs one of two ways, through demand recovery ( this recovery comes either through increased user utility at lower price points, or an economic recovery) or supply destruction, where the industry retires or mothballs productive capacity that is temporarily or permanently sub economic. All indications suggest that this bear market cycle will end through supply destruction, a long and painful process. Decapitalizing industries that were very over capitalized in the previous bull market cycle takes a long time, and we would not be surprised to see the current malaise in industrial materials continue for two or even three years, in the absence of a meaningful economic recovery.
These industries are further challenged by rapidly increasing costs of capital, in a world where other industries are enjoying lower costs of capital. Rapidly declining share prices among industrial material producers, combined with sharply higher interest rates on project debt will continue to constrain emerging producers.
The good news is that the eventual recovery from a “supply destruction" resolution to this” bear market" can be expected to be very dramatic, as any increase in demand, or even a continuation of current demand cannot be supplied from shut in or shut down sources, and restarts are capital intensive, and time consuming. The decapitalization of the oil and gas industry in the last cycle, and the subsequent explosion of oil and gas prices are a great example.
The precious metals markets are more nuanced. The narrative surrounding the precious metals price escalation in the 2000 to 2011 bull market ( US$260- U.S.$1900) included unsustainable on balance sheet, and off balance sheet government liabilities, quantitative easing ( counterfeiting in Sprott parlance) and an over leveraged financial services sector, is unchanged. What has changed is investor’s willingness to tolerate these conditions. As an American citizen, the global faith in American political leadership is flattering, and the global hegemony enjoyed by the U.S. dollar, and U.S. treasury securities is more than flattering. We (Americans) etch promises to ay on bit and bytes (printing in these quantities is too expensive and old fashioned) and send them around the world in exchange for cars, electronics and other good stuff. How nice!
How long can faith last? I don't know, but this faith is not founded on math. I'm not one who believes that te dollar, or the U.S. economy will collapse, and I don't believe that precious metals will defeat dollars, or fiat currencies in general, but I do believe tey will begin to lose less badly, as they did last decade, and more famously, in the 1970's.
This bleak outlook has caused the TSXV to appear historically cheap. An index which has declined by 90 percent can double, and still be down by 80 percent. Put another way, it is nine times as attractive as it was, when it was popular. In truth, deep difficulties remain in the junior Canadian resource industries separate and apart from commodities pricing. Sprott estimates that perhaps two thirds of the TSXV companies are non-viable in any almost any commodity price scenario, and we estimate that the general and administrative costs of these non-viable public entities exceeds C$1,500,000,000 annually, an unsustainable tax on speculators and the industry.
These statistics, while grim, disguise the " silver lining" that was so well hidden during the sectors last bear market: the performance by the best companies in the sector is so spectacular that they add legitimacy and occasional luster to the entire group, and we believe that the best of the best are on a " once a decade sale.
**For compliance purposes, we don't provide "picks". I will discuss three companies we are purchasing for performance based accounts right now. Note that a “pick" implies an investment recommendation, which Sprott believes is improper conduct in the absence of knowledge concerning each recipients means, tolerance, and time frame.