Happy New Year to the best readers in cyberspace! I hope your 2019 is fabulous… and that you don’t have too many heart palpitations following the last couple weeks of market and political brinksmanship.
I haven’t written to you in a while, thanks to my much-appreciated time away with family and friends in the mountains, so in addition to the first part of the Friday File (released this morning, a teaser solution for your edutainment), I’ve got some minor updates on the Real Money Portfolio to share… as well as some thoughts about gold.
First, today I’m adding a little bit to my Altius Minerals (ALS.TO, ATUSF) position, just to be contrary for a stock that’s been falling sharply.
It’s falling for good reason, China slowdown fears mean that everyone is panicked about raw materials costs falling — so copper prices are down and iron ore prices are down, which drive much of Altius’ royalty revenue… though potash prices, their other big contributor, have been steady to rising a little.
Altius continues to have some debt, about C$120 million, but also plenty of financing flexibility and some equity and debt investments beyond the royalty portfolio and project generation portfolio, so the (small) dividend looks quite safe and they should be able to make further deals if they see anything compelling. I don’t know if they’ll get anything out of their Alberta coal claims other than a long drawn-out legal fight, but they are again getting royalties on Voisey’s Bay after settling that long legal fight, so that’s going to again be a revenue-generating part of the business instead of an odd footnote on the reports.
I allow my Altius dividends to reinvest, and this week I decided to boost the portfolio position slightly with some new money as well. I’ve done that pretty regularly for years, and it hasn’t worked out particularly well yet — Altius has been a drag on the portfolio, but I continue to think that their assets are more valuable than they’re being given credit for… and that they should be able to earn a stronger valuation if the commodities markets turn positive again (as they typically have, eventually, at least over the past 20+ years), along with possible windfall gains if some of their prospecting projects or spinoffs can be sold at high prices in the next peaking market, as they have managed to do a couple times in the past. I’m patient and stubborn with this one, so your mileage may vary, but I’m pretty sure copper and iron ore and potash will still be important and valuable in 20 years, and Altius will still be collecting royalty revenues on some solid projects. Like most of my past buys, this is not a huge one — I increased my position by about 5% at about US$8.
And in my other substantial metals-focused investment, I also exercised some of my Sandstorm Gold (SAND) call options that are due to expire in two weeks… I think gold is still important, and is likely to be more important if recent manic moves in the currency markets are any indication. Sandstorm is essentially all “optionality” for gold, with low operating costs… but with a substantial risk factor baked in thanks to their heavy reliance on the Hod Maden mine to provide most of their future (4+ years from now) revenue growth. That’s both because the mine hasn’t been built yet, they’re still in the study stage, and because it’s in Turkey, which scares people (though there are plenty of productive and operating mines in Turkey today, including some owned by foreign companies). Gold tends to do very well after the market does poorly, so the odds of a substantial rise in gold have increased a bit — though, of course, an agreement on China trade and a government Kumbaya moment could change that narrative quickly and send folks away from the ‘safety’ of gold.
That term is dumb, of course — gold is a way to protect yourself against currencies blowing up, and tends to be a last resort when you don’t trust other assets, it’s not “safe” in any timeframe that’s meaningful for most investors. I like it because it gives me some confidence to take other risks in my portfolio, since gold tends to do well after the market does poorly and can do well (though not always) when inflation scares people out of cash, but I also think of it as a global high-friction currency… it is pretty universally accepted as valuable, and has been so for thousands of years, but it costs money to buy and sell and hold it, and day-to-day demand for the physical metal seems largely to be driven by Indian consumers and the Chinese government, so there’s always potential for a shocking rise or fall in demand.
But I’ve been thinking some about gold as the recent market upheaval has put, at least temporarily, a little bid under the shiny stuff. That could change in a second, of course, particularly because gold prices are so driven by the value of the US$, which itself is often driven by changing interest rates (higher rates make keeping your money in US$ relatively more appealing, and if the dollar goes up then the value of gold in dollars generally falls… and, though both “gold” and “the dollar” have acted as something like a “let’s hide here” trade during times of distress, the dollar now pays a couple percent in interest… gold pays nothing and generally has a carrying cost in storage or management fees).
And adding a bit to Sandstorm here also got me to thinking about what was probably last year’s most heavily hyped gold story — the pitch from Dan Ferris at Extreme Value about his “new kind of royalty” investment that he thought would be his best idea ever.
That idea turned out to be Sprott (SII.TO, SPOXF), which I agreed at the time was likely to be levered to gold, mostly because of its heavy reliance on management fees for its exchange traded funds that provide liquid (and redeemable) access to physical gold. That hasn’t really been the case, at least in any kind of direct way — here’s the chart of Sprott shares versus Gold over the past year:
And even more recently, with gold in a bit of an uptrend since mid-August, Sprott shares have still failed to show any spark:
Sprott should be increasingly levered to those management fees IF we get a surge of interest in gold that lasts longer than a few weeks. Sprott charges a management fee to its trusts — the fee for the Sprott Physical Gold Trust (PHYS) is 0.35% of assets, for example — and the fee goes straight to Sprott to cover their “management,” it doesn’t cover the actual operating costs of the Trust (like storage, taxes, lawsuits, etc.) They say that if the total operating costs exceed 0.65%, including all those other costs, then they’ll reduce their management fee accordingly… though they do leave themselves some leeway for “extraordinary costs,” presumably stuff like big legal judgements or dramatic tax changes.
And that’s a lot of money for an asset that shouldn’t require much “managing” — they’re not trading in and out of complicated companies, they don’t need a lot of analysts traveling around the world and wining and dining management teams, they’re literally just buying gold bars in storage when people demand more shares of the Trust, and selling them when shares are redeemed for physical gold… so this is obviously an extremely scalable business. If, for example, they can convince more people to choose PHYS over the GLD ETF, the longtime market leader from State Street, the returns could quickly escalate.
Let me illustrate a little:
GLD has about $30 billion in assets right now, down from a high of about $75 billion during the gold surge in 2011-2012… PHYS has about $2 billion in assets. Sprott receives 0.35% per year on that $2 billion, so that would be about $7 million.
What happens if gold drops? The assets drop — it’s marked to market continually based on the gold price, after all, so if gold drops in price by 20% then, assuming no net creation or destruction of ETF shares, the assets under management (AUM) would be down to $1.6 billion and the fee would drop to $5.6 million. Sprott didn’t do anything, but their revenue drops just because gold falls.
That’s not the half of it, though, because rising or falling gold prices change investor behavior — remember when gold surged higher in the first half of 2016? The price of gold went up by 25% in about six months… but the assets under management for the GLD ETF were up by 90% at the peak, because the rising gold price attracted new investors who wanted to buy GLD shares as their easiest way to get quick exposure to gold. ETFs expand and contract with demand, so when there is net demand for shares they create new ones, buying the gold to cover themselves… when there is net selling of shares they destroy shares and effectively redeem them, selling the gold.
So during that six month period, when both PHYS and GLD saw their AUM roughly double, their management fee would have doubled… even though the price of gold only went up by 25%. That’s the leverage of being an ETF manager… and, as both of these managers have found this year, leverage works in both directions. This year, the gold price fell by about 9% from January to the October low, and yet the AUM for GLD dropped 20% at the low and PHYS dropped 16%.
What you really want from Sprott, I think, is for their management fees to easily cover their total expenses… that gives them some reasonable chance at outsize profits when other income sources come in, like their interest income or their carried interest from the private partnerships that they also manage (most of the ones that have any chance of generating fee or incentive income are their lending funds — managing outside money to lend to natural resources companies… the more venture-type funds of various sorts are so far underwater right now that the existing ones might never earn any incentive fees, though they do start new ones all the time so there’s some hope for the future if the sector turns).
And that’s about where they are right now — in the third quarter the net management fees were $13.7 million, making up almost all of the net revenues of $15.4 million, and the total expenses were $13.4 million. So even though management fees are down considerably from where they were in the past couple quarters, mostly because of redemptions in the Central Fund of Canada CEF that they acquired early in the year, they’re still profitable.
Not super profitable, mind you, but they did earn a penny a share… and an “Adjusted base EBITDA” of four cents per share, which covers the quarterly three cent dividend. The dividend is growing pretty meaningful again with the decline in the share price, it’s now up to 4.8%, and they can likely sustain that dividend without any pain as long as there aren’t a lot more redemptions in the CEF Trust, and as long as they don’t see substantial declines in gold that scare people out of the PHYS Trust ETF.
Those are meaningful caveats. And beyond the risk of gold falling again, anything can happen to this company — particularly because they’re also involved in much more opaque financing in the natural resources market, doing stuff like lending money to frightening little tiny gold miners. Sprott was a substantial broad-line mutual fund provider in Canada for a long time, but has now really gotten out of the “normal” asset management business, they’re back to focusing on Eric Sprott’s (and Rick Rule’s) favorite markets in gold and precious metals and natural resources… which takes some stability away from the business, but does make them a little bit less susceptible to competition (there aren’t many big asset managers plying their trade in the natural resources market, not after losing money for this long).
And there isn’t quite as much cost competition in the gold ETFs as we see in the rest of the ETF space, at least so far — the GLD ETF has an expense ratio of 0.4%, which is really high compared to the largest ETFs in other sectors that charge less than a quarter of that amount, but they seem to get away with it just fine… PHYS offers a slightly more transparent exposure to physical gold, in promising to actually have allocated gold storage for each share and to redeem large positions in physical gold, which gold bugs think is REALLY IMPORTANT and are willing to pay a little more for, so they seem to be able to get away with charging a still higher effective rate (and not really disclosing it nearly as clearly as GLD does). There is a lower-cost competitor that’s taking share right now, AUM for the iShares Gold Trust (IAU), which is also very large (about $12 billion in AUM) has been climbing faster than GLD in the past year or two, likely because of its lower fees (0.25%), and other much smaller low-cost competitors like GraniteShares Gold Trust (BAR, 0.17% — AUM only a few hundred million) are also trying to attract attention.
Sprott’s focus on redeemable physical gold and a promise of allocated bars of gold in a vault is their marketing strength, that’s what makes them stand out among the “gold bugs” if not among regular institutional investors who trust GLD and IAU just fine… and I don’t know if that will work in the end or not. With marketing and a focus on growth, perhaps they could balloon the AUM and cut their management fee, I don’t know, but they do have some established market presence and they will also get a natural and pretty large growth boost just from a rising gold price… at least if the history of 2016 is any indication.
But yes, now it’s looking better than it did back when I first covered Dan Ferris’ pitch about Sprott back in February, when the takeover of Central Fund of Canada was first getting attention (and ballooning Sprott’s AUM). The stock is down about 25% in US$ since then, with gold down about 5% and gold miners down about 6%… I think that’s overdoing the pessimism a bit, and I added a small position in Sprott shares this week as a “maybe gold will rise sharply this year” speculation.
But will gold rise sharply this year? I don’t know… the Federal Reserve will likely have an outsize impact on that, which is probably why today’s surprisingly good employment report, which likely supports the continued raising of interest rates, helped gold fall in price a little. The real economy is still mostly booming, unemployment remains historically low, and we’re finally seeing some more inflation in payrolls, so as each bit of news comes out in the coming weeks and months we’ll probably continue to see opinions whipsaw about whether the Fed will keep raising rates this year or “pause” or even, in a bizarre twist that would not have been predicted by anyone a few months ago, that they might cut interest rates if President Trump’s trade and budget showdowns persist and slow the global economy (and that was the signal Fed President Jerome Powell gave today when he said the Fed would be cautious and flexible, and that he also wouldn’t kneel to President Trump’s pressure, further cheering the market).
So uncertainty about the broad market persists, with sentiment that seems to shift several times an hour, and I’m largely sitting on my hands while I think over my portfolio positions… but I’ll allocate a little more to hard assets and gold here — potash, copper, iron ore and other natural resources with Altius, gold with Sandstorm Gold, and now a little bit for Sprott thanks to their expected leverage to rising gold through rising ETF management fee income. Cash still is pretty much my favorite investment right now, but I’m glad to have a few investments that aren’t correlated with the Nasdaq or the S&P 500 to nibble on as well.
There was one other minor note on the portfolio this week, my short position in Stellar Acquisition (now Phunware, PHUN) was mostly called away at no real effective cost, so I just adjusted the position size without registering the trade. Rational trading has not yet settled in for that small cap, the pricing doesn’t make any sense (you’ll see it pop from $10 to $50 if you track the ticker, but there’s no actual trading taking place at those prices — and the warrants, which trade in much more volume, are not reflecting those unreal prices), so I’d consider shorting it again if shares are available and some trading actually happens. I’ll let you know, and I’m also always on the lookout for other SPACs that look junky or well-priced for a warrant pairs trade, but I’m not holding my breath.
Over the next couple weeks, I’ll be completing my annual review of every position in the Real Money Portfolio (yes, including Apple and all the other stocks that I’ve partially stopped out of in recent months), updating my analysis and my opinion and trying to step back from the day-to-day market churn to see if changes are needed… so stay tuned, and enjoy your first days of this new year!
P.S. Yes, for those of you who are writing in asking about Paul Mampilly’s latest pitch for his $10 Million Portfolio, I can hazard a guess… but that’s about it for now.
Here’s what he says:
“In fact, if everything goes as planned, fast-acting investors could be looking at gains of up to 6,127% or more.
“And it’s no surprise when you consider the U.S. Treasury has had the brakes on this company for years — depressing its stock price to about a $1 a share, while the company sits on more than $91 billion in cash and over $3.1 trillion in long-term assets.
“But with this critical announcement from the White House on January 6 and bipartisan support in Congress urging the U.S. Treasury to get this company off to the races, this stock has nowhere to go but straight up.”
That’s very likely to be another pitch for Fannie Mae (FNMA), the mortgage repackager and guarantor that is still under federal conservatorship and paying dividends to the government instead of private shareholders. There’s been some chatter recently about real reform coming again, as Trump’s administration has talked up a few times this year, and the most recent talk from Treasury Secretary Steve Mnuchin did give the shares a boost in recent weeks.
I have no idea whether FNMA will be returned to private control, or partially private control, or what that will mean for FNMA shareholders — it’s been widely discussed for years, touted by many newsletters and hedge funds (most loudly Bill Ackman) as a “windfall” investment if the government lets shareholders profit from FNMA again at some point, and it has been in litigation for almost that long, but there’s no way to know what the actual terms of any reform might be before it happens… and real reform would require Congress and the President to agree on something, so I’m not holding my breath.
Both FNMA shares and the potentially very high-yield preferred shares are very high risk/possible high reward speculations in my book, (the preferred dividends have been suspended since 2008, so I wouldn’t assume the future promises of those dividends are “real” or immutable… or that preferred shareholders are necessarily in a better position than the common shareholders), and I don’t feel compelled to bet on any particular political outcomes at this point. I last covered the topic almost a year ago when the Oxford Club was touting the preferred shares, in case you want some more chatter on that topic.