In a presentation at the Toronto Resource Investment Conference Sept. 12, David Franklin of Sprott Asset Management said that after a tough first half of the year “we have turned the corner” and that investors can take advantage of price distortions in the market caused by quantitative easing.
Some of the best opportunities related to shortages can be found in precious metals, he argues. “As soon as Germany requested its gold back look at what happened to inventories—they fell off the table,” he said. “This is only circumstantial evidence—but the way we interpret this is that Germany requested its gold back and someone had to enter the market and deliver. Complicating this was the voracious appetite for gold from the Chinese in the East.”
Franklin noted that Comex gold registered inventory is at 12 month lows and in June, there was a $30 premium to the London price of gold.
Another shortage he said can be found in the bond market. “Who would think there would be—in this debt-fuelled world of ours—a shortage of bonds?” he remarked. “But 55% of the entire universe of bonds is owned by the central banks... the central banks also own two-thirds of the government bond market. Quantitative easing has sucked the market dry of bonds. This year...the Bank of Japan is buying more bonds than it is issuing, so there are very few bonds available for investors. What happens if the central banks all of a sudden start selling bonds?”
To illustrate his point further, he turned to the squid market in Japan. What Japan did by devaluing its currency with quantitative easing and lowering the yen, which has fallen by about 15% against the U.S. dollar, he explained, is hurt the country’s fishermen. Because the yen has been devalued, every boat that goes out to catch squid loses money. But the fishermen didn’t stop fishing, he said, they went to the government and got a fuel subsidy instead. “Here is a price distortion as a microcosm of the impacts of QE,” Franklin said.
And price signals no longer correlate with the realities of supply. “The gold price is not the price of gold; we see huge premiums paid in Shanghai for gold to entice supply, and the price of squid is not high enough to justify the act of fishing for it.”
Turning to the S&P 500, Franklin pointed out that it is currently trading at 16-times forward earnings and so the market is fully valued. But contrast that with decreasing GDP estimates, which are moving down for the third and fourth quarter. “The U.S. market is fully valued at the moment,” he remarked. “So here is another market where prices are completely distorted.”
As for the uranium market, Franklin cited a presentation earlier this year in February by Cameco Corp. (TSX:CCO; NYSE: CCJ) in which the company said that there was not enough supply to meet 20% of the world’s uranium demand and that management had no idea where this uranium is going to come from. In addition, Cameco recently pushed back production from Cigar Lake for another year. So the fundamentals for uranium look good. “Now look at the pricing,” he said. “Does that look like a market with a 20% hole in it? No not at all. I think there are some dynamics in the uranium market that show this is an unsustainable point.”
Looking at base metals, Franklin said that tin is in its fifth year of shortage and that the price of the metal has shot up by nearly 15% in the last three weeks alone after Indonesia, which produces most of the world’s tin, changed the rules and required that miners sell their tin in the local market before it can be exported. “The largest producers said: ‘No, we’re not going to do that,’ so now the price of tin has gone up nearly 15%,” he said. “The shortage has created that. So will Indonesia change the rules or will it continue? It’s tough to say, but there’s a huge opportunity there in tin.”
Franklin then talked about platinum and palladium. In terms of platinum, 70% of the world’s platinum comes from South Africa where he calculates that it costs the top producers on average about US$1,800 to produce an ounce of the metal. But at current prices of about US$1,450 per oz., you can’t make that up on volume. “They lose US$300-400 per oz. for every ounce produced,” he explained. “So platinum production is dropping, as it should. No one wants to be in money-losing production. And there is no end in sight. Platinum production has almost turned into a work/welfare program and that’s going to continue. In this case as an investor, you look for these kinds of opportunities. You don’t buy the miners, because they’re losing money, you buy the platinum.”
One can see the same trend in palladium, he added. There’s a huge hole in the supply of palladium and that is why palladium has been the top-performing precious metal so far this year. And Franklin expects that to continue. “When you look at these numbers it’s astonishing,” he said. “You see a million-oz.-deficit in palladium. There are only 6.5 million ounces of palladium produced a year—so one-sixth of the market is gone. … Is it going to get better? This deficit will persist until 2020.”
Platinum is the second-best performer this year. Franklin said he doesn’t expect platinum will hit the 1-million-oz.deficit mark until 2016 or 2017, but he sees huge opportunities as an investor, particularly given the rebound in the car industry, which is the biggest consumer of the two metals. “This is a huge opportunity,” he concluded. “As a precious metal investor the dynamics could not be any better.”
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