Rick Rule
President & CEO
Sprott US Holdings
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Prospectivity, Workforce Form Bullish Case for Mexico

By Alejandro Ehrenberg | Thu, 07/02/2020 - 14:44

Q: What is the short-term investment outlook for precious metals?

A: Sadly, I think precious metals will do quite well. I say “sadly” because precious metals usually do well when other sectors of the economy and the social fabric do poorly. In my experience, periods of high precious metals prices occur when confidence in other markets and the US dollar are strained. As an example, negative interest rates diminish the return on the 10-year US Treasury bond. Consequently, gold, which is normally viewed as an insurance asset, should gain strength. That is not so good for the world, but it is good for gold producers and for people who own gold. In short, precious metals and equities related to precious metals have a bright three or four years ahead of them.

Q: What factors are driving up gold prices?

A: The gold price is pretty easy to understand. Societies have been focused more on consumption than on production. Thus, debt levels in societies — and not just in emerging markets but also in developed ones — are unsustainably high. In the US, for example, the on-balance-sheet liabilities of the federal government are US$22 trillion. That is 22 with 12 zeros after it. The off-balance-sheet liabilities are in excess of US$100 trillion. The national debt — before state and local debt, unfunded pension liabilities, corporate debt and individual debt — exceeds US$120 trillion. You pay this debt with the national income: taxes and fees minus expenses. The problem is that that number is negative, so the debt grows every year. That circumstance, in a free market, would cause a bond yield in the US of around 10 percent. But we have a bond yield of 1.2 percent. The US has manipulated interest rates down at the same time that it has inflated the debt.

There are two ways out of that. One, an honest liquidation, where young voters say to old voters, “You made all these promises to yourselves, so you keep them because we are not going to,” which is politically unlikely. Two, debase the currency and inflate away the net present value of the obligation. Mexico has experience in its history with things like that, and the decision is coming to countries that traditionally have not had to make it before. And that is very good for gold. If you think about the value proposition of the US 10-year Treasury, the government promises to pay you 1.2 percent over 10 years, in a currency that is losing its value at 1.8 percent. They will give you back less than what you gave them. That is an unattractive proposition that has been called return-free risk. Gold is remarkably appealing, given these circumstances.

Q: How involved is Sprott US Holdings in the Mexican market?

A: Of our 200,000 clients, our equity clients total around 5,000. We have been active in Mexican equities for 40 years and have been active lenders to Mexican mine development for five or six years. In addition to Sprott shareholders who participate indirectly in the Mexican economy, we have between 2,000 and 2,500 active institutional participants in Mexico. Furthermore, Sprott is well-established in the silver sector. Mexico enjoys a disproportionate share of our exploration assets because of its prominence in silver.

Q: Which of your services adds the most value in Mexico?

A: Because there are no financial institutions of our size and scope that are willing to finance early-stage exploration, exploration finance is Sprott’s most useful Mexico-specific service. Access to exploration finance is usually fairly informal and distributed. Alternatives start to appear once you have enjoyed success and moved past the initial exploration stages. Our strategy is to develop a good relationship based on trust with the issuer from this early stage. Our competitors usually come in once the feasibility study is in place. Doing business with companies at the exploration stage for 10 or 12 years enhances our competitiveness in later stages. Once there, we try to be the senior secured lender in mine construction. Under the right set of circumstances, when the mine has reached commercial production, we also try to participate in permanent financing.

Q: What do you look for in a potential investment target among exploration companies?

A: First, scale. A big part of the Mexican mining industry is made up of small-scale, family companies. That is not our target. Our experience tells us that a small mine has all the risks of a big mine but can only make small money. Second, we look for a management team with expertise specific to the challenge at hand. The exploration thesis has to be strong enough to justify the risk of exploration, and there must be a technical team around the thesis who we trust. Lastly, we need a local team that has obtained a community license before the Canadian or the American gets there. In Mexico, there are challenges that only a local knows how to navigate.

Q: Why is exploration in Mexico attractive for Sprott US Holdings?

A: Mexico’s mining industry has an abundance of human resources. There is a younger generation of geologists in Mexico who are highly trained and still in their 30s. That is hugely valuable, and my expectation is that Mexico will be exporting mining technology within the next decade. Exploration in Mexico can be undertaken almost entirely with local personnel. This was not the case 15 years ago: the acceleration has been remarkable.

Moreover, Mexico’s prospectivity is among the best in the world. There is a lot of exploration work still to be done in Mexico. Take Juanicipio as an example. Seven kilometers away on-trend from one of the finest silver mines globally, there was an identifiable surface feature that was undrilled. Also, six or seven miles away from Cananea, Azure found a deposit sticking out of the ground. They literally tripped over it. Furthermore, the whole Trans-Mexican Volcanic Belt is unexplored, with the exception of Almaden Minerals.

The circumstances where there is a mining culture, robust human resources and auspicious prospectivity make it silly not to be bullish on Mexico over the next five to 10 years. That is, of course, if the Mexican government and society do not find a way to botch up this wonderful endowment.

Q: Why is investment in exploration in Mexico not as vigorous as it could be?

A: Mexico’s downturn in exploration is not more pronounced than it is in other emerging economies. That being said, two things constrain exploration in Mexico: potential violence and fear of the government’s resource nationalism. Furthermore, there has been a tendency for social rents taken from the extractive industries to be spent at the center, while the localities that bear the cost of the extractive activity do not get a share. This explains the fact that there is local opposition to mining. Recent developments around the Mining Fund are worrisome in this sense. A clear scheme that specifies the part that the center and the regions will take from social rent is key for making exploration in Mexico more appealing. Fiscal stability is of the essence, as well.  

Sprott Inc., based in Toronto, is a publicly-listed diversified-resource holding company focused on businesses in the natural resources industry and is managed by a team of resource investment professionals.

Alejandro Ehrenberg Alejandro Ehrenberg Journalist and Industry Analyst