The Second part of Evan Harp’s interview with Sprott Asset Management CEO John Ciampaglia focuses on precious metals. You can read part one, which focuses on uranium, here.
Evan Harp: Let’s pivot to precious metals. How will sanctions in Russia impact that space?
John Ciampaglia: Russia has a big role in providing oil and natural gas, and on the metal side, nickel and palladium are probably the biggest. It’s interesting because the prices of nickel and palladium spiked at the beginning of the Russia-Ukraine conflict. Now, they have completely retraced and gone back to lower levels. It’s as if markets have concluded that there’ll be enough demand destruction to offset whatever supply is lost from Russia. It seems a bit absurd, especially since it is very hard to substitute away palladium in particular, given how much of this metal comes from Russia.
On the gold side, Russia does produce a substantial amount of gold. But again, gold is not as critical a mineral as palladium, which is essential for the catalytic converters used in gasoline-powered engines. Overall, sanctions have had the most impact on industrial metals and less so on gold.
Evan Harp: Sprott recently launched the Sprott ESG Gold ETF (SESG). It is launched at a time when ESG is has become a weirdly controversial term for some. I would love to hear you speak to what the fund is and how you think it’s going to interact with the ESG space, given some of the kind of controversy out there right now.
John Ciampaglia: There has been some backlash against ESG, and it’s coming from two directions. One is regulators, who have scrutinized ESG-related investment products and questioned, “Are these ESG-centric? What exactly is the ESG methodology that is being employed?” Rightfully so, given that the regulators caught some fund sponsors taking the ESG-light path. If you’re professing to be “dark green”, you better be dark green. This pulled the curtain back on a lot of sponsors. The story that blows me away is that German officials back in May raided the Deutsche Bank’s DWS Unit offices based on allegations of greenwashing and prospectus fraud related to some of its ESG products. A bit of a witch hunt is going on from a regulatory perspective. Europe has very high standards for ESG investments and robust, sustainable finance disclosure regulations. They have worked on this for years and are way ahead of North America. In Europe, if you claim to have a Dark Green, Article 9 Fund, you had better meet the requirements. Many funds claiming to be Article 8, called “Light Green Funds”, and Article 9, “Dark Green Funds”, were not as robust as they claimed, and regulators have slapped them on the wrists.
In the U.S., the ESG backlash is a little different and more politically driven. Conservative states like Arizona claim that ESG is nonsense and that ESG screens have hurt state pensioners. And it impacts investments in oil and gas, fossil fuel-based industries.
Taking a step back, the ESG investment landscape can be very confusing and needs to be standardized. There is some legitimacy around the regulatory pushback given that there are so many different ESG frameworks and they are not consistent. I like to point to a gold company that we follow at Sprott. We have one institutional client who may say that a gold miner is on its exclusion list because of ESG considerations. Meanwhile, that gold mining company annually puts out a press release saying, “We’ve been included in the Dow Jones Sustainability Index again, we’re great!” This illustrates how much subjectivity is involved in ESG-related decisions.
I think there is confusion concerning ESG and gold mining. It’s not political, rather it is about the miner’s social license to operate. I mean that gold mining companies are running capital-intensive businesses that are extractive. They are visibly going into the earth to mine and are likely to impact biodiversity, water, local communities, etc.
For gold mining companies, mining responsibly is not about ESG, it’s about the basic table stakes you need to operate effectively over the long term. You will lose your permits to operate if you are not a responsible, sustainable producer. Environmental agencies and local communities will protest and blockade your mine site, so mining companies are very sensitive and responsive to these issues. For gold miners, there is a bifurcation between the companies operating in safe jurisdictions with high levels of regulatory oversight, environmental controls, labor laws, health and safety of workers, etc., and the mining companies operating in less regulated countries like the Democratic Republic of Congo, one of the most corrupt, poorest countries in the world.
We do think that there are key differences between gold companies. We prefer the miners in which ESG-related issues are part of their DNA and corporate culture. It’s In their scorecards and performance measurements in terms of how they get paid.
For Sprott ESG Gold ETF (NYSE Arca: SESG), we have identified the companies we think are the most responsible, sustainable producers and we are sourcing the ETF’s gold just from those producers. When you look at most gold ETFs, it is hard to figure out where the gold comes from and where it was refined. What region in the world is the gold from and what mine? How much recycled gold does it hold? And where did the recycled gold come from? I don’t know if the ETF holds any artisanal gold, either legitimately or fraudulently. There’s just no chain of custody, no provenance, and that bar could have been cast honestly, 100 years ago, when standards in the world were wildly different than today.
By contrast, with Sprott ESG Gold ETF, we provide total transparency and traceability to the gold producer and the specific mine site. You can feel good about who produced your gold, where it came from, in terms of the jurisdiction, the gold mining producer and the gold mine. We perform due diligence not just at the company level but also at the mine level to ensure there are no issues at each and every one of the six mines we’ve reviewed. These are issues related to health and safety, water issues, tailings, issues with the local community, safety track records, accidents, etc. We are trying to provide investors with what we believe is best in class regarding full transparency around where SESG’s gold is coming from and how it is produced. We don’t hold recycled gold or gold from artisanal mining.
Two historically vulnerable parts of the gold supply chain have been conflict gold and recycled gold. Conflict gold can be smuggled into the supply chain from high-risk areas, whether those are regions undergoing armed conflict or areas with high levels of corruption. With recycled gold, there was a very famous case a few years ago in which South American drug cartels were laundering money through a gold refiner. When this story was exposed, the gold bars the refinery had produced were all deemed proceeds of crime. With SESG, we are not trying to raise an alarm bell by indicating that there are big problems with the gold supply chain, but to point out that the gold journey is opaque to the end investor in most cases.
Evan Harp: One of the things that’s striking to me about all that is it sounds like we’re not just talking about sustainability. It’s very easy, I think, with ESG funds to focus on the E and it sounds like you are very focused on the S and the G as well with SESG. How has the investor reaction has been, especially given the odd year gold has had?
John Ciampaglia: SESG is a new ETF, and we are ramping up our outreach right now. I think our biggest challenge is educating the market. This is a new category for gold. Some gold funds say they’re responsible gold funds, but what does that mean?
In 2012, the London Bullion Management Association implemented the first responsible sourcing standards to address some of the most egregious issues around child labor and conflict zones, the most unfortunate parts of the supply chain. From 2012 to today, the LMBA has undergone nine versions of its responsible sourcing standards, constantly changing and improving them. What most responsible gold funds do is they will only own a bar that was cast from 2012 onwards. Is that a higher degree of comfort and standard versus a bar made before 2012? Yes, but it’s a far cry from what we’re doing for SESG. We do think we have a lot of explaining to do because unless you’re a real gold geek like we are, you’re not going to get all these little nuances. We think there’s a meaningful difference between “we will only buy bars from 2012 onwards,” versus 2022 Sprott ESG Approved Gold based on all the significant due diligence we perform at Sprott.
Evan Harp: Let’s talk about gold’s strange year. There’s been a feeling, what with inflation, its reputation as a safe haven asset, that it could take off at any minute – but it hasn’t yet.
John Ciampaglia Yes, gold’s recent performance has been incredibly frustrating because it’s typically been a safe haven investment. But gold has been hit hard by rising interest rates, just as other safe haven assets like bonds have been hurt.
Gold needs to break out, but it will not move until we see a signal from the Fed that they will pause on rate hikes or potentially pivot. Gold is also seen as a liquid investment, and when with market calamities, investors find it easy to sell. Gold often acts as an insurance policy that can be converted to cash when portfolio liquidity is needed. The market has been starved of liquidity for the past six months. We have found that gold is often sold at the beginning of major market sell-offs, but it eventually stabilizes and rebounds well. Right now, gold is stuck in a range bound zone.
Evan Harp: Silver has been an interesting one this year. It’s traditionally tracked closely to gold, but this year it’s been closer to copper performance-wise. I’d love to get your mile-high view on the silver market.
John Ciampaglia: Silver has probably been the most frustrating metal this year. Silver is a hybrid metal that has both monetary and industrial characteristics. Half of it gets used as a financial store of value and the other half gets used for everything from solar panels to antibacterial applications to electronics. For silver, it’s almost like the perfect storm because both parts of its utility have been hit this year. Precious metals have been hit on the financial side because of rising interest rates. Industrial metals have been hurt because of fears of recession and demand destruction. The good news is that silver provides tremendous value right now. Gold will probably move first as it has done in the past, and then silver could just slingshot higher. It happened in 2020 when gold took off in the summer and rallied into the new year. Then, in January 2021, silver went on a run. That is the typical pattern. We are simply waiting for the next catalyst.
Evan Harp: I think that’s a solid diagnosis and I’d love to hear your thoughts on the long-term case for silver.
John Ciampaglia: Silver is critically important for innovative technologies. About 10% of all the silver produced goes into solar panels, which is one of the biggest applications on the industrial side. Solar is going to continue to take more market share.
There’s slow, steady demand for silver every year, but the supply side is the most interesting part of the silver story. There are very few pure silver mines left in the world and many of them are getting towards the end of life. Silver is now mostly mined as a byproduct of other metals, including gold and copper. The silver supply is a lot more vulnerable to changes in the host metals being mined and is becoming more scarce to find. Many silver companies are both gold and silver mining companies. Because it is harder to find and mine silver, we think the fundamentals look pretty good. The investor interest side has been quiet for the last year as we’ve seen much momentum leave the silver monetary side of the story.
Evan Harp: It does sound like the supply story is an interesting angle that people aren’t tracking. One more question, is there something else about the precious metal space in general that not enough people are thinking about right now?
John Ciampaglia: Good question. I would say that investors are likely not aware of the high demand for gold right now coming from Asia, specifically India and China. Investors in the West are indifferent to gold right now. But when gold sells off, Asia buying picks up. They tend to be value buyers, hoarding gold when prices are low. By contrast, Western investors tend to buy gold as the price increases and has positive momentum. They tend to buy on the upside and then when the price rolls, they sell and Asian investors start buying. Gold imports coming into Hong Kong from Switzerland are at multi-year highs, and premiums for gold in India are currently very high.
That indicates buying tension in the gold market. People are willing to pay upwards of $60 an ounce premium over gold’s spot price. I find it interesting that Western gold investors tend to be momentum buyers and Eastern investors are more value conscious.
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