Sprott Inc.: An Investment Idea Inspired by Jeremy Grantham

Includes: SCPZF, SPOXF
by: Devon Shire
On a fairly regular basis now GOM’s Jeremy Grantham has been trying to warn us that the inevitable problems that come from the world having finite resources and exponential population growth are nearing a head.
Grantham’s is not a voice that should be ignored. He was among the first to warn of a Japanese stock market bubble in the 80s, a technology stock bubble in the '90s and a debt bubble in the '00s.
In his most recent quarterly letter Grantham lays out his hierarchy of resource problems the world is facing:

“A Possible Hierarchy of Problems

1) Energy

The transition from oil will give us serious and sustained problems. We passed peak oil per capita long ago and we are within 30 years, possibly within 10, of peak oil itself. The price will be volatile beyond our wildest dreams (or nightmares), and the price trend will rise, although at times this will be difficult to discern through the volatility.

Transportation will be difficult in general and air transportation in particular. But behind oil, there is a relative plenty of natural gas and coal, which can, although with cost and difficulty, be substituted for oil.

2) Metals

Metals are, of course, a bigger long-term problem than energy. They are entropy at work ... from wonderful metal ores to scattered waste. Even the best recycling will have slippage. Entropy is impressive; everything really does run downhill, iron really does rust. So our future will undoubtedly be increasingly constrained, particularly if our population and its wealth both grow steadily. Eventually, the growth of both population and wealth will be limited and possibly even stopped by a lack of metals, but that should, with luck, be a long time away.

3) Agriculture

The trouble really begins with agriculture. This is the factor that I believe almost guarantees that we end up with a world population between 1.5 and 5 billion. The only question for me is whether we get there in a genteel, planned manner with mild, phased-in restraints, or whether we run head down and at considerable speed into a brick wall.

There are three particular aspects of agriculture where the shoe pinches the most: water, fertilizer, and soil. All three must be seen in the context of a rapidly growing population. To set the scene, Exhibit 1 shows arable land per person.

Unlike us, suitable land for agriculture has not increased since farming started some 10,000 years ago. In fact, with our help it has declined considerably, perhaps by as much as half or more!”

I’m going to be honest with you. It is hard as a Canadian to read Grantham’s resource problem hierarchy which basically suggests price spikes in oil, metals and agriculture prices and not think Canada is headed for a boom. I’ve actually been thinking somewhat along these lines with respect to resource for quite a while and have made sure that I’m pretty much fully exposed to the Canadian and not American dollar.
For American investors, I have to think that having some investments in Canadian dollars might not be a bad idea. And if those Canadian dollar investments also provide exposure to the above mentioned resource sectors all the better.
I think I have a good idea that hits the oil/metals/agriculture and Canadian dollar theme.
Sprott Inc (OTCPK:SPOXF)
Sprott Inc is a publicly traded investment manager that specializes in the resource sector. If you refer to page 7 in their most recent presentation you will notice that they are focused on the “must have assets”:
  • Precious metals
  • Energy
  • Agriculture
They are on the same page as Grantham.
Sprott is assembled as follows:
  1. Sprott Asset Management - $8.4 billion AUM (10 mutual funds, 7 hedge funds)
  2. Sprott Private Wealth - $3.9 billion AUA (over 2,000 clients)
  3. Sprott U.S. - $2.0 billion AUA/AUM
  4. Sprott Consulting – Directly manages 3 publicly traded companies with a combined $900 million market cap
With the amount of money Sprott Inc. is managing it is clear that they are an established manager.
My thinking on this is simple. I could invest in one of the Sprott managed funds, which will excel if commodity prices as predicted by Grantham continue to rise. Or I could invest instead in Sprott Inc., which will get a double whammy if commodity prices and their funds do well. First you get the direct benefit of Sprott’s earnings growing as performance drives their assets higher. And second investors will eagerly add cash to the Sprott funds as money always chases performance. Performance and subscriptions will drive Sprott Inc.’s earnings higher.
Basically investing in an asset manager focused on the sectors recommended by Grantham is a form of a leveraged bet on prices of these commodities. If commodity prices rise inevitably Sprott Inc’s various funds will perform well, create more cash flow for shareholders and attract more assets (which will again create more cash flow).
And the various Sprott Funds typically don’t just go along for the ride with commodity prices increases, they add value outperforming their benchmark indices by a wide margin. Consider 2010 investment performance as detailed in the annual report:

“On the year, 98% of our equity and hedge Funds exceeded their benchmark indices – some by a wide margin. The majority of our Funds posted returns of more than 30%, of which four Funds delivered returns greater than 50%. This truly exceptional performance speaks to the outstanding talent and breadth of our investment management team.”

And this outperformance isn’t cherry picking off one good year of data. The Sprott fund with the longest track record from which we can judge performance is the Sprott Canadian Equity Fund which since 1997 has returned over 22% annually versus 7.3% for the S&P/TSX Composite.
The complication of using this sort of “leveraged” investment strategy is that like any leverage it works both ways. While commodity prices are booming Sprott’s funds are going to soar and money will flow through the door as investors always chase performance. But when there is a bump in the road like we saw in 2008 the funds are going to drop and investors flee. These bumps are inevitable in commodities and will make the earnings, cash flow and stock price of Sprott Inc. volatile.
If you are an investor who doesn’t mind a bumpy ride then you can simply buy and hold letting the long term wind of at your back (rising commodity prices) work for you. If you don’t like the volatility then you can wait for one of those bumps and the following stock price drop in Sprott Inc and build your position.
Also important to note is that much of Sprott’s revenue and cash flow is from performance and not management fees. So if performance isn’t there, neither is the performance fee. And this is going to make this an even bumpier ride as earnings and cash flow will fluctuate wildly depending on the size of performance fee income. In 2010 for example Sprott Inc. had over $300 million in revenue with $200 million of that from performance fees. While in 2009 revenue was only just over $107 million because only $12 million of performance fees were earned.
Personally, like Buffett, I’m more interested in earning a bumpy 15% per year than a smooth 8%. Sprott Inc. is not going to be the smooth 8%.
So if you would like to follow Grantham into the commodity space I think Sprott Inc. is likely going to be an excellent long term holding. But please keep in mind that holding Sprott Inc. will also undoubtedly be a bumpy ride so a strong stomach would be required.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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