The market is out of step with reality, Eric Sprott tells Tekoa Da Silva in this recent interview.

“We had no growth in the economy to speak of. Yet these stocks were trading at record-high prices,” he says of the overall market.

He also believes the banking system is over-exposed to assets which stand to depreciate in value.

The strength of bonds and stocks so far has masked these weaknesses in banks’ balance sheets, says Eric, but that could change if markets came under more strain. “When you have people starting to take money out of the banking system,” he warns, “that’s when we all find out what the assets (of the banks) are worth.”

Especially worrying for investors in stocks should be the massive build-up in debt and unfunded obligations in developed countries, says Eric. This is leading towards a big breakdown in world bond and stock markets, he believes.

Eric also discusses his “principles” for success and how anticipating a crash in tech stocks during the late 1990s led him to first become interested in gold and silver.

Read on for Tekoa Da Silva’s full interview with Eric Sprott, Chairman of Sprott Inc. (For a video re-play of Eric’s speech and other keynotes at the Sprott-Stansberry Natural Resource Symposium, click here.)

Tekoa Da Silva: Eric, it’s a pleasure to be speaking with you again. To start out with a broad open-ended question — what are your thoughts here from a macro perspective when you look at the world economies, financial markets, gold?

Eric Sprott: Sure. Well, Tekoa, I’ve never been a believer in the economic recovery that we’re supposedly in. I think that the powers-that-be are pulling out all the stops to try to hold it together. I go back to the NASDAQ break which I think should have caused a huge cascade of stock values to stay low for quite a while. And then of course the powers-that-be used whatever methods were available to them to try to stimulate things. Back in those days, it was “cash-for-clunkers,” the new homebuyer tax credits and of course the whole zero-interest-rate thing. Then we had TARP and TALF in ’07 and ‘08.

We had conservatorships of Fannie and Freddie, and AIG, which I’m sure nobody really understands. It’s all “try to keep it together.” I think we learned in ’07 and ’08, when Lehman went down, that the powers-that-be can’t allow a liquidation where a financial organization has to sell something, which unfortunately is what happened to Lehman and nearly took the whole system down.

So subsequent to that, we’ve never had a liquidation. Even, for example, in the Cypriot bank crisis, the Cypriot banks never had to sell anything because they just took from the depositors. It looks like the Greek situation that we have today; the Greek banks don’t have to sell anything because the ECB just comes in and supplies the Emergency Lending Authority. I think if you allowed the market to function as it should function, where values are determined by the market, we would see this sort of domino effect where the Greek banks would have to sell their loans off and then the Greek stock market would collapse, the bond market would collapse and then people [in countries] around them would start thinking, “Well, that could happen to me.”

So we have this constant interference by the powers-that-be to not let the markets function properly. In the bond market, it’s through low interest rates. I personally suspect that governments are in the stock market. We know the Japanese buy stocks. We know that the Swiss national bank buys stocks. We don’t know for a fact that the US government buys stocks but there might be methods by which they can convince people to “keep it together.” Every time we get a little correction, it bounces right back up again.

So that’s just the environment we’re in. We’ve spent all this money. We’ve taken rates as low as we can get them and we’re just hanging in there. Even recently we had the GDP for 2011 to 2014 revised down so that it turned out to be 2% a year. Of course the 2% is a function of the inflation rate. Say, if inflation was reported as 1% but is really 3%, then you had no growth because GDP is just a dollar number.

My own feeling is that inflation is way beyond what’s reported. If inflation really was 5%, and you said GDP growth was 2%, then the real growth is -3%.

So I’m not a believer that there is any economic recovery that’s sustainable. I always say we’re trying to get liftoff. But we don’t get liftoff because we haven’t finished the cleansing process yet.

TD: Do you feel that inflation is the goal, longer-term, for the Western world?

ES: Well, they talk about that. I can’t believe that that’s really the goal. I think they use it as a reason to have zero-interest-rates. They pretend that inflation is low but I don’t think inflation is low. As you would have seen in my presentation, there’s an index called the Chapwood Index that measures 500 different items in 20 different cities in the U.S.  The index, every year from ‘11 to today, has been in the double-digits.

So imagine double-digit inflation with 2% GDP growth. You would be really shrinking at 8%. Today we saw that wage gains in the second quarter were 0.2%. Well, 0.2% in the quarter is like 0.8% for a year. I can assure you that everyone’s increases in health care costs this year will suck up more than that wage gain. Somehow these costs don’t go into the CPI thing. I don’t know how they don’t, but they’re just not going to tell us what inflation really is. It’s much higher than is being reported, I think.

It tends to distort all the numbers. It makes GDP way higher than it would otherwise be and tries to keep a certain calmness in a very, very difficult economic environment.

TD: Eric, I’ve heard it said that when those types of disparities become too grotesque - inflation with wage growth and real wages - that disruptive events can occur within societies. Does that concern you? How much does that bother you as a person who has accumulated quite a bit?

ES: Well, I’ve actually been very surprised that there hasn’t been more disruption at the university level for example. I mean here we have all these people taking on all these loans with the promise of some job that they don’t get.

They can’t possibly pay off the loans, and yet nobody seems concerned about them. How about if you’re at university today and you know darn well that when your time comes to get the social security, there’s not going to be any social security? Literally, people of my era are benefiting at the expense of people that are going to be in your era because all these programs that we have, we can’t afford. But nobody wants to cut them down to size - not on their watch, not while they’re running the government, even though it’s so obvious that there’s no way that when you retire the social security benefits that you’ve been promised can be paid.

For example, they just announced that the disability fund is going to be out of money next year and then the retirement fund will be out of money in 2034. Well, that’s maybe getting to when you might retire.

But there won’t be any money there. So it’s a very difficult situation and I’m surprised that there haven’t been more people complaining. Maybe someday if food prices go up shockingly high - perhaps because of the drought in California or other things - when you start affecting food and its availability, then people will be more disruptive.

I don’t like to even contemplate those things. I would much rather just look at the economy. Let’s not get into how people are going to react, although it could be very negative to markets.

I just know that the economy is not functioning smoothly. Sooner or later - because I have to care about these things - stocks won’t sustain the highs that they’re at and the banking system won’t be able to pretend that it’s solvent.

And of course it’s the banking system not being solvent that always takes me to precious metals.

I think of the people in Greece, who could only get – what was it? - sixty euros a day? Well, if they’d had their gold somewhere, they could cash something in. But they go to the bank and they get in the line-up and they get 60 euros in a day. I mean that doesn’t carry you too far. So I still believe that’s the ultimate manifestation that there’s no economic recovery. The banks will suffer. People will figure out that banks are risky and the money will go to where it should go - precious metals.

TD: How do you see that unfolding? How do you see that happening? In a gradual, contained, method or some explosive manner?

ES: Well, it’s a great question. Of course we had these examples – like Cyprus. Obviously some people were negatively affected who had money in those banks.

We’re going through the exact same thing in Greece. There has been no bail-in announced yet but if there’s a bail-in announced in a country that’s a little more developed than Cyprus, then in the countries around them who might be in similar situations, maybe then people will start reacting sooner.

I can think of Italy or Portugal or Spain or maybe some of the Eastern European countries. It could catch fire very quickly. I’m not suggesting it will. But when you have people starting to take money out of the banking system - in terms of deposits - that’s when we all find out what the assets [of the banks] are worth if they have to sell them.

When you have to sell an asset, it’s nowhere near the worth of some quote in the newspaper or some housing index that somebody says is up five percent this year.

You’re not going to get that market price. Now you have to sell it. The market will adjust to that.

TD: Eric, in a moment I want to ask you a bit more about – to use the phrase I’ve heard you mention in the past - the “physical-ness of the gold market.” But before I do, I want to ask, where do you find your greatest area of passion in being an analyst as I’ve heard you say in the past?

ES: Well, I describe myself as being in the stealing business and you want to steal value. You want to find something that is very cheap relative to where everything that’s comparable already is. It’s almost assured that if you can buy something that’s worth 2X and you’re paying X for it - and you can explain to people why it’s worth 2X -  then that’s a pretty substantive gain.

What if you can also find something that today is worth X, but you think through the normal growth of that business or events unfolding that it could be worth 5X? Imagine that you buy it at 0.2X. It becomes worth 5X. Now you made 25 times your money.

So to me it’s a great hunt all the time to find something that will be re-rated and it will be re-rated to “one,” just to get to its normal value and then, if it really has “the goods,” then it will rise above other comparative investments. So that’s always pretty exciting.

TD: Have there been one or two re-ratings in your lifetime that you’ve experienced that really stand out as having been some of the most exciting?

ES: Well, yeah, I have had many actually. One of the more unique ones is when Internet gaming started and a company in Toronto called CryptoLogic was essentially the first company in it and I was a very early investor. I think I bought the shares at a dollar and ultimately the stock went to $65.

So that’s a 65-bagger. I wasn’t there the whole time. Every time someone in U.S. Congress would try to pass a law to ban Internet gaming, of course the stock would get pounded and then it would come back up again. It was very stomach-churning at the time. But it was a wonderful investment. Of course Internet gaming has survived and prospered and the threat of government interference has massively diminished because everyone is going there now.

So that’s an example. I could give you other examples. I bought a company called Bowflex which then became Direct Focus. They were mass-marketing fitness machines. I think it was trading at a dollar and it went to $35.

I was also in a company called Taser International. All of a sudden the police department was taking on these Taser guns as a safer way to suppress people than bullets. I would have bought that very, very inexpensively. I don’t even know what the price was. Probably like $5. It went to $120 as people realized, “oh my goodness, this thing is catching on.”

It was early days when I was there. So those are the sorts of things that you look for because you compound your wealth very quickly when you get what Peter Lynch called the multi-bagger. I mean you start making five or ten times your money. You’re seriously outperforming other people. So that’s the sort of thing I like to look for.

TD: How did you go, Eric, from being a value micro-investor looking at companies that way that you just described, to being – as I’ve heard my boss Rick Rule describe - a “directional” investor.

ES: Well, the reason is that back before the NASDAQ crash, you could sense that the market was in for a great comeuppance. I was kind of all over it. I could see it coming and so I had to look for how to survive a market meltdown. And we had a market meltdown in NASDAQ. I mean it went down 75%, and my studies indicated the only way to survive this thing was with precious metals. As it turned out, gold bottomed in 2000 as the market was crashing.

I think gold bottomed at $255. It then went to $1,900, which is a huge gain. We’re talking a 600% gain. The stocks went up by something like 1,700% in that 11-year-period.

Because you had to dismiss the whole stock market, you had to find some niche that could carry you through. It’s interesting, Tekoa, when I got into gold and gold stocks, I just wanted to hold on. I thought, “I just don’t want to lose money.” And I guess I was a little – or very - pleasantly surprised that rather than just holding on, it was a huge investment opportunity at the time. It worked out very well - until the last four years where it hasn’t worked out at all. It has been, in fact, a disaster. But I think we will have a rebirth here and get back to the good times.

TD: We spoke about that a little bit already - the fundamentals for gold. But what gives you the confidence now that we will see a rebirth in the mining equities - the gold mining stocks?

ES: Well, of course you won’t get a rebirth in the stocks unless you get a rebirth in gold and silver. I find it interesting that as we sit here today, though we don’t have the final numbers for the month of July, U.S. mint sales I believe will be up at least 400% year over year.

Gold is dead. But we have a 400% increase in demand.

In the month of July, the U.S. mint stopped silver sales. And ultimately silver sales for July, even though they missed about two or three weeks, I’m going to guess that we’re up at least 100% with two weeks of non-selling.

So you can see that there’s a move afoot here. It’s not just in the U.S. mints or the Canadian mint in Canada, the Perth mint. Even at a company called Sprott Money where we sell coins on the internet, our business was very substantive in July.

So people are coming in to buy. I suspect that as we move into the second half of ’15, the physical demand out of Asia, and particularly India, really gets going. So there are lots of signs that there’s true interest in gold and if the interest in gold comes back, of course the leverage in the stocks is mind-boggling. I mean when the HUI index was last at around 110, the price of gold was probably $400. Today it’s at $1,100.

So you tend to think that there’s a lot of torque here. People actually started to believe that gold was going up. Most people, probably in the market, think gold is going down. So they’re probably pricing maybe $800 in the gold stocks today.

Well, if it ever reversed here, there would be a lot of catching up to do. So that could be very exciting if it were to manifest itself.

I believe that the physical buyers are there. The Russians are buying, the Chinese are buying, and the Indians are buying. People are buying. You would imagine everybody in Europe would be thinking, “OK, we got Greece going on. Is there going to be another one? Where is that other one?” There have been good sales in Europe recently of gold coins and silver coins. So you get enough of a groundswell that we could find out that we have shortages very, very quickly.

TD: What would need to happen, Eric, to convince you that you could be wrong about all the stuff we’re talking about -- gold, the mining stocks? What would you need to see?

ES: That’s a great question. Well, one might even say I have been wrong in the sense that they’ve just crashed here. But you look at the financial system out there which I would almost use the word “Ponzi” to describe. Certain things happen that probably shouldn’t happen and all of my logic says that shouldn’t happen. The stock market shouldn’t be at a new high. Bond yields shouldn’t be at zero interest rates. We shouldn’t be printing money. Gold should be higher.

Ultimately, when you see the evidence and it suggests that those things you’re thinking about are still going to play out, then you just hold on. We have to listen day after day to how great the economy is or how great it’s going to be into 2015 -- “it’s going to be 3.5% growth.” Well, we’re going to be down to probably 1.5% by the time we end the year. We do it every year. 3.5% ends up at 1.5%.

I mean, 1.5% is just a rounding error in a way. So there’s really nothing substantive going on in the economies or there’s no reason that the stock market should have gone up by whatever the number is -- 200% in the last few years. We had no growth in the economy to speak of. Yet these stocks were trading at record-high prices.

So as long as the logic says you should stay [in gold and silver stocks], I stay there. And maybe it does go lower. But it will make the opportunity that much bigger over time.

TD: Regarding “physical-ness” of both gold and silver, what do you see here in the world that you like?

ES: Well, in a gold market that has 4,000 tons of supply, I see 6,000 tons of buyers. You know that the 2,000 tons has to come from somewhere. It has got to come from Western central banks and I think these Western central banks are depleting their gold resources. Someday they’re not going to be able to make the payment when somebody demands the gold.

Of course the guy demanding the gold would be either Indian or Chinese or the US retail coin buyer -- people like that. And all of a sudden people will realize that the demand was always way above supply. And the same thing for silver. I mean look at what India has done in the last two years. They’re buying 30% of the silver market up from 10%. How is that possible?

You could buy an extra 20% of the market and have the price go down. It’s mathematically challenging to come up with that conclusion unless somebody in the paper market just wants to make the price whatever he wants to make it. Somebody who has got deep pockets can make the price do anything he would want as long as nobody asks for the silver. So I’m pretty convinced that the physical argument is a very powerful one.

TD: Eric, I want to ask you now. You’ve made multiple fortunes.

ES: And lost multiple fortunes.

TD: Throughout your life. You deal with business builders on a daily basis. You’ve received an award from the Order of Canada -- the highest civilian award that can be offered by the country. What have you found with your own life and from your observations to be the formula for building wealth for a person and to deliver that wealth to society -- to become wealthy not in strictly financial terms, but to have an abundant life?

ES: Well, I will go back to why I am able to make contributions to my country in various charities and things like that. You can only make contributions if you make money, OK? I mean if I was making 50 grand a year, I can’t be supporting universities and hospitals and things like that.

So the first principle is that you have to find a way to make an outsized return. I didn’t start with a large amount of money -- just like anyone else starting off, making my $4,800 bucks a year, saving a little and investing and having it grow. The key thing is you have to be, I’m going to say, a risk-taker.

But the risk is really only whether the market is going to see it your way.

So for example, when I described buying something I think is worth 0.2 X and that the market, if they understood it, probably would value it at X, you have to hope the market comes along and provides you with that return.

It always seems risky at the time. Buying gold stocks in 2000 probably seemed like the dumbest thing anyone could ever do. It’s hitting the low in gold and I’m out there buying all these gold companies.

Well, I guess I was looking for some kind of outsized return. I got that outsized return. You have to go against the crowd quite often to do that. But at the same time, you must see evidence of something coming together that you believe in.

One of the great evidences, by the way, particularly as it applies to an individual stock, is if you’re sitting there analyzing the stock and you see it’s cheap, then you start to buy it in the market and all of a sudden it starts to go up. You know why? Because somebody else knows it too and now you’re competing with them.

If you start buying a stock at two bucks and the next thing you know it’s $2.50 a week later, you kind of know you’re on to something because it’s not just you. You’re not going to take it from $2.00 to $2.50. You will sit there and buy it at $2.00 if you can bet somebody else is also doing it.

Then you realize, OK, I’m not the only guy in this game here. Others recognize it. Normally when you get that kind of jump start on things, it tells you that the 0.2X could become X and then it’s kind of an easy road, right? You think, “We got a few more guys on board here.” One of the things that I like in a stock is that no one covers it. I prefer there’s no analyst to cover a stock because then all you can do is bring him in.

You’re not going to lose anybody because no one is covering it already and the next guy, of course, is going to write a bullish report on it. Otherwise, why would he be there? If you can beat them to the punch in terms of analyzing the value, you’re going to have that groundswell that just comes behind you which would force the issue to get back to X again.

TD: What about work ethic? Do you punch out at 5 o’clock?

ES: Well, I quite often punch out at 5 o’clock. But I start a little earlier than the average guy. I can be up at 3:00 or 4:00 in the morning, almost always by 4:00. So if I get to the office at 9:00, I’ve essentially done 4.5 hours of work already, which I love doing. I mean it’s a great time to work. You’re on your own. You can do kind of native research. You can investigate things. I mean that’s one of the great things about the Internet. The way to garner information is so easy now relative to what it was like in my day. In my day, you used to have to go get the quarterly reports and the annual reports and read them.

Now you can just go to the various websites. They’re all right there. They’ve probably all been analyzed for you.

They get all the ratios and things like that. It was a lot more difficult. But by the fact that other people wouldn’t put the effort in back then or it was more difficult, it gave you a better launching pad if you finally found something. If you looked at everything from a numbers base and it looked good, and by reading the inner reports and the company’s forecast, you could get a leg up in things. That still exists because the use of analysts has diminished a lot here because we have this market where everything just moves together.

So the benefit of separating A from B can be quite significant. If it looks like it’s 20% of where it should be, it can catch up to the market and you can get an outsized return.

TD: Eric, in winding down, is there anything you think we may have missed?

ES: Well, I think the biggest thing that we haven’t talked about is where this is all going in the long run. How can we sit back when all the analysis out there tells you that so many countries are way beyond their capacity to service their debt and their obligations?  And it’s the obligations that are the big things.

We’re constantly reading about under-funded pensions and it’s always something like: “that will happen five or ten years from now.” But in some instances, it is happening today. It happened in Puerto Rico today. I think it happened in Detroit six months ago. It will happen in Greece. It’s just ongoing. We don’t even know where it’s going to happen and there are so many other kinds of black swans that you know would have to happen.

They have to happen sometime. So I think the most important message you can leave people is that you’re dealing in a market that is very unrealistic as to long-run expectations here.

The powers-that-be don’t want to have to admit that there’s a problem now. They want to delay that announcement. It’s like how Detroit put off their bankruptcy for 10 years.

Ten years ago they were bankrupt but they were waiting, waiting and waiting. Finally one day they couldn’t write the check and they declared bankruptcy to our great surprise, right? I think that’s the biggest thing. Where is this world going with all that debt? And the un-serviceability of the debt and the other obligations at hand  is by far the biggest concern. It’s hard for investors to take that long view but we all know where it’s going someday, so be prepared.

TD: Eric Sprott, Chairman of Sprott Inc. Thank you for sharing your comments with us.

ES: OK, Tekoa. Always my pleasure.

For questions or comments regarding this article, or on investing in the precious metals & resource space, you can reach the author, Tekoa Da Silva, by phone 760-444-5262 or email tdasilva@sprottglobal.com.

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