Thanks to a reader's help we are continuing our coverage of the UK positions that various prominent hedge funds hold. This time around we're focusing on Sprott Asset Management (Eric Sprott). Of all the funds tracked here on Market Folly recently, Sprott Asset Management has surely been the most circumspect. This caution is reflected in both their gloomy analysis of the economy's prospects and their defensive portfolio positioning. Whilst Sprott are currently focused on playing defense, it’s important to remember that their track record shows that in the past they have also been able to go on the offensive. They were ranked 49th in Barron's top 100 hedge funds for 2009.
Here is a quick recap of Sprott's analysis of the current economic situation. In their report of July 2009 entitled “It’s the Real Economy Stupid” they argued that we are in the early stages of a depression. They suggest the current bear market may be similar in magnitude to the great depression of the1930s. Back in July, they pointed out that we were in week 90 of 149 in comparison to the 1930’s bear market.
Sprott’s view is that the only thing propping the market up is investor sentiment. They are particularly worried that investors might turn their backs on stocks, thus sending the market lower. Using Robert Shiller’s S&P 500 historical data and P/E ratios they set out three scenarios for the future. It is interesting to note that in all three scenarios they expect the S&P 500 to trade below the March 2009 low of 666.
1. In the first scenario, they see earnings staying constant; P/E ratios hit cycle lows: We (Sprott) assume a scenario where investors are nervous, people need to sell stocks to pay for lost wages, or for retirement, but the companies continue to perform as of June 2009. Assuming a P/E of 6, which is close to the all time low, and using an earnings value of $63.04 for the S&P 500 Index, we derive an S&P 500 Index value of 378.16
2. In the second scenario, earnings get halved; P/E stays constant: Earnings have been half of their current value three times over the last 30 years – so it is entirely within the realm of possibility that they could be halved once again. In the late 1970’s, early 1980’s and early 1990’s the S&P 500 Index generated half the earnings per share that it did this year in 2009 dollars. Using today’s P/E multiple of 16.08 results in an S&P 500 value of 506.
3. In the third outcome, earnings get halved; P/E ratios hit cycle lows: double trouble. If we combine these cases where earnings are cut in half from today and the P/E ratio drops to a cycle low, it implies an S&P 500 Index value of 189 (depression territory).
Let’s now briefly review Sprott’s portfolio. If you believe the stock market could fall in the way that Sprott do, it’s unsurprising that they have few if any of the growth stocks beloved by many hedge fund managers. In fact, they have very few stock positions in sectors other than basic materials at all. As of March 2009, Sprott had a huge 42.9% of their net asset value invested in gold and silver bullion. They then followed this up by continuing the theme with another 22.2% in mining stocks and precious metal plays. In addition, they had 33.5% of their NAV in cash and short-term investments. It will be interesting to see whether they have made changes to this Armageddon portfolio when the next round of filings is received. In the mean time, we can provide some details of two positions in the UK market that we have not reported before. There are no prizes for guessing what the holdings are in. Because, if you've followed them at all... you already know. Drumroll please...
Cluff Gold Plc – On 4/21/09 (U.S. date format for our European readers) the London Stock Exchange reported that Sprott owned 6,900,000 shares in Cluff Gold Plc, representing 5.9% of the ordinary shares issued.
Cluff Gold plc is focused on the identification, acquisition, development and operation of gold deposits in West Africa that are amenable to open-pit mining and low cost production techniques. The Group has assembled a portfolio of mineral interests at various stages of development in Côte d’Ivoire, Burkina Faso, Sierra Leone and Mali. The Company is incorporated in England and Wales and its ordinary shares are dual listed on the AIM market of the London Stock Exchange and the Toronto Stock exchange.
That wraps up their UK positions for now. And, as you can see, they've continued with their precious metals theme and overall defensive stance. This article is a part of the new series we are doing where we track prominent hedge funds' positions in the UK. Our hedge fund portfolio tracking series typically focuses on SEC filings that detail holdings in American markets. And, in an effort to cover all things hedge fund, we are now also focusing on positions in other markets. In this series we've already covered the UK positions of Stephen Mandel's Lone Pine Capital as well as Timothy Barakett's Atticus Capital. Check back daily as we expand our coverage thanks to a reader's help.
For more resources on Sprott Asset Management, we've started covering them more in-depth and just yesterday posted up their July market update. Additionally, you can also peruse their insightful yet gloomy market commentary. And last but not least, we have also covered the long and short positions of their Canadian Equity Fund for those interested.