PROFILE

Sprott Hedge Fund LP was founded by Eric Sprott, a Canadian asset manager, in November 2000 in Toronto, Canada. Eric obtained his undergraduate degree from Carleton University and joined the investment industry as a research analyst at Merrill Lynch after earning his Chartered Accountant designation. Later he started Sprott Securities Inc. (SSI) – one of Canada’s largest independent institutional brokerage firms, in 1981.

However, Eric exited SSI in 2000, after Sprott Asset Management was formed as a separate entity and chose to focus his sole attention on investment management business. When Sprott launched his first hedge fund, unimaginatively named Sprott Hedge Fund LP, it was only the third such fund in Canada. Today, with more than $10 billion assets under management, Eric Sprott is the largest hedge fund manager in Canada. Eric manages Sprott Canadian Equity Fund, Sprott Hedge Fund LP, Sprott Hedge Fund LP II, Sprott Offshore Funds, Sprott Energy Fund, Sprott Bull/Bear RSP Fund and Sprott Managed Accounts. He is a widely acclaimed fund manager and has received the Ernst & Young Entrepreneur of the Year Award (Financial Services) in 2006 along with the E&Y Entrepreneur of the Year Award for Ontario in the same year. Investment Executive named him the fund manager of the year in 2007.

Eric is known to be outspoken and his journey to the top has not been without controversies. He has been criticized for being aggressive who takes too much risk. However, his funds have managed to reward investors handsomely, beating markets by wide margins. His first hedge fund – Sprott Hedge Fund, now closed to investors, delivered a cumulative return of 718.1 per cent till July 2011 since inception. The S&P 500 (CAD) had grown negative 43.7 per cent during the period.

The second fund – Sprott Hedge Fund II – started in August 2002 and open to investors, follows a similar investment philosophy and has clocked a cumulative return of 149 per cent till July 2011.

Sprott’s investment strategy can either be risky or extremely defensive. Defensive positions revolve around bullions and commodities. Explaining his swinging-for-the-fences philosophy, Eric says since early days he has focused on hidden gems – small undiscovered companies that have largely been ignored but with the potential to return not just 30-40% of current market price, but multiples of that. Legendary investor Peter Lynch followed the same principle – make a large number of small initial investments that can really become very big. Eric would like to hear what a company thinks it can do, conduct due-diligence to find out the likelihood of the outcome and the potential upside if it does. If research shows there’s room for 50% growth but the market expects only 10%, then there’s enough margin of safety.

Explaining his defensive strategy, he says it’s extremely important to have a broader view of the market, to learn to identify long-term secular trends, and be prepared for major risks. Incorporating his insight to take advantage of market conditions is his responsibility, he adds.

For some time now, his view of the market has been extremely defensive. His mantra: ‘go long gold and silver, short everything else.’ In times of high volatility, “Make sure you own some physical gold and silver. You should buy it though a fund that has it for sure or from a bank,” he cautions.

His love affair with gold began in 1999 as a portfolio manager after witnessing the NASDAQ soar to heights beyond reason. “I had to assume when the mania ends you go into a bear market,” he recounts. “So, I became a student of bear markets. How long does a bear market last? What do you do in a bear market? Unfortunately, bear markets last a long time. And the worst one was 1929 when history showed that the best thing to do was to buy gold and/or silver. You buy gold to protect yourself. So then I had to become a student of gold but luckily there were quite a group of active prognosticators who had done a lot of work on the gold market.”

A secular bear run started after the internet bubble had burst ten years ago, he maintains. However, a cyclical bull run started in 2003 after the Fed started a housing mania that triggered a general lending mania, which resulted in a massive over-leveraged economy, ultimately blowing the financial system off. Global stimulus programs have failed to remedy the situation; rather the system has become more leveraged and private sector debt has been taken over by the sovereign state. Though the stock market may rally for short-periods, the real economy including retail sales, employment rate and corporate earnings continue to struggle. This is an area of concern since the artificial demand created by massive stimuli will start wearing off and there will be nothing left to create more demand. So the system either remains stuck in a secular bear market or witness a hyper-inflation as money-printing continues. Unfortunately, both situations demand for defensive investment position. It’s no coincidence that the price of gold has gone up over the last nine years, since the current bear market started, he says. A full cycle could easily last 15 to years, he observes.

Talking of his investment strategy, Eric says he is typically 30% long on silver bullion, 30% in gold related equities, 10% in cash, 10% in energy and 5% in miscellaneous stocks.

On the short side, he’s short about 70 cents for every dollar of capital. Since cash is not counted as a long position, it means he’s approximately 20% net long. The short positions are fairly diversified, though it remains concentrated in banking, retailing and home building industries.

Holding the government responsible for devaluing paper financial assets, he says only precious metals can ensure future wealth preservation.

Eric has great affinity for silver. There’s fundamental difference between gold and silver, he observes. While most of the yellow metal produced in the history of the world still exists, most of the silver has been consumed. World silver reserves have been massively depleted and the supply is unlikely to keep pace with demand in future. This will inevitably result in faster price movements compared with gold.

Eric is not a big fan of gold ETFs since he’s not sure if physical gold is actually bought and held by companies. Buying gold ETFs defeats the whole purpose of owning gold in troubled times since gold custody is no one else’s liability and Eric doesn’t want to take chances.

He’s reasonably bullish on energy stocks and particularly hopeful of uranium producers since nuclear power generation is set to witness rapid growth. Uranium stocks will be available at attractive multiples once prices of uranium start moving. However, the market needs to be a little patient, he concludes.

Quotes:

Quote 1 (On small undiscovered or ignored companies with huge growth potential): “We want to hear what a company thinks it can do, focusing our analysis then on how likely that is to happen and what the upside is if it does. People might consider that swinging-for-the-fences are risky, but we don’t look at it that way. If we’ve done the work and believe something can grow 50% per year, if the market is only expecting 10% growth, we’ve got a lot of room for error.”

Quote 2 (On why he bets on gold and silver): “If we believe we’re in a secular bear market or entering a world of hyper-inflation and debased fiat currencies, there’s no better place to be than gold and precious metals. I find it quite instructive that the price of gold has gone up every year for the past nine years, since the bear market started. That’s not a coincidence and we think the full cycle could easily reach 15 to 20 years. There is a survivalist aspect to having such a big stake in tangible assets. As long as governments show such low regard for policies that support the real value of paper financial assets, investing in precious metals is about the only way to guarantee the preservation of your wealth.”

Quote 3 (On why he won’t buy gold ETFs): “As gold investors ourselves, we know the difficulties involved in taking physical delivery of gold. Are they truly buying all that gold? Where in their chain of sub-custodians is it actually held? If any of the numerous counterparties involved were to default, it could be difficult for GLD to actually get at the gold it’s purported to own. We’re not saying anyone is doing anything untoward, but we just think using an ETF defeats one of the main reasons for owning gold in troubled times, which is the fact that it’s no one else’s liability. Why take the risk?”