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Sprott Asset Management p.1
Surviving the Depression 
December 2008
 
MARKETSAT A GLANCE
Eric Sprott Sasha Solunac 
Sprott Asset Management
Royal Bank PlazaSouth Tower200 Bay StreetSuite 2700, P.O Box 27Toronto, OntarioM5J 2J1T: 416 943 6707F: 416 362 4928Toll Free: 888 362 7172
www.sprott.com
 
Far be it from us to mince words. Make no mistake – we are in a Depression.That’s right, it’s the dreaded ‘D’ word. And we are knee deep in it
right now 
. This isnot a run-of-the-mill recession. Does anyone still believe we’re in for just a fewquarters of, at worst, low single-digit economic contraction, after which things willreturn to normal? We find it shocking that most economists still do. This is farworse than a recession. It’s a Depression. To call it anything else is to ignore theobvious.The official GDP data by the US Department of Commerce is, of course, woefullyunreliable, being continually revised years after the initial release. Be that as it may,the National Bureau of Economic Research officially announced, albeit almost ayear after the fact, that the US has been in recession since the fourth quarter of2007. But if Q4 of 2007 was an economic contraction, then Q4 of 2008 is anoutright economic collapse. All the data points are showing that economic activity,right here and right now, is falling off a cliff in unprecedented fashion.Auto sales in the US in the month of November were down 37% year-over-year, toan annualized rate of 10.2 million units. This is a level not seen since 1982. Lastyear at this time (during a recession) cars were being sold at a 16.4 million unitannual rate. Throughout this decade, 16-18 million automobiles have been sold inthe US each and every year like clockwork. Now it’s 10 million. That’s adepression-sized decline. US housing starts in the month of November were down18.9%
from October
, and down 47% from November of last year, to a 625,000annual rate. To put this in perspective, during the first half of 2006 housing startswere running at a 2 million annual rate. Once again, this is a depression-sizeddecline in economic activity. Just think of all the construction jobs being lost.US jobless claims for the week ended December 6 were 573,000, the highest in 26years. Mass layoffs are making headlines on a daily basis. In finance. Inmanufacturing. In retail. In construction. In transportation. In services. In tech…you name it. Challenger Gray reported 182,000 announced layoffs from bigcorporations for the month of November, the worst month since the monthsfollowing the 9/11 attacks. The ADP report just released estimated that 250,000 jobs were lost in November. All sectors are in steep economic decline and laying offworkers
en masse 
. US industrial production was down 5.5% in November over lastyear, making this quarter the worst since 1980. Little wonder that consumerconfidence continues to fall off a cliff, with the RBC Cash Index falling to 15.3 inDecember from 34.7 in November, and the University of Michigan consumersentiment index recently hitting a 28-year low. Furthermore, the company surveysthat we follow (timely measures of recent economic activity across a broad swath ofthe economy) are all currently plunging, showing depression-type declines.
 
 Sprott Asset Management p.2 
 
Sprott Asset Management
Royal Bank PlazaSouth Tower200 Bay StreetSuite 2700, P.O Box 27Toronto, OntarioM5J 2J1T: 416 943 6707F: 416 362 4928Toll Free: 888 362 7172
www.sprott.com
If Q4 2007 was the start of the recession, then Q4 of 2008 is the start of theDepression. It’s only getting worse. We’re not aware of a single bright spot in theeconomic data that would even remotely hint at things getting better anytime soon.We are in the midst of an unprecedented
globa
l economic contraction, with noprospect for one region to ‘save’ the others. This depression is global, pervasive,and deep. Some may point to plunging interest rates, already at zero in the US, asa ‘data point’ indicative that things are about to turn around soon. We believe theopposite to be the case. Zero percent interest rates are an ominous symptom, notthe cure. In a recession, zero interest rates are highly stimulative. In a depression,they are not. Monetary policy has been little more than a sugar-coated placebo.Credit is neither cheap nor plentiful. Just ask the Bank of Montreal, one of the bigbanks in the highly admired Canadian banking system, that recently did a bondissue (not stock, not preferred, but straight-up plain-vanilla bond) at a 10% interestrate. Central bank interest rate policies have become irrelevant. Once again, this ishighly indicative that we are in a depression. Corporate spreads have gone throughthe roof. Not just for junk bonds, but
all bonds
, even AA rated.Any belief that this will be a short and shallow recession, or even a relatively longand deep recession (but still a recession), is, in our opinion, woefully misguidedwishful thinking. This is a depression – one that has only just begun. One that thevast majority of us (the sole exception being those over 80 years of age) have neverexperienced in our lifetimes.From an investment standpoint, we believe survival will be the name of the game.By all accounts, 2008 was an awful year to be an investor in the markets. TheMSCI world index, a rough proxy of the developed world’s stock markets, is downalmost 45% year to date. The developing world’s stock markets have performedeven worse. That said, in any environment, even in a depression, there are assetclasses that can prosper. What are they? Looking at 2008 through a rear-viewmirror for the moment, there were four investment strategies that paid off and‘survived’, at least for the time being. One is cash, specifically the US dollar (andthe yen, but we won’t be discussing the yen in this article). The second isgovernment bonds (not munis, not state, not county, but
only
Treasury bonds). Thethird is gold (the physical, incorruptible currency/store of wealth). And the fourth isshorting, specifically the stock markets, but any risky asset would have done nicely.By any measure, these four strategies have been winners in 2008. The realquestion, of course, is will these investment strategies also be winners in 2009, ayear when the financial crisis will have morphed into an economic one as well?Let’s tackle the last first: shorting. Shorting is not an ‘investment’ strategy in the truesense of the word. After all, if money could be made in the long term by shorting,then capital markets as we know them would cease to exist. That said, shorting haspaid dividends (pardon the pun) from an investment survival standpoint, especiallyas a hedge against other asset classes. Going into 2009, we believe shorting willcontinue to be a prudent investment strategy. In a depression, corporate earningsfall off a cliff, if they exist at all. Corporate survival can become tenuous, as debtsthat were incurred during more prosperous times become increasingly onerous(especially in a deflationary environment) during not-so-prosperous times.Financing can be very hard to come by, oftentimes being extremely dilutive toexisting shareholders. We believe the stock market can fall a lot further from here.Although current valuations may seem reasonable by most measures, they have yetto fall below reasonable. In a depression, stocks will become downright ‘cheap’,
 
 Sprott Asset Management p.3 
Sprott Asset Management
Royal Bank PlazaSouth Tower200 Bay StreetSuite 2700, P.O Box 27Toronto, OntarioM5J 2J1T: 416 943 6707F: 416 362 4928Toll Free: 888 362 7172
www.sprott.com
and still get cheaper. Going into 2009, there is definitely further downside risk in thestock markets. Shorting will continue to be an effective strategy to offset this risk.Next, let’s look at the US dollar and US government bonds, also winners in 2008.But will this continue to be the case in 2009? We doubt it. For one thing, with zeropercent interest rates, the upside for Treasuries is effectively nonexistent. Theyshould perform no better than cash, and potentially worse. Treasuries havebecome the opposite of cheap – they are downright expensive. By historicalmeasures, with 10-year yields at 2.1% and even the 30-year at 2.6%, US Treasuriesare the most expensive they’ve ever been. So let’s combine US Treasuries and USdollars into one asset class, paper assets that promise to give essentially no return.We continue to believe that the strength in the US dollar throughout most of 2008was completely devoid of any fundamental basis. The recent relative weakness ofthe dollar in the past two weeks, having broken down against other currencies, maybe signaling that the bull market in the US dollar is now over. As we mentioned inprevious articles, the dollar has been a beneficiary of the massive deleveraging thathas occurred as the 2008 financial crisis unfolded. However, very aggressivemeasures, both monetary and fiscal, currently being employed will severely put intoquestion the notion of the US dollar as a ‘safe haven’ store of value. With a $400billion budget deficit in the first two months of the 2009 fiscal year (started October),the US government is well on its way to posting a $1 trillion deficit this year, morethan double any deficit in history and the largest deficit as a percentage of GDPever. Furthermore, in its desperate attempts to reflate the financial system, theultra-aggressive policies and programs of the Federal Reserve (to date the mostaggressive central bank in the world) also promise to ultimately debase the dollar asa store of value. At a zero fed funds rate and quantitative easing now in full force,the Fed has entered the realm of experimentation in uncharted territory, havinggone well outside the rules. On top of bailing out financial institutions left and right,it is now also buying CDO’s and, in the new year, programs will be implemented tobuy asset-backed securities such as car loans, consumer credit card loans, andstudent loans. What’s next? The Fed may soon be the buyer of last resort forcommercial real estate, or common equities. The long-held rule that the Fed is onlyto deal in the highest quality and most liquid securities has been thrown out thewindow. Although they may be justified in breaking the rules, the rules have beenthere for a reason; namely, to maintain a sound and stable currency that people cantrust. When central banks start breaking the rules, look out. There are alwaystrade-offs and unintended consequences. Hyperinflation could be around thecorner. Don’t let the dollar’s status as the world’s reserve currency lull you intobelieving that it couldn’t happen here. Any fiat currency is only as good as the faithpeople have in its central bank. In 2009, we believe this faith will be severelytested, especially in a depression scenario where the desire for competitivedebasement may be too tempting to resist.Lastly, there is gold. Having started the year at US$800, as we go to press it is nowUS$860. In other currencies, gold has performed even better. Although there maybe some who are disappointed that gold hasn’t performed better still, by now therecan be no question that in the midst of the 2008 global financial crisis,
gold hasdone exactly what it was supposed to do
. Namely, protect portfolios against thecarnage that was experienced in almost all financial assets around the world. Asreaders of this article know, we have been gold bulls for several years now. Givenrecent developments,
we have never been more bullish
. Gold has proven itself to
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