Animal Spirits Podcast - Talk Your Book: The Most Important Thing Nobody Owns

Starting point is 00:00:00 Today's Animal Spirits Talk Your Book is brought to you by Sprott ETFs. Go to Sprotetetetfs.com to learn more about the Sprott Critical Materials ETF. That's ticker SETM. That's Sprottetefs.com. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Redhol's wealth management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Britholt's wealth management may maintain positions in the securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben.

Starting point is 00:00:45 Michael, on today's show, we speak to Steve Schaftall, who's a managing partner head of ETFs at Sprott ETFs. Critical materials we're talking today, which is funny because you wouldn't have ever really thought of commodities as a technology play back in the day. There's a ton of like unintended winners, I guess, for this AI thing. I don't know if anyone would have thought at the time like, oh, it's going to be commodity material producers, obviously, right? Because we're going to need all this stuff. And that is obviously one of them, though. Like if this is going to happen, there's a ton of material that needs to be extracted from the earth and used to build this stuff. Data centers and battery and energy.

Starting point is 00:01:21 And would this be considered a picks and shovel supply? Absolutely. Okay. Corning, for example, not a stock that we spoke about today. not a manufacturer of critical materials, but all of the glass they make for fiber optic cables, all the data center stuff, like that all needs a gigantic amount of materials. Some of them critical. That sounds like a great Jason Statham movie, Critical Materials, starting Jason Statham.

Starting point is 00:01:45 It really does. By the way, it's not just a phrase. There's some sort of governing body that has termed these here materials critical. Right. It's a definition. And obviously, those materials. are all over the earth, right? Some easier to get, some harder.

Starting point is 00:02:01 How rare do you think rare earths really are? Remember that's seen of Mighty Ducks, too? Actually, Iceland is pretty green. Am I getting that right? Or is Greenland the icy one? Either way, it turns out that rare earths are not that rare. Okay, that's possible. If this whole energy transition,

Starting point is 00:02:19 get from here to there in terms of data centers, and then electric vehicles and battery, all these different, like, it's going to require a lot of stuff. You know, robots are made of metal. That's true. So we talked to Steve about all of this, about who Sprott is what they, who they manage money for. We got into all about the portfolio management and Sprott critical materials ETF.

Starting point is 00:02:41 That's SETM, which is called SETM. Usually have the wrong, what's your stance on this? Come on. What would you say? Because it's the opposite of what you say. I mean, there's literally only one thing to call it. It's set M. Okay.

Starting point is 00:02:52 Anyway, here's our conversation with Steve. Steve, welcome to the show. That's great to be here. Thanks. I believe this is the first time that we spoke with somebody in Sprott. Can you tell us 30 seconds about the company? Yeah, so we're a publicly listed asset manager. We're listed in Canada as well as on the New York Stock Exchange. We're most well known for our physical trust.

Starting point is 00:03:13 So we primarily focus on metals and mining. Our physical trust will cover things like precious metals, physical copper, physical uranium. And we have a growing ETF lineup now that's 13 U.S. funds and five different funds in USATs rappers in Europe. And old told, we're about 65 billion in assets, maybe a little lower than that with the recent market sell off. Okay.

Starting point is 00:03:37 Interesting. So you guys are Canadian-based? For Canadian-based, we have offices throughout the United States, including Connecticut and New York, which is the office I work out of. Got it. All right. So thank you for that. I coincidentally listened to an audiobook accidentally in preparation for the show.

Starting point is 00:03:54 A listener recommended it. The book is called Material World. You familiar with this one? I've heard of it. Yeah, I haven't read it myself. It's the six raw materials that shape modern civilization by a guy named Ed Conway. And in there is salt, oil, lithium, copper, and iron. And so I was finishing the book this weekend.

Starting point is 00:04:14 One of the companies they mentioned was Auburn Mall. And I know the ticker, ALB. And I got to be honest, Steve, just between you and I, I had no idea that was even a material stock. Not a clue. She's in the stock. I don't think I ever traded it. Had no idea. So needless to say, the material world is becoming more important, not unless it's a

Starting point is 00:04:34 paradox or not, as we build out the digital world, like the materials that are helping to power all of this are increasingly important. And investors have the opportunity to get access to it through the Sprott critical materials ETF. What are you trying to deliver? The ticker for that is, by the way, what is the ticker? SETM. What are you trying to deliver to investors through this vehicle?

Starting point is 00:04:56 Yeah, this is a fund that we've launched a little over three years ago now. Good timing. Yeah, good timing. And one of the things that we try to do when we roll out new funds, as we try to look into the future and as best as we can tell, look at those different commodities that we think have long-term potential. So looking mainly at supply and demand dynamics and kind of how the world's changing. SETM and our view kind of fits right into that.

Starting point is 00:05:21 It provides exposure to the miners of up in nine different critical materials. So think of energy generation. You're talking rare earths companies, uranium miners, silver miners, on transmission of energy, that would be copper miners. And then also miners of different battery metals like lithium, nickel, cobalt, graphite, manganese. And the whole thought behind SCTM was that if you were to look at broader investor portfolios, most investors are underweight miners.

Starting point is 00:05:46 And most investors that might have mining exposure are underweight a lot of these critical materials. So SETM was designed to be a pure play ETF that in one ticker provides exposure to a basket of critical materials without investors having to pick one metal versus another. Dumb question here. How do you define the idea of critical materials? Steve, I'll take this one. I just finished the audiobook, as I mentioned. Like was an expert. Critical materials, critical minerals, similar things, right?

Starting point is 00:06:17 So where we start is if you look at most countries now have a list of, of critical materials, U.S. Geological Survey in the United States maintains ours, Europe, Canada, they all have their own. And basically what you're looking for, and those lists are much broader than the nine different metals that we're focusing on, but we're looking for those metals that are, one, investable from an investment standpoint. You know, we're not looking to get exposure to maybe there's one or two miners to a certain metal. But the other aspect of that is they have to be significant from a defense or national security or economic security standpoint. but at the same time subject to supply disruptions.

Starting point is 00:06:53 And so that's really what kind of the baseline definition is for a critical material. And that's how we landed on the nine that we have. I'm going to ask a long-winded question. So forgive me in advance. There is a shortage of compute. That's all we keep hearing about. And given that these are critical materials, I'm guessing that there is more demand than supply. So my question for you is there's the underlying commodity.

Starting point is 00:07:18 But ultimately, a lot of these business, a lot of these business, a lot of these things that we're investing in are equities. And miners and particularly have a long history of booms and bust and terrible management. So have these companies learned from the mistakes of the past? Like, how is management delivering returns to shareholders? Because this could be the type of thing where, oh, my God, this makes so much sense. Like the thesis makes a lot of sense. But then you go and look at like the actual results and it's not what you were hoping for. So how does management, how do these companies deliver for their shareholders? Yeah, no, great question. And usually when we get that question, it's in response to gold miners, right? So if you were to look at, you know, we'll use that kind of as example because I think that's one that if somebody owns mining stocks, it's probably gold miners. Early 2000s, gold was doing well. At that point, we saw a lot of the miners were, you know, really looking to leverage up and and take advantage of higher gold prices. And when gold prices came down, you know, miners weren't necessarily in a very strong position from that standpoint. When you go through the 2010s, there was, you know,

Starting point is 00:08:18 mining in general, about a lost decade of investment. So that really impacted critical materials, and we can unpack that. But what we've seen this go around, if we're sticking with that gold miners analogy, is that miners have generally this go around, been much more prudent in the way that they're managing their books. They're not over leveraging. They're not constantly looking for new acquisitions. They've been much more reserved in that standpoint. I think they got the message from 15 or 20 years ago that that's something that investors value. How much of the critical material play is just a play on new technologies? Because I think that that's an interesting way to think about this,

Starting point is 00:08:54 is that there's just so much more demand for new technologies, batteries, energy, data centers. How much of that fits into your thesis? It's an increasingly important part. But if you look at those metals that we talked about, copper, for example, we've been mining that for thousands of years. And roughly about every 25 years, the demand for copper doubles. And usually we see that with structural shifts in the global economy. We saw that as China was moving into their industrial age.

Starting point is 00:09:22 We now see that, you know, kind of that next leg up with the technology and energy transition theme. But what's really at the root of a lot of the growing demand for these critical materials is increases in electricity demand. So that can come through technology, which is typically what we're seeing in Western countries. If you're looking at more developing type countries, it's really increases in their standard of living, you know, things that we take for granted here in the United States. but, you know, India, for example, is a great one where, you know, air conditioning is not very,

Starting point is 00:09:52 you know, widely available. That's actually a significant demand driver for copper. But when you start to focus out a little more, if you look at the strategic uses, those would be things like defense, artificial intelligence, energy transition. Those three are becoming increasingly important across a lot of these metals. Where does geopolitics fit into the equation? Because increasingly companies are playing less nice with each other. then maybe they have historically. What's going on there and what are some of the risks that investors should know about? Yeah, I'd say the biggest for that would be, you know, how China fits into the

Starting point is 00:10:26 landscape for a lot of these critical materials. They by far have the largest smelting capacity for copper, so that's refining the copper. So a lot of it, if it's mined outside China, finds its way to China in order to get refined and then export it out from there. Similar thing for lithium, they have a lot of the, you know, if they're not extracting the lithium, themselves, a lot of the processing. We see it in rare earths where they control about 70% of rare earths mining, over 90% of the refining and magnet capacity. So geopolitics is becoming increasingly important because what we've seen several times now over the last 20 years or so is that China is increasingly weaponizing their leadership position just at the end of June. They put export restrictions

Starting point is 00:11:10 on rare earth to 10 U.S. companies. And then same thing with some European companies here at the end of July, they hit 14 companies there with export restrictions that include rare earth. So geopolitics is an evolving story and along the premise of our tilt away from China because we expect that a lot of the investment will happen in United States and its allied countries. And we're starting to see that play out now. When you're trying to build a portfolio out of this thesis of growing demand for these critical materials, is it just, are you saying, hey, this is kind of a beta play? And we're just going to ride the wave and we're going to kind of, spend our bets and try to hit each of these in the way we can, or is it more active?

Starting point is 00:11:51 No, no, no, we're going to concentrate on specific types of companies that are going to benefit the most from there. Like, how do you try to play this from an investment angle? Yeah, so SCTM is a passive strategy. Unlike what you might see with other passive strategies, where an asset manager can go to an index provider and say, hey, we like your strategy, we're going to launch a fund on it, or ask for an index provider to go create an index for them. We've actually been very much involved from the onset with NASDAQ and creating these indexes. So with our background and metals and mining, this is an area where we have unique expertise. And so each twice a year, this fund is going to go through a rebalance or reconstitution.

Starting point is 00:12:31 And we actually go through a process here with our proprietary scoring system. And we create the eligible universe that gets sent to NASDAQ who then creates the index based on the rules of the index. but it is a passive strategy. The goal of SCTM is to provide that broader-based exposure so that investors don't have to say, you know, I expect copperd outperform uranium, for example, will provide that one-taker solution. What actually is driving the prices for these companies?

Starting point is 00:12:58 Is it the commodity price? Is it just the structural supply demand and balance? I don't even know if it's structural. I guess I just made that put up. What is, like, how much beta is there to the overall stock market itself? Yeah, typically what you see with, miners is they tend to outperform the commodity on the upside. They'll underperform on the downside. That's because they have operational leverage to the underlying metal. You're correct in that a lot of these

Starting point is 00:13:25 metals do have what we believe to be a structural supply deficit. Either they're already in that phase or one's expected to come. If you look at copper, for example, this is a metal that's becoming increasingly important as electrification continues. Last year, we slipped into a supply deficit given some market disruptions that we had at some large major mines. We're expecting this year, maybe we go back to a surplus, but long term. The growth in a lot of these metals is expected to outstrip supply and our ability to meet that supply. So what we're seeing is a lot of investment coming from public and private institutions,

Starting point is 00:14:02 so U.S. government, European governments, and then as well as Silicon Valley is investing quite heavily in a lot of these themes, uranium mining and nuclear energy, for example. So that investment's crowding in additional investment. And we're seeing higher commodity prices that are staying higher longer. Copper prices are still near all-time highs. And with that, we're seeing improving in balance sheets and financial conditions for a lot of these miners. And that's what's really been driving their performance outside of some of the noise that we've had here with the larger market volatility we've seen over the last four or five months. In terms of public companies, what is the investable universe look like for this?

Starting point is 00:14:38 Is there a huge universe of stocks? Is this a global fund? Like, where do you go to find the areas to fill this portfolio? Yeah, it's a great question. It's a growing area. When you look at the number of names in this fund, it's about 157 as we're taping this today. It's pretty broad geographically. We have, you know, Canada's going to make up about 35% of the portfolio. Australia's in there about 21%. And then we see the United States, about 20%. So very heavy in those three. But outside of that, there's another, you know, a dozen, 15 named countries or so that have mining equities related to these critical materials. It's going to be about 52% large cap and then they're about 30,

Starting point is 00:15:19 35% midcap and the rest small cap. But it's a growing index universe and one that, you know, we've seen growing considerably since we've launched this fund. It seems like everything these days is a bet on AI one way or the other. You're either lever to it or you benefit when it's out of favor, where does this fit into the equation? I would assume it's more the former than the latter. Yeah, so we see investors that are actually looking to critical materials as a way to, a non-technology way to play artificial intelligence, right? So when you look at, you know, the data centers and everything that powers these, not only do you need energy, right? So you can look at things like rare earths, which are used in wind turbines, silver is used in

Starting point is 00:16:01 solar panels, uranium obviously used in nuclear energy. A lot of these AI, companies are looking specifically to power their data centers using clean energy sources. So those three in particular get a lot of interest, particularly nuclear energy. And then also when you look at how you build these data centers, you need things in there like silver, like copper. Increasingly, we're seeing a lot of these data centers being backed up by battery power. So the battery metals also play a huge component into that. Increasingly, investors are looking at ways outside of the large tech names to play

Starting point is 00:16:35 artificial intelligence and SCTM's kind of called on from that. Can you talk about the growth of the materials powering batteries with electric vehicles becoming such a huge portion of cars on the road? Ben's not super familiar with the story. So just for his benefit, please. Hey, I drive a hybrid. It's an EV. Funny you mentioned hybrid. That's, you know, if we were having this conversation, you know, three years ago, I think

Starting point is 00:16:57 the kind of the estimates on what we would see from, you know, EV sales were quite astronomical. I think some estimates had about 350 million EVs on the road by the end of this decade. Not at that level, but in the United States, the hybrid, you know, in our view, is probably going to be that next step where you do need to start seeing more critical materials like copper, like the battery metals that you don't see from the gas powered cars. But when you start looking at, you know, demand for, you know, lithium specifically, just from EVs and, you know, grid storage systems out through about 2035 or so, it's expected to account for about 91% of overall lithiums.

Starting point is 00:17:33 So it's really driving what we're seeing in lithium and, you know, in particular, as we're seeing multiple battery chemistry emerge here. I saw a stat the other day. I think it was the RAV-4, not a stat. I think the RAV-4 is eliminating their gas-only options. It's either purely electric or a hybrid. Either you guys see that? Yeah, we're seeing that in some places in Europe, right?

Starting point is 00:17:56 Where, you know, EV sales are pretty much 100% of new car sales, right? geographically and from a population disbursement in the United States, that doesn't seem as realistic at this point, given the range of how far any of you can drive. And we're pretty much a driving culture relative to more urban cultures like we see in Europe. Makes everything quieter, that's for sure. I'm curious the correlation between the prices of the underlying critical materials and then the public companies themselves. So I guess my question is just, do you need to keep having the prices for the underlying commodities, keep pumping higher to have these public companies work out well, or is there another layer to it in terms of,

Starting point is 00:18:36 no, even if the prices just kind of stabilize where there are these companies going to be fine, like how do you think about the relationship between the prices of the commodities and the public companies themselves? There's definitely a correlation that we tend to see. It tends to be different from each commodity, but typically we get that leverage on the upside and leverage on the downside as well that comes with it. But, you know, one thing about the market and physical commodity market and the stock market, there's two different things at play, right? So if you're looking at spot prices, that's kind of looking at the here and now, whereas when you start looking at the miners in the equity market, you know, ideally, you know,

Starting point is 00:19:13 it's going to be pricing in future expectations as well, right? Something that we don't necessarily see in the spot market. The other aspect is that the spot market for a lot of these different metals is, you know, not as liquid as what you see out of the miners. So it can be difficult necessarily to say, you know, uranium prices, for example, have been around the $85 to $86 a pound. They're up about 6% on the year. Uranium miners have sold off just a little bit on the year.

Starting point is 00:19:43 Some of that is because, you know, what we're seeing from this general risk-off sense given market volatility, that can tend to impact, you know, miners more than it may the underlying commodity, which is, you know, still being used and in demand at that moment. So it's not a perfect one-for-one correlation or two-for-one correlation, but the underlying trajectory of the commodity does impact the miners in future outlook there. All right. Jerry Seinfeld-voice, what's the deal with uranium equities? So it's the second biggest behind copper. So we were just talking about lithium and what it's done with batteries.

Starting point is 00:20:21 What is uranium's critical, however you finish that sentence? Yeah, I'm a huge Seinfeld fan, so I can appreciate the reference there. The deal with uranium, rather, is that, you know, it started out, I'd say five, six years ago, where a lot of the focus on nuclear energy started to shift away from countries being opposed to nuclear energy, whether it's for perceived environmental reasons or risk associated with the sector. We've really seen a lot of countries and even environmental groups that were once opposed to nuclear energy really pivot 180 degrees. We see countries that were moving away, completely decommissioning their plants, are now looking to start them up again. We saw one of the leaders in the European Union come out and say that moving away from nuclear energy was just a strategic error.

Starting point is 00:21:11 That came in light of what we've seen happening in the Middle East and the Strait of Hormuz closure and the impact that's having on fossil fuel markets, particularly. crude oil. What nuclear energy gives you is the ability to stockpile the material. Typically, you know, once you feed a reactor can be up and running for 18 months or so or even longer than that. And so you can stockpile that material, very little down tide inside, very reliable base load power, unlike things like solar and wind, which are going to be impacted by environmental conditions. So energy security, in addition to the clean energy aspect of nuclear energy, has really pushed the move for more nuclear energy and the prevalence there. And Silicon Valley, you know, with the AI data centers investing directly in next generation

Starting point is 00:21:57 technology, nuclear reactors are really driving demand and investment in the space. How much of this demand is coming from outside of the United States? Because you mentioned that this is a global fund and not a big part of it is in the U.S. The EV market is right a lot bigger in China and a lot bigger in Europe that it is here. Is this more of a global story for this fund? It's a global shift, I think, in the way that the economy is being structured. So if you were to look at the Bloomberg New Energy Finance every year, they put out a report on the energy transition, for example. And last year, the estimates on spending just on the energy transition was about $2.3 trillion globally.

Starting point is 00:22:33 Typically, what we see is China is the leader in this space, whether it's nuclear energy or building out mining capacity or smelting capacity. They're not necessarily doing that for clean energy purposes, like maybe you're a lot. European countries are. But it is very much a global story as we're starting to see these geopolitical risk, you know, starting with Ukraine, now we see it with the U.S. Iran conflict. All of this is putting a magnifying glass on the need to have energy security. So it really is a global story. And, you know, the one thing about commodity investing is we don't get to pick where the metals are located. And because of that, we see a lot of emerging economies are benefiting from foreign investment. we see that in parts of Asia and throughout Africa as well.

Starting point is 00:23:18 I feel like there was a public groundswell for, for nuclear. It was starting to come back, talks about how we should, we should build. And then the Chernobyl miniseries, I feel like just stopped it dead in its tracks. Everybody saw that show, it said, hey, wait a minute. Yeah, I think, you know, maybe from people who are watching the miniseries might have had that feeling. But if you look practically in the United States, basically every nuclear reactor that was either being decommissioned or was already shut down like Three Mile Island, for example, all of those are now on a path to being reopened. And we're seeing life extensions across the globe being increased in a lot of the large reactors. And I think one of the things that really hasn't hit the market yet and it really figures into the uranium theme is small modular reactors.

Starting point is 00:24:07 These are much smaller in size. think of them almost as like Legos before nuclear reactors. You can build them off-site, a much smaller footprint, bring them on, plug them into the existing grid infrastructure. Estimates are in the next four to five years or so, we'll really start to see these roll up a commercial basis.

Starting point is 00:24:23 But that's where we're seeing a lot of the investment happened from U.S. government, Department of War, Silicon Valley, and the SMR technology. How much do you think about how technology changes this field in the coming years? I don't know if anyone 30 or 40 years ago was assuming that the U.S. would be like this energy dependent nation or something, but technology's got to the point where we could

Starting point is 00:24:43 extract more. And so how do you try to build out like demand forecasts with the uncertainty of who knows how technology is going to make us more efficient in the years ahead? Yeah, it's a great question. I'd say, you know, going back again, four or five years ago, I think net zero was kind of the prevalent, you know, barometer for let's see what the demand expectations are for a lot of these metals and for energy. I think a lot of countries have kind of moved away from that, particularly the United States, as we've had a change in administration. You don't hear about it quite as much as you do. I think what is really driving is the rapidness that we're seeing technology change. The data centers, for example, by 2030,

Starting point is 00:25:22 could require the same amount of electricity that Japan uses. So a very significant electrical footprint. In the United States, for much of the 2010s, we were able to get away with efficiency standards, and that was offsetting the increase in electricity. We're now past that point where the efficiency standards can offset our growth, and we're really seeing that hit the market as it relates to artificial intelligence and other aspects. It tends to be a little difficult. A lot of the projections are about to 2040, 2050. But I think what you can do is kind of look at where the market's shaping up now and use that to kind of see what the midterm looks like. And without, you know, But make sure that you're taking a supply and demand with a grain of salt, I guess, is probably the best approach.

Starting point is 00:26:07 No one could have possibly foreseen chat GPT moment in 2022 happening and that leading to all this demand. There's no one who no one's radar that was on, right? Yeah, that's right. And when we launched this fund, a lot of it was around, you know, the energy transition side, just growing electricity. Artificial intelligence really starts to ramp up, what, about three years ago now. And with that, it's actually been even more bullish than, you know, what we were expecting when we rolled this fund out. a few years ago. So we'll have, you know, things like that likely that will continue to come into the market. We could see some efficiencies that come in some of these technologies and, you know,

Starting point is 00:26:42 decrease in demand a little bit. But when you start looking at things like uranium, like copper, like rare earths, there's such a ground swell for what's needed from those metals. And there's a large foreseeable gap that closing that gap takes considerable investment from that. We expect to see miners do well. All right, Steve, for people that want to learn more about S. E-T-M. Where do we send them? I'd say send them over to Sprottetefs.com. One of the things that we try to do is put out as much information and it's not behind a paywall, no email address or anything.

Starting point is 00:27:15 We put out monthly insights, plenty of content, whether it's videos or media and podcasts like this show has been very helpful in getting the story out. And we find that a lot of investors understand critical materials and just need a little bit more education so we put that out there. So I'd say head to sprot etfs.com. All right. Great job. Thank you. Thank you. Thank you to see. Remember check out sprotetfs.com. Learn more and email us animal spirits at compound news.com.

Animal Spirits Podcast - Talk Your Book: The Most Important Thing Nobody Owns

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