Dan Denning at Daily Reckoning: Why the Fed Can''t Raise Rates

Section:

ByAngela Barnes
Investment Reporter
The Globe & Mail, Toronto
Monday, April 26, 2004

http://www.theglobeandmail.com/servlet/story/RTGAM.20040426.wxrbestbet
26/BNStory/Business

The U.S. stock market has staged an impressive cyclical
rally from its March 2003 low, but fund manager Eric
Sprott isn't convinced that the bear has been banished.

"We still believe that the odds favour the continuation of a
secular bear market," said the president of Toronto-based
Sprott Asset Management Inc.

"There are two things that kill stock markets: Interest rates
going up and oil prices going up, and we have them both,"
he said. Oil prices have risen significantly and interest
rates are starting to break their "almost 20-year downtrend."

But it isn't just those factors that lead him to believe that
the market will go back into a secular bear phase. It is the
imbalances in the system that worry him, particularly those
that arose from the fact that the U.S. Federal Reserve
Board and the U.S. government "threw everything" in terms
of stimulus at the economy to help it and yet they "didn't
get that great of an economic recovery."

The stimulus included dividend tax credits, a falling U.S.
dollar, tax cuts, changes in pension legislation, and
uncommonly low interest rates. And after all that
stimulus, "everybody ultimately is probably worse off
than before" in the sense that both individuals and the
government have taken on more debt and the
budgetary deficit has worsened, he said.

Those factors and others make Sprott think that "we
have always been in a secular bear market here."
Furthermore, he warns "we have not yet seen the lows."

He sees gold and gold stocks continuing to be among
the better ways to play this market. He is also drawn to
energy issues. He thinks world oil production may be
peaking at the same time as the demand side is "going
crazy."

Most of the major oil discoveries were made 40 years
ago or so, Sprott said. "Today people think 500 million
barrels is a big find" and yet "500 million barrels is
about seven days of oil consumption in the world," he
noted. "So you need to find 50 of them every year." He
added that "we basically consume six barrels of oil for
every barrel that we are finding these days."

He is interested not only in conventional energy stocks,
but also other energy issues as well, including coal,
uranium, solar, geothermal, and alternative energy such
as coal-bed methane.

Energy issues account for about 30 percent of the
weighting in the Sprott Canadian Equity Fund, of which
he is lead manager. Gold stocks make up another 20
percent or so and gold bullion about 15 percent. The fund
has gained 11.4 percent so far this year.

Sprott recently purchased or added to positions in:

* Silver. The precious metal has been one of his favourite
buys recently. "We think that demand is far in excess of
supply and it is only a matter of time that there will be
physical manifestations of a shortage of silver," he said.
He expects the shortage, when it materializes, will be a
major one, and there could even be a short squeeze on
silver because production has seriously lagged demand
for well over 15 years. U.S. and Chinese government
stockpiles filled the gap, but they have now been
depleted, he said. He expects the price of silver, which
closed Friday on the New York Mercantile Exchange at
US$6.16 an ounce, will go a lot higher over time. "I
believe that silver is going into the double digits," he
said, adding that he wouldn't be surprised if the price
got to $20. He has also been buying shares of several
silver companies, including Western Silver Corp. The
Vancouver-based firm has a world-class ore body in
Mexico, which has significant grades of silver, he
said. Western Silver's shares ended Friday's session
on the Toronto Stock Exchange at C$8.71. The
52-week high was C$11.84 set on April 7; the 52-week
low of C$2.71 was established on June 4, 2003.

* NEMI Northern Energy & Mining Inc., Compliance
Energy Corp., and Fortune Minerals Ltd.. All three
companies have large coal deposits in British Columbia
that are close to rail lines and other facilities, Sprott
said. The deposits could probably be "rushed into
production" when the economics become attractive. The
price of coal has doubled in the past 12 months, he
said, adding that he thinks there is a "dramatic shortage"
of coal in the world, brought on mostly by China's need
for it in electricity generation and steel production. He
sees coal as "the most immediate substitute for
declining oil and gas supplies." Northern Energy closed
Friday at C$1.28 on the TSX Venture Exchange and
Compliance Energy at 53 cents. Fortune Minerals
finished at C$3.45 on the TSX. Northern Energy's 52-week
high was C$1.60; its 52-week low 26 cents. Compliance
hit a 52-week high of 82 cents on March 26 and a low of
22 cents on Sept. 16, 2003. Fortune Minerals' 52-week
high was the C$3.95 established on Feb. 10. The
52-week low of 60 cents was reached a year ago.

* Thunder Energy Inc. Calgary-based Thunder Energy is
one of the leaders in Canada in the coal-bed methane
business, Sprott said. It has recently been estimated
that Thunder's coal-bed methane assets could be worth
as much as C$10 a share, he added. The stock is
currently trading for considerably less than that. It
closed Friday at C$8.08. Most of its coal-bed methane
assets are undeveloped. Coal-bed methane production
involves the extraction of natural gas from coal
deposits.

"Thunder finds itself very well positioned to have
significantly increasing cash flows as they develop their
coal-bed methane reserves, along with other conventional
reserves they have," he added. Those conventional
reserves alone may well justify the current stock price
and "the coal-bed methane in our view is just a bonus,"
he said. Thunder Energy shares climbed to a 52-week
high of C$9.05 on Dec. 9 from a 52-week low of C$5.45
on July 22, but they have since eased somewhat.

In a May 17, 2002, Best Bets interview, Sprott mentioned
several gold stocks, including High River Gold Mines Ltd.
and NovaGold Resources Inc. He still holds large positions
in both stocks. He also mentioned Hurricane Hydrocarbons
Ltd., which has since become PetroKazakhstan Inc. The
stock has "been a spectacular performer for us," Sprott
said. It remains a major holding. "The stock has always
been inexpensive, even at today's prices," he added.

Another issue cited was Energy Savings Income Fund.
At one time, he held more than 10 percent of the units but
sold them and took profits. About a month ago he
reinitiated a position in the trust but the holding is not as
large as it was originally.

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