Rick Rule: “The Same Set of Circumstances Exist As In 2010---But Prices Are Now Off By 80%”
Published in October 3, 2013on
During a time of deteriorating sentiment and share prices in the natural resource sector, Rick Rule, Chairman of Sprott US Holdings, was kind enough to opine on the marketplace. Rick has dedicated his entire adult life to many aspects of natural resource securities investing, and leads a highly skilled team of earth science and finance professionals with a worldwide reputation for resource investment management.
Here are his interview comments with Bull Market Thinking’s Tekoa Da Silva:
Tekoa Da Silva: Rick, starting out with gold---we had a strong sell-off this week, down about $40 on Tuesday. What are your thoughts there? Are we going to move into another manic drop in your opinion?
Rick Rule: I don’t think we’ll go into a manic drop but I do think we’re approaching a situation where it’s not unreasonable to expect very, very volatile markets. I think the problems we’re having, as an example the dysfunction of the US congress with regards to the spending authorizations and the upcoming problem with regards to the debt ceiling, and the fact that those occur in October which is a psychologically important month, raises the specter in everybody’s mind of a sort of asynchronous or black swan event that takes down all markets and drives everybody to respect liquidity.
I think what happened certainly in the gold futures markets Tuesday is that whatever remaining leverage longs there were thought about the fact that there could be a constraint in available capital as a consequence of a broader financial panic, brought about largely by US political dysfunction and people decided to go to the sidelines and go to cash.
TD: Rick, you’ve commented in the past that there are about 200 or so global corporate issuers that are qualified as far as being deserving of your firm’s capital. How is that market developing in terms of those people being realistic in terms of asking for money and what they’re willing to give in return?
RR: Tekoa, they are absolutely willing to take capital but they are amazingly stubborn in terms of the conditions that they’re asking for in the context of contributing the capital that they very much need.
Those issuers are certainly aware of the fact that they are the best of the best and I think given that they’re entrepreneurs, they are very, very optimistic in their outlook which is a good thing generally. It’s a bad thing if you happen to be a capital provider because I think one of the things that happen as a consequence of their naturally optimistic orientation is they regard the capital raising conditions that existed in the period 2003 to 2010 as normal conditions rather than optimal conditions and they believe that this market downturn is much more temporary than I happen to believe it is.
I am in most cases older than they are and I have been through more cycles than they have and I think I understand more about normalized funding conditions than they do. But the truth is that the market will teach us over the next 18 months who is right and who is wrong.
TD: So what are your thoughts on the extent of this bear market? There’s also this ongoing talk of the majors’ divesting of core assets and maybe “de-conglomerating”. Is that going to add a few years of downward pressure on property prices in your opinion?
RR: Yes, I think we’ve got 18 months of that. I think it’s going to be a very turgid and very interesting 18 months. The majors are definitely going to sell projects that aren’t going to get built this cycle. They’re going to turn them into cash because they’re going to have to, and if these sub-$1300 gold prices remain, the majors are going to have to take new write-downs on their balance sheets which are going to unnerve investors.
There are also a bunch of juniors, that if the funding climate doesn’t return, are going to go to junior heaven. They’re going to go away which is actually a very good thing.
At the same time, there is a dearth of projects that make really good returns on capital employed at these gold prices. So the juniors like the Reservoir Minerals of the world as an example that make good discoveries or the companies that are still advancing on very economic feasibility studies will get taken over in the next 18 months.
At the same time that the majors understand that they have to sell, they also know that they have to buy. If you will witness Newmont’s sudden interest in Las Bambas, the sale by Xstrata, that’s a $5 billion transaction. So it says that the majors are going to have to be fluid.
But what it also says that’s very beneficial for the long term is that the mining industry is beginning to understand that they have to deliver something besides production. They have to deliver profits. While the reckoning, that is getting through the period where the expectation is to production, and to the period where the expectation and the realization is profits is going to be ugly and could be 18 months. The truth is, it’s very, very possible for the industry.
Having said that Tekoa, I think the damage in the juniors has been extensive enough that I am personally of the view that the very best issuers are cheap enough. It isn’t to say that they couldn’t get cheaper but my own personal bias is much more on the long side than on the short side with the best issuers.
TD: So would that suggest that at this time you might be steadily accumulating those issuers or deploying a larger portion of your cash than you have maybe in the last 12 months?
RR: In the very near term, I’m holding cash through the month of October where I think there’s an unusually high possibility of an asynchronous event brought about by market volatility.
I’m not trying to say that we’re going to have a 2008 style event but I think if ever there was a set of circumstances that came together that would give an asynchronous event the ability to take the financial system off the rails again, it would be this month.
So for the balance of this month, I am cash, cash, cash, and cash. But if we survive this month I am certainly much, much more inclined to be making some big bets on the best assets in the sector.
TD: Rick, you’ve mentioned in the past that you’re not as disinclined to the general US equities markets as maybe some of your colleagues. Does it appear strange to you that the general US equities are at such heights, maybe increasing the likelihood of an October event?
RR: I’m certainly concerned about the strength in things like the Russell 2000. While I’m not a general market analyst, when I look at the individual components of the S&P 500, if you look at companies like Hershey, you see some absolute financial fortresses. You see companies that are selling at six times EBITDA to enterprise value, meaning companies that could take themselves private from their own free cash flow.
You see companies with balance sheets that are absolute fortresses. So if I am able to divorce myself which is difficult to do from my own fairly anemic outlook for the US economy relative to other commentators and just look at the individual companies, look at the cash they generate and look at the strength they have vis-à-vis their competitors, I can make a bullish case. Your readers need to understand that you are talking to a credit analyst with a background in natural resources who is pretending in this case to be an equities analyst and a generalist.
So it’s a comment that is of probably limited value but I certainly look at the market through a variety of eyes and when I look at the market, you know the analogy couldn’t see the forest for the trees. When I regard the market as a forest, I’m pretty leery. When I start to look at the individual trees, I see some really truly spectacular specimens out there. So I’m of mixed minds that way.
TD: Rick, how would you describe the internal dialogue, the conversation in the Sprott organization right now? You talked about in the past in terms of this market as being the sort of market where great fortunes are made. Is that sort of a consistent sentiment right now within the firm?
RR: There isn’t a consistent sentiment in the firm. Eric Sprott who runs the firm is as aggressive as I have seen him since the year 2000.
Eric believes that we are truly at a tipping point with regards to precious metals prices and as a consequence, he is as is his style, the style that has made him a billionaire, very aggressively going into the marginal junior producers. He’s looking for companies that aren’t going into production but are in production.
Eric believes that gold within 12 months will certainly be above $2000 and could be above $2500. So he’s looking for companies that barely make money at $1400 but would be making $800 or $900 an ounce if the gold price went higher that are producing 100,000 ounces a year.
Eric believes that this is the year where his portfolio will see ten to fifteen, 10 to 20 baggers. So he is at the most bullish end of the internal spectrum of the firm.
I am probably the most conservative in the firm. I am enjoying not so much my inability to attract equity placements but I am certainly enjoying the ability that the firm has had in participating in debt and mezzanine markets and lowering our return outlooks in return for obviating most of our risk.
We are also within Sprott I think universally sanguine about the fact that our own balance sheet is unblemished by debt and we have a lot of working capital and a lot of spare cash. So we see ourselves really uniquely equipped to deal with a range of market circumstances that we could see ourselves in over the next 12 to 24-month period although as I said at the beginning of this monologue, there isn’t a sort of a unified Sprott outlook as to the state of the markets, in particular the junior precious metals markets.
TD: Rick, in terms of your more conservative approach, I assume you must have had many hard learning lessons in acquiring your perspective. Is there a #1 Rule that you’ve sort of chipped away at and concluded on over the years in terms of resource investing? If so, how did you learn it and was it through a hard lesson?
RR: Tekoa, that one is easy. Natural resource based businesses are capital intensive and they’re cyclical as I said on your show many times. You are either a contrarian or a victim. The nature of things is that bear markets beget bull markets and bull markets beget bear markets.
The same set of circumstances that existed in 2010 exists now but the prices are off by 80%. You need to make yourself be a buyer in bear markets and make yourself be a seller in bull markets and as you suggest, I learned that lesson the very hard way.
I was an extremely successful young man in the 1970s bull market in resources. Like many young men, I chose to confuse a bull market with brains. I thought the fact that the gold price went from $35 to $850 and the oil price went from $3 to $30 was somehow my fault.
I also believed the big thinkers, the Jeremy Rifkins and the Jimmy Carters and the Club of Rome who projected those trends ad infinitum and in fact ad nauseam. I believed that my genius and the trend in natural resources would continue and in 1982 when the whole bull market came apart, I came apart too. I was reasonably leveraged as a consequence of my confidence and conviction and what I learned is that while my assets were very ephemeral, my debts were all money good. I managed to get through that period without going bankrupt but it took me really two and a half years, the period between 1982 and the period up to about 1985, to become solvent again.
It was that very lesson---that the grand bull market begot a grand bear market---that you need to be a contrarian or you’re going to be a victim, because I certainly was a victim of my own hubris to be sure, but a victim nonetheless.
It gave me the most important lesson that one needs to learn in participating in particular in natural resource markets but I would suggest in markets overall.
TD: Rick, would you say that, that learning lesson, that stumbling block that you hit---is that a place where many resource investors might give up and completely abandon the sector without struggling through, as you said, becoming solvent again and continuing your education?
RR: Sadly, they don’t give up. They make the mistakes again and again and again. I interview investors at these various conferences that get shaken out at bear market bottoms and return during bull market tops for several cycles. They just don’t get it. Their timing is excellent. They do exactly the wrong thing at exactly the right time and I would suggest that’s almost a characteristic of junior speculators. They’re emotional as opposed to rational and the excitement of the bull markets is overwhelming. It reinforces the paradigm that’s natural to them and the lessons that are learned in bear markets are somehow not taken into account, which is really a tragedy. It would be better for those people if they got shaken out entirely.
TD: Well Rick, in winding down, are there any other items you think we may have missed?
RR: Well one other thing, we talked about important lessons, I think the other lesson that people particularly in the juniors need to remember is that it’s all about leadership and it’s all about people.
Mines are made and you have some people who I regard as “A” players who are consistently successful and to be consistently successful as a speculator, what you need to remember is that you need to buy aggressively the best of the best of people during the worst of the worst of times and if you do that one thing which is awfully goddamn hard, you will do very, very well.
TD: All right. Well, Rick Rule, Chairman of Sprott US Holdings, thanks so much for sharing your comments.
RR: Always a pleasure Tekoa. Thank you.