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This article presents the outlook for investing in resource markets in 2013 based on the views of Rick Rule and Mishka Vom Dorp (Sprott Global Resource Investments).

The macro environment: The over-indebted government

Mishka Vom Dorp believes that we will most likely see a continuation of the "kicking the can down the road" rather than real solutions that solve the underlying problems. The fundamental problems facing the governments are over-indebtedness and overspending. The deficit is absolutely unsustainable but keeps on deteriorating with the monthly $85 billion additional stimulus announced on December 12th, 2012. This makes the economic outlook grimy. Ironically, politicians today spend time and effort on debates about "the fiscal cliff" which is only a minor issue.

Rick Rule adds to this that the artificially low interest rates are like a war for savers (i.e. the hard working people). Money is transferred to people that are less prudent and that do not save. Besides, the idea that taxing the rich is a viable solution, appears to be a total misconception. Suppose that 100% of the income of the top 5% earners are taxed (which account for 65% of economic utility), the government will be able to generate $450 billion per year (rounded number). That's nothing against the yearly $1.5 trillion deficit (excluding the unfunded liabilities).

The irrational U.S. bond markets

The yield on bonds cannot go much lower. We are facing today already negative real rates of return. Negative real rates are a guarantee that investors are losing the purchasing power of their capital. Rick Rule: "It is beyond me how investors consider this a risk off trade."

It is given that default is in front of us. The service cost is simply too high, and there is no way anymore to meet our obligations. Rick Rule believes there are two ways to default:

  1. Either honestly, vis-à-vis bond holders who will lose (part of) their invested capital

  2. Either dishonestly, defaulting on the underlying obligations, vis-à-vis the entitlement beneficiaries.

Rick Rule expects the second option to happen, which will be bad for the bond market but good for bullion market. It is not clear if this event is to occur in 2013 or later.

The ongoing European Debt Crisis

Into its third year, the European debt crisis continues to resurface time and time again. Rick Rule puts it this way:

Europe is ten years further in terms of consuming the children's well being for own well being.

Mishka Vom Dorp notes that Angela Merkel is up for reelection in 2013, and through recent polls it is looking like her party, The Christian Democratic Union, will be reelected. This means that her pro-EU fiscal conservatism will most likely remain and will most likely offset the chance of Germany leaving the Union. Greece, Italy and Spain will remain central to the problem. The question will remain of whether Northern European economies will remain intent on bailing out the PIGS and whether the peripheries will accept the conditions placed upon them by the stronger economies. This will most likely be the year when one side draws a clear line in the sand of how far they are willing to go.

Improving living standards in Asia & emerging markets

Rick Rule sees continuing improvements in the living standards of frontier, emerging and Asian markets. Those countries become slowly more free, which means they become rapidly more rich. In general, compared to Western countries, they are under-leveraged; they have good current account balances; their current deficits are lower; they even larger reserves of foreign currency than domestic currency into circulation. With 3.5 billion people reaching higher living standards and disposable incomes, increasing consumption of commodities is inevitable, which is very bullish for resources.

Mishka Vom Dorp zooms in on China. The export driven economy of China has been affected severely by the crises in the western world, resulting in a stagnation of its consumption of raw materials. We hear a lot of sound bites from "news" commentators about how China supports America through its large ownership of our debt. Some claim that the Chinese could cripple the American dollar if was so inclined through outright sales of that debt. What those rather ignorant commentators fail to notice is China's absolute necessity to suppress its currency to keep its exports affordable to foreign buyers. In many ways, the U.S. measures its growth through consumption, whereas China tabulates it through production. Selling that debt would strengthen the Yuan and crush China's export capacity. So it is in turn (wisely) converting those reserves into commodities.

With a new government elected in Japan, Prime Minister Abe has vowed to restart the 50 nuclear reactors which have been idled since the meltdown in 2011. Furthermore, he has put in question the ousted Liberal Democratic Party's policy of phasing out of nuclear power by 2040. This is indeed the jump start that the uranium sector needed and will most likely result in a further increase in investor sentiment within the sector.

Outlook for the resource market in 2013

With resource equity indexes off 50% in the past two years, and senior indexes down some 30%, Rick Rule points out we are in a cyclical decrease in a secular bull market. Savvy investors are able to see the temporary opportunities that are inherent in this phase of the bull market.

The resource market will face the following three serious challenges in 2013:

  1. Input costs are surging and will continue to do so. The cost for energy, steel, construction, etc are increasing worldwide and are a real challenge for resource companies.

  2. Because of the tight equity and debt markets, resource companies have no easy access to capital.

  3. Depletion keeps on challenging resource companies. The likely effect will be acquisitions of high grade discoveries.

Rick Rule believes that junior markets overall will go (much) lower. He expects that 80% of the 4.000 junior exploration companies (TSX-V) are non-viable. They will attempt to reach their intrinsic value, which is zero. We are going back to 1991, a period in time that was characterized by frequent delisting of junior companies. That movement will likely start in the first quarter of 2013. The best five to 15% of the juniors and explorers have probably already bottomed although the bottoming process may take an additional period of 6 to 12 months. Occasionally, however, we will witness pretty dramatic escalations, comparable to the best-in-class juniors in 2012:

  • Goldquest Mining (OTCPK:GDQMF) went from 6 cents to 2 dollar

  • Reservoir Minerals (OTCPK:RVRLF) moved from 30 cents to 3 dollars

  • Africa Oil (OTCPK:AOIFF) increased from 80 cents to 10 dollar

In addition, Rick Rules expects all sorts of amalgamations in the coming 24 to 36 months. Companies that are part of it will benefit from a reduced administrative cost, and will be able to create value to their shareholders with a premium on their shares (bringing hope and liquidity to the market). Moreover, it will create a natural "push" for companies to focus on discoveries.

Sprott Global Resource Investment is optimistic for 2013, although not the same kind of optimism that the markets experienced in 2009/2010. The resource market is cheap and will be behave in a rational way. However, we can expect volatility and major disappointments caused by the looming risks in the first section of this article (the macro environment). Savvy investors will use the volatility to buy oversold assets. It is advised to keep cash in a portfolio to buy quality assets with a clear disconnect between their value and price.

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Source: Investing In Resource Markets In 2013