Rick Rule - Founder, Global Companies
Mr. Rule has dedicated his entire adult life to many aspects of natural resource securities investing. In addition to the knowledge and experience gained in a long, successful and focused career, he has a worldwide network of contacts in the natural resource and finance worlds. As Chairman of Sprott US Holdings, Mr. Rule leads a highly skilled team of earth science and finance professionals who enjoy a worldwide reputation for resource investment management.
Mr. Rule is a frequent speaker at industry conferences, and is interviewed for numerous radio, television, print and online media outlets concerning natural resource investment and industry topics. He is frequently quoted and referred by prominent natural resource oriented newsletter and advisories. Mr. Rule and his team have long experience in many resource sectors, including agriculture, alternative energy, forestry, oil and gas, mining and water.
Sprott US Holdings is active in securities brokerage, segregated account money management and investment partnership management involving both equity and debt instruments, across the entire spectrum of the natural resource industry.
The following is the transcript of a brilliant interview that took place recently. In this interview, Rick shares with us his candid and very eloquent perspective on interest rates, precious metals and the mining sector for 2013 and beyond.
Patrick MontesDeOca: Thank you once again for joining us at the Equity Management Academy. I want to go right into the interview. With regard to the current bond market situation, Rick, it is showing signs of a potential long-term top in the making with prices coming down in the neighborhood of about 8 points I think in the past 9 weeks.
My question has 2 parts to it, the first part is are we looking at a market beginning to demand higher interest rates and much lower prices to compensate for the risk that the US debt currently carries?
Rick Rule: Well, I'm not a bond analyst but that would be my suspicion. Jim Grant famously referred to the US long-term market as return free risk and certainly I would suspect that at least traditionally oriented bond analysts like the people at Pimco don't feel that they are being adequately compensated in terms of real yield for the risk associated with the credit.
There's another group of investors of course on a global basis who have responded to declining interest rates and the 20-year-long bond bull market by saying that the returns that they get are adequate because their risk is so high in every other field. I'm part certainly of the prior camp. I don't believe that the yields offered in conventional debt markets including government markets are anywhere near sufficient to accommodate for the risk, particularly when you're looking at absolutely negative real yields. The idea that I'm going to take an interest rate risk and a credit risk over time in return for a negative real yield doesn't sound like a lot of fun to me so while I couldn't comment in terms of the overall market, certainly my own prejudice would be that there is nothing like the kind of yield that would be required to sustain this market.
PM: If this is the case that rates are moving higher, how is this going to affect the world economy and indirectly affect the price of precious metals, gold and silver in particular?
RR: Well the first comment I have is that if rates have to move higher, which is my belief, what I have learned in 30 years of following these things is that just because something is inevitable doesn't mean it's imminent. It may take 2 to 3 years to roll over so your listeners should not interpret my remarks as things that might occur this week or next week. These things play out over time and I think higher interest rates are a mixed blessing for the precious metals markets. In the first instance, they raise the costs associated with having precious metals, but to the extent rising interest rates are a recognition of investors' response to the appreciating currency-in other words, if the interest rates go up like the way they went up in the 70s, being pulled by rather than pulling the economy-that would be indicative of a overall market environment that would be extremely good for precious metals. Witness what we saw in the 1970s.
PM: Is the gold-platinum ratio indicating possibly that the worst is behind us and to expect maybe some kind of global economic recovery, or are we moving into some kind of inflation recycle?
RR: I'm not prepared to comment on ratios like the gold-platinum ratio, because our own work is decidedly less technical than fundamental. I think in terms of the macro economy we're in a space where leadership is in transition from the older mature markets, the markets that have become politically less free, places like Western Europe and Japan, to frontier and emerging markets that are becoming slightly more free.
It is ironic that the countries that were the focus of credit concerns in the 1980s and 90s are the countries that have the better balance sheets now, not because they were not necessarily better run, but simply because they couldn't access world credit markets. I'm thinking of places like Russia, Chile, and Indonesia. I'm not suggesting that these places were more prudent fiscally, it's just that after the series of contagions we saw after the 1990s, they were frozen out of global credit markets and as a consequence the collective part of their societies are less indebted than we are, and I think that's where you're seeing leadership in the economy begin to go to. There's a whole bunch of interesting manifestations about that; one is that early recovery in smaller markets isn't as good for the overall world economy as a recovery in the European or American economies. But it's very, very good for the natural resources space. People get richer. The things that they spend their money on are made with stuff. When Americans get richer they buy more services; when poorer people get richer they buy things that are made of stuff. So I think the outlook is going to be mixed as I say, but I think it's going to be very good for commodities.
PM: I want to get into that a little later on. My next question is about how we have been able to maintain control over the currency crisis here recently with the Euro trading at 135 levels against the US dollar now, and the Japanese government aggressive monetary policies to devalue the yen in order to stimulate their economy, are we looking at potentially and inevitably a global currency war environment?
RR: Yes, I think we in the West have for two decades lived beyond our means, and I think we need to put our economy on a different footing. The subtle way to do that is to depreciate the denominator, the US dollar, the Yen or the Euro. I think your question is very prescient because I think that is precisely what is happening. There is a tacit agreement at the top to appear not to be doing that, but certainly the very aggressive Japanese moves have been accompanied by pretty severe jawboning by both the US and the European economic communities. Being highly disruptive, it would seem to me that both in terms of preserving domestic employment and also depreciating the denominator of the sovereign debt, the moves that the Japanese have done recently have mirrored the moves that were done in the United States and Europe. So we're sort of accusing them of what we have done, which is somewhat disingenuous I think.
PM: Let me go back here to what we talked about before regarding your expertise in the mining/natural resource area which I think is suffering from a tremendous correction here. You have described gold as both catastrophe insurance and an investment vehicle. What is the best form of gold to invest in for as insurance and as an investment vehicle?
RR: That depends on the investor. For many years I believed in owning gold myself physically, and I still own some physically. Now that I'm somewhat older and I can afford more gold, for me, I own most of my gold in the form of Sprott Physical Gold, which is a closed, trusted and trades on the exchange. I am cognizant in why one would own physical gold but I am not unsympathetic to people who do it. What I found myself was that the cost associated with buying and selling it, that is the market and discount to buy and sell gold became problematic. Arranging for and insuring physical storage that I trusted, not some third party deposit that I didn't know and trust was problematic. So although I still own some physical gold, my personal gold holdings now are large enough that it is much more convenient for me to own certificated gold and I'm talking my own book, but I believe that the Sprott physical products because of the tax advantages they afford US investors like myself are the finest certificated forms of bullion ownership in the world.
PM: How can our viewers have access to that information?
RR: The easiest way is to go to our web site which is www.sprottglobal.com and contact us and we'll certainly send out information appropriate to investors respective of where they live. We'll refer Canadian investors to information appropriate to Canadians and the same to Americans or citizens of other places. And by the way, in the context of talking about the Sprott product, I'm not arguing against the physical holding or ownership of gold for people, but it is for investors who have come to believe like me or particularly US investors who are interested in more advantageous tax treatment than they would get as collectables. That decision was appropriate to me and it may be appropriate to others in similar circumstances.
PM: For the benefit of the listeners, could you please give us your expert opinion on the natural resource and mining industry for the foreseeable future.
RR: Well, you know I love bear markets. It has been my experience that what a bear market really is is a sale! It's funny that when we go to buy consumer products we love markets that are on sale. For some reason when we go to buy financial products, maybe because of our existing inventories, we don't like goods on sales. I would remind your listeners that it is bear markets that are the authors of bull markets. These extremely oversold situations that kick off the market rallies that reinforce the confidence that become bull markets, and the idea that you want to buy financial assets that have been marked up because the act of marking them up reinforces your prejudice is pretty silly. The time when you would want to buy goods is when they are on sale and you by definition can't buy goods on sale in a bull market. You have to buy them in bear markets. So from our point of view we believe that this soft market will continue for a reasonably long period of time; when I say reasonably long period of time certainly at least a year or two years. We believe also that the very best of the juniors have probably bottomed now. It won't feel like we are in recovery because so many of the juniors have much farther to fall, but certainly from the point of view of Sprott, we are seeking to aggressively allocate capital in this market now with the sense that our rewards will come more as a consequence of stock selection than a general market rebound.
PM: Most mining companies shares obviously as you mentioned have not risen with the rise in gold prices, why not?
RR: We think with regards to the junior space where we have particular knowledge and I suspect where your listener base is particularly interested, that 60% or 70% of the public companies that populate the junior mining space are valueless. We think that the bull market, the sort of 2003 to 2010 bull market, certainly punctuated of course by 2008 on the down side, we think that very long bull market generated so many excesses in the junior market that you need to work through those excesses before the junior market as a whole turns up. That disguises the fact that good companies and bad companies rose in the bear market, and good companies and bad companies have fallen in the bear market. Success in this market is going to be more a function of the investor and the investor's advisors being able to differentiate between the good and bad instead of seeing an overall rebound of the market itself.
PM: How close will the correlation between gold prices and gold mining stocks be at that point?
RR: I think that in the next 18 months they are going to be uncorrelated. Last year as an example, which is not a year that anybody would accuse of being a good year for exploration stocks, when companies actually performed, when they delivered deposits, when they delivered exciting exploration information, the market responded well; witness Gold Quest that went from 6 cents to 2 dollars. It certainly came off when subsequent holes didn't excite people as much as the first hole, but Africa Gold Group would be another example; 80 cents to 10 dollars. Reservoir Minerals would be a third example, going from 26 cents to 3 dollars. This is not a market that won't reward success but success has been fairly sparse. I think that investors that are looking for a rise in the overall market will be disappointed for the next year or two because there are still many excesses from the bull market to wring out in the bear market, but speculators who are willing to do the work, the qualitative work, to differentiate between the good, the bad and the ugly will do extremely well this year, I think, because the good goods are on sale.
PM: What would you look at in a small mining firm if you were looking to invest as an individual investor or an institutional investor?
RR: I would be looking in particular at the preliminary economic assessment or pre- feasibility stage developmental junior, which would be the subject of an accretive takeover from a mid-size or major. The companies that have preliminary economic assessment grade or prefeasibility grade stage deposits are selling at the greatest discount to the net asset values associated with those studies that I've seen in my career in the mining business, and I don't think that all of them are going to work. I think very large resource-based companies with low grades and high upfront capital expenditures, and as a consequence lower returns on capital employed, won't do well. The deposits, as an example, that exhibit the most leverage to gold won't do well. But the companies that have better grades, lower capital intensity and higher financial internal rates of return, I think in the next 18 to 24 months will be the subject of very accretive, surprisingly accretive transactions. I think that when you start to see some of the targets go, that there's going to be a real feeding frenzy. One of the things you've noticed with the mid tier and larger companies is that they've spent maybe two-thirds of their market cap just maintaining their production and while they've maintained their production in the past three years their production costs have soared. And I think you're going to see a renewed focus on financially accretive transactions rather than transactions that increase merely the production profile of the acquirers. We think that there are 15 or 20 potentially accretive transactions to take place on a global basis. We know that there are as an example about 80 companies worldwide that produce less than 200,000 ounces a year. The industry probably needs 20 accretive transactions, so you have to consolidate that space.
PM: How important is a company's management team to a company's success?
RR: Critical, absolutely critical, and what you point out is subtle but your readers need to understand that the skill sets evidenced by the management team has to be very specific. As an example, a management team that distinguished themselves operating a gold mine in French-speaking Northern Quebec in artean or protozoan terrain may not be very confident at all in drilling off a copper discovery in Spanish-speaking Peru in very young tertiary volcanics; meaning that the management skill set has to be identified very, very closely with the specific task at hand, which is the part of the whole qualitative process that we described earlier in this interview.
PM: Rick, I have one more question. This has been a wonderful and brilliant interview and I really appreciate it. What is your opinion on the precious metals like silver and gold including platinum for 2013?
RR: Well, I'm bullish on bullion. I've always believed that bullion was, among other things, catastrophe insurance and as we described earlier in the interview it's a historic medium of exchange; a money if you will, but it is unique in that it's not simultaneously somebody else's liability. It is not a promise to pay. It constitutes payment in and of itself, which is very, very, very important. It's also, of course, as John Molden would say a financial asset that central banks cannot print. It can't be counterfeited or debased. It has no political constituency for devaluation like other currencies would have as we discussed earlier.
With specific regard to platinum and palladium, I am personally particularly bullish there, because the industrial applications, basically pollution control, have such utility to society that we see the demand for it not only being sustained but increased at higher prices and we see supply falling off fairly dramatically. So in the near term, I'm probably more bullish on platinum and palladium than I am the other two (gold and silver) but that isn't to suggest that I'm not bullish on gold and silver. It is just that I am more bullish from a fundamental point of view with regard to platinum and palladium.
PM: Rick Rule, Sprott Asset Management, thank you so much for your time and until next time take care.
RR: I've enjoyed it.
PM: Thank you, take care!
Additional disclosure: The information in the Market Commentaries was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed therein constitutes a solicitation of the purchase or sale of any futures or options contracts.