Founder, Global Companies
We have the honor and pleasure to have with us today Mr. Rick Rule, founder and Chairman of Sprott Global Resource Investments. Mr. Rule has dedicated his entire adult life to many aspects of natural resource securities investing and in addition to the knowledge gained in a long, successful and focused career.
He has a worldwide network of contacts in the natural resource and financial worlds. As chairman of Sprott U.S. holdings, Mr. Rule leads a highly skilled team of scientists and financial professionals who enjoy a worldwide reputation for resource investment management. Welcome.
The following is a transcript of this interview that took place the week of April 25, 2013.
PM: To get right into it, we seem to be entering a currency war environment. What do you see as the future for the U.S. dollar in relation to the GDP ratios? Can our debt be sustained and if so, for how long?
RR: There's a bunch of questions in the near term. Is the dollar is going to be strong? Remember that this is still the world reserve currency. It is still the deepest and most liquid currency in the world. Ironically in the currency wars, it is what you might call the prettiest horse in the slaughter house. The Japanese have of course, reacted to take down the yen, as the yen comes down and Japanese export goods become cheaper, the other Asian exporting nations like Korea, Taiwan, Vietnam and China will have to answer or face competitive pressure in their export markets. As that happens, of course, the euro nations will have a choice between weakening the euro or themselves being uncompetitive as export nations on a global basis and of course the biggie, the U.S., will have one of two choices: devalue or else have our own trade deficit grow. Longer term, I think the problems for all of the Western nations with regards to their debt and currency, and with regards to the lives that the citizens live, which probably can't be continued at this level of economic output, would argue in favor of either a default on social promises and obligations or else weaken the currency. That's a long way of saying that currencies will be weaker in the near term. The dollar will be stronger compared to the rest.
PM: What do you make of the current monetary policies in the eurozone in regards to the banking system and the possibility of a wider bank contagion, you might say, or a large-scale bank run?
RR: Well, I think it's inevitable. I think one of the things that Cyprus proved to us is that the deposit insurance -- the idea that if you put your money in a bank, you can do it without considering the bank's solvency and without the value of the assets that secure your deposit -- it's just another social promise. A hundred years ago, it was expected if a bank failed, the depositors would lose some of their deposits. They didn't like it, so the depositors voted at the political level the deposit insurance, which is another social promise like healthcare, like pensions, and it is another promise that will have to be obviated as time goes on. I think the realization is slow to dawn on people. They don't want to realize, so they don't realize it, but there's been a range of social promises in the eurozone that are going to be too expensive to keep. The economies at the core of Europe are strong, but while they are strong, they are not strong enough to support the social promises that all of Europe is voting itself or attempting to at Germany's expense.
What I find really interesting is the complacency that seems to be there, or maybe is it the lack of information that we're getting through the media. They're not reporting what's really happening.
I don't think it's that. I think the media has a conventional orientation. The financial journalists are long on journalism and short on analysis, but I think the problem is much deeper. I think in terms of the investment market or investment reaction to the news, I think it can be explained fairly easily. In that first off, people's minds search for information that reinforces their existing prejudices. Conformation: that's the first thing. Your expectations of the future are set by the immediate past, which is another thing and our experiences since 2008 have been relatively benign. It is comforting to believe you don't have to secure your own financial future; that you don't have to prepare for catastrophe. Merkel will do it for you. If you observe this excess, they have been keeping markets tranquil since 2008. Your experience is fairly benign and you would like to believe, I think, that their use of liquidity, which is the substitute for solvency, is something that will work in the market. I think it will work in the market for awhile. Remember, we said this before, that the root word of confidence is con and most of the investors want to be conned because of their past experiences.
PM: They don't want to believe the reality that's happening.
RR: Correct. The people that are about to receive Social Security don't want to conceive of not receiving it. We don't want to conceive of the chaos that would happen in North America if the social benefits that the citizenry expects were cut to an affordable level. We don't want to think about what will happen to global debt and equity markets if, in a free market, which will be 250 basis points higher than these interest rates are, took effect. All those things are extremely unpleasant to think about. If we think the political leadership is smart enough, we can avoid them. The immediate situation suggests that's the case. It's more pleasant.
PM: Let's switch to gold and silver. Your thoughts on this massive, orchestrated attack on…
RR: I'm not sure it was an attack. I'm not saying it isn't. Either one of two things I think is happening. One is that on a global basis, a lot of leverage momentum players, when they started to see the trades turn. The other thing is I think there is an awful amount of structured prices, which revolve around gold and silver. Structured products become uncomfortable for the holders at the viable end for the holders….
PM: When you say structure, you mean leveraged?
RR: Yeah. People were involved in yen/gold carry trades, which would be an example where people were required to meet margin calls, or as they're called in this area, performance guarantees, as trade went along, an unwinding of momentum-oriented leverage structured plays can be very vicious. It was particularly instructive, I think, to see the downside volatility occurred in the futures in paper markets, while the underlying physical demand was incredibly strong.
PM: Well, that's exactly what we are experiencing. In fact, one of our affiliated companies that we work with, a wholesale precious metals bullion dealer, notified us that yesterday the wholesale price increased by 400 percent: the wholesale margin. Is there any reality to the reports that we are in a physical shortage?
RR: I think we are in a shortage in retail denominations. There's no shortage of kilo bars. There is a shortage of coins. There is a shortage of coin rounds; the things that mints use to make coins. There is a shortage of coin strip, which is the material to make rounds, and there is a shortage of small denomination bars. The shortage isn't a localized shortage. We are seeing reports of shortages in the U.S., in Canada, in the eurozone, in Dubai, in Hong Kong. So there is a global shortage in retail denominations. There are no reported shortages we can see in kilo gold or kilo silver or 10 kilo silver bars. On a global basis, there is beginning to be a reported shortage in 300 gram or 10 ounce gold bars, which is the upper end of the retail product offerings.
PM: Is that some kind of sign, maybe, that we're beginning to see demand, finally, integrating into the reality in which we're looking at?
RR: Well, it will be very interesting going forward to see the collision between the silver physical and paper markets because the physical demand has been spectacular. I think what you will begin to see now is a tightness in the wholesale bar market as the wholesale bar market gets converted into coin strip (laugh) because the retail demand is truly spectacular. The dealers may kill off the retail demand because of their widening the margins unbelievably with 20% and 25% premiums on retail orders; the price for the retail buyer premium to spot.
PM: Would a physical shortage develop when the paper market, which is attempting to set the price, comes to see the reality?
RR: I don't know the answer to that. You know, we watched the same circumstances in the silver market a few years ago and certainly, the physical demand began to drive the futures market, but the futures market survived the shock. You know, what you ask is the 64 billion question and believe me, I wish I had the answer to it, but I don't (laugh).
PM: Can we trust the commitment of traders report numbers?
RR: I'm not an expert in those matters, so I would rather keep my comments to subjects I thought I was competent to discuss. In terms of the commitment of traders, the idea that someone might talk their book has occurred to me, but it's not really something that I am prepared to discuss. If you look at the commodity price forecast, the platinum forecast, the energy forecast, base metal forecast, if you look at the major forecasts two years and three or more forward, the commodity price forecasts for the last 15 years, these people have been so consistently wrong that I wonder what value one might get out of their price estimates. Their track records regarding commodity forecasts on the 24 to 36 month forward basis are virtually unblemished by success. I mean I regard them as useful in cash flow forecasting. So despite the fact that I don't have the information necessary for the forecast, what I do personally, is I look at the forward strip price. I look where people have spent money and that to me is more important.
PM: Let's move into the mining sector for a minute. Any thoughts on why the hedgers do not demand the real price?
RR: They can't get it. If you look at the spot price and then look where the state of the market is in forward commitments in hedging transactions, in the prices you're requiring, there's a disconnect. I think the hedge market represents an inside futures market because of the underlying volatility in the metals price, so I think in fact the hedgers are getting a real price. They are getting the price that someone is willing to put up in return for 100,000 doubts going forward. The speculators who are on the other side of the hedge are taking a lot of price risk themselves, interest rate risk, and the idea they do it for no margin… these guys aren't the Red Cross.
PM: Are they considering at this point lifting their hedges?
RR: I would suspect the intermediaries always try and hedge out. It may be that some of their hedges unwound in this last downturn. It would make sense, wouldn't it? That was a violent correction. I think you will see a pretty volatile hedging in the futures market, you know, on a going forward basis, as long as short-term credit is available, as it is the near-term hedges, the 2 and 3 month hedge markets with these interest rates low and inequity high, should be fairly liquid.
PM: What happens if interest rates start to rise?
RR: Oh, boy. Look out below…. pick any asset class you want.
PM: You potentially may have some sort of short squeeze.
RR: Well, I think you have all kinds of problems. I don't think it will be confined to the silver markets.
PM: When do you feel we are beginning to see a bottom for the mining stocks?
RR: I don't think so. I think they're cheap enough to buy, but it wouldn't surprise me to see a resumption of it in the next 3 weeks. I think last week was very helpful. I said on your show before what we need to get us out of this market is an ugly bout of desperation selling where we totally wear out the sellers and we were beginning to see that last week…. I begin to think we might have a recovery market in the fall, but we will only see a recovering market for the very best of the names. I have said before and I want to reinforce the message that most of the companies on the TSX are valueless and I suspect they will continue for the next 2 years in pursuit of their net present value. I think the TSX will turn up at the end of next year, but it won't feel like a market recovery because many mining stocks will still have no value at all.
PM: Any comments on reports that Sprott sold physical silver to buy undervalued mining companies?
RR: There was a trust press release issued, which I can site, which says that a charitable trust associated with the Sprott family liquidated some physical silver or re-certificated silver positions in order to make the cash portion of a grants promise, also to pay the trust operating costs, but primarily to re-invest the proceeds in the shares of silver mining companies, which the trustees believe had more upside leverage than the physical silver, but I would refer people to the Sprott family trust as opposed to relying on information obtained from friends of Sprott, like myself.
PM: Will the silver market, in your opinion, bottom here, and do you have any idea for targets for the rest of the year?
RR: No, I don't. The markets are going to be volatile enough that I wouldn't be comfortable making projections with regards to the silver market. Laughingly the other day, someone said is silver going to go up or down. I said, yes. Of course, my belief is that over time, keeping these interest rates low and debasing the currency, gold should do well. Silver genuinely does outpace gold in both directions and is more volatile. The bullion commodity that I continue to find most attractive from a fundamental point of view is platinum because it's easiest to understand the physical supply and imbalances then it is for gold and silver.
PM: Any final thoughts for our audience?
RR: I think that two years from now or three, people will look back at the summer of 2013 as truly the good old days in terms of equities. Many of your listeners say that's fine but I don't have any money left, and those listeners need to look at their portfolio and they need to figure out the 20% of the portfolio they love and the 20% of the portfolio they hate and everything in between and they need to sell everything in the portfolio irrespective of price and put the money back in that stuff that's very, very, very important. It's key that you understand that most of the juniors in the world are valueless and the fact that you paid two dollars for them and they're selling for 30 cents is irrelevant. It's only the 30 cents that's relevant. If you own something that's gone from two dollars to 30 cents, you should sell it. If you ain't going to buy, it's really the time to go to quality. I do expect the market to be soft because there are so many companies that are going to zero. I believe the companies are now cheap enough, and we have been very consistent buyers and I'm absolutely confident that when I look back to today, I'll be kicking myself for not being more aggressive, absolutely kicking myself. Well, this could fall 20% from here; absolutely true, but select names could well be up 500% and 600% from here, so when I just parse the better names, I could lose 30% against the equally likely scenario that I could make 500%, and that sounds like a pretty well differentiated bet to me.
PM: Sounds more like an opportunity of a lifetime to build wealth.
RR: Speculative wealth. This is not for the faint of heart, but absolutely, it's worked for me in the past.
PM: It certainly looks that way, Rick, and I want to thank you again for your wisdom and insight, and I really look forward to speaking with you again.
RR: Always a pleasure.
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.