In a recent phone interview, we had the pleasure and honor to chat with Rick Rule, chairman of Sprott US Holdings. In this exclusive interview he talks about the academic nature of the Fed, the continued need for low interest rates, the hidden strength of the U.S economy, and the durability of the U.S dollar as the world's reserve currency.
Sprott U.S 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 with more than $7 billion under management.
JP: Let's move into recently the latest Fed meeting we had with the new chairwoman Janet Yellen. Can you comment on her first testimony in front of congress yesterday.
RR: Well it was, from my point of view, unfortunately predictable. I think she's probably a very nice woman I think she is very intelligent and I think in terms of candidates they considered for Fed chairman she was probably a good pick. My problem is with the candidates that they considered. It would appear that among the credentials that you need to become Fed chairman is never having to have had gainful employment at least in the private sector, never having had to produce a product other than an academic paper. And never having to have had to meet a payroll. In other words there's a disconnect between the Fed members and the Fed chairman and the real economy. It reminds me of an article written by Alan Greenspan in Foreign Affairs magazine where he was asked why he missed the 08 collapse and the real estate bubble. And to summarize his response it was because the market didn't conform to the model. The idea that our economy is run by people who believe that the market ought to conform to the model rather than the other way around is the strangest sort of public policy announcement I've ever seen. So in the context of their paradigm I think Mrs. Yellen was an interesting choice. I'm terrified with regards to the implications to the country, not of Mrs. Yellen herself, but of the process that would select her.
JP: Do you think that the Fed will continue with this strategy and how will this affect the emerging markets moving forward from here.
RR: Well she has clearly said that the 6.5 % unemployment trigger that was put in place before with regards to the end of the interest rate manipulation is no longer a hard and fast subject. She knows and all the big thinkers know that the aggregate debt of U.S Fed government let alone state and local constituencies is such that they can't afford higher interest rates so they will use whatever policy excuse they can for as long as they can to facilitate artificially low interest rates. The other thing is that I think we need to consider is that the voters in the United States by in large support this. There are more consumers than there are more spenders in the U.S. than there are producers and savers, and an income transfer from saver to spender ,which is what artificially low interest rates are, is unfortunately very popular. So we can expect broad public support for this mandate despite the fact that it isn't in the counties interest.
JP: Are we turning a corner for the U.S. economy to warrant a change in this policy with the Fed funds purchases or tapering strategies?
RR: Well I think there are still some good aspects of the U.S. economy none of which have to do with the Fed or the government. We still have the most innovative economy on the face of the earth, we still have an economy where despite the best efforts of the government and dept of energy the private sector can come up with a conjunction of technologies like management while drilling, horizontal drilling, multi stage fracturing, all that kind of stuff and kick off the shale revolution where you take a mature producing province like the U.S. and you increase production by 2 million barrels a day. Incredible, it could only happen in America. We still have an economy where despite burdensome regulation and all the idiocy imposed upon us by government that a group of pimply faced college students could start up something like Facebook and change the world. There are wonderful things about the U.S economy all of which are dramatically divorced from the government and government policy the difficulty is that the U.S. is becoming more and more political. Which is to say that we're focusing on the destructive and constraining the productive. And the recovery of the U.S in the 10-15 yr time frame will depend on whether the private sector begins to triumph over the public sector again or whether the inverse is true.
JP: Rick, my following question has two parts to it. Since interest rates have started to move higher in reaction to the tapering of U.S bond by the Fed, how will this affect the U.S interest payments on its current debt and will this have a major repercussion across the world economy?
RR: It would appear that they are beginning to be able to taper because they raised marginal tax rates on the productive sector of the U.S economy. What they describe as QE I have described on your show before as counterfeiting. The truth was that we had a deficit current account deficit in the U.S. of 1.3 to 1.4 trillion dollars as a consequence of the fact that we have stolen more of the productive activity of wealthy Americans we have reduced the current account deficit to about a trillion dollars a year. Which means that we only have to counterfeit 250 billion a year rather than 6 or 7 hundred billion that we used to have to counterfeit. That is what the tapering is all about. It is my belief that as a consequence of that the continued diminishment of interest rates probably declines, that interest rates stabilize and if interest stabilize and maybe increase a little bit the impact of that will probably be challenging time for markets on the periphery speculative market emerging markets frontier markets as more money flows to the center.
JP: If the economy retracts due to the tapering strategies what are the alternatives for the Fed as we move into the second half of 2014.
RR: The Fed doesn't have any alternatives. The Fed's only hope is to hope for an organic recovery in the U.S that isn't liquidity related. They have already pumped so much liquidity in there that there is not too much more that they can do. They need to hope for an organic recovery that would help them enormously. Those are the only alternatives. The truth is that the center spends faster the periphery can sustain it. So you need to default, either by saying to beneficiaries of government programs and entitlements I'm sorry we can't sustain this level or you need to default by way of inflation. You need to reduce by net present value of the purchasing power of those obligations to the extent that you can't do one or the other then you have to continue to counterfeit. You have to pay the bills with money that you fake as opposed to money that you earn.
JP: Let's talk about gold and silver for a minute. As we do this interview gold is trading over 1300 1302 and silver is trading at 20.46. It looks like we have seen some kind of bottoming process take place since late December. Do you think this is the beginning of a bigger trend developing?
RR: I do. But I think that this may be a head fake rally. In other words I think that we are going to see a very volatile market. With lots of ups and downs. But I think we're going to see higher highs and higher lows. And for those listeners of yours who are primarily traders I think about a range bound metal but with the range moving constantly higher. Don't be too excited about technical breakthroughs to the upside because there are plenty of things that could constrain us to the downside but think about a rising channel with higher highs and higher lows, but incredible volatility along the way.
JP: We have seen the mining shares come back nicely since December, is this confirmation that the whole sector has bottomed as well?
RR: I think it is, but I can't say. Certainly what you described with regard to the juniors and the seniors is very hopeful. And it is hopeful for a couple of reasons. One bull markets as we have discussed before are born of bear markets and the extraordinary bear market pricing let to some buyers tepid buyers into the market. If we observe the year 2013 we see the following broad attributes the beginning of the first third of the year was catastrophic we had forced selling in the face of buyer exhaustion so the stock charts looked like the topographic maps of ski hills, just catastrophic falls from the upper left to the lower right. In the middle part of the year what we saw was buyer exhaustion still but seller exhaustion as well. So the stock charts went horizontal. We joked that they looked like the electrocardiogram of a corpse. At the end of the year what we saw was complete seller exhaustion, no sellers left with the better majors and the better juniors starting to get a bid. So we saw share price rises sometimes very dramatically. But on very low volumes. There wasn't really conviction buying, but there was no selling. This is absolutely consistent with the bear market bottoms that I have observed in the last four cycles that I have observed in my life. So in terms of calling this a market bottom the pricing levels, absolutely, the narrative, absolutely, the price performance absolutely. What has been missing has been at least in the juniors has been issuer capitulation. The sense that you need to raise money to advance your projects not merely to survive. You have to understand the fact that the market cap of your company is dramatically lower than what it was in 2010 but you can't worry about what the market cap of your company was back then. You have to raise money now on terms that clear the market now. So that you can benefit your projects and grow. That occurred in July of 2000 I remember it absolutely crystal clear. And while the market continued to be soft 2001-2 for the broader markets for the better exploration juniors they began to generate 100% compound annual returns at the bottom of a bear market. If we see issuer capitulation this year and I pray we will we see a recovery that I suspect stuns even the most aggressive commentators in this market.
JP: Rick, there are many reports that China's economy is on the way down and it will take the rest of the world with it, any comments on this?
RR: Well I do think that China is going to experience a hiccup. China decided to address the difficult aspects of the crisis in 2008 the same way we did. Which was a mistake. The whole world experienced a hangover in 08 from a very aggressive party that they enjoyed through the rest of the decade. And what we tried to do was finance a vodka hangover with rum. And China tried to do the same thing. What they did is introduce a lot of liquidity into the system and they did it through a lot of opaque and ill advised loans. And that needs to work its way through the system. But the truth is there is a lot to like in China as well. Particularly the people. If you look at the success of the Chinese people the Chinese Diaspora outside of the Chinese mainland it is a proven fact that if you allow the Chinese people to become more free they become rapidly more rich. And the process of political liberalization in China I think is a bigger story than the inefficient allocation of capital. So my suspicion is that in China you will have to deal with the impact of three years of malinvestment which will take two to three years. But as long as the government of china continues to have the courage to allow the gradual reforms of the Chinese market and allow the Chinese individuals to work hard to save to invest to send their kids to school and to allow them gainful employment that China will continue to be the engine that pulls the world.
JP: Developing countries like Zimbabwe for example have replaced the dollar with the Chinese yuan as their local currency. Is this a sign of the demise of the U.S. dollar as the world reserve currency?
RR: I don't believe so. My Chinese clients my high net worth clients tell me that although emerging markets don't trust the U.S. they trust each other less. The U.S currency, I mean it is ironic that four months ago we had a situation where we threatened to default on our U.S sovereign obligations and the market response was to bid up the U.S dollar, the U.S debt. That will tell you something the durability of the franchise that we are proposing to waste. I would describe the U.S. dollar in the context of being the world currency as being the prettiest mare in the slaughterhouse. The renminbi is challenged by the opacity of the Chinese economy, its challenged by the structure of an economy where 20k people attempt to rule 1.2 billion people, it's challenged by the depth of the securities market, it's challenged by the liquidity with which it trades on a global basis relative to the U.S dollar. In other words it is useful to talk about the Chinese currency superseding the U.S. dollar in the context of the fact that it helps sell newsletters. But that's its sole utility. It can't compete against the U.S. dollar in a fair fight. That isn't to say that the Chinese economy can't grow faster than the U.S. economy. That's a very different discussion, but the idea that any currency on a global basis, any fiat currency on a global basis can compete with the U.S. dollar for the next 2-3 decades is a non starter.
JP: But what about the idea that China is buying the yellow metal in preparation to back their currency against the dollar as the world reserve currency or a competing currency.
RR: I think that their buying gold because they realize that they are getting bagged with U.S treasury securities. Their buying securities that are paying them 3% while the purchasing power of the bond is declining by 6% compounded. Which is a different way to say that they are being bagged for 300 basis points a year, and their diversifying out of the dollar as rapidly that they can. The idea that the 20k people that run China would constrain their power by tying their currency to gold is a non starter. Those politicians like politicians everywhere regard power as their mother's milk and the idea that they would discipline themselves by tying their currency to gold in other words the idea that they would give their citizens a fair shake will never occur, in any country, ever!
JP: Can the world withstand such a transformation if that were the case basically where the Chinese currency and the dollar become competitive in terms of gaining control of the reserve currency or will it be maybe a basket of currencies that might replace it or may the dollar become part of a basket of currencies.
RR: Competition is always great. But I don't see a basket of currency replacing the U.S. dollar. Because the only people in favor of basket of currency approaches are central bankers in countries that would like to be included in the coalition. What the market is telling you is that the U.S dollar for all its faults is the world's reserve currency and any other discussion is simply academic. Now you and I can take the point of view that is an extremely risky proposition and that we would like to hold our own wealth in a variety of assets including of course gold, silver, platinum and palladium and that is an equally intelligent discussion but the idea that there is a practical alternative in the near term by near term I mean 10-20 years, to the depth, liquidity and transparency of the U.S dollar debt markets in anywhere else in the world in any shape or form is fantasy.
JP: Rick, you recently completed a couple of mandates that were assigned to Sprott Asset Management from China to invest in the mining and precious metals sector. Can you expand on that a little bit?
RR: Yes, after a three year engagement we successfully completed mandate, or excuse me received mandates in the fourth quarter of last year from Korea Electric Power, the National Pension Service of Korea, and in a joint venture for mining in China. Raising a substantial amount of long term fresh capital for deployment in energy and mining markets on a global basis both in terms of debt and equity. This is very important because it aligns Sprott with investors that don't have 2 or 3 week view of capital markets associated with natural resources. It allies us with for example with the interests of the pensioners of Korea that have a 30-40 year horizon. It also points out that Asian countries are eager to develop the resource financial and capital markets that the U.S and Canada enjoy. And that these economies are embarked on the same sort of strategic investment with regard to securing raw material supply that happened in Japan the U.S and Western Europe in the 1960s in this sense the past is very much prolonged. We think that the availability of this money and the availability of money in the context of making long term investment in a long term market is good for the underlying industries that is good for the mining business and good for the oil and gas industries. It is certainly also very good for Sprott and we will do our damndest to make it very good for the pensioners of Korea electric power, the national pension service of Korea, and the Chinese taxpayers, we think what is says to the industry when the industry says there is no capital available we say this is ridiculous, we say there is lots of capital available. We have it and some of our intelligent competitors have it. There is very little dumb money available. And a lot of the problems that the industry suffers now, it suffers as a consequence of in reliance of the dumb money that was spent in the last decade. Most of the money available now is private equity money sovereign wealth money or industry money determinedly smart money. And I think that is very good for the industry
JP: Do you see some of the money moving now into the precious metals gold and silver areas?
RR: The money that we raised will not go into bullion specifically. But it will go rather into project finance and exploration finance in terms of the companies. We are also involved when I say we I mean Sprott in talking to some of the largest money in the world in terms of making what we think are highly intelligent bets in the bullion space. We haven't successfully concluded those discussions but the truth is that it took us three years to win the mandates that we announced in the fourth quarter of last year. And if somebody suspects that Sprott is a party to one or two month discussions with regards to what we would like to do in the bullion markets they're sadly mistaken. we are talking to the biggest smartest money in the world. And those discussions take a long time. If they're successful you would see Sprott led endeavors in the bullion markets that would surprise people.
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Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AGOL, AGQ, DBS, DGL, DGLD, DGP, DGZ, DSLV, DZZ, GLD, GLDI, GLL, IAU, PHYS, SGOL, SIVR, SLV, SLVO, TBAR, UBG, UGL, UGLD, USLV, USV, ZSL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.