- Record gold exports continue.
- High interest rates can be ugly for the economy.
- Mining shares have bottomed.
We had the honor and pleasure to speak with Mr. Rick Rule, founder and Chairman of Sprott Global Resource Investments, which has more than $7 billion under management. Mr. Rule has dedicated his entire adult life to many aspects of natural resource securities investing, and has had a long, successful and focused career. 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 exclusive transcript from a recent phone interview for Seeking Alpha.
Welcome to Trading Talk, Rick.
James P. Montes (JP): According to the latest data points, the US has exported a massive amount of gold in January (close to 500 tons), primarily to Hong Kong and Switzerland. Where is the gold coming from to meet such record demand?
Rick Rule (RR): I suspect there's continued disintermediation from places like GLD and perhaps from the leveraged long hedge funds that we have talked about in our earlier interviews. But the truth is, no one really knows. It brings up the question of why when the German citizenry demanded the return of 1,200 tons of gold that the United States allegedly stored on their behalf, they were told that they would get some of their gold back and that it would take seven years to return that gold. The truth is, I don't know the answer and almost nobody in the world knows the answer. But it certainly is an interesting question, isn't it?
JP: What is your opinion of Goldman Sachs (NYSE:GS) calling gold to drop to $1,085 as "a sure bet" on the face of this record physical demand?
RR: It reminds me very much of their call at $1,800 that it was going to go to $2,500. They are an extremely accomplished firm that is out of their element in gold.
JP: Can you just describe what you mean by that? Is there a difference in the paper from the physical market?
RR: Well, it would appear that when gold was in favor, the narrative associated with gold caused them [Goldman Sachs] to say that it was going to go from $1,800 to $2,500 precisely when it was topping. It would now appear that the Goldman Sachs people, at least in regards to the gold market, are momentum players. The idea that most people have that the way that you make money in markets, including the gold market, would be to buy low and sell high, seems to be something that they have reversed when you look at their recommendations, which would be to buy high and sell low. I have a lot of respect for Goldman Sachs and I know a lot of people there, and while they have a lot of expertise in a lot of markets, their track record, at least with regards to gold, seems to be unblemished by success.
JP: Let's talk about interest rates a little bit. Why is the Fed tapering (another way of raising interest rates short term) in the face of a weak economy?
RR: I think that the Fed's position is that the economy is recovering, but of course I don't believe that quantitative easing ever had to do with very much other than the fact that the Fed had to counterfeit, which is what I call quantitative easing, to make up for the difference between what the Federal Government spends and what it makes. You will recall that we had "tax reform" last year, which is a different way of saying that the president embarked on a populist scheme to steal more money from the most productive elements of society. And as a consequence of the fact that he has been able to steal more from the citizens, he needs to counterfeit less. Tapering is just a function of the fact that he needs to counterfeit $10 billion a month less because he's stealing $10 billion more; nothing more, nothing less.
JP: A credit bubble in the making?
RR: I'm not so sure that US stocks are in a bubble. I think we may have seen a bubble in certain sectors of the US stock market; biotechs would be an example. I'm not a general market securities analyst because I don't understand all those businesses well. But certainly when I look at random [stocks], at the balance sheets of the income statements of the S&P 500 companies in the United States for example, I see a fine collection of businesses. I see record high earnings, albeit with low interest rates and low cost of capital. I see pristine balance sheets. I actually see companies hiding cash on their balance sheets to appear to be less flush than they are. But I think you need to consider that these earnings and these balance sheets are taking place in a very low interest rate environment. I am concerned about what would happen in the context of higher interest rates, where the cost of capital went up and where the capitalized value of the dividend yields went down. I'm not saying that this market is going to collapse. What I am saying is that these companies are existing in an almost greenhouse environment where it would appear to me that it couldn't possibly get any better and as a consequence, could get worse.
JP: Web definitions: An economic bubble is "trade in high volumes at prices that are considerably at variance with intrinsic values." It could also be described as a situation in which asset prices appear to be based on implausible or inconsistent views about the future. Does this describe clearly the present condition of the Fed and world central banks when it comes to interest rates and the level of debt?
RR: I think that's absolutely true. I think that the federal bankers on a global basis have done a wonderful job of convincing a citizenry that was desperate to be convinced that liquidity was a substitute for solvency. The idea that increasingly insolvent central banks can pay record low interest rates when their ability to service the debts is at record low levels is implausible, [which is] to me [the] most generous I can be.
JP: Is China in a bubble?
RR: I don't think China is in a bubble. I think you have seen extraordinary examples of misallocation in China. You would expect that from an extremely powerful central government and a nascent market. One of the things that has always impressed me about the potential of China has been the accomplishments [of the] Chinese people outside of China. When you make people more free, you make them more rich. I'm thinking back about thirty years ago when Deng Xiaoping said, "To be rich is glorious." All the Chinese have to do to fix China is nothing. I'm just not so sure that they have the courage to do that. Certainly a situation where you favor certain industries, where you allow rent seeking, which is a favorite term for bribery and influence peddling, where you attempt to control an economy with 1.3 billion people with a power structure on top of only 10,000 people, [it's a recipe] for disaster. You have to juxtapose that, however, against the incredible industriousness, the education-oriented elements of that society, the notorious aspirations for saving exhibited by that society, and I have to believe that in the intermediate and the long term, I am extremely bullish about the future of China. I suspect it will be said someday about China what has been said about the United States, which is that the Chinese often do the right thing when they are left with no plausible alternative.
JP: How is a high-interest-rate environment going to affect the stock markets, the world economies, and the price of gold and silver moving forward from here?
RR: Truly ugly. Initially, when the cost of capital goes up, everything including gold and silver go down. You need to remember that ultimately the causes of high interest rates are good for gold and silver. But when you raise short-term and long-term interest rates, the holding costs associated with gold and silver go up, and the speculative sort of juices that fuel the greed side of the fear and greed duo that drive precious metals will be affected. But the truth is that we need an honest interest rate. We need an interest rate that rewards the savers to a degree sufficient to cause them to continue to forgo consumption in favor of savings. My own belief is that, going back to the later part of the decade in the nineties, that if we would have taken our pill in the United States and allowed interest rates to rise the same way that [Fed Chairman Paul] Volcker raised them in the early part of the eighties, while we would have had a very ugly two or three year period, an ugly recession, that we would have come out of that with the same strength that we had as a country and exhibited in the early part of the eighties. We didn't do that; what we did is we really postponed the day of reckoning. But the day of reckoning will come at some point in time.
JP: Can the world economies afford such a fundamental change, and what are the risks particularly for developing economies?
RR: Well, the world economy is going to have to. You can survive whatever is thrust upon you, and certainly as a species we have had things like the Great Depression and World War II thrust upon us. It just will not be very pleasant. Listen, if you look as an example at the US circumstance with $17 trillion in on-balance-sheet liabilities and $65 trillion in off-balance-sheet liabilities, the simple math argues for default. There are two ways of default. You can do it honestly, which is, for example, James, your generation saying to mine, "Yes, you made all those promises to yourself but you left us with the tab and we're not going to pay you. That Social Security that you didn't save for, you're not going to get. That Medicare that you didn't set aside money for, you're not going to get that, either." If we were honest with each other, we wouldn't have a fiscal problem. We'd have social problems to be sure. But that's not going to happen. What's going to happen is that we are going to take the easy way out. We're going to default on the installment plan by using inflation to reduce the net present value of these unsustainable obligations, which is very unfortunate.
JP: It seems central banks, particularly the US and Japan, have been taking the path of currency destruction by printing record amounts of fiat currency in order to pay for their debt obligations. By historical standards, is this inflationary or deflationary?
RR: Deflationary first and then inflationary. The truth is that this incredible amount of money printing that's going on is really an attempt to shovel money in a deflation hole that began to expose itself in 2008. And the truth is on a global basis, at least in the advanced countries, we have made promises that we cannot keep. We have obligated society to bills on behalf of certain aspects of the citizenry that the rest of the citizenry cannot afford, so we need to obviate those bills. We need to default on those bills in some way, shape or form.
JP: Have we gone through a deflationary cycle, or basically do we still have some pain to go through before we start to come out on the other side?
RR: I think that's right. We are having a war between inflation and deflation right now. In other words, we are having a war between the honest economics that defaulting on our obligations would bring, which is very deflationary, and the reorganization of society that's attempting to be affected by the central banks, where you forward shift the liability from my generation to yours. We're going to leave you with the bill, James. That's the idea. The idea is that we are going to honor all the promises that we made to ourselves and then as they are carrying us out on the stretcher on the way to the ambulance, we're going to lift up the middle finger and say, "Thank you, Montes."
JP: How do you think precious metals like gold and silver will act in a deflationary environment?
RR: Historically, as an example, in the deflation of the 1930s, they acted very well. What gold in particular has done, and to a lesser degree silver, is that it has formed for many societies in many times in history real money as a hedge against catastrophe, as a form of storage of wealth that is at once a medium of exchange but also a store of value in itself. One of the problems that you have with deflation is that nobody trusts anybody else to pay. And money, cash, is really a promise, so if you accept it, you accept that the person who is obligated to you, will pay you. Gold is not a promise to pay. James, it's important that your readers understand this; [gold] constitutes payment in and of itself, and it does well in periods of nervousness. I live, as you know, in north county San Diego, which is very close to a community called Westminister, CA, in Orange County, which is the home of 60,000 to 70,000 Vietnamese. People who have the best recent experience in the United States of social chaos, and they're all gold bugs as a consequence of that social chaos. What happened in [South] Vietnam wasn't inflationary and it wasn't deflationary. It was merely catastrophic. The people who had access to gold were able to bribe themselves out of that catastrophe and into the United States. If you ask them the question of whether or not gold should be a part of someone's portfolio, they look at you as if you've lost your mind.
JP: Can you comment on Russian and US relations deteriorating over Crimea? Is this potentially a Black Swan in disguise?
RR: I don't think so. I think this is a return to Cold War politics, which both countries understand extremely well. The really good news about where we are now as opposed to where we were then is that we're reliant on the Russians and the Russians are reliant upon us. And the fact that we are reliant on each other lessens to a great degree the probability that we'll shoot each other, which I think is a good thing, although once again I'm too old to fight the fight, that would be left to you. I would prefer that you would provide the service that you provide yourself to mankind as opposed to being shipped east to shoot Russians. Now, will the dispute between us cause economic uncertainty and economic dislocation? Absolutely. Will we perhaps increase the level of sanctions against the Russians? Absolutely. Will the Russians perhaps retaliate as best they can, although they don't have many ways that they can retaliate? Certainly. Will it be an inconvenience? Absolutely. Ten years from now will it be anything more than a footnote in history if you are not Ukrainian or Crimean? Absolutely not; I don't see it. By the way, where we suggest that the Russians are actively manipulating Ukrainian politics and Crimean politics, Mr. Putin absolutely accurately points out that we have done the same thing. The soft coup that went on in the Ukraine with an elected politician was done very much at the urging of the United States. I happen to believe that the US in this instance is probably less evil than the Russians, but all of the hueing and crying that goes on doesn't seem designed to illustrate the fact that we are competing to see who is less evil as opposed to competing to see who is right. A pox on both houses.
JP: Is the US petro dollar in the middle of this at risk?
RR: Oh no, I don't think so. You know that Sprott has done a lot of work of late with very, very large Asian semi-sovereign investors, and what we have learned is that those investors see no substitute for the US dollar. It is the deepest, most liquid and most transparent market in the world. As much as the Russians dislike us, if you gave the Russians a choice as to what currency they would settle debts in other than the ruble, they would say the US dollar. And if you ask countries outside Russia whether they would rather settle their debt in rubles or dollars, everyone would say dollars.
JP: Have we bottomed in gold and silver mining shares, and what is your take on it?
RR: I think we have. I think we have. Notice I said, "I think" twice, because one can never be certain. But the fact that we didn't see aggressive capitulation in those markets tells me that the recovery will be saucer shaped rather than V shaped. So I think that we are in for a 12 to 18 month gradual recovery before the bull market gets under way in earnest. We'll see higher highs and higher lows to be sure, but we'll see 15% to 20% volatility. It was amusing for me to see the hope return to the junior mining sector in January and February with the market up by 25%. And it was amusing to me to see the despair set in when those markets gave back 10%. You know a market that is off 10% is 10% cheaper. And the truth is that all of these advances need to back and fill. That's the way markets work. You need to consolidate your gains, so what's happening right now is absolutely expected and it's absolutely healthy.
JP: So buy corrections?
RR: Absolutely, but most important, worry about stock selection. Worry less about the market and worry much, much, much more about the companies that you talk about. James, we have talked about this on your show before; the junior mining sector as a whole is valueless. It has no value at all. Do not ever buy this market. You buy the best 10% of the companies in this market because they perform better than any other asset class in the world in recovery. The performance of the best 10% of issuers in this market is so spectacular that it adds credibility and sometimes luster to a sector that is overall a disaster.
JP: Rick, is there anything else you want to share with our audience?
RR: Yes, absolutely. I think in the context of resources, while I think the whole sector will recover and recover nicely in the next five years, I would ask your audience, as I have asked them before, to ask themselves investment questions where the answer begins with when, not if. Find commodities for which there is ongoing demand. Find commodities where the utility to user is very high and the users will pay more if they have to. And find commodities where the selling price of the commodity on a global basis is less than the cost of production. In other words, where the industry is in liquidation. If you do that, you will find a commodity price that has to go up, not one than can go up. Do those commodities have names now? Yes; water in the West and Southwest in the United States; platinum and palladium on a global basis, and certainly uranium on a global basis. Will these commodities recover any time soon? I don't know, but the answer to the question begins with when not if; very important.
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 herein constitutes a solicitation of the purchase or sale of any futures or options contracts.