By Patrick MontesDeOca
On October 12, 2012, I had the pleasure to chat for a few minutes with Mr. Rick Rule from Sprott Asset Management, a money management and securities firm with more than $10 billion under management. In this very personal interview, Mr. Rule details the current economic and political condition globally with uncanny honesty and transparency.
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 U.S. 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 and his team have long-term experience in many resource sectors, including agriculture, alternative energy, forestry, oil and gas, mining and water.
See what he has to say about the mining shares, gold as a Tier 1 asset, and his thoughts on why China continues to acquire physical gold.
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.
Patrick MontesDeOca: Once again, we are talking to Rick Rule, founder of global companies and partner of Sprott Asset Management (with Eric Sprott). Rick, I want to move right in and get an idea for our audience -- how did you get involved in the natural resource area?
Rick Rule: When I was coming of age, if you will, it was late '60s, early '70s, and it was pretty clear to me as a young man that commodity markets were going to do fairly well. I enjoyed the whole sort of romance of the treasure hunt associated with the exploration of minerals and exploration for energy as well. So I sort of fell into it naturally. It just was an extremely appealing location for me, appealing enough that, I guess I was 16 or 17 when I decided that, even though I was American, to attend the University of British Columbia in Vancouver, B.C., which at the time had a commerce option in natural resource finance. So I knew fairly early on that was what I wanted to do.
PM: You also have a background as a credit analyst, is that correct?
RR: That's correct. The part of the natural resource business that interested me the most was the financial part rather than the technical part. I had no particular interest at any point in time in working on a drill rig or working in a mine, and my interest in finance led me to an interest in credit and lending. I may be the world's only accountant wanna-be! But anyway, I got attracted to the credit side of the finance business fairly early on as well.
PM: So we're talking to the right person, then, regarding the natural resource sector. What mining companies, in your opinion Rick, should we be looking at, stocks or ETFs?
RR: I don't want to give specific names as a consequence of U.S. securities regulations, but I can talk to you about classes of companies with some alacrity. The opportunities that we're seeing are probably the most timely for the developmental stage gold or silver producers that already have either preliminary economic assessment or a pre-feasibility study. The discounts that we're seeing for development in the stage assets from the net asset values established in the first public offer fair party evaluation documents exist the preliminary economic assessments that are the deepest that I have seen after 30 years in the business. Which is ironic, given the shortage of development in the early stage projects that exist in the world, and the relatively attractive gold prices. In particular, we look for companies that have third party verified net asset values that exceed the sum of the company's enterprise value and the up-front capital cost, that generate internal rates of return at 25% or better -- preferably 30% or better -- and have capital paybacks in three years or less, and there's a reasonable universe of companies like that around to buy, which is very unusual.
The second class of companies that I'm attracted to would be much earlier stage in the value creation chain, and those are the exploration companies that practice what we call the prospect generator joint venture business model. These are aggregations of extremely talented geologists who use their brains, but other companies' money to explore multiple exploration targets on a global basis.
This has worked out very well for us over time -- and by over time, I mean over 30 years -- and these companies are similarly cheap -- the cheapest they have been since the 1998-2002 bear market.
The third and final class of company that we are attracted to is the sub-500-million-dollar market cap oil and gas producer that is involved with and has proved up a repeatable resource play. In particular, the Canadian companies who are involved in the western Canadian sedimentary basin, who have had their market capitalization absolutely decimated from the 2010-2012 period. We believe that those companies will either increase in price, or they will be taken over.
PM: They certainly have experienced a historical level of pessimism in the last few months, needless to say. So the opportunity is still very attractive, even at these levels? Even if we have seen a move of 10% or more?
RR: Yes, we think so. You've seen a three-week move up, which certainly has taken these things up off the bottom. But that three-week move up comes after a 14- or 15-month 50% down move and by the way, I'm not sure if this up move in the near term lasts. It wouldn't surprise me to see this market peter out in the fairly short term. But looking out over two or three years, I'm very, very, very attracted to the values you see in the market today.
PM: When you are talking short term, you're talking the remainder of the year, or the next six months?
RR: Yes I am. It wouldn't surprise me at all to see this market give up some of the gains that it's enjoyed recently in the near term, but looking longer term, I'm pretty sanguine about the values for the better companies of the sector.
PM: Why do you think so many advisors frown on gold as a legitimate investment?
RR: I think there are a couple of reasons for that. I think that the most important thing is that people's expectations of the future is set by their experience in the immediate past, and in the period 1982 to 2002, there wasn't very much money to be made in gold so that meant that advisors who were in gold didn't enjoy a very good performance, which gave them a bad taste in their mouth. But more importantly for many advisors who don't have any particular expertise, what they really are is very, very high rent marketers. It's difficult to market a story that doesn't have broad market acceptance. So I don't think you have the adherence to gold that you had, as an example, back in the decade of the '70s, when gold performed for 12 years. But you are just now beginning to see much broader-based advisor consensus around gold. For example, Bill Gross from Kitco -- the bond king -- who basically has been pounding the pulpit for gold for some five or six weeks. Certainly, Paulsen and Soros have been noted proponents for perhaps at least noted adherence by the way of what they have been buying.
PM: On a bigger picture, we are looking at the Bank of International Settlements announcing that in January of 2013, the classification of gold is going to be changed to a Tier 1 asset. What kind of an impact -- in fact, if this is moving forward -- will that have in addition to all these other fundamentals that we are dealing with?
RR: Well, I think that could be important. I think the fact that the banks can use gold and can own gold and can carry gold on their balance sheet without any sort of perceived discount will be an important thing. I think it will be important for banks that are solvent. European banks, in particular, are very constrained right now in terms of the asset classes they can have because they have so little assets on their balance sheets. About the only thing they can have on their balance sheets are sovereign obligations, which they are allowed to mark to par (rather myth), as opposed to market. And for some of the smaller solvent euro banks, I would suspect that being able to hold gold on their balance sheet and have it count as a Tier 1 asset would be a powerful inducement, because I can't imagine any bank that didn't have to buy sovereigns as a consequence of their funding from the European Central Bank would want to own them. It would make a lot of sense than they would want to own gold
PM: China has been in the market purchasing substantial quantities of gold and in fact, I believe in Bloomberg, they announced that so far they purchased just about the same amount or more than the European Central Bank, which I believe is around 500 tons. Do you think that this is a move that could essentially be more of a fundamentally driven move with regard to possibly putting the Chinese yuan currency right up against the U.S. dollar as the world's reserve currency?
RR: I don't think that the Chinese moves with regards to purchasing gold are related to their attempt to globalize their currency. I think that their real function is two things. I think that they understand themselves the need to diversify their currency holdings. I realize that calling gold a currency is a stretch, but I believe it to be a currency. The Chinese are holding well in excess of 2 trillion dollars in non-yuan denominated reserves, and diversifying out of the U.S. dollar and out of the euro seems to make perfect sense.
To be continued in Part II...