The following is part II of an interview that took place on October 12, 2012 with Mr. Rick Rule from Sprott Asset Management.
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 $10 Billion under management.
In part II of the interview, Mr Rule comments on the Chinese situation with regards to exports, the U.S. Dollar and the "Fiscal Cliff" potential crisis. Mr. Rule gives us his candid prospects on the Middle East and the U.S. Elections affecting the price of gold and crude oil over the long-term.
RR: The second thing that we are seeing in China is the encouragement by the Chinese government and authorities for individuals to include gold denominated products in their savings. They are facilitating the private purchase by individuals in China of gold, and this is very important because of the historic affinity that some elements of Chinese society have had for gold-- the fact that they are not only allowed to buy it which they were not able to do 10 or 15 years ago, but are encouraged to buy and to store it. The non - governmental buying in China and the democratization of gold ownership among the Chinese upper class and middle class represents as a consequence of their historic affinity for gold a very, very deep and important market for gold.
PM: In your opinion, do you think that the silver market is in the public consciousness enough to potentially trigger a big rally, or will the price have to start another large move before the public will get involved?
RR: Silver is always very problematic. Eric Sprott, whose name is on the door I work under, will tell you that he thinks that silver is the most explosive commodity on the planet right now! He points in particular to the fact that there is somewhere between 100 -150 million ounces of silver available for good delivery in certified bonded warehouses, but the futures market in silver trades 100 million oz a day. This suggests that there is about a day and a half's worth of inventory against the futures trade and that means that the market could do accidentally what the Hunts tried very hard to do 30 years ago. You could have an accidental cornering of the silver market which is a very, very interesting phenomenon.
PM: Turn it the other way around!
RR: In terms of answering your question directly, I don't think that the public is as enamored of silver as they are of gold but that is generally something that happens later in a market. Silver functions, of course, as the poor man's gold. The most interesting thing about the silver market for me has always been how opaque it is. It is very difficult to understand the supply side of gold because maybe 20% of silver production comes from silver mines and the rest comes from by products of base metals mines or gold mines, so it is difficult to get a handle on supply because you have to know something about what the prices of zinc, lead and copper are going to be-- in terms of forecasting futures supply and then in terms of above-ground supply and above-ground demand.
The incredible cultural affinity that people in South Asia, India, Nepal, Pakistan, Bangladesh, Sri Lanka have for silver means that somewhere between 20 and 25 % of the world's above-ground stockpile is in private hands-- often peasant hands in South Asia and they are loathe to report how much they have. In order to understand whether they will be motivated to buy and sell you need to be able to understand things like, what kind of harvest season they enjoyed. So it is very difficult to get an accurate handle on silver's physical supply and physical demand on a forward looking basis. It is an extremely opaque market which is one of the reasons why it is so incredibly volatile.
PM: To just touch upon the current canvas, the political environment that we are dealing with right now at least and moving into election time, do you think that the election outcome is going to have any bearing on the price of metals moving forward?
RR: I suspect it will. I need to couch that by saying I am neither Democrat or Republican. My own leanings are I suppose Libertarian. I couldn't bring myself to vote for either of the current candidates. So I have no particular dog in this fight! My experience has been that business people prefer Republican candidates and my instinct tells me that in the law of lies that is this election the Democratic lies are more palatable to more people than the Republican lies. I think that Obama is going to win and I think that he is going to win in a walk. I don't think it is going to be close and I think the consequence of that Obama win will be to scare the investment community and scare the business community and that fear could very well spill over into the gold market.
PM: Do you think that we will fall off the Financial Cliff if the U.S. mandatory budget cuts take effect?
RR: I don't think so, but I don't think the mandatory budget cuts will take effect. The idea that the Republicans have the political will to stop delivering services to their constituencies isn't something that I regard as a real threat. I think that there is a lot of posturing and bargaining. I look to the fact of the vice presidential candidate of the republican party threw into the race the guy that is allegedly the orthodox fiscal conservative is a guy who just voted for continuation, he's a guy who voted for the bailouts, he's a guy who voted for the auto bailout. The idea that there's actually a tremendous degree of difference in a fiscal point of view between the Democrats and the Republicans is something that I struggle with based on their record, with of course the exception of Ron Paul, who is of course retiring.
PM: Yes, unfortunately. I think he definitely has the right ideas about how to resolve this crisis we are dealing with right now. We have been looking at the bond market for example the last couple of weeks, just as a major indicator in terms of the pulse of interest rates. What was strange last week was when Bernanke announced basically the expected policy, the QE3 implementation and so on, the bond market dropped 2 points which was counter intuitive of what everybody was expecting. So, is the bond market the "canary in the coal mine" with regard to the credit markets especially with regard to the downgrade of the U.S. credit markets that we really don't hear many people talk about?
RR: I think it may very well be, and if it is-- it's problematic for markets overall. How far can you drop interest rates from here? What would be required to give you another uptick in the bond market. Jim Grant, one of my favorite writers from the Interest Rate Observer, famously called the U.S. long bond "return free risk". If you think about what it would take to get a further up move in bonds, it would take lower interest rates, and how on earth can you take interest rates below zero? The set of circumstances where you give somebody $100 based on their promise to give you back $98-- from my point of view at least-- that doesn't seem particularly compelling! So it's difficult for me to see how the bond market can go much higher unless there is just so much fear of a psychotic break in equities of the type that occurred in 2008, the people want to park their money someplace where they will only lose 5% of their money as opposed to losing 30% of it.
PM: What are we looking at in terms of the dollar? You know... particularly as a reserve currency?
RR: That's a really funny question! And I'll tell you why that's funny! Driving to work today I passed a Motel 6 on the highway. Motel 6-- your older readers will know-- is named that because when I was in my early 20's you could rent a room there for $6 a night, that was why it was called Motel 6. This particular Motel 6 had a sign up that said "Motel 6 $69.99 per room". In other word,s in the course of my adulthood the price of a room at Motel 6 has gone up more than ten fold. This will tell you something about the purchasing power stability of the dollar over time. And that 30 years was a 30 years that happened without quantitative easing. It was a 30 years that took place without the explosive increase in both on balance sheet and off balance sheets liabilities that we've witnessed in the past 5 and 10 years, when you look at the math rather than the myth of the U.S. fiscal situation. I'm just talking about the federal situation right now - it's very difficult for me to understand how we get out of this with the purchasing power of the dollar intact.
PM: We have already 98% loss of purchasing power in just the last 30 years, where can we go with that?
RR: Correct, and it appears from the math that the decline in purchasing power of the dollar might accelerate. Now, one of the great jokes at these investment conferences that I go to is that it would appear that the dollar may be the worst currency in the world, except all the others you are dealing with are a series of societies that are issuing, if you will, fiat fibs. When you talk about the problems that the dollar has, the dollar's problems look somewhat less severe when you compare it to currencies like the euro. Certainly history has shown us when we have really severe financial market instability, the currencies that get hurt the worst are the smaller peripheral currencies, currencies that probably don't deserve to get hit because many third world nations got frozen out of credit markets in the 90's and as a consequence are nowhere near as deeply as indebted as we are. That notwithstanding, people-- for whatever reason, perhaps as a consequence of the dollar status as a reserve currency-- tend in times of crisis to regard dollar denominated instruments as risk off trades. I don't know how long that is going to last.
PM: One more question, if I may. What do you think of the recent development in the Middle East and what does it mean for the price of crude oil and precious metals moving forward?
RR: Well, let's do them in the order that you took them, I think that some of the developments in the Middle East are looking beneficial in the long term. I think that the Arab idea that more elements in Middle Eastern societies will have voices will probably end up taking the lid off the pressure cooker. I think it is going to be extremely tumultuous getting from here to there, but I think that moderate voices as well as extreme voices will be heard-- over 10 years that's probably a good thing.
In the shorter - term, of course, you are going to see lots of social instability. You will see societies that are used to being run in a very hierarchical fashion becoming a lot more chaotic and you will, I think, see intra-national and international rivalries and historical rivalries play out. The near term worry of course, is the fact that the United States, Israel and Iran are engaged in a dumb president's contest and it's very difficult for the people to win.
The market is looking at the fact that there are a lot of suggestions in terms of civil defense preparedness in Israel, which suggest that Israel might do something preemptive to Iran and there are people who suggest that the best time for them to do that is before a U.S. presidential election. Certainly, if hostilities, even limited hostilities commenced between Iran and Israel or Iran, the United States and Israel, the threat of the interruption to the crude oil traffic through the Straits of Hormuz would lead to sharply higher oil prices. I think the spectrum of ongoing turmoil in the Middle East will lend something to gold, simply because you are seeing the elites in the middle east countries now, who are threatened by the Arab Spring invest more and more of their money anonymously in instruments like gold
PM: Rick Rule, I want to thank you so much for this incredible interview. Can you give us an idea how our readers can get in touch with you or have access to your products and your company.
RR: We would be delighted to speak to your readers and subscribers. We can be reached at 800 477 7853 across the US and Canada, you can also access us at www.sprottglobal.com.