Interview by Ellsworth Dickson
As attendees of resource investor conferences know, Rick Rule, President and CEO of Sprott U.S. Holdings Inc., often speaks to standing room only crowds. His dynamic presentations usually go against the grain of the usual ways of looking at mining stocks. Resource World was fortunate to catch him for this interview as he is often on the road.
RESOURCE WORLD: When you were attending the University of British Columbia, did you have a plan laid out for your career?
RICK RULE: Yes – but I didn’t follow it. I wanted to become a taxation lawyer focused on natural resources.
RW: Weren’t you studying mineral economics there?
RR: My interest was natural resource finance in mineral economics but I was in the faculty of commerce. My view was that UBC had a compound degree that gave you a Bachelor of Commerce and a law degree and so my initial idea was to become a lawyer specializing in international natural resource taxation.
RW: What was your first job related to the resource sector?
RR: I had substantial success as a speculator. Owning a bar in the financial district of down-town Vancouver gave me unparalleled access to information. Building on that success, I became securities licensed.
RW: I’ve heard you say to your audiences at presentations: “Be a contrarian or a victim.” Can you outline your contrarian philosophy and how investors can make it work for them?
RR: Absolutely! There’s no business that I know of that is as cyclical as natural resources. Anybody who’s been in the business for 20 years will understand this boom and bust nature; first of all – commodity prices and then, the prices of equities that are tied to commodities.
Commodities go from boom to bust in fairly predictable cycles. When a commodity is in favour, i.e., it is expensive, two things happen. Users of the commodity find ways to conserve. They find alternatives and find more intelligent fabrication techniques. At the same time, producers, which are enjoying spectacular cash flows and have low cost of capital, find ways to expand production. Declining demand and increasing supply, of course, crash prices.
At the bottom of the cycle, the opposite thing happens. Nobody bothers to conserve. In fact they find other ways to utilize the material because it is so cheap and the utility to consumers is so high. And with the existing producers losing money on every unit of production they make, they’re in no hurry to increase production and, hence, losses. The consequence of that increasing demand with decreasing supply is that commodity prices rise. We’re in a commodity situation right now where the industry average selling price of the commodity is less than the median cost of production, meaning that the industry as a whole is losing money on every unit of production that they’re producing. This is, despite the fact that it’s currently painful, a wonderfully bullish sign for the future.
RW: How would you characterize the prevailing investor sentiment with regard to mining stocks?
RR: The prevailing investor side of it is almost always wrong. When mining stocks have done well for two or three years, people are drawn like moths to light because of the very success that the sector has enjoyed, but it’s illusionary because the cure in a market for high prices is high prices. So people become bullish in a sector after its produced positive returns for three or four years, right at the point in time when the Bull Run is almost over. People are discouraged from the sector in periods like we’re in now where we’ve seen several years of vicious bear markets where people are afraid and they miss the sector just as it’s about to turn. You’ll notice that as an example, 2015 was a horrific year for gold and a horrific year for gold stocks. This set up year 2016 where virtually all gold stocks doubled. Once again, the cure for low prices is low prices; the cure for high prices is high prices.
RW: With a negative geopolitical event, gold often spikes and then falls back. With the heightened geopolitical tensions regarding North Korea and the possibility of a chain reaction of bad geopolitical events that could potentially keep gold prices rising, is it even possible to anticipate the future gold price?
RR: I think if you look at the real determinant of the gold price over the last 40 years, it’s been the popularity or lack of popularity of the US dollar and, in particular, the US 10-year treasury. People use geopolitical events as a narrative to justify what they were going to do anyway. It seems to me that the most effective determinant of the gold price since 1980 has been the negative correlation between the US 10-year treasury and the price of gold. I think that’s the most important thing. I believe that the US 10-year treasury, having been in a 35-year bull market, is either at the end of that bull market or at the beginning of a bear market. If you believe, like I do, that gold trades inversely to the US 10-year treasury, with the US 10-year treasury at the end of a bull market or the beginning of a bear market, that would suggest to me, the gold price is at the end of a bear market or at the beginning of a bull market. I’m quite bullish about the gold business.
RW: What kind of an effect has the Trump administration had on the price of gold, if any?
RR: Virtually none. Trump has been an extremely polarizing person and Trump himself is an important narrative but he hasn’t had very much impact on the market for US 10-year treasuries. My own suggestion is that the rest of the world that holds Trump in disfavour has been irrelevant in the sense that the US dollar continues to do well against other currencies, not because of the strengths of the US economy and certainly not because Trump is held in high favour in other places, but simply because other countries’ currencies and economies are in even worse shape than our own. Our mutual friend, Doug Casey, refers to the dollar as a “I owe you nothing” and he refers to the euro as a “who owes you nothing.” It’s my belief that the strength of the dollar has nothing to do with Trump at all. It has to do with the weaknesses of competing currencies.
RW: Continuing with gold, the US Mint reports sales of Gold Eagle coins is down 67% from last year. Bloomberg reports that gold exports to China from Switzerland almost doubled to 46.4 tonnes in March, up from 23.6 tonnes in February. Gold buying in India is also ramping up. Is this another example of interest in gold moving from West to East and why is this happening?
RR: I think what’s happened is that China and India, at least in the official sense or reported sense, were nonentities in the gold business 10 or 15 years ago and they have moved to being important entities. The second part of the equation though, or really the first in the context of your question, is that physical coin sales have been a less dominant means of participating in the physical gold market in the last 15 years, relevant to the ETF (exchange trade funds). The ETF, GLD [NYSE], has seen positive net formation in the last six months, and I think what you’re seeing, is the ETF beginning to steal market share in the US market from physical sales, while in India and China, the official sector associated with individuals being able to legally own gold and silver has increased the attractiveness of those investment vehicles in those countries.
RW: Newsletter writer Brien Lundin thinks 2017 will be the “peak gold” year and then global production will decline. What is your take on peak gold?
RR: I sort of agree with Brien. I think the pattern of new discoveries has slowed up. Certainly, the cost of capital for non-investment grade gold mining companies has gone up and is a consequence of the new Basel three banking regulations and I think those two factors mean that new mine supplies will begin to decrease. It’s important to note that new mine supplies are a less important determinant of the gold price because most of the gold that’s ever been mined still constitutes supply, but I think it does have profound implications for equity pricing in the gold business; less important to the bullion price, but very important to some share prices.
RW: Do you think that investors should have some precious metals in their portfolio?
RR: Absolutely. I think it depends on the nature of the investor, of course. I own physical precious metals because I consider them to be ‘social catastrophe insurance.’ I own them in the strange hope that they don’t go up in price because a set of circumstances that would make them worth a lot of money would be deleterious to my life style. But it’s difficult for me to imagine an investor who could afford to have precious metals as part of their portfolio who doesn’t. I simply sleep better owning precious metals.
RW: There’s been almost a doubling of money raised for exploration in 2016 compared to 2015. Could a major discovery jump-start the Venture Exchange, à la Ekati or Voisey’s Bay?
RR: If you give a good salesman like me, use of the word ‘could’; I could make anything happen. The truth is that exploration expenditures are still very low, and the exploration process is still very inefficient. The amount of money being raised is fairly insignificant relevant to exploration expenditures 10 or 15 years ago, and my experience has been that from the beginning of an exploration cycle, you can expect that cycle to bear fruit. It takes a very long period of time, so we could have some luck with money that was raised last year, but I’m reminded of the fact that, as an example, Carlin Trend exploration in Nevada began in earnest with the publication of that famous paper, Alignment of Mineral Deposits in Northeast Nevada, in the early 1970s. Those exploration expenditures really began to deliver exploration success 10 or 12 years later. Most speculators have too short a time frame in terms of their expectation of exploration success. It takes a long time and a lot of money and wears out most speculators before the real fruits of their success are enjoyed.
RW: There appears to be a great deal of interest in the metals and minerals that go into lithium ion batteries, namely lithium, graphite, manganese and cobalt. Do you think investors should consider investing in companies targeting those commodities?
RR: I think really sophisticated investors could have considered investing in them five years ago. My own belief is that the supply bottleneck that we have in lithium is really a consequence of the processing bottleneck, not a supply bottleneck. I think there’s a lot of lithium in the world. That being said, we are aware of strategic interests by Chinese industrial groups acquiring high quality lithium deposits. So to the extent that very good world class discoveries were made, they could probably be sold. With regards to whole suite of so-called battery metals – I think they’re in a bit of a bubble right now. You have a bunch of teams exploring for them, but five years ago, couldn’t have spelled ‘lithium’ or ‘manganese’ so it’s very important if you’re considering speculating in those businesses, that you pay attention to the resumes of the teams exploring for them and find out whether or not in the last 20 years if they’ve had any success in that particular endeavour.
The metal that is the most attractive to me of the suite that you’ve mentioned is cobalt. The difficulty with cobalt is that it occurs in really big economic quantities in two countries – Russia and the DRC. Most speculators are afraid of those countries. You will certainly have area plays; stories associated with cobalt in mafic and ultramafic complexes around the world, including Canada and Australia, but my experience has been that the concentrations of cobalt, particularly in Canada, are never large enough that Canadian companies can be low on the cost curve unless they’re producing it as a by-product of nickel or some other ultramafic substances.
What might be useful in the cobalt cycle, and I don’t want to sound cynical, but I am, would be the teams use the cobalt story to do mafic and ultramafic exploration in places like the Canadian Shield in hopes that they can actually find nickel and copper. That would be very bullish indeed.
RW: The newsletters I receive are now being cautiously optimistic on uranium prices. What is your present take on uranium and uranium stocks?
RR: We had a melt up in the uranium stocks early this year that I think was very interesting and was indicative of market psychology. What happened in 2015 and 2016 was that we wore out the sellers of the junior uranium stocks. You will probably remember that when those stocks began to move up in price, they moved up on very very low volume. Ironically, once the junior uranium stocks had doubled, the volume picked up. In other words, as a consequence of price actions, the stocks were half as attractive but because they doubled, people piled in and then we wore them out.
Two comments here: the first is that the uranium price of US $25 a lb is substantially less than the global cost of production. The industry is losing money on every pound it produces. The uranium price is going to have to go up for these juniors to have any chance of developing the projects. The sole determinant, in the near term, and by near term, I mean by two or three years, as to whether the uranium price goes up, is simply the pace of Japanese reactor restarts. If we begin to see an increasing pace of Japanese reactor restarts, the gain will truly and really be one. If we don’t, we’re going to have to shake out and disappoint another group of uranium speculators. The people who came into the uranium juniors in the first quarter of this year; we’re going to have to disappoint them again before we can move off another depressed base.
RW: What do you look for in a junior mining stock?
RR: I begin with people. I look for guys – and now gals – who have been serially successful in endeavors that are related directly to the task in hand. In other words, if someone is looking directly for copper, I want them to have found copper before. You’ve had some people who have been serially successful and then you have, what is for want of a better word, mostly the great unwashed. I want a big deposit or I want the opportunity to find a big deposit.
Too many management teams dream of boot strapping and finding a small high-grade deposit and using that cash flow to build a company. It’s a wonderful dream but it almost never works. If you’re going to take the risk of inheriting a mine, you better make sure that the reward is consistent with the risk. In other words, it better be big!
And I also look at value for money. When people tell me what could happen, I have to ask them what does happen. What’s your market cap? If it’s $25 million, say OK, I see you have $3 million in the treasury; that explains the first $3 million. How do you explain the other $22 million? Don’t tell me just where it’s going to go. Tell me what my downside is by describing to me the difference between what the company is selling for and what it’s actually worth when liquidated.
RW: Looking at the world as a whole, would you say that the combination of infrastructure building and population growth will generate a significant demand for mineral commodities in the medium future?
RR: If you define the medium future as five years from now and out, the answer is yes. In the nearer term – no. In the nearer term, what is going to drive commodity prices will be supply destruction. The prices of commodities have been lower than the cost to produce them for a substantial period of time and the longer that goes on, the higher the probability that the productive capacity comes offline and we drive production up by meeting supply and demand at a lower level. When that happens, and the price spikes, the spike can’t be dampened in the near term by supply increase because the productive capacity has already been destroyed. This is a very important point.
RW: Is there any particular commodity that investors should target with a related mining stock?
RR: Well, the easiest one to target from my point of view would probably be copper because it’s a big market. There are a lot of people that know how to find it. In fact, I joke that over 40 years of my business, people have raised most of their money on gold and made most of their money on copper. Uranium, certainly with the caveats that we discussed, needs to go up. I continue to be attracted to platinum and palladium, although the very soft global economy has constrained demand for them more than I foresaw. I am looking in the agricultural mineral sector because it bores everybody else to tears and I like to write cheques when I have no competition. I also think people need to pay attention to gold and silver because I think there’s going to be some surprises in the commodity price with regards to those metals.
RW: Do you think that many of the mainstream stocks are now fully valued or overvalued and due for a correction?
RR: With the caveat that I’m not a general securities analyst, when I look at the mainstream stocks that are an example of S&P components of the United States, I think they are probably at the high end of fairly valued. I’m not one of those that believe we’re in a real bubble at least with regards with the large cap US stocks. These are very fine companies, they’re globally competitive and have maintained their sales in the face of a very strong US dollar which has made their goods more expensive overseas. They learned their lessons in 2008 with regards to excessive leverage and by and large have very good balance sheets, and so I think yes, they’re expensive because part of their sales has been driven by very low interest rates. Their cost of capital is a function partly of low interest rates and part of the implicit share price is a function of the fact that investors have looked at equities for dividends rather than bonds for yield because the bond market is so expensive. I don’t see the overvaluation in many of the large stocks that some of the natural resource newsletter writers are reciting. In fact, my own experience is the most overvalued sector in the market at all times is the junior exploration sector because 80% of that sector is always valueless at any commodity price point.
RW: Do you try to time the market or do you like to take a longer view?
RR: I believe you have to take a longer view. I time the market in the sense that when I find a commodity where the selling price is less than the cost of production, in other words, an industry that’s in liquidation, I know that either the material becomes unavailable or the price goes up and the longer the situation lasts, the more dramatic the response will be. If that type of fundamental analysis is market timing, then I’m a market timer but most of the money that I have made in junior stocks has come about as a consequence of answering unanswered questions, either through process improvement or through exploration and that’s a very long term gain. So my own expectation is that my minimum holding period is going to be 18 months and my ideal holding period is probably five to six years.
RW: Would you care to reveal any stocks that you are following?
RR: Well, certainly I’m closely identified in the public markets with Ivanhoe Mines where I’m still a very large shareholder. I’m a very large shareholder of the company I work for, Sprott Inc., and of its recently refinanced private merchant banks, Sprott Resource Holdings where I am now Chief Investment Officer. But the truth is, that I am quite bullish in my outlook for natural resource commodities, and the consequence of that is we’re actively trying to increase our positions in a fair number of companies, most of which I wouldn’t want to talk about because I know how broadly read you are and I wouldn’t want any competition from your readers (chuckle).