I had the opportunity to interview Rick Rule a few days ago. Rick is the CEO, president and director of Sprott U.S. Holdings, a securities brokerage and asset manager specializing in natural resource plays. In my opinion he is the smartest guy out there, one of few who really knows how to successfully invest in the resource market long term. See questions and answers from the interview below:
1.) One of the hot topics at the moment is the russian ruble, as I write this, the ruble has fallen over 40 percent in about 5 months against the US dollar, thats an extremely large move. During the same period the ruble lost 40 percent, oil has fallen almost 50 percent in price. Should there be such obvious correlation between the Ruble and the price of oil? Any thoughts on this development?
Rick: There is a correlation, energy exports are the life force of the Russian economy. If they had other economic competencies, the lower ruble would be partially self correcting, lowering the cost of other categories of Russian goods, and increasing demand for them, which would ultimately settle in rubles.
2.) Looking at the long term oil chart, this current crash in price is one of the largest we have ever seen in such short period of time. Technical indicators has reached the most oversold level in 25 years. Is it likely that the price will bounce back up quickly or will it take time to recover and adjust to a more sustainable price level?
Rick: This is the third major oil price correction of my life, and certainly the most violent. I believe that recovery will be gradual.
I say that for two reasons: Demand needs to recover, and I see no signs of a genuine economic recovery, and the industry is substantially over capitalized, giving them the ability to cannibalize their capital base and produce down to cash lifting costs for a substantial period of time. I saw the US and Canadian natural gas industry do just that in the decade of the 1980’s. If we enjoy any kind of global recovery, commodity prices will recover with a ferocity that will surprise us all.
3.) We are seeing more positive economic numbers coming from the the US, for example, credit (loans and leases in bank credit, all commercial banks http://research.stlouisfed.org/fred2/graph/fredgraph.png?g=Uxb) i.e money used for economic transactions recently reached 7,5% growth rate (yoy), highest since the 2008 crash. US banks do create a lot of money right now (in the form of numbers in banks accounts), at the same time unemployment figures are improving. Is the US economy really improving and is this a sign of more inflation coming, what’s your view on this trend?
Rick: I’m a credit analyst, not an economist, forewarned is forearmed! The most recent quarter seemed encouraging, with employment and income numbers generally positive. I’m personally very cautious, because the “headwinds” are so strong: very low labor force participation, anemic income growth, an eminent downturn in domestic oilfield employment (the only source of real income employment for blue collar workers), anemic global demand, and very high debt levels at federal state and local levels.
The countervailing strong points would be extraordinary private sector balance sheets and income statements, increased savings and investment rates among the wealthiest Americans, an aging auto and consumer durables fleet (in need of a replacement cycle) and plenty of surplus productive capacity in the economy.
4.) The TSX Venture Exchange where lots of resource stocks are traded is now at the lowest point in 15 years, down 37 percent since September this year. Is this a good time for patient value investors to start building positions in high quality resource companies?
Rick: You may be as much as a year early, but in five years we will remember these as the “good old days”. Just remember your quality admonition. Most TSXV companies are dross.
5.) ASIC for large gold producers is at about $1000/oz, should this level be considered as some kind of floor for the price or is it possible that i goes lower? From where the price is today, what’s most probable long term, the price moving higher or lower?
Rick: ASIC is interesting in the near term for securities analysis, but less critical in the context of the gold price. Remember, almost all of the gold that has ever been mined still constitutes supply. What matters in the context of the gold price is the strength of the denominator, the US dollar. Gold does not have to win the war versus the dollar, the supply of each is grossly disproportionate, but if gold begins to lose less badly, the gold price would surprise to the upside.
6.) I really enjoy your Paladin (PDN.to) story where it went from 10 cents to 1 cent and from there to almost $10 (see chart). For investors with patience who hunt similar kinds of gains, in short, what should they in be looking for in a resource company and what kind of market condition should be prefered (when to invest)?
Rick: These exact market conditions, where the market expectation is catastrophic failure, and where companies needs for capital compels them to offer investors a fair deal. Look for small companies involved with very large deposits of despised commodities in political jurisdictions that inspire terror or simple loathing. Use money you can afford to lose all of.
7.) On December 22, Lundin Gold will start trading on the swedish stock exchange. They recently bought FDN from Kinross, thereby making a huge bet on Ecuador. Interestingly, Ross Beaty recently bought a large position in Odin Mining which has properties in Ecuador. Any thoughts on this? What about the timing?
Rick: I’m attracted to the geology of Ecuador, and I love the fact that most folks hate it. I believe ALL countries are and always have been run by thugs, and Ecuador is no exception. Mr. Correa has concluded two important things: he needs to have money, to redistribute money (all smart thieves prefer rich victims), and more importantly, that he must share the social take from extractive industries with the regions where the activities take place. Too often, particularly in Latin America, the regions bare the social and environmental costs, while the center steals all the gain.
8.) Lukas Lundin and Ross Beaty did participate in a private placement in Kaminak located in Yukon not that long ago, Lukas is also a large holder of a gold company called Newstrike (NES.v) in southern Mexico. Do you like Yukon and southern Mexico as areas to invest in?
Rick: I like both, as a consequence of geology, and due to the fact that both enjoyed investment booms, which lowered the cost f capital for the better explorers, and the boom has turned to bust, so I can buy the rare successful efforts at pennies on the dollar.
9.) Another interesting move this year was the decision by Frank Guistra, Ian Telfer, Richard Warke (founder of Ventana Gold that was bought by Eike Batista for $1,5 billion) and Tookie Angus to buy a large part of Catalyst Copper (CCY.v) which owns a large copper deposit located in Mexico. What’s your opinion on copper going forward, is that a metal to own in the coming cycle?
Rick: An old adage in mining is “raise money on gold, make money in copper.” I love the copper business, it’s made me way more money than gold, and the managers and fellow investors are rational. That said, until we see an economic recovery (a real one, with jobs, and demand) copper will be a tough slug, with high costs of capital and struggling prices. The copper industry is suited to players like me, who can wait a decade for ten fold returns, on large amounts of invested capital.
10.) There are a few resource companies with high quality projects permitted for construction, high after-tax NPV and IRR even at current prices, the ‘only’ thing missing is money. What should managements in such companies do right now to maximize shareholder value longer term?
Rick: There are only a very few of those, and they need to bite the bullet, and raise capital on market clearing terms. They need to be producing WHEN the market turns, so they can capture the economic surplus generated by temporary supply shortages.
11.) Where do you put your money right now, which countries, what resources, and why?
Rick: In analyzing my response, it is important that your audience first consider my circumstance; I’m a professional investor and speculator, with patience, experience, contacts and substantial surplus wealth. I can afford, financially and psychologically, great risk. I am very patient, and inured to volatility. Do not mistake my answers for recommendations!
If the price of my employer, Sprott Inc. (SII.to) stays low, I’ll likely buy substantial quantities. I’m already a large holder, and very familiar with the company. At the bottom of the resource cycle, Sprott has a great balance sheet, generates free cash, pays a 5% dividend and invests substantial cash in building a franchise, when its competitors cannot afford to do so. I believe that Sprott has a superb intangible asset, our brand. I think we are the most recognizable financial brand in the world for precious metals and small cap resource equities.
With my investment funds, I’ll likely be a big player in bridge and mezzanine lending to resource developers, through Sprott generated private placements. These activities have generated very acceptable rates of return, through the downturn. I’ll also be a buyer of certificated physical commodities, particularly Platinum and Palladium as well as Uranium, but also gold and silver. If the current weakness in energy pricing causes the producers to monetize their midstream assets, I’ll be a very large buyer of the entities that buy and operate those assets, particularly if they are incorporated as master limited partnerships, and distribute their income to holders in a tax efficient manner. In any broad general market selloff, I’ll likely greet the panic by buying the largest lowest cost commodities producers I can, either as direct on market equity purchases, or through closed end proxies like Petroleum and Resources, if it sells at a greater than 15% discount to NAV.
On the speculative side, I hope to increase my direct participation in oil and gas drilling. The need for capital will likely become so dire that issuers will have to allow investors once in a decade terms to attract capital. I like to be treated fairly.
I will buy all of the highest quality juniors, run by “A” league owner managers that I can afford. I’ll buy the best of the best prospect generators. I’ll buy “cash boxes”, companies selling at big discounts to working capital. And unlike most speculators, I’ll buy very large, out of the money “optionality plays”.
I favor commodities and locales that others hate, so you will see me in Platinum, met coal, ag minerals and things like that.
12.) If anyone who reads this wants to get involved with Sprott, how do they do so?
Rick: First off, depending on your circumstance and beliefs, buy us. We are basically a closed end fund of resource opportunities that pays you a dividend, rather than charging you a fee. Subscribe to our free blog “ Sprott’s Thoughts” which gives you the best thinking available from within, and outside our organization. Visit our website www.sprottglobal .com and for a free, no obligation benefit, if you email me your resource portfolio (names and symbols, in text, no attachments) to email@example.com, I’ll rank your portfolio, and return it by email.