Investors who have managed to do well in the metals and minerals space will be familiar enough with the cycles and risks associated with the market, and have developed their own strategies in order to deal with them. This year, however, with the market for hard commodities beset by a potent and qualitatively more serious combination of forces, even the most seasoned mining investor has had to contend with a much more challenging environment.
Indeed, the decline has been as sudden and precipitous as the rise was slow and steady. The spot price of yellow metal began the new millennium at just under $300 per ounce, and by Aug. 22, 2011, advanced to an all-time intraday high of over $1,900. That this bull market took place during a time in which the global economy was rocked by two massive financial crises only solidified gold’s reputation as the safe haven.
As is by now well-known, however, 2013 has knocked gold off of its perch, and the brutal sell-off has sent spot prices at times to below $1,200 per ounce. There are a number of reasons for gold’s decline over the year, but whatever theory one chooses to explain gold’s downturn, or the downturn in any market for that matter, investors who prioritize returns will have to bring their best efforts to bear.
Enter Rick Rule, founder of Sprott Global Resource Investments Ltd. Rule’s reputation as an authority in natural resources investing rests on a long career devoted to the space. His success is attested to by his regular, if not relentless, appearances as a keynote speaker at metals and minerals investment conferences throughout the world, such as the upcoming San Francisco Metals & Minerals Conference on November 25-26, where he will share the stage with former Congressman Ron Paul.
Far more important than reputation, and even success, however, are the means by which they are achieved. From the perspective of investors and fund managers, there are of course the literal means of engaging with markets, like financial instruments, futures contracts, equity vehicles, and the like, as well as all the rules and regulations according to which they operate.
But familiarity with the psychology and history of markets are both just as indispensable when it comes to the cycles that lead to sharp declines like the one gold is in at the moment.
We sat down with Mr. Rule ahead of the San Francisco event to get his take on some of the trends in metals and commodities, the gold bear market, Quantitative Easing and its discontents, the horizon for junior mining companies, which areas of natural resources will be the most promising, and, of course, the upcoming event in the Bay Area.
EQ: I would like to begin by getting your thoughts on the current gold bear market. My guess is that your view is slightly more nuanced than much of the doom and gloom we’ve been hearing in 2013. Could you use the example of gold to lay out the contrarian philosophy of metals and minerals investing for our readers who may not yet be familiar with it?
Rule: That’s a great question, and I’ll take you up on the challenge. There’s three parts to the answer, which, as you say, is nuanced.
In the first instance, none of the narrative that existed when gold was at $1,900, in 2010, has changed. Quantitative Easing, for example, which I happen to think is a long phrase for counterfeiting, is still occurring. Competitive devaluations are occurring on a worldwide basis. And interest rates are being held artificially low by governments. The whole narrative, then, about why gold should go up that existed in 2009 and 2010 exists today. Given that all the facts are the same but the price is lower, I think the rational tendency would be to suggest that a different word for bear market, if it existed in physical goods, would be called a sale. And sales are good!
The second thing that people need to understand with regards to gold and gold price-action is that the decline in gold price during a bull market, a secular bull market, is a normal and natural response. In the bull market in gold that existed from 1970-1981, when the gold price danced from $35 oz to $850 oz, truly an epic bull market, there were, as my memory serves me, ten declines in the gold price of more than 20 per cent, and one decline in 1975 of 50 per cent. So the fact that gold price has fallen from $1,900 to $1,300 does nothing from my point of view to derail the prospect that we are in a secular bull market for gold. It is important to remember that people in 1975 and 1976 who got shaken out of that gold bull market by a 50 percent decline missed the subsequent 5-year move from $100 per ounce, which was the corrected price, all the way back up to $850 an ounce. I would argue in this case that past may be prologue. People need to take that into account.
I guess the third argument I have to make separates the real from the nominal price of gold. And I think what you need to do there is examine the fact that the US dollar is the denominator, the thing that all goods on a global basis are valued in, and if you look at the performance of the purchasing power of the dollar over the last thirty years, the idea that you can get nominal price gains because of the depreciation of the denominator is pretty attractive. On the way to work this morning I drove past a Motel 6. Thirty years ago, Motel 6 was called Motel 6 because rooms there cost six dollars. The sign today said Motel 6: $69 dollars. I would argue that there’s not 11 times more utility in a room at Motel 6 than there was 30 years ago; the sheets are probably still the same. That tells me that at least the nominal price of gold will increase with the depreciation of the denominator. I suspect it might change at some in time fairly dramatically.
A fourth piece of data to be considered is that gold traditionally has served as catastrophe insurance, and insurance against the depredations of wealth originated by governments. One can never tell when this is handy, but I would argue that at today’s price, you’re getting that insurance for free. And while it may or may not be timely, it certainly is worth more than nothing. So I hope that goes to answer the question, as you would suggest in a fairly nuanced fashion.
EQ: I ask because along with all the bear market talk, there is also what India is doing to tamp down on imports for example, and after what happened with the Central Bank of Cyprus earlier this year, it almost seems as though there is this notion of gold being under assault, or that it is in the process of extinction. Could you unravel this for us?
Rule: Well, I think that one of the things you need to look at is what would appear to be a bifurcation between the physicals market and the futures/paper market. Certainly in the 2007-2010 timeframe, the physicals market led the futures market in terms of direction, and I think that’s because the futures market and the GLD market, the ETF market, were driven by hedge funds and leveraged-long financial institutions that would get a position in a commodity that had some momentum, at very very very low real interest rates. When the gold quote at $1,900 rolled over and when US short-term interest rates went up, the cost of the carry became heavy, and the leveraged-long financial institutions began to bail, both in terms of the futures complex and also in terms of the GLD. As the gold price fell, what is interesting is that the physical demand for gold, which was already fairly strong, became extraordinary.
I would suggest that what you witnessed there is, classically, the movement of an asset, in this case gold, from weak hands- leveraged-long hedge funds and financial institutions - to strong hands- retail buyers who buy for cash. The Chinese housewife, if you will.
EQ: It’s what you see in a lot of Asia, really. India, Iran, places like that, where gold is traditionally used in that manner.
Rule: Sure. As the world gets smaller, and as frontier and emerging markets generally become politically more liberal, people who have a cultural affinity toward gold are able to buy it in terms of being allowed to, politically, and are also able to buy it because their income and savings are increasing rapidly. As you point out, the political liberalization in places like the Persian Gulf, south Asia, and China, very very very much favors gold. It’s interesting that in India, where the government put an enormous excise tax on gold, all they seem to have been able to do is shift the demand from gold to silver, increase smuggling, and increase the premium on physical gold in-country, the import duties, up to 20 percent. They didn’t do very much to stem physical demand for gold from the Indian citizenry who, as a consequence of a thousand years’ experience with organized government, has no trust in the rupee.
EQ: You mentioned bifurcation, and that brings me to the next question I wanted to ask, having to do with junior mining companies. You said back in April that the market for junior mining companies was indeed bifurcating, and echoing some of what you just got through saying, the top 5-10 percent of juniors are or will be rebounding off of bottoms, with another 60-70 percent heading toward what I suppose you could call their intrinsic valuelessness. How do you see that playing out now, and what is Sprott Global’s approach to the situation?
Rule: I think we’re in it. If you make enough calls, you make a few good ones! I think we have begun to witness bifurcation this year. I think we are seeing the better juniors at least flatten out, and in some cases even move up. It’s not going to feel like that when you look at the entire market because, as you point out, most of the market has no value. I suspect that it’s not going feel like we’re in a bull market for the juniors for 18 months to two years, as the flotsam and jetsam in the market gets purged.
But the truth is that I think that this year is analogous to the year 2000 in the last bear market. And the year 2000 turned out to be an extraordinarily good year for stock-pickers. It wasn’t a good year for the market overall, but it was very good for the people who had the ability to differentiate between the good, the bad and the ugly. I think what you’re going to see is a year of reasonably good return for stock-pickers, and also probably a pretty good year for speculators who are cashed up well enough to buy psychotic dips, and also cashed up well enough that they can participate in private placements, because the need for capital in the sector is still very strong.
EQ: As for the larger picture, which areas of natural resources do you see offering the best potential for value over the near-to-long term?
Rule: Well, I think there’s opportunity all over the space. I think that the gold and silver equities are probably reasonably priced relative to the price of gold and silver, but I’m constructive with the fact that gold and silver prices are going to go up. Certainly, it’s unusual in the gold and silver space to be able to buy the most attractive stocks at fair, as opposed to great, prices. And that opportunity is presented today.
As attracted as I am to gold and silver, however, I am much more attracted to platinum and palladium. In the case of platinum and palladium, the thesis is that the industry doesn’t earn its cost of capital, so it’s very difficult to own the stocks. But I think that any reasonable investor or speculator needs to own the metal, or at least the trusts and ETFs that represent certificated ownership of the metal. I think that platinum and palladium have every advantage offered by other precious metals, but I also think that the supply-demand scenario is very compelling. And while I think that gold and silver prices should go up as a consequence of at least nominal pricing increases, I think platinum and palladium prices will go up in real terms because the industry doesn’t earn its cost of capital, and the utility of the commodity to users is so high.
I also think that uranium is unloved. I don’t know if it will find any love for two or even three years, but again, you have a situation where the industry estimates their cost of production, including getting a return on capital employed, or rather the cost of capital, is in the $75 per pound range. Conversely, they’re selling it for $35 per pound on the spot market. The idea that you’re making something for $75 and selling it for $35 indicates that you’re losing $40 per pound and trying to make it up on volume. There is substantial above-ground inventory, but when that goes away, either the price of uranium goes up, or the lights go off. Those are the two choices.
My call is that uranium is a three or four-year double. The idea that you could buy something that is a very high probability in a three-four year time frame may be boring to speculators, but it’s an extremely attractive proposition to someone like me. I would suggest to your readers that uranium is a “when” equation, not an “if” equation, and I’ve found in my life that if I can find myself the questions where the answer begins with “when”, I do fairly well. So, as an example, I am attracted to Uranium Participation Corp on the Toronto Stock Exchange, and I am also attracted to a short list of uranium producers, explorers, and developers, precisely because nobody else likes the space, and the outlook is uncertain.
EQ: I wanted to touch on the San Francisco Metals and Minerals conference that is coming up at the end of the month, and where you are featured as a keynote speaker, as you often are at these events. Is there a thematic focus we can expect from the proceedings?
Rule: I think so. It’s going to really be fun for me. Most of the speakers are going to have been so beat up over the last two years that they’re going to be extremely cautious. I was just in Australia for a couple weeks, speaking at three investment conferences and giving probably 20 interviews, and what struck me is that I was the only bullish speaker on most rosters. 2009, 2010, I was uniformly the most bearish speaker on these rosters. I will attempt to point out in San Francisco that the response that we’re going to get in this market is almost like the response that one could expect from physics: day will follow night, bear markets are the author of bull markets, bull markets are the author of bear markets. It is precisely when your experience over the last two years has been so bad that your expectations of the future is set by your immediate past, in other words you’re pathologically bearish as a consequence of the all the punishment you take, and all of your competition feels the same. Warren Buffett says he made his money by being brave when others were afraid, and having the good sense to buy straw hats in winter when they are cheap. You need to buy when there is no competition in the market, which is precisely where we are at, and that will certainly be my message in San Francisco.
In the workshops, which are of course much more constrained environments, I’m going to name some names, and I’m not going to name them in the sense that people should buy them as a tout; I’m actually going to take them through the names based on why they should buy them, how they can use these individual companies as lessons, in a sort of Harvard Business school case-study format, which I really think will be fun. It isn’t the sort of thing you can do in a bull market, because in a bull market your recommendation becomes a self-fulfilling prophecy, and the crowd buys so much stock that they make it unvaluable, they compete with each other.
In a bear market, you can teach these wonderful real-time lessons with impunity, because people are so beat up that they don’t act on the best advice that you can give them.
EQ: For those planning to attend the event, what advice can you offer in terms of how best to prepare in order to maximize the experience?
Rule: There are going to be some very high-quality exhibitors there. Normally what happens is that attendees go to hear the headline speakers, and then when the companies speak they go for coffee or beer. This is a conference where money will be made over the next twelve months. I think what you do is listen to the keynote speakers, you listen to themes, you listen to presenters, and then you hone in on four or five booths and dive very very deeply into the information. I think money will be made over the next twelve months from this conference, and I think lots of money will be made over the next 24 months from this conference. What I think people need to do is allow their intellect to override their emotions, which will be negative, as well the emotions that they’ll pick up from their neighbors, which will also be negative. Precisely because those emotions will be so negative, this conference will have some very high quality goods on sale. It also bears repeating that you need to confine your efforts to the top decile, or at least the top quartile, don’t go too far down the value chain in this market or at this conference. If you constrain yourself to high quality names, you are going to do very well coming out of this conference.
For more commodity market insights From Rick Rule, Eric Sprott, and other top-notch analysts, visit the Sprott Global Resource Investments Ltd. site, where you can sign up for the free Sprott's Thoughts e-letter.
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