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Rick Rule: This Is Turning Into a Long Rant, But You Asked For It

Tuesday April 23, 2013 15:25

Sprott USA Chairman Rick Rule

Rick Rule Illustration: Graeme Berglund / CEO.CA

Rick Rule rules the junior resource world with his checkbook. The acclaimed speculator has been financing mining and energy companies for nearly forty years and has the big scores and scars to prove it. From his perch as chairman of Sprott USA, Rule possesses exceptional insights into the global natural resources space. We were able to connect with Rick for an hour on Friday to get his perspective on gold, the macroeconomic backdrop, the TSX-Venture Exchange, Sprott Inc., and success in natural resources. In his words, “This is a long rant, but you asked for it.”

Navigating the gold market

Sprott and Rule are very public proponents of precious metals ownership. In light of gold’s recent near-$300 crash, it was the natural place to begin our conversation. “If my memory serves me correct, we’re in the 8th or 9th cyclical decline in what I think’s a secular bull market. This correction is perfectly normal and healthy. It may or may not be pleasant — but how you look at it is your problem.”

To illustrate his point, Rule brings up the ‘70s-era epic bull market in gold, when the metal ran from $35 to $850. “Many people don’t remember that in the middle of that run there was a cyclical decline in ten harrowing months from $200 an ounce to $100 an ounce,” he said. “Sadly, even gold-owning investors who actually knew what they were doing let their fear get the better of them. So they missed its $100 to $850 move.”

Gold in the 1970s

Gold actually hit $850 intraday, but these are the London Fixed prices, which are recorded just once per day.

Gold vs the US dollar

“In the US, we have almost $17 trillion in on-balance sheet liabilities, and almost $70 trillion in off-balance sheet, unfunded liabilities, like social security and medicare,” Rick told me. “We’re running deficits of $1.5 trillion each year — we’re borrowing half of that and printing the other half. Combine that with off-balance sheet liabilities, which are growing at almost $4 trillion per year, just at the federal level, and you can see where the problems are coming from. Trillion is a big number.”

US Unfunded Off Balance Sheet Liabilities

US unfunded liabilities are at least $55 trillion, according to the St. Louis Fed.

“Take a look at the experience we just had in Cyprus, where it looks like deposits are going to be tapped,” he explains. “90 years ago, to think depositors wouldn’t be tapped would be silly. What’s happened is we’ve added deposit insurance to a great list of social promises, like old age security and health care benefits, despite the fact that we may be alcoholics or morbidly obese. There have been a whole range of social promises that are in excess of our ability to honor. The great question of the next 20 years will be how we discharge these liabilities. Will we be honest about it and default — which is very deflationary — or will we be dishonest and inflate away the liability over time? If it’s door #2, as I expect it will be, it’ll be extremely beneficial for the price of bullion.”

On investor psychology

“The average human mind forms its perception about events that are likely to occur in the future in the context of very, very recent experience. The fact that the US bond and stock markets have been relatively good reinforces the perception that they’ll continue to be so,” Rick continued.

“People tend to search for information that reinforces (and doesn’t challenge) their existing preconceptions. They don’t want to confront frightening realities. They would rather immerse themselves in pleasurable circumstances that they believe are true,” he told me. “So it makes perfect sense that the media and government have convinced the investing public to believe that liquidity and easing is a substitute for social solvency. We’ve lived beyond our means and we’re leaving the bill with people your age. Wonderful work if we can get it, but I don’t know how long it will last.”

Advice for investment advisors

“A plan that I’d articulate to clients would include some number, depending on the client’s wealth and liquidity, of up to 10% in bullion and bullion-related products,” Rick said. “Despite the fact that your purchasing power on cash is beginning to erode, accounts need to be very liquid, because I don’t see that the possibility of a psychotic break like 2008 has been eliminated. If we do get another psychotic break, having the cash might not give you the courage, but it will provide the tool to take advantage of irrational activities by others. I think that the bulwarks of portfolios now are bullion and cash.”

“Moving up from there, we’re encouraging clients to participate in natural resource equities — particularly smaller resource ones. The narrative hasn’t changed since 2006. All the factors that were in place for a secular bull market in resources are intact. The very best assets in the junior natural resource sector are on sale for up to 70% off. Investors have to understand that the down cycle can go on for 4-5 years, but in my experience, being early is enormously preferable to being late.”

He continued, “We spent about 5 million dollars yesterday. I’m pretty certain I’m early. We’re in the early phase of capitulation selling — the last phase of a bear market. Soon we’ll go into the summer doldrums, and the junior market — the TSX-Venture — will I think truly bifurcate this fall. I think the best 5-10% of issuers have flattened and will go up beginning this fall. I think there will be a cleansing in the rest of the market though, that could last 18 months, where the real penny dreadfuls will flirt with their intrinsic value, which is zero. So it’ll feel like we’re in a bear market for another two years. But the money that can be made when goods are on sale in volatile markets is extraordinary if one doesn’t buy the sector, but buys individual issues which are irrationally priced down. With regards to the TSX Venture index, if you ever buy it from your broker, you will get broker and broker and broker.”

“This is the first time since 1992 that I’ve seen high-quality gold development assets reasonably and cheaply available in the market, and by ‘cheaply,’ I mean after tax IRRs above 25% and hopefully above 30% using current prices,’ he said. “We aren’t seeing large companies acquire smaller ones because the seniors are busy digesting the mistakes they’ve made over the last 10 years. They will definitely need to begin acquiring. Because in the mining sector, where your business is in constant liquidation, if you’re not exploring, which they’re not, or acquiring, you are six or seven years from extinction.”

Who deserves more credit in mining?

Mining investors 'stay cool'

Friedland

“Brent Cook does an anomalously good job as newsletter writer,” Rick praised. “The person who doesn’t get anywhere near enough respect in this market, although he demands it (laughs), is Robert Friedland. He has Kamoa, Flat Reef, and Kipushi in one vehicle, and has had it for 18 years. He’s had the persistence, tenacity, and brilliance to build that company through thick and thin. He’s assembled two game changers and three-world class assets in one vehicle. It’s astonishing.”

When I asked Rick what made Friedland such a special promoter, he explained, “20 years ago you’d have what you thought was a casual conversation with Robert, and you’d figure out later that you’d been interrogated. He’d carefully ask you questions and make statements to gauge your reaction, so he could identify what your hot buttons were and tailor his story to your individual needs. He also has a memory unlike any I’ve ever seen.”

He continued, “Adolf Lundin was equally seductive, but that was because he made so much money for me, and I liked him so much. We’d have dinner together, and I’d say, ‘Adolf, lets just get this over with, who do you want me to make the check out to, and for how much? Then we can just have dinner.’” Rule said Lundin was an early mentor to him, as was Chester Miller, who founded Glamis Gold. “I had been lucky enough to associate with those guys in the 1970s, and I did very well with them, but I confused a bull market with brains, and I paid an extravagant price for that ignorance in the early 80s. The good thing that happened to us old guys, and is happening to your generation now, is there were a couple times when our intestines got spilled. Everyone I know who was successful had vicious times, let’s not forget that.”

Thanks for the interview Rick.

By Tommy Humphreys,
tommy@ceo.ca
CEO.CA

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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