Rick Rule | The Mining Industry Is Not As Capital-Short As It Pretends To Be

Rick Rule is the President and CEO of Sprott US Holdings and has been in the natural resource investment business for about four decades.  In this interview, Mining Stock Education host Bill Powers questions Rick regarding what he learned at the 2018 Sprott Natural Resource Symposium, how he assesses younger mining CEO’s, his thoughts on tin as a commodity, and his current assessment of the mining sector.  Throughout the interview Rick offers sage investment advice on how to succeed at resource investing.

0:05 Introduction

1:23 What Rick Rule learned at the 2018 Sprott Natural Resource Symposium

4:10 How Rick Rule assesses and vets a younger, unproven mining CEO

7:28 Does Rick Rule think the junior mining sector generally attracts a lesser-quality CEO compared with other industries?

8:09 Discussing the appropriate compensation plan for an exploration company CEO

9:54 Rick Rule’s thoughts on tin as a commodity

13:01 What past time period does today’s resource sector remind Rick Rule of?

17:11 Does Rick Rule currently see any top-quality investment opportunities selling at a 50% discount?

18:53 Rick Rule’s parting advice and offer to rate and rank your resource portfolio

BEGIN TRANSCRIPT:

Bill: Welcome back, ladies and gentlemen, and thank you for tuning into another Mining Stock Education expert interview. And this episode, hopefully like all of them, will be educational. I have someone on the line that we all know very well if we’re anywhere familiar with resource investing, and that’s Mr. Rick Rule, the President and CEO of Sprott US Holdings. So, Rick, thanks for taking the time and coming on the show.

Rick: Always a pleasure, thanks for the opportunity.

Bill: Rick, I met you in person a couple times this year, the last time was at your own conference in July in Vancouver, the Sprott Natural Resource Symposium. At that time I asked you what you were learning during the conference, it was, I believe, at the end of day two, and you told me to follow up with you a little bit down the line so you could consume your own cooking and listen to the MP3’s of the conference. So that being said, what did you learn from your own conference?

Rick: Well, I relearned an important lesson, which is the importance of people in any business, but particularly in the exploration business. Which you’ll remember that we described as more of a research…you know, sort of a human resources-intensive, rather than a physical resources-intensive, business. And if you look at who the winners and losers have been since that conference, it’s obvious once again that great people have carried the show.

The second thing that I learned on reflection, but also looking at my notes from the conference and listening to the MP3’s, is that the industry is not as capital-short as the industry pretends to be. One immediate aftermath of the conference was a reaffirmation to me from high-net-worth clients that they had equity available for the sector as long as we felt that the equity would be treated well by the investors. Subsequent to that you may know that Sprott has embarked on its second institutional lending partnership where we’re targeting about a billion dollars from existing and new institutional investors and it looks as though we will achieve that goal.

So the idea that the industry puts forward that it’s somehow underfunded, I think, is false. I think the industry is used to being overfunded and has a preference for dumb money over smart money. But one thing that we learned from the conference and subsequent to that there’s lots of money around for good projects.

It’s also interesting to note, and we talked about this at the conference, that one of our chief competitors, by “ours” I mean Sprott’s chief competitors, in terms of doing fundings now is other mining companies. So rather than competing as sources of capital with generalist institutions, that is people who might be more comfortable in supermarket investing or technology investing, we’re competing directly with the industry. Which, while that’s hard on Sprott because they’re better competitors, certainly augers to the fact that the smart money, mining money, is returning to mining, too. All of which are, I think, useful points.

Bill: I have some follow-up questions as it relates to deciding who you’re going to partner with, mining company management. When you’re interviewing a management team that you have not partnered with before, you don’t have a reputation with them, you don’t know them that well, and maybe they don’t have a track record of success behind them, maybe it’s a younger CEO starting out, what are some things that you’re going to look at in a younger, unproven CEO that would cause you to maybe consider investing in his or her company?

Rick: If I don’t know him, or her, I better know a couple people who do. It’s a fairly small business. And if somebody hasn’t proven themselves with their own friends, they’re not going to prove themselves with my clients. I remember going back many, many, many years we wrote one of the start-up checks for a great junior success called Altius Minerals. The CEO at that time was a 23-year-old, painfully skinny, prospector from Newfoundland, Brian Dalton, that, you know, wasn’t known in financial markets. But it turned out that he was extremely well-known in exploration markets in Newfoundland. The two geologists that generated the Voisey’s Bay Mine, Chislett and Verbiski, they became legendary, both knew and vouched for this young man extraordinarily.

So if I don’t know the person, I better know somebody who does know them, or else the chances of them getting some money from Sprott are nil.

Bill: When you’re querying a newer CEO that you’re being introduced to, do you sometimes ask them regarding their knowledge of mining history or past successful mining promoters or CEO’s?

Rick: Well, I normally ask other people about them. In other words allowing them to tell me good things about themselves is something that you have to endure, that’s something that promoters do. But I’m much more interested in hearing them tell me the names of people that I already know who I can query them about that.

The next thing that you do, having had passed the sniff test, in other words having had people who know them who I know vouch for them, is I try and figure out what it is on their résumé, however short their résumé might be, that qualifies them specifically for the task at hand. Understanding that the process of exploration is very much a research and development process, it’s about answering a series of unanswered questions. And what I want to know then about the CEO is his or her résumé sufficient that I care about the thesis that they might have developed and do I believe that they have enough experience answering the same kinds of questions that the method by which they propose to test the thesis is both efficacious, in other words will it answer the question, and efficient, which means will it answer the question reasonably from an economic point of view.

When somebody says to me that they have been a success in mining but the part of mining that they have been a success in isn’t directly related to the task at hand, I don’t equate that prior success with any indication that they may or may not be successful in the future.

Bill: I’ve heard it said that the junior mining sector does not necessarily attract the best CEO talent available. Do you agree with that?

Rick: I do. I do. Mining is a small business, it’s a business that has been out of favor for a substantial amount of time. And unless you have a real love of geology and exploration, which I happen to do, there are probably other industries with a similar sort technological bent that one could get into that has more immediate prospects of success. So one of the things that you would look for in a CEO is absolute passion.

Bill: In terms of attracting talent and how that correlates to what a junior mining CEO might be paid, I was speaking with a couple fellow investors and we were talking about a particular company and two of us liked the company and the third one chimed in and said, “Well, that person is being paid too much.” Do you think it’s right for a junior mining CEO, let’s say of an exploration company, market cap $10 to $30 million, being paid $300,000 Canadian, is that okay if it’s…they could justify by saying, “Hey, we needed to attract talent to run this company”?

Rick: It depends on how much that investor…that, pardon me, CEO has invested in the company. We like to see officers in the company have stock value at approximately five times their annual salary. So in the circumstance that you describe, a $30 million-dollar market cap with the CEO earning $300,000 a year, that would be okay with me if I liked every other aspect of that person, provided that they were my partner in the business, in other words they had substantial capital at risk. I want to make sure that the interests are aligned. If what I am in a highly speculative situation is that I’m in business with a manager as opposed to a partner and a zealot, I have no interest. Someone whose entire interest is in salary will be motivated to maximize salary rather than maximize return on capital employed because they don’t have any capital employed.

Bill: After our last interview a listener wrote to me and he said could I get your take on tin the next time I interview you. He writes, “Rio Tinto and other giants are demonstrating that it’s the most needed metal in percentage with the most proportionate upside as compared to other base metals. Could you get Rick’s take on it?”

Rick: I won’t comment on the most proportional upside because that involves looking too far into the future. And sadly my crystal ball is cracked and cloudy. It is certainly a metal where the existing deposits that the world is living off of are very long of tooth. And in the context of the alluvial extraction of tin in Asia, enormously environmentally damaging. So that tin production from some historic sources is mercifully for mankind failing fast because of the environmental destruction that it does.

So I think it’s a very, very attractive commodity to be looking for. I will say that trying to play the tin game is difficult because there aren’t many listed entities in the tin business. As an example, we are, at Sprott, taking a substantial amount of risk by backing a tin development in Democratic Republic of Congo, a fairly harsh political and social environment. But we’re doing it because the average grade and the scope of this deposit is so large and we’re so fond of tin as a commodity.

So I would agree with the general assertion of the caller, although I won’t comment specifically, on his suggest that tin has greater upside than any other metal.

Bill: As you were mentioning the Congo I was thinking about something you’ve said in the past to where you’ll take jurisdictional risk if it gets rid of technical risk. So I knew it had to be a tier one asset if you were going into the Congo.

Rick: It’s absolutely a tier one asset. The Alphamin asset is one that sadly was responsible for some substantial amount of the warlord activity in Northeastern Congo. The deposit is of such high grade that artisanal mining on the deposit 10 years ago was rich enough that miners could move run-of-mine material manually on their backs walking out two days to a road where they then smuggled the material into Uganda and Rwanda. It’s extraordinarily high-grade material and there’s extraordinary exploration potential.

This isn’t meant as a promotion of Alphamin, it simply suggests that what you say is true. You know, we would take the risk of operating in a jurisdiction like Congo only in the event that the asset was absolutely tier one, which this one is.

Bill: As you look at today, it’s the end of 2018, we’re about five weeks or so away from the new year. You’ve been at resource investing for four decades. What time period does 2018 going into 2019 most remind you of?

Rick: You know, I’ve been asking myself that question a lot and it reminds me a little bit of a bunch of different periods. But what I’ve noticed is that every cycle has different features to it, and this one is no different. The bear market, of course, with regards to junior equities, was particularly steep. There’s no law that says that the recovery has to match the bear market in either, you know, sort of duration or extent. What is important on the good side with regards to the minerals and the energy business is that we’ve had substantial supply destruction, meaning that the bear market has destroyed productive capacity. So that when markets rebalance to supply and demand and the price begins to go up, the supply won’t be able to keep pace because productive capacity is destroyed. That’s a very good thing.

That’s partially counterbalanced because we’ve been in a general recovery, a general economic expansion for eight or nine years. And although I’m not on an economist, I wonder if this expansion isn’t becoming long of tooth. If you have a general economic slowdown, what that does is constrain supply. So maybe…I’m not saying this is going to occur, but maybe unfortunately demand and supply come into balance again as a consequence of both reduced supply and reduced demand.

The other thing that I would put out in this instance is that sentiment among generalist investors in most of the world, but particularly in the developed world with regard to gold, are at multi-decade lows. Gold traditionally has been viewed as a sort of flight-to-quality asset. And the flight-to-quality asset that most of the developed world seems to default to now is the U.S. 10-year Treasury. I don’t believe that gold necessarily will win the war against the U.S. dollar as expressed by the U.S. 10-year Treasury, but I do believe that gold will lose the war less badly. And I think that has profound implications for the gold price.

I was told, I don’t know this to be true but I believe it was Morgan Stanley or JPMorgan, that pointed that in 1981, the top of the last gold cycle, that precious metals and precious metals-related assets comprised over 8% of total invested assets in the United States. A similar figure for 2018 is between one third of 1% and one half of 1%. So the market share, if you will, of precious metals and precious metals-related securities has fallen from 8% to a top of one half of 1%. The four-decade median, or mean, in terms of market share of precious metals in the U.S. investable assets market is about 1.5%.

So never mind regaining the favor it once had. If it regains the favor that it has traditionally had, in other words if it reverts to mean, that means the demand for gold and gold-related assets in a market that, while in decline, still has a quarter of the investable assets in the world, that is the United States, would see between a three and fourfold increase in demand for gold or precious metals-related assets. And that’s what I think is going to occur.

Bill: Recently you were on a panel at a conference and you were asked to rate specific mining investment opportunities. 1 was the best, 10 was the worst. And at that time you said you’ve probably had about six 1’s in your 35-plus years of resource investing. And you defined a one as something that’s selling at half of what you think it’s worth, a tier one deposit, a management team that you know and love, and an upcoming catalyst. Now three of those four I could see out there that being a catalyst, a good management team, and a tier one deposit. But that one quality, something that’s selling at half of what you think it’s worth, are there any of those out there right now for you?

Rick: There are no 1’s in my list right now. 1’s are extremely rare. Trying to think of… Well, one example of a one would have been in late 2015 when Ivanhoe Mines, two tier one deposits, a promoter who I certainly know and love, he’s made my clients an awful lot of money, selling at 60 cents a share with 93 cents a share in cash contributed by two partners, one JOGMEC which is basically a parastatal arm of the government of Japan and the other being Zijin Mining. That’s one that was selling at a greater than 50% discount to cash, the easy sort of catalyst in place was the market’s recognition that this asset…that you were getting the assets for free and that it was selling for 60% of cash in the Treasury. That was the last one I had.

Bill: Well, Rick, I appreciate your time. When we were in Vancouver over the summer the last question I asked you was what Rick Rule-ism should we most be aware of and apply to our investing at the time and I believe you said that we must be a contrarian or we’ll be a victim. Is that still the number one Rick Rule-ism for you right now?

Rick: Yeah, I think it is. I think it is. I think another Rick Rule-ism that I tried to get across at that conference, and it isn’t really a Rick Rule-ism but I’d love to take credit for it, is simply knowing yourself as an investor and knowing what you’re about gives you the courage of time. One of the things I’ve learned, and this is sort of amusing to me, as I get older and I have less time on earth I become much more patient. And I think that’s a consequence of knowing myself and the investment process. In particular when I have a question in front of me where I know that the answer begins with “when,” in other words I know it’s going to occur. Rather than the question where the answer begins with “if,” that is the fact that it might occur. “When” questions, even having to give up the time preference, are much higher quality questions than “if” questions.

Now related to investments, an example would be, for me, in the uranium business where I know that it costs the industry $60 a pound fully loaded, including cost of capital, to make the stuff and they sell it for $30 a pound, in other words they lose $30 a pound. And they repeat this 80 or 85 million times a year. That gets sort of boring. I also know that uranium is a critical component of base load electrical generation worldwide. So the question comes down to will the uranium price rise to the cost of production over six or seven years or will the lights go off. It can only be one or the other. I believe that the lights aren’t going to go off, which means that I think that uranium prices are going to rise to $60 or $65 a pound. The question then becomes when is that going to occur.

You juxtapose that with a more popular question in mineral exploration, which is what will the result of a drill hole be. Very much an “if” question, but one that gets settled positively or negatively in 60 to 90 days. It’s ironic to me that people’s time preferences are so extraordinarily short-sighted that people would rather take a 1 in 10 or 1 in 20 or 1 in 30 risk knowing the time than invest money in what is a certainty but where you don’t have the advantage of time.

I guess one of the things that’s made me a success in the last 30 years is I’ve come to appreciate “when” questions relative to “if” questions.

Bill: And those are the best investment opportunities to average down on, aren’t they? If you’re going to average down.

Rick: Yeah, no, absolutely. You know, Buffett talks about averaging down as a very good thing. He says if you’ve spent the time and attention to understand and investment well enough to buy some, you should be delighted to see it fall in price 20% or 30% after you’ve purchased it so that you can use the same knowledge to buy more for a lower price. The truth is that I’ve been tested with that numerous times in my career and it’s seldom pleasant, but mostly profitable.

Bill: Rick, before you go, is there anything going on with Sprott or any offerings you’d like to make the listeners aware of?

Rick: Most of what we do here involved fairly bespoke questions between ourselves and our customers. One special offer that we’d like to make to your listeners, which we’ve made in the past, is if they like what they heard today, I offer an absolutely no-obligation natural resource portfolio review. If your listeners would like me to rate and rank the natural resource docs in their portfolio, they should send me those in an e-mail. It’s important that both the name and the symbol be in the text of an e-mail, not in some attachment which I may or may not be able to open. And that they send me that e-mail to [email protected]. I will rank and return those portfolios.

Note that this isn’t investment advice, because I don’t understand all aspects of those people as investors. Rather these are company rankings.

Bill: Rick, I appreciate your time today, thank you for stopping by and sharing your insights.

Rick: Always a pleasure, thank you for the great questions.