Rick Rule | Natural Resources Bull Market Not Confirmed Yet

Rick Rule, president and CEO of Sprott US Holdings, provides his insights on today’s junior resource market and the opportunities available to speculators.  Rick shares his key takeaways from the 2019 Sprott Natural Resource Symposium and comments on the type of money flowing into the gold equities.  Rick offers his current thoughts on how investors might look to profit from the expected divestiture of projects by the gold majors after the wave of mega-mergers.  He also talks about how junior mining companies are marketed and some ways investors can conduct due diligence on companies.

0:05 Introduction

1:38 Key takeaways from 2019 Sprott Symposium

5:11 Type of money flowing into gold equities

7:32 Updated thoughts on investing opportunities as a result of the gold majors’ mega-mergers

9:54 Discussing junior mining stock promotion

14:38 Upcoming catalysts and how mining companies market themselves

18:41 What non-standard, potentially risky things junior miners do would you be okay with?

19:42 Speculating in legal uncertainty plays

22:07 How does being a libertarian inform your approach to resource investing?

TRANSCRIPT:

Bill: Rick, thanks for taking the time to join me again. Let’s start off by talking about your key takeaways from the 2019 Sprott Natural Resource Symposium that ended there about six weeks ago.

Rick: Key takeaways? That’s an interesting question. I haven’t tried to quantify that. I guess there’s a couple interesting takeaways. The first is, that we are fairly early in, what I think by all indications, is at least a precious metals bull market, maybe not abroad, natural resources, bull market. The interesting takeaway there, I showed a 40 year chart, which I’m happy to share with your subscribers if they asked me for it, which shows where we are in terms of the precious metals equities in the historic context. The chart’s crystal clear. We are either at the bottom or just off the bottom. Importantly, in the last seven or eight recoveries, a poor recovery was sort of 150% recovery from the bottom. A good recovery was as much as 1,000% recovery from the bottom.

So, it’s pretty clear that if we aren’t at the bottom, we are coming to the bottom or off the bottom and that, if past is prologue, a fairly dramatic move ahead of us. It’s worthy to note that this bull market, if we are in the gold bull market, is acting the way others have. It isn’t shooting up. That happens longer in a recovery. It’s grinding up. So, what we’re experiencing right now is a normal and healthy precious metals and precious metals equity bull market.

The second point, and this will make your subscribers somewhat less happy, it’s not at all clear that we are in a natural resources bull market as different from a precious metals bull market. The price action in things like copper and cobalt and oil, at least until the attack on Saudi Arabia and other industrial materials, has been very tepid. Certainly, at today’s commodity prices, the incentive to increase supplies, it doesn’t exist. In other words, prices need to go higher in order to incent new supply. On the other hand, we are nine or 10 years in an economic recovery and many people believe that that recovery is fairly long of tooth, so the demand may or may not be present in the industrial materials.

So, to repeat pretty clearly, we’re in a precious metals and precious metals equity bull market. Pretty clearly, if past is prologue, it has a very, very long way to go, but it’s unclear as to whether that recovery will extend to industrial materials.

The third point was, and I think this is important to note for people who invest in smaller, more speculative stocks, that there has been a real hiatus in exploration going on for a very long time. So, two things here. The big mining companies will need to return to the exploration sector, but for right now, discoveries are few and far between because it takes five or six years of development work to get to the discovery stage. The industry as a whole has under invested in exploration for a fairly long time.

What that means is that we can expect a two or three year period without very many major discoveries, but the major discoveries that we enjoy, because they will be so rare, could yield some real eye-popping gains. Those gains will be scarce, but they will likely be dramatic.

Bill: As gold has been rising substantially the last few months, what’s your observation about the type of money that is or isn’t coming into the gold equities right now?

Rick: Well, the gold equities have disconnected a bit from the gold. The precious metals has done quite well and the precious metals equities, particularly the very small ones, have lagged. We are seeing to be sure, generalist money coming into the bullion, the Ray Dalios of the world, the Paul Tudor Jones of the world, the Mark Mobius of the world, people who have been very unfriendly towards gold for the last 30 years are suddenly very friendly. So, as to the question what’s coming into precious metals? The truth is everybody is coming into precious metals, albeit in a fairly slow fashion.

With regards to the equities, I would suggest that that’s still mostly the province of the precious metals mutual funds, which are finally getting some inflows rather than outflows, and sector investors. We haven’t seen too much outside capital come into precious metals. One thing that is very, very interesting though, I have to say, is the sudden emergence in the speculative part of the sector by very young people, by very young people, I mean people under 40. Traditionally, the appetite for the exploration companies, for the precious metals micro cap, has been among investors who are, to be charitable, baby boomers and over. What has happened just in the last six months has been an emergence of interest in the speculative precious metals theme from people who are, I guess, now called millennials. I would just prefer to call them younger speculators.

Interestingly, they’re coming in from around the world. So, there’s just, I guess, the beginnings of a pulse of interest among people who were traditionally tech investors or if they were speculators, were either cannabis or crypto speculators, and just probably in the last month and a half, we’ve received inbound inquiries from probably 500 people under the age of 50, which is very unusual for us.

Bill: Do you have any updated thoughts on how a resource investor might profit as a result of these gold mega-mergers, which occurred earlier in this year?

Rick: Yeah, I think that’s a great theme. I think that continues. I think there’s two ways to play the game. The first is, that larger companies, more liquid companies have higher trading volumes because of the ETFs and hence, a lower cost of capital. So, you will see mid-tier mining companies gobble up each other and be gobbled up by the majors, and you will see juniors gobbled up too, both ways. These have the potential to be accretive for all concerned, meaning that if you can find a company that’s selling for less than one of its peers relative to the net present value of its cashflow and buy it, you will likely receive a takeover premium. At the same time, the results in the company will likely, over the next year, trade higher on all bases as a consequence of the fact that larger, more liquid companies enjoy higher trading volumes and higher share prices.

The second thing that you’re going to see, and you’re just beginning to see it now, is that the byproduct of these mergers is that when a company acquires another company, assets that aren’t focused, either in the company that did the acquiring or the company that were acquired, are resold. You will see very much like you saw in the last decade in the period 2002 to 2005, 2006, smaller companies that are able to buy redundant assets as a consequence of these mergers, assets that didn’t receive the love and the care and affection from the large company, but will receive it from a small company.

Great companies were built this way. Silver Standard was built this way. Pan American Silver was built this way. Lumina Copper was built this way. B2Gold was built this way. So, there’s going to be two games in mergers and acquisitions. One is, to be buying the companies that are going to be taken over by the larger companies. The second is going to be, and this is more specialized, finding very high quality groups who know how to buy and beneficiate assets that are redundant to the larger companies that are doing the amalgamation.

Bill: Rick, I’d like to take a couple minutes here. I have a few questions about marketing and promoting a junior mining companies. I was reading through some press-releases a couple of weeks ago and I came across a unique press-release where a junior gold company had to comment on the unsolicited promotional activities that occurred around their stock. The three takeaways from it, as I highlighted a couple of things in the press-release, were that the company did not condone the use of the sensational language that the promoter used, they didn’t condone the comparisons of the investment potential of their company with whatever the promoter was comparing it to, and they didn’t agree with the urgency, of the need to buy the stocks today.

When it comes to comparisons, because this is a venture capital business, the promoter needs to lay forth the potential of the project, otherwise, there’s no reason to even invest in it, but can you talk about what is a honest comparison and what should potential speculators when they’re doing their due diligence on a company, what should they look for in these comparisons that the promoter makes?

Rick: I think the first thing that you need to do is look at the history of the promoter and find out if you care what he or she has to say at all. If the employment history of the promoter was that he or she sold used cars, or had been in the cannabis business, or the crypto business, or in some business unrelated to the business that they’re in, I wouldn’t pay too much attention to the claims at all. As for these third party promotions, while it often happens that the promotion isn’t paid for by the company itself, but is is paid for by one or more large shareholders, which means that the company has deniability, but a paid promotion is a paid promotion. The idea that the company isn’t necessarily taking the “credit” for it may or may not be ingenuous or disingenuous.

The truth is that the subject of how to read a press release, how to take into account what they say, is the subject of a very, very, very long call. I can tell you a few things that are silly. The first is, the concept of in-situ resources or ounces in the ground, accompany, may say our total resource base is 10 million ounces and another company that has a million ounces is viewed as such and such and says, “We could be valued 10 times as highly”. That doesn’t take into account the grade, the cost of production, the time to production, the net present value of money, in other words, ounces that are produced 20 years from now probably have no net present value. Ounces in the ground is an easy to measure metric, but it’s a useless measurement mostly. The most important thing is probably net present value, after capital costs, and this can be, I guess you discount that net present value number by the nature of the estimation.

In other words, a preliminary economic assessment is just that. It’s very, very, very preliminary. So, while it gives you some scope, that’s all it does. A pre-feasibility study, in other words, if you get that number with a much higher degree of certainty or scrutiny, pardon me, then the number is worth more. Bankable feasibility study is a document that’s done to the lending standards of a bank and is generally much more thorough than a preliminary economic assessment. Any sort of scoping exercise that purports to do net present value that’s earlier than a preliminary economic assessment is probably not worth very much at all. Any comparison that doesn’t have economics included with it is interesting, but generally fairly irrelevant.

Bill: Have you ever not invested in an opportunity that was brought to you because you did not think that the Chief Executive and the company was doing a good job marketing the company?

Rick: I would say that we probably look closely at only 1 in 15 submittals to us. A submittal is only important if we, or somebody who we know very well, knows and trusts the people who are presenting that to us.

Bill: I had about 30 one-on-one meetings at Beaver Creek, the Precious Metal Summit last week, so this question comes out of my experience last week where I experienced a couple of the management teams that I met with. It seems to me that the catalyst and a lot of the potential that they talked about with their company, it was too far out, even a decade to 15 years with one company, and I was thinking that through and saying to myself, “If you’re going to appeal to a retail audience, I think you need to be laying out some catalysts that are probably within five months of where we are today”. What are your thoughts on this?

Rick: I think it depends on the kind of company that you’re investing in. Without naming names, there are a few companies where we believe they’re extraordinarily good allocators of capital, and we believe that they’re selling at a discount to net present value, and we believe that they will continue to invest in ways that will make us money over time. In that case, we don’t need a catalyst. The catalyst is simply the accretion of value that takes place under extraordinary management teams.

Similarly, in a class of speculative company that I like, the prospect generator, the process is more important than catalyst, meaning that given that they’re not doing sole risk exploration, given that their business is employing their intellectual capital to attract other people’s physical capital, I am less in need of catalyst. Now, in the pure exploration business, the sole risk exploration business, certainly there the question becomes answering unanswered questions.

I am more concerned about the probability of a yes answer relative to the probability of failure, and the sort of scope or value of a yes answer than I am when it will take place. It has always amused me that a circumstance where there is a probability that an event will take place, but that the time is uncertain, repels some speculators as opposed to a situation where there is no probability. In other words, people seem to prefer a question where the answer begins with, “If…”, rather than a question where the answer begins with, “When…”. I personally prefer questions where the answers begin with, “When…”, to, “If…”. So, the nature of the catalyst is less, the timing around the catalyst is of less importance to me than the probability of the catalyst, the credibility of the person proposing the question ,and the value of a yes answer. Do you understand where I’m going with this?

Bill: I do, and Rick, when I referenced the 15 year out catalysts, I know I didn’t give you all the details, but it’s actually an, “If…”, not a, “When…”, the potential 15 year catalyst. I guess that was part of the turnoff.

Rick: Well, I guess the only thing, the only place where that could be of use would be an extremely large deposit that requires higher precious metals’ prices that likely wouldn’t be built this cycle, but acted as a call on precious metals. Yeah, that was a… Optionality was a game that worked very, very, very well for me in the 90s when optionality was free. In other words, where there was no expectation in the market that precious metals’ prices would rise. Then of course they did rise in the last decade and those optionality plays worked. They worked so well that people are willing to pay, from my point of view, much too much for metals’ price optionality, particularly metals’ price optionality that would take $6 billion, or $7 billion, or $8 billion to realize.

Bill: When it comes to investing in these junior resource companies, what nonstandard and, therefore, possibly risky things are you okay with? I’ll give you an example of a company that’s going to build a mine based solely off a PEA. Would you be okay with something like this in certain circumstances?

Rick: Almost never. We have seen too many failures building off PEAs. There are people who have very low cost of capital. I’m thinking like Robert Friedland, who do stealth construction off PEAs. In other words, they go underground to do exploration from underground and low and behold the drift becomes the production drift, but for mortals trying to go to production from a PEA is extremely risky. History is littered with past failures. I’m thinking Rubicon and things like that… Very, very unusual where sophisticated investors will permit that.

Bill: How do you approach, at Sprott, doing your due diligence on legal uncertainty plays? We had the Escobal mine in Guatemala, that whole contention a couple years ago. What’s your approach here?

Rick: I don’t want to speak for Sprott on the lending side. I will tell you personally, that my success speculating on legal outcomes is almost unblemished by success. I try not to allow myself that luxury. If I see a company where I think that the markets have valued the outcome at zero, where there’s a possibility of success, I will often allow myself to speculate in that name. I will almost never recommend that to clients given the fact that any success that I’ve had, anything in my background that contributes to my success has had to do with mobilizing engineering support, geological support, and financial support, not legal support. So, I’ll leave it there.

Certainly, if you have assets like Escobal, where you have a tier one asset, it is worth it for people who believe they can afford the risk associated with speculating on legal systems that they’re not familiar with to do so if they can afford that risk. Certainly, when Ross Beaty went and bought Tahoe, Ross Beaty was taking the view that Escobal was acquired legally, first of all, and that his social team could eventually acquire social license in Northern Guatemala. You will note that when Ross builds companies, he takes a sort of seven to 10 year timeframe and Pan American has been very clear with regards to Escobal that while they believe they’re going to succeed, they can’t tell you when they’re going to succeed. Company builders often take a much longer view than speculators too.

Bill: Rick, as we conclude here, politically and philosophically, you are a Libertarian, how does that inform your approach to resource investing?

Rick: I think it’s helped me a lot. I assume that the government that’s the closest to me is the most dangerous. I don’t believe that political risk is confined to third world jurisdictions. The worst experience with political risk I’ve ever had financially was here in the people’s Republic of California. This is politically incorrect to say, but the truth is that money that’s stolen from me by white people, that is by legislatures, in English, according to the rule of law, is just as gone as money that’s stolen to me in jurisdictions that I could neither spell nor pronounce. So, I would suspect that a healthy fear of government, the suggestion that there’s probably nobody in government that has my best interest at heart, I think is one of the reasons why I have succeeded in a business over 40 years where government has proven to be the enemy of industry basically at every turn.

Bill: Rick, you mentioned earlier about emailing a chart. Would you like to share your contact information?

Rick: I’d like to do two things if I may for your audience. I have enjoyed helping people understand the business and any of your subscribers who would like, can email me a copy of their natural resource portfolio. It’s important to note that I’m a 66 year old inadvertent Luddite, so it’s important that people who wish to take advantage of this, email me their portfolios with both the names and the symbols in text, not as an attachment that I may not be able to open, but rather in text, If you would like that 40 year chart from Barron’s magazine, it’s the Barron’s gold mining index, it’s really, really, really worth having. Just mention that you would like the chart. I’m willing to do both the portfolio reviews and the chart or either, depending on the subscriber’s preference. You can email me at [email protected] to get the portfolio rankings, and of course, the stock chart, which this is the first chart in 40 years has was ever really made sense to me.

Bill: You’ve been listening to Rick Rule, President and CEO of Sprott US Holdings. Rick, I really appreciate your time. Thank you for joining me today.

Rick: My pleasure. Thanks for the call.