Rick Rule | The Crazy Speculator Needs to Be in Silver Stocks Right Now [PDAC 2018 Interview]

In this PDAC 2018 interview, Rick Rule, President and CEO of Sprott US Holdings, shares his analysis of the current commodity cycle and where investors and speculators should be positioning themselves right now. Rick also discusses his development as a speculator and a value-investor, three things he sees that could potentially go wrong for mining investors in 2018, and his thoughts regarding both CEO and investor sentiment right now in the mining sector.

0:19 Introduction of topic and guest

0:34 Rick’s thoughts on the current commodity cycle

2:24 How extreme will the coming gold bull market be?

6:02 Where is the best opportunity for the natural resource speculator right now?

7:42 The best current opportunity for the natural resource value-investor right now

8:40 Rick offers sage advice regarding speculating

11:17 Rick discusses his development as both a speculator and a value-investor

16:48 Three things that could go wrong for mining investors in 2018

21:18 Rick’s thoughts on both CEO & investor sentiment right now in the mining sector


Bill: This is Bill Powers with MiningStockEducation.com, and I’m on-site in Toronto at PDAC 2018. And it’s my pleasure to be able to speak to Rick Rule, the President and CEO of Sprott U.S. Holdings. Rick, it’s a pleasure to be joined by you.

Rick: My pleasure, thank you.

Bill: Let’s jump right in to your thoughts on the current mining investment sector and commodities. If we’re talking about a nine-inning baseball game, number one, what inning is golden? Number two, what inning are the commodities in general in? And number three, what commodities are currently closest to being in the first inning? 

Rick: Let me see if I remember the question. Gold, top of the third. Coming into a pretty good year, I think, if you’re talking about the gold stocks as opposed necessarily to gold.

Industrial materials, between the first and the second inning. We had a great year last year. They flattened out a little bit, but, I think, we’re still very, very, very, very early in the game. There’s a couple of commodities, and in the baseball context, haven’t shown up at the park yet, they’re pre-first inning. I would say, in particular, the agricultural minerals. Potash and phosphate, they have no signs of life, the market hates them, there’s price wars between suppliers. A perfect place for a long-term investor.

The one that’s most interesting to me, probably in that context, is what I’m gonna have to tell you that I don’t know what inning it’s in at all, that’s uranium. Certainly, if you look at three or four years, the pace of new reactor construction, I don’t mean preyed for construction, I mean funded, commenced construction. The uranium price takes care of itself. What’s of interest is this year. I think you’ve heard me say before the EU cure bear markets either through demand creation or supply destruction, and we’ve seen incredible supply destruction in uranium. The excess levels of inventories that were a consequence of the Japanese shutdown are still hanging over the market. Japanese restarts, should they occur? Take that away.

Bill: Regarding gold, Doug Casey talks about the gold stocks and the mad rush that we’re gonna see into gold is gonna be like forcing the contents of Hoover Dam through a garden hose. Could you see extra innings in this gold bull market with what we see going on in the world, the excessive debt in dollar devaluation, things like that?

Rick: You know, if you give an enthusiastic salesman, like me, use of the word “could” many bad things come of that.

I hope Doug Casey is wrong. The set of circumstances that causes gold to go to $5,000 or $10,000, invariably involve widespread social disruption. I’m a very comfortable, fat, 65-year-old guy, that’s extremely sanguine with his life. And that set of circumstances is not one that I would like to experience, except as Doug Casey describes from somewhere else on a broad screen TV.

I am very happy with the way gold has performed for me in the last 18 months. It’s preserved my purchasing power without causing my neighbor to be covetous.

Now, answering the question, you gave me a wonderful platform for a statement, answering the question, the truth is that I’m a gold bug. The truth is that I look at the on-balance sheet and off-balance sheet liabilities of the federal government. I, of course, feel them more directly now because, at 65, I am one. And I wonder about the ability or the willingness that your generation has to subsidize my generation, given the promises that we’ve made for each other, and I wonder how you resolve that dispute.

When people say that we’re in a low inflation era, part of me gets it, but part of me also gets that when the U.S. government talks about a 1.6 CPI, they don’t shop where I shop, and I don’t think they shop where you shop.

Particularly, I have three problems. First, they often don’t include food and fuel, and as you can see, at least, I eat. But beyond that, and this is really silly, they don’t include tax. Now, if it wasn’t part of my cost of living, well, I’m not complaining so much about the index, but the idea that my purchasing power is only declining by 1.6% a year, doesn’t reflect the way I live and I don’t spend any money. My own belief is that the purchasing power of the U.S. dollar where I shop for the basket of goods and services I consume, and I’m a cheapskate, is deteriorating at, sort of, 4% or four-and-a-half percent a year.

And that leaves out the discussion of whether the escalation of financial assets really represents inflation. Let’s leave that one aside for the time being. If you are experiencing purchasing power deterioration of 4% and you’re being compensated for that at 1. ….well, I guess the10-year treasury is now 2.6-2.7, what they’re doing is they’re guaranteeing you absolutely, positively, backed by the full faith and credit of the United States government, that you’re gonna lose 1.3% of your purchasing power compounded over 10 years. That’s a lousy deal.

And I think that we resolve these conflicts one or two ways. We either have an honest default, that is your generation says to my generation, “You made these promises, you keep them.” Or, more likely, you have a dishonest default. You inflate away or debase the purchasing power of your obligation. And so, in that sense, I’m a gold bug, but I’m too old and smart to put a price target on it.

Bill: if we can look at where we are in the commodity cycle right now, from the perspective of both the speculator and a value investor, where would you first find the best opportunity as a speculator in a given commodity and type of mining investment?

Rick: Speculator wants to be in the gold space now. The gold stocks did poorly last year while the commodity did well. There’s a catch up that needs to take place. And gold, and probably better yet, for the crazy speculator, like me or Doug Casey, would be the silver stocks, for a couple reasons. The equities need to play catch-up to the commodity, which did well.

The second is that sectors themselves do well when they outperform expectations, and the expectations of the gold industry are so low that the challenge will be to get under the bar, not over it. At the same time, the industry, for the first time in my career, has begun to focus on business efficiency rather than simply evidence themselves as a gold warrant. Which means at the same time that the industry has begun to put itself in a place to deliver on expectations, there are no expectations. And I suspect you’ve already begun to see it.

I think you’re gonna see a series of quarterly beats that are gonna surprise people, and the consequence of that is that the gold sector is gonna re-rate. I’m not suggesting to you that based on today’s currency…pardon me, today’s gold price, that the sector is cheap, but it never gets cheap. I’m suggesting to you that it’s reasonably priced that the industry’s expectation of itself has changed, but that the investors’ expectations are so low that they can’t help but be exceeded.

Now, on the value side, very different question. The major base metal miners, I think, still offer some value, the Rio’s and BHP’s, some of them had good runs. But names like Nutrion, that most people don’t know of and those who do know of hate, that’s, I think, a good circumstance. I think, Cameco, for somebody who has a three-year horizon, a listener that you have that listens to this that thinks about that recommendation in four months might be angry with me, but my suspicion is in 36 months they’ll be happy.

I continue to hold Norilsk, and Gazprom, and Lukoil. I continued to believe that the Russian market is very, very, very cheap, although there’s some…I wouldn’t say political risks so much as opaqueness risks, but I do think they’re cheap. I think dry bulk shipping, although it’s up off the bottom, is extremely cheap, so there’s lots of places for a value investor.

Bill: If I could jump back to the opportunity for a speculator, in light of what you just said, would the best place for a speculator being like a late-stage developer, what type of mining investment for a speculator, where should they be looking?

Rick: The speculator needs to look to the right of their left ear and to the left of the right ear and analyze themselves as a speculator before they determine the type of speculation that they go into. Because of the way that the investor approaches speculation, the speculator’s timeframe, the speculator’s skill at trading or lack of skill in trading, the speculator’s reward expectations, all go into the outcome.

There was a point in time when what worked for speculators was optionality, you buy very, very, very large gold deposits that weren’t gonna make any money at $700 but could make a lot at $1,500, those stocks went up in 500% or 600%. That was a good deal at that place in time. There are other speculators, many speculators, who think that their time preference matters. That’s a mistake, but you have to acknowledge the mistakes that you’re willing to make. Many speculators seem to have trouble holding stock over a long weekend, and I think that’s a function of the fact that they don’t know the companies that they’ve speculated in very well, they have no confidence in their judgment.

For myself, everything with me is about probabilistic, risk-adjusted rewards. And when I look at mineral speculation, even development stage speculation, my expectation is failure. In other words, I expect that, in 10 decisions, I’m gonna lose money on 5 or 6, do okay on a couple, and I, hopefully, am gonna whack the ball out of the park once or twice. I also prefer, personally, to ask questions where the answer begins with “when” not “if.” So if I’m speculating on something where there’s a probability that I’m gonna be right, but it might happen three years from now or four years from now, I’m inclined to do that. Most speculators don’t have a time preference that extends past months into years.

And I would say if you look at my record over 35 years, my success has come from two things. It’s come from backing very good people, and many other people don’t discriminate as well as I do, but it’s also because of my preference for the “when” issue, not the “if” issue, and the willingness to be patient when I knew that the answer began with “when.”

Bill: If I could jump back to your early years as both a speculator and a value investor, I’ve listened to you share how from the podium, you know, once you get down and your wife chastised you because you chastised the investors listening to you regarding speculation, but then she reminds you that while you invest now with the money you made speculating, could you clarify for me what was the role in the relationship of speculating and value investing in your development pre when you lost everything and found yourself in debt, and post when you gathered yourself and made a lot.

Rick: That’s a great question. My original career aspiration was to be a tax lawyer, international tax lawyer in natural resources. I pursued that, and I was an earnest young man. So, I found the best tax lawyer I could and told him I’d pay him his billing rate for career counseling and he said, “Skip it, buy me lunch.” And in the course of that interview, he says, “I’ve been watching you for a while, and if you graduate from law school I’ll hire you, and I’ll spend a couple years slapping the nonsense out of you that they taught you there. And in about five years you’ll be a lawyer, and you’ll be pretty good but you’ll be miserable.” Not what I wanted to hear.

He said, “There’s a really, really, really good investor I know who knows you and likes you, and he’s watched you as a businessman and thinks that you’d be a good investor. And I think you’d be a good investor, too. So, what you really ought to do is stop talking to me and start talking to this guy.” And I didn’t know this guy from Adam, but his name was Peter Cundall, legendary value investor.

And I visited with Peter, out of politeness, and he gave me a copy of the “Intelligent Investor” which I was going to read, out of politeness. And I opened it and I couldn’t put it down, and my life changed right then.

So, I started off as a deep value investor, not a value investor but the old…well, partially, the Ben Graham model where you bought companies that were selling at discounts and that working capital that were cash flow positive, Ben Graham called them “free bonds,” which I always loved. You know, the value of the cash meant the bond was free but it still distributed cash from operations. I loved that. And so we did those with Cundall.

But Cundall’s real specialty was finding inactive publicly held companies that had assets that were undervalued and distal, if you will, to the value creation, you know, in the company.

There was a brewer in San Francisco, as an example, that traded at relatively cheap multiples, nobody would buy it because the sales graph looked like the electrocardiogram of a corpse, but they had…I don’t know what the number was, 110 acres in San Francisco. And Cundall figured out that they could have the beer brewed by somebody else, and they had 110 acres in San Francisco carried on the balance sheet of the land acquisition cost in 1910. These redundant assets are what Cundall taught. And, coming from a resource background in the early part of the ’70s when people hated resource-based businesses, it was pretty easy to find closely held illiquid companies in the resource business that had enormous redundant assets.

And so, I became known as a resource guy, and as the resource prices began to go up and I was successful, I made the young man’s mistake of confusing a bull market with brains. I somehow thought the fact that the gold price went from $35 to $850 was my fault, you know. And so, I became much more speculative, much more speculative. I remember trying to figure out where the oil price was gonna go and so I got data from the International Energy Agency and Exxon, and Chase Manhattan Bank, and the Royal Bank of Canada. You know, all these guys, basically, in those days, just, sort of, extrapolated current trends in motion ad infinitum, ad infinitum, ad nauseum.

And that narrative was supportive to me because I was a young guy making lots of money when all my peers in financial services were getting slaughtered. I wanted to believe the resource narrative and I wanted to believe that I was a genius and, of course, they were both wrong. The banks ignored the fact that markets work and I ignored the fact that I wasn’t a genius. And so, I ended up going from being a very wealthy guy to having a negative net worth.

And I rediscovered the joys of value investing. I managed to dig myself out of that. I always managed to earn well and, mercifully, for me, I had a group of creditors that knew me, and liked me, and decided to work with me. So I didn’t have to declare bankruptcy and I was able to pay them off every dime, even, unfortunately, the tax, which I realize now, was unpatriotic act on my part but I did that. And then became, probably, a more balanced financial player, both speculating when it’s to my advantage, and it turns out that I have the internal composition of a speculator, but also understanding that when you enjoy success and speculation you owe it to yourself to scrape a bunch of your winnings off the table and get them out of harms way.

Bill: I’ve heard it said or heard you say that when you were young, you were told that before you invest in a company you need to know at least three things that could go wrong with that company, otherwise you don’t know enough about the company to invest in it. With that being said, what three things, in 2018, should mining investors avoid or be aware that these are potential things that could go wrong?

Rick: Well, with a caveat, that’s supposed to be a micro question, not a macro question. I’ll answer it.

I think the first thing that any investor in a capital-intensive business needs to understand is that the government is your enemy. Political risk is endemic to mining. If the three of us had an intellectual capital business, and the Canadians or the Americans or somebody became unfriendly, we could take our intellectual capital and we could go somewhere else, you know. If you have the bad fortune of discovering a mine in the wrong jurisdiction, governments love it, they’re fixed assets, you can’t move it, they can plunder it. And if they can, they will.

So, one thing is that all investors must embrace political risk. And it’s important to embrace the fact rather than the narrative of political risk. People who look like you and I believe that countries that are populated by people who look like you and I are less risky than other countries. Specifically, we believe that money stolen from us by white people, in English, according to the rule of law is less gone than money stolen from us by darker people, by more traditional methods, and it’s not. So that’s the first thing, political risk is vicious

The second is that markets work. These are deeply, deeply, deeply cyclical. And when they seem their most expensive on an EBIT enterprise value basis, they’re often their cheapest because the revenue line is depressed by commodity prices where the industry average selling price is less than the cost of production, and when things seem cheap they’re often very expensive because you’re operating in an industry that is, all of a sudden, earning 50% operating margins and they’re investing to increase supply at the same time that the high prices are reducing demand.

So, the second lesson is, of course, that markets work. The cure for low prices is low prices, the cure for high prices is high prices. You have to buy businesses if you’re gonna make it in this business when the selling price of the commodity is less than the cost of production if there’s gonna be ongoing demand for that commodity. And it’s really hard to buy industries in liquidation. An example would be uranium right now. The International Energy Agency says it takes $60 bucks a pound to make this stuff, that’s not cash cost prior your write-downs cost of capital. So you’ll make it for $60, you sell it for $25, you lose $35 bucks a pound, you try and make it up on volume. Horrible business, horrible business, and everybody hates it.

You make the investment case for it and some little old lady in the front says, “Hiroshima-Nagasaki.” You know. It’s not even about the economics. But five years from now, if the uranium price doesn’t go up, the lights go out, it’s that simple. And you’ve got to decide, as a speculator, what’s gonna happen. Is the price of uranium gonna go up irrespective of Hiroshima-Nagasaki or the lights are gonna go out? I reckon that the lights are gonna be on and the uranium price is gonna go up. It’s a hard, hard, hard way of thinking.

The third thing is, particularly in the smaller resource companies, that while they are partially acid-intensive businesses, they’re actually intellectual capital businesses, and the people, particularly in the smaller companies, are absolutely critical. In terms of performance dispersal curves, you learn that the 80/20 rule applies. 20% of the population generates 80% of the utility, 20% of the 20 or 4% generate 65% of the utility, one-tenth or one-eighth of 1% generates about 40% of the utility. We call those the seven footers. And if you hang out with the seven-footers, you do better than when you hang out with the pygmies, you know.

So people are really critical. And when I say people, I don’t just mean guys that have been successes in mining, I mean people that have been successful in a task very similar to the task that they have at hand. A guy who was successful operating a mine in Archaean terrain may not be a success looking for a mine in tertiary volcanics. You know, the skill set has to track, I’m sorry, the job at hand very carefully.

Bill: This is the second day of PDAC, what is your feel for investor sentiment, and even if you have interacted with any CEOs, what are you sensing right now? 

Rick: Among the CEOs, the aftermath of the BMO conference is gloom. There is money around in the mining business, but it’s smart money, and the CEOs prefer dumb money. So the CEOs are suggesting that the industry is underfunded. The truth is that there’s a lack of good projects. I haven’t circulated widely through PDAC, but the best survey I can give you was yesterday’s newsletter forum where I both moderated and spoke. And I would say that conversely to the mood of the CEOs, the mood among the high net-worth retail investors is pretty ebullient. Representing, I guess, a disconnect between the expectation of the value offered up by some of the CEOs and the expectation of a discerning audience that’s finally learned to choose between the good, the bad, and the ugly.

Bill: Rick, before you go, could you update us on what’s going on with Sprott and the upcoming conference you have this summer?

Rick: Sure. Sprott Inc., the parent company, we joke we’ve now worked five years to be overnight successes. You know, we worked very hard through the bear market. We maintained our staffing level, we maintained our investment level through very, very, very hard times.

EBITA, in the course of that decline, fell by 90% so maintaining the courage to hire people and spend was an interesting challenge. Many of our competitors ceased to exist, so our market share, for various reasons, has expanded, and the circumstance that we’re in now is perfect for Sprott, it’s tailor-made for us.

Our passives business, having acquired the Central Fund of Canada assets, is now the largest passive precious metals business in the world. Our lending business is firing on all cylinders. It’s a lovely lovely, lovely, time to be Sprott.

And the second part of your question, we would love to see you at the Vancouver Natural Resources Investment Symposium. This will be the 26th year that that symposium has been in place. It takes place July 17th to July 20th. At the risk of exposing pride of authorship I think, it’s the best high-end retail natural resource conference on the planet. We have a great range of speakers: Jim Grant, David Stockman, Jim Rickards, Doug Casey, of course, Grant Williams who had the bad manners to outpoll me as the top speaker at my own conference last year. Importantly, a range of exhibitors that’s chosen differently. Our attendees have told us that they consider the exhibitors to be content, not advertising.

And so, what we have done is decided that nobody, who we don’t have our own money invested in, can exhibit. Now, that doesn’t mean that we don’t make mistakes as investors, but what it does mean is that we have vetted every single exhibitor well enough to invest Sprott partners and Sprott Capital’s money in. It’s a very different set of circumstances. The qualification to exhibit at most mining conferences is a check that cashes in a pulse, and our criterion is different.

Bill: Well, Rick, I appreciate you joining me. I’ve listened to so many lectures and interviews with you over the years that I consider you a mentor, so thank you, again, for sitting down with me.

Rick: Always a pleasure, I hope my mentorship doesn’t cost you any money.

Bill: No, hopefully, it’s made me some.

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