Rick Rule | I Am Deploying My Own Money in the Royalty and Streaming Space Right Now

Rick Rule is the president and CEO of Sprott US Holdings.  In this PDAC 2019 interview, Rick shares his current commentary regarding opportunities and trends in the resource sector.  He also discusses if he will invest in a company where the management are involved in multiple companies at the same time.  Rick also offers insights on his approach to mining investment regarding the timing of catalysts, analyzing sentiment and much more.

0:05 Introduction

1:21 Will we see the PDAC curse this year?

2:17 Thoughts on PDAC 2019

4:42 Commentary on the M&A trend

9:07 On management that is involved in multiple companies at the same time

11:44 The Resource investor and sentiment

13:38 Exit strategy for mining stocks

16:05 How far out Rick allows catalysts to be for his early-stage exploration stocks

19:42 Thoughts on investing in royalty and streaming companies now

23:52 If Rick Rule was 21yrs old again would he still pursue a career in resource investing?


Bill: You are listening to Mining Stock Education. Thanks for tuning into another episode. I’m Bill Powers, your Host, here at PDAC 2019 with one of my favorite people, Rick Rule, the President and CEO of Sprott U.S. Holdings. Rick, thanks for joining me.

Rick: Pleasure. Thank you.

Bill: I always appreciate catching up with you at conferences, you’re one of my favorite people to talk to, and I’d like to start off with your insights on the PDAC curse. We saw gold go down about $30 in the last three trading days. Is this the PDA curse in action?

Rick: I don’t know. The truth is, that my own experience has been that I make money in sort of three or four-year periods. I pay very, very little attention to week-by-week fluctuations. Had I done that over the last 40 years, I would already be dead from stress and broke. So the suggestion that moves like that on a weekly basis are relevant, they may to be some people, people who are adept traders and make their living at trading. I don’t happen to be one of those people. So for me, it’s a non-event.

Bill: We’re in the second day of the PDAC, what are your thoughts on the conference this year so far?

Rick: Very constructive thus far. My own experience is, of course, limited because you’re one person among 25,000, but the mood here is sober. People are looking for things to do with their money. They don’t want to be stupid. This is not a capital constrained environment. This is an opportunity constrained environment to the extent that an opportunity is a nice opportunity, presented by people who have already been successful. There’s a lot of money around. What the industry, of course, would prefer is dumb money, and most of the dumb money has gone to things like crypto, and cannibals, and stuff like that. So what’s left is very sober, very applied, and very professional. I’m impressed with what I’ve seen so far.

Bill: Last year at PDAC when I interviewed you, you brought up silver, and you said the crazy speculator, like yourself and Doug Casey, needs to be in silver stocks right now. Is that still your perspective?

Rick: Yeah, there’s a shortage of silver stocks. I’m not trying to say that these silver stocks are good investment, they aren’t. They’re speculations. But the truth is, when a move in silver gets underway, and sadly, I’m not smart enough to tell you when that might be, when a move in silver gets away, crazy money comes into the silver space. And crazy money comes into the space that’s underpopulated with vehicles, even underpopulated with bad vehicles. It’s extraordinarily underpopulated in terms of good vehicles.

Doug Casey famously says in these manic markets that result, that the impact of a limited number of issuers, and very, very, very strong demand, is akin to trying to siphon Hoover Dam through a garden hose. I’m not suggesting that this is a strategy for a sober investor, but it is a wonderful strategy for a speculator, who is willing to take some time-risk in anticipation of the ultimate event.

Bill: We’ve seen a lot of mergers and acquisitions amongst the major gold companies, and now we’re seeing Barrick trying to do a hostile takeover of Newmont. What do you think the significance of this is?

Rick: Well, the M&A trend is extremely important and it’s all good. It’s wonderful. I’m not going to comment on a take-under. I think Bristow was really trying to start a conversation. My suspicion is that Bristow knew that if he offered a 20% premium, he’d be refused. So why not offer a discount and allow the big shareholders of both companies to say, “This is a good idea,” and propose a price that they in turn superimposed on the managements. I don’t know this to be true, I’m making that up, but I’ve known Bristow for a very long time, and I have a very high regard for him. Going back to the original question, everything about these mergers is good. One of the big problems that the mining industry has faced is excessive general and administrative expense. And the idea that has been stated in the Barrick-Newmont transaction is that there’s at least $350 million a year in redundant overhead.

Bill: In Nevada mostly, right?

Rick: But and at the head offices. The idea that you could use the Toronto head office to cut the Denver head office in half, and use the Denver head office to cut the Toronto head office in half, $350 million is almost a million dollars a day in savings. Putting that into context would be one of the best mines, were it a mine in their portfolio, except for it’s one that has no sustaining capital requirement, and it doesn’t deplete. On a net present value basis, the savings and combined overhead would be the best asset in the combined companies, so that’s great. And it’s great not just in the context of that merger, but other potential mergers, too, reducing general administrative expenses.

Second thing that happens is that the combined companies have an excuse and an incentive to sharpen their focus in terms of return on capital employed to rationalize and evaluate all the company’s assets, sell those to reduce the cost of the merger, that aren’t germane to the combined enterprises and focus more money on fewer, better assets. The third is the market is proven in many sectors, not just ours, that larger, more liquid vehicles command higher market capitalizations, higher share prices. So you reduce your cost of capital in the capital-intensive business. That’s a very, very, very virtuous circle.

What many people have forgotten about in terms of the health of the entire industry, is that you take assets that are superfluous to a company the size of Barrick-Newmont, sell them, and you put them in the hands of people to whom those assets aren’t redundant or superfluous at all, so you have a better focus on asset quality from top to bottom. Money will be made identifying takeover targets and enjoying the premium. More money will be made investing in the companies that utilize assets that were redundant to others, and maximizing their benefit.

I looked back on the last cycle to Ross Beaty building Lumina Copper, on castoffs from companies like BHP, he spent if my memory serves me correctly, $30 or $40 million acquiring projects. He spent another $80 million or so beneficiating them. So he had between $100 and a $120 million in, sold the resultant businesses for almost $2 billion. That type of value creation will occur repeatedly in the next five years.

And then, of course, there’s the human resources that will be freed, unwillingly to begin with, people who have a job would like to keep the job, and they’d like to keep the job in the place that they’re at. But the truth is, and I’m looking back to when Placer was taken over some years ago, the assets that were sold out of Placer into the junior market built several companies, but more importantly, the human resources that came out of Placer increased the intellectual capital available to the juniors, particularly in Vancouver, by an order of magnitude. We at Sprott were able to hire Andy Jackson and Dr. Neil Adshead, getting those two people out of the Placer fold generated tremendous wealth for Sprott investors, and we see this happening. Of course, we’d like to see Sprott benefit, but we see the entire industry benefiting from the reformulation of assets, both human and physical that exist in companies where they’re redundant now.

Bill: You teach speculators that human assets are the most important thing to look at for a potential mining investment, and I always like to get your insights regarding what to look for in management. Question I’ve had, as an investor in my personal investments, has been when I look at a company, and maybe I like it, but then the CEO is also involved in a different company, or he’s on five boards. When you look at an investment, when do you say, “Enough is enough. This guy’s got to focus on this investment vehicle that I’m putting my money in?”

Rick: If the person hasn’t been successful operating multiple companies before, I have no interest.

Bill: Multiple companies at the same time?

Rick: At the same time. As an example, I’ve invested with Ross Beaty for 30 years. Ross has shown that he can operate as chairman or better phrase might be chief ego, of three or four companies simultaneously. He can do that. He provides really superb adult supervision and leadership for CEOs that he hires, while he maintains defacto control through his shareholdings and reputation, similarly Lucas Lundin can do that. Most people can’t, so there’s a temptation for people after they’ve enjoyed success to attempt to monetize the success through multiple vehicles, maybe they charge multiple salaries, maybe they seek to reduce their own risk. What’s good for them is not necessarily good for me, and my interests, of course, representing the interest of my investors. So if someone hasn’t proven to me that they can operate in a vehicle where their interests are divided, I have no interest myself in being, in funding their experiment.

Bill: I was recently reading a book on resource investing, and I want to read you something that the author writes, and I’d like to get your feedback. He writes, “If you understand the key to profitable investing in different markets, you will never need to know anything more about the commodity than what people think about its price. As an investor, you must use every possible sentiment indicator to get your hands on. As it turns out, the daily sentiment indicator has been flashing warning signs for two month s before the 2011 top in resources. I’m trying to get readers to understand that sentiment is the most important key to successful investing, and that there are a variety of ways to measure sentiment.” Your thoughts?

Rick: I agree with part of what he said. I would probably, in that circumstance, substitute the word speculation for investment. And I would also suggest that while sentiment is important, managing your own sentiment is probably more important than engaging other peoples’ sentiment. Further, in terms of a discussion with regards to commodities, I would argue that the most important thing to know about commodities, in terms of attempting to forecast future movements, is where the commodity cost curve is relative to the selling price.

Meaning, as an example, if the median average cost to produce a pound of uranium is $60, including cost of capital, and the stuff sells for $25, it’s pretty clear that unless there’s going to be a substitute for uranium in the next five years, the price is going to go up. Peoples’ sentiment towards uranium is worth knowing, too, because it impacts your future cost of capital. But I would argue, that the most important part of commodity pricing knowledge is the discrepancy between the selling price and the cost to produce it.

Bill: If you were sitting down with a newer retail investor who just discovered this sector, what would you tell them, some key things you would tell them about an exit strategy for some of their speculations?

Rick: I think an exit strategy depends a lot on the speculator. A smart speculator, who operates his or her own portfolio, a 100,000 or $200,000 portfolio, has a real competitive advantage over me, in that-

Bill: Because of liquidity?

Rick: Yeah. Yeah, I mean, you could have goals that are defined, and you can control your exits. I have to be right, I’m trying to move the dial for an organization with $11 billion in assets under management (AUM). So in order for me to really move the dial, this isn’t to say that all of my investments are in $5 million chunks, but in order for me to really move the dial, I need to have sort of, well, $5 million is a nice round number, where I’m looking for a 10-bagger or a 20-bagger.

If you remember that most of your speculative decisions end up being mistakes, and that your winners have to amortize your losers, and leave respectable return on capital employed left over, you understand the fact that I have to cope with a lot of illiquidity. I have to sell when a bid’s available. If I’m down on an investment, I have to work my way out over a very long period of time.

An investor with a 100,000 or $200,000 in the market is in a very, very, very different circumstance. That investor as an example, could buy 10 penny dreadfuls on December 15th, in the middle of tax loss selling season, and sell that same portfolio on February 1st, just as a consequence of the dead cat bounce, that investor could probably make a 20 or 25% rate of return on a reasonably well-chosen package of juniors, with a 100,000 or $200,000 capital employed, and could probably do it every year for the rest of time. That is a strategy that I employed myself in university, but you have to remember, that was in 1971. My circumstances have changed, although the market hasn’t.

Bill: When you look at early-stage exploration companies, obviously, you’re looking for the timing of an upcoming catalyst. You teach speculators that they need to know what the thesis is, how the thesis is going to be proved, how much it will cost to prove the thesis, and what determines success. When you look at how far out from your investment when you put money in that company to when that catalyst or the results are supposed to come in, what’s your maximum time-frame? Two years?

Rick: Oh, no. Much longer. My wish list, the sort of box that I try and fit all these ideas into, is that there is some catalyst, which will allow me to see a doubling of the share price in the 12 to 18 month time-frame. But my goal in every circumstance, every speculative circumstance, is a 10 for 1 return. My experience has been that most of the 10 to 1 returns that I’ve enjoyed have required four or five years to come true.

What I like, I’m not trying to say it’s what I achieve all the time, what I like is a circumstance where the catalyst that I have anticipated occurs, and I have the ability either to sell down my position, if the reaction of the catalyst is too extraordinary. Or, if the reaction in the market cap has been too tepid, to increase my position as a consequence of the increase in value rather than price. My anticipated time-frame is always four to five years, which is why I always raise 10-year gated funds.

The other thing that I think is worthy of note, it isn’t a question you asked, but I think it’s a note that your listeners should consider, it’s very rare that I experience a 10-fold gain without experiencing a 50% decline during the period of time that I’ve held the stock in order to enjoy the 10-fold gain. I look back on successes that I’ve enjoyed with Ross Beaty as an example.

I think in the formative years of Pan American Silver, I remember we did the first financing at 50 cents. In the period of time between 50 cents and $20, there was probably five or six years in elapsed time. Now when people look at that headline number 50 cents to $20, it seems like a dream come true. But the stock probably fell 50% in price three times during that period of time. If you don’t, as an investor, have some sense of the value relative to the price, if the only thing that you follow is price, you get shaken out long before you enjoy that sort of return.

That’s a really difficult thing for most speculators to grasp. Most speculators are unwilling to do the work to form an opinion as to value, and they also understand that their opinion as to value is uncertain, which is okay. You’re trying to get a range of probabilities, but if you don’t have a sense of value and potential value, the price information’s irrelevant. It’s a floating abstraction.

Bill: Yeah, I like how you’ve said that you’ve been so successful because of the caliber of your competition is so low. And there’s a knowledge arbitrage that you’ve been able to capitalize on.

Rick: Yes, and it’s horrific, given the low caliber of the competition, when I fail anyways.

Bill: Rick, what’s your thoughts on royalty companies? This is a genre of company I’ve been turned on a lot more to in the past year. What are your general thoughts?

Rick: If you could expand the discussion to royalty and streaming… love the space. There are some knocks on the royalty and streaming companies. The most common two knocks are that they trade at higher valuation multiples than the rest of the industry, which is true. The other is that their greatest period of growth is behind them, which is false, but let’s observe those two from the first instance, the valuation discussion. They deserve to be priced at higher valuations. In the first instance, depending on how you define margin, the operating companies are generating sort of 14% operating margins, while the royalty and streaming companies are delivering 65% operating margins.

But if you look at the operating sector and you add back write offs, the operating margins fully costing those prior year write offs are much closer to zero. So do you pay up for a business with a 65% operating margin? Or, do you buy zero for a lower number? My suspicion is that the answer is fairly clear. The suggestion in the market that the period of growth for the royalty and streaming companies is over, is wrong. It’s wrong for several reasons. It’s wrong because a big arbitrage exists between the valuations of cash flow for base metals producers, and the valuation of byproduct precious metal streams, the base metals producers trade at five, or six, or sometimes seven times EBIT, while the precious metals streams from those big base metals mines trade in the form of Franco or Wheaton Precious at 12 or 13 times EBIT.

What that means, is that a transaction can occur that simultaneously lowers the cost of capital for the base metals producer, and increases net asset value per share of the streamer. The idea that you can have a win-win transaction in billion dollar chunks, is something that means that these transactions are going to occur going forward. The second thing is that Basel Three banking accords changed the financing market for project and construction finance for non-investment grade issuers. Sprott, of course, has been a primary beneficiary of this with our lending business. But the truth is, that we don’t have enough capital, nor do the other specialty lenders, our competitors have enough capital to finance 10 or $12 billion a year in financings, which is what the non-investment grade community will require in the next five years. The royalty and streaming companies are going to be and are now an increasingly important component in non-investment grade construction finance. A stream is quasi equity, which lowers the cost of capital if the issuer is genuinely selling at a substantial discount to net asset value, which of course, all of them believe they are.

Finally, at the beginning of the discussion, we were talking about mergers and acquisitions. We believe there’s about $14 billion in assets that are in big companies that will be made redundant as a consequence of mergers, and financing the acquisition and development of these $14 billion in transactions will require capital that doesn’t exist necessarily in the industry in conventional form today. And my suspicion is that the royalty and streaming companies will provide as much as a third of that capital, so the suggestion that the big transactions, the formative transactions that cause the growth of Franco, Wheaton, Royal, the smaller ones, Anglo-Pacific, Sandstorm, the idea that the golden period for the deployment of capital by those businesses is passed is wrong.

Bill: Its an excellent perspective. And I know from going to the Sprott Conference, you had a lot of royalty companies there, as well.

Rick: I’m deploying one of the things I’ve been talking about recently, and I will be talking about on BNN, I guess tomorrow night, is what I’m doing with my own money now. I’m deploying money now. Historically, I’ve deployed most of my own money in private placements with warrants, but the truth is, that there are opportunities now for companies that have no need of additional capital. And one of the places I’m deploying my own capital right now is in the royalty and streaming space. I’m prepared to concede, I may be wrong for three or four months. Certainly wouldn’t be the first time that’s happened, but I see the outlook for these companies as being particularly attractive relative to the risk.

Bill: Rick, when I meet with you, and when I listen to you talk, it just seems you love what you do. But I want to ask this question, as we kind of wrap it up. If you had to do it all over again, if you were 21, would you go down the same career path?

Rick: Nope. No, if I was 21, I would go into the insurance business. I love risk, and I love the fact that the insurance business involves investment risk and insurance risk, they’re credit decisions. So if I was 21, and I was starting fresh, I would be a green eyeshade guy, and I would go in the insurance business.

Bill: That’s not the answer I expected.

Rick: I understand completely. I understand completely. One of my great regrets for being 66, is I’m probably too old to reinvent myself. I mean, what I would really, really, really like to do now is build a company that did environmental insurance and bonding in the natural resource industry. That’s what I’d really like to do. I understand, however, at age 66, that I probably don’t have 25 years to build a new company, so I won’t do it.

Bill: Well, Rick, I appreciated this conversation, and I know our listeners do, as well. Thanks for meeting with me, and I look forward to catching up with you at your own conference, I believe at the end of July.

Rick: Always a pleasure. I look forward to seeing you there. This is a wonderful conference, but of course, mine is better.

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