Mines and Money spoke with Rick Rule, Chairman of Sprott Global, ahead of his keynote presentations at Mines and Money Australia and Mines and Money London in 2013.
We asked Rick for his opinions on the state of the market, his top picks for commodities and what questions investors should be asking the management teams of mining companies to gauge their investment potential.
Listen to the Podcast version of this interview
M&M: Do you think that we have reached the bottom of the market for mining stocks, and what sort of signals are there to support your position on that?
RR: I don’t think we’ve reached the bottom for mining stocks, but I have to say that my response is more intuitive than empirical. It’s really a function of remembering the last three or four cycles where the bottom was marked by an almost farcical capitulation; a one or two week period where there were almost literally no bids.
As I recall, that period was followed by a fairly long period of very low volumes, where both buyers and sellers were exhausted, so I don’t feel like we’ve reached the bottom.
We’ve had brief periods of capitulation, in particular last April, but I haven’t seen the really violent capitulation which has marked the bottom of prior junior markets.
M&M: What do you think will be the factors that do trigger a recovery in stocks, and what sort of timeframe do you think that we can see that happen?
RR: My experience has been that the best part of the junior market just gets too cheap. The whole narrative becomes negative, and we’re getting towards that. You know, you’re going to see now a situation where the larger gold producers have to write down some of their reserves and resources. They may have been carrying them on the books at $1,500 U.S. as an example, which is tough to do in a $1,300 world. They may have to take into account higher costs. I’ve noticed, without naming names, that a couple of the majors appear to be mining material that’s substantially higher than their average reported reserve and resource grade. I also note that they may or may not be reporting their depreciation charges on a grade basis rather than on a tonnes-mined basis.
These are the sort of things that contribute to market declines, and to final market washout. Of course for North American investors, particularly Canadian investors, today’s news that the Russian potash producers have pulled out of the potash pricing mechanism has sent potash prices down, and the shares of the senior potash producers down, and it’s this sort of thing that contributes to the washout.
The turn comes because things simply get too cheap. In very good markets the punters take up the bad management teams with the good management teams, and in bad markets they take down the good management teams with the bad management teams.
What happens is simply that bear markets themselves are the cause of bull markets, and bull markets themselves are the cause of bear markets, and we will come to a period in this market where the better Aussie juniors are just absolutely, positively, laughably cheap, and they’ll find footing.
M&M: Which commodities do you think will display the strongest upside in the next three to five years, and what do you think the drivers will be behind that?
RR: Myself, I’m particularly attracted to platinum and palladium, because of the grim supply side characteristics around platinum and palladium, particularly with regards to South African production.
South African platinum and palladium industry has not earned its cost of capital for a long time, six or seven years. As a consequence, structural supplies from South Africa are falling, and falling fairly rapidly. Unfortunately for that country, they’re facing a headwind, not a tailwind, so I’m attracted to platinum and palladium.
But you know, I’m also a gold bug. The whole set of circumstances that contributed to the gold rise above $1,900 U.S a few years ago, I believe is very much intact. I think the only thing that’s changed is investor confidence on a global basis, and I think that’s misplaced. So, I’m attracted to the gold industry and by extension, of course, the silver industry.
I also believe that the uranium industry is not earning its cost of capital. I think maybe not this year, or next year, but two or three years out we have a choice between higher uranium prices, or the lights going out in places that require nuclear energy for their ongoing power consumption.
I think that an equally interesting question is which commodities are still overpriced, and I think a rebound in nuclear utilisation, particularly in Japan, will take the marginal demand out of the seaborne liquefied natural gas strait, which could of course have fairly profound implications for the Northwest Shelf in Australia.
Listen to the Podcast version of this interview
M&M: At Mines and Money Australia in late October and Mines and Money London in December, both of which you’ll be presenting at, there’s going to be a large selection of mining companies who are showcasing their companies and their projects. I wanted to ask you, as this presents a chance to speak directly to the senior executives from these companies, what sort of questions should investors be asking to gauge a company’s investment potential?
RR: That’s a great question. I think the time that we’re in presents once in a decade opportunity to stock up on the best juniors. You need absolute sector drivers among the juniors. That’s what’s going to work. You need companies that are involved in an endeavour that, if it is successful, has the scale both in terms of tonnage and grade to make a meaningful contribution. The risks that we take in this business are so great, that if you aren’t playing the game for very, very meaningful stakes there’s absolutely no purpose in participating in the sector.
The other thing, and too many investors forget this, is that success among junior companies is really a question of progressive de-risking or put differently, answering a series of unanswered questions, and what I often like to do is ask the CEO, or whomever I’m able to speak with ‘What is the most important unanswered question in your quest for adding value? What are the ground truths that lead you to believe in your thesis? How are you proposing to test the thesis? How long will it test the thesis? How much money will it require to test the thesis? Do you have that money? In other words, can you get me to a yes answer?’ Those are the important questions to ask.
M&M: To spin that around then, how should junior mining companies be positioning themselves to attract investment?
RR: Well, the sad truth is that many, many junior companies in Australia and Canada both, don’t have any meaningful questions to ask, and don’t have the capital to ask them anyway. To spin your question around, one of the nice things about bear markets is it allows many of the nothing, nowhere juniors to go to their rightful place, to zero.
This cleansing, while brutal for the shareholders and employees of the subject firms, is extremely healthy for the industry in general. For those surviving companies, those will be companies that were prudent enough in good times to be reasonably well cashed up. They will be companies that the management team that has been assembled to prosecute, if you will, a given strategy.
If a team isn’t really experienced in mining, but rather is a team that is experienced pretty specifically in the disciplines suited to the task at hand. A company that understands its quest for value very well, and has a well thought out and well articulated plan in terms of how to answer first one, but ultimately perhaps two or three unanswered questions, and can also tell strategic investors like myself what will happen as an example if they get early on in exploration, a no answer as opposed to a yes answer?
We want to see the management team that we are entrusting our resources to has thought through the process of creating value for us, and also thought through the contingencies very, very, very well.
M&M: I’m going to change tack a little bit here. I want to ask you about the current state of the mine finance market. With traditional funding sources remaining tight, which sources of alternative finance do you think that we’ll see the most growth in over the next year?
RR: Well, I would argue that the traditional sources of mining finance aren’t tight. The industry in the last decade came to rely on small hedge funds, and generalist mutual funds to finance them. These people were not traditional sources of mining finance. The traditional sources of mining finance were of course larger mining companies, and institutional investors with a specialty in mining, and certainly in North America at least, the institutional investors with a specialty in mining.
People, as an example, like ourselves at Sprott, Liberty Mutual, the life insurance company in the United States, Dundee Bank Corp, these are all people who are ready, willing, and able to write cheques. The major mining companies as recently witnessed by Antofagasta are also ready, perhaps less ready to finance juniors.
What has changed in this market, and I think probably changed for the better, is the incredible interest that we at Sprott at least are getting from sovereign wealth funds, state owned enterprises, and private equity investors. That is a group of money that you haven’t seen in this sector as aggressively before and they are circling the sector with some eagerness.
These are extremely sophisticated investors, but they’re investors with very deep pockets, and they’re also investors with strategic interests. They will be hard to attract because they are very picky investors, but I suspect that they will be very good long term partners for sophisticated management teams.
M&M: As an end note, my final question then, with share prices having gone through a fairly sustained phase of under-performance, could you outline the case to any detractors out there about investing in mining stocks? Could you outline the case for the long term benefits of investing in the mining industry?
RR: That’s really, really, really simple. Bear markets are really sales. When people go to buy physical goods they look for deep, deep discounts. If you look at the junior mining sector it’s as though you were going through a shopping mall and there was a sign flashing that says ‘Gigantic sale, 75% off. No reasonable offer refused.’ It’s absolutely compelling. The fact is that the whole narrative surrounding natural resource investing that existed in 2009 or 2010 exists today.
What happened is that that market got over hot. It had too much hot air in it. The hot air has been released. The idea that the ascent of man is going to somehow stop, or we can somehow 3D-print basic energy, basic food, basic materials is fallacious.
That whole set of circumstances that caused the investment community to be so bullish about resources in 2009 and 2010 exists today. That bull market ran its course, because things got overhyped, things got ahead of themselves. The circumstances are the same today, but the entry points are 75% cheaper.
I want to reiterate to your readers and listeners that bear markets, like we’re in today, are the cause of bull markets, and bull markets, the over pricing, the hyper-pricing, that we observed first in 2007/2008 and then later in 2009/2010 are the cause of bear markets.
People who remember that, people who remember that mining is capital intensive and cyclical, and people who remember the admonition that ‘you must be a contrarian or you will be a victim’, will do extraordinarily well in this market.
Let me personalise it, in the last four or five cycles, my own experience has been that you sort of know if the top of the cycle and stuff is too expensive, but the truth is that you’re hubris bound from having made to much money, and you need it passed. You have faith in your management teams, you like your assets, so although you do some selling, you don’t do enough selling, and you go over the waterfall just as you have in prior cycles, and you lose 35% or 40% of portfolio values that you had at the top of the cycle. At the bottom of the cycle, you must rearrange your portfolios very, very, very aggressively.
You have to sell your mistakes and put the proceeds from the sales into the best possible juniors that you can, and when the cycle returns, having lost 30% or 40%, you make 200%, or, 300% or 500%. If you think about that math, losing 35% to 50% , and then making 200% or 300% or 500% on the rebound, the math is very, very, very attractive.
We’re at a position now, where you no longer have to consider losing 35% to 50%. You’ve done that. You may as well having gone through the pain now, in the next five years go through the pleasure of the inevitable upturn.
M&M: Rick, thank you so much for having a chat with me today, and I am very much looking forward to catching up at Mines and Money Australia in October, and also Mines and Money London in December of this year.
RR: I look forward to appearing on your roster. It looks like an absolutely great roster, and I’ve seen some of the exhibiting companies and I can’t wait to interrogate them, and with any luck invest in some of them.
As Rick Rule put it, current market conditions create a “once-in-a-decade opportunity to stock up on the best juniors”. At both Mines and Money Australia and Mines and Money London, investors have the ability to speak directly with the executive management teams of a wide range of global mining companies to assess their investment potential and make informed investment decisions. For a list of mining companies being showcased at each event, click here for Australia and here for London.
Along with the chance to assess and compare mining companies and projects, delegates will hear from expansive speaker rosters of leading resource investors and mining entrepreneurs for market analysis, forecasts, networking, interactive sessions and deal-making.
Download the Agenda for Mines and Money Australia
Download the Agenda for Mines and Money London
Rick Rule invites you to subscribe to Sprott’s new daily investment newsletter, Sprott’s Thoughts, which features daily market commentary from his team (and himself) at Sprott Global Resource Investments Ltd., as well as his partners at Sprott Asset Management. Go to sprottgroup.com/subscribe to subscribe (you’ll also receive a FREE electronic copy of the “Sprott Gold Book,” by Eric Sprott).
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