- The 10-year economic recovery was more driven by low interest rates than an increase in productivity.
- Low oil prices will affect the roll out of electric vehicles and distress faced by sovereign governments may hamper their ability to subsidize conversion in the near-term.
- Mid tier, single-asset producers will surprise to the upside and continue to be taken over by multi-asset producers for another 18-24 buoyed by decline in AUD, increase in gold price, and savings from low oil prices.
Rick Rule is Senior Managing Director, Sprott Inc., founder of Global Resource Investments, President and CEO of Sprott U.S. Holdings, Inc. and a member of the Sprott Inc. Board of Directors . With over 40 years in the resource sector, he shares his outlook on the macro environment and the resource sector, in both a historical context and considering supply and demand forces. The following is a transcript of the video:
Lara Smith: Hello, I’m here from my home in Tel Aviv. I’m joined by Rick rule, who looks like he’s in his home in Toronto. Am I right?
Rick Rule: My home in Encinitas, California. Actually somewhat warmer than Toronto. Thank you.
Lara Smith: Oh, that’s great. Yes. Okay. So have you been going into the office at all or are you in lockdown?
Rick Rule: Some of both. I’m 67 years of age and so, while some of the aspects of the lockdown sort of irritate me, it seemed intelligent from my own point of view. That being said, when we feel it’s appropriate, various of us go to the office, it’s just important to have enough segregation internally that we don’t put anyone at risk.
Lara Smith: Yeah. Okay. Yeah. So I’ve been working from home, which has had its own challenges. My husband’s working from home as well. The baby’s also home. The dog is also home. He might join us for the interview. So we’ve had some differences, we’ve some getting used to during this time.
Maybe we could just jump to it. I like these markets just because I’m from a deep value investment hat, where when we’re put into a bear market everything kind of goes on sale for a while. The difficulty which I’m finding here is how long is it going to be on sale? Are we on the bottom and what does the recovery look like?
And maybe you can shed some light on that?
Rick Rule: Well, I’ll do my best, like you, I come from a deep value background. My mentor, 45 years ago was the now deceased Peter Cundill, who was a very well known deep value manager and analyst. I agree precisely with your sentiment that bear markets are best characterized as sales. And I empathize rather than sympathize with the time value of money argument. It can be said, if as an example, you’re four years wrong, at an 8% discount, you’re not early, you’re wrong.
I answer these questions by referring people to the Barron’s Gold Mining Index, which is an index of gold mining equities published by Barron’s magazine in the United States. I refer to it cause it’s a broad based index and also because it goes back about 50 years. And when you look at that index, and when you look at where the gold equities, well precious metals equities are today in a historic context, and by the way, I’m not a technical analyst, I refer to the chart more as a visualization tool. When you look at the chart, however it shows you that in last 45 years, the periodicity of the oversold bottoms, which is what I would suggest that we just have been through, makes the bear market that we’ve suffered through in gold equities, very, very long by historical standards, which would in and of itself suggest that we are approaching the bottom at the bottom or much more likely off the bottom, relative to historic markets.
The second thing that’s very apparent from this chart is that recoveries from oversold bottoms, there have been, I believe, eight in 45 years, vary in dimension between somewhere around 180% gain all the way up to 1200% gain. And this isn’t select stocks, this is the index as a whole. Those two factors tell me that we are in recovery. Probably from my point of view, a very strong recovery in the gold equities.
And if I’m right that we’re already up off the bottom, I think that the timing takes care of itself, too. My good friend, Steve Sugar, had said, a contrarian must buy something that’s demonstrably cheap. And I would suggest that with the free cash yields and the balance sheets in the gold sector, it is demonstrably cheap, but something that’s unloved, and I think that’s accurate too; most generalists investors couldn’t spell gold, despite the fact that it’s a four letter word. But, he says in an uptrend, and I suspect that we have ticked all those boxes, I would also remind your listeners, who probably don’t need any reminding of this, that the macro circumstance is very, very good, unfortunately, for gold. Gold tends to do well when faith in the ongoing purchasing power of people, savings in Fiat currencies, and in sovereign debt, is challenged. And I think the circumstance that we’re in today, the policy response to the unwinding of the economy, and the Covid 19 virus, suggest that those factors are very much in place. When they say quantitative easing, your listeners should think counterfeiting. If you engage in quantitative easing, they would put you in prison. So if it were really a good idea, why wouldn’t they let us all do it? Quantitative easing debases the currency. That’s really all it does. Debasing the currency reduces faith in the ongoing purchasing power of savings instruments. Of course, balance sheets around the world are being stretched too, running enormous deficits against ugly balance sheets is not a recipe for confidence.
And then finally, the interest premium that you are paid to take these balance sheet risks is minuscule. My friend Jim Grant, refers to the US 10 year treasury as quote, “return free risk.” And I think if you look at the macro associated with no risk premiums, in fact, negative premiums, deteriorating balance sheets and income statements, and in the depreciation of the currency, that the near term outlook for gold, unfortunately, it’s quite good, it is true that the gold equities trail the gold performance, they have in each of the last eight recoveries.
So one would not expect that the gold equities would really catch on fire until the increased gold price is reflected first on the income statement, and then on the balance sheets of gold producers. But that’s in the process of happening as we speak.
For companies that produce outside the United States, it’s also important to note that there the costs are denominated in the currencies, where they’re domiciled, which is to say that their costs in real sense are declining at the same time that the price of their product benefits from at least a temporarily strong US dollar and US dollar gold prices.
And finally, I recognize this as a long winded answer to your question, but finally, the incredible decline in oil prices has meant that one of the most important inputs in the mining industry, which is to say energy has fallen fairly drastically in price, and my suspicion is that you will see that show up in the income statements of these companies as well.
Lara Smith: So it sounds like even the gold is well over 1600 bucks, and all know the ceiling is at 1900, which was seen in 2011, you’re not holding cash, you’re holding gold at this stage.
Rick Rule: I’m holding both.
Lara Smith: Contrary to what people are doing with their money, they’re trying to conserve cash.
Rick Rule: Yes. You know, I think we’re coming into a period, well, I think we’re in a period which continues of extraordinary volatility and having liquidity in cash, despite the fact that the purchasing power of that cash will be declining, the decline in purchasing power, I think is an insurance premium you will have to pay.
I found in my life, I’m 67 years of age. I found that the cash enhanced my sense of wellbeing, and it allowed me to take advantage of volatility rather than being taken advantage of. Cash simultaneously gives you the courage and the ability to take advantage of distress in the markets. It might be that you could regard gold as simply good cash, which is to say it’s extremely liquid; it is a medium of exchange, albeit less efficient currently than sovereign currencies. But it’s simultaneously a store of value in the medium of exchange, it can’t be counterfeited, at least easily. And so one might call gold cash. I don’t, I call it insurance, but I wouldn’t quibble with your listeners in terms of why and how they held it.
Lara Smith: And what do you think about other juniors? So outside of the precious metals, I think silver is still cheap on a historic basis. Gold, you’re saying that there’s still value there, but what about some of the other resources? We’ve seen extreme volatility in the lithium market for instance, we’ve seen cobalt come up and cobalt go back down. We still going into an electric vehicle space. We’re envisioning an electric future. Where do you see value in the resource stocks?
Rick Rule: That would require someone with extraordinary patience. There will always be a market for a tier one deposit, irrespective of commodity. But my personal belief is that we, before this virus, we had a 10 year long economic recovery, and the economic recovery on a global basis, I think was more to do with artificially low interest rates than it was increases in productivity or increased economic activity.
I’m not an economist, I’m a credit guy, but my experience has been that a 10 year economic recovery was extraordinarily long of the tooth, a bubble perhaps, and Covid, in that sense, could be regarded as the pin that pricked the bubble. My suspicion is that we have to unwind as a globe. Some of the excesses that we enjoyed during that prior 10 year period. Which would suggest, if I’m right, reduced economic demand, which would, if I’m right, suggest reduced demand for many, many, many commodities. Make no mistake, on a global basis, many commodities are now priced well below the cost of production, which means if we’re going to maintain our standard of living over time, which I think we will, the prices have to go up. The problem is that they don’t have to go up soon. My suspicion is that we will enjoy a bull market in gold and the gold equities that will last two to four years. And my suspicion is that three or four years out, we will begin an economic recovery from an oversold bottom in the rest of the industrial materials complex.
So people in the mining business might be able to look forward to four or five, six years of relatively pleasant trading conditions, understanding that in materials other than precious metals, the next two or three years could be unpleasant.
The truth is, in terms of timing, the virus may have done us a favor. I had been expecting a long, brutal grinding, boring, bear market in materials.
Lara Smith: Well, this is anything but boring.
Rick Rule: The nervousness l had was that this decline would last three or four years, the bottom would last a couple of years, and then the recovery would come. My suspicion is in terms of pricing, we may see the bottom this year. Catastrophic? Sure. Cataclysmic? Yeah. But at least we get it over with and that might set the stage for a rebound. The rebounds that occur in these bottoms, like the rebound that we saw in 2015, 2016 in the gold stocks, will maybe feel anything like a rebound given the pain that you’re remembering from the immediate past.
But I would suspect that you need to approach the rest of the raw materials on a sort of sector by sector, prospect by prospect management team, by management team basis. Lithium as an example, I suspect is in oversupply. I suspect the price spike that we saw two or three years ago had to do with an incredible increase in demand, which outstripped processing capacity in the industry rather than reflected any basic shortage of the material itself. I’m reminded that SQM, in their annual report, said three or four years ago, that at current lithium prices, that they had about 85 years of reserves present. That doesn’t feel to me like an industry that’s in critically short supply. Of course, many of the juniors that are looking for lithium and don’t have any report that it is short, but I think they’re referring to their own inventories rather than the world’s inventories.
There are other industrial materials that are, I think in the near term, interesting. I think uranium is stupidly cheap and has been for some period of time. Whether we’re going to see…
Lara Smith: Is that not because Cameco’s come off? So is that not just going to swing demand because of Cameco?
Rick Rule: Well, I think we need demand. You know, the supply cuts that we’ve seen are of course helpful, but somebody needs to use this stuff and to get any increase in price in the near term, by near term I mean the next 18 months, I think requires an increase to the pace of Japanese restarts. I don’t know if the Japanese feel that they need to do the restarts because of reduced energy demand in Japan and the extraordinarily low price of liquified natural gas.
These questions are all above my pay grade.
What I do know is that longer term, even in countries that believe themselves to be rich, and could therefore in their narrative, switch to alternative energy, places like the United States still have 15% of their base load power demand supplied by nuclear, and to ask an American if he or she believes the uranium price is going to go higher, it becomes fairly simple.
What you say is, if you think five years from now or six years from now, when you hit the light switch, that electricity will come out of it, that means that you believe that the price of uranium will return to a price where the companies earn their cost of capital. It’s a pretty simple equation. Now, telling that to most speculators elicits a real yawn, five years to them seems to be an eternity, many of them have trauma from holding stock over a long weekend. The truth is, if you’ve been in the racket as long as I have, it’s ironic when you have less time left on earth, you become much more patient. And my suspicion is that the potential upsides that you can see in some of these oddball materials, uranium being one of them, are pretty attractive.
Another circumstance, so I think could be attractive for Australians, would be cobalt. I think that a good argument can be made that if there were access, if fabricators had access to cobalt supplies, that they considered to be more politically secure than South Africa, Zimbabwe and Russia, the demand for cobalt would increase. It’s an odd circumstance where the users tell me that the fabrication demand is constrained because of supply, that they would develop more fabrication technologies and use substantially more cobalt if they had a deeper belief that they could get it when they needed it. It’s a very odd sort of chicken and egg situation, but it’s one I’m attracted to.
And in the intermediate time frame, I’m extremely attracted to the oil and gas business, which of course everyone else hates as a deep value person with the paradigm that you expressed at the beginning of this interview, bear markets are sales, oil is really, truly on sale, and the oil producers and the oil service companies are on sale, too.
Your question, of course, is that how deep will the sale go and how long will the sale last and in truth, I don’t know the answer.
Lara Smith: Yeah. The other question which comes from a low low oil prices, and this is something which I did… I haven’t done this for a while, but in 2009 I tracked production and demand for hybrid electric vehicles, and I realize that hybrid electric vehicles were not as mainstream as what they are now, and even now, they’re substantially less driven than the typical ICE vehicles, internal combustion engine vehicles. But when you track that against the oil price, what we believe was peak oil at the time, and we’re going back to 2009 when I think oil was around $120 a barrel, it actually kept the correlation very well.
And now the question is, if you’ve got such low oil, but you’ve got battery manufacturers well invested, and I don’t know the answer to this, will we still see a lithium universe, say lithium vehicle cars, electric vehicle cars or perhaps there is no need? Perhaps economics trumps environmental plays, if you will, and that’s something which maybe you can shed light on that? What are your thoughts?
Rick Rule: I thought about this a lot and what I’ll do by way of question is to make everyone more confused. It’s certain that the lower energy prices that we’re enjoying as consumers today, make hybrid and electric vehicles less competitive. It may or may not be true that the increasing distress that sovereign governments find themselves in, will reduce or limit their ability to subsidize conversion to more politically correct forms of transportation.
It may, on the other hand, be that the citizenry around the world will use the virus as an excuse to demand more subsidies, and more debasement of the currencies, which would be good for electric vehicles. But my suspicion is that a conversion on a global basis that was meaningful enough to impact the oil price and oil demand will take a very long time. Remember that one of the growth markets for vehicles is not Australia or New Zealand, but in fact, frontier and emerging markets, the vehicle of choice, I guess is something like, you know, a Toyota Hilux. It’s not Tesla. Zambia as an example, or Malawi or Bolivia or India for that matter are not Tesla markets. And my suspicion is that while the electrification of motor transport is in our future, it’s in a longer future that doesn’t dampen the outlook from current levels for battery materials, because distributed power, is growing from an extremely small base, which is to say that the vehicle market can be good for battery metals while at the same time in the near term, not harming petroleum products. And there are of course, a myriad of other uses for distributed and stored power, which is a fancy way of saying batteries.
So I think we can have both. I think the near term determinant in terms of demand will be broader economics, rather than improved technologies. Improved technologies will certainly make the difference in the longer term.
Lara Smith: Yeah, thank you. And, and maybe before we go so that people can buy something over the weekend, three hot tips, give us a hot tip.
Rick Rule: I’m actually not allowed to do that. I’m securities licensed and hot tips fall under the purview of investment advice and the regulators for once wisely have suggested that I’m ill-advised giving advice to people I don’t know.
Lara Smith: Fair enough.
Rick Rule: If you are an Australian investor or speculator, which I assume much of your market is, I would suggest to you that the mid-tier Australian producers, which have already been doing a fine job, will surprise people to the upside, as a consequence of the decline in the Australian dollar, and an increase in the selling price of gold. And also, I think people underestimate the impact on the income statement that will be provided in the next six months to nine months from energy prices.
I’m particularly attracted to single asset producers, which are perceived as more risky than multi-asset producers. They seem to be selling at substantially lower multiples, which means their cost of capital is higher. And in my experience, the market is fairly efficient over 18 months in sorting that out, which is another way of saying that the multi-asset producers will take over the single the asset producers, and I think that the industry will continue the consolidation phase that you’ve seen in the last 18 to 24 months I think that that has at least 18 more months to go. And so sophisticated speculators, the type that might listen to your blog, might do well to move beyond the biggest and the best of the best and try and find high quality producers that have lagged the market and therefore will either catch up or be taken over.
Lara Smith: That’s good non-advice, advice. Thank you. Thank you so much, Rick. I really appreciate it and I’m sure our viewers will really appreciate your insights.
Rick Rule: My pleasure. Thank you for your time.
Thank you. Take care.
