During a time in which few investors are considering the possibility of a recovery in natural resources, Rick Rule, Chairman of Sprott U.S. Holdings was kind enough to share a few comments.
Speaking towards the overall market Rick noted that, “The market itself is very healthy. You are seeing a transition…a transition that doesn’t suggest, but rather screams that [junior resource issues are] under accumulation—which is a very, very bullish sign.”
When asked if the current recovery might outperform the early 2000’s recovery, Rick indicated that, “[S]tatistically, this market shows it can be done because the bear market that preceded this bull market was a bear market that was more severe… bear markets are the authors of bull markets, and the recoveries in some way, shape, or form are related to the declines.”
Here are his full interview comments with Sprott Global Resource Investment’s Tekoa Da Silva:
Tekoa Da Silva (TD): Rick, we had a meeting at our offices here recently, in which all our brokers, money managers, geologists, sat down around a table for what was a fascinating discussion on the resource markets.
You commented at one point during that meeting that we’re beginning to see a stair step formation building in the charts of the resource market; a series of higher highs and higher lows, suggesting a move of paper from weak hands to strong. Can you talk about that for our readers?
Rick Rule (RR): Sure. I’m not a technical analyst but I have some friends who I think are fairly adept at this, [so I’ll say that], the chart pattern we’re seeing in the junior mining market in particular (but in the precious metals markets as well) is sort of a saucer-shaped recovery that is a slow, gradual recovery featuring higher highs and higher lows.
It’s important to note that the advances then consolidate—and that’s very important. The advances that don’t consolidate tend to [later] consolidate or fall off very rapidly. So what we’re seeing is a market that will advance by 10% or 12%, and then decline by 5% or 6%.
This is unnerving for people who can’t stomach volatility, people who have too much margin in their account, or people who are simply unrealistically impatient with regards to markets. But the fact that it’s frustrating doesn’t have anything to do with the market.
The market itself is very healthy. You are seeing a transition in the better stocks of the GDXJ—a transition that doesn’t suggest, but rather screams that they’re under accumulation which is a very, very bullish sign.
The slowness of the recovery suggests that the recovery is not fragile or over-extended at all. It’s very powerful and very deliberate. So I’m extremely encouraged by that. Most people of course, most speculators, want the later stages of a recovery, the “J curve”. Unfortunately for them, most speculators when they get excited, they buy. So when that J curve takes place, when the strong upward right momentum starts to build in a chart, that’s the time when one should be selling, not buying.
TD: Rick, are there other technical indications that you’re seeing now which suggest the juniors is being aggressively accumulated?
RR: Well, the chart shows just what I’ve described. If you [use] the base of a hundred, the chart would run to 112 or 113 and then consolidate back to 105 and then run to 120 or 121 and consolidate back to 109 or 110…then run to 127 or 130 and consolidate back to 115.
[So] that’s precisely what we’re seeing. It’s interesting that we aren’t seeing extraordinary volumes, just like we didn’t see extraordinary volumes in June, July and August of 2013 which [marked] the bottom.
We saw a situation then where the buyers were exhausted but there was some residual selling. So you had a down to flat market on no volume. Now you have a situation where the sellers are exhausted. It’s going up on limited volume but the buyers have the predominance.
The market will move from this recovery phase to a bull market phase, and exceeding expectations in this market is absolutely inevitable because the expectations for the sector are so low that they can’t help but be exceeded.
TD: Rick, could you comment on your expectations for the strength of this recovery, and do you feel it may be more intense than what we saw in the early 2000s?
RR: That would be difficult. The recovery we saw from the bottom in 2000 through the beginnings of the bull market in 2004 and then through the top of the bull market in 2007 were extraordinarily powerful. That was the best period of performance in my career albeit from a small base.
So outperforming that recovery would be difficult. Now statistically, this market shows it can be done because the bear market that preceded this bull market was a bear market that was more severe. The TSX Venture fell by 75% percent from its top in early 2011 to its bottom in late 2013 and we have seen in a very rough sense that bear markets are the authors of bull markets, and the recoveries in some way, shape, or form are related to the declines.
So from a statistical or empirical sense, I think that what you say could come true. From a practical sense, the recovery from the 2000 bear market was so kind to me personally that it seems disingenuous to expect a replay.
TD: Rick, I was reading the annual statement put together by Ned Goodman at Dundee Corporation who you’ve noted to be a mentor of yours over the years and he indicated that he has learned that you don’t make money when everyone is running into stocks.1 You make money when no one wants to buy.
Despite that statement—few people seem to be interested in investing in resources. What are your thoughts?
RR: It’s common at a bear market bottom that while people empirically understand the goods are on sale and they’re going to make money, that their recent experience has been so bad that they won’t allow themselves to reenter the market until they have confirmation from the market itself that it’s safe and attractive to do so.
It’s amusing to me that you point out Ned Goodman. I remember a speech that he gave at the Prospectors and Developers Association of Canada in 1999 basically saying that the pivot point was in, and the bear market was over.
I would suspect that Ned was within three or four months of being right. I don’t really consider Ned to be a market timer but what he is, is a 76-year-old guy who has been in resource markets for 50 years, and right now, people are saying to Ned with regards to his bullishness on the market that, “Well, Ned has been saying that for a year and a half. Why would anybody possibly listen to him?”
Well, how about the fact that he’s a self-made billionaire? That might be a reason. How about the fact that he was stupendously right in the 1998-2000 bull market? How about the fact that when he spun Dundee Corp. out of Corona in the early 90s bear market, the stock of Dundee went from $.80 cents to $42 in the ensuing bull market?
I’m one of those who believe that past is prologue and I am one of those who believe that self-made billionaires who are still active in the market are people worth listening to. So I think that Ned may be anecdotal data but I think he’s very, very good anecdotal data. Of course it doesn’t hurt that his conclusions are very similar to my own.
TD: I’d like to ask you about the idea of pyramid portfolio allocation. I remember you noting it could be a rewarding strategy for an interested speculator. What are your thoughts on how one could construct a pyramid portfolio in the resource space?
RR: With regards to the precious metals, I think that an investor needs to ask himself or herself first of all if they believe in the precious metals thesis, and if they believe that there is a place in their portfolio for precious metals and precious metals equities; A, because they’re unloved, and B, because they’re traditional antidotes for popular instruments like the U.S. 10-year treasury.
If the answer is yes, then investors and speculators need to ask themselves whether the precious metals they have in their portfolio are sufficient or whether they need to add more. We have found that most general market investors are under-invested in precious metals from our own point of view.
If the investor agrees with that statement, they need to decide further whether they want to hold their precious metals in physical form or in the form of ETFs or trusts. I have chosen (not surprisingly) to hold most of my precious metals in the form of the Sprott Physical Trusts; the Physical Gold Trust, the Physical Silver Trust, and the Physical Platinum and Palladium Trust.
I’ve done that for three reasons. One, because it’s a hassle to hold physical precious metals although I do hold some, two, because the ease with which one can buy and sell on the New York Stock Exchange (as opposed to a coin dealer), favors particularly for an older person like me, a certificated product.
Finally, because the certificated product for American taxpayers (of whom I am one unfortunately), affords one capital gains tax treatment, while on the other hand holding the physical precious metals affords one income tax treatment. So the tax arbitrage between the capital gains and ordinary income rates in the upper tax brackets is very substantial.
So the first thing that one needs to do is decide whether or not their precious metals holdings are sufficient and two, in what form they wish to own them.
The second decision then if you buy the precious metals argument after having achieved the beta of the metals with physical precious metals holdings is—do you want to chase alpha? In other words, do you want the leveraged performance that a precious metals bull market would generate in the equities?
If that’s the case, how do you want to do it? With regards to the big companies, I am increasingly convinced that investors should not be buying the market, or a market cap weighted ETF like the GDX which rewards size, but rather through buying very high quality individual companies or an ETF that concentrates on qualitative rather than size selective measures.
That was the thinking behind Sprott’s launching of the Sprott Gold Miners Index, the SGDM, which is a low fee ETF product that selects stocks not by aggregate size but rather by corporate performance metrics such as increased revenue, which means that their production base is growing rather than declining. A key problem in the gold business is cash flow generation because the industry as a whole doesn’t generate much cash even at higher gold prices, but individual companies such as Franco-Nevada, Goldcorp, or Royal Gold generate substantial cash.
So I would suggest that if somebody wants to capture alpha that they first start with the major mining companies. The high quality major mining companies will be the first to move in the event that the metals prices go up.
Then at the top of the triangle are the speculative juniors that we at Sprott Global are so well-known for and there are two different ways to play those. You can play the after market in those stocks which are free trading shares on the exchange (the higher quality ones of course), and then there’s the tippy top of the pyramid for those investors who are accredited investors. By that I mean participating in private placements in the junior sector. The attractiveness of that is if the private placement is intelligently constructed, you get “warrants” which are the right but not the obligation to buy more stock at a fixed price over time, which you can exercise if the company generates value internally or if the market itself recovers.
TD: Rick, Warren Buffett is known for having said that a bull market is like sex in that it feels the best right before it ends.2 I asked you back in January, your thoughts on the general equities market. I’d like to ask again: When you look at the strength of the S&P 500, reaching all-time highs3 —what are your thoughts?
RR: Well Tekoa, with the caveat that I’m not a general market securities analyst and also with the caveat that I’m not an economist—I’m a credit analyst—the sentiment associated with the broad market seems too strong to me.
I own some general market securities and I have some money managed by others in the broad market, but I have to say I’m nervous. I’m nervous because [the market strength] presupposes that the North American economy (at least) is in recovery and I see no particular evidence of that recovery, although I will say that over the last quarter, there are signs that the biggest companies in the United States are beginning to invest in property, plant and equipment—which is a useful sign.
But I’m not seeing much by way of increased worker’s incomes outside of the oil and gas industry in the United States, so it’s difficult for me to see a recovery happening without rising real wages in the middle class.
If we began to see rising wages, then we would see a consumer cycle where the North American auto fleet and North American durable goods, things like refrigerators and washing machines (consumer durables), begin to get bought because the used inventory – in terms of its age, is at an all-time high. If we had real growth in workers’ incomes, we would be replacing the auto fleet and we would be replacing our durable goods inventories.
If we saw that, then we would begin to see greater property, plant and equipment investments by major companies in the United States. That increased capital employed by workers would continue to increase real workers’ wages. It seems to me like the strength we’re seeing in the S&P 500 presupposes that this is going to happen, and if that’s true, the S&P 500 isn’t expensive. I just don’t know that it’s true.
The second thing that’s worrying to me is that the debt and equity markets rally we’re in is surely the stuff of very, very low interest rates. I talk to investors every day whose behavior is being determined by the very low return that they’re getting on savings.
Investors are getting forced into riskier and riskier activities. They’re going further out the yield curve to increase their income, and remember that debt instrument pricing is set by the delta between their yield and the yield on the U.S. 10-year treasury.
As an example, in the junk debt markets (which more and more people are being forced into), if the median yield is 7%, and the yield on the U.S. 10-year treasury is 2.7%, the delta is 4.3%, something like that. If the yield on the U.S. 10-year treasury were to go from 2.7% to 3.5%, the delta (which is what the pricing is based on) would decline by about 25% or 30%, and it wouldn’t surprise me to see a commensurate impact on the debt markets, meaning a pretty ugly decline, and I could see that spilling over into the equities markets.
So I would tell readers with regard to the general securities markets, please don’t buy the entire market. Buy individual securities where you believe the business will grow of its own volition for old-fashioned reasons, like the company servicing its customers well and as a consequence of that, beating its competitors well. Don’t buy the market. Buy individual stocks.
TD: Rick, in wrapping up, is there anything else you think we may have missed?
RR: No, I think we’ve asked people to understand an awful lot Tekoa. I would ask the readers that if they agree with this way of thinking, that they reach out to us. I espouse what I of course believe to be correct and we would welcome the opportunity to do business with like-minded people.
TD: Rick Rule, chairman of Sprott U.S. Holdings, thank you for sharing your comments.
RR: Thank you Tekoa.