By Henry Bonner (hbonner@sprottglobal.com)
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2015 is well underway and starting to look at lot like 2014. Commodity markets remain weak with uranium, copper, gold and oil prices still near their lows.1
Rick Rule, Chairman of Sprott US Holdings, sat down with me recently to discuss the resource and precious metals markets.
Rick, since many commodities are at or near their lows since the resource bear market began, is it time to reexamine any of our premises?
Yes. The one that comes to mind is uranium.
It really is a function of the interconnectedness we see in all aspects of the world economy. All parts of the world economy, including the US, have stubbornly refused to stage a meaningful recovery (as we discussed in a recent report). We are not seeing higher consumer wealth and greater ability to spend, which has led to a decline in oil price and in the prices of seaborne liquefied natural gas.
Liquefied natural gas prices have been cut in half. In turn, there is less pressure on the Japanese to restart their fleet of nuclear reactors.
A year ago, the Japanese were paying between $15 to $20 per million Btu (British Thermal Unit). Now they’re paying around $8 or $9 per million Btu. So the pressure is off for the restart of their nuclear power plants. The recovery that I saw for uranium prices, which I believed could go from the low $40s to high $60s, has been postponed.
If the world economy revives, if Japanese manufacturing revives, and if electrical demand revives, then the Japanese will have to restart their nuclear capacity. For now, the low prices for liquefied natural gas serve as a depressant for uranium demand.
What needs to happen for gold to recover?
Do we need to see a change in investor attitudes towards holding gold? Or are we waiting to see some event – say a currency collapse – that shakes people’s faith in currencies and increases the demand for gold?
I know you want me to choose one, but the answer to both is “yes.”
With regards to a gradual lessening of faith in the dollar, I believe it would not be event-related but arithmetic-related. There are trillions in sovereign bonds worldwide that trade at negative real yields. For instance $1.7 trillion of European debt maturing in more than a year paying a negative yield.2 There are also many US bonds trading for a negative yield, after you adjust for inflation. You lose money, guaranteed, by investing in these bonds. This is important for gold investors.
First of all, your cost of holding gold is the lost yield from not owning bonds. When you could make 5.5% or 6% in bonds in a supposedly riskless fashion that was the cost of owning gold. But that cost is now gone. Your holding costs for owning gold are nil.
Second, the very low bond yields lessen the appeal of savings instruments issued by governments. The lessened cost of owning gold and the lessened returns from bonds increase the relative value of gold compared to bonds.
Now, could there also be a ‘black swan’ or an exogenous event that lessens the appeal of owning bonds instead of gold? Of course, but the nature of black swans is that they are very hard to predict.
Have you felt frustrated that there has not been a ‘capitulation’ in resource stocks, whereby many companies and investors close up shop or leave the sector as a precursor to a recovery?
I have felt extremely frustrated by the lack of issuer capitulation.
By that, I mean that Sprott’s ability to invest money on behalf of investors in projects that are suitable has been constrained. The mining industry wails and moans about the lack of capital and their inability to go forward. Those same people in the mining industry aren’t willing to offer equity or debt at market-clearing prices.
The last time we saw capitulation was in the summer of 2000. That was concurrent with issuer capitulation. The very best issuers decided that they had to raise capital at almost any terms that they could. The attractiveness of the returns they could get from deploying capital at a market bottom overcame the near-term pain that they suffered to their egos for issuing at prices below previous issuance prices.
In the issuer market today, you see these really luminary financiers, like Robert Friedland, willing to issue full warrants in order to attract capital. Financiers and promoters with, let’s say, less established reputations than Mr. Friedland’s, aren’t willing to do that. I think that the irony there is apparent to everyone.
Speaking of mining and exploration companies that are looking for money, does it make sense to invest in early-stage exploration right now? If the stocks in proven discoveries are cheap already, why not stick to those?
The truth is that you’re taking on less commodity risk.
With regards to discovery stories, the current price of the underlying commodity is less important. A mineral discovery made today will be in production 10 or 12 years from now. An oil and gas discovery might be producing 5 years from now.
Discovery stories advance or decline on their own, in some ways disconnected from the market. An example would be a few years back, Reservoir Minerals Corp. and Freeport-McMoran Inc. made a discovery of high-grade copper and gold. Separate from lower copper and gold prices, the price of Reservoir Minerals advanced from its initial public offering price of $0.65 in 20113 to almost $7.50 in March 20144, in complete contradiction with the market around it, because of the attraction of the wealth created by the drill bit. The market acknowledged that when the property would be brought into production that prices might be very different.
There is a whole different set of risks in pre-discovery, the most important being the risk that you won’t discover anything. The truth is that in extractive and speculative types of stocks, the most dramatic successes come from exploration.
Investing in pre-discovery exploration has entirely to do with the pursuit of 20-1 or 30-1 returns that can occur almost irrespective of market conditions, simply because of the aggregation of wealth that occurs thanks to a discovery.
It’s like what André Gaumond said: He turned a swampy patch of land in Northern Quebec with near-zero value into a $10 billion discovery.
That’s correct.
P.S.: Our own Andy Jackson, a veteran of the resource industry, conducts research and due diligence on early-stage exploration stories worldwide. Andy just got back from visiting a mine site in Malawi – click here to see his travel log from the visit.
1 Bloomberg
2 http://blogs.wsj.com/
3 http://www.bloomberg.com/apps/
4 Bloomberg
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