Sprott U.S. Holdings Chairman Rick Rule spoke to investors on a call December 10, 2013 to give his outlook for commodities and precious metals. He believes all the drivers in favor of natural resources are still there – so what we are seeing today is a sale in these assets.
As Rick explains, bear markets provide the upside that contrarian investors should seek.
“We have built our business for thirty years by focusing on natural resources. We focused on backing select public and private issuers during ‘trying times.’ This was crucial to building our business. Natural resource markets are cyclical and highly volatile. Stocks are most expensive when they look their best. Conversely, stocks tend to offer the best upside when the market’s outlook is the ugliest.
“As a consequence of cyclicality, you are either a contrarian or a victim in the natural resources business. That’s the reason I’m still actively seeking opportunities in natural resources. In my view, right now and probably the next year and a half will prove to be some of the most opportune times to be involved in the natural resource business.”
What happened to the commodities bull market?
Through the first decade of the 2000’s, the case for commodities and precious metals was front-page news. The world population was growing, and developing nations were getting richer and buying up raw materials and energy to improve their standards of living. Governments were printing currency. A wave of new retirees leaving the workforce would put pressure on the dollar – which would be good for hard assets like precious metals and commodities. As Rick asks listeners, “what’s changed?”
“Have any of you noticed the Federal deficit going down? Is the population in the US not still aging? Is global population no longer increasing?
“Another part of the narrative was that competitive devaluation would cause more people around the world to turn to gold. Devaluation would allow a country to reduce the cost of its exports creating more industry and gaining more employment. But its competitors would have to follow suit.
“Well, the Japanese have now lowered the value of the Yen by 25 percent. Does anybody believe that Korea, Taiwan, Vietnam, or China will allow the Japanese to gain a competitive advantage on exports?”
“If nothing has changed to the narrative, then what we have today is a sale. Historically, assets in the natural resource sector are cheap.”
Will the market recover?
As Rick explains, natural resource markets have historically recovered following a pullback.
“For instance let’s consider the gold bull market from 1970 to 1980. The price of gold went from $30 per ounce to $850. In the middle of this bull market – in 1975 – the gold price fell by 50 percent. From around $35 in 1970, the price of gold rose to around $175 in 1975. In August 1976, however, it hit a low of $103 per ounce. It subsequently recovered to $850 per ounce by 19801. Investors who lacked the conviction to stay the trade bailed in 1975 and missed an 850 percent move in four years.
“If past is prologue, today’s pullback is merely a cyclical decline in a secular bull market – the natural resource sector is on sale.”
Are other asset classes more attractive?
The Fed’s actions have caused certain assets to rise, but this move is mostly caused by optimism, not reality, says Rick. This is particularly true of US Treasury Bonds, he believes.
“My view is that Treasuries are held up by confidence and nothing more. The political leaders of the United States and the ‘big thinkers’ around the world convinced us that we have avoided the worst parts of the 2008 financial crisis (through their adroit leadership).
“By printing money, they have convinced many of us that liquidity, provided by ample short-term capital in the system, is a substitute for solvency – the inability to meet our debt obligations.
“But that’s like saying that because you have $10,000 in your pocket, that you can sustain a million-dollar mortgage without sufficient income to discharge your debt. The truth is that liquidity will never be a long-term solution to insolvency.
“Specifically, let’s look at the 10-year Treasury. It yields around 2.8% today2. At the current CPI, by which the government measures inflation, you are guaranteed to gain no purchasing power over the next 10 years. That’s what Jim Grant calls ‘return-free risk.’
“From my point of view, it gets even worse when you consider that the CPI does not take into account all costs of living. First of all they delete food and fuel from the index. It also doesn’t include tax. In my personal experience, my cost of living has increased by around 5 or 6 percent every year. If I buy a US 10-year Treasury, the government guarantees a loss of purchasing power of around 3 percent a year. That comes out to about 30 percent less in purchasing power after tne years.
“In my view, this backdrop makes natural resource equities much more attractive.”
Sector likely much closer to bottom than top…
Natural resource stocks are highly volatile, and especially the small and micro-cap companies, says Rick. He believes this niche also provides the opportunity for outsize returns commensurate with the risk that investors face.
“In previous bear markets, such as 1981 and 1982, or 1990 and 1991, we have seen small and micro-cap equities fall with very high volatility. Indexes that track these stocks have fallen by 50 or 60 percent in short time frames. Today, small gold companies as measured by the GDXJ index have declined by around 80 percent in three years3.
“My experience in the past is that the gain after a bear market compensates you for the pain when stocks were falling. In resource bull markets, carefully selected portfolios can see gains which more than compensate for the losses during the pullback.
“We play this game because, historically, the gains that occur are disproportionate between a bear market bottom and a bull market top. Of course, history does not always repeat itself. Nonetheless, I believe that we are entering the period of recovery now. I can tell you that having suffered an 80 percent decline, the sector is likely a lot closer to the bottom than to the top.”
Finally, some opportunities provided through Sprott can help investors gain exposure to the natural resource sector at terms unavailable to most investors, Rick explains. For instance, Sprott is engaged in originating loans to small mining companies at terms that are commensurate with the high risks associated with being a creditor to these issuers.
With a long-term positive view on natural resource equities, the current market may provide an opportunity to enter a cyclical market during a period of weakness, when companies that were expensive at the peak of the bull market have become more affordable for contrarian investors.
P.S.: Sprott Inc. announced today that its private equity arm, Sprott Consulting LP, will co-manage a fund of $750 million from South Korea’s National Pension Service and state-owned Korean Electrical Power Company. Click here to read the press release.
Rick Rule is the Chairman and Founder of Sprott Global Resource Investments Ltd., a full-service brokerage firm located in Carlsbad, CA. Sprott Global is an affiliate of Sprott Inc., a public company based in Toronto, Canada. Mr. Rule leads a team of earth science and finance professionals who form an intellectual pool for resource investment management. He and his team have experience in many resource sectors including mining, oil and gas, water, agriculture, forestry, and alternative energy.
1 Gold Price Chronology 1971-2007. The World Gold Council. Page 3
By Henry Bonner ([email protected])