Hello! I am back with more from the Casey Conference…
Honestly, I could write about this for weeks and still not cover everything—it was a terrific conference and I had a great time visiting with friends old and new. If you couldn’t make this one on the East Coast, you’re in luck…I believe the next Casey Conference is sometime in September on the West Coast (San Diego area) and I will keep you posted as I hear more about it!
I know I’ve said this before, but conferences are a wonderful way to learn and network with other fellow investors (and the Casey conferences are the best of the best!). There is such an opportunity to connect with seriously smart people—for example, I had the honor of sitting next to James Rickards, author of Currency Wars, for the entire second day. He is such a nice man and extremely smart (plus he got extra bonus points for treating me like a respected fellow investor and didn’t instantly assume I was someone’s wife!).
I also met and spoke with Dr. Lacy Hunt and John Mauldin in person and had a wonderful conversation with them. Lacy used to work for the Federal Reserve and my investor-friend Winston (whom I met at an accredited investor event on rare earths many months ago in San Francisco) and I were able to ask him all sorts of questions you’d just love to ask someone like that:
Winston: “Have you read The Creature from Jekyll Island?”
Lacy: “No, but I’ve heard of it”
Winston: “What did you hear? What did you think about it?”
Lacy: “I understand it is about the formation of the Federal Reserve…the infamous meeting where they met on Jekyll Island and drafted the bill that created the central bank.”
Winston: “Who really owns the Fed?”
Lacy: “It’s 2/3 owned by the member banks, and 1/3 owned by the government”
Amazing…the first authoritative answer I’ve ever heard on the age-old question of “who owns the Fed?”.
John Mauldin is also extremely smart and a super-nice man, and the four of us chatted for 20 minutes about the Fed, China, the government, our families, and more. Truly fascinating and fun.
So, long story short…if you can possibly make it to a live conference you will absolutely reap the rewards! Your investor/friend network will grow, you will be able to meet many of the people whose opinions you read, and you will learn a tremendous amount. (OK, stepping off soap box now…although you know I harp continually on the importance of meeting people in person!).
Anyway, enough about me and my experiences…onto the report!
Rick Rule on the Junior Resource Sector
Rick, like Doug, is always entertaining and gave a great speech on resource stocks (his specialty). They were hit hard last year, and so I’m sure many investors were wondering what the prospects are for this year.
He pointed to the doubt in the air…Why haven’t any or all of these black swans happened yet? Why hasn’t there been a reckoning? Why hasn’t what happened to Greece happened to California yet?
He mentioned that as Bud Conrad had said, here in Silicon Valley where Bud (and Kung Fu Girl) live, there doesn’t seem to be a crisis at all…you have to wait hours to get a table in a popular restaurant and multiple all-cash offers are being made on million-dollar homes. Rick said that we all took planes to get to this conference, and the planes had gasoline, and took off, and landed, and we’re in a nice hotel…and all in all things don’t seem that bad.
Why is that?
Well, Rick believes that a reckoning is going to occur, though probably not in the way that we think or in the time that we think, and reminded us that “inevitable” doesn’t necessarily mean “imminent”.
He encouraged us to focus on the facts, and pointed out that the penalty for ignoring facts in your portfolio is steep!
[Kung Fu Girl Note: Amen to that!]
He discussed the good, the bad, and the downright ugly…a good metaphor for the resource market right now.
1. Commodities Bull Market Super-Cycle
We are still in the midst of a commodities bull market super-cycle, which is the consequence of the previous 20-year bear market.
That 20-year long bear market constrained investments in natural resources, which caused a supply constraint as there were little-to-no investments in oil fields, copper mines, or agriculture. And on the demand side, during that same time period there was some level of political liberation around the world, which caused the standard of living to go up, particularly in emerging markets. He quoted Deng Xiaoping: “as people become a little more free, they become a lot more rich”, which increases demand for resources.
So the good news is that we are still in a resource super-cycle (although he admitted that this past year has been “a little less buoyant” than in the past). He urged us to remember the great bull run in the 70′s where gold went from $35 / oz. all the way to $850 / oz., but how in 1975 in the midst of that run, the gold price fell by half. These retrenchments, while unpleasant, are facts, but Rick said to remember we are still in a commodities super-cycle.
2. Individual investors in the U.S. are awash with cash
Individual investors in the U.S. are awash with cash, by some estimates as much as $8 trillion! And the government is forcing us to speculate with it—when you put it in a bank you get something ridiculous like 5 basis points (that’s how professional finance guys talk—that’s 0.05% for the rest of us).
Rick is hilarious and said that you practically have to give the bank a toaster today (unlike in the past when they solicited your business by giving you free gifts!).
And long government bonds are a joke…as Jim Grant famously said, they are “return-free risk”.
So the government is forcing us not to save and almost not to invest, but instead, is forcing us to speculate.
But the good news is, all of that money has got to go somewhere…and the resource arena looks ripe for the picking.
3. Ingenuity in Society
Human ingenuity is amazing, and in fact can solve most of the problems we face today. In fact, there has been an absolute boom lately in energy supply due to three new technologies:
- Horizontal drilling
- Multi-stage fracturing
- Amplitude vs. offset seismic processing
Most of the problems we face today are solvable with human ingenuity.
1. The $8 trillion is offset by some $80 trillion in on- and off-balance sheet liabilities.
The people who run this country say this is not a problem because “we owe it to ourselves”. But Rick said, “Hey, but some small part of that is my problem! Because if they are thinking of taking some of my part of the $8 trillion to fill their $80 trillion hole…that’s a problem for me!”
2. Increasing level of social “take”
Rick said that social take is really just theft, and it’s been going up around the world.
Specifically, he was referring to political risk…the theft imposed by governments on owners of assets, much like what has happened to the resource companies in Indonesia, Argentina, and Ghana.
Mines are fixed targets—Rick said if we were instead partners in a tanker or an ocean liner and were treated badly by a government, we would simply say, “Well, we’re never going back to that country again!” and just move onto a new country where we would be treated better. However, mines are extremely fixed and therefore are very easy to plunder.
And it’s not just Argentina and Indonesia…even Alberta, Canada doubled the royalties they took from the natural gas companies when the prices of natural gas improved a few years ago!
3. Black swans
For black swan watchers like Rick, he said there is such a cloud of them on the horizon they practically block out the sun.
Rick said if you thought Greece was fun, wait until Spain hits, and he pointed out that you don’t even need to look as far away as Spain, or Italy, or France…
For example, he just moved to a little town in California called Encinitas. Apparently the mayor of Encinitas was incredibly proud of his “balanced budget” on a cash basis. But this little town, with 35,000 people, has…
Wait for it…
$70 million in unfunded pension liabilities!
And if you compound this problem across the U.S., and to Spain, and Italy, and France…you don’t have to look too hard for an upcoming black swan event to unfold.
The Ugly (Specifically for the juniors)
1. Incredible explosion in the sector of general & administrative expenditures.
Mining explorers have become “mini-governments” lately, and there has been a huge expansion of general and administration expenses relative to exploration expenses.
He told us to remember that these companies don’t make any money, they just lose money. [Kung Fu Girl Note: much like the vast majority of technology start-ups!]
Rick said this wasn’t true of all of the resource companies, but in general the sector is becoming more and more lifestyle oriented and less and less exploration oriented. This is Ugly with a capital U.
2. Private inflation
This was fascinating to me, and I didn’t realize this:
Rick said that it’s fine to talk about Central Banks and money-printing and looming inflation and all, but to always remember that the private sector can do anything better than the public sector can, including inflation.
If you look closely at the junior resource sector over the past few years, the share prices haven’t gone up (this is obvious), but what is not obvious is that the market capitalizations have gone up.
Why? How has this happened?
This is what Rick calls “private inflation”.
The companies have issued more and more shares so their market caps have increased, but the share prices have not.
Rick also pointed out that if you pooled all of the juniors together into one giant “Jr. Explorer Co., Inc.”, that company would LOSE $2 billion to $8 billion a year!
He joked about how to value the whole sector…5 times losses? 7 x losses?
And he reminded us that the sector, as a whole, always loses money, which begs the question of course…
So why do we speculate on these companies?
The answer is because there is a lot of money to be made in identifying the best players in the sector.
And for people who are willing to do the research, and who spend the money and the time to obtain quality information and who concentrate their efforts on the very best-of-the-best top 4% stocks, can do very, very well.
But, you must concentrate your efforts and use common sense. [Kung Fu Girl Note: YES—think for yourself and do your research!]
To drive his point home, Rick said that the activities of maybe five management teams in Vancouver have generated the lion’s share of all of the profits in the sector in the past 30 years.
(Rick, like me, believes it’s all about the people, and Casey Research says the most important “P” in their “8 P’s of resource investing” is people.)
And remember… “inevitable” doesn’t necessarily mean “imminent”.
So that’s “The Ugly”…What does this mean for us as resource investors?
Rick reminded us that bad markets are good and good markets are bad (meaning that your expectation of the future is based on your immediate experiences in the past. In bull markets, when you have recently been making tons of money even on your mistakes, you tend to want to buy more; and in bear markets, where you are possibly losing money on multiple positions, you certainly don’t want to load up on yet another loser.) But remember that everyone in that market along with you, your competition, feels the exact same way, and high prices correct to low prices and low prices rise to become high prices.
Very, very good markets set up very, very bad markets, and vice versa.
So where are we now?
We’ve had a pretty good correction, and Rick expects this to continue and maybe even to worsen this summer.
The junior industry has been increasingly institutionally financed for the last ten years, by sector mutual funds and small hedge funds. These two sectors, the private funds (hedge funds), and particularly the open-ended mutual funds, have been hemorrhaging money!
They are suffering from something called disintermediation, which simply means money going home. Rick said that one fund manager he knows is suffering outflows of $10 million a day. Ouch. This is not the stuff that a bull market is made of in the near term.
So the traditional sources of funding for the junior resource sector have dried up, leaving the juniors to seek financing elsewhere…like from us private individual investors.
Rick also talked about something he termed “financial roulette”—his phrase for describing how the issuers of equity, the junior companies themselves, have responded to this market.
He recalled the boom of 2010 and how private placements were announced a dozen at a time and companies raised a truly stupendous amount of money.
But last year, in 2011, there was a dearth of private placements.
Companies didn’t want to raise money because they saw their share prices down 20% and saw raising money to be diluting share values (which you might think as a shareholder is the responsible thing to do…but they didn’t stop spending money, either!).
So this created a vicious, dangerous circle, with companies spending money to generate exploration results to create excitement in order to raise the share price…so that the company can raise more money. They are spending money to raise money!
And Rick believes they have to come back to the market to raise money this year, because otherwise all of that “lifestyle” general and administrative expense will disappear, and they don’t want that.
From Rick’s point of view, this sets up a year as an individual private placement investor the likes of which we haven’t seen since 2002!
He went on to explain that in a market like this where there is what he called “professional capitulation”, where the big-league investors aren’t putting money up, the terms the companies will have to offer us individual investors will be the best terms offered to us in a decade.
He said this year and maybe into next year is shaping up to be a spectacular entry point (although he reminded us that it probably won’t “feel” spectacular).
[Kung Fu Girl note: I wish I knew how to do those cool word clouds because if I could count the number of times Rick said "spectacular" that word would be in GIANT 36-point black font...he truly believes this will be a great year for individual private placement investors!]
He said that although institutions are running out of money and courage, the mining and oil and gas industries have lots of money, and spectacular (there it is again…) margins.
What types of stocks should we look for?
Namely, who is going to buy our shares from us when we are ready to sell?
Rick believes we are going to sell our shares to a different buyer than in the past…in particular, to industry.
He contrasted that to the past ten years where investors have been buying institutional momentum stocks—stories that appealed to the small institutions and to the mutual funds. He gave the example of very large, very low-grade gold deposits that provided a high number of in situ ounces, because those companies were looking for leverage to gold, but he said those guys are out of money now.
Now, you must look for companies that are going to sell to industry (e.g. to larger, more established companies within the mining industry). Basically, you are looking for plays that will get acquired by the bigger guys. These acquiring companies want good cash-on-cash return for the capital that they deploy, and according to Rick, that sector of the market is really cheap right now.
In fact, he said that they’ve done work at Sprott and found that the discounts to the Net Present Value’s (NPV’s) associated with the preliminary economic assessments are the greatest he’s seen in 30 years in the business.
Wow. That’s pretty good.
He pointed out that the preliminary economic assessment is not a perfect document, but it’s better than anything produced by the company because at least it is a third-party document!
(Company-provided documents remind me of the pro forma in real estate…they can be anywhere from a “wild-a$$ guess” to an honest representation, but usually lean more toward the former!)
To top it all off, before (he mentioned the past 20 – 25 years) when Rick has seen big discounts to NPV like this, he’s also seen that the larger acquiring companies have been unable or unwilling to complete transactions. But now, acquirers DO have the will AND the money and want to do transactions and to gobble up the smaller companies.
So, when looking for your junior stocks, Rick says you should do two things:
1. Try to speculate on issuers who are selling at big discounts to NPV based on their preliminary economic assessments
You can speculate on these with the knowledge that when the junior delivers the next document in the process, the bankable feasibility study, they will most likely be taken over by a larger company.
In fact, Rick said that the merger and acquisition activity that we will see in the next few years will be…
wait for it…
Major companies have a lot of money, AND they have the will right now to complete these transactions.
2. Speculate on discovery plays
We are truly in a discovery cycle now, which is fantastic, and according to Rick is to be expected, because we’ve been supplying lots of money to the explorers over the past ten years.
And, as Rick says, when you put money into the hands of good explorers it’s “inevitable” (but not imminent) that you will come into a discovery cycle. There have now been ten years of hard work exploring, and so the discovery cycle has arrived.
Rick said there will be two things that will make you money in the private placement business:
- Pre-development stage projects selling at big discounts to the preliminary economic assessment, and
- Process plays: prospect-generators in anticipation of discoveries or discoveries in a down market where “nobody cares” about discoveries.
To sum up… there is a lot of money to be made in the resource sector (but as Rick says, it’s inevitable but not imminent…it might take you 18 or 24 months).
[Kung Fu Girl Note: Just remember to put in the time to increase your education on these...they are wildly exciting but as a whole, the sector is a gigantic loser so you've got to spend the time and find the best of the best!]
Whew, so that was Rick Rule! Just remember me, your faithful nerdy note taker, when you are rich and famous thanks to Rick!
And actually, because I provided such detailed notes on his talk, let me also provide you a link to his company, Global Resource Investments, which is now a division of Sprott Asset Management. They do great work, as does Casey Research, who puts on these conferences and invites all of these interesting speakers to come.
If you want to learn more, check them out, and I’m sure Casey will be selling the audio from the event (it’s usually around $300 or so…much cheaper than attending the conference, but TRULY invaluable as I hope you can see from my notes!). I’ll let you know the link when they release the audio—I’m unaffiliated, just a happy customer. Update: They just released the link— it’s $395 for the collection and you can order it here!
To your financial success,
— Kung Fu Girl
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