Continuing my interviews from the recent Casey Summit, with big thanks again to the awesome Casey Research team, I had the great honor to sit down and talk with one of the (if not THE) best investors I have ever met (although he might consider himself more of a speculator). 🙂
Rick Rule is Chairman of Sprott U.S.A. and is a legend in the natural resource investing world. He has been an instrumental investor in not one, not two, not three, but multiple “10-baggers” and more. (Pretty amazing!)
He is also one of the hardest working people I know (and one of the nicest). I cannot actually remember a conference that I have been to recently where he has NOT also been there and working (and I have been to a lot of investment conferences this year!).
And when he is working, he really works. Hard. (Although I’m sure he enjoys it, too — he loves what he does and it shows!)
He is the first one up and giving workshops and sessions every single morning at the very earliest time slot (usually 7am), giving at least one if not multiple keynote speeches, granting interviews (thank you, Rick!), and serving on panel discussions. And when he is not on stage actively presenting and educating attendees, he is personally sitting at the Sprott Global booth patiently answering question after question from prospective and existing customers alike.
I point this out because by all accounts Rick is a very wealthy man, and sometimes there is a perception (thank you, Paris Hilton…) that wealthy people don’t work very hard or didn’t “earn it” — somehow they just “got lucky”. While I’m sure Rick considers himself lucky (he loves what he does, loves his wife, loves his life, and seems like a very happy and fortunate man), I doubt that he would attribute his success in either business or investing solely to “luck“. He’s an outstanding credit analyst, businessman, and investor, and works very, very hard at what he does (and he’s the best!).
It was a real honor and pleasure to sit down and talk with him about investing and what he believes it takes to be a great investor, and of course where he sees the junior resource market today.
I hope you enjoy watching (or reading…transcript is below) as much as I enjoyed talking with him!
You’ll discover the book that changed his life (hint: nope, it’s not the same one that changed mine, although it’s a great one…), to what he attributes his success, the assets that he personally invests in with his own money and how, how he develops his investment theses (and sticks to them…), how much cash he’s holding right now, what he believes you need to learn and do to become a good investor, and much more.
I hope you enjoy it!
Please let me know what you think in the comments!
Hello, I’m Susan Fujii, here with Kung Fu Finance, and today I’m honored to be speaking with Rick Rule, Chairman of Sprott USA, true smart money investor, and an amazing track record of success in all of the resource and mining industries and beyond.
Thank you so much for being here.
Thanks for the opportunity, Susan.
Yes. I really want to know how you do it. You are one of the few people who I know who is able to actually buy low, and sell high, and you have an outstanding track record of doing that. What is your secret?
Well I’m delighted that you haven’t tracked all of my trades, but it’s something I endeavor to do and mercifully do more often than not.
It’s something that nobody ever gets completely right.
And I would say that my relative success has to do with three things:
1. I’ve been at it a long time.
Malcolm Gladwell teaches in The Tipping Point that you become good at something after 10,000 hours. Mercifully because I’ve been on the same thing my whole life, I got my 10,000 hours in by the time I was thirty. That helps a lot.
2. The second thing is that I really like what I do.
Most people in finance are in finance because they like to spend money.
I don’t. I like to make money.
I joke that I would do this for free if it didn’t pay so well. That’s a lie, in fact, but I do really, really, really truly enjoy what I do.
3. And the third thing is that I’m not a generalist.
I am very competent in understanding resource-based investments, which is different than watching the oscillation of the share prices.
I’m reasonably skilled as an investor in financial services businesses, because I’ve started some and operate some, and I also invest for my own account, although not with other people’s money, in classical, old value stocks, Ben Graham-type stocks that are cash-flow positive, where you are buying them at a discount to net working capital…in other words, enterprises that offer you a free bond. Free is a good price, so I do that. And I don’t do anything else.
If I hear the Casey Research editor, Alex Daley, talk about technology stocks, it fascinates me, but I won’t let myself be tempted, because I don’t feel like I have any competitive advantage over anybody else in sectors I don’t understand.
So I would credit my success first of all to experience, secondly to passion, and thirdly to the discipline which probably comes with age, of not doing things I don’t understand.
Fantastic, yes. Reminds me of a quote from Bruce Lee, who said, “I fear not the man who has practiced 10,000 kicks, but I fear the man who has practiced one kick 10,000 times.”
(laughs, nods head)
Yes, wise words.
So, if a person were to get into the resource sector, and want to become a resource investor, what is the best way to start down that road and learn how to evaluate companies and stocks?
The best way to become an investor, not a resource investor, an investor, is to start by reading a book called The Intelligent Investor by Benjamin Graham.
That book changed my life. I read it when I was 19…I was going down the road to evil, and I wanted to become a tax lawyer in the resource business, and reading The Intelligent Investor literally changed my life.
It’s an easy book to read, the value to the reader relative to the effort required to read it is astonishing.
If you read that book, and importantly if you practice the techniques that Ben Graham teaches, you will make money investing in any field, once you get to know the field.
Beyond that, in the resource business, because the resource business is highly specialized, the investor needs to invest in himself or herself, with as much diligence as they invest in companies.
You need to educate yourself. Most of your phyle, in one way, shape, or form, is associated with Casey, which is a great place to start. I’ve met a lot of investors who have a million dollars invested in the sector, and don’t spend a thousand dollars a year on information acquisition.
It’s insanely stupid.
There are lots of resources out there that people can access. There are conferences, there are books, there are newsletters, and educating yourself is incredibly important.
The third thing that a resource investor needs to do is understand that resources are fairly unique asset classes, and some of the rules associated with general market investing don’t apply to resources.
In particular, resource businesses are extraordinarily cyclical, and they are extraordinarily capital intensive.
And because they are capital intensive, in the short term, supply / demand imbalances don’t get fixed by the market. Classical Austrian Economics don’t apply in the near term to resources because they are so capital intensive.
If the copper price runs from $.75 to $4.00, you would expect an immediate response from the market to increase copper supply and reduce demand. But because increasing supply takes 10 years, the material imbalances can last for a long time.
Similarly, when the copper price collapses back from $4.00 to $1.00, the surplus supply doesn’t go away easily because there is too much stranded capital.
So what a resource investor has to learn is that markets do work, but they work over time. I say, in resource investing, you are either a contrarian, or you become a victim.
Those are your two choices, and the choice is yours.
And how do you go about formulating your investment thesis?
My basic investment thesis in natural resource-based businesses is, from an industry viewpoint, I try and find a commodity where the industry is in liquidation. I know it sounds odd, but I try and find an industry…let’s go back to copper.
There was a point in time in the early 90’s when copper was selling in the market for $0.62 / lb. and it cost the industry $0.80 / lb. to make it. So the industry was losing $0.18 / lb. and being miners, trying to make it up in volume. Profoundly bad business.
But it’s interesting when the industry is in that situation only one of two things can happen:
1. Either the world runs out of copper and there’s no electricity,
2. Or the copper price goes up.
And you have absolutely no competition buying copper stocks when they are losing $0.18 / lb.
You have to understand that they can go on losing $0.18 / lb. for awhile, you have to have some patience, but if you buy into a sector where the sector is truly in liquidation, the price of the commodity can only go in one direction.
The optimization discussion, that is how you participate in the sector, is something that really depends on your risk tolerance, your time tolerance, and things like that, but my basic thesis is to buy into industries that are temporarily, structurally flawed, and hold those investments for longer than most people dare…six or seven years.
And how do you come up with the fortitude to hold, when sometimes it doesn’t go quite your way? You gave an example the other day I think of $0.10 down to $.01 then to $10.00…
Experience, experience, and that was a useful example. The ultimate contrarian investment, the one that has been the archetypical contrarian investment for me was uranium.
The uranium business had done extraordinarily well in the 60’s and 70’s, it did extraordinarily well, and then three things happened:
1. Three-Mile Island
3. The energy price contraction of the early 80’s
When the uranium market crashed, it was a crash of epic proportion. The price of uranium fell from the mid-thirties to $8.00.
The industry was producing uranium for $20 / lb. and selling it for $8.00 / lb., losing 60%, and of course trying to do it spread over millions and millions of pounds.
But from a contrarian point of view, it was better than that—people weren’t just bored of the investment thesis…they hated the stuff. When you mentioned “uranium”, people looked at you with spite and said, “How can you invest in Chernobyl? How can you invest in Hiroshima? How can you invest in Nagasaki?” and I would patiently say, “I’m not. I’m investing in something that when you walk into a room and hit the switch, the lights go on. That’s what I’m investing in.”
But anyway, it didn’t matter, and it was very clear to me that in the late 90’s, because the industry was so far underwater, and because we were using 150 million pounds of uranium a year, and only producing 80 or 90 million pounds, that when the above-ground surplus went away, that the uranium price would go absolutely crazy!
And so I started buying uranium stocks. I think I mentioned, but at least I will mention for your viewers, one of the problems with my approach, one of the problems of being me is that I’m an extremely linear thinker.
My principal investing problem in fact is that if I know this to be true, this to be true, this to be true, and this to be true, and the ONLY possible outcome is this, I confuse the words “inevitable” (which I got right), with “imminent” (which I got wrong).
And with regards to uranium, I was in fact, four or five years too early. Four years or five years early at a 10% cost of funds is often “wrong” as opposed to “early”.
In the case of uranium, however, and in the case of most commodities, when the commodity snaps back in price, the operating margins that the producers enjoy are so extraordinary that the gains that you make are spectacular.
We bought a package of five uranium stocks, the only five uranium juniors in the world, at that point in time, we bought the whole waterfront—we bought vast amounts of those stocks.
And I was sort of congratulating myself for my genius in 1998, thinking that a huge fortune was inevitable, and in 1999, I was underwater, in 2000 I was seriously underwater, and in 2001 one of the stocks had fallen by 90%, which is a true test of fortitude.
Those are useful tests, because I looked at it and said, “let’s rethink this thesis—what went wrong?”
And the answer that came back to me was time…nothing else went wrong.
I had used up three or four years of the time by then, so the risk that I had exposed myself to had lessened over time, and I said, “OK, you’re either right or you’re wrong. You either have to sell all of your stock, or you have to at least double your position, and you have to do it this week, you can’t procrastinate.”
You either have to sell and admit defeat, or you have to say, “no, I was right, but I was wrong in terms of time, but time has passed, so I am really right.”
Mercifully for me, I took the latter course, and I bought a bunch more stock. And the stock that I had given the example in, Paladin, had gone from in 1998, $0.10 and then $0.12, down to $0.01. We bought a large position at $0.015 (1 ½ cents) and the stock in 3 ½ years went to $10.00. It was a very, very, very instructive lesson.
When you have had an experience like that, it gives you….well, first of all it gives you more cash than you’ve had before, but having the cash gives you the courage, too.
Very instructive lesson.
Definitely, that’s wonderful. You do a lot with private placements, and I have people asking me all of the time, “how do I find private placements? How do I get involved in them?”
I think they hear about them and think “This is the panacea, the answer to all of my problems, if I can only get into a private placement, then I am going to be rich!”
How do you go about diversifying your risk among these private placements? How do you judge which ones are good, which ones are not, and how would you recommend someone get into that?
Well, first of all you apply standard securities analysis. Picking the right company is the first step.
Private placements are certainly for sophisticated speculators, the way that you play it, the reason that you play it.
And here’s why: in the juniors, the Casey style stocks, these are exploration companies, and your listeners need to know, in exploration, the most predictable outcome is failure.
And if you’re going to be in the business, you need to understand that if you buy ten stocks, you are going to lose money on six of them. You’re going to break even on a couple. You’re going to make some money on one.
But if you select well, one of them will be successful. The beauty is that if you lose 20% of your money on six of them, and you make ten times your money on one of them, the math is so solidly in your favor that your winner amortizes your losers plus gives you an acceptable rate of return.
The reason that you do private placements is that if you negotiate correctly in a private placement, you get a warrant. A warrant is the right, but not the obligation, to buy more stock at a fixed price at a fixed period of time.
In a private placement, you are contributing capital to a company to answer an unanswered question in exploration—“no” answers are frequent, “yes” answers are profitable.
And having the ability to double your position at the same cost retroactively after you get a “yes” answer is the thing that is the difference in exploration speculation between wild success and moderate success or worse, dismal failure.
But it’s important that you understand the selection criteria.
In the context of resource speculation, we talked first about finding commodities that are disfavored. The second thing is that looking at the financial plan of the company is critical!
And I would say in 80% of the cases where I’ve interviewed exploration company managements and I have asked them their plan with regards to answering unanswered questions, they didn’t have an answer, they didn’t have a plan.
That is as though you and I set out to walk from San Diego to Los Angeles and headed East…it doesn’t work.
The third thing is, and as an Austrian you’ll understand this well, Pareto’s Law works. Pareto’s Law, for your listeners who aren’t familiar with it, is popularized as the 80/20 rule, where 20% of the population generates 80% of the utility in any given task.
From an investor’s point of view it is critical to understand that the 80/20 rule is what the bell-shaped curve is about.
There is one 20% of the population that generates 80% of the utility. There is a different 20% of the population that generates 80% of the disutility or aggravation.
It’s equally important to know that the results are logarithmic.
Meaning that if you take the lip of the bell, the 20% that are achievers, and you run them through the same performance dispersal curve, they align conformably again, which is a different way of saying that 20% of the 20 do 80% of the 80, or 4% of the population generates about 65% of the utility.
And this is true with money company managements.
If you think about the fact that worldwide there are 4,000 juniors, understand that of the 4,000 juniors, 200 of them will generate 65% of the gains. If you as a speculator focus on teams that have been serially successful, and importantly, successful at endeavors that very closely resemble the endeavor they have chosen for themselves this time, statistically over a decade, you will succeed.
Those are really the three tests.
That is great. How do you see the market now, speaking for these junior mining companies…it’s been tough over the past two years, but is this a good time to buy?
This is a wonderful time to buy if you are selective. The overall junior market is going to go lower—your listeners need to understand that.
If you merged every junior exploration company in the world, all 4,000 of them, into one enterprise, called Junior Explore Co., this business would lose, that is spend, between $2 billion and $8 billion a year more than it earned.
So if you looked at the whole business as one enterprise, what would be an appropriate valuation? Should you value it at 5 times losses? 8 times losses?
Gold is glamorous, maybe 15 times losses…you get my point.
John Kaiser, whom I respect a lot, published a study eleven weeks ago, which I haven’t independently verified, but I trust him, and he suggests that 50% of the companies on the Toronto Stock Exchange, the Venture exchange (TSX.V), share three common characteristics:
1. They are selling for less than $0.25
2. They are selling for substantially less than their 52-week highs
3. They have less than six months’ working capital
This is a herd of lemmings that is approaching a cliff at some speed. That would suggest that since we’re in a market that took bad companies up with good companies with reckless abandon in 2009 and 2010, we’ll take good companies down with bad companies on a going forward basis.
I think we’re approaching a period like 1991 and 1992, where every week the exchange publishes a list of companies that have been delisted or suspended.
And for people who aren’t or haven’t had much experience in stock selection, whose portfolios are populated with these, for want of a better phrase, pigs, will experience the kind of market that they sadly deserve.
At the same time, the best 5% or 10% of the companies in the sector are already beginning to rebound, and the rebound will continue for three reasons:
1. In the first instance, these stocks are already unnecessarily cheap
2. In the second instance, it is as a consequence of these low capitalization levels.
It is cheaper for larger companies to acquire smaller companies rather than to discover and develop reserves themselves. It’s cheaper to buy resources on Bay St., than it is to find them in the boonies.
3. And in the third instance, and this is the most important, we have now, in this market, been funding junior exploration well for ten years. And ten years is what it takes.
The discovery cycle that we enjoyed in Central Nevada in the mid-80’s came about as a consequence of money that we started spending in the early 70’s. It took ten years to refine our skills, to develop the databases, to drill, and once the discovery cycle began in earnest it was truly spectacular.
We’re now ten years into an exploration cycle worldwide in the juniors, and we’re just trying to see the discoveries. Everybody wails and moans about what a bad market this is, and yet, if you give this market an excuse, GoldQuest is an example, $0.06 to $1.60, Reservoir Minerals, $0.30 to $3.30, Africa Oil, $0.80 to $10.00—this is a market that rewards real discovery.
And people don’t recognize it, but after ten years, hiring better and better and better people in the better juniors, note “better, better, better”…
(laughs) Right, not the pigs!
We’re in a discovery cycle, worldwide! And we’re going to have in the next two years, twelve discoveries, or eighteen discoveries, we’re going to have serial discoveries, and these discoveries are going to propel stocks 15-fold, 20-fold, 25-fold, adding hope and liquidity to the sector.
Not enough to float the whole sector, because the sector is terminally flawed, but enough success to make absolute boatloads of money for people who understand the process.
Fantastic. So if you choose the top 20% of the top 20% then you’ll be in good hands.
That’s right, that’s right. And don’t worry! Don’t worry about the sector making money.
Worry about YOU making money. That’s all you can control. It would be nice if you could take care of everybody, but that’s not going to happen.
Pareto’s law applies to stockbrokers, applies to investors, applies to newsletter writers, too.
What about the macroeconomic environment? How do you take that into consideration when you’re investing? We’ve been talking a lot about that at this conference, obviously — are you with Lacy Hunt, thinking that interest rates are going to be low for the next 20 years possibly? Or do you see us hitting a wall in a much shorter time period?
I think about it, but it’s maybe in fifth place in terms of the risks I consider. Your website is a good place to say that the greatest risk that an investor faces is located to the left of the right ear and to the right of the left ear. You are your biggest risk.
Markets themselves are topics I think that have so many variables that understanding them well is impossible.
For me a market is a facility for buying and selling fractional interests in businesses—it’s not a source of information.
And I think about macroeconomics a lot, but macroeconomics isn’t what drives what I do—human action drives what I do.
If I paid too much attention to my own political analysis or my own economic analysis, I’d probably be a hermit.
You know, I’d probably take what I had, and take my wife, and take whatever friends would go with me and go someplace where I could defend them…and that’s not really productive.
Certainly, I’m not a political analyst or an economic analyst—I’m a credit analyst, that’s really what I am—a shylock, for want of a better phrase, and when I look as an example at the math associated with the U.S. Federal Government, it’s not a pretty picture.
At a prior Casey Conference we had David Stockman as a dinner speaker, and Stockman said a couple of things that were useful to me:
He said the on balance sheet obligations of the U.S. Federal Government were about $15 trillion…by the way that’s 15 with twelve zero’s behind it…it takes a long time to write it…and he said that the off balance sheet liabilities (things like Medicare, Medicaid, unfunded future liabilities) were variously described as being between $70 trillion and $150 trillion.
And he said the aggregate household savings in the United States had increased a lot, to $500 billion.
So just for fun, I forgot about Medicare and Medicaid and all that kind of stuff, and I forgot about the $75 trillion, whatever the number is, and I concentrated on the $15 trillion.
And I wrote down $500 billion, which is the new income with which we could service this debt, and I wrote down the $15 trillion, and I scraped nine zeros off of each.
And it looked to me like a household that had, you know, $15,000 in credit card debt and they were going to service it on $500 / year income.
It was not pretty.
And what’s interesting about it, is that it obviously isn’t a problem confined to the United States. I joke at conferences like these, where people are down on the dollar, that the dollar is the worst currency in the world, except all the others!
And so you have a situation where as dire as the U.S. situation is, at least mathematically, the European situation, from the numbers at least, appears to be worse.
And so when I think about macroeconomics, the only thing that it really causes me to do, which is useful, is it causes me to continually run pretty good cash reserves.
I think that’s the only way that you can protect yourself.
Clients say to me, in the partnerships I manage for example, “Rick, you’re 35% in cash, and that cash only generates us 25 basis points. So we’re losing 5% per year in purchasing power.”
And I have two answers to that.
The first is that losing 5% is better than losing 35%.
But from the point of view of a speculator, from the point of view of a shylock, really there’s an opportunity cost associated with not having cash.
Because if you experience some precipitous decline, the decline of the type that we enjoyed in 2008, having the cash gives you the ability, and it gives you the courage to take advantage of calamitous mistakes made by others, and not having the cash exposes you to making those same mistakes that you would otherwise hope to take advantage of.
And I would say that a sense of the political economy, a sense of macroeconomics, would leave a rational observer, somebody who had graduated third-grade math, to want to maintain relatively large cash balances.
I wouldn’t dissuade people by the way from keeping some portion of the cash balances to what Doug Casey famously calls “good cash”—gold, silver, platinum, and palladium—the physical precious metals.
That is great advice—thank you. Do you have any last words of advice for investors?
Yeah, I do. If it isn’t fun, don’t do it!
I’m really lucky. I’ve made…I work very hard, I’ve taken a lot of risks, I surround myself with spectacular people…the people I do business with are my best friends.
I can’t WAIT to get out of bed and go to work. When I’m on vacation I enjoy time alone with my wife, but after about two weeks I think, “you know, I’d really like to do something!”
Find a sector in investing, whether it’s natural resources or biotechnology or financial services that fascinates you.
If you like chess, find a sector in financial services that you enjoy strategizing about the same way you enjoy chess and stick to it. Do it.
That’s great, thank you so much.
Thank you, Rick! I hope you enjoyed that…Rick is a great man and investor. Please let me know what you think in the comments!
Also, I want to let you know that I will be in Denver from Thursday afternoon – Sunday morning, so if any of you local to Denver would like to meet up, please shoot me an email and let me know! My schedule is pretty packed on Friday and Saturday, but I am always up for grabbing a drink and can also maybe meet for an early breakfast on Sunday.
Thank you again for being an awesome Kung Fu Finance subscriber! I hope you are enjoying this interview series!
To your financial success,
— Kung Fu Girl