Rick Rule: Bear Markets Are Best

Happy Thanksgiving to those of you in the U.S., and a happy thankful Thursday to my dear international readers! I hope you have a wonderful holiday (or day) filled with gratitude and love.

I have a little gift for you as my way of saying thanks for being such a loyal reader and awesome part of our Kung Fu Finance community of investors!

First, a happy announcement: I hired an amazing company, enfusionize, to bring the Kung Fu Finance website and newsletter into the 21st century and to help me provide better service to you, so be on the lookout for some upcoming enhancements soon!

(No more broken links! No more unchangeable small fonts! No more ugliness! Hip, hip, hooray!)   🙂

Next, I created a PDF document for you, with huge thanks to Rick Rule and Sprott Global, of Rick’s top questions to ask these junior mining CEO’s when interrogating (er, I mean “interviewing”) them, and it’s also a terrific reference to have when thinking about buying most any new investment — I hope you like it and find it useful!  (This is a first draft, but I wanted to get it out to you ASAP!)

Finally, I had Rick’s first keynote speech from the recent SF Hard Assets Conference transcribed and I hope you find that useful and entertaining, too! (Many thanks to Rick and the awesome team at Sprott Global for giving me permission to share it with you!)

(I also sat down with Rick for a separate interview on Day 2 and will have that to share with you shortly.)

Please let me know what you think about all of this in the comments!

Have a wonderful holiday (or thankful day) and I will see you on Black Friday (doesn’t all of that shopping sound grim? I know it is called that because it’s the one day of the year that helps the retail sector get “into the black” instead of “into the red”, accounting-wise, but black makes me think of the grim reaper…which is actually not a bad analogy, come to think of it!). Instead of hitting the sales in your local mall, maybe you will find a great junior exploration mining company…they certainly appear to be on sale!)   🙂

Without further ado, here is Rick Rule…Bear Markets are Best!

(With apologies on the less-than-stellar audio quality…I think it’s time to upgrade my trusty iPhone!)

Good afternoon ladies and gentlemen.

My topic is to discuss “Bear Markets are Best” and I think that I can make a common sense case to you that this is true. It’s a pretty straightforward case, I think…most shoppers want to buy goods on sale. I think it’s appropriate that this conference, this setting, this stage, this speech takes place in proximity to Union Square, the great retail shopping district of San Francisco.

And at least for the ladies in the crowd, and this may sound like a sexist remark when I’m actually trying to flatter you, the people who have the most shopping experience, but I want to ask the ladies in the crowd, if you were walking around Union Square and you saw a sign that said “Full Price!” all the time and there was a sign across the street that said “Goods on Sale!”, which sign would attract you?

Would it be the bear market sign or the bull market sign?

My wife today, came back, having been to one of the stores around here, with a wonderful jacket and skirt suit, that she bought at a Union Square store.

My wife is vicious. I feel sorry for the merchants when she goes into the store. She looks like a pussy cat, but do not underestimate her…she is vicious.

She came back with this wonderful skirt and jacket, a suit. And she said she paid $40 for it, this suit that everywhere else would be $200 or $300.

So ask yourself, as you think about the talk I’m going to give, whether or not you would prefer to buy that suit for $40 or for $200. If the answer is $40, then you have already heard the best part of my speech.

But I know that you all feel more uncomfortable now, when it’s time to buy, than you felt in 2010 when the analysts here were abundant and it was time in fact to sell.

Show of hands, how many people here in the next 5 years would like to buy a better house than they live in now? (many hands raised) Thank you.

How many here, figure in the next 5 years, you are going to buy a car? (hands raised)

This week, how many of you are going to go buy food or clothes? (all hands raised)

Thank you, thank you.

Because the way you look at buying financial goods, stocks and bonds, and the way you look at buying other goods, are very, very, very disconnected.

And I would suspect that most of us are relatively good at shopping for cars. Pretty good at shopping for houses. Very good at shopping for food and clothes, and lousy at buying financial assets.

Everything else we buy on sale!

Do you go to an automobile dealer and say…look, this is an upscale crowd, so say if you want to buy a Lexus or something like that, do you go to an automobile dealer and choose a Lexus for $70,000 and then say to the dealer, “do you prefer $80,000?”

Does anybody do that? (laughter and “no’s”)

If you are going out to buy a house. Would you rather buy a house in San Francisco in 2012 or would you rather have bought that house in 2006?

Anybody have an answer?

Goods on sale! Goods on sale!

And what everybody needs, and everybody knows this intuitively, but we forget. Bear markets, what a bear market is, is a sale. Which is specifically why bear markets are good.

Now I’m going to talk about our behavior, our collective behavior in two different time periods. And during this discussion I want you to bear in mind a simple fact, or a couple of simple facts about human behavior:

  1. The first fact is that we like positive reinforcements in our decisions. We like, in addition to making money, we like to feel like we’re smart. We like to feel like we’re successful. We like decisions that have worked out well for us.
  2. The other thing is that our, how would you say this, our anticipation of the future is set by our experience in the immediate past.

This is very important. I want you to remember these two things.

Because it’s a very, very, very easy thing in financial markets to confuse a bull market with brains.

The price of gold goes up. The price of gold stocks go up. We buy a couple of gold stocks, they go up. We think that happened because we were smart.

That’s not what happened. And, of course in a bull market, if you buy a stock, and it goes up, and then you sell it, you are inclined to anticipate success in the next position, because you had success in the immediate past position.

And you feel good about the market. You feel good about the position of your prices.

Bear markets by contrast are different. You buy a stock for a buck, it goes down to 70 cents, you get angry, you sell at 70 cents. And you are leery to redeploy capital having first of all lost money, and secondly you felt bad about your decision-making process. So in fact, bull markets, which are dangerous, where goods are marked up, are the times where we feel most aggressive and bear markets when the market has less risk, are of course when we feel worse and we are, in fact, the most cautious.

Everybody in this room remember how smart and how aggressive we felt in 2010? Remember that? Very, very, very heady feeling. This exhibit hall probably was twice the size and had half of the empty seats. Very bad signpost.

This year, the speaking hall now is half the size and has lots of empty seats…pretty good sign!

One period which I like to talk about now in San Francisco and you’ll understand why in a minute, was the juxtaposition between that market high in 2006 and the cataclysmic market bottom in 2008.

How many people remember 2006? How many people were here?

That was probably the most enthusiastic San Francisco Hard Assets conference in history.

I gave a presentation where there were probably, I don’t know, 1500 or 2000 people in the conference hall.

I mean it was odd, I felt like a rock star or something!

And, what was interesting about that is before I spoke, and this is maybe too much information, but I had a little too much coffee.

As a consequence, when I got off the podium, I got off the podium with some enthusiasm, and proceeded to the men’s room.

And the ebullient feelings among the participants and the aggression of the participants was exemplified by virtue of the fact that 30 people, hopefully all men, followed me into the men’s room!

They formed a couple of concentric semi-circles behind me as I was going about my business. They were asking me, literally, they were asking me questions, and if anything were more private than the function I was engaging in, I would have needed to go to my room!

It was wasn’t that these were bad people. It wasn’t that these were people who wouldn’t have normally respected my privacy.

It was really the function of a bull market. And the animal spirits…that might be the wrong phrase to use in San Francisco…overwhelmed their sense of social decorum.

You contrast that with 2008, you had a psychotic break in the market. Never mind people didn’t follow me into the men’s room; people didn’t even follow me into the speaking hall! I think to the time of 2008, when without too much difficulty, we identified 19 companies selling at 50% discounts to net-net working capital.

Thank about that, there were 19 companies that were selling for half cash. And people were unwilling to buy them!

Now, if you walked out the front door of this hotel, you know, on Mission, and somebody came up to you and said “Listen, I’d like to give you a dollar bill for those two 25 cent pieces that you have.”

The correct answer is “Yes”. “Yes, I’ll do that for you! A dollar for my 50 cents. I’m there!” That’s what a bear market is.

In 2006 when the value proposition was very different, “I’ll give you 50 cents for those two dollar bills of yours!”, everybody was eager, so eager they followed me into the men’s room.

In 2008, when in fact goods were on sale, and I had something intelligent to say, not that I wasn’t kind of intelligent in 2006, but I couldn’t have made you any money, there was absolutely no interest, whatsoever. But let’s bring it forward a little bit.

In 2010, the level of the companies that are exhibiting here, and by level, I mean the share price, or market capitalization…was substantially higher than it is now. 50% higher, 60% higher, 100% higher?

What happens to an asset? To a decent asset? Where nothing with regards to the asset changes, and the price falls by half?

It gets precisely half as risky!

If nothing else changes but the price falls by half, it’s half as risky.

And yet, this is regarded by speculators as a bad thing. Are you with me?

We need to shop for financial assets the same way we shop for every other kind of asset. It is unique in terms of our response to financial assets.

One of the stories that I like to tell so much, and those of you who have heard it will have to endure it but those of you who haven’t will perhaps look at this as an illustrative story.

Our old Sprott offices, our old offices in California, were located in a Southern California shopping center.

I will tell you a story of an apocryphal Southern California couple, who, being efficient shoppers, the wife would go to the supermarket, while the man would come to our offices. The wife goes into the super market, a Von’s Market, and she sees a brand of tuna fish, a good brand of tuna fish that her family is familiar with, a good brand of tuna fish, and it is selling for $2.00 / can, which she ascertained was a fair price and her family likes tuna fish so she bought some tuna fish, and put it in the car.

Her husband came to our office and there was a stock he had been familiar with from his newsletter and it was selling for $2 per share, which he ascertained was a fair and reasonable price so he bought some stock for $2 per share, and they both went home reasonably satisfied with their purchases.

They came back two weeks later, and repeated the same process…the wife went to the store, and the same can of tuna fish was $4 per can…it had been raised in price 100%. And she was outraged! She went and gave the store manager a piece of her mind, and she was just totally disgusted, and managed finally to buy herself some chicken, to substitute for the tuna fish.

The husband of course came to our office and saw that nothing had changed with his stock except that the price was now $4 per share, and he was delighted! He was so happy he bought himself another 1000 shares! So they both get in the car, she’s disgusted, he’s elated.

They come back two weeks later, and she goes to the store and she finds out that all of the other housewives had the same reaction to this price-gouging in tuna fish, and this store is buried in tuna fish, nobody is buying this tuna fish, they are stacked from the floor to the ceiling with goddamned tuna fish, and so they mark the stuff down to a buck a can…and she’s delighted. She buys so much tuna fish that their car is riding like this (hand movement to show weighted down trunk of car).

The husband of course comes to our office and sees that the shares that had gone from $2 to $4 are now at $1, and in disgust, he sells it all.

Who made the right decision?

The woman who bought the goods on sale!

And what is a bear market?

A bear market is very, very, very simply goods on sale. What we all have to understand is that the cause of a bull market is a bear market, and the cause of a bear market is a bull market.

That’s the way things ebb and flow. Markets actually work!

Let’s look, as an example, at the U.S. natural gas market over the last ten years. Ten years ago, the price of natural gas was over $10 per million BTU, and we were standing on liquified natural gas (illegible) to import gas from other parts of the world.

What happened? Exactly what you would think would happen when you were in first year economics…the high price reduced demand. People found a way to conserve—as an example they would substitute coal for natural gas and generation of power, and the very high prices, the high margins that existed for producers, caused people to go out and find new ways to drill for natural gas. So supply increased, demand fell, and what happened?

The price fell accordingly.

Bull markets beget bear markets, and bear markets beget bull markets.

The bull market that is in front of us is being caused by the bear market that you are enduring today.

They say you make money in markets by buying low and selling high, but everybody wants to be a contrarian only when it’s popular!

It doesn’t work that way. If you are going to sell high, you have to remember to buy low.

Now we’re going to go through the thesis as to how we do that, but I want you to remember, in the beginning, that bear markets are what cause bull markets.

What happens, people tell me in markets like this, if these markets *don’t* come back? How do we know that this is a rational expectation as opposed to aberrant financial behavior?

And I think you have to look at the underlying investment thesis.

This is an important thing to do anyway, of course…I digress, but one of the mistakes that most of us make is that we misunderstand what a market is.

Many people think that the market is a source of information. And in the short-term the market certainly isn’t a source of information, because the information that’s displayed in the market is the opinion of the mob.

It’s interesting to me that many, many, many smart geologists I know second-guess themselves in penny-stock markets based on pricing levels in stocks that were established by 10,000 people who know way less geology than they do!

The market isn’t a source of information, it’s merely a facility for buying and selling fractional ownership of businesses.

What the market gives you is price information, and price information only has utility if you understand something about the value.

It’s the discrepancy between price and value, which is where you make money!

If you misinterpret the signal that the market gives you, the price information, and allow your decision to be made by the mob, you are my rightful prey!

It is only the discrepancy between price and value that matters.

So let’s look at the underlying thesis. It is my belief that we are about midway through, and I can’t tell you whether that’s accurate, but it is my belief that we are in a natural resource bull market.

I believe that we are in a cyclical decline in a secular bull market.

And let me defend that thesis:

Markets happen for two reasons: supply and demand.


Let’s look at supply first: these are capital-intensive cyclical markets—periods of high prices bring on more supply slowly because of the capital that is required to develop productive capacity, and because of the political constraints of adding to supply—permitting, taxes, political uncertainty.

We are living, today, in the natural resource business, on investments that were made in the 1950’s and 1960’s and 1970’s.

We had in this market, a tremendous bear market that lasted from 1982 – 2002, a twenty-year bear market that constrained investment in natural resources of all types around the world. And remember that these investment constraints lead to long-term declines in supply.

We all know that you can’t stand on the lip of a gold mine and throw in fertilizer and water and have the mine grow more gold.

Every day you produce a mine, the mine gets smaller, and so you constantly have to look for new deposits, and build more productive capacities, which for 20 years we did not do.

We are supply-constrained, and the supply constraints continue today. Supply constraints such as credit markets…although there is plenty of credit in the world, it’s all short-term credit. And increasingly, the credit that’s offered goes government→big bank→ government. It doesn’t get outside of that nice little circle to do things like build copper mines. I think it’s a truism today that if you went to somebody like Deutsche Bank and asked them for $4 million to build a copper mine, if they could raise the $4 million they would take it, but they would keep it—they wouldn’t lend it to build a copper mine.

So we have supply constraints as a consequence of credit.

We have increasing supply constraints because governments around the world are responding to higher commodity prices by demanding higher social and political risk from resource activities— higher taxes, which is a different way of saying more theft from the center against investors, and finally there is a threat of resource nationalism, because it’s not enough to steal 50% of the cash flow—we’ll take it all, thank you!

These are all supply constraints that will have a serious long-term impact on markets.


On the demand side of the equation, I think that the message is also longer-term bullish, and this is a very, very, very important thesis. Economic leadership in the world is changing slowly, from the stagnating Western economies where people are becoming slowly less free and rapidly less rich, to emerging frontier markets where people are becoming slowly more free and as a consequence, rapidly more rich.

Just as markets ebb and flow, political cultures ebb and flow. And it’s a truism that countries that can’t get any worse generally get better, and a country that can’t get any better, sadly gets a little worse.

What’s important in this context is that 3 1/2 billion people at the bottom of the demographic pyramid are for the first time in history becoming slowly more free and rapidly more rich. And what’s important about that in the context of natural resources is that as poor people get more money, the goods that provide utility to them are made of stuff.

All of us have too much stuff. If we get more money it doesn’t impact on our resource markets much because we buy some little gadget from Apple or we load 1000 songs on it and give it to a grandchild, but there’s nothing in that that impacts resource markets.

But when poor people get more money, they take the per capita calorie consumption in their family from 1500 calories to 2500 calories, something I’ve done, too (laughs), but that’s not something we should do. But that’s an example…as calorie consumption increases energy consumption increases, and people might upgrade from an adobe home to a cinder block home, or they may change out a thatch roof for a steel roof.

The point is when poor people become more rich, the stuff that they buy is made of stuff. And so on both the supply side, as a consequence of twenty years of under-investment, and as a consequence of constraint from capital and politics, the outlook for resources is good.

On the demand side, as a consequence of 3 1/2 billion people striving to have a life like yours, and increasingly able to afford to compete with you for resource commodities, the demand is strong.

What happens when supply is weak and demand is strong? Prices increase—that’s a bull market, not a bear market.

The Bullion Market

And let’s talk about this same thesis with regards to bullion, because you could argue that the real prices of precious metals have not been in a bear market at all, but they’ve been in a bull market. Why would this bull market continue?

Let’s talk about that for a little while. Did anybody here watch the Presidential debates and listen to them?

I defy, but maybe you can do it…I defy anybody who listened to the Presidential debates NOT to be a bullion bug!

Why? When I listened to those two things, I can’t describe them as people, running for President or Vice President, either thing…I don’t know if any of you were struck by how little either of them had to say that made sense!

They were very good at evoking emotion, and both very good public speakers, I was actually impressed because I had a low expectation of Romney’s performance in terms of public speaking…I was impressed by how well they were able to speak to emotion.

The problem was that neither of them could have passed a class in third-grade math. Nobody talked about numbers!

I want you to think about this—the U.S. Congressional Budget Office (CBO) has told us that the on-balance sheet liabilities, and I’m just talking at the federal level of the United States, not worldwide…the on-balance sheet liabilities of the U.S. federal government are between $16 and $17 trillion.

Those of you who have a pen or pencil and paper, do this for me…write down “16” and a comma, and twelve 0’s. ($16,000,000,000,000) !!!

People throw around “trillions” the way people used to talk about “thousands”. A trillion is a LOT!

OK the ON-balance sheet liabilities are $16,000,000,000,000. The OFF-balance sheet liabilities are somewhere between $65,000,000,000,000 and $100,000,000,000,000. That’s “TRILLION”.

This. can’t. be. serviced!

It can’t be serviced. And just in case you don’t feel bad enough about this, here in the People’s Republic of California, we’ve managed to do the same thing on a grander scale per capita. And those of you who live in the Bay Area cities of San Francisco, Oakland, Vallejo, San Jose, Stockton…make California’s finances look pretty good!

So, it seems to me, given that our capacity to earn relative to the obligations that we have to service…that we have two choices:

  1. We can default, or
  2. We can default.

And that’s in the United States. The U.S. dollar of course is the strongest currency in the world. My friend Doug Casey says this about the U.S. dollar—he says “this is an I owe you nothing”…it’s a promise to pay.

As distinguished from the euro, which he says is a “who owes you nothing?”

As opposed to the yen, as opposed to the renminbi…

There are two points to this:

Is that around the world, the obligations of the center are beyond the ability of the individuals to service, and where they aren’t, the countries are engaged in competitive devaluations, deliberately devaluing their currency to maintain domestic employment and domestic demand.

Gold, silver, and platinum bullion are the only commonly accepted mediums of exchange that aren’t promises to pay…they constitute payment in and of themselves. They are currencies that don’t have a domestic constituency which favors devaluation, because if you devalue them you do nothing of use to the political class, you don’t encourage employment or anything like that.

So from my own personal point of view, mathematical expression is a truism, and you cannot add a column of negative numbers and come up with a positive, no matter how hard you try in the Presidential debates. You cannot do that.

And the fact is that bullion is the only commonly accepted medium of exchange that is simultaneously an asset without being somebody else’s liability, and is a medium of exchange that has no domestic constituency for devaluation.

Those things tell me that the bull market in gold and silver and platinum, the bull market in bullion, is very, very, very much intact.

Some of you may disagree with me, and honestly I hope you’re right. One of the things, well I don’t know if it amuses me, but one of the things that interests me and terrifies me is when I come to a conference like this and some people stand in front of you and sort of rub their hands with glee in anticipation of $5000 gold!

I hope I’m wrong…gold is catastrophe insurance.

The set of circumstances that would cause gold price to rise dramatically are sets of circumstances that would indicate a very sudden drop in people’s living standards and I like my living standards—I don’t want to experience this. But I certainly feel more comfortable myself owning bullion than not owning bullion, and I suspect that in this crowd, many people feel as I do.

So, what I hope I’ve been able to discuss in this part of our talk is that I believe that a bull market in natural resources is very much intact because of factors related both to supply and demand. And I also believe in the gold and silver bullion sector that a bull market is very much intact because it competes as an asset class against other asset classes that are actively trying to lose, and they will succeed.

Certainly the U.S. treasury market is deeper and more liquid than the bullion market, and certainly the U.S. treasury market is succeeding as we speak, because it is the least bad alternative among the fiat currencies, but when I look at the value proposition offered by U.S. treasuries, I think it’s best summed up by Jim Grant who described U.S. long-term debt as “return-free risk”.

The idea that a long-term treasury is going to pay you 3% while our currency is depreciating at 4.5% compounded, and we have proved mathematically that the operations of the federal government, at least I think we have…$100,000,000,000,000 on-balance sheet and off-balance sheet liabilities make it insolvent…the idea that I would take a below-inflation interest rate from an insolvent borrower, seems to me to believe that my alternative over time, which is bullion, is a preferable alternative.

And I suspect that there are people in the crowd who agree with me.

Why have I gone through this enormous digression? Because I believe that the set of circumstances that we are in today have a parallel in an earlier bull market that some of you might have experienced.

How many of you were gold investors in the 1970’s? Gold and silver investors? Great. You will remember fondly that bull market when the gold price went from $35 / oz. to $850 / oz., a truly spectacular bull market, a bull market on steroids. Of course it came from an oversold market, a government-controlled market, a price-controlled $35 to $850, but what I want you to remember, in addition to the fact that gold did so well, was in the middle of that market in 1975, we had a cyclical decline in a secular bull market.

Gold had risen, from 1970 at $35 / oz. to an early-1975 $200 / oz., pretty good move, a 6-bagger. And in 1975, gold fell from about $200 / oz. to about $100 / oz., a 50% decline in a secular bull market.

And many people who had the thesis about gold right in the 1970’s lacked either the cash, or the courage, or both to stay the trade. They got shaken out of the gold bull market from $200 to $100 and they missed as a consequence of that, a subsequent move from the end of 1975 at $100 / oz. to $850 / oz. in 1981. They missed an eight-fold move in six or seven years as a consequence of lacking either the cash or the courage to stay the trade.

It is my belief that what we’re in right now is a cyclical decline in a secular bull market. It is my belief that what we are experiencing as we speak is a sale.

It is my intention to take advantage of it, and it is my hope that some of you take advantage of it, too.

So, I hope what I’ve done is made the case…now I’m going to try and tell you, not what you should do about it, but rather, what I’m doing about it, and you can decide from your point of view if the strategies that I’m employing on behalf of myself and the clients of Sprott are strategies that work for you.

Firstly, I believe in establishing a core portfolio in bullion, or in certificated or bullion-related products. We own (my wife and I) a bit of physical gold and silver, we own a LOT of Sprott Gold, Sprott Silver, and soon we’ll own a lot of Sprott Platinum.

While of course I would prefer that you buy a certificated product that says “Sprott” on the top of it, what I want you to do is buy some gold or some silver or some platinum and PRAY that you don’t make a whole bunch of money on it. Own it for insurance purposes. But own it.

Please, please, please own it.

When you compare it with other sources of liquidity it will be more volatile, but at least it will be worth something. It can’t be counterfeited. You can’t quantitatively ease gold or silver or platinum.

Does anybody know what Quantitative Easing is, actually?

It’s counterfeiting!

I guess it isn’t counterfeiting if they have the right to do it, but it’s counterfeiting. Anyway, I’ve beaten this to death, but the groundwork of a personal portfolio, I think, has to include some bullion.

I also think, and some people will be happy to hear this, I’m actually not, but I think the bear market in the juniors has about run its course, which is unfortunate, I’d like to say it will last a little longer, but I don’t think it’s going to FEEL like it’s run its course.

I think that this junior market is bifurcated; I think that some substantial number of the juniors in this market are going to go to their intrinsic value, which is zero. And I think this washout is going to occur in the next 12 – 18 months, maybe 24 months, and I think this is a consequence of the fact that 60 – 70% of the juniors in the market have no value whatsoever.

It’s going to FEEL like the overall market is in a bear market, but my suspicion is that the best 10% of the juniors have already bottomed and are turning higher.

That doesn’t mean that they couldn’t go lower before they go higher again; it also doesn’t mean that they couldn’t be negatively impacted in the context of a psychotic break like the one we enjoyed in 2008.

But my belief is that the better juniors have bottomed and are heading higher. It will feel like and they will occasionally be dragged sideways or down as a consequence simply of the weight of the rest of the juniors. This means, as an example, that stock selection, as always, is paramount.

And by the way, I think this cleansing of the junior market is extremely, extremely beneficial.

John Kaiser, a good friend of this conference, showed a few months ago that over 50% of the companies on the Toronto Stock Exchange Venture Exchange shared three common characteristics:

  1. They were selling for less than $0.25 (by now probably selling for less than $0.20)
  2. They were selling substantially below half of their 52-week highs
  3. And they had less than 6 months’ left of working capital, and that was 3 months ago, and they haven’t done any financing since then

That would suggest that roughly half of the exchange is headed towards the cliff…and that’s a really, really, really good thing!

We studied a fair number of these $0.25 stocks at Sprott, and one of the things we determined to our horror, is that the median of these penny-dreadfuls had general, administrative, and listing expenses that were 60 – 70% of total expenditures, meaning that of the money you put into these companies…if you put a dollar in, only $0.35 went into the ground!

That’s no way to participate in exploration with sense. So, the good news is that these things are going to go away. And good riddance.

The bad news is of course that they constitute the bulk of the exchange, so them going lower is going to make it feel like the whole exchange is going lower…but nothing could be further from the truth.

Remember we learned earlier, that what causes a bull market is a bear market, and we are in a bear market, and the simple fact that we come off of bear market pricing will give this market some momentum.

One thing that will happen is a dead cat bounce. We are approaching a period right now, tax-loss selling in December, where we have that final, spasmodic excuse to sell. But we are already experiencing this in this market, seller’s exhaustion, which means when stocks go down, they go down on such low volume that it doesn’t indicate anything about the market, it just indicates an absence of a bid.

This is indicative of the end of a bear market; this bear market will tail for a long time, because unlike earlier bear markets, this is going to be a bear market like the ’91-’92 bear market, where many penny stocks go to their intrinsic value, which is of course, zero.

But I hope I can make a case to you in the time I have left that there is a class of junior stocks that if they haven’t bottomed, first of all certainly offer value, and will certainly trade higher in the next 2-3 year time frame.

One thing you are starting to see, you will see with much more earnestness in the next 12 – 18 months, will be takeover and amalgamation.

As Brent Cook points out in his wonderful speech, every year we produce a carbon trend in the gold business, but we don’t replace the carbon trend, and every year, we consume a bigger canyon of the copper business, but we don’t discover a bigger canyon every year.

If you look at the cash-on-cash returns of the major gold mining companies in the last 20 years, they’ve been truly spectacular destroyers of capital—they have not been efficient explorers, they have not been efficient developers.

And the truth is, these companies have to acquire ounces to grow, they can’t grow organically.

They have proven that conclusively. I wish they could, they wish they could, but they can’t.

Good gold deposits are scarce, and when good gold deposits get discovered, they get taken over at a premium.

And there are several good gold deposits (ineligible) in the juniors now. Specifically, my belief is, the leadership in the market for juniors is going to shift from the institutional investor who has dominated the market for the last 15 years to the industry investor.

Institutional investors are still experiencing disintermediation, which is a different way of saying, “money is leaving”. When money leaves a mutual fund, a mutual fund manager can’t be a buyer, he must be a seller. And so leadership can’t come from sellers, leadership will come from buyers.

And buyers will be major and intermediate size mining companies that are looking to grow.

It is also my thesis that the type of company that they buy has changed, and will change, and this is important for you to know.

The acquirers five years ago were looking for increased leverage to the gold price, they were looking for marginality, and they certainly achieved their goal…they became extraordinarily marginal.

I don’t think that’s what they’re going to be looking for—they are going to be looking for financially accretive transactions. And this market, because of its pricing, offers them up.

I believe, and specifically we are screening at Sprott, for developmental stage companies that offer three common characteristics:

  1. We are looking for enterprise value and front end capital costs that are combined, less than the Net Asset Value (NAV) established by the Preliminary Economic Assessment (PEA)
  2. We are looking at Internal Rates of Return (IRR) certainly above 25% but preferably above 30%
  3. We’re looking at payback of capital in three years or less

This is the first time in my life that these type of values have been on offer in the junior mining sector, and I don’t think that this opportunity will last more than two years.

It’s important that you understand this because the values that are established in the PEA are not perfect values, but they are the first 3rd-party values that get established in the business. And understanding the relationship between a financially accretive transaction and what you pay for, the initial parameters in the PEA, in the two years that pass approximately between the PEA and feasibility study, the bankable feasibility study, a couple of things happen:

First, usually these deposits get drilled more thoroughly, so the tons go up and often the grade goes up, and certainly the certainty associated with tonnage and grade, and the certainty associated with the costs and capital expenses will go against an increase.

But the other thing that happens is the bankable feasibility study becomes third-party validation and it becomes possible for the outside directors of a potential acquirer to be immediately covered to make the acquisition.

I’m telling you this because the arbitrage between preliminary assessment and bankable feasibility study is one of the surest traits in the junior mining industry.

How many people here own Canplats a few years ago? Not very many of you. At least I can’t see your hands. Canplats, thank you. Canplats was a classic example. In the preliminary economic assessment stage, the chart of Canplats looked like the electrocardiogram of a corpse. It went absolutely nowhere. For two years it tested me. I bought it and bought it and bought it… Sometimes I thought, listen, if you are the only guy that is right, you aren’t right, you are probably wrong. I was going against my own thinking and I was taking my cue from the mob.

But what was interesting was when they got the bankable feasibility study back, one of the outside directors, for want of a better phrase, had their ass covered legally.

It was about 90 days, after the bankable feasibility study came out, that the first takeover bid came, then the second takeover bid, then the 3rd takeover bid.

And that’s what I think is going to happen here. These companies that are financially accretive to acquirers, that have a low capital intensity, high risk, and high payback, will get taken over in the next two years. And the trigger will be the bankable feasibility study.

So the first thing that I think you need to concentrate on in your portfolios is, if you will, the lower risk junior strategies, note I didn’t say “low” risk.

The lower risk junior strategy, will be speculating on mergers in the arbitrage between preliminary economic assessment and bankable feasibility study.

This is the part where I hook you on my workshop… Tomorrow morning at 7:40 I’ll tell you more about this, and if you are very, very nice to me, I will even name some names.

The second thing, and this is much more speculative from my point of view, but I think it’s true, is the one leading the discovery cycle…(illegible) There is nothing (illegible).

Everyone says this is a bad market now, but look at GoldQuest— 6 cents to 2 dollars. Reservoir Minerals— 30 cents to 3 dollars. Africa Oil— 80 cents to 10 dollars! This is a market that rewards results, and this market has been starved for results.

For 10 years, we’ve spent money exploring. And it takes 10 years to get into a discovery cycle. And we’re in a discovery cycle. We will be surprised in the next 12-24 months with regards to discovery. And we’ll be particularly surprised because all of the hope will have been weeded out of us because of the bear market.

Finally, and I notice that my time is almost up. A couple of commercial announcements. I’d like all of you to come by my booth, which is 421. This year, like every other year, we have exhibitor stock charts. We have a stock chart for every exihibitor here. Given that we’re in a bear market, most of these stock charts look like the topographic map of a ski hill, from the upper left to the lower right, but they’re worth having.

And finally, I am doing a workshop tomorrow morning, which I would like to see as many of you as possible at. It’s at 7:40 and there I will talk to you about how to analyze, how to interrogate, how to interview the management teams at the booths here, which I think this year will be an extremely profitable endeavor for you.

I hope I have made the case that bear markets cause bull markets, and that bear markets are nothing more than “Goods on Sale”.

And I hope that you take advantage of the sale.

Ladies and gentlemen, as always, I thank you very much…

Leave a Comment: