Rick Rule: How to Interview Mining Companies

Back by popular demand, here is Rick Rule on how to interview mining company managements. Even if you are not in the junior mining company space, I bet you will find a lot of wisdom packed into his 35 minute talk (I know I did!). Rick is an amazing investor and resource speculator, and he really goes into teaching mode in this talk and shares with you exactly how to determine whether or not a junior mining company is worth risking your money on…or not.

This gets back to our Price vs. Value discussion — Rick definitely knows how to go about determining the value of these junior mining companies (and that is not an easy task!)

With great thanks to Rick and the team at Sprott Global for allowing me to share this with you…I hope you enjoy it! (I also sat down with Rick separately for an interview and will have that ready for you next week.)

Also, big thanks to the team at Future Money Trends for capturing a much better video than I did! (They have a great site if you are interested in resource-investing, by the way—they interview mining company execs, publish fact sheets, and post lots of videos…check it out!)

And now, here’s Rick…enjoy!

First of all, I’m delighted and flattered to see so many of you here at 7:40 in the morning. As many of you know, I’ve taken these early-morning shots for years, figuring that the audience self-selects; that people who came to San Francisco because they want to get away from the wife and go out to eat and stuff like that were all fine people, but I didn’t want to talk to them.

I wanted to talk to people who were ambitious and greedy like yourselves [much laughter]; who, regardless of what they did to themselves the night before, were willing to be here drinking coffee at 7:40 in the morning. I found that dedicated audiences are audiences that are more fun to talk to, so first of all, I’m flattered that so many of you decided to come.

So let’s get started! Interviewing mining company managements. The first thing is that increasingly management teams have been schooled by investment bankers to have a pitch. They have a script. And the easiest thing for you to do is to show up in front of a booth, push a button, and they give you a script. And the script is often, though not always, designed to minimize the wear and tear on the executive, as opposed necessarily to educating you about the affairs of the company. There’s nothing wrong with that; the executive that’s talking to you is necessarily charged with creating value for you in many ways, shapes or forms, not just talking to investors; but it’s up to you, not to them, to get the information that you need.

And so, while it’s useful if you would like to sit through the pitch, you should say, “OK, now let’s get down to business,” because you are trying to ascertain a few things. (By the way, most of these guys are proficient, they can get through the pitch in seven or eight minutes—they flip the charts, and if you don’t ask too many questions in the interim, which is a good thing to do, don’t ask questions — just let them get through the whole chart if you want to hear their pitch.)

But before you do that, you need to orient yourself as to what you’re doing in the business. When I say mining company managements, now I’m talking mostly about the juniors, the exploration-stage companies. It’s important for you, first of all, to understand that value is created in the juniors in exploration by answering a series of unanswered questions. That’s how value is created.

Don’t worry too much about when options exercise periods happen, when hold periods come off. All of that stuff is interesting, but it doesn’t really matter very much. What matters is: are these guys going to make a discovery? And if they make a discovery, is it worth anything? Do they have the competence to make the discovery? That’s what you’re careful about.

A big mistake that we all make in this business is that we assume that these juniors are asset-rich; we assume that they are asset plays. First of all, remember this: most exploration properties have no proven reserves, and an intelligent accountant would probably put them on the balance sheet as liabilities; that is, the obligation to spend money, rather than assets. So when you think about this business, don’t think of it as an asset intensive business, think of it as an intellectual property business.

These are really research and development businesses, just like people who are doing biotechnology or software. These guys are answering unanswered questions in an exploration process, which is very much like research and development. So, if you think about Nevada Gold exploration the way that you would think about Silicon Valley microelectronics or software, you begin to understand the process better than you would thinking about it in some other fashion.

The consequence of that realization is that in the earlier stages, people are more important than property. People are more important than property.And the first thing that you’re going to do in analyzing a junior company, in interviewing mining company managements, is you are going to do an inventory of the intellectual capital associated with the company. And so hopefully in the booth you can start with the CEO—start at the top.

But many people say, “But Rick, CEO’s will only talk to you, they won’t talk to us.” That’s not true. A passionate CEO in any business is somebody that is so driven by his or her mission that they don’t want to talk about anything else but their business. They’re like me! They can’t talk baseball, they can’t talk movies—they don’t give a damn! It’s just what they’re doing. They will talk to you. And if they won’t talk to you, that makes the decision easy – you throw the presentation away and leave. It’s really, really, really simple.

So you start with the CEO, and you say to the CEO, “What are you doing? What is this company about? And what are your specific skill sets? What have you done in the past that qualifies you to take my money in this endeavor? What specific skill sets do you have? And tell me how you were successful before, not just for yourself, I mean, if you happen to drive a Rolls Royce I think that’s wonderful, but how many other people are driving Rolls Royce’s as a consequence of your earlier activities?”

How many people here are familiar with Pareto’s Law? Pareto’s Law is the 80/20 rule, where 80% of utility in a given task is done by 20% of the population base. It’s important to note that it’s a bell curve; that’s important because there are two 20’s. There is a “good” 20% that does 80% of the good, and a “bad” 20% that does 80% of the bad. It’s odd, but these performance dispersal curves work over many population subgroups and many tasks.

What’s also important to note is that the lips, the good 20% and the bad 20%, if you run them through the same performance dispersal curve, they conformably align again, which is a different way of saying that 20% of the 20% do 80% of the 80%. Or 4% of a population base generates 65% of the utility and 65% of the disutility. And probably conformably aligns again, but we’ll leave that alone—the third standard deviation we don’t care about.

What that means in just plain English is that 4% of the management teams generate 65% of the capital gains. And your job interviewing mining company managements is to at least find the good 20%, and preferably the good 4%. That’s what we’re about. There is no guarantee that someone who has been successful in the past will be successful in the future, but it turns out to be statistically the best determinant.

So you are asking the CEO, to begin with, “What specific skill sets do you have? What have you accomplished in the past? Specifically, what have you accomplished in the past, and what was your role?” Write all of this down.

The second thing you say is, “Who is the second most important person in your business?”

Let’s say just for fun he says it’s the VP of Exploration. It’s an exploration company, it stands to reason, right? So, ask him, “Why did you hire this person? What specific skill sets does this person have and what have they accomplished in the past? Why is it that I should believe they are going to be successful in some endeavor? What skills, what attributes do they have that are deserving of my money?

And the third person, perhaps this is the Chief Financial Officer (CFO)…you understand what I’m saying. And you need to get very, very, very specific with them, because after this, you’ve got this list of people, and you take them through every director, “Why was this director chosen? What role does this director have?”

What happens in the course of this discussion is that in at least half the instances of these questions, you will find out the CEO has assumed that role because he/she wanted to make themselves 2 million shares at a nickel, and issue 4 million shares at fifty cents per share, so that they could enjoy the step-up from $0.05 to $0.50 and live for 2-3 years on the money that they raised. That’s really good for them, that’s really, really, really nice. They get to make a little bit of money and they get to have a nice lifestyle. But mostly, for more than half of the companies, this whole thing is a lifestyle- and paper-trading exercise. And it’s really good if you can come to that conclusion early, because you can throw away the presentation and you don’t have to waste any more time with them. Very, very, very useful. But you have to have the skills inventory just in case these guys get asked some more questions.

We’ve done people, now we’ll do property. This is what they love to talk about. Go in the exhibit hall; it’s interesting. If there were as much gold as the exhibitors say there were, the price of gold would be $100 per ounce! [much laughter] I saw in that room, 20 or 30 ten-million-ounce deposits. There is a boatload of gold over there! Didn’t have any drill holes in it, but there’s a boatload of gold! [much laughter]

So you have to have the property discussion with them, and you have to have your notes from the discussion about the management skills, because you’re going to let them trap themselves, maybe.

You say, “So now, tell me about your property.” And you can blame me, you can say, “Rick Rule said that exploration success is answering a series of unanswered questions. What do you think this exploration property is about? Describe the property, describe what you’re trying to achieve, describe this asset to me, describe the target size.”

One thing that I always like early in a discussion is a management team that says to me, “Everybody out there is looking for these great big deposits—they’re going to sell the company. What I’m looking for is a small, high-grade deposit that I can put in production so I can use the cash flow from that and bootstrap and build BHP.”

Wonderful seductive story, we’re all entrepreneurs so we like this idea. The problem is it doesn’t work. Everything that can go wrong with a big mine can go wrong with a small mine, but a small mine can never make you big money. So if a guy is trying to answer an unanswered question that is irrelevant, in other words, if the guy is looking for a small deposit, Bingo! I get to throw him away, I don’t have to waste any more time with him.

What you are trying to do in every step of the process is eliminate the company so that you don’t have to waste any more time with it and you can focus on companies that can actually make you money.

So if the answer to your question is that they are looking for a deposit type, and the reward size associated with that deposit type is irrelevant, thank you very much, best of luck to you, next booth. Go to the next booth. If, however, they are looking for a more attractive deposit – if the value associated with a “yes” answer is high enough that you can afford to take the risk – what’s important to determine, and this takes time, but what’s important to determine is, “Tell me, as reasonably as you can, you being a geologist and me being a layperson, why you believe this property is what you think it is? Explain to me the evidence that would support your thesis—is your thesis that you have a 5 million ounce deposit merely because you need a 5 million ounce story to get me to buy stock? Or is there in fact some evidence that would suggest that potentially, this is a 5 million ounce deposit?”

And let’s just say for fun that they have nice surface geo-chem, they have good alteration, they have some nice grab samples—they’ve done a bunch of surface work, which in fact does indicate that they have a large mineralized body. They have some grab samples that showed some grade…it seems like a reasonable story to you. The next thing that you say to him or her, running this company, is “So, tell me how you plan to test your thesis, and tell me why the plan that you have chosen, in the first instance, answers the question, but tell me how you are going to get from A to B; and tell me, if you get a “no” answer, what your next step is, and tell me if you get a “yes” answer what your next step is.”

This is important because of what you learn. Just as when you go through the management team’s resumes and you ask for the plan associated with the human resources, about 50% of the time when you do that you find they have no plan. Which is good; bingo, you don’t have to talk to them anymore. Mostly, about 50% of the time when you talk to companies about their exploration plan, “what will happen if they get a ‘no’ answer—will they drop the property? What will happen if they get a ‘yet’ answer—what question does that presuppose?”

Mostly you’ll find in more than half of the instances, that they don’t really have an exploration plan. Their exploration plan is that they are going to drill a couple of holes, try and get lucky, and if they get a good result they are going to try and raise some more money so that they can keep at it for a couple of years.

Mostly, if they get a “no” answer, they will tell you, “We didn’t adequately test the property so we have to dream up a new scheme, a new explanation to explain away our failure.” It’s very, very, very important to note that most of these people don’t have a plan, and if they don’t have a plan, any success they might enjoy is random. There’s enough risk in this business that you don’t want to expose yourself to random outcomes. So again, bingo! You get to throw the company away. You don’t have to waste any more time on it.

The point of this whole exercise is that if you’re wandering through an exhibit hall with 300 exhibitors, and you have a list of 40 that you’ve gleaned from your newsletters or from unrepentant touts like me on the podium, that you get rid of as many distractions as you possibly can and focus down on what you want.

So now we’ve gone through the management challenge and we’ve gone through the property challenge. This is where it really starts to get fun. Let’s just say that it’s a guy who runs the company, and you say to him, “Listen mister, I noticed something interesting and a little troubling to me. You have told me that you are successful in mining –in fact that you built and operated a gold mine in Archean terrane in French-speaking Quebec; but now, you’re exploring for copper in tertiary volcanics in Spanish-speaking Peru. What is it about operating a mine in 2 billion year old rocks in French-speaking Quebec that equips you for exploring for copper in 15 million year old terrain in Spanish-speaking Peru?

I have an off-color analogy that I love to use – it’s early in the morning but you’ll have to bear with me…it’s as though you went to the doctor’s office for some dentistry, and a proctologist appears. They’re both medicine, but the wrong practitioner would leave a bad taste in one’s mouth. [much laughter]

The nature of this is that not all mining tasks are created equal. Now you refer back to your notes about the skill sets of the management team, and you say, “What part of the skill sets that you described are appropriate to this property? You don’t have the skill sets associated with the task that you have organized yourselves around today; Why is it that I should give you money to do something that you haven’t done before?”

Their answer of course will be, “Well, it’s all mining.”

Well no, it’s not all mining. It’s very, very, very important that you do this. Very, very, very important that you do this. Because by doing just those two things, finding out about the property and about the the plan and the unanswered questions, and finding out about the suitability of management’s existing experience relative to the tasks that they’ve assigned themselves and that they are asking you to fund, you will eliminate probably 80% of the companies out there. Those two tasks, which you can accomplish in 15 or 20 minutes, eliminates 80% of the confusing data points that you have to screw around with.

Now we go one more step.

We’ve gone if you will, in very short form, over Mines and Management, and there’s one more M: it’s Money.

This one’s fun, too. This one’s particularly fun because the management teams almost never can answer these questions, which is very, very, very scary. It helps to have a portable computer so you can pull up either SEDAR or EDGAR and refresh the company’s management with current data available from filing statements.

You need to say, “Sir, in my experience, it takes 2 field seasons to answer an unanswered question; so it is probably going to take you 18 months to generate the kind of response that is going to get me the value that I need in your stock. If we assume it’s going to take 18 months, I have a couple of money questions. How much money has to be spent on the ground over 18 months to get me my ‘yes’ answer.”

And let’s just say for fun that the guy says, “Well, our budget is $5 million.” And you say, “Is that for a year or 18 months, sir?” Mostly the answer is, “Well, I’m not really sure.”

Well, if the president isn’t sure about a $5m budget, who else is going to be sure? So we help him along. We say, “I think that’s probably going to be for a year, so why don’t we assume it’s going to be $7.5 million.”

“Oh yeah, that’s probably a good assumption, that makes some sense.”

Then say, “Tell me, what is your burn rate? How much do you spend on G&A?”

A surprising number of times when you ask this question sort of pointedly, the guy will say “You know, I think it’s about $100,000 / month.”

“Really? Not $50,000 / month? Not $150,000 / month? Is it $200,000 / month?”

“Well, I, um, er…I don’t really know, I’ll get back to you.”

If you have a personal computer, that’s really handy, because you can pull up the guy’s quarterlies. “In fact you’re spending $200,000 per month on G&A, so to get through 18 months, you’re going to need about $3.5 million, maybe $3.2 million?” So you’re going to spend $7.5 million in the ground, and $3.5 million in G&A. Sounds like you need the sunny side of $11 million to get through 18 months to get me a “yes” answer.

“How much money do you have in the treasury?” “Uh… um… two million…” “So you need $11 million, and you have $2 million. Any ideas? It seems to me that you’re the sunny side of $9 million short of getting me the ‘yes’ answer that I need. So, how am I going to get a ‘yes’ answer and how am I going to get a double on my stock if you are going to be broke next quarter? Can you help me through this?”

I’d like to digress now and tell you a little story. About 25 years ago, there was a predecessor to this show, called the Boston Gold Show. I don’t know how many of you were ever there, it was the one before the New York Gold Show. One day I’d been speaking, and after I got done speaking I was going to fly, so I was in civilian clothes, jeans and a polo shirt or something like that, wandering around the exhibit hall. And there was a very, very, very aggressive white-shoed promoter who basically tackled me in the aisle.

It was sort of a slow show, and so, thinking, “this is going to be amusing,” I go in and he was this really wonderful, hyperbolic sort of guy, just nuts. He was going to do this, he was going to do that, he was going to drill this…I said, “Gosh, that’s very ambitious! You’re an amazing guy—you’re practically doing jumping jacks here! Tell me, what’s this drilling program going to cost, and how much do you have?” He said, “Well, money’s not the important issue.” [pause, much laughter]

“Hmm, that’s interesting, I’m here to learn, tell me more.” This is precious, I hope something like this happens to everybody here at some point in time. This guy, not recognizing me in civilian clothes, says “there’s a really hot California broker named Rick Rule who’s going to finance me!”

“You know, I’ve heard of this guy, I think he was speaking here!” He says, “Yeah, he’s really well known and is going to finance me.”

I say, “Oh, OK, why?”

He says, “He really, really, really likes the property! But the interesting thing is, Rick doesn’t like financing companies below $2/share. And so the opportunity for you is that you buy this thing at 60-70 cents per share, and as the stock goes up and Rick finances at $2, you get to leverage off of his money!”

“No shit?” I thought. So I said, “So if Rick really liked this property at $2, why wouldn’t he want to buy it at 60 cents?” “Well, you know, he has issues with low-priced stocks, I don’t know, maybe it’s the SEC, I don’t know, it’s just the way he is.” Finally, I pull out my driver’s license, and say “listen Leroy, I know this Rick Rule really well.” [much laughter]

So, it’s important you ask these money questions with a certain intensity. There’s a tendency in this industry to exaggerate. And this is really, truly, for lack of a better phrase, where the money meets the road. This is a capital-intensive business, and if these guys don’t have any money, they don’t have any business.

Remember that what you are doing is answering a series of unanswered questions. Answering these unanswered questions takes money. Without money, it’s just plain hyperbole. Every dream in the world, every wild arm wave, every good intention, every shred of intellectual capital in the absence of the money to carry it out, is completely ephemeral. These guys are selling dreams.

Which is OK, this is how the world gets built—dreamers are a wonderful thing! But these need to be really, truly applied dreams. And one of the things that happens, and you can’t really get this by interviewing management, you have to do a little bit of work on the numbers yourself, is you have to find out if these companies are truly exploration companies.

I presided over an exercise that Sprott did, looking at some number of these penny dreadfuls, maybe twenty of them. And we determined that the median of these companies were spending 65% of the capital they raised on listing, audit, general and administrative (G&A) expenditures. Which would suggest to me that 35% of the capital raised went into exploration. The probability of an exploration success, backing a management team that employs 35% of the capital at their disposal in exploration is extremely, extremely low. These turn out in many cases to be “lifestyle companies”. And I’m not opposed to anybody living a good lifestyle, I just don’t feel any particular obligation to fund it. I pay tax to other people; I don’t need to pay tax to junior mining companies.

It’s very, very, very important that you ask these kinds of questions. And assuming that you have survived all of this, assuming that you like the resumes of management, and assuming you understand why the management was chosen, and assuming that you like the property, and you like their explanation to why the property was chosen, and you like the method by which they propose to test the thesis, and you have determined they have access to the capital required to answer the unanswered question; the next thing you need to ask them is about the future.

Let’s say the unanswered question is, “We’ve established on the surface, strike, width; we don’t have the third dimension; we don’t have depth.” The unanswered question is, “We need to drill 3-4 holes and see if the surface anomaly projects to depth.” What you then say is, “OK, you think you can test this adequately with 4 holes?” “Yes, I do”. “Fine. What happens if the 4 holes are duds? Do you drop the property? What do you do in the event of a “no” answer, and what do you do in the event of a “yes” answer?”

If you get a “yes” answer, what question does that presuppose? And this is very, very, very important, because the risks in speculation are such that most of your investment decisions, most of my investment decisions, end up being failures. The expectation is failure. So your winners have to amortize your losers; and the way that your winners amortize your losers is not by shooting for 30% gains; it’s by shooting for 1000% gains. And getting a 1000% gain usually does not happen after answering just one unanswered question. You get a “yes” answer, which sets up a second question. Then you get a second “yes” answer.

I have found that by back-testing my partnerships going back many, many, many years, most of the results came from 5-6% of my positions, and the average holding period for 10/15/20-bagger was 5 or 6 years. Which means 2 or 3 exploration season campaigns, in other words, 3 “yes” answers in succession. So it’s important for you in this interrogation process to find out not merely what the value of the yes answer is, but the question that establishes, and the value of a subsequent yes answer.

What you’re doing in exploration is you are trying to be in a situation where the first yes answer gives you a double or triple, but it sets up a second question that gives you a second double or triple. What you’re trying to do if you’re rational is, if you get a double as an example, sell some stock back into the market, take your capital out of the market and get a free ride on the rest, and then try to get a 10-bagger or a 15-bagger on the balance. And that presupposes that second question.

Is everybody with me so far? OK, good.

The next thing you need to determine is “How am I going to determine your progress? Who is going to tell me? Am I going to get it from a press release or may I call you?” There’s nothing illegal about this. There is something illegal about obtaining material non-public information, but there is nothing illegal with calling the company’s president or VP of Exploration and asking them to interpret the drill holes.

“Tell me about this drill hole. Tell me what this drill hole, in this campaign of 5 drill holes, was intended to achieve; and tell me what you think it achieved; and tell me what you are going to do with the data you got from this drill hole.” Very, very, very often what you’ll find out from asking this question is that the person tasked with interpreting the drill holes, didn’t interpret those drill holes. Didn’t think in a granular fashion about what the mineralization, what the alteration that he or she encountered in the drill hole means in the context of their thesis in regards to this property. They didn’t think about what answer or what question should have evolved from the data that you paid for in that drill hole.

I know this sounds hard. It really, truly isn’t. Because the point of all this is not to get yourself a whole bunch of “yes” answers. It doesn’t happen very often. The point is to start with a list of 30+ companies and whittle that list of 30 companies down to 4 or 5. You will never, ever, ever in your life get an interview where every question that you ask comes back to your satisfaction. It won’t happen. You’re not looking for a situation where you ask 10 questions and you get 10 perfect answers. What you’re trying to do is take a list of 30 companies and make it a list of 5 companies, and then spend the rest of your time on the 5 companies. It’s important that you do that.

For those of you interested who are interested in this line of reasoning, on our website, http://www.sprottglobal.com/, there’s an article I wrote probably 25 years ago, called “9 Nosy Questions to Ask Mining Company Managements”. I see a lot of people still walking around the exhibit hall today with the 9 Nosy Questions, with those questions, as it’s sometimes easier to use my questions than to think up your own.

It’s not as efficient, however; it’s very important that you establish your own relationships. I think I’ve beaten you with enough data and technique this morning.

So I think what I’d like to do now for the 2 1/2 minutes I have left is to let you to ask any questions that may have come as a consequence to this or to ask any other questions that you may have in any way, shape, or form.

You know, I consider this an education mission…In a biblical sense I’m here to teach you to fish. And the gentleman here said, “That’s very good, Rick, but what I’d like you to do is catch the fish, clean the fish, fillet the fish, and serve it up to me cooked perfectly with garlic.” That great American economic philosopher, Janet Jackson, Michael Jackson’s sister, she paraphrased this very well, she said, “And what have you done for me lately?” [much laughter]

You need to understand that because I do transactions I can’t do research, and recommendations are regarded by the SEC as research so I can’t do them. I am required, however, to disclose conflicts of interest, so if I say something nice about a company, you need to understand that this is NOT a recommendation, which would be a felony, it’s a disclosure, which is a requirement. Do we all understand that?

I have been increasing my conflicts of interest in virtually all of the prospect generators. These are companies that use small amounts of working capital to generate ideas which they farm out to other mining companies and let the other mining companies do the heavy lifting. My experience in prospect generators in the last thirty years, is that my prospect generator portfolio has outperformed the general market portfolio by three standard deviations.

It’s the single-best exploration activity that I have ever been involved in. And so we have recently done micro-financings, because these companies won’t take much money, something that I’m mostly grateful for, but occasionally resentful of if I don’t own enough…we have recently done micro-financings in Miranda (TSX.V: MAD), and I’m just talking about exhibitors that are here, Evrim (TSX.V: EVM), Millrock (TSX.V: MRO), and probably a couple of others that are here but I can’t remember the micro prospect generators that we’ve been buying. But we’ve done financings in those companies, and so I’m adding to my position in prospect generators. I always do in bad markets, I love that.

I have been adding to my conflicts of interest in Fission (FIS.V), which is a small uranium explorer, I LOVE the uranium sector because everybody else hates it. They have a new discovery which may turn out to be something or may turn out not to be something, but I think the company gets taken over by Denison (NYSE: DNN), consolidating the Athabasca Basin and whoops! No time, I can’t give you any more names.

Ladies and Gentlemen, I have overstayed my welcome by about 20 seconds and I don’t want to cut into the next speaker. I want to tell you that I’m grateful and flattered that you got up at 7:40 this morning, and I hope that some of this made it worth your while.

Good luck this year, tell me how the questions went next year. Thank you very much.

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