Rick Rule, president and CEO Sprott U.S. Holdings, shared his investment ideas and view on exploration in an interview on the sidelines of the recent Prospectors and Developers Association of Canada convention in Toronto.
Rule’s top names include prospector-turned-royalty generator Eurasian Minerals (TSXV: EMX; NYSE-MKT: EMX) and prospect generator Riverside Resources (TSXV: RRI). Sprott Global Resource Investments currently holds 13.5% of Riverside and 8.9% of Eurasian.
Simply put, prospect generators focus on adding value through exploration before attracting a buyer or partner to further advance the project.
“We see a dearth of exploration taking place, and arithmetically our experience has been the most efficient form of exploration finance is in prospect generators, where our money provides working capital for the assemblage of intellectual capital, where the risk is farmed out to others,” Rule says.
Asked what he liked about Eurasian’s properties or the company, which expanded its prospect generation business model to include royalties, Rule responded he does not “fall in love with properties.”
“What I have found is exploration is not an asset-intensive business, but it is like research and development.” He believes the best way for him to participate in exploration is by having a skilled group of people propose and test an exploration thesis, before selling that idea to “a third-party to do the heavy lifting.”
Rule shares he learned early on that the probability of a “mineralized anomaly” becoming a mine was 1 in 3,000. Those odds lower to 1 in 100 if you explore in prospective terrains with generous exploration budgets, and further decline if you employ a “serially successful explorationist” or people with previous exploration success, he explains.
“If you have a team in a prospect generator that originates and turns four projects a year and you have a portfolio of 10 prospect generators. What you are doing is you are building every year a sack of 40 partial lottery tickets, where somebody else paid for most of the ticket.”
So far, in his over 30-year career, Rule has invested in about 60 prospect generators, which has allowed him to be part of 21 economic discoveries. “If you think about that statistically, 21 successes in 60 starts relative to 1 in 3,000. The success I experienced, relative to the success I should have expected, is three standard deviations better.”
He reiterates for him exploration success is always about the process. “Properties, put very rudely, are things you should date not marry. Following that sort of ridiculous line of thinking, a prospect generator allows you as an investor to be very promiscuous; it exposes you to an awful lot of opportunity.”
Another characteristic Rule likes about prospect generators is that other companies interested in the assets would complete their own technical due diligences. “From my point of view, first the due diligence is free to me, and second, it is completely un-conflicted. So it’s a better level of due diligence.”
Commenting on the state of the industry, Rule, like many market observers, points to both the lack of exploration spending, as well as the ill-advised investments in the past five years. “The consequence of this is we see everybody’s cupboards being very bare with the regards to exploration.”
Rule notes he has seen this happen three times before in his career, and in each case “stepping into that void has had a very happy ending.” Something he hopes to repeat.
Another name Rule is “re-entering” is Nevsun Resources (TSX: NSU; NYSE-MKT: NSU), which is the 60% owner of the Bisha copper-zinc mine in Eritrea and wholly owns the Timok copper-gold Upper zone in Serbia. He concedes when Nevsun started having problems with Bisha’s copper recoveries, he lost his nerve and sold.
“The stock has retreated to the price where I think some of the difficulties are priced into the market. I also believe they are smart guys, and it is an addressable challenge in regards to metallurgy.”
His personal favourite junior remains Robert Friedland’s Ivanhoe Mines (TSX: IVN). “If you measure my affection for companies by the position I have in my personal portfolio at cost. The largest position I ever had in my life is Ivanhoe.”
Ivanhoe is advancing three large projects, including Kamoa-Kukula and Kipushi in the Democratic Republic of the Congo, and Platreef in South Africa.
Friedland has been “ludicrously successful” at finding large deposits, Rule says. Part of that may be due to Friedland’s appetite of venturing into riskier jurisdictions and investing heavily into exploration and exploration techniques.
“The process of adding value in exploration is answering a series of unanswered questions. Most speculators don’t understand that and don’t understand how value is added,” Rule says. Most speculators often rely on hunches and fail to assess whether a company’s management could address the unanswered questions related to a project.
“You have to determine for yourself, as a speculator, whether or not the management skill sets are sufficient, specifically sufficient, that you give a shit about their answer. In other words, do you trust them to be able to come with a valid thesis?”
The next thing, he maintains, is to check if the thesis could address the unanswered question and if the market will trust the result. Ultimately, would a “yes” answer to that question add enough value to justify the risk?
“Many of these guys are looking for small mines, and heaven forbid that they succeed. 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.
“The nature of prospect generation is all these questions get answered for me by other people, using their money. And I really like that.”