The Northern Miner recently interviewed Sprott US Holdings chairman Rick Rule on commodity trends, his investment strategy and the junior exploration market. Listen to the podcast at www.northernminer.com, or read the edited transcript below:
The Northern Miner: Let’s start with what you think will be the best and worst performing commodities for the next year.
Rick Rule: Ah, that is interesting. This won’t play with a Canadian audience, but the best performing commodity in North America would easily be water. It’s one in shortage. It is one in where shortages can’t be made up. And it is one where the infrastructure to fix it is just not available.
I would say the worst performing commodity would continue to be iron ore. It is in systematic oversupply and weak demand in the Western world, and probably oversupply in China.
TNM: Going back to water — how would that affect mining companies?
RR: It won’t really. Mining companies in the Western U.S. might have a problem. Well, let me rephrase that: water shortages are localized problems. In places of the world like the Southwestern U.S., Australia and Chile, there are definite water shortages and it will begin to impact the mining industry probably in the state of Nevada, although rural mining operations — remote mining operations — seldom compete with other water users. I would expect the water theme won’t be particularly important to the mining industry, but it will be important to the rest of the world.
TNM: What would be the best performing metal?
RR: I suspect by year-end — because it probably has so far been — palladium. We are in real short supply in regards to platinum and palladium metals. Both metals enjoy very, very, very strong demand in consequence of their use in catalytic conversion. And there is no global pressure for less smog, so demand is intact. And it costs the mining industry more to produce platinum and palladium than they sell it for. So the companies don’t have their cost of capital and the price has to go up for platinum and palladium, and it has been.
TNM: In August you recommended three mining companies — Virginia Mines (TSX: VGQ; US-OTC: VGMNF), Ivanhoe Mines (TSX: IVN; US-OTC: IVPAF) and Reservoir Minerals (TSXV: RMC; US-OTC: RVRLF) — as your top investment ideas. What are your top investment ideas going forward?
RR: I’m leery about the phrase “top idea” because that suggests they are [investment ideas] for other people. You may recall when I gave that interview last year that I said the things I was buying myself, because it is improper to give advice to investors that you don’t know. I’m willing to take much more risk than most investors, and I’m willing to take political risk. So I would certainly continue with those three.
But in terms of new ideas, I think Altius Minerals (TSX: ALS; US-OTC: ATUSF) — thinking about Canadian names — is one that doesn’t have much downside risk, superb royalty cash flow and a very, very, very strong management team.
I guess I have to reinsert Ivanhoe in the mix, because I continue to buy it. It hasn’t performed particularly well, which is why I am able to buy it. And I have been buying it extremely aggressively.
TNM: What are your investment criteria, and how do you pick these companies?
RR: At Sprott, we serve the needs of investors that are as large as national superannuation funds, and as small as sort of retail investors in suburban Toronto. So there are no one-size-fits-all picks. I am particularly well-known in small-cap natural resource stocks. And my first criterion in every case is people. When I was younger, I was seduced by assets or seduced by stories. But the truth of what works in microcap stocks are the people — serially successful people.
The key to my success in life has been the extraordinary good fortune of meeting people like Pierre Lassonde, Ross Beaty, Robert Quartermain and Lukas Lundin when they were young — backing them in bad markets — and enjoying the incredible facility people like that have for business.
The truth is that maybe 5% of the management teams in the junior mining space are competent. And what is amazing is that 5% generates so much performance that they add credibility and even lustre to an industry like the junior exploration business that is so fraught with failure. The people are the most important thing.
I guess the other thing that has worked for me is that I have been willing to take fairly large risks, but in pursuit of large rewards. I have never been particularly interested in a company searching for a small mine. A tragedy might happen and they may find it. And everything that could go wrong with a big mine could go wrong with a small mine. But, a small mine can never make you big money. And taking the risks inherent in the mineral business — the cyclicity, the exploration risk — you have to play for very, very, very large stakes.
I would say something that sets me apart from most of the other successful speculators is that I have a different definition of political risk than other people do … I have done extremely well in countries where other people won’t go. That isn’t to say I haven’t been punished before — because of course I have.
The truth is that the biggest risk we face in exploration — other than our own mistakes, which is truly the biggest risk — is a technical risk: not finding a deposit. And easy deposits, the ones you literally maybe stub your toe on in politically friendly places, have been found. Increasingly we have to go to Kyrgyzstan, we have to go to Kazakhstan, we have to go to Congo, we have to go to Bolivia, we have to go to very, very, very hard places. I would say that is what really separates me from other speculators.
TNM: You say the best companies are the ones with the best people. Which companies have the best management?
RR: There are teams that have been absolutely, serially successful. They are ridiculous. If Ross Beaty ever decided to do anything again — I mean he’s 65, he’s dirty, filthy, slimy rich, he might not do it — I’ll be there. Young Brian Dalton — you know, the young guy with Altius — I’ll be there. [Virginia Mines’ CEO] Andre Gaumond, I’ll be there. Robert Quartermain is serially successful. The Lundin family.
There are a lot of good people out there, but it is just unfortunate that there are more bad people than good.
TNM: How much should management own in terms of equity?
RR: That’s a great question. [In September] a great young crew agreed to sell Cayden Resources (TSXV: CYD) to Agnico Eagle. And it is really great to find young teams in their thirties and forties that can carry the industry forward. I think collectively they owned 19% of the company, which is fantastic. It meant although they got salaries, they weren’t in it for a job, they were in it as partners. They were acting for shareholders because they were shareholders.
TNM: What do you think of Goldman Sachs’ prediction that gold is
going to be US$1,050 an ounce by the end of this year?
RR: Goldman people are bright. I have known them for a long time. If they have a fault, it is that they are traders. You may recall that in 2010 and 2011 when the gold price was US$1,700 to US$1,800 per oz., Goldman Sachs said it would be US$2,500 … I’m not discounting the fact that gold could be US$1,100. But I really don’t assign much importance to market predictions by pundits that are aggressive about gold, or pundits that are negative about gold.
TNM: You mentioned that companies are spending too much on general and administrative expenses (G&A) compared to project expenses. What is a better percentage?
RR: If you and I staked an exploration project and we farmed out to a major and conducted exploration for them, or in other words, we were our own mini-junior. The major would give us between 12% and 15% of project expenditures by way of G&A. Junior mining companies consistently run above 50%. That is scandalous. It can’t go on.
TNM: What’s the solution?
RR: With the TSXV the best thing to do would be to see 50–60% of the listings go to listings heaven. Just go away. We’re doing that pretty well in the money-management business. Not voluntarily, but a bunch of shops that used to compete with us are no more. They are completely gone.
I suspect the number of institutional brokers on Bay Street — given there is not much commission left — will go the same way … at worst, the former mining investment bankers will be in some fashionable area like marijuana, or something they know something about.
TNM: What’s your best advice for investors?
RR: If they are interested in the mining sector or the resource sector, understand that it is an extremely, extremely cyclical sector. Understand that competitors’ expectations of the future are set by their experience in the immediate past, which exacerbates both bear and bull markets. In resources, you are either a contrarian or a victim. You have to buy this stuff when nobody wants it. In three or four years from now, when there is this lustrous return to the sector and you feel smart, you have to remember that you are not that smart and you have to sell. Buy when others are selling. And sell when other people are buying. Repeat. Do not vary. Repeat. And buy companies with really, really, really good people. People who have been serially successful in the past.
TNM: Thank you so much for your time.
RR: Pleasure, thank you.