This content was originally published on Stansberry Radio November 2013

S&A Investor Radio looks beyond the regular headlines heard on mainstream financial media to bring you unscripted interviews and breaking commentary direct from Wall Street right to you on Main Street.
Frank Curzio: Hey, we’re talking to Rick Rule, director, president, and CEO of Sprott US Holdings, over 40 years of experience financing, investing in resource companies, and just about the smartest, most respected person in the resource industry.  Rick, I want to thank you for again appearing on the S&A Investor Podcast.
Rick Rule: Frank, it’s always a pleasure.  I enjoy participating in the Stansberry products and I appreciate the work you guys do with other people, listening in and learning.
Frank Curzio: Thank you.  I appreciate that.  Well, you know, I’ve listened to your presentations a lot.  You’ve been on this podcast numerous times, and there’s one thing that you always say.  You want to buy resource stocks when no one else is interested, almost like a Warren Buffett type—when you see blood in the streets.  Are we there yet with a lot of these resource companies?  Because they’re still down a lot.  A lot of people are starting to pick away.  Is it time to buy resource stocks?
Rick Rule:  My suspicion is that we’re early.  My suspicion is also three or four years from now you’re gonna look back at today’s prices and say, “It doesn’t matter that you were early,” if that makes any sense to you.  It wouldn’t surprise me to see them either go a little lower or wait a while for their recovery.  But given the fact that these businesses are so deeply cyclical, what you are going to decide with hindsight looking at this period is that it is ridiculously, ludicrously cheap.  And I think for an investor as opposed to a speculator, being involved at market bottoms is more important than trying to get the timing precise.
So we’re looking to allocate aggressively at this point in time in the market, which as you know from previous calls, is a market change from our normal demeanor.
Frank Curzio: No, definitely.  I love the word “aggressively.”  And you’ve been in this market for such a long time.  That’s why I love talking to you—for decades.  You’ve seen so many of these markets.  Could you talk to investors a little bit about cyclical markets?  Because when you saw the housing market crash people said, “There’s no way it’s gonna come back,” and look where it is now.  You’re looking at steel come back tremendously.  You’re seeing Goldman Sachs recommend the steel industry when a lot of these stocks are up 30, 40 percent.  Even the auto industry was left for dead and you’re seeing huge production numbers.  Talk about what happens to these stocks and to the market when they finally do turn to the positive.
Rick Rule: Well, you make a wonderful point, and you’ll note that the industries that you talked about are all capital-intensive like the resource business.  The resource business is even more cyclical because it’s an earlier stage in production and it’s more capital-intensive with longer lead times.  What that means is that in recoveries supply doesn’t increase fast enough to meet demand because adding supply costs so much money and takes so much time.  Similarly when demand falls apart, supply doesn’t come off as fast because there’s so much stranded capital.  So these businesses, or at least the valuations of these businesses, experience 80 or 90 percent swings, you know, truly dramatic swings.
 The reason for this I think is fairly straightforward.  People all regard themselves as searchers for information.  Everybody thinks that they have sort of a disciplined, organized, fair mind, and they sort of search the information universe for information to process.  That’s not what happens.  The human mind searches for information that reinforces comfortable paradigms and prejudices.  In other words, rather than having open minds all of us, including Buffett, actually have to fight against the temptation to search for information that reinforces your existing fears.
The second thing is that people’s expectations of the future are framed by their experiences in the immediate past.  So investors forget about how they felt in 2008 because the last three months have been pretty good.  These two facts—the fact that we search for information that supports our existing paradigm and the fact that we don’t search very far, that our expectation of the future is set by our experience in the immediate past—exacerbates bull markets and exacerbates bear market.  Your experience in the immediate past, whether success or failure, determines your near-term outlook, which determines your action.  What that means is in periods like 2009-2010 in the resource business the bull market seems to get exacerbated because all of the story, all of the narrative associated with resources has been reinforced in a positive sense.  In 2013 the bear market pricing gets dragged out for exactly the same reason.  The information that circles us in the market, the narrative, is turned in a negative context rather than a positive context.
 Making money in these markets is a function really of disciplining yourself to look through all the noise in the market and find the music.  And I think it’s also in one particular measure the ability for the individual investor or speculator to understand that what the market is, is a facility for buying and selling assets.  It’s not a subject per se.  It’s merely a facility.  Too many people talk about the market as if the market itself were the investment, and people need to remember that the market is a facility for buying and selling assets, and it’s the price of the individual asset relative to its ability to generate earnings over time that make you money—a very Buffett-like approach but one that everybody needs to assume.  And they need to assume it in all the sectors that they participate in, not just natural resources.
Frank Curzio: You know, Rick, I think you could probably do a 40-minute presentation just on what you just talked about, the psychology of investing and how difficult it is, because you know as well as I do, when you’re probably talking about an industry and you’re getting e-mails saying, “You’re absolutely crazy,” you almost know to the point that you nailed it, you’re gonna be right.  And almost the opposite is true when you’re recommending a stock and you get so much positive feedback.  You’re almost like nervous about it.  But it’s really amazing how you go through the psychology of investing, and how the markets—it’s really cool.
But I wanted to—‘cause we have a little bit of time here, I wanted to talk a little bit about the gold market.  People buy gold for several reasons.  It’s a safe haven.  They buy gold as an alternative currency.  But I wanted to—you travel all over the world.  I wanted to talk about demand statistics.  I mean, is there a lot of demand for gold out there?  What would push prices higher other than gold being the safe have and an alternative currency?  Because right now it seems like as a safe haven—the stock market seems like it’s going up every single day, so why put your money in gold?  And alternative currency right now—I think those fears, at least temporarily, have kind of faded.  You and I both know and I’ve listened to your presentations that, you know, they can’t go on printing money forever and it’s gonna end badly, but it seems like in order for gold to move higher it’s gonna be more about demand. Is that a correct saying?
Rick Rule: Well, I think you’re seeing demand.  One thing that you’re seeing is the gold market itself has begun to bifurcate in the last six months.  The futures market for gold, the paper market if you will, has been very soft having been the leader in the 2008, 2009, 2010 timeframe.  At that point in time the momentum, when gold went up to $1,900.00 an ounce, was driven not so much by physical buying but by leveraged long hedge funds and financial institutions that were able to strap on either GLD positions or futures positions in a carry trade, borrowing money very, very, very cheaply and deploying the money with a lot of leverage in a trade that had momentum.
 When the gold price and the silver price rolled over, and in particular when short-term US interest rates went up which raised the cost of the carry, the futures market in gold and silver began to fall apart.  And as the gold quote fell from $1,900.00 to $1,400.00 and then to $1,300.00, leadership changed to the physical market.
Now I would suggest to you, Frank, that that’s a very old-fashioned investment is, that is, a first-class asset—gold—was going from weak hands—leveraged long hedge funds, banks, and financial institutions—to strong hands—unleveraged retail savers who planned on holding the gold for a decade.  At the same time physical transfers took place from central banks, Western central banks managing fairly sclerotic, aging, indebted societies, to emerging and frontier market central banks, certainly societies that hadn’t been disciplined in the 1990s but rather societies that were frozen out of credit markets so they weren’t over-encumbered.  My suspicion is that the dichotomy that we’re seeing between the futures market and the physical market resembles nothing so much as a coiled spring.  Price leadership takes place in the paper market, but the paper market is gradually ceding volume to the physical market.  And I suspect the physical market will overcome the paper market.
At the same time that the physical market in the last six months was very weak, the physicals market was the strongest that we have ever seen it in terms of transactions and accumulations on a per-ounce basis.  And when I say strong, I mean strong in every market.  US retail gold and silver sales were the highest that they have ever been.  Our own physicals business at Sprott registered the highest volumes it’s ever been.
But that masked incredible demand from places that we didn’t see in the market at all ten years ago.  As an example, in India, despite the imposition of very strong excise taxes on gold, the premium for physical in India over the spot price is 20 percent.  The physical demand in India is absolutely unbelievable right now, and you can see if you go on the web the lineups for physical in Hong Kong and China.
So I suspect what you’re seeing is a real ground wave of support for precious metals in the physicals market at the same time that you see the paper or futures market still fairly weak.
Frank Curzio: And you know, a lot of things that you’re telling me here—I read a quote.  I don’t know if it was from you, but it was about Eric Sprott, that he’s more bullish as ever, also since 2000.  He’s buying junior miners and he sees gold prices at $2,000.00.  Maybe that _______ a lot what you’re just talking about.  My question is do we need at least $1,500.00 an ounce for this market to get going again?  Since last time we talked and the last two times we talked, and even when I had a personal discussion with you at one of our conferences you were talking about the all-in cash costs, where they could be anywhere from $1,300.00 to $1,400.00, which is amazing ‘cause you don’t really see that number.  You see more like $1,100.00, $1,200.00.  Where do you need to see gold prices where it’s beneficial for the producers?  Let’s talk about the stocks and for these guys to actually make money, which will probably be reflected in their stock price going a lot higher.
Rick Rule: Well, I think surprisingly that the industry’s all-in cash cost is probably more like $1,700.00.
Frank Curzio: Wow.
Rick Rule: Two things are happening.  The industry all-in cash costs are now falling fairly rapidly, which is a good thing.  All-in cash cost of course includes acquisition costs, and many acquisitions happened in the 2009-2010 timeframe.  And so the depreciation associated with those ounces with very, very high-cost acquisitions are burdening companies’ income statements, but they’re now being written off the balance sheet.  The second thing is that the cost pressures that were driving the industry in terms of salaries and input costs are falling fairly rapidly.
So all-in cash costs are falling, but I suspect that the best quartile of gold producers, that is the most efficient 25 percent, have all-in cash costs that are much lower, all-in cash costs that are in the sort of $900.00 range.  And if we got to $1,500.00 US, that becomes a fairly attractive business.  In particular it’s a fairly attractive business because the best quartile of producers have growth that’s baked in the cake.  In other words they have capital projects that are funded.  They have exploration work that is completed.  And the very best producers, if say they’re producing 400,000 ounces a year today, will absolutely, positively be producing 600,000 or 700,000 ounces four years from now.  And if they can increase their production by 50 percent at the same time that they increase their margins by 30 or 40 percent, and if the outlook associated with the industry is such that the payment matrices—in other words the premiums hat are paid relative to things like EBITDA and production increase—if you get the conjunction of those three factors coming into a market, you’ll see dramatic share price escalations.
In illustration of the question that you just asked, Frank, I was visiting with Eric Sprott on the phone about three weeks ago, and he pointed out two interesting facts to me in a historical context.  One, the Sprott business over 30 years measured by any relevant metric has increased 100-fold—not 100 percent, 100-fold as a consequence of the aggressive deployment of capital at market bottoms.  That’s really what we have done.  We’ve been a natural resource-centric firm that has aggressively deployed capital at market bottoms, which says something about the efficacy of the strategy long term.
Probably more importantly in the near term, Eric said, “The truth is that from peak to trough in a bad market, a well-selected, speculative, junior portfolio loses at least 50 percent, but more likely 60 percent in value,” and that these peak to trough moves take three to four years.  Conversely in the trough to peak period, these well-constructed portfolios, at least looking at the Sprott portfolios over the last 30 years, increased between 500 and 1,000 percent.  So while the declines are certainly unpleasant, particularly relative to more stable businesses, the recoveries are so violent, they are so dramatic that if one has the discipline, if one has the patience, if one has the ability to endure the pain, the rewards associated with playing these cycles are absolutely incredible.
And what’s more important in terms of our discussion, Frank, is that we’ve been through three years of the pain.  If you’ve hung out through the pain, you may as well enjoy the gain, particularly because in a historical context the gains are more dramatic than they are in any other sector I know.
Frank Curzio: And you know, it’s funny that you mention that, ‘cause when we look at housing or when we look at other cyclical industries that have come back, you see the housing sector _____ stocks go up 100, maybe 150 percent off the lows.  You can see—and I’ve been through this with the last cycle—where these stocks, like you said, if you have the patience, the reward isn’t 100 percent.  It’s 300, 400, 500.  And Rick, how many stocks have you seen go up 1,000 percent when these cycles turn over your career?
Rick Rule: Literally scores, literally scores.  And it’s important to segregate the resource sector from other extremely volatile sectors with big upside.  People often compare and contrast the resource sector with, as an example, the technology sector.  The truth is that if you segregate qualitatively in the resource sector, that is that you choose resource stocks that have resources, real resources as opposed to stories, the supply of the real ones is completely constrained.  With regards to, as an example, technology as a sector, the supply is constrained only by the human imagination.  So what happens when the resource sector moves is at the beginning of the move at least, the move is not orchestrated but really participated in by people who are fairly discriminating.  And the money that is involved in the first part of the recovery is really money that’s oriented into a fairly limited number of silos.  Those are companies that have real resources that have been developed over the past decade.
 In other sectors recoveries are much more broad-based, which means on an individual security basis the recoveries are much more muted, simply because the money that flows back into the sector flows into a much greater number of participants than it does in the natural resource sector, which is a different way of saying that because our sector is constrained by prior capital expenditures, the recoveries are much more concentrated, and as a consequence of that much more dramatic.
Frank Curzio: We’re talking to Rick Rule, one of the smartest if not the smartest resource investor in the world in my opinion, and just a few more questions here.  I wanted to talk really quick about the uranium market, and we’ll stay on topic here because this is a market, you said, where the resource sector—it’s been three years of pain.  It’s been a little bit longer, and even since 2011 price has basically been in a free fall.  Of course we had Fukushima, which reports suggest that the nuclear plant is still leaking radiation there.  But there seems to be bargains of a lifetime in this industry.  I mean, companies that I’ve bought—Fission Uranium from my Phase One newsletter, also Denizen Mines.  Is it time to buy this sector?  Especially, like you said, it seems like a lot of the pain is already reflected, but as a long-term investor the reward could be great.  Am I off-point here?  Do you agree with that?
Rick Rule: Well, first of all, let me compliment you on your selection.  There are a lot of uranium stocks out there, and I think you’ve, with the two names that you’ve mentioned, done a very good job on the speculative side of the uranium market.  So you’re to be congratulated.
Frank Curzio: Thanks.
Rick Rule:  I love discussing uranium because it’s, if you will, sort of a leveraged laboratory for everything that we do in resources.  The volatility in uranium prices and hence the volatility in the net asset value of resources in uranium is amazingly dramatic.  The industry estimates that it takes $75.00 a pound to earn back its cost of capital on a global basis.  We’re selling at least in the spot market for $36.00 a pound or $35.00 a pound.  That means that the industry is losing $30.00-something a pound and of course trying to make it up on volume.  The industry is in fact in liquidation.  It sounds like it couldn’t possibly get any worse, so sentiment with regards to uranium is really, really bad, and it’s particularly bad because of the problems at—in Japan, at Fukushima.
 It stands to reason that when perception of the industry is terrible, that the industry will be at its cheapest.  And people say, “Why on earth would I buy an industry that’s in liquidation?  Why would I buy an industry that’s losing $30.00 a pound?”  The reason that you would do that is very simple: because either the uranium price goes up over three or four years to $75.00 a pound, or the lights go out around the world.  It really, truly is that simple.
 If I said to you—and I didn’t use the word “uranium”—that XYZ was selling for $36.00 and it was almost certain to double over four years, almost certain, the idea of an almost certain double in the three- to four-year timeframe is a fairly attractive proposition—until you had back the word “uranium.”  And if you can overcome the emotion associated with the word, you get to add back the near certainty of a three- or four-year double, which to me is fairly attractive.  And if you double the price of the commodity, the margins associated with producing it for the efficient producers don’t double; they go up five-fold or six-fold.  And if you overlay then the return to favor of an asset class and the prospect of higher pricing matrices relative to EBITDA, you get the same type of—and I apologize for the pun—you get the same type of explosive appreciation in the uranium sector that you got in 2004-2005 where the uranium equities were uniformly up ten-fold or twenty-fold.
 I think this is an extremely attractive proposition.  It’s something that might not play out in 12 months.  It might not play out in 24 months.  It will certainly play out in 36 months and I think be dramatic over 48 months.  And the idea that you could in the commodity itself by buying something like Uranium Participation Corp have a fairly high probability three- or four-year double, and in a well-selected portfolio of uranium producers or developers have the possibility, the strong possibility of 500 or 1,000 percent returns over the same period of time from their market bottoms, I mean, to me that’s an extremely compelling argument.
Frank Curzio: You know, I’m laughing here and trying not to laugh into the microphone.  If you really do take out the word “uranium”—you can’t put it better than that, because I would bet anything that prices will double within three years or four years.  I’d bet anything, and I’m sure everybody else would—if you really took out the word “uranium.”  But when you hear “uranium” people are just like, “Uh”—you know how it is, which probably means we’re definitely near bottom, right?  ‘Cause nobody—still today, right, I mean, even when you probably pitch uranium at different conferences, people are probably like, “Ah, nah, I’m not getting into uranium.”
Rick Rule:   I get two responses.  Some people say, “Why bother?” and some people say, “It’s immoral!”  And I remember the immoral argument at the bottom in 2000.  You know, people would say, “Rick, you’re talking about Hiroshima, Nagasaki, Three Mile Island, blah, blah, blah, blah.”  Those same people at 2005 after the uranium price had gone from $10.00 to $130.00—they’re something about a thirteen-fold escalation in uranium prices that—let’s just say it changed the morality, and those same people were looking for stock tips.
[Laughter]
Frank Curzio:  I love that.  I love that story.
Rick Rule:  I hate to sound cynical, but you know, I experienced this personally.
Frank Curzio: That’s great stuff.  One last sector and I’ll promise I’ll let you go is oil.  I mean, we’re seeing prices now—you know the pattern, Rick.  If we push through $100.00, which we had news on Syria—you know, we have guys talking $150.00 oil prices.  Once oil falls below $100.00, like it recently did, we get the $60.00 forecast being mentioned on TV.  I don’t know where prices are gonna be next month.  I don’t know where they’re gonna be a year from now.  But let’s take a five-year outlook.  Where do you see oil prices averaging over a five-year period?  Which means maybe they do hit $60.00 and maybe they do hit $150.00 in that timeframe, but over the next five years where do you see oil prices averaging?  Which is still kind of a tough question.
Rick Rule:  I wouldn’t be surprised in the next 12 months to see the oil price down in the $80.00s, $70.00s or $80.00s.  The reason for that is that I see demand continuing to be weak.  For all the discussion of a Western world recovery or a US recovery, the US recovery seems to be a recovery in everything except for production and jobs, which is to say it’s a liquidity-led recovery.  And liquidity doesn’t burn oil, so I see fairly soft demand, and I see fairly soft demand on a global basis.
 What is gonna help oil prices is continued tightness in supply, certainly not in terms of US supply, which is doing very well, or even North American supply if you constrain the definition of North America to the United States and Canada.  But what’s happening on the supply side is that contrary to most of your readers’ and listeners’ beliefs, most oil is not produced by the big oil companies.  It’s not produced by Shell and Exxon.  It’s produced by national oil companies.  Oil is produced by the same people who run the Department of Motor Vehicles and the Department of Education.  And these national oil companies have diverted too much of their free cash flow away from sustaining capital investments and to politically expedient domestic spending programs.
 The consequence of that—and I’ve been talking about this in your interviews for years—you have major export countries like Mexico, Venezuela, Peru, Ecuador, Indonesia, and Iran where their ability to satisfy their domestic demand, never mind to export oil, has been seriously constrained.  And it’s important to note that you can’t just add back capital and restore those export volumes right away.  It takes five or six years.
So what we’re seeing in the oil market, at least in the oil export market, is really unexpected tightness.  That was driven home six or seven months ago when the oil price went up on political unrest in Egypt and Syria, neither of which are oil producers to any particular extent.  What it means is that the world’s export supply of oil is increasingly constrained.  It’s only really the rebound in Iraqi production which has kept oil below the sort of $115.00, $120.00 a barrel level.
If you look out two or three or four years past the weakness in demand that we’ll experience in the next 12 to 18 months, I think you’re gonna see surprisingly strong prices for oil as a consequence of systemic weakness on the supply side with regards to many of the non-OPEC exporters.  I think this is gonna be particularly good for the United States, by the way, because the United States as a consequence of its very, very fervent market is seeing supply increases at the same time that the United States is finally beginning to see on a systemic basis the crossover of natural gas as a substitute for oil throughout the production cycle, in base chemicals, in power generation, and increasingly as a motor fuel.  I think that the worldwide supply-demand picture in oil pricing will be particularly advantageous for the United States, but I think the sector as a whole will do much better than people think it will.
Frank Curzio: That’s interesting.  Well, I always end our interviews with this final question, and I know it’s one of the favorite questions from listeners, is what are some of your favorite ideas if possible that you could share with us, even if they’re large cap, small cap, across any of the sectors that we talked about?  What are some of the things that are interesting to you maybe in terms of specific ideas?
Rick Rule: Well, I’m attracted to the uranium sector.  I think the easiest way to play it for your readers is probably to look at a Canadian-listed vehicle called Uranium Participation Corp that has a very simple business.  They buy and store uranium.  And I think the uranium business is a business that over three or four years is a probability, not a possibility.
 I like the whole precious metals complex, too, but I particularly like the platinum and palladium sector.  Platinum and palladium are priced well below the cost of production, and most of the production is constrained in South Africa, which is experiencing real difficulties.  I think platinum and palladium prices will be up substantially over the next two years.  I think they have all the attributes of the other precious metals, which will do well, but I think the supply-demand fundamentals associated with platinum and palladium are such that they will do spectacularly well.
 In platinum and palladium I have to say I like our own vehicle, the Sprott Physical Platinum and Palladium Trust, traded on the New York Stock Exchange under the symbol SPPP, particularly well.  I’m nervous about the platinum and palladium equities because I don’t see any of the major producers being able to make any money at all in this context, and I see them all challenged because of their participation in South Africa with the social and political challenges associated with that.  So I would play that game very much towards the metal itself rather than towards the producer.
But I think it’s time really for your readers to begin to think about secular exposure towards resources.  I think a case can be made for the very large mining companies like Rio Tinto and BHP, the biggest mining companies in the world, companies that made monumental mistakes in the up cycle but have world-class resources, world-class reserves, very good balance sheets, and generate really substantial free cash flows at a market bottom.  The idea that you’re delivering substantial free cash flows at a market bottom and then you get to experience the rebound in pricing and the re-pricing based on people’s increasing appreciation of natural resources gives you the ability to probably begin to enjoy penny stock returns in much, much, much larger companies.
Of course for more aggressive investors there are greater profit opportunities coming down the quality scale, but those aren’t the type of opportunities that either you or I would like me to talk about on this broadcast—
Frank Curzio: Yes.
Rick Rule: Without deep and detailed discussions of the risk and the strategies.
Frank Curzio: Exactly.  That’s why people pay us for our services.  [Laughter]
Rick Rule: Right, right.  And, you know, you guys have done a wonderful job over time drilling down with various experts and bringing more detailed discussions to bear on more speculative companies where your investors have needed to know in more detail how to play the game.
Frank Curzio: Yeah, and we appreciate that.  And the reason why we’re able to do that, in all seriousness, is we get to talk to guys like you.  And, you know, a lot of times when I recommend stocks, especially in the resource sector, I’m calling you first because you know the histories and especially the management teams for a long time behind these companies.
So, Rick, I usually keep these interviews to 20 minutes; I went a little bit over 30 ‘cause everything was so interesting.  I really appreciate you taking the time.  I say this to a lot of my guests.  I know how busy you are.  You travel the world.  And it means a lot that you took the time to come on this podcast.
Rick Rule: I have always enjoyed these processes, Frank.  I think your background in a whole bunch of industries makes you uniquely qualified [Laughter] to ask questions of a specialist like myself, and I always enjoy the process.  So thank you for the opportunity to speak to your audience.
Frank Curzio: Thanks.  I really appreciate that.  I’ll talk to you soon.
Rick Rule: Thank you.
Frank Curzio: Thanks.
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