Saturday 1st October 2016

Resource Clips


‘Unapologetically contrarian’

Rick Rule celebrates bear market opportunities at the Sprott-Stansberry forum

by Greg Klein

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Vancouver’s the venue as over 500 attendees, 60 exhibitors and 25 speakers meet and mingle at the Sprott-Stansberry Natural Resource Symposium from July 28 to 31. In the unlikely event that any of the people who paid big bucks to attend have somehow forgotten, Sprott U.S. Holdings chairperson Rick Rule will be on hand to remind them emphatically of the market downturn. That, of course, is where the “unapologetically contrarian” investor sees so much opportunity. Rule took time to discuss a range of topics with ResourceClips.com prior to the conference.

His early days: How Rule got rich

About 40 years ago Rule enrolled at Vancouver’s University of British Columbia, drawn by its focus on natural resources and natural resource finance. “A consequence of being in Vancouver in the 1970s, which were real bull market times across the whole banner of resources, meant that I enjoyed business success fairly early,” he says.

Rick Rule celebrates bear market opportunities at the Sprott-Stansberry forum

Unapologetically contrarian and irrepressibly optimistic,
Rick Rule hosts the Sprott-Stansberry Vancouver
Natural Resource Symposium.

But with a laugh, he adds, “At the cessation of the resource boom in the 1980s, it also meant that I experienced the downside of the cyclicality of resources very early. But having in the first instance a direct experience in resource businesses at an earlier age than most people, and then having gained the wisdom that came with understanding the nature of cyclicality, I was really set up in my business career by the time I was 30. So I guess you could say I’ve lurched successfully from one mistake to another.

“But the truth is I developed the skillsets in resources early on and I also learned from bitter personal experience the nature of cyclicality in resources and the importance of being a patient, durable contrarian.”

Now experiencing his fourth such cycle, he maintains that “the resource sector, relative to other business sectors, is more predictable and relatively easier to understand.”

More predictable? He returns to that in his next answer.

On the Ned Goodman thesis and Rule’s irrepressible optimism

That optimism’s easily understood, he insists. “Natural resources are the stuff of mankind. There are sectors that are periodically much more attractive. But there is nothing as durable as natural resources. Everything that is, was mined or grown. It’s as simple as that. When you have a commodity for which there is ongoing demand and the commodity is priced below the industry’s average cost of production, only two things can happen. Either the price goes up or the necessary commodity becomes unavailable.

“So if you believe that 20 years from now there’s going to be a market for electricity, and if you believe that the most cost-efficient mechanism for distributing electricity is copper, and if copper is priced below the cost of production for too long, then there isn’t enough copper to distribute the electricity and the lights go out—a highly unlikely circumstance. It’s for that reason, the very predictability over time associated with resources, that I’m attracted to them and particularly attracted to them in bear markets.

It’s for that reason, the very predictability over time associated with resources, that I’m attracted to them and particularly attracted to them in bear markets.

“It was pointed out to me by one of my mentors, Ned Goodman, who has been through one resource cycle more than I have, that the normal pattern in resources, particularly junior resource equities, is that during a bear market your portfolio loses at least 50% of its value.

“It is said that the TSX Venture has lost 86% of its nominal value. So I have two comments. The first is that the index is 86% cheaper than it was when it was popular. The second part of the Goodman thesis is very important because Goodman has demonstrated that the junior resource subsector overshoots to the downside and the upside. So after you experience this 50% loss, in Goodman’s experience, during the upcycle you experience a 500% to 1,000% gain.

The very fact that this bear market has been of such duration and magnitude suggests to me that, if past is prologue, the bull market that follows will rival the magnitude of the bear market.

“The sector, if you have a decade, is an extraordinary sector to participate in. And from my own experience, having been through four years of pain, I’m going to hang around for the gain.”

Rick’s rule: Bears beget bulls

“I know, from 40 years’ experience in resources, that bear markets are the cause of bull markets. The very fact that this bear market has been of such duration and magnitude suggests to me that, if past is prologue, the bull market that follows will rival the magnitude of the bear market.”

Key factors affecting markets now and the looming possibility of gold’s tipping point

“I see the broader natural resource market dividing into at least two subsets. The first is precious metals and precious metals equities. The rest is, if you will, industrial commodities.

“Starting with industrial commodities, I see the possibility of the bear market going on for two or three years. I see specifically no increase in demand on a global basis. Bear markets are resolved in one of two ways—through demand creation, which occurs either in an economic recovery or increasing utility as cheaper commodity prices increase demand for commodities to the extent that industries earn their cost of capital. That resolution is characterized by a quicker end to the bear market but a more moderate increase in commodities prices.

“The other resolution is supply destruction resolution, where commodity prices are below the average cost of production for a longer period of time, to the extent that productive capacity gets abandoned. When supply destruction takes place, supplies can’t increase to meet demand when it recovers, because the industry is capital-intensive and the durations required for capacity expansion are very long—witness the bull market from 2002 to 2006. That was the classic recovery from supply destruction. As a consequence, basic commodities like iron ore and coal went up 400%.

“We’re setting ourselves up now for the probability that the industrial commodities market flatlines or declines for two or three years, which will set up an absolutely spectacular bull market in industrial commodities, but later in the decade.

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