Mining’s old guard needs strong medicine
A new report details subpar investor returns in the mining industry over the last decade, particularly big cap diversified companies which have not adapted to new realities.
Rick Rule, the renowned resource investor who founded Global Resource Investments, returned to cyberspace last week for a webcast in which he explored some of the implications for resource investors when two megatrends from opposite ends of the socioeconomic spectrum collide. This phenomenon will inevitably result in incredible market turbulence, Rick tells us, and, in the context of the ancient Chinese curse, some mighty interesting times.
It was on a dark and stormy night in 1752 when Ben Franklin took his kite out to snag lightning from the sky and prove that it’s a stream of electrified air. It led to his invention of the lightning rod as a means to protect people, buildings and ships against this dangerous force of nature. Ben’s experiment took courage. It also took appreciation of what he was dealing with and wisdom enough to do it safely. In short, he was prepared—and his preparation paid off.
Fast-forward 259 years. Rick Rule, the widely known and well-respected founder of Global Resource Investments (GRI), tells investors that such qualities will serve them well over the next year or two, as markets become ever more turbulent. Returning to cyberspace for one of his popular webcasts last week, Rick warned of extreme volatility ahead, in the broad economy generally and in the natural resource market in particular. Girding for the violent roller-coaster ride he foresees calls for both emotional fortitude and financial preparation, he says, suggesting that investors make up their minds now to stay on the sidelines if they don’t have the stomach and the cash to climb aboard.
“The bottom line is that your own financial and psychological preparedness for dealing with volatility will determine whether you come out of the next year or two substantially better off—or substantially worse,” Rick says. “It’s your responsibility to determine your response and hence your own financial future.”
Psychological Ammo
On the psychological side, as he has pointed out in the past, Rick believes that the nature of profiting from volatility lies in being “on the other side of the trade.”
“When the market is rising and your stocks are behaving in a way that generates uncontrollable greed,” he says, bring in another element of the psychological-preparedness equation. “Begin to react with fear,” Rick says. “Take some profits. When stocks go up 50%, 100% or 200% with no underlying reasons justifying those moves other than the market phenomenon of more buyers than sellers, move the cost of your position to zero.”
Rick dubs that zero-cost position “the point of no concern,” at which time you can sell enough to make what you retain virtually cost-free. He readily acknowledges that it’s tough to unload a stock that’s grown from, say, an initial investment of $10,000 two years ago up to $60,000 and is still on the march. But if the increased “value” is merely a function of the fact that the market is “in melt-up mode,” he tells investors to ask themselves whether they’d spend $60,000 to buy those shares now. If not, sell some. “It’s difficult psychologically to sell a stock that’s performing well. It feels good and you’re afraid of missing out on a potential quantum move,” Rick says. “But this is precisely the time to take some money off the table and prepare for the other eventuality.”
In addition to giving savvy, disciplined investors the opportunity to buy at a discount, market volatility also enables them to mark up equities they bought low and sell them to others for substantially more. “So take partial profits in the manic melt-ups,” Rick advises, “and establish new positions in the panic meltdowns.” To do so, he says, “manage your own temperament, be disciplined and pay attention to reality—not the noise of the market.”
Cash Up
And you must have cash, he adds. Despite the fact that the U.S. dollar is losing value (particularly with the help of quantitative easing [QE] initiatives) and real interest rates are at minus 4% or 5%, he tells investors to hold cash as ammunition in a market crash. “Although you get penalized for maintaining liquidity—as investors should recall from the 2008 liquidity crunch—when the market collapses, cash is the only thing that gives you the fiscal and psychological strength to react.”
He further recommends maintaining some liquidity in physical gold and silver and their proxies. “It’s not in anticipation of profiting from a run in gold and silver prices—although that isn’t a bad aim either—but because they increasingly constitute good cash in a world where many forms of cash aren’t so good.”
In terms of equities, Rick advises investors to establish wish lists of stocks that you may not want to buy except at a 50% to 60% discount. “The nature of volatile markets is that the markets will give opportunities to buy bargains in the next two years if you have cash and the courage to take advantage of the opportunities.”
Selectivity or Bust
Furthermore, he advises being “extremely selective” with equities, particularly junior equities. “You need to be asset-centric versus story-centric with junior equities, or at least be involved in exploration endeavors run by experienced exploration professionals, in companies that have successful track records and adequate capitalization.” According to Rick, the bull market that junior equities have enjoyed over the past 12 to 14 months “has been unblemished by selectivity, with 80% to 90% of mineral juniors having no net present value. They’re absolutely worthless. They’ve increased in price because the ‘mineral exploration industry’ and the financial services businesses that surround them can tell sexy stories. When moving from a greed-induced bull market to a fear-induced sector decline, the value of these stories goes to zero.”
Back to the Future
Drawing upon some fairly recent history, Rick recalls “how we all confused the bull market for brains” in 2006. “Had we simply felt a little less smug in 2006 and a little more aggressive in 2007,” he says, “we would all be substantially wealthier than we are today.”
Looking back on 2007 and 2008 and remembering the liquidity squeeze in the markets when confidence disappeared and euphoria evaporated, he advises investors to take a lesson from history. “Think about your own reaction to a replay of those circumstances,” he says, “because the preconditions of that collapse haven’t been addressed.” Individual, municipal, state and provincial, national and international debts have risen rather than contracted, he says, noting that the ability of societies to service their debts contributed to the problems of 2007 and 2008. For instance, he points out that Greece couldn’t afford to service debts at 115% of its GDP, and they’re hardly better off now servicing debts at 150% or 160% of GDP.
Rick anticipates a powerful replay of the problems that led to the financial collapse of the last decade, impelled by the inevitable collision of two megatrends that he compares to enormous weather systems. The first involves the “very challenged economies” of the developed world and their aging populations.
Western Woes
Unwillingness to save for the future coupled with a penchant for people to live beyond their means in the U.S., Western Europe and Japan—even before the devastation that began there on March 11—have thrust nations of the western world into “an unfortunate position of consuming more wealth than they generate,” Rick says. After some 70 years of “welfare state” programs distributing what were perceived as the excesses of economic gains, those programs will shrink or cease, further eroding standards of living. Rick expects serious, even violent, reactions to erupt among citizens who regard government-funded programs as birthrights and who won’t take kindly to compromised lifestyles. “Furthermore, the fact that these challenged economies and their constituents have failed to save seriously diminishes their already-compromised ability to respond to “exogenous black swan events”—because adaptation requires strong systems capabilities and lots of savings.
For instance, with Japan’s debt already twice the size of its GDP, Rick wonders where the $240 billion (or more) will come from that it needs to rebuild. Countries in the developed world have fewer and fewer savings to bounce back from events such as the earthquake and tsunami in Japan, he notes, suggesting that other black swans are hovering. In addition to the situations that have erupted in Egypt, Tunisia, Yemen, Libya, Bahrain and elsewhere—which will give rise to a “black swan on steroids” were the citizens of the United Arab Emirates, Kuwait or Saudi Arabia to follow suit—crises waiting in the wings include:
In addition, the U.S. is coming face-to-face with its inability to service pension obligations that have been promised but not funded for the last generation. “This is truly an ugly set of circumstances that requires substantial savings to deal with,” he summarizes, “and the savings don’t exist.”
Damned Either Way
And quantitative easing, because it devalues the currency practically by definition, undermines what meager savings do exist in the U.S. and other Western economies. Rick sees a “damned if you do, damned if you don’t” situation. “I don’t think we can continue quantitative easing and I don’t think we can afford to discontinue it either. I really sort of expect that we’ll end up having QE90,” he continues, “and I don’t like the potential of that. Not just in the context of the U.S. dollar, but in terms of the Western world standard of living.”
Without quantitative easing, he points out, interest rates would inevitably climb. Federal, state and local governments in the U.S. are already challenged to service current debts in a no interest rate environment—or with real interest rates even at negative 4%–5%. “If the real interest rate poked its ugly head up,” Rick says, “I think we’d see widespread defaults. I also think that large numbers of individual citizens still owe substantially more than they can service as a function of the predilection for enjoying standards of living beyond their means.”
He imagines, for example, what will stem from an increase in the cost of servicing mortgages. As for the 30% of U.S. housing stock that’s believed to be under water in terms of the current value of those homes relative to the mortgages held on them, he says that he’d expect a sharp drop in residential real estate prices and a corresponding hike in the number of homeowners who simply mail their keys back to the bank.
To Be Rich Is Glorious
Meanwhile, on the other side of the globe, China saves nearly half of its GDP. A few years ago, a Morgan Stanley Global Economic Forum report discussed the shift in the mix of global saving away from the “rich countries of the developed world toward the poor countries of the developing world.” The latter group, accounting for only 19% of world GDP in 1996, saved to the tune of approximately three times their weight in the world economy. The report said that the U.S. “stands out for extreme negligence on the savings front (with) by far the lowest domestic savings rate of any major economy in the developed world,” while in contrast, “the major countries in the developing world have increased gross domestic savings from 33% in 1996 to 42% in 2006. Among those, China’s gross domestic savings rate rose from 40.5% to 50% in 2004.” And of course, savings isn’t the only economic indicator on the rise in China. Between 1989 and 2010, its GDP growth averaged 9.31% per quarter, and was up to 9.8% for Q4 2010.
China probably serves as the best—and certainly the most prominent—illustration of the second enormous weather system on Rick’s radar. It’s part of a broader front emanating from what he calls “emerging markets’ liberalization,” a phenomenon taking hold in fits and starts in developing nations around the globe. China started down the capitalist road in 1979, and the post-Mao mantra introduced by Deng Xiaoping, the paramount leader of the People’s Republic of China then and throughout the 1980s, set off what Rick describes as “the greatest boom we’ve seen in my lifetime.”
As Rick sees it, Deng wasn’t seeking to diminish his power when he said, “To be rich is glorious”—words that sent a signal to the senior bureaucracy that the Chinese people should be a little more free and a little more self-reliant. Since the shift in sentiment, China’s economy has grown to 10 times the size it was then, 300% just in the last decade, and per-capita incomes are rising every year.
This second megatrend that Rick identifies contrasts markedly with the declining fortunes and retreating standards of living underway in the developed economies. Nations that didn’t benefit from the economic miracle of the last 70 years are beginning to experience one now, he says, as political liberalization is taking hold in fits and starts in emerging markets around the world. “It may be just a little more free,” he says, but as China, India and Brazil have shown, “when these societies become a little more free, they become a lot more rich; a little less constraint and a little more self-reliance generate absolutely incredible economic growth.”
Demographics also enters the picture. As Rick puts it, “The Western world is old, fat and lazy; the emerging markets are not only becoming more free, their people are younger,” with a greater proportion of them in the wealth-forming rather than wealth-consuming years of their lives.
He cites yet another factor tipping the scales in favor of the developing economies. “As a consequence of the previous series of busts,” he says, “financial institutions were less likely to advance credit to third-world nations. Being deprived of the ability to borrow, many of these nations built enviable balance sheets. The U.S. was not so lucky. Everybody in the world loaned to the U.S., and it took all comers. As a result, the ability of countries such as Madagascar, Myanmar and Suriname to service their debts is substantially greater than the U.S.”
Rick expects the developing nations’ phenomenon stemming from these forces to be a boon to the resource sector in particular, and he explains why.
Resource-Intense Lifestyles
In the Western world, Rick says, wealthy people who get wealthier tend to spend their money on services, but prosperity at the bottom of the economic pyramid “really benefits those in the resources business.” The ability of these billions of people to enjoy a better lifestyle is increasing fairly rapidly, he says, noting that the lifestyle they seek involves things that demand not only energy but many other resources. They’re spending their growing wealth on “things that require stuff.”
“Per capita demand for resources is expanding very rapidly as a consequence of rapidly expanding incomes,” Rick observes, because “when people get more money, they consume more calories, which drives agricultural demand, fertilizer demand, water demand. They may upgrade their Visqueen houses to cinderblock houses or houses with wood or metal roofs.”
He cites, too, the fact that India and China are building national highway grids, selling large numbers of vehicles and building infrastructure. “And they’re the tip of the iceberg,” Rick emphasizes. “Other countries are on the same path, such as Indonesia, which has 230 million people.” The fact that for the first time billions of people increasingly have the means to compete for the standard of living the Western world has enjoyed will increasingly drive up the prices of commodities, Rick says.
Throughout his illustrious career, Rick has encouraged investors to summon the courage to buy whatever the masses of investors are snubbing. “It’s the panic markets that offer the best opportunity to buy good assets and solvent companies at extraordinary discounts,” he professes. “Act in panics. More often than not, the huge gains come with having the courage to buy when nobody else is buying.”
As Rick sees it, “The ascent of emerging markets and the ascent of people in emerging markets are as bullish for resources as the other megatrend is bearish.” The intensifying emerging markets’ dynamic is propelling demand for all forms of resources—water, agriculture and metals. Their demand is increasing rapidly and their capabilities are expanding at the same time that “we in the West are destroying demand and destroying capabilities.”
And as he says, count on “incredible turbulence and incredible variability” as the commodities supercycle, fed by the developing nations, comes up against the secular bull market enveloping the Western economies. “Both the risks and the rewards will come much more frequently and with much more urgency,” he predicts. “This market will give you extraordinary opportunities to either make or lose money. Your response will determine whether the next two years are extremely pleasant or unpleasant for you.” It could turn out otherwise, he says, but he hopes that in 10 to 15 years “we can look back on this as an exhilarating and profitable experience.”
“In the context of the Chinese curse,” Rick concludes, “these are very interesting times, times that will favor the prepared and the bold, and be catastrophic for those who are neither prepared nor bold.”
Founder and CEO of Global Resource Investments (GRI), Rick Rule began his career in the securities business in 1974 and has been principally involved in natural resource security investments ever since. He is a leading American retail broker specializing in mining, energy, water utilities, forest products and agriculture. Rick’s company has built a sterling reputation for its specialist expertise in taking advantage of global opportunities in the resources industries. Last month, Rick closed a landmark deal with Eric Sprott, another famous powerhouse in the arena. With GRI now a wholly owned subsidiary, Sprott, Inc. manages a portfolio of small-cap resource investments worth more than $8 billion and boasts a workforce of more than 130 professionals in Canada and the U.S. This article is based on Rick’s Global Resource Investments webcast, Monday, March 21.
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