Sprott U.S. Holdings CEO Rick Rule also describes why he likes precious metals royalty and streaming companies
SmallCapPower | March 5, 2019: Rick Rule, Chairman and CEO of Sprott U.S. Holdings Inc, gave the final presentation during the Letter Writer Presentations for Investors on Sunday, March 3, 2019 at the PDAC 2019 convention in Toronto. Here’s a summary of some of the points he made:
Major Trends in the Global Macro Environment
Supply destruction is a circumstance where commodity prices stay low enough for a long enough period that the industry cannibalizes its capital. Sustaining capital investments aren’t made, new investments aren’t made, and as a consequence of that, the industry relies on deposits that are “long in the tooth.”
Supply destruction is the most bullish of all phenomenon because when supply is destroyed with demand remaining constant, the price has to increase to return to equilibrium. The mining industry cannot increase supply in the near term to meet pricing signals. This is because the mining industry is capital intensive and takes a long time to ramp up production.
If the copper price were to move to ~US$4/pound in the near term, supply response in the copper business would not exist because it takes 4-6 years to bring on new supply, which is one of the reasons why commodity booms are so exaggerated. When supply dries up, the price dries up.
Gold Macro
U.S. debt is currently sitting at $22 trillion, plus another $120-140 trillion in unfunded liabilities, which include things like Medicare and Social Security. In the future, it is most likely that the U.S. government will have to make a choice: an honest default or a dishonest default. An honest default is where the U.S. government says that they made a promise to honour these obligations, but they cannot keep them anymore, or a dishonest default were they inflate away the debts. Both circumstances are good for gold.
Precious metals and precious metals related assets currently represent between 0.3%-0.5% of all investable assets in the U.S. In 1981, precious metals and precious metals related assets represented 8.5%. It is unlikely that we will see 8.5%, but the three-decade-long mean is between 1.5% to 2%, mean reversion suggests that we should go back to this level. In other worlds, demand for gold should quadruple, therefore the upcoming gold bull market is closer to the beginning than the end.
3 Ways to Play the Precious Metals Market
Mergers and Acquisitions. Currently, the biggest problem in the mining industry is too much G&A (General and administrative expenses), Bristol Capital has suggested that the merger between Barrick Gold and Newmont would free up $300M in surplus G&A. If you merge these two companies you can make a million dollars a day, equivalent to the best mine in their portfolio. Let’s say you put a 10x EBIT multiple on the merged company. That means you add $3B in enterprise value, which means your cost of capital decreases by a sum that is diving the shares outstanding by $3B. Larger companies are more liquid, larger more liquid companies attract more capital. They have higher share prices, lower cost of capital, gold mining is a capital intensive business, which means that lower cost of capital is good, lower G&A is good.
Royalty and Streaming Companies. These include names such as Franco-Nevada (TSX:FNV), Royal Gold (NASDAQ:RGLD), and Osisko Gold Royalties (TSX:OR). These companies are operating at 60%-75% operating margins while the operating margins for the industry as a whole are negative. Royalty companies also have an advantage over traditional miners because they have no sustaining capital expenditures. Owning royalties – the cost of capital for a non-investment grade company to build a mine is 15%, increasingly with less capital available to non-investment grade issuers, the market share of streaming companies in mine finance will only grow. Streaming will also become increasingly important in financing M&A, as they have lots of cash coming in with minimal expenses. Royalty and streaming companies also pay dividends.
Exploration Companies. The mining industry has underinvested/mis-invested in exploration since the mid-1990s. Major miners have decided it is a marginal expense. Thus, they have understaffed exploration departments. This will lead to a surprising boom in exploration sometime during the next five years. Prospect generators such as EMX Royalty Corporation (TSXV:EMX) and Riverside Resources Inc. (TSXV:RRI) are some of the best ways to play the exploration game.
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