Sprott’s Rick Rule Talks Junior Resource Stocks

Rick Rule, Chairman and Founder of Sprott Global Resource Investments, recently spoke with Small Cap Power following his appearance at the Sprott Vancouver Natural Resource Symposium. In this discussion, Mr. Rule talks about the prospects of a dramatic recovery in the resource sector, why this junior resource bear market has been so prolonged, as well as some of the warning signs speculators should be aware of before buying these types of stocks.

Video transcription

Female Narrator: The SmallCapPower Expert Interview.

Mark Thorburn:SmallCapPower recently spoke with Rick Rule, Chairman and Founder of Sprott Global Resource Investments, following his appearance at the Sprott Vancouver Natural Resource Symposium. In our discussion, Mr. Rule talks about the prospects for a dramatic recovery in the resource sector, why this junior resource bear market has been so prolonged, as well as some of the warning signs speculators should be aware of before buying these types of stocks. At your recent Natural Resource Symposium, you gave a speech in which you said, “The situation is in place for a dramatic recovery in the resource sector.” Given that investors have been so risk averse for so long, what catalyst do you think will prompt people to pile back into the space? 

Rick Rule: I think the same catalyst has prompted to come back into every rebound that the sector has enjoyed since I’ve been in the business. And that’s simply that the authors of bull markets are markets that exceed expectations. It’s important to note that expectations for this sector are so low that not exceeding them would be almost impossible. In truth, over the next 12 months getting under the expectation bar would be more difficult than getting over the expectation bar. We have a virtuous circle of operating in a sector that was grievously overcapitalized five or six years ago. So we’re buying prior capital contributions at a discount, attractive valuations and some senses in their own right, increasing commodity prices, increasing merger and acquisition activities, and the nascent beginnings of the discovery cycle. Those five factors brought together make it almost impossible from my point of view that this market won’t generate positive surprises. And it’s positive surprises, a market that exceeds expectations, that is the launch of a bull market recovery. 

Mark Thorburn: Why do you think this junior resource bear market has lasted so long? And when do you see a turn-around? 

Rick Rule: Answering the first question first, the resource bear markets are generally three or four years in duration. So this market by historical standards isn’t particularly lengthy. What is remarkable about it was the depth of the fall. The TSX-V, admittedly a constraint index becauseit’s market-cap weighted, has fallen by 75% in nominal terms and 82% or 83% in real terms. This is truly a savage bear market. And I think the depth of the market decline is really reflection of the excesses that the markets enjoy during the prior bull market. In other words, bull markets are the authors of the bear market, and bear markets are the authors of bull markets. If past is prologue, the recovery should mirror the decline, which suggests that overtime, this will be an epic bull market to recruit the losses in an epic bear market.

As to the beginnings of this recovery, I think they began a year ago in July. I think we bottomed out last summer. And because we didn’t have a capitulation style sell-off at the bottom, we aren’t going to have a hockey stick shaped recovery. We’re going to have a saucer shape recovery with higher highs and higher lows but all of the volatility that the market is famous for, which is to suggest that it’s still going to unnerve people during the recovery; to see 12% or 15% TSX-V declines. But the truth is we’re past the bottom,we are into a saucer shaped recovery, and the surprises will be to the upside, not to the downside. 

Mark Thorburn: So if you were to put together a portfolio of junior resource stocks today, what would it look like?

Rick Rule: That’s a very interesting question. The stocks, I think, that will move first are the undervalued companies that are in the Feasibility or Pre-Feasibility stage that will be acquired by other developers as a consequence of their atrophied exploration development pipeline. Those companies, I think, could be counted on to give you 50%, 60%, 70% gains, absent of moves in the commodity price. But the truth is that returns on risk will look better in the two to two and a half year time-frame; which is to say, the little tiny market cap companies that have very good teams that are respectable enough to catch a bid in the market when the market returns, I think the sort of market response we’re going to see in this market is the same type of response that we saw in 1993 and that we saw in 2002, which is that the nickel stocks, the $5 million market capitalization stocks with good teams when they catch a bid will all of the sudden be $0.50 stocks, 10 baggers. So the first thing to do is take less risk in hopes of less reward and takeovers, but then move further down the quality trail and further up the risk trail as the market develops. 

Mark Thorburn: What are some of the warning signs that speculators should look for before considering putting money into a junior resource stock?

Rick Rule: Well, I think the risks are muted now. The people who have survived the last three years are probably realistically pretty decent people. It goes without saying that most of the TSX-V in this or any other market is worthless. So you need to confine your activities to the sort of top quartile in the sector. And that would be, I think, demonstrated by past success in mineral exploration. In other words, teams that have had past successes whose current endeavor resemble very closely the prior success that they enjoyed. If somebody enjoyed success exploring for copper and gold in young volcanic rocks in the Andean Corridor, if they’re doing exactly the same thing, there’s a higher probability that they will be successful than if they were engaged in some sort of distally related mining activity.

You also need to be sure because capital will be expensive for the next year and a half that the company either has capital or has the access to capital that will be required to keep them alive until the floating tide raises all ships. And finally, I think that targets that of reasonable size will be important. Remember that this is a dreamer’s market and nobody dreams about small deposits. Don’t concern yourself too much with technical successes. Look for something where the rewards are commensurate with the risk that you’re taking. I think it’s very important that you take bit more risk for a higher quality, bigger deposit, and worry less about the technical success about finding small mining production. 

Mark Thorburn: Which resource sectors do you think will outperform this year? 

Rick Rule: If you constraint me to this year, I don’t have an answer for you other than gold and silver M&A. The commodities that we’re attracted to in the two or three year time-frame which we consider to be a much more predictable timeframe, would be those commodities which are priced in the market below the cost of production; industries and liquidation where the price must go up. So certainly, in that vain, we like platinum and palladium. We like the PGM metals. We like uranium. We like zinc. We’re still attracted to nickel. We like lead. And increasingly, because of the turmoil that we see in potash markets, we like potash and other agricultural minerals. Investors with the longer term perspective who can afford optionality should begin to look at the coal sector now. 

But only investors with cast-iron stomachs that have a longer investment parameter like Sprott should be looking at the coal sector. I would point out to you also that this is the first time since 2001 that gold and silver stocks have been reasonably priced; not cheap, but reasonably priced in terms of the underlying economics of their projects at current gold prices. Precious metal stocks in my opinion have only been cheap twice in my career and usually when they are reasonably priced; it is intelligent for investors to build positions in them. 

Mark Thorburn: Which specific junior resource stocks do you think investors should take a look right now? 

Rick Rule: I think I’ll pass on that question simply because it becomes a liability for me if something changes. And this webcast hovers around the web as it’s going to do for two years. A specific stock recommendation is usually good for a week. The half-life of the recommendation moves so much and become self-fulfilling prophecies. I can tell you in a very broad sense that we are attracted among the juniors to the prospect generators, the people who use their accounts and other people’s money. People can figure out for themselves the names that we care about. We also like the optionality stocks, which everybody hates. We like the guys that have big deposits, that are commodity price sensitive, that have very large upfront capital costs. 

Precisely the stocks that cost everybody money five or six years ago are hated now. We see much more upside room than downside room in the commodity prices and we see companies that commanded, you know, $400 million and $500 million market caps five or six years ago that command $40 million or $50 million market caps today. Some equalization of that would be extremely pleasant for today’s prices and you have no competition in that trade. 

Mark Thorburn: Thanks for taking the time for the interview today, Rick. 

Rick Rule: I always enjoy your questions. Thank you for giving me opportunity speaking to your audience.

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