Searching through the old issues of Rick Rule’s Accredited Portfolio Profile,
co-authored with Kim Bradford, some of the past of natural resource investing
came into focus.
The slump in the early 90s’ had occurred because of too much debt and
excitement leading to a peak in the business cycle. In turn, the bull market
turned to a bear market. That led to an oversold market, which certain
investors were able to profit from substantially when a recovery came by 1992.
“Buy low, sell high,” Rick admonished readers in the April issue of the
year 1990. In retrospect, considering the vigor of the recovery that came
later, this was extremely prescient. The following discussion of buying low and
selling high should be familiar to investors who have heard Rick speak about
investing over the years…
“As Benjamin Graham has taught us, be brave when all around are afraid,
and afraid when all around are brave. Always buy straw hats in the winter. The
phrases seem so simple and logical, and yet most investors act so differently.
“Financial assets are among the few commodities that increase in
popularity as the price increases. Imagine being encouraged at the grocery
store, as you are at the checkout stand, seeing your bill increase
significantly week after week. Imagine cheering your service station owner for
increasing the price you pay for gasoline. Imagine complaining to a plumber
because he lowered his rates. Think about this phenomenon as you analyze
potential investments.”
A reasonable reader might take issue with Rick here… Is he comparing
apples to oranges? After all, we consume goods and services whereas investments
are usually held in the expectation of selling later at a higher price.
The point is that your willingness to buy a stock should not be
diminished by the fact that it has fallen in price. In everyday purchases, we
want to buy things that are selling at discounts. In investing, people tend to
prefer stocks when they are expensive and hate them when they are cheap. Rick
continues…
“In the stock market, the fact that shares are increasing rapidly
somehow makes them more desirable. But as more capital is attracted to a
certain economic activity, its relative usefulness diminishes, and the
investors inevitably pay more and more to get less and less.
“Let’s follow this cycle from trough to crest and back again. The bottom
of the cycle is characterized by product prices below the industry’s average
productions cost. With prices this low, no productive capacity is added; in
fact, production declines as high cost and marginal productive capacity
disappears, and even low cost producers constrain capital spending.
“These low product prices increase the utility of the product to
its users, and they begin to consume more. As declining supply collides with
increasing demand, prices begin to increase. Product users often begin to hoard
product in anticipation of further price rises or to guard against shortages,
so some price rises have a near term result of actually increasing demand.
“These events allow producer profit margins to widen, and this improved
financial performance enhances the sector’s investment image.
“The higher product prices and enhanced industry image set the stage for
the cycle’s crest. Investment capital floods into the industry attracted by
high operating margins and the industry utilizes that capital to build more
productive capacity to supply increased demand. Meanwhile, higher product
prices have lowered the product’s utility to its users, so demand begins to
falter.
“This time, increasing supply collides with decreasing demand and
product prices begin to fall. Product users, sensing price softness, may begin
to ‘dishoard,’ reversing the earlier paradox. The industry’s profit margins
decline and its investment image erodes. Now investment capital declines,
prices fall further and productive capacity declines; but with lower product
prices, product utility begins to increase.”
“Share prices fall below what would be rational given the expectation
for an eventual recovery. Only a few investors have the interest to notice;
fewer still have the courage to act. Most investors call us twice during this
cycle: once in a panic to buy at the top of the cycle and again in a panic to
sell at the bottom.
“We aim that through our exclusive focus on natural resources we will
notice sectors that are inefficiently priced by the market. Hopefully, you will
have the foresight and courage to buy straw hats in winter.
“’The time to take hors d’oeuvres is when they are passing them out.’ In
other words, when summer comes, sell those straw hats. Sell the stock and find
another one that is underpriced. We believe that these industry cycles will
always repeat.”
Today, resource stocks are suffering one of the harshest declines in
decades. Can buying resource stocks when they are ‘on sale’ work today? An 80
percent decline in resource stocks certainly creates a situation reminiscent of
the resource market in the lows of 1990 and 2000.
As Rick explains, “Natural resource companies are capital intensive
businesses with long development cycles and extreme short term price
elasticity. Understanding the basic cycle of extractive industries and
investing using the contrarian approach are essential elements of successful
natural resource investing.”
If you follow Rick’s media and public speakingappearances, you know that this 3-year slump has not deterred his belief in
contrarian investing. Will the contrarian approach work again in the current
bear market? Well, if the cyclical nature of resource markets is intact, we
should expect that bear markets should eventually lead to bull markets which
may compensate investors for their willingness to build or maintain their
position in times of depressed market prices.
This information is for information purposes only
and is not intended to be an offer or solicitation for the sale of any
financial product or service or a recommendation or determination by Sprott
Global Resource Investments Ltd. that any investment strategy is suitable for a
specific investor. Investors should seek financial advice regarding the
suitability of any investment strategy based on the objectives of the investor,
financial situation, investment horizon, and their particular needs. This
information is not intended to provide financial, tax, legal, accounting or
other professional advice since such advice always requires consideration of
individual circumstances. The products discussed herein are not insured by the
FDIC or any other governmental agency, are subject to risks, including a
possible loss of the principal amount invested.
Generally, natural resources investments are more
volatile on a daily basis and have higher headline risk than other sectors as
they tend to be more sensitive to economic data, political and regulatory
events as well as underlying commodity prices. Natural resource investments are
influenced by the price of underlying commodities like oil, gas, metals, coal,
etc.; several of which trade on various exchanges and have price fluctuations
based on short-term dynamics partly driven by demand/supply and nowadays also
by investment flows. Natural resource investments tend to react more
sensitively to global events and economic data than other sectors, whether it
is a natural disaster like an earthquake, political upheaval in the Middle East
or release of employment data in the U.S. Low priced securities can be very
risky and may result in the loss of part or all of your investment.
Because of significant volatility, large dealer spreads and very limited
market liquidity, typically you will not be able to sell a low priced
security immediately back to the dealer at the same price it sold the stock to
you. In some cases, the stock may fall quickly in value. Investing in foreign
markets may entail greater risks than those normally associated
with domestic markets, such as political, currency, economic and
market risks. You should carefully consider whether trading in low priced and
international securities is suitable for you in light of your circumstances and
financial resources. Past performance is no guarantee of future returns. Sprott
Global, entities that it controls, family, friends, employees, associates, and
others may hold positions in the securities it recommends to clients, and may
sell the same at any time.
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