Commodities Are Too Cheap to Ignore, Says Rick Rule

Rick Rule told an audience at PDAC 2020 that he believes commodities are in a multi-year bear market and it is unlikely they will go lower

SmallCapPower | March 6, 2020: Rick Rule, CEO of Sprott U.S., began his career in the securities business in 1974. He is a leading retail broker specializing in commodities such as mining, energy, water utilities, forest products and agriculture. Here are some highlights from his presentation at the 2020 PDAC convention.

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You are either a contrarian or you are going to be the victim.
Rick Rule

Rick Rule began his presentation by highlighting two charts to put the current market for commodities into perspective.


The first chart that Rick Rule highlighted is the Barron’s Gold Mining Index (BGMI), the longest running gold mining equity index. Looking at the chart, gold is one of the most volatile investments in the world. This tells you a couple of things – “you are either a contrarian or going to be a victim” – and the chart shows us this. Human nature shows us something else, when do people get into the gold market, either at the top or the bottom. This is due to investor emotion when people buy financial assets, they typically buy them overpriced because the price action verifies the narrative. The price action itself takes some of the value out of the narrative. Looking at chart you see the danger of being convinced of a narrative when it is not longer true.

Bottoms typically v-shaped and there have been eight major recoveries since 1970. But there can be ugly bottoms that vary between 2-5 years. Looking at the current decline, relative to other declines, this bottom is extraordinarily long of tooth – one for the record books. Most tepid recovery was 180%; the best recovery is 1,200%. So, there are four key takeaways Rick Rule wants investors to learn from this chart.

1) Variability of price of gold
2) Periodicity of decline
3) Amount of upside in the index
4) Short period of time that takes place with regards to the index

Key takeaway. One thing Rick Rule has told retail investors over the years is that if you are going to try to outperform an index, you are almost pathologically stupid. It is better to just buy the index that has show rallies between 180% and 1,200% historically.

Source: Goehring & Rozenwajg

Next chart is the GSCI to Dow Jones ratio over 100 years. We are at the bottom; this is because commodities producers are so capital intensive there is a lag (lead time) to finance and build a mine. Similarly, when commodity prices fall, mine production does not slow down as quick as you would think.

Could commodity prices go lower in the future? Unlikely. First, we are in a 10-year recovery. About 30% of growth in precious metals demand over the past 10 years has come from China. Second, the nature of the recovery we are in is not a real recovery like in the one in the 90s, which was spurred by economic growth mainly from China. Think about commodities that are responsible for power consumption, like copper. A lot of these commodities are selling for lower than their cost of production. You must ask yourself will we still use copper in five years, will buildings still require electricity and plumbing. If the answer is yes, then there will still be copper demand.

Why gold? Gold has done historically well during periods of negative interest rates. If you had bought a 100-year Argentina bond in 1920 you would have paid for eights defaults. You would have gotten negative yield buying Greece bonds in the early 2010s. Gold’s market share is 1% of total assets worldwide, compared with 7% in 1981. The three-decade average is 2%, which translates into a 400% increase in demand for precious metals and precious metals mining stocks. Money is made on the delta between price and value. Did the value of mining stocks change over that time, or did the price change? If the price of gold increases way more than costs, then eventually the price of the equities will jump up to match.

Key takeaway. Commodities are in a multi-year bear market and it is unlikely that they will go lower. This is a good buying opportunity.

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