Source: Karen Roche and JT Long of The Gold Report (5/9/12).
One special session at the April 27–29 Casey Research Recovery Reality Check Summit wasn’t on the agenda—a private panel for The Gold Report readers with three of the premier summit speakers: Global Resource Investments Founder and Chairman Rick Rule, Casey Research Senior Editor Louis James and Casey Energy Opportunities Senior Editor Marin Katusa. You won’t pin them down to a timeframe, but they’re looking forward to a buyer’s market, as equity prices fall and volatility increases. As Rule puts it, “When the luster is off the sector, it’s off all parts of the sector, so in bad markets the best companies are cheap. When the best come cheap, you have to play.”
The Gold Report: When we talked last fall after the When Money Dies summit, Rick, you were looking forward to the volatility preceding the decline of paper currencies as an opportunity to take advantage of the liquidity crisis.
Rick Rule: The volatility I anticipated didn’t happen because the amount of quantitative easing—I would call it counterfeiting—was extraordinary. That cash coming into the system acted as a soporific, so the volatility I had hoped for did not in fact come to pass. People whose portfolios declined probably felt they experienced volatility, but I think it was the weight of the chronically overvalued junior resources sector. Probably 80% of the sector is nonviable and in a state of permanent decline, with the market occasionally punctuated by up moves driven by performance among the best companies.
TGR: So, you were disappointed.
RR: I was very disappointed. I expected a Volatility S&P 500 (^VIX) in the range of 30. For somebody who makes a living basically as a pawnbroker, there are no better circumstances than extraordinary volatility. I didn’t get to practice my trade.
TGR: Do you think it will change in the second half of 2012?
RR: I don’t know, but the disconnect between the way we in the West live and the way we can afford to live will be problematic, particularly because the productive part of society—the so-called one percenters—is being vilified. The conflict between good and bad news will create incredible volatility at some point, but I’d be pressed to tell you when.
Inevitable is not the same as imminent – Rick Rule
TGR: That sounds like more social than economic volatility.
RR: Social volatility manifests itself in the economy. We’ll see less productive investing if the politics of envy drive increasing taxes on capital. To raise workers’ real wages, the workers must employ more capital, and you can’t do that if the capital isn’t finding its way into the economy.
TGR: Last fall, Marin, you said quantitative easing was deflating equity valuations. “He who has cash will be king,” you said, “because he can afford to buy discounted stocks. If you do your homework and be sharp you’ll make a fortune in the next three years.” Is that still the case? Are we too late?
Marin Katusa: Not too late at all, and I still believe we’re in deflating equity prices. I’d say it’s going to get a lot worse, especially for the junior resource companies. Less money is flowing into the sector and it’s now a buyer’s market. This is the riskiest investment segment on the planet. Risk mitigation is the key to succeed, and any opportunity to reduce risk is the most important thing moving forward. By mitigating risk, being strategic, always taking Casey free rides—the portfolios for 2011 for both the Casey Energy Report and Casey Energy Confidential gained over 20%. And Q1/12 was over 20% for both newsletters also. So if you do your homework and buy good companies, you can do well.
TGR: Louis, you said that the secret is to figure out what real stuff people need because it will retain value. When prices on valuable stuff go down ridiculously it’s a godsend because you can buy when it’s cheap and sell when it’s expensive. Is the stuff people need cheap now?
Louis James: Stuff is not really cheaper. There is deflation in some asset classes and some equities, but life for the average Joe is not cheaper and commodities in general are not cheaper. Gold is trading between $1,600 and $1,700/ounce (oz). Copper is at what looks like maybe reasonable long-term prices, but short term, they’re ridiculously high. I can’t believe the way copper has defied gravity in the face of all the economic turmoil the world is in. It says something about the supply destruction industry is seeing and the supply pinches coming.
It’s actually fantastic if you have high, driving prices in the commodities, find good companies with good management, money in the bank and the wherewithal to weather the storms, buy them cheap and profit from some of the volatility Rick is looking for.
But I agree with what he said. I also think we’ll see more volatility, and the chances of seeing much lower prices are pretty good. When a bear sentiment grabs the market, it takes everybody down, both the best and the worst players. If you have the courage to face it, that’s very good news. There’s a good chance we’ll see much more of that over this summer and I’m looking forward to it.
After the sector bounced back from 2008,
I wrote that we should be so lucky as to have another one – Louis James
TGR: Participants came to this conference for a Reality Check. Rick, you said a reconnoitering is inevitable. But how do you tell the difference between a correction or retrenchment in a supercycle and the start of a bear cycle?
RR: I don’t know how to know. Eric Sprott is a student of markets. I’m not. My response to a market is simply to try and figure out what I think a company’s worth and buy or sell based on that. I think the resource equities markets are headed lower this year. I also think we’re going to see increased merger and acquisition (M&A) activity simply as a consequence of the fact that the entry points are going lower. Although I think the overall market is going down, I’m writing more buy than sell tickets today. When the luster is off the sector, it’s off all parts of the sector, so in bad markets the best companies are cheap. When the best come cheap, you have to play.
I’m keeping powder dry, too, because I think we’re going to have the best private placement market in 2012 since 2002, when it was truly spectacular, when management thought they either had to raise money or forego their salaries. It made them reasonable about things like warrants.
MK: There are already more private placement opportunities on the buyers’ terms, with full warrants, three years minimum. We’ll also see management teams participating in the private placements. New terms will specify a certain amount that must go in the ground. A lot has unraveled and the mergers have started. Just on April 27, IAMGOLD Corp. (IMG:TSX; IAG:NYSE) bought Trelawney Mining and Exploration Inc. (TRR:TSX.V) with CA$585 cash.
A lot of the easy money has been blown up. Half the companies listed on the Venture Exchange have less than $5 million (M) in the till. They cannot do a serious exploration program. Drilling 4,000 meters in the Yukon costs a minimum of $2M. But the good companies will do very well, better than any bull market because there are more willing buyers for those few superb companies.
LJ: Because a rising tide lifts all ships, during part of a frothy bull cycle you have a reasonable chance of making money on the greater fool theory: buying something in the hopes somebody else will come along and pay more for it simply because the market goes up—not because any value has been added or the company has achieved any of its goals. But that’s a pretty risky proposition; the greater fool theory is exceptionally dangerous. You never know if the market will go up, or whether a dip is a bottom or an increase is a top. Nobody in his right mind tries to time the market.
A much better procedure is to buy value. A rising tide will raise all ships but it should raise those with real value higher. The people who know the quality players certainly know what they’re looking for, and they will buy the successful exploration companies.
TGR: Do you also anticipate increased M&A activity?
LJ: We’ve always had an eye out for the takeovers and kept them on the radar, but we started to focus on them more when the liquidity issue became very serious, because, frankly, as the number of subscribers grew we became market movers. We moved toward more liquid shares in the newsletter, and takeovers are among the best liquidity events.
As Rick says, M&As aren’t an “if” but a “when” question for the larger mining companies, because if they don’t buy the successful exploration efforts, they will no longer be larger companies. There’s no way a mine can be anything but a depleting asset, so if these companies don’t spend money replacing reserves through their own grassroots efforts, they have only one choice.
TGR: Rick, you say only a handful of management teams have created most of the value in the mining sector. Who are they?
RR: Two generations of relationships with the Lundin family reminds me of owning a row of slot machines. They’ve done something good for me every year for 35 years. I’ve also known Bob Quartermain for 35 years. I’ve done two companies with him, and he’s been spectacularly successful. And the worst of the four companies that he wasn’t involved in but recommended to me over a period of 20 years was a tenbagger. Same with Ross Beaty, who I’ve known since I was in university. A serially successful man.
In Calgary, there’s Murray Edwards. Serially successful. If all you did for 20 years was hang out with Murray Edwards, you would have made truly spectacular amounts of money. Most junior resource investors won’t spend time and don’t have the education to make technical decisions with regard to the length and breadth of the market, but if they discipline themselves to stick with people who do that for them for the long term—management teams that may make mistakes and stumble but will deliver—they’ll do well.
TGR: So even those with the Midas touch sometimes stumble?
RR: Oh, yes. I talk about how much money Ross Beaty has made my customers over the years. There hasn’t been a Ross Beaty stock we’ve ever been in that hasn’t fallen by 50% or more at one point in time when we owned it. In the first incarnation of Lumina Copper Corp. (LCC:TSX.V), I think the financing was $2/share. The stock ran to $6/share. Everybody loved it. It fell back to $2.80/share. If you lost your nerve and sold out then, you missed a 4½-year move to $44/share.
Marin runs a fund that I invest in, the KCR Fund. I told him, “Visit everybody you can in Canada between the ages of 30 and 40 and find me the next Ross Beaty. It ain’t going to be easy but it’s more important than anything else you can do for us.”
TGR: Whom did you find, Marin?
MK: We created the NexTen, which is the next generation. Those in Rick’s generation are Casey League Explorer honorees, a kind of hall of fame in junior exploration. Amir Adnani, one of the first NexTen, actually built a uranium mine, and he’s 33 years old. He sat behind me in organic chemistry class in university, so I’ve known him since then. And there’s Nolan Watson, who was the youngest CFO of a NYSE-listed company with a market cap over $1 billion and probably knows more about royalty structures than anyone else in our business.
Morgan Poliquin, president and CEO at Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE.A) is also among the NexTen. His father is Duane Poliquin, Almaden’s founder and chairman; he’s a Casey League Explorer honoree. When it comes to the geologists, you stick with the young ones who have it in their blood. They are true company builders. They aren’t serving on the boards of 10 different companies, spending half their money on Canucks box tickets and the other half on their Ferraris.
LJ: We did a panel in Vancouver in January with maybe six Explorers. If you’d invested in their plays in this cycle in the last couple of years, you would have doubled or tripled your money. That’s striking because it’s not just the 80/20 rule. It’s 80/20 and then 20% of that 20%, who make most of the discoveries. It’s very much the cream of the crop, with those serially successful track records.
Rick mentioned how Ross Beaty’s companies have had 50% haircuts on their way to multiple gains. We have to cull the herd in our newsletters, so we exited the second-generation Lumina when everything went into reverse in 2008. But we didn’t say “sell” in our newsletters. We said we were closing our position for portfolio reasons, that we may not sell our own personal shares and we didn’t think there was any hurry for readers to sell theirs—but we weren’t going to be following the company anymore.
Interestingly enough, a good number of our subscribers didn’t sell either. Now that political risk has increased in Argentina, where Lumina operates, we’re getting more “should we sell?” questions—which tells me how many people held on to that stock. When we closed our position at about a 50% loss, it was at about $0.50/share. Last I noticed, it was in the $6–7/share range; if you’d held on, you’d have had a high multiple on your investment. Or if you bought at $0.50/share as a contrarian, you’d have done extremely well—more than a tenbagger.
Every time Ross pitched something to me and I didn’t buy it, the stock went up a lot. The least was a little bit better than a double on Ventana Gold Corp. (VEN:TSX). I thought it was already expensive, but darned if it didn’t more than double after I didn’t buy it. It pays to bet on winners like this.
TGR: You’re talking about company-builders providing a lot of value in the share price, and how stockholders will get the value out of the some of these equities through M&A. Are the majors looking at management?
LJ: I doubt Newmont Mining Corp. (NEM:NYSE) cares whether quality operators like the Poliquins have advanced a project. They look at the numbers and decide, “Yes, this fits our needs, it dovetails with our existing production or whatever. It works for us and at X price, its value-accretive to us.”
I don’t think the majors look that much at management. Good management does the things the majors want to see. They derisk a project and advance it properly. When the majors review the data, they see this is a real resource.
Anybody who thinks an NI 43-101 will protect them from a fraud
is smoking something or should be– Louis James
RR: Professional speculators, too, can focus on second-tier management teams and segregate properties. Most investors don’t have the ability to separate the wheat from the chaff. If they’re attracted to the performance this sector can produce, the most reliable way is to stick with the very best operators. With something like 250,000 geoscientists in the world and 3,000–4,000 operating mines, most geoscientists will never be part of a discovery. But others, like those in the Explorers’ League, are responsible for 4–5 discoveries each.
MK: These aren’t one-man shops, either. They build exceptional teams. Ross Beaty has David Strang as Lumina president and CEO, and Leo Hathaway as vice president of exploration. A close friend of mine, Jim O’Rourke, chairman of Copper Mountain Mining Corp. (CUM:TSX), has built five mines and teams around him. He’s 72 years old and still drives up to the Copper Mountain mine near Princeton, British Columbia, on Friday nights because that’s what he loves.
TGR: Bud Conrad, Casey Research’s chief economist, pointed out during the summit that gold stocks have never been lower compared to the gold price. When will this change?
LJ: My gut says that we don’t have real capitulation yet—just price destruction and desperation that has Rick rubbing his hands together gleefully. Companies are hoping for the next round of drill results to raise their stock price so they can raise money at a better price and so forth. They aren’t yet saying, “Forget it. Name your terms.” When we start hearing that, it’s a good sign of bottoming.
I’m quite happy for the bottom to pass and then say, “Clearly that was a bottom and now we have upward momentum,” particularly in the context of a supercycle, which I don’t believe is over. Looking at supply and demand and political factors I have a high level of confidence that this major bull cycle for metals has a longer way to go. Until the fundamentals change, any retrenchments along the way, no matter how major, are buying opportunities. It’s just a matter of when and how much to deploy.
RR: The gap between gold and gold equity prices came about for several reasons. In the first place, before 2010, gold stocks increased in price very rapidly, more rapidly than gold itself. As a result, gold stocks simply overshot and needed a rest. The second factor was partly a function of the first—the explosion of gold ETFs. People who hadn’t traditionally been gold buyers but bought gold stocks for leverage to gold could buy bullion-like instruments in retirement accounts and hoard gold in some fashion more efficiently than buying it and burying it in the backyard.
The third factor was the gold industry’s extraordinarily poor performance. Between 2000 and 2010, the price of gold advanced from $250/oz to $1,200+/oz. One would have expected a meteoric rise in the free cash generation of the gold companies, but the industry’s cash-generating and earnings response was pathetic. Worse, while cash didn’t explode, equity issuances did, so they diluted the cash they already had. That led to disgust with the gold companies, which carried over into their stock valuations.
A fifth factor, of course, is that the junior sector is perpetually overpriced. The sector itself is valueless and always will be. Added to that, these little companies incredibly inflated the number of shares they issued. The private sector is always more efficient than the public sector, even in counterfeiting, and the Canadian dealer network printed more phony share certificates than the Fed printed phony dollar bills. So although share prices didn’t escalate, the market capitalization of the sector escalated dramatically.
If you step back and look at all those factors, you’ll see the stage set for a rebound in the better gold companies. The performance of the senior and intermediate gold companies has been much better over the last 18 months. The cash is really starting to come out. Strip the tax gobbledygook from the accounting and look simply at cash at the beginning and end of period and capital expenditures, and you’ll see how much cash these companies are generating.
That’s good in a bunch of ways. It allows them to grow organically so they don’t have to issue equity. It allows them to do takeovers, which adds capital and liquidity and hope to the sector. And increasingly the companies are sharing some of that capital with their shareholders either as dividends or equity buybacks. That’s making the gold equities more attractive.
Ironically, the stage is set for a rebound just as gold share investors have conditioned themselves to expect the worst. Does that mean it’s going to happen anytime soon? I’m long past confusing inevitable with imminent. And I would caution against reading too much bullishness into what I say with regard to juniors because you have to remember that most of them have no value.
That said, we’re in a discovery cycle. Although the industry has all kinds of flimflam artists, every year we get a few better people and over the past 10 years we’ve empowered them with lots of capital. We now have some great people using great tools to make discoveries in many places that have never before been prospected by means more sophisticated than a pick and a mule.
So I expect an increasing cycle of discoveries that will really surprise people, and more money may be made farther down the value chain than at the very top. If I’m ever right about volatility—if the volatility index gets up to 25 or 30 again—one of the easiest ways in the world to make money is to buy very good companies and sell short-dated puts and calls against them. Being particularly volatile, gold stocks are especially appropriate for put and call ratings. So for the next year, I’d suggest buying a couple of majors if you’re so inclined—they may not be cheap but they’re reasonably priced—and sell puts and calls against them, particularly when the volatility goes nuts.
TGR: How about explorers versus producers?
RR: If you’re willing to play the game, nothing makes money like successful exploration. Most speculators don’t have the patience to speculate on a process, which is what anticipating exploration takes, but that’s what’s made me the money I have. Buying ATAC Resources Ltd. (ATC: TSX.V) at $0.10/share nine years ago, it was frustrating to watch it go to $0.22 to $0.13 to $0.27 to $0.11. But then it went to $7/share and you say, “Oh yeah, that’s why I did that.” So for people willing to take the risk and the time, the exploration sector is a nice place to be.
TGR: In conclusion, tell us about the best investing advice you have ever received or given.
RR: I think the best investing advice I’ve ever received I read in Ben Graham’s Intelligent Investor—the chapter on Mr. Market. On the whole, he’s your manic-depressive business partner. If you trade against his mania and depression, he’s the best partner you could possibly have. By the same token, probably the best investing advice I’ve given was merely paraphrasing Ben Graham. I’ve told people for years that in an extremely cyclical business such as natural resources, you can either be a contrarian or a victim. That’s applying cyclicality to Ben Graham. It’s the same message; I just have a catchier slogan.
MK: My best advice came from two people. Doug Casey always said to focus on people, and Rick told me to focus on people of my generation to reap the rewards for the next 30 years. The main advice I’d give anyone is before buying anything, go to free shows, sign up for the Casey newsletters and figure out whether you even like this sector. You’re not going to succeed if you don’t enjoy learning about it and enjoy the people in it. If you follow your passion, whatever that may be, you will succeed.
LJ: Back to what Rick said—and he continues to be one of my mentors—is the critical concept of being either a contrarian or a victim. It’s certainly proved true. Of course, Doug Casey is the quintessential contrarian. Maybe I’ll go one further and add Bill Bonner’s quip that a bull market is a random market movement that causes average investors to mistake themselves for financial geniuses. I’ve done a number of things wrong and there are things I might do differently, but I’m pretty sure I haven’t made the mistake of assuming that the beneficial results of a bull market had anything to do with my particular genius. I’ve been cautious and the bull market has made me disciplined.
I think the advice I have given—and it’s not mine but reiterating things that I’ve heard that have worked—is about discipline. You have to know yourself. As Marin said, you have to do something you care enough about to do the hard work, learn what you need to learn. Rick said something about staying in the play until you get to the end game. That takes a lot of discipline. A good speculator is not just lucky. A good speculator is very disciplined.
TGR: That’s a wonderful note to end on. Thank you all for your time.
Founder and chairman of Global Resource Investments and president of Sprott Asset Management USA, 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 and asset manager specializing in mining, energy, water utilities, forest products and agriculture. Rule’s company has built a sterling reputation for its specialist expertise in taking advantage of global opportunities in the resources industries. In 2011, Rule closed a landmark deal with Eric Sprott, founder of Sprott Inc., another famous powerhouse in the arena. Sprott Inc. offers resource-oriented investors opportunities in segregated managed accounts, mutual funds, hedge funds and private partnerships. The collective organization offers unparalleled expertise and access to investment opportunities in all resource sectors. 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.
Louis James is chief metals and mining investment strategist at Casey Research, where he is also the senior editor of Casey International Speculator, Casey Investment Alert and Conversations with Casey. When not in meetings with mining company executives in Vancouver, British Columbia, James regularly travels the world evaluating highly prospective geological targets and visiting explorers and producers, getting to know their management teams. For more than 25 years, Casey Research, headed by investor and best-selling author Doug Casey, has been helping self-directed investors to earn returns through innovative investment research designed to take advantage of market dislocations.
Investment Analyst Marin Katusa is the senior editor of Casey Energy Report, Casey Energy Opportunities and Casey Energy Confidential. He left a successful teaching career to pursue what has proven an equally successful—and far more lucrative—career analyzing and investing in junior resource companies. With a stock pick record of 19 winners in a row—a 100% success rate last year—Katusa’s insightful research has made his subscribers a great deal of money. Using his advanced mathematical skills, he created a diagnostic resource market tool that analyzes and compares hundreds of investment variables. Through his own investments and his work with the Casey team, Katusa has established a network of relationships with many of the key players in the junior resource sector in Vancouver. In addition, he is a member of the Vancouver Angel Forum, where he and his colleagues evaluate early seed investment opportunities. Katusa also manages a portfolio of international real estate projects.
Rule, Katusa and James were featured in daily Gold and Resource Stock Roundup sessions at the Casey Research Recovery Reality Check Summit, where they revealed their favorite resource companies and specific investment strategies. You can hear every word of these invaluable discussions, as well as over 20 hours of presentations by contrarian investor Doug Casey, former U.S. Office of Budget and Management Director David Stockman and 29 other financial experts in the Recovery Realty Check Summit Audio Collection.
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1) Karen Roche and JT Long of The Gold Report facilitated this panel discussion. They personally and/or their families own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: None.
3) Rick Rule: I personally and/or my family own shares of the following companies I mentioned in this interview: ATAC Resources Ltd. I personally and/or my family am paid by the following companies I mentioned in this interview: None.
4) Louis James: I personally and/or my family own shares of the following companies I mentioned in this interview: None. I personally and/or my family am paid by the following companies I mentioned in this interview: None.
5) Marin Katusa: I personally and/or my family own shares of the following companies I mentioned in this interview: None. I personally and/or my family am paid by the following companies I mentioned in this interview: None.