- TSX: SII
- Shares Outstanding: 255M
- Share price C$3.52 (14.05.2020)
- Market Cap: C$893M
Interview with Rick Rule, President & CEO of Sprott U.S. Holdings.
We go back to where it all started, and ask about what he wanted to be when he grew up. Rule talks to us about his personal and business philosophy.
We look at the end game and legacy. As Sprott’s largest shareholder, what is he trying to build. And can they be considered an 800lbs gorilla yet? What does it take to move market and sentiment?
Can a company like Sprott, which has availability to cash and investors who follow their investments, afford to be less selective with the investment choices? Why does he spend so much time on marketing? We look at the different revenue and income streams and discuss perhaps why somer investors aren’t equipped to invest. Rule’s answer may surprise you.
Everyone has a different business model and will therefore have different outcomes even if they follow the same strategy. But we look at the importance of actually having a strategy. So how do the target investments? What about distressed companies? Who is in the driving seat.
What are the options available to retail investors. And how important are they at different times in the companies life cycle and different market conditions. And where do brokers fit in to the mix? Is the landscape changing?
And finally, what does the most recent bout of QE do for the global economy and the US?
- 1:49 – Background of Rick Rule & Sprott
- 4:42 – Rick’s Childhood and Influences
- 9:26 – All About Sprott: On End Game, Competition, Power to Turn Markets and More
- 19:55 – Retail, High Net-Worths and Family Office Investors; Are They Equipped to Make Good Investment Decisions?
- 22:28 – Discussing Their Portfolio Approach, Business Model, and Uranium Holdings & Market Situation
- 31:50 – Confirmation Bias: Buying Behaviours Should Revolve Around a Strategy
- 36:28 – Approaches to Companies With(out) a Business Plan
- 39:42 – Success Follows Success: Precision of Investment and Peoples’ Belief in Sprott
- 46:01 – Establishing Trust: Types of Deals Approved by Mr. Rule
- 52:10 – Broker Relationships and Working Together
- 53:37 – ETF Fund Management
- 56:16 – Opinions on Naked Shorting, Ill Fates for Juniors, and the US Quantitative Easing Program
CLICK HERE to watch the full interview.
Matthew Gordon: Hey Rick, how are you doing, Sir?
Rick Rule: I’m doing well, and I have to say I’m a fan of Crux Investor, so I’m delighted to be invited to participate. Thank you.
Matthew Gordon: That’s a pleasure. I think we could almost cut it there. That is perfect for us. But given we’ve made all this effort to get together, let’s talk. So, Rick, you know, we obviously know Sprott and Rick Rule from all of the work that you do in the mining sector. You are very well known in North America, not so much over here. So, I’d wonder if you could take some time out and sort of share a little bit about you and the company?
Rick Rule: Delighted. As you can see by now, I’m a rather elderly investor: I’m 67. I’ve spent my entire adult life in natural resource investing and investing management. I built a business called Global Resource Investments, and another business called Resource Capital Investments Corp, which I sold to Sprott in 2010, and I have been since then, Sprott’s largest shareholder and a Sprott employee.
I’ve actually been reasonably involved in Australian markets going back to 1988. I tend to be more active in Australia when Australians aren’t. I have found that in local markets like that, the bear markets are more conducive to my presence than bull markets. So, I remember in 1989, 1990 1991, as an example, attending Diggers and Dealers, and having a strange sense that I was a very pretty girl in a short skirt. A new cheque in Kalgoorlie was very, very welcomed. In good markets, of course, it’s difficult for non-Australian investors to participate against the locals, but in bad markets, when Australians go on strike, it’s an extraordinarily good market, even for foreigners like myself.
So as to Sprott, we are Canadian domiciled, enlisted, but most of our business is in the US. We manage something in excess of USD$12Bn in assets, virtually all of which is involved in precious metals and natural resources. As you suggest, we have about USD$7Bn in New York Stock Exchange-traded physical precious metals, trusts and ETFs. Then we have a variety of bespoke equity strategies and we are, I think, the largest provider of development and bridge credit for non-in investment grade issuers. That is sort of sub BHP issuers. And we have a fairly small but active wealth management business. Active primarily in the United States and Canada, but also frankly with many, many individual clients from both Australia and New Zealand.
Matthew Gordon: Okay, nice summary. I’m going to explore a little bit deeper, dig a little bit deeper please. We are speaking to some of the great and the good in the mining space and we are trying to understand the mentality and you know, perhaps what drives them. But let’s start off with; where were you brought up, what was your upbringing like?
Rick Rule: This will expose my first great career mistake. I was born and brought up in San Jose, California, the heart of Silicon Valley. It had zero interest in technology.
Matthew Gordon: I just spotted the glaring error. Right? Okay.
Rick Rule: It was a consequence of a very poor decision made when I was 16 years old; I became merely rich as opposed to filthy rich. But I was even at that point in time, interested in, particularly, agriculture, mining and oil and gas, and I attended the University of British Columbia in Vancouver, British Columbia, beginning of 1970 as a consequence of both of them having a degree program in natural resource finance, which wasn’t available elsewhere in this hemisphere. And also, because in 1970, a young American was going to have to travel. Most of them went to Vietnam and I chose to go to Canada, which I still think in retrospect was a very good decision. Vietnam was warmer, but I didn’t want to be shot at or have to shoot other people. So, I chose Canada and I’ve been involved in natural resource investing literally ever since. For me, it was a wonderful, wonderful career choice. I have had an interesting and varied life and I’ve met a wonderful crew of people. It’s truly been a blessing.
Matthew Gordon: But what did you think you were going to be? I mean, you know, back in the day, you’re sort of making those choices. You know, you’ve got different visions and pictures in your head.
Rick Rule: This will expose me as a real nerd; my aspiration when I was 18, was to become an international taxation lawyer specialising in natural resources. How an 18-year old who should have been interested in girls or something, decided to become an international taxation lawyer specialising in natural resources is beyond me to today. I had the good fortune to befriend an international tax lawyer in Vancouver and I asked him for career advice and he said he’d come to know me fairly well and he thought that I’d be miserable as a lawyer and that I should become a businessman and investor, and in fact, hire lawyers. And he introduced me to one of the all-time deans of value investing, deep value investing: Peter Cundall, who became my first financial mentor and was responsible for my original investing discipline, which was value and deep value, particularly in natural resources. Much of the style that I have today, not all, but much of the style I have today owes itself, in fact to the influence of Peter Cundall. For those listeners that you have that are sort of into the values of the business, Peter Cundall is sort of the holy grail of deep value and the concept of valuing redundant assets and peak of cycle trough of cycle valuation disparities.
Matthew Gordon: Right. And would you say that that’s been your philosophy ever since? So maybe business philosophy, yes, but as your own personal philosophy too and the way that you go about your everyday life?
Rick Rule: I suspect it is, frankly, many value investors have odd personalities and I would certainly buy off on that. I know for Peter Cundall, a book that was of importance to him; coming of age was ‘Human Action’ by Ludwig von Mises which turned out to be other than perhaps securities analysis, no, even including securities analysis, ‘Human Action’ was probably the most important book I’ve ever read in terms of understanding human motivation; both in terms of finance and other aspects of our lives, and also volition: how we get along with each other and how we function. So, I would suspect that the psychological formulation that goes into a value investor, the sort of tolerance or even reverence, frankly, for being lonely, for me it’s other aspects of my life.
Matthew Gordon: Well, I think that’s fantastic. I mean we’ve long held that, I think for our team, we want them to be able to read people, read situations, read sentiment in the market. And I think that never has that been truer than today and maybe what we are about to step into in terms of the unknown reaction after COVID-19. But maybe that’s a conversation for another time.
Let’s get on to Sprott. So, I think that’s given us a little flavour of what you have been about. You’ve told us about some of the things that you have built with Sprott, you’ve sold with Sprott and what they are trying to build, but what’s the end game there? Because I know you are a 67, spritely, very dynamic individual, but what are you trying to get out of this, and what is Sprott the company trying to build?
Rick Rule: I humbly, I would suggest that we are trying to build the finest, focused natural resource investment manager on the planet. And I think, frankly, we are pretty close to being there. Our franchise is mostly precious metals, and the consequence of that, I think that the next two or three years are going to be extraordinarily kind to us. The nature of all extractive industries, but particularly precious metals is that they are both capital intensive and cyclical. And we need to think for our clients and for the organisation itself beyond precious metals. My experience is that precious metals markets give you 3 or 4 extraordinarily good years, and then 3 or 4 or 5 or 6 fairly painful years. But if you are diverse, diversify across the whole spectrum of natural resource investments, which is to say, if you search in a forward-thinking manner for bear markets, that will become bull markets, you will do well over time. And that’s certainly worked for me. I am one of those who had come to understand that in cyclical businesses it’s bear markets that are safe, and bull markets that are in fact risky.
We have been through maybe the mother of all bear market in precious metals equities; beginning 2011 through 2019. Our thinking is that bear markets are the very authors of bull markets. And so, while our competitors were either in foetal position, doing nothing, or diversifying into businesses that they knew and loved like marijuana, we were focused on natural resources and precious metals. So, the consequences that we have been working 10-years to be the overnight successes that we are enjoying now. Our suite of products, as an example, include these New York Stock Exchange, physical precious metals trusts, which have tax advantages for US investors, but they end up being for investors who are concerned about the structure of the financial services business or concerned about the political structure of countries – very good vehicles in the sense that they are a hundred percent precious metals based. They don’t accept deposit receipts or anything like that. So, there’s never a chance that a holder in our trust could be the unsecured creditor of the counterparty. These were really built for bespoke precious metals portfolios. Built in fact because before we constructed the product, we had a lead order for USD$250M from a guy named Sprott, the same guy whose name was on the door. So, when we talk about a bespoke product, that was truly a bespoke product.
Matthew Gordon: Yes, you’re in the fortunate position that you’ve got money. This has been building up over time. If you were maybe starting off today, you might have to approach things differently. So, but, let’s stick with this – do you think you are the 800lb gorilla in the room? Can you compete because you are so niche? In terms of natural resources, particularly precious metals, and I know you’re trying to build a portfolio of products here, but can you claim to, say, move markets or move sentiment or change sentiment?
Rick Rule: We don’t try to move markets. We are definitely trying to change sentiments. Our whole marketing and advertising thesis involves investor education and investor outreach. And so, efforts like these, as an example, consume most of the time and treasure that we spend on marketing. And we are definitely trying to change the way that both institutional and retail investors address the market. And we are also trying to change in our own way the way that issuers face the market. So, in terms of trying to change sentiment, I would say that’s an important part of who Sprott is at its core. Trying to move markets – no, not so much. The markets are bigger than us.
As to the competition, we are blessed and cursed with a reasonable amount of competition. At the very top, in terms of equity markets, of course would be BlackRock. They forget from time to time that they have a precious metals business. It doesn’t matter much to them, but they matter an awful lot to the market. And there are, of course, lots of investment banks that are agents as capital providers.
We are probably unusual in the sense that we are as much principled as aged. If there’s a transaction, either lending or equity transaction that comes out of Sprott, it’s likely that the lead order for that transaction is Sprott. So, in terms of our capital markets group, think of a sell-side group with buy-side roots, which I think is healthy. I think investors should look at whether or not the agents are in fact are enthusiastic consumers of their own investment products. At Sprott, we certainly eat our own cooking because it’s the right thing to do. And over 40-years, it’s tasted pretty good.
Matthew Gordon: Yes, no doubt. You have done very well out of it. And you know, your name appears with most of the conversations that I been having at the moment, you seem to have a little piece of the pie. But tell me specifically about what you’re trying to do; when you’re saying, I’m trying to change the sentiment and that could be, you know, at a corporate level, whether it be the issuer or otherwise, what is it you want them to do? I mean clearly some branding component? Because I see you rather eloquently; you’ve got a very cultured language, and I see these interviewers who are either doe-eyed or glazed over, not quite, you know, grasping the importance of what you’re saying. I do enjoy you when you’re having these conversations, but what is it that you’re trying to get out of the market and what do you think the immediate benefit to Sprott is? Is it just at a corporate level – that’s all you can hope to effect change in?
Rick Rule: I think that the first thing we’d like to do is on the retail investor side, is to cause people to exercise common sense and work a little harder. Common sense turns out to be fairly uncommon. And many speculators make many, many correctable mistakes. We would like the process to be more focused.
We believe in the contrarian approach to natural resource investing. We think that the first truth is the bear markets are the authors of bull markets and bull markets are the authors of bear markets. And so we would ask our clients and people who propose to become our clients to adopt a portfolio that’s more contrarian and more value oriented and less momentum oriented. We have also learned that in businesses below a billion dollars in market cap in particular, that the most important asset on the company’s books are seldom physical. They are much more commonly human. We have learned that almost all of the value delivered to resource equity investors over the last 40-years has been delivered by less than 5% of the management teams employed in the sector.
So we try to cause our clients to invest all of their money, if we can talk them into that, with tier-one management teams; with management teams that have been serially successful in the past, and in fact, confined their activities to companies where the business focus is the same as the business focus that the management teams have enjoyed success on in the past.
If someone comes to me and he says, ‘You know, Rick you know, I’ve listened to your blogs. I’ve been a success in mining because I turned around and operated successfully a Gold mine, a producing Gold mine in our key terrain in French speaking Quebec.’ But the value proposition in front of me is that the same person is exploring rather than producing for Copper-Gold in the Spanish speaking Peruvian Altiplano in tertiary volcanics. While the person may have been a success, it’s arguable that the task at hand is so different that his or her success is irrelevant.
So we would ask our clients to employ common sense. We would ask them to have a value orientation, in fact, search out sales rather than search out sectors that have already performed. And we would ask them to pay particular attention to the management teams and the concurrence between the management teams resumes and their task at hand. We would also finally, at least in the speculative aspects of our business, we would ask the clients to understand when they are analysing a company, that they look for the process of answering unanswered questions. In exploration, that might be a, will the drill hole prove the third dimension? In development, it might be on time, on budget, that kind of thing. But if you focus on answering the unanswered question, understanding where value might be delivered, you will do better over 10-years than if you skip from story to story with less of your own involvement in your own portfolio. So, I would say that that’s what we are trying to cause to occur with the mining and retailing.
Matthew Gordon: Okay. I buy that, but do you think that retail investors, or high net worths (HNWIs), even family officers are equipped to do that and you know, because I would put it to you that they don’t know what questions to ask, let alone look for. So that leaves them in a very difficult position.
Rick Rule: The answer to that is, yes. I think that a high net worth, retail investors and family officers, more small family officers, have an advantage over other investors in first of all that they know the client themselves better than anyone can. They need to be prepared to do the work, but the truth is that when you’re competing with many money managers, money managers often aren’t invested in their own product, first of all. They are employees rather than partners. But more importantly, they have a very short-term orientation, very short-term focus. Many managers seem to have trauma holding stock over a long weekend. When a high net worth investor or a family office can take a three year or four year or 5-year point of view, which is important.
It’s important, however, that the investor do the work; many people who transfer accounts to us, including family officers present us with a laundry list of securities: 60 or 70 securities, and it’s impossible that they could know all that they need to know about every security. So, as a rule of thumb I ask high net worth retail investors to own in their portfolio the number of speculative companies that corresponds with the number of hours per month that they are prepared to spend working on their portfolio. You don’t need to spend an hour a month, perhaps on BHP or Rio or Exxon. You have to have a point of view of where we are in the economic cycle, certainly. But if you are involved in smaller names, I think it’s really, really important that you yourself, not just your advisor, you yourself read the annual report, you read the proxy, you read the various disclosure documents, whatever form they take place in, and you ask informed questions of your advisor, be he or she with Sprott or anyone else. It’s really the proprietor’s involvement in his or her own portfolio that ultimately determines the success or failure of that portfolio.
Matthew Gordon; Agreed. Do your homework – that drum should be beaten loud and clear and repeatedly. So that’s great. Can we come back to you though, in terms of your blended portfolio approach? Because it’s that you can have commodities which are in a bull cycle and others which are a in a bear market, right? So, I’m thinking Uranium for instance, has not been flavour of the month for the last few years, but you weren’t pro it, then you realised that Gold was going to go shooting past it on the outside lane. So, you switched cars, well, you didn’t switch cars, there was another horse in the race for you there. So you’ve got options there because you can sit back, one of my favourite phrases that you use is the, ‘I will be correct, eventually,’ or words to that effect, which is when you have placed a bet and you can sit back and wait, which, you know, some people have the luxury of doing, and I think retail perhaps get a little more frustrated than you do. You are saying I’ve got foresight, but you are all in on Gold at the moment, which is great. Fantastic. But do you feel that therefore you’ve got the luxury of a different type of approach. You’ve got a different business model to retail and family officers, haven’t you, in effect?
Rick Rule: Maybe, because it’s mine, I think it’s correct. I’m not going to change. I think they should. I think first of all, I think that the wind is in Gold sales. I think that the policy response from the political class worldwide is awfully likely, maybe not certainly, but probably going to continue to propel precious metals higher. And the consequence of that is when the higher Gold price becomes reflected in the balance sheets and the income statements of the producers that they will follow, like they have in the last eight recoveries from oversold bottoms. That doesn’t keep me out of the Uranium space. The exact quote, to demean myself was, I usually forget that there’s a difference between inevitable, which I almost always get right and eminent, which I always get wrong.
What I’ve learned at age 67, however, is that three to five years is not an interminable length of time. In my career now, I’ve been through nine, five-year cycles, and oddly, while I have left less time on earth and time should be more precious, I become much more patient. So, I see, for a variety of reasons, the pressure off the Uranium price to go higher. I had believed two years ago that it was sort of 18 months before the Japanese reactor fleet restarted. And in that case, I wasn’t early, I was wrong. But I love the arithmetic associated with Uranium. I love the amount of energy that can be generated from a fairly small amount of fuel. I love the fact that if you had USD$7Bn or USD$8Bn into a reactor and that reactor is using, say, a million pounds of fuel, the price of Uranium is actually irrelevant to you, relevant to the cost of the capital employed, regulatory affairs and things like that.
So, if the price is USD$30/lbs, you’ll use it. If it’s USD$60/lbs, you’ll use it. If it’s USD$100/lbs, USD$120/lbs, you use it. The price of the input, the price of the Uranium is irrelevant to the price of the output, the electricity. And if you have a circumstance like today where the stuff is priced at $60/lbs but the fully loaded cost to produce it, including cost of capital, which the industry never talks about, is $50/lbs, that means that the industry worldwide is losing sort of USD$20/lbs.
Matthew Gordon: You said USD$60/lbs, I think you meant USD$30/lbs? The price is USD$30/lbs.
Rick Rule: Yes. But fully loaded in including cost of capital and importantly including prior year write downs, which companies never like to talk about, the total cost associated with producing a pound of Uranium worldwide, we believe exceeds USD$50/lbs. So if you’re making this stuff for $50/lbs total cost and selling it for $30/lbs, losing USD$20/lbs, and of course, being a miner trying to make it up on volume, over time, that’s simply unsustainable. And I would suggest to you that the price of something that has to go up and can go up will go up. I just can’t tell you when.
Matthew Gordon: I won’t even ask because I think I’ve long lost faith in the ability to call that market. As you say, the maths is fantastic. The reality is somewhat more opaque in that inventory and mobile inventory is, it seems to be an unknown; for such a small market that’s quite extraordinary. Well, let’s kind of move on from, well actually, let’s talk about Uranium just a little bit more because obviously there’s a lot of, COVID has impacted supply. You’ve been talking about the demand side there partially, but the supply side has been knocked for 6, to use a cricketing analogy, whereby 25Mlbs to 40Mlbs has been taken out of the market, depending on how long this goes on for, because it’s rather indeterminate at the moment. So, there’s hopefully a big, I’ve got to be careful with my wording here; there’s a wave of price discovery to happen, which is great. Are you at all concerned about the lost opportunity cost? Having had your money tied up there for the last three, four years, you could have come back in now made your cannabis money, made your Bitcoin money?
Rick Rule: I resent it. But it’s a cost of doing business for me. Yes, it’s a cost of doing business. The last Uranium bull market, which I was early on too, I began to come into that market in 1998, and I guess the market started to move in 2002, I had the same circumstance. I had forgone rent in the money that I had employed in the sector for 4-years. But the truth is, in that bull market, the five Uranium juniors that had survived the 20-year bear market that led up to that bull market were such extraordinary performers in that brief bull market. The worst of the 5, the poorest performing of the 5 generated 22:1 returns. And what you find, pardon the pun, is that’s the sort of explosive upside in the better Uranium juniors is so much that they can impose, they can advertise almost any time value of money discount that you want to put in place.
Matthew Gordon: Do you think that is realistic this time around? Given the lessons learned.
Rick Rule: There are two reasons: there is still a club of investors, if you will; old fat rich guys that went through the last bull market, and if you give them half an excuse I think you’ll see a stampede into the few Uranium juniors that are left, and the Uranium juniors that are left are, you know, pretty tough survivors. They’ve managed to hang on since 2007, 2008. You know, they managed to hang on for 12 or 14-years of pretty hard markets. It is strange that there were five Uranium juniors at the beginning of the last full cycle. There were 500 Uranium juniors at the top of the last bull cycle, and there are probably 12 viable Uranium juniors, and I may be overstating the number today. So, the same circumstance happens when the investment community gets tempted back into the Uranium space there is a very small opportunity set available relative to the cash that remembers the last cycle and wants to come into it.
Matthew Gordon: But therein lies the problem: there were a lot of people left holding the baby the last time around: some people made a lot of money and a lot of people lost money and that enthusiasm. So, it comes back to the question of, are people equipped to make these sorts of decisions? You know, which horse do you bet on? You’ve given some clues as to what people should be looking at in terms of doing their homework and so forth, but Uranium is quite an interesting space. If it does replicate the last cycle, it replicates the last cycle.
Rick Rule: I think that is accurate. I think what you say is true across the broad spectrum of resources. Markets always over-correct. What will, what happens, let me rephrase that, what happens is that people who are interested in the Uranium narrative will because of their concern about time-value of money and because investors want the immediate gratification, people won’t buy the Uranium stocks in anticipation of a price move. The price move itself will be the stimulus that causes people to come into it. This is very strange to me and I’m guilty of this too, just probably to a lesser degree than some others. We believe that we are sort of, you know, sentient, rational human beings gathering information from the whole cosmos, processing this information, making rational conclusions, and that’s not true. What we really are, are people who are looking for information that supports and makes us comfortable with our existing paradigms.
Matthew Gordon: Confirmation bias, we call it.
Rick Rule: Correct. And the most important information to us is the most recent. Expectations of the future is set by experiences in the immediate past. What that means, oddly, is that, let’s say that there is a stock that is selling for USD$10, okay? And let’s say that it comes to the attention of some people, and it’s selling for USD$20, but there’s been no in the underlying fundamentals of the company. The investor who owns it at $10, loves it at $20, and the price information justifies his or her narrative. Now, the fact that it’s gone from $10 to $20 makes it arithmetically precisely half as attractive as before the move. But oddly, it becomes a Geffen good. It becomes one that is valued more highly as a consequence of the price than of the value.
When I, the first time through in the Uranium stocks came into them, the price of Uranium was between USD$8 -$10/lbs, and I remember thinking, you know, the price could go to USD$40. I was wrong: it went up to USD$150/lbs or something. Now, at about USD$60/lbs, it was very clear to me that the price of Uranium didn’t have to continue to go up and I began to loosen up. The truth was much, much, much too early, in retrospect, but I’d rather make that kind of mistake than overstay my welcome.
When you look at any commodity subset, what you see is, in Canadian parlance, a series over 30 or 40-years of hockey stick graphs. The front side of that chart is a lot of fun, but the backside is just as steep and much less fun. And so, you have to have a mechanism, a discipline that will cause you to sell. If your mechanism is a value-focused mechanism like mine, what happens is that you will inevitably buy too early and you will inevitably sell too early. You will make often a stunning amount of money in the middle, but you will punish yourself, or at least be punished psychologically, for two and a half or three years on the way in and you’ll punish yourself again for the last 12 to 18-months of the bull market, taking, however, perhaps a fat slug out of the middle.
Matthew Gordon: I agree with everything you’ve said. We do a lot with confirmation bias and trying to understand it from, you know, we’ve spoken with financial psychologists – did you know they existed? Neither did I – to try and understand people’s behaviour around these things. And I do agree with you, you know, if it’s at $10, goes to $20, it’s worth half. But the impassioned belief of the holder more than doubles, quadruples in effect. And we have been attacked and vilified for our views on that, and that’s fine – everyone is allowed their opinion, but it is a thing, and I wish people would sign up to your philosophy there, which is, at least have a strategy and stick to it.
Rick Rule: No, that’s very true. But, you know, we asked issuers that come to us for a business plan, and we ask speculators and investors to understand that investing is in fact a business and they should have a business plan too. It doesn’t mean that if circumstances change, that the plan shouldn’t change. But the truth is understanding why you buy a stock, what the value proposition is and importantly, what will cause you to sell a stock. If you’re a speculator, the expectation on any individual speculation is failure. The arithmetic is that if you cut your losses, that your successful speculations will amortize your losers. But that presupposes that when data comes back that tells you that you’ve made a mistake, that you act on that data and limit the damage that you do to yourself from your mistake.
Matthew Gordon: Yes, I think that’s absolutely right. But the part of that, the flip side of that coin is the investments that the companies that you’re about to invest in, did they have a business plan? It’s one of the first questions we ask, and I would say mining is extraordinary like no other sector we’ve been in, in that I can count maybe less than 20 companies that I’ve spoken to this year, and we spend about 350 who have a business plan.
Rick Rule: In every case where an issuer comes to me, particularly a pre-revenue issuer, an explorer, I go in with the mindset that these aren’t asset based businesses, that they are intellectual property businesses, that you employ the intellectual property on a piece of ground and you propose a thesis and do you test the thesis? And so, in every circumstance I ask the people to explain to me what their thesis is and what facts caused them to develop a thesis, how they propose to test that thesis, and what is the big unanswered question? Over the years, about 80% of the companies that I’ve interviewed have said, ‘Oh, that’s interesting. We’ve never thought of it in that context,’ which you know, I think corresponds with the fact that 80% of junior resource issuers are valueless. The unanswered question for most of the managers is, will I have a salary in 18-months? And I realised that that’s a valid question to them, but I’m completely unconcerned about it.
Matthew Gordon: How do you make them money?
Rick Rule: Yes. When an issue where it doesn’t have a business plan the ability to execute a plan that one doesn’t have must necessarily be fairly difficult. But the same thing confronts the speculator; when speculators transfer these laundry lists of stocks to me and I try to go through them one by one, the process is always very similar. We’ll start, you know, with A, so, I don’t know, Amalgamated Aardvark or something like that. And the client will say, ‘Well, Rick, what do you think about Amalgamated Aardvark?’ And I try to be polite. You know, I say, ‘Well, I’ve been untroubled by its existence for a long time. What do you think about it?’ They will say, ‘Well, I don’t know anything about it.’ And I’ll say, ‘Well, why on earth do you still own it?’ And they say, ‘Oh, well, Bob Bishop recommended it,’ Bishop’s been retired for 12-years. ‘Well, yes, that’s true.’
‘Well, why don’t you sell it?’
‘Well, I can’t sell it.’
‘Why can’t you sell it?’
‘I bought it for USD$4 and it’s selling at $0.25. And if I sell it, I’ll lose USD$3 and $0.75.
And I said, ‘No, you’ve already lost the USD$3.75 cents. The real question is what are you going to do with the remaining $0.25?’
This is a very, very, very simple process, but people need to force themselves to go through it and they need to force themselves to go through it frequently.
Matthew Gordon: But I can understand the difficulty of that because you’re viewing it as a percentage of the remaining capital available, not as a percentage of the original bet, which it sounds like it would have been with the ‘Aardvark’ company. But it brings onto a nice point, and I segue off to the fact that, and I had this conversation with Ross Beaty last week and then he acknowledged that this existed, which was the mere fact that a Sprott name is associated with a company is enough to draw people in. That’s what you would hope. I mean, you’ve been doing all this marketing, you’d hope so, wouldn’t you?
Rick Rule: The fact that the Sprott in premature is useful in a market like this is useful to us. We have certainly spent a long time on brand recognition. We would hope that investors pay attention to the company as opposed to merely the fact that Sprott has invested in the company or lent money to the company. Our needs and perceptions, our risk tolerance, the amount of intellectual capital that we can bring to bear might exceed that speculator’s capabilities. And it’s unlikely that we will give the market prior notice when we are going to sell.
Matthew Gordon: I think that’s tremendously honest of you because again, when we speak to CEOs, they literally think they’ve cracked the code. The fact that the Sprott name is there in some way or another, and it may be a legacy thing because they have a bet which went wrong, you know, an investment which went wrong and it’s been regurgitated. But you’ve placed a lot of bets over time because you have a different risk tolerance and time thresholds and so forth. And as you say, you choose when you exit it because your model is different from everyone else’s. So, you’re not, you know, you’re not misleading anyone there. But likewise, I would encourage people, like you do, that people walk in with their eyes open and understand, does this meet my strategy, my thresholds before they follow blindly, as it were. So that’s not a negative about Sprott, it’s a call to retail investors and similar, to walk in and be clear about why they are making that investment, placing that bet.
Rick Rule: You know, what you say I think is equally appropriate to institutional investors. You will find, particularly when resources are out of favour, that well, first of all, the ETFs don’t consider fundamentals at all. They consider market cap and liquidity, which is to say they tend to favour the oversold, pardon me, the overbought overpriced equities. Active managers in big multi-sector funds when the sectors are out of favour, tend to attract managers that are popular with the fund group and who have failed in other specialties. You know, if somebody failed as a supermarket analyst and they failed as an auto analyst, but he went to a good school and his family is friends with the family of the CEO, you know, they will put this man or this young woman in charge of resources because the sector is so small, it’s unlikely that they can do much damage there. Those managers need to employ the same, precisely the same stratagem that you and I are encouraging a high net worth, retail and family offices to employ it. And believe me, that type of discipline is rare among institutions too.
Matthew Gordon: I think we are in violent agreement, which is wonderful. But again, just exploring the nuances here, but nevertheless, it does happen: people do follow you. And knowing that, are you able to be a little more casual or a little bit more, less precise with the investments that you do make, knowing that there’s a slew of money coming in behind you who know your name, recognise your expertise, I’m talking about Sprott’s name generally here and of course yourself, because it kind of papers over some of the cracks potentially, because money can do that: if the company has money, it has options.
Rick Rule: We first of all employ a variety of strategies with a variety of managers. And there may be some of the managers that may that manage small enough amounts of money that they can be nimble enough to do that. I tend to have a fairly concentrated portfolio. I often enter these circumstances in private placements, which is to say a negotiated transaction with warrants. The good news about that is that when I’m right, I’m usually really wrong, really, right. Pardon me. The bad news is that I can’t be too nimble with those positions. The idea that I could get into a private placement and then when the hold comes off that the fuel engendered by my participation lets the stock trade up and I can sell into it. Given the size of the positions that I take and the reasons behind my positioning that isn’t anything that’s of particular advantage to me.
Now, there are a couple of small issuers that we got involved in two years ago that used the furore engendered by our participation, the sort of legitimacy that conferred on the market, to broaden their constituency, which lowered their cost of capital, and they were able to raise capital subsequently from people other than ourselves at prices that we as existing shareholders felt were very attractive from our point of view, but they weren’t attractive from the point of view of new money. So, to the extent that promotional groups, successful promotional groups use the entree we had suggested to broaden your constituency, raised their share prices, and lower their cost of capital; we are certainly long-term indirect beneficiaries.
But for me, having a large position in the stock, let’s say it goes from AUS$0.25 to AUS$0.40, and let’s say it now trades 100,000 a day, If I have a USD$3M position, the ability to monetise any of that a hundred thousand dollars in volume a day is really infinitesimal. I have to be right in order to make money.
Matthew Gordon: Yes. So, what type of deals do you like doing? So, I have noticed a few deals that you’ve done recently, which were placements, but you know, if it goes right, if it helps the company to get to where it needs to be, it’s great. It’s good for you, it’s good for everyone, but you’re papering these things. So, if it doesn’t go well, it’s a slightly more painful upside for you in that it means the company hasn’t delivered what it said it was going to. And presumably, you’re either perfecting some kind of security or you’re taking a bigger chunk of the company because they owe you, well, it depends on what the terms are. But what’s your favourite kind of deal?
Rick Rule: That really depends on, as you probably know, I prefer now in my declining years, to be a lender rather than an equity investor. The reasons for that are fairly obvious: in the bear market that we endured in the last decade, the Toronto Stock Exchange Venture resource index, which is the index against were measured, fell by 88% in nominal terms, in value, which is to say that the performance over a decade was -88%. In our on-balance sheet lending activities during the same period of time, we generated a 15% annualised return on capital employed. 15% is a handsome headline number in any circumstance. But the relative performance is silly – really, really, truly silly. The idea that I can effect a reward transfer without very much of a risk transfer and I leave the shareholders in the management team and the ups, but I eliminate the downside for me is extremely attractive.
As a lender, if you’re lending money to an issuer with no visible means of support, you know, no visible means of repayment, you are really truly an asset-based lender. So, we look at all the financial projections associated with the loan and we certainly consider that, but we look at the management resumes and more particularly, the strategic value of the asset to other buyers, assuming that our borrower wobbled. And that’s the criteria that we use to make alone. We are more concerned with loan covenants and restrictions frankly, than we are with coupon because one bad deal obliterates the return on 12 good deals.
When you look at our track record relative to our competitors, and by the way, we have some very, very good competitors in that space. I think what you’ll see is that other guys at periods of time have written more business than us, but we have had to foreclose much, much less often. That obscures the fact that probably 40% of the loans that we’ve written in the last 30-years have violated one or another of the loan covenants over the course of the loan. If we have a management team that is honest with us, works hard and gives us prior notice that they are experiencing difficulty, we’ll move heaven and earth to support them. If by contrast, we don’t get a call and we don’t get a cheque, then the relationship gets different.
Matthew Gordon: Yes, I’ve seen both sides of that. I’ve spoken to someone this morning who, you know, has had a very positive experience with you guys. You know, they basically paid off the first loan, then got another loan and great, you’ve allowed them to grow, be able to tell that growth story, deliver that growth story. And you know, likewise, I’ve seen where it hasn’t worked out, but no one really wants that. Well, maybe that’s not true. Sometimes that’s what, you know, the terms are geared up to do, but it’s not easy. It’s not easy.
Rick Rule: We are not in the loan to own business. We are lenders. If we work out a loan, if we have to operate something, we have failed because it takes us away from what we are good at and we think it damages our reputation on the street. You know, we’ve had a relationship providing both debt and equity to the aforementioned Ross Beaty, going back to 1987 – a very, very long time. The first negotiation between Ross and I probably took 35 hard bloody hours. And I don’t think that the sum total of negotiations that we’ve done since, which probably number 30, have consumed 3-hours. Once the trust was established and once the basic framework of how we could do business with each other, various assets at various points in five minutes cycle was established, the relationship was extraordinarily clear cut and very, very mutually beneficial. And I think that’s one of the things that Sprott looks towards in its issuer facing business in every circumstance. We’d rather do more business with less people than less business with more people. We would rather concentrate where we know that we bring value and we know that they bring value and each side looks to develop a commercial relationship where everyone benefits.
Matthew Gordon: Yes. again, thank you. You’re not in the loan to own business. I get that. But when that second phone call comes in saying, we need a little bit more cash, you’re in the driving seat though?
Rick Rule: Certainly, we construct the loan based on the assumptions that the customer gave us and we tell them ahead of time what it will cost them if they wobble. So, if there are extension fees or if other capital is required, we will support them, but we won’t support them for free. If our risk increases, our coupon is going to increase too. That’s the way it’s going to work. If we are supposed to be able to redeploy the money in 12-months and we don’t get to redeploy the money for 30-months, we get it but there’s a cost associated with that because there’s a cost to us.
Matthew Gordon: Beautiful. Last opportunity cost. Right. We are getting to the end, you will be glad to hear. That’s the good news. So, we’ve talked about retail a bit, but can we talk about another component of, which really seems to be prevalent in Canada and North America more so than the UK, they are a different sort of animal; which is the broker relationship. Now, I asked about you being an 800lb gorilla in the room. As you’ve got bigger, do you still have to work with brokers or are they coming to you? I mean, how does it work now for a large USD$12Bn under management company in North America?
Rick Rule: We spend a lot of money cultivating broker and dealer networks. And of course, we have our own small private wealth business. So, we also have direct retail and direct to institutional. But in terms of the big products, the physical products and the ETF, those are very much distributed through normal distribution channels in North America. We are working now to build out our UK and European relationships too; we have our first Eustace product, European fund as a consequence of our acquisition of the Tocqueville Gold group. And we have explored from time to time a London listing for some product associated with our lending and yield oriented activities. So, I think that you can look to us instead of establishing dealer and distribution relationships in Europe to compliment what is by now a very deep us distribution.
Matthew Gordon: Fantastic. Okay. I look forward to that and look forward to hearing about it and I’m sure it will be imminent once we are allowed to leave our homes on a permanent basis. Can you just tell us a little bit about the ETF funds that you manage at the moment, if you don’t mind?
Rick Rule: We have, we have two ETFs: the Sprott Gold Miners Index, which is a small competitor to the Vanek product. Ours is different in the sense that it isn’t just oriented towards liquidity and market capitalisation. It’s a factors-based fund, and we take margin and profitability and revenue growth into account. The nervousness that we have with the non-factors based funds is that large companies, which may be shrinking, tend to dominate the market cap race, and we don’t want to have a circumstance where we own a lot of accompanies towards the end of its mine life and we face a precipitous decline. So, we look as much to margin and revenue growth as we do to market capitalisation and liquidity. We have a smaller company fund, the Sprott Junior Gold Miners Index which is similarly focused on factors rather than market capitalisation and liquidity.
The truth is that our ETF offerings are substantially smaller than VNX ETF offerings, and ours are small enough that this is convenient and inconvenient that we do not move markets when there are inflows into the major ETFs, especially the major junior ETFs. Their rebalancing becomes, in the near term, the most important part of the market capitalisation of their constituents. We are fortunately saved that challenge by virtue of the fact that we are smaller, but factors based. We suspect that over the course of the decade that we will be able to handle the out-perform them because we think that a blind ETF will always underperform the market to the exact extent of their fees. And we hope that by tailoring our own offering to some factors which are really pretty easy to construct algorithms for, but are also important over time in success, that our factors-based approach will overcome the impact that they have on markets as a consequence of their gorilla status.
Matthew Gordon: Okay. You mentioned a word there; kind of got me excited – algorithms. We’ve been talking this week about naked shorting and you referred earlier on to the fall of the market over since, what, 2012-ish? I know Eric is a sponsor of the savecanadianmining.com. Are you a believer?
Rick Rule: I’m not.
Matthew Gordon: There you go.
Rick Rule: With reference to Eric, he’s one of my favourite human beings and he was as good a partner as I ever had. The junior mining industry’s worst challenges are all self-inflicted. The general and administrative expense. The zombie listings. Without going into too much detail, it is alleged that 25 years ago, in addition to being a money manager, that I occasionally dabbled in promotion. Without going too deeply into those allegations, I can only say that if it were true, I would have loved to have a good short position against me because a short position is a committed buyer. We have a little saying down here: he who sells what isn’t his has got to buy it back or go to prison. And the truth is that if you catch somebody short, sort of 10 or 12% of your float, they have to buy back. And the question becomes at what price? And that’s established by whether you are right, or they are right. So, if it is in fact true that I was a promoter 25-years ago, I would have been delighted to see large short positions. If your product is good, you win the war against the shorts. If your product is not so good, you lose the war against the shorts. And so, I think the shorts perform a useful function both for the market And, frankly for the better companies that long short positions get built up against.
There are several companies that I had been around a lot in earlier days. First, Quantum Silver Standard, Pan-American Silver, famously in Australia, Paladin, BIMA, that all had very large short positions against them. All of them had circumstances where the backers and the management teams understood the short positions, worked hard to catch the shorts and use that short position to do financings that occurred at higher prices than they otherwise would have as a consequence of the short squeezes that were engendered.
Matthew Gordon: That’s fascinating. Again, worth exploration another day, but I’m going to, because we are only halfway through – I’m going to kidding. Last question. Last question is, I can’t help every day, but watch US politics. It’s just Golden TV. It’s fantastic. It’s entertainment that that I didn’t know was possible. So, as a credit analyst, can you tell me your view of the recent quantitative easing program and is it possible for a country USD$24Tn in debt to ever recover?
Rick Rule: Let’s do the arithmetic first. Yes, we are not, we are not USD$24Tn in debt. We are USD$130Tn in debt. $24Tn on balance sheet liabilities, but that doesn’t include the net present value of entitlements. When your viewers look at me in the screen, they see what an on-balance sheet liability is: social security, Medicare, Medicaid. So, it’s important to understand the quantum first of all, we are not USD$24Tn in debt. We are USD$124Tn in debt. Is that serviceable? Well, you service it from the national income, which is taxes and fees, less expenses. The problem is that the national income is also in deficit of USD$2Tn a year. But maybe they teach better math in Great Britain than we teach here. But I don’t understand how you add a column of negative numbers and arrive at a positive sum. So, I would say no. The only thing that keeps us afloat, I think, and keeps US treasury securities, the world benchmark securities as US dollars is the reserve currencies. This is horrible to say, but as pathetic as we are, we are better than anybody else.
Matthew Gordon: You’re the least pathetic.
Rick Rule: The United States is very competitive, and we are endeavouring right now to win the race to the bottom. But the Euro and the Canadians and the Aussies and the Japanese are, in that sense, enjoying a great head start.
Doug Casey described the US dollar as the prettiest mare in the slaughterhouse, which might be a bit harsh but the circumstances that we are in today, unless you can’t do your arithmetic is very challenging.
Look, let’s unpack it 3 ways: the first is quantitative easing. If you and I did it, it would be called counterfeiting. It debases the currency. There can be no doubt about that. Making a whole bunch of new currency units out of thin air debases the currency. Now, you and I both probably have some problem with the people who are creating these false currency units too, but that’s not arithmetic, that’s personal.
The second is different, quantitative easing is one thing. The debt and the deficits are a different thing. The debt and the deficits challenge of course, the current account, the income statement while they obliterate the balance sheet. And so, at the same time that we are debasing the currency by USD$4Tn, 3 or USD$4Tn a year, we are adding to the aggregate debt, including the off-balance sheet, net present value of off balance sheet liabilities by another 3 or USD$4Tn a year.
And then the third leg of the stool, if that’s what you might call it, is artificially low interest rates. The interest rate is of course the reward that savers get for subsidising spenders. They at once preserve the purchasing power of the money that’s been lent, and they reward you for taking the risk. The problem with that is that we don’t have interest rates anymore. We have negative interest rates, which is to say you’re being penalised to save. I understand why this is; we exist in functioning or semi functioning democracies.
The circumstance that we have now really constitutes attacks on savers to benefit spenders, and in a democracy, spenders are much more numerous than savers. There’s a wonderful saying in the Western United States, ‘an election is where four coyotes, small dogleg predators and a lamb vote on the lunch menu’. And I think that the circumstance that confronts us with regards to quantitative easing debts and deficits and the interest rate is very much a function of that vote between four coyotes and the lamb. I must say, it gets tiring to be the lamb. So, one does the best one can.
Matthew Gordon: What’s going to happen when everyone works this out? What happens when everyone watches this video and goes, ‘Oh boy.’
Rick Rule: You know, when most people watch this video, they will say, ‘You know what? The big thinkers have handled it somehow. They got us through 2008. They got us through March’. I think most people want to consign responsibility for their financial future to other people, big thinkers. Most people believe that the function of politics is to benefit them and defend them from their neighbours simultaneously. There’s another, a couple of great political quotes that I think will put this in mind. You can understand the word politics by examining the root words: poly of course from the Latin for many, but tic from the English colloquial for small blood-sucking insects. If you think about many small blood-sucking insects, you understand something about politics.
And then of course, there was the famous Mencken quote that, ‘elections are best understood as advanced auctions to stolen property’. And if you take all that into account, I think you understand something about our current circumstance. How long can this go on? We are an innovative world. We create wealth individually faster so far, than we manage to steal our wasted collectively – may that continue.
As long as the big thinkers are able to maintain confidence in the system, I think that the system can continue to limp along. I myself have decided to maintain very large cash balances despite the fact that I understand that the purchasing power of my cash is declining on an ongoing basis. I believe that the declining purchasing power is an option premium that I have to pay because cash will give me the means and the liquidity to take advantage of volatility rather than to be taken advantage of. And I consider precious metals to be very good liquidity, volatile liquidity to be sure, but I would love to see somebody try and quantitatively ease Gold or Silver. It’s a very difficult thing to counterfeit over time. So, you know, my own defence mechanism is to try and divorce myself from the prevailing ethos as much as I can and to prepare myself to become in the Taleb phrase, ‘antifragile’.
Matthew Gordon: These are great topics that I’m really excited and I hope I get the opportunity to talk to you again. I’m conscious of time because I know you have another call.
Rick Rule: I love the circumstances; in too many interviews it’s a, ‘Well Rick, what do you think of a consolidated orangutan? Will it be $0.45 cents by Christmas? You know, honestly, I have no idea. These are much more amusing interviews for me.
Matthew Gordon: Great. Well, I’m glad you said that. It’s been fascinating. I do love your phraseology I do love your grasp and execution of the English language, when doing these interviews with some groups, and I do feel that sometimes the importance of what you said isn’t necessarily always grasped, and you do beat a few drums very loudly, and long may you continue to because I think they are super bits of advice. Have a wonderful day. Whatever the rest of the day holds in store for you. And let’s talk soon.
Rick Rule: I look forward to it to, Cali can always schedule it and I look forward to doing this.
Company Website: https://www.sprottusa.com/
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