Sprott Inc. Chairman Rick Rule on Barrick Gold, Sprott’s Gold Miners ETF, Quantitative Easing
Sprott Inc.(TSX:SII) (OTCMKTS:SPOXF) (USA) Chairman Rick Rule joins James for a lively discussion on the nature and effect of quantitative easing on commodities, gold and base metals. We also discuss the Sprott Gold Miners ETF (NYSE:SGDM), and why its a superior choice for investors to Barrick Gold (NYSE:ABX) (TSX:ABX).
[four_fifth_last padding=”0 0 0 20px”]Listen to the interview with Rick Rule:
James West: Rick, thanks for joining us today.
Rick Rule: Always a pleasure. Thank you for having me on.
James West: Rick, I wanted to talk about a few things today. First of all, let’s discuss what the implications are of the European Central Bank’s commitment to essentially print 60 million Euros per month worth of quantitative easing. What effect is that going to have on the commodities sector?
Rick Rule: Well, I don’t think it will have much impact on the commodities sector in the near term. The US government has been doing this quantitative easing, or as you and I would refer to it, counterfeiting, for a substantial period of time, and it doesn’t appear to have done much to produce an economic recovery. If a recovery has taken place, a recovery which sees a 40 percent decline in copper prices and a 50 percent decline in oil prices is certainly different than any kind of recovery that you and I have experienced in our lives thus far.
I would suspect that the Europeans will be as successful with counterfeiting as the Japanese and the Americans have been, which is to say, not very successful at all.
James West: So the beneficiary of US quantitative easing has been, more or less uniformly, American stock markets and technology companies. The overall benefit of Japanese quantitative easing also seems to have been US equities. Do you think the same is going to happen with the European program? Is it going to be the US market that’s the main beneficiary?
Rick Rule: I don’t know the answer to that. I mean, it’s old, fat, rich guys like me who have some assets that they own that they can borrow against and benefit from low interest rates. While I’m delighted that they’ve chosen to subsidize me, I’m well beyond, in years, any sense that I deserve that subsidy. Certainly you have a situation where there’s an income transfer within societies from prudent savers to imprudent spenders. And I guess that makes sense in a democracy; there’s probably more spenders than there are savers.
I suspect that bond markets will do better than you and I would otherwise have suspected that they do. I certainly think that the very large money-setter banks will be able to do relatively well, because they can borrow from European governments short-term at the credit window and lend back to them in the five-year window and take the time spread without too much risk.
Certainly the larger industrial corporations that are capital consumers will benefit from having lower cost of capital. But the truth is that the pain will be felt much more ubiquitously. Citizens who have ultimately their purchasing power debased over time. People who believed in saving for their retirement that will see the yields on their investments artificially depreciated as a consequence of this counterfeiting. More of the same, I guess, is what I’m saying.
James West: So Carmen Reinhardt (phon), the economist who suggested that the 0 interest rate universe was how the US was essentially going to devalue its way out of its problems by victimizing savers and retirees.
Rick Rule: Which is accurate. The sort of sense of the competitive race to the bottom is troubling. You and I have talked before about the strength of the US dollar in the face of rather strong headwinds, but as our mutual friend Doug Casey says, the US dollar really is the prettiest mare at the slaughterhouse, and there’s a consequence of a lack of competition where the challenge was to get under the bar as opposed to over it. It’s done really surprisingly well.
James West: What do you think this is going to do for precious metals?
Rick Rule: I feel pretty sanguine about precious metals. I’m not expecting some great precipitous leap forward unless something happens to shake confidence. But I’ll tell you, people look at 50 or 60 factors that they argue are important in the precious metals markets, and I really think it gets down to an epic brawl between the US dollar and precious metals. And I don’t think precious metals need to win; I think they need to lose a little less badly, given the enormous disparity in the quantities available of each.
When I – and I really truly believe that arithmetically, gold can’t help but do better – the value proposition that is put up by the US dollar would appear to be the benchmark. The US 10-year treasury. And the last time I looked, that was yielding 1.68, something like that.
So the US treasury promises absolutely, positively, to give you back 1.7 percent a year for 10 years. The problem with that promise, of course, is that even by the CPI-stated rate of inflation, what they’re promising is to give you back a tenth of a percent in interest a year. Which is to say that if you give them $100,000 today, in ten years they give you back $100,000. That in and of itself is not a particularly attractive proposition for me; in fact, Jim Grant calls it ‘return-free risk’.
But from my point of view, the truth is much more pernicious, because the people who construct the CPI don’t shop where I shop. And although I don’t buy very many things, it appears to me that the basket of goods and services that I consume evidences depreciation in purchasing power of between 4 and 5 percent per annum.
If you take the lower number, 4, then the value proposition is that they’re destroying your purchasing power at the rate of about 2.5 percent a year. Which means over 10 years, if you give them $100,000, they give back $60,000. And it’s precisely that arithmetic that tells me that while gold may not rip, I certainly want to be involved in precious metals. And I am not, for both moral and practical reasons, an owner of US 10-year treasuries.
James West: Okay. So you would concur, then, with the idea that the US dollar is being debased essentially to the point of inviability. So all gold has to do, and holders of gold have to do, is essentially wait out that process.
Rick Rule: I wouldn’t suggest inviability, I would suggest that gold will be – I believe differently than many people of our ilk. I believe that gold will be the reserve currency of the world for a long time. I don’t believe that gold is going to win against the dollar, I think it’ll do less badly. And as a consequence of it doing less badly, for those of us who own it, it’ll do pretty well.
James West: Okay. Well, this past week, in the last five days, in Canada alone, there has been over $750 million in financing in gold mining companies, which one might argue portends a recovery, or at least on the part of the investment banking community, the anticipation of a recovery in the gold price that is going to be sustained. Do you think that that is the case right now? Is it time for investors to get into gold miners?
Rick Rule: I think that the financing came about as a consequence of the fact that they could. I think that’s useful, because the industry can’t save its way into prosperity; it needs to build its way into prosperity. I have a lot of opinions with regards to the financings, in particular, some of them, which seem to be fairly overpriced relative to the current state of the market. And I’ve always joked, in fact, that the private sector can do everything better than the public sector, including printing phony securities; that is to suggest that all the financings were lousy.
I think that the sector will do relatively well, particularly compared to what it’s done in the last three years, irrespecting of the state of the financings. But the state of the financings do tell you that there is an awful lot of cash that would like to come back into the sector, given appropriate opportunities.
I think a more important thing to say with regard to the gold equities is that some of the senior gold companies are becoming much more responsible stewards of capital than they were for the last 15 years. You and I have talked before about many of the mining companies’ worst ills being self-inflicted: doing stupid acquisitions, putting marginal projects into production, bringing projects on double-budget, and things like that. And you’re beginning to see a much more rational allocation of capital in the sector, which I think ironically will do at least as much, and perhaps more, for the sector than an increase in the metals price will. And from that point of view, I feel very attracted.
My second comment with regards to the juniors is that the juniors are doing precisely what you would expect them to do in this market, which is to say, they’re bifurcating. There are 20 percent of the juniors that are run by good people that have viable projects, that really probably bottomed a year ago and that are doing fairly well.
You have 80 percent of the juniors which are truly flotsam and jetsam, that continue to languish, and with any luck at all, will become extinct.
James West: Or become medical marijuana companies.
Rick Rule: Yes. Go into a business that they know something about and care about.
James West: Okay. Now let’s talk a bit about the base metals and the industrial metals. China has obviously just come out with some data suggesting that it is, in fact, slowing down. The soft landing might become a little harder than anticipated. But the outcome of the G20 Summit in Australia in Q4 last year was a commitment from the leaders to spend at least $2 trillion on infrastructure. That would suggest to me an imminent increase in apparent demand, at least, for things like copper and iron. But we certainly haven’t seen that reflected in the prices. What’s your take on that?
Rick Rule: Well, you’re a better big picture guy than I. I’ve admired your work on the big picture. I don’t see any light for awhile on demand. This collapse in the oil price, many pundits have suggested that it’s a supply-led collapse; I don’t see that at all. I see an absence of demand, and I see that in the failing copper price, I see it in the price of specialty metals. The tungstensthe rare earth metals, things like that. I see it in every metal that I look at, with the sole exception of palladium, which is moving in the face of fairly tepid auto demand. Really is a function of extraordinarily constrained supplies.
So we see the talk about $2 trillion in infrastructure spending, and I’m sure they’ll try and do it, because it’s a wonderful way to reward their cronies and constituents; but I don’t see any evidence of an economic recovery, particularly a private sector recovery. So I’m ambivalent as to their ability to reflate commodity demand by promising to build highways.
James West: Right. Just as the US had planned to earmark a certain amount of money for infrastructure reconstruction and development, which never seemed to materialize. So then, what is the purpose of quantitative easing in Europe?
Rick Rule: I think the purpose of quantitative easing in Europe is counterfeiting. I think that they understand that the governments’ need for revenue, if left to the market, would back out all of the available credit to the private sector.
I also see it as a way, of course, to reward cronies. I forget if it was Milken or who, but one of the stodgy old guys on our side once described elections as advanced auctions of stolen property, and $60 billion a month is an awfully juicy plum to auction off.
James West: Okay. So now, just for my own edification and that of my listeners, does $60 billion a month in quantitative easing through the practice of fractional banking become a much bigger impact on the global supply of money?
Rick Rule: It has the ability to do that if there’s private sector demand for the credit. One of the things that I learned from watching Allan Greenspan, in fact talking to him at the New Orleans Investment Conference, was, he drew the distinction between the $4 trillion that were added to the Fed’s balance sheet, and true credit, by saying that that money, if it’s money, those bits and dots or those computer credits were still stuck in the Treasury, and that the reason that they hadn’t constituted inflation was that they hadn’t been lit on fire; that they were in fact merely tinder.
And to the extent that they found their way into the economy, then things would change dramatically, but what really has happened is that we have in effect printed credit and consumed credit all within the Fed. And that that credit hadn’t found its way into the broader market yet. Which I found interesting. I don’t know if it’s right or not; Dr. Greenspan is one of the big thinkers. I’m just a loan shark.
James West: Okay. So finally, let’s talk a bit about, Sprott launched a gold ETF last year at what could broadly be considered as the worst possible time in the last five years certainly. How is that happening, why did you do it, and why are people attracted to gold ETFs?
Rick Rule: Well, that points up something very interesting. You know, our competitor, which has been a great product, was the GDX. The GDX attraction was that it was simple: it was a market-cap-weighted index, and what we learned looking at the gold market was that the broad gold market included too many shrinking companies and too many inefficient companies. And so we created an ETF that was rules-based. We wanted companies not merely to exhibit leverage to the gold price, but we also wanted them to do things like make money. We wanted decent free cash flow relative to debt, and importantly, we wanted revenues to be increasing. We didn’t want companies that were unable to continue to produce gold over four or five years.
The market looked at the logic of rewarding companies for acting positively, as opposed to rewarding companies for merely being good, and it was delightful. We believe we were the second most successful ETF launch in 2014, in the worst performing sector in 2014.
So the market obviously still has an appetite – a very healthy appetite, for the gold mining industry. And the market still has an appreciation of the value of gold and the virtue of a well-run company, because the market has given us, I think it’s now $250 million for our new product in a very, very poor-performing sector simply because I think we provided the market with a low-cost way to participate rationally in the gold investment process.
James West: Okay. So let’s just take a quick comparison: how does an investment in your gold ETF compare to, say, an investment in Barrick Gold?
Rick Rule: Well, Barrick constitutes a piece of our ETF, but it’s a smaller slice than you would see in a market-cap-weighted fund. We are looking for companies that have consistently grown production with revenue growth, and Barrick hasn’t had that. And we also look for companies that have generated substantial free cash relative to their debt load. And so while Barrick constitutes, I’m going to say, three or four percent of our fund, companies that generate more cash relative to their market cap, companies like Franklin Nevada Gold Corp. and Rand Gold, occupy much more prominent places simply as a function of the fact that they generate much more cash relative to market capitalization than some of the older, larger, more well-known names like Barrick and Newmont Mining.
That doesn’t mean that if those businesses, if those management teams, turn those businesses around in two or three years, that they won’t earn their way into a higher weighting. It’s just been based on their performance over the last five years. Their weighting is very constrained, relative to their market cap against the sector.
James West: Would you say that there is an inherent flaw in the structural lifespan of a mining company like Berrick, whereby at some point, they are faced with the conundrum of needing to acquire ounces at a higher cost in order to maintain a growing production increase?
Rick Rule: Well it’s certainly a challenge. Early on in Berrick’s lifespan, the fact that they understood that markets work and the gold price was higher than it ought to be, led them to do something very rational: they sold a bunch of gold forward and as a consequence, their selling price for gold was greater than all of their competitors and their cost of capital was lower, and they grew fairly well.
The problem was that they carried that to the sort of illogical extreme. But the second problem was probably less the fault of Berrick and more the problem with us on the investment side: our anticipation of what created value in the gold mining industry was set in the decade of the 1970s when the gold price ran from $35 an ounce to $850 an ounce. And what we, on Wall Street and Bay Street, came to ask the gold mining industry to do was to exhibit leverage to an increase in the gold price.
Ironically, of course, the most leveraged companies are the least efficient companies. The high-cost companies generate more of a margin increase in the face of an increased gold price than the efficient companies do.
So for 40 years, we asked the gold mining industry to be marginal, to be inefficient, and they succeeded beyond our wildest dreams. Mercifully for us now, through understanding that markets work and gold prices go up and down, we have come to want companies to be efficient in exploration. We have come to want companies to do intelligent acquisitions, accretive acquisitions, as opposed to acquisitions that make them more marginal. We want companies to prudently manage their balance sheets. And there mercifully have been companies that exhibit precisely these traits emerging out from the rest of the pack over the last decade.
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