I interviewed Sprott's Rick Rule on the floor of the 2019 Sprott Natural Resource Symposium in Vancouver earlier this week. I was most interested in his insights on the psychology of investing, especially going from a precious metals bear market to a bull market, and that's the direction the conversation took.
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James Kwantes: We’ve come out of a gruelling bear market -- where for the most part if you get a double you’re laughing all the way to the bank. Moving into what looks like a bull market, how do you or how should somebody just starting out manage emotions as far as being too quick to take profits?
Rick Rule: I would suggest that they first of all understand, early in the bull market you don’t need to look for leverage inherent in the riskiest and wildest of the juniors. In a natural resource bull market, the best of the best companies can generate 200 and 300% returns. So build a portfolio around the best of the best before you worry about the rest. It’s difficult for people to understand, having heard the stories about 1,000% gains and 1,500% gains, how much money there is to be made early in a resource market owning very good companies.
So I would say you concentrate probably 60-75% of your portfolio on very, very high-quality companies that will do extraordinarily well for you. I’m talking about the Barricks, the Wheatons of the world. When you come down to the juniors, only come as far down as companies that are really truly successful in their sector. So with regards to the prospect generators, as an example, companies that have extremely well-regarded managers. How can you tell they’re well-regarded? Companies that can farm out projects. There are prospect generators that generate a lot of prospects and never farm them out, so you never get the leverage inherent in a prospect generator. With regards to selling, I think your exit is determined by your entrance. It is more important to deploy than it is to harvest capital. I tell investors that when you interview a public company, they must have a business plan -- they must tell you what the unanswered question is that adds value. Similarly, as an investor, you have to have a business plan too. Why do you own Company A? What is the unanswered question? What is the probability of a yes answer? What is the value that you might assign to a yes answer? How can you tell that a yes answer is going to occur, or that a no answer is going to occur? And if the reason to own the stock disappears, which it often does in exploration, the stock must disappear too.
JK: Binary …
RR: Yeah. If you own a stock because they have a mineralized surface anomaly that’s 600 metres wide by 30 or 40 metres wide and the unanswered question is five drill holes, does the deposit extend to depth? If you’re three drill holes into it and 0 for 3, the probability is you’re going to be 0 for 5. The stock may be down from a dollar to 70 cents, but your reason to own the stock is gone. So the stock MUST BE GONE. Critical.
JK: I know you like project generators, I cover a couple in the newsletter … but it’s hard owning stocks like that and being patient when things are moving or starting to move elsewhere in the sector, among the drill plays for example.
RR: People need to define themselves as investors. There are people who are good traders; there are people who understand the value of a story in the public market. I am a person who doesn’t own a television set, who doesn’t know how to dress himself. So any competitive advantage that I might have as a market psychologist doesn’t exist. I need to succeed by being right. So for me, it’s process: the fact that I have a highly skilled team of scientists who are extremely well regarded in one area of exploration gives me a statistical defined probability of success. For many investors, if I describe a statistical defined probability of success, their eyes would glaze over and they would fall asleep on the pillow. That’s fine -- they have other ways up the hill. This is what I do, and it’s worked for me over four markets.
JK: But regarding statistically defined methods, it is tricky in the junior sector because of the illiquidity and inefficiency of the sector, and even randomness.
RR: Let me give you a wild statistic that may bore your listeners, but I hope they suffer through. When I was in the University of British Columbia many, many years ago, I was taught that 1 in 3,000 mineralized anomalies became a mine. That means the Howe Street value proposition was 1 in 3,000 chance of a tenbagger. It made the B.C. lottery look like a good deal. Now, you can certainly change the odds in your favour. The best way is to wait until a discovery drill hole, which lowers the odds to 1 in 100 which is much better.
The other way to change the odds in your favour is to align yourself with serially successful entrepreneurs. Don’t ever deal with the unproven guys. You miss the odd person starting up who achieves spectacular success, but statistically that’s the right thing to do. But again, start with the headline number, 1 in 3,000. Now let’s go to prospect generators. I’ve speculated in prospect generators for 35 years. If memory serves me correctly, which it probably doesn’t, I’ve participated in in 65 or 66 prospect generators. That group of 65 companies has now generated 22 economic successes or takeovers. That means I’ve cut my odds from 1 in 3,000 to 1 in 3. In other words, I cut three zeroes off the downside. What have I had to endure? I have to endure stocks that bore me. But at age 66, boredom is preferable to terror. But I think that’s the continuum, the boredom-terror continuum.
JK: Speaking generally, for human beings, it’s hard being bored. You can get stock quotes by the millisecond now. For people investing in this sector, how do you temper that boredom even if you have a high degree of confidence the story is going to work out. How do you manage your emotions?
RR: Experience, I guess. I am very linear, very logical. So this is a circumstance that works for me. If you’re going to speculate in mineral exploration, the first thing you have to do is anticipate loss. You will make more bad decisions than good decisions. If you can’t acquaint yourself with the fact that you’re going to do that -- but the fact also that your good decisions will make you so much more money that you’ll amortize your bad decisions plus have room left over, if you don’t take that point of view, you will ultimately transfer your wealth to me. Which is OK by me, but probably not what you want to do (laughs). There are a lot of people in the business who want to be excited. I decided early on I wanted to be rich. And those are very different words. It would be nice, I guess, if those two things co-existed but I don’t think they do.
There are a lot of people in the business who want to be excited. I decided early on I wanted to be rich.
JK: So it’s a benefit not having a TV, not following the markets on a minute by minute basis or hourly, although you have to watch the markets closely in this sector …
RR: Here’s a wonderful statistic that will scare the hell out of your listeners. When I look back over the course of my career at the tenbaggers I’ve enjoyed, and mercifully I’ve been around for a long time so I’ve enjoyed a lot of them, very few of them have gone 10 for 1 in less than 4 years and very few of them have not declined by 50% in price during the period of time that they went 10 for 1. If you don’t have the courage of your convictions -- that is, if you let the stock chart make your investment decisions for you, if you’re a manic depressive -- I guarantee that you will lose money. If you buy a Ross Beaty stock like I did, Lumina Copper. It goes from 50 cents to 2 bucks and you feel great. You’re a genius. It goes from 2 bucks to a buck, you feel less good at a buck. It goes from 2 bucks to 6 bucks, you feel great again. It goes from 6 bucks to 4 bucks. If you get shaken out in those down moves, in other words if you don’t know why you own the stock and if you don’t have the courage of convictions that lets you stay long when other people sell, and allows you to take profits if the stock gets ahead of itself, you’re in the wrong business.
JK: Logic vs. emotion, really. OK, we’ve touched on boredom and patience, I have to ask you about uranium. You’ve been pounding the table for a while.
RR: I like it, but I guess three things we have to know about uranium right now, maybe four. The first thing is that in the near term, precious metals are more attractive than uranium because we’re IN the market. It’s moving and it’s moving for definable reasons. The second thing is that in the near term the uranium markets are still determined by the pace of Japanese restarts, which are -- to be charitable -- glacial. The third thing is good news: we now use more uranium on a global basis than we did before the Fukushima crisis, because shutdowns in places like Germany and the United States were met by new construction in China. And even in the markets that shut it down -- Germany is the most important -- while the Germans shut down nuclear production in Germany, they make up for it by buying electricity from France and Poland. Which is generated by nuclear, of course. An important circumstance. The last, really, is the wild card. The pace of uranium demand going forward will be partly a function of interest rates and partly a function of global economic growth.
My real nervousness about the uranium business, personally, is we’re 9 years into a global economic recovery. I’m not an economist but in my experience this recovery’s long of tooth. If the global economy slowed down and electricity demand slowed down, particularly if interest rates rose, which would increase the cost of establishing new generating capacity, I could be wrong. So you need to right-size your uranium portfolio to take into account the fact that you need to be patient, and ultimately, you may be wrong. For me, that’s easy to do, because of the arithmetic. In the United States as an example, 15% of baseload electrical demand is uranium. Either the price of uranium goes up over the next 5 or 6 years to cover basic costs plus cost of capital, or the lights go out. Those are the two choices, there’s no middle ground. It’s not like we’re going to establish enough solar or wind to take back 15% of baseload demand. So that statistic is extremely appealing to me.
The other thing that’s extremely appealing to me, having lived through the last uranium bull market, is that uranium prices don’t go to the uranium clearing price, they go through. It’s a capital-intensive business, it takes time and money to add supply to a market that’s out of balance. And when it shoots through, the prices of the uranium juniors are astonishingly volatile. So I am willing to take the risk that I might be wrong by right-sizing my bet and understanding that if I’m right, I have 5 or 6 small stocks in my portfolio that will EACH generate 10 for 1 returns. If past is prologue, back in the year 2000, there were only 5 uranium juniors worldwide that had survived a 20-year bear market in uranium. By 2006, the worst performer of those five had generated a 22 to 1 return.
JK: So are uranium exploration plays the place to be when uranium picks up? Would you mix it up between explorecos and developers?
RR: No, I would start with developers or small producers. In the beginning of the uranium market, what people look for is companies whose earnings are going to explode to the upside b/c their margins increased b/c the uranium price increased. With regards to the explorecos, I think what we learned in the last bull market is you have to be extremely selective of where they’re exploring. In 6 years last time, we went from 5 uranium juniors to 500 uranium juniors. That’s problematic because in 2000 there were probably 15 teams worldwide that were competent to explore for uranium. That means the probability of your uranium junior having a competent management team was a function of dividing the number of teams -- 15 -- by the number of competitors -- 500. A truly lousy number. The second thing is that you have to look in places that are amenable to discovery and amenable to development. Mercifully for Canadians, the best place in the world to look for uranium is Saskatchewan. It’s the Persian Gulf of uranium.
JK: You’re a contrarian. The grades in the Athabasca Basin are off the charts -- I cover NexGen in the newsletter -- but does that more than compensate for some of the Canadian regulatory barriers that may not exist in other more far-flung parts of the world?
RR: I wouldn’t want to discover a uranium deposit here in the People’s Republic of British Columbia, fighting the NDP and the Greens. I’m 66, right -- that’s not going to work. Saskatchewan is one of the finest mining jurisdictions in the world. Importantly, the regulators in the uranium business know how to spell uranium. They have been regulating uranium mines for 40 years. They employ regulations that are intelligent based on their experience. It’s a very, very good jurisdiction. It’s not a place where, as a uranium explorer, you want to cut corners because the regulators will know you’re cutting corners. But that’s good for everybody else; it keeps the rogues out of the province. Now I’m not saying only Saskatchewan. Namibia, for example, looks attractive to me; Kazakhstan looks attractive to me. What I’m trying to say is there are 100 other jurisdictions in the world that are, in effect, “why bother” jurisdictions. If you care about uranium and you’re Canadian, a case can be made that the only jurisdiction you learn to spell is Saskatchewan.
JK: I consider nuclear clean energy, but there’s a lot of stigma with nuclear waste storage, Fukushima and Three Mile, etc. And many people on the environmental side do not consider nuclear clean energy. Do you think that stigma will linger -- do you think nuclear will ever be considered “clean energy”?
RR: Well, you certainly have responsible people on the environmental side, like Mr. Moore, one of the co-founders of Greenpeace, saying the answer is uranium. So, there are technology-oriented greens who understand that we need uranium. There are narrative-oriented greens, Luddites basically, that object to the lives we as humans live. I would urge them to commit suicide -- you know, make the world greener by ceasing to consume. I don’t think uranium will ever be popular because I think that social sciences and liberal arts are much more popular majors than physics and engineering. That is, that the narrative will always win out over facts. Mercifully, checks are written by people who understand the science. And while people debate what type of energy should be in our future, the smart money says yes -- meaning all forms of energy. Wind? Of course. Solar? Of course. Hydrocarbons? Of course. Nuclear, of course too.
JK: What’s the last stock you bought in the public market?
RR: The last stock I bought, pro, was Adriatic Resources. Nice discovery play, very nice discovery. The way Sprott works is we can’t buy pro if there’s a client order in the books. So I either buy them because I’m a shareholder in funds I manage and so I buy them for the fund, or I have to buy them when retail demand in the placement or in the after-market has been exhausted. The truth is, I’m always last in line, which is fair.
JK: OK, thanks a lot for doing this, Rick.
RR: My pleasure.