Rick Rule talks investing in precious metals and commodity markets in a crisis

Rick Rule, President and CEO, Sprott US Holdings, Inc.

Presented by The MoneyShow, popular resource investment speaker Rick Rule recently provided his thoughts on investing in mining stocks and precious metals during a time of crisis in a virtual presentation from his office in Carlsbad, California.

Rule has been a highly successful resource sector investor and has financed numerous exploration and mining companies over his 45-year career and is widely recognized as an astute analyst.

He notes that there are bullish factors underway. One is what he calls “the ascent of man” who has survived and generally prospered through famines, poverty, war, turmoil and disease over time. “As a species we have managed to survive and we will thrive,” he said.

He states that as poor people become more prosperous, there will be a need for more natural resources, that is, there will be more people trying to live better.

He pointed out that the poorest 2 billion people in the world, while still desperately poor, are getting richer faster than at any time in history. “There are still some 1.7 or 1.8 billion people around the world that don’t have reliable electrical service,” he said. “However, it is anticipated that the world will be fully wired within 20 years.”

Rule said that the important thing to note is that when poor people get more spending power they tend to buy things made from natural resources as opposed to reasonably wealthy people (who already have material goods) that like to buy services – vacations, for example.

Poor people around the world look to electrification which takes copper and oil. They upgrade their mode of transportation from being on foot to a bicycle, to a Honda motorcycle to a small pickup truck – all of which take natural resources – while improving their family’s daily calorie count. “That’s the good news.”

Regarding bad news, Rule said he is concerned about debt and deficits. The last five years have seen a deterioration of many balance sheets – individuals, corporations and governments – particularly governments and the debt they carry. “The idea that you can pay off their debt at a government level with deficits presents a complex challenge – one that challenges debt markets because the credit quality deteriorates,” he said. “It also challenges equity markets as the cost of capital and the risk associated with that capital increases.

“The way that we have seem to have dealt with economic slowdowns in the last 20 years has been artificially low interest rates, that is, an artificial decline in the borrowing rate and an increase in the supply of money,” said Rule. “What this really does is forward shift demand – demand that the economy might have experienced or enjoyed in 2021 and 2022 – is front-loaded into 2020 as a consequence of excess liquidity. That’s OK in the near term but what happens is that when you get to 2021 or 2022 you have already used up some of the demand that might have run the economy then.”

He stated that what is means is that every dollar of official liquidity that is created generates less economic growth. “It means that debt and deficits and quantitative easing have to increase to generate the same purchasing power that it did before,” he said.

“Another question that I see with regards to precious metals and natural resources is the difference in our society between liquidity and solvency,” said Rule. “I would suggest that part of the market strength that we are enjoying today, both in terms of the credit markets, which is to say, bonds, and equity markets, which is to say, stocks, is a consequence of many investors misinterpreting liquidity – that is, the presence of cash in the system – for solvency, which is to say our ability, on an individual level, a corporate level and a societal level, to repay the  debts we owe and leave substantial liquidity for reinvestment and consumption.”

“It is normal and natural after an economic expansion to have a slowdown,” Rule explained. “They call those recessions. It would seem that societies have decided that we won’t have recessions anymore. In my experience, that is something beyond our control. Make no mistake – the economic expansion that we enjoyed hosted the 2008 liquidity crisis after a 10-year long expansion. In the historical context, a 10-year old expansion is very long in the tooth. That expansion was due to come to an end anyway as a consequence of its age and its artificiality in the sense that that 10-year economic expansion was driven by excess liquidity, quantitative easing and artificially low interest rates as it was by any expansion in world trade and economic activity. The COVID-19 was more of a catalyst than a cause.

“At this time of the COVID-19 virus, I would say that the V-shaped recovery we have seen in particular in debt markets is more a consequence of manipulation – in fact, downright purchases by the Fed – rather than economic strength,” said Rule. “I hope I’m wrong – I think I’m right.

“In terms of natural resources, I think the place to be is in precious metals,” suggested Rule. “Right now the wind is in the sails of precious metals. Gold markets have traditionally moved for many reasons. In my 45 years of experience, the most important reason is a decline or lack of faith in government securities such as the world’s benchmark security, the US 10-year treasury that other securities have traditionally been measured against. I think that faith in the US 10-year treasury is, for good reason, being called into question.”

Rule remarked that the first question is about reward. Today, treasuries are yielding 60 or 70 basis points. The government says that the U.S. dollar purchasing power is declining about 1.6% per year. “If you give your money to the U.S. government for a 10-year treasury, they promise to give you back less purchasing power than what you gave them,” he said.

He explained that there is risk associated with 10-year treasuries in two different ways. One is the quantitative easing. “If you or I did quantitative easing, it would be called counterfeiting. However, the US government does quantitative easing – about $1.5 billion in counterfeit currency every day through quantitative easing. They think it’s a good thing but it’s not because it debases currency. And with regards to 10-year treasuries, investors around the world know that they are getting paid back in a currency that is debasing itself rapidly.”

He goes on to state that then there is the credit quality of the issuer, that is, the U.S. government. “Ironically, we are the world’s reserve currency. For all our problems, we are probably the strongest currency in the world, but that doesn’t mean we are absolutely strong. It merely means that we are relatively strong,” Rule notes. “At the federal level, we have $22 trillion in recourse obligations, that is, bonds outstanding. The Fed itself holds $4 or $5 trillion in treasuries itself so the net number is somewhat lower but still problematic. More problematic are entitlements, which is to say, the off balance sheet liabilities of the U.S. government which the congressional government office suggests exceeds $100 trillion.”

“So at a federal level – I’m not adding state and local governments or unfounded pension plans, we owe $120 trillion,” said Rule “The spenders owe it to the savers and they can’t pay it back. We service this debt and fund these obligations with surpluses but we don’t have a surplus; we have a deficit of well over a trillion and a half dollars this year.”

Rule states that gold moves with a lack of faith in fiat currencies and sovereign issuances.

That lack of faith is manifesting itself and so the gold price is beginning to move, he said. “In prior recoveries from oversold bottoms, gold moves first and gold equities move later. Silver also moves after gold but generally moves further and faster. In this circumstance, history will repeat itself. We have seen a nice move in gold but a lesser aggressive move in gold stocks that began about six weeks ago. Gold itself caught wind about six months ago.”

Rule said that he believes that gold and silver as well as gold and silver equities will make higher highs and higher lows. “But these markets will be volatile. Precious metals and precious metal equities are some of the most volatile investments and speculations in the world. In my experience, these markets can lose 20%.”

How much volatility? “Let’s look at history,” he said. “In the greatest gold bull market of my lifetime between 1970 and 1981. The gold price between 1970 and 1975 was controlled at US $35 an ounce and then rose to US $200 an ounce over those five years – a 600% move. Then, in 1975, the bull market faltered and in nine and a half months fell from US$200 an ounce to US$100 – a 50% decline.”

He commented that many people that had believed in the gold thesis had their faith shaken and got shaken out of the gold bull market. “That mistake cost them from participating in a market that went from US$100 an ounce to US$850 an ounce in five and a half years. That is volatility with plenty of opportunities to get shaken out of your position.”

How to play this? “If you don’t own physical gold, you should buy some because it is insurance. There is no insurance that has such attractive circumstances around it paying off as gold,” Rule aid. “I believe that gold and gold equities are going higher – much higher. If you look back at recoveries from the oversold bottoms in the gold equities markets, the weakest major recovery (and there have been eight since 1970) the index itself was up 180%. The best recovery was up 1,200%. When gold stocks move, they really move. But remember, they lag the metal.”

Rule said that the best and most liquid stocks move first and it works its way down to the juniors. “We have seen that take place in this market,” Rule said. “I think the big, liquid, high margin gold companies – the Barricks, Newmonts and Franco-Nevadas – that have already moved up will continue to move up.”

He notes as the big gold stocks become expensive, investors begin to look for other companies that offer better value while the big companies look for acquisitions. Meanwhile, he said that silver has just started to get a bid and silver stocks move the last.

“Moving on to industrial materials, they are at least as volatile and cyclical as gold, said Rule. “My motto for investing in industrial materials is that ‘you are either a contrarian or you will be a victim.'”

He said that industrial materials are strange but predictable. At the top of the cycle, these companies appear to be cheap and sell for low price:earnings ratios but that is partly based on unsustainably high product prices. “High prices are the cure for high prices,” he said. “Very high commodity prices bring out more supply at the same time that they discourage demand which leads to price crashes. At the bottoms, the stocks look expensive and the commodity prices are unsustainably low.”

For example, he noted that the International Energy Agency said it costs about US $60 to produce a barrel of oil. If you are producing oil at $60 a barrel and selling it for $30, you are losing $30 a barrel. As an industry, that would be 90 million times a day. Rule asks: “What happens in that circumstance? Cheap oil encourages demand and reduces conservation. In time, the industry can’t meet sustaining capital requirements. The oil business will see sunnier days. If you want your car to start in a few years, the price of oil has to rise.”

“For speculators, I also see an increase in the price of uranium,” said Rule. “Uranium is way too cheap relative to its supply.”

Rick Rule will rank readers’ natural resource equities, on a free, no obligations basis. The rankings are 1-10, with 1 being best. He will comment on individual holdings, where he believes my comments may be of value. He will include, with the rankings, a 45-year gold equities index chart, and a 100-year commodities valuation chart. To access the offer, go to the weblink sprottusa.com/rankings, and enter your resource equities portfolio on the web form. Mentioning Resource World in the source line would be helpful.