Recorded March 3, 2020
An event that causes panic, that is other than permanent, is an opportunity.
INTERVIEW TRANSCRIPT (EDITED)
Albert Lu: I’m joined on the phone by Rick Rule, president and CEO of Sprott U.S. Holdings, and he joins us today from the PDAC Annual mineral exploration and development conference in Toronto. Rick, thanks for joining me here at Sprott Media.
Just a couple days into the conference there, what are your thoughts so far on PDAC?
Rick Rule: Well, it’s very interesting, Albert. Attendance is down this year, not surprisingly, as a consequence of things like the coronavirus. When I say down, it’s probably down to 24,000 people. It’s easily the largest mining convention in the world, so there’s three floors of exhibitors, equipment suppliers, host governments, mining companies, financial services providers … a real smorgasbord of every possible sort of vendor, really.
For me, of course, it’s an absolute must-attend event. It’s the most important mining convention of the year. It probably saves me, personally, 100,000 air miles by having people from everywhere under one roof.
AL: Rick, you probably are able to get a barometer on what’s going on in the gold market, or in mining in general, just from the people that you speak with, people who request meetings with you. I’m wondering, how is this year different from prior years?
RR: Well, there’s two predominant themes in the precious metal side. [There are] people who are in the physical business — that is, they are actually investing in or selling or buying physical precious metals bullion specifically. There is a not very quiet confidence, [a] uniformity of opinion in the gold business, that several factors are converging which are likely to take bullion higher. You’re familiar with all of those of course: quantitative easing, low real interest rates, lack of faith in the economy, all those types of things. I would suggest that the gold industry, the physical gold industry, feels that if the Fed does cut interest rates by 50 basis points, that that’s probably the catalyst for a real romp in the gold price. The only thing about that thesis that scares me is the unanimity with which it is held in the mining equities.
On the other hand, there is a brave face being put forward [by] many of the issuers [that] didn’t come to market in the last four months, although they needed capital, because the market for the shares was going up and they thought they’d be able to raise money at higher share prices, i.e., a lower cost of capital. They played chicken with capital markets and, as a consequence of the market disruption that they’ve seen, there’s some fear on the part of those people that they have lost that bet. So while the junior mining industry, at least, is putting a very brave face forward, there is the real sense that capital markets are closed for some period of time. Nobody knows how long it is.
The volatility that we’ve seen in equities markets, depending on your point of view, is either good or bad, but my personal opinion, of course, is it’s good. I like to take advantage of volatility, but the truth is that it has unnerved people. In many regards, the extraordinary sell-off on Friday, and then with many people believing that the sell-off would continue to Monday and Monday being a fairly strong up day, I would suggest that the investor sentiment here on the floor is merely confused.
AL: I was going to ask you that because you are [a] highly sought-after interview guest at these types of conferences. I’m wondering, from the retail perspective, what kind of questions are you getting in the various interviews that you’re doing there?
RR: It would seem that what the interviewers would like me to do is hold their audience’s hand. I think the real advantage I have in those interviews is simply age — I’ve been through this before. I think that the sentiment is pretty realistic right now. There is a widespread belief, I think, that gold, as an asset class, is going to do well. There is some trepidation about gold equities in the near term and probably some confidence about gold in the long term. Some of the questions, of course, are beyond my capabilities to answer but people have asked me a lot of questions about the virus itself. Albert, you know I’m no epidemiologist, so I’ve had to respond to those that they’re above my paygrade.
People seem to be looking for reassurance as much as anything else. People are looking, in many cases, to have things that are unexplainable explained. There are other portals, web-based information distributors, who have asked me questions that are probably more contrarian and are saying, so where do you see value here? What are you doing? There’s really been a range of questions.
AL: Those are all great questions. Some of them, I admit, cannot be answered, but those are oftentimes the most fun to ask. Rick, I’ll try to keep mine more down your alley. We can’t avoid acknowledging what’s going on in the media right now with this scare, the coronavirus scare, and I wonder … let’s try to add some perspective to the investing side of this. On the personal side there are people, Rick, in our neighborhood, going out and buying three- to six-months-worth of food and other provisions. Incidentally, the market seems to be going into the tank but I can tell you Costco is probably going to have a great quarter. People are going crazy there, and when I’m asked about this I just tell people, from my own experience — non-expert experience — that you should do whatever lets you sleep at night. As long as it’s not harming you, go ahead and do it.
We may be overreacting to certain things but I wonder if we’re underreacting to the economic fallout from this, because if we do indeed have a bubble, and 19-20 multiples on general equities is certainly within that category, it doesn’t take a large catalyst or pin to pop a bubble like that. Do you think, maybe, we’ve been underestimating the potential economic fallout from this?
RR: I think you are likely on to something. I think that a rate cut would, at least temporarily, help the equities markets. The sense that, for the last 25 years, any time there was a problem we exercised the Fed put — we cut interest rates, we added liquidity to the system and animal forces took care of the rest. I think there may be broader issues with regards to the economy, and I think that those broader issues are probably a specific interest of Sprott clients. It’s arguable that almost any likely policy response that might happen would be good for the gold price. The underlying economic implications of in particular the slowdown in China for the rest of the commodity complex is not pleasant. China as I understand it — these are World Bank statistics not Rick Rule statistics — has been responsible for about 35% of global economic growth over the last few years. As you know, Albert, prices are set on the margin. When you reduce marginal demand, you reduce price much more than you would suspect.
So I think, in terms of the broader commodities complex, if the coronavirus, as an example, shakes up the availability of capital and liquidity at the same time that a slowdown in economic demand in China or more generally impacts the broad economy, the outlook for many sectors of the [economy], including basic materials, is challenged. Interestingly for me, I sort of see a silver lining in that my nervousness, as you and I have talked about before, was in a normal economic slowdown, the kind that you might expect to occur after a 10-year economic expansion. My nervousness was that we’d see a long, slow grinding bear market, including a bear market and materials, where the excesses of 10 years of liquidity became unwound in a two- or three-year-long bear market, including a bear market in materials. What may be happening as a consequence of the coronavirus is that the down cycle, at least in materials, gets compressed from three years to six months. My suspicion was, and I’m no economist, but my suspicion was that oil as an example might fall from $60 to $40 over two or three long, ugly boring years. That might occur now over three months or four months.
So, in a sense, we may be, in the broader commodity complex and maybe even in the broader economy, going to experience a much sharper, but shorter, decline. That’s sort of the way I’m feeling. Who knows if that’s true? As you know, I’m certainly no economist, and I wouldn’t want to speak to the broader equities. I’m obviously concerned about the broader economy because I see the economy as being liquidity driven, and I think it’s been liquidity driven for 10 years. [In] these liquidity driven expansions, what really happens is the availability of liquidity forward-shifts demand from later periods to sooner periods, and my suspicion is at some point in time, for a while, you simply run out of that demand. We’ll see whether or not that comes to pass.
AL: Let’s stick with the theme of energy for a second, Rick. Lots of pressure on oil. The reports I’m reading are saying that the high-yield markets were essentially closed down last week — issuance was [essentially] stopped.
What effect is this going to have, liquidity wise, on some of these high-yield issuers?
RR: Well, that’s an amazing topic, and you may recall you and I visited on that subject about a year ago. One of the interesting aspects of the high-yield market is that so much high-yield debt is owned in very, very liquid exchange-traded funds, ETFs. The challenge is that the top structure, the ETFs, are both large and extremely liquid but the assets that they hold are illiquid. If you have a panic at the ETF’s, it might have the effect that an old-fashioned bank run used to have, where a 50- or 60-billion-dollar ETF has a series of $25 million underlying positions which are, themselves, very illiquid. As investors go to redeem the ETF, the managers have to sell the ETF issues. The issues in the ETF are really illiquid and they can’t do it.
I think there’s a real risk of that. I think — I’m not saying it’s going to happen. But, [in] a circumstance where you have a highly liquid vehicle whose only assets are illiquid vehicles, if there’s a redemption run, it has the impact of a run on the bank. We could very well see more turmoil in the high yield markets, not only in the issuance but, in fact, in the aftermarket for these things.
AL: That’s right, and I think the first test was last week. It wasn’t what anyone would describe as a run but there certainly were significant outflows from the most prominent high-yield ETFs, and the market appeared to clear. Does that surprise you at all?
RR: I think that there is enough liquidity in the market for now. You’ll recall that in the 2008 circumstance, and I hate to make that obvious connection, but in the 2008 circumstance the unwinding of real estate credit and the unwinding of instruments in real estate credit took three or four months to move from worrisome to catastrophic. To the extent that the redemptions in the high-yield market are stemmed — and they could easily be stemmed, I think, by a 50 basis point interest rate cut if the high-yield market, yielding five-and-a-half or six, began to get investor inflows as a consequence of certificates of deposit yielding half a percent — then the potential crisis that we described, the illiquidity crisis, is perhaps averted. I can see a circumstance where, at least for a year or a year and a half, we can skate through this.
If, by contrast, even with the 50 basis point rate cut, two, three or four high-yield issuers default because of low interest rates, or the lack of availability of supplementary bank credits, and the consequence of those defaults cause more high-yield investors to exit the high-yield market, then I think the systemic risk that we talked about is still high.
AL: Let’s move from high yield to the proverbial safe haven, and that would be U.S. Treasuries. We hit all-time lows on the yield, and, Rick, often times when discussing gold you talk about the demand of gold stemming from, or being inversely correlated to, faith in the U.S. Dollar — particularly as expressed by the 10-year Treasury. As that yield drops closer and closer to 1%, are you surprised that that can happen while, at the same time, gold can edge toward an all-time high?
RR: I am. It doesn’t make any intuitive sense to me, but I guess the markets aren’t designed to make intuitive sense. One near-term outcome from lowering the interest rate substantially is that the capitalized value, or the capitalized prices, of bonds increase. If you look, not just at the 10-year but rather at the 30-year, the long end of the yield curve, a 50 basis point rate cut makes existing bonds relative to the newly issued bonds seem cheap.
We’re in this odd circumstance right now, Albert, where people seem to be buying stocks for yield and bonds for capital gains. Now, I personally have absolutely no interest in buying a 10-year, 20-year or 30-year piece of paper. The idea that the United States proposes to pay me below a hundred basis points, in a currency where even the CPI-stated rate of inflation is 1.6%, 1.7%, 1.8%? — I mean basically what they’re telling me is that my purchasing power is going to disappear at the rate of 70 or 80 basis points a year. I don’t have much of a sense of humor for that.
I like cash, in fact, so I could see myself in the three-month market or the six-month market, but the idea that I personally would be in the 10-year market just makes absolutely no sense to me— not that I make a market.
AL: Rick, I think your information may be maybe ninety minutes old — I think we’re talking about 100 points now in the market, for the Fed. You make an interesting point about equity investors seeking yield and fixed income investors seeking capital appreciation. When you look at the shift in investor behavior, you see the bond market starting to behave more like the equity market in the sense that it fluctuates, it’s moody, it chases momentum and those sorts of things — that’s really interesting.
As we close out here, Rick, I just want to ask, how is Rick-Rule-the-speculator going to approach the market in the next month? And how is Rick-Rule-the-investor going to approach markets?
RR: I’m going to take what the market gives me. First, Albert, if you look at me six months from now, I am almost certainly going to be a buyer of the big, big oil stocks. Not now but the idea that, even now, Exxon generates a 7% yield. Yes, they’re challenged by low oil prices, and, yes, Greta [Thunberg] doesn’t like them, but they’re one of the better capital allocators of our generation. I suspect that we’ll be driving, most of us will be driving the petroleum fuel vehicles for the next 10 or 15 years. So I will certainly be in the big oil stocks over the next six months.
In the near term, I don’t need to buy any more gold and silver bullion because I’ve been relatively aggressive, personally, doing that for the last year and a half, but I certainly will take advantage of the terror that I see in the small mining sector to provide capital, on terms that I consider to be attractive, to companies that need to find capital in a market where that capital is very scarce.
The circumstance that we have in front of us, from my point of view, in the precious metals equity space is really quite attractive. The fact that I have very little competition that’s willing to write checks at this point in time means that I need to work up the courage to write those checks, and I’m not, by the way, belittling the possibility of increased turmoil as a consequence of the coronavirus but I’ve learned from many, many, many intelligent contrarian investors’ teaching that an event that causes panic, that is other than permanent, is an opportunity.
I suspect, just like every other crisis that mankind has faced, that we will find a technological or social solution to the coronavirus. I believe that this circumstance is other than permanent. I’m not suggesting that it won’t get even more unpleasant, but my training is that when you have a circumstance that is other than permanent that causes panic, you must, at least in a measured way, take advantage of it, which is what my intention is.
AL: Rick, we’re out of time but thanks for taking time out of your day to join us here on Sprott Media.
RR: Well, thank you very much for organizing this, Albert. I’ve found it pleasant so I hope it’s useful to our listeners.