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This year has been a ride already in the junior mining sector and we’ve seen a nice run in 2014 in precious metals stocks. Is this just a dead cat bounce or are we forming a bottom? This of course is the million dollar question but it’s a good sign to see a Legendary Investor such as Rick Rule optimistic on this sector. We had the pleasure to chat with Rick Rule of Sprott Asset Management on speculating without gambling and actually getting rich.

My honest opinion is that there will be many millionaires made in the junior mining sector who are investing now when all else are fearful.

Prosperous Investing

Kenneth Ameduri
Chief Editor at CrushTheStreet.com

Transcript

Crush The Street: I’m Kenneth Ameduri with CrushTheStreet.com and I’m here with Rick Rule of Sprott Asset management. Thank you so much for being here.

Rick Rule: Pleasure Ken, thank you.

Crush The Street: I wanted to talk about speculating today. And you consider yourself a speculator, I’ve heard you talk about that. And I wanted to talk about portfolio strategy. A lot of times people are trying to design their portfolio, and maybe get themselves in to large cap, or small cap, or just fit it the right way. And I’m curious, how do you get rich speculating without gambling?

Rick Rule: That’s a great question, and I think that you look at the fact that the process of speculation and the process of gambling are very different. Gambling is trusting to luck and fate, and speculating involves attempting to understand or control the odds. It’s a very different process.

Perhaps because I’m a speculator, I’m not a gambler. When I walk in to a big casino in Las Vegas and look around, my instinct tells me that this great big opulent building was not built by winners, it was built by losers. And my speculative instinct tells me that when I walk in, I’m at a disadvantage to the house.

A speculator looks for the place where he’s at an advantage to the house. I think that’s the key difference between a speculator and a gambler. A speculator looks for a place where he or she, as a consequence of some facet within their control, believe that they have an edge over other speculators, or against the market at large. They’re not trusting to fate; they’re not trusting to luck.

Crush The Street: When someone is speculating, what are they going for? Obviously people like 12% returns, when you talk about large cap stocks. And over many years that can result in big gains when you talk about the compound interest effect. But what is your portfolio strategy over 30 years? You know if you compare it apples to apples, to investing in 12% gaining stocks, how do you set your portfolio up over 30 years, speculating?

Rick Rule: Well I don’t want to seem argumentative, but being 61 I would suggest that having 12% compounded gain anticipation is speculative.

Crush The Street: Yeah, it’s a little high. Dave Ramsey says you get 12% gains in mutual funds.

Rick Rule: I think that’s a wonderful way to sell newsletters. I have lower expectation in terms of the market. But the type of speculation that we’re talking about here at Cambridge House is a different style of speculation anyway. I speculate well in extractive industries because I’ve been in those industries for so many years that I have knowledge that’s an advantage compared to most of my competitors.

So I start with an edge. I have a reputational edge too, which means that people come and show me stuff that other people don’t normally get to see. And I have discipline, which I think is required of a speculator. I probably look at 30 transactions for every transaction I do. Most people aren’t willing to do that. I understand my business. The natural resource based businesses are capital intensive, and they are deeply cyclical. What that means is, as a speculator, that you are either a contrarian or you will be a victim.

Most people in the resource business get the timing exactly wrong. In bull markets, when things are over-priced and their recent expectation is success, they become aggressive precisely when they should become conservative. At market bottoms, after a market’s fallen by 70% and their recent expectation is failure, they become cautious. The truth is, that what you need to do is be on the backside of both of those trades. That’s most of what being a speculator is.

The second part, in this business, in the microcap part of mineral exploration speculation, as an example, is that most speculators again misjudge the nature of the business. They think it’s an asset-intensive business. But these assets, mineral properties, have a 1 in 3,000 chance of becoming a mine. The only advantage that they convey you is the obligation to spend money. A rational accountant would call these assets liabilities.

So the second thing you need to know, after you need to know that these things are vastly cyclical, is that the human resources are much more important than the mineral resources in these companies. Because they’re actually research and development businesses. So most people fail in speculation in the business, even if they got the timing right, because they misjudged the nature of the business.

Crush The Street: Transitioning specifically into the junior mining sector. The DOW Jones is at new highs, though we’ve seen a correction now, and the junior mining sector has been relatively beat up over the last couple years. But going in to this since January 2014, I’m feeling a little better about things. I’m seeing companies start to raise money, and I’m seeing stocks start to go up a little bit. How cyclical do you see this time period, or do you see it as a potential bottom? And is it, I don’t want to put you on the spot where you have to call something, but are you optimistic about what we’re seeing right now?

Rick Rule: Very optimistic. I’ve been in this business almost 40 years, and I can tell you with absolute certainty, and I can’t tell you many things with absolute certainty, but I can tell you with absolute certainty, that bear markets are the authors of bull markets. And bull markets are the authors of bear market. A market that has been in a protracted and deep bear market, like the one we’re in, where the TSXV is off circa 75% is arithmetically 75% less risky than it was when people felt better about it. That’s a truism. In terms of turning, they say history doesn’t repeat but it rhymes.

What I have seen that is indicative of the fact that the market has bottomed, is really two things. One, if you look at the first third of 2013, the charts of the various companies resembled nothing so much as the topographic map of a ski hill. Steep decline from upper left to lower right. That was a situation where you had fore-selling and you had buyer capitulation. More sellers than buyers means the stocks go down. Middle of the year, it flattened out completely. It looked like the electro-cardiogram of a corpse. That’s a situation where you have buyer exhaustion and seller exhaustion.

Beginning of November of last year, the better part of the junior market began to tick up on low volumes. That means that they found some bids, they got cheap enough to find some bids, but the sellers were still exhausted. That happened in 1992, it happened in 2000, and before that it happened in 1986. That’s a very good sign. This flatline bottom, and then the best issuers of the bunch, it’s called bifurcation. When the top 20% of the issuers in the bunch begin to head up, while the rest of them are going sideways to down.

What’s missing in this market, for me to be absolutely able to call a bottom, has been capitulation. In prior markets, you saw both retail capitulation, where you’d have a two or three week period that was farcically tumultuous with no bids. Where you call your broker to sell $3,000 worth of stock, and your broker says: “To who? There’s no bids.” So that retail capitulation hasn’t been present. And issuer capitulation hasn’t been present either. In issuer capitulation, the issuer’s say, “we’re not going to do $1,000,000 survival financing, we’re going to do a $5,000,000 financing at whatever price clears the market, because we can’t continue to manage this business for survival. We have to grow it, irrespective of how the shareholders who bought it four years ago, at four times the price, feel about it.” We haven’t seen those two things. When we see those things we will have put in a bottom.

Crush The Street: I think you kind of touched on it, but I wanted to ask you one more question. It’s the inflation story. And I think that’s what is keeping a lot of people out of the market, and the retail investors that you’re not seeing come in… do you think it’s going to be the inflation story that causes people to rush back in to the junior mining sector? Let’s call it the dumb money, when it gets in to that bubble phase. Or do you think that it will just be prices going up? Or is it going to be something else that the junior miners are going to have to sell, to get the retail investor back in to junior miner stocks.

Rick Rule: Well what I hope happens is that half the junior sector becomes extinct. That the lame, the halt, and the blind, like in 1992 get the dot and go away. With regards to the inflation story, I think what you’re seeing right now is on the part of both voters and investors, confidence in the current construct of the global economy. I personally believe that that’s misplaced confidence, but I think most people don’t care. I don’t think that most people study the economy particularly well.

Crush The Street: It’s holding together long enough. It’s been five years since the 2008 crisis, so it’s too big to fail.

Rick Rule: So if we have something that shakes confidence that could ignite resource stories. But I’m not sure that it would ignite the juniors. If you had a situation like 2008, where the crisis in confidence engendered a liquidity squeeze… Liquidity squeezes are the ugliest on the peripheries, and junior resource stocks are certainly on the periphery. So junior stock promoters have to be very careful in terms of what they hope for.

What turned around the 2000 market was, yes rising commodity prices, but more importantly what turned it around was just moving off a very over-sold bottom in 2000. The value buyers came in in 2000, and in the absence of sellers started a kick up. And then the momentum buyers came in and it became a self-fulfilling prophecy. The thing that turned around the sector in the cycle before that, the ’92-93 cycle, was better.

It was a discovery cycle. The junior resource industry did something it hasn’t done for 20 years, it created value. This is a market, the one that we’re in right now, where everybody thinks it’s such a dismal market, that will reward value creation. Sirius Resources in Australia, a twelve-bagger in four months of discovery. Reservoir Minerals in Canada, $0.22 to $6, Africa Oil in Canada, $0.80 to $12. The problem is the investors are begging for corporate performance and the industry has not delivered it.

Crush The Street: Well I’m hoping that with stocks at relatively decent highs, I’m hoping that with that momentum people start looking for other sectors. And people will be looking for other areas to invest their money, and thus we potentially see an over-flow into the junior mining sector.

Rick Rule: I don’t suspect that you’re going to see a liquidity over-flow in our sector. If people are enjoying success in the major market sectors, I think that spill over, when it comes in to the speculative side, will probably go into technology, which it’s done. I don’t think we’ll see it. I think in our sector we need to perform independently of the big markets. I think the big markets can only do us harm. If they come off, we’ll suffer a liquidity squeeze. If they go up, we won’t benefit from their liquidity.

We have to achieve of our own volition. The narrative that surrounds what we do, the narrative of things that existed in 2009 and 2010, is as true today as it was then. It’s just perceived differently. The idea that the U.S. fiscal situation is any more sustainable now than it was in 2010 is ridiculous. The idea that the commodity thesis, with regards to more and more people being born every day and those people wanting to live like you and I, is as true today as it was in 2009 and 2010. It’s just perceived differently. If all of the facts are the same, period to period, but the pricing is reduced in commodities terms by 40% and in equities terms by 75%, what that means is that a recovery is inevitable, irrespective of what happens in the major markets.

Crush The Street: There you have it, Rick Rule of Sprott Asset Management. Thank you so much.

Rick Rule: Pleasure, thank you.

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