At the Casey Research/Sprott Summit When Money Dies, Rick Rule spoke with Stefan Molyneux about energy and gold investments and his outlook for the near-future market overall.
[The sold-out When Money Dies summit was a huge success, with attendees and participants alike receiving much to think about. If you missed it, you can still “be there,” via a full set of audio recordings. These are available now, in CD or MP3 format for your convenience.]
Stefan Molyneux: Hi everybody, it’s Stefan Molyneux from Conversations with Casey. I have Rick Rule, the founder and owner of Global Resource Investments. Thank you so much for taking the time.
Rick Rule: Always a pleasure.
Stefan: So, we have lots of gold bugs here, and it may be fair to call you an energy bug. Would that be a term that would work for you?
Rick: I’d plead guilty to gold and energy.
Stefan: Gold and energy, okay. So, your approach is that the supply and demand of energy is global mathematical formulas, that the rising demand for energy for 3.5 billion people who want the Western lifestyle is driving the market. Is that a fair characterization of your approach?
Rick: Certainly. Two things: Western demand, as a consequence of destruction of Western economies, is leveling off, but emerging market demand is increasing. Yes, absolutely. You see year-on-year growth in world import demand – not total demand, but world import demand growing as sort of 2-2.2% a year compounded.
Stefan: Now if, because they say there’s going to be the big correction in China – which given the amount of malinvestment, and if you’ve ever seen the videos of these ghost cities, it’s really quite chilling what they’ve done to real estate down there – do you think that there might be an issue with the leveling-off in demand in the developing worlds as well as in the Western world?
Rick: Yes, it absolutely could occur. The growth in emerging frontier market demand is less a function of government stimulus than a function of – in the last 30 years or 35 years, there’s been gradual political liberalization in emerging markets. Deng Xiaoping famously said, “To become rich is glorious,” and the people took him at his word; and as people become a little more free, they become a lot more rich to the extent that the trends in political liberalization in frontier markets reverse themselves, then certainly the growth that you see in energy demand reverses itself.
The other side of the energy story is much more predictable, which is the supply side. People look at supply constraints in the context of peak oil, which from my viewpoint is more of an economic phenomenon than a physical phenomenon in the near-term. What isn’t subject to debate is that most of the oil in the world is produced by national oil companies – by government entities. The same people who can educate kids, who deliver the mail, can’t produce oil, and around the world the trend that you see in national oil companies is the companies are spending increasing amounts of their free cash flow on politically expedient domestic social spending and constraining reinvestment in the national oil industries, which is immediately constraining their ability to produce.
I can’t tell you what’s going to happen necessarily on the demand side in the near-term in China, but I can tell you pretty conclusively that in the next five years, Mexico, Venezuela, Peru, Ecuador, Indonesia, and probably Iran will cease to be oil exporters. If oil imports grow at 2.2% compounded and the oil exports decline by 25%, the collision of those two trends is pretty ugly in terms of prices.
Stefan: And I thought that was a really intelligent and original insight that you had, because most people talk about peak oil as if it’s an engineering problem or a scientific problem, but the idea that growing restlessness within some of these semi-dictatorship countries is going to lead people to want to turn the firehose of government spending on the people rather than on oil exports, is a very interesting take on it now. Some of the alternatives that you’ve talked about – liquefied natural gas is one and you’ve had some very interesting things to say about nuclear power as well and our dependence upon historical reserves of uranium, I wonder if you could talk a little bit about that?
Rick: Sure. The uranium business has been very good to me over the years, but one needs to be involved in uranium markets when they’re unpopular. In 1998-2002, if people talked about uranium, they talked about it in the context of Hiroshima and Nagasaki – hardly flattering themes for the industry. When the price went up in 2005-2006, the people who had moral objections to uranium suddenly took an economic interest in it and there was a boom and it became interesting. Now we are back to the point again where the uranium price has declined, and of course as a consequence of the events in Japan, uranium is out of favor again and cheap – and cheap is good in terms of energy. It’s my thesis that the lifestyle that you and I enjoy – which is the lifestyle that the rest of the world aspires to – is particularly energy dense and we’ll need all forms of energy. It just so happens that the most efficient form of energy for the most reliable baseline power is nuclear, and the fact that we can buy the feed stock for nuclear energy at wholesale prices in the context of rising energy prices globally needs to be viewed by speculators as a gift.
Stefan: Right. Now do you think, given what happened in Japan and some of the reactions of the European governments – in particular Germany where they’re stomping around, thumping their chests, saying, “We’re off nuclear, we’re off nuclear,” – do you think that’s more posturing for the electorate and the greens at the moment? Do you think that’s a sustainable policy in Europe to go non-nuclear?
Rick: I don’t think it is. If Germany were to succeed in going non-nuclear – and by the way I don’t think they’ll be able to; what they’ll do is they’ll import nuclear energy from Poland, Russia, and France. In other words, the Germans won’t produce nuclear energy in Germany, they’ll pay too much for it. It’s produced at other places.
Stefan: They’ll offshore the risk to another place.
Rick: Of course, of course.
Stefan: Right, right.
Rick: And you run into what Porter Stansfield describes as “the second law of thermodynamics:” The further you are away from a source of energy, the less efficient the energy is. In other words, if you import that nuclear power from Russia, you’re going to lose 15% of the power that was produced in line loss getting it from Russia to Germany. So the Germans are going to impose a pretty substantial tax on themselves, to no benefit whatsoever. I don’t think that’s going to occur. Even the Japanese have said as a policy statement that the only fuel that’s reliable in terms of its energy density for Japan’s energy security is nuclear.
Stefan: I think it’s a fairly reliable gauge of political intention that if a political leader says, “We’re going to do this before the end of my term,” it may happen, but if they say it’s going to happen at some point 10 or 20 years from now, there’s nobody down by that. There’s not any particular risk that could happen.
Rick: Even if you assume that they’re exhibiting good will – which I don’t think you and I would ever accuse them of – reality is going to get in the way of their promise. The fact is that as nervous as people are about nuclear power, in Germany if they walk into a hall and flip the switch and the lights don’t go on, they’re going to come to an accommodation and that accommodation is going to be partly a nuclear accommodation.
It’s also worth noting that Germany is rich enough to be sort of fake green. I regard green as the new pink, and the Germans are also opposed to the burning of fossil fuels. They’re opposed to coal, relying on things like solar. Now solar has two problems in Germany: One is universal, of course – night; and the other is the fact that Germany is not a very sunny place. And the idea that you’re going to rely for your energy security on something that doesn’t work for part of the day and also doesn’t work most of the other days, well it’s a political statement. It has nothing to do with the way that people are going to live.
Stefan: Yes, I mean it’s a real tragedy that you need wealth in order to have environmental protection, but so many environmental protections destroy the wealth that are the foundations for its continuance, and that certainly seems to be the case in Germany. Now you are also bullish on opportunities on the service side in the oil and gas industry. I wonder if you could talk a little bit about this.
Rick: I am; and I need to disclaim the fact that I’m not a service industry expert. I know a lot about the oil and gas business, but I don’t know so much about the service businesses. What I do know is that in North America the conversions of several technologies – three-dimensional seismic and amplitude versus offset processing technologies, horizontal drilling, and multistage fracturing – has set off a drilling boom that is going to continue, and the oil and gas industry’s spending cycle for the next two or three years on shale gas plays and shale oil plays is going to be extraordinary. The industry has the demand for the product, they have the cash to invest, and these plays are highly economic at current prices. This drilling boom is taking place and is going to continue. The service industry is under capacity. The service industry does not have the ability to keep up with demand. That’s a very, very, very bullish scenario.
Is this a scenario that’s going to play out for 10 years? Of course not. Markets work over time, but I’m not concerned about the next 10 years, I’m concerned about the next two years. I’m concerned about finding a bright spot that people can take advantage of now and certainly select oil field service companies – in particular, companies that have enough of a market share and enough technological lead that they can be price makers as opposed to price takers – will do very well.
Stefan: You’re also quite a big fan of Canadian juniors.
Rick: I am.
Stefan: And let’s talk a little bit about that because I think it’s sort of an underrepresented area for investment and a lot of people are quite nervous about juniors because of the volatility and it’s a hard business to know, so what is your bullish outlook? Where does that come from?
Rick: Well in the first instance, I like volatility. What volatility means to me is that things frequently go on sale. For some reason, people like volatility to the upside. I regard myself as a relatively young 58-year-old, and I am looking to become more wealthy. And one becomes more wealthy by buying assets at a discount. Volatility gives me the ability to do that, and the juniors are certainly volatile. Now, it is particularly interesting with regards to the Canadian oil and gas juniors, because that market has become increasingly an institutional market, and the institutions have a natural aversion to illiquidity. They might have redemptions which they can’t meet, and the juniors can be very, very, very illiquid. As a consequence of that, the primary sources of capital in Canada avoid these stocks. They stay out of them, which makes them cheaper.
There are metrics in Canada that say, “a company with a $400-million market cap trades higher on all metrics than one with $100-million market cap.” Another metric says to get institutional support, a company needs to be producing more than 5,000 barrels a day. One of the easiest arbitrages in Canada is to find successful small companies that are below the metrics necessary for institutional support, but ones that will either merge or grow organically until they get through those breakpoints, and then they get repriced by the institutions automatically.
Stefan: Like when you go onto the stock exchange, that’s when you can move into the institutional investment. Right, right.
Rick: I’ve been making money doing this for 20 years. I’m not trying to say that it’s predictable, but it’s relatively simple.
Stefan: And it’s repeatable and there’s a sort of event horizon wherein you get a surge in value when the institutional investors can get a hold of it because it passes those thresholds.
Rick: Correct, and what’s unique about the situation that we’re in today is that the drilling inventories of some of these juniors is a consequence of the conversions of the technologies that we’ve talked about, make their ability to get through these thresholds, like 5,000 barrels a day, fairly predictable. There are companies that we follow with sort of $150-million market caps that have 600 proved, undeveloped locations. Each undeveloped location [is] probably worth $800,000 or $900,000 per location, that have the free cash flow and have access to the bank lines that will make them able to reach the production thresholds organically with nothing else changing.
The missing ingredient is of course time, and I have learned as a speculator myself that time is my friend, if I choose well, not my enemy. I have come to prefer outcomes that are “when” outcomes, not “if” outcomes. By allowing myself to take a longer speculative horizon, but in an investment with a higher degree of certainty, I have learned that I can outperform my competitors.
Stefan: Now, as the price of gold surges and as the price of other precious material commodities surges, do you think that there are juniors in Canada and in other places that are sitting on properties that they’re waiting for the right economic signals to develop them? Do you think that there’s a latency there, do you think that, that information is available enough to an investor to make a good investment?
Rick: I think the latency is gone. We were in some senses in partnership with Doug Casey many years ago, proponents of a strategy called “hoarding.” Why would you go look for silver when you can buy silver deposits that were discovered by other people historically that weren’t economic at these prices for pennies on a dollar? The company Silver Standard was built in that fashion. We were saying when silver got above $20 an ounce that you’d have to develop these things. Well, silver is substantially above $20 an ounce and people are developing. What stands in the way now of more aggressive development is simply, I think, development capital. Although there’s lots of money being printed in the world, there is still a shortage of committed long-term capital. We are seeing now, as an example, crises in interbank lending, banks not trusting each other. It’s probably true, given the nature in particular of economic dislocation in Europe, that if Deutsche Bank was in a position to make a $3-billion loan, in the near term they might keep the $3 billion, understanding that some of the loans that they’ve already made to places like Greece and Italy, they might not get back, and the constraints on development that we see in the minerals business now are more related to capital and regulation permits.
Stefan: The companies that supply the mining and the gas companies and the other kinds of mining companies, are they small and specialized enough that you can look for investment opportunities that surround this sort of resurgence in mining in Canada and at other places?
Rick: The mining service business is very small and is a very tricky business. I wouldn’t consider it for most people to be a fertile area for investment simply because the mining business is so cyclical and so capital intensive. The energy business is a very big business and the service providers in the energy business have much more predictable outlooks in the next 2-2.5 years, and I think there’s enough opportunity in the bigger sector that one doesn’t need to come down and take the analytical risks involved in the smaller sector.
Stefan: And of course you’re dealing with people who’ve got a lot of experience who have been focusing on that for a long time.
Stefan: Now, let’s put on our “speculotron helmet” for a moment and just play complete science fiction because there’s been some talk – certainly in the libertarian circles and the Doug Casey circles – about the deaths of fiat currency (there’s this conference we’re at right now), and what people suggest is of course a replacement with currencies based upon the gold standard or what they call the “basket of commodities,” that there’s going to be some sort of level of commodities that a currency is going to be tied to. Let’s say that over the next 10 years, there is some move from a major currency towards founding itself on a basket of commodities. I know this is really speculative, but if that were to happen, what effect do you think that would have on investments within those commodities?
Rick: I think in the near-term, it would have a positive effect. My nervousness is that such a currency would almost by necessity be an artificial construct, and with society as organized today, it would almost certainly be a government-backed construct. I don’t think it matters particularly which lie you back a counterfeit currency with. For myself – and I’m not dispensing investment advice here – for myself the most liquid lie in the world right now is the US dollar. It’s the worst currency in the world, except all the others, and I hold reasonably large amounts of dollars. I’m expecting to lose 5% or 6% compounded on them, which I think beats losing 30 in a very volatile market.
As a store of value that is exchangeable, I still like gold and silver. I like the consequence of a financial asset that isn’t simultaneously somebody else’s liability. I’m not interested in a promise of payment. I’m interested in payment. And the idea that you would have an artificially constructed fiat currency that was allegedly backed by a basket of currency – a basket of commodities, pardon me – where are those commodities, how is it that I surrender my certificate and receive payment, and do I want payment in that basket of currencies?
Stefan: And if they’re based on commodities like oil, which is as you say is controlled by government entities around the world, it is not a free market. It’s not even close in the same way that gold would be.
Rick: Correct, correct.
Stefan: Now just before we started talking – this will be my last question, I appreciate your time – just before we sat down, you were saying that among this group, you are the spring-dancing optimist.
Stefan: So what do you mean by that and where does your optimism come from and how can you give some to others?
Rick: The theme of the money, the theme of the conference is “when money dies,” and I’m going to rename my talk tomorrow. Just because other people’s money dies doesn’t mean that yours has to; and it isn’t a sense that I’m going to give people advice about their currency. Simply that when most people’s outlook is extremely bleak, their spending decisions are necessarily constrained and the price of assets often falls substantially below their value. I have been saying for a year that we are going to go into period of hypervolatility, volatility on steroids. I think the last three weeks we’ve got our down payment. I think that we’re going to see the volatility index, as an example, substantially above 30 for extended periods of time. That’s unnerving for most people. People like the idea of sales, but they don’t like it when their goods go on sale. And if you have lessened participation in markets, that is less liquidity, the volatility actually gets enhanced, which from my point of view means that the sales become more frequent and deeper. Now what on earth could be better than frequent, deep sales of assets that one would like to own? I don’t think that this is an event that is necessarily good for mankind, but I think it’s something that is going to happen anyway and I would hold out to people that since this set of circumstances is going to occur, you have a choice yourself between being a beneficiary or being a victim. And it would be better for the world as a whole if there were more beneficiaries than future victims, so at the same time that you can benefit yourself you can benefit mankind by taking advantage of this situation and being able to sustain your family and maybe a couple of other close families as well.
Stefan: Well, I think it would be to the benefit of the world as a whole if libertarians in general came out of a financial crisis with lots of assets, because you know that would be good for helping to rebuild things afterwards.
Rick: Of course we want our tribe to succeed. My nervousness – and maybe I’m descending into the gloom of the conference – my nervousness is if our community comes out being perceived as wealthy rather than being ignored, we might become targets. I hope to the extent that we’re successful that we’re simultaneously quiet.
Stefan: What is that old Japanese proverb, where the hammer that sticks up gets hammered down? – the nail that sticks up gets hammered down.
Rick: Yes, yes.
Stefan: And if people want to get more information about your organization, your expertise, where can they go on the web to find you?
Rick: We’re available at http://www.gril.net/ or by phone at 800-477-7853.
Stefan: Thank you so much for your time. It was very enjoyable.
Rick: Always a pleasure.