(Interviewed by Louis James, Editor, International Speculator)
L: Today we’re speaking with Rick Rule, founder and driving force of Global Resource Investments, and legendary investor in resource stocks, among many other things. Rick is a longtime friend of Doug Casey and is well known to many of our readers, especially those who have come to our conferences. Now, Rick, to start off, I know from my several years’ acquaintance with you that you’re one of the most effective human beings I’ve ever met: you do what you set out to do, and in the investment world, that’s an enormous achievement. So how do you do it? What are Rick’s Rules for making money in these markets?
Rick: Well, first of all, I only do a few things. I don’t believe my business skills in resources are transferable to other areas, nor do I think I have a lot to add to the debate in most parts of the resource sector. There are a few things I do fairly well, and in my declining years, I stick to them. I would say my second advantage, having spent 35 of my 57 years in natural resources, particularly exploration finance, is that in addition to having know-how, I have “know-who.” As a consequence of doing the same thing for a very long time, many of the people I came up with in the business are now in senior positions in extractive industries worldwide. So I suspect it’s the conjunction of know-who and know-how – leavened with liberal dosages of hard work – that has probably made me more successful than many of my competitors.
L: Hm. You didn’t say this, but I can see that you can’t just transfer your knowledge and experience and connections to someone else. Fortunately, your company places your unique strengths at the service of your clients. But it isn’t all bad news for those who want to learn from your success themselves, because if you can do it, other people can do it too.
Rick: Absolutely. One of the interesting things about mineral exploration analysis and speculation is that the bars are… abnormally low.
Rick: Most speculators are emotionally driven, rather than empirically driven. And most speculators are lazy. Most people think that what they want or hope for is some topic worthy of discussion. Fact is, you have to take a very cold, calculating view of the business. You have to decide for yourself what your competitive advantage as a speculator is, and you have to work that advantage. If you do these two things – if you understand yourself and you work on your edge – you too are likely to be stricken by the general incompetence of the participants in the competitive field in mineral extraction exploration speculation.
L: I’ve noticed it. Earlier on in my days with Doug, I would ask exploration company executives what seemed like obvious questions about their stories and they would often say, “Wow, that’s a really good question!” My immediate reaction wasn’t to feel complimented, but rather to think that other people can’t have been asking many questions.
Rick: Yes, it is interesting. One of the things that I’m sure you’ve experienced is that you go in to a meeting with some management team, and you ask them fairly general questions about their business plan, and you discover to your shock and dismay that they don’t have one. It’s as though they were setting out to walk from, say, Canada to Mexico, and they head north. They just absolutely have no concept of anything, any plan other than getting the next financing done that will cover their salaries for another 18 months.
L: How often do you think such failures are driven by malfeasance, as opposed to simple incompetence? There are times when I’ve asked a basic question like, “How much cash do you have in the bank?” And the CEO says: “Oh, I’d have to ask our accountant.” That’s BS. He’s the CEO – he knows, or has a very good idea. If he doesn’t answer, then he doesn’t want to answer.
Rick: I suspect that the answer is the latter more often than you might think. It seems incomprehensible to us that people would know that little about their own business, but one of the things that has struck me again and again about mineral exploration speculation – in the public sector, at least – has been the high level of incompetence.
But there’s a bright side. You and I talked at the last Casey conference in Las Vegas about my supposition that fully 90% of the entrants in the sector are valueless. That means that speculating in this sector is really a hell of a lot easier than it might appear. Your principle job as an analyst in the sector is to very, very, very quickly discard companies so that you don’t have to do any work on them.
L: Wheat from chaff.
Rick: There are perhaps 4,000 companies in the sector. Your first job is to wipe 3500 of them off your desk in the least time possible. And, because of what we’ve just been saying, that’s usually pretty easy.
L: Yes. That’s true. That’s an optimistic way to look at what would normally be viewed as a fairly negative thing. If you have even a modest setting on your ‘BS’ meter, then you can separate a lot of gold from pyrite very quickly.
Rick: Absolutely. And I think that’s the first thing that your readers and listeners need to do.
L: I’ve done my best to try to encourage people to do their own due diligence and educate themselves. I’ve just about begged them to become active, and not passive, investors – so that’s music to my ears. What’s next, then?
Rick: It’s a continuation of number one, in effect. People need to understand that this is a capital-burning business. Companies that don’t have sufficient capitalization, relative to the expense needed to get a “yes” answer on whatever their project is, have no business. Let me repeat that: they have no business.
So many times you hear about a company, that they’re going to spend this, they’re going to spend that, they’re going to spend something else, and 18 months from now they’re going to discover the mother lode. Everyone’s going to get rich and go to heaven. Then you find out that their capital budget is $7 million, there’s $2 million required in G&A, so they need $9 million to live 18 months. And they have $700,000 in the treasury. It’s not gonna happen. Just plain not going to happen. This is one of the first things you look at.
L: Even if they do pull a rabbit out of the hat and raise the money to carry out their exploration plan, if you buy now, you’re faced with certain dilution of your equity and uncertain value to be added for that dilution. Much better to buy stock in a company that has the money to do what they say they will do to add shareholder value.
Rick: Sure. Many years ago at the D&R conference in Boston, I had finished my speech, and was out of my suit and in civilian clothes – jeans and a shirt – wandering around the exhibit hall. There was a particularly aggressive promoter in his booth, with particularly aggressive exploration plans. I asked him, “How do you plan to fund these plans?” He said: “That’s the really good part of the story. There’s this very prominent West Coast broker named Rick Rule who will fund me.”
Rick: I played along, saying, “Oh, that’s interesting. Why hasn’t he funded you yet?” And the young man looked at me and said, “Well, Rick doesn’t fund companies under $2 and our stock is at $0.50. When our stock gets to $2, you’ll have gotten to front-run Rick, and he’ll provide the funding to complete the exploration and add the value.” At that point, I pulled out my driver’s license and showed it to him and said, “I’m very, very close to this Rick Rule and I have some doubts as to your story.”
L: [Still chuckling] That’s amazing. Reminds me of what Mark Twain said: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”
Rick: [Laughs] It was not a good day for that young man.
L: Okay, what else?
Rick: The second thing – I think this is really critical, and failure in this regard hurts most speculators – is to be a contrarian. You know that’s my theme song at these conferences: either you’re a contrarian or you’re a victim. People need to understand that bear markets are very good things.
L: Best way to “buy low.”
Rick: What happens in a bear market is that goods go on sale. For some odd reason, when a stock goes from $1 to $2, even if the speculator can’t understand why, the fact that it did makes him or her more positive. They’d rather pay $2 for the same piece of merchandise that used to be $1. This is one thing that leads me to think people are making emotional, rather than empirical, decisions. And that’s, of course, very wrong. If bear markets are good things, times when assets get marked down or go on sale, then bull markets are bad things. Put it this way: bull markets are made for selling and bear markets are made for buying.
L: Gotta “sell high” to profit from buying low – “sell” being the key word here.
Rick: The third thing I would suggest to readers – and I’ve always admired Doug Casey for this – is knowing that volatility isn’t a risk, it’s a tool. Resource stocks are hyper volatile. There are stocks that vary between $1.30-1.70 in the same fashion that you and I inhale and exhale. That type of volatility occurs for no foreseeable reason. For example, a $25-30 million market cap company may have a $4-5 billion institution as a 9% shareholder. If that institution experiences disintermediation and has to sell the stock, then that 9% can hit the market for no reason that has anything to do with the company or its prospects. That type of selling can knock a stock down by 30-40% in a single trading day. Many speculators, as a consequence of the stock going down for reasons that they don’t understand, join the selling stampede. And you can literally have one of these stocks sell off 50%, for no reason that has anything to do with the value of the company. This is, of course, an opportunity rather than a risk. But it’s only an opportunity if the speculator is temperamentally and intellectually prepared to take advantage of it.
L: I’ve seen that happen. Somebody decides to dump a whack of shares, that triggers stop-loss selling, and the thing just cascades, totally out of the blue. But yes, you have to screw up your courage and buy when others are selling. There’s one company in our portfolio that we’ve doubled our money on twice – and the stock is still roughly the same price it was when we first recommended it.
Rick: [Laughs] That’s wonderful. And the thing that amuses me is that most speculators regard this as a bad thing – you know, the fact that you get periodic “50% off” sales. They focus too much on the price of the stock without any regard to its value. If you don’t have any idea of the value of something, price information is of no consequence.
L: It’s like a shopper walking down the street, stopping at a store she frequently shops at, seeing something that she frequently buys – reduced by 50% – and saying, “Oh, that’s bad.”
Rick: Exactly. Certainly one element of my success has been the fact that I enjoy shopping at sales. As I say, one of the things I’ve always admired about Doug is his ability to control his emotion with regard to volatility – and in fact, his contrarian instinct. If I can digress, I remember very, very well 15 years ago, in the wars that followed the breakup of Yugoslavia, when the Serbians were shelling Dubrovnik. I got a call from Doug, saying, “We have to go to Dubrovnik!” I said, “You know, Doug, there are fireworks closer to home. It’s probably safer.” He said, “No, no, no. We could probably buy a villa on the Adriatic now that the shells are falling, for $50,000-60,000. Only one of two things could happen: it could be blown up, and we’d lose that sum, or it could survive, and in a few years it’d probably be worth $2-3 million.” It’s that type of contrarian attitude that makes for a great speculator.
L: Just last week, he was telling us about buying in Spain when Franco died and the place was a mess – and almost buying in South Africa when gold was approaching its nadir. I love those stories. Any other key points?
Rick: Information is vital. By definition, your readers are doing this. If you’re going to be speculative with a portfolio of $100,000-$300,000 or more, it makes sense to spend some money on information. One of the interesting things about being a Casey subscriber is that a lot of the screening techniques we’ve talked about are already employed by you on behalf of your readers. If they aren’t going to do it, then they should either have you do it, or employ some consultants. The easiest screening to do is the stuff you can you do off the management information circular and the filing statements. The tougher part has to do with geological information.
L: This is, I think, a key point. I sometimes give talks on due diligence at investment conferences, and people say, “Oh, that’s what we hire you for.” And I say, “Thank you very much for the vote of confidence; but I can’t kiss all the girls. And I can’t give you individual advice. If you see something interesting, and you don’t want to miss the opportunity, you need to be able to look into it yourself.” And I tell people what you just said; I tell them to start with the financial statements. “Look at what they have to disclose – what the promoter is not going to tell you standing there in the booth – and see if it makes sense. Is the G&A out of whack? What other things might be buried in the management discussion and analysis?” A guy once told me, “I tried doing that once, and that thing was 80 pages long!” And I answered, “You want to make millions of dollars and you’re not willing to read 80 pages?”
Rick: Yes. And you don’t actually have to read 80 pages in most cases. The balance sheet and the income statements are the critical elements. And then, pay attention to the germane notes.
For example, if you see a CEO getting paid, say, $200,000 a year, and the guy owns $80,000 worth of stock, that should tell you something. He has no particular incentive to get you rich. He’s in the game for salary. I remember – but I’m not going to name the company – some years ago, a CEO was calling me, imploring me to buy the stock because it was such a wonderful, spectacular, screaming buy. And I noticed in the filing statement that he himself didn’t own any. I asked him, “If this is such a spectacular buy, why don’t you own any?” He said, “Well, I have three million options.” In other words, he’s asking me to spend money while he has a free option. That’s sort of disingenuous.
I’ve always been curious as to companies that have not wanted to give me a two-year warrant on a private placement, and yet they set themselves five-year options. Why should money earn less duration than sweat?
L: Well, they’ll argue that they’re looking after shareholders, minimizing dilution and so on. But yeah, it cuts both ways.
Rick: It sure does.
The fourth thing is to sell. Speculators need to make a plan when buying a stock. A speculator needs to ask: “What unanswered question will be answered, over what period of time, for what sum of money – and what will the answer be worth if it’s ‘yes’?” That’s in effect your speculative business plan. If you get a “no” answer, then your reason to own the stock is gone, and you should sell it. If you get a “yes” answer and it fulfills your price expectations – unless that “yes” answer sets up another very valid question – you have accomplished your business plan, and you should sell. If you get a “yes” answer but the market hasn’t responded, and so from your point of view the stock becomes undervalued, you should buy. A difficulty is that most speculators, having made the decision to buy something, default to “hold.” They don’t ask themselves the questions that should cause them to either sell or buy more of the stock. This is a very, very important thing speculators have to learn, to make money.
L: Let me challenge you a bit here. If you’re in a bull market and things are going up – bearing in mind Bill Bonner’s definition of a bull market being a random market fluctuation that causes the average investor to mistake himself for a financial genius…
Rick: [Laughs] Guilty as charged!
L: What if the underlying commodities driving valuations are on the rise, and you believe those are going to continue rising? Let’s use the example of gold. Many gold investors see inflationary consequences to government actions in response to the global financial crisis and believe that gold has a long way yet to go up – that it may spike vertically as it did in 1980, creating a great exit point. If you believe that’s coming, and you’ve got a stock that’s performing – it’s doing what you wanted it to do, perhaps giving you the “yes” answer you wanted – but the story’s not over. The bull market’s not over, with maybe the best yet to come. Is it irrational to want to hold on for that?
Rick: I think there are two points of view on that. In the first instance, what I suggested is that you try and price the “yes” answer in, and you can use your own range of commodity price assumptions to do that. Yours is certainly as good as mine. Now, of course, if the information changes over the period of time that you own the stock, it’s possible to change the valuation.
In the second view, however, if you are of a mind that commodity prices are going up and you want to participate in that rise, you have to look at opportunity cost, and risks associated with exploration. You might be better off owning the commodity itself in the futures market.
Too often, people use their belief with regard to the direction of the market to mask the mistakes they make when unwilling to sell stocks that haven’t performed or to justify hanging on to companies that have hit nosebleed valuations.
Mines are businesses in terminal decline – every day they operate brings them closer to the end of the mine’s life. The idea that such businesses deserve to sell at two times net asset value is … well, let’s just say it’s interesting speculation. It involves one of two assumptions, or probably both. In the first instance, it involves the “commodity warrant” implicit in the company in valuation. Suppose XYZ gold company has eight million ounces of gold in the ground and is producing 700,000 ounces a year. If the net present value of that production at today’s gold price is $100 a share, and the company is selling at $200 a share, effectively half of the purchase price involves a “gold warrant.” Buyers are saying that the net present value of the cash flow is understated because the gold price is going to go up, and a whole bunch of that will be captured as margin. The difficulty with this is that … it just ain’t so. In the period of 2000-2010, when the gold price rose fourfold from $260 to $1200 an ounce, the experience of the industry in terms of margin expansion was terrible.
L: Costs went up too, so profits didn’t rise as much as gold did. Many companies were hedged, too.
Rick: Whatever happened, the margins haven’t expanded anywhere near as rapidly as one would have supposed. Another argument in favor of paying a multiple of the net asset value of an asset in decline is that you believe management can redeploy cash flow from production to grow the company – in oil and gas terms, we’d call that a recycle ratio.
L: But that’s betting on discovery, which is almost always against the odds.
Rick: Correct. And the 50-year history of the mining business as a generator of wealth has been terrible. It’s been a consumer of wealth. So, if people believe the gold price is going up, I suspect they should buy gold rather than gold stocks. The reason for buying a gold stock is that you think there is something in that company – something internal to the company, in addition to the gold price – that gives you value. I am not saying, by the way, that there aren’t individual gold equities that you or I wouldn’t see as being good values. What I’m saying is that you buy them because there is something in the company, not just in the price of gold, that will cause that company’s share price to go up.
L: Right. And when I asked the question, I wasn’t implying that you were wrong. In fact, we just sold some stock that exceeded our target price way earlier than we thought it would. The story’s not over. But the risk when the stock was cheap was commensurate with the reward; now that we have the reward, the risk weighs much more heavily.
Rick: This is precisely the calculation that you need to do in order to survive and thrive in the business.
I’d like to add that if you’re taking the risk inherent in the exploration business, make sure that the size of the prize is commensurate with the risk. Too many small companies try to employ what the industry refers to as “bootstrap techniques,” whereby a company discovers and develops a small deposit and uses the cash flow from the small deposit to grow. This is a seductive story for anybody who’s entrepreneurial, but it’s almost always wrong. To the extent that the initial discovery generates cash flow, it usually has brackets around it – meaning it generates losses. Management spends so much time fixing the small production asset that they never get around to discovering anything else.
L: And operating a mine requires a very different skill set from discovering one. Geologists sometimes get excited about the rocks they discover and decide they want to play with big trucks – but I’ve seen that this is often a mistake.
Rick: One key to my success is that I have focused on circumstances in which, if I got a “yes” answer, I got a very large “yes” answer. If you’re going to take the risk of discovery, make sure that you discover something worth discovering. Scale is extremely, extremely important. The second thing that I would say in a very general sense – and you guys have done an extremely good job with this – is that this is a people business. These deposits are latent wealth until somebody makes them work. As a consequence of that, focusing on groups like the Casey Explorers League – proven performers – is very important. In addition to focusing on proven performers, you need to focus on proven performers who are active in very, very specific challenges that relate directly to their expertise. The fact that somebody has been successful building and operating a gold mine in Quebec does not mean they are qualified to look for a copper deposit in Peru. You want your management team to have resumes that have already demonstrated past success, but of equal importance, you want that success to have been in a field very closely related to the task at hand. This is very, very important. You see these serially successful entrepreneurs in our business – a few of them – and you see really, really large numbers of B players, C players, D players, or fill-ins. They sort of pollute the rest of the field. A very important thing to do is simply to hang out with the A players. Back the people who have been serially successful, who are constricting their search ellipsoid to subject matter that they’re very familiar with.
L: So these two points can be summed up with the famous Vancouver sayings: “Go big or go home,” and “Bet on the jockey, not the horse.”
Rick: That’s absolutely correct. I would also say, harking back to our discussion of business plans, that in pure exploration, which is something that I enjoy a lot, I favor process over product. In other words, I like the “prospect generator” business model, where people employ their acumen and other peoples’ money, better than the “drill-hole play.” We’ve been over this before, but the probability of success any mineralized anomaly has of becoming a mine is about one in five thousand. So, from my point of view, process over product is an extremely important equation.
L: Another saying: “Get rich on process.” How well has that worked for you?
Rick: In my investing career, I’ve speculated on 52 different prospect generators. As a consequence of that, we now have 17 economic discoveries, soon to be 19, and we have participated in 12 takeovers. If you think of 12 highly successful speculations in 52 starts, relative to the statistic that one in 5000 mineralized anomalies becomes a mine, you understand that my experience speculating in prospect generators relative to the general exploration market is probably two standard deviations to the good.
L: That’s a phenomenal track record. We like prospect generators too – though the patience they can require can be difficult when you’re selling a newsletter, as opposed to simply managing your own investments. People get bored with process. They want discovery now, or production next quarter.
Rick: That’s very true. You know, Warren Buffet, who’s not a bad speculator, has said his favorite investments are ones that require of him sloth and lethargy. I’m increasingly attracted to that. I’m noticing that my own track record – well, on occasion I’ve been lucky enough to find a stock that’s done very well in 30, 60, or 90 days – most of my track record comes from stocks that have risen tenfold, or twentyfold, over a four-, five-, or six-year time frame. It actually takes time for these things to gain weight. We talked earlier about “yes” answers. The really big money is where you get a succession of “yes” answers – “compound yes” answers, if you will.
L: I agree. The goal of our main metals newsletter is a double in twelve months – a 100% gain in a year. We don’t always deliver that, but that’s the potential we want to see in a story before we recommend it to our broader pool of readers. With our investment alert service, however, the idea is to seek higher multiples within two or three years. Sometimes it works out that you hit something at just the right time for immediate gains, and it’s great, but most times it requires more patience.
Rick: My own criterion is very similar: I look for something where my potential twelve-month downside is less than 50%; my potential 18-month upside is a double; and my potential 72-month, or six-year upside, is tenfold.
L: This sort of continues in the education of a speculator vein of my last conversation with Doug. Maybe we should do a two-parter here, because we’ve talked a long time and haven’t even gotten to the markets yet.
Rick: That works for me. We’ve probably exhausted your readers’ patience for one session.