(Interviewed by Louis James, Editor, International Speculator)
L: So, we’ve talked about how you make money in these markets – can you tell us where are you looking to make money these days? Are you bullish on energy, bullish on gold, bearish on something – where are you focusing your efforts these days, Rick?
Rick: I am bullish on gold. I am very bullish on energy. I am near-term – meaning twelve months – bearish on base metals and industrial minerals.
When I say I’m bullish on gold, I’m bullish, probably in the way that you and Doug are: bearish on social promises, and as a consequence, bearish on currencies. I suspect that in the near term gold will do well, because it doesn’t go down. Then gold will start to do well because people will perceive it as going up, rather than merely holding its own in terms of purchasing power.
I came of age in investing in the ’70s – a great gold bull market. Beginning about 1978, when gold began its hyperbolic rise, it was going up from both greed and fear buyers. I’m a fear buyer of gold; I buy it as catastrophe insurance. What happened at the beginning of 1978 is that the fear buyers would buy it, creating momentum that caused the greed buyers to step in. The uptick then reinforced the fear of the fear buyers, and there was this sort of stereo buying in gold that caused a true hysteria, taking the gold price from $400 to the $850 blow-off. It wouldn’t surprise me to see the same set of circumstances take place in the next two or three years.
Certainly, gold’s strength in the last six weeks is a partial consequence of events in Greece. I don’t think the events in Greece – and I suspect you don’t either – are a one-off. Bill Bonner has noted that the metrics of the Greek economy relative to their debt are reminiscent of those of the United States; and yet the U.S. dollar seems to be regarded as a safe-haven currency, as people focus on the trouble in Greece.
I live in California, and the fiscal situation in the state of California is insane. Truly, truly insane.
L: I heard somewhere that if you added state budgets to the federal budget, debt-to-GDP of the U.S. is something like 160% – worse than Greece.
Rick: And I don’t think that these circumstances are restricted to Europe or the United States; I think that we have a crisis of expectation around the world, really, in terms of the collective ability to address various concerns. I think that democracies tend to live well beyond their means; and I suspect that will mean that the currencies they use will continue to be debased. So I suspect we’re going to see a revolving series of crises that will play into gold’s hands.
There’s something else very important for people to understand: gold is a store of wealth and a medium of exchange that has no constituency for devaluation.
Consider the United States dollar: it’ll go lower, but the United States is still the largest consumer of goods and services in the world. The Chinese have made it very clear that tying their currency to our currency is a development strategy – they’re trying to provide employment for their people by selling stuff to us. If the yuan doesn’t appreciate, then the other four principle Asian currencies can’t appreciate relative to the dollar. If none of those currencies appreciate, neither can the euro; because Europe would become a dumping ground for goods that were diverted from America, and the Europeans would lose their access to U.S. markets. Most of the developing nations’ currencies are caught in the same sort of vortex.
What’s interesting then is that every national government has some incentive to devalue – to protect their own domestic economy and employment.
Gold has no similar constituency for devaluation. That’s an important reason why I’m attracted to gold, going forward.
L: You subscribe to the “race to the bottom” concept.
Rick: I do. In two ways. There’s a race to the bottom that’s a natural consequence of a society’s living beyond its means. There’s also a race to the bottom in consequence of currency devaluation to protect domestic employment, in the competitive global market.
L: One question we get a lot from readers on this is, “Suppose you’re right and governments inflate/devalue, and gold responds accordingly – what if they confiscate it? Or what if they control the price again?”
Rick: I think that’s a real risk. I would hope that… [chuckles] I don’t know how to say this politely; I guess I can’t. Well, I would hope that the state is stupid enough to act like a rattlesnake, and rattle long and hard before it strikes. That would give people enough time, for example, to get out of the gold ETF. I also know that it’s not illegal, for now, for American citizens to hold gold outside the U.S. I’m not encouraging these shadowy offshore accounts, but there are perfectly legitimate, legal ways to open accounts offshore that are completely in compliance. And that’s something that somebody might want to do if for some reason they didn’t trust the U.S. government.
L: I can’t imagine why they might not… Okay, so, for the same reasons we’re bullish for gold – trouble in the global economy, etc. – we’re short-term bearish on industrial metals. But those same concerns also tend to push down energy prices. Why do you have a different view of base metals than energy?
Rick: For a couple reasons. First, emerging markets are becoming slowly more free, and as a consequence, more rich. Energy consumption grows faster than other consumption in those markets.
Second, I think that energy supply on a global basis, going forward, is much more constrained than is commonly believed to be the case. The driver in energy – retail consumption of energy worldwide – is oil. Contrary to most investors’ beliefs, most export crude in the world is not produced by major international oil corporations, but by national oil companies. There is an inescapable truth regarding oil production by government-controlled oil companies in many countries: they have diverted too much of their free cash flow away from sustaining capital investments and energy production and to politically popular domestic government spending programs.
For example, Mexico subsidizes the prices of gasoline and kerosene – and tortillas. And that subsidy is – paradoxically – increasing demand while constraining supply due to the diversions of working capital. These capital diversions in Mexico, and in other places, like Venezuela, have been so severe and so longstanding that I believe we’ll have absolutely irreversible declines in production within a five- to-ten-year time frame. That would be true even if the host governments start reinvesting today.
L: Not likely. Hard to get elected canceling subsidies.
Rick: As a consequence of that, I believe that Mexico, Venezuela, Ecuador, Peru, Indonesia, and perhaps even Iran will have very dramatic declines in the availability of export crude that they can sell on the world market. It’s my supposition that between 20-25% of export crude supplies on a global basis are at severe risk in the next five years. If you take the International Energy Agency’s expectation that worldwide import demand is increasing 1.4% compounded per year, then juxtapose that with a 20% decline in supply, you have an amazing potential impact on the price of oil.
Thinking the unthinkable – some sort of military intervention in Iran, for example, which would constrict the supply of export crude through the Straits of Hormuz – it isn’t impossible to talk about oil prices that are three or four, maybe even five times current prices, for relatively extended periods of time. Certainly I suspect that five years out, in real terms, oil prices will be at least double current prices. And oil is the roof for many other energy prices.
From a consumer’s point of view, I have a very negative outlook on energy. But from a speculator’s point of view, seeing a certainty of increasingly constrained energy supplies over the next five years is positive – it’s a trend to bet on.
L: Okay, but you specified a twelve-month short-term bearish outlook on base metals. Now you’re talking longer-term on this energy scenario. Are you saying that you would just treat short-term weakness on energy as buying opportunities? But if so, why not the same for industrial metals? The world is still going to need copper, nickel, iron, and so forth.
Rick: Yes. I absolutely would buy on near-term weakness in energy speculations. But I have a less negative view on base metals supply, looking out five years. I don’t think we have the same supply shortfalls baked into the cake in base metals.
L: There’s a lot of supply constraint. There’s been supply destruction as a result of the crash of 2008 – projects put on hold or not started up on schedule. A lot of governments are sharpening their knives to take a bigger ounce of flesh out of the mining companies – those “greedy miners.” There’s reason to be concerned about the supply in metals, too.
Rick: I think if you look out a decade, you’re very, very right. The credit market conditions that we’re in right now are bullish for base metals prices, but differently constrain supply. While there’s lots of liquidity in the market for short-term borrowers, the ability to obtain project finance – particularly non-recourse project finance – for large base metals projects is still very, very constrained. So even assuming all other factors are successful for base metals development, for projects of this sort it’s very hard to get the capital needed to build the mines.
The second point you bring out is very useful for the discussion with regards to commodities-based businesses, and that is that in a bull market like we’re in right now, the tendency for host countries to try and steal a bigger and bigger and bigger piece of the pie comes to the fore. Witness the Australian government’s recent decision to greatly increase the tax on extractive industries in Australia. Australia was viewed as one of the safest countries in the world for miners, politically. In the context of effect, taxation is really partial retroactive nationalization. From the point of view of iron or coal miners, the place is becoming Australiastan.
L: Yes, it was quite a shocker. We’ve had a lot of questions from our readers on that.
Rick: Very, very aggressive revenue crowd in Australia. But don’t forget that both Canada and the United States instituted an excess profits tax on the oil and gas industry in the late 1970s. When oil and gas prices went high enough, the governments decided that it was just too tempting a source of revenue to ignore. Could that happen again in North America? Without question. Look at Alberta’s revenue grab against the natural gas producers four years ago; it’s a perfect example of a government deciding to increase the social take from an economy that’s almost solely dependent on energy. One of the things that interest me about this is that a government’s greed seems to reach its maximum at the tippy-top of a bull market.
L: [Laughs] A great contrary indicator!
Rick: Yes. The really excessive demands of the state on the extractive industries – both the United States and Canada – reached their peak just as prices were about to collapse. Certainly, on philosophical grounds, I hope that the Australian government succeeds in imposing a rougher tax regime that coincides – at least temporarily – with a handsome price decline. The net present value of their theft would decline precipitously.
L: And we’d get our buying opportunity. That’s interesting. You know, we get questions from readers when stuff like this happens, asking, basically, “Is nothing sacred? Is no place safe?”
Rick: No… No.
L: Hm. But this can be a good thing, because of what it means for calling trends. As you alluded to earlier, if some jurisdictions that are perceived to be premier, very safe mining jurisdictions, and the companies working there, get a premium, but the actual risk is much greater than people think, those companies are overpriced. Other places are perceived to be very risky and the companies doing business there are trading at a great discount, but they are actually not that much riskier, because every place is risky. So the discounts are overdone and the companies are more likely to be undervalued. This points to an opportunity: the market is reading things wrong.
Rick: That’s very perceptive. We talked about bull markets and bear markets, or investing in cycles – well, countries go through cycles as well. My experience has been that when a community of voters can afford to be stupid, they will. When they can’t, they won’t. Paradoxically, the trend is always better in the broken places and always worse in the healthy places.
L: Time for Doug’s favorite comment on the world: it’s perverse!
Rick: It comes down to this: if there are resources to steal, if there’s wealth to redistribute, the temptation to do it will be overwhelming. When they’ve run the wheels off the wealth-generating cart, when there’s nothing left to steal, they stop stealing.
Political risk is partially a function of price and perception. I remember some years ago, I traded fairly frequently in the shares of Peñoles, a premier silver producer that wasn’t particularly well known among Americans. I noticed Peñoles’ volatility was extraordinary, but particularly extraordinary as it related to the perceived political risk of Mexico. When the Mexican presidential candidate Colosio got shot in Tijuana, the price of Peñoles declined overnight by half.
Rick: There was not one ounce of silver missing – nothing changed on the balance sheet. The only thing that happened was that the perception of political risk in Mexico changed. Peñoles’ share price recovered everything it lost in seven weeks. So, one of the things that’s really worth doing is paying attention to the nightly news – but using the nightly news as a negative indicator. If you, as an example, saw some social discord in Turkey that caused a reflexive reaction for people to cut their assets in that country, it could be a buy signal.
L: This is sort of like Doug’s story in our last conversation about the guy backing out on the gold stocks that he bought because he saw the news about the riots in Soweto. I’m just back from Guatemala, a place perceived to have very high political risk, higher than it deserves, I think. I understand you just came back from a trip as well. What did you see?
Rick: I was in Serbia, another country regarded as high-risk. They were engaged in a ten-year civil war and much of their infrastructure was obliterated – parts of it by the United States. There are existing ethnic tensions in Serbia and the country is widely believed to be corrupt, not transparent. The experience that I have had on two visits to Serbia is that the process of doing business is highly political – although frankly not as political as it is in California—
L: [Laughs] The PRC – the People’s Republic of California, where no tax goes un-loved.
Rick: Thus far in Serbia, we’ve not had to pay a bribe. The situation has been fairly transparent. I was struck by the relative good state of the infrastructure. I was very struck by the high levels of education and competence exhibited by the population. I was very positively impressed. While I’m not trying to say it’s without political risk, I don’t see the political risk for resource development in Serbia being anywhere near as high as the political risk for resource development in the United States, or Germany, or France, or Great Britain – or any countries that believe that they can afford to constrain resource development.
Serbia knows – I was there on a hydropower project – they know that they need energy and they know that they can’t raise the capital for green energy. As a consequence, they are highly desirous of investment in energy-generating projects. In other countries that perceive themselves to be richer – we could argue how rich the United States actually is – the risks associated with resource development are actually higher because they aren’t perceived as being needed by the population. In Serbia, they understand that when the United States blew up their power grid, they became less wealthy. They understand that the key to improving their and their children’s standard of living is more abundant energy. I suspect you had the same experience recently in Guatemala and in much of your experience in Latin America. There’s a realization in those countries that their development rests to some degree on investment in extractive activities.
L: Yes, there certainly is a perception amongst people who are hungry that business is a good idea. There’s certainly plenty of that in Latin America, though there’s also enough stupidity in some places to try to tax the goose before it can lay any golden eggs, hence scaring it off. I’ve actually been to Serbia four times, and share many of your perceptions – particularly regarding the people. That was the main thing that sold me on Serbia: the people. There are old nationalist hardliners and so on, but most of them – particularly the young people – they just want to work and get ahead. They’re smart, they’re motivated, they’re well educated – I found it a really bullish, up-beat atmosphere. The future of that country, if those young people have their way, seems very positive to me.
I want to rewind to the higher-risk country that you mentioned, the United States.
L: There’s been talk about reforming the 1872 mining law, and that got shelved for a while by Congress, because health and other higher priorities took all their attention. Now we have taken a great step toward socialized medicine in the United States and that’s out of the way, and the recent West Virginia mining disaster has many people all up in arms about mining again. So I’m wondering if mining law reform – so-called reform, but really a new mining tax in the form of a federal royalty – might pick up steam now.
Rick: I think that the 1872 mining act is doomed. I think it came off the table because Harry Reid was running in a close election. Mr. Reid is fairly long of tooth, and he won’t be around to protect the industry much longer. Besides, the industry is less important now, even in the state of Nevada. Nevada is carried economically by Clark county, where Las Vegas is. If you live in northern Nevada, you’re not going to think you’re irrelevant, but in terms of political calculation across the country, you are, in fact, irrelevant. The gold mining industry in the United States, in the context of the American economy, is totally, totally irrelevant. That the mining industry will be sacrificed politically isn’t just an idea, it’s a certainty…
L: Strong words.
Rick: If you saw the response to the BP blowout deep in the Gulf of Mexico recently, there was no discussion of the fact that this was only the second blowout that the industry has experienced in 30 years. There was no discussion about how far oil and gas technology has come. There was no discussion about the fact that technology in U.S. oil and gas leads the world; and that this technology is responsible in large measure for our standard of living. The response to this accident – which was and is, in fact, a catastrophe – has been to constrain drilling for six months, at least. If an industry as important as the oil and gas industry can be challenged politically with no particular basis in science, the mining industry – which is an absolute irrelevance politically – is certain to be sacrificed.
L: So, the consequence here, just to be specific, is that if you’re involved in any exploration or development plays on U.S. federal lands, you might want to head for the exits when mining reform starts heating up again. Don’t wait for the gold market to top out; get out before whatever bad news is brewing hits the fan.
Rick: That’s accurate. And I think that you need to consider the U.S. a high-risk jurisdiction, not low-risk.
L: Political risk indeed. Food for thought. Thank you very much for your time.
Rick: Thank you; it was fun.