Skip to main content
bnn market call

Rick Rule.

Rick Rule is chairman, Sprott U.S. Holdings. His focus is precious metals stocks.

Top Investing Ideas

Ivanhoe Mines (IVN.TO)

The best collection of assets assembled in a junior in my lifetime, fronted by the most successful mining promoter of this generation. Political and financial risks to be sure, and gut-churning volatility.

Franco-Nevada (FNV.TO)

Should be thought of as the world's dominant "specialty finance" company in mining. Superb investment discipline, as well as industry-leading scale and capital cost advantages.

Alterra Power (AXY.TO)

Ross Beaty's "green" play. A sleepy market disguising a rapidly improving balance sheet, with very broad growth opportunities.

Past Investing Ideas August 7, 2014

Dundee Corp. (DCa.TO)

Then: $18.25 Now: $10.28 -43.67% Total Return: -43.67%

Delphi Energy (DEE.TO)

Then: $3.87 Now: $0.84 -78.27% Total Return: -78.27%

Altius Minerals (ALS.TO)

Then: $14.24 Now: $13.71 -3.72% Total Return: -3.37%

Total Return Average: -41.77%

Market outlook

Trading conditions in natural resources, and particularly extractive industries, continue to be very challenging. The dominant trend in industrial materials, (base metals, Ag minerals, energy minerals and oil and gas) is very soft; the oft forecast "economic recovery" would appear to be non-existent everywhere. Even the U.S. economy is only strong in comparison to our anemic competitors; real incomes in the U.S. are weak, as is labour market participation, constraining both demand and productivity gains.

Recovery from commodities "bear markets" occurs one of two ways: through demand recovery (this recovery comes either through increased user utility at lower price points, or an economic recovery) or supply destruction, where the industry retires or mothballs productive capacity that is temporarily or permanently sub-economic. All indications suggest that this bear market cycle will end through supply destruction, a long and painful process. Decapitalizing industries that were very over-capitalized in the previous bull market cycle takes a long time, and we would not be surprised to see the current malaise in industrial materials continue for two or even three years, in the absence of a meaningful economic recovery.

These industries are further challenged by rapidly increasing costs of capital, in a world where other industries are enjoying lower costs of capital. Rapidly declining share prices among industrial material producers, combined with sharply higher interest rates on project debt will continue to constrain emerging producers.

The good news is that the eventual recovery from a "supply destruction" resolution to this bear market can be expected to be very dramatic, as any increase in demand, or even a continuation of current demand cannot be supplied from shut in or shut down sources, and restarts are capital-intensive and time consuming. The de-capitalization of the oil and gas industry in the last cycle and the subsequent explosion of oil and gas prices are a great example.

The precious metals markets are more nuanced. The narrative surrounding the precious metals price escalation in the 2000 to 2011 bull market (from $260 (U.S.) - $1,900) included unsustainable on-balance sheet and off-balance sheet government liabilities, quantitative easing (counterfeiting, in Sprott parlance) and an over-leveraged financial services sector, is unchanged. What has changed is investors' willingness to tolerate these conditions. As an American citizen, the global faith in American political leadership is flattering, and the global hegemony enjoyed by the U.S. dollar and U.S. treasury securities is more than flattering. We (Americans) etch promises to pay on bit and bytes (printing in these quantities is too expensive and old fashioned) and send them around the world in exchange for cars, electronics and other good stuff. How nice!

How long can faith last? I don't know, but this faith is not founded on math. I'm not one who believes that the dollar or the U.S. economy will collapse, and I don't believe that precious metals will defeat dollars or fiat currencies in general, but I do believe they will begin to lose less badly, as they did last decade, and more famously, in the 1970s.

This bleak outlook has caused the TSX-V to appear historically cheap. An index which has declined by 90 per cent can double and still be down by 80 per cent. Put another way, it is nine times as attractive as it was, when it was popular. In truth, deep difficulties remain in the junior Canadian resource industries separate and apart from commodities pricing. Sprott estimates that perhaps two thirds of the TSX-V companies are non-viable in any almost any commodity price scenario, and we estimate that the general and administrative costs of these non-viable public entities exceeds $1,500,000,000 (CDN) annually, an unsustainable tax on speculators and the industry.

These statistics, while grim, disguise the "silver lining" that was so well hidden during the sector's last bear market: the performance by the best companies in the sector is so spectacular that they add legitimacy and occasional lustre to the entire group, and we believe that the best of the best are on a "once a decade" sale.