Palisade – Sprott Monthly Market Update: How to Identify a Worthy Private Placement Investment

Palisade Radio August 16, 2016

When making private placement investments, it’s imperative to understand what the company will do with the money. You are basically providing catalytic capital to an unanswered question, and Rick Rule has found that 80% of issuers fail to sufficiently answer what that question is. This takes them out of the picture as a smart investment.

The funding investors provide should fundamentally change the affairs of the company, and you should get a warrant which is a right to contribute more capital at a fixed price over a fixed period of time. In this interview, Rick gives great advice on the right questions to ask including what is the thesis, what is the process proposed to test the thesis, and the probability of each outcome.

During his 40 years in mining, Rick has learned that pure silver equities ultimately outperform other precious metals equities. Most silver is produced from byproducts, not primary silver, so finding a pure play is hampered by scarcity. The silver price should run further than gold, and silver equities will outperform the metal. There’s a small chance gold will go down if confidence in government, central banks and the economy goes up.

We are seeing a few weeks of rest in the junior mining space, and many are predicting a massive rally this fall. Markets move up when there are more buyers than sellers, and down when the opposite occurs. Both the metals, and mining equities markets are extremely well bid. If there is a break in the market it’s likely to be on the upside, not the downside.


Palisade Radio Host, Collin Kettell: Welcome back to another episode of Palisade Radio. This is your host, Collin Kettell. Back with us again Rick Rule for our monthly installment of the Sprott-Palisade Market Update. Rick, what a great show. I just got back from Vancouver. You were networking and working the floors diligently. I thought it was a fantastic show and the place was packed up to a fire code limits.

CEO and President, Sprott US Holdings, Rick Rule: Thank you for that, Collin. All the people worked very, very hard. We are just beginning to go through the attendee, the speaker, and the exhibitor evaluation forms now. So far it seems like everybody believed that they got a very good return on their investment both in terms of the money they spent to be there and time they spent. Thank you for that.

CK: I think one of the most captivating talks, and I must admit I did not hear very many of them because I was talking to people all day, Robert Friedland gave an exceptional talk. It started out on a conversation about global pollution focused on countries like China and India. One of the solutions for that is going to be the metals of the world, platinum group metals, used, of course, in catalytic converters; silver; gold even. I noticed that Robert’s stock moved up about 35 or 40% on the next trading day. I do not know if that can be attributed to the talk but quite a result.

RR: I think Robert gave a spectacular talk. That was the third year he has been present for us. I am embarrassed to say that even at my own conference Robert consistently out-polls me for best speaker. No, it was a great talk. Robert is a serially successful entrepreneur. If you think about the number of world class exploration discoveries his team has made; if you think about the literally billions of dollars of returns he has generated for investors it is pretty obvious that he is an absolutely first class brain. I am delighted that our attendees responded by buying his stock which I think has just superb speculative characteristics.

CK: Let us talk about Ivanhoe as an example. Looking back at the past you have got Ivanhoe right now a little over a billion dollar US market cap and they practically have as much cash in the bank than they did before his talk as the entire market cap of the company. When you look at a company like that and you look at the context of the market and, say, the biggest mining companies in the world like Barrick or $20, $30 billion market caps, how do you justify saying Ivanhoe could be a 20 or, 50-bagger, because that would put a company like Ivanhoe today at the largest market cap in the world on a gold company? I guess what I am trying to outline is that things are just so darn cheap right now still.

RR: I think you are right, Collin. I think that Ivanhoe is a metaphor for the market conditions in mining today with the exception, of course, of gold companies. You have a guy who is literally the most successful mine financier of the last 60 years; a guy who found the Fort Knox deposit which has now produced, I think, about 10 million ounces of gold. He found the Voisey’s Bay nickel deposit, the most important nickel sulfide deposit discovered in this hemisphere in the last hundred years. Of course, Oyu Tolgoi, a world class copper-gold discovery in Mongolia that will be producing, Collin, for your lifetime, not just mine, 700,000 ounces a year of by-product gold.

Now in one wrapper— the superlatives that you use for this are incredible. He has a platinum deposit in South Africa. That is the probably the largest undeveloped precious metals deposit in the world; platinum-dominant, not gold-dominant, of course. He really has two copper discoveries: Kakula and Kamoa, which are two of the most important copper discoveries in the last fifty years. His throwaway asset, if you will, is the best copper zinc deposit in the world. This in as you point out a billion dollar market capitalization with an excess of $500 million in cash. The enterprise value on this is about $500 million US dollars. When people ask me how far you can run with a $500 million enterprise value I am reminded that his last effort, also named Ivanhoe, ran to a $16 billion market cap. This is a truly exceptional set of circumstances.

It is also worth noting that the platinum deposit has a fairly interesting partner in the government of Japan which pay just a shy of $300 million for a 10% interest in deposit. That would seem to value Robert’s side at $2.7 billion assuming that government of Japan did not make an egregious mistake. The point of it is that this is anomalously cheap. Why? Well, large capital expenditures needed to put the projects in production. But with partners like Zijin Mining, the government of China, and the government of Japan one would think that the company might have access to that kind of financing, and, secondly, because the countries that they operate in: South Africa and Congo.

My own experience is that very high quality deposits really financed themselves almost irrespective of jurisdiction. Remember that his last effort was in Mongolia before the mining industry could spell Mongolia.

CK: First Majestic Silver Corp. has been our sponsor for the last year on Palisade Radio. I believe they have been the best or one of the best performing mining companies on the Canadian Exchange since this bull market started. Keith Neumeyer, the all-star there gave a great talk about silver. I do not necessarily want to focus on First Majestic Silver Corp. here, but his point was the benefit of having a primary producer with silver going up as the best performing commodity this year; just a tremendous amount of leverage that comes out of a company like First Majestic that plays specifically off of one commodity.

RR: Certainly in my experience, Collin, if past is prologue, one would expect the silver price to run further than the gold price. I am not sure why this is other than the lower unit cost in silver. But the other thing that I have examined in my 40 years in this business is that the silver equities, the pure silver equities, ultimately outperform any other precious metals equities simply, as you put, because of the scarcity value in the market.

As you know, Collin, most silver in the world is not produced from primary silver mines. It is produced rather as a consequence of by-product production from other base metal or other precious metals mines. The ability to find a pure play is hampered by their scarcity, and one would expect, again, if past is prologue that silver will outperform gold as a metal as it has in the last twelve months and the silver equities as a consequence of their scarcity will outperform the metal.

CK: Rick, what is your feelings on the market? I never ask for specific predictions, but we have had a couple weeks of I guess a rest in the junior space. It has not gone down but it has not really been surging in the last few weeks, and now we are going to be entering the fall season soon. A lot of people have said to me they think we are going to have just a massive rally coming in the fall here based on the time of the season and the gold prices moving up. Are you having a similar feeling?

RR: My own feeling is mixed. I think the precious metals equities, especially the juniors, needed a rest. Markets do not go straight up. They usually back and fill. That said, Collin, that is narrative. Our Chief Investment Officer at Sprott, Paul Wong, has been absolutely right on precious metals and precious metals equities the last five years trading them technically.

What Paul points out to me is, the narrative aside, markets move up when there is more buyers than sellers and they move down when there is more sellers than buyers. He points out to me that both the metals markets and the metals equity markets are extremely well bid. Although my narrative tells me that the junior precious metals equities need to move lower the market reality is that the markets are extraordinarily well bid. Paul Wong believes that if we have a break in the market it is going to be to the upside not to the downside. All I can say to that he is lips to God’s ears.

CK: The last couple interviews we have had had been with some pretty big names. We have had Mark Faber and Peter Schiff on and Don Coxe. They all of underline the same similar theme and that the global money printing that is going on, the negative rates, the stock markets being overvalued, all put a very, very strong case in place for gold. I know that you are not a global economist as you pointed out before, but my question here is do you see any way that gold can be derailed at this point?

RR: Gold has a lot to do with confidence. As an example, the recent US jobs report was reasonably strong. Understand that I am solidly in the Coxe, Schiff, Faber camp, but if you ask me to construct a scenario where gold would do poorly it would be a scenario where confidence return: confidence in government, confidence in central banks, confidence in the economy. I do not see that confidence returning particularly in politics with the circus in the United States.

But certainly the longest unbroken bull market in history is the ascent of man, and to extent that investors begin to believe that separate and apart from our collective stupidity are individual achievements were substantial enough that we could in some way, shape or form, grow our way out of our political idiocy than we would do poorly. Sadly, I think that that is a task for your generation, not mine. We have proven ourselves to be completely inept in terms of managing our collective and political affairs.

CK: Rick, we have beaten this topic to death if you go back to the last fifteen or twenty interviews that we have done. But I have a lot of audience members reaching out to me and I think it is a good thing to address again because they can always reach out to yourself or your team on participating directly in financings of companies and maybe taking a very basic approach here on what it means to participate in a financing, why companies would need money, and, of course, the optionality that you get through warrants by participating.

RR: Collin, we cover this very extensively at the conference and I must say it was an extremely popular feature. The first thing to know about private placement investing is that you need to be either an accredited or qualified client particularly with some knowledge in the space, and probably more important from a regulatory viewpoint that you have a portfolio value in excess of a million dollars.

The second thing to remember is that private placement investing is not like any other junior stocks which ought to be regarded really as research and development activities rather than as asset intensive businesses. What you really are doing is you are contributing capital to answer an unanswered question. It is important when you make the investment to understand why the company wants to raise the money.

When I ask the question to issuers, “Tell me the most important unanswered question that my capital will help answer.” Fully 80% of the issuers do not have an answer which means I cannot invest in at least 80% of the people I ask the question to. Because truly what you are doing with a private placement is providing catalytic capital to answer an unanswered question. What is the question? What is the thesis? Was the thesis evolved using very good inputs? What is the process proposed to test the thesis? Will it do it? Will it do it effectively? Over what period of time? What is the probability of a yes answer? What is the probability of a no answer? What is the value of a yes answer? Does the company have sufficient capital to answer the question? All investment fundamentals. There is nothing magic about participating in a private placement. It is just a more efficient way of allocating capital.

More efficient, why? Well, you pointed it out. The first thing the capital should go in to change fundamentally the affairs of the company, and, secondly, you should get a warrant, the right but not the obligation to contribute more capital at a fixed price over a fixed period of time.

CK: Rick, for people who are kind of just getting into the private placement game I have had questions come up such as how do I find out that a company is raising money? How come when a company raises money and you see a press release come out and call the company the money has already been raised? I guess the question here and part of the answer is getting in touch with a group like yours. But access to private placements, how do people get in touch better with the resource market and start to understand and network and get into these deals?

RR: I think there are really three ways. You, if you are going to do this seriously, should be attending very high quality investment conferences like the one that we just ran so that you can network and get involved with centers of influence in the business. Secondly, you should be accessing one or more very large mining distributions. But, finally, you should be developing your own shopping list separate and apart from your other contacts and distribution networks like ourselves, and you should be contacting the companies saying to them, “We know. I know that you are approaching time when you need capital for some catalytic event. I would like to be on the president’s list.” As often as not that simple technique will get you included in private placements just by expressing interest, perhaps by expressing interest repeatedly. It is important that you develop a shopping list and contact them rather than wait for them to contact you.

CK: Okay, thanks for that, Rick. I am going to keep the interview very short today. I know that you have got a busy schedule. I am going to put a picture up on the screen here. I do not know if you recall us taking it, but it was the Palisade team and we had a great set of guys in there: yourself, Ross Beaty, Rob McEwen, and Brent Cook. I am probably missing a couple of them, but just goes to underline just how many great people you had at the conference. I wish that it kept going on because there is so much networking to be done. I assume next year you are going to have to pick a larger venue and hopefully the show continues to grow.

RR: Next year, Collin, we will use the Hotel Vancouver again because they are revamping the second floor conference space and we will be able to include 200 more attendees without incurring the ire of the fire marshal. The speaker’s lineup that we have for next year we will reveal in about five weeks. It is astonishing. This year’s conference was a very, very good conference. Next year’s conference will be substantially better. I have no idea what I will do for the year after next, but the qualitative improvement of this year over last year was very good and the qualitative improvement of next year over this year will be very good, so we are really looking forward to it.

CK: Yes, I think what was most interesting to me about the conference is the attendees that you had. Probably a lot of that was that they are Sprott clients, but just a lot of accessible people that are in similar shoes to myself or other listeners that are investing not necessarily with the same amount of money that Rick is investing but very interested and educated about the space and looking to learn so very, very different type of conference than, say, PDAC, for example.

RR: I think what really carries this conference is the fact that our attendees told us over 20 years that they consider our exhibitors to be content, too. In most conferences the exhibitors are regarded merely as advertisers, so the qualification to be an exhibitor is a pulse and a check that cashes is in reverse order of importance. Because we charge our attendees first of all as opposed to admit them free our loyalty is to the attendees, and given that the attendees have told us that our exhibitors are content the solution that we have come to is that we will not allow somebody to be an attendee if their stock is not owned in a Sprott performance fee generating account.

Now, sadly, not every stock that Sprott buys goes up. But the guarantee to attendees is that we know the exhibitors well enough that we have invested our own money in them. That makes the tone of the conference much higher than it would otherwise be. From the exhibitors point of view I guess they get two things. They get the explicit endorsement from the podium which is useful, but they also get access to a group of investors who are interested enough in the conference and interested enough in investing that they pay money to be at the conference.

CK: Rick, on that point thank you very much for coming back on the show. I will talk to you again in three or four weeks time here for our September version of the show.

RR: All is a pleasure, Collin. Thank you for your time.

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