Palisade – Sprott Monthly Market Update with Rick Rule: Cobalt Bubble Coming; Kaminak & the Yukon; Streaming & Royalties

Palisade Radio May 24, 2016

In the current bull market, with more equity available, streaming and royalty companies continue to provide much needed revenue in the base metals and industrial materials sectors.

By-product precious metals revenues in a base metals companies can trade at 5 – 7 times EBITDA and top tier companies at 15 – 20 times EBITDA. Gold equities are in the midst of a momentum trade having been under-owned and gold being the one resource that is actually moving up.

In the very near term, if the gold price doesn’t follow the equities, some weakness in the junior equities is possible. The discovery market in the 90s caused a dramatic bull run in the juniors, a big precious metals discovery now could be spectacular although the highest chances of large discoveries are in political unstable or risky areas that have been under explored.

Successful long term speculation discipline and rationality set apart the successful long term speculator; money is made in the long term by the arbitrage between stupidity and reality.

 

Palisade Radio Host, Collin Kettell: Welcome back to another episode of Palisade Radio. This is your host, Collin Kettell. As you can see on our screen we have Rick Rule back for another Palisade – Sprott Monthly Market Update. Rick, welcome back to the program.
CEO, Sprott US Holdings, Inc., Rick Rule: Thanks Collin.

CK: I want to try to step outside the box a little bit today. We can talk about ‘Is the market in a bull market’? It seems pretty obvious we can talk about where you expect gold to be but nobody really knows, so I want to ask you some outside questions, and something we have touched on several times in the past is the streaming and royalty companies.
The streamers and the royalty companies are something that have done quite well over the past few years. You have said on the show before that you think they will continue to perform well. But now that equity is more available at least to the small companies – and I would assume that at some point debt is going to become more available – will it be harder for the streaming companies to prey on the best assets and get very good streams?

RR: Well, I think prey is the wrong phrase. I think the streaming and royalty companies have been a useful source of capital when capital is hard to come by. My suspicion is that the smaller companies will have more options than royalty and stream. But I still believe that the three biggies, Franco Nevada, Silver Wheaton, and Royal Gold have major opportunities in the next 18 to 24 months to provide desperately needed capital for the base metals and industrial material sectors.
You will recall in earlier interviews- but it is worth recalling again, for those that did not hear them that byproduct precious metals revenues in a company that is considered by the market to be a base metals company- trade in the market at between five and seven times EBITDA. Those same revenues structured as the precious metals stream in Franco Nevada or Royal Gold or Silver Wheaton traded 15 to 20 times EBITDA. So a transaction can take place transferring that revenue from a base metals company to a precious metals royalty company that is accretive to both parties and both parties in a very large sense.
The base metals companies between new build capital and particularly sustaining capital have the need for about $15 billion in the next two years. And because their cash flows had been constrained and their market caps are small it may be for some of them that the only source of capital they have available to them for sustaining capital or for debt service or debt repayment are royalty and streams, and the possibility exists that some very, very large transactions between base metals companies and royalty and streaming companies. So as big as the business is it has the ability in the next 18 to 24 months to grow much larger.

CK: It appears that a very strong trend is in place with these gold miners and the exploration stocks, but there has not really been a major catalyst at this point. I want to ask you if you think that a major catalyst or the major catalyst or what is going to really kick this bull market into a long term trend, is that going to be something like a discovery or do you expect just the political nature going on right now, the interest rates, Fed policy is going to be what continues to drive things?
RR: Right now I think it is macro factors as you have described. I think the fact that the gold price is up some and that the gold equities have responded so well. My own belief in the gold equities is that we are in the midst of a momentum trade. They were under-owned. The gold moved. They started to move and in particular the Canadian generalist institutional investor had to be in the sector. A lot of those guys are closet indexers and gold and resources in Canada is 30% or 35% of the index when you had a generalist that was 5% exposed to the only sector that was moving – he or she literally had to be in place, so you have had funds flows into the precious metals mining side that were more sort of market-related than fundamentally-related. I would point out that the gold price is up 17 or 18% and the gold equities that is represented by most indexes are they are up 70% or so.

My suspicion is in the very near term if we do not get a follow through in the gold price that we may see some weakness in the junior end of the gold equities. That is not a forecast; just an observation. A correction in a bull market is normal and natural, and a market that has advanced as far and as fast as this one is normally needs to consolidate its gains. But one micro factor it that you pointed to, I think bears pointing out. And that is that we have had a reasonable number, not a large number, but a reasonable number of transactions taking place. Transactions crystallize value. They add a hope and they add liquidity.
The one micro factor that we do need to look at is transactions. What you describe is a possibility – that is a big discovery – would, of course, really shake up the market. You are probably too young, Collin, to recall the discovery market that we had in the early part of the 1990s. But that generated the most spectacular, most dramatic up moves I have ever seen in the junior space. And a big discovery, particularly a big precious metals discovery, would really, really juice this market were it to occur.

CK: Yeah, and speaking of activity – recently, Kaminak up in the Yukon was just taken over by Goldcorp. As I said in this interview I’m going to be jumping around a bit, just trying to ask you a bunch of out of the box questions. But what is the importance of the Kaminak takeover? If anything it is sizable but not huge. Do you like the Yukon? What does this mean for the Yukon?

RR: I do not think it means much for the Yukon myself. That was a unique deposit in terms of its grade, in terms of its metallurgy, and also in terms of its exploration upside. I think it says something for the exploration process. High quality deposits are rare and when they are discovered they go for fairly fulsome prices. Another example would be reservoir minerals where one acquire Erlan Neme Mining tried to buy the majority stake from Freeport and another acquirer are Nevsun came over the top bid for Reservoir – up 100%, by the way, in six months – and allowed Reservoir to take the majority stake itself. High quality deposits are rare and high quality deposits will sell at very, very good premiums even after the stocks have run.

CK: Historically speaking, Rick, where are we right now in terms of exploration? There has been quite a bit of takeover activity. I have not been around long enough to compare this point in the cycle to ones of the past. Are there a lack of ounces out there? Is there an urgent need for more ounces to be discovered if you have looked at this? And an extension to that question is how much exposure do you have to these exploring companies?

RR: Absolutely an urgent need. In the last exploration cycle that we experienced, the one that was through the beginning and the middle of the last decade, the truth is that many of the exploration dollars spent by the juniors were misspent. They were not spent looking for minerals; they were spent looking for markets, and by that I mean that the great Canadian paper hanging machine rather than looking for high quality green field deposits sort of retreaded properties that had failed in two or three prior bull markets where they knew that they could twin the one, good existing hole on a project.
They were looking to mine markets rather than mine deposits. One of the reasons why so few discoveries were made relative to the dollars that were spent was because the promoters were actually looking for discoveries. They were looking for salaries and they were looking for a pop in the market. The consequence of that is that although a reasonable amount of money was spent in the last decade very few discoveries resulted from it.

A second problem is that discoverers- for good reasons and for bad, are mostly sticking to tried and true terrain which they feel, sometimes rightly sometimes wrongly, is politically secure. If you look where discoveries have taken place, I am looking particularly to Robert Friedland, but also to Platinum Group Metals, the real large, real world scale discoveries are taking place in places like Serbia, politically risky; Congo, politically risky; South Africa, politically risky. The truth is that the chances of discovering ten or fifteen million ounces in Timmins or Abitibi, particularly easy to find non-buried ounces are very, very low. You have to go to places that have been improperly explored. Just as you have to take exploration risk you have to take some political and social risk to make big valuable discoveries.

CK: I think over the last couple years I have had a lot of people on the show talking about how this bull market would be different from the last one or the one before that in that people have learned their lesson and money would not be misallocated. But just in the first three to four months I have seen so many of the worst offenders of past bull markets coming out of the woodworks and raising money for projects that really do not deserve it. And yet it is hard to tell people not to get a shotgun approach in the junior sector because some of what looked to be the worst deals or things that are not real end up making you four or five times your money very quickly. I guess this is an open-ended question, but how do you deal with this situation as an investor? What is the point of looking for the quality when money can be made this way?

RR: I am perfectly happy to avoid making four or five times my money backing the scamster where the probability is that he or she will end up in failure. The truth is that over time good people will make you good money. It is interesting that you use the phrase shotgun in the context of bad people. I will leave the rest of that statement to your imagination. But the truth is I do not miss at all not buying a $0.10 stock that goes to $0.50 and instead concentrating my efforts on people like Bob Quartermain, Ross Beaty, Robert Friedland, Lukas Lundin.

The truth is that by hanging out with Ross Beaty I was involved in taking Pan American Silver from $0.50 to $45. I was involved in taking Lumina Copper from $0.50 to $140; by the way, real number. All pass up the odd 5-bagger where the odds are against me in favor of the slim possibility of 100-bagger where the odds are for me. Discipline and rationality is what sets apart the successful long term speculator.

In the very near term markets are voting machines, but in the long term markets are weighing machines. If you are comfortable with the way people vote, as an example in the elections that we are having in the United States, maybe you want to hang out with the scamsters that ignore value in the near term. But the truth is that money is made over time in an arbitrage between stupidity and reality; stupidity measured by the voters, reality measured by reserves.

CK: Thank you for that, Rick. One of the biggest booms over the last six to eight months has been lithium. We do not need to get into that because we did an entire interview based around that just a couple months ago. A new energy metal that is just being recognized by the market and is the biggest component of a battery is cobalt. There are a couple cobalt companies out there, but the rush that hit graphite years ago and lithium most recently has yet to come to cobalt. I know you like long term investments so I will ask the question this way: Do you expect at least a short term boom coming in cobalt in the near future?

RR: Yes, I do. I do not know that it will follow through in the stock market because to look for cobalt you have to go to Russia or you have to go to Congo, and most of the promoters of these sorts of things could not imagine anything worse than having to go to unpleasant countries looking for people. What I suspect that you might get is nickel as cobalt in drag. In other words what you might get is people pretending to be looking for cobalt in the Canadian Shield, in Timmins, in Ungava, and places like that; people who use the cobalt story to raise money for nickel exploration. Much as I did, frankly, in the early 1990s with platinum. Both FNX and Aurora Platinum, which later merged, were in effect nickel exploration stocks in platinum clothing, and I suspect you will see that in cobalt. What you really need to know in the context of cobalt is mostly northern Russia, the Norilsk region, and Congo.

CK: Very well. Well, Rick, I got one more out of the box question. It is a company that I believe Eric Sprott is invested in. It is called BitGold and it has had a tremendous amount of upside and the stock they have had huge adoption rates. For me BitGold is going to be a little bit difficult in the long term potentially because people do not necessarily want to transact and lose 1% on both side of a trade. It might end up storing gold with BitGold which does not necessarily work for their model. What is your feeling on the company?

RR: Collin, you are younger than I and better able to appreciate the technology than I. We have made a lot of money on BitGold. People have commented on the Sprott selling in BitGold. But the truth is in the market that we inhabited last year a stock that is up 500% is a rarity, and at Sprott we have learned that the back side of a Hockey Stick Chart is just as steep as the front side.

I am attracted to BitGold in the sense that I am attracted to gold and I am attracted to the ability to use gold as money rather than merely as a store of wealth. I am also extremely attracted to the two young gentlemen who are the primary drivers behind BitGold. For myself, although I am an owner of BitGold in my own account rather than in client accounts, it is difficult for me to justify that market cap based on the cash flow generated by BitGold. One who would properly be able to analyze that stock would be much more likely to be a technology or a social media analyst rather than a resource or a credit analyst like myself.
I own it because I no longer have any investment in it, meaning that I have recovered my investment out of it one times over. I am keeping the residual portion to see if these guys can pull off what they say they can pull off. This is highly risky. Do not try this at home unless you are much better informed about social media adoption rates and technology than I.
CK: All right, Rick, many thank yous for coming back on the program. You do this every single month with us. Anything else you would like to add in context to the market or for people to reach out to you, please go ahead.

RR: Well, in terms of reaching out to me I would like to reiterate my proposal to your listeners, hundreds of whom have taken me up on the offer, which is to evaluate and rank the resource companies in your portfolio. Send me your portfolio in the text of a letter, not as an attachment, with both the name and the symbol. Send it to contacts@sprottglobal.com and I will send you back a ranking, 1 through 10, the way Sprott sees it right now of the resource companies in your portfolio. Hundreds of your viewers and listeners have taken me up on the offer and it is something that we continue to like to do. We spend about $3.5M a year on information gathering analysis at Sprott and we are willing, on a no obligation basis, to share some of that with your listeners and subscribers.

CK: Great! One thing I would like to add is that we will be attending at Palisade the Sprott Conference which will be taking place in Vancouver on July 26th and 27th. Of course you will be there, Rick, as will Eric Sprott and other world renowned people in the resource space- And I would invite all our listeners to sign up. It is a low price for the amount of knowledge that one will gain and, of course, the context one can make by attending. Rick, thank you again for coming on the show.
RR: Thanks, Collin, and thanks for refreshing my memory about my own conference. I appreciate that.
CK: You are welcome.

Rick Rule began his career in the securities business in 1974.. He is a leading investor specializing in mining, energy, water, forest products and agriculture. Rick founded California-based Global Resource Investments, Ltd., which grew into a much larger organization with significant affiliated companies. As Director, President, and Chief Executive Officer of Sprott US Holdings, Inc., Mr. Rule leads a highly skilled team of earth science and finance professionals who enjoy a worldwide reputation for resource investment management.

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