Rick Rule: On Your Portfolio, Bonds And Precious Metals

We have the honor and pleasure to have with us today Mr. Rick Rule, founder of global companies. Rick Rule has dedicated his entire adult life to many aspects of natural resource securities investing, in addition to the knowledge and experience gained in a long, successful and focused career. He has a worldwide network of contacts in the natural resource and financial worlds. As chairman of Sprott US Holdings, Mr. Rule leads a highly skilled team of earth science and finance professionals who enjoy a worldwide reputation for resource investment management.

What I wanted to do here is break away from the old format of just asking you direct questions in terms of gold or silver or a particular situation and allow for some questions that we received directly from our investors around the world. I thought we’d take the opportunity and respond to some of these questions. During this platform we have gotten an incredible amount of inquiries, particularly regarding the future of the next generation of retirees in America. I thought it would be a great chance to get your point of view on this very delicate issue. Let’s get right into it. For the next few years where should I diversify to protect what is left of my retirement fund?

RR: I think in the very near term, the very, very, near term, cash is a very good place to be. What I often ask investors to do in their retirement funds is to invest in very stable sources of long-term income and depending on the taxable status of their retirement funds those are often things like master limited partnerships or high dividend paying corporations. What’s interesting about the set of circumstances we find ourselves in right now, Patrick, is that we we were very, very close and may still be close to synchronize decline in markets which means that all asset classes get cheaper. If you have a panic like we had in 2008, you may have a once-in-a-decade or once-in-two-decades opportunity to buy the type of very stable income generating assets that are perfect for retirement. I think the subthrust of your question probably has to do with re-balancing and reducing the bond holdings in a retirement portfolio, which I would certainly concur with. My suspicion is, the next direction in interest rates is up and that the gold market in bonds is effectively over when the interest rate rises the impact of that capitalized value of the cash flow from the bonds falls and you get yourself involved in a pretty ugly interest rate trap so people need to consider that.

PM: Obviously, you have got to be very careful right now in terms of interest rates rising with relation to stocks looking for better returns. How would the interest rates rise and will that affect stocks if, in fact, bonds or interest rates are moving up?

RR: Well, I think one of the things that’ll happen if you are involved in the right company is that the company can continue to raise distributions. In other words, they can grow the dividends. The beauty of a brick and mortar bond if it’s well run, is that the ability to generate cash can increase over time. Some of these companies have pricing power. Particularly, pricing power in the context of inflation, because the asset bases that they have become increasingly expensive to replace. It means that there are barriers to the entry of other people competing with them as opposed to bonds where your distribution is, of course, fixed. That isn’t to suggest that the stocks have no risk. It’s just that they have the ability; although, they don’t always make it, to keep pace or exceed inflation.

PM: Another question from one of our viewers regarding interest rates: “As interest rates rise which funds or stocks will give me better returns?”

RR: Well, perversely, in the beginning of an interest rate rise, the financial service of stocks, in particular, the banks, do the best. The deposit rates that they pay are sticky while the rents they receive on capital employed in variable rate loans, like prime rate loans, increase. So, the first movers will be the banks. Over time, of course, a rise in interest rates can hurt the banks, but in the near term the best performers are the leverage financial service companies. There’s a lot of risk associated with them, because you have to know enough about banking to be able to analyze those balance sheets. Not all of our clients or your readers will be able to do that. But, certainly the first responder, will be people who have access to fixed rates deposits and, at the same time, have the ability to put out variable rate loans which are, you know, the whole banking complex. Over time, more expensive capital costs everybody money it’s an unalloyed bad unless you happen to be a straight variable rate saver. My own suspicion is that interest rates have to rise substantially before the real interest rates that American CD savers are experiencing, turn positive. You and I have talked on your show before about the consumer price index. You know I have 3 comments to that in the context of interest rates: 1) The idea of a CPI excluding excluding fuel is pretty silly, because of the eden drive. 2) Those guys don’t shop where I shop. 3) And, this is amazing to me. The consumer price index, which is what it’s supposed to be, doesn’t include tax. Tax is certainly part of my cost of living. Believe me, if I didn’t have to pay the tax, I wouldn’t complain about the index. But, the idea that the CPI index accurately reflects the cost of living and is a useful juxtaposition to the interest rates that we’re receiving in bonds and certificates of deposits, I think, is pretty silly.

PM: Next question, “Bonds have come down and I am worried about what they will do. Old school says bonds are best for retirement. What are your thoughts on them now?”

RR: Well, I don’t think bonds are best for retirement. We have been in a bond market beginning in 1981, when many bonds were paying 20 percent and the interest rate has fallen from 20% to 2% over 30 years. Bond markets move in major, major cycles and I think we are at a very, very low point in the interest rates cycle. So, I think for people who don’t understand how to buy and trade bonds, that we’re in for 10 to 20 years of subpar returns. There was a time in the 60’s and 70’s, the last time inflation was on the mark and certainly when stagflation happened, that bonds were, to quote I think it was Franz Pick, ‘certificates of guaranteed confiscation’ where in fact your purchasing power deteriorated on the quarterly basis, when you held the bond as a consequence of the fact that your fixed yield was substantially below the rate of inflation and so your purchasing power got taken away. The reflection of that was that not only your purchasing power got taken away, but the principle that the market was willing to pay for this deteriorating purchasing power went down. So, we had a period of time from the mid 50’s to the late 70’s where the bond prices went down for about 20 years, then a period of time from the mid 70’s when it went up for 30 years. And, the cycle is going to repeat.

PM: The silent killer called inflation… Do you foresee bailings coming in to the US and, if so, in what form do you foresee them taking place?

RR: It wouldn’t surprise me. But, I don’t think you’ll see them quickly. Deposit insurance, from my point of view, is just another social promise. We have decided in democracies to allow ourselves free beer and free lunch and that’s not the way that the world works. Deposit insurance is the same type of social life that social security and medicare and medicaid are in western societies, for 20 years, we’ve lived beyond the utility generated by our effort. And, the range of social promises we made to ourselves… the idea that we can have a no fault, no work world is fallacious. And, the idea that society ought to bail out depositors who are stupid enough that they deposit money in subject banks, is as stupid as the suggestion that people who abuse themselves with drugs, alcohol, tobacco or obesity ought to be covered in terms of health care costs, or the idea that people who spent through their career, ought to be sheltered in their retirement years by society savings. There’s a whole range of social promises that we’ve made ourselves in the last 20 or 30 years that we can’t afford to keep and deposit insurance is one of those

PM: What advice would you give to those looking to secure their retirement given these uncertain times?

RR: Well, work more, earn more, spend less, save and invest, not in the context of a 3 month cycle, but in the context of a 5 or 6 year cycle. Your listeners, and I’m sure there are many who are or will shortly be receiving social security, need to look back at the origins of the social security program. That was put on the US to provide poverty level income to people 65 years of age or older when the average life expectancy male was 66 years. In other words, the social promise was that we would maintain you in the better of starvation but at the poverty level of the last year of your useful life. The promise, the mandate of the program beyond that is unsustainable. You are responsible for your own retirement. The idea that you ought to be able to retire at 62 or 65 is probably a fallacious idea. Some of us have worked hard and have been lucky and could afford to, but most of us in that boat don’t want to. So, I think the first thing in regards to your retirement is people need to understand is that they are responsible for their own retirement. They need to begin to look at how much they spend and how much they save. And, Patrick, they need to begin to do it when they’re your age.

PM: Would you advise to keep money in a Roth IRA or a 401k?

RR: I would. I don’t suspect the federal government will steal from its citizens by confiscating the retirement account. It is much more efficient for the federal government to steal from its citizens via taxation or steal from the citizens via quantitative easing, which is counterfeiting, or steal from the citizens by artificially depriving people of interest income, in other words, by manipulating the interest rates down. There are many easier ways to steal from people’s IRA’s. At the risk of sounding inflammatory, I don’t think with 440 million guns in private circulation in the US, the politicians have the guts to steal from people’s IRA’s. I think that would be where people drew the line.

PM: I think we’ll have a social issue, at that point.

RR: Correct. There are easier places for the government to steal your money.

PM: As an investment strategy, options to maximize investment and maintain my standard of living longevity, will my savings take me there and give me some considerations?

RR: I think the first thing people need to understand is that they need to lengthen their investment horizon. So many readers of services like yours, believe themselves to be investors when, in fact, their actions suggest they’re traders and speculators. I think people need to pay more attention to companies’ fundamentals. And, they need to lengthen their time horizon. Of course, people want stocks that are going to triple, but thats not a realistic expectation. People need to pay attention to companies that are more likely than not to be higher over the 3 to 5 term. Yes, they need to speculate or at least they can speculate. But, speculate with 20% of your portfolio, while you invest with 80% of your portfolio. The other thing that is critical for people your age, because we had a 20 year bull market and inequities and 30 year bull market in bonds, people have become real sort of reward chasers, rather than risk managers. I think that, to the extent that we ask ourselves investment questions that begin with when not if, I think we do better. Let me explain that as an example.

In things like the platinum and palladium market or the uranium market, they’re out of favor now. But, the commodities are selling for less than the cost to produce them and society needs the product. In that case, if the price must go up and the price can go up, because the utility is high, the question we ask ourself considering the commodities when will the price rise. Many times, we ask ourselves the speculative question, if this happens and this happens and this happens then this can happen. Asking yourself an if question is inherently riskier than asking yourself a when question. Many people don’t like uncertainty as to time, but, ironically, they’re willing to take uncertainty relative to outcome. If the question I’m asking myself is, ‘Do I get paid in 2 or 4 years?’ the subtext of that is that I’m going to get paid. And, people need to ask themselves more when questions and fewer if questions.

PM: Are there any limits to how much I can have an asset and still have my pension?

RR: I don’t know. My tax and legal advice are free and worth less than what I charged you for them.

PM: I think this was primarily from one of our foreign investors. The next question here is regarding age care issues and costs. Are they becoming increasingly expensive? What do I need to know and where can I source the information?

RR: I think if you’re an American citizen, what you need to know is, the promise we’ve made each other with regards to Obamacare are unsustainable. And, by the way, Bushcare, too. The sort of subscription supplement program the Bush administration put in place, is completely unaffordable. The truth is that the population base is growing older. And, what’s really happened is people like me have decided people like you should take care of us in our old age. There’s more of us than there is of you. It’s completely unsustainable. So people need to understand, first of all, their healthcare costs are going to go up, because wealthier people are going to have to subsidize poorer people. Healthcare is going to be determined, not by need, but rather by vote until it’s completely unsustainable. So, people are going to have to save for their own healthcare despite the fact there is a social promise that says we the people are going to take care of us. That is a lie. And, people need to know that.

PM: Where is the money gonna come from?

RR: It’s gonna come from you and you may or may not be willing to pay for it. The truth is, the tax base in the US is increasingly progressive, progressive being an odd word. The top 5% of the taxpayers pay one on the most disproportionately high percentages of government expenditures in the world. The top 1% pay completely ludicrously disproportionate percentage of all tax. And, despite that fact, the federal government can’t pay to sustain the demands of society, but rather has to resort to quantitative easing.

PM: That’s my point. I think, ‘Where is the money gonna come from?’ You’ve mentioned before all these other areas are being depleted in terms of purchasing power.

RR: We’re gonna have to default in this and other problems.

PM: That’s what I’m getting, too. It’s a real possibility that eventually the system has to break.

RR: We have to think, as users, about the fault against a variety of social programs… deposit insurance, tension, federal pension and many of the services we take for granted, including healthcare. We have to plan to take care of ourselves personally. We have to plan on the fact society is not going to be able to keep the promises it made us. Default is in the future.

PM: Moving with that sense of color that we’re talking about, turbulent times, I want to move right into just a couple of more questions into an area that is my favorite subject and I’m sure it’s yours. I just want to get your opinion on the new world gold and silver markets that we’re dealing with right now. What are your comments, Rick?

RR: Well, we talked on your show at least twice before, about the fact that gold markets wind in upside blow offs and down markets end in capitulation. I think we can say this week we are in the capitulation phase. I don’t know how long it lasts. This is the 4th capitulation phase I’ve been through in my career. We’re in it. I think the sell off in precious metals in the near term is overdone, so I think we’ll have a rebound, albeit a technical rebound. But, it wouldn’t surprise me to see precious metals go lower after that in reflexive selling. The reason I say that is because, gold and silver prices are increasingly controlled in the futures markets and the futures markets were driven by momentum oriented leverage long carry trades, both in terms of futures and the gld. And, those are unwinding everywhere. So, the pressure in futures markets is the unwinding of these leverage longs, which could have a while longer to go.

I’m not concerned, personally, about the bullion price in the 2-3 year term, but I am concerned in the 2-3 month term, with regards to the precious metal equities. If I’m right, and if in the very near term, the gold and silver market are oversold, they rebound. I would not expect that rebound to extend to the precious metal equities, in the near term. The juniors, in particular, and we’ve talked about this before, enjoyed such a robust gold market in the 2002 – 2010 time frame. The sins that were accumulated by the sector need farther to unwind.

My suspicion is that we are actually going to put in a junior market bottom this summer. My suspicion is also, however, that there’s going to be a long tail coming out of this bottom where both buyers and sellers are exhausted. The appearance of a bear market in the juniors will continue in the 18 months to 2 years because 60 or 70 or 80 % of the juniors are valueless. They need to approach their intrinsic value. And, the shareholders who own those will be punished. However, it is also my suspicion that the market has already begun to bifurcate and the better juniors will begin to creep up in price this fall, not enough so you’ll notice. The population of the good juniors vs. bad juniors is so diminished, the junior market will still feel like it’s in a bear market. Coming up the quality trail, some of the mid-tier producers that have reasonable balance sheets and focused managers, I think, will do extremely well in this market, because they’ll be able to buy second-tier assets from the majors and top-tier assets from the cash strapped juniors.

I see the potential over the next year for some of the mid cap miners to do extremely well through an amalgamation and through old fashioned blocking and tackling. But, I also see trouble at the very top of the food chain. The major gold mining companies have spent an amount of money that is the equivalent of their market cap of over 7 years. And, their production is still declining. They have shown themselves to be inefficient mine operators and deplorable at deploying capital, so I think there’s softness at the top. I think there’s softness at the bottom. I think there’s some strength in the middle. The higher quality juniors, having said that the whole juniors market is in disarray… I think the higher quality juniors, in fact I know this statistically, are selling at the cheapest prices relative to the cash flow that they could generate, at prices established by the futures markets. They’re selling at the cheapest prices they have been selling at since 1991 or 1992. Despite the fact that the overall market outlook is lousy, we’re making selective purchases in the full knowledge that it may be 2 years or 3 years before we get rewarded for that. And we may get substantially punished as we have been for the last 12 months as a consequence of our aggressiveness.

PM: Where can our viewers and readers get in contact with you or learn about some of the products you have?

RR: Yes, absolutely. I would urge your readers in this market to contact me directly. You can do that by emailing rrule@sprottglobal.com. I am, as I’ve told you before, happy as an example, to do as a no-obligation portfolio review of resource stocks whether or not your reader is a client of ours. Also, anybody who wants to, we could subscribe them to our free daily publication called sprott’s thoughts. Any of your readers or listeners who want a portfolio review, email directly rrule@sprottglobal.com.

PM: Thank you, once again for your wisdom and insight, Rick. Until next time, friend, take care.

RR: Thanks for the opportunity to speak, Patrick. I appreciate it.