Rick Rule: “Every Billionaire I Know Took Bets Contrary To Conventional Wisdom At The Time That Were Highly Risky”
By December 23, 2013– Published in on
Full Audio Recording Available Here
During a time in which most investors have thrown in the towel on precious metals and natural resources, Rick Rule, Chairman of Sprott U.S. Holdings was kind enough to share a few comments.
Rick noted that during these periods of extreme market pessimism, bets are presenting themselves, “Where you have [a] chance of losing half your money and another chance of making 10 times your money.” Rick further noted that these are the types markets which create billionaires, in that, “Every billionaire I know has been willing to take bets that were contrary to conventional wisdom at the time that were highly risky.”
Here are his full interview comments with Bull Market Thinking’s Tekoa Da Silva:
Tekoa Da Silva: We made it through the fall Rick without the occurrence of an asynchronous event, some type of devastating market crash. Have conditions remained such or changed such that have allowed you to consider some big bets in the natural resource sector?
Rick Rule: We’re ready, willing and able. We have a lot of cash here and we have a belief that industry pricing is such that it is advantageous to us to invest. What’s holding us back has been the issuer’s unwillingness to do financings with us at prices that we think are fair and reasonable.
As we've discussed in prior interviews Tekoa, we prefer at this juncture in the market, rather than doing on-market participation, to participate through private placements to get warrants.
We would like leveraged upside from market bottoms and our inability to obtain warrants related to equity financings has been the primary deterrent from us investing more money.
TD: Rick, you've mentioned in the past that you are a bit older than many of these issuers and can remember the length that some of these bear markets go through. Do you expect the sentiment to change in the months ahead if we remain here or possibly go deeper?
RR: I can only hope. I believe that I can thrive longer not writing checks than they can thrive not cashing checks. Experience certainly teaches me that that’s true. But one never knows. I think it’s going to be 18 months or 2 years before it feels like we’re out of a bear market because I think that the bottom 60% or 70% of the issuers have much farther to fall because they’re not viable.
My suspicion is that even absent either market or issuer capitulation that we have reached a market bottom in the sense of bifurcation, which is where the best of the issuers at least exhaust the sellers and begin to catch bids. It’s interesting if you look at the stock charts in the various investment conferences around the world.
What you saw last year for the junior resource companies was stock charts that all resembled the topographic maps of ski hills, very challenging ones. It’s steeply dipping from the upper left to lower right.
What you see now in about 30% of the conference exhibitors are stock charts that go flat line from left to right resembling I guess if you will the electrocardiograms of dead people. What that means is that we’ve reached the part in the market where the bear market has played out with the exhaustion of buyers. But you also have an exhaustion of sellers. You have sideways stock charts on very low volume either way.
And we’re starting to see the odd incidence of a melt-up in this market. We’ve see meltdowns for three years where there was a preponderance of sellers over exhausted buyers. Now you’re starting to see melt-ups where the odd buyer comes in the market and there’s nobody left to sell.
This is a classic sign. Capitulation with seller exhaustion…and I think it’s indicative of where we are in the market. The thing that would confirm it for me would be either or both a market capitulation which we’ve talked about before as sort of a two-week tumultuous sell-off which could occur right now in the context of tax-loss selling but hasn’t, or else it’s issuer capitulation where the issuers, rather than trying to do a private placement that will keep them alive for five months, until in their minds the cycle turns, would rather finance for the two or three-year timeframe. In other words, try and move their company forward irrespective of the dilution that they incurred.
If either of those events or preferably both of those events took place, it would be easy to say, “Bang! We put in the bottom, clear sailing from here.” But we haven’t seen that yet.
TD: Rick, if I can ask you about two chapters in Benjamin Graham’s The Intelligent Investor, Chapter 8, Market Fluctuations, and Chapter 20, The Margin of Safety. For most of my life the word “margin” meant that red line on a sheet of paper that you don’t write to the left of. But in investment terms it means much more than that. What is the margin of safety? What does it mean to you Rick?
RR: Well, margin of safety is a wonderful phrase and the interesting thing about margin of safety is that you can apply it in many ways to merit many different kinds of businesses. Traditionally, the margin of safety in exploration stage companies comes from three things. It comes from an intangible called human capital and your margin of safety there is—have these guys done this before? Is the management team practiced and experienced in a task that is almost precisely the same as this task? In other words—do you have more than sufficient human capital to discharge the task at hand?
That’s an intangible. A tangible is if the answer to the unanswered question, that is if the way the management team proposes to add value can be accomplished for a certain sum of money over a certain period of time, is the company amply financed? This is the classic margin of safety in the Ben Graham circumstances.
In other words, if answering the unanswered question takes $5 million including capital costs and G&A during the period that the unanswered question is being answered, does the company have enough money that they can afford a foul-up? Do they have $7 million or $8 million? If the answer to that question is no, you do not have adequate margin of safety. The third way that margin of safety works in junior resources which was never anticipated by Ben Graham or perhaps it was when he discussed redundant assets is, “Are there residual values in the property, residual optionality as an example that isn’t figured into the share price?”
One thing that has happened to us in the past is that we have invested in companies that had mineral projects, where in addition to the mineral projects, the company has actually owned the land and in two or three occasions, what happened is that as a consequence of making investments in very, very, very small cap junior mining companies, we got control of the simple land where the real estate values exceeded the ultimate realizable value of the mineral rights. Our margin of safety there was the fact that we were able to sell the real estate and recapitalize the company. That’s a different way of figuring out margin safety.
It’s a very, very, very important concept. Speculators are of course always taught to look to the upside in every investment and it’s important to know the upside so that you understand whether the risk is worth taking. But the successful investor looks at the downside and the downside is best measured by margin of safety as you rightly point out in Ben Graham’s Chapter 20.
TD: Rick, last time we spoke you mentioned that Eric Sprott is now looking at marginal gold producers who make money at $1400 an ounce or higher, and getting really aggressive in that area. Graham talks about the “fair weather investments” being the greatest loss to most investors. But to the professional operator, he knows that those declines of 80% to 90% offer value of four to five times market quotations. So is this setting up to be another example of the many times in your career that you’ve seen that play out?
RR: Well, time will tell. Eric is making an extremely time-sensitive investment and I am much less likely to make those, which is probably why I work at a place called Sprott. He doesn’t work at a place called Rule.
For myself, I would be making investments probably more related to optionality where my anticipation was that I would hold an asset for four or five years like we did in Lumina Copper.
Eric is making a very different bet. Eric is making a bet that we’ve reached the capitulation point in precious metals and that the precious metals will pivot sharply higher in the next 12 to 18 months.
Eric rightly points out that by putting sort of $50 million into this bet, that only one of two things will happen. He will either lose a substantial amount of the $50 million he put up, past being prologue, or he will make an extraordinary amount.
Now the bet he is making for somebody who can afford the bet is pretty attractive. The idea that he might lose 50% of $50 million or $25 million, is certainly not a pleasant outcome.
But juxtaposed against that is the fact that if he is right about the timing of the move in precious metals and the quantum of the move of precious metals, he could easily turn that $50 million into $500 million and a bet where you have one chance of losing half your money and another chance of making 10 times your money to the extent that you can afford to make that bet—that’s how you build businesses like Sprott.
TD: Rick, if I can ask you about the concept of becoming rich to be blunt, based on your experience, what are some of the characteristics that you feel lead to becoming rich as an outcome?
RR: Not focusing on becoming rich is one. Focusing on delivering value. You gain utility by providing utility. Simply put, if you make rich people richer, they will make sure that you get rich. So I think [it’s] doing something that you love that adds value to other people, so that your work isn’t work. It’s something that you can’t help but do.
People look at me and tell me I’m an extraordinarily hard worker. The truth is in a conventional sense, that is with regards to my vocation as an obligation, I’ve never worked a day in my life. I’ve only had fun.
I have expended a hell of a lot of energy having fun and I’ve made stupendous sums of money, but it has to do with the fact that I really like what I’m doing. So it’s very easy to add utility for others because it’s like playing for me.
The second thing is that particularly earlier in your career, you must be thrifty. You can’t be a capitalist if you don’t have capital and if what you want out of money is bass boats or fancy clothes or vacations, you’re doomed to being upper middle class at best.
If what you want with money is to make money, as opposed to spend money, what you learn is that compounding interest is truly the eighth wonder of the world but you can’t enjoy compounding interest if you don’t have any principal.
So to become rich, one must save and one must save absolutely ruthlessly, absolutely ruthlessly. One must save every paycheck. One can’t defer savings. One can defer and must defer spending but you cannot when you’re early in life defer savings.
It’s important to teach your children to save and to save every week. It’s critical if you want your children to be rich. I’m not trying to say that being rich is the be-all, end-all. The third thing, getting from rich to being really, really rich is that you have to take chances. I’ve had the good fortune in my life to know 12, 15, 20 self-made billionaires and what segregates the billionaires, what segregates the people to get that last digit is guts.
You have to take risks. You have to see a situation that you think has outsized possibility of reward and you have to really, really, really swing for the fence. I’m reminded of George Soros who said that he became a billionaire by finding “broadly held public precepts that were wrong and betting against them,” when he had the cash and the courage to stay the trade.
Before he beat the Bank of England on his raid of the British pound, he had a negative margin carry of I don’t know, $40 million, $50 million a month for a long time. It was a lonely expensive trade and his partners were very, very, very critical of him until he made several billion dollars when he won.
Every billionaire I know has been willing to take bets that were contrary to conventional wisdom at the time that were highly risky. Another example would be John Paulson when he was short the housing market.
You remember John Paulson sort of got short US housing in 2006 and he was a lonely human being in the period 2006 to 2008. Every month, he was writing millions of dollars of checks on a margin carry on his bet.
Now, ultimately he made his investors $20 billion but he made his $20 billion by risking his entire fortune, a lot of money from his investors and his entire reputation over a two-year period of time. To get from being rich to being very rich, you have to take big, concentrated bets.
TD: Rick, for people that are looking for other people to invest in, what do you look for in deciding whether or not you should give your capital to someone whether it be the CEO of a company or otherwise?
RR: Passion, curiosity, experience and diligence. Passion meaning that you don’t want somebody working for you who works eight hours a day. You want somebody who thinks about what they’re doing 24 hours a day.
Diligence means somebody who isn’t satisfied having an opinion with regards to the big picture, but in fact has done a deep dive and done due diligence on their specific area of investment expertise.
Money is made in the micro, not on the macro. Determination, you need somebody who can overcome what are going to be inevitable difficulties, somebody who isn’t discouraged but somebody who is really, really, really tenacious.
And curiosity. When you think you know everything about something, you’re set up to lose a lot of money. There are always facts that you don’t know. There are always people who know more than you. The facts always change. You have to keep up with them.
So the good investor’s mind is constantly curious. The good investor is always starting conversations and is shutting up and listening to gather more information about other people. Looking not for information that supports his or her existing paradigm, but rather information that challenges the paradigm and alters the paradigm.
TD: Rick, as a final question, what might be the competitive advantage that listeners, people out there, could enjoy by pooling their capital with you and Sprott U.S. Holdings?
RR: Well, I would certainly argue that the Sprott organization has built itself over 30 years by being both contrarian and aggressive. We’ve had a point of view. We stuck to that point of view. We’ve done one thing for 30 years. We haven’t tried to be all things to all people. We’ve tried to be thought leaders in natural resources and precious metals.
So we certainly have the focus. We certainly have the tenacity. We certainly have the curiosity. We certainly have the track record.
Somebody who decides to invest with us must be tolerant of cyclicality. They must be tolerant of volatility. They must be tolerant of the fact that we invest in countries that some people can’t spell and other people are terrified of when they see them on the nightly news and they need to be tolerant of the fact that what we do is extremely capital-intensive.
When we deliver a good year, we deliver historically outstanding years. But given the fact that what we do is risky and volatile – in baseball parlance, what we do is we stand very, very, very close to the plate as batters, to rattle the pitcher, to get them to throw up soft pitches. But if the pitcher throws an inside fastball, we get hit in the face.
Investors need to be willing to exhibit the same traits of persistence, tenacity, and courage that they would expect of us, in order that we could have a mutually beneficial relationship.
TD: Rick Rule, Chairman of Sprott U.S. Holdings, thanks for sharing your comments.
RR: Tekoa, always a pleasure. Thank you.
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Tekoa Da Silva
Bull Market Thinking