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Rick
Rule, the renowned resource investor who founded Global Resource Investments,
returned to cyberspace last week for a webcast in which he explored some of
the implications for resource investors when two megatrends from opposite
ends of the socioeconomic spectrum collide. This phenomenon will inevitably
result in incredible market turbulence, Rick tells us, and, in the context of
the ancient Chinese curse, some mighty interesting times.
It was
on a dark and stormy night in 1752 when Ben Franklin took his kite out to
snag lightning from the sky and prove that it's a stream of electrified air.
It led to his invention of the lightning rod as a means to protect people,
buildings and ships against this dangerous force of nature. Ben's experiment
took courage. It also took appreciation of what he was dealing with and
wisdom enough to do it safely. In short, he was prepared—and his
preparation paid off.
Fast-forward 259 years. Rick Rule, the widely known and
well-respected founder of Global Resource Investments (GRI), tells investors
that such qualities will serve them well over the next year or two, as
markets become ever more turbulent. Returning to cyberspace for one of his
popular webcasts last week, Rick warned of extreme volatility ahead, in the
broad economy generally and in the natural resource market in particular.
Girding for the violent roller-coaster ride he foresees calls for both
emotional fortitude and financial preparation, he says, suggesting that
investors make up their minds now to stay on the sidelines if they don't have
the stomach and the cash to climb aboard.
"The bottom line is that your own financial and
psychological preparedness for dealing with volatility will determine whether
you come out of the next year or two substantially better off—or
substantially worse," Rick says. "It's your responsibility to
determine your response and hence your own financial future."
Psychological Ammo
On the psychological side, as he has pointed out in the
past, Rick believes that the nature of profiting from volatility lies in
being "on the other side of the trade."
"When the market is rising and your stocks are
behaving in a way that generates uncontrollable greed," he says, bring
in another element of the psychological-preparedness equation. "Begin to
react with fear," Rick says. "Take some profits. When stocks go up
50%, 100% or 200% with no underlying reasons justifying those moves other
than the market phenomenon of more buyers than sellers, move the cost of your
position to zero."
Rick dubs that zero-cost position "the point of no
concern," at which time you can sell enough to make what you retain
virtually cost-free. He readily acknowledges that it's tough to unload a
stock that's grown from, say, an initial investment of $10,000 two years ago
up to $60,000 and is still on the march. But if the increased
"value" is merely a function of the fact that the market is
"in melt-up mode," he tells investors to ask themselves whether
they'd spend $60,000 to buy those shares now. If not, sell some. "It's
difficult psychologically to sell a stock that's performing well. It feels
good and you're afraid of missing out on a potential quantum move," Rick
says. "But this is precisely the time to take some money off the table
and prepare for the other eventuality."
In addition to giving savvy, disciplined investors the
opportunity to buy at a discount, market volatility also enables them to mark
up equities they bought low and sell them to others for substantially more.
"So take partial profits in the manic melt-ups," Rick advises,
"and establish new positions in the panic meltdowns." To do so, he
says, "manage your own temperament, be disciplined and pay attention to
reality—not the noise of the market."
Cash Up
And you must have cash, he adds. Despite the fact that the
U.S. dollar is losing value (particularly with the help of quantitative
easing [QE] initiatives) and real interest rates are at minus 4% or 5%, he
tells investors to hold cash as ammunition in a market crash. "Although
you get penalized for maintaining liquidity—as investors should recall
from the 2008 liquidity crunch—when the market collapses, cash is the
only thing that gives you the fiscal and psychological strength to
react."
He further recommends maintaining some liquidity in
physical gold and silver and their proxies. "It's not in anticipation of
profiting from a run in gold and silver prices—although that isn't a
bad aim either—but because they increasingly constitute good cash in a
world where many forms of cash aren't so good."
In terms of equities, Rick advises investors to establish
wish lists of stocks that you may not want to buy except at a 50% to 60%
discount. "The nature of volatile markets is that the markets will give
opportunities to buy bargains in the next two years if you have cash and the
courage to take advantage of the opportunities."
Selectivity or Bust
Furthermore, he advises being "extremely
selective" with equities, particularly junior equities. "You need
to be asset-centric versus story-centric with junior equities, or at least be
involved in exploration endeavors run by experienced exploration
professionals, in companies that have successful track records and adequate
capitalization." According to Rick, the bull market that junior equities
have enjoyed over the past 12 to 14 months "has been unblemished by
selectivity, with 80% to 90% of mineral juniors having no net present value.
They're absolutely worthless. They've increased in price because the 'mineral
exploration industry' and the financial services businesses that surround
them can tell sexy stories. When moving from a greed-induced bull market to a
fear-induced sector decline, the value of these stories goes to zero."
Back to the Future
Drawing upon some fairly recent history, Rick recalls
"how we all confused the bull market for brains" in 2006. "Had
we simply felt a little less smug in 2006 and a little more aggressive in
2007," he says, "we would all be substantially wealthier than we
are today."
Looking back on 2007 and 2008 and remembering the
liquidity squeeze in the markets when confidence disappeared and euphoria
evaporated, he advises investors to take a lesson from history. "Think
about your own reaction to a replay of those circumstances," he says,
"because the preconditions of that collapse haven't been
addressed." Individual, municipal, state and provincial, national and
international debts have risen rather than contracted, he says, noting that
the ability of societies to service their debts contributed to the problems
of 2007 and 2008. For instance, he points out that Greece couldn't afford to
service debts at 115% of its GDP, and they're hardly better off now servicing
debts at 150% or 160% of GDP.
Rick anticipates a powerful replay of the problems that
led to the financial collapse of the last decade, impelled by the inevitable
collision of two megatrends that he compares to enormous weather systems. The
first involves the "very challenged
economies" of the developed world and their aging populations.
Western Woes
Unwillingness to save for the future coupled with a
penchant for people to live beyond their means in the U.S., Western Europe
and Japan—even before the devastation that began there on March
11—have thrust nations of the western world into "an unfortunate
position of consuming more wealth than they generate," Rick says. After
some 70 years of "welfare state" programs distributing what were
perceived as the excesses of economic gains, those programs will shrink or
cease, further eroding standards of living. Rick expects serious, even
violent, reactions to erupt among citizens who regard government-funded
programs as birthrights and who won't take kindly to compromised lifestyles.
"Furthermore, the fact that these challenged economies and their constituents
have failed to save seriously diminishes their already-compromised ability to
respond to "exogenous black swan events"—because adaptation
requires strong systems capabilities and lots of savings.
For instance, with Japan's debt already twice the size of
its GDP, Rick wonders where the $240 billion (or more) will come from that it
needs to rebuild. Countries in the developed world have fewer and fewer
savings to bounce back from events such as the earthquake and tsunami in
Japan, he notes, suggesting that other black swans are hovering. In addition
to the situations that have erupted in Egypt, Tunisia, Yemen, Libya, Bahrain
and elsewhere—which will give rise to a “black swan on
steroids” were the citizens of the United Arab Emirates, Kuwait or
Saudi Arabia to follow suit—crises waiting in the wings include:
- The
potential failure of state-owned enterprises and events that will strike
in the context of local and state government bankruptcies in the U.S.
- Events
that will strike as a consequence of foreign sovereign failures in
places such as Portugal, Ireland, Greece and Italy.
In addition,
the U.S. is coming face-to-face with its inability to service pension
obligations that have been promised but not funded for the last generation.
"This is truly an ugly set of circumstances that requires substantial
savings to deal with," he summarizes, "and the savings don't
exist."
Damned Either Way
And quantitative easing, because it devalues the currency
practically by definition, undermines what meager savings do exist in the
U.S. and other Western economies. Rick sees a "damned if you do, damned
if you don't" situation. "I don't think we can continue
quantitative easing and I don't think we can afford to discontinue it either.
I really sort of expect that we'll end up having QE90," he continues,
"and I don't like the potential of that. Not just in the context of the
U.S. dollar, but in terms of the Western world standard of living."
Without quantitative easing, he points out, interest rates
would inevitably climb. Federal, state and local governments in the U.S. are
already challenged to service current debts in a no interest rate
environment—or with real interest rates even at negative 4%–5%.
"If the real interest rate poked its ugly head up," Rick says,
"I think we'd see widespread defaults. I also think that large numbers
of individual citizens still owe substantially more than they can service as
a function of the predilection for enjoying standards of living beyond their
means."
He imagines, for example, what will stem from an increase
in the cost of servicing mortgages. As for the 30%
of U.S. housing stock that's believed to be under water in terms of the
current value of those homes relative to the mortgages held on them, he says
that he'd expect a sharp drop in residential real estate prices and a
corresponding hike in the number of homeowners who simply mail their keys
back to the bank.
To Be Rich Is Glorious
Meanwhile, on the other side of the globe, China saves
nearly half of its GDP. A few years ago, a Morgan Stanley Global Economic
Forum report discussed the shift in the mix of global saving away from the
"rich countries of the developed world toward the poor countries of the
developing world." The latter group, accounting for only 19% of world
GDP in 1996, saved to the tune of approximately three times their weight in
the world economy. The report said that the U.S. "stands out for extreme
negligence on the savings front (with) by far the lowest domestic savings
rate of any major economy in the developed world," while in contrast,
"the major countries in the developing world have increased gross
domestic savings from 33% in 1996 to 42% in 2006. Among those, China's gross
domestic savings rate rose from 40.5% to 50% in 2004." And of course,
savings isn't the only economic indicator on the rise in China. Between 1989
and 2010, its GDP growth averaged 9.31% per quarter, and was up to 9.8% for
Q4 2010.
China probably serves as the best—and certainly the
most prominent—illustration of the second enormous weather system on
Rick's radar. It's part of a broader front emanating
from what he calls "emerging markets' liberalization," a phenomenon
taking hold in fits and starts in developing nations around the globe. China
started down the capitalist road in 1979, and the post-Mao mantra introduced
by Deng Xiaoping, the paramount leader of the People's Republic of China then
and throughout the 1980s, set off what Rick describes as "the greatest
boom we've seen in my lifetime."
As Rick sees it, Deng wasn't seeking to diminish his power
when he said, "To be rich is glorious"—words that sent a
signal to the senior bureaucracy that the Chinese people should be a little more free and a little more self-reliant. Since the shift
in sentiment, China's economy has grown to 10 times the size it was then,
300% just in the last decade, and per-capita incomes are rising every year.
This second megatrend that Rick identifies contrasts
markedly with the declining fortunes and retreating standards of living
underway in the developed economies. Nations that didn't benefit from the
economic miracle of the last 70 years are beginning to experience one now, he
says, as political liberalization is taking hold in fits and starts in emerging
markets around the world. "It may be just a little more free," he
says, but as China, India and Brazil have shown, "when these societies
become a little more free, they become a lot more rich; a little less
constraint and a little more self-reliance generate absolutely incredible
economic growth."
Demographics also enters the
picture. As Rick puts it, "The Western world is old, fat and lazy; the
emerging markets are not only becoming more free, their people are
younger," with a greater proportion of them in the wealth-forming rather
than wealth-consuming years of their lives.
He cites yet another factor tipping the scales in favor of
the developing economies. "As a consequence of the previous series of
busts," he says, "financial institutions were less likely to
advance credit to third-world nations. Being deprived of the ability to
borrow, many of these nations built enviable balance sheets. The U.S. was not
so lucky. Everybody in the world loaned to the U.S., and it took all comers.
As a result, the ability of countries such as Madagascar, Myanmar and
Suriname to service their debts is substantially greater than the U.S."
Rick expects the developing nations' phenomenon stemming
from these forces to be a boon to the resource sector in particular, and he explains
why.
Resource-Intense Lifestyles
In the Western world, Rick says, wealthy people who get
wealthier tend to spend their money on services, but prosperity at the bottom
of the economic pyramid "really benefits those in the resources
business." The ability of these billions of people to enjoy a better
lifestyle is increasing fairly rapidly, he says, noting that the lifestyle
they seek involves things that demand not only energy but many other
resources. They're spending their growing wealth on "things that require
stuff."
"Per capita demand for resources is expanding very
rapidly as a consequence of rapidly expanding incomes," Rick observes,
because "when people get more money, they consume more calories, which
drives agricultural demand, fertilizer demand, water
demand. They may upgrade their Visqueen houses to
cinderblock houses or houses with wood or metal roofs."
He cites, too, the fact that India and China are building
national highway grids, selling large numbers of vehicles and building
infrastructure. "And they're the tip of the iceberg," Rick
emphasizes. "Other countries are on the same path, such as Indonesia,
which has 230 million people." The fact that for the first time billions
of people increasingly have the means to compete for the standard of living
the Western world has enjoyed will increasingly drive up the prices of
commodities, Rick says.
Throughout his illustrious career, Rick has encouraged
investors to summon the courage to buy whatever the masses of investors are
snubbing. "It's the panic markets that offer the best opportunity to buy
good assets and solvent companies at extraordinary discounts," he
professes. "Act in panics. More often than not, the huge gains come with
having the courage to buy when nobody else is buying."
As Rick sees it, "The ascent of emerging markets and
the ascent of people in emerging markets are as bullish for resources as the
other megatrend is bearish." The intensifying emerging markets' dynamic
is propelling demand for all forms of resources—water, agriculture and
metals. Their demand is increasing rapidly and their capabilities are
expanding at the same time that "we in the West are destroying demand
and destroying capabilities."
And as he says, count on "incredible turbulence and
incredible variability" as the commodities supercycle,
fed by the developing nations, comes up against the secular bull market
enveloping the Western economies. "Both the risks and the rewards will
come much more frequently and with much more urgency," he predicts.
"This market will give you extraordinary opportunities to either make or
lose money. Your response will determine whether the next two years are
extremely pleasant or unpleasant for you." It could turn out otherwise, he
says, but he hopes that in 10 to 15 years "we can look back on this as
an exhilarating and profitable experience."
"In the context of the Chinese curse," Rick
concludes, "these are very interesting times, times that will favor the
prepared and the bold, and be catastrophic for those who are neither prepared
nor bold."
Founder and CEO of Global Resource Investments (GRI), Rick Rule
began his career in the securities business in 1974 and has been principally
involved in natural resource security investments ever since. He is a leading
American retail broker specializing in mining, energy, water utilities,
forest products and agriculture. Rick's company has built a sterling
reputation for its specialist expertise in taking advantage of global
opportunities in the resources industries. Last month, Rick closed a landmark
deal with Eric Sprott, another famous powerhouse in
the arena. With GRI now a wholly owned subsidiary, Sprott,
Inc. manages a portfolio of small-cap resource investments worth more than $8
billion and boasts a workforce of more than 130 professionals in Canada and
the U.S. This article is based on Rick's Global
Resource Investments webcast, Monday, March 21.
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