Tuesday, 3 December 2013

Rick Rule - on Hubris & Bifurcation (plus Stock Picks)

An interview discussing his familiar themes HERE
Also a Transcript of another interview HERE
Plus a lengthy list of stocks discussed in August and older picks at Stockchase

Rule's style can be 'cocky' but he does have consistent messages, warning caution in bull markets and looking for quality and balance sheets at the bottom. He goes with the Sprott party line more nowadays but nonetheless Rule & Sprott have been extremely successful in these cyclical markets

But given the fact that these businesses are so deeply cyclical, what you are going to decide with hindsight looking at this period is that it is ridiculously, ludicrously cheap.  And I think for an investor as opposed to a speculator, being involved at market bottoms is more important than trying to get the timing precise.So we’re looking to allocate aggressively at this point in time in the market, which as you know from previous calls, is a market change from our normal demeanor.
The industry all-in cash costs are now falling fairly rapidly, which is a good thing.  All-in cash cost of course includes acquisition costs, and many acquisitions happened in the 2009-2010 timeframe.  And so the depreciation associated with those ounces with very, very high-cost acquisitions are burdening companies’ income statements, but they’re now being written off the balance sheet.  The second thing is that the cost pressures that were driving the industry in terms of salaries and input costs are falling fairly rapidly. So all-in cash costs are falling, but I suspect that the best quartile of gold producers, that is the most efficient 25 percent, have all-in cash costs that are much lower, all-in cash costs that are in the sort of $900.00 range.  And if we got to $1,500.00 US, that becomes a fairly attractive business.  In particular it’s a fairly attractive business because the best quartile of producers have growth that’s baked in the cake.  In other words they have capital projects that are funded.  They have exploration work that is completed.  And the very best producers, if say they’re producing 400,000 ounces a year today, will absolutely, positively be producing 600,000 or 700,000 ounces four years from now.  And if they can increase their production by 50 percent at the same time that they increase their margins by 30 or 40 percent, and if the outlook associated with the industry is such that the payment matrices—in other words the premiums hat are paid relative to things like EBITDA and production increase—if you get the conjunction of those three factors coming into a market, you’ll see dramatic share price escalations. 
What Goes Around Comes Around…
“In a conversation with Eric Sprott about four or five weeks ago, I was lamenting my own behaviour at the peak in 2010. I observed at the time that it was hard to buy – which probably meant it was time to sell. I even communicated this to clients at the time. And we did sell some at the time – but not our entire position. Why did I hold on when I believed the market would go lower?
“What I learned from Eric was that you never sell everything at the top. This is a consequence of our own confidence and simple hubris. We believe ourselves to be better investors and analysts than the rest. We believe our management teams are smarter than others, and that our properties are of higher quality. We believe our companies have better balance sheets. What happens is that we ride our stocks over the top and then, with some of them, back down to the bottom.”
Were we wrong to think that we owned better stocks than most investors?
“The truth is that the market does not care whether you do or not. And that is true on the way down — and on the way up.
“In the context of very rapid and very violent market moves – particularly on the way down – having the best is very little consolation when your position has declined by 50%.”
So why stay in the sector when the market ignores our expertise at analyzing stocks?
“Once in a decade, natural resource markets fall by at least 50%,” says Rick. “The best investors lose half their money even though they have the best positions. At the bottom the best investors sell the worst of their stocks and redeploy the money among the remaining companies. When markets recover, those portfolios can be up dramatically, compensating them more than handsomely for their courage in the bear market days.”
“Closet Bull Market” May Be Under Way…
Has the market bottomed yet? Rick says the better stocks may have already turned around.
“In my last market update, I said the market would begin to ‘bifurcate’ – meaning the top 10 to 20 percent of issuers would start moving higher, while the rest of the issuers continued to trend lower. This ‘bifurcation’ may already be three or four months old at this point.
“These types of moves may leave behind investors looking for a broad-based recovery in the resource sector, because the overall market will continue to decline, dragged down by the majority of stocks.”
This type of phenomenon is nothing new, says Rick. “As with prior bear market bottoms, buyers are exhausted, which is the reason for lower and lower prices – but sellers are exhausted too. As an example, one stock that we follow closely was recently up 50% on only $300,000 of buying.
“So at this point, we should see some of the better companies begin to receive higher bids, because sellers are scarcer than before. It can take a small amount of buying to change a market cap substantially.”
Beware, nonetheless, that there could be more rounds of selling, even in the better companies, specifically because of tax-loss selling in December, Rick warns.

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