Sunday, 7 December 2014

Sprott's Rick Rule interview with Tekoa Da Silva - On Speculative Profits

Widely linked around the blogs already this is an excellent interview with Rick Rule picking up on many repeated themes and more. The transcript (on the link above) is pretty complete but listening to the interview is worthwhile and probably more worthwhile in a few years time in any improved market. Some more notes below......

Rule, by all accounts, is extremely successful in the resource space and it has made him very wealthy, he is here to sell his, and Sprott's, superior investment skills so give him your money.
There is a certain swagger, which can irritate but following Rule's interviews over time I think there is some real candour, about his own failures and the reality behind the 1,000's of poor junior companies in the market. I have seen him advising caution at the tops rather than pumping, and pointing to the buying opportunities to be found as a contrarian towards the bottoms, but as he admits there is a difference between inevitable and imminent, he is often early and at the tops his own hubris stopped him selling all he should. There is good discussion of recognising your own character as trader, investor or speculator.
We’re in a very interesting situation from a valuation viewpoint. The best 300 of the juniors out of the 3000-junior universe are not merely cheap; they’re very, very, very cheap. So while the stage is set for a move to the upside from an empirical point of view, in the near term, markets aren’t driven by empirical data. They’re driven by emotion.
So any further weakness we could see in commodity prices, in particular weakness as a consequence of a strengthening US dollar, could push us over the edge again into a capitulation, which I think is a condition for a higher market.
 We’ve already seen a transition from weak hands to strong hands, but we need one more emotional sell-off I think in order for the market to clear and move higher.
people’s expectation of the future is set by their experience in the immediate past, and if all of your experience in the immediate past is negative, the expectation you have for the future is that you’re going to get spanked again.
If you own stock that is recommended by a newsletter writer, and the editor (or an investment conference) generates a response in the stock, you’re wise to sell. Very often a newsletter recommendation can cause a stock to trade up by 25%. We call it “newsletter syndrome.” Using that response to sell the stock and then waiting five or six weeks until the response intended by the newsletter writer subsides, before buying back the stock can be a very good way to trade. I did that for years when my business was small enough that I had the time to do it. I can’t do it anymore but there’s nothing to stop our clients from doing that. Conversely, a position in a company that has been held for a long time by newsletter subscribers who are suddenly advised to sell can cause a stock to move down by 25% or 30%. What has really changed is simply the editor’s opinion of the company. It doesn’t necessarily mean that the company has changed. So utilizing sell recommendations by newsletter writers is still a technique that I employ to the extent that I see a stock come off a lot that is on my acquisition list. Certainly you should study the reason for the recommendation and test it against your thesis. But if you believe you are right and they are wrong, they may be giving you a 25%-off-sale, which is very, very good. 
With regards to what happened in Burkina Faso, the probability of that set of events being unpleasant for mining is very small, and so it’s pretty obvious to me that the sell-off engendered an opportunity.
Having the cash and the courage to make a binary bet in an extraordinarily bad situation where the juxtaposition of risk to reward is $.20 cents on the downside and $10.00 on the upside, is a set of circumstances that everybody should be lucky enough to have once or twice in their career. I have made bets like that successfully in places like Congo, the Ivory Coast, Sudan, Ethiopia, and Eritrea. I made a bet in Afghanistan and had the other kind of experience—I lost all the money I put up. 
The big opportunity in streaming and royalty as I see it is the delta between the market valuations and free cash flow.there’s a $20 billion opportunity in the market right now for big streaming companies that can afford to do $2-$3 billion sized transactions; to buy streams from base metals producers of byproduct precious metals production, in transactions that simultaneously lower the cost of capital.For base metals producers, it allows them to put mines into production at a lower cost while enhancing the visibility of free cash flow on a per share basis. This is a $20 billion opportunity and I see it being realized over the next two or three years. This is a catalyst to change the affairs and valuations of the senior streaming companies.  
The junior streamers will have to inhabit a different place in the landscape. They’ll have to be more aggressive, they’ll have to fund definitive feasibility studies and development, and they’ll have to take on smaller but attractive opportunities. They also won’t be able to avail themselves of the single greatest opportunity in the streaming trade that exists today, which is the arbitrage of the insane delta between the valuations of free cash flow as a precious metal stream or as base metals free cash flow. 
“How do I make money here?” It caused me to think about the process of making money. Do you make it when you buy or do you make it when you sell? What are the ingredients required to make money as an investor based on your experience?I think you start by examining yourself and the environment in which you’d like to make the money. There’s a bunch of ways to make money in the markets. I myself am not particularly suited to trading. There was a point in time where I did more trading because I had less capital. But I am by nature a capitalist, which means I employ capital for the long term, and I’m a speculator. I have also learned techniques that are suited to my personality. One thing I understand well is that the process of speculation involves accepting failure. It involves accepting the fact that six or seven out of ten of my decisions will end up being bad. I am willing to accept 20% to 30% losses on 60% to 70% percent of my positions. Conversely, one or two out of ten may provide returns that more than make up for these losses. I’ve also come to understand the admonition I’ve told you so often Tekoa, which is that you have to be a contrarian or you will be a victim. Another truth in resource markets—at least if you’re Rick Rule—is that you will not sell as much at the top as you should. A rational person would look at the fact as I did in 2011—that there wasn’t much to buy, and that in itself should mean they ought to be selling. Did I sell enough? No, I didn’t. Hubris set in, and it will again for sure. My thinking was that, I’m a better analyst than the other guy, and I am. I think that I back better management teams with more discipline, and I do. I think the balance sheets of companies I invest in are better than others, and they are. I think the projects my analytical team helps me choose are better than the competition’s, which is also true. But none of that matters when the market goes down. When the market goes down, everything goes off the bridge. The fact that I sold 30% or 40% of my positions at the market top doesn’t excuse the fact that I held 60% or 70%. The 60% or 70% I held lost me 50% or 60%. But the interesting part of being a contrarian is this: Once every 10 years you experience a 50% decline in the value of your speculative holdings. I believe that’s followed four or five years later by an inevitable up cycle where you make a five or tenfold return. So let’s think about the arithmetic associated with that. Let’s assume that you start the exercise with $100,000 and you draw it down to $50,000. Then you turn the $50,000 into $250,000 or $500,000, which means what you ultimately did was turn $100,000 into some amount of money between $250,000 or $500,000 or better. Now what part of this bargain don’t I like? Of course the part I don’t like is the fact that it goes down. But the fact is that it’s going to go down and you have to accept that. The other arithmetic people need to take into account if they’re going to be speculators — not investors but speculators — is that most of the investment decisions they’re going to make will be wrong. They have to understand that you need to “court” risk in order to generate alpha because it’s the risk that generates reward.
I know what I always get wrong. What I get wrong is that I’m entirely empirical and entirely rational. My fault is this: I confuse two words, which are “inevitable” and “imminent”. So I’m always too early on the buy side; it can also lead to being too early on the sell-side, though, as the example of 2011 illustrates, not always. When I say you can’t get everything right, I mean that if you are a good buyer, sometimes you can get a market bottom. But if your psychological makeup is that you’re going to catch a market bottom, you’re not going to catch a market top on the sell side. That’s just the way it works. If you’re a good trader, you’re going to cut your wins before they’ve fully matured. You’ll cut your losses too probably, which is a good thing. What’s more important is for people to understand their own emotional makeup and how that makeup is going to govern their actions in the marketIt’s important for one to compensate as best as they can for their psychological makeup by a disciplined plan of speculation, which will enable them to use their own skill sets and prejudices to their advantage as opposed to being disadvantaged by who they are. 
The biggest risk is to the left of your right ear and to the right of your left ear. ....The biggest risk is not being able to work hard. The biggest risk is “got a hunch, bet a bunch”. The biggest risk is going into a speculation without a plan, not knowing why you made the investment, not knowing what would cause you to sell, both in terms of success or failure. Indiscipline is a big risk. If a stock goes down, does that mean you sell it reflexively or does it mean you reexamine your premise and buy more if you think you are right and the market is wrong—because the market is frequently wrongRemember that making money in speculation is done by taking advantage of the delta between opinion and fact. It has been said by many knowledgeable observers that the market in the near term is a voting machine. In the long term it’s a weighing machine. Speculative profits are the delta between the way people vote (which is always stupid) and what stuff weighs.


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