Rick Rule: The Case for Underinvested Commodities | Oil, Nickel, and Zinc

Key Concepts

US Dollar Purchasing Power Decline: Projected 75% decline in the US dollar's purchasing power over the next 10 years, mirroring the 1970s.
Gold as a Store of Value: Gold is expected to perform well both absolutely and relatively due to fiat currency devaluation.
Gold Cycle: Gold may be short-term overbought but is considered a good entry point for long-term investors.
US National Debt: Significant on-balance sheet and off-balance sheet liabilities ($150 trillion total) pose a risk to the US dollar.
Commodity Complex: Focus on "hated" commodities with potential for catch-up trades, including oil, gas, nickel, rare earths, and zinc.
Oil and Gas Investment: Underinvestment in sustaining capital is creating future supply constraints, making oil and gas attractive.
Mining Investment: Emphasis on high-quality, low-cost producers with strong balance sheets and return on capital employed.
Nickel Market: Attracted to sulfide nickels and high-quality laterite deposits with rational environmental standards.
Copper Market: Long-term structural deficit expected due to underinvestment, despite current economic softness.
Zinc Market: Volatile but attractive due to its tendency to run when tight and the potential for new production.
Uranium Market: Long-term price appreciation expected due to underinvestment and the increasing irrelevance of the spot market.
Battle Bank: A new bank offering interest on checking accounts, flexible retirement account investments, multi-currency savings, and bullion-backed lines of credit.

Summary

This discussion features Rick Rule, an analyst, investor, and founder of Rule Investment Media, sharing his perspectives on the gold market, the US dollar, and the broader commodity complex with Palisades Gold Radio.

Gold Market and US Dollar Outlook

Rick Rule forecasts a significant decline in the purchasing power of the US dollar, estimating a 75% drop in absolute terms over the next 10 years, drawing a parallel to the 1970s. He believes gold will perform exceptionally well during this period, both in absolute terms and relative to other currencies. While acknowledging that gold might be short-term overbought, he considers it a good entry point for investors with a five- to ten-year horizon. For traders, he advises taking profits if holding a position over a long weekend.

Rule's conviction stems from his 50 years of experience, observing that gold thrives when savers and investors are concerned about the deterioration of purchasing power in fiat currencies. He notes that while the US dollar may perform in line with other currencies relatively, its absolute purchasing power will diminish. The 1970s saw a 30-fold increase in gold prices during a period of significant dollar devaluation, and while he doesn't predict a similar magnitude, he suggests a three-fold nominal increase in gold could mirror the dollar's purchasing power decline.

US National Debt and Fiscal Concerns

A key driver for the dollar's decline, according to Rule, is the alarming state of US national debt. He highlights that on-balance sheet debt relative to GDP is higher than in the 1970s. More critically, he points to off-balance sheet liabilities such as Medicare, Medicaid, Social Security, and pensions, which the Congressional Budget Office estimates at over $120 trillion. Combined with on-balance sheet liabilities (approximately $30 trillion), the total debt burden reaches an estimated $150 trillion. This figure is juxtaposed against a federal income of only $5 trillion, presenting a dire fiscal arithmetic.

Investment Strategy and Risk Management

Rule discusses his recent decision to derisk his portfolio by selling 25% of his highly speculative junior holdings. This move recouped all his invested capital in the sector over the past five years, effectively trading 25% of his upside for 100% of his downside protection. He is reallocating half of these funds into physical gold and top-tier gold equities like Franco Nevada, Wheaton Precious Metals, and Agnico Eagle. The other half is being invested in the oil and gas sector, which he describes as "hated."

He clarifies that while he believes speculative juniors will likely outperform the majors over time, his priority is to reduce downside risk and capture the "beta" of gold while reducing "alpha" exposure.

Framework for Taking Profits

Rule's framework for taking profits is not solely based on intrinsic value, especially for exploration-stage companies. He considers market sentiment and capital formation windows. When the market is signaling that "your money is worth more than their paper" through widespread financings, he views it as an opportune time to take profits. He acknowledges that taking profits too early might be a mistake in the long term but emphasizes that "no one ever went broke taking profits."

Commodity Complex: Opportunities and "Hate"

Rule identifies several commodities that are currently "hated" and present opportunities for catch-up trades:

Fertilizer Complex (Nutrients): Considered too cheap, with potential issues in the potash market due to geopolitical factors.
Nickel: Attracted to the market due to its "hate," anticipating that environmental codes in Indonesia and the Philippines will impact the cost of laterite nickel production.
Rare Earths: Focus on high-quality deposits outside of China, driven by rising Chinese costs and geopolitical considerations.
Zinc: Punishes the faithful, running significantly when tight but collapsing thereafter. He notes the potential moderation of demand due to new production at Kapushi and Chinese capacity expansion.
Oil and Gas: This is his primary focus, citing underinvestment in sustaining capital to the tune of $2 billion per day globally. He believes this will lead to future supply constraints.

Oil and Gas Sector Deep Dive

Rule is particularly bullish on the oil and gas sector, viewing it as the "best of the resource businesses" and "cheap cheap cheap." He uses Exxon as an example, believing it is undervalued at $60 oil, potentially selling at a 50% discount to its net present value. He anticipates Exxon's net present value to double in three years, partly due to its discovery in Guyana. He sees this as an opportunity to buy a major company with a long reserve life (15 years) at a discount, offering a potential "five-bagger" return without the high risk of junior explorers.

He contrasts his view with that of environmental advocates, arguing that fossil fuels will remain the dominant energy source for the foreseeable future, despite significant investment in alternatives. He points out that $5 trillion invested in alternative energy over 40 years has only reduced the market share of carbon-based fuels from 83% to 81%.

Key metrics for evaluating oil companies include:

Reserve Life Index: The duration of proven reserves.
Recycle Ratio: The amount of oil discovered and developed relative to the margin from selling one barrel.
Balance Sheets: Financial flexibility, debt-to-equity ratios, and debt maturities.
Efficiency: Cost relative to competitors.

Mining Sector Considerations

In the mining sector, Rule distinguishes between the volatility of gold juniors and the predictability of oil and gas. He prefers a "return on capital employed" approach for oil and gas, while for mineral exploration, it's more about "return of capital employed." He highlights the technological advancements in the oil industry compared to mining, making it a more efficient business.

For value investing in mining, he suggests buying commodities where the selling price is below the cost of production, as this forces either price increases or unavailability. However, he notes that most investors lack the psychological fortitude for this.

Specific Commodity Analysis

Iron Ore: While a superb business, Rule doesn't consider it "hated" due to its strong performance. He prefers to own the "best of the best" with low costs and high return on capital employed, rather than marginal producers.
Nickel: He is attracted to sulfide nickels and high-quality laterite deposits that can comply with environmental standards. He highlights Centaurus as a speculative investment in an undeveloped deposit, warning of significant risk but also potential for substantial returns.
Coal: Considered "hated," but Rule struggles to find small, pure-play coal companies that meet his criteria for efficiency and return on capital employed.
Copper: Despite near all-time high prices, Rule sees a coming ugly supply deficit due to three decades of underinvestment. He is concerned about the near-term economy but sanguine about copper's long-term prospects.
Zinc: A volatile commodity that requires early entry and nimbleness. He notes the potential moderation of demand due to new production and Chinese capacity.
Uranium: He believes the price should go higher due to underinvestment and the increasing irrelevance of the spot market. The term market, or contract market, is more important, offering price and volume certainty for producers. He cautions that only a small percentage of uranium juniors have value.

Rule Investment Media and Battle Bank

Rule promotes his platforms:

Rule Investment Media: Offers free ranking of natural resource stocks and educational content through the "Rule Classroom."
Battle Bank: A new bank designed to offer interest on checking accounts, flexible retirement account investments (including real estate and franchises), multi-currency savings, and lines of credit secured by bullion. He emphasizes its innovative features and the significant waiting list.

Conclusion

Rick Rule's insights paint a picture of a challenging but opportunity-rich environment, particularly within the commodity complex. He advocates for a disciplined approach, focusing on undervalued assets, managing risk, and understanding the long-term structural trends driving supply and demand. His emphasis on "hate" as a contrarian indicator and his detailed analysis of various commodities provide actionable insights for investors.