Among the most successful resource investors is undoubtedly Rick Rule. During an interview, earlier this week, he talked with Resource Investing News about the prospects of the junior and exploration resource market. He believes that the bottom has not been reached yet. If you would merge all junior mining companies into one company (Junior Explore Company), you would lose $2 billion per year, explained Rick Rule. “The sector as a whole is a disaster,” is his current view.
What makes the sector work is the top ten percent of the companies in the sector. If you are not doing the work to segregate the wheat from the chaf then get out of the sector. People wanted to be in the sector in 2010 at the market top, and they don’t want to be in the sector 3 years later with the prices 70% off. It is like someone walked in the street and ignored every store that a “for sale” sign and went to the only store that had the “full price, no discounts ever” sign. Now is the time to time to buy as we are in a bear market. We sell high in a bull market; we buy low in a bear market.
This view is not very promising, especially in a time when the gold and silver miners struggle to keep their stock valuations. After the spectacular run-up between 2002 and 2006, and a significant rally after the financial crash of 2008, the gold shares have been clueless. Looking at the junior miners, the following chart shows how the GDXJ stands even lower than three years ago in spite of a gold price that stands some 60% higher.
Given the difficult state of the sector, especially the junior and exploration miners, it is interesting to know that Rick Rule his research framework to find the winners is based on the “Prospect Generator Model.” The model is based on the fact that the exploration business is at its core high-tech, high-IQ research and development oriented. The companies are not asset-intensive but rather intellectual capital businesses. For investors, this all boils down to risk management, as explained in a brilliant way by Rick Rule with the following quote.
Preserving your interest in a property where you have a one in 2,000 chance of success and sacrificing through dilution your interest in the knowledge base in the company is stupid. Using your company’s knowledge base to secure third-party funding for exploration risk gives you the highest probability of success in exploration. Most speculators fail because in high-risk, high-reward businesses they’re reward chasers. If you manage your risk, the reward will take care of itself. In prospect generation, you sell the risk while keeping part of the reward for yourself. It’s all about probabilities and it’s all about managing risk.
The tip for investors is to look for exploration and junior companies that do a lot of joint ventures. Companies that rely on other juniors or major mining companies to do their prospect generation run a lower risk than the ones that are funding their own exploration.
The mid-tier and senior segments are currently not performing slightly better than the juniors, but the disconnect with the gold price is comparable. Casey Research just released their view on that disconnect. They point to the disbelief by the institutional world in permanently higher gold prices and expectations of rising input costs (for instance oil).
We see the potential in gold equities, as we believe the price of gold is going higher, but big investors with billions of dollars to pour into a market don’t. Their money, for the most part, is still on the sidelines.
This phenomenon leads us to predict that someday these institutional investors will enter this sector en masse. Once the facts sink in and the institutional world becomes convinced gold and silver prices will maintain a sustainable uptrend, they’ll be much more attracted to the equities – and just as stubborn about changing their minds once they’re on board.
Casey Research expects much higher prices in the future especially for producing miners. For now, as the institutional world does not see higher gold prices, no official role of gold in the monetary system, bonds as a safe place for money, controlled inflation, their interest in the sector seems very fragmented and not a catalyst.