State Of The Gold & Silver Market by Rick Rule

In this excellent interview with FutureMoneyTrends Rick Rule looks at the current trend in gold and silver bullion and miners. In particular he answers three important questions (1) is there any relevance in the fact that gold and silver prices are falling through their cost of production (2) is the current bear market (un)usual (3) which fallacies to avoid in order to get significant returns out of mining companies in the years ahead.

Before looking into those questions Rick Rule gave his view on rising interest rates and the latest announcement of the Fed. His suspicion is that the Fed has voluntarily let the interest rates go up in order to calm down the creation of bubbles in bonds and equities. Simultaneously, the Fed needs to continue to “counterfeit away” the current account deficit of the US government (which they do through the bond purchasing program).

Is gold and silver production cost relevant for pricing?

Rick Rule says the cost of production is not of any relevance in pricing the metals. In other words, the prices of gold and silver are now more or less at their cost of production but that is not a reason to “necessitate” a price increase. Near term, price is insensitive in the market to production cost. The underlying reason is that capital cost is so high that people ignore total cost of production in a down cycle. Besides, related to gold and silver, there is a substantial above the ground inventory of bullion.
Specifically related to silver, the production cost of primary silver production in silver mines is not of any great importance. Some 80% of silver is produced as a byproduct of other metals (copper, zinc, lead, gold).The newly mined supply of silver is more dependant to the price and production schedules of those metals, rather than the production cost of primary silver production.

Is the current bear market in metals and shares (un)usual?

Rick Rule believes the current bear market is normal and natural. Especially the situation in the mining sector is comparable to the bear market of 1998 – 2002. He believes we are in the capitulation phase and that we begin to see a rebound (in bullion and miners) although we could see another leg down. However, investors should not expect an immediate rebound in precious metals juniors. The reason is that the excesses in the market between 2002 and 2010 were so extraordinary that the market did not flush the excesses out yet.

There are currently almost 4000 juniors globally. If one would merge all those juniors in one company it would make for a yearly loss of between 2 and 10 billion dollars. Rick Rule expects to see 1000 juniors disappear in the next 2 years. Rick Rule’s best guess is that 5 or 10% of the juniors will bottom later this year while most will continue to trade lower in the coming 2 years.

Two fallacies of resource investing

Money will be made in the next ten years in the classic Ben Graham sense. The pricing in the market that is the result of an anticipation by investors who do not understand the industry with the underlying valuations in the market. Ben Graham once said: “In the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine.” It means that the true value will in the long run be reflected in its stock price. You make money in the market by arbitraging between the way people vote (which is seldom rational) and what assets weigh (which is always rational).

Rick Rule discusses a second mistake that most people make in terms of valuation in resource markets. Most investors pay more attention to simple market metrics while they should look at relevant market metrics. One market metric that belongs to this category is dollar of enterprise value per in situ ounce. In other words, the value (in dollars) of ounces in the ground. The really relevant metric is the cost to get the ounce out of the ground. The costs that are related to it are the capital costs, operating costs and the time when the ounces will be ready to be sold.

“The idea that all ounces are the same while every ounce generates a different return is probably the biggest fallacy that has confrontend in the resource market. It is a fallacy that because of its simplicity the market will continue to use in the next ten years. If investors learn to arbitrage between the economic value and the perceived market value will be able to make money.”

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