“Elvis” On Why You Should Invest in Gold
I just saw an excellent presentation by the “Elvis of the Resource Industry,” and I wanted to share it with you.
I’ll explain: This week I’m at sea, cruising to the Virgin Islands. But I haven’t stopped working. I’m speaking at a MoneyShow event aboard the Crystal Serenity. “Elvis” is how Gold Newsletter publisher Brien Lundin describes my shipmate and fellow presenter, Sprott U.S. Global’s Rick Rule. That’s because Rick is entertaining and a storyteller. He’s also very insightful.
To me and a small gathering of elite investors, Rick explained why he thinks we’re near the bottom in the natural resource market.
He started by addressing the disappointment everyone has been feeling in gold, silver and other metals for years, and now in oil as well. “Markets are messy but they work,” he said. “And the best cure for low prices is low prices.” (This is a famous quote of Rick’s, which Marc Lichtenfeld happened to mention in his Investment U column yesterday.)
In other words, markets are cyclical. And Rick is looking for the current bear market in precious metals to end in a spectacular new bull run.
That means this is a great time to buy gold if you have an eye on the longer term. In Rick’s words, once again: “If you aren’t a contrarian, you’re a victim.” He added that he remembered how crowded the long side of gold got when it was at $1,800. Now, at $1,200, it seems a very lonely place.
Of course, it helps to understand what’s driving those price movements.
People, Industry and Capital
Both bull and bear markets are made up of two parts, according to Rick: People and industry.
People confuse a bull market with brains. “You not only think it’s a good sector or industry, you think you understand it,” he said. Then, when the market turns, all the brains in the world won’t save you in a waterfall sell-off.
As for industry, the fact is most people don’t understand that the natural resources market works very differently from others.
In a normal business, when supply is constrained and demand goes up, prices go up. That brings on new production. When there is a surplus of supply, prices go down and production ends. That’s because capital is unconstrained, and it works out inefficiencies very quickly.
However, natural resources are capital-intensive. It takes time to find and develop a copper mine, for example. There are sunk costs that restrain capital. When prices go down, miners keep producing.
Rick calls this the “Last Man Standing Complex.” Miners try to outlast each other and wait for the competition to go out of business. “Miners will amortize sunk capital because it’s already sunk,” he said. “You will produce down to and below the cost of production.”
So natural resources lag in their response to price changes. And that means there are sometimes huge disconnects in those industries. These disconnects are corrected with powerful price swings down the road.
Understanding this is key. As Rick explained, “Success in natural resources is finding companies where the product is selling for less than the cost of production.” As long as the company is financially sound and it can wait for prices to normalize, then investors should expect to see a corresponding big move in its share price.
The example Rick gave was Australian mega-miner BHP Billiton (NYSE: BHP), which was trading at 4.5 times cash flow before the last bull market in metals. Rick knew that BHP could triple or more when metals prices went up again. And he was right.
Now he says we’re looking at the same potential in big names like Exxon Mobil (NYSE: XOM), Potash (NYSE: POT) and Cameco (NYSE: CCJ). “These companies could give you penny-stock moves without penny-stock risk,” he said.
Cameco, in particular, says the average global cost of production for uranium producers is $70 a pound. Yet uranium trades for around $35 a pound. That’s the kind of disconnect that can pay off big time in the future.
Going for the Gold
Rick spent quite some time addressing gold. The yellow metal, he said, “is locked in a war with the U.S. dollar. And it is losing.”
That is to say, gold is losing for now. However, Rick thinks two things point to much higher gold prices.
One is that the U.S. government is $18 TRILLION (“With a ‘T’”) in debt. In the past, people didn’t seem to mind the high U.S. national debt, he said. But now it has grown to the point that more and more folks are starting to realize it is unsustainable.
That’s why he personally owns gold. It’s a medium of exchange and a store of value. And part of the premium you pay for it is catastrophe insurance.
The second thing that will push gold higher is the fact that there are now more than 7 billion people in the world, and more and more of them aspire to the lifestyle we big, fat Americans enjoy.
Rick says he has noticed a huge change happening during his travels through Southeast Asia. “People are slowly becoming more free, and as a consequence, they are rapidly becoming more rich.”
He added: “When poor people get more money, they buy stuff. And they can increasingly compete with us for the stuff of life.”
Rick thinks this is bullish for gold, even more bullish for silver - “poor man’s gold” – and positive for all sorts of commodities.
“So are cheap commodities an opportunity or a problem?” he asked the crowd. “Rather than think of it as a bear market, think of it as a sale.”
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P.S. If you’re interested in seeing Rick speak live, he’ll be joining us at the 17th Annual Investment U Conference in March. For details about this special four-day event, head over to InvestmentUConference.com.