Commodities, including gold, have hit a cyclical decline inside a secular bull market...
RENOWNED MINING INVESTOR, analyst and founder of Global Resource Investments during the late 1970s' inflation, Rick Rule is a legend in the energy and exploration business.
In this edited transcript – taken courtesy of The Gold Report from a presentation made to his clients – Rule shares his thoughts on the current situation.
"I expect the outlook for commodities to be good relative to other sectors, and I think in certain instances...we're going to see this year some extraordinary opportunities.
"My belief is that we are still in a secular bull market in commodities. [Right now] we're in a cyclical decline that's very strong, very sharp, very ugly. But I think we're in a cyclical decline in a secular bear market. Let me explain this thesis.
"In agricultural minerals, base metals, and energy – worldwide – we are living off of resources that were discovered and developed in the 1950s, '60s, '70s and maybe the early '80s. The natural resources business had already been in a 20-year recession, and that 20-year recession limited exploration and it limited production. To the extent that there has been exploration in the last 15 years which was successful, the current credit crisis probably forestalls the development of many large new deposits, meaning that the very credit crisis that we're experiencing will limit new supplies of base metals, agricultural minerals, and energy as a consequence of the fact that we have 6.5 billion people in the world, and all of those 6.5 billion people want a better standard of living.
"There will always be some base level demand for natural resources. What is important to know about the current economic climate is that, perversely, many developing economies have the ability to borrow enough money to get themselves in the kind of trouble first world developed economies are in today. As a consequence of that, to the extent that we see political liberalization and a little more individual freedom in very poor countries like China, India, Indonesia Mexico, Pakistan and Egypt, we see pretty decent increases in wealth – wealth at the bottom, if you will. And what is interesting about increases in wealth at the bottom is that when people at the bottom spend money on things, they spend money on things that have inordinate amounts of inputs of natural resources. Let's go deeper into this...
"In estern economies – where people are rich and they have houses, and they have cars, and they have things like that – the stuff they buy is largely services, largely intellectual services. Somebody might buy a new cell phone; they might buy an iPod; they might buy music to load their iPod with music; but none of that requires very much natural resource input. But if you are a poor person who is becoming less poor in Southern India, you live on the equator, so the first thing you might buy is a refrigerator. If you have a little more money, you might buy an air conditioner. After that you might buy a motor scooter to replace your bicycle. In this case, you're not buying a service – you're buying something that has steel, copper, aluminum, and it consumes energy.
"The input of natural resources is very, very, very important in the products that people buy as their wealth increases in developing markets, and that's a big, big, big thing. It used to be that our standard of living was so much better in the West that we were the only ones who could afford these natural resources, but that's no longer the case. We're facing competition from around the world, and that's why the natural resource prices have been headed higher.
"This will not cease. If you look suddenly at where the aggregations of capital, the aggregations of savings have happened on a global basis, it has not happened in the United States. It has not happened in Germany; it has not happened in Iceland; it has not happened in Great Britain. It has happened in India; it has happened in Dubai; it has happened in China, and places like that. And in those societies, two things are happening.
"The consumer class, if you will, is going further and further down the traditional economic scale, leading to incremental demands on a per capita basis, spread over billions of people, at the same time that the countries' saving rates as a whole are allowing them to update their infrastructure.
"In both China and India they have under construction the equivalent of the US Highway Commission; they're electrifying the countries on a very broad scale, and these types of increases in demands for commodities, both on the individual and the societal level are increasing demands for things like cement, coal, oil and gas. And I suspect that over the next five or six years, the natural resource base and commodity-based businesses will do surprisingly well.
"[But] there will be challenges, [especially] capital-market challenges, for those companies. Appetite for risk, which was rampant a year and a half ago, three years, five years ago; that's gone. That's gone. So, the surpluses enjoyed by explorers in the context of the worldwide appetite for risk is gone. Credit will be very, very difficult to obtain I would say, for the next 18 months. The fact is if you want to build a big copper mine now in Chile, let's say you need to borrow $1.5 billion. If you go to Citicorp and talk to them about $1.5 billion, you are going to find out that if Citicorp can raise $1.5 billion dollars, they're going to keep it, not use it to finance some copper mine in Chile. So that's going to be a problem.
"I believe this problem will work itself out in two to three years, maybe five years, because there are large aggregations of capital available in the world right now to finance natural resources. Those large aggregations exist in the Persian Gulf. I know because I go there fairly frequently. They exist in China; they exist in India. What is missing right now in those countries is the knowledge of how to structure the financing of these things. In other words, the software for deploying capital in natural resource markets. It doesn't exist in the places that have the capital to deploy it. They have for the last 15 to 20 years relied on their friends who were bankers in London or New York, and right now, they're licking some pretty serious wounds as a consequence of their trusting the Western world intermediaries. But they're developing their own capabilities fairly quickly.
"I think you will see in the context of viable natural resource projects an unlocking of credit markets over a three-to-five year time-frame, particularly as societies that are short some types of commodities – the Middle East is an example in terms of metal, or China and India in terms of metal and energy – raise high-debt associated with these projects. In other words, they use the debt finance to get an assured supply of commodities that they need for their economies to grow.
"In precious metals, it is my belief that in the very, very, very near term, the only thing you're going to see in precious metals prices is extraordinarily volatility. What the world is doing now, perversely, is putting money in US Treasuries – not because they like the Dollar, but because the Dollar is liquid and the US markets are very, very transparent. It is my belief increasingly, however, that some of that money will spill into gold.
"I think the Gold Market will be extremely volatile in the near term. I believe it has the potential to be extremely biased to the upside in a three-to-five year timeframe. I am very, very, very bullish on Gold Investment looking longer term."