Natural Resources In Jeopardy? An Interview with Rick Rule, Part I
Source: Stealth Investor††(2/27/08)
Rick Rule of Global Resource Investments, in a conversation with John Pugsley of Stealth Investor, gives his thoughts on the current situation. Rick founded GRI in the late 1970s, in middle of a commodities price boom, and led it though the subsequent recession of the early 1980s and all the economic ups and downs since then. His success is legendary in the mining, energy, and exploration business. There is simply no one who is more knowledgeable, in Pugsley's opinion.
Following is the first part of an extensive discussion with him in which he gives his thoughts on the potential for a continuation of the bull market in commodities. In coming issues, Iíll share his analysis of prospects for a deepening recession.
SI: Rick, considering the turmoil in the worldís economies, and the potential for a deepening recession, is the resource bull market still intact?
RR: I think it is intact. I think the easy money has been made, but thereís big money ahead of us. Industries that are as cyclical as natural resources experience two kinds of bull markets: a cyclical bull market and a secular bull market. A cyclical bull market runs for 4-5 years; a secular one can run for decades. If this is a cyclical bull market, we have a problem, because itís over. A secular bull market is what we experienced in the late Ď60s, all the way to 1981. That was a market driven by a history of under-investment in natural resources resulting in supply constraints.
SI: Whatís the difference on stock prices between a secular market and a cyclical one?
RR: In a cyclical bull market the commodity price might move by 50% and the equity prices might move by 150 or 200%. An example of that would be the mini-bull market that we had from 1992 to 1996. It was a lot of fun, but it didnít mean much. A secular bull market is a kind of market that we experienced from 1968 to 1981, when the gold price went from $35 to $850 and the copper price went from 35 cents to $1.50. Itís where you experience runs like the rise in Coeur díAlene from 10 cents to $60.
SI: The basic difference is in the magnitude of the change?
RR: Time and dimension, both. Jim Rogers says that most real commodities bull markets last 15 years. I donít know if heís right or heís wrong, but among other things, heís smarter than I am. Heís older, too. So he would know better.
I do have the feeling that this natural resources bull market is different than any bull market I have seen since the market that brought me into this business, which was the big bull market of the Ď70s. Itís my belief that we are in a secular bull market and it has some room to run. I would guess that weíre half or two-thirds of the way through the run. I think weíre at the part of the market where not all commodities and stocks move up simultaneously, but rather where thereís sector leadership. Some commodities and stocks have done very well and they take a breather, while other things that have under-performed start to catch up.
The reasons that this bull market has legs is three-fold.
First, commodities on a global basis are still priced in US dollars. Itís my belief, particularly with interest rates falling, that the US dollar will go lower. Hence, dollar-priced commoditiesówhich is most commoditiesóare going to go up.
Second, political liberalization is increasing in areas that traditionally havenít been very free. Weíre talking particularly about India and China, but also other places. As people become more free, they become wealthier. And as they become wealthier, they want more material things. The earlier stages of material demand require lots of natural resources. As an example, in China the question isnít one of trading a fairly fast computer for a very fast computer, itís a question of trading a house that was made of mud and wattle for a house thatís made of cinder blocks. In very poor economies like China, the difference in demand as people trade up is very different in terms of the commodities it needs than is the case in a much more advanced economy like the United States.
SI: Here youíre primarily talking about hard commodities ó metals and energy ó rather than agricultural ones?
RR: Not necessarily. The demand for agricultural commodities has, in a sense, the same sort of impact. In very poor economies, as people decide to eat better, they make selections higher on the food chain. Whereas 30 years ago, the people in China mostly consumed the grain directly, now theyíll feed that grain to cattle and pigs. It might take seven or eight pounds of grain to produce one pound of beef or pork. Thus, the amount of grain consumed increases six or seven times.
Of course, this increases demand for the other commodities that go into producing grain, e.g., phosphate for fertilizer, water, fuel for harvesting, etc. Consumption of all these things increases. And it increases exponentially as peoplesí incomes increase.
The third leg under this commodities bull market is the supply factor. Nobody anticipated the incredible increase in demand that is being generated by the political liberalization in so much of Asia, and particularly from China. The industry wasnít prepared for a bull market of this duration, so we are behind the curve in terms of everything from exploration to processing. Building new productive capacity takes time.
SI: Itís a given that when demand for a good rises, thereís a lead time to ramp up production and meet the demand. That lead time is much longer for industrial commodities like minerals, oil, and gas.
RR: Absolutely. Before you can increase production, you first increase exploration, and that means building more drill rigs. Then to develop whatís found you need more heavy equipment, more infrastructure, and then more processing plants, pipelines, ad infinitum. Weíre behind the curve in a whole bunch of commodities, energy commodities, mineral commodities, and food commodities.
In the case of energy, the other thing that I see exacerbating demand is the widespread state control of energy resources. Contrary to what many American consumers believe, most of the oil in the world is not produced by Shell or Exxon. Itís produced by national oil companies in countries like Venezuela, Mexico, Indonesia and Iran. The populist political regimes of those countries stay in power by increasing social expenditure. As a consequence, the revenues of these nationalized oil companies are used for social welfare programs. As a result, the companies arenít left with sufficient capital to make investments to maintain their current levels of production, let alone to increase it to meet rising demand.
SI: Venezuela is clearly doing this.
RR: And so are Mexico, Indonesia, and Iran. The countries that are currently exporters, such as Mexico and Venezuela, may actually turn into importers in the next three to five to ten years. I see a lot of supply problems on the horizon, particularly in crude oil.
SI: How about other countries, such as Saudi Arabia? If you talk to most people about the problems with the supply of oil, most seem to blame the Arab countries for holding back production. I remember the oil shortages of the 1970s with the Arab oil embargo and the creation of OPEC.
RR: This just isnít the case today. The most aggressive re-investment in the world in state-run oil regimes is being done in countries that U.S. consumers most frequently suggest are trying to deprive us of energy. Abu Dhabi is attempting to double their production. The Saudis are throwing incredible resources into increasing their production. But, that production is nowhere near enough to solve the problem. Those increases probably will only cover the increasing demand from poorer countries, but wonít offset the decline in production from under-investment, primarily in Iran, Venezuela and Mexico. So, from my point of view, this bull market has legs. The things that could derail it would be a recession of an order of magnitude thatís much more severe than most people are forecasting now. I suspect the recession will have to get markedly more severe to derail the world demand for commodities.
SI: Thank you, Rick.