Submitted by Henry Bonner, Sprott’s Thoughts:
Rick Rule, Chairman of Sprott U.S. Holdings Inc., warned last week that “capitulation” was beginning to occur in resource stocks.
Precipitated by sudden volatility in the general stock market, small resource stocks could witness another big sell-off, he said.
Resource stocks could bottom off the selling, he explained, finally putting an end to the bear market.
What will this capitulation look like? And how will we know it’s over?
Rick responded to numerous questions from readers in his latest market commentary. To listen to Rick’s latest market update and answers to readers’ questions, click here.
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Rick believes the Fed is likely to step away from raising interest rates. The Fed could rescind that 0.25% increase in rates that it has promised markets. Instead, it could launch another round ofquantitative easing. But as Rick detailed in his recent call, he believes that QE are “stealing demand from the future.”
The weak demand worldwide for commodities today, Rick believes, is partly thanks to stimulus measures over the last 10 years. By seeking to “juice” demand back then, today’s consumption of commodities is tepid, Rick believes.
Will we see a “V-shaped” recovery?
“I think the answer is ‘no,’” says Rick. “I see a gradual recovery, not counting on some exogenous shock. Certainly, if Fed Chairman Yellen were forced to rescind a 25-basis –point rate increase, it would be bullish for the gold. A 25% increase in the gold price would take it to the $1,400 or $1,500-per ounce level, which would probably lead to a doubling of some of the better stocks Would this be a ‘V-shaped’ recovery in the context to of what we’ve seen before? Not really. But would we welcome it? Of course yes.”
Why say that capitulation is “upon us?”
“Conditions are ripe for capitulation,” Rick advises, “any reasons to be hopeful have been taken out of the market after many years of a bad market.
“Capitulation is an emotional response and we’re seeing bad news come out ahead of October, a time of year where investor emotion is typically high.”
Of course, a recovery can still occur even if we don’t have capitulation, according to Rick. “The TSX Venture (where many Canadian mining stocks trade) is off by around 85% from its peak. So the market might not need to go lower. But from an emotional point of view, you usually need a capitulation before the market takes off again,” he says.
How much cash should you hold?
“Personally, I’m holding about 35% of my resource portfolio in cash,” says Rick. “This is because I’m keeping the gunpowder dry for ‘issuer capitulation.’”
“I’ve been keeping cash for private placements (where small resource companies issue new shares to raise cash, but I haven’t been finding enough private placements on good terms.
“In addition, I am disciplined about selling stocks once I no longer have a specific reason to own a company – win, lose, or draw,” says Rick. As a result, he’s been selling some shares in companies where he had previously participated in a private placement. Since new opportunities are not arising, he’s holding the cash.
Should you buy the companies that drop the most during ‘capitulation?’ Or those are outperform the rest?
“Generally, I like companies that are doing well in a bear market,” says Rick, “even if I have to ‘pay up’ for those particular companies.
“The fact that they’ve outperformed in a bad market is often an indication of being a superior company,” Rick explains, “and the slight premium for the most attractive companies you’ll pay today will likely be insignificant compared to the potential gains in a resource bull market.
“Of course, we evaluate companies on a case-by-case basis,” he adds, “a deep discount can make an opportunity more attractive.”
What’s in store for precious metals and commodities generally?
“I think it’s important to distinguish between industrial metals – base metals, ferrous metals, or metals used in energy and agriculture – and precious metals,” Rick explains.
“For industrial metals, you’ll need to see a broad economic recovery – or at least a recovery in demand somewhere,” he says, “and so I think it will take a long time for them to recover.
“For precious metals, on the other hand – and in particular gold stocks – I believe they will benefit as the US dollar reaches a peak and begins to roll over,” Rick explains.
In his view, the US dollar would begin to decline before we saw a broad economic recovery in demand, so we should see gold – and precious metals – move higher before other metals.
Is capitulation going to affect the broad stock market?
“I don’t think we’re ready for capitulation in the general stock market,” says Rick. ‘Too many people are still willing to buy the dips.”
But we could still see big moves lower in general markets, Rick warns. “We could have a flash crash, but capitulation would not occur until the general stock market had suffered losses over a long period.”
Of course, capitulation could also affect peripheral sectors, he notes. “Capitulation could occur in small and micro-cap stocks – not just resource stock, but also emerging and frontier stock markets, very small tech stocks, ‘over-the-counter’ stocks, as well as small resource stocks.”
Is oil likely to recover?
“I see the price of oil going sideways for 2 or 3 years unless we see some economic recovery,” says Rick.
Of course, a recovery in the US economy would be good for oil, he notes, but if he’s right and “the economy is moving sideways,” then it should be bad for oil.
Before a recovery, Rick believes we might see the dollar start to “roll over,” which would be good for gold.
What about uranium?
“I believed that uranium would have recovered by now,” he says, “because I didn’t realize how soft global economic growth would be. The Japanese didn’t need to restart their nuclear reactor fleet as urgently as expected because their electricity consumption has been subdued and natural gas prices remain tepid.
“Cheap natural gas and soft power consumption have allowed the Japanese to delay re-starting their nuclear power plants – preventing a price recovery for uranium,” Rick explains.
Still, uranium will eventually return to favor, he believes, as “nuclear power is here to stay and demand for uranium will return over time.”
Should investors be interested in early-stage exploration companies – where a company has a few drill holes but no proven deposit?
“If you can afford the risk, speculating in exploration can be extremely rewarding,” says Rick, “but it also fails to produce a valuable discovery most of the time and still costs you money.
“We recently saw an example of the potential upside – even in a bear market – with a small company holding an enormously attractive joint-venture property in Turkey, a London-listed company called Mariana. In one of the worst markets in recent memory, the stock doubled on the results of a few drill holes.
“Now, speculating in exploration requires courage and specialized knowledge. But it’s this game that built Sprott Global into a sizeable business. We have a lot of good people focused on early-stage geological studies.
“We have absolute confidence that coming out of this bear market, speculating on exploration will be a hallmark of the Sprott Global organization. For the right kind of investors – if you have the emotional and financial ability to stomach the risk – this is potentially a very good place to be.”
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