Tuesday, November 10, 2015

Why Resource Stocks Will Fall Further From Here

"We still haven’t seen capitulation yet," Rick Rule told me.

Two weeks ago, I met up with my good friend Rick at Sprott’s headquarters in Toronto. Sprott is one of the largest resource companies in the world. They have over $8 billion in assets under management.

I also spent the day with Sprott founder Eric Sprott and chief portfolio strategist John Embry. These men are considered the Warren Buffett, George Soros and Carl Icahn of the resource industry. They have over 140 years of combined experience in the resource sector.

I was excited to catch up with Rick. After all, resource stocks have been in one of the biggest bear markets in decades. And I was sure Rick was about to tell me why investors should be aggressively buying stocks in this sector right now.

But his advice caught me by surprise.

Rick told me, "It’s still an incredibly risky market that could see more pain ahead over the next few months." And he explained why investors should be "extremely careful" when buying gold and silver stocks right now.

If you are not familiar with the resource industry, most stocks have lost more than 80% of their value over the past four years. Some experts (including John Embry) say it’s the worst bear market in resources in more than 30 years.

These types of extreme conditions in the resource sector often lead to incredible opportunities for investors.

For example, most resource stocks fell sharply during the late 1990s. By 2002, the sector finally bottomed. Over the next few years, resource stocks enjoyed an incredible run — with many individual names surging more than 10 times in value.

Resource stocks also fell sharply during the 2008-’09 credit crisis. Once again, this cyclical market reversed and sent stocks sharply higher. Smaller names like ATAC Resources, Kaminak Goldand Africa Oil surged more than 500% in just a few years’ time.

I’m sure huge opportunities will open up for investors once the current bear market reverses. However, Rick cautions that investors should be patient as resource stocks could fall further from here.

He highlights how most companies in the resource sector are "delusional." They have less than nine months of cash left on their balance sheets. Yet, these companies refuse to raise money "hoping" that the sector will finally bottom.

Rick also says that larger companies are not restructuring fast enough. They still have huge amounts of debt on their books. This will force industry leaders like Barrick Gold to sell assets well below net asset value (to raise cash).

Sprott is in a great position to weather a further downturn.

Rick says the company is only invested in a few dozen names today. That leaves more time for its portfolio managers and geologists to see more projects and spend time with their largest clients.

Plus, Sprott is sitting on over $330 million in cash. I’m sure this money will be used to fund some of the well-run resource companies who have fallen victim to the bear market. Based on Rick’s history of being an exceptional dealmaker, I’m also sure the terms of these deals will be extremely favorable for Sprott.

I suggest paying close attention to Rick’s advice. Many resource names are still sitting on piles of debt and need to restructure. Most junior mining stocks (which do not generate revenue) are also running low on cash. In fact, Rick says 90% of these small speculative names are worthless.

However, if you do venture into this volatile sector, be sure to buy stocks that are flush with cash. Also be sure they have experienced management teams and high insider ownership.

Most resource companies that are currently in Sprott’s portfolio fit this profile.

Good investing,

Frank Curzio