Precious Metals Expert Rick Rule Shares 'Gold Nuggets of Wisdom'

Maurice Jackson of Proven and Probable and Rick Rule of Sprott USA engage in a wide-ranging discussion covering Pareto's law, the importance of courage and conviction in investment, copper, mentors and the upcoming Sprott Natural Resource Symposium. 

Maurice Jackson: Joining us for conversation is legendary investor Rick Rule of Sprott USA. Mr. Rule, welcome to the show. In our interview last month, we addressed a number of topics regarding where and what Sprott USA is focusing their attention on in the natural resource space. And at the conclusion of the interview, Rick, you stated that we should discuss Pareto's law, which is known as the 80/20 law. But you put an interesting perspective on the law that I had not considered. Mr. Rule, expand the narrative on Pareto's law and please introduce us to the concept of the 4%.

Rick Rule: Sure. And actually I'll take a little further than that with your permission. Most people have heard of the 80/20 principle, which suggests that in any sort of major field of human endeavor, 20% of the people engaged in that activity generate 80% of the utility. In other words, 20% of the people do 80% of the work.

This turns out to be, broadly speaking, true. And it was pointed out in social sciences by an Italian social scientist at the turn of the last century named Pareto. Hence it's called Pareto's law.

It's appropriate to junior mining speculation because among other things, the performance dispersion curves—that is, the performance of relative management teams—aligns well, meaning that 20% of the management teams in junior mining generate 80% of the money made.

What's important for readers to understand is that if you take that successful population, the 20%, and you run them through the same performance dispersion curve, they conformably align. Meaning that 20% of the 20 do 80% of the 80. Or 4% of the population base generates about 65% of the positive utility in the sector.

And I think it works for at least one more standard deviation, which would suggest that 20% of the 20% of the 20%, or eight-tenths of 1% generate about 40% of the total utility generated in the sector. Which is to say that one of the most important things that you can do as a speculator is identify and align yourself very patiently with the serially successful operators in the sector. And that is probably the most important work that you can do as a speculator.

That isn't to say that identifying a Robert Friedland, or a Ross Beaty, or a Lukas Lundin, or a Bob Quartermain, is the only work you need to do. The truth is that when you buy stocks that are headed by those people, you are still subjected to risk. You're still subjected to volatility. You're still subjected to the vagaries of exploration.

But your most important task is to identify the serially successful people—particularly identify the serially successful people in bad markets where you don't have to pay a huge premium to be associated with them. And then hang on for dear life and let them work their magic over time.

Maurice Jackson: We brought you on today to share some of your golden nuggets of wisdom for those of us that ascribe to join you with the serially successful. Now you're famous for stating you must have courage and conviction, which is a critical distinction you've mastered. Expand for us the psychology of courage, because this is a key attribute that you have.

Rick Rule: Well, it turns out it does take courage, Maurice. We were looking back over the exploration capital partnerships series, which is a series of investments managed by myself going back to 1998. And we found, interestingly, that first of all, the vast majority of the money that was made was made in a relatively small number of stocks—ones that increased in price 1,000% or more. Particularly where, of course, those investments were accompanied by warrants.

What was interesting was that despite the fact that we all want immediate gratification, the average holding period for a ten-bagger or 1,000% gain was almost five years. So one needs to be patient.

The courage comes in because almost every stock that we enjoyed 1,000% gain in, we experienced a 50% share price decline in at some point in time or another during our holding period for the stock.

The most dramatic example was the most successful stock that we speculated in during that period, which was Paladin Uranium. That stock was a bellwether in my career. We participated in a $0.10 financing, and I think it was probably 1999, when nobody cared about uranium. And we were rewarded for our contrarian genius by seeing the stock go from $0.10 to $0.01. That is, we experienced a 90% loss in the stock. When you experience a 90% loss, Maurice, there's no such thing as a hold. It's either a buy, or a sell.

Mercifully, we had the courage to reexamine our precept and determined that we were right, and the market was wrong. We did buy some more stock. And amazingly, over the next five years, that stock went from $0.01 to $10. Two times after the initial 90% decline, that stock fell by 50% or more.

So you had in the course of an almost fictionally good gain depending on how you count the start, $0.01 or $0.10 to $10. The initial test of courage came with a 90% loss, and there were two future losses in excess of 50%.

Similarly, Lumina copper backed by the serially successful Ross Beaty: We did the first financing, if my memory serves me well, at $0.50. And that stock ended up being liquidated in this series of seven transactions. I forget what the total was, but somewhere in the $140 range.

But either two or three times during the seven years that we held that stock, the stock declined by 50% or more. So it's important that you understand that while price is interesting, price is only relevant to the extent that it varies appreciably from value, which means that you have to have an opinion as to value and an opinion as to the ability of a management team to continue to add value. Following price alone, if you experience a 50% decline and you assume as a consequence of that decline that there's something wrong with the company, almost always you will be shaken out of circumstances that can give you a big gain.

And let me give you one further illustration, Maurice, that I think will amuse readers. We aren't just talking about speculation in this context. Warren Buffett, the legendary investor and CEO of Berkshire Hathaway, points out that four times during his stewardship of Berkshire Hathaway, arguably the most successful investment company in the history of American investing—four times during his tenure, the stock has fallen by 50% or more.

Now interestingly, if you examine a price chart of Berkshire Hathaway going back to 1968, from 1968 until present, those 50% declines relative to the share price escalation can't even be seen on the stock chart. They're invisible because the stock has moved so much over 40 years. But if you experienced those 50% declines at the point in time when you experienced them, they still caused you trouble. So I think that's where the courage comes in.

Maurice Jackson: And before we leave courage, does the thesis, or is the scenario, very similar with uranium and copper today?

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