PDAC 2017: Rick Rule likens prospect generators to ‘partial lottery tickets’

Rick Rule, president and CEO of Sprott U.S. Holdings, shared his top investment ideas and views on exploration in an interview on the sidelines of the recent Prospectors & Developers Association of Canada convention in Toronto.

Rule’s top names include prospector-turned-royalty generator Eurasian Minerals (TSXV: EMX; NYSE-MKT: EMX) and prospect generator Riverside Resources (TSXV: RRI). Sprott Global Resource Investments holds 13.5% of Riverside and 8.9% of Eurasian.

Prospect generators focus on adding value through exploration before attracting a buyer or partner to advance the project.

“We see a dearth of exploration taking place, and arithmetically our experience has been that the most efficient form of exploration finance is in prospect generators, where our money provides working capital for assembling intellectual capital, where the risk is farmed out to others,” Rule says.

Asked what he liked about Eurasian and its properties, Rule responded he does not “fall in love with properties.”

Instead, he says that “exploration is not an asset-intensive business, but like research and development.” He says the best way for him to participate in exploration is having a skilled group of people propose and test an exploration thesis, before selling the idea to “a third party to do the heavy lifting.” 

Rule shares that he learned early the probability of a mineralized anomaly becoming a mine was 1 in 3,000. These odds lower to 1 in 100 if you explore in prospective terrains with generous exploration budgets, and further decline if you employ a “serially successful explorationist,” or people with previous exploration success, he says. 

“If you have a team in a prospect generator that originates and turns four projects a year, and you have a portfolio of 10 prospect generators, what you are doing is building every year a sack of 40 partial lottery tickets, where somebody else paid for most of the ticket.”

In his more than 30-year career, Rule has invested in 60 prospect generators, which has helped him be part of 21 economic discoveries. “If you think about that statistically — 21 successes in 60 starts, relative to 1 in 3,000 — the success I experienced, relative to the success I should have expected, is three standard deviations better.”

He reiterates that exploration success is about process. “Properties, put very rudely, are things you should date, not marry. Following that sort of ridiculous line of thinking, a prospect generator allows you as an investor to be promiscuous. It exposes you to an awful lot of opportunity.”

Another characteristic Rule likes about prospect generators is that other companies interested in the assets would complete their own technical due diligences. “From my point of view, first the due diligence is free to me, and second, it is completely unconflicted. So it’s a better level of due diligence.”

Commenting on the state of the industry, Rule, like many market observers, points to both the lack of exploration spending as well as the ill-advised investments in the past five years. “The consequence is that we see everybody’s cupboards being bare, with regards to exploration.”

Rule notes he has seen this happen three times before in his career, and in each case “stepping into that void has had a happy ending” — something he hopes to repeat.

Another name Rule is returning to is Nevsun Resources (TSX: NSU; NYSE-MKT: NSU), which owns 60% of the Bisha copper-zinc mine in Eritrea, and wholly owns the Timok copper-gold Upper zone in Serbia. He concedes that when Nevsun had problems with Bisha’s copper circuit recoveries, he lost his nerve and sold.

“The stock has retreated to the price, where some of the difficulties are priced into the market. They are smart guys and it is an addressable challenge, in regards to metallurgy.”

His favourite junior is Robert Friedland’s Ivanhoe Mines (TSX: IVN), saying that “if you measure my affection for companies by the position I have in my personal portfolio at cost, the largest position I ever had in my life is Ivanhoe.”

Ivanhoe is advancing three large projects, including Kamoa-Kakula and Kipushi in the Democratic Republic of the Congo, and Platreef in South Africa.

Friedland has been “ludicrously successful” at finding large deposits, Rule says. Part of this could owe to Friedland’s appetite of venturing into riskier jurisdictions and spending on exploration and exploration techniques.

Exploration

“The process of adding value in exploration is answering a series of unanswered questions. Most speculators don’t understand that and don’t understand how value is added,” Rule says.

Most speculators often rely on hunches and fail to assess whether a company’s management could address the unanswered questions related to advancing a project.

“You have to determine for yourself, as a speculator, whether or not the management skill sets are sufficient, specifically sufficient, that you give a shit about their answer. In other words, do you trust them to come with a valid thesis?”

The next thing, he says, is to check if the thesis addresses the unanswered question and whether the market trusts the result. Would a “yes” to that question add enough value to justify the risk?

“Many of these guys are looking for small mines, and heaven forbid that they succeed. Everything that can go wrong with a big mine can go wrong with a small mine. But a small mine can never make you big money.

“The nature of prospect generation is that all these questions get answered for me by other people, using their money. And I really like that.”