Optionality Tekoa Da Silva: Rick, I’d like to ask you about a...

Optionality

Tekoa Da Silva: Rick, I’d like to ask you about a concept we’ve talked a little bit about in the past called ‘optionality.’ In the resource business, I understand that term has a pretty specific definition.
For the person reading—can you talk a little bit about the meaning of that term in the context of the resource business?

Rick Rule: Optionality is a speculative technique that works particularly well when entered into during bear markets, transitioning into bull markets. What optionality refers to is buying into a company or a deposit that isn’t economic at current commodities prices, but could be very economic at much higher commodity prices.
An example would be a copper deposit that makes no money at $1.50 lb. copper, but might be extremely economic at $3.00 lb. The consequence of that is that you might be able to buy the deposit at $1.50 lb. copper based on its net present value (which is almost nothing) and sell it if the copper price goes to a much, much higher price.
In the last bear market we went through, the 1998 to 2002 bear market, the predecessor to Sprott Global which was Global Resource Investments used this technique to very good effect.

As an example, Paladin Uranium, which we’ve talked about before, was a play on higher uranium prices. It benefited by going—I’m not kidding—from a low of $.01 per share to a high of $10.00. But it wasn’t the only uranium play that soared on higher uranium prices.
The whole early stage uranium group, the ‘hoarders’—groups that were playing on optionality, all went higher and it wasn’t just in uranium.

Pan American Silver went from a financing price of $.50 cents to a high of $40 something. Silver Standard went from $.72 cents to a high of $40 something. But the real winner was Lumina Copper.
Run by Ross Beaty, Lumina Copper was a classic hoarding strategy which went from a low of $.50 cents per share. As I remember, it was sold off in pieces for a total realization of about $160 per share over the course of six to eight years, [from about 2005-2014].

So the optionality idea goes like this: One of the fallacies in the exploration & development business is that if you think a commodity is going to go up in price, you should buy a deposit and spend hundreds of millions of dollars putting it in production because you think the commodity price is going to go up.
Often, 5 or 6 years later, when the commodity price actually does go up—all you have left is a hole in the ground where your gold used to be. The gold price is up and your gold is all gone.
Why not leave the gold in the ground and when the price goes up, sell it to somebody else who wants to use the then present gold price to establish the deposit’s value?

TD: Ok. So the term “optionality”—that means a company or a deposit that functions like a ‘call option’ on the price of a given commodity?

RR: Yes, but truly a leveraged call option. One of the things about commodities options is that they have ‘fuses’. A two-year option gives you a play with a two-year ‘fuse’. A six-month option gives you a play for six months.
A well-constructed public company that has fairly low general and administrative and holding costs is almost like a perpetual option—a 10-year or a 12-year option. The leverage inherent in these options is unbelievable.
When Bob Quartermain was constructing Silver Standard, he didn’t pay more than $.05 oz. for silver in the ground. Six or seven years out, people were paying $1.00 oz. or $1.20 oz. for silver in the ground.
Along the way, Bob didn’t have to do anything to advance his ounces. All he had to do was own them and not mine them.
So one thing I’ve learned over 40 years in this business is that not mining is much easier than mining.