Exactly 1 year ago we sat down with Rick Rule of Sprott Asset Management to talk about what investments excited him the most. He listed water, uranium, and precious metals as his top picks, he framed them as not likely to go up, but the question was "when" they go up.

He talked about a major water crisis coming in the South West, specifically the socialist republic of California. Today, California is in a full blown water crisis with over 20 cities at risk of having no water within 6 months! The entire state is suffering through the largest drought on record.

In our two part interview we discuss the water crisis and ways to profit from it, as well as other investments in the resource sector which is Rick Rule's specialty.

Rick is a fun guy to listen to, very witty, charming, and probably the smartest investor I know.

Last year while my family and I drove up to Spokane, Washington, from California I remember listening to YouTube videos of Rick Rule almost the entire way up...We tend to travel at night so the kids can sleep (1yr & 3yrs old at the time), so Rick was able to keep my mind wide awake for the trip.

Watch our video interview or read the transcript below.

Listening to Rick WILL make you a better investor.

Click to watch our Rick Rule Interview

Transcript

Future Money Trends: Greetings and thank you for joining us at FutureMoneyTrends.com. I'm here with Rick Rule of Sprott Asset Management. He's a legendary investor. Rick, thanks for joining us.

Rick Rule: Always a pleasure, thank you.

Future Money Trends: Rick, this time last year at this show I asked you about water. You said it was the best question of the day, which made me feel pretty good because it was the end of the day. And I was kind of thinking of Asia, and you said, “no, Southern California. That's where it’s going to happen.” Now here we are, in the biggest drought ever on record. What is going on since last year, as far as the drought? Are you investing in companies that are providing solutions and what kind of solutions? What kind of money is there to be made from the drought?

Rick Rule: I've been investing in water for 25 years, which would appear to be what it takes for me to be right. I say that jokingly, investing in water has paid a lot of rent for me over the last two decades. But I think where we're at right now where we call the question. Water hasn't been priced by markets, it's been priced politically, which is a different way of saying it's been mispriced. We say for water the free market physics don’t apply. Water flows downhill to votes rather than uphill to money. And we're seeing the effects of that in California now. Probably before you were born, 1977, was the last time we had a drought in California. And that caused enormous economic dislocation. It caused dislocation such that 12,000,000 fewer people lived in California. There were 12,000,000 fewer straws in the sponge, and in 1977 we were able to take excess flows out of the Colorado river because nobody lived in competing places like Phoenix or Las Vegas, but that party is over. We're going to have a reckoning in California if we don't have substantially above average rainfall between right now, early February, and April. We have two months left to avert what will be a very interesting set of circumstances.

Future Money Trends: You know it's weird; I live in California and I haven't heard anyone talk about turning off (the faucet), stop watering your grass, or anything like this. Is that what you think is coming? Because likely it's not going to rain, we're not entering our rainy season, it's pretty much behind us now.

Rick Rule: Two answers to that question. The first is that the realization that the crisis has occurred, comes when you turn the tap and nothing comes out of it. The second thing is that water is irrationally cheap, so customers are happy. It takes you perhaps a penny to flush your toilet. Now you're a young guy, you probably have one of those conservation low flush toilets, so you have to flush it twice. So it's two flushes. What would you pay to make that material go away? I don't know what the answer is, but it's more than a penny. When you look at what it costs you to keep your lawn green, your landscaping in good shape, your teeth brushed; relative to what it cost to deliver that water in the first instance, but much more importantly, relative to the utility that that water generates to you, water is pathetically cheap. So everybody is thrilled with the status quo, and they will be thrilled until their lawns die, and their landscaping wilts. If we don't have a rain, a good rain, in the next three months, that is precisely what's going to happen. Water has been allocated politically, as I say in California. Those viewers of yours who watched the movie Chinatown will know the history of water. Los Angeles went up and, fair and square, bought all the water in Owens Valley, and diverted it from agricultural uses to urban uses. The farmers in California who controlled the legislators, a hundred years ago, said, “we don't want to compete with city users. We want to steal the water.” They've done a great job. California agriculture contributes 3.5% to the state's GDP and they use 85% of the water. There's a political arbitrage in water, where water is worth $45 an acre foot, to grow rice in the desert, and $1200 an acre foot to flush toilets and brush teeth. When that arbitrage ends politically, and it will when the urban users don't have water, the money that will be made re-using or, pardon me, selling water from agricultural uses to urban uses, will be incredible.

Future Money Trends: So is that the companies you're buying? Is it in the agricultural sector, or?

Rick Rule: Yeah, pardon my pun, but we've bought the water front. We have principally bought the agricultural companies who own water that we hope will be able to be re-deeded. We have already, also for 25 years, bought physical water rights. In Sprott, we have been negotiating now for three months, and are about to buy, the best US-based water investment management company on the scene - a private water investment which we've been working on for a long time. But there's a whole bunch of ways that people can play the game. Because I'm a resource guy, I haven't bought the filtration companies, the utility companies, the distribution companies, the process companies, because I believe them to be service and supply businesses that I'm less good at. I have tried to focus myself on owning water as a resource, the same way an oil company would own oil and gas.

Future Money Trends: Do you foresee if rain doesn't happen, actually water wouldn't come out of our faucet? I mean, that just seems impossible.

Rick Rule: Absolutely. You'll remember six or seven years ago when we had a power crisis in California. The legislators, in their genius, de-controlled what their...

Future Money Trends: That was fourteen years ago now, by the way.

Rick Rule: Was that fourteen years ago?

Future Money Trends: That was 2000 Gray Davis.

Rick Rule: You see, you lose your mind over time. We were able to deal with that shortage because you can transmit electricity easily. We called up the Canadians and said, “we're out of electricity. Send us some right now, we'll pay you any price.” The Canadians sent us the power, the lights went back on, and then we stiffed them. We decided not to pay because they were price gouging. The point is that when water runs out, there is no infrastructure to get water here. When it runs out, it runs out. There is no more, there simply is no more. Drive around any reservoir in the state that you want to. These reservoirs are 20 - 25% of normal and we're in the winter. Look at the snow pack in the Sierras, what you'll notice is that there isn't one. The snow pack is less than 40% of normal. But our consumption is not going down. If you consume something that runs out, the result is simply that, and it's not pretty.

Future Money Trends: So, as far as the cities, is it the whole state of California, Nevada, and Arizona that are at risk right now? Because I went to the Hoover Dam probably a year, two years ago, I was shocked that you could see where the water was. It was dramatically lower.

Rick Rule: Those are two different questions. The Colorado river compact has, I think, seven states involved. And there's one state that substantially exceeds its maximum draw, that state is California. Nevada, Colorado, Utah, Arizona, those states are living within their water budget. But California isn't. So California will run out of allotment at precisely the wrong time for the state of California. The problem that we have in California with regards to water distribution could be solved. It could be solved by fallowing half the farm land in California. That would work. Politically that is going to be a very difficult challenge for us. The farm workers, who are certainly a disadvantaged population, would become much more disadvantaged. And California farmers, who have contributed a lot to the California economy over the last hundred years, would certainly be disadvantaged. But the easiest way to deal with the problem is to let the market work. If you took $45 farm water and made it $400 farm water, you wouldn't have a water supply problem anymore. You'd have a political squawk, to be sure.

Future Money Trends: Let's move to the junior resource space. We're at the Cambridge House investment conference. The juniors have been doing great this year. I mean some of the good juniors, at least I would call them good juniors, they're up like 50% in the last month. Is this what a bottom looks like?

Rick Rule: Well we talked, I don't know if you remember this, but the last time you interviewed me we talked about specifically this. And I said that I thought we were in a market bifurcation period, where the best 20-25% of the juniors would start heading up. Not on big volume, but simply because they caught bids. If you look at the year 2013, the first half of 2013 or at least the first third, looked if you were to graph it, very much like the topographic map of a ski hill. A steeply descending line from the upper left, to the lower right. The middle part of the year began to graph like the electro-cardiogram of a corpse. Flat lined, where the sellers were exhausted and the buyers were exhausted. Beginning in perhaps September or October, the bare issuers began to catch bids. Not big bids, but the sellers were exhausted. The down trend was buyer exhaustion. The flat trend was buyer and seller exhaustion. The up trend is seller exhaustion. So we're in the market now where I say the market is bifurcated. It's too early for me to say that we've really put in a bottom for two reasons. One reason is that the bottom 50-60% of the issuers, the true penny dreadfuls, have an intrinsic value of zero. And it would be poetic to see them achieve their intrinsic value in mass. That would be a wonderful thing from my point of view. The second thing is that we have not yet seen issuer capitulation. The last bare market, the 1998-2003 bare market, bottomed in July of 2000. And the thing that caused it to bottom was that the better issuers, the Lukas Lundin, the Ross Beaty's, The Bob Dickenson's said, “OK, we get it. We can't survive, what we have to do is raise the money we have to raise, irrespective of delusion to shareholders who came in three years ago, and grow our businesses.” When people stop saying, “I have a $4 stock, I have a $0.40 stock, I can't raise money because I'm at $0.40,” and they say, “if we don't raise money, we don't grow, we're going to die,” that's when a bottom is put in. If we see issuer capitulation in conjunction with bifurcation than we will be where we were in 2000. And for intelligent stock-pickers, the second half of 2000, all of 2001, all of 2002, were the finest times on the planet.

Future Money Trends: Could this be happening, could this be bad timing for the juniors or people? Because if the DOW is, let's say the DOW starts to meltdown. Maybe we're in a correction or maybe it really is going to meltdown, does that effect a market? Because I guess the whole time you've been investing, the general market has been in a bull market but you have the resource cycle. Well now, we might be entering a bear market in the general market just as the resource stocks have gone through one hell of a bear market.

Rick Rule: Two answers to that question. First of all, stocks are stocks. And if there's a major market decline, which reduces liquidity and reduces the animal spirits, that will be bad for the sector. Let's get that one out of the way. It seems like, with the general market, when it's good it hurts junior stocks because it sucks capital out of them. When the market is bad it hurts junior stocks because it sucks capital out of them. I think as an investor, what I have learned that I need to do, over 61 years of life and 40 years in the business, is worry about what I can control. I can't control the major market, but I can control how I allocate my capital among juniors. You will notice in 2012, which nobody would describe as a generous market, that there are companies like Sirius in Australia that went 12 for 1. Reservoir Capital, in this market, went $0.26 to $6. Your advertiser, Fission, did well. Africa Oil went from $0.80 to $12. We are not in a market that ignores good performance. We are in a market that's starved for performance. And the reason why this down-cycle has been so ugly is because we were so stupid and generous in the up-cycle. As we come out of this cycle, it will be discovery and performance that will lead us out of the cycle, irrespective of what happens with the DOW.

Future Money Trends: With gold and silver, most people here actually buy the physical precious metals. Gold went up in January and silver was just kind of stuck. Any thoughts on the silver market and gold market?

Rick Rule: Sure, the silver market has historically followed the gold market. Gold is regarded as a safe-haven investment, a beta investment. Silver is regarded as a speculative vehicle, an alpha investment. People have come in to the gold market this year because they were afraid of stuff. When gold moves, the ethicacy of the precious metals trade is available to people, the momentum chasers, the alpha chasers will come back into the market, and they'll bid up silver too.

Future Money Trends: On the uranium sector, I've talked about this with you every single time. It's still $35 spot, people are buying uranium stocks but you had the Russian treaty ending, so a lot of people thought that it was going to go up. What are your thoughts on uranium right now?

Rick Rule: I think the Russia treaty ending is a non-entity. What it means is that re-processed uranium will be sold by Russians, not by Americans. The reactor doesn't care if it's Russian wrapped uranium or American wrapped uranium. So I think that's a non-issue. There are two things that you have to think about in uranium, only two. One is that according to Camico, who should know, the world's largest uranium producer, it costs the industry worldwide on a fully loaded basis, $70 a pound to make uranium, including their cost to capital. So you make the stuff for $70 a pound, you sell it for $35 a pound. You lose $35 a pound, and being miners you try to make it up on volume. That doesn't work. Either the price of uranium goes up, or the lights go out. In a rich country like the United States, where we have many energy sources, uranium, nuclear power, generates 16-17% of the electricity consumed. If the price does not go up, the lights will go out. Now, which do you think is more likely?

Future Money Trends: Uranium is going to go up.

Rick Rule: That's the first question you have to ask yourself. The second question is this, we had reached equilibrium pricing in uranium at $80 or $85 a pound, and then one event– Fukushima happened. When Fukushima happened it took all of the Japanese reactors offline, and taking those reactors offline took 20-25,000,000 pounds of annual demands out of a 200,000,000 pound market. At the same time that it increased supply, because some of their reactors sold inventory that they had, that they weren't going to use selling electricity, in to the market to generate cash. I don't know what that number is, but let's assume it was 10,000,000 pounds. So let's assume that you have an imbalance 200,000,000 pound market, where you reduce demand by 25,000,000 pounds and you increase supply by 10,000,000 pounds. A 35,000,000 pound supply-demand imbalance in a 200,000,000 pound market. Normally in markets like that a 3-4% swing in supply or demand can increase or decrease prices by 10-15%. What we need to think about, having answered the question that price needs to go up to sustain production, is when do we use up that big lump of supply that came in to the market as a consequence of Fukushima. And I don't know the answer to that.

Future Money Trends: It's interesting because so many people talk about how silver and gold are upside down right now, but uranium is seriously upside down.

Rick Rule: Way upside down. So is zinc. Way upside down.

Future Money Trends: In your history of investing, this is pretty much a guaranteed thing right now?

Rick Rule: This is a great question, especially for a young person like you to ask. Because in the course of my career, when I have confined myself to asking investment questions where the answer begin with when? I have done better than asking myself questions where the question begins with if? In the gold business, you can say if this happens, and if this happens, and if this happens, then the gold price goes up. That isn't the question you ask yourself with uranium. It's a when question. Because if the question doesn't occur, the lights go out. "When" questions make you more certain money over time than "if" questions. People object to the fact that they have imprecise answers. But in no way, shape, or form, is a when answer ever more imprecise than an if answer.

Future Money Trends: Is patience one of the best things that you've learned over time? Because it seems like people got in the gold trade, but they're just not patient.

Rick Rule: I think four attributes. Curiosity is extremely important. If you come in to this business simply to make money, if you're not fascinated by the business, and are not willing to do the sort of esoteric work around the trade, you're going to screw up the trade. Patience is certainly important. Discipline is really important. Don't do this thing intuitively, do it empirically, its very important. And then patience. Importantly, Warren Buffet teaches at many points in time in the market there's nothing to do. And what you have to discipline yourself to do when there's nothing to do, is nothing. And nothing is very hard to do. Nothing is particularly hard to do in bull markets, where all of your recent experiences have been success. Bull markets breed aggression, aggression breeds overpriced opportunity, and overpriced opportunity isn't opportunity, it's risk. Having the ability to do nothing in a market top, a test by the way that I have repeatedly failed, is a very important test. And then there's that fifth attribute that you need in times like these, aggression.

Future Money Trends: Your recent experience has been nothing but pain.

Rick Rule: Well, my recent experience has been...

Future Money Trends: I'm saying in general here.

Rick Rule: Well, absolutely. Part of discipline is the fact that you need to be able to do nothing at market tops, and you need to be able to put the pedal to the metal when every body is in retreat.

Future Money Trends: Great interview, thank you so much Rick. I appreciate it.

Rick Rule: Always a pleasure, thank you for great questions.