Investors are cautious about the markets. And although sometimes there are glimmers of hope, things don't look like they'll get any better any time soon. But experts are saying that this is exactly what investors should be hoping for. And one of those experts is Rick Rule, someone we look forward to interviewing whenever we can.

Rick Rule is the founder of Global Resource Investment Group (now part of the Sprott Group of companies). He spoke at the San Francisco Hard Assets Investment Conference and we interviewed him after his speech. He summarized his speech and then gave investors a way to move forward in the murky economy.

We started the interview by asking Mr. Rule about his speech. "There were three parts to the talk yesterday," he responded.

The first point, Mr. Rule said, was: "… There is good news in the market and bad news in the market. The good news is that demand for resources continues unabated. There 7 or 8 trillion dollars in cash in the US looking for a home and some of it may find its way into resources. The bad news is that the overall economy is in very bad shape. We've made promises as a society that we can't keep and there are extraordinary levels of debt."

Then Mr. Rule illustrated this idea with a meteorological analogy: "I liken these two forces to two large weather systems. When two large weather systems collide, the weather becomes turbulent. In financial markets, that's called volatility."

"The second part of the talk was about volatility," Mr. Rule continued. "The volatility that we've seen in the last six months is, in my opinion, a down payment on two years of volatility, which will unnerve investors and unnerve markets."

Many investors don't like volatility but Mr. Rule gave us a different perspective: "[The next year and a half of volatility] is good news and bad news, too. Since volatility is going to happen to you, what you can control is your reaction to it. One way of looking at volatility is a series of 30% or 40% off sales. A series of sales – if you're a consumer of goods – is good!"

Then Mr. Rule delivered a helpful way of looking at the market. He said: "What you have to do as an investor is understand that the market is not information. The market is a facility for buying and selling pieces of companies. If you view the market as information, volatility will kill you. If you use the volatility, it will work for you."

"The third part of the talk," Mr. Rule continued, "was what I call the financing roulette game. Many of the junior companies financed themselves well in 2009 and 2010 but didn't finance in 2011 as a consequence of fairly weak equity prices. Although they didn't finance, they kept spending. It's my belief that you're going to have a financing cycle present in 2012 because the companies will need the finance. If market conditions in 2012 are constrained because of volatility, the opportunities that will exist among intelligent investors who are solvent, financing companies that absolutely need to finance could be the best opportunity that we've seen in the sector since 2002. That's my hope."

So, we asked Mr. Rule if he thought it was time for investors to buy. He answered: "I smell blood. It's my belief that these companies neglected to finance in 2011 – which isn't a bad thing – but they didn't slow down their spending. The reckoning is coming. Whether or not they have to finance at prices that are advantageous or disadvantageous to them will really be a function of the market conditions that exist at the time. The need for the money will be there. It's going to be the mood of the market that determines the level of opportunity for prudent speculators."

We pressed further for more information what investors can expect in the months to come, both in the larger economy and how it should impact those who invest in junior mining companies: "I see the market declining. If you look at the 4,000 junior mining companies that exist worldwide, 80% or 90% of the junior resource companies are (in my opinion) valueless. It's the performance of the top 10% of the company that draw attention to the sector. The sector overall is an absolute disaster area. Speculators need to know that if they participate in the sector, they will lose money. That's what happens."

At first, that didn't sound good but then he continued: "Investors need to confine their efforts to the best 10%. As a consequence of that, and as a consequence of the volatility I see in the sector, overall market conditions for the next 12 months will be down. Perversely, from a sensible speculator's point of view, that's wonderful. If you are consuming financial assets, you want them to be cheap and they will be cheap. If you are looking for a way out of your existing positions, you will not be happy. If you are looking to upgrade the quality of your portfolio, the next 12 months in front of us may very well be the best 12 months we've had in ten years."

Then Mr. Rule talked about the market in the US and what investors could expect. He also gave some advice that investors might find both scary and inspiring: "Market conditions will be very tough as a consequence of volatility. We also face the possibility – but maybe the probability – of a credit contraction of the type we saw in 2008. The last time, you had large public banks that had extraordinarily strained balanced sheets (like the European banks do now). If we have a combination of liquidity markets that are roiled by volatility and credit markets that are roiled by the absence of short term inter-bank lending, we could have a once-in-a-lifetime investing opportunities but it would take real courage to avail yourself of those opportunities."

So, what should investors do? Mr. Rule gave three pieces of advice.

First, he said: "Look at your portfolio. Any position that you don't love and know why, turn it into cash. A lot of these companies are going to need to finance to stay alive and if they finance, they're going to have to finance at a lower price than you paid. If they don’t finance, they're going to go to zero."

Second, Mr. Rule said: "Understand that you need to have cash in your portfolio, even though you know that the cash is going to cost you 5% per year in purchasing power… but holding cash and paying the 5% is a function of opportunity cost. For myself, I hold a reasonable amount of bullion. For me, bullion is a different form of cash."

And third, Mr. Rule tells investors not to sit out of the volatility. "Having cash will give you the means and the courage to participate in financings if they occur under extraordinarily advantageous terms. They only occur on advantageous terms because the people that compete with you are scared to death. You will be scared too, but you will simply be less scared than other people if you have a lot of cash and if you have prepared yourself for the set of circumstances that we described."

Lastly, Mr. Rule wrapped up with an encouraging word for investors: "The biggest risk you face as an investor is conveniently located to the left of your right ear and to the right of your left ear. The only thing you can control is your reaction to [what is happening in the economy]. You will make money this decade and you will lose money this decade. If you prepare yourself, you'll do fine. If you don't prepare yourself, you'll get what you deserve."

REFERENCES

Rick Rule: http://www.gril.net/

San Francisco Hard Assets Investment Conference: http://www.hardassetssf.com/