Election 2020: Gold the Real Winner

Red or blue, you know what wins...

 

CEO and chief investment officer of US Global Investors, Frank Holmes says it doesn't matter if the US sees a Red victory or a Blue victory in the presidential election, says Streetwise Reports, publishers of The Gold Report.

 

In this far-ranging interview with Streetwise Reports, Holmes discusses gold's prospects post-election, inflation, stock market performance, and criteria to evaluate mining companies.

 

Streetwise Reports: Frank, let's begin with gold. After a substantial rise in the price of the metal earlier this year, which went as high as $2,036 an ounce in early August, it has since been trading sideways, consolidating roughly around the $1,900 mark. What effect do you think the US presidential election will have on the price of gold? Do you see different scenarios based on which candidate wins?

 

Frank Holmes: Well, you can hit the red button or the blue button, but I'm hitting the gold button, no matter which one it is. You have to sit back and look at macro forces and macro themes to understand gold and the drivers of gold.

 

When we go back 30 years ago, as Pierre Lassonde pointed out at the Denver Gold Show a year ago, China and India represented only 10% of gold demand – 6% India, 4% China. Today, however, these two countries comprise 53% of all gold demand. Why is that? Because a rising gross domestic product per capita and purchasing power parity are highly correlated with what I call the love trade, that is gold jewelry demand and gifts in gold. So that's the underlying factor that keeps driving gold demand. The supply side has peaked and outside of recycling, there are no major new discoveries being made and no major deposits coming onstream. So I think this bodes very well for 60% of all gold consumption.

 

Now we get into the fear trade, and that's what really accelerates things – negative real interest rates and unprecedented money printing. The G20 finance ministers and central bankers started their own cartel 20 or so years ago. At the beginning of the century, they were consumed with global trade, the World Trade Organization, China, and, all of a sudden, there's a huge global boom. Gold stocks took off. Bullion went from $250 to $800/ounce. We had this incredible cycle. Along comes 2008-2009 and we go to synchronized taxation and regulation. Today, we have synchronized money printing to fight Covid-19. There is not one country printing money faster than another. They're all taking turns at it.

 

If we take a look at the Federal Reserve's balance sheet and how it's exploded under this cycle compared to 2008-2009, simple math would suggest in the next three years gold could be $4,000/ounce. The other big part is the inflationary number, because it's changed several times. If you use the inflationary algorithm, when gold hit $850 and silver $50, inflation was over 18%, today we have inflation running 8% so gold would be valued about $7,000. So I comfortably feel that in the next three years, in this next cycle, we could see gold double from here based on just the US money printing.

 

Streetwise Reports: You've looked at broad stock market performance in presidential election years. What have you found?

 

Frank Holmes: Well, historically, the first two years of a presidential election cycle are very sloppy, some are modestly up. But it's in the last two years that the market usually is on a tear. If it's not, then it usually derails the political party in power, such as we saw with President Obama's election in 2008. During President George W. Bush's last term, his last quarter, we had Lehman Bros. go bankrupt, and then there was just incredible turmoil in stocks and the economy.

 

This is a very different world. Even though we have Covid, the US Purchasing Managers' Index (PMI) is the highest in the world, and that means six months from now, we're going to see higher energy, copper and iron prices. This has been trending up all through the summer. So that remains very bullish.

 

We also track the airline industry very carefully. We have the only airlines exchange-traded fund (ETF) available to investors: the US Global Jets ETF (JETS:NYSE). The Transportation Security Administration used to clear 2.7 million people a day; in April it fell to fewer than 90,000 people a day. Just last week, we went through 1 million, so we're climbing. This is very positive for the travel industry and for JETS, and it's a reflection of the PMI and the stock market being stronger.

 

When you have negative real interest rates, what we're seeing is that it's not just Americans buying stocks because of low yields – and dividend yields are more attractive than what you're going to get from a money fund or a bank – but also you're seeing central banks like Switzerland print negative money. No one's going to buy it, so it buys it itself, and then goes and buys real assets like Apple Inc. When you take a look at what we see now in Japan – this is where capital formation morphed dramatically – 15% of the stock market is owned by the government, the central bank. So this is a very different world.

 

What we saw in this cycle, in the past six months, is the Federal Reserve starting to buy bond funds. It dropped the interest rates to zero, but the real cost of capital was running at 14%. So what did it do? It came in and started buying muni bonds. That helped get the pressure off a trillion Dollar muni market when bonds are being rolled over. Then it came in and bought corporate bonds to get corporate yields down so it didn't put a burden on corporations. Now, one of the largest bond holders of ETFs is the Federal Reserve. So we're seeing things change in that formation of capital.

 

Streetwise Reports: Going back to gold, it is often touted as a hedge against inflation. What's the situation with inflation in the United States currently and looking ahead?

 

Frank Holmes: If we look at what the inflationary number is today, and if we look at 10-year, 5-year and 2-year bonds, they all have negative real interest rates. That says that gold is a very attractive class. For me, gold stocks with rising dividends and free cash flow are even more attractive. I think that's one reason why Warren Buffett all of a sudden bought Barrick Gold Corp. (ABX:TSX; GOLD:NYSE). It has strong leadership. Newmont Corp. (NEM:NYSE) also looks attractive for many fundamental factors. Both have free cash flow. I think the free cash flow allows for rising dividends, so it's much higher than what you're going to earn with the negative real interest rates.

 

I can't see interest rates rising dramatically. John Williams has a newsletter called Shadowstats. He looks at the old algorithms used to determine the Purchasing Power Index, Consumer Price Index, etc. And if you use his factors, inflation really is 8% today. So that says back up the truck and buy as many physical assets as you can. That's why real estate is up 10% in this bearish crisis. It's amazing.

 

Streetwise Reports: One thing that's happened this year is that investors have flocked to physical gold ETFs. Is this a good way to invest in gold bullion?

 

Frank Holmes: I've always advocated having a 10% weighting in gold – 5% in either the SPDR Gold Shares ETF (GLD:NYSE) or 24-karat gold jewelry and another 5% in quality gold stocks. In particular, I've always loved the royalty companies.

 

I think there's a big push for GLD because if you look at data for the past 20 years, bullion has outperformed the S&P 500 by almost 3:1. Bullion has been up 80% of the time. The largest hedge fund in the world, Ray Dalio's Bridgewater Associates, has always had exposure to gold, from 7-15%. I think this has led to other institutions looking at gold as an asset class.

 

But I think the real charm here is because great investors like Warren Buffett all of a sudden buying a gold stock is going to change the paradigm during this quarter. Our data suggest that when we look back on the past 20 years at pre-cash flow yields, and we track 88 global gold producers and 200 explorers, under those 88 global producers – I'm talking about ones with market caps more than $50 million ($50M) – what I find interesting is that this will be the third quarter in over 15 years that they have a free cash flow yield. Even a year ago, they did not have an overall average free cash flow yield, and the S&P 500 had a free cash flow yield of 2.5%. In March, because of the crisis, the S&P 500 went negative on free cash flow yield as a whole, but gold just exploded.

 

I think we're going to see record free cash flow yields from North American gold producers, and that will be a pivot point for many institutions to start buying gold as an asset class. This summer, in Investors Business Daily's Top 50 stocks to buy, all of a sudden, like back in 2005, gold producers were added to this list of growth stocks. We're now seeing Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) on there, we're seeing Kirkland Lake Gold Inc. (KL:TSX; KL:NYSE) on there. So I think gold will slowly climb. It's been in a bull cycle since January 2019 when the 50-day moving average went above the 200-day moving average. It has accelerated this summer and then corrected perfectly. In the next big wave, I think we're going to see gold stocks really outperform.

 

Streetwise Reports: US Global Funds manages a number of mining funds. Could you talk a little about what you look for in a company when making the decision to invest? Is there any one type of company investors should focus on right now for the greatest upside potential – senior, midtier, junior, royalty companies?

 

Frank Holmes: We look at what is called "The Five Ms of Mining" – mine lifecycle, market cap, management, money and minerals. Basically when we go down the food chain, for explorers, management is key, as is where they are in the lifecycle of a mine. The early explorers can give you tenbaggers, twentybaggers – 20 times your money – but, in time, they can fizzle out early and quickly, so you can lose your money. In that lifecycle, you want to have proven management track records in a well-known area and companies that are well funded and have good daily trading liquidity.

 

When we go up the food chain, we want to look at the producers that have expanding production or have a free cash flow yield, which means with rising gold they're going to be able to pay higher dividends. We think that those stocks outperform.

 

The most superior model is the royalty companies. They're like a technology stock, a software-as-a-service (SaaS) stock. They have recurring revenue and cash flow every month. They have high gross margins. If you look at financial accounting from streaming, etc., royalty companies push 45% gross margins, where the average gold mining company is at 15%. Royalty companies are in a very advantageous position, and we're seeing more new junior royalty companies trying to capitalize on that model.

 

Streetwise Reports: Is there anything else you'd like our readers to know?

 

Frank Holmes: Yes. Go to USFunds.com, and you can learn more about the ETFs and our research. We publish a lot. We're on YouTube as well, with many educational videos. We, also, every Friday write the Investor Alert, which goes out to 60,000 people in 180 countries. We really try to help people be educated on various sectors of the market in this publication. We have won 90 awards now for educational information in the investment management world.

 

Streetwise Reports: Thanks, Frank, for your insights.