Gold News

Gold Down? Stay Positive

US Global Investors' Frank Holmes reveals his "no-drama" investing strategy...
 
FRANK HOLMES is CEO and chief investment officer at US Global Investors Inc., managing a diversified family of mutual funds and hedge funds specializing in natural resources, emerging markets and infrastructure.
 
Holmes purchased a controlling interest in US Global Investors in 1989 and became the firm's chief investment officer in 1999. Under his guidance, the company's funds have received numerous awards and honors including more than two dozen Lipper Fund Awards and certificates.
 
Here he speaks to The Gold Report about what investors should do with precious metals as the price slump wears on...
 
The Gold Report: Your talk at the New Orleans Investment Conference was titled " The Optimistic Investor in a Pessimistic World". How do you stay so positive when gold falls 2% or even more in a day?
 
Frank Holmes: The biggest thing when it comes to gold – something I've always advocated – is to maintain a 10% weighting, 5% in gold stocks and 5% in gold jewelry or coins, and to rebalance each year. That has been a wonderful way for investors to deal with the volatility of the capital markets and to sleep at night.
 
TGR: What is happening in commodities? What are the most important indicators you're watching?
 
Frank Holmes: If you're really in tune to the stock and commodity markets day in and day out, it's kind of similar to arriving at a party and being able to tell if there is good energy or if it's not the place for you. There are these patterns you notice.
 
When it comes to commodities, a magic number for looking toward the future is PMI, which stands for Purchasing Manufacturers Index. In America, it's often called the ISM Manufacturing Index, which is exactly the same. J.P. Morgan publishes a global PMI every month, which surveys the major economies of the world, the G20 countries. I like to look at what happens when the one-month average of the world is above the three-month average, and what happens when it goes below. It's remarkable to see the law of inertia take hold.
 
The global PMI was so very strong in 2003, 2004, 2005 and 2006. Europe, America and Asia were just roaring, and commodities were ripping. Since 2008, the patterns have changed. There are so many new fiscal rules, Federal Advisory Committee Act (FACA) rules, money movement rules, etc., that you can't get the synchronized global PMI running in a very constructive way.
 
But it's important to look at what Europe is doing, because Europe is a bigger economic trading partner with China than America is. So when Europe slows down, that puts a real dent in China's economic prosperity. But the real psychology in the stock market is Quantitative Easing 3 (QE3) ending.
 
TGR: Do you think the headlines about ending QE3 are a short-term pain for the commodities market, particularly precious metals?
 
Frank Holmes: The biggest thing that's really hurting commodity markets, and gold in particular, is a stronger Dollar. Whenever the real rates of return in America are negative, gold starts to rally, which it did for the first six months of this year. And now the rates have gone positive. So all of a sudden, gold starts taking it on the chin. But the positive note is that India has been buying gold and so has China – there has been record demand on the back of these selloffs. There is a slow tectonic shift taking place globally for this credible metal.
 
TGR: Let's talk about how the fundamentals vary among asset classes and whether the volatility we're seeing right now is normal.
 
Frank Holmes: We did a special report in August/September, trying to explain this DNA of volatility. The piece was called "Managing Expectations: Anticipate Before You Participate." Everything in life is about managing expectations. As Warren Buffett says, if you want to have a long-lasting marriage, have low expectations, and everything is on the upside. The same thing happens with earnings. Do you expect the PMI to be positive? Do you expect the earnings to be positive?
 
What we have done in our research is look at all the asset classes, and we have noted that they each have different DNAs of volatility. When you look at gold and the stock market, it's about the same. It's a nonevent for gold to go +/-15%, and it's normal for the S&P 500 to go +/-15%. But mining stocks, energy stocks, emerging markets and biotechnology have a DNA of volatility of +/-35%. If biotechnology is off 35%, it's brutal feeling it as an investor, but it's just normal. So right now, we have gold stocks off 35% over 12 months, and they're down one standard deviation.
 
Now, if gold falls 50%, that means the odds favor a reversal. Last year at Christmastime, we commented that gold stocks and bullion were down two standard deviations, and we were due for a big rally. And positive interest rates went negative until June. Over those six months, gold rallied right back to its mean. Everything reverts to this mean average, which is important for investors to recognize. So when you're looking at the volatility, it shouldn't frighten you. The only time you really lose on this is if you're forced out of a holding.
 
TGR: As we're entering tax-loss selling season, what is your strategy for the end of the year?
 
Frank Holmes: I look for companies that are trading way below their book value and are candidates to be taken out. When you go down the junior spectrum, the question is how much cash does a company have, and can it survive for two years without any funding. If not, then there is dilution risk. I try to stay away from the micro-cap stocks, which often spend money faster than they're able to get their per-share reserves or production up.
 
TGR: You still have more than 80% of the Gold and Precious Metals Fund and more than 90% of the World Precious Minerals Fund in gold. What is your strategy there? What are your top performers?
 
Frank Holmes: I think royalty companies are the safest plays. They have high-margin businesses and low cost of capital, and there are very smart people running these companies. When you take a look at a company like Silver Wheaton, 30 people are generating $500 million ($500M) in revenue. It's probably the most profitable company per employee in the world.
 
TGR: And lower risk.
 
Frank Holmes: Correct, much lower risk. Now, when it comes to the junior spectrum, we like the stock to have great management, have a wonderful footprint from a geological point of view, be increasing its production and be very conscientious of dilution. 
 
TGR: Frank, you just won some awards for education. What is the role of education in your operation?
 
Frank Holmes: My blog goes out to tens of thousands of people in 193 countries, so it's amazing to see the readership. We've won about 64 awards in the past seven years. This year it was a record 10. The one that gets the No. 1 e-letter is Investor Alert. That is written every Friday night. Many publications can't produce a product like this because compliance is so rigorous, but we are able to get it out to shareholders for the weekend read. It's written by our investment team. It assesses the strengths and weaknesses of the portfolio, presents an outlook for the following week and notes major opportunities and threats. The SWOT model always has three sentences for each section and usually a chart. The fact that it's put together by the investment team makes it much more credible and timely, but it's also succinct.
 
TGR: Educate us. Give us something to be hopeful about.
 
Frank Holmes: There are lots of opportunities in basic materials and resources. While we're talking, there are 7 billion people on Mother Earth. On the other side of the world, there are 100 million people having sex. And in nine months, there are going to be 1 million screaming babies, and that population growth is not going to stop.
 
TGR: And you have a great chart (see beginning of interview) that shows how many resources that baby will use over his or her lifecycle. What are some of the highlights on the commodity side?
 
Frank Holmes: In 1972, China and India had no global footprint. They only had 2% of the world's gross domestic product. Today, they're 25% and 40% of the world's population. Down the road, this is very positive for commodities. When these commodities turn and we finally get synchronized growth, then I think what's going to happen is a streamlining of rules and regulations. Where you are getting the fastest growth is where there are tax breaks.
 
TGR: Do you think the results of the recent midterm elections will be positive for this regulatory environment?
 
Frank Holmes: We'll see what happens when it happens. The difficult part for the average investor is that the best the stock markets have been is with a Democratic president and a Republican Congress. That's why we like to say that you should be diversified and follow the money. I've written about the fact that under Obama, there's been a spectacular stock market run. It's shocking. Why? Because so much capital has been injected into it. I think that one has to sit back and be balanced.
 
Investors age 50-55 are about 15 years away from retirement. It's not a good time to take big risks like putting all assets in the stock market. Witness the huge crash of 2008 when individuals about to retire lost their nest eggs.
 
TGR: Thanks for talking with us.
 
Frank Holmes: A pleasure, as always.

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