Precious Metals

Gold Investing

Mining Journal’s Best Americas Based Fund Manager tells us about the four-year gold cycle, the current correction phase, the Trump impact on the economy and where gold will be in 2017.

The Investing News Network caught up with Frank Holmes, CEO and Chief Investment Officer of US Global Investors (NASDAQ:GROW) at the Silver & Gold Summit, and spoke about the ups and downs of the junior resource market in 2016, and what lies ahead in 2017.
Frank Holmes, together with portfolio manager Ralph Aldis, CFA, won Mining Journal’s Best Americas Based Fund Manager award in September. Holmes manages two precious metals equity funds, the  World Precious Minerals Fund (UNWPX) and the Gold and Precious Metals Fund (USERX).
Some highlights of our conversation include:

  • The four-year gold cycle and the current correction phase
  • Where gold will be in 2017
  • The Trump impact on the economy and the price of gold
  • Another commodity that Holmes follows, apart from gold
  • Data mining and its big impact on investing

Below is the full transcript of our conversation with Frank Holmes. It has been edited for clarity and brevity. Read on to see what Holmes had to say.

Investing News Network: What are your thoughts on the junior resource market in 2016?
Frank Holmes: What we found last year at this time, I was commenting, is that there’s a four year cycle. Like the US presidential election cycle, there’s also a four year gold cycle that comes in waves and what is important is recognizing that gold cycle.
What’s interesting is that it [the gold price] bottomed around December 27th, 2015. Most generalists and pension funds in both Canada and the US were still anti-gold. Even through the first quarter when gold had a massive move. Most Canadian pension funds are two percent weighted in gold stocks and the TSX index is eight percent. So those funds are way underweight. And this is going to continue until gold goes to new levels.
We’re going through a correction phase short term, and it’s a normal process. But I think what’s disruptive for short term is the carry trade. The carry trade is where people borrow cheap, cheap money such as demand loans from Japan. They go and reinvest that money whenever there’s negative interest rates into bullion. They buy dividend paying stocks or high yielding countries’ currencies.
When the Japanese, every so often, say, “We want our money back,” it creates a massive unwinding and selling. Right now there is about a trillion dollars now in this carry trade.
We saw this in a big way back in 1997 when the carry trade collapsed. The Malaysians, the Thais, the South Koreans had used the funds and couldn’t return it. They had to put the funds into building infrastructure for example and they couldn’t return the money. So they had a massive currency devaluation. In South Korea the government turned to the citizens of the country. The were in newspapers and on radio every day asking people to ‘Please turn in your gold’. The citizens did, so the country wouldn’t lose face and default. Korea didn’t default because of her the citizens, who gave up their gold to protect the country.
We had this again in 2006 when we won an award for the best gold fund in the world. We were 40 percent in cash. All of a sudden, May of 2006, the Japanese said, “We want our money back” and you had this huge currency unwind and being in cash protected our investors.
INN: How will President-elect Donald Trump impact the economy?
FH: There were comments last week just prior to the election that the monetary authorities in Japan were starting this process. Then with the Trump win all of a sudden it becomes even more so. We saw one billion dollars go into TIPS (Treasury Inflation-Protected Securities), which is basically a government bond, which is inflation adjusted. That was significant because you usually don’t get billion dollar TIPS bond trades in a day. So that’s an inflection point like when you go from ice to water all at once at 32 degrees (zero Celsius). There was a similar change with Brexit. And now with Trump, there’s another change.
So at this point we’re digesting this change. But the fact is that Trump is going to own the highest ever level of debt in America. And he’s not afraid of borrowing. I think they would like to see interest rates get up a hundred basis points. Inflation is going to be running with his programs if he goes through with a trade war. We’re going to get inflation surging because you slap a 30 or 40 percent tax on China, Walmart is going to pass that on to the consumer, especially the bottom half in terms of income earners. So you are going to get an inflationary slap in the face. And then if interest rates go up too quickly and too high, the housing market basically implodes. So, the country is in a “big drama” state.

A big part of Trump coming in is that he has talked about dropping taxes and regulations. Zero interest rates in the US, or very cheap money, has allowed for certain people to borrow which should have lead to growth. But high levels of regulation has usurped that huge growth.
The only way you can raise rates and still get increased economic activity is to change your fiscal policy. It’s a real teeter-totter when monitoring fiscal policy. On one side is cheap money, the other is lower regulation. The only way to get rates to rise without stifling the economy is to drop taxes and deregulate.
INN: How much influence does the US government have on the monetary policy when the Fed is supposed to be an independent group?
FH: They are independent. They are very proudly Democratic Party members. They’re unionized. People don’t realize, but the Federal Reserve is unionized and so is the SEC. There are 7.1 million unionized government workers. They all gave to Hillary. They don’t give to the Republican Party. So you have this interesting dynamic. The Federal Reserve and the Treasury Department have been reaching out with regulation to every segment of society. An example is anti-money laundering laws but it goes on and on. The cost of compliance has been a massive burden on the flow of money.
We heard Elizabeth Warren say to a financial sector that anyone who was going to challenge her on the fiduciary rule she was imposing by the Department of Labor (which is a union organization), is going to be charged by the Department of Justice.
All of this regulation only helped Trump. There is a real constipation right now of regulators that are ruling themselves rather than being a good refereeing of economic engines.
What do I think? I think that we’re going to end up seeing gold trading higher. I don’t think that Trump has any alternatives. He’s not going to be able to shrink the debt load and I think that we’re going to get inflation.
If you recall, when gold took off in 1980, in the first run to $850, what was important is that interest rates were negative. People don’t realize. Interest rates were at 12 percent but inflation was running at 20 percent. That’s why interest rates had to go to 20 percent when Paul Volcker came in [to chair the Federal Reserve] to knock it down. So you had a negative 8 percent coupon then. Right now we have a negative 150 basis points. If we do start getting this inflation, we can get a gold move.

It is important for your audience to understand the gold standard deviation. 70 percent of the time, it is a non-event when, over any rolling 12 month period,  gold goes up or down 20 percent. That is the same volatility as S&P 500. Gold stocks have a 40 percent standard deviation. Biotechnology stocks are 40 percent, emerging markets are 40 percent. So you see that different asset classes have a different DNA of volatility. Gold was up at the end of September by 24 percent, so it’s slightly over one standard deviation. Now it’s correcting. If you look at it over the next 12 months, it would be nothing for gold to still rise higher from this level. Odds are, going for another standard deviation would have to be a real crisis. But for it to gradually go up is a non-event. Also, for it to correct 20 percent is a non-event. This is the reality of the volatility of gold.
INN: What are you expecting from gold in 2017?
FH: I think we’re going to see peak gold. I don’t think there are any major discoveries. I think that the environmentalists control the narrative, still. It’s not about clean air and clean water it’s just about no mining. There have been no major discoveries and if you do have a deposit and you try to expand it, it’s next to impossible to get that new mining permits. I think you’re going to start seeing mine supply shrink. That is going to be a positive constructive element for the gold price to find a new base.
INN: Are there any other commodities you’re particularly excited about or that you follow?
FH: Well one thing is we love silver. Silver is a warrant on gold so if gold goes up 10 percent silver’s going up 15 and if gold falls 10 percent, silver’s falling 15. It’s important to recognize that you’re always going to get more leverage with silver than with gold.
INN: Are there any companies that stand out that you’re excited about what’s going to happen for them in 2017?
FH: We won this award from Mining Journal for best gold fund in the world and our success comes from a combination of factors. I’m picking some juniors and they are plat of the story. Several of them presented earlier at this show. But our success is also in part due to the bigger liquid companies with market caps more than $200 million. With these companies most of the buying, on order of 60 percent, has been quant funds and they’re looking at momentum or relative valuations.
The quant funds are driven by the same data mining that led to Trump coming to power. The ability to data mine is going to be the most powerful tool to make decisions. One of the funds just looks for companies with the lowest G&A (general and administrative expense) to revenue. Each quarter they just pick ten stocks that have the lowest G&A to revenue. That fund is up 180 percent today whereas the GDX (NYSE:GDX) is up 80 percent.
Other metrics quant funds look at is operating cash flow to enterprise value. Or maybe revenue per employee. Why do the royalty companies do so much better? Because Silver Wheaton (TSX:SLW,NYSE:SLW)  has $24 million of revenue per employee, Franco-Nevada (TSX:FNV,NYSE:FNV) is $15 million of revenue per employee and Newmont Mining (NYSE:NEM) is $200,000. Margins are much higher with a royalty company. Then every time they do a financing, this is accretive to the book value. If you look at the mining space around the world, the royalty companies have this 45 degree angle in book value. One of the factors you can look for as a value investor is to look at price to book. Most of the mining companies have had such big losses that their price to book as an industry has been shrinking.
When we were doing our data mining we found that out of the 88 gold stocks we follow, they actually had negative one percent in revenue per share growth. Gold is up! How could you have negative per share revenue? They are issuing shares faster than gold is going up to repair their balance sheet. It’s a continuous issue.
We created an index and the companies that have the highest revenue per share growth over four quarters are up 120 percent. The companies that are better stewards of capital, as Warren Buffett would say, and are protecting value on a per share basis, are getting higher valuations.
INN: There does seem to be much more awareness among the junior resource CEO’s on the value represented by their shares. They are being more cautious with their financings rather than to keep issuing more and more stock.
FH: Unless they can show the reserves per share going up, they run the risk of impacting their value per share. If they have a big successful drilling program and they increase their reserves by 100 percent and they do a 10 percent financing, it still shows growth in reserves per share.
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The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in the interviews it conducts. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.
Securities Disclosure: I, Nick Smith, hold no direct investment interest in any company mentioned in this article.


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