by JT Long of The Gold Report (6/18/14)
Close your
eyes. Imagine India growing and importing gold again freely. China and
the U.S. investing in infrastructure. Europe stable. The Middle East
conflict-free. What would that mean for commodities? In this interview
with The Gold Report,
U.S. Global Investors CEO Frank Holmes outlines the developments that
could move us toward that vision and the impact that scenario could have
on gold, diamonds and steel.
Related Content:
The Gold Report: You
recently wrote an article called “It’s Morning in India” that marked
the election of Narendra Modi’s pro-business government. How much of an
impact can one man have on the demand for commodities?
Frank Holmes: At U.S.
Global Investors, we believe that government policies are a precursor to
change. That is why we focus on fiscal policies all over the world to
understand the impact they will have on everything from interest rates
to money supply. What makes Modi special is that he understands that job
growth and creativity come from fiscal stimulus. Creating tax-free
zones, breaking up monopolies and streamlining regulations and
bureaucracy can unleash intellectual capital. Modi’s track record in the
state of Gujarat illustrates his ability to produce significant growth.
He is a no-nonsense, pro-business person.
TGR: Let’s look at what
you have called the love trade. Its traditional seasonal impact on the
gold market was quashed by taxation and import bans. How much of an
effect could the pent-up demand have on the gold price if the government
eliminates those disincentives?
FH: India is a big
market and it can have a big impact. There is a high correlation of
rising per-capita GDP in China and India and rising consumption of gold
for gift giving. In the past three years, global GDP has shrunk from
5.5% to 3%. This year, it looks as if it is going to be back up to 3.5%.
Growth and prosperity in America creates an economic sounding board
that creates money around the world. Add to that the demand created by
the religious holidays in the second half of the year—first Ramadan and
then wedding and Diwali seasons, followed by Christmas and Chinese New
Year—and it looks very positive.
Even JPMorgan Chase’s Global
PMI, the Purchasing Managers’ Index is looking up. The forecast of the
next six months of economic activity shows the 1-month above the 3-month
average. When that happens, consumption usually increases significantly
in all commodities.
TGR: Let’s quantify the term “significantly.” Are we talking about a 2% increase? A 10% increase? More?
FH: Well, that’s hard to
say, but I have a suspicion that gold can easily jump 30%, up two
standard deviations, because it’s been down two standard deviations.
Meanwhile, gold stocks are cheaper today than they were during the
crisis of 2008, relative to the price of gold. So if we have a 30%
increase in the price of the gold over the next 12 months, the gold
stocks could rally 60%. For that to happen, we would have to see peace
and prosperity in China, India, Southeast Asia and the Middle East,
because that really triggers the consumption of gold.
TGR: How do you determine what companies in your portfolio are poised to do well if the gold price increases?
FH: Quality of
management is a key factor. We look for technical engineers and
geologists, but also at whether leadership understands the capital
markets and has relationships with newsletter writers, buy-side and
sell-side analysts. Those companies that have those relationships when
they come out with news will enjoy a better response in the capital
markets. So the quality of senior management is very important.
Our investment philosophy is driven more by the quality of the company rather than by leverage to the gold price.
We love Virginia Mines Inc. (VGQ:TSX).
It’s a high-quality, low-risk exploration and royalty company managed
by André Gaumond, who has an incredible track record. He knows all the
newsletter writers, he knows all of the sell-side and buy-side analysts,
and the company owns a role in Goldcorp Inc.’s (G:TSX; GG:NYSE) high-grade Éléonore project, which he found and is slated to go into production in late 2014.
Another low-risk, high-grade gold producing company that we see as having significant upside is Klondex Mines Ltd. (KDX:TSX; KLNDF:OTCBB).
At the beginning of the year, Klondex Mines completed what we think is a
transformational transaction with the purchase of Midas mine and mill
from Newmont Mining Corp. (NEM:NYSE). Management is highly respected. At
one time, Franco-Nevada Corp. (FNV:TSX; FNV:NYSE)owned
the Midas mine. Klondex Mines and Virginia Mines delivered 6% and 20%
returns in 2013 when the Market Vectors Gold Miners Exchange-Traded Fund
(GDX:NYSE) was down 60%. That is impressive.
TGR: What is the next catalyst for Klondex Mines?
FH: We see the value in
the Midas project facilities. That’s the catalyst. Once you unleash that
and the quality of management and its ability to communicate its future
growth, it could have an impact.
Another high-grade name with strong performance is MAG Silver Corp. (MAG:TSX; MVG:NYSE), which has two projects in Mexico.
TGR: MAG Silver just released a new resource estimate for the Juanicipio mine. Did that meet your expectations?
FH: MAG’s 44% share is
71 million ounces grading 601 grams per ton silver. That makes MAG
Silver stock very desirable right now. We think it could get taken over
at some point.
Another company that we like is NGEx Resources Inc. (NGQ:TSX).
It’s got a great promoter, Lucas Lundin as chairman, and it’s led by
well-known CEO Wojtek Wodzicki. Los Helados, Filo del Sol and Josemaria
are major copper-gold porphyry deposits between Chile and Argentina with
tremendous upside. Lucas Lundin is not afraid of drilling up something
and selling it. A lot of time management falls in love with the asset
and the value never gets unlocked. We like the way NGEx’s management
thinks.
TGR: All three of these stocks are up since the beginning of the year. Do you credit that to management?
FH: Absolutely. They are
always communicating. We don’t have to hunt them down to find out about
a press release or news. The top analysts and fund managers know what
they are doing. That proactive attitude creates trust in a personal or a
professional relationship.
TGR: What are some other performers in your portfolio?
FH: One thing that is very important for stability in a portfolio is the royalty companies. Sandstorm Gold Ltd. (SSL:TSX; SAND:NYSE.MKT), Franco-Nevada, Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX), and Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) are all up this year.
Royal Gold has been the big
champ. Last year, Franco-Nevada was the leader. Silver Wheaton was able
to borrow $1 billion ($1B) for five years at 1.6%. That is unbelievable!
Why would you ever want to own Newmont Mining or Barrick Gold Corp.
(ABX:TSX; ABX:NYSE), when you can own Franco-Nevada? It has 60% gross
profit margins and a royalty on all those operations. You don’t have to
worry about all the fiascos or leveraged balance sheets. Management owns
a big portion of the company. Franco pays dividends on a regular basis.
Just consider revenue per employee, which is $50 million ($50M). In
most companies, $500,000 revenue per employee is good.
Today, royalty companies
function like mining finance houses. That’s a great business model. That
is why they are one of the core holdings for any portfolio.
TGR: Is this an important time for royalty companies because there is such a desperate need for capital?
FH: Capital markets are
broken. Regulations are so excessive for junior mining companies that it
is increasingly difficult to just walk in with a beautiful piece of
property in Quebec and raise money. Therefore, private equity and
royalty companies are very significant for junior mining companies right
now.
We are seeing a shake-up. Weak
properties and weak management are just not going to get funded. Great
management and great properties can go to Franco-Nevada or Royal Gold or
Silver Wheaton and really advance their projects.
TGR: Your Gold and
Precious Metals Fund (USERX) did very well at the beginning of the year
considering the market. You’re up 11.83% compared to the last 12 months
when it was down 32%. Is that upswing a sustainable trend?
FH: It’s all about
concentration. Alpha comes from two things: a) the ability to pick
better companies; and b) overweight them relative to any index.
If an index is 5% Franco-Nevada
and I have 15% for my portfolio, I’m three times overweight the index
and that stock outperforms. That is how I’ve massively outperformed the
index. Conversely, underperformance comes from overweighting in a very
poor stock. Our alpha is coming from focusing on the companies that I
mentioned, like MAG Silver, Virginia Mines, NGEx Resources, and
balancing those volatile names with the royalty companies.
TGR: Does the same logic hold in other commodities?
FH: The other commodity we love is diamonds. We love Lucara Diamond Corp. (LUC:TSX.V),
which is another Lucas Lundin company. For less than $50M, he got his
money back in a year. It’s really simple math. We now have seven billion
people on earth and if even 1% of those people experience a dramatic
rise in per-capita GDP and they all buy luxury goods, that is a boon for
companies like LVMH Moët Hennessy Louis Vuitton S.A. (LVMH:IT), which
currently has a market cap bigger than Goldman Sachs Group Inc. We own
Tiffany & Co. (TIF:DE) because when things start to get better,
people want nice things.
Disruptive technologies are
making millionaires and billionaires out of a concentrated percentage of
the population like Dr. Dre and the five people behind WhatsApp.
TGR: Well, this isn’t as sexy, but what about nickel and steel?
FH: Nickel is much more
of a straightforward supply-demand story. Nickel is used in alloying
steel, including the steel that will be used in the $550B pipeline China
is building to Russia. If there is a supply shortage out of South
Africa and mines shut down in North America, the price could immediately
go up. Copper levitated a couple of years back even though the economy
had slowed because earthquakes and strikes impacted the supply. If we
get any type of supply constraints, then prices could change quickly.
Right now, we have an
oversupply of steel. The Chinese have been dumping steel on the world.
But that pipeline agreement with Russia could be a signal that the
country is embarking on an infrastructure boom that will absorb a lot of
the steel. Combined with Modi’s infrastructure ambitions in India, that
could mean a lot more demand for steel and copper.
TGR: Are you predicting the same significant impact as in gold, a couple standard deviations?
FH: I think we have the
potential for one of those great global rallies we witnessed in 2003,
2004 and 2005. If China and India start building meaningful projects for
their people and we get a bottom in Europe, with America on an upswing,
I think that we could see a global surge. It’s not going to be as
inflated as it was in 2003 because the housing component is not going to
be as leveraged. Housing has the highest multiplying effect for money
because so many people touch each dollar to create a house. Therefore, I
don’t think we’re going to get close to the surge we had 10 years ago,
but I do think we can get at least three-quarters of that.
TGR: Your Holmes Macro
Trends Fund (MEGAX) is a diverse basket of industrial, energy,
technology, healthcare, consumer product and financial stocks that are
impacted by the macro-issues you just outlined. What criteria do you use
for building that portfolio?
FH: We look at companies
that are actively growing their revenue more than 10%, generating
bottom line up to 20% return on their equity, and demonstrating 20%
growth in earnings.
As John Derrick described in
his Periodic Table of Sector
Returns, we can learn a lot by examining movement in the top sectors.
This is an amazing indicator. We track quarterly how many S&P 1500
companies across all sectors qualify for this beauty contest. This past
March the number went from 160 names to 180 names even though GDP was
down in America. That shows wonderful, broad-based economic growth. Back
in the peak of 2006, it was over 200 names, then it fell down to under
100 names. So it is going in the right direction.
Another positive is that
industrials are strong, and that is usually highly correlated to the
consumption of commodities and good for per-capita GDP because wages are
typically more than $15/hour in that sector.
TGR: More than half of
the Macro Trends Fund is composed of large-cap, over $10B companies. Are
you worried about a bubble in the large indexes?
FH: The word bubble has
been abused. If you research the causes of a true bubble, it’s usually
excessive leverage, borrowing. The great crash of 1987 when investors
lost 40% of their wealth in two days was predominantly because the
S&P futures market was leveraged 10:1. In the crash of 2008, we had a
housing market leveraged 90:1. Today, there is some concern about
leveraged buyouts, but governments are going to have to keep interest
rates negative or extremely low to counter regulatory creep and keep the
economy moving.
TGR: So you think today’s stock prices correlate to the true value in the companies?
FH: Sure they do. Look
at dividend yields. A 10-year government bond is 2.5%, and you can buy
some of these big-cap stocks with a dividend yield greater than 10 years
out. We don’t know who will be president 10 years from now, but we do
know we will still be using Procter & Gamble’s products and drinking
Coca-Cola.
Plus, fewer companies are
issuing stock options. Instead they are giving executives stock grants
over five years so there’s a real aligned interest for senior management
in these companies to buy back their stock, and increase their
dividends against their cash flow. Look at Apple Inc. (AAPL:NASDAQ ). It
announced a 20% buyback; revenue per share is jumping 20%. That’s
profound. There are very few IPOs relative to companies buying back
their stock and increasing their dividend. That means the stock market
is still very attractive.
TGR: Thank you for your time, Frank.
Frank Holmes
is CEO and chief investment officer at U.S. Global Investors Inc.,
which manages a diversified family of mutual funds and hedge funds
specializing in natural resources, emerging markets and infrastructure.
Holmes purchased a controlling interest in U.S. 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. In
2006, Holmes was selected mining fund manager of the year by the Mining Journal.
He is also the co-author of “The Goldwatcher: Demystifying Gold
Investing.” He is a member of the President’s Circle and on the
investment committee of the International Crisis Group, which works to
resolve global conflict, and is an adviser to the William J. Clinton
Foundation on sustainable development in nations with resource-based
economies. Holmes is a much sought-after keynote speaker at national and
international investment conferences. He is also a regular commentator
on the financial television networks CNBC, Bloomberg and Fox Business,
and has been profiled by Fortune, Barron’s, The Financial Times and other publications.
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DISCLOSURE:
1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report,
and provides services to Streetwise Reports as an employee. She owns,
or her family owns, shares of the following companies mentioned in this
interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report:
Klondex Mines Ltd., Virginia Mines Inc. and MAG Silver Corp. Goldcorp
Inc. and Franco-Nevada Corp. are not associated with Streetwise Reports.
Streetwise Reports does not accept stock in exchange for its services
or as sponsorship payment.
3) Frank Holmes: I own, or my
family owns, shares of the following companies mentioned in this
interview: None. I personally am, or my family is, paid by the following
companies mentioned in this interview: None. I was not paid by
Streetwise Reports for participating in this interview. Comments and
opinions expressed are my own comments and opinions. I had the
opportunity to review the interview for accuracy as of the date of the
interview and am responsible for the content of the interview.
4) The following securities
mentioned were held by the Global Resources Fund, Gold and Precious
Metals Fund and World Precious Minerals Fund as of June 16, 2014:
Franco-Nevada Corp., Goldcorp Inc., Klondex Mines Ltd., Lucara Diamond
Corp., MAG Silver Corp., NGEx Resources Inc., Royal Gold Inc., Silver
Wheaton Corp. and Virginia Mines Inc.
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