Announcer: The SmallCap Power Expert Interview.
Mark Thorburn: Frank Holmes is CEO and Chief Investment Officer at U.S. Global Investors. U.S. Global is a boutique investment management firm specializing in actively-managed equity and bond strategies, with a longstanding history of expertise in gold, natural resources, and emerging markets.
He’s a regular commentator on financial TV networks, including CNBC, Bloomberg, and FOX Business, and it’s a pleasure to have him in the SmallCap Power studios today. Welcome Frank.
For the benefit of viewers, can you tell us about U.S. Global Investors as well as your role there?
Frank Holmes: Well, I am the Chief Investment Officer and the CEO. So I get a good flavor as the CEO of a public company — the ticker is GROW for GROW — to understand all the regulatory world and things you have to do is running the business, and then I look at companies in a similar fashion and I have an empathy with CEOs and what they have to do and CFOs. But also I have to hold my own self and company accountable. So therefore it’s easy for me to hold other people accountable.
Mark Thorburn: We see that the gold price has been falling for the past three years now. So what catalyst do you think will move the precious metal’s price either sharply higher or lower?
Frank Holmes: Well it’s been horrific, and I’ll try to explain the two demand drivers. I call them the Fear Trade and the Love Trade. The first factor is the Fear Trade, and that predominantly is negative real interest rates. So when gold peaked at $1,900, the 10-year government bond had a negative interest rate of about -3%. It was unbelievable. Today, it’s +50 basis points. So as the yield on the 10-year government has improved because CPI numbers have fallen and overall cost of money has risen, as a positive rate return gold will fall. So that’s the Fear Trade, and that’s the most prominent thing that Americans have to be cognizant of.
But the other factor that took gold to $1,900 was the Love Trade, and the Love Trade is Chindia’s (China and India) impact around the world, who have a cultural affinity for gold, and what correlates there is the GDP per capita. So if you have rising GDP per capita in the emerging Asian countries, then you have a higher consumption of gold. Well, they all peaked in 2011, September 2011.
Now do I think 2015 that interest rates will remain negative in the U.S. or they’ll go back to being negative for the 10-year? That’s possible. What would trigger that? I don’t think it’s going to happen for six months, but that’s a headwind for gold. But I do think the Love Trade could be a more important factor in seeing gold firm up. On the supply side, 2015 is forecasting shrinking mine supply.
Mark Thorburn: China’s economic growth has been slowing in recent years. In your opinion, do you think the commodity super cycle is coming to an end?
Frank Holmes: Well, I think one of the key factors to the global super cycle for commodity demand was synchronized fiscal policies. Global fiscal policies, which were trade, trade, trade, we had that prior to 2008. Now, it’s tax and regulations when the G20 get together.
So when we swing back from a very aggressive monetary policy and to lighten up and streamline the regulatory tax regime of the world, then that fiscal stimulus will ignite a bigger demand for globalized growth in commodities. But what’s really important long term is demographics. Aging population, about 7 billion people, that every day, there is a million babies being born, and the world is wired and hooked up, and the poorer parts of the world can all see the great American dream, which they couldn’t see 10 years ago.
Mark Thorburn: At what level do you see oil prices bottoming out, and where do you see the price of crude at the end of 2015?
Frank Holmes: You know, it’s a great question regarding crude. When you look at oil and gas, in particular the cycles they have, oil historically bottoms on a seasonal time period in February when it’s the coldest in New York. It’s sort of contrarian. So I think between now and then, we’ll find a bottom for oil prices.
What I do think is impacting oil is not just the fracking supply and the battle between Saudi Arabia and the frackers. No, I think it’s geopolitical, and I think that Saudi Arabia and Kuwait have aligned themselves with the U.S. and it really hurts the Axis of Evil. It hurts Venezuela. It hurts Iran. It hurts Syria, and it really punishes Putin because Russia’s largest source of foreign reserves and cash flow to run their economy is exporting energy.
Mark Thorburn: Do you have any favorite resource picks that you like at this time?
Frank Holmes: Well, I like free cash flow, and there are really not that many oil companies who are throwing out that big free cash flow that’s necessary in this type of market. But this drop in energy prices is a huge, huge tax stimulus in America. Forty or fifty billion dollars is showing up now in the Walmart stores, etc., and what I recommend investors to look at for this higher increase in consumption is Tiffany’s(NYSE: TIF). You want to look at Tiffany’s, and I give you a classic example. Twenty five years ago, a perfect carat would cost you about $6,000. Today it’s $12,500. That $6,000 investment in Tiffany’s is now worth $300,000, and the dividends are greater than $6,000.
So when you see that commodity prices have declined, like they have, but the disposable income has risen, Tiffany’s is one of those great stocks. So I like companies like that.
When it comes to the gold space, I like the royalty companies, companies like Franco-Nevada (NYSE: FNV), which have 70% profit margins, that have a dividend yield higher than a U.S. 5-year government bond, and the dividend’s been rising and management owns a big piece of the company. So I like that, and we own them in our funds.
Mark Thorburn: I understand your company has a short-term municipal bond fund called NEARX. Why do you call it a no-drama fund?
Frank Holmes: Because there’s been no drama, and it’s done so good and that’s where I keep my cash, and I think it’s just a great vehicle. There are several unique features to it, but it’s our Five-Star fund. As a Five-Star fund, what do we do that makes it special is that we focus in AAA, muni paper and we look for where we can get a critical edge and we don’t have to buy 10 million lots. We’re on lot buyers. So we have a whole slew of brokers across the country who call us, and we’ll buy, at the end of the day, 350,000 at a better price. So that impacts our ability to be able to get good pricing power, because we will trade in the odd lots. But we only trade with AAA-rated paper.
Two is the model is very quant driven and how we look at the volatility of markets over rolling 20 and 60-day periods and how we will bank up cash and then deploy it. That’s helped us generate alpha for that fund.
The third factor, which is really important for investors in a low interest rate environment, is that price is $2. Why do we have a $2 NAV rather than $10? Because you have substantially less price volatility, and if you’re looking to park cash, the last thing you want to do is to have a lot of penny volatility because you’re moving money in and out. So that fund has become a great go-to product for investors.
You know what I forgot? It’s had 14 years, and it’s not had a down year, and I think that that’s the real key factor for that long-term place to park your cash, because you’ve got to really take a look at the volatility. We did a piece that if two guys investing in the year 2000, one puts $100,000 into Near-Term, no drama. The other puts it in the S&P because the S&P had a 10-year record of 18.5% growth rate. Well, that person that put in the market lost 40%, and it took 7 years before they clawed their way back to their $100,000 investment, and then 2008 hit them and they lost 40% again. So now it takes to 2013, 13 years later, before the S&P breaks even to what Near-Term, and Near-Term every year has had a conservative, modest, incremental growth rate and that gives you the ability to sleep at night.
Mark Thorburn: Thanks so much for taking the time for today’s interview Frank.
Frank Holmes: It’s a great opportunity to share our products and our lineup and our thought process with your readers.
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