Streetwise Reports: Since the beginning of the year, gold has been trading fairly narrowly in the $1,300 range. What are some of the macro factors working behind this and how do you believe they'll affect the price moving forward?
Frank Holmes: When we look at macro factors at U.S. Global—and we write about them every month, in particular the Purchasing Managers' Index (PMI)—we try to take this complexity and simplify it by dividing it into big chunks.
The first is commodities; 50% of all commodity demand is China, so China is very, very important. When you add the populations of China and India—"Chindia"—you get 40% of the world's population. That's a lot of food. That's a lot of clothes. That's a lot of airplanes they'll be buying for India.
Next we look at global trade. Interestingly enough, if you put China and America together, that's 40% of the world's global trade.
Then we take a look at gold demand. That's predominantly China and India, but more generally from the Middle East to Southeast Asia. Sixty percent of all gold demand is for the love trade.
So we get these chunks, and we try to understand the movement of those chunks. One of the things that contributes to those big numbers is rising gross domestic product (GDP) per capita seems to be one of the strongest correlations for the love trade of gold, in particular for Chindia. Today, China, America and India have the largest GDPs per capita. China's GDP, on a per capita basis, has surpassed America. That means a continuous consumption of gold. Rising GDP is highly correlated to grams of gold. That's an important long-picture demand cycle.
Then we have supply. There have been no major gold discoveries. There have been no technological breakthroughs as there have been in oil and gas with fracking. A lot of the mines are low grade now, so it takes more and more dirt to get an ounce of gold out of them. Then you also have political risks around the world where you have rich deposits. So the supply of gold is basically slowing down.
We believe that gold has peaked. Some analysts say gold production is always growing because they're looking at the gold mines that are reporting rising production. But a great data point, and it never changes, is that if a company says it's going to grow at 8%, it's in reality negative 5% because Murphy's Law hits these gold mining companies for so many different reasons. It's not just because management may be inept. You can have social unrest in Central America, you can have an earthquake or you can have environmentalists slowing down production. So we believe peak gold production is behind us.
Another thing that's interesting is that gold now, with the Bank for International Settlements, has become recognized as money, and banks can use it as collateral. Gold is the fourth most liquid asset class in the world, so it has taken on this new meaning of money.
In the past year, we've had some really serious new buyers of gold—Poland, Czech Republic, Hungary. China and Russia continue to consume gold, but they are joined by many new countries. And gold got knocked down dramatically the other day because Turkey has a currency crisis, and blew up its gold. But then the last time it did this, we found out Poland bought it. Not since President Nixon have there been so many central banks as net buyers of gold, a 50-year peak.
So we have rising GDP per capita for the love trade, and for the fear trade gold is money. An increasing number of central banks are owning gold.
This is all behind why gold is trading higher. I am amazed that with the real rates of return in America, gold would normally be $1,200, $1,150, not where it is. So that's a very positive sign that with any real drop in interest rates as the Federal Reserve tries to make sure the economy stays okay, gold is going to $1,500. I remain bullish on it.
SR: How do you feel about precious metals stocks?
FH: One has to be very selective. I think what you can learn from what Eric Sprott did is you focus on high grade. Don't focus on the big low-grade picks at this stage. Unless you're trading for optionality, you should be looking at the high grade.
One of those stocks that we love is Gran Colombia Gold Corp. (GCM:TSX), the largest gold producer in Colombia, and it's also high grade. It is way undervalued relative to other names. The company offers gold notes. It's like getting a money market fund of 8.5%. It's called Gran Colombia Gold Corp 8.25% nonconvertible senior secured gold linked notes (GCM.NT.U;TSX). They are gold-backed bonds.
You get a yield that's 8.25 basis points at gold at $1,250. Anything above $1,250, you get a higher yield. So if gold goes back to $1,900, all of a sudden you'll have a 20% yield. You just can't get money market funds to give you an 8.25% base rate now.
Gran Columbia produces 200,000 ounces of gold, it's very profitable and it's going through a new rerating. Again, it's very undervalued relative to its peers. If you look at the gold notes for yield, they're excellent. It's just excellent to have 5% of your portfolio giving you almost a 10% yield, monthly, and it's listed so you get quotes every day. So it's liquid.
SR: How is the U.S. Global GO GOLD and Precious Metal Miners Exchange-Traded Fund (ETF) (GOAU:NYSE.Arca) doing?
FH: I'm really proud of it. It's unique because it has a portfolio structure that recalibrates every quarter, and then there is the stock picking element. Half of the portfolio is looking for momentum, and the other half is looking at the cheapest stocks for that quarter. As stocks appreciate, the fund sells them out and looks for the next cheapest. So it's like a natural scooper. And that's why we’ve witnessed it outperform the VanEck Vectors Junior Gold Miners ETF (GDXJ:NYSE.Arca) 92% of the time in rolling quarters.
SR: You now have nearly two years of history with the fund. I'm curious to know what you've learned running an ETF.
FH: One thing is we have a third party run our algorithms, and then we run them too. Every quarter there are one or two names we have to discuss because we differ on whether we believe they should be in the portfolio or not. That means it's somewhat active. It is very dynamic, too. I've learned that you have to have an outside set of eyes and let them run the model and see if they come up with different names.
SR: Have you had to tweak the model or the algorithms along the way? Or are they basically working as planned?
FH: No, it's working like clockwork.
SR: What are some of the best performers in the fund?
FH: What's unique is 30% of the fund is royalty and streaming companies. One of the things I like about royalty companies is they preserve their values per share. In fact, when you own a royalty company like Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX) or Wheaton Precious Metals Corp. (WPM:TSX; WPM:NYSE) or Franco-Nevada Corp. (FNV:TSX; FNV:NYSE), they have royalties in many junior miners. You basically get tremendous exposure to a lot of juniors through their portfolios. Plus royalty companies have very low debt compared to mining companies. They have rising dividends. These are some factors that make GOAU a superior business model, I believe, embedded inside the ETF. I don't know of any active gold fund manager who beat it last year. Even our own guys didn't beat it.
SR: Let's talk about some companies that you are excited about.
FH: I love Goldspot Discoveries Inc. (SPOT:TSX.V). It offers huge optionality and is run by a team of really intelligent people. They have young staff members, men and women, with PhDs in machine learning, applying Monte Carlo simulation to geostatistical models. Montreal is becoming a center for artificial intelligence. It's so big there that Microsoft is opening a campus for 5,000 people because they can't get these young people to move to Seattle or New York. It's so exciting for me because I'm around all these really smart young people.
SR: Tell me a little bit more about GoldSpot, what it does and where it is going.
FH: As a little background, the company won second place in an artificial intelligence (AI) competition back in 2016, against as many as 4,600 worldwide applicants. It consolidated more than 30 years of historical mining data into a 3D geological model, and was then able to identify a handful of target zones with the highest potential for gold mineralization. Rob McEwen was pretty impressed with the team's skill set and now owns 3% of the company. Hochschild Mining Plc (HOC:LSE) owns 10% of the company and gave Goldspot a multimillion-dollar contract.
GoldSpot realized the IBM Watson model is really expensive—a $25 million contract, $5 million a year over five years. That's what Goldcorp Inc. (G:TSX; GG:NYSE) is doing. GoldSpot is so much less expensive. The difference is Goldspot has geologists and engineers in Montreal that work for the company. For companies using IBM, because IBM's experts weren't geos, they'd always have to ask the geos questions, and the geos were busy with their work. So this is a completely different turnkey operation. Goldspot looks to help mining companies cut some of the costs and risks associated with discovering high-quality deposits—something it's already managed to do for a number of its clients and partners, including Hochschild Mining, McEwen Mining and Yamana Gold.
Goldspot will also invest in junior companies. It invests in and acquires royalties from exploration companies, similar to the business model practiced by firms like Franco-Nevada and Wheaton Precious Metals. The companies use Goldspot's technology to advance their understanding of their projects, and drill where there are great targets. Goldspot helps de-risk it, but also gets a royalty on that. So with one discovery, the stock can go up fivefold.
SR: Are there other companies you would like to talk about?
FH: Speaking about optionality, there is CopperBank Resources Corp. (CBK:CSE); we own 12% of the company. We have quant model for juniors where we take the amount of reserves a company has plus the cash, minus $300,000, divided by the shares outstanding. So a dollar is treated the same as a pound of copper or an ounce. If a company wastes money and doesn't find more reserves, then the stock gets sold.
Copper is so inexpensive, it's in deficit. When I look at CopperBank, using our algorithm, you get 38 pounds of copper per share trading at $0.06–$0.07. With all the buildup for data centers, electric cars, alternative energy—there's going to be a greater need for copper than ever—so when copper does make this move, then these things tend to snap. Copper goes to $4, and all of a sudden the stock will be $1. That's why we buy it. CopperBank's CEO Gianni Kovacevic doesn't take a salary. He's very frugal, and he's trying to tie up assets that have other money calls on copper.
SR: Is there anything else that you'd like our readers to know?
FH: For the past 20 years, the biggest hedge fund in the world has been Bridgewater Associates LLC, run by Ray Dalio. He is an intellectual gold investor and if you drill down into Bridgewater’s SEC filing for the fourth quarter of 2018, you’ll find that Dalio holds significant positions in gold across all tiers in the industry. He also always likes to pair gold against other countries' currencies, and he's had this incredible track record for the past 20 years. On top of that, now we’re seeing that the second best performing asset class for the past 20 years, according to J.P. Morgan's research, has been gold. So Dalio is on to something.
And that just relates to the 10% Golden Rule I always talk about, where I advocate having 10% of your liquid assets in gold and rebalancing each year. I think the only thing that has outperformed gold since 1999 has been REITs. Last year, gold bullion outperformed the market. So I can go short term or long term. Gold is just a great asset class. And I think that more people are going to wake up to it as a portfolio diversifier.
If readers haven't watched Ray Dalio's animated videos on YouTube, please, they should all go see them. They're so well done. And they're great for young kids to understand how the economy works. He talks about where he lost all of his money and how he clawed his way back. It's his voice narrating the animation.
TGR: Thanks for your insights, Frank.
Frank Holmes is CEO and chief investment officer at U.S. Global Investors, which manages a diversified family of funds specializing in natural resources, emerging markets and gold and precious metals. In 2016, Holmes and portfolio manager Ralph Aldis received the award for Best Americas Based Fund Manager from the Mining Journal. In 2011 Holmes was named a U.S. Metals and Mining "TopGun" by Brendan Wood International, and in 2006, he was selected mining fund manager of the year by the Mining Journal. He is also the co-author of The Goldwatcher: Demystifying Gold Investing. More than 30,000 subscribers follow his weekly commentary in the award-winning Investor Alert newsletter, which is read in over 180 countries. 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, BNN and Fox Business, and has been profiled by Fortune, Barron's, The Financial Times and other publications.
Disclosure:
1) Patrice Fusillo conducted this interview for Streetwise Reports LLC and provides services to Streetwise Reports as an employee. She owns, or members of her immediate household or family own, shares of the following companies mentioned in this article: None. She is, or members of her immediate household or family are, paid by the following companies mentioned in this article: None.
2) The following companies mentioned in this interview are billboard sponsors of Streetwise Reports: Wheaton Precious Metals. Click here for important disclosures about sponsor fees. The information provided above is for informational purposes only and is not a recommendation to buy or sell any security.
3) Frank Holmes: I, or members of my immediate household or family, own shares of the following companies mentioned in this article: None. I, or members of my immediate household or family, are paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this interview: None. Funds controlled by U.S. Global Investors hold securities of the following companies mentioned in this article: Gran Colombia Gold Corp., Royal Gold Inc., Wheaton Precious Metals, Franco-Nevada, CopperBank Resources Corp., McEwen Mining, Hochschild Mining PLC. I determined which companies would be included in this article based on my research and understanding of the sector. 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.
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