Streetwise Reports: Frank, let's begin with gold. After a substantial rise in the price of the metal earlier this year, which went as high as $2,036 an ounce in early August, it has since been trading sideways, consolidating roughly around the $1,900 mark. What effect do you think the U.S. presidential election will have on the price of gold? Do you see different scenarios based on which candidate wins?
Frank Holmes: Well, you can hit the red button or the blue button, but I'm hitting the gold button, no matter which one it is. You have to sit back and look at macro forces and macro themes to understand gold and the drivers of gold.
When we go back 30 years ago, as Pierre Lassonde pointed out at the Denver Gold Show a year ago, China and India represented only 10% of gold demand—6% India, 4% China. Today, however, these two countries comprise 53% of all gold demand. Why is that? Because a rising gross domestic product per capita and purchasing power parity are highly correlated with what I call the love trade, that is gold jewelry demand and gifts in gold. So that's the underlying factor that keeps driving gold demand. The supply side has peaked and outside of recycling, there are no major new discoveries being made and no major deposits coming onstream. So I think this bodes very well for 60% of all gold consumption.
Now we get into the fear trade, and that's what really accelerates things—negative real interest rates and unprecedented money printing. The G20 finance ministers and central bankers started their own cartel 20 or so years ago. At the beginning of the century, they were consumed with global trade, the World Trade Organization, China, and, all of a sudden, there's a huge global boom. Gold stocks took off. Bullion went from $250 to $800/ounce. We had this incredible cycle. Along comes 2008–2009 and we go to synchronized taxation and regulation. Today, we have synchronized money printing to fight COVID-19. There is not one country printing money faster than another. They're all taking turns at it.
If we take a look at the Federal Reserve's balance sheet and how it's exploded under this cycle compared to 2008–2009, simple math would suggest in the next three years gold could be $4,000/ounce. The other big part is the inflationary number, because it's changed several times. If you use the inflationary algorithm, when gold hit $850 and silver $50, inflation was over 18%, today we have inflation running 8% so gold would be valued about $7,000. So I comfortably feel that in the next three years, in this next cycle, we could see gold double from here based on just the U.S. money printing.
SWR: You've looked at broad stock market performance in presidential election years. What have you found?
FH: Well, historically, the first two years of a presidential election cycle are very sloppy, some are modestly up. But it's in the last two years that the market usually is on a tear. If it's not, then it usually derails the political party in power, such as we saw with President Obama's election in 2008. During President George W. Bush's last term, his last quarter, we had Lehman Bros. go bankrupt, and then there was just incredible turmoil in stocks and the economy.
This is a very different world. Even though we have COVID, the U.S. Purchasing Managers' Index (PMI) is the highest in the world, and that means six months from now, we're going to see higher energy, copper and iron prices. This has been trending up all through the summer. So that remains very bullish.
We also track the airline industry very carefully. We have the only airlines exchange-traded fund (ETF) available to investors: the U.S. Global Jets ETF (JETS:NYSE). The Transportation Security Administration used to clear 2.7 million people a day; in April it fell to fewer than 90,000 people a day. Just last week, we went through 1 million, so we're climbing. This is very positive for the travel industry and for JETS, and it's a reflection of the PMI and the stock market being stronger.
When you have negative real interest rates, what we're seeing is that it's not just Americans buying stocks because of low yields—and dividend yields are more attractive than what you're going to get from a money fund or a bank—but also you're seeing central banks like Switzerland print negative money. No one's going to buy it, so it buys it itself, and then goes and buys real assets like Apple Inc. When you take a look at what we see now in Japan—this is where capital formation morphed dramatically—15% of the stock market is owned by the government, the central bank. So this is a very different world.
What we saw in this cycle, in the past six months, is the Federal Reserve starting to buy bond funds. It dropped the interest rates to zero, but the real cost of capital was running at 14%. So what did it do? It came in and started buying muni bonds. That helped get the pressure off a trillion dollar muni market when bonds are being rolled over. Then it came in and bought corporate bonds to get corporate yields down so it didn't put a burden on corporations. Now, one of the largest bond holders of ETFs is the Federal Reserve. So we're seeing things change in that formation of capital.
SWR: Going back to gold, it is often touted as a hedge against inflation. What's the situation with inflation in the United States currently and looking ahead?
FH: If we look at what the inflationary number is today, and if we look at 10-year, 5-year and 2-year bonds, they all have negative real interest rates. That says that gold is a very attractive class. For me, gold stocks with rising dividends and free cash flow are even more attractive. I think that's one reason why Warren Buffett all of a sudden bought Barrick Gold Corp. (ABX:TSX; GOLD:NYSE). It has strong leadership. Newmont Corp. (NEM:NYSE) also looks attractive for many fundamental factors. Both have free cash flow. I think the free cash flow allows for rising dividends, so it's much higher than what you're going to earn with the negative real interest rates.
I can't see interest rates rising dramatically. John Williams has a newsletter called Shadowstats. He looks at the old algorithms used to determine the Purchasing Power Index, Consumer Price Index, etc. And if you use his factors, inflation really is 8% today. So that says back up the truck and buy as many physical assets as you can. That's why real estate is up 10% in this bearish crisis. It's amazing.
SWR: One thing that's happened this year is that investors have flocked to physical gold ETFs. Is this a good way to invest in gold bullion?
FH: I've always advocated having a 10% weighting in gold—5% in either the SPDR Gold Shares ETF (GLD:NYSE) or 24-karat gold jewelry and another 5% in quality gold stocks. In particular, I've always loved the royalty companies.
I think there's a big push for GLD because if you look at data for the past 20 years, bullion has outperformed the S&P 500 by almost 3:1. Bullion has been up 80% of the time. The largest hedge fund in the world, Ray Dalio's Bridgewater Associates, has always had exposure to gold, from 7–15%. I think this has led to other institutions looking at gold as an asset class.
But I think the real charm here is because great investors like Warren Buffett all of a sudden buying a gold stock is going to change the paradigm during this quarter. Our data suggest that when we look back on the past 20 years at pre-cash flow yields, and we track 88 global gold producers and 200 explorers, under those 88 global producers—I'm talking about ones with market caps more than $50 million ($50M)—what I find interesting is that this will be the third quarter in over 15 years that they have a free cash flow yield. Even a year ago, they did not have an overall average free cash flow yield, and the S&P 500 had a free cash flow yield of 2.5%. In March, because of the crisis, the S&P 500 went negative on free cash flow yield as a whole, but gold just exploded.
I think we're going to see record free cash flow yields from North American gold producers, and that will be a pivot point for many institutions to start buying gold as an asset class. This summer, in Investors Business Daily's Top 50 stocks to buy, all of a sudden, like back in 2005, gold producers were added to this list of growth stocks. We're now seeing Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) on there, we're seeing Kirkland Lake Gold Inc. (KL:TSX; KL:NYSE) on there. So I think gold will slowly climb. It's been in a bull cycle since January 2019 when the 50-day moving average went above the 200-day moving average. It has accelerated this summer and then corrected perfectly. In the next big wave, I think we're going to see gold stocks really outperform.
SWR: U.S. Global Funds manages a number of mining funds. Could you talk a little about what you look for in a company when making the decision to invest? Is there any one type of company investors should focus on right now for the greatest upside potential—senior, midtier, junior, royalty companies?
FH: We look at what is called "The Five Ms of Mining"—mine lifecycle, market cap, management, money and minerals. Basically when we go down the food chain, for explorers, management is key, as is where they are in the lifecycle of a mine. The early explorers can give you tenbaggers, twentybaggers—20 times your money—but, in time, they can fizzle out early and quickly, so you can lose your money. In that lifecycle, you want to have proven management track records in a well-known area and companies that are well funded and have good daily trading liquidity.
When we go up the food chain, we want to look at the producers that have expanding production or have a free cash flow yield, which means with rising gold they're going to be able to pay higher dividends. We think that those stocks outperform.
The most superior model is the royalty companies. They're like a technology stock, a software-as-a-service (SaaS) stock. They have recurring revenue and cash flow every month. They have high gross margins. If you look at financial accounting from streaming, etc., royalty companies push 45% gross margins, where the average gold mining company is at 15%. Royalty companies are in a very advantageous position, and we're seeing more new junior royalty companies trying to capitalize on that model.
In fact, we're going to be doing a broadcast program with Streetwise on Thursday, November 12, at 1pm EST on 10 junior stocks that we like and we've invested in. You can register here. These companies will be telling their story "PechaKucha" style, which is 20 slides, at 20 seconds per slide, comprehensive but concise, in 6.4 minutes total. The presenting companies are Magna Gold Corp. (MGR:TSX.V; MGLQF:OTCQB), TriStar Gold Inc. (TSG:TSX.V), Barksdale Resources Corp. (BRO:TSX.V; BRKCF:OTCQB), Allegiant Gold Ltd. (AUAU:TSX.V; AUXXF:OTCQX), Revival Gold Inc. (RVG:TSX.V; RVLGF:OTCQB), Silver Viper Minerals Corp. (VIPR:TSX.V; VIPRF:OTCQB), Orex Minerals Inc. (REX:TSX.V), Barsele Minerals Corp. (BME:TSX.V), Brixton Metals Corp. (BBB:TSX.V) and Gran Colombia Gold Corp. (GCM:TSX).
For producers, Gran Colombia Gold Corp. is the least expensive of the whole universe of gold producers we follow. It also has an interesting gold note, which we own. Caldas Gold Corp. (CGC:TSX.V; ALLXF:OTCQX) is a spinout, which has been funded by Wheaton Precious Metals Corp. (WPM:TSX; WPM:NYSE) and the capital markets. But it will go from producing 24,000 ounces a year to 180,000 over the next three years, so I think it has probably the biggest ramp-up of a higher grade deposit that we see. There are very few gold mining companies that can increase their production sixfold over the next three years.
They are the companies that we like, and we remain bullish in this sector.
Now, I think what everyone wants to hear about is a takeover. With Ivanhoe Mines Ltd. (IVN:TSX; IVPAF:OTCQX), its richest deposit is copper, and it is funded by the Chinese. I think you're slowly going to see a change in management where the Chinese have more control. They own a big part of the deposit. I think they take this company out, and probably at double the price of what it is now. It's interesting to watch how this is going to unfold, but the deposit is coming into production earlier than expected.
So those type of catalysts and interesting stories are what we find investors like to hear about, and we own that.
SWR: Are there other companies that you want to talk about that you think offer investors good upside potential?
FH: I'm very biased when it comes to our U.S. Global GO GOLD and Precious Metal Miners ETF (GOAU) trading on the New York Stock Exchange. GOAU is 30% royalty companies, 70% gold producers. It's a quant approach to picking gold stocks, from big cap down to small cap. Once they do anything to destroy their revenue per share growth, their cash flow per share growth or their reserves per share, with a merger or a silly financing, etc., they get kicked out of the model. Each quarter we recalibrate that and only look for the superstar companies that offer the biggest bang for the buck on those metrics. In that universe, the royalty companies are Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX), Wheaton Precious and Franco-Nevada Corp. (FNV:TSX; FNV:NYSE). After that, it's other very attractive gold stocks.
SWR: Do you have explorers in the ETF too, or is it only producers?
FH: No, only producers, and they have to have a $200 million market cap for liquidity. When you rebalance something and you have to move around $2 million at a minimum, you can have a big impact on the stock price up or down, so we want to have at least a $200 million market cap.
SWR: Is there anything else you'd like our readers to know?
FH: Yes. Go to USFunds.com, and you can learn more about the ETFs and our research. We publish a lot. We're on YouTube as well, with many educational videos. We, also, every Friday write the Investor Alert, which goes out to 60,000 people in 180 countries. We really try to help people be educated on various sectors of the market in this publication. We have won 90 awards now for educational information in the investment management world.
SWR: Thanks, Frank, for your insights.
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.
[NLINSERT]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: Revival Gold and Silver Viper. 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: N/A. I, or members of my immediate household or family, are paid by the following companies mentioned in this article: N/A My company has a financial relationship with the following companies mentioned in this interview: N/A. Funds controlled by U.S. Global Investors hold securities of the following companies mentioned in this article: Barrick Gold, Newmont, Wheaton Precious Metals, Ivanhoe Mines, Royal Gold, Franco-Nevada Corp., Allegiant Gold, Barksdale Resources, Barsele Minerals, Brixton Metals, Gran Colombia, Magna Gold, Orex, Revival Gold, Silver Viper and Tristar Gold. 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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