Due to last quarter’s market volatility, we hosted a webcast in June titled “Anticipate Before You Participate” to educate our investors about volatility in commodities and emerging markets.

We explained then why we had such a large cash position going into the correction. We are now going through the second leg of the correction after a nice rally during July and August, so it’s timely to communicate with you again as 2006 winds down.

The sudden collapse of Amaranth Advisors’ $9 billion hedge fund has called into question a popular hedge-fund strategy of using excessive margin/borrowings to generate hefty returns. This margin trading — in some cases, its energy positions were leveraged five times — greatly amplified Amaranth’s gains when times were good, but it quickly became a catastrophe for shareholders when the natural gas market declined.

For the shareholders of U.S. Global Investors funds, it is important to point out that our funds do not use any form of margin debt or borrowing to leverage an exposure to any asset class.

In fact, particularly for the gold funds, we have had relatively high cash balances as a defensive position before the corrections in June and September as a result of our quantitative models. For the past six months, our single largest investment has been cash.

Bearish Market Sentiment

With the Amaranth Advisors blow-up and the widely watched CRB commodity index having the worst performance for any three-month period for the past 10 years, the market sentiment is excessively bearish.

Now there is a lot of guessing about where the next blow-up might be. Another hedge fund or asset manager? Or perhaps mortgage lenders overextended in the declining real-estate market? Or could it be that the worst is over?

When it comes to housing, for instance, there are conflicting signals in the marketplace. According to research from Societe General, homebuilders are very pessimistic in their outlook about new-home sales in the coming six months while at the same time there’s been a significant upswing in the number of people who plan to buy a new home in the next six months.

Both housing and commodities are now extremely oversold. To be a contrarian investor requires courage, an appreciation for history and a matrix of investment processes to recognize relative value in order to make risk-adjusted investment decisions. We believe our fundamental and statistical models have helped us make risk-adjusted decisions.

1	How were the returns generated?
2	What kind of leverage is being used?
3	How are the securities being valued?
4	Are the securities liquid or illiquid?

Questions Investors Should Ask

 

A recent Barron’s story regarding the Amaranth implosion suggested that hedge-fund investors ask money managers four straightforward questions when above-average returns are generated.

We thought it would be timely to apply these questions to the U.S. Global Investors resources funds: the Global Resources Fund (ticker PSPFX), the World Precious Minerals Fund (UNWPX) and the Gold Shares Fund (USERX). These three funds have demonstrated consistent sector leadership for the past one-,
three- and fi ve-year periods.