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Please note: The Frank Talk articles listed below contain historical material. The data provided was current at the time of publication. For current information regarding any of the funds mentioned in these presentations, please visit the appropriate fund performance page.

Welcoming the New Addition to the S&P 500: Real Estate
September 20, 2016

Welcoming the New Addition to the S&P 500: Real Estate

In case you haven’t noticed, the S&P 500 Index is looking a little different these days. Once a subindustry of the financials sector, real estate now has its own zip code in the universe of blue chip stocks. It’s the first time since 1999 that such a change has been made to the S&P’s composition.

The new sector has a weighting of nearly 3 percent, all of it taken out of financials.

An Then There Were 11
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As I told CNBC Asia’s Bernie Lo recently, I think real estate’s promotion will attract more institutional and individual investors to the space. It tells them this is no longer a niche market but one with a distinct and significant presence, with its own unique business drivers.

This has been a long time coming, to be perfectly honest. Ever since the housing and financial crisis, real estate investment trusts (REITs) have been pulling in some serious cash as more become available for trading on the New York Stock Exchange and elsewhere. Altogether, REITs currently have a market cap of over $1 trillion, according to REIT.com.


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With investors on the hunt for yield, it’s not hard to see why. As of August 31, the FTSE NAREIT All Equity REITs Index yielded an average of 3.61 percent, compared to the S&P 500’s 2.11 percent. During 2015, stock exchange-listed REITs paid out a whopping $46.5 billion in dividends.

U.S. Equity REITs continue to climb since the housing crisis
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Builders Rush to Meet Demand

Looking just at the residential housing market, business is definitely booming. With 30-year mortgage rates at below 3.5 percent, the market is scorching hot in many parts of the U.S.—so much so, some builders are reporting a shortage in construction workers to meet demand.

Banks Lending Historic Sums of Cash to Real Estate Projects
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New construction starts rose to 1.2 million in July, beating analysts’ forecasts and suggesting the U.S. housing market appears to have finally made a full recovery eight years following the recession, with Bloomberg calling this the “strongest home sales since the start of the economic expansion.”

…But Homeownership Is Falling

Trouble could be brewing, however. As I shared with you last month, millennials just aren’t buying homes at the same rate we’ve historically seen from 18- to 34-year-olds. There are many theories as to why this is, from millennials delaying starting families to focus on careers, to a loss of trust in homeownership as a reliable investment or even as an institution, to a preference to rent. This trend has contributed to the lowest U.S. homeownership rate in five decades.

But how can this be? How could there be both massive housing demand and yet declining homeownership?

One answer might lie in population growth. Simply put, there are more of us living in the U.S. than ever before, which translates into more renting and more buying. And with single-person households on the rise every year, a need for additional housing units has become a priority. Whereas one unit would have served a married couple only a few years ago, now two are needed.

Whether you believe this or not, it seems reasonable to expect the new real estate sector to attract assets to the space, as more mutual funds will add to their exposure to better reflect the S&P 500. If anything, it will help investors monitor and track this important segment of the market.

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

There is no guarantee that the issuers of any securities will declare dividends in the future or that, if declared, will remain at current levels or increase over time.

The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The FTSE NAREIT All Equity REITs Index is a free-float adjusted, market capitalization-weighted index of U.S. Equity REITs. Constituents of the Index include all tax-qualified REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real property.

Investing in real estate securities involves risks including the potential loss of principal resulting from changes in property value, interest rates, taxes and changes in regulatory requirements.

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The War on Cash Is Still Good for Gold
September 19, 2016

Negative Real Rates Real Positive Influence Gold

The consumer price index (CPI), a measure of inflation, came in hotter than expected Friday, registering 2.3 percent year-over-year in August on expectations of 2.0 percent. With the five-year Treasury yielding 1.19 percent, government bond investors are now receiving a negative real rate of return (because 1.19 minus 2.3 comes out to negative 1.11 percent).

This is highly constructive for the price of gold. As I’ve discussed many times before, the yellow metal has benefited when real rates have fallen below zero. This was the case in September 2011 when gold hit its all-time high of $1,900 per ounce. And last year around this time, the opposite was true—positive real rates were a drag on gold.

Although gold sunk to a two-week low on a strong U.S. dollar and fears over this week’s Federal Reserve meeting, the drivers are firmly in place to push prices higher.

LEARN MORE ABOUT WHAT’S DRIVING GOLD

   

Rogoffs new book calls end paper moneyMaybe you’ve heard that a new book out right now is planting propaganda in the war on cash. In “The Curse of Cash,” Harvard economics professor Kenneth Rogoff makes the case that nixing paper money—at the very least, larger-denominated bills—“could help more than you might think” in combating criminal activities such as drug trafficking, corruption, extortion and money laundering. It could even prevent the spread of terrorism and discourage illegal immigration, Rogoff argues.

It gets even worse. Central banks, he adds, should have the latitude to drop interest rates below zero during recessions to spur spending. If the Federal Reserve tried this now, of course, many people would likely convert their savings into paper—which at least yields 0 percent—and hoard it in bedroom safes. This is precisely what many Germans have reportedly done, prompting safe manufacturers to scramble to meet demand

But in a world where nothing larger than a $10 bill exists, hoarding cash would be highly impractical. Better to buy that new boat you don’t need!

While we all agree that corruption and terrorism are things that should be stopped, killing cash is the absolute wrong way to go about it.

Instead, perhaps Rogoff should consider “The Curse of No Cash.” Does he not recall what happened in Cyprus just three years ago? The government ransacked citizens’ bank accounts to “fix” its own mistakes and mismanagement. In example after example, people’s rights to save and freely hold cash have been disrupted, with tragic results.

I’ve written about this topic before. In a cashless society, your economic liberty is forever at risk. Every transaction could be monitored, taxed and charged a fee. Capital controls would be crippling, assets could be seized. Just ask the Colombians and Venezuelans

I’m not the only one who disagrees with the ideas in Rogoff’s polemic against money. As of this writing, nearly three quarters of Amazon customers have given the book a rating of two or fewer stars. And in a scathing Wall Street Journal op-ed, respected financial writer James Grant strips away the book’s “technical pretense” to uncover its true motive. Rogoff, he writes, “wants the government to control your money,” which is the extreme form of Keynesian economics.

Gold Has Shined Brightly During Currency Crises

There’s one area where Rogoff and I both agree, though. “As paper currency is phased out,” he writes, “gold prices will rise.” Were cash eliminated and interest rates plunged underwater, gold’s role as a store of value would become even more apparent and demand for the yellow metal would turn red hot, despite its price appreciation.

This has been the case in countless past examples. Rogoff himself cites Indians’ longstanding love of and cultural affinity to gold jewelry as protection against currency uncertainty. For centuries, inhabitants of the Indian subcontinent saw continuous regime change, not to mention imperialist rule by various European forces. During all this time, the one stable and widely accepted currency was gold.

Indian Households Own More Gold Than Top Six Central BanksThe tradition carries on today. A third of Indian gold jewelry demand comes from rural farmers, who annually convert a portion of their crop revenues into the yellow metal. Whether this gold is stored or given to a female family member, perhaps a daughter, before her wedding day, its purpose is twofold: one, as a beautiful heirloom to be worn and passed down to the next generation, and two, as a form of financial security.

It’s estimated that Indian households currently hold more than 20,000 tonnes of gold. To put that in perspective, 20,000 tonnes is more than the official gold holdings of the U.S., Germany, Italy, France, China and Russia combined.

With speculation strong that a rupee devaluation is imminent, it makes just as much sense now as ever for Indians to have at least some of their wealth in gold. When the rupee unexpectedly dipped to record lows in August 2013, the wealth that prudent Indians had stored in the precious metal was, for the time being, safe.

Indians Gold Jewelry Protect Wealth Against Currency Devaluation
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Although there’s little fear right now that the U.S. dollar is in trouble, I still recommend that investors maintain a 10 percent weighting in gold—5 percent in gold stocks, 5 percent in gold coins and jewelry.

Is Chicago Next to Declare Bankruptcy?

Is Chicago the next DetroitIt’s not just Indian investors who should be aware of currency fluctuations and imbalances in monetary and fiscal policy. These can happen right here in our own backyards, and investors who aren’t paying attention—specifically municipal bond investors—could pay a steep price.

In the past few years, we’ve seen how financial mismanagement can bring calamity to state and local economies, the most notable example being Detroit’s $18 billion bankruptcy in July 2013, the largest in U.S. history. Right now, the U.S. territory of Puerto Rico is in dire financial straits, owing some $70 billion, more than any state government except California and New York.

And then there’s Chicago, which is looking at $170 billion in unfunded pensions and other costs.

This came to my attention earlier this month when I visited Chicago to attend the Morningstar ETF Conference. While there, I had the opportunity to speak to several locals, who shared with me their frustration of high local tax rates—some of the highest in the country.

Taxes are high, they said, mainly because of outrageous pensions for public and union workers. Entitlement spending has exploded. Now, Chicago, which has the lowest credit rating of any major U.S. city, is edging scarily close to bankruptcy.

Unfortunately, it isn’t hard to see why. For starters, the state has one of the most highly unionized workforces in the country, compared to the national average.

Illinois Has Among Largest Unionized Workforces
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And instead of reining in costs, state and city officials continue to add to the pile of debt. The Land of Lincoln already has the least funded retirement system in the country, according to Bloomberg, and is on track to end the year $7.8 billion in the hole.

Lawmakers and other government workers are among the highest paid in the nation and enjoy “Cadillac” health care benefits and pensions. It’s not uncommon for them to retire in their 50s. The Illinois Policy Institute estimates that the total annual operating cost for each state lawmaker—including salary, insurance and the like—stands at more than $100,000, with private taxpayers footing most of the bill.

“It’s like we work for the government,” one Chicagoan told me. “Everything we make goes to their pensions.”

Conveniently, the state constitution includes a clause that forbids any reduction of public pensions.

For these reasons, Illinois is saddled with some of the highest income and corporate taxes in the United States. Chicago’s sales tax is the highest of any major U.S. city. Despite the revenue this generates, it doesn’t come close to touching what’s been promised.

Look at the chart below. Between 2000 and 2015, Illinois tax revenue increased 57 percent. That’s a significant jump. But over the same period, state-employee insurance and pension benefits skyrocketed—166 and 586 percent respectively—while essential services such as higher education suffered.

Unfunded Promises Illinoiss Runaway Spending Government Workers
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What this means is very little of taxpayers’ money is going toward anything tangible—new schools, new hospitals, new wastewater treatment plants. Nothing that provides jobs or has a multiple effect is being produced.

We’re already seeing serious consequences as a result of the state and city’s fiscal woes. In a recent study of jobs market competitiveness, CareerBuilder found that Chicago is the least competitive metropolitan area in the U.S. in terms of jobs growth. Between 2014 and 2015, the Windy City’s rate of adding jobs was far short of the national average.

Because of this—among other reasons, including crime, unemployment and political infighting—Chicago had the largest population loss of any metro in the U.S last year (6,263). Meanwhile, Illinois was one of only seven states to see a net decline (22,194).

And where are these people going? Where the jobs are, of course. I always say that money flows where it’s most respected. People behave the same way.

It’s no wonder, then, that the state that attracts the most Illinois expats is Texas, according to the Chicago Tribune. This falls in line with what I wrote just a couple of weeks ago. Between 2014 and 2015, Texas added more residents than any other state because of its strong economy, abundance of jobs and low taxes. CareerBuilder’s jobs study, I should point out, rated Dallas as the most competitive city. And within the next eight to 10 years, Houston is expected to surpass Chicago to become the nation’s third largest city by population.

I’m not saying this to beat up on Chicago, but to emphasize my earlier point about being aware and prepared—especially, in this case, when it comes to municipal bond investing. Many passive muni funds might hold Chicago debt because it’s high-yielding. But those yields could come at a huge cost. Three years ago, bondholders of Detroit’s bad debt learned the hard way that, in the event of a default, pensioners get paid first, investors last—or worse, not at all.

As active managers we’re well aware of this. We sincerely hope Chicago can straighten out its balance sheet, but in the meantime, we feel it’s not a space to be a buyer right now. Instead, we seek to invest primarily in high-quality, short-term munis.

LEARN MORE ABOUT SHORT-TERM MUNIS

 

The Consumer Price Index (CPI) is one of the most widely recognized price measures for tracking the price of a market basket of goods and services purchased by individuals.  The weights of components are based on consumer spending patterns.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. None of the securities mentioned in the article was held by any accounts managed by U.S. Global Investors as of 6/30/2016.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

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5 Reasons Why Active Management Works
September 13, 2016

As we all know, exchange-traded funds (ETFs) have increasingly become the hot menu item, attracting a lot of money away from actively-managed funds such as mutual funds. But don’t discount active management just yet! There’s still plenty of room in your portfolio for this type of investment.

Consider the following:

1. First-Mover Advantage

Active management gives us the ability to act swiftly and strategically, with the surgical skill of a highly-trained team of Special Forces. It allows us to push out of the starting blocks much faster.

As active managers, we closely monitor key indicators and macroeconomic themes such as PMI (the Purchasing Manager’s Index), which we’ve written about many times, and negative real interest rates. These indicators, among other factors, often serve as the signals we’re looking for.

2. Explicit and Tacit Knowledge

Some people have book smarts (explicit knowledge), while others have street smarts (tacit knowledge). Active management requires that you have both.

Not only are we experts in geology and mineral resources, we’re also world travelers with “boots on the ground” experience visiting mines, spending time with mining crews and meeting with management teams.

Frank Holmes Gold Mining

3. Technical Models

We are practitioners of quantitative analysis on a per-share basis. We use a matrix of top-down macro models and bottom-up micro stock selection models to determine weightings in individual securities. When looking at mining stocks, for instance, we screen for the following factors:

Our Factors For Selecting Mining Stocks

4. Hidden Gems

Using technical stock screens and tacit knowledge of management teams can help us uncover hidden gems with attractive growth prospects.

One such company is Nevada-based Klondex Mines, which reported incredible second-quarter growth of 82 percent in net income and 25 percent in the amount of gold produced compared to the same time last year. Klondex is up more than 156 percent year-to-date, as of August 30.

Granted, this type of performance is out-of-the-ordinary, and there’s no guarantee it will be repeated in the future. But when it happens, active management can help us capture the upswing.

gold mine

5. Portfolio Manager Tenure

Active management is only as good as the people running it, and at U.S. Global Investors, we’re fortunate to have one of the best in the business—Ralph Aldis.
Ralph has over 20 years’ worth of experience at USGI alone and was even named a metals and mining “TopGun” fund manager by Brendan Wood International last year. The capital markets performance measurement firm recognized a group of investors as “optimal leaders of thought in the industry” during the year. The honor was given based on a vote from 269 sell-side professionals, and this was Ralph’s second time to receive such recognition from his peers.

Ralph Aldis Portfolio Tenure

 

Explore opportunities in precious metals and mining investment!

 

The Purchasing Manager’s Index is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

Cash Flow Return on Invested Capital (CFROIC) is defined as consolidated cash flow from operating activities minus capital expenditures, the difference of which is divided by the difference between total assets and non-interest bearing current liabilities. 

Holdings may change daily. Holdings are reported as of the most recent quarter-end. The following securities mentioned in the article were held by one or more accounts managed by U.S. Global Investors as of 6/30/2016: Klondex Mines Ltd., Silver Wheaton Corp.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

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Look to Chindia for Gold’s Love Trade
September 12, 2016

Diwali trigers gold's love trade in India. The five-day festival of lights kicks off on October 30

A few weeks ago, I shared with you what I brought home from my trip to Toronto, Vancouver and New York City, where I had met with gold fund analysts. The current gold bull run began in January, but as I told you, the general retail investors weren’t buying then. The only people buying that early were quants and huge hedge funds. The question, then, was: What factors or models were the quants using to uncover gold’s meteoric rise this year?

One of the factors they were looking at, I learned, was low SG&A-to-revenue. “SG&A” stands for “selling, general and administrative expenses” and refers to the daily operational costs of running a company that are not related to making a product. It includes everything from shipping fees to salaries to utilities. SG&A-to-revenue is an unusual factor, not typically used among analysts and fund managers, so we were curious to apply it.

Using this information, we looked just at the first quarter to find the mining companies that spent the least amount of money on these daily operations relative to revenue. Mining companies, after all, have had trouble with expense discipline.

What we discovered was nothing short of astonishing. All combined, the top 10 gold companies for the quarter—led by South Africa-based Harmony Gold—returned a spectacular 88 percent. That’s almost double what the Market Vectors Gold Miners ETF (GDX) returned over the same period (45.5 percent). 

Top 10 Gold Names Based on SG&A-to-Revenue
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As early as January, the drivers were in place to fuel gold’s best first half of the year since 1974. The yellow metal is now in position to have its best year overall since 2010, when it rose 29.5 percent.

 

DISCOVER INVESTMENT OPPORTUNITIES IN THE GOLD SPACE

 

Upcoming Festivals Could Activate Love Trade

I talk a lot about the differences between gold’s Fear Trade and Love Trade. Loyal readers know that the Fear Trade is associated with negative real interest rates and excessive money supply, which triggers an imbalance of monetary and fiscal policies and macroeconomic uncertainty. Historically, investors in the U.S., Japan, Germany and the U.K. have been the main drivers of the global Fear Trade.

The Love Trade, on the other hand, is all about gold’s powerful allure and its timeless role as a gift without peer. It has two significant benefits: one, as beautiful gold jewelry to be worn, and two, as financial security. Although gold jewelry is often given as a special gift in Western countries, it pales in comparison to what takes place in China and India, or “Chindia”—home to about 40 percent of the world’s population, and the two largest gold importers.

The following image, courtesy of Visual Capitalist, shows emphatically just how enormous this region’s population is. More people live inside the green circle—which covers not just India and China but also Japan and some South China Sea countries—than outside it.

More than Half of the World's Population LIves Inside This Circle

As I shared with you last month, the two Asian countries together accounted for more than half of total global gold jewelry demand in 2015. The U.S., by comparison, represented about 5 percent of demand. All of Europe, even less.

Significant to boosting the metal’s price are important cultural events, from India’s upcoming Diwali festival and fourth-quarter wedding season to the Chinese New Year in January. Going back decades, the yellow metal has tended to perform best in September, when jewelry, coin and bullion dealers restock their inventories in preparation for these celebrations.

Also known as the Festival of Lights, Diwali begins October 30 this year, followed by the wedding season. To give you a sense of scale, as many as 150 million Indian weddings will be held between 2011 and 2021, according to the Government of India. For each wedding, between 0.7 and 70 ounces of gold are typically purchased, which is equivalent to 35 percent to 40 percent of total wedding expenses.

Of course, you can’t convert cash into gold if you don’t have the cash. What’s more, gold priced in Indian rupees and Chinese renminbi has really taken off, making it more expensive to Indian and Chinese consumers than America buyers.

Gold Priced in U.S. Dollars, Indian Rupees and Chinese Renminbi
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Gold consumption, then, really depends on household income. Fortunately, income growth in Chindia is booming with the rise of the middle class.

Rising Incomes = Golden Opportunity

And just how much income growth are we talking about? According to Boston Consulting Group (BCG) data, consumer spending in both China and India will soon overtake spending in Germany and France, and is on a trajectory to match Japan’s level of consumption.

India and China's affluent class will consume as much as some major countries by 2020
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By 2020, the number of “affluent” households in China—those with annual incomes of at least $20,000—will grow to 280 million, equal to 30 percent of the country’s urban population. That’s quite a leap up from today’s 120 million households labeled as “affluent.” It’s also good news for the Love Trade.

As for India, the number of middle class consumers is expected to triple between now and 2025, eventually reaching 89 million people, according to McKinsey & Company.

What I find even more incredible is that by 2030, the economic output of India’s top five cities is expected to reach the size of five middle-income countries today, according to McKinsey. Mumbai’s massive $245 billion economy, for example, could soon exceed the entire country of Malaysia. Likewise, India’s capital city of New Delhi could one day be bigger than the Philippines.

This presents a huge opportunity for the Love Trade to expand even more, as rising incomes and economic momentum have been a tailwind for gold demand.

I’ve pointed out before the relationship between M2 money supply growth in China and the price of gold. Money supply isn’t the same as income growth, of course. But it serves as further evidence that the more money that’s available—and the more people who have access to that money—the more it can be converted into gold.

Gold Price Has Largely Followed Chinese Money Supply
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Negative real interest rates play an important role as well, as I’ve discussed many times before. The yellow metal shares an inverse relationship with real rates, which is what you get when you subtract inflation from nominal interest rates.

silver is the best performing commodity of the year having returned more than 38 percent as of September 9

Speaking of which, many investors are wondering if rates will rise this year or not. December is still on the table, but the likelihood of a hike this month seems to have been doused by the August jobs report, which came in below expectations. CNBC reports that Goldman Sachs economists walked back their call for a September rate hike when it was revealed the U.S. economy added only 151,000 jobs, 32 percent fewer than the same month a year ago and a whopping 69 percent decrease from July’s payroll additions.

Be that as it may, markets seem to be betting the end of easy money could arrive sooner rather than later. Stocks sold off today in their worst session since June 24, the day after Brexit.

The Friday before last, both gold and silver jumped on the underwhelming jobs numbers. As I told Daniela Cambone during last week’s Gold Game Film, which you can watch here, silver is an important metal to follow because as people develop more confidence in the precious metal area, silver could begin to take center stage.

India Now the Fastest Growing Large Economy

In June, I asked if India is the new China. I think the jury’s still out on that question, but what we do know is that India has pulled ahead of China to become the world’s fastest growing large economy. In its June update to its world economic outlook, the International Monetary Fund (IMF) sees India advancing 7.4 percent this year, compared to China’s 6.6 percent. On a relative basis, these are much stronger growth rates than what we find in advanced economies such as the U.S., European Union and Japan.  

Real GDP Growth Around the World
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India’s manufacturing sector appears to be growing at a faster clip than China’s, when we compare the two Asian giants’ purchasing manager’s indices (PMI). For the month of August, the India PMI rose to 52.6 from 51.8 in July, indicating healthy sector expansion.

China and India Manufacturing Headed in Right Direction
click to enlarge

Meanwhile, China logged a neutral 50, indicating neither expansion nor contraction. But as you can see above, the trend is headed in the right direction and making steady improvements from its recent low of 47.2 in September 2015.

For the one-year period, the First Trust ISE Chindia Index Fund (FNI) is up more than 23 percent, as of September 4, suggesting the bad news we’ve been seeing in the media might be over, and the markets in China and India may have reached a bottom. This is good for global growth and the Love Trade. 

Book Your Flights!

At the end of this month, I will be a speaker and panelist at Mines and Money in Toronto. The conference, one of the biggest and most attended in the world, brings together leading institutional investors, mining developers and sought-after industry experts. It will take place September 26 through 28, so don’t hesitate to book your flights. I hope to see you there!  

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

The Caixin China Manufacturing PMI, released by Markit Economics, is based on data compiled from monthly replies to questionnaires sent to purchasing executives in over 400 private manufacturing sector companies.

The Nikkei India Manufacturing Purchasing Managers’ Index, reported by Markit Economics, measures the performance of the manufacturing sector and is derived from a survey of 500 manufacturing companies.

M2 Money Supply is a broad measure of money supply that includes M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. The following securities mentioned in the article were held by one or more accounts managed by U.S. Global Investors as of 6/30/2016: Sibanye Gold Ltd., Northern Star Resources Ltd., Regis Resources Ltd.

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Use This Tax Strategy Like the Top 1 Percent
September 8, 2016

Use This Tip to Help You Avoid Taxes Like the Top 1 Percent

Many people might have the impression that the top 1 percent of society—those making over $521,411—deal mainly in exotic investments such as derivatives, fine art and rare French wines.

The truth is actually a lot less exciting.

It’s well documented that high-net worth individuals (HNWIs), in many respects, tend to be more practical in their spending habits than most folks. They appreciate a good deal, and they’re finely attuned to saving money where they can—one of the biggest contributors to how they got where they are.

“What are the three words that profile the affluent?” ask Thomas Stanley and Willian Danko in their bestseller The Millionaire Next Door: The Surprising Secrets of America’s Wealthy. The answer? “FRUGAL FRUGAL FRUGAL.”

This penny-pinching attitude extends to their investment decisions.

So if they’re not investing in Picassos and Renoirs, or $20,000 bottles of Romanée-Conti, what are they investing in?

Munis.

That’s the finding of Rick Fleming, the SEC’s top investor advocate, charged with analyzing how regulations might impact investors and their investments. Muni bond income, after all, is entirely exempt from federal and often state and local taxes—a feature that should appeal not just to money-saving HNWIs but to all investors.

Avoiding Income Tax with Tax-Free Municipal Bonds

At an SEC summit held August 25, Fleming revealed some statistics he finds both “interesting” and “disturbing.”

“The wealthiest one-half percent of U.S. households,” Fleming said, “now own 42 percent of all municipal bonds, as compared to ownership of 24 percent in 1989.”

Meanwhile, “The bottom 90 percent of U.S. households, as measured by net wealth, now hold less than 5 percent of muni bonds, falling from almost 15 percent in 1989.”

Wealthiest U.S. Households Own an Increasing Share of Municipal Debt
click to enlarge

Let’s do the math. The muni market is currently valued at $3.71 trillion. Using Fleming’s data, that means a very small percentage of muni investors holds around $1.5 trillion—a vast sum of money for so few people. On the flip side, a great number of people—nearly all muni investors, in fact—collectively hold “only” $185 billion worth of muni debt.

This is indeed disturbing.

Muni bonds’ favorable tax exemption was created a little over 100 years ago to attract investors of all stripes, not just those at the very top of the socioeconomic ladder, to help boost infrastructure spending. Although HNWIs have historically been more drawn to munis than investors in lower tax brackets, the spread has widened alarmingly in recent years.

Fleming sees this as a problem, and you should too. I always say to follow the smart money, and in the case of municipal bonds, it’s clear the smart money has spoken.  

HNWIs are unfazed by the perception that munis are “boring” or “plain vanilla.” They don’t care about that. What they do care about is a reliable, tax-free income stream, not to mention a history of stability in times of economic and political uncertainty—both of which munis can deliver.

No Loss of Momentum

To be clear, muni investment is not in decline. Quite the contrary. There’s a clear uptrend in the amount of money that’s flowing into muni bond funds on a weekly basis, fueled by not just the appetite for tax-free income but also a need to preserve capital. For the 48th straight week as of August 31, muni bond funds, excluding ETFs, attracted net new money—a spectacular run, according to Investment Company Institute (ICI) data.

Net New Cash Flowing Into Municipal Bond Funds
click to enlarge

Meanwhile, capital continues to leave domestic equity funds as investors de-risk in the face of global macroeconomic uncertainty and the possibility of rising interest rates in the U.S. this year.

What I find most interesting is that, although investors are increasingly moving capital from actively-managed equity funds to ETFs, they still prefer actively-managed muni bond funds. For the 12-month period ended in July, active muni funds collected $48.7 billion. That’s eight times more than what passive funds brought in over the same period, according to a recent Bloomberg story.
In this case, I think what muni investors seek is a manager who knows how to conduct deep credit research, adjust for duration and monitor the market for risks and opportunities. That appears to be investors’ demand, whether they’re in the top 1 percent or not.

 

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Net Asset Value
as of 09/23/2016

Global Resources Fund PSPFX $5.70 -0.05 Gold and Precious Metals Fund USERX $9.58 -0.30 World Precious Minerals Fund UNWPX $9.01 -0.19 China Region Fund USCOX $7.86 -0.08 Emerging Europe Fund EUROX $5.58 -0.06 All American Equity Fund GBTFX $23.25 -0.11 Holmes Macro Trends Fund MEGAX $19.08 -0.04 Near-Term Tax Free Fund NEARX $2.25 No Change U.S. Government Securities Ultra-Short Bond Fund UGSDX $2.01 No Change