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Patiently Waiting for Mean Reversion
September 15, 2014

So far this year, small-cap growth stocks have surprisingly been lackluster. After 2013, when it gained a scorching 38.8 percent, the Russell 2000 has delivered a tepid 0.62 percent year-to-date (YTD).

Russell 2000 Index's 2013 Total Return Compared to 2014 YTD
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Performance has been so poor, in fact, that the spread, or bifurcation, between the 12-month return residuals of small and large caps is at its widest since the dotcom bubble of the late 1990s and early 2000s. This bifurcation is one of the largest since 1975.

According to Morgan Stanley, we’re in the worst beta-adjusted period for small-cap stocks since the late 1990s. The 12-month return in August for small-caps was -9.7 percent, placing it in the bottom 6 percent of any 12-month period since the mid-1970s. 

Small-Cap Bifucation
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The bifurcation is more than apparent when you compare the year-to-date (YTD) total returns of the big boys (those in the S&P 500 Index and Dow Jones Industrial Average) to their little brothers (those in the Russell 2000 and S&P SmallCap 600 Index). The Russell, though it led the other indices in March, has failed to reach a new record high, which the S&P 500 and Dow managed to achieve in the last couple of months. 

Small-Cap Stocks Are Lagging Behind Large-Caps This Year
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Are We on the Verge of Another Bubble?
We don’t think so. History shows bubbles are associated with excessive leverage and lofty valuations. That is not the case this time.

In July, Federal Reserve Chairwoman Janet Yellen stated in her semiannual report to Congress that small caps appear to be “substantially stretched,” even after a drop in equity prices at the beginning of the year.

Fed Chairwoman Janet Yellen questions the valuation of small-cap-stocks, specifically in the biotech and social media spaces.There may be some truth to Yellen’s remark, an ideological echo of former Fed Chairman Alan Greenspan’s now-famous “irrational exuberance,” his description of investors’ rosy attitude toward dotcom startups of the late 1990s and early 2000s.

Much of the valuation gap has evaporated. Looking at the price/earnings to growth ratio—20x for the Russell 2000 and 18x for the S&P 500—small caps have slightly higher yet reasonable multiples and may offer better long-term growth prospects.

Mean Reversion to the Rescue
The recent underperformance among small caps has been a headwind for a few of our funds, most notably our Holmes Macro Trends Fund (MEGAX), whose benchmark, the S&P 1500 Composite, tracks the performance of not just large- and mid-cap U.S. companies, but small-cap as well. With a bias toward small-cap companies, the fund has underperformed compared to last year, when such stocks were doing well.

Because small caps tend to have higher beta than blue chips, you would expect them to outperform in a generally rising market—which we’re currently in. So it appears that a major rotation out of these riskier, more volatile stocks has inexplicably occurred, leading to the wide bifurcation between small and large companies. 

The good news is that, based on 20 years of historical data, stocks in the Russell 2000 tend to rally in the fourth quarter and continue steadily until around the end of the first quarter. Over this 20-year period ending in December 2013, the Russell has generated an impressive annualized return of approximately 10 percent.

Russell 2000 Index Historically Sees a Rally in the Fourth Quarter Through First Quarter
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Whether or not this fourth-through-first-quarter rally will recur in 2014 and early 2015 is impossible to forecast. What can be said, however, is that prices and returns do tend to revert back to their mean over time.

I discussed this concept in full last month in the second part of my “Managing Expectations” series, “The Importance of Oscillators, Standard Deviation and Mean Reversion.” Although small caps are underperforming right now, the concept of mean reversion suggests that they’ll return to their historical relationship with large caps eventually—just as they did following the dotcom bubble.

Small-cap stocks traditionally outperform large-cap-stocks in most twenty-year periods. O'shaughnessy writes.

In his 2006 book The New Rules for Investing Now: Smart Portfolios for the Next Fifteen Years, investor James P. O’Shaughnessy makes the case that small stocks have a performance advantage over large stocks simply because, well, they’re small. This might sound like circular logic, but as he writes:

A company with $200 million in revenues is far more likely to be able to double those revenues than a company with $200 billion in revenues. With large companies, each increase in revenues becomes a smaller and smaller percentage of overall revenues. Small stocks, on the other hand, have a much easier time delivering great percentage growth in revenues and earnings.

O’Shaughnessy examined every 20-year rolling time period beginning each month between June 1947 and December 2004. That’s 691 20-year rolling time periods. What he found is that “small stocks outperformed the S&P 500 84 percent of the time.”

Small-Cap Stocks Historically Outperform Large-Cap Stocks in Most 20-Year Periods
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If O’Shaughnessy’s research is accurate, it seems very reasonable to be optimistic in the long term. It would be myopic to look only at the Russell 2000’s recent underperformance and impulsively rotate out of small caps without also considering the decades’ worth of data showing the growth that can be achieved.

Why It’s Important to Have Your Funds Actively Managed
Comparing index funds to actively managed funds, Kiplinger columnist Steven Goldberg wrote last month: “[I]ndex funds are designed to give you all the upside of bull markets and every bit of the downside of bear markets. Only good actively managed funds can protect you from some of the pain of a bear market.”

We at U.S. Global Investors agree with Goldberg’s attitude toward good active management. Although MEGAX might be temporarily underperforming right now as a result of the sentiment-driven and disappointing performance of small-cap stocks, we’re confident that they will eventually revert back to their historical pattern as fear over Fed tightening settles down and fundamentals prevail.

In the meantime, we will continue to apply our dynamic management strategy of picking stocks in the fund using the 10-20-20 model: we focus on companies that are growing revenues at 10 percent and generating a 20 percent growth rate and 20 percent return-on-equity. This approach has served us very well in the past and enabled us to select the most attractive growth-oriented companies for our clients. 

A Note on the Strong U.S. Dollar and Gold
As I explained in a recent Frank Talk, a strong U.S. dollar could spell trouble for commodities such as gold, which tend to have a historic inverse relationship to the dollar.

The Inverse Relationship Between Gold and the U.S. Dollar
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When the dollar does well, investors often choose to store their money in paper rather than bars. Though September is statistically the best month for gold, with the dollar rising almost two standard deviations above its mean, this month might not be kind to the yellow metal and other commodities.

Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

Past performance does not guarantee future results.

Stock markets can be volatile and can fluctuate in response to sector-related or foreign-market developments. For details about these and other risks the Holmes Macro Trends Fund may face, please refer to the fund’s prospectus.

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 Russell 2000 Index is a U.S. equity index measuring the performance of the 2,000 smallest companies in the Russell 3000. The Russell 3000 Index consists of the 3,000 largest U.S. companies as determined by total market capitalization. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry. The S&P SmallCap 600 Index is a market capitalization-weighted index consisting of 600 small-capitalization common stocks that is used as a benchmark to measure the performance of small cap stocks. The S&P 1500 Composite is a broad-based capitalization-weighted index of 1500 U.S. companies and is comprised of the S&P 400, S&P 500, and the S&P 600.  The index was developed with a base value of 100 as of December 30, 1994.

Fund portfolios are actively managed, and holdings may change daily. Holdings are reported as of the most recent quarter-end. Holdings in the Holmes Macro Trends Fund as a percentage of net assets as of 6/30/2014: Morgan Stanley (0.00%).

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.

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U.S. ISM Manufacturing Index Heats up While China PMI Cools
September 10, 2014

Jobs, jobs: The U.S. ISM manufacturing Index for August is at a three-year high - U.S. Global InvestorsYou can always count on the United States of America to help boost global manufacturing growth. In its monthly Purchasing Managers Index (PMI) report, JP Morgan announced that the global PMI showed a slight uptick from 52.5 in July to 52.6 in August. The U.S. is again one of the top drivers alongside the Czech Republic, Taiwan, the United Kingdom, Ireland and Canada.

The U.S. ISM Manufacturing Index—our version of the PMI—rose more than 3 percent to close at a stellar 59.0, a three-year high. Meanwhile, China’s PMI inched down 0.6 points in August, from 51.7 to 51.1, ending a five-month winning streak beginning in February.

The monthly index tracks five major indicators in the manufacturing sector, including inventory levels, new orders, production, employment and supplier deliveries. The greater the number above 50.0, the greater the manufacturing expansion over the previous month. Anything below 50.0 would indicate a contraction. Economists rely on these numbers to adjust their GDP estimates.

That the U.S. nearly reached 60.0 supports the belief that we’re in for a robust second half. As I told Palisade Radio’s Collin Kettel recently, the U.S. “hit the ball right out of the park. You can’t even find the ball. It’s gone right past the parking lot. And that makes the dollar very strong.” 

U.S. ISM Manufacturing Index at a Three-Year-High - U.S. Global Investors
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This news is tempered somewhat by the most recent nonfarm payroll employment data released by the U.S. Bureau of Labor Statistics. Total employment in the U.S. rose by a weaker-than-expected 142,000 in August, compared with an average monthly increase of 212,000 over the last 12 months.

On the bright side, the National Federation of Independent Business’s Optimism Index, which measures job openings, job creation, capital spending and inventory investment, gained 0.4 points in August to end at 96.1, the second-best reading since October 2007. The largest gains in employment occurred in professional and business services and health care.

Emerging Markets
Commercial and business services also topped the growth ranking in August among global emerging markets, while health care services came in at number six. Business-facing and financial sectors posted their fastest expansion rate since January 2012, closing in on 60.0.  

Detailed Breakdown of Global Sector PMI - U.S. Global Investors
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Again, China cooled in August, interrupting its positive five-month run. But at 51.1, manufacturing activity is still expanding, just at a slower pace.

Despite a Slight Pullback in August, China's PMI Maintains Growth - U.S. Global Investors
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This slowdown is partially attributable to fewer orders from and weaker outputs to Europe, which trades more with China than the U.S. does. Europe’s flagging economy, as a result, has been a setback for China.

European imports to China, in fact, declined in August to a 14-month low compared to August 2013. Of the five indicators that compose China’s overall PMI, the New Orders Index dropped the most, from 53.6 to 52.5, a loss of 2 percent.

Another factor that led to China’s downgraded PMI is the country’s reduction in manufacturing jobs as part of cost-cutting measures. Its Employed Persons Index saw a minor dip from 48.3 to 48.2.

Many economists, as well as portfolio manager of our China Region Fund (USCOX) Xian Liang, are now waiting to see if China will announce further stimulus measures to prevent the world’s second-largest economy from slipping even further. Although Premier Li Keqiang has repeatedly dismissed the possibility of another full-blown bailout, typical monetary policy solutions might include cutting interest rates and reducing the amount of reserves banks must hold as deposits.

Will the People's BAnk of China enact further forms of monetary easing? U.S. Global Investors

To learn more about what’s driving the global economy, be sure to sign up for our upcoming webcast, “One World Market, Many Central Banks: How Will Your Investments Be Impacted?” The free webcast is scheduled to be held on Thursday, October 2, at 4:30 ET. We hope you’ll join us! 

Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

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.

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio.

The J.P. Morgan Global Purchasing Manager’s Index is an indicator of the economic health of the global manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The ISM manufacturing composite index is a diffusion index calculated from five of the eight sub-components of a monthly survey of purchasing managers at roughly 300 manufacturing firms from 21 industries in all 50 states.

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Strong U.S. Dollar Weakens Gold Prices this September
September 9, 2014

Last week I wrote about the historic correlation between the month of September and the strength of gold. Now it appears that this September might be shaping up as one not to remember but forget.

Based on data reaching back to 1969, gold rises 2.1 percent on average in September. Ten days into this year’s month, however, the precious metal has lost 2.6 percent, slipping from $1,288 to $1,254.

Average-Month-to-Month-Percentage-Changes-in-S&P-500-Index
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As I pointed out last week, a dip such as this might be common in other months, but it’s somewhat rare in September. In the last 20 years, there have been only five Septembers in which gold prices ended lower than they started: 1996, 2000, 2006, 2011 and 2013. Although we remain optimistic, 2014 might see another such down September.

So What Gives?
September is statistically both the best month for gold and worst month for stocks. Though there isn’t an absolute certainty that each September will be as equally kind to gold, decades’ worth of data support this inverse relationship. Investors, aware of the probability, typically move some of their stock positions into gold.

Average-Month-to-Month-Percentage-Changes-in-S&P-500-Index
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But another inverse relationship exists that also influences gold’s performance: the relative strength of the U.S. dollar. When the dollar does well, many investors choose greenbacks rather than yellow metal as a reliable safe haven from volatility.

Average-Month-to-Month-Percentage-Changes-in-S&P-500-Index
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This month, the inversion has only intensified as the U.S.’s ISM Manufacturing Index for August rose to a three-year high of 59.0, strengthening the dollar. While a jump in the ISM index is a welcome event, commodities such as gold tend to take it on the chin.

Another factor weighing on the metal is the weakening euro, which statistically has the opposite effect. When the euro is down, so too is gold because dollar-denominated gold becomes more expensive for Europeans and other non-Americans. Recently the eurozone’s currency hit 14-month lows against the dollar.

Again, even though this particular September has thus far fallen below expectations, we remain bullish on gold in our Gold and Precious Metals Fund (USERX) and World Precious Minerals Fund (UNWPX). As I’ve frequently written about, the Love Trade is a reliable occurrence around this time of year that helps bolster the metal’s performance.

And as always, we at U.S. Global Investors recommend a 10 percent weighting in gold: 5 percent in bullion, the other 5 percent in gold stocks, then rebalance every year.

Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

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

Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in these sectors.

The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The Nasdaq Composite Index is a capitalization-weighted index of all Nasdaq National Market and SmallCap stocks. The ISM manufacturing composite index is a diffusion index calculated from five of the eight sub-components of a monthly survey of purchasing managers at roughly 300 manufacturing firms from 21 industries in all 50 states.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.

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The New Challenges of Price Discovery
September 8, 2014

Investing in the Age of High-Frequency Trading, Falling Volumes and Widening Bid-Ask Spreads

As investment managers, one of our most important fiduciary responsibilities is buying and selling stocks for the best possible price and execution. We do this by using the statistical strategies I’ve previously covered, from monitoring short- and long-term cycles; implementing probability models such as standard deviation, mean reversion and oscillators; and identifying the relative valuation of stock with the portfolio manager’s cube.

If only it were that simple.

In the past few years, price discovery—or the act of finding the “right” price for a security—has become much more challenging because of falling stock volume and widening bid-ask spreads. These challenges are directly attributable to the infiltration of high-frequency traders into the market, not to mention the expansion of dark pools and non-exchange trading.

Simply put, when stock volume is high and transactions increase, the bid-ask spread narrows. Brokers and dealers accordingly price shares to move, and investors have a pretty good estimation of what they’re going to spend on a security.

But when there are fewer transactions and volume is down, the bid-ask spread widens. Price discovery, then, becomes difficult because stock valuation has a broader range in which to move. I discussed this last week using the intraday performances of the TSX Venture Index and Market Vectors Junior Gold Miners ETF (GDXJ) as examples: in the afternoon, after volume and activity tend to decrease, spreads widen.

Think of this in terms of real estate. If volume is up and homes are selling rapidly in Neighborhood A, both buyers and sellers have a good idea of what a fair price is, based on the dollar amount of square footage of nearby homes sold within a certain timeframe. Price discovery, therefore, is reasonable.

But if homes in Neighborhood B languish on the market for lengthy periods of time, relative price comparisons begins to dissolve. Who knows what the homes should go for? Closing deals becomes tough because, in such a scenario, a buyer’s bid might come in way under what the seller is willing to accept. As a result, the price of homes, even those in adjacent lots, can fluctuate wildly.

Volume Drops, Volatility Rises—But Opportunity Remains
To see these concepts in action, look at the chart below. The S&P/TSX Venture Composite Index, which lists about 500 Canadian micro-cap venture companies, has seen a drop in volume of more than 60 percent since mid-2011. This has widened the bid-ask spreads of individual equities in the index—not the index itself—complicating price discovery.

Average-Month-to-Month-Percentage-Changes-in-S&P-500-Index
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Despite the challenge, we try to take advantage of the volatility that other investors might flee from. Decisions to buy or sell a company are first fundamentally driven, and then trading is based on statistical analysis of fund flows, volatility over different time periods and relative performance to the gold indices we strive to beat. For the Gold and Precious Metals Fund (USERX), it’s the FTSE Gold Mines Index; for the World Precious Minerals Fund (UNWPX), the NYSE Arca Gold Miners Index.

Our style resembles that of the Navy SEALS, in that we prefer to be nimble, surgical and tactical. During the bear market that ran from mid-2011 until February 2014, we nibbled rather than munched on inexpensive companies that were lagging in relative performance over one day, one month and one quarter. And when these companies showed a surge in price and volume, we often trimmed our holdings rather than sold outright. This incremental “nibbling” strategy is a little like investment reconnaissance, enabling us to test our conviction in a company before taking a weightier position.

Another disruptive factor to price discovery has been the proliferation of exchange-traded funds (ETFs). Accounting for more than 30 percent of trading volume in the markets, some ETFs are influencing the markets they track and impacting their underlying holdings. A study by Goldman Sachs confirmed that ETF trades influence stock prices. The study looked at which individual stocks move more with the dynamics of the ETF than on their own fundamentals and found that those stocks most affected by ETF activity are in the Russell 2000, probably because of their lower levels of liquidity, lower volume and cheap prices.

We’ve witnessed this same phenomenon with some junior gold stocks in the GDXJ. A gold stock can have a significant price move based not on changes to its fundamentals or a corporate event but rather shifts in sentiment toward gold that is compounded by fund flows. The inclusion or exclusion of a stock in the underlying index can result in a flurry of disruptive trading unrelated to changes in the company’s fundamentals.

Just as one man’s trash is another man’s treasure, one man’s fear of volatility is another man’s opportunity. Part of successful active management is not getting discouraged, learning to adapt to a changing climate and coming to terms with the market’s often erratic behavior.

But the erratic behavior has only ramped up in recent years.

HFT: Trading at the Speed of Greed
As I said earlier, price discovery has become much more difficult in recent years because of growing high-frequency trading (HFT), dark pools and non-exchange trading—all of which have changed, perhaps irreversibly so, the formation of capital in the investment industry.

HFT is a controversial practice whereby automated computers using sophisticated algorithms transact orders at lightning-fast speeds. In a process called latency arbitrage, high-speed traders are able to gain access to crucial order information and other market data milliseconds before “normal” or “slow” traders. They manage to do this through a number of means, including placing their computers as close as possible to stock exchanges and using best-of-the-best fiber optic cables.

After acquiring the information, such traders can get in front of other buyers’ purchases and, almost instantaneously, turn around and scalp the shares within less than a blink of an eye. Often gains are less than a penny per share, but because they trade so frequently and rapidly, it’s easy to make fast money.

This new form of legalized front-running became the talk of Wall Street after the March 2014 publication of financial writer Michael Lewis’s critical book on the matter, Flash Boys: A Wall Street Revolt. In one passage, Lewis deftly recounts the infamous Flash Crash that occurred at 2:34 on May 6, 2010:

[F]or no obvious reason, the market fell six hundred points in a few minutes. A few minutes later, like a drunk trying to pretend he hadn’t just knocked over the fishbowl and killed the pet goldfish, it bounced right back up to where it was before. If you weren’t watching closely you could have missed the entire event… Shares of Procter & Gamble, for instance, traded as low as a penny and as high as $100,000. Twenty thousand different trades happened at stock prices more than 60 percent removed from the prices of those stocks just moments before.

A spread of $99,999.99. If that doesn’t give a trader pause, I’m not sure what will.

The chart below shows just how dramatically HFT has heightened intraday volatility in the SPDR S&P 500 ETF, arguably the most popular of its kind in the U.S. Up until 2007, daily price changes had a relatively steady heartbeat. But in 2007, when HFT as we know it today emerged, the average intraday volatility more than doubled. In August 2011, the peak volatility climbed to one that was 10 times higher than in 2006.

Average-Month-to-Month-Percentage-Changes-in-S&P-500-Index
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Lewis’s book has created a much-needed awareness of what HFT has brought to the market: disruption, unsettlement and a loss of trust and transparency. Like thieves in the night, high-speed traders can swoop in to a market that you created and take advantage of it.

Michael Matousek, head trader at U.S. Global Investors, has experienced this unpredictability firsthand. On numerous occasions he has put in a buy order, based on up-to-the-second liquidity information, but received only a fractional amount.

As for liquidity, Michael says that HFT might increase it, “but when an order is ‘sniffed,’ [high-frequency traders] cancel. So the perceived liquidity is gone within fractions of a second.”

Not only does the liquidity disappear, but because transactions often come with a flat fee, costs increase when orders are only partially filled.

Fellow U.S. Global trader Mike Ellingsen notes how HFT has also affected depth of market, or the measure of the liquidity of open and, I should add, transparent buy and sell orders.

“True depth in the equities market has become hard to gauge,” he says. “Trust is key in this entire conversation.”

This trust, however, has been tarnished in a system dominated by HFT, which currently accounts for approximately 70 percent of all market activity in the U.S.  

Trading in the Dark
So what do you do if you’re a large institutional trader who has a million shares to move but doesn’t want to be preyed upon by high-speed front-runners? The solution for many is to use not a conventional exchange, where market information is publically shared, but a private exchange. In such exchanges, known as “dark pools,” transactions are conducted secretly and anonymously. There is no trading floor, no orders visible to the public and no transparency.

Dark pools aren’t anything new; they’ve been around since at least the 1980s, mostly to reduce market impact and lower transaction costs. But an increasing number of large investors are using these exclusive pipelines to (allegedly) hide and protect their transactions from high-speed traders. In recent years, non-exchange trading has surged, accounting for close to half of all stock trades today.

The problem, as you might guess, is that stock volume in the U.S. is being usurped from the trading floors and drying up faster than the Aral Sea. Again, when volume drops, bid-ask spreads widen, which complicates price discovery.

According to TabbFORUM, whose Equities LiquidityMatrix™ consolidates monthly exchange data, industry volume dropped 1 percent in July. That doesn’t sound like much, but when you’re dealing with more than 5 billion shares in the U.S. market alone, a decrease of 1 percent is huge. And every month seems to tell the same story.

In the last decade and a half, the greatest loss of volume occurred in 2012. The S&P lost 27 percent; the Dow Jones Industrial Average, 28 percent; the NASDAQ, 20 percent; and the Russell 2000, 22 percent. Since 2000, 70 percent of NASDAQ volume has disappeared.

3-Days-Before-and-3-Days-After-Labor-Day
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Two years years ago, a headline for a Bloomberg BusinessWeek article asked: “Where Has All the Stock Trading Gone?”

The answer: dark pools.

Fair Games Call for Fair Rules and Referees
Lewis’s book has convinced many in the securities industry that the rulebook has not just been amended but also put through the shredder. Regulators have taken notice. Back in April, U.S. Attorney General Eric Holder announced that the Justice Department is looking into the legality of HFT. His department is joined by the Federal Bureau of Investigation (FBI), the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC).

We welcome the regulators exploring ways to manage these issues better for a fairer playing field and more transparent trading arena.

It’s not just the high-speed traders themselves that need refereeing. The “real black hats,” as New York Times financial columnist Andrew Ross Sorkin points out, are the big stock exchanges.

“These exchanges don’t just passively allow certain investors to connect to their systems,” he writes. “They have created systems and pricing tiers specifically for high-speed trading. They are charging higher rates for faster speeds and more data for select clients. The more you pay, the faster you trade.”

The U.S. has a lot of catching up to do to level the playing field and soften the deleterious effects of predatory trading. Some of the SEC’s proposals—registration of all high-frequency traders, an increase in market transparency, among others—are still months and perhaps even years away.

Canada, on the other hand, already has many such regulations in place. Germany’s High Frequency Trading Act, which became effective in May 2013, mandates that all high-frequency traders apply for a Federal Financial Supervisory Authority license and imposes fees on traders who make “excessive use” of HFT. In Italy, a 0.02 percent tax is levied against all HFT transactions.

However you feel about HFT, you cannot deny that it has greatly affected the investment industry and changed how easily price discovery is conducted and capital is formed. Despite the added challenge, our investment team at U.S. Global Investors continues to believe in and use the time-honored strategies that have served us well in the past.  

Be Nimble, Yet Nibble
So what do we do as active managers? We use statistical models to try and sniff out both value at a reasonable price and accumulate at attractive relative prices, even when there are so many new factors to consider. We remain confident as we adapt to changes in the landscape, taking a nimble approach while nibbling on opportunities we find. 

Curious investors who have read our previous writings on these themes recognize that we navigate all of the complexity and intensity of constantly changing landscapes by using patterns in trading, from standard deviation moves to daily patterns to broader, seasonal patterns.

In case you missed any of them, you can read them here:
The Importance of Cycles in the Investment Management Process
The Importance of Oscillators, Standard Deviation and Mean Reversion
Picking Mining Stocks in a Bear Market
Anticipate Before You Participate: Patterns in Trading

As active managers we are confident in our use of these analytical tools, enthusiastic in our approach and optimistic about the future. Happy investing!

Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

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.

Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in these sectors.

The S&P/TSX Venture Composite Index is a broad market indicator for the Canadian venture capital market. The index is market capitalization weighted and, at its inception, included 531 companies. A quarterly revision process is used to remove companies that comprise less than 0.05% of the weight of the index, and add companies whose weight, when included, will be greater than 0.05% of the index. The Market Vectors Junior Gold Miners Index is a market-capitalization-weighted index. It covers the largest and most liquid companies that derive at least 50 percent from gold or silver mining or have properties to do so. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The Nasdaq Composite Index is a capitalization-weighted index of all Nasdaq National Market and SmallCap stocks. The FTSE Gold Mines Index Series encompasses all gold mining companies that have a sustainable and attributable gold production of at least 300,000 ounces a year, and that derive 75% or more of their revenue from mined gold. The NYSE Arca Gold Miners Index is a modified market capitalization weighted index comprised of publicly traded companies involved primarily in the mining for gold and silver.  The index benchmark value was 500.0 at the close of trading on December 20, 2002. The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry. The Russell 2000 Index is a U.S. equity index measuring the performance of the 2,000 smallest companies in the Russell 3000. The Russell 3000 Index consists of the 3,000 largest U.S. companies as determined by total market capitalization.

Fund portfolios are actively managed, and holdings may change daily. Holdings are reported as of the most recent quarter-end. Holdings in the funds mentioned as a percentage of net assets as of 6/30/2014: Market Vectors Junior Gold Miners ETF (0.55% in Gold and Precious Metals Fund, 0.55% in World Precious Minerals Fund); SPDR S&P 500 ETF (0.00%); Proctor & Gamble (0.00%); Goldman Sachs Group, Inc. (0.00%); E*TRADE Financial Corporation (0.00%); Virtu Financial (0.00%). 

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.

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Remember, Remember, Gold in September
September 4, 2014

Gold BullionIn American poet W. S. Merwin’s poem “To the Light of September,” the speaker calls the ninth month “still summer,” yet with a “glint of bronze in the chill mornings.”

I agree—to an extent. Here in San Antonio, Texas, home of U.S. Global Investors, we’re most definitely still in the summer season. But in the investing world, when we talk about September, there’s a glint not of bronze but another precious metal: gold.

That’s because September is historically gold’s best-performing month of the year, returning 2.16 percent on average since 1969.

September is Historically the Best Month for Gold
click to enlarge

I invite you to compare the chart above, updated to reflect the most recent monthly returns, to the one published this time last year.

September is gold month - U.S. Global InvestorsDrivers of Gold
There are several seasonal factors that explain why gold glitters a little more brightly in September. The most notable reason is what I call the Love Trade. In India, this month marks some of the most spirited gold-buying in anticipation of Diwali, which falls on October 23 this year. Following closely behind is the Indian wedding season, when gold is purchased for the bridal trousseau and as gifts in jewelry form. And September is normally when retailers restock their wares ahead of Christmas and after the Islamic month of Ramadan, at the end of which gold jewelry is commonly exchanged.

Another explanation might also be the inverse relationship between bullion and stocks, which only becomes more apparent in September. Earlier this week I discussed how September is historically the worst month of the year to trade stocks in. It’s very possible that many investors turn to gold in September, knowing that the month’s stock returns are typically poor.

Inverse Relationship Between Gold Bullion and Stocks is Most Dramatic in September
click to enlarge

The yellow metal had a tough 2013—its worst since 1981, in fact—and in September its price fell 5 percent, from $1,396 an ounce to $1,327. Although a movement such as this is generally normal for gold, a loss in the ninth month is somewhat rare. In the last 20 years, there have been only five Septembers in which gold prices ended lower than they started at: 1996, 2000, 2006, 2011 and 2013. That’s once every three and a half years on average.  

We’re only a few days into the month, and so far spot prices have dropped about 1.6 percent. But this is completely in line with gold’s normal behavior. As I pointed out in the second part of “Managing Expectations,” it has a daily standard deviation of ±1 percent.

Be sure to check out our Gold and Precious Metals Fund (USERX), recognized by Morningstar with a four-star rating*. Also, to find out which countries contribute the most gold annually, explore our updated interactive “Global Gold Mining Production” map.

 Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

*Morningstar Overall Rating™ among 71 Equity Precious Metals funds as of 6/30/2014 based on risk-adjusted return.

Past performance does not guarantee future results.

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

Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in these sectors.

Morningstar Ratings are based on risk-adjusted return. The Morningstar Rating for a fund is derived from a weighted-average of the performance figures associated with its three-, five- and ten-year (if applicable) Morningstar Rating metrics. Past performance does not guarantee future results. For each fund with at least a three-year history, Morningstar calculates a Morningstar Ratingä based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a fund’s monthly performance (including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. (Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in the distribution percentages.)

The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The Nasdaq Composite Index is a capitalization-weighted index of all Nasdaq National Market and SmallCap stocks.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.

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Net Asset Value
as of 09/15/2014

Global Resources Fund PSPFX $9.54 0.02 Gold and Precious Metals Fund USERX $6.85 0.04 World Precious Minerals Fund UNWPX $6.49 0.06 China Region Fund USCOX $8.15 -0.12 Emerging Europe Fund EUROX $7.89 0.03 All American Equity Fund GBTFX $33.21 -0.15 Holmes Macro Trends Fund MEGAX $23.86 -0.24 Near-Term Tax Free Fund NEARX $2.25 No Change U.S. Government Securities Ultra-Short Bond Fund UGSDX $2.00 No Change