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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.

Comparisons to 2008 Spark Gold’s Fear Trade
January 25, 2016

Are we headed for another 2008? George Soros thinks so.Plunging oil prices, rising market volatility, surging global debt—it’s all beginning to remind some investors of 2008. Earlier this month, billionaire former hedge fund manager George Soros warned of an impending financial crisis similar to the last major one, which sent shockwaves throughout global markets.     

The comparisons to 2008 have triggered gold’s Fear Trade, with many investors scrambling into safe haven assets. Jeffrey Gundlach, the legendary “bond king,” recently made a call that amid further market turmoil, the metal could spike as much as 30 percent, to $1,400 an ounce.

Making such predictions is often a fool’s game, but there’s no denying that gold demand is on the rise, both in the U.S. and abroad. For the one-month period ended January 20, gold (and silver) outperformed, comfortably beating domestic equities as well as a basket of other commodities.

Precious Metals on Top in 2016
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I’ve already shared with you the fact that gold has historically had a low correlation with equities. This point is worth reiterating: When equities have zigged, gold has zagged. And with volatility high in global markets right now, many investors are choosing to rotate a portion of their portfolios into the precious metal.

Marc Faber suggests that it might be a good time to get back into gold.

This was the advice of my friend Marc Faber, who recently warned investors in his influential “Gloom, Boom & Doom Report” newsletter that global stocks could fall an additional 40 percent on mounting liquidity and debt problems. In the event such a crisis occurs, Marc says, investing in gold—which, again, has been shown to be inversely correlated with stocks—might be one way to protect one’s wealth.

I’ve always recommended a 10 percent weighting in gold: 5 percent in physical bullion, the other 5 percent in gold stocks or mutual funds. This applies in all market conditions, good or bad.

Something else I want to draw attention to in the chart above is the extreme divergence in performance between gold and oil, which is trading at levels we haven’t seen in a long while. Declines in oil have traditionally invited enormous selloffs in other commodities, making gold’s resilience at this time all the more impressive.

China Consumed Nearly All of Global Gold Output in 2015

Investors in China appear to recognize the importance of gold in times of market uncertainty. Since June 2015, the Shanghai Composite Index has dropped close to 45 percent, prompting scores of retail investors to pivot into safe haven assets such as gold. As you can see below, 2015 was a blowout year for the Shanghai Gold Exchange (SGE), which in the past has served as a good measure of wholesale demand in China.

Physical Gold Delivered from Shanghai Gold Exchange (SGE) vs. World Mining Output
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Not only did gold deliveries climb to a record number of tonnes in 2015, they also represented more than 90 percent of the total global output of the yellow metal for the year.

The SGE has made it incredibly easy for Chinese citizens to participate in gold investing. Recently it rolled out a smartphone app, making it more convenient than ever before to open an account and begin trading.

Gold Miners Are Winners of the Currency Wars

Gold priced in the strong U.S. dollar might have netted a loss in 2015, but in many other parts of the world, prices were either stable or even made gains. For buyers of gold in non-dollar economies, it’s the local price that matters most, not the dollar. In Russia, the third-largest producer, the metal rose 12 percent—and came close to an all-time high. In South Africa, the sixth-largest, it was well above the all-time high. Investors there saw returns of greater than 20 percent in 2015.

Gold Was Positive in Non-Dollar Currencies
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This has been beneficial to many mining companies based outside the U.S. Operations are paid for in local currencies—most of which have weakened in the last year—but companies sell their production in U.S. dollars. This has helped offset the decline in gold prices since they peaked in 2011.

Canadian-based companies such as Claude Resources, Richmont and Agnico Eagle Mines are performing well, even in the gold bear market and amid high volatility.

Canadian Gold Stock Performance
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For the last three years, gold miners all over the globe have been thoroughly beaten up. Today, they’re heavily discounted, and there are signs that conditions are stabilizing.

Managing Expectations

With the Fear Trade heating up, it’s important that we manage our expectations. The length and extent of the current bear market, which began in September 2011, might seem unprecedented to many investors. In actuality, it doesn’t veer very far from what we’ve seen in the past, according to data presented by the World Gold Council (WGC).

Current Gold Bear Market Not Far off the Mean
January 1970 – January 2016
Current Gold Bear Market Not Far off the Mean BULL MARKET Current Gold Bear Market Not Far off the Mean BEAR MARKET
Dates Length (months) Cumulative Return Dates Length (months) Cumulative Return
Jan 1970 -
Jan 1975 
61 451.4% Jan 1975 -
Sep 1976
20  -46.4%
Oct 1976 -
Feb 1980
41 721.3% Feb 1980 -
Mar 1985
61 -55.9%
Mar 1985 -
Dec 1987
33 75.8% Dec 1987 -
Mar 1993
63 -34.7%
Apr 1993 -
Feb 1996
35 27.2% Feb 1996 -
Sep 1999
43 -39.1%
Oct 1999 -
Sep 2011
144 649.6% Sep 2011 -
Present
52 -44.1%
Average 63 385.1% Average 47 -44.0%
Median 41 451.4% Median 52 -42.7%
Source: World Gold Council, U.S. Global Investors

Reaching back to 1970, the WGC identified five bull and bear markets, with bull markets defined as periods when gold prices rose for longer than two consecutive years, bear markets as the subsequent periods when they fell for a sustained length of time. Although these lengths vary, the cumulative loss in each bear market is relatively uniform, with median returns at negative 42.7 percent.

The present bear market, at negative 44.1 percent, falls easily within the realm of normalcy.

Further, the table suggests that a turnaround in gold prices is overdue.

This past Sunday I spoke at the Vancouver Resource Investor Conference. In the coming days, I’ll share with you what I saw and heard from fellow investors in the resources and commodities space. Stay tuned!

 

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 Thomson Reuters Core Commodity CRB Index, created in 1957, is an equal-weighted index of 19 commodities. The Shanghai Composite Index (SSE) is an index of all stocks that trade on the Shanghai Stock Exchange.

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 12/31/2015: Claude Resources Inc., Richmont Mines Inc., Agnico Eagle Mines Ltd.

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How Gold Got Its Groove Back
January 11, 2016

Gold begins 2016 with the right moves

Who says gold lost its appeal as a safe haven asset?

After five straight positive trading sessions last week, the yellow metal climbed above $1,100, its highest level in nine weeks, on a weaker U.S. dollar.. The rally proves that gold still retains its status as a safe haven among investors, who were motivated by a rocky Chinese stock market, North Korea’s announcement that it detonated a hydrogen bomb last Wednesday and rising tensions between Saudi Arabia and Iran.

Here in the U.S., gold finished 2015 down 10.42 percent, its third straight negative year. Until the new year, sentiment appeared poor, and many gold bulls were finding it hard to stay optimistic.

But after the price jump last week, large exchange-traded gold funds saw massive inflows, confirming a shift in investors’ attitude toward the precious metal.

It’s worth remembering that about 90 percent of physical demand comes from outside the U.S., mostly in emerging markets such as China and India. In many non-dollar economies, buyers are actually seeing either a steady or even rising gold price. The metal is up in Russia, Peru, South Africa, Canada, Mexico, Brazil and many more.

Note the differences in returns between gold priced in U.S. dollars and gold priced in the Brazilian real, Turkish lira, Canadian dollar, Russian ruble and Indonesian rupiah.

In 2015, Gold Performed Better in Non-Dollar Currencies
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Gold demand in China was very robust last year. A record 2,596.4 tonnes of the yellow metal, or a whopping 80 percent of total global output for 2015, were withdrawn from the Shanghai Gold Exchange. As for the Chinese central bank, it reported adding 19 more tonnes in December, bringing the total to over 1,762 tonnes. Precious metals commentator Lawrie Williams points out, though, that China’s total reserve figure is widely believed to be “hugely understated,” meaning the central bank might very well have much more than we’re being told.

Forget Interest Rates—Real Rates Are the Key Drivers of Gold

Despite all the talk of rising interest rates in connection to gold, they’re not a dominant driver of prices. Sure, rising nominal rates have tended to make the metal less attractive, since it doesn’t pay an income, but the larger driver by far are real interest rates. When real rates drop into negative territory, gold has historically done well.

As a reminder, real rates, important for the Fear Trade, are what you get when you subtract the consumer price index (CPI), or inflation, from the 10-year Treasury yield. As of January 6, the 10-year yield was 2.18 percent, while the 12-month CPI for November—December data will be released later this month—came in at a barely-there 0.50 percent. Real rates, therefore, are running at a positive 1.68 percent, which is a headwind for gold.

That’s why we need inflation to pick up, because then gold would be more likely to rally.

Regardless, the World Gold Council (WGC) writes in its 2016 outlook that gold’s role as a diversifier remains “particularly relevant”:

Research shows that, over the long run, holding 2 percent to 10 percent of an investor’s portfolio in gold can improve portfolio performance.

The reason for this is that gold has tended to have a low correlation to many other asset classes, making it a valuable diversifier. During economic contractions, for example, gold’s correlation to stocks actually decreased, according to data between 1987 and 2015.

Since 1987, Gold Has Had a Low Correlation to Other Assets
click to enlarge

For the last three years, gold has disappointed many because other investments, specifically equities, have seen such huge gains. But with global markets hitting turbulence, the yellow metal is looking more attractive as insurance against the currency wars.

I always recommend 10 percent in gold: 5 percent in gold stocks or an actively-managed gold fund, 5 percent in bullion and/or jewelry. It’s also important to rebalance every year.

This should be the case in both good times and bad, whether gold is rising or falling. As highly influential investment expert Ray Dalio said last year: “If you don’t own gold, you know neither history nor economics.”

USGI Among the First to Discuss the Significance of PMI as a Forward-Looking Indicator

Aside from real interest rates, gold prices are being challenged by weak manufacturing data around the world. China’s purchasing managers’ index (PMI) fell to 48.2 last month, down 0.4 points from the November reading. The Asian giant’s manufacturing sector spent a majority of 2015 in contraction mode, managing to rise above the key 50.0 level only once last year, in February.

China Manufacturing Still in Contraction Mode
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Although fears of a Chinese slowdown are real, they’re largely overdone. Consulting firm McKinsey & Company’s Gordon Orr calls these fears a distraction, writing that “the country’s economy is still massive—as are its potentional opportunities.”

Something to keep in mind is that China recently approved a new five-year plan, its 13th since 1953. Although we won’t know exactly what’s in it until March, we do know that these plans have been good for economic growth in the past. It’s likely that interest rates will be trimmed even more to stimulate business, with more funding diverted to infrastructure and “green” initiatives.

Manufacturing around the world showed signs of deterioration in December as well. The JP Morgan Global Manufacturing PMI declined to 50.9 from 51.2 in November. The sector is still in expansion mode, but just barely.

Global Manufacturing Cools in December
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The reading also fell below its three-month moving average in December, which, as I’ve shown many times before, can have a huge effect on materials and energy three to six months out.

We were one of the earliest investment firms to monitor this important economic indicator closely and bring it into public, everyday discourse. (From what I can find, the first time we wrote about it was in January 2009, as it applied—wouldn’t you know?—to China.) Today, I hear and read about the PMI on the radio and in newspapers as often as I do more common economic indicators such as GDP and unemployment rates.

That’s a testament to the sort of cutting-edge analysis we do and pride ourselves on here at U.S. Global Investors.

Looking Ahead in the New Year

Until we see global synchronized growth with rising PMIs, we remain cautious going forward. A constant source of hope is the Trans-Pacific Partnership (TPP), which, when ratified sometime this year, will eliminate 18,000 tariffs for 25 percent of global trade.

We also anticipate more stimulus programs this year around the world. Lately we’ve experienced strong fiscal drag as more and more regulations and taxes impede progress that not even cheap money has been able to offset. A 2014 report by the National Association of Manufacturers (NAM) revealed that federal regulations in the U.S. alone cost businesses more than $2 trillion a year. To ignite growth, G20 nations should commit themselves to cutting red tape.

Burdensome regulations around the globe have led to massive fiscal drag

A good model for such a task is Canada’s “One-for-One Rule,” introduced in April 2012 during former Prime Minister Stephen Harper’s administration. The rule mandates that when a new or amended regulation is introduced, another must be removed.

However it’s accomplished, regulatory burdens placed on businesses must be reduced.

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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 Report on General Manufacturing is based on data compiled from monthly replies to questionnaires sent to purchasing executives in over 420 manufacturing companies. 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 article references the investment theory of an investment as insurance against a separate market event that could negatively affect performance of an investment. The reference does not guarantee performance or a safeguard from loss of principal by investing in that asset.

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Franco-Nevada: Royalty of the Gold Industry
January 6, 2016

Standing next to Pierre at Mines and Money London in December 2015

In 1983, my friends and early mentors Seymour Schulich and Pierre Lassonde founded Franco-Nevada Mining, the world’s first gold royalty company.

The two uniquely gifted money managers were on to something big. It was originally Seymour—then an oil analyst at the Canadian investment firm Beutel, Goodman & Company, where he and Pierre met—who recognized that the royalty model used in the oil and gas industry had some of the highest returns on capital.

At the time, no one had applied this business strategy to the precious metals industry. Venture capital was challenging to secure. But with Seymour’s fastidious money management and Pierre’s vast mining expertise, the two raised $2 million. (That’s according to “Get Smarter,” Seymour’s 2011 memoir aimed at mentoring young Canadian professionals, which I highly recommend.)

Fast forward more than 30 years, and Franco-Nevada now has a market cap of over $8.2 billion, making it the world’s largest and most successful gold royalty company.

Franco-Nevada was my first initial public offering (IPO) to work on as a young analyst at Toronto-based, boutique investment firm Merit Investment Corp. Even then, I recognized the superiority of the business model. For the next 20 years, until it merged with Normandy Mining and Newmont Mining in 2002, I watched the company return an average 38 percent to shareholders annually.

Ever since its second IPO—Newmont spun it off in 2007—Franco-Nevada’s stock has outperformed both gold bullion and global gold miners.

Franco-Nevada Ahead of the Curve
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Today, I’m just as convinced of Franco-Nevada’s business model. Its uniqueness allows the company and its royalty peers to generate high gross margins and ever-expanding dividends.

Class Acts in Philanthropy

I feel extraordinarily blessed to be able to call Seymour and Pierre my friends. The two are certified superstars of the resource sector. Pierre’s “The Gold Book,” published in 1990, is a seminal masterpiece on the topic of gold investing.

But beyond that, they’re just exceptional human beings, both of them loving husbands and fathers. Their differing personalities complement each other well. Whereas the frugal Seymour prefers to drive the same Lincoln for decades, Pierre enjoys the engineering and sleek design of a Ferrari.

The colorful interior of the Pavillons Lassonde de I'Ecole polytechnique MontrealBoth are among the most generous philanthropists alive today, responsible for donating hundreds of millions of dollars to various causes in Canada as well as abroad. Pierre is a benefactor of the Lassonde Entrepreneur Institute at the University of Utah, which pairs faculty members with business, engineering and science students and helps them write business plans. In 2011, he donated a massive $25 million to expand the School of Engineering at York University, where the Computer Science & Engineering Building was renamed the Lassonde Building in honor of his generosity over the years.

At the École Polytechnique de Montréal, Canada’s top engineering school—and where Pierre received one of his many degrees—a series of buildings named for Pierre and his late wife Claudette house the library and departments of computer and electrical engineering. In 2004, these buildings received the coveted Pilier d’or—Canada’s highest award for philanthropy in the French-Canadian community—for their “respect for the environment, efficiency objectives with a focus on sustainable development, technological innovation and innovative energy use,” according to the university.

In December 2015, Pierre received Mining Journal’s Lifetime Achievement Award at the Mines and Money conference in London.


Similarly, Seymour is a benefactor of several schools and organizations, including the Schulich School of Business at York University in Toronto, which offers the Kellogg-Schulich Executive MBA program—ranked #1 in the world by The Economist—as well as the Schulich School of Medicine and Dentistry at Western University. He’s also benefactor to the Schulich Heart Centre at Sunnybrook and Women’s College Health Sciences Centre in Toronto, the Library of Science and Engineering at McGill University and many others across Canada and the U.S. McGill, in fact, renamed its music program the Schulich School of Music in September 2005 in recognition of Seymour’s gift of $20 million, the largest such gift in the history of the university.

The schulich School of Business at York University, recognized as one of the world's most beautiful business schools.

“My main focus now is a $100 million project called the Schulich Leader Scholarships, which go to students pursuing science, technology, engineering and math studies,” Seymour told The Globe and Mail in January 2015. “The scholarships amount to $80,000 over four years. You can’t believe these kids. They are going to be the future of this country.”

Each year, the Schulich Leader Scholarships fund 50 undergraduates in the fields of engineering, science, technology and math. In 2000, Seymour was awarded the Order of Canada, the highest honor a Canadian citizen can receive. It’s comparable to being knighted (in the UK) or receiving the Presidential Medal of Freedom (in the U.S.).

I still remember being invited by Seymour to accompany him during one of his famous Sunday morning, two-hour walks. As we strode along, he shared with me the topic of a book he was reading, “Learned Optimism” by University of Pennsylvania professor Martin Seligman. He explained in detail that just as people can learn helplessness, so too can they cultivate optimism.

Similarly, many resource investors right now might feel discouraged by low commodity prices. But Franco-Nevada gives us reason to feel optimistic.

Blue Skies Ahead: Superior 14 Percent Dividend Growth Rate

As a refresher, royalty companies basically serve as specialized financiers that help fund cash-strapped producers’ exploration and production projects. In return, they receive either royalties on whatever the project produces or rights to a “stream,” a commitment to an agreed-upon amount of the commodity per year. 

Royalty companies have a history of rewarding their investors handsomely, even during economic downturns. Between 2007 and 2014, Franco-Nevada, Silver Wheaton and Royal Gold—the “Three Amigos”—had a combined dividend growth rate of 14 percent. Compare that to 5 percent growth for S&P 500 Index companies and between -3 and 3 percent for precious metals miners.

Royalty Companies Provided Better Dividend Growth than
click to enlarge

Since 2011, Franco-Nevada has raised its dividend incrementally from $0.04 per share to $0.21 per share—a phenomenal increase of 424 percent. What’s even more amazing is that it’s managed to do this even as spot gold has declined 38 percent.

Like other royalty companies, including the new kid on the block, Osisko Gold Royalties, Franco-Nevada has a much lower total cash cost than miners do. Dundee Capital Markets estimates that whereas gold miners produce at a breakeven cost of $1,087 per ounce, royalty companies get by with a materially lower cost of just $441 per ounce.

They’re just better allocators of capital and very aware of the risks of dilution and value factors on a per share basis. The mining companies, on the other hand, have diluted the value of their reserves and cash flow on a per share basis with poor acquisitions.

Take a look at how Franco-Nevada, Silver Wheaton and Royal Gold stack up against Newmont, the only gold company in the S&P 500 Index, and Goldman Sachs. When it comes to sales per employee, the royalty companies largely win out. Their balance sheets are also much less leveraged. Franco-Nevada, in fact, carries no outstanding debt. This helps eliminate many of the investment risks faced by operators such as Newmont, which typically have huge capital and operating costs. Franco-Nevada’s balance sheet and gross margins make it a much more attractive buying opportunity.

Royalty Companies vs. Newmont Mining & Goldman Sachs

It’s also worth pointing out that Franco-Nevada has a broader portfolio of royalties than its peers and pays its fair share of Canadian income taxes. One of the few risks involved with Silver Wheaton is its dispute with the Canada Revenue Agency, the “IRS” of Canada, which hopefully will be resolved sometime this year. Not all royalties companies are entirely risk-free, but their business model remains superior.

Another big value is the power of optionality. Royalty companies get an option on all future exploration and potential growth at no additional cost. In other words, mineral deposits are very often larger than what a royalty company pays for.

“The transaction price is largely determined by known reserves on the resource statement, as the royalty company is not going to pay a premium for undiscovered ounces,” explains USGI portfolio manager and precious metals expert Ralph Aldis. “However, the mining company is always incentivized to find more ounces, thus deferring the closing costs of the mine, which is beneficial to both parties.”

This is what’s known as “blue sky.” At the time of the deal, only the documented reserves and some portion of the defined resources are generally part of the valuation proposition. However, as time passes, the company will explore for new resources on the property. If anything is found, the royalty company will generally get paid for any future ounces, with some limitations.

Royalty Companies Dodge Many of the Risks Miners Face

Royalty companies avoid many of the industry’s most common challenges, including huge operating expenses, unions, liabilities and legal hurdles. They don’t build the mine’s infrastructure, experience capital cost inflation or have teams of miners and other personnel on their payrolls. (Franco-Nevada currently has fewer than 30 employees. Newmont, by comparison, has around 28,000.) They’re not responsible for cost overruns or maintenance.

Nor must they worry about mining in a country that operates under a completely different legal system. The U.S., Canada and Australia, home to some of the world’s largest mining companies, all follow common law. Yet many American, Canadian and Australian companies produce in civil law countries found mostly in Latin America and parts of Africa.

Common and Civil Law Countries

In civil law countries, the government has eminent domain over all mineral wealth of the country. Securing rights and permits is therefore much more bureacratic and arduous, and at any time, the government can attempt to revoke them. Surface rights and subsoil rights are often governed by entirely different sets of laws. And although they’ve improved since the 1980s, mining duties, income taxes and tax royalties still tend to be steep and unstable.

Is the “Smart Money” Telling Us that Gold Has Hit a Bottom?

When gold soared to $1,900 per ounce in 2011, many producers, expecting the good times to last, spent like crazy. The royalty companies, meanwhile, prudently kept their powder dry and built up their cash. Now that gold is hovering in the $1,085 range, down 38 percent since the all-time high, they’ve started deploying their massive reserves to buy streams from desperate sellers. Franco-Nevada recently agreed to pay $610 million for a portion of silver production from Teck Resources’ Antamina copper and zinc mine in Peru.

Many analysts call Franco-Nevada and the other two major royalty companies the “smart money” of the gold industry. I have to agree. They have huge intellectual capital and employ mining engineers, metallurgists, geologists and financial consultants. They’ve acted as bellwethers in the past, giving investors a good reading of where prices and sentiment could be headed.

Such is the case right now.

Investment dealer Paradigm Capital reports that the top three royalty companies have spent a collective $3.8 billion over the past half year of 2015.

“We doubt there has ever been such a spending period,” the investment group writes, noting that when you see this level of investing, it’s often a good sign of a bottom in prices.

For more on gold and other hard assets, be sure to follow our award-winning newsletter, the Investor Alert.

 

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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. 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 Philadelphia Gold and Silver Index (XAU) is a capitalization-weighted index that includes the leading companies involved in the mining of gold and silver. The S&P/TSX Global Gold Index is an international benchmark tracking the world's leading gold companies with the intent to provide an investable representative index of publicly-traded international gold companies. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.

Portfolios are actively managed, and 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 Funds as of 9/30/2015: Franco-Nevada Corp., Newmont Mining Corp., Silver Wheaton Corp., Osisko Gold Royalties Ltd.

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Hope for the New Year: 3 Asset Classes for 2016
January 4, 2016

Earlier, I reflected back on 2015 by revisiting the 10 most popular posts of the year. Today I’d like to look ahead to 2016 by pinpointing three asset classes that I believe hold opportunities for investors.

Three Asset Classes and Airlines

Gold

Going forward, gold prices will largely be affected by U.S. monetary policy. The Federal Reserve began its interest rate-normalization process with a small but significant 0.25 percent increase, and unless the Fed has reason to mark time or reverse course in 2016, rates should continue to rise steadily.

This will bump up not just the U.S. dollar—which historically shares an inverse relationship with gold, since it’s priced in dollars—but also real interest rates. As I’ve discussed many times before, real rates have a huge effect on the yellow metal.

Real interest rates are what you get when you deduct the rate of inflation from the 10-year Treasury yield. For example, if Treasury yields were at 2 percent and inflation was also at 2 percent, you wouldn’t really be earning anything. But if inflation was at 3 percent, you’d see negative real rates.

When gold hit its all-time high of $1,900 per ounce in August 2011, real interest rates were sitting at negative 3 percent. In other words, if you bought the 10-year, you essentially lost 3 percent a year on your “safe” Treasury investment. Since gold doesn’t cost anything to hold, it became more attractive, and the metal’s price soared.

But today, the U.S. has virtually no inflation—the November reading was 0.5 percent—so real rates are running at less than 2 percent.

Across the Atlantic, many investors are now realizing that Europe’s quantitative easing (QE) programs have failed to improve market performance in any substantial way. Earnings per share growth estimates in the European stock market have not budged. The lack of real growth in this market is a compelling argument for global investors to own gold for the long term.

Low interest rates, higher taxes and tariffs and more labyrinthine global regulations since 2011 are all contributing to the global slowdown. Neither QE3 in Europe nor QE3 in the U.S. has led to a marked improvement in growth. What markets need now to ignite growth are fewer taxes, tariffs and regulations and smarter fiscal policies.

European Earnings per Share (EPS) Growth Estimates Not Responding to ECB QE
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The chart below, courtesy of Evercore ISI, helps to illustrate some of the challenges we’ve faced in 2015 in terms of the investments we manage. Growth remains scarce globally. M2 money supply in the U.S. also looks dim.

Global Trade Volumes Are Declining
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Looking forward, we’re hopeful that these two indicators—global trade volume and money supply—will turn up. Both are necessary to improve commodity and emerging market investments.

On the upside, gold demand in China remains strong. It’s important to remember that more than 90 percent of demand comes from outside the U.S., in China and India in particular. Precious metals commentator Lawrie Williams reports that Chinese gold withdrawals from the Shanghai Gold Exchange (SGE) crossed above 51 tonnes for the week ended December 18.

Already Chinese demand is higher than the previous annual record set in 2013, and if total withdrawals for 2015 climb above 2,500 tonnes, as Lawrie expects, this will be “equivalent to around 80 percent of total global annual new mined gold production.” We expect demand to rise even more as we approach the Chinese New Year—historically a key driver for gold’s Love Trade—which falls on February 8 in 2016.

Gold: 24 Hour Composite Historical Patterns
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Oil

BCA Research believes oil markets will rebalance in 2016, not because of a price collapse but because production will continue to slide and consumption, grow. Most of these adjustments are being made in nonmembers of the Organization of Petroleum Exporting Countries (OPEC). In the U.S. alone, over 600,000 barrels per day have fallen out of the market as the rig count falls.

Oil Production Falling in Non-OPEC Nations, Helping to Rebalance Markets
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Russia, however, is unwilling to cut its production in a bid to compete with OPEC. In November, the country hit a post-Soviet record of 10.8 million barrels produced per day. And even more oil is expected to come out of Iran in 2016 once international sanctions are lifted.

For these reasons, Moody’s recently trimmed its 2016 oil forecast. West Texas Intermediate (WTI) crude will average $40 per barrel, down from $48, according to the ratings agency. The projection for Brent was slashed even more significantly, from $53 to $43.

To put this in perspective, oil averaged $55 per barrel in 2015, compared to $85 in 2014.

In all likelihood, then, oil prices probably need to remain lower for longer in order to rebalance the market.

Airlines

Last month I shared the latest report from the International Air Transport Association (IATA), which states that global airlines will post record net profits of $33 billion for 2015. Because fuel prices are expected to stay low, airlines could very well hit another record at the end of 2016—$36.3 billion, according to the IATA.

Savings from lower fuel prices are partially to thank for these profits. Goldman Sachs points out, however, that we shouldn’t expect prices to fall at the same magnitude as they did in 2014 and 2015.

Fuel Price Windfalls Tightening Up
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As a result of lower fuel prices and airlines’ improved discipline in capacity growth and capex spending, the group is poised to see increased operating margins in the coming years, according to Morgan Stanley.

U.S. Airline Industry Operating Margins Are Expected to Rise in 2016
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In short, operating margin tells you what percentage of every dollar made the company keeps as revenue before taxes. The higher the operating margin, the better off the company is.

Ancillary revenue is also contributing more to airlines’ bottom line. Such revenue comes from non-ticket fees such as baggage and handling, cancellations, seat upgrades, meals and the like. According to ancillary revenue expert IdeaWorks, the total global amount generated from these fees is estimated to rise to a whopping $59.2 billion in 2015, up from $49.9 billion in 2014. That accounts for 7.8 percent of global airline revenue, an improvement from the 6.7 percent in 2014.

Global Ancillary Revenue From $2.5 Billion in 2007 to $59 Billion Estimated in 2015

The increased revenue is helping to boost domestic airlines’ free cash flow. Bank of America Merrill Lynch has forecast that airlines will see the highest free cash flow in years, one of the best indications of a company’s ability to generate cash.

Domestic Airlines are Forecasted to See Greatest Free Cash Flow in Years
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Managing Expectations in 2016, a Presidential Election Year

As we reflect back on 2015, it’s important to remember that everything happens in cycles—from the presidential election cycle to the gold seasonality cycle and even to weather patterns. Similarly, every asset class has its own DNA of volatility.

By recognizing these cycles and patterns, it becomes easier to manage your expectations and become more proactive than reactive. With that in mind, I’d like to focus specifically on opportunities and threats for the coming year. 

1. 2016 is the fourth year of the presidential election cycle. According to research by market historian Yale Hirsh—and later his son Jeffrey—markets have tended to perform well in presidential election years. Between 1833 and 2012, the Dow Jones Industrial Average rose on average 5.8 percent during election years.

2. After a flat year, 2015 being one of them, the market has historically been up, as you can see in the table below:

The S&P 500 Has Rallied in Years after a Flat Year
  Following Year
Flat Year S&P Earnings
1970 +11% +25%
1978 +12% +6%
1984 +26% +5%
1987 +12% +16%
1994 +34% +11%
2005 +14% +9%
2011 +13% +9%
Average +17% +12%
Source: Evercore ISI, U.S. Global Investors

3. The Trans-Pacific Partnership (TPP) should help spark a light under global trade by eliminating thousands of tariffs and other barriers that currently stand in the way of foreign investment.

4. China, an essential market for commodities demand growth, continues to stimulate its economy with low interest rates and financial stimulus.

5. As for potential threats, the biggest one in the new year continues to be global terrorism. Aside from the fact that it has increasingly made society feel less safe, terrorism reportedly cost the world $53 billion in 2014 alone, according to the latest data from the Institute for Economics and Peace. That’s the highest amount since 9/11.

I want to wish all of our readers and shareholders the very best in 2016! I would also like to invite each of you to subscribe to our free, award-winning Investor Alert newsletter and share it with family and friends.

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.

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.

The Dow Jones STOXX 600 Index is an index of 600 stocks representing large-, mid- and small-capitalization companies in the developed countries of Europe. 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.

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Christmas Edition: 2015 in Review
December 28, 2015

Wishing you robust health, buckets of wealth, and tons of happiness

Christmas is my favorite holiday, as I’m sure it is for many of you reading this. We probably all agree that 2015 had more than its fair share of pain and tragedy around the world. But during Christmas, love and charity triumph—if only for a day—helping us recharge as we approach the new year.

I remember accompanying my mum, who was a social worker in downtown Toronto, as she delivered what we call “Star boxes” to needy children on Christmas Eve. Named after the Toronto Daily Star, which still operates the Santa Claus Fund that started in 1906, the purpose of the gift parcels remains the same:  to make sure that no child in Toronto under 13 is overlooked by Santa Claus.

Delivering these packages was more instructive than any textbook. It helped me keep my own family’s financial struggles in perspective and encouraged me to count my blessings. Although we didn’t have much, things could have been many times more challenging. I was grateful to have lots of love and plenty to eat when so many had neither during the cold, snowy Canadian winters.

The experience also showed me that love, family and friends should all be cherished much more highly than any material things. Having money is important, but real happiness can be found only in helping to spread happiness to others.

Merry Christmas: President Signs $680 Billion Business Investment Deal

President Obama signing the $1.1 trillion spending bill

Before we reach 2016, I want to reflect back on 2015. Everyone is talking about interest rates and monetary policy right now, but the role fiscal policy plays is just as important—if not more so. As I always say, government policy is a precursor to change, and very recently we saw this firsthand.

Only a day after President Barack Obama signed the spending deal Tuesday that lifted the oil export restriction that’s been in place since the mid-1970s, West Texas Intermediate (WTI) crude oil rallied $2 and is now trading higher than its European counterpart, Brent, oil for the first time since 2010.

WTI Crude Oil Cross Above Brent Crude
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Time and again, when regulations are rolled back and markets are allowed to act freely, we see constructive moves such as the WTI rally. It’s much more significant than a 0.25 percent rate hike.

Speaker of the House Paul Ryan was Instrumental in Passing the Spending Bill

Along with $1.1 trillion, the bipartisan deal includes $680 billion in tax cuts over the next decade, which should help accelerate the velocity of money and lead to the creation of new jobs. This is a positive development that wouldn’t have happened without the much-needed leadership of the new Speaker of the House, Paul Ryan.

It’s important for investors to follow the money in this case, just as it was important in February 2009 when the $800 billion stimulus package was signed into law. House Speaker Ryan was able to negotiate a reasonable extension to government spending and usher in a substantive tax incentive program as we head into 2016, an election year.

Top 10 Frank Talk Posts of 2015

As we head into the final days of 2015, I want to share with you the 10 most popular Frank Talks of the year. Among other things, they tell the story that gold, despite being oversold, managed to hold its value better than many other investments deemed “safe.” I’m optimistic to see what 2016 has in store for the yellow metal.

10. Show Me the Stocks, Not the Cash, Say Optimistic CEOs (May 4)

A growing trend among chief executives of successful companies is to be compensated in company stock rather than cash. In May we learned that American Airlines CEO Doug Parker elected to do just that.
“This is the right way for my compensation to be set,” Parker wrote, “at risk, based entirely on the results achieved.”

9. How These 12 TPP Nations Could Forever Change Global Growth (October 12)

One of the most significant news stories to come out of 2015 was the signing of the Trans-Pacific Partnership (TPP) by 12 participating Pacific Rim nations, the United States among them. Many analysts believe that Vietnam is poised to see the biggest upside potential, as precipitously high tariffs on its important textiles, apparel and footwear exports will vanish.  

Vietnam Poised to Benefit Most From Trans-Pacific Partnership Agreement
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8. China to Take Reins in Funding Regional Infrastructure Projects (March 31)

A similar development that’s likely to have huge global consequences is the establishment of the China-led Asian Infrastructure Investment Bank (AIIB), designed as a competitor to the U.S.-led International Monetary Fund (IMF), World Bank and Asian Development Bank (ADB).

Part of the reasoning behind China’s creation of the bank was to firm up the renminbi as a preferred global reserve currency on par with the U.S. dollar. And indeed, in late November the IMF voted to include the renminbi, also known as the yuan, in its Special Drawing Rights (SDR) currency basket.

7. Gold Holds Its Own Against These Media Darlings (August 10)

July 2015 was the seventh-worst-performing month for commodities going back to January 1970. Gold in particular was hit hard. But then in the week ended August 7, U.S. media companies took a huge dive, losing $60 billion for shareholders. Compared to that amount, gold managed to hold up well.

Media Stocks Collapse, Gold Hold Its Own
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6. Currency Wars Heat up as Central Banks Race to Cut Rates (February 2)

After Switzerland unexpectedly unpegged its currency from the euro in mid-January, it became clear that 2015 would be the year of the central banks. In that month alone, 14 countries cut interest rates and loosened borrowing standards. The U.S. stands as the only major economy, in fact, that has started to tighten its monetary policy.

5. Why We Invest in Royalty Companies (February 26)

One reason gold royalty companies have outperformed over the years is because, simply put, they’re not the ones getting their hands dirty. Their only obligation is to lend capital to the producers. Since its initial public offering (IPO) in 2007, Franco-Nevada, the world’s largest gold royalty company, has torn past both spot gold and most gold equity benchmarks.

Gold is Second Best Performing Currency of 2014
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4. Gold on Sale, Says the Rational Investor (August 3)

In late July, gold experienced its first “flash crash” in 18 months after five tonnes of the metal appeared on the Shanghai market. In what many called a “bear raid,” gold fell through its key support of around $1,150 and began to look extremely oversold.

Gold Price Falls Through Key Support Level
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3. Will Gold Finish 2015 with a Gain? (October 19)

In October, two events occurred almost simultaneously: The U.S. dollar signaled a “death cross”—meaning its 50-day moving average fell below its 200-day moving average—while gold broke above its 200-day moving average. At the time, it appeared as if gold might have a chance at doing something it hasn’t done since 2012—end the year in positive territory.

2. A Tale of Two Economies: Singapore and Cuba (March 28)

It’s almost impossible to believe now, but Cuba was once a wealthier nation than Singapore. But in 1959, Fidel Castro and Lee Kuan Yew both assumed power and took their countries in very different ideological and economic directions.

Yew, who passed away in March 2015, emphasizes free trade and competitive tax rates, which helped transform Singapore from an impoverished third world country into a bustling metropolis and leading global financial hub.

Lee Kuan Yew's Singapore Flourished while Fidel CAstro's Cuba Floundered
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1. Gold in the Age of Soaring Debt (June 18)

The world now sits beneath a mountain of debt worth an astonishing $200 trillion. That’s greater than twice the global GDP, which is currently $75 trillion. If we were to distribute this amount equally to every man, woman and child on the face of the earth, we would each owe around $28,000.

More surprising is that if gold—at its June 2015 price level—backed total global debt 100 percent, it would be valued at $33,900 per ounce.

Make sure to check out our most popular interactive favorites from 2015:

To all of our readers around the world, to our investors and shareholders, and to our friends and family, I wish you happiness and good health in the new year!

 

Some links above may be directed to third-party websites. U.S. Global Investors does not endorse all information supplied by these websites and is not responsible for their content. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

Past performance does not guarantee future results.

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 09/30/2015: American Airlines Group Inc., Franco-Nevada Corp, Time Warner Cable Inc.

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Net Asset Value
as of 02/05/2016

Global Resources Fund PSPFX $4.48 -0.02 Gold and Precious Metals Fund USERX $5.70 0.18 World Precious Minerals Fund UNWPX $4.07 0.07 China Region Fund USCOX $6.41 -0.05 Emerging Europe Fund EUROX $5.04 -0.03 All American Equity Fund GBTFX $21.77 -0.45 Holmes Macro Trends Fund MEGAX $16.02 -0.68 Near-Term Tax Free Fund NEARX $2.26 No Change U.S. Government Securities Ultra-Short Bond Fund UGSDX $2.01 No Change