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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.

It's Time for Contrarians to Get Bullish on Gold
August 14, 2018

It’s Time for Contrarians to Get Bullish on Gold

Gold can’t seem to catch a break. The yellow metal normally acts as a safe haven in times of political and economic strife, but in the face of Turkey’s lira meltdown, investors have taken cover instead in the U.S. dollar. On Monday, the stronger greenback pushed gold to end below $1,200 an ounce for the first time since January 2017.

The lira fell to its lowest level ever recorded against the dollar Monday, mainly in response to President Donald Trump’s call to sanction and double steel and aluminum tariffs on Turkey. This sent gold priced in Turkey’s currency to all-time highs. If you recall, we saw the same thing happen recently in Venezuela, where inflation is expected to hit 1 million percent by the end of the year.

Turkish lira down more than 45% for the year
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Turkey’s faith in gold was on full display this week as President Recep Erdogan urged his fellow Turks to convert their gold and hard currencies into lira in an effort to prop up the country’s hammered currency. The same strategy was used in December 2016, a month after Trump’s election sent the lira tumbling against the dollar.

The Love Trade Is Strong in Turkey

As I’ve discussed before, Turkey has a long and rich history with gold. Home to the world’s very first gold coins more than 2,500 years ago, Turkey still stands as one of the largest buyers of the yellow metal. In the June quarter, the Eurasian country was the fourth largest consumer of gold jewelry, following India, China and the U.S. Twelve and a half metric tons were purchased in the three-month period, up 13 percent from the same time a year ago.

Along with Russia and Kazakhstan, Turkey also continues to add to its official gold holdings. Its central bank’s net purchases in the first half of the year totaled 38.1 metric tons, up 82 percent from the same six-month period in 2017, according to the World Gold Council (WGC). This made it the second highest buyer, after Russia.

Time to Get Contrarian

Gold investors might be discouraged by its performance this year, compounded by news that hedge funds are shorting the metal in record numbers. A lot of this has to do with the fact that, so far this year, gold has had a very high negative correlation to the U.S. dollar—more precisely, a negative 0.95 correlation coefficient, according to gold research firm Murenbeeld & Co. What this means is that gold prices have been moving in nearly the exact opposite direction as the greenback.

I think it’s important to point out that, despite a stronger dollar, gold is still up for the 36-month period—and climbing even higher over the long term. The dollar has only recently broken even, whereas gold has continued to hit higher lows since its phenomenal breakout in December 2015.

despite a stronger u.s. dollar, gold is still up for 36-month period
click to enlarge

The dollar could be ready to peak, with the potential for even higher gold prices. The metal is currently down two standard deviations over the past 60 trading days, so the math is currently in our favor for gold to rally.

Vanguard Just Gave Precious Metal Investors the Short Shrift

There’s another sign that gold has found a bottom.

Last week, I spoke with Kitco’s Daniela Cambone about Vanguard’s decision to change its Precious Metals and Mining Fund. Starting next month, the fund’s exposure to metals and mining will be dropped from 80 percent today to only 25 percent—meaning the world’s largest fund company will no longer offer investors a way to participate, should gold and precious metals rally.

does vanguard's latest fund name change mean gold has found a bottom?
click to enlarge

This isn’t the first time Vanguard has done this to investors. Back in 2001, it removed the word “gold” from what was then the Gold and Precious Metals Fund. The change coincided with a decade-long precious metals bull run that saw gold rally from an average price of $271 an ounce in 2001 to an all-time high of more than $1,900 in September 2001. That’s more than a sevenfold increase.

And now it’s dropping the fund altogether—at a time when gold might be ready to break out.

So could this mean another bull run is in the works? No one can say for sure, of course, but the timing of Vanguard’s announcement is certainly interesting.

What I can say with certainty is that there are likely many investors in the Vanguard ecosystem who are in for a rude awakening when they find out their exposure to the metals and mining sector has inexplicably shrunk.

Fortunately, investors have other options! Learn more by clicking here!

 

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 U.S. Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies.

Standard deviation is a quantity calculated to indicate the extent of deviation for a group as a whole.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. None of the securities mentioned in the article were held by any accounts managed by U.S. Global Investors as of 6/30/2018.

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Overbought or Oversold? Let These Mathematical Signals Be Your Guide
July 23, 2018

overbought or oversold? let these mathematical signals be your guide

just the facts, ma'am dragnet TV series sgt. joe friday

Anticipate before you participate in the market. This is a classic piece of advice I like to give investors and have written about extensively in my CEO blog, Frank Talk. Financial markets are influenced by relatively predictable cycles and trading patterns, and by better understanding these we are able to react thoughtfully to headline noise or unexpected market developments.

How many of you remember the old police procedural Dragnet? In it, Sgt. Joe Friday famously uses the line “Just the facts, ma’am.” I’ve always felt this nuts-and-bolts attitude relates perfectly to how our investments team makes its decisions on where to allocate capital. Follow the models, look at the math—and leave emotions at the door.

A Sentiment Indicator for Contrarian Investing

At U.S. Global Investors, one tool that we find particularly useful to track the different market cycles is our U.S. Global Sentiment Indicator. This indicator tracks 126 commodities, indices, sectors, currencies and international markets to help monitor volatility and cash flow levels.

Using this indicator, we note the percentage of positions that have five-day moving averages above or below the 20-day moving averages. Then we compare it to the S&P 500 Index. As you can see in the chart below, as of Wednesday, the sentiment indicator rebounded to 54 percent, rallying from a low of around 20 percent at the end of June.

The U.S. global sentiment indicator reaches 54 percent mid-week
click to enlarge

While a drop below 20 percent means the market is extremely oversold, we do not view the market as overbought until around the 80 percent mark. Having a keen awareness of these movements allows our investments team to be more proactive rather than reactive. It helps us manage our emotions and not be swept away by negative media or overly optimistic headlines.

Explore this topic further in the Managing Expectations whitepaper!

Is the Gold Market Being Suppressed?

Gold continued its trek lower last week, the price steadying around $1,220 an ounce on Tuesday following Federal Reserve Chair Jerome Powell’s congressional testimony.  Powell commented that he thought the U.S. was on course for continued steady growth, supporting his expectation of a rate hike every three months. These comments sent the dollar up and gold down.

Despite this movement, I’m amazed that gold is holding up so well, particularly when you compare real interest rates in the U.S., Japan and the European Union.

Japan leads the world in government debt that trades negative yield
click to enlarge

In addition to these price moves, we’ve seen suppression and manipulation in the gold market in recent years. This is a topic I discussed last week in our webcast, cohosted by Randy Smallwood, CEO of Wheaton Precious Metals.

What do I mean by “gold suppression”? Historically, the price of gold has tracked U.S. debt, but as you can see in the chart below, that seems no longer to be the case.

suppression of gold? gold price has traditionally tracked U.S. debt
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The question, then, is not whether gold is actively being suppressed, but to what extent and by whom. Traders working at some big banks—including UBS, Deutsche Bank and HSBC—have already been charged for manipulating the price of precious metals futures contracts and fined as much as $30 million by the Commodity Futures Trading Commission (CFTC).

However, I’m skeptical that this has resolved the issue. In the past several years, gold has traded down in the week prior to China’s Golden Week, when markets are closed. As much as $2.25 billion of the yellow metal was dumped in the futures market in October 2016, as someone clearly sought to take advantage of the fact that markets were closed for the week in the world’s largest buyer of gold.

gold and silver price manipulation headlines

During the webcast, Randy Smallwood thoughtfully pointed out that the deliberate suppression of prices can't go on forever. I agree, and believe that precious metals such as gold and silver are significantly undervalued right now.

So what should investors be paying attention to?

The Magic Behind the Math

Using an oscillator chart, let's compare the U.S. dollar to gold. I believe oscillators are vital to identifying the optimal time to buy or sell, and right now it appears that the greenback is overbought while gold is oversold.

Looking back over five years of data, we've discovered that, historically, when gold exceeded two standard deviations above the mean, the commodity fell 51 percent of the time in the following three months.

In contrast, when gold prices exceeded two standard deviations below the mean, it rose 77 percent of the time in the following three months. This is because gold is undervalued at this level.

Is gold due for a reversal?
click to enlarge

Buying the laggards when the time is right could enable you to participate in a potential rally—and right now, that rally could be in gold, currently down 2.24 standard deviations.

Understanding this kind of math is almost like being adept at counting cards. In the 2008 film 21, an MIT professor helps six students become experts at card counting. The story, based on true events, shows how these students end up taking Vegas casinos for millions in winnings by following their professor’s teachings. Of course, there’s no way I can promise such an extraordinary outcome in your investments, but I do think there’s something to be said for the magic behind the math.

King Copper Could Also Be Due for a Reversal

Gold isn’t the only commodity that might be due for a reversal. Take a look at this chart showing copper versus the U.S. dollar. The red metal looks even more oversold than gold, down close to four standard deviations as of July 18. As I mentioned in the 2018 Commodities Halftime Report, copper looks attractive on surging demand for electric vehicles (EVs), which require between three and four times as much copper as traditional gas-powered automobiles.

copper looks oversold relative to the U.S. dollar
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What’s more, based on these mathematical models, emerging markets have the potential to move higher as well. I encourage you to take a look at the chart featured in the Europe section of Friday’s Investor Alert to see what I mean.

Always Remember the Golden Rule

10 percent portfolio weighting in gold recommended by frank holmes

Gold continues to be a classic example that helps illustrate seasonal rotations and price fluctuations based on a number of different factors geopolitical noise, inflation, wedding season in China and India, and much more.

The DNA of volatility, as I like to call it, shows that it is a non-event for gold to move up or down 17 percent over a rolling 12-month period. Knowing this has helped me to develop the 10 percent Golden Rule.

I have always advocated investors have around 10 percent of their portfolios in gold—5 percent in gold bullion or beautiful gold jewelry, and 5 percent in well managed gold mutual funds or ETFs. And then rebalance.

While no investment rules or statistical tools are accurate 100 percent of the time, investors can take ownership in how they use certain tools to manage emotions of the market and position themselves for greater success.

Capturing opportunities and understanding the ins and outs of the markets are what make investing so exciting.

Know a fellow investor who could benefit from this type of weekly investment analysis? Share our Investor Alert sign up page  with them—subscribing is always FREE!

 

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.

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.

The S&P 500 Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.

The U.S. Dollar Index is a measure of the value of the U.S. dollar relative to the value of a basket of currencies of the majority of the U.S.'s most significant trading partners. This index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.

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 (06/30/2018): Wheaton Precious Metals Corp.

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Minute with the Manager: Meet Ralph Aldis
July 18, 2018
ralph aldis portfolio manager U.S. Global Investors

Meet Ralph Aldis – one of the longest standing members of the investment team at U.S. Global Investors. Ralph is responsible for analyzing gold and precious metals stocks in his role as co-portfolio manager for our two gold funds. As part of his gold stock research and analysis, Ralph frequently meets with key players in the mining space, including company management. Whether he’s visiting a mine site in another country or speaking on a panel at a gold conference here in the states, this tacit knowledge is a crucial part of his success as a fund manager.

I invite you to learn more about Ralph’s role and hear his insights into the gold world in this short Q&A.

Where do you expect to see gold production in the next few years?

It’s possible that the U.S. could see a rise in gold output this year. China production fell last year, Australia production has been going up slightly and Russia production is somewhat flat. I think with some of the new revisions to the Environmental Protection Agency (EPA) rules, mining projects could move forward on a more known timetable. One of the things the Trump administration has been trying to do is simplify the process of obtaining a mining permit. If companies can get the permits more easily then I think we’ll see some production growth in the U.S.

What are your top three gold stock picks right now?

One of my favorite gold stocks right now is St. Barbara Ltd. The company is based in Australia and has two mining operations. It’s been hitting it out of the ballpark in terms of performance driven by strong management. The CEO came in to our office about two years ago, Bob Vassie, and the stock price was 18 cents then and today it’s 5 dollars. I think St. Barbara is consistent in terms of management and has solid execution – everything that you’d want in a gold miner. 

ralph aldis observing grade samples at the klondex mines property in nevada

Another stock I like that’s in the mid-cap space is Wesdome Gold Mines based in Canada. One of its mines that is on care and maintenance recently had phenomenal drill hits down to deeper levels. What we’ve been finding with mines in the last few years is seeking funding in order to drill deeper to find deposits. I think it will probably be one of the next take outs in Canada, in terms of someone seeking a safe jurisdiction to operate in.

A third stock I like right now that is a micro-cap is Barksdale Capital Corp., a base metals exploration company located in Arizona. Its property sits right next to Arizona Mining’s property, which was recently bought out for $1.4 billion. Right now Barksdale has a market capitalization of $30 million. This valuation difference is massive and I think someone will probably want to buy them too and develop the project, since it’s too cheap to just leave it.

Describe a memorable mining project visit.

I visited a gold discovery site in Ecuador many years ago and for this particular visit it was very difficult to reach the site. It was in the southern part of Ecuador, near the border with Peru, a previously contested area, which is why it had not been explored and discovered for some time.

We first took a commercial aircraft to Quito, then from there we took a charter aircraft to get to another location. Then we rode in a helicopter and then a canoe! We canoed for a while since the helicopter couldn’t land closer to the site due to heavy tree coverage. It was a relatively new discovery and, in fact, it’s only just now going into production 10 years after I visited it.

During the trip we were evaluating the potential of the project and its deposit size, but since there was thick jungle coverage it was difficult to assess. Often times there will be a deposit discovered with high drill grades of grams per ton, but it has to be large enough to eventually justify the capital to build an operating mine.

Get to know Portfolio Manager Ralph Aldis 28 years at U.S. Global Investors

Explore investment opportunities in gold and precious metals!

 

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

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 06/30/2018: Klondex Mines Ltd., Barksdale Capital Corp., Wesdome Gold Mines Ltd., St. Barbara Ltd.

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Top 10 Countries with Largest Gold Reserves
July 5, 2018

Beginning in 2010, central banks around the world turned from being net sellers of gold to net buyers of gold. Last year official sector activity rose 36 percent to 366 tonnes – a substantial increase from 2016.

top 10 central banks ranked by largest gold holdings as of june 2018

The top 10 central banks with the largest gold reserves have remained mostly unchanged for the last few years. The United States holds the number one spot with over 8,000 tonnes of gold in its vaults – nearly as much as the next three countries combined. For six consecutive years the Russian Central Bank has been the largest purchaser of gold, increasing its holdings by 224 tonnes in 2017 and overtaking China to hold the fifth spot, according to the GFMS Gold Survey.

Not every central bank is a net buyer. For the second year in a row, Venezuela has been the largest seller of gold, with 25 tonnes sold last year to help pay off debt. However, gross official sector sales declined by 55 percent last year, to the lowest since 2014, indicating that central banks are happy to keep their reserves in gold, historically viewed as a safe-haven asset.

Central Banks Continue Gobbling Up Gold central bank purchases from 1997 to 2017
click to enlarge

2018 could be another strong year for central bank gold demand. According to the World Gold Council (WGC), demand in the first quarter was up 42 percent year-over-year, with purchases totaling 116.5 tonnes for the highest first quarter total since 2014. As global debt continues to skyrocket, central banks and individual investors alike might want to keep gold in their pockets, as it historically has performed well during times of economic downturn and geopolitical uncertainty.

Below are the top 10 countries with the largest gold holdings, beginning with India.

 

10. India

Tonnes: 560.3

Percent of foreign reserves: 5.5 percent

It’s no surprise that the Bank of India has one of the largest stores of gold in the world. The South Asian country, home to 1.25 billion people, is the second largest consumer of the precious metal, and is one of the most reliable drivers of global demand. India’s festival and wedding season, which runs from October to December, has historically been a huge boon to gold’s Love Trade.

Construction on the Golden Temple in Amritsar, India, concluded in 1604

9. Netherlands

Tonnes: 612.5

Percent of foreign reserves: 68.2 percent

The Dutch Central Bank announced that it will be moving its gold vaults from Amsterdam to Camp New Amsterdam, about an hour outside the city, citing burdensome security measures of its current location. As many others have pointed out, this seems odd, given that the bank fairly recently repatriated a large amount of its gold from the U.S.

The Gold Souk building in Beverwijk, The Netherlands, houses a marketplace for gold dealers and goldsmiths

8. Japan

Tonnes: 765.2

Percent of foreign reserves: 2.5 percent

Japan, the world’s third largest economy, is also the eighth largest hoarder of the yellow metal. Its central bank has been one of the most aggressive practitioners of quantitative easing—in January 2016, it lowered interest rates below zero—which has helped fuel demand for gold around the world.

The Gold Pavilion in Kyoto, japan, features beautiful gold-leaf coating

7. Switzerland

Tonnes: 1,040.0

Percent of foreign reserves: 5.3 percent

In seventh place is Switzerland, which actually has the world’s largest reserves of gold per capita. During World War II, the neutral country became the center of the gold trade in Europe, making transactions with both the Allies and Axis powers. Today, much of its gold trading is done with Hong Kong and China.

Credit Suisse gold bars and coins

6. China

Tonnes: 1,842.6

Percent of foreign reserves: 2.4 percent

In the summer of 2015, the People’s Bank of China began sharing its gold purchasing activity on a monthly basis for the first time since 2009. Although China comes in sixth for most gold held, the  yellow metal accounts for only a small percentage of its overall reserves – a mere 2.4 percent – the lowest of the top 10 central banks with the most gold. However, this figure is up slightly from 2.2 percent of holdings in 2016.

China is also the number one gold producing nation. What other countries are top gold producers? Find out here!

Over 2,000 ancient Buddha statues have been excavated in China

5. Russia

Tonnes: 1,909.8

Percent of foreign reserves: 17.6 percent

The Russian Central Bank has been the largest buyer of gold for the past six years and earlier this year overtook China to have the fifth largest reserves. In 2017 Russia bought 224 tonnes of bullion in an effort to diversify away from the U.S. dollar, as its relationship with the West has grown chilly since the annexation of the Crimean Peninsula in mid-2014. To raise the cash for these purchases, Russia sold a huge percentage of its U.S. Treasuries.

Gilded domes of the Annunciation Cathedral in Moscow, Russia

4. France

Tonnes: 2,436.0

Percent of foreign reserves: 63.9 percent

France’s central bank has sold little of its gold over the past several years, and there are calls to halt it altogether. Marine Le Pen, president of the country’s far-right National Front party, has led the charge not only to put a freeze on selling the nation’s gold but also to repatriate the entire amount from foreign vaults.

Anne of Brittany's wedding crown

3. Italy

Tonnes: 2,451.8

Percent of foreign reserves: 67.9 percent

Italy has likewise maintained the size of its reserves over the years, and it has support from European Central Bank (ECB) President Mario Draghi. The former Bank of Italy governor, when asked by a reporter in 2013 what role gold plays in a central bank’s portfolio, answered that the metal was “a reserve of safety,” adding, “it gives you a fairly good protection against fluctuations against the dollar.”

Detail of a gold lion in St. Mark's Basilica in Venice, Italy

2. Germany

Tonnes: 3,371.0

Percent of foreign reserves: 70.6 percent

Last year Germany completed a four-year repatriation operation to move a total of 674 tonnes of gold from the Banque de France and the Federal Reserve Bank of New York back to its own vaults. First announced in 2013, the move was expected to take until 2020 to complete. Although gold demand fell last year after hitting an all-time high in 2016, this European country has seen gold investing steadily rise since the global financial crisis.

A variety of Germman coins

1. United States

Tonnes: 8,133.5

Percent of foreign reserves: 75.2 percent

With the largest official holdings in the world, the U.S. lays claim to nearly as much gold as the next three countries combined. It also has the highest gold allocation as a percentage of its foreign reserves at over 75 percent. From what we know, the majority of U.S. gold is held at Fort Knox in Kentucky, with the remainder held at the Philadelphia Mint, Denver Mint, San Francisco Assay Office and West Point Bullion Depository. Which state loves gold the most? Well, the state of Texas went so far as to create its very own Texas Bullion Depository to safeguard investors’ gold.

The US holds most of its gold at the US Bullion Reservatory at Fort Knox

Can't get enough of gold? Learn all about the yellow metal's seasonal trading patterns by downloading our free whitepaper, Gold's Love Trade, today!

gold love trade whitepaper frank holmes

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

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Take the Long-Term View in a Late-Cycle Market
June 18, 2018

rebalance, stick to a plan and remember: get invested and stay invested. J.P. Morgan's Samantha Azzarello

The U.S. inflation story made further inroads this month, with year-over-year price growth for consumers and producers alike hitting multiyear highs. U.S. consumer prices expanded at their strongest pace in more than six years, climbing to an annual change of 2.8 percent in May. Prices for final demand goods, meanwhile, grew 3.1 percent, their strongest annual surge since December 2011.

annual consumer prices advance the most in six years
click to enlarge

As you might expect, energy was the greatest contributor to higher prices in May, with fuel oil jumping more than 25 percent from the same month a year ago. The current average price for a gallon of regular gas nationwide was just under $3.00, compared to only $2.33 in June 2017, according to the American Automobile Association (AAA).

Inflation is set to get an even bigger jolt now that President Donald Trump has formally approved 25 percent tariffs on as much as $50 billion of Chinese goods. China has already announced retaliatory action. While I agree some targeted tariffs are welcome to address intellectual property theft, tariffs at the wholesale level are essentially regulations that threaten to undermine all the work Trump has done to supercharge the U.S. economy. They act as headwinds to further growth, which in turn makes gold look attractive as a safe haven investment.

Blaming OPEC

Let’s return to energy for a moment. Hot off the success of his historic summit with North Korea leader Kim Jong-un, Trump took a stab at foreign oil producers last week, tweeting: “Oil prices are too high, OPEC is at it again. Not good!”

The president isn’t wrong, but I believe he may be overselling the Organization of Petroleum Exporting Countries’ influence here. In May, the 14-member cartel added an extra 35,000 barrels per day (bpd) in output compared to the previous month, to reach a total of 31.8 million bpd. This is down from the average 32.6 million and 32.4 million bpd OPEC collectively produced in 2016 and 2017.

Venezuela’s output deteriorated once again, falling more than 42 percent in May to 1.4 million bpd, which is less than half of what it produced 20 years ago.

The beleaguered South American country didn’t have the biggest monthly decline among OPEC members, however—that title belonged to Nigeria, which saw its April-to-May production tumble 53.5 percent to 1.7 million bpd. Analysts predict output could fall further to 1.4 million bpd by July—a level not seen since 1988—as the country’s Nembe Creek Trunk Line (NCTL) has had to be closed recently to address product theft along its route.

OPEC will meet later this month and is widely expected to loosen production curbs as global demand strengthens. In the meantime, the U.S. continues to pump even more oil on a monthly basis, and by 2019 it could be producing more than 11 million bpd for the first time ever. This would make it the world’s top oil producer, above Russia.

Want to learn more? Watch this brief video featuring Samuel Pelaez, who outlines the six factors we use to select best-in-class oil and gas exploration and production companies!  

Gold Glitters on Inflation Fears and U.S. Budget Imbalance

gold surged to a four-week high after the fed raised rates a second time this year and signaled two more hikes in 2018

The inflation news helped support the price of gold, which traded as high as $1,309 an ounce last Thursday, its best intraday showing in four weeks.

The price jump came a day after the Federal Reserve lifted interest rates another 0.25 percent, the second time it has done so this year. Although rising rates have historically made the precious metal look less competitive, since it doesn’t offer a yield, gold markets could be forecasting slower economic growth as a result of higher borrowing costs, not to mention costlier servicing of corporate and government debt.

On that note, the Treasury Department announced last week that in the first eight months of the current fiscal year—October through May—the U.S. government deficit widened to a whopping $532 billion, or 23 percent more than the same eight-year period a year ago. That’s already more than the total deficits in fiscal years 2014 and 2015. Because of higher spending and lower revenues, it’s estimated that the deficit by the end of the fiscal year will balloon to $833 billion, which would be the greatest amount since 2012.

I believe this makes the investment case for gold and gold equities even more appealing as a store of value. In the chart below, notice how the price of gold has responded to government spending. I inverted the bars, representing surplus and deficit, to make the relationship more clear. In the years following the Clinton surplus of the late 90s, the difference between expenditure and revenue surged to new record amounts on the back of military spending in the Middle East and the multibillion-dollar bailouts of financial firms during the subprime mortgage crisis. Consequentially, the price of gold exploded.     

relationship between price of gold and u.s. government deficit spending
click to enlarge

Learn more about what’s driving the price of gold right now by clicking here!

How Close Are We to the End of the Business Cycle?

But back to the Fed. Besides lifting rates, the central bank has also signaled that we can expect two more hikes in 2018, suggesting it sees less and less need to accommodate a booming U.S. economy. Since the start of this particular rate hike cycle two and a half years ago, we haven’t yet seen four increases in a single calendar year.

This raises the question of how close we are to the end of the business cycle.

Rising rates, among other indicators, have often preceded the end of economic expansions and equity bull markets. Among other telltale signs: a flattening yield curve, record corporate and household debt, an overheated jobs market and increased mergers and acquisition (M&A) activity. So far this year, the value of global M&As has already reached $2 trillion, a new all-time high. The last two periods when M&As reached similar levels were in 2007 ($1.8 trillion) and in 2000 ($1.5 trillion), according to Reuters. Careful readers will note that those two years came immediately before the financial crisis and tech bubble.

Now, the world’s largest hedge fund, Bridgewater Associates, has reportedly turned bearish on “almost all financial assets,” according to one of its most recent notes to investors.

In the firm’s Daily Observations, co-CIO Greg Jensen writes that “2019 is setting up to be a dangerous year, as the fiscal stimulus rolls off while the impact of the Fed’s tightening will be peaking.”

Don’t Miss the Opportunities

Be that as it may, calling the end of the cycle would be a fool’s errand and could result in missed opportunities, as J.P. Morgan’s Samantha Azzarello points out in a recent note to investors. Late-cycle returns can still be quite substantial, she says. Take a look at the chart below, which highlights returns 24 months, 12 months, six months and three months leading up to the past eight market peaks. Obviously returns were higher in the longer-term periods, but even the three-month periods delivered some attractive returns—returns that would be left on the table if skittish investors exited now. According to Azzarello, it’s important to “rebalance, stick to a plan and remember: get invested and stay invested.”

S&P 500 Index Returns Leading up to Market Peaks
click to enlarge

As further proof that many investors still see plenty of fuel in the tank, the June survey of fund managers conducted by Bank of America Merrill Lynch (BAML) found that equity investors are overweight U.S. stocks for the first time in 15 months. Commodity allocations are at their highest in eight years. And two-thirds of managers say the U.S. is the best region in the world right now for corporate profits, which is at a 17-year high.

That’s not to say there aren’t risks, however. Forty-two percent of survey participants said they believed corporations were overleveraged. That’s well above the peak of 32 percent from soon before the start of the financial crisis. Fund managers cited “trade war” as the biggest “tail risk” for markets at present.

This is largely why we find domestic-focused small to mid-cap stocks so attractive right now. These firms are well positioned to take advantage of Trump’s high-growth “America first” policies, yet because they don’t have as much exposure to foreign markets, they bypass many of the trade war pitfalls large multinationals must face. Since Election Day 2016, the small-cap Russell 2000 Index has outperformed the large-cap S&P 500 Index by more than 8.5 percent.

Get the scoop on small to mid-cap stocks by clicking here!

Rethinking Market Cap-Weighting

On a final note, I want to draw attention to a change we’ve observed in S&P 500 returns—specifically, the difference in performance between an equal-weighted basket of stocks and one that’s market cap-weighted. For the longer-term period, equal-weighting outperformed. But more recently, market cap-weighting has pulled ahead. This is the case for the one-year, three-year and five-year periods.

market cap-weighted has beaten equal-weighted more recently
click to enlarge

So why is this? Simply put, the phenomenally large FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) have made the S&P 500 top heavy. Today, these five stocks represent a highly concentrated 12 percent of the S&P 500, nearly double from their share just five years ago. Apple alone represents 4 percent of the large-cap index.

Ten years ago, the FAANG stocks—excluding Facebook, which wasn’t public yet—had a combined market cap of $390 billion, according to FactSet data. In 2018, they’re valued at more than eight and half times that, or right around $3.32 trillion—a mind-boggling sum.

Market cap-weighted also means more money is disproportionately being reallocated to top winners such as Apple and Amazon, and so it becomes a self-fulling prophecy. This leaves you with too much exposure to companies that would be hardest hit in the event of a market downturn, and too little exposure to names and sectors that might rotate to the top in the next cycle.

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The S&P 500 Index is a market capitalization weighted index of the 500 largest U.S. publicly traded companies by market value. The Russell 2000 Index is a small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. None of the securities mentioned in the article were held by any accounts managed by U.S. Global Investors as of 3/31/2018.

Share “Take the Long-Term View in a Late-Cycle Market”

Net Asset Value
as of 08/15/2018

Global Resources Fund PSPFX $5.37 -0.17 Gold and Precious Metals Fund USERX $6.60 -0.37 World Precious Minerals Fund UNWPX $3.38 -0.12 China Region Fund USCOX $8.98 -0.36 Emerging Europe Fund EUROX $6.22 -0.07 All American Equity Fund GBTFX $25.96 -0.19 Holmes Macro Trends Fund MEGAX $19.90 -0.10 Near-Term Tax Free Fund NEARX $2.20 No Change U.S. Government Securities Ultra-Short Bond Fund UGSDX $2.00 No Change