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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.

America’s Infrastructure Shortfall Could Be an Investor’s Best Friend
March 15, 2017

America's infrastructure shortfall could be an investor's best friend

Every four years, the American Society of Civil Engineers (ASCE) releases its report card on the condition of America’s infrastructure, and for the second time since 2013, our nation’s roads, bridges, waterways, airports and more scored a barely-passing D+.

As disconcerting as this might be to American taxpayers who expect and depend on quality infrastructure, it could be a huge opportunity for investors in companies that stand to benefit from President Donald Trump’s $1 trillion infrastructure spending proposal.

Although the plan will likely include public funding, private investment is expected to play an exceptionally large role. House Speaker Paul Ryan recently commented that for every $1 of public funds earmarked for infrastructure, there should be at least $40 in private sector spending. This is investment that will be much-needed.

Failure to Act

According to the ASCE, the U.S. is facing a “yuge” spending gap in both the near term and long term. Between 2016 and 2025, the nation will be short nearly $3 trillion for surface transportation, water, electricity and more. Between 2016 and 2040, the spending gap pushes closer to $10 trillion.

Public Spending on Transportation and Water Infrastructure Has Dropped in Recent Years
click to enlarge

This gap has “a cascading impact on our nation’s economy,” as the ASCE puts it. If nothing changes in terms of infrastructure spending, U.S. gross domestic product (GDP) could lose up to $4 trillion by 2025. Business sales could fall $7 trillion, and 5 million American jobs could be lost.

Take a look at the cost of congested roads alone. In 2014, the most recent year of available data, an estimated 3.1 billion gallons of fuel were wasted while we sat idly in traffic. Combined with lost time and productivity, this amounted to approximately $160 billion—all because of clogged roads and highways.

Total cost of vehicle congestion is rising
click to enlarge

Without the proper funding for surface repairs and expansion, this figure could easily continue to surge in the coming years as more and more Americans use public roads. In 2016, Americans drove over a jaw-dropping 3 trillion miles, equivalent to more than 300 round trips between Earth and Pluto.

More and more americans make use of public road and aviation infrastructure
click to enlarge

They’re also flying more than ever before, as you can see in the chart above. With U.S. airports serving more than 2 million passengers every day, congestion is growing. During one of the presidential debates in September, Trump compared U.S. airports  to “a third world country,” specifically calling out Los Angeles International, LaGuardia, John F. Kennedy and Newark. In their efforts to address these capacity issues, airports are facing a $42 billion funding gap between last year and 2025.

America's Bridges by AgeTransit, which includes commuter rail, is also grossly underfunded, according to the ASCE. Like roads and airports, transit is increasingly depended on by millions of Americans, who took a whopping 10.5 billion trips on light rail in 2015. Despite growing demand, transit faces a $90 billion rehabilitation shortfall.

Perhaps no U.S. infrastructure has aged more than bridges, with nearly four in 10 of them older than 50 years. Of the more than 614,000 bridges in the U.S., 56,000, or 9 percent, were considered “structurally deficient” last year. According to the ASCE, our nation’s bridges are in need of $123 billion to rehabilitate them.

And as I told you last week, about 70 percent of America’s 90,000 dams will be at least 50 years old by 2025, according to E&E News.

Help Wanted/Needed

In a 2015 study, Standard & Poor’s found that government spending on infrastructure as a percentage of GDP had fallen to a two-decade low of 1.7 percent. This is precisely what Trump wants to remedy with his pledge to inject $1 trillion into the system, as it will not only rejuvenate our roads and airports but could also have a huge multiplier effect. S&P estimates that for every $1 allocated to public-sector infrastructure, about $1.70 is generated and added to real GDP.

But to close the gap described by ASCE, private investment will be needed. I believe this infrastructure buildout—which aspires to be as massive and consequential as President Eisenhower’s in the 1950s—presents some attractive opportunities for commodities and materials investors.  

 

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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Time to Take Trump Seriously on Infrastructure Spending?
December 8, 2016

Cancellation new Air Force One project

Earlier I shared with you that when it comes to President-elect Donald Trump, the media takes him literally but not seriously. His supporters, on the other hand, take him seriously but not always literally.

We saw an example of this polarity Tuesday morning when Trump took a shot at Boeing, tweeting to his nearly 17 million Twitter followers that the jet-manufacturer “is building a brand new 747 Air Force One for future presidents, but costs are out of control, more than $4 billion. Cancel order!”

When journalists sought clarification, Trump said he wants Boeing to make money, “but not that much money.”

As the Wall Street Journal pointed out, the current Air Force One has been in use for 30 years—since Ronald Reagan’s administration—and includes many cutting-edge modifications for communications and defense. It’s designed to withstand a nuclear blast. For the value we get out of the president’s main ride, in other words, the exorbinant sticker price might not be so exorbinant as it initially appears.

But then, the $4 billion Trump refers to couldn’t be confirmed. Boeing responded by saying it’s currently under contract to build the jet for only $170 million, and production hasn’t even begun yet.

Again, in questioning the details of Trump’s tweet, the media might be missing the forest for the trees. It’s possible the president-elect means simply that we need to keep government cost overruns in check—not literally cancel the Air Force One order—something we can all agree with.

Investors Take Trump Seriously—and Somewhat Literally

Investors have so far managed to find the right balance between taking Trump seriously and literally, to a certain extent. Since Election Day, small-cap stocks have rallied more than 12 percent, suggesting the market sees Trump’s “America First” policies benefiting them the most. Because they have less exposure to foreign markets than blue-chip companies, small caps are in an attractive position to take advantage of lower corporate taxes, streamlined regulations and a stronger U.S. dollar.

The market’s also betting big on Trump’s proposal to spend $1 trillion on infrastructure over the next 10 years. For the one-year and three-month periods, the energy and materials sectors were among the best performers in the S&P 500 Index. Both landed in the “leading and gaining” quadrant in the chart below. 

energy and materials among the best sp 500 sectors
click to enlarge

We see similar results in the small-cap Russell 2000 Index. Materials and processing was the best performer for the one-year period while energy led over the past three months.

energy and materials among the best russell 2000 sectors
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Granted, a lot of the growth in energy can be attributed to OPEC’s recent announcement that it would trim production for the first time since 2008. Such an agreement was rumored back in October. Oil rallied sharply following the announcement but has retreated slightly on news that the cartel raised production to more than 34 million barrels a day in November. Speculation is also high on whether non-OPEC countries such as Russia will join the coordinated effort to help prices recover.

But like small-cap stocks, energy and materials appear to be getting a boost on hopes that Trump will make good on his commitment to opening the fiscal valves. If he succeeds at getting what he wants from Congress, we could very well see another major infrastructure boom and commodities bull market similar to the one led by China a decade ago.

No Better Time Than Now

Construction Californias Shasta Dam

It’s worth noting that Trump will likely face some tough opposition from Congress. Even though most of the $1 trillion will allegedly come from private investment, the same fiscal conservatives who said no to President Obama’s 2009 stimulus package, worth over $800 billion, might also balk at Trump’s request.

But if the government is serious about rolling out such a monumental spending package, there’s really no better time than now, with borrowing costs still at near-historic lows.

As Steve Bannon, Trump’s controversial advisor, told the Hollywood Reporter: “With negative interest rates throughout the world, it’s the greatest opportunity to rebuild everything. Shipyards, ironworks—get them all jacked up. We’re just going to throw it up against the wall and see if it sticks.”

I don’t know if I’d be so flippant about $1 trillion, but most everyone agrees that more needs to be done about our nation’s infrastructure. According to the American Society of Civil Engineers (ASCE), each American household could lose as much as $3,400 per year if roads, bridges and tunnels never see an upgrade. The longer we put off repairing our infrastructure, the more expensive it might get.

In a report this week, Deutsche Bank agreed that the U.S. should dream big or go home:

To drive strong infrastructure spending growth, the country will need to get much more aggressive in building new (or replacing) major transport bridges and tunnels, and to reach for Earth-altering infrastructure that addresses national risks like floods, droughts… If the U.S. is to meaningfully stimulate its economy via infrastructure, it must think bigger and act quicker.

Besides roads and bridges, Deutsche writes, the U.S. should pursue “ten-figure projects” such as levee systems, storm protection systems, water tunnels and river dredging, not to mention “new science and technology super structures like new rocket building and launch facilities, biotech labs,” and “next-generation communication and air traffic control.”

Such projects would benefit many more people than those using them. According to BCA Research, public spending on infrastructure has one of the highest multiplier effects, making it more effective at stimulating the economy than tax cuts.

Not All Stimulus Is Created Equal

 

Estimated Multipliers

Type of Activity

Low Estimate

High Estimate

Purchases of goods and services by the federal government

0.5x

2.5x

Transfer payments to state and local governments for infrastructure

0.4x

2.2x

Two-year tax cuts for lower and middle-income people

0.3x

1.5x

One-year tax cut for higher-income people

0.1x

0.6x

Finally, the U.S. is due for another major infrastructure build. Under Obama, total public construction spending dropped relative to spending during his two predecessors’ administrations

total public u.s. construction spending fell under president obama
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Global Economy at Point of Inflection: OECD

Increasing infrastructure investment would be good not just for the U.S. but also the world economy, which has struggled to gain traction for the past couple of years. In its just-released Global Economic Outlook, the Organization for Economic Cooperation and Development (OECD) strongly endorsed the idea of “using the fiscal levers to escape the low-growth trap”—similar to what Trump has proposed.

With the U.S. and China both planning sweeping stimulus efforts in the next one to two years, the Paris-based group sees global GDP growing 3.6 percent in 2018, the fastest pace since 2011. The OECD also revised its earlier 2017 growth estimate to 3.3 percent, up from 3.2 percent.

increased government spending could help global growth pick up speed
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Speaking in Paris last month, OECD Secretary-General Ángel Gurría commented that “there is reason to hope that the global economy may be at a point of inflection.”

I agree. Although I have my differences with Trump, I’m optimistic he can negotiate an infrastructure deal that will jumpstart growth, both here and abroad.

Explore investment opportunities in commodities and natural resources!

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

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 9/30/2016: The Boeing Co.

 
 

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Muni Bonds a Key to Making America Great Again
November 16, 2016


Ever since he made his presidential bid in June 2015, Donald Trump has vowed to “make America great again.” Part of that promise includes rebuilding the nation’s infrastructure, a monumental task that will require the financial backing of tax-free municipal bonds.

“We are going to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals,” the president-elect told reporters the day after his historic victory. “We’re going to rebuild our infrastructure, which will become, by the way, second to none.”

To accomplish this, Trump has proposed a spending package as high as $1 trillion over the next 10 years. Although the private sector will be expected to finance a large portion of the work, massive amounts of public debt will be necessary.

This could be a “very big item for the muni market in the coming years,” according to John Vahey, managing director of federal policy for Bond Dealers of America, a trade association for  fixed-income dealers.

Americans already appear eager to get started repairing their infrastructure, which is facing a $3.6 trillion shortfall, according to the American Society of Civil Engineers (ASCE).

So far this year, state and local governments have issued nearly $150 billion in municipal bonds for new infrastructure projects, putting 2016 borrowing on a path to exceed levels in each of the last five years. And on Election Day, U.S. voters approved $55.7 billion in debt, the most since 2008.

Stay the Course

A possible headwind for munis is Trump’s proposal to reduce the top marginal income tax rate, from 39.6 percent to 33 percent. Although good for your pocketbook, such a move could limit the appeal of munis’ tax-exempt status among some top-earning investors.

Individual Income Tax Brackets Under the Trump Plan
Ordinary Income Rate Capital Gains Rate Single Filers Married Joint Filers
12% 0% $0 to $37,500 $0 to $75,000
25% 15% $37,500 to $112,500 $75,000 to $225,000
33% 20% $112,500+ $225,000+
Source: Tax Foundation, U.S. Global Investors

Other investors might be dazzled by what the media are calling the “Trump rally.” With the Dow Jones Industrial Average ending at a record high on Monday and Tuesday, munis could lose favor as investors increase their exposure to equities.

However, it’s important that we don’t overreact to market swings. A well-structured, diversified portfolio—one that also includes munis—is still the most prudent strategy going forward.

Reduce Volatility with Short-Term, Investment-Grade Munis

Something else to keep in mind are interest rates. It’s highly expected that the Federal Reserve will raise them next month, the first time it would do so since December of last year.

Even though rates will likely be lifted as little as 0.25 percent, it’s important to be aware that when rates rise, bond prices fall. At first glance, this inverse relationship might seem illogical, but it makes sense. If newly-issued bonds carry a higher yield, the value of existing bonds with lower rates declines.

That’s why investors should consider taking advantage of shorter-duration, investment-grade munis, which are less sensitive to rate increases than longer-term bonds whose maturities are further out.

Our Near-Term Tax Free Fund (NEARX) invests primarily in high-quality, investment-grade muni bonds in attractive jurisdictions. This strategy has led to more than two decades of positive annual returns, regardless of where interest rates were, what equity markets were doing or who occupied the White House.

Near-Germ Tax Free Fund Annual total Return
click to enlarge

I invite you to explore NEARX, which has delivered a phenomenal 21 straight years of positive returns. That’s a rare accomplishment that has been achieved by only 39 out of 31,306 equity and bond funds—around 0.12 percent—according to Morningstar data.

 

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. Foreside Fund Services, LLC, Distributor. U.S. Global Investors is the investment adviser.

Past performance does not guarantee future results.

Total Annualized Returns as of 9/30/2016
Fund One- Year Five-Year Ten-Year Gross
Expense
Ratio
Near-Term Tax Free Fund (NEARX) 1.26% 1.80% 2.88% 1.09%

Expense ratios as stated in the most recent prospectus. The Adviser of the Near-Term Tax Free Fund has contractually limited, through April 30, 2017, the total fund operating expenses (exclusive of acquired fund fees and expenses, extraordinary expenses, taxes, brokerage commissions and interest) to not exceed 0.45%. Total annual expenses after the waiver of 0.64% were 0.45%. Performance data quoted above is historical. Past performance is no guarantee of future results. Results reflect the reinvestment of dividends and other earnings. For a portion of periods, the fund had expense limitations, without which returns would have been lower. Current performance may be higher or lower than the performance data quoted. The principal value and investment return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance does not include the effect of any direct fees described in the fund’s prospectus, which, if applicable, would lower your total returns. Performance quoted for periods of one year or less is cumulative and not annualized. Obtain performance data current to the most recent month-end at www.usfunds.com or 1-800-US-FUNDS.

Bond funds are subject to interest-rate risk; their value declines as interest rates rise. Though the Near-Term Tax Free Fund seeks minimal fluctuations in share price, it is subject to the risk that the credit quality of a portfolio holding could decline, as well as risk related to changes in the economic conditions of a state, region or issuer. These risks could cause the fund’s share price to decline. Tax-exempt income is federal income tax free. A portion of this income may be subject to state and local taxes and at times the alternative minimum tax. The Near-Term Tax Free Fund may invest up to 20% of its assets in securities that pay taxable interest. Income or fund distributions attributable to capital gains are usually subject to both state and federal income taxes.

The Near-Term Tax Free Fund invests at least 80 percent of its net assets investment-grade municipal securities. At the time of purchase for the fund’s portfolio, the ratings on the bonds must be one of the four highest ratings by Moody’s Investors Services (Aaa, Aa, A, Baa) or Standard & Poor’s Corporation (AAA, AA, A, BBB). Credit quality designations range from high (AAA to AA) to medium (A to BBB) to low (BB, B, CCC, CC to C). In the event a bond is rated by more than one of the ratings organizations, the highest rating is shown.

The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry.

Diversification does not protect an investor from market risks and does not assure a profit.

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

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Manufacturing Activity in China Just Shifted into Overdrive
November 7, 2016

Nanpu Bridge  

A wave of positive economic data suggests the Chinese economy is stabilizing and that business confidence is improving. The country’s purchasing managers’ index (PMI), which measures the health of its manufacturing industry, rose to 51.2 in October, handily beating economists’ estimates of 50.3.

Chinese Manufacturing Beats Expectations
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Expanding at its fastest pace since July 2014, the industry was stimulated by a strong rebound in new orders and higher commodity prices. Output rose to an incredible five-and-a-half-year high. And with backlogs of work beginning to pile up, manufacturers trimmed employees at the slowest pace in 17 months.

I’ve previously written about the importance of tracking the PMI, which you can read here.

Also encouraging is the country’s third-quarter gross domestic product growth, which came in at 6.7 percent for the third straight quarter, all but assuring investors that the economy can achieve the government’s earlier guidance of between 6.5 percent and 7 percent. Higher business confidence helped maintain steady growth, “as proved by the rebound of medium to long-term corporate loans and reacceleration of private investment growth,” according to Singapore-based OCBC Bank.

Consumer spending appears to be robust. In the first nine months of the year, consumption contributed nearly 60 percent to GDP growth, with significant demand gains made in health care, education, financial products and entertainment.

Automobile sales jumped a phenomenal 32 percent year-over-year in September, the fourth straight month of growth exceeding 20 percent. Sales have been so robust—reflecting a rush to purchase new cars before the government’s reduction in sales tax on small vehicles expires at year-end—that new vehicle purchases in China are expected to surpass sales in North America for the first time ever this year.

China Expected Surpass North America Automobile Sales
click to enlarge

Such a great number of cars on the road has resulted in famously massive traffic jams that turned miles of highways into parking lots. Some as many as 50 lanes wide, the very worst incidents in Beijing found hundreds of drivers stuck in lines for days. Beijing officials have recently proposed stopgap measures, but the nightmare congestion underscores the need for greater capacity, which will require even more investment from the Chinese government, not to mention untold amounts of cement, asphalt, steel and other materials.

But really, these are traffic jams you have to see to believe.

China Attracting Assets

The market seems to like what it sees. The Shanghai Composite Index is back up to levels last seen in January, fueled by not only encouraging manufacturing data but also hopes the government will make good on its promises to support infrastructure spending and restructure state-run enterprises. Stocks recently signaled a bullish “golden cross,” when the shorter-term moving average crosses above the longer-term average. 

Chinas Golden Cross
click to enlarge

In a note last week, Goldman Sachs analysts reported they expect reforms to accelerate in the next few years as China transitions from a middle-income country to an advanced economy. Reforms include efforts to restructure or eliminate “zombie” state-owned enterprises and remove marginal capacity. New policies on how to address public corruption have also been floated.

Among ETFs focused on a single emerging market, China funds attracted the largest inflows in the month of October, with new money totaling $275 million, according to Citi Research data.

Inflows into Mexico-focused ETFs were a distant second, at $133 million, indicating a surplus of bets on a Hillary Clinton presidential win this week.

Who Will Lead the SEC in a Clinton Administration?

SEC Chair Elizabeth Warren

SEC Chair Elizabeth Warren
Photo by Tim Pierce / CC-BY

While I’m on the topic of the election, I find it worth sharing that a shake-up at the very top of the Securities and Exchange Commission (SEC) could be unfolding in front of our eyes—with some potentially serious ramifications.

Massachusetts Sen. Elizabeth Warren, one of the most outspoken critics of Wall Street serving in Congress today, recently urged President Barack Obama to remove Mary Jo White as head of the SEC for, among other things, failure to fully implement the Dodd-Frank financial reforms.

The White House flatly rejected Warren’s request, but it raises a few questions: Is she positioning herself to run the SEC herself? Could Sen. Warren, a strong supporter of Clinton, be appointed as the new SEC chair if Clinton were to win? What effect would that have on capital markets?

Although pure speculation, the scenario is worth pondering.

Another Infrastructure Boom Ahead?

Much has been made of the Chinese economy’s transition from one driven by industrial production to one supported by consumption and services. While this shift is indeed taking place, China still remains the world’s largest engine for energy and materials demand, with support from a growing population and rising household income.

The country imported a record amount of crude oil in September, up 18 percent year-over-year, surpassing the U.S. for the second time in 2016. Averaging 8 million barrels a day, imports came close to the 8.6 million daily barrels the U.S. produces on average.

China Imported Record Volumes Crude September
click to enlarge

I also would like to point out that China remains the world’s number one generator of electricity. The chart below shows just how dramatic capacity growth was in the first decade of the century. In 1990, the country’s electricity needs were equivalent to Latin America’s, but as its government pushed ahead with fiscal spending for huge infrastructure projects, demand blew past the continents of Europe and North America.

China Leads World Electricity Generation
click to enlarge

Although infrastructure investment has declined overall from this period, there’s still plenty to get excited about. In the first eight months of 2016, infrastructure spending rose an impressive 19.7 percent over the same period last year, and in May, the government announced it would be pumping more than $721 billion into as many as 303 transportation projects over the next three years.

Two projects in particular are worth noting here. Construction on what will eventually be the world’s largest airport by surface area is currently underway in Beijing. Upon completion in 2019, the $12 billion airport, to be called Beijing Daxing International Airport, will serve as many as 100 million passengers a year, roughly in line with the world’s busiest airport, Hartsfield-Jackson Atlanta International Airport.

Then there’s the ongoing Belt and Road Initiative (BRI), one of the most ambitious undertakings in human history. With total infrastructure costs estimated at $5 trillion, the biblical-size trading endeavor—a sort of 21st century Silk Road—will cost 12 times as much as what the U.S. spent on the Marshall Plan to rebuild Europe following World War II. The initiative has the participation of 65 countries from Asia, Africa and Europe, and is poised to raise the living standards for more than half of the world’s population.

Chinas multi trillion dollar belt and road initiative
click to enlarge

“Though China’s pace of expansion has slowed from the double-digit rates seen in the first decade of the century,” writes HSBC’s Noel Quinn, Chief Executive of Global Commercial Banking, “its global influence—as the world’s second-largest economy and a trading powerhouse—is far greater than 10 or even five years ago. The country’s overseas investments are only likely to increase, further underlining its pivotal role.”

HSBC: Your Candidate’s Win Could Reward Gold Investors

With the U.S. presidential election upon us, London-based HSBC says gold investors should see a significant bump in price no matter who wins.

The bank sees a Trump victory more supportive of gold as a potential “protection against protectionism”—the New York businessman has been very critical of trade deals, including the North American Free Trade Agreement (NAFTA) and the proposed Trans-Pacific Partnership (TPP)—but a Clinton win could also help boost prices to as high as $1,400 by year end, HSBC says.

As always, I recommend a 10 percent weighting in gold—5 percent in bullion and coins, 5 percent in gold stocks. Rebalance every year.

 

The Shanghai Composite Index (SSE) is an index of all stocks that trade on the Shanghai Stock Exchange.

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 panel is stratified by company size and Standard Industrial Classification (SIC) group, based on industry contribution to Chinese GDP. Survey responses reflect the change, if any, in the current month compared to the previous month based on data collected mid-month.

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

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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The Case for Natural Resource Equities
September 26, 2016

The Case for Natural Resource Equities

Last week I attended the Denver Gold Forum along with three other U.S. Global Investors representatives, including our resident precious metals expert Ralph Aldis. I was happy to see sentiment for gold way up compared to last year’s convention, as was turnout. I was also pleased to see Franco-Nevada, Silver Wheaton and Royal Gold in attendance, all of which I’ve written extensively about.

One of the most interesting presentations was held by Northern Star Resources—the third biggest listed gold producer in Australia, a dividend payer and a longtime holding of USGI. I’ve always appreciated Northern Star’s insistence on being a business first, a mining company second. This shareholder-friendly mantra is reflected in its stellar performance.

Compared to other companies in the NYSE ARCA Gold Miners Index (GDM), Northern Star is a sector leader in a number of factors, including five-year cash flow return on invested capital. Whereas the sector average is negative 1.6 percent over this period, Northern Star’s is a whopping 27 percent, the most of any other mining company in the GDM.

This has helped it return an amazing 800 percent over the last five years as of September 23. Compare that to the GDM, which returned negative 56 percent over the same period.

Australian gold miners as a whole trade at an impressive discount to North American producers, 5.7 times earnings versus 8.3 times earnings, according to Perth-based Doray Minerals.

Top Performing Australian Gold Producers Based Relative Valuations
click to enlarge

Screening for high cash flow returns on invested capital, as you can see, helps give us a competitive advantage and uncovers hidden gems such as Northern Star and others.

Resource Equities Offer Attractive Diversification Benefits

A recent whitepaper published by investment strategist firm GMO makes a very convincing case for natural resource equities. I urge you to check out the entire piece when you have the time, but there are a few salient points I want to share with you here.

In the opinion of Lucas White and Jeremy Grantham, the paper’s authors, “prices of many commodities will rise in the decades to come due to growing demand and the finite supply of cheap resources,” presenting an attractive investment opportunity. Over the long-term, resource stocks have traded at a discount and outperformed their underlining metals and energy by a wide margin.

According to White and Grantham, a portfolio composed of 50 percent energy and metals, 50 percent all other equities, had a standard deviation that’s 35 percent lower than the S&P 500 Index. What’s more, the returns of such a portfolio outperformed those of the S&P 500, resulting in a risk-adjusted return that’s 50 percent higher than that of the broader market.

Long Term Diversification Benefits Resource Stocks
click to enlarge

Resource equities have also historically shown a low to negative correlation to the broader market, which might appeal to bears. The reason? When metals and energy have risen in price, it’s been a drag on the economy. The reverse has also been true: Low prices have been a boon to the economy.

The thing is, general equities currently do not give investors enough exposure to natural resources. The weight of energy and metals in the S&P 500 has been halved in the last few years as oil and other materials have declined. Considering the diversification benefits, investors should consider a greater allocation to the sector.

Timing Is Key

There’s mounting evidence that now might be an opportune time to get back into resource stocks. Following the sharpest decline in crude oil prices in at least a century, as well as a six-year bear market in metals, the global environment could be ripe for a commodity rebound. From its January trough, the Bloomberg Commodity Index has rallied 17 percent, suggesting commodities might be seeking a path to a bull market.

During the down-cycle, many companies managed to bring costs lower, upgrade their asset portfolios and repair their balance sheets. As a result, many of them are now free cash flow positive and are in a much better positon to deliver on the bottom line when commodity prices increase.

I’ve often written about the imbalance between monetary and fiscal policies. My expectation is that unprecedented, expansionary global monetary policy will be followed by fiscal expansion. Consider this: Total assets of major central banks—including those in the U.S., European Union, Japan and China—have skyrocketed to $17.6 trillion dollars as of August 2016, up from $6.3 trillion in 2008.

Total Assets Major Central Banks
click to enlarge

This expansion is expected to result in significant inflation gains over the next decade, an environment in which natural resource stocks have historically outperformed the broader market.

Infrastructure Spending About to Increase?

China largely drove the global infrastructure build out over the past decade as rapid economic growth and rising incomes increased the demand for “advanced” and “quality of life” infrastructure. This resulted in a breathtaking commodities bull market.

Infrastructure Spending Evolves Regions Economic Growth
click to enlarge

Now, other advanced countries, the U.S. especially, are readying to sustain the next cycle to repair its aging and uncompetitive infrastructure.

As you can see, most major economies dramatically cut infrastructure spending after the financial crisis, indicating it might be time to put some of that $17.6 trillion to good use.

Time Major Economies Boost Public Infrastructure Spending
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According to the Center on Budget and Policy Priorities (CBPP), the U.S. is presently facing a funding gap of $1.7 trillion on roads, bridges and transit alone—to say nothing of electricity, schools, airports and other needs. Meanwhile, state and local infrastructure spending is at a 30-year low.

If this financing can’t be raised, says the American Society of Civil Engineers (ASCE), each American household could lose an estimated $3,400 per year. Inefficient roadways and congested airports lead to longer travel times, and goods become more expensive to produce and transport.

Let’s look just at national bridges. After an assessment of bridges last year, the American Road & Transportation Builders Association (ARTBA) found that 58,495, or 10 percent of all bridges in the U.S., are “structurally deficient.” To bring all bridges up to satisfactory levels, the U.S. would currently need to spend more than $106 billion, which is six times what was spent nationwide on such projects in 2010.

Infrastructure backbone US economy

Fortunately, both U.S. presidential candidates have pledged to boost infrastructure spending—one of the few things they share with one another. Hillary Clinton says she will spend $275 billion over a five-year period, while Donald Trump says he’ll spend “double” that.

Trump’s central campaign promise, as you know, is to build a “big, beautiful, powerful wall” along the U.S.-Mexico border, which analysts at investment firm Bernstein estimate could cost anywhere between $15 billion and $25 billion, requiring 7 million cubic metres of concrete and 2.4 million tonnes of cement, among other materials.

As I like to say, government policy is a precursor to change. I’ll be listening closely for further details on Trump and Clinton’s infrastructure plans this coming Monday during the candidates’ first debate. I hope you’ll watch it too! Media experts are already predicting Super Bowl-sized audiences.

Don’t Count China Out

In the past year, a lot of ink has been devoted to China’s slowdown after its phenomenal spending boom over the last decade, but there are signs that spending is perking up—a tailwind for resources. According to the Wall Street Journal, Chinese economic activity rebounded in August, driven by government spending on infrastructure and rising property taxes.

“In the first seven months of 2016,” the WSJ writes, “China invested 962.8 billion yuan ($144.1 billion) in roads and waterways, an 8.2 percent increase from the previous year.”

The Asian giant still accounts for a large percentage of global trade in important resources such as iron ore, aluminum, copper and coal. This is why we closely monitor the country’s purchasing manager’s index (PMI), which, according to our own research, has been a reliable indicator of commodity price performance three and six months out.

 

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

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

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 S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The Bloomberg Commodity Index is made up of 22 exchange-traded futures on physical commodities. The index represents 20 commodities, which are weighted to account for economic significance and market liquidity.

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.

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.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. The following securities mentioned in the article were held by one or more accounts managed by U.S. Global Investors as of 6/30/2016: Franco-Nevada Corp., Silver Wheaton Corp., Royal Gold Inc., Northern Star Resources Ltd., Doray Minerals Ltd., Saracen Minerals Holdings Ltd., Evolution Mining Ltd., St. Barbara Ltd.

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Net Asset Value
as of 05/26/2017

Global Resources Fund PSPFX $5.38 0.03 Gold and Precious Metals Fund USERX $7.05 0.01 World Precious Minerals Fund UNWPX $6.29 0.06 China Region Fund USCOX $8.92 -0.01 Emerging Europe Fund EUROX $6.37 -0.02 All American Equity Fund GBTFX $24.22 -0.03 Holmes Macro Trends Fund MEGAX $19.38 0.06 Near-Term Tax Free Fund NEARX $2.23 No Change U.S. Government Securities Ultra-Short Bond Fund UGSDX $2.00 No Change