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Finding Gold in the Mainstream
June 21, 2010
The New York Times dedicated a chunk of last Sunday’s paper to gold as a mainstream investment. In other words, gold is now legit -- no longer can it be dismissed as the asset of choice for fringe types with a cellar full of canned goods and a stash of bullion buried in the backyard.
And to illustrate just how far gold has moved into the American mainstream, the paper goes bipartisan by holding up investor George Soros on the left and commentator Glenn Beck on the right as examples of the newly converted.
Now there’s an old saying that the time to sell an investment is when it’s finally “discovered” by the popular media, but that may not be good advice for gold in today’s environment. This week spot gold and gold futures hit all-time highs as the latest government reports cast doubts on the economic recovery.
In its story, the Times points out many of the same gold drivers that we have been citing for a while now – the tandem risks of near-term deflation and longer-term inflation, massive U.S. budget deficits and crushing sovereign debt burdens in Western Europe that threaten the euro’s viability.
Gold’s safe-haven qualities now make it attractive to worried investors. It’s true that this fear won’t last forever, but it’s not at all clear that investors will have a good reason to be less fearful any time soon.
From a recent research note by UBS: “The sense that some investors only trust a gold holding if they can see it and touch it is a clear indication that some investors are buying gold as a hedge against a full-scale financial crisis and currency debasement.”
There are other factors supportive of gold. One is the renewed interest of central banks in adding to their gold holdings to diversify their foreign reserves.
The chart above shows how little gold has been sold by the 18 European countries covered under the Central Bank Gold Agreement. The annual limit is 400 metric tons, but through the first eight months of its latest fiscal year (ends September 2010), only a tenth of that amount changed hands, nearly all of it being sold by the International Monetary Fund.
Russia’s central bank added more than 26 metric tons to its reserves in the first quarter of 2010, according to the World Gold Council. The Philippines has boosted its gold reserves by about 10 metric tons, and China is widely believed to be quietly adding large quantities of gold to its vaults. China is the world’s largest producer and is consuming all of its production, so this supply is not seen in the market.
Gold mine supply also comes into play. After a nice bump up in 2009, gold mine output is on track to decline this year and in 2011 (chart) at the same time that investment demand is strong. The World Gold Council forecasts that overall gold consumption in China could double in the coming decade as income levels rise – it is very unlikely that China’s production will be able to keep the same pace.
Other appeal: gold’s historic non-correlation with other financial assets, household debt reduction and the uncertainties created by the efforts in Washington to raise tax rates and impose new regulatory schemes. And as we approach the important 2010 midterm elections, it would be no surprise to see government deficit spending climb even higher into the stratosphere to curry favor with the voting public.
Some extreme gold bulls are urging investors to move half or even more of their portfolio into gold – we are not in that camp. We consistently suggest that investors consider a maximum 10 percent allocation to gold-related assets – half in bullion or bullion ETFs and the other half in gold stocks or a good gold fund – and that they rebalance each year to capture the swings.
On the gold equities, our research via a basic regression analysis shows that gold equities appear undervalued by 8 percent to 9 percent relative to bullion. This may present a buying opportunity for long-time gold investors and those New York Times readers who are among the many new believers.
Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in these sectors.
World Spotlight on South Africa
June 14, 2010
South Africa takes to the world stage as it hosts soccer’s first World Cup to be played on the African continent. For the next 30 days, the eyes of the globe will be watching Rooney, Cristiano Ronaldo, Maicon and Messi battle it out for world soccer supremacy.
South Africa’s $287 billion economy is already the largest in Africa and it’s estimated that the World Cup will generate 400,000 jobs and contribute $7.3 billion to the country’s GDP, according to research firm Grant Thornton. It estimates 450,000 tourists will visit the country spending a total of $1.1 billion.
In preparation for this event, South Africa has given itself quite the makeover. This infographic from MENA Infrastructure details how South Africa has made substantial upgrades in its infrastructure.
A reported $2.2 billion was spent on 10 stadiums that will host the matches. Some of these, like the 46,000 seat Nelson Mandela Bay stadium in Port Elizabeth, the first stadium in the world to be completely powered by green energy, were new construction while others, like the 95,000 Soccer City stadium in Johannesburg, received major upgrades.
Another $9.1 billion was invested in the country’s road systems, $2.4 billion in airports and $2 billion on a new commuter rail. In all, the World Cup infrastructure program is estimated to have brought $52 billion in investment.
Once the games are over, the South African government hopes the investment will continue to pay dividends. World Cup hosts have experienced increased economic growth in the two years following the event. Analysis from Credit Suisse shows the host countries experienced 2.7 percent and 2.6 percent growth, respectively, in the years leading up to the World Cup but saw 3.2 percent and 3.7 percent economic growth in the two years after.
Only time will tell if this scenario plays out. Luckily we have the world’s best tournament to keep us entertained in the meantime. Enjoy the Cup!
ETFs and the “Flash Crash”
May 24, 2010
Liquidity is one of the key selling points for exchange-traded funds (ETFs), but the Dow Jones “flash crash” of May 6 shows how that supposed advantage can turn into a huge liability for investors.
A report this week from the SEC and the Commodities Futures Trading Commission (CFTC) found that ETFs accounted for the overwhelming majority of securities that fell at least 60 percent that day. Many of those ETFs fell all the way to $0.01 per share during trading.
The SEC-CFTC report blames a lack of liquidity for the crash. Many registered investment advisors, brokers and institutional investors use ETFs in their hedging strategies, but this backfired when a spike in volatility caused a stampede of sellers that crushed prices.
I don’t believe ETFs caused the “flash crash” but the events of May 6 give investors a good reason to look closely under the hood of ETFs. When they do, they might be surprised by what they find.
Research shows that the tradability of ETFs can actually be a costly curse in terms of real returns.
The chart above from MoneyWatch.com shows investor returns minus fund returns for both index mutual funds and ETFs in each available Morningstar “style box” for the five years ending June 2009. Negative figures mean investors lagged the mutual fund or ETF’s return by buying at the wrong time and vice-versa for a positive return.
For example, the average small-cap value ETF investor achieved a return 4.3 percent below what the ETF returned over the same time period. This happens by buying high and selling low. In contrast, the average small-cap value mutual fund investor return was only 0.2 percent below the fund’s performance.
The returns for index mutual fund investors were higher than the returns for the ETF investors for each of the nine style boxes.
And an examination of the five-year returns of more than six dozen ETFs across a range of asset classes by the founder of Vanguard Group concluded that the ETF investors made 18 percent less than the returns of the ETF itself because of the investors’ trading activity.
Unlike mutual funds, ETFs can trade at a premium or discount to their net asset value (NAV). When an ETF investor buys at a premium, he overpays for the asset. Likewise, if he sells at a discount, he receives less than the asset is worth. These premiums and discounts can be wide, especially on days with big NAV changes, and the premiums/discounts can swing very quickly from one extreme to another.
The chart above shows the NAV trading premiums and discounts for the new Market Vectors Junior Gold Miners ETF (GDXJ). Going back to inception, investors have paid premiums to purchase as high as 3.23 percent and sold at discounts as much as 1.28 percent. For the SPDR Gold Shares Trust (GLD), investors paid a 2.15 percent premium to buy in on May 6 (the day of the “flash crash”), but that swung to a 1.3 percent discount just seven trading days later on May 17.
This can work both for and against the investor. Bid-ask premiums or discounts to NAVs can both positively or negatively affect investor return depending on the timing of the transaction. An investor who purchases an ETF at a discount and sells at a premium will receive a higher return than the ETF over the same period of time.
There’s no such thing as a free lunch when it comes to investing. ETFs have relatively low expense ratios compared with actively managed funds in the same sectors, but that doesn’t mean that in the end an ETF costs less to own or that an ETF generates better returns. They can be expensive to trade on volatile days and the events of May 6 uncovered some new weaknesses.
ETFs can have a place in many investment strategies, but before buying, investors need to know what they are getting into so they can make the best decisions consistent with their investment goals.
The full SEC-CFTC Report at SEC.gov and the research from Vanguard is available at IndexUniverse.
By clicking the links above, you will be directed to third-party websites. U.S. Global Investors does not endorse all information supplied by these websites and is not responsible for its content. The following securities mentioned in the article were held by one or more of U.S. Global Investors family of funds as of March 31, 2010: SPDR Gold Trust
Why More Investors Like Gold
May 17, 2010
Gold is charging up to new highs, so it’s no surprise that the level of interest in this financial asset is charging up as well. Last week I did interviews with CNN, CNBC, USA Today and Reuters, and in most cases a specific question came up – “Should people be buying or selling gold right now?”
That’s a tough one. The monetary turmoil in Western Europe and some early signs of inflation create the right conditions for gold to continue its run, and while we see potentially higher prices in the long term, it’s difficult to predict what might happen in the here and now.
Sovereign debt is a key driver of the current economic jitters. The chart below shows next year’s sovereign debt estimates for the G-7 and other key global economies – the U.S. debt in 2011 would be about equal to GDP ($15 trillion), while the debt loads carried by Japan, Italy and Greece would exceed GDP.
With all that’s been said and written about gold lately, it’s rare to find new insights and perspectives. But this week, Martin Murenbeeld, the head economist at Dundee Wealth Economics, offered something new about the nature of the gold investment market in an interview with Mineweb.
Investment demand for gold - and investment demand for commodities generally - is in early days. This is only just starting to develop… One of the things that I see when I travel around North America is that more and more people are starting to question “What is currency debasement? How does it work?” - that sort of thing.
Now what's interesting about that is that Americans and Canadians by and large never thought about currency debasement. This was something that maybe an old German would think about or Asians and Latin Americans. But not North Americans - but that has changed… There is a concern among investors that not all is right with the financial world and they don't fully understand it. They think central bankers might be debasing their currencies and so there is an interest developing in gold.”
If he’s correct – the masses in the developed world are just now waking up to how their personal wealth can be affected by the future inflation spawned by the trillions of dollars and euros created to finance economic rescue plans – the potential implications for gold are profound.
Here’s one way to look at currency destruction -- 10 years ago this week, $1,000 bought nearly four ounces of gold, and today $1,000 won’t even get you a single ounce. This is because the dollar’s value has fallen by a startling 78 percent just in the past decade.
Murenbeeld goes on to make another interesting point – investment demand, rather than jewelry demand, has been the key driver for gold for most of modern history. We are returning to that scenario as gold’s safe haven appeal grows during this period of unstable government and monetary policies.
Central banks in China, India and elsewhere have snapped up hundreds of tons of gold to add to their reserves in recent years, and a growing number of other investors are following suit – the Shanghai Gold Exchange, for example reports that its volume was up 36 percent in the latest quarter. Overall investment demand is double what it was in the 1970s.
Our experience shows that whenever you have deficit spending, rapid money supply growth and negative real interest rates (inflation rate higher than nominal interest rate), historically gold has performed exceptionally well in that currency. Right now, we’re seeing massive deficits, negative real interest rates in the U.S., and a worldwide debt problem that is projected to get bigger.
We have long recommended, based on regressional analyses, that prudent investors consider an allocation to gold – not to get rich, but as a way diversify assets and protect wealth. Our suggestion is a maximum 10 percent allocation – half to bullion and the other half to gold equities or a good gold fund that invests in unhedged gold stocks.
For more of our thoughts on gold, check out the gold section of Frank Talk, a blog from Frank Holmes and the rest of the U.S. Global Investors investment team.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. Diversification does not protect an investor from market risks and does not assure a profit.
China Imports Success
April 26, 2010
Just as the U.S. consumer is key for Chinese exporters, so too is the Chinese consumer key as an export destination for the rest of emerging Asia.
A research note this week from the Hong Kong-based brokerage CLSA Asia Markets spells out how important the Chinese consumer was in pulling its neighbors up and out of the Great Recession. Many of these countries have more than doubled their exports to China since the depths of the recession in late 2008 and early 2009. Exports from technology-oriented Taiwan to the mainland, for example, are up more than 160 percent from the bottom, while Singapore has boosted its exports to China by more than 120 percent and South Korea by nearly 100 percent.
Those are relative numbers – how important is China to its neighbors in absolute terms? Nearly 30 percent of Taiwan’s total exports, accounting for 15 percent of its GDP, now go to the mainland. A quarter of South Korea’s exports (10 percent of GDP) are China-bound. For both of these countries, and others as well, China is more than twice as important as the United States in terms of exports.
The visual shows China’s current account trend lines – sharply rising imports intersecting with a slightly flagging export sector.
Now we’re not ready to dust off the D-word – “decoupling” – quite yet, but the regional trend is clear and it appears sustainable if for no other reason than an ever-richer China as the market hub of a dynamic regional economy makes both geographic and demographic sense.
Rapidly rising incomes in China are making its consumers look more and more like those in the developed world. They want nice clothes and the latest high-tech gadgets, and their desire for more spacious homes outfitted with modern conveniences is a primary driver of the nation’s housing market. Housing prices in Beijing and Shanghai may be getting a little ahead of themselves, but the government is taking prudent measures to slow things down in a measured and orderly fashion. The respected analysts at BCA Research see a frothy and vulnerable housing market, but they still say “Chinese consumer spending will remain robust.”
Another point worth mentioning – Beijing and Shanghai may be China’s most important cities, but the country and its economy is so much more, just as New York and Washington, D.C. don’t represent the entire United States. The central government is clearly serious about spreading the wealth now concentrated on China’s eastern coast deep into the nation’s interior.
The inland provinces and cities present a vast growth opportunity, and to seize that opportunity, the government is moving forward with a long list of high-speed “bullet train” projects, regional airports, new power plants and other infrastructure. This is the spade work that must be done before a vibrant economy can grow and flourish.
Income levels drop off as you move inland in China, but there’s a growing market in those areas for luxury goods. We pointed out a few weeks ago that high-end retailers like Gucci and Louis Vuitton are opening shops in the back country, which is a testament to increasing wealth levels.
Along with luxury goods, Chinese citizens with rising incomes and accumulations of wealth are likely to become bigger consumers of gold. China has a centuries-long cultural attraction to gold, but affordability has been an obstacle. Even at today’s high prices, the Chinese are in a good position to buy gold as jewelry or for investment purposes. They and other Asians (foremost Indians) see small price corrections as an opportunity to stock up.
The chart above shows where China stands on a per-capita basis among countries with a traditionally high affinity for gold. China’s currently near the bottom of the list but the World Gold Council believes per-capita gold consumption by the Chinese could easily double in the next decade. This, obviously, would have a massive impact on the global supply-demand balance.
As part of our investment process, we examine intermarket relationships to try to determine whether or not we believe they are sustainable. In the case of the Chinese consumer, we not only believe he is here to stay, but also that he will grow in influence both regionally and globally in the years ahead.
Net Asset Value
as of 09/08/2010
- Global Resources Fund
PSPFX $8.78 +0.05 - Gold and Precious Metals Fund
USERX $17.44 +0.03 - World Precious Minerals Fund
UNWPX $20.18 -0.01 - China Region Fund
USCOX $8.61 -0.02 - Eastern European Fund
EUROX $9.11 +0.13 - Global Emerging Markets Fund
GEMFX $8.17 +0.08 - Global MegaTrends Fund
MEGAX $7.71 +0.04 - All American Equity Fund
GBTFX $20.02 +0.09 - Holmes Growth Fund
ACBGX $16.04 +0.15 - Tax Free Fund
USUTX $12.58 -0.01 - Near-Term Tax Free Fund
NEARX $2.26 -0.01 - U.S. Government Securities Savings Fund
UGSXX $1.00 No Change - U.S. Treasury Securities Cash Fund
USTXX $1.00 No Change