- November 1, 2012
- A Tipping Point for Gold Companies
Did you know that gold stocks tend to underperform during election years? As shown in the chart below, over the past quarter-century up until the prior election, the performance of the Philadelphia Stock Exchange Gold and Silver Index (XAU) was weak during the year of a presidential election.
The silver lining for gold stock investors is that the XAU has historically bounced back the year after the election.
I often say that life is all about managing expectations. The difficult part of investing in gold and gold companies is experiencing the typical price swings, so it’s important to understand the inherent monthly and annual volatility.
Along with the normal volatility, gold equity investors have had to deal with plenty of challenges in recent years, as many executives overpromised and underdelivered, diluting their production per share and their reserves per share. In addition, margin costs have been rising. The result is unhappy shareholders, with bullion outperforming gold miners.
Perhaps investors can anticipate a sea change occurring in the management of gold companies. As I explained in a recent interview with Kitco, I believe a tipping point took place last summer when Gold Fields’ CEO Nick Holland discussed the future of mining companies. In my opinion, his thought leadership regarding growing production volume, expanding margins and optimizing capital is crucial in shaping the future decision-making of boards, with an enhanced focus on protecting the value per share for their shareholders, increasing dividends, as well as an effective leveraging of the balance sheet.
2013 may be a pivotal year for gold stocks: With the presidential election year behind us, and executives making best use of their capital, it appears that miners are poised for a comeback.
What else is in store for investors after the U.S. election? Tune in to my webcast with Money Map Press’ Chief Investment Strategist Keith Fitz-Gerald on November 12 at 2 p.m. Central Time as we discuss energy prices, the “fiscal cliff,” and the presidential cycle over the next four years. Register today.
The Philadelphia Stock Exchange Gold and Silver Index (XAU) is a capitalization-weighted index that includes the leading companies involved in the mining of gold and silver. The following security mentioned was held by one or more of U.S. Global Investors Funds as of 9/30/12: Gold Fields Ltd.
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- October 29, 2012
- Don’t Fear a Normal Gold Correction
I spent the latter half of last week at the New Orleans Investment Conference, talking with investors, mining companies and analysts about the state of the gold industry. The annual conference falls at an interesting time of the year, as the price of gold typically corrects in October. In fact, going back 30 years, the historical seasonality of gold has been to rise during September, with a subsequent correction in October.
This fall, gold has followed this historical trend, with the metal climbing throughout the month of September to reach a high of $1,790 an ounce on October 4, only to have a normal correction to $1,701 by October 24. This decline typically comes ahead of the Love Trade fueling demand prior to the Hindu festival of lights, Diwali, which begins in November.
Miners, Show Me the Money!
At the conference, I’ve been discussing the multiple forces squeezing the profits and earnings out of gold miners, causing equity investors to become the Rod Tidwells of the gold world, getting miners energized to “Show me the money!” In my opinion, this phenomenon highlights the importance of selectively choosing among those gold companies that exhibit the best relative growth and momentum characteristics to help obtain outstanding investment results.
My workshop presentation in “The Big Easy” integrated preeminent thinking from multiple gold experts, including research firm CIBC, Gold Fields and the World Gold Council, about how gold companies’ performance has been neither “big” nor “easy.” There’s been a decline in production per share, an 80 percent increase in the average cost per ton of gold over the past six years, and a 21 percent decline in global average grades of gold since 2005. Cash taxes per ounce of production have increased dramatically, and, according to CIBC World Markets, the replacement cost for an ounce of gold is now $1,500, with $1,700 as a sustainable number. Cash operating costs eat away the most, at $700 an ounce, while sustaining capital, construction capital, discovery costs, overhead and taxes eat up $800. At the October 24 gold price of $1,700 an ounce, only $200 is left over as profit, says CIBC.
Gold companies have had their share of challenges in the past. Prior to the huge run-up in gold prices in the late 1970s, forward price-to-cash flow ratios crashed from a high of about 22 times to just under 9 times. Eventually, as gold climbed to its high, multiples spiked back up to 21 times.
Miners also didn’t increase the supply of the precious metal in the 1970s. Back then, there were only a few major players in the gold game. South Africa was a significant gold-producing country, as well as Russia and North America.
However, following years of a gold bull market in the 1970s, production climbed. In fact, Pierre Lassonde, chairman of Franco-Nevada and a living legend in the mining and resource world, says it took seven years for the gold industry to respond after the rise in the price of gold. Ironically, as the price kept falling over the next 20 years, production doubled, says Lassonde.
Beginning in 2000, gold companies have experienced a similar phenomenon, with production remaining flat, even declining in some years. In 2008, mine supply of gold fell to levels not seen since the early 1990s.
Now, after a seven-year lag, the industry has responded as we’re beginning to see some growth in supply.
From 2006 through 2011, production throughout the entire gold industry has increased about 3 percent, says CEO Nick Holland of Gold Fields. During his keynote presentation at the Melbourne Mining Club in July, he indicated that most of the growth was not coming from the major producers. In more mature markets, such as South Africa, Australia, Peru and the U.S., annual production decreased by about 5 million ounces since 2006. Emerging markets on the other hand—China, Colombia, Mexico and Russia—added about 7.6 million ounces over the last six years, Holland says.
Of gold finds that contain at least 2 million ounces of gold, research from the Metals Economics Group (MEG) finds that there have been 99 significant discoveries between 1997 and 2011. Only 14 of the 26 major gold producers made these major gold discoveries. “Today, the major producers and their majority-owned subsidiaries hold 39 percent of the reserves and resources in the 99 significant discoveries made in the past 15 years.” This amounts to less than half of the yellow metal needed to replace the gold companies’ production from 2002 to 2011, says MEG.
According to Lassonde, this is the “elephant in the room,” as new finds have become elusive. The chart below from CIBC shows that there was only one major discovery that was more than 3 million ounces in 2011. Over the past seven years, there have been only nine major discoveries of gold.
Lassonde doesn’t think we have hit “peak gold,” but believes the gold industry needs a “3D seismic” event similar to what occurred in the oil industry before we see considerable finds.
For as many challenges as gold companies face today, they have rarely experienced such a well-diversified consumer base and diversified demand for their product: It’s “the best we could ask for,” says Lassonde.
A newer trend that I’ve discussed is the reemergence of emerging markets central banks as buyers of gold, as they have been “relearning that all paper currencies are suspect,” says Lassonde. Today, he says “cash is trash,” with the value of euro, dollar and yen in question.
He believes this source of demand could be long-lasting and quite significant if you look at emerging market countries’ gold holdings as a percent of total reserves. In 2000, the European Central Bank decided that the right proportion of gold to own should be 15 percent. Pierre says if you apply that figure to the potential gold holdings of the emerging market central banks, they would need to accumulate 17,000 tons of gold. At a purchase of 1,000 tons a year (or about 40 percent of today’s production), these central banks would have to buy gold for the next 17 years!
Another growing source of demand has been from the Fear Trade’s scooping up of gold exchange-traded funds (ETFs). Eight years after the products were launched, 12 gold ETFs and eight other similar investments are valued at around $120 billion and hold 2,500 tons of gold, says Nick Holland.
I believe the Fear Trade will continue buying not only gold but also gold stocks, as the group is driven by Helicopter Ben’s quantitative easing program. In the latest Weldon’s Money Monitor, Greg Weldon discusses the consequences of the Federal Reserve’s debt monetization and liquidity provisions, showing the “somewhat frightening pace” of expansion in money supply.
Weldon says that over the last four years since August 2008, the U.S. Narrow Money Supply, or M1, which is physical money such as coins, currency and deposits, has increased 73 percent, or more than one trillion dollars. This is about as much as it expanded in the previous forty years!
Don’t let the short-term correction fool you into selling your gold and gold stocks. The dramatic increase in money suggests that monetary debasement will continue, and in addition to all the above drivers, I believe these are the positive dynamics driving higher prices for gold and gold stocks.
The following securities mentioned were held by one or more of U.S. Global Investors Funds as of 9/30/12: Franco-Nevada, Gold Fields Ltd.
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- October 22, 2012
- Chinese Stocks Looking Like a Bargain
With negative sentiment toward China reaching an extreme in recent months, patient investors have been rewarded with recent news of improving data from the Asian giant.
CLSA Sinology’s Andy Rothman reported that in September, retail sales growth rose 13.2 percent, which was the fastest pace of the year. Real urban disposable income grew nearly 10 percent and real rural disposable income rose more than 12 percent during the first three quarters of the year. And, while export numbers are weak, China has “so far avoided the large-scale export-sector layoffs that led to 2009’s massive stimulus,” says Andy.
There was strength in commodity imports, too. Copper imports into China increased 11 percent compared to the previous month due to increased demand from power infrastructure, white goods restocking and auto production. Iron ore rose a modest 4 percent compared to the previous month, which is encouraging. There was also a sharp rebound in oil imports most likely due to holiday restocking and lower international prices. In fact, Pareto Securities found that Chinese implied oil demand came in at an all-time high of 9.8 million barrels per day in September.
The markets also saw an increase in fixed asset investment (FAI), a measure of capital spending, which grew at “the fastest pace since October 2011,” says CLSA. According to Credit Suisse, “a surge in transportation spending in the month of September [is] starting to reflect the project approvals for highway, rail, airport, and metropolitan transport projects announced in May and June.”
While Credit Suisse says FAI growth was boosted by government investment stimulus, CLSA also notes that fixed asset investment and capital spending by private firms has been rising faster than state-owned firms for 30 of the last 31 months.
Money supply, a key lubricant of the economy and markets, also continued to increase, and this has historically driven Chinese equities. Take a look at the chart below, which shows the year-over-year money supply compared to the MSCI China Index over the past decade. Over the past 10 years, after the supply in money bottomed, stocks soon rebounded.
On January 31, 2012, money supply hit a near decade low of 12.4 percent year-over-year growth. Since then, the number has been creeping higher, rising sharply to 14.8 percent in September, and shortly thereafter, equities responded.
The Wall Street Journal recognized the improvement in Asian stocks and investor sentiment recently, suggesting that the “region’s economy could be nearing the end of a slowdown.” I’ve been trying to temper investors’ expectations of China as weak economic data caused investors to be skittish, telling Investor Alert readers that it wasn’t the time to be bearish. Now, “if the Chinese economy shows sustained signs of stabilizing, it would remove a major overhang of worry for investors in Asia, and may spur more capital raising and other deals as investors become confident enough to switch money out of bonds and back into equity markets,” says The Journal.
This appears to be a good time to be investing in China, as stocks are historically cheap. At the beginning of October, BCA noted that there was a “prevailing pessimism” around China and that the stocks were “currently trading at hefty discounts to world averages and even to euro zone stocks.” The firm indicated that Chinese shares had a forward price-to-earnings ratio of below 9 times; the world and U.S. benchmarks traded at 12 and 13 times, respectively.
Chinese stocks are also cheap compared to emerging markets. In 2007, China traded at a 75 percent premium to emerging markets. Today, Chinese stocks trade at a 20 percent discount. If you look at a comparison of price-to-earnings in China to those in emerging markets, you have to go back to 2006 to find that ratio as low as it is today.
The low price-to-earnings indicates to me that the negativity pendulum has swung too far. “Investors have turned from euphoria at the height of the ‘China mania’ five years ago to extreme pessimism,” says BCA.
Back in April, I listed three trends that global investors should watch in China: A rebound in the liquidity cycle signaling a rally in equity prices, a new leadership with an incentive to maintain growth, and Chinese stocks reverting to their mean, as history appears to favor Chinese stocks landing in the top half of emerging markets. Time will tell.
The MSCI China Index is a capitalization weighted index that monitors the performance of stocks from the country of China. M2 Money Supply is a broad measure of money supply that includes M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds.
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- October 18, 2012
- Play Housing and Agriculture with Resources
This week, the U.S. received favorable news on the housing market. After four years of dismal performance, housing starts and building permits in September surged, climbing to the highest number since July 2008, according to Bloomberg. As you can see below, new private housing data has been very weak compared to several previous decades.
Homebuilder confidence is also climbing. Bloomberg says the National Association of Home Builders/Wells Fargo builder sentiment index is at its highest level since June 2006. According to BCA Research, the U.S. housing bubble is over as the supply of homes and rental vacancy rates fall.
For several months, Global Resources Fund (PSPFX) Co-Portfolio Managers Evan Smith and Brian Hicks have been watching these housing statistics improve, as they believe a U.S. housing recovery is a significant catalyst for timber and forest stocks held in the fund’s portfolio.
People are often surprised when they hear that global resources are actually more than just commodities like oil and copper. In fact, over the past year, we’ve shifted our emphasis of resources stocks to focus on 10 different sectors. Each of these areas include global companies that are involved in the production, exploration or processing of various commodities which stand to benefit from the world’s growing population, urbanization and rising income trends.
To help address the misconceptions, Evan Smith steps in for me today. He has been researching global resources stocks for more than eight years and answers some of our most frequent questions.
What makes up the universe of global resources companies?
At U.S. Global, we look at not only companies involved in producing coal, iron ore and steel, or copper or aluminum, but various types of companies involved in oil. These include refining, exploration and production, and drilling companies. There’s also energy infrastructure, such as pipelines and tankers. Other areas are agricultural chemical, such as fertilizers, and companies involved in food and forest and paper products. These are all the essential ingredients in the lives of the billions of people around the planet.
With a fund that is able to invest globally, how do you decide where the best opportunities are?
Before analyzing a particular company, we consider a variety of broad economic factors across developed and emerging countries. We believe government policy is a precursor to change. Therefore we closely track countries’ fiscal and monetary policy actions. To determine rising or falling demand of certain natural resources, we look at factors including GDP rates, rising urbanization rates and other demand factors which would affect the use of commodities.
Over the past decade, the buildout of China’s high-speed rail was significant for the use of natural resources. There were numerous factors that were bullish for base metals and the involved mining companies: Supportive government policies, rising GDP per capita, an increasing urbanization rate across the country, and the construction of stores, hotels, office buildings and homes along the railway path.
This infrastructure buildout continues today, as China announced an estimated $156 billion in infrastructure approvals in an effort to stimulate a stagnating domestic economy. The projects span subway, highway, port, waterway, airport and energy investments and are scheduled to progress over the next four years.
It’s not only China—many other emerging markets are pursuing policies that encourage economic growth and improve the living standards for their residents.
What other areas do you find interesting right now?
We think the agricultural sector offers opportunity today. With 7 billion hungry people around the world, yields will need to increase on arable lands, benefitting certain processing, farming and agricultural companies. Feeding a growing global population means we need better fertilizers, mechanization and seed technologies to increase the production of grains on less arable soil.
Take a look at the USDA’s World Grain Supply today compared to previous decades. The stock-to-use ratio is one way of measuring supply and demand. It compares the “leftovers” to the total use of a commodity. You can see that the world grain stock-to-use ratio is at a low that we haven’t seen since the 1970s. In one of its research reports, BCA says that the implication is that the imbalance of supply and demand will “likely get resolved via a reacceleration in grain prices, which will encourage an aggressive planting program.” We believe this provides opportunity for global agricultural companies.
How does the fund differ from other commodity investments?
The Global Resources Fund invests in commodity producers rather than a basket of commodity futures such as the Dow Jones-UBS Commodity Index (DJUBS). We believe a well-managed and diversified portfolio of commodity-related stocks can provide significant leverage relative to the underlying commodities over the course of a cycle. The fund’s active strategy also provides potentially greater diversification benefits because of its exposure to a broader array of commodities.
Lastly, investors often struggle with the complexity of the key risks of passive futures strategies, but can more easily understand the key value drivers of commodity stocks, such as the direction of a certain commodity and growth in production, reserves or cash flow on a per share basis.
What’s the benefit to investors for the fund’s diversification across commodities?
Diversification helps investors take advantage of the tremendous growth opportunity in commodities while potentially decreasing the risk, as commodity prices tend to be very cyclically and seasonally volatile from year to year. The fund has historically had a lower correlation to the S&P, which tends to reduce volatility in a portfolio.
Financial Planning has recognized this correlation benefit of resources stocks, naming the Global Resources Fund (PSPFX) as adding the most return among natural resources peers with 10 year returns, when included in a diversified portfolio and rebalanced annually.
And over the past year, our diversified approach has been advantageous for shareholders. As of September 30, 2012, the fund experienced a lower volatility compared to the benchmark Morgan Stanley Commodity Related Index (CRX) and its natural resources peers.
Past performance does not guarantee future results.
Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.
Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. Because the Global Resources Fund concentrates its investments in a specific industry, the fund may be subject to greater risks and fluctuations than a portfolio representing a broader range of industries.
The Morgan Stanley Commodity Related Index (CRX) is an equal-dollar weighted index of 20 stocks involved in commodity related industries such as energy, non-ferrous metals, agriculture, and forest products. The index was developed with a base value of 200 as of March 15, 1996. The Dow Jones UBS Commodity Index is composed of futures contracts on physical commodities, and includes commodities traded on U.S. exchanges, with the exception of aluminum, nickel and zinc, which trade on the London Metal Exchange (LME). The National Association of Home Builders/Wells Fargo builder sentiment index is derived from a monthly survey and gauges builder perceptions of current single-family home sales and sales expectations for the next six months.
Diversification does not protect an investor from market risks and does not assure a profit.
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- October 15, 2012
- China’s Pyramid of Power
China celebrated another achievement last week, as Mo Yan became the first Chinese citizen to win a Nobel Prize for literature. The selection of Mo was praised by a Chinese nationalist tabloid as a sign that mainstream China could “no longer be refused by the West for long.”
Mo grew up in Shandong province in northeastern China, and during the Cultural Revolution, he left school to work in the fields, finishing his education in the army, according to The Guardian. The author draws upon his rural upbringing in his novels, mixing historical perspective with mythical elements. His real name is Guan Moye, but he chose “Mo Yan” as a pen name meaning “don’t speak,” to reflect the culture in which he grew up.
The new Nobel laureate is of the same generation as the new leaders set to take over the Politburo Standing Committee next month after the convening of the 18th National Congress of the Communist Party of China. This group of men (and one female contender) are “old enough to remember the suffering of the Cultural Revolution, but also young enough to fully experience how China has grown through Deng [Xiaoping]’s opening of the economy to market forces,” says CLSA China Strategy research.
They’ve seen vast political reforms take place, transforming China “from a country ruled by the contradictory personal whims of Mao to one ruled through institutions and rules,” says William H. Overholt in The Washington Quarterly. During these decades, “freedoms blossomed, affecting everything from clothing to haircuts to job or marital choices to social and political speech,” says Overholt.
As a result of these policies, they’ve been able to witness China’s incredible growth, with GDP averaging 10 percent per year and more than 500 million people moving out of poverty over the past 30 years.
Now after three decades of tremendous expansion, this new generation of leaders will have to carefully maneuver the country into the next decade, towing the line between maintaining the stability created during the previous Hu-Wen administration and continuing the political and economic reform necessary to adjust to the country’s slowing growth.
China’s pyramid of power is headed by the Politburo Standing Committee (PSC), which will likely have seven to nine new members led by Vice President Xi Jinping and Vice Premier Li Keqiang, selected by a vote of the Central Committee.
Unlike prior committee members who were mostly engineers, the new PSC members have varying liberal arts backgrounds, including history, law and economics, which may help to “address social concerns after decades of focusing mostly on growth,” according to CLSA.
These leaders tend to be more globally aware than their predecessors. They are better traveled, and many have family members, relatives or friends who have gone to school overseas and have foreign residency. “The rapid proliferation of mobile phones, broadband, internet has made unbiased information much easier to access,” says CLSA.
Incoming President Xi Jinping is a princeling who was born into privilege as the son of Xi Zhongxun, who was among the first generation of Chinese leadership and “one of the most liberal leaders under Deng.” His father’s claim to fame was in creating a special economic zone in Shenzhen, which transformed the area from a small village to one of the fastest-growing cities in the world and one of the busiest container ports in China.
Premier Li Keqiang comes from a more common background, as his father, Li Fengsan, was an official of the local government. After the Cultural Revolution, Li was one of the “Class of ’77” when only 273,000 people won admission to universities out of a total of 5.7 million candidates. (By comparison, 58 percent of nine million people in 2007 won admission to universities, according to a 2008 article in The New York Times.) He spent 16 years at the Central Communist Youth League, and then 10 more years in the Henan and Liaoning Provinces before becoming a member of the standing committee.
Underneath the PSC is the Politburo with 25 members, then the Central Committee with 371 members, who then dictate to more than 80 million Communist party members.
So what direction will the next generation of leaders take? This remains a “great enigma,” says Overholt. Xi has been “extremely cautious” about stating his opinions, however, “he has the confidence that comes from being a princeling and from having some military background.” In addition, the other members of the PSC have agendas that are “ambitious and outspoken.” The tensions and inconsistencies that exist within the committee members could be “creatively dynamic or immobilizing,” says Overholt.
CLSA believes that the new leadership will likely push for reform since they will be “forced to adapt to China’s slowing growth.” The research firm says that historically, large reforms successfully occurred after a crisis, including Tiananmen Square and the Asian Financial Crisis.
A nearly 500-page document by the World Bank and China’s Development Research Center of the State Council may give “promising insight into China’s future policy,” says CLSA. The comprehensive report called China 2030 identifies a long-term strategy for Chinese policymakers. The report says that “after more than 30 years of rapid growth, China has reached another turning point in its development path when a second strategic, and no less fundamental, shift is called for.”
It irons out six areas that need to be addressed:
- Structural reforms to strengthen the foundation for a market-based economy need to be implemented
- Innovations need to be accelerated
- The country should pursue “green” opportunities
- All citizens need opportunities and social security
- The fiscal system needs to be strengthened
- China needs to seek mutually beneficial relations with the world
The report concludes by saying that “a successful outcome will require strong leadership and commitment, steady implementation with a determined will, coordination across ministries and agencies, and sensitive yet effective management of a consultation process” that encourages the support of the public. The potential for China to be a “modern, harmonious, and creative high-income society” is there, however, “achieving this objective will not be easy,” says the report.
In November, the U.S. will be focused on its own political situation as Americans head to the polls. While staying active and involved in national politics is important, I believe it’s just as vital to pay close attention to how the leadership change will unfold in the second-largest economy in the world.
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