Investor Resources

Fear, Gold and the Dollar

By Frank Holmes
CEO and Chief Investment Officer

The U.S. dollar is up this week against the euro out of fear of how debt problems in Greece and elsewhere in Europe will be resolved, and as a result gold has had a tough week.

The dollar’s rally appears to be a short-term safe haven move, rather than a response to improving economic conditions in the U.S.

In fact, Friday’s report of a net loss of 20,000 jobs in December (the expectation was for a net gain in employment) and that many thousands more would-be workers have given up looking for jobs is evidence that the economy remains somewhat weak.

This weakness makes it less likely that the Federal Reserve will play it safe by not raising interest rates, and more likely that Congress and the Obama administration will pump more financial stimulus money into the system.

Both keeping rates near zero and expanding the monetary base are negative for the dollar, and thus positive for gold. We’ve seen that after a period of money-supply tightening in December and January, it appears that money is loosening again.

The federal deficit is pegged at more than $1 trillion this year and more than $8 trillion through 2019—this will slowly weigh on the dollar. On top of that, the TARP money being repaid by banks is not being removed from the monetary base—we shouldn’t be surprised if that money is used as a stimulus booster shot ahead of the 2010 midterm elections.

Our gold-dollar oscillator (above) shows that the dollar is approaching being overbought over the past 60 trading days, while the gold is showing signs of being oversold.

The magnitude of the current spread between gold and the dollar typically means that both could be close to a price reversal—dollar heading back and gold back up toward the mean.

In the 1990s, a strong dollar was associated with a strong U.S. economy, but the current one-month dollar rally has been accompanied by a drop in the S&P 500. With most of the world’s economic growth coming in emerging markets, many U.S. companies are relying on overseas sales to drive revenue and profit growth. A stronger dollar hurts U.S. companies trying to thrive in the global marketplace.

This is clearly evident in the illustration below. Here you can see that the world has changed and a strong stock market is aided by a weaker dollar.

Index Summary

• The major market indices were lower this week. The Dow Jones Industrial Index fell 0.55 percent. The S&P 500 Stock Index dropped 0.72 percent, while the Nasdaq Composite finished 0.29 percent lower.
• Barra Growth outperformed Barra Value as Barra Value finished 1.13 percent lower while Barra Growth fell 0.29 percent. The Russell 2000 closed the week with a loss of 1.50 percent.
• The Hang Seng Composite finished lower by 1.73 percent, Taiwan lost 5.53 percent, and the KOSPI declined 2.20 percent.
• The 10-year Treasury bond yield closed at 3.57 percent, down 7 basis points for the week.

Domestic Equity Market

The figure above shows the performance of each sector in the S&P 500 Index for the week. The best-performing sector was materials, up 0.83 percent. Other top-performing sectors include technology and energy. Underperforming sectors were utilities, healthcare and financials.

Within the materials sector the best-performing stock was Airgas Inc., up 44 percent, on news that is was subject of a takeover offer. The other top-five performers in materials were Newmont Mining Corp., Freeport-McMoRan Copper & Gold Inc., Cliffs Natural Resources Inc., and FMC Corp.

Strengths

• The gold group was the best-performing group for the week, up 8 percent, led by its only member Newmont Mining Corp.
• The electrical component & equipment group was the second-best performing group, up 6 percent, driven by its largest member, Emerson Electric Co. The company reported first quarter earnings and issued full-year earnings guidance above the consensus.
• The home entertainment software group was the third-best performing group, up 6 percent. Electronic Arts Inc. announced late on Friday of last week that its new game Mass Effect 2 had sold 2 million copies in its first week and received an average quality score of 96 percent, making it the highest-rated game ever produced by the company.

Weaknesses

• The trucking group was the week’s worst performer, dropping 9 percent. Ryder System Inc. reported a fourth quarter profit below street expectations and issued 2010 earnings guidance below the consensus estimate. In addition, the earnings release referred to “the challenges of the prolonged multi-year freight recession which extended through the fourth quarter.”
• The healthcare facilities group was the second-worst performer, down 8 percent. Tenet Healthcare Corp. had been expected to benefit from the proposed healthcare legislation but its enactment is uncertain at this time.
• The regional banks group underperformed, down 5 percent for the week. There was investor concern that some of these banks would have to raise additional equity money in order to repay the government loans.

Opportunities

• There may be an opportunity for gain in M&A (merger & acquisition) transactions in 2010.
• The recent decline in the market could be an opportunity to initiate positions in selected stocks with good fundamentals which had previously been considered to be overvalued.

Threats

• Should investors’ expectations for an improving economy not come to fruition on a reasonable timeframe, it could be a threat to stock prices.
• As governments around the world begin to wind down the monetary and fiscal stimulus programs put in place during the economic crisis, this will likely present a headwind for stocks.

The Economy and Bond Market

Treasury yields were mixed this week as the middle part of the curve rallied while the long end rose slightly. Concerns over the potential of a debt default in Greece early in the week quickly spread to wider problems in the euro zone which include similar concerns surrounding Spain and Portugal. The U.S. dollar rallied strongly on these concerns, which helped support the Treasury market.

Two important pieces of economic data were released this week: the ISM Manufacturing Index and the amount of change in nonfarm payrolls in the unemployment report. These two series are graphed below and represent the past 20 years of data and shows how these two series tend to move in tandem. This week the ISM index hit the highest level in more than five years, which bodes well for job growth in the near future if history is any guide.

Strengths

• The ISM Manufacturing Index hit 58.4, well above the economic breakeven level of 50, the highest level in over five years. The jobs index component also rose the highest levels since 2006.
• Retail sales in January broadly beat expectations, reinforcing the idea that the economy is improving and consumers are becoming more confident.
• The ISM Nonmanufacturing Index also rose in January, hitting 50.5 with strength seen in the amount of new orders.

Weaknesses

• Concerns over the potential of a debt default in Greece early in the week quickly spread to wider problems in the euro zone which include similar concerns surrounding Spain and Portugal. These concerns caused risky assets to fall across the board and are a threat to global economic recovery.
• January’s employment report was somewhat disappointing as nonfarm payrolls failed to break into positive territory as the economy lost 20,000 jobs last month.
• Construction spending fell 1.2 percent in December and a record 12.4 percent for the full year.

Opportunities

• The economic recovery is still intact but looks more fragile now than it did just a couple of months ago. This will likely keep the Fed on hold for some time.

Threats

• If one of the euro zone countries were to seriously threaten default, the entire euro currency system could come into question, threatening global financial stability.

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World Precious Minerals Fund - UNWPX • Gold and Precious Metals Fund - USERX

Gold Market

For the week, spot gold closed at $1,065.85 per ounce down $15.00 or 1.39 percent. Gold equities, as measured by the XAU Gold & Silver Index gained by 4.27 percent for the week. The U.S. Trade-Weighted Dollar Index gained by 1.07 percent.

Strengths

• The U.K.’s Royal Mint more than doubled gold-coin production last year as investors diversified into physical assets. Output rose to 125,469 ounces from just 46,315 ounces during the previous year, according to data from Bloomberg News. Sales of American Eagle coins by the U.S. Mint increased 66 percent last year to 1.43 million ounces.
• The Russian Gold Industrialists’ Union said Russia’s gold production rose 11.2 percent in 2009 on a year-over-year basis to 205.2 tonnes. Output of gold production by refining the metal from scrap rose 52.4 percent to 12.4 tonnes.
• According to the Indian Bullion Market Association, 37 tonnes of gold were imported during the month compared with 27 tonnes for December and 30 tonnes in November. The increase was primarily attributed to jewelers shifting to the precious metal as record prices began to drop.

Weaknesses

• During the week, gold posted its biggest one-day loss since 2008, hitting a three-month low. This came as risk aversion resurfaced throughout global markets, triggering massive selling in the metal and other commodities. Also, tightening in Chinese monetary policy may have caused the Reserve Bank of Australia to remain reluctant in raising rates once more because of speculation there will be a lack of demand for the region’s commodities, a prime contributor to its overall economic growth.
• The eruption of policy and sovereign credit risk, most notably in the euro zone area, has resulted in a flight-to-quality causing the U.S. dollar to strengthen relative to a faltering euro. Greece’s fiscal imbalances combined with Spain and Portugal’s weak bond auction earlier in the week witnessed rising borrowing costs and credit default swaps for the region. Spreads were further exacerbated on fears that striking Greek workers would hinder Greece’s plan to shrink its massive deficits to acceptable European Union standards.
• Bloomberg has reported that commodity investors in China are reducing their open interest in futures markets ahead of the country’s biggest national holiday. The director of research from Wanda Futures Co. said the exit of funds from commodities is accelerating and that any rally may have to wait until the country's New Year celebration ends.
• Reserves for the world’s largest bullion-backed exchange-traded fund fell 21.7 tonnes or 1.9 percent in January, against a rise of 63.36 tonnes or 8.1 percent in the same month of 2009.

Opportunities

• Andy Smith, Senior Metals Strategist of Bache & Co., believes the latest correction in the gold price is a very opportunistic event for further sovereign and central bank gold buying. The International Monetary Fund still has 191 tonnes of gold available for purchase. Smith has also said that India, Mauritius and Sri Lanka may buy more gold at depressed prices to average down earlier purchases at much higher prices.
• The World Gold Council has demanded tax benefits for gold investments in India, primarily for working women and the bottom level tax bracket. The Council has also said that gold should play a more significant role in the sustainable growth of the Indian economy.
• The White House has unveiled its plans to double U.S. exports in a bid to boost the economy and reduce the deficit by pledging to pursue more trade agreements, increasing pressure on trading partners to open markets and by the creation of an export promotion cabinet.

Threats

• A Bloomberg news columnist expressed that China’s large foreign exchange reserves pose a severe risk to the global economy. If the dollar were to collapse, actions taken by central banks to sell the currency could shake global markets more than the U.S. credit crisis has. Also, excess reserves can overheat an economy as it sells its currency to increase investments abroad, triggering an imbalance from an excess in the money supply which leads to higher levels of inflation.
• The Reserve Bank of Zimbabwe failed to redeem scheduled bonds it issued to mining companies instead of cash payment for gold deposited with the central bank by mining companies. The central bank has already failed to pay for gold delivered to it by miners in 2007 and 2008, leading to the issuance of the negotiable bonds, and now intends to extend the term of the bonds for six months. This is a major blow to miners as they struggles to recover since they cannot have access to foreign currency to conduct their business.
• The African National Congress of South Africa is pushing for the nationalization of at least 60 percent of the country’s mining sector which will involve expropriation with or without compensation. However, analysts say the proposal is unlikely to become government policy, but it has still managed to rattle investors.
• The U.S. government intends to cut more than $1 trillion from the deficit over the next decade by allowing billions of dollars in tax breaks to expire by the end of the year and possibly sending personal income tax rates to higher levels. Investors may also pay more on their earnings next year as well, with the tax on dividends jumping to 39.6 percent from 15 percent and the capital gains tax increasing to 20 percent from 15 percent.

Energy and Natural Resources Market

Despite Concerns over the Global Economy, Leading Indicators & Global Industrial Production are Improving

Strengths

• The American Iron & Steel Institute reports that for the week ending January 30, steel utilization rates increased to 66.9 percent versus the prior week of 65.6 percent and 42.4 percent last year.
• Prices for Indian iron ore shipments to China jumped $1-2 per metric ton to a range of $127-130 per ton after news broke that India may increase export duties to 15 percent.
• The U.S. Rig Count is up 18 from last week to 1,335 but is still down 64 year-over-year.

Weaknesses

• Commodities such as crude oil and copper declined by 1.3 and 6 percent, respectively, in response to fears that some European nations could default on their debt as budget deficits widen due to the global recession.
• Chinese steelmakers are “almost not profitable” in their main business because of overcapacity and high raw material costs, Nanjing Iron & Steel United Co. said.

Opportunities

• According to the International Copper Study Group, global copper mine capacity will expand to 20.04 metric tons in 2010, versus 19.51 metric tons in 2009.
• An article from Reuters states that Transocean is nearing a deal with Exxon to build a $1 billion arctic drillship. The article mentioned the new rig could be deployed to places such as Greenland, Iceland or offshore Alaska at a rig rate in the range of $650,000 per day.
• Zimbabwe’s platinum exports are set to double after Impala Platinum Holdings Ltd. completed an expansion project in the country during the last quarter of 2009, according to Mines Minister Obert Mpofu.
• Indonesia’s Department of Energy and Natural Resources expects coal exports from the country to fall 1.5 percent in 2010 despite a predicted production rise of 6.3 percent to 270 metric tons. The department expects domestic demand, led by the electricity generation sector, to rise by 34 percent.

Threats

• U.S. Interior Secretary Ken Salazar said that drilling for oil and natural gas on government land will face increased environmental scrutiny and slower approvals under new requirements currently being debated in Congress.

Emerging Markets

Strengths

• Hong Kong’s retail sales rose 16 percent year-over-year in December, the fastest pace in 20 months and ahead of market expectations. The growth was thanks to improving employment and a 14 percent year-over-year increase in tourist arrivals from mainland China.
• South Korea’s exports jumped 47.1 percent in January from a year earlier, the highest growth rate in more than 20 years, as the continued global recovery drove external demand for autos, appliances and electronics.
• Chile’s economic activity expanded by a higher than estimated 3.9 percent year-over-year in December, the country’s highest growth in 15 months, due to a rebound in services and retail sales.

Weaknesses

• China’s official Purchasing Managers’ Index moderated to 55.8 in January from 56.6 in December, partly due to seasonal factors.
• Fitch described Hungary’s fiscal prospect as uncertain ten weeks ahead of the country’s general elections and remained undecided whether to increase its credit rating outlook.
• Emerging market equity funds saw a $1.6 billion outflow in the week ended February 3, the biggest liquidity exodus in 24 weeks. The outflow came amid rising concerns on the sovereign debt situation in such European countries as Greece, Portugal and Spain.

Opportunities

• While China’s city population has been consistently growing in the last decade, over 40 percent of the counties in central China still have an urbanization rate of merely 20-30 percent. According to CEBM, consumer spending can be boosted by more than 45 percent when the urbanization rate rises by 10 percentage points to the 30-40 percent range. Expanded urbanization, especially in inland China, remains one of the policy solutions for stimulating domestic demand and bodes well for consumer plays in the long term.

Threats

• The current rally in the U.S. dollar may continue to be a headwind for investors in Asia given the longstanding negative correlation between the U.S. dollar and Asian equities.

Leaders and Laggards

The tables show the performance of major equity and commodity market benchmarks of our family of funds.

Please consider carefully the 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.

An investment in a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. Past performance does not guarantee future results. Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio. The Eastern European Fund invests more than 25 percent of its investments in companies principally engaged in the oil & gas or banking industries. The risk of concentrating investments in this group of industries will make the fund more susceptible to risk in these industries than funds which do not concentrate their investments in an industry and may make the fund’s performance more volatile. 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. Gold funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The price of gold is 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 percent to 10 percent of your portfolio in gold or gold stocks. Tax-exempt income is federal income tax free. A portion of this income may be subject to state and local income taxes, and if applicable, may subject certain investors to the Alternative Minimum Tax as well. Each tax free fund may invest up to 20 percent 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. Bond funds are subject to interest-rate risk; their value declines as interest rates rise.

These market comments were compiled using Bloomberg and Reuters financial news.

Holdings as a percentage of net assets as of 12/31/09:

Airgas Inc.: 0.0%
Newmont Mining Corp.: Gold & Precious Metals Fund: 1.01%; World Precious Minerals Fund: 0.46%
Freeport-McMoRan Copper & Gold Inc.: Gold & Precious Metals Fund: 1.03%; World Precious Minerals Fund: 0.50%; Global Resources Fund: 2.93%; China Region Fund: 1.29%; All American Equity Fund:1.48%; Holmes Growth Fund: 1.31%; Global MegaTrends Fund: 1.31%; Global Emerging Markets Fund: 1.39%
Cliffs Natural Resources Inc.: Global Resources Fund: 1.25%; All American Equity Fund: 1.12%
FMC Corp.: 0.0%
Emerson Electric Co.: 0.0%
Electronic Arts Inc.: 0.0%
Ryder System, Inc.: 0.0%
Tenet Healthcare Corp.: 0.0%
Nanjing Iron & Steel United Co.: 0.0%
Transocean Ltd.: 0.0%
Exxon Mobil Corp.: 0.0%
Impala Platinum Holdings Ltd.: Global Resources Fund: 1.99%

*The above-mentioned indexes are not total returns. These returns reflect simple appreciation only and do not reflect dividend reinvestment.

The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry.
The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.
The Nasdaq Composite Index is a capitalization-weighted index of all Nasdaq National Market and SmallCap stocks.
The S&P BARRA Growth Index is a capitalization-weighted index of all stocks in the S&P 500 that have high price-to-book ratios.
The S&P BARRA Value Index is a capitalization-weighted index of all stocks in the S&P 500 that have low price-to-book ratios.
The Russell 2000 Index® is a U.S. equity index measuring the performance of the 2,000 smallest companies in the Russell 3000®, a widely recognized small-cap index.
The Hang Seng Composite Index is a market capitalization-weighted index that comprises the top 200 companies listed on Stock Exchange of Hong Kong, based on average market cap for the 12 months.
The Taiwan Stock Exchange Index is a capitalization-weighted index of all listed common shares traded on the Taiwan Stock Exchange.
The Korea Stock Price Index is a capitalization-weighted index of all common shares and preferred shares on the Korean Stock Exchanges.
The Philadelphia Stock Exchange Gold and Silver Index is a capitalization-weighted index that includes the leading companies involved in the mining of gold and silver.
The U.S. Trade Weighted Dollar Index provides a general indication of the international value of the U.S. dollar.
The S&P/TSX Canadian Gold Capped Sector Index is a modified capitalization-weighted index, whose equity weights are capped 25 percent and index constituents are derived from a subset stock pool of S&P/TSX Composite Index stocks.
The S&P 500 Energy Index is a capitalization-weighted index that tracks the companies in the energy sector as a subset of the S&P 500.
The S&P 500 Materials Index is a capitalization-weighted index that tracks the companies in the material sector as a subset of the S&P 500.
The ISM manufacturing composite index is a diffusion index calculated from five of the eight sub-components of a monthly survey of purchasing managers at roughly 300 manufacturing firms from 21 industries in all 50 states.
The ISM Services Non-Manufacturing Index is a national non-manufacturing index based on a survey of roughly 370 purchasing executives in industries including finance, insurance and real estate (or FIRE), communications and utilities. This sister of the Purchasing Managers’ Index measures service-sector activity.
The China Purchasing Managers’ Index, a gauge of nationwide manufacturing activity, is issued by the China Federation of Logistics & Purchasing and co-compiled by the National Bureau of Statistics.