The Fire Fueling Gold
Frank Holmes

Gold took quite a beating in September, bucking its seasonal average monthly return of 2.3 percent. The political battle between President Barack Obama and Congress, China’s Golden Week, and India’s gold import restrictions likely weighed on the metal.

September’s correction only adds to the negative sentiment toward the precious metal. The assumption from many market pundits is that gold is no longer attractive as an investment. With rising rates and continuing low inflation, U.S. investors believe they have a solid case for selling their holdings.

However, this could be a premature assessment, causing these bears to potentially lose out on a lucrative position.

Allow me to use an ice cube to explain.

One of the strongest drivers of the Fear Trade is real interest rates. Whenever a country has negative-to-low real rates of return, which means the inflationary rate (CPI) is greater than the current interest rate, gold tends to rise in that country’s currency.

Our model tells us that the tipping point for gold is when real interest rates go above the 2-percent mark

Consider the ice cube, which shows how new equilibriums can have significant effects. At 31 degrees, H2O is a solid chunk, but when the temperature increases, the mass slowly begins to turn into a liquid. Above 32 degrees, ice changes form from solid to liquid, but it’s still made of hydrogen and oxygen.

Because money is like water, when many other economic dynamics, such as population growth, urbanization rates and changes in government policies, reach their tipping point, the velocity of money tends to be altered.

As global investors, we watch for changes in these trends to know how to invest in commodities and markets, find new opportunities and adjust for risk.

So, how close to gold’s tipping point are we? In other words, what is the real interest rate today? As you can see below, Treasury investors continue to lose money, as the 5-year bill yields 1.41 percent and inflation sits at 1.5 percent. This is nowhere near the 2 percent mark.

I would be worried about gold if real interest rates solidly crossed the 2 percent threshold for an extended amount of time, because it would have a dramatic effect on gold as an asset class. In a high interest rate environment, gold and silver lose their attraction as a store of value.

In order for that tipping point to happen, rates would need to continue rising above inflation, and inflation would need to remain low. These are the forecasts made by many gold sellers today; however I wouldn’t get too trigger happy just yet, as recent data challenges these assumptions.

Take the monthly unemployment figure, which is one of the primary indicators the Federal Reserve studies when evaluating the economy

But depending on the definition of an unemployed person, the numbers reveal different results.

The official U3 unemployment rate, the exact figure Ben Bernanke uses, tracks the total unemployed as a percent of the civilian labor force.

The broadest gauge calculated by the Bureau of Labor Statistics (BLS) is the U6 unemployment rate. For this number, the BLS adds in all those people who are marginally attached to the labor force, plus people working part-time but want to work full-time.

What does “marginally attached to the labor force” mean? These people are neither working nor looking for work but indicate they want a job, are available to work and have worked during some period in the last 12 months. These marginally attached people also include discouraged workers who are not looking for work because of some job-market related reason.

Then there’s a measure of the labor market the BLS tracked prior to 1994. This is the seasonally-adjusted alternate unemployment rate that statistician John Williams continued to calculate. It’s basically the U6 plus long-term discouraged workers.

While the figures closely followed one another from 1994 through 2009, there’s recently been a shift. U3 and U6 have been trending downward over the past few years, whereas Williams’ ShadowStats unemployment rate shows a noticeably upward trajectory. Perhaps the official unemployment figure overstates the health of the economy?

Based on the jobs market, a limited housing recovery and regulations that have been slowing down the flow of money, the Fed may have no choice but to raise rates very gradually to keep stimulating the economy.

Then there’s the suggestion of inflation manipulation

Even though the U.S. has been reporting a low inflation number, things feel more expensive to many Americans. Disposable income has been growing less than inflation in recent years; perhaps that’s why many people feel “squeezed.”

Also consider Williams’ chart below. It shows monthly inflation data going back for more than a century. The blue and grey shaded areas represent BLS’ historical Consumer Price Index (CPI). You can clearly see the wild swings of inflation and deflation, especially during World War I, the Great Depression, and World War II, as well as the stagflation of the 1970s and early 1980s.

However, shortly after disco, bell bottoms, and episodes of “All in the Family” faded from memory, the U.S. adjusted CPI, not once but twice, first in the early 1980s and again in the mid-1990s. If you use the pre-1982 calculation, you end up with a much different inflation picture. This is the area shaded in red.

Figures don’t lie, but liars figure

Way back in 1889, statistician Carroll D. Wright, in addressing the Convention of Commissioners of Bureaus of Statistics of Labor, talked about the impartial and fearless presentation of its data, using the above play on words. He said,

“The old saying is that ‘figures will not lie,’ but a new saying is ‘liars will figure.’ It is our duty, as practical statisticians, to prevent the liar from figuring; in other words, to prevent him from perverting the truth, in the interest of some theory he wishes to establish.”

Wright’s speech seems particularly relevant today.

For patient, long-term investors looking for a great portfolio diversifier, a moderate weighting in gold and gold stocks may be just the answer. And, today, when looking across the gold mining industry, you’ll find plenty of companies that have paid attractive dividends, many higher than the 5-year government yield.

What Gold Miners Are Thinking Today

Having one-on-one conversations with numerous executives from gold companies is an invaluable way to evaluate the state of the gold mining industry. We believe this is unmatched experience you can’t gain from reading financial statements.

Even though the Denver Gold Forum experienced a small drop in attendance, the number of one-on-one meetings grew sharply, which suggests buyers might be on the prowl. In addition to the increase in registration from value-focused funds and private equity funds, there was a 61 percent rise in one-on-one meetings this year. According to Mineweb’s Lawrence Williams, this bodes well for a considerable increase in mergers and acquisitions activity in the sector over the next few months.

Ralph Aldis, Brian Hicks and Samuel Pelaez gained useful “boots-on-the-ground” knowledge at the Denver Gold Forum, which primarily has senior miners, and at the Precious Metals Summit, which is focused on the juniors. At 30-minute increments, they met with an incredible 58 different companies on an individual basis.

Here are some of their takeaways:

• Companies may be resource rich, but they are capital poor. Despite the optimism in mergers and acquisitions, the junior gold exploration cash crisis continues to mount, with no quick turnaround in sight. According to Kaiser Research, back in November 2012 the number of juniors with less than $200,000 in Canadian dollars available to them was 632 out of around 1,800 public gold companies. In June this year, the number grew to 751, and more recently it grew to 816, nearly half the equities measured.
  
  
• Some seniors are focused on organic growth, others want to be more profitable. Some large mining companies, such as Yamana and Goldcorp, indicated that they want organic growth. Others, such as Barrick, are scaling down to ensure that ounces are more profitable. It’s all about proper capital budgeting.
  
  
• Geographically stable areas are a big focus. Countries such as Canada and the U.S. are a huge draw. Take Klondex Mines, for example. The U.S. Global team recently trekked to Nevada to check out the Fire Creek project. With nearly 300,000 ounces of gold at a grade of 44.7 grams per ton in the measured and indicated category, Fire Creek’s minerals are impressively high-grade.

  It’s also located in one of the safest mining jurisdictions with excellent infrastructure and experienced management to develop a narrow vein deposit. Klondex is run by a top-notch guy. CEO Paul Huet has great operational experience working with Nevada mines, resulting in a shift in drilling and mining methodology, which allows the team to complete work more quickly.

• Specifically related to Goldcorp, CEO Chuck Jeannes outlined that the company is not ruling out participation in new takeovers. Jeannes hinted the company is not against looking at large multi-billion-dollar capital-intensive gold projects that have alarmed investors in recent months. In his view, Goldcorp’s strong balance sheet is a result of outstanding capital discipline in recent times, and even though the company’s focus is on building three existing projects to boost production, the company will continue to look at new opportunities.
  
  
• What impressed us most was a simple, bullish statement made by President and CEO Kevin McArthur from Tahoe Resources, former president and CEO of Goldcorp. He believes the evidence supporting gold is clear due to the fact that currencies around the world are being debased. This currency debasement makes the precious metal as a currency and store of value remain attractive.

These notes only skim the surface of the tacit knowledge we’ll be applying to our investment decisions for the Gold and Precious Metals Fund (USERX) and the World Precious Minerals Fund (UNWPX). You may also want to go to Kitco’s website, which had great coverage of the Denver Gold Forum, including some additional thoughts from Ralph and Brian on the gold market. Read the article now.

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.

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 above, you will be directed to a third-party website. U.S. Global Investors does not endorse all information supplied by this website and is not responsible for its content.

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.

Holdings in the Gold and Precious Metals and World Precious Minerals Fund as a percentage of net assets as of 6/30/13: Agnico Eagle (Gold and Precious Metals Fund 2.10%, World Precious Minerals Fund 2.49%), AngloGold (Gold and Precious Metals Fund 0.01%, World Precious Minerals Fund 0.01%), Barrick Gold (Gold and Precious Metals Fund 2.18%, World Precious Minerals Fund 0.12%), Gold Fields (Gold and Precious Metals Fund 0.01%, World Precious Minerals Fund 0.01%), Goldcorp (Gold and Precious Metals Fund 0.21%, World Precious Minerals Fund 0.12%), Harmony (Gold and Precious Metals Fund 1.95%, World Precious Minerals Fund 1.55%), Kinross (Gold and Precious Metals Fund 1.00%, World Precious Minerals Fund 0.14%), Klondex Mines (World Precious Minerals Fund, 3.48%), Newcrest (Gold and Precious Metals Fund 1.56%), Newmont Mining (Gold and Precious Metals Fund 2.25%, World Precious Minerals Fund 0.06%), Polyus Gold 0.00%, Randgold (Gold and Precious Metals Fund 0.06%, World Precious Minerals Fund 0.06%), Sibanye 0.00%, Tahoe Resources 0.00%, Yamana Gold (Gold and Precious Metals Fund 2.37%, World Precious Minerals Fund 1.54%)

Frank Holmes
website: www.usfunds.com

www.usfunds.com