In the latest edition of the Mines and Money interview series, we spoke with Frank Holmes, CEO & CIO of US Global Investors.
We asked Frank about the current macro-economic drivers that are affecting the gold price (including what he refers to as the love trade and the fear trade) and explains why gold mining stocks are currently “extremely attractive”, offering a better investment proposition that gold bullion.
Frank Holmes is speaking at Mines and Money London this year where he’ll be presenting a keynote session on Day 1 called ’50 Shades of Gold’, a sideways look at the state of the gold market.
Mines and Money: Frank, I want to begin by asking you are there indicators that suggest we’ll see a rebound in the gold price in the near future and potentially reaching the highs of near $1,900? What are the current factors at play here?
Frank Holmes: You could try to simplify looking at the macro picture when it comes to gold and what are two demand-drivers. In simple terms, try to characterise them as the fear trade and the love trade. When we look at the fear trade the key factors there that seem to capture 80% of the noise, is the monetary money supply base – what it’s doing- and two are real interest rates, are investors receiving on a 90-day treasure bill, a return that is less than the CPI of that country’s currency? So, when inflation is greater than what the government is willing to pay you on short term money, then gold starts to rise on that country’s currency, that’s part of that fear trade. If real interest rates, that is, if real interest rates are 2% above the inflationary rate, gold is usually unattractive on that country’s currency. Now, when we come to love trade as a factor to look at is we like to track GDP per capita, and GDP per capita is very important because rising incomes in China, India, South East Asia, the Middle East etcetera it’s highly correlated to buy more gold because they have a cultural affinity. So there is a combination that most of the Middle East – the whole of Middle East – and going over to Asia has this cultural affinity of giving gold to celebrate any type of a special event. How much gold they will buy and give is highly correlated to the GDP per capita.
So, what do we see at US Global? We see the GDP per capita, which has been stagnant for two years now in emerging countries, is finally starting to pick up and it’s just modestly. So if you go back two years ago when gold was at $1900, we had that perfect storm. We had the beginning of Ramadan, religious holiday, cultural affinity, we had a strong GDP per capita throughout the emerging countries and you had, in America, the currency under siege because it was being derated and Obama was fighting to raise the debt ceiling and all that drama created, what we like to call, a two standard deviation movement, the price of gold was up 30% over 12 months. Since then, its corrected but what’s really interesting to us in looking at that, is in the past three years, gold is still up 12%, more than money funds or bond funds and further to that, when you look in Rupee terms in India where currency has been under siege this year, gold is up 58% over three years. So, not only has it been a good investment for love, it’s also been a good investment to protect your currency against currency devaluation.
MM: How about gold mining stocks? We have seen devaluations across the sector, will an upward move in the gold price be enough to see it rise in the stock market?
FH: I think you’re going to have a combination and it’s going to hit. I don’t know when it is going to take place over the next 12 months, but these companies that had a wake up call. Mike Tyson, the great boxer had a great line that everyone gets in the ring and has a plan until they gets punched in the face. And I think many CEOs of gold mining companies just got punched in the face on growth for the sake of growth, deluding shareholders with stupid acquisitions that are not a creative and to expansion– growth just for the sake of growth. Now, they’re licking their wounds and you are starting to see cost control. So, I was recently at the Bank of America’s conference for gold mining and resource companies in Toronto and my team was at the Denver Gold Show and a common theme throughout the industry right now is get costs under control, slow down the development projects, cancel projects, whatever you do, you must stay focused on getting profit margins up and getting your cost under a $1000 an ounce. As this is going through and you get a rise in the price of gold, all of a sudden, the cash flows will expand dramatically and you’ll see money flow into these gold stocks after that re-rating. What’s really important for investors – patient investors – is that gold stocks are, I think, much more attractive than bullion at this stage and the reason for that is because I’ve never seen where you are getting divided yields on companies like Franco Nevada. It is a wealthy company, as is Goldcorp. They both pay monthly dividends and those monthly dividends, those annualised incomes are greater than a five year US government note and a five year US government note has a unit on it that is less than a CPI number. So I think that gold stocks are extremely attractive and going forward that is where you’ll make your biggest money.
MM: At the junior end of the market, if you are an investor looking at juniors and trying to identify those who have been most successful with these cost efficiency strategies, how do you go about identifying them?
FH: We screen 88 gold producers and another several hundreds of junior mining companies that don’t have any production and we take a look at the size of their footprint, how many ounces they have, the grade they have and the location and the track record of management to try to make a determination of what the opportunity is for that risk. There are certain countries that have no-fly zone, basically they are just too unstable for resource investing and so we try to also eliminate those numbers but I think the big part here is, what is the track record of management? One of those we look at CEOs, it’s not just are they mining engineers or geologists, how well do they know the street?
When we say the street, on the buy and sell side, how many analysts do they really know? How many analysts have they made their presentations to? Who they have a rapport with? How do they communicate on a timely basis to those investors and let them know where they are in their life cycle of that mine to have that support? And we find that a lot of these guys only show up when they want money and they should just go to the HR department to look for a job then because that’s basically what happens. When we put money to these juniors, we are employing these people and what happens when they don’t have the results? What’s external versus internal? How well do they know how to resolve issues? So, I think that a lot, it has been a big wake up call to many of these juniors and they have to make sure they communicating on a very cost efficient way, but on a consistent and regular basis.
MM: At Mines and Money London in December where you will be presenting a keynote, for investors it gives them the opportunity to speak directly to senior management teams of a large range of mining companies. What’s your advice to investors wanting to get a piece of the action? What sort of questions should they be asking these gold mining companies who will have booths at the event?
I think the first thing is what’s their criteria? What everyone, these junior mining guys have to realise, is that they’re trying to get shelf space. So let’s say we have a Walmart, we choose Walmart and you’re trying to get shelf space at those product lanes just like Proctor and Gamble is trying to get shelf space in any type of a store and so that is the same metaphor for a portfolio. What are they going to do that makes them attractive? I think a lot of companies don’t think this way in presenting their story, because they have to compete with other mining companies. It is a very competitive space for capital and its very competitive space in how they have to position themselves in the eyes of investors for us to say, ‘You know what, we’re going to sell something to buy you, your particular company because your story seems more compelling to unlock value,’ I think that is one key factor. Another one is to listen to people like Mark Bristow at Randgold who is very structured in his discipline. Not only is he very smart, with a PhD in geology, but he’s also very sensitive to capital markets and who’s in the buy side and who is in the sell side from the analysis. When it comes to companies, he has a very strict discipline of a 20% return on capital with a higher discount rate than a lot of the street. How do you turn around these junior companies that say, ‘Well, we have a model that says that at a 15% discount rate, that we can generate 20% return on our capital.’ Well, that’s very appealing to someone like Randgold and its how companies try to study, junior companies with senior companies, what’s their criteria to look at a project? The same thing when it comes to a company like ourselves is buying one of these deals, or financing one of these companies, how do we make five bagger or a ten bagger? When we buy these little junior companies, we have to think over the next two years, can these things, these particular companies, rise five-fold, ten-fold? What’s the probability of that?
M&M: Finally, I wanted to ask, as we march towards the final quarter of 2013, what are the key reasons that investors should include gold mining stocks in their investment portfolio?
FH: There’s been a lot of research, and very compelling research, that shows- and we quite often advocate that, it’s a 10% weighting in gold and go say 5% bullion and gold jewelry, or 5% in gold stocks and re-balance each year. The magic is having a 3% weighting but re-balancing so that when you do get these spectacular runs where gold does rise over 12 months 30%, you take some profits and you re-position them to your other holdings and when gold has been down, like you see in gold stocks are sold undervalued on a wealth of basis, you turn around and add to your positions. It’s just re-balancing, it’s a second derivative of A) having a 10% weighting and B) it’s just re-balancing, which is the key.
You can hear more from Frank Holmes along with a host of other mining investment leaders at Mines and Money London where he’ll be presenting a keynote session on Day 1 called ’50 Shades of Gold’, a sideways look at the state of the gold market.
Mines and Money London is Europe’s leading mining investment and capital raising forum, bringing together over 3000 investors, financiers, brokers and mining developers for up to five days of learning, knowledge sharing and deal making. With 260 mining companies showcasing their projects, some of the world’s largest fund managers in attendance, and a packed program of keynotes, market analysis, company presentations, discussion panels, and workshops, Mines and Money London will deliver fresh ideas and opportunities for 2014.