Frank Holmes: Gold Is for Fighting Deflation, Not
Source: Zig Lambo of
The Gold Report
Whether out of fear or love, everyone is running to gold, says
Frank Holmes, head of investment firm U.S. Global Investors. The
lengthy Congressional battle to raise the debt ceiling left many
investors clinging to gold for safety. But a growing world
population continues to stock up on the honeyed metal for
weddings and holidays. In this exclusive interview with
The Gold Report,
Holmes explains where our love-hate relationship with gold is
headed and how to profit.
The Gold Report:
After the protracted battle in Congress over the debt ceiling and
budget cuts, there were some expected consequences and some
unintentional ones. What trends in precious metal equities have
developed as a result of the activity in the last few days?
After the recent sell-offs, almost every equity market is in bear
territory and deeply oversold. According to our mathematical
models, gold is the only exception. There is a huge fear trade
going on-a flight to safety.
The rhetoric surrounding the debt ceiling proved that
politicians are not serious about balancing the budget. This is
alarming to investors. Add to that unease the European contagion
potential where many German and French banks have been selling
their gold for the past five years to buy sovereign debt. Gold
was not considered Tier 1 capital and was carried at a discount.
These central banks sold their gold at $500, $600, $700,
$1,000/ounce (oz.) to buy Greek, Portuguese, Italian and Spanish
bonds in an attempt to earn a higher interest rate. If any of
those countries were to default, then German and French banks
would not be able to lend. This fear is very significant.
What do you see as a resolution? Or is there a resolution?
The most significant factor in our capital markets is
regulations, or "oppressive regulations," as Bill Gross, founder
of Pacific Investment Management Co. LLC (PIMCO), calls it. The
cost of regulation is so expensive; it's like injecting
cholesterol into the veins of the economic system. Blood has to
flow freely through an economy to get growth. Right now, all we
see is an exponential growth of regulations. The Dodd-Frank Act
regulations are only supposedly 10% implemented. That leaves a
lot of blockage yet to come.
The financial sector, which is the second biggest sector of
the S&P 500, is leveraged 12-to-1. Federal Reserve Chairman
Ben Bernanke can inject capital into the market, but if it is
overwhelmed with regulations, there is not going to be turnover
of that money supply. We will see continued deflation.
You can see how it's creating a traffic jam. It's not just
political. It's not just an issue of Democrats versus
Republicans. Runaway regulations on steroids are jamming down
every aspect of the economic system.
Gold stocks should have some significant positive fallout as
investors clamor for safety. Are exchange-traded funds (ETFs)
going to see the bump first?
Gold equity bullion ETFs have made it easy for investors to get
gold exposure. However, I think that gold has gone up
exponentially and is due for a correction. It's up more than 36%
over 12 months. Any time it makes a move like that over 12
months, there is a 90% probability of an 8% to 15%
But there are themes in play that are favorable to gold, such
as the "love trade." The world's population has doubled since the
1970s. Half of that population gives gold for religious holidays,
weddings and birthdays. There is a high correlation of the gross
domestic product of countries that follow these practices and
growth to the consumption of gold. The World Gold Council said
that rural housewives in India hold roughly twice the amount of
gold that the U.S. has stored in Fort Knox.
We have noticed in our financial models that any time a
government pays less on their Treasury bills than inflation, gold
starts rising in that country's currency. Of the seven most
industrialized countries in the world, only one has a positive
real rate of return above inflation. China, India, Russia, the
U.S., Europe-they all have negative real rates of return. They
are all offering a negative real rate of return in short-term
deposits and bonds. Gold will start to rise on that financial
aspect. Add in the deficit spending taking place and that gold is
in a secular bull market, and investors should want to add to
How do banking regulation and models like the international bank
capital accords, Basel I and II, play into this?
Now we are going to Basel III, which is basically banking
requirements for how much capital they have to lend against. If a
bank has $1 billion (
) in capital, that means that it can take deposits and have a
debt portfolio of $12B, or 12 times that. But what do they put up
for $1B of capital? Gold was always classified as a lower tier
asset class, meaning it had to be carried at a discount. It was
never treated as money. Basel III, coming out in the fall, will
treat it as sovereign debt.
Central bankers sold their gold to buy junk debt. Now there is
going to be a shift in central bank buying. During the past eight
years, emerging markets have been buying gold. India bought $6.7B
in gold in 2009 from the International Money Fund. Recently,
South Korea and Mexico bought tons of gold. Once Basel III goes
through, central bankers in Europe along with commercial banks
will likely become net buyers of gold. That will change the
landscape as gold will be treated equally with sovereign
Along with the backdrop of rising GDP-per-capita in emerging
countries, gold has a probability of doubling over the next five
years. The last bit of math that has a high correlation to gold
from a financial point of view is money supply growth. The G7
countries have money supply growth on a year-over-year basis of
around 4%. Emerging countries have slowed down to 18%. I think
that money supply in these emerging economies will continue to be
strong. They haven't been cancelling huge infrastructure projects
such as the mega-railway project in China. The country earmarked
$300B to connect 700 million people with high-speed trains. I
think that will add to the gold consumption because this is
highly correlated to rising GDP-per-capita.
Wouldn't new construction also have a positive effect on base
Yes, it will. There is no doubt. Fear of a slowdown and a
recession could cause copper prices and other metals to correct
10% or more, but they won't collapse like in 2008. This build-out
will continue. Investors should use this type of correction to
their advantage. We tell investors that volatility is only
dangerous if you are borrowing against it.
In any 12-month period during that past 10 years, it has been
a non-event for gold to go up or down 15%. Any time it goes up
twice that then there is a 90% probability of a correction.
During the last nine months, gold stocks have been
underperforming bullion. I think the greatest opportunities are
picking gold stocks where investors can get dividends that are
higher than a five-year government note.
Franco-Nevada Corp. (TSX:FNV)
is a classic example. It pays a monthly dividend. The yield is
higher than any government debt. It has no debt on its balance
sheet and management owns a big piece of the company. Since 2007,
it has a growth rate of more than 30%.
Franco provides good diversification and a kind of mutual fund
approach through various royalty interests.
It's a brilliant model with high profit margins. Since it went
public as a spin-out from Newmont Mining Corp. (
), Franco-Nevada is up about 300%, while Newmont is up about 6%.
It just goes to show that having growth, revenue-per-share and
high profit margins and returns in capital do work for any
long-term investment theme.
Royal Gold Inc. (TSX:RGL; NASDAQ:RGLD)
has grown about 25% compounded during this time. Even through the
crash of 2008 and back up, some of these stocks have done
The most important aspects of a gold-producing company are
production-per-share and reserves-per-share. Underperforming gold
stocks destroyed their production-per-share with acquisitions.
Even though gold has gone up to over $1,700/oz., these gold
stocks have not participated in the upside because they kept
issuing stock and diluting production-per-share.
Normally companies get better movement in the shares than in
gold. Yet it seems most stocks are underperforming. Some of them
are down much further than you would expect. Why?
There are two reasons for that. One is this fear of owning any
equities. I think the real bubble is putting your money into CDs
where investors are going to lose money on interest. Investors
will get an interest payment below the inflationary rate and
their money is locked up. It just shocks me. Right now, Mellon
Bank charges to park cash with them. It's charging investors a
fee. It's not paying. It's charging.
It is just bizarre that people are so fearful when you can
turn around and buy gold. I think there will be a wakeup call and
the companies that will be the beneficiaries of that cash will be
the gold mining companies that have not diluted the
share-of-production factor. When there is a banking scare,
equities as a whole get punished and gold equities as a whole get
dragged into that market. Secondly, there is a failure to
appreciate the importance of protecting the reserve-per-share and
the production-per-share in acquisitions and building out
Randgold Resources Ltd. (
was a huge winner for us, then it had a slow down. Its
production-per-share dropped because its production dropped.
Immediately, the stock went into the penalty box, but now it has
reversed that. The stock has been a spectacular performer this
Would you say that the mid caps are a better shot at this point
than the smaller caps?
I think that the mid caps are the most overvalued. The Market
Vectors Junior Gold Miners (
) ETF has over $2.5B in mid caps and it just jams up all these
silver and gold stocks. One reason you've seen money going into
these products is that gold analysts can't recommend a junior
gold stock without research coverage on the company, however,
they can recommend an ETF like the GDXJ without research on all
of the companies it holds.
I think any big-cap company is going to have to end up looking
for those companies that have 10 million ounces (Moz.) in
reserves and acquire them. One of the companies that we have
taken a big position in is
Gran Colombia Gold Corp. (TSX.V:GCM)
, which has over 10 Moz. of reserves and one of the best
valuations. You are only paying $45/oz. of gold in the ground.
Gold producers trade at six to seven times that level. That makes
it a takeover candidate. It has a higher grade and is producing
over 100 thousand ounces (Koz.), with plans to ramp up to 400
Koz. of gold production. We like to buy where we get a big bang
for our buck-lots of gold-per-share.
To increase production and not dilute the shareholders, the
company just raised $80M by issuing a 5% silver note. It is
convertible at $15/oz. of silver, which allows you to buy silver
at a massive discount. That gives them the cash to ramp up
production for the final build out phase. This is brand new and
very interesting. We like to invest in those types of companies.
We like those companies that are very protective of themselves on
a value-per-share basis.
The other one that we think is very exciting is
Romarco Minerals Inc. (
in the Carolinas. It continues to have a high grade. It likes to
spend its dollars on increasing its reserve profile. That is
always beneficial for shareholders.
People forget that gold mining in this country started on the
East Coast and in the Appalachians in pre-Revolutionary War days.
Romarco's in an area where there has been gold production for 300
Yes, for centuries. We like to look at how much bang for a dollar
we are getting for a ton of rock. When we look at silver
companies, we look at
Silvercorp Metals Inc. (TSX:SVM; NYSE:SVM)
to get the most dollar-value/ton of rock moved. That makes
Silvercorp an attractive silver play. It also pays a dividend. It
is a fascinating way to play the silver market and get a
dividend. When I compare it to the
Coeur d'Alene Mines Corp.s (TSX:CDM;
of the world, it just has more value.
Any final thoughts you would like to share with us?
We are in a secular bull market in gold. It's like the
1930s-fighting deflation, not inflation. It will eventually
become inflationary, but right now there are negative real
interest rates and deficit spending, and that always bodes well
for gold. When the love trade and the fear trade show up
together-bingo! Higher highs. I don't think it is like 2008.
Governments have shown they are going to print money when push
comes to shove. That's important for investors to recognize and
gold should be a key component in a diversified portfolio.
Greatly appreciate your time, Mr. Holmes.
is CEO and chief investment officer at
U.S. Global Investors Inc.
, a registered investment adviser with $3.1B in assets under
management for the quarter ended March 31, 2011. Its 13 no-load
mutual funds, which offer a variety of investment options, have
won more than two dozen Lipper Fund Awards and certificates over
the last 10 years. The company's
World Precious Minerals Fund
was the top-performing gold fund in the U.S. in 2009-it was the
second time in four years that the fund has achieved this
distinction. Frank has been CEO since purchasing a controlling
interest in the company in 1989. He co-authored
The Goldwatcher: Demystifying Gold Investing
which was published in 2008. A regular contributor to a
number of investor-education websites and speaker at investment
conferences around the world, he maintains an investment blog
called Frank Talk, writes articles for investment-focused
publications and appears as a commentator on business channels
such as CNBC, Bloomberg Television, Fox Business Channel and
CNN's Your Money. Frank, who has been profiled in
and other publications, was named Mining Fund Manager of the
The Mining Journal,
a London-based publication for the global natural resources
industry, in 2006. The World Affairs Council's chapter in San
Antonio, Texas-where U.S. Global Investors is based-named him
2009 International Citizen of the Year. In addition to
achievements as an investor in international markets, the award
recognized his involvement with the William J. Clinton Foundation
to provide sustainable development in emerging nations and with
the International Crisis Group to avoid and resolve armed
conflicts around the world.
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1) Zig Lambo of
The Gold Report
conducted this interview. He personally and/or his family own
shares of the following companies mentioned in this interview:
2) The following companies mentioned in the interview are
The Gold Report:
Franco-Nevada Corp. and Royal Gold Inc.
3) Frank Holmes: I personally and/or my family own shares of the
following companies mentioned in this interview: None. I
personally and/or my family am paid by the following companies
mentioned in this interview: None. The following securities
mentioned in the interview were held by one or more of U.S.
Global Investors Fund as of June 30, 2011: Newmont Mining Corp.,
Franco-Nevada Corp., Royal Gold Inc., Gran Colombia Gold Corp.,
Romarco Minerals Inc., Silvercorp Metals Inc., Coeur d'Alene
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