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Frank Holmes discusses the implications of recent PMI data as well as interest rates, the Asian love trade and the outlook for gold equities.
GEOFF CANDY: Hello and welcome to this week’s edition of Mineweb.com’s Gold Weekly podcast and joining me live here at the Mines and Money Show in Islington, London is Frank Holmes who is CEO and cio at US Global Investors. Frank you gave the keynote speech yesterday morning at the start of the show. There are still a lot of people that are concerned about where we are in the market, you were pretty bullish, the sentiment though still at the moment fairly bearish with regards to gold.
FRANK HOLMES: No one rings a bell at the bottom and these great bull markets climb the proverbial wall of worry and doubt just like the S&P hitting all-time highs and everyone doubting it and so it’s spectacular... you can look at the fundamentals why the market is doing what it’s doing as the S&P 500. But I do think that energy stocks, and I do think basic material stocks, mining stocks are extremely under owned by the generalists. A lot of data points demonstrate that, but the PMIs, the global PMIs, that is the Purchasing Manufacturers’ Index the one month is above the three months and that trend is your friend and usually that starts to run for many quarters then all of a sudden everybody starts believing. And we’re starting to see US Steel, Alcoa all of a sudden have big pops in trading volume prices coming up, the lows in anticipation. We’re seeing iron ore in anticipation of something taking place. And last night their PMIs were also quite attractive in their numbers that came out – the global PMI, China’s PMI numbers, so I think it’s important for investors to see that PMIs are a leading indicator. They're not a lagging and they're not a coincidence, they lead and they're important for job creation.
GEOFF CANDY: You also mentioned interest rates and the correlation between gold and real interest rates and you had some interesting views on what the five year, the 10 year interest rates and where that’s leading gold as well.
FRANK HOLMES: Well you know gold is very challenged right now because usually in the second half of the year going back 35 years, gold stages a spectacular rally, and in particular the past 12 years. But this year it’s having some real headwinds to it and one of those headwinds happens to be the shrinking negative real rates of return. That is what will the government pay you, minus the CPI number, so if we go back a year ago, you were making 100 basis points, you were losing 100 basis points correct me, on a five year government note so why would you buy a five year government note when you're going to lose money. Now just this month, its gone positive 36 basis points. If we go back three months ago, it was still negative. If we go back two years ago or 18 months ago, the 10 year government note had negative real rates of return. So when gold hit $1900 the 10 year government bond was just such a rip off because it has such a negative real rate of return that it was a fundamental reason for gold trading at such high levels at $1900. Now that’s starting to reverse and there are reasons for that and one of the factors has to do with the US is importing less oil and they're also producing more oil internally and that helps its current account deficit. So these are factors that investors have to take into consideration, but nevertheless we’ve always advocated it and it’s just prudent to have a 10% weighting in gold and rebalance. So if 90% of your portfolio is made up of stocks and they're up doing outstanding, non-gold stocks this year you’ll be taking profits in our model and you’ll be buying gold stocks at a screaming discount.
GEOFF CANDY: Do you think that we’re going to see increasingly generalist investors coming into this market eventually, do you see that concept of 10% weighting in gold... and it’s not the case across the board really in terms of the generous investors yet. Do you think it’s going to happen?
FRANK HOLMES: Yeah I think it will eventually happen. Finally you have one big down year after a stretch of over a decade of gold being up and it’s just what happens in markets. I think what's important for investors to recognise also, I’d mention is love trade, and the love trade has to do with this cultural affinity of Asia buying gold for every type of a ceremony or religious event. It’s highly correlated to GDP per capita. The GDP per capita in India has basically gone sideways, while China has been modestly growing, but for 12 years we had almost a 45% growth rate in GDP per capita for 40% of the world’s population and then when you add the Middle East, it’s also been rising GDP because of higher energy prices so therefore they’ve been buying more and more gold.... well that’s slowed down. Is it going to reverse itself, I don’t believe so. I believe it’s important for investors and like I mentioned yesterday in the presentation, there are 600 million kids basically under the age of 25 in India and unlike in the 1970s they are now hooked and wired up like Facebook and they all want to be Slumdog millionaires. It’s a very different world. It has the largest young population in the world and now China is going to allow having two babies so you just think what's going to take place with 40% of the world’s population being young. And now a new growth cycle taking place in China you rate now the maths says that every three seconds a baby is being born – well they're going to be buying gold.
GEOFF CANDY: Well it’s clearly something that you need to focus on, as you say the love trade is there... the 600 million people. And I suppose the other question then is the rest of Asia... it’s not just India or China. Turkey for example has a long tradition of gold as well. How are the other emerging markets playing this trade at this stage?
FRANK HOLMES: It’s a positive contagion through it, this rising GDP per capita, it’s very important, but here’s your big opportunity more short-term, is that platinum, palladium and silver are all going down in sympathy with gold going down and the dollar being on a relative basis stronger. So you take a look at the ETFs and what you notice with bullion the ETFs is that there have been net redemptions out of bullion, however, the on balance volume, the open interest into silver, into platinum and palladium is growing. So whenever we get this rally which will be substantial in gold because gold is down almost three standard aviation’s over a rolling 12 month period... when that takes place I believe that you’ll get a massive move in silver and platinum and palladium because platinum and palladium are highly correlated to rising GDPs per capita which is highly correlated to, which I mentioned yesterday, global PMI numbers.
GEOFF CANDY: Moving quickly from the commodity itself to the equities you did have fairly harsh words to say about the management teams and the focus on growth that we’ve seen over the last few years from the equities. One gets the sense and these criticisms have been coming for the past few months indeed. There were people and I think you were included, in them last year at the same conference saying these kinds of things. Has there been an improvement in the last 12 months in terms of the focus on costs?
FRANK HOLMES: Well I think that more independent directors are worried and having meetings. I have seen an avalanche of CEOs losing their jobs. Next it’s going to be chairmen – this whole idea of separating chairmen from CEOs, and chairmen pushing the agendas and then blaming the CEOs – that’s got to stop and chairmen are going to have to be held accountable for decisions for growth for the sake of growth where there's no profit, there's no cash flow there for the investors. They’ll take salaries, they’ll take their stock options, they’ll get their bonuses and the investors are left with nothing. That’s going to change. Reminds me of the tech boom in 1998-1999 when Cisco was buying four guys in a garage for $1bn and they had no revenue. I think that model is going to change when it relates to the gold mining sector... the overall mining sector and there's been much more prudence, and what we’re seeing is a private equity coming in the space. Private equity is very stringent on the dollar being spent and getting my return on my capital immediately so I think that this will be a constructive positive change for these companies. Stick with companies like RandGold which is a low cost producer who’s CEO Mark Bristow is very focused on high returns on capital, Franco-Nevada, Silver Wheaton, these are worldly companies and in fact when 90% of the industry starts losing money under $1100 an ounce gold, 90% except for the likes of RandGold, Franco-Nevada, Silver Wheaton and Royal Gold - they show up as a higher concentration in what our holdings are. And the other thing we have our gold funds we love, is Tiffany’s because tiffany’s have rocket sales and their inputs for buying gold and for buying silver to sell for jewellery, that input is getting cheaper for them so at the same time at the store, there are buyers. So the rising stock market means Tiffany’s is going to do well.
GEOFF CANDY: Well that’s definitely something to keep an eye on and quite a nice thing to have in your back pocket just as well.
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