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Interview with U.S. Global Investors’ (GROW) Frank Holmes

Investing in metals and minerals can be a tricky for most investors. There are a variety of different factors that can affect supply and demand. And any smart play involving mining stocks requires

Investing in metals and minerals can be a tricky for most investors. There are a variety of different factors that can affect supply and demand. And any smart play involving mining stocks requires having details of the geography and geology of the properties being mined. While there’s plenty of money to be made, it’s not for the faint of heart. There are few sectors where real, in-depth knowledge of the industry is key to having success. The same can be said of emerging economies, where one needs to know what they're getting into in order to make a really informed investment. That's why there are people like Frank Holmes out there to steer us in the right direction.

Frank Holmes is the CEO and Chief Investment Officer for U.S. Global Investors, Inc. (GROW), an investment management firm that specializes in mutual funds with exposure to gold, natural resources, and emerging markets. Frank has overseen a number of top-performing mutual funds, including the Global Resource Fund ($PSPFX), Lipper’s top-performing global natural resources fund of 2010, and the World Precious Minerals Fund ($UNWPX), Lipper’s top-performing gold fund of 2009. Both funds were also both Lipper’s top performing fund in their respective categories for 2006, 2007 and 2008.

Frank is going to be sharing his insight and expertise with attendees of the San Francisco Metals and Minerals Conference, held this year on November 25-26. Prior to the conference, got a chance to talk with Frank about the global market for natural resources and why mutual funds may be the ideal vehicle for metals and minerals investing.

EQ: Could you tell us a little bit about U.S. Global Investors and how do your funds help investors build effective portfolios?

Holmes: Our funds focused on gold, natural resources and emerging markets opportunities provide diversification and potential alpha to investors’ portfolios. It has been well documented that for the best risk-adjusted returns, it’s prudent to have 25 percent international emerging markets, 25 percent should be in natural resources, 25 percent in blue chip stocks, and another 25 percent in short term, high yielding stocks or short term bonds, in particular tax-free ones. The magic of this diversified portfolio is to rebalance.

EQ: What are the potential advantages of using mutual funds to invest in the market and particularly in the metals and minerals space where you’ve had a lot of success?

Holmes: We’re big believers that there are two forms of knowledge: explicit and tacit knowledge. Explicit knowledge is your capacity to understand geology and financial models. Tacit knowledge is when our portfolio managers visit properties and kick the tires. The best metaphor for understanding the difference is that you can study the rules of the road to get your driver’s license, which would be explicit knowledge, but that doesn’t make you a good driver. You have to gain experience by driving on the roads and freeways. And if you go from driving in the U.S. to driving in England, you have to relearn all the rules to learn to drive on the opposite side of the road. The key is in combining explicit and tacit knowledge.

We’re big believers that an active money manager has to have financial models as well as technical expertise, such as geology or engineering. They have to go and travel into the heart of Mexico, Col0mbia, Brazil, Africa, and at the same time go to big steel mills and car production lines in America, to try to understand the integration of these factors. On a regular basis, our managers are in China, Russia, Africa, Latin America, Central America, Canada, and Singapore. Investors don’t get that kind of experience with an index.

EQ: Currently, what is your biggest focus when you’re trying to sort of enhance those advantages?

Holmes: It would be our dedication to educating investors on the importance of having diversification in emerging markets and resources. This year, U.S. Global was the proud recipient of 11 STAR Awards from the Mutual Fund Education Alliance, which is a national industry association committed to investor education and awards mutual funds for outstanding communications.

An as example of our efforts, we’ve published a number of articles that focus on helping investors ‘Anticipate Before You Participate’ so that they understand the DNA of the volatility of each different asset classes and the importance of rebalancing. Because emerging markets and resources are twice as volatile as the S&P 500, it becomes essential to rebalance to attempt to capture these huge upswings and mitigate the downside.

We also educate investors on the significance of following the Purchasing Manufacturer’s Index, which is a precursor to economic activity that drives demand for commodities. When PMIs turn positive in Europe, America, and China, there’s a longer demand cycle for commodities. So, we try to educate on the cause, effect, and possible ramifications of many macro trends.

EQ: What are some factors that all investors need to understand when they’re using mutual funds as opposed to other asset classes when dealing with metals and minerals?

Holmes: When investors are looking at ETFs, what they have to realize is that on days with big inflows into an equity ETF, those actual holdings trade at premium to the underlying shares. And they trade it a much higher premium than we would have to strike the NAV at with mutual funds. In days that there’s big redemptions of selling, the market maker can buy the underlying stocks cheaper. So, you end up selling your ETF at a lesser price than the underlying stocks. And it’s recognizing that, if you’re going to be an active trader in and out during the day, if you’re late in buying in an up day you’re actually gonna be paying a big premium. So, that’s part of the trade-off between buying an actively managed gold equity fund like ourselves and buying the ($GDXJ).

EQ: It has been a rough few years for metals and minerals, what are some opportunities that you see for the long term?

Holmes: Well, it’s been very difficult for investors to deal with the debt crisis that took place in 2008. The government policies to resolve and deal with the crisis have been in an ongoing battle. Whereas only a few years ago, we saw riots in Greece, now, that same country is the best performing stock market in Europe! It’s been a spectacular performer last year and this year.

History has shown that every time you have one of these crises, it takes about four years to recover and get the turn. And we’re seeing that now. Five years later, stocks making all-time highs. That’s why it’s important for investors to, both domestically and internationally, follow the money.

The key to following the money is for investors to focus not just on the political party, but on the political policies. There are two types of policies, monetary and fiscal. Monetary policies affect interest rates and money supply while fiscal policies affect taxes and spending.

So, when a country regulates, I see that as a kind of informal tax and when a country streamlines regulations, I consider that a tax break. Breaking down political policies this way helps to recognize which countries are providing the best tax incentives to invest in, which countries have stable tax regimes, and which countries have the ability to offer a stable monetary policy.

Here’s an interesting comparison from this last year is Europe. Spain lowered requirements for tourism visas for Russians and Chinese. As a result, luxury good sales jumped 38 percent. The Brits joined forces and lowered the requirements for visa entries and luxury good sales increased 25 percent. The French refused to and luxury good sales dropped 2 percent.

This is one example of how streamlining regulations can make it easier for money to flow around, creating a big economic boom. We also see this with visas between Brazil and America. The Olympics and the World Cup are going to be in Brazil, but the process is a tremendous burden for Americans who want to fly down there. There are many challenges and delays with the visa process. So, after ABC, CBS, NBC complained, all of a sudden the U.S. government fast tracks the process and streamlines visas.

The visa process is easing up for Brazilians to come to America, too, which is why you see a huge influx of Brazilians heading to Orlando and Tampa. Recently, about 65 percent of all home sales in Florida have been cash, and you have very strong Brazilian investors coming to America and buying real estate.

Now directly related to resources, we made a big score on the resources cycle very early after seeing what Santos has done with oil prices in Colombia. He changed the process for oil and gas. He said that he was going to make it much more stable, he’s going to protect from FARC and these other problems, and he’s going to increase security. At the same time, he drops the taxes that’ll be imposed upon oil companies and money started to flow into Colombia.

We had the opportunity to participate with Pacific Rubiales, which is a $5,000,000 investment that now has a billion dollar market cap nine years later, producing $4,000,000,000 in cash flow. It is the government policies that drive intellectual capital to move to it. So, we are very sensitive and cognizant when looking around the world as to who is streamlining regulations.

EQ: A lot of investors are interested in getting into metals investing, particularly precious metals investing. What are the crucial things that you think most investors should understand before they jump into that market?

Holmes: I think it’s important for investors to appreciate that there are times when the metals outperform the companies and times when the stocks outperform the metal. And right now, I would say the stocks are much cheaper than the metals. It’s the first time we see gold stocks trading to cash flow at a multiple that is less than the companies in the S&P 500. The dividend yield is higher than 5-year government notes. But I think you have a value proposition, such that the energy stocks and gold stocks are much more attractive than the underlying commodities.

If you want to go buy gold, buy gold jewellery. That’s the best way to enjoy the gold, just like most of Asia does. You wear your wealth and then you have the opportunity to make your money on owning some of these stocks.

EQ: You are a keynote speaker at the upcoming metals and minerals investment conference. What are you planning on talking about?

Holmes: I have been a speaker at the conference a couple of times and a big part of my presentation is to have hope and make sure that investors consider the benefits of diversification and rebalancing. At the beginning of this discussion, we talked about the significance and importance of having exposure to this asset class. And we have a simple chart for U.S. investors, which shows that over the past 10 years, an investment made of 10 percent in U.S. Global’s gold funds and 90 percent in the S&P 500, with annual rebalancing, has outperformed the investment in the S&P 500. You have lower bulk selling and overall, your investments were ahead.

I think that going forward, gold companies are not going to have ‘growth for the sake of growth’ but companies are going to be much more disciplined on profitable growth. And those companies that are not disciplined? I’ve seen many CEOs who have lost their jobs in the past couple of years because of the ‘growth for the sake of growth’ mindset and have not made money with growth. And so, I think going forward, the industry is going to be very, very prudent.

And the other thing to share with investors is that every second, two and a half babies are being born. Every second. The world’s got 7 billion people and the world has never been more connected with the internet. You see the success of Twitter, you see how people are wired and connected, with Facebook having over a billion users. And what does that do? People in the other parts of the world, in evolving and emerging countries, they can see what the developed countries have and they want it. So, I think we’re going to see a continuing secular bull market in the demand for commodities, and I think that those governments in these frontier countries that are smart are going to have focused infrastructure spending like the Chinese have. And this will keep them in power because it creates jobs. But it brings something sustainable, too. And what happens is continuous growth because the people want safety, infrastructure.

EQ: Could you tell us why conferences like this upcoming metals and minerals conference important for investors and particularly retail investors?

Holmes: Well, it comes back to that thought process about explicit and tacit knowledge. There’s a tacit knowledge from attending and seeing the energy, meeting people, hearing perspectives, both what they think is an opportunity and what they view as threats. This is that feel you get. And then there are the technical experts and their presentations on what the opportunities are. When you meet with these companies, it’s easier to be able to make a relative comparison of what you think is a better economic value for you and your buck.