Why Investing in Energy Could Mean Big Returns: an Interview with US Global Investor's Frank Holmes

Joel Anderson  |

A savvy investor has to keep their ear to the ground. While certain tried and true strategies can produce results year in year out, the one true constant of the markets is their inconsistency. As such, as certain sectors and industries go through slumps and boom times, keeping an open eye to market trends can help turn your portfolio's modest performance into something more substantial.

And Frank Holmes, CEO and Chief Investment Officer of US Global Investors, understands this all too well. Frank talked with Equities.com about how his company offers a variety of funds that allow the retail investor to access exposure to global markets with a diversified portfolio of securities, as well as several options that are designed to react to the shifting marketplace to maximize returns.

EQ: Your last Frank Talk entry delved into investing in energy companies, observing that energy stocks have outperformed the S&P 500 since mid-March. Do you think the recent flight from traditional growth stocks is setting up energy for a big run?

Frank Holmes: What we think is fascinating about energy as a sector is that if you consider wealth evaluations of a barrel of oil in the ground, price to book, and price to cash flow on an international basis, energy stocks are one of the cheapest propositions out there. You’re starting to see a substantial rallying the energy stocks, and we thinks it’s a value proposition in both dividends and top-line growth.

We think the Putin factor is also significant. Will he make the oil market unstable? Who knows? But it does create an interest, so we’re seeing money flowing in to get median energy stocks and gas stocks.

The other thing that we find fascinating is that many of the major energy companies have said they will not expand their exploration programs for dry gas unless gas prices are much higher. So if you take a look at this past cold winter and how much gas would be needed to replenish the reserves, we’re talking about 3 trillion cubic feet of gas.

Well how long does it take? How much fracking and exploration and drilling do they have to do to get 3 trillion cubic feet of additional gas to replenish the reserves? And guess what that means? Gas prices trade higher and these stocks are reflecting that.

So with that, we think that they’re undervalued, like San Juan Basin ($SJT), which pays a monthly dividend. It’s much better than buying any 5-year or 10-year government bond. The yield on it is twice a 10-year government bond’s, you get paid monthly, and, if gas prices rise, its income rises and that’s showing up in the stock price rising. So an investor has the opportunity in a rising gas area with companies like San Juan Basin to get two for one. Rising income and capital appreciation.

EQ: What advice would you have for an average investor looking to make an energy play based on the market conditions you just described? What would you say they should be looking at when they’re examining stocks?

Frank Holmes: In a very biased way, it would be our Global Resources Fund ($PSPFX). And right now, our Global Resource Fund has its largest exposure now to Canadian energy stocks in eight years. It’s increased its exposure to gas, and it has several of the wealthy companies I’ve talked about.

I think that companies like San Juan are just very attractive for a retail investor, and it’s a stock that I’ve recommend on television. I feel so comfortable with it. It goes up and down with gas prices, but there are some very, very smart investors in that particular company.

Particularly, Seymour Schulick has taken a major stance in that company and he believes there’s a huge fracking opopruntity with the surrounding San Juan Basin reserves. It offers a very, very compelling, rational reason to play the natural gas conservatively. So it’s following the money, you follow Warren Buffett, you follow a smart person.

EQ: Gold appears to have settled down some, trading consistently between $1,200 and $1,400 an ounce for some time now. What sort of factors do you see potentially driving gold prices in the near future?

Frank Holmes: There’s two key drivers for demand: the fear trade, which gets most of the publicity, and the love trade, which is the bigger component of actual demand for gold.

The love trade is highly correlated to GDP per capita in Asia, India, and the Middle East. So as long as those GDPs are rising, there will be a strong undercurrent of the consumption of physical gold. In the past year, we saw big gold bricks leaving the US, going over to refiners in Switzerland, being melted down to smaller wafers, and then being sold to China, which had record imports. In fact, China consumed all of the world’s mine supply last year. And, year-to-date, they’ve also been a strong consumer. It’s amazing to us because the GDP per capita has been flat for China, and when that turns up as we expect it will in the second half of this year, we think you’re going to see an increase in that love trade coming out of China.

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Another headwind in the love trade that’s been a head wind has been India. India’s has been trying to slow down the consumption of gold by putting a tax on it, and there’s a big push back with that. I think when the upcoming elections are over that changes, so you’ll see an increase in consumption in India as well.

Now with the fear trade, it’s basically an inverse relationship to real interest rates. A US 5-year government bond had a negative rate of return a year ago. That is if you bought it, you were locking in a 50 basis points loss each year for five years. By December of 2013, that shifted to plus 50 basis points.

So all of a sudden, you’re making money over the inflationary rate. So what did that do to the price of gold? It went down down from $1,600 to $1,100 an ounce.

Now, since December, we’ve now witnessed interest rates going from positive back to negative, and gold rallies 10 percent. So there’s a very strong inverse relationship to the real interest rates, which is what will the government pay you minus the CPI number. It’s a simple mathematical model and through most of the past ten years we’ve been living with negative real interest rates, and that is what propelled gold from $300 all the way up to $1,900.

EQ: For investors looking for some more interesting mutual fund plays to invest in, what sort of options does US Global Investors have?

Frank Holmes: Well, there’s two exciting funds we have that I would like to suggest.

I think what your readers would be quite interested in is the All American Equity Fund ($GBTFX). It has a two-part program for looking at stocks focused on US companies that are buying back their stock and increasing their dividend. Because those stocks have had spectacular performance. So the All American companies are basically buying back their stock, increasing their dividend, or both; and that fund has outperformed the S&P 500.

The other one, which has my name on it, is the Holmes Macro Trends Fund ($MEGAX). It’s got a sexy system of looking at stocks; I call it sexy because it favors robust fundamentals. We look at the S&P 1500 and we take companies that are growing revenue at a rate of 10 percent or greater, are generating a 20 percent growth rate in earnings, and getting a 20 percent return on their equity. So with those three simple factors, the universe of those 1,500 stocks now becomes 150. Then we say we want to be GARP (growth at a reasonable price) investors, and we want those stocks that where we won’t pay a high multiple of earnings. All of a sudden we have 50, 60 names.

What we then do with those stocks is take 100 basis points in each of them, but then we overweight and make a concentrated bet in the strongest sectors. Of the ten sectors that compose the S&P 500, health care has been in the top half for the past ten years, so we’re overweight there. We’re also overweight in industrials and basic materials.

When a sector is in the top half of the ten sectors in the S&P 500, we’ve found that they stay in the top half they stay in the top half for many years. Many. And then all of a sudden they fall into the bottom half for many years. So you get this incredible rotation that helps you focus by overweighting the sectors that have the wind at the sails, not in their face, while also making sure you always have great underlying stocks.

When we back test just those stocks with the configuration of 20% growth in earnings, 10% growth in revenue, and 20% ROE, then you outperform the S&P 500. If you overweight the best-performing sectors, that outperforms the S&P 500. So what we try to do is a have a combination of both.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.

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