-- Posted Tuesday, 28 July 2009 | | Source: GoldSeek.com
Increasing the money supply invariably leads to inflation—but that's not the only factor driving it. "Populist policies that are focused on protectionism and unionism will force inflation in America," says Frank Holmes, CEO and chief investment officer at U.S. Global Investors. While he doesn't anticipate across-the-board inflation, he does foresee certain commodities having stronger inflation than others. In this exclusive interview with The Gold Report, Frank discusses changing patterns in commodity prices and how investors can gauge where they're headed next.
The Gold Report: Frank, U. S. Global Investors has published a chart showing copper price fluctuations on a monthly basis with 30-, 15- and 5-year trend lines. Can you speak to why that chart is important?
Frank Holmes: First let me start with a little background. There was a wonderful book written back in the 30’s called The Battle for Investment Survival by Gerald Loeb. When I first got in the business, I was told I had to read it every year to remind myself of the cycles, different asset classes, and the value drivers for them. And the book says buy copper when it’s soft in November and sell in March.
The 30-year pattern on the graph follows what Loeb's book advised and what was the rule of thumb when I first got into this business—that "buy in November and sell in March." This was because of seasonal stockpiling during winter months leading into major building and construction projects in the spring and summer months.
About 15 years ago, when China started becoming a significant buyer of copper, the pattern started to change. This pattern shows copper prices rising from January through May and then trading pretty much sideways for the rest of the year, with modest peaks and valleys along the way. A similar pattern is drawn to represent the past five years. The five-year and 15-year cycles are very much aligned with the infrastructure spending taking place in China, as well as with the lack of new mine supply coming on-stream from anywhere in the world to meet this increasing demand.
China has changed the demand for copper by making very strong commitments in infrastructure spending. Five years ago they were building power stations –now they’re building power lines. They’re basically expanding their spider web of copper wire all across the country to get more people access to electricity, especially in the rural areas, and this is setting up demand for copper that relates to their infrastructure spending.
TGR: One of the theories I’ve heard is that China has been divesting U.S. dollars by stockpiling basic commodities, one of which is copper. If that’s true, could China's copper buying boom be short-lived?
FH: You’re not seeing the Chinese dump dollars to go and buy copper or gold, etc. What we're seeing is, rather than rolling dollars over and buying new notes where the yields are so much cheaper, they’re going and buying other commodities. And that’s a much different statement than saying “I don’t like American dollars.” They’re just saying that they prefer at this stage to own commodities rather than a note that’s paying 10 basis points.
I think it’s important to take a look at seasonal patterns. You can see the relationship between infrastructure spending and demand. And one should always take a look at China and ask whether or not they are a net exporter of a specific commodity. If they are, then they’ve stockpiled that commodity. That’s just a well-known fact. For example, at the beginning of this super-cycle, zinc prices lagged. Then prices exploded and all of a sudden China became a net exporter instead of a net importer. That's the tipping point.
TGR: How could a regular investor monitor this? Are there some key elements to look for?
FH: Use a good money manager. The best money managers understand macro themes and they understand stocks and stock picking.
TGR: When we spoke last October, you indicated that we were at a tipping point, moving from deflation to inflation. Clearly a lot has happened. Do you think we’ve moved from that tipping point yet?
FH: When I made that statement, it was because of the huge increase in money supply. Money supply is one important aspect of inflation. The other real key factor is protectionism and unionism. If you go back to the '70s, it was a combination of rising money supply, rising oil prices, and huge labor strikes all over Europe and all over America.
And so right now all this money that’s going into the system is like shoveling sand with a pitchfork. Populist policies that are focused on protectionism and unionism will force inflation in America.
Do I see across-the-board inflation? No. Do I see certain commodities having stronger inflation than others? Yes. Will that permeate and destroy and create a huge inflationary cycle? I don’t see that yet, but the threat of that happening is still there over the longer term.
TGR: What sectors do you think will do well over the next six months to the end of the year?
FH: As far as commodities demand, China is the 800-pound gorilla. After that it’s India, and also Japan. Even if North America's economic growth is slow and Europe's growth is slow, it will have an impact on demand for oil and other commodities.
I think the real sleeper is platinum. If the car business turns around in America, I think platinum has the capacity to have a spectacular move. Something like 90% of all cars sold in America are financed with loans in some form. Of course, the car business started a huge contraction when banks weren't funding the loans, and that affected the platinum industry since it's used in automobile emissions control devices.
If that process of money turnover starts to expand, however, and if there are low interest rates, then we could see a boom in car demand. With such a strong environmental movement, commodities like platinum will do exceptionally well because of industrial needs coupled with environmental concerns.
TGR: What percentage of gold bullion versus stocks do you recommend in a portfolio?
FH: We’re consistent in suggesting to investors that they consider a maximum 10% allocation to gold, half in gold equities and half in bullion. We preach a message of moderation. You shouldn’t try to get rich with gold or gold stocks because you would take too much risk trying to do that. I have said you buy gold and gold stocks as a form of financial insurance in your portfolio. Even when the price of gold is soaring, as it was in 2006 and again last year, we never changed our position about not chasing the momentum. It’s also important to rebalance at least annually, so every year or even each quarter when gold is up substantially, you take some profits and you maintain that allocation.
TGR: Regarding gold equities, what do you recommend that individual investors look at—explorers, near-term or producers?
FH: That depends on the risk profile and volatility they are willing to assume. The biggest potential for alpha is going to come from the junior mining stocks, particularly the mid-caps, where there is something coming into production.
The big money to be made with the least amount of risk is when a company is just coming into production, or a bigger company is going to increase its production. At that point there’s sort of a re-rating that takes place in the market. The greatest risks are the explorers who have a discovery. It doesn’t matter how far they go up, it all falls 70% before they ever produce an ounce. It’s very risky as they go through this production phase, as it takes time and money. When you’re within six months of that new production, and it’s been well funded, that’s a less risky decision.
When looking at the major companies, one has to look at the currency impact of the country where it’s being produced. If you’re looking at South African gold stocks, for example, one has to be aware of the Rand. If the price of the Rand is going up faster than the price of gold, that means there’s going to be a compression in the profit margin. If the price of gold is rising and the Rand is falling, that means you’re going to have a huge expansion in profit margin.
Look at those currency patterns when looking at the big producers; it's the number one, simple way to look at it. Those stocks that outperform their peers on an historical basis have the highest production per share. There have been so many gold-mining companies that immediately do a financing, and they dilute, which dilutes the investors’ upside.
TGR: Thanks very much Frank, this has been great. We appreciate your time.
Frank Holmes is the CEO and chief investment officer at U.S. Global Investors Inc., a registered investment adviser managing 13 no-load mutual funds specializing in natural resources, emerging markets and global infrastructure. He is one of the world's most authoritative and respected voices on gold, and is the co-author of the book “The Goldwatcher: Demystifying Gold Investing.” (2008: John Wiley & Sons). He is also the lead contributor to U.S. Global’s award-winning investment blog “Frank Talk: Insight for Investors.” U.S. Global’s funds have received numerous awards and honors during Mr. Holmes' tenure, including more than two dozen Lipper Fund Awards and certificates. Mr. Holmes was named 2006 Mining Fund Manager of the Year by Mining Journal, a leading publication for the global natural resources industry. He is a much-sought-after keynote speaker at national and international investment conferences. He is also a regular commentator on the financial television networks CNBC and Bloomberg, and has been profiled by Fortune, Barron’s, The Financial Times and other publications.
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-- Posted Tuesday, 28 July 2009 | Digg This Article
| Source: GoldSeek.com
