Introduction: Frank E. Holmes is chief executive and chief investment officer at U.S. Global Investors, which specializes in natural resources and emerging markets investing. U.S. Global, based in San Antonio, Texas, manages 13 U.S. mutual funds and other client accounts. Holmes is co-author of the book The Goldwatcher: Demystifying Gold Investing (2008: John Wiley & Sons). He has written investment articles for investment-focused publications, and is a regular contributor to a number of investor-education websites and he maintains an investment blog, "Frank Talk". He is a regular commentator on the business television channels CNBC, Bloomberg Television, Fox Business Channel and CNN's Your Money, and he has been profiled by Barron's, Fortune magazine, the Financial Times and other publications.
Daily Bell: Thanks for sitting down with us. Your Goldwatcher is a full-length book. Can you pack the central theme into just a few dozen words?
Frank Holmes: There's never just one factor driving the price of gold. When you see a big surge in gold it's because many factors – such as production declines, an increase in industrial use, inflationary expectations, low limits on official sales and geopolitical worries — are aligned. In the current bull market, such factors are being exaggerated by the dollar's decline against other currencies.
Daily Bell: Tell us a little about your background and your professional experience.
Frank Holmes: Years ago I was a pre-med student at University of Western Ontario. I didn't become a doctor, but I do try to approach everything in a scientific way. I went into the investment industry as a research analyst and from there went to corporate finance. I raised hundreds of millions of dollars for flow-through funding for Canadian resource companies back in the ‘80s. Then I moved from Canada to Texas, 20 years ago, and I acquired a mutual fund management company that was known for its concentration on gold stocks.
Daily Bell: Canada to Texas. That must have been an interesting transition.
Frank Holmes: It was a big change. Texas has a sophisticated capital market. But Canada has the most efficient markets for raising capital for resource companies. There are more resource-listed companies on the Toronto Stock Exchange than all the other exchanges in the world combined. You have the ability to quickly assess and invest in a country like Colombia, where 50% of the capital comes from the US, 100% of the assets are Colombian, but the stocks are often traded on the Toronto Stock Exchange.
Daily Bell: How did you decide to write the book Goldwatcher?
Frank Holmes: The publisher approached me to write it because I was managing the number-one fund gold fund in the U.S. It's hard to know for sure, but I believe my success with the fund came partly from my passion for beautiful things, especially gold. I've been attracted to gold as an investment vehicle for a long time. Gold makes lovely jewelry. But gold is so much more. When poor monetary and fiscal policies take hold in any country, people start turning to gold. The book pulled together all the factors driving gold, in one simple approach, and showed that gold was much more than a beautiful metal or a commodity. There are at least six separate factors that together determine the price of gold.
Daily Bell: You write that years from now, the events of late 2007 and early 2008 will be remembered as a classic case of the flawed thinking by governments that choose to use monetary policy to try and sustain an unsustainable economic bubble. What is the damage that's being done?
Frank Holmes: The real damage, right now, comes from populist policies that are rewarding and encouraging envy and justifying jealousy. If you follow the Ten Commandments, the tenth is "Thou shall not covet." When jealousy and envy come to dominate a society, the society becomes dysfunctional and most people lose.
Daily Bell: More good points. With its emphasis on group rights, the U.S. government seems to be legislating encouragement for envy.
Frank Holmes: The populist attitudes being promoted by so many politicians are being formulated into an all-purpose "fairness doctrine" that rationalizes attacking anyone who builds wealth. It's a doctrine that gives you a lot of power if you are part of the group of who decide what is fair and what is not fair. It's a tool for a class-war being promoted by publications like the New York Times. Anyone who earns money or shows acquisitiveness is bad, and there are people in government and the media who will gladly give you the names of the villains. Every CEO is probably bad – because he or she made money that others didn't, which is "unfair." It's the politics of envy.
Daily Bell: And it remains so. Yet people's wealth in some cases is in the stock market. Given that the stock market has started to move up, will envy reignite? Where do you think we are headed with this bubble?
Frank Holmes: The people running the government are running hard. Right now we are witnessing tremendous monetization of debt. In one recent week, the Federal Reserve spent $38 billion to purchase four different types of government debt. China, which is the biggest foreign holder of dollar assets, is recognizing that such practices are an inflationary monetization of government debt.
Daily Bell: Are they right to be concerned?
Frank Holmes: It is a massively flawed program. The U.S. government has put $1.2 trillion into the economy and only US$68 billion has gone to job creation – and much of that went to jobs for lawyers. And let's not forget, meanwhile, that people are starting to save. People are saving because of fear. Class war makes people fearful, they're not going to spend money, they are going to protect their cash. The powers that be continue to try to put money into the system, but it doesn't seem to be buying the recovery they're looking for.
Daily Bell: Sounds like flawed thinking at work.
Frank Holmes: It's a lack of clear thinking. The country that has had the most positive effect from putting money into the system is China. Unlike in America and the UK, you have to put money down in China to get things done. Just signing another IUO doesn't work. The "money talks" attitude creates a different dynamic in the market place. And it creates a dynamic for gold.
Daily Bell: Do central banks still need gold, and does gold still need central banks? In your book you ask, "Did gold cause the Great Depression?" Can you elaborate?
Frank Holmes: Did gold cause the Great Depression? No, highly leveraged investing did – along the lines of what took place last year. When you are leveraged at 25 to 1, a 4% mistake wipes out your company. If you are leveraged at 33 to 1, it only takes a 3% set-back to wipe out your company. The leverage that built up in the ‘20s was the set-up for the Depression.
Daily Bell: Interesting point. You see parallels.
Frank Holmes: There were managed pools of capital that were all leveraged, and the investors seldom knew what they really owned. There was a titanic wave of margin calls. When banks needed cash to satisfy nervous depositors, they started an unwinding process just like we saw last year.
Daily Bell: Given this sort of behavior, how long will Asians go on lending?
Frank Holmes: They are already buying fewer dollars and more gold. They are buying natural resources because they have plans for infrastructure spending and job creation. They are going to need copper for building, and they know they are going to need gold as a monetary asset.
Daily Bell: How about energy? You believe that oil is going to be in shortage. Can you give us a feel for where oil is headed?
Frank Holmes: It is important to look at relationships — oil, gold and the dollar. There is a strong inverse relationship of oil to the dollar and gold to the dollar and on the other hand there is a very high correlation of money supply and the direction of oil. When you look at the consumption on a per capita basis, America is 25 barrels of oil per person per year, Japan and South, Korea are 18 barrels of oil per person per year, India is two, China is three.
Daily Bell: Yet China and India are growing quickly.
Frank Holmes: The Two countries — call them Chindia — have 40% of the world's population and are growing at twice the rate of the US and Europe. Their infrastructure is growing so fast and adding so many roads that China just surpassed the US in car manufacturing, only a couple of months ago. So you have a shift and that is going to keep adding to the demand for oil.
Daily Bell: Will alternative energy come to the rescue?
Frank Holmes: You have to have higher energy prices to do that. So I think you are going to see a forcing of higher commodity prices to trigger a certain level of attractiveness to alternative energy, such as wind farms. You need to have oil between $85 – $100 per barrel to really make alternative sources of energies attractive and competitive.
Daily Bell: This will certainly put more pressure on world finances.
Frank Holmes: The pressures come from policies that often have good intentions but are poorly thought out and are written and drafted primarily for the legal profession. A lawyer cannot tell you how to do brain surgery, but this is what is going on. Two percent of the American population are lawyers, but 50% of all the policy makers are lawyers, who are re-writing everything to fit their view of the world.
Daily Bell: Yes, definitely, too many lawyers.
Frank Holmes: Now in a country like India, they produce more engineers, 400,000 a year. America produces more lawyers and more sports trainers each year than they do engineers.
Daily Bell: How do you identify the best gold stocks?
Frank Holmes: You have to have a list of gold stocks, not just a favorite. Any one stock can have a big problem. That's why I don't like to say buy this one stock. I would say this is all our research, and we have done detailed analysis on this, and we know that several factors drive gold stocks. Growth in production, growth in reserves and growth in cash flow. They dictate. And based on those factors, we have built a list of gold stocks likely to be the out-performers.
Daily Bell: What else?
Frank Holmes: Cash flow per share. These are the magic words – "Per Share." And what has been a real tragedy is so many gold mining companies will do a financing when they don't need it. That dilutes your upside potential from growth in production and reserves. You can win more with companies that don't dilute. We had our best month ever in May. Our biggest holding, Randgold, was 10% of our portfolio. The company refused to do anything dilutive and the stock jumped almost 50% in a month. Yes, we took profits. If it corrects, we will buy it back.
Daily Bell: Sounds like a rare breed.
Frank Holmes: Unfortunately rare. Then there are CEOs and chairmen who shun dilution. But some CEOs of global mining companies make more money trading stock options from their companies than they do running their companies. Every time gold falls, they call a board meeting to get themselves more stock options (more dilution for other stockholders). When gold runs back up, they sell. It's like a money machine. Some chairmen, I'm told, made 15 million dollars in the past five years with stock options.
Daily Bell: You have written that the Fed is literally flooding the market with enough excess liquidity to support the banking system and the shadow banking establishment and even Zombie banks.
Frank Holmes: The Federal reserve started putting all this money into the system before it recognized that its own policies were causing the credit contraction. It will continue adding cash because it doesn't stop to consider whether its policies, taken as a whole, are consistent. The Fed has been creating money at a rate of $2 trillion per year, helping out banks that are extremely leveraged, trying to keep them alive. It's much, much easier to control society if you have oligopolies and a concentration of corporations. And that's what the bank rescues produce.
Daily Bell: What do you think will be the result of the current economic crisis? Depression, hyperinflation or both?
Frank Holmes: Well you are already in a depression, and it is a matter of what policies the politicians can use to get themselves out of this depression. The rally we have had since March is the same type of rally that took place in the ‘30s. I think you run the risk of getting inflation and then hyperinflation. Hyperinflation will come when they print money to pay welfare checks.
Daily Bell: Will the bailouts taking place in the West help out at all?
Frank Holmes: No, and hyperinflation will be the result. You are going to see platinum prices spike, and you are going to see most commodities will trade higher. That is when you are going to get the inflation.
Daily Bell: What are the biggest industry and investment issues affecting gold today?
Frank Holmes: The biggest is mother nature. It's hard to make a big discovery. 80% of the world's population is living in emerging countries, but 80% of the world's resources are in the same countries. And many of these countries don't have reliable legal systems that produce clear titles. Make a big discovery, and you face a huge issue about who really owns it. Even if you win that battle, you lose years in doing so.
Daily Bell: Is the gold market manipulated?
Frank Holmes: It's a great question. The Federal Reserve manipulates short-term rates and, to a lesser extent, long-term rates. We saw them put in $300 billion in March to buy long-term mortgage bonds to push mortgages under 5%, to support real estate prices. This is what they hoped. Well that is manipulation. If they are doing that, guess what – they are probably manipulating the price of gold. There is always a sort of manipulation happening.
Daily Bell: Do the world economy's long-term fundamentals remain bullish?
Frank Holmes: They do. China and Russia now have surplus dollars. So if the dollar does fall, they can turn around and start buying hard and soft goods. That's the big difference between the ‘90s and today. Not only are interest rates lower, but if you looked at what has happened to the world in the past 20 years, 80 % of the world is better off. You hear all this negative news, and it is so distorted. The quality of life in emerging countries is much better than 20 years ago. So, yes, I remain bullish.
Daily Bell: Can you give us the names of some important gold mining companies?
Frank Holmes: The biggest part of "better" is better management. Among the producing companies, for example, you have companies like Franco Nevada, whose Chairman is probably the wealthiest Chairman in the mining industry (and not from trading stock options). He got that way from being a very sophisticated investor, and he has made Franco Nevada a premium company with a high-margin business. All in all, the management are very astute and smart people, they all own a big part of the company, they don't like paying dividends, they don't like having big salaries, and they don't like giving out tons of stock options. That makes Franco Nevada very special.
Daily Bell: What would encourage everyone to read?
Frank Holmes: Every Friday we publish an Investor Alert. We do the swat analysis, the strengths and weaknesses of the past week, the opportunities present for next week. All great money managers are fascinated by philosophical thought to improve models. Rather than thinking just stocks or just bonds, what is the financial eco-system?
Daily Bell: What else?
Frank Holmes: Books by Malcolm Gladwell, a wonderful Canadian writer. He wrote the Tipping Point and Blink. His latest book is Outliers, and in this book he present his rule of 10,000 hours. To truly be a master at a sport or anything else, you must commit a minimum of 10,000 hours. There are many examples of people who have a minimum of 10,000 hours behind them. So if you want to be competitive at investing, you need 10,000 hours of focused work.
Daily Bell: Finally, do you have any ideas for our readers who are trying to understand the financial problems in the US?
Frank Holmes: Don't let your thinking get caught up with political party. A vs B. Getting caught up in the "I am a Democrat or I am a Republican" – this is really flawed thinking. Address the policies. Good government is good refereeing.
Daily Bell: Thanks again for sitting down with us.
Frank Holmes has some very good points to make in the above interview. At one point he bluntly states that oil will be shoved back toward 80 or 100 dollars, and there is no mistaking his position – oil will be moved higher so that green solutions will become prevalent. Why green solutions? To put people back to work? Maybe other reasons as well.
He also makes the logical point that since money itself is manipulated by the Federal Reserve, it is reasonable to think that other elements, including gold, are manipulated as well. We've made this point ourselves, and it extends to the larger picture these days. The Federal Reserve in dealing with the current economic crisis has shown that it has access to as much money as it chooses to print. This goes for other central banks. Those inclined to be suspicious of the powers-that-be have found plenty of reasons in the way that central banks have acted lately. Their power is seemingly unbounded and has been illustrated by the trillions that they have seemingly poured into the market overnight. It is obvious now – and the Internet has merely magnified their incredible access to wealth. They obviously can print as much as they wish and worry about the consequences later.
The problem is even larger than central banking. If one grants that commodity markets, even gold and oil, are manipulated and then follow Holmes' reasoning, it seems as if an entire new industry is being created under our noses: green transportation.
This is no small thing. If, as Frank Holmes suggests, oil prices surge higher due to manipulation, taxes, etc. especially in America, then this will artificially support the kinds of green industry initiatives now taking root In American and Europe. Never mind that green energy has been a bust – wind and solar power would not exist without extensive government subsidies. Now, Holmes suggests, green transportation will become another part of the environmental-industrial complex.
It is strange to see this all building. There are cars that run on water and even soda pop. But at great cost and with great earnestness, the auto industry along with Western governments, are making achingly slow progress in offering the public battery powered cars.
One cannot help but wonder at the motives of the players. Is it to reduce carbon dioxide so as to ameliorate global warming? More and more the evidence is that global warming does not exist – and carbon dioxide has been around almost as long as the earth itself. So what are the real motives? To create new industries? To put people back to work?
Ourselves, we, are uncomfortable with the electric alternative, especially one that does not incorporate any fuel at all. It seems to us that such cars restrict travel rather than abet it. And given that the monetary elite thrives on control – and that its dominant social themes seem always aimed at scaring people into giving up more power over their lives and circumstances – we remain fairly suspicious of green transportation and the motives behind it.
Of course, not much of the above has to do with gold, per se. But if you read between the lines of the interview graciously provided by Holmes, you will see with a wink and nod he is explaining to you that the reality of investing probably has as much to do with what the monetary elites are trying to do as with the marketplace itself. Or to put it another way, the monetary elites, by exercising enormous control via central banking and other monetary and fiscal levers, have made themselves a critical part of the marketplace.
Mr. Holmes, we agree. Your approach to investing is the proper one. Define the role of the monetary elite and then determine whether you believe the dominant social themes are going to stand or fall. Bet with them or bet against them. But always remember – your investments are part of a constant conversation with the monetary elite. Your determination of their success or failure will have a large impact on your returns, perhaps the largest.
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