4 Big Reasons Why You Might Want to Consider Gold Stocks Right Now

The price of gold has been feeling the pressure lately from a stronger U.S. dollar, which is at a four-month high, and rising Treasury yields. Nevertheless, the yellow metal eked out a positive March quarter, returning close to 1.3 percent, while the S&P 500 Index posted its first negative quarter since 2015. This tells me the investment case in gold and gold mining stocks remains as strong as ever.

Below are four more reasons why I think you should consider adding gold stocks to your portfolio right now.

1. Gold mining stocks look inexpensive.

Billionaire investor Warren Buffett once said: “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

Compared to the broader equities market, gold mining stocks, as measured by the NYSE Arca Gold Miners Index, look incredibly “marked down” right now. They’re far below the average gold miners-to-S&P 500 ratio of 0.7 for the nine-year period, and nearly as undervalued as they’ve ever been.

Gold mining stocks are incredibly undervalued relative to broader equities
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I believe that for investors with a long-term horizon, this makes gold miners look especially attractive as we await valuations to revert their mean, or average. Hopefully this can be achieved without a significant decline in the S&P.

2. Rising inflation has historically lifted gold prices.

Inflation can be understood as the destruction of wealth. Every time consumer prices head higher, a dollar loses some of its value, whether in your pocket or your savings account. Inflation can also weigh on stock prices, as some investors anticipate it cutting into corporate earnings. They might therefore decide to move their money into other assets.

That includes gold, which has enjoyed a long history of being an attractive store of value during times of higher inflation.

After being mostly stagnant for several years, inflation looks as if it’s ready to stage a strong comeback, thanks to rising oil prices and new trade tariffs imposed by the Trump administration, among other factors.

But which measure of inflation is most accurate? The Federal Reserve prefers the consumer price index (CPI), but there are others, including the New York Fed’s Underlying Inflation Gauge (UIG) and ShadowStat’s Alternative CPI.

no matter which gauge you use, inflation is on the rise
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From the chart above, we can surmise that inflation could be highly understated right now. According to the official CPI, prices rose 2.4 percent year-over-year in March. But if we use the Fed’s methodology from 1980, as ShadowStats does, it’s possible prices advanced more than 10 percent from a year ago.

Regardless of which measure you trust the most, it’s clear that inflation has been heating up at a faster pace—meaning it might be time for investors to consider adding to their gold exposure.

3. Gold supply is shrinking while demand continues to grow.

Like most hard assets, prices of gold and other precious metals respond to supply and demand. If supply goes up but there’s little demand, prices tend to struggle to gain momentum. But if the reverse happens—if supply can’t meet demand—prices have a better chance of increasing.

It’s possible we could see the latter scenario in the coming months.

That’s because many explorers and producers went into cost-cutting mode after the price of gold broke down from its record high of around $1,900 an ounce in August 2011. Exploration budgets were slashed, and partially as a result, there have been fewer and fewer large-deposit discoveries.

What this all means is that if gold demand were to spike unusually high, there’s a strong probability that not enough gold would be available. We would expect the metal to be traded at a premium.

gold supply crunch ahead?
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In the chart above, you can see how a smaller number of projects have been added to the pipeline in some recent years, thanks to a decrease in exploration budgets. Meanwhile, demand has continued to grow as incomes rise in emerging markets that have a strong appetite for the yellow metal—India, China and Turkey chief among them.

4. Gold prices have historically tracked government debt—which appears to be increasing dramatically.

I think what’s also driving gold demand right now are concerns over the U.S. budget deficit and ballooning government debt. The Congressional Budget Office (CBO) recently said it estimated the deficit to surge over $1 trillion in 2018 and average $1.2 trillion each subsequent year between 2019 and 2028, for a total of $12.4 trillion.

Believe it or not, servicing the interest on this debt alone is expected to exceed what the government spends on its military by 2023.

Now, the International Monetary Fund (IMF), in its April “Fiscal Monitor,” says U.S. government debt will continue to expand as a percent of gross domestic product (GDP), even surpassing levels we last saw during World War II.

gold supply crunch ahead?
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This is a cause for concern, the IMF writes, because “large debt and deficits hinder governments’ ability to implement a strong fiscal policy response to support the economy in the event of a downturn.”

You can probably tell where I’m headed with all of this. Savvy investors and savers might very well see this as a sign to allocate a part of their portfolios in assets that have historically held their value well in times of economic contraction.

Gold is one such asset that’s been trusted as a store of value in such times. As I’ve shown elsewhere, gold has tracked U.S. government debt up since 1971, when President Richard Nixon ended the gold standard.

 

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China’s Money Supply Could Indicate Additional Room for Gold Demand

Frank Holmes’ of U.S. Global Investors’ latest weekly SWOT (Strength, Weakness, Opportunity, Threat) analysis of what’s been going on in the global precious metals sector

Strengths

  • Palladium followed by platinum was the best performing precious metals this week, up 2.87 percent and 2.23 percent, respectively.  The platinum group metals responded positively to news that automobile demand continues to be strong globally, boosting platinum and palladium prices. The European Automobile Manufacturers Association reported over 1 million more car listings in November. The number of vehicle sales in China rose nearly 20 percent.
  • It seems that bullish gold investors may be able to breathe a little easier after the Fed finally made its decision to raise rates 25 basis points earlier this week. Bob Haberkorn, a senior market strategist at RJO Futures in Chicago, commented that sentiment has shifted, and traders are seeing less downside potential in the gold price.
  • Goldcorp CEO Chuck Jeannes also said that he thinks the increase in rates will be a net benefit for the gold mining company, now that the uncertainty around the Fed’s action is behind us.  Newsletter writer Dennis Garman was interviewed by ETF.com and he opined that we have likely seen the low in gold prices now.

Weaknesses

  • With the hike in interest rates and the ensuing strength in the dollar the next day, it is not too much of a surprise that gold came in at the bottom in terms of price performance last week.  What is nice is that this is the third Fed meeting in row that gold was stronger on the day of the announcement.  Absent was the manipulative middle of night plus $1 billion dumping trades of gold bullion to push gold down on the Fed meeting dates.  Fortunately for the perpetrators, the regulators were asleep.
  • More rate hikes could be on the way, warn some analysts. Macquarie analyst Matthew Turner said that if the economy continues to strengthen after this rate increase, then the Fed may go ahead with further tightening. Historically, gold doesn’t perform well in periods of tightening monetary policy with rising real interest rates.
  • Gold is headed for the third annual loss, according to BloombergBusiness. Societe Generale’s Alain Bokobza said bullion will likely drop to $955 per ounce by the end of the year.

Opportunities

  • Klondex Mines announced this week its acquisition of the Rice Lake Mine near Bissett, Manitoba. For the total purchase price of $32 million, Klondex is acquiring a fully operational mine, mill and fleet of equipment that was recently put on care and maintenance as the property went into receivership earlier in the year.  Over $375 million of capital improvements have been made on the property since 2007 and the mobile equipment fleet was appraised at close to $20 million. Klondex plans to calculate a new resource for the operation and design a new mine plan for developing the ore in a profitable manner.  It will likely be fourth quarter of 2016 before they start production back up.  In our opinion, the prior operator had oversized the mill and dropped the cutoff grade to try and grow the number of ounces produced.  To accomplish this they also got overextended on the debt side.   Klondex has a great opportunity here to do the proper work and right size the operation so it can be profitable.  Klondex Mines still offers investors an attractive opportunity to participate in the turnaround of Rice Lake.
  • According to research from Cornerstone Macro, the dollar has historically appreciated before the first hike and typically has depreciated afterwards. If the historical pattern is any indication, the dollar will not strengthen further as many of the flapping mouth airheads have pontificated, of course without looking at the facts.

swot 2115 1

  • China’s money supply far exceeds that of other developed nations. Bloomberg Intelligence noted this presumed spending power seems to indicate that China still has plenty of room for additional gold demand.

swot 2115 - 21 - 2

Threats

  • Commodity headwinds continue, as the Bloomberg Commodity Index closed at the lowest level in 16 years on Monday. The slowing commodities demand from China continues to affect the diversified mining companies, as China shifts to a service-driven economy.
  • Former U.S. Treasury Secretary Lawrence Summers and economist Nouriel Roubini said earlier this week that the Fed policymakers may be making a mistake if the rate hike was premature. There is still much uncertainty in the global markets about the prospects of growth and stalling growth rates in the U.S.
  • Deutsche Bank views gold miners as a possible hedge against global uncertainty. DB notes that the combination of deficit spending, poor merger & acquisition decisions and the China commodity demand slowdown have resulted in “toxic” levels for balance sheets. Markets have been watching these disturbing credit conditions, as Goldman Sachs noted that “U.S. corporate credit quality has deteriorated to the weakest level in a decade.” In this environment, DB favors a defensive posture in companies with stronger balance sheets and non-integrated names.

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China’s economic transformation – NOT an economic collapse

China’s Economy Is Undergoing a Huge Transformation That No One’s Talking About

By Frank Holmes, CEO and Chief Investment Officer, US Global Investors

The photo you see below was snapped recently in Beijing. It might not be that special to some readers, but in my 25 years of visiting the Chinese capital, I’ve never seen a blue sky because it’s always been blotted out by yellow smog. Beijing is clearly undergoing a massive transformation right now. This might please proponents of the green movement, but it’s ultimately harmful to the health of China’s manufacturing sector.

Blue skies ahead? A cyclist pedals through Tiananmen Squar in Beijing

On the other hand, blue skies could be ahead for China’s service industries.

Misconception and exaggeration are circling China’s economy right now like a flock of hungry buzzards. If you listen only to the popular media, you might believe that the Asian giant is teetering on the brink of economic disaster, with the Shanghai Composite Index’s recent correction and devaluation of the renminbi held up as “proof.”

Don’t get me wrong. These events are indeed significant and have real consequences. They also make for some great, sensational headlines, as I discussed earlier this month.

But what gets hardly any coverage is that China’s economy is not weakening so much as it’s changing, much like Beijing’s skies. Take a look at the following two charts, courtesy of BCA Research:

China's Economy is Shifting Away from Manufacturing More Towards Services
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You can see that the world’s second-largest economy has begun to shift away from manufacturing and more toward consumption and the service industries. While the country’s purchasing managers’ index (PMI) reading has been in contraction mode since March of this year, the service industries—which include financial services, insurance, entertainment, tourism and more—are ever-expanding. The problem is that the transformation has not been fast enough to offset the massive size of the manufacturing sector.

the Czech Republic's PMI came in at an impressive 57.50 in July up from 56.90 in June

Just as a refresher, the PMI is forward-looking and resets every 30 days. It helps investors manage expectations. Consider this: The best-performing country in our Emerging Europe Fund (EUROX) is the Czech Republic—which also happens to have one of the highest PMI readings. Coincidence?

In China, overseas travel, cinema box office revenue and ecommerce are all seeing “explosive growth,” according to BCA. The country’s once-struggling real estate market is also robust. The government just relaxed rules to permit more foreigners to purchase mainland property.

But you’d be hard-pressed to come across any of this constructive news because it’s not particularly good for ratings.

A recent Economist article makes this point very clear:

The property market matters far more for China’s economy than equities do. Housing and land account for the vast majority of collateral in the financial system and play a much bigger role in spurring on growth. Yet the barrage of bearish headlines about share prices has obscured news of a property rebound. House prices have perked up nationwide for three straight months. Two months after the stock market first crashed, this upturn continues.

“Commodity Imports Have Actually Been Quite Strong”

Again, China’s transformation from a manufacturing-based economy to one that focuses on consumption has real consequences, one of the most significant being the softening of global commodity prices. As I told Daniela Cambone on last week’s Gold Game Film, gold’s Love Trade has become not a No Trade, but a Slow Trade. We’ve seen demand cool along with a decline in GDP per capita, the PMI readings and China’s M2 money supply growth.

Below you can see the relationship between China’s M2 money supply growth and metal prices. Since its peak in late 2009, money supply growth has been dropping year-over-year, driving down metal prices.

China's falling money supply since 2009 peak has driven down metal prices
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Money supply growth tends to be a “first mover.” When it has contracted, the PMI has usually followed. Recently, this has hurt economies that depend on China as a net buyer of raw materials, including Brazil, which supplies the Asian country with iron ore, soybeans and many other commodities, and Australia.

Australian Dollar and Brazilian Real Retreat with Drop in China's Money Supply
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When M2 money supply growth and the PMIs are rising, commodity prices can also rise. But that’s not what’s happening. It’s important to recognize that when new orders for finished products fall, there’s less consumption of energy to manufacture and ship. Again, this might make the greenies happy, but it’s ultimately bad for manufacturing.

I’ve said several times before that China is the 800-pound commodities gorilla, and it continues to be so. The country currently consumes about a quarter of the total global output of gold. For nickel, copper, zinc, tin and steel, it’s around half of world consumption. For aluminum, it’s more than half.

These are huge figures. But investors should know that Chinese imports of these important metals and materials still remain strong. Tom Pugh, a commodities economist at Capital Economics, told the Wall Street Journal last week that the market has it wrong about China, that the drop in demand has been overstated:

If you look at Chinese commodity imports over the last few months, they’ve actually been quite strong. A lot of it is just that people thought China would continue to grow at 10 percent a year, ad infinitum, and now people are just realizing that’s not going to happen.

Reuters took a similar stance, reporting that “there were at least 21 commodities that showed increases in imports greater than 20 percent in July this year, compared to the same month in 2014.” Weakening demand has been caused by a number of reasons, including “structural oversupply” and “the impact of the recent volatility in equity markets.”

But it’s important to keep things in perspective. Compared to past major market crashes, China’s recent correction doesn’t appear that bad.

China's Crash is Big, But Not the Biggest

Any bad news in this case can be seen as good news. I think that in the next three months we might see further monetary stimulus, following the currency debasement nearly three weeks ago. We might also see the implementation of new reforms in order to address the colossal infrastructure programs China has announced in the last couple of years, the most monumental being the “One Road, One Belt” initiative.

Dividend-Paying Stocks Helped Stanch the Losses

As investors and money managers, it’s crucial that we be cognizant of the changes China is undergoing. With volatility high in the Chinese markets right now, we’ve raised the cash level in our China Region Fund (USCOX), and after the dust settles somewhat and the right opportunities arise, we’ll be prepared to deploy the cash. We’re also diversified outside of China.

We managed to slow the losses during the Shanghai correction by being invested in high-quality, dividend-paying stocks.

According to daily data collected since December 2004, the median trailing price-to-earnings (P/E) ratio for the Shanghai Composite Index constituents currently sits at 48.6 times earnings. If it reverts to the mean, risk is 32 percent to the downside for the index. Currently, the P/E ratio of our China Region Fund constituents sits around 16 times. This suggests that USCOX has less downside risk and is cheaper than the Shanghai Composite.

Median Trailing Price-to-Earnings Ratio for Shanghai Composite Index Constituents
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We seek to take advantage of the trend toward consumption by increasing our exposure to the growing service industries—technology, Internet and ecommerce companies (Tencent is one of our top 10 holdings); financial services (AIA and Ping An Insurance); and enviornmental services (wastewater treatment services provider CT Environmental).

Golden State Warriors guard Klay Thompson unveiling the KT Fire ANTA EARLIER THIS YEAR

Rising sports participation among white collar workers in China is very visibile these days. Xian Liang, portfolio manager of USCOX, says that his friends back in Shanghai share with him, via WeChat, how they track their daily runs using mapping apps on their phones.

With that said, an attractive company is Anta Sports, an emerging, innovative sportswear franchise. Fans of the Golden State Warriors might recall that guard Klay Thompson endorsed its products earlier this year.

We believe the China region remains one of the most compelling growth stories in the world and continues to provide exciting investment opportunities.

Gold’s flash crashes – what should be done?

There’s a Huge Disparity Between How Regulators Deal with Gold and Stock Market Manipulation

By Frank Holmes – CEO and Chief Investment Advisor, U.S. Global Investors

Gold futures were going bonkers in the fall of 2013 and early 2014.

On a weekly and sometimes daily basis, unbelievably massive gold contracts were coming on the market at non-peak trading hours, only to be withdrawn almost instantaneously. In one particularly alarming instance in January 2014, the yellow metal plummeted $30, from $1,245 an ounce to below $1,215, in as little as 100 milliseconds.

The GOld Futures "Flash Crash" of January 6, 2014
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Whatever the cause of this behavior—“fat finger” errors, as some people suggested, or “quote stuffing,” as others suspected—markets were effectively shaken.

From the very beginning, we reported on these anomalies in a series of commentaries that read now like notes from a foxhole. In the September 13, 2013 edition of our Investor Alert, the USGI investments team wrote:

The bullion plunge this week sent the yellow metal breaking below the 100- and 50-day moving averages. Strange dealing patterns are adversely affecting the gold price. These dealings revolve around the “flashing” of massive gold contracts for sale to traders, at a time of day that there is normally little or no activity in the markets, and no news story being released.

Then, on October 25:

You can see massive trading volumes every day of over 5,000 contracts, all around the same time. On the first of October, as well as on October 10, there were massive trades of over 20,000 contracts. This amount represents well over two million ounces, or around $2.6 billion. It’s safe to say nobody has that amount of physical gold, apart from the big central banks, so these trades are being done by entities trading gold they do not have in a manner designed primarily to trigger stop loss orders.

Unusual Gold Trades Triggering Sharp Swings in Gold Price
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And again, on December 20, 2013:

In recent weeks, there have been concerns among market participants and regulators that the process for establishing the price of gold may lend itself to insider trading and other forms of unfair dealing. The spot price of gold tends to drop sharply around the London evening fixing, or 10:00 a.m. Eastern. A similar, if less pronounced, drop in price occurs around the London morning fixing. For both commodities, there were, on average, no comparable price changes at any other time of the day. These patterns appear to be consistent with manipulation in both markets.

Although these “strange dealing patterns” eventually tapered off, it remained a mystery who or what was behind them.

Until now.

Last week, the CME Group officially accused Mirus Futures, a now-defunct brokerage firm, of failing to “adequately monitor the operation of its trading platform,” which resulted in “unusually large and atypical trading activity by several of the Firm’s customers.” This is what allegedly led to the disruption in price discovery in the gold futures market.

The Partyallegedly behind the gold "flash crashes" in 2013 and 2014 has been identified.

What’s unclear is how culpable Mirus Futures really was in all of this. At the very least, it acted carelessly. Did its trading platform have a glitch, and if so, when did Mirus become aware of it? Was it deliberately trying to manipulate the gold markets? There’s no way we can know the answers to these questions. That Mirus has since been acquired by another brokerage firm would make any investigation into its intentions—if there were any to begin with—even more challenging for authorities.

What I find especially notable, though, is that the firm settled with the CME by paying a fine of only $200,000.

This is already a pretty paltry amount, considering how far-reaching its actions (or inactions) were. But when you compare the $200,000 penalty to what Navinder Sing Sarao faces, a huge disparity in the enforcement of such white collar crimes emerges.

Flashing the Stock Market

You might not be familiar with the name Navinder “Nav” Sarao, but it’s likely you’ve heard of the event he’s accused of orchestrating, thanks largely to Michael Lewis’s bestselling book Flash Boys. On May 6, 2010, Sarao, a 36-year-old British day trader, allegedly spoofed American markets using a familiar technique: mammoth-size orders were placed, only to be withdrawn right before execution. Price discovery broke down. In the brief timespan of five minutes, the Dow Jones Industrial Average was taken on a wild 1,000-point ride. Shares of Procter & Gamble fell to as little as a penny. Altogether, nearly $1 trillion in value vanished from U.S. stocks.

Down Jones Industrial Average on May 6, 2010
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Two months after being arrested by Scotland Yard, Sarao now sits in a British prison on bail set at $7.5 million, his assets completely frozen. He awaits extradition to the U.S., where he will face multiple charges, including several counts of market manipulation, commodity fraud, wire fraud and more. According to the Department of Justice, “Sarao’s alleged manipulation earned him significant profits and contributed to a major drop in the U.S. stock market.”

The maximum sentence for all charges is 380 years in jail. Next to that, a $200,000 fine seems more reward than punishment.

You could argue that the upheaval that Sarao contributed to, if not singlehandedly caused, is more significant than the series of gold flashes that occurred in 2013 and 2014. Or that Sarao demonstrated nefarious intentions more unambiguously than Mirus Futures did. Still, the discrepancy is colossal and hard to ignore.

“Apparently regulators care much more about manipulation of the stock market than gold,” commented Ralph Aldis, portfolio manager of our Gold and Precious Metals Fund (USERX) and World Precious Minerals Fund (UNWPX).

This could be a problem. As long as rogue traders are convinced that their actions will go unchecked, the gold market could continue to be a target and the metal’s fair value remain under pressure. As I wrote last year in my whitepaper Managing Expectations: “We welcome the regulators to explore ways to manage these issues better and create both a fairer playing field and more transparent trading arena.”

But until gold is allowed to find its true, fundamental value, now might be a good time to accumulate. As always, I recommend that investors allocate 10 percent of their portfolios to gold—5 percent in bullion, 5 percent in gold stocks, then rebalance every year.

 

 

Pulling the rug: The consequences of breaking from the gold standard

a 1928 Federal Reserve Note

 

 

 

 

By Frank Holmes

CEO and Chief Investment Officer, US Global Investors

About 100 years ago, in his testimony before Congress, banking giant J.P. Morgan famously stated: “Gold is money, and nothing else.”

At the time, this was true in every sense of the word “money,” as the U.S. was still on the gold standard.

Of course, that’s no longer the case. Despite the fact that previous attempts in other countries to adopt fiat currency systems wreaked havoc on their economies, the U.S., under President Richard Nixon, cut all ties between the dollar and gold in 1971. Gold rose 2,330 percent during the decade, from $35 per ounce to $850.

Today, money supply continues to expand while federal gold reserves remain at the same levels.

M2 Money Supply Rises While Gold Supply Remains the Same, 1959 - 2010
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Many people still view the yellow metal as something more than just another asset. They also contend that it’s grossly undervalued. In a recent interview with Hard Assets Investor, author and veteran gold investing expert James Turk explained that the money we use now in transactions is not real money at all but a substitute for gold—real money—which he sees fundamentally valued at $12,000 per ounce.

That is to say, if the U.S. government decided tomorrow to return to the gold standard, one ounce of the metal could be valued as high as $12,000, according to Turk’s model.

The current fiat currency system in the U.S. is more than 40 years old. That’s much longer than many in the past lasted, including two of the earliest attempts by central bankers Johan Palmstruch and John Law, both of which I summarize below. Some readers might identify more than a few parallels between then and now.

Johan Palmstruch, the Dutchman Who Started a Paper Ponzi Scheme in 1661

a 1928 Federal Reserve Note

In the mid-1600s, a Dutch merchant named Johan Palmstruch founded the Stockholms Banco in Sweden, the first bank in Europe to print paper money. The Swedish currency at the time was thedaler, essentially a copper plate. Palmstruch’s bank began holding these and issuing banknotes, which were exchangeable in any transaction and fully backed by the physical metal.

At least, that’s what customers were told.

As you might imagine, people found these notes to be much more convenient than copper plates, and their popularity soared. But there was one (huge) problem. Palmstruch had been doling out so many paper bills, that their collective value soon exceeded the amount of metal on reserve. When customers heard the news, a major bank run occurred, but Palmstruch was unable to honor the rapidly-weakening notes.

By 1664, a mere three years into his monetary experiment, the Stockholms Banco was ruined and Palmstruch was jailed—just as Bernie Madoff would be three and a half centuries later.

John Law, the Infamous Scottish Gambler Who Defrauded the French with Worthless Paper

A little over 50 years later, in the early 1700s, a similar experiment was conducted in France, with even more disastrous consequences. This time, the perpetrator was a Scottish gambler and womanizer named John Law, who as a young man had been forced to flee Britain after he killed a man in a duel over a love interest—and bribed his way out of prison. After escaping jail time, Law spent 10 years or so gallivanting about Europe and developing his economic theories, which he outlined in an academic paper.

It was the Age of Enlightenment, when great iconoclastic thinkers such as Descartes, Locke and Newton emerged, changing our understanding of consciousness, politics and physics. Baroque music was all the rage in Europe, as were composers like Bach, Handel and Vivaldi. It was also a golden age of get-rich-quick schemes, and as investors, it’s important that we be aware of the history of human behavior.

In 1715, France was insolvent. It had just lost its king, Louis XIV, and the Duke d’Orléans was named regent until the late monarch’s great-grandson came of age to rule. Familiar with Law and his unorthodox ideas, the duke established him as head of the Banque Générale in hopes that he might reduce the massive debt Louis XIV left behind.

To this end, Law began printing banknotes—lots of them—and flooding the economy with easy money. Doing so, he believed, would expand employment, boost production and increase exports.

John Law, the central banker who broke the Banque de France (and many women's hearts)

It indeed had those effects—for a time. Paris was booming. The number of millionaires multiplied.

Unlike Palmstruch, Law made no claims that the notes could be converted back into gold or any other metal. He believed that a currency, whether gold or paper, had no intrinsic value other than as a government-sanctioned medium of exchange. Instead, his notes were “secured,” vaguely, by French land, including its colonies in the Americas. There was also no limit to the amount of money that could be pumped into the French economy. Like many of today’s central bankers, Law was of the opinion that if 500 million notes were good, a billion were even better.

But to make it all work according to plan, he had to take extreme measures. Law outlawed the hoarding of money, the use of coins and the possession of more than the minimalist amount of gold and silver.

The system turned out to be untenable and the paper money became worthless. After only four short years, the currency bubble burst. Law was not only removed from office but exiled from the country. Until his death in 1729, he roamed Europe heavily in debt, making his way by his former occupation, gambling.

The incident had long-lasting effects. It sustained the country’s economic woes for years and contributed to the start of the French Revolution later in the century, as it stoked working class disenfranchisement.

Lessons Learned?

Just as we still read Locke and listen to Bach, we should remember what Palmstruch, Law and other reckless central bankers did—which was essentially pull the rug out from under their countries’ monetary systems. It would be extreme to suggest that a similar collapse in currency might one day happen in the U.S., but it’s worth repeating that the gold supply has not kept pace with the money supply.

This could have huge implications.

As James Turk points out:

Eventually people are going to understand that all of this fiat currency that is backed by nothing but IOUs is only as good as the IOUs are good. And in the current environment, the IOUs are so big, a lot of promises are going to be broken.

Should those IOUs one day become as worthless as Palmstruch’s or Law’s paper—however unlikely that might be—I suspect many readers would feel relieved to know that they had had the prudence to invest in gold.

I always advise investors to hold 10 percent of their portfolios in gold—5 percent in bullion, 5 percent in gold stocks, then rebalance every year.

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Junior Mining Companies Have Taken a Senior Role

By Frank Holmes

Smaller-cap explorers and producers are generating greater wealth for investors

For the past decade, junior mining companies have outperformed senior miners at finding new mineral deposits and generating wealth for investors.

These are among some of the findings released in a study conducted by resource company strategist MinEx Consulting, which analyzed the performance of explorers and producers operating in Canada between 1975 and 2014. What the consultancy firm found is that, in the last decade, junior companies were responsible for more than three quarters of all new mineral discoveries and were approximately 30 percent more effective than senior companies at generating wealth.

Ralph Aldis, portfolio manager of our two precious metals funds— the World Precious Minerals Fund (UNWPX) and Gold and Precious Metals Fund (USERX), which holds four stars overall from Morningstar, among 71 Equity Precious Metals funds as of 3/31/2015, based on risk-adjusted returns—agrees with the results of the study. In a March interview with The Gold Report, he noted that junior gold producers “have the flexibility to be able to adjust” to varying commodity-price conditions.

“It’s the smaller, midsized companies that have a better handle on their operations,” Ralph said.

A good example of such a small-cap miner would be Claude Resources Inc., which we own in both USERX and UNWPX. Claude, the only producer operating in Saskatchewan, Canada, managed to turn its operation around fairly quickly after netting a huge loss of $73 million in 2013. The company just reported a profit of $4.6 million in 2014, driven by “record production performance,” according to President and CEO Brian Skanderbeg. For the one-year period, the company is up a phenomenal 216 percent.

“Claude has been around for a long time, but its new management understood that it had to change its mining method, which has made a big difference,” Ralph said in The Gold Report.

Junior companies have increasingly played an essential exploratory role in Canada. Nearly 40 years ago, they were responsible for only 5 percent of all capital spent on exploration; by 2007, that amount had ballooned to more than 65 percent. Over the past decade, juniors have accounted for 54 percent of all spending on exploration in Canada.

Importance of Junior Mining Companies in Canada Has Been Rising Over Time
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As a result, major producers have steadily lost ground to the smaller players in terms of discovering new mineral deposits. In three of the previous 10 years, in fact—2009, 2010 and 2012—senior companies failed to make a single new discovery.

In the Last Decade, 3/4 of All Mineral Discoveries in Canada Were Made by Junior Explorers
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Quality or Quantity? How about Both?

Frank Holmes in the copper Mountain Mine in Princeton, British Columbia

Not all mineral deposits are created equal, of course. Some might be all a producer needs to be successful, whereas others aren’t even worth the time and capital to develop.

You can think of a Tier 1 deposit as a “company making” mine—one that might yield up to 250,000 ounces of gold per year over its lifespan of 20 years or more. Some of these projects can easily be valued at over $1 billion.

A Tier 2 deposit is significant but not as profitable as a Tier 1, with a typical valuation of between $200 million and $1 billion.

Finally, a Tier 3 deposit is considered marginal, valued at anywhere between $0 and $200 million.

About 80 percent of the mining industry’s wealth is generated from Tier 1 and Tier 2 projects. But such discoveries, as you might imagine, are muchrarer than Tier 3s. To give you an idea of just how rare they are, consider this: Every decade in Canada, the industry discovers on average 40 Tier 3 deposits, seven Tier 2 deposits—and only three Tier 1 deposits.

So how do the juniors stack up against the seniors when it comes to finding quality mines? In the table below, you can see that they’re running slightly behind. In the past decade, juniors made 7.3 Tier 1 or 2 discoveries in Canada, compared to the seniors’ 8.7.

Spend and Performance in Canada: 2005 – 2014
Exploration Spend in Billions Number of Discoveries Tier 1 and 2 Discoveries Estimated Value of Discoveries, in Billions Value/Spend
Seniors $12.5 46% 21 24% 8.7 54% $7.9 39% 0.63
Juniors $14.6 54% 66 76% 7.3 46% $12.1 61% 0.83
Past performance does not guarantee future results.
Source: MinEx Consulting, U.S. Global Investors

But—and this is a big “but”—they handily beat the seniors when it came to the total number of discoveries. Of all the deposits found, over three quarters were made by junior miners.

As I said earlier, juniors spent more than the seniors on exploration during this timeframe ($14.6 billion compared to $12.5 billion), and their discoveries collectively had a much higher valuation ($12.1 billion compared to $7.9 billion). Accordingly, they were roughly 30 percent more effective than seniors at generating wealth for investors. Put another way, they had a greater “bang for your buck.”

Small Cap, Big Opportunities

This news bodes well for our two precious metals funds. Although they both invest in junior explorers and producers, the Gold and Precious Metals Fund also allocates assets to the large-cap, senior mining companies.

Market Capitalization Breakdown for USGI's Gold Funds
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Not only that, but Canada is the top investment destination in both funds: 57 percent in USERX, 77 percent in UNWPX. Canadian mining companies have lately seen margin expansion because the majority of their costs are in the relatively weak Canadian dollar, yet they sell their commodities in the strong U.S. dollar.

According to MinEx, 19 percent of the world’s high-quality Tier 1 and 2 mineral discoveries were made in Canada between 2005 and 2014. That’s second only to the entire continent of Africa (25 percent). The country’s mining industry also has an estimated value of $19 billion, or 21 percent of total valuation worldwide. At 0.77, Canada’s value-spend ratio, or “bang for your buck,” was better than the global average of 0.67.

frank Holmes is CEO and Chief Investment Advisor for U.S. Global Investors – http://www.usfunds.com