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Please note: The Frank Talk articles listed below contain historical material. The data provided was current at the time of publication. For current information regarding any of the funds mentioned in these presentations, please visit the appropriate fund performance page.

Hope for the New Year
January 3, 2017

Happy New Year 2017 from your friends at U.S. Global Investors

In the early decades of the 19th century, a new cultural and philosophical movement emerged that embodies all that makes America great. Led chiefly by Ralph Waldo Emerson and Henry David Thoreau, American transcendentalism praises the purity of the individual and stresses the importance of self-reliance.

“The great man is he who in the midst of the crowd keeps with perfect sweetness the independence of solitude,” Emerson wrote.

I recognized these uniquely American values early on when I made the move from Canada to Texas. Individualism, non-linear thinking, a rebellious streak—without them, the U.S. might not have been the birthplace of world-changing innovations such as the locomotive, automobile, airplane and microprocessor.

Today we have these same values to thank for the creation of Facebook, Amazon, Google and other tech giants, without which we can hardly imagine our lives now.

They’ve also helped make many people fabulously wealthy. Of the 400 Americans on Forbes’ wealthiest list, about two thirds can be labeled as self-made, including Jan Koum, a Ukrainian immigrant raised on food stamps who became an overnight billionaire when he sold his instant messaging app, WhatsApp, to Facebook in 2014.

Other countries have little choice but to emulate America’s economic and cultural biosphere that allows such innovations to flourish. In an effort to become a leader in autonomous driving, Germany-based Volkswagen is currently in the process of recruiting as many as 1,000 experts in artificial intelligence, virtual reality and big data—many of whom hail from Silicon Valley and other American tech hubs. According to Volkswagen Chief Information Officer Dr. Martin Hoffman, research teams in Berlin and Munich “work the Silicon Valley way. We have brought the Valley to Volkswagen… with over 20 experts from San Francisco and Boulder, Colorado.”

Volkswagen is in the process of hiring 1,000 IT experts, many of them from Silicon Valley

As I’ve pointed out many times before, the reason Silicon Valley must be imported from the U.S.—instead of built in-house—is largely because the European Union’s crushing regulations and policies of envy stand in the way of ingenuity and entrepreneurship. Their best brains, therefore, end up in the U.S., the land of opportunity.

“If anybody believes Europeans will create a better business environment than Americans, they’re completely dreaming,” Mark Tluszvz, CEO of a Luxembourg-based venture capitalist firm, told the Financial Times in 2015. “We don’t have this in our culture."

It’s essential we don’t lose it in our culture, either. Many U.S. lawmakers and bureaucrats, however, seem intent on significantly weakening our ability to innovate and stay competitive. The more rules and layers of regulations that businesses must contend with, the more the U.S. will resemble Brussels.

We can’t allow that to happen.

“Any fool can make a rule, and every fool will mind it,” Thoreau sagely wrote nearly 200 years ago.

Although “fool” might not be the word I would use, it must be recognized that the U.S. became the innovative powerhouse it is today not because of rules but because of the values of individualism espoused by the transcendentalists all those years ago.

Trump Pushing Back on New Rules

I’m convinced this is one of the key reasons why U.S. voters elected Donald Trump, despite his rough edges. Trump has pledged to streamline or altogether eliminate many financial regulations that have stymied the creation of capital over the years, from Dodd-Frank Wall Street Reform to the Sarbanes-Oxley Act (SOX). We add can to this list the Department of Labor’s (DOL) new Fiduciary Rule.

Signed by President George W. Bush, SOX seeks to prevent massive corporate fraud such as we saw from Enron and WorldCom in the early 2000s. Although a noble mission, SOX has had the unintended consequence of barring small to medium public companies from getting ahead. It’s also prevented retail investors from getting in on the ground floor. Because the requisite internal control procedures are so costly and cumbersome—necessitating additional compliance and accounting positions, not to mention hundreds of hours spent on compliance-driven tasks—smaller firms are inevitably at a disadvantage.

As a result, many small to mid-sized companies are delaying going public, or avoiding it altogether, to escape the regulatory burden. Before SOX, there were an average 528 IPOs a year. Since it was enacted, that number has fallen to 135, a decline of nearly 75 percent.

Sarbanes-Oxley Act Has Contributed to Fewer IPOs
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As for Dodd-Frank, signed by President Barack Obama, market experts ranging from Warren Buffett to Alan Greenspan support its repeal, with Buffett saying the legislation “has taken away the Federal Reserve’s ability to act in a crisis.” Many banks have done away with free checking, giving lower-income customers fewer and fewer banking options.

Joining the chorus in calling for deregulation is billionaire CEO of Koch Industries, Charles Koch. Speaking to ABC’s “This Week” back in April, he called our political and economic system rigged “in favor of [multibillion-dollar] companies like ours,” and criticized “corporate welfare that benefits established companies and makes it difficult for somebody to get started.”

Charles Koch: The system is rigged in favor of big corporations.

Protecting the Little Guy?

These rulings, among others, have been detrimental to the formation of capital, especially for the little guy, whom they purport to be protecting. But it doesn’t exactly help or protect the little guy if his investment, banking and business options are dramatically limited. See this chart I shared with you back in July, which shows how retail investors have been locked out of participating in the best-performing asset classes.

Or consider the DOL’s new Fiduciary Rule. When it goes into effect in April 2017, it will inevitably limit the number of investment products available to retail investors. The ruling states that all retirement planners, advisors and broker-dealers must now “act in the best interests of clients” and charge only “reasonable” fees. This all sounds fine, but what’s naturally going to happen is financial professionals—in an effort to remain compliant with the rule—will recommend only the least expensive products, regardless of whether they’re a good fit. Many mutual funds—which might be better performing but have higher expenses than other investment vehicles—will fall off of brokerage firms’ platforms.

It would be like the DOL telling consumers they can only shop at Walmart and buy their coffee from Dunkin’ Donuts because anything more expensive—Target or Starbucks, say—is “riskier,” even though they’re of higher quality.

This type of anti-capitalist mindset is expected in the EU, not the U.S. Trump’s win certainly puts a target on the DOL’s Fiduciary Rule, which he has pledged to repeal, but like Sarbanes-Oxley and Dodd-Frank, we’ll have to wait and see.

And Yet, Business Owners Are Optimistic

Whether Trump can succeed at reversing some of these rules remains to be seen. If you remember, Obama failed to roll back—and, in fact, he extended—Bush-era legislation he strongly campaigned against, such as the Patriot Act and Bush tax cuts. The same might very well happen under Trump. Even Carl Icahn—whom Trump named as his special advisor on deregulation—has commented that Dodd-Frank is needed.

But Trump is a pragmatist, as Obama himself described him. “He is coming into this office with fewer set-hard-and-fast policy prescriptions than other presidents,” Obama said.

Indeed, Trump isn’t guided by ideology from the religious right, as Bush was, or the socialist left, as Obama was. Remember, he long identified himself as a Democrat and has supported Democratic candidates (including Hillary Clinton). So I think that, after 16 years of Bush and Obama, the pendulum is finally swinging back to the center. The question is: Can Trump make it work?

Many small to mid-sized business owners seem to believe he can. In a Business Journals survey taken the day after the election, 82 percent of businesses said they felt confident their prospects would improve over the next 12 months. That’s the highest reading in nearly a decade.

Small to Mid-Sized Business Owners Most Optimistic in Nearly a Decade
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How Markets Are Betting

As I’ve pointed out before, investors seem to be betting that, despite the uphill battle ahead, Trump can deliver on financial deregulation. Below, the chart shows sector performance before Trump’s election compared with performance since the election. As you can see, financials jumped seven places to become the top-performing sector. What’s more, health care turned positive, suggesting investors are confident Trump and the Republican-controlled Congress can dismantle Obamacare.

S&P 500 Sectors Before and After U.S. Election
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Small-cap stocks, as measured by the Russell 2000 Index, are also way up on bets that Trump’s protectionist policies will benefit domestics with limited exposure to foreign markets, more so than multinational blue-chip stocks.

Investors Bet on Domestic Small Caps Following Trump's Win
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It might be too soon to tell, but I expect these trends to carry on into 2017. 

Rising Rates Ahead in 2017

With economic conditions and expectations improving, especially since the election, it’s very likely the Federal Reserve will continue to tighten throughout 2017. Rate hikes will be limited, but 3 percent mortgage rates are probably a thing of the past.

Lenders are already slashing their refinance-volume expectations for 2017 and beyond, according to a mortgage lender sentiment survey conducted in December by Fannie Mae.

In addition, Kroll Bond Rating Agency (KBRA) believes we’ve likely seen peak lending: “While 2016 has been an excellent year for the U.S. mortgage industry, with almost $2 trillion in new loan originations, we believe that this year is also likely to be the peak in terms of lending volumes for years to come.”

Declining Mortgage Lending Volumes Ahead?
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As I’ve pointed out several times before, when interest rates are on the rise, short-term municipal bonds are the place to be, since they’re less sensitive to rate increases than longer-term bonds, whose maturities are further out.

I want to wish all of my loyal readers, investors and shareholders a most Happy New Year! As we begin a new American chapter in 2017, complete with a new series of challenges both big and small, remember to hold fast to H.O.P.E.—Have Only Positive Expectations!

 

Some links above may be directed to third-party websites. U.S. Global Investors does not endorse all information supplied by these websites and is not responsible for their content. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

The Russell 2000 Index is a U.S. equity index measuring the performance of the 2,000 smallest companies in the Russell 3000. The Russell 3000 Index consists of the 3,000 largest U.S. companies as determined by total market capitalization. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. None of the securities mentioned in the article were held by any accounts managed by U.S. Global Investors as of 9/30/2016.

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Gold Technically Oversold, Ready for a Price Reversal
December 28, 2016

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In more ways than one, 2016 was a roller coaster year.  One need only look at gold’s performance to confirm this. After rallying more than 30 percent in the first half, the precious metal stalled in the days before the U.S. election, then retreated on a weekly basis, under pressure from a strengthening dollar and tightening monetary policy.

As you can see in the oscillator below, gold is now down more than two standard deviations from its mean, or average, dollar amount. The reason I show you this is because, in the past, this was a good time to begin accumulating, as mean reversion soon followed.

Gold vs. 2-Year Treasury Yield Percent Change Oscillator
click to enlarge

The 2-year Treasury yield, meanwhile, is looking overbought and set to correct, based on our model. I’ve explained several times before how gold has tended to share an inverse relationship with Treasury yields. The math suggests a nearly 90 percent probability that mean reversion will occur over the next three months, with yields falling and the gold price rising back to its mean.

Even though gold stocks have given up a large portion of their gains since the summer, they were still up close to 40 percent for the 12-month period, as measured by the NYSE Arca Gold Miners Index. Over the same period, blue-chip stocks were up 12 percent, with the Trump rally driving most of it. Therefore, a portfolio composed not just of S&P 500 equities but also gold stocks and bullion would likely have performed better than one composed only of equities. 

Gold Miners Had a Phenomenal Year
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I always recommend a 10 percent weighting in gold, with 5 percent in gold stocks, the other 5 percent in gold bars, coins and jewelry.

Looking Ahead in the Near Term

U.S. debt dynamics are expected to turn positive for gold in 2017. That’s according to ICBC Standard Bank, which makes the case that the costs of higher yields are being overlooked. The Congressional Budget Office (CBO) calculates that net interest payments on the nearly $14 trillion of U.S. debt will amount to about $250 billion in 2016—or 1.4 percent of U.S. gross domestic product.

“If we apply an 80 basis point increase to the CBO’s net interest forecasts and keep the other variables unchanged, then by 2026 the Treasury would be paying an additional $185 billion in interest annually, and interest will have increased to 3.3 percent of GDP,” the bank writes, with emphasis my own. 

Effect of 80 Basis Points Increase on U.S. Treasury's Interest Costs
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In the note, Tom Kendall, head of precious metals, stresses that the financing costs for the U.S. have already jumped. But under President-elect Donald Trump’s policies—which may or may not have a positive impact on U.S. growth—the effects will likely lag. Any disappointments on the growth front, then, combined with higher interest costs and contentious negotiations on raising the debt ceiling in the first quarter, could well result in a more bullish scenario for gold.

Looking Ahead in the Long Term

Gold’s rarity is one of the key reasons why it’s so highly valued across the globe and for most of recorded human history. Back in August, I shared with you that the precious metal makes up only 0.003 parts per million of the earth’s crust.

“Peak gold” has been a topic for years now, with major discoveries on the decline. According to a recent Bloomberg article, the number of new gold deposits discovered in 2015 was down a whopping 85 percent since 2006.

This means annual production is expected to peak in 2019, followed by a steady decline until at least 2025. 

Global Gold Output Expected to Top Out in 2019 Before Declining
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Regardless of when peak gold might occur, it’s pretty widely accepted that all of the low hanging fruit, with regard to major deposits, has already been picked. As a consequence, we’ll likely see an increase in gold recycling, but the metal’s price could also rise as supply becomes restricted.

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

The NYSE Arca Gold Miners Index is a modified market capitalization weighted index comprised of publicly traded companies involved primarily in the mining for gold and silver. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.

A basis point, or bp, is a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001).

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Holiday Edition: Here Are the Top 6 Frank Talk Posts of 2016
December 27, 2016

Good Tidings we bring to you and yours

This year has been one for the history books. Donald Trump was elected as the 45th president of the United States, gold had its best quarter in a generation, Warren Buffett decided he likes airlines again and voters in the United Kingdom elected to leave the European Union. Loyal readers of the Investor Alert newsletter and my CEO blog Frank Talk know that we covered it all, too.

As we head into the New Year, I want to share with you the six most popular Frank Talk posts of 2016. Before I do that, however, I think it’s important to note one recurring theme I write about that continues to help our investment team and shareholders better understand the movement in commodities and energy: the purchasing managers’ index (PMI).

Using PMI as a Guide

As I explain in this January Frank Talk, our research has shown that PMI performance is strongly correlated with the movement in commodities and energy three and six months out. PMI forecasts future manufacturing conditions and activity by assessing forward-looking factors such as new orders and production levels.

When a PMI “cross-above” occurs—that is, when the monthly reading crosses above the three-month moving average—it has historically signaled a possible uptrend in crude oil, copper and other commodities. The reverse is also true. When the monthly reading crosses below the three-month moving average, the same commodities and materials have in the past retreated three months later.

In the three months following a “cross-above,” oil rose about 7 percent, 75 percent of the time, based on 10 years’ worth of data. Copper, meanwhile, rose more than 9 percent most of the time.

Commodities and Commodity Stocks Historically Rose Three Months After PMI 'Cross-Above'
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In November, the JPMorgan Global Manufacturing PMI reading clocked in at 52.1, a 27-month high. This shows that sector expansion has extended for a sixth straight month, which is very encouraging news. Following OPEC's recent production cut, we believe the decision is constructive for energy in the near-term, while a rising PMI is good news for the long term.

JPMorgan Global Manufacturing PMI Continues Upward Momentum
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We are finally seeing major media outlets and other Wall Street thought leaders recognize the importance of PMI as well.

2016 In Review: The Top 6 Posts

Every year I have the opportunity to engage and educate curious investors through my Frank Talk blog, and I am grateful to all of my subscribers who continue to stay engaged with the stories I share. Below are the top six Frank Talk posts of 2016 based on what you found most fascinating. I hope you enjoy this brief recap.

1. Gold Had Its Best Quarter in a Generation. So Where Are the Investors?

In April we were pleased to report that gold was having its best quarter in 30 years—rising 16.5 percent year-to-date at the time. During the first quarter, the yellow metal had its best three-month performance since 1986, mostly on fears of negative interest rates and other global central bank policies.

What we noticed, however, was an anomaly in terms of investor interest. Retail investors were very bullish on bullion but remained bearish on gold stocks.

This was a missed opportunity. Even though gold stocks have retreated since the summer, the NYSE Arca Gold Miners Index is still up 40 percent for the 12-month period. Over the same period, the S&P 500 Index is up only 10 percent, with the Trump rally driving most of it.

As you can see in the oscillator below, gold is currently down more than two standard deviations. In the past, this was a good time to accumulate, as mean reversion soon followed.

Gold vs. 2-Year Treasury Yield Percent Change Oscillator
click to enlarge

The 2-year Treasury yield, meanwhile, is looking overbought and set to correct, based on our model. The math suggests a nearly 90 percent probability that mean reversion will occur over the next three months, with yields falling and the gold price rising back to its mean.

What’s more, ICBC Standard Bank recently highlighted the growing costs of higher yields, which are being overlooked. Net interest payments on the nearly $14 trillion of U.S. debt will amount to around $250 billion this year—or 1.4 percent of U.S. gross domestic product. “If we apply an 80 basis point increase to the net interest forecasts,” the bank writes, “then by 2026 the Treasury would be paying an additional $185 billion in interest annually, and interest will have increased to 3.3 percent of GDP.” This could strengthen the investment case of gold.

2. What Brexit Is All About: Taxation (and Regulation) Without Representation

Just three days before U.K. voters went to the polls, I shared my thoughts on why those betting on the “stay” campaign might be surprised to find Eurosceptical Brits prevailing in the Brexit referendum. British citizens voted to exit the EU on June 23, a move that many were not expecting. One of the main grievances of voters was the heavy burden of EU regulations, which are decided by unelected officials in Brussels with little to no cost-benefit analysis.

According to Open Europe, a nonpartisan European policy think tank, the top 100 most expensive EU regulations set the U.K. back an annual 33.3 billion pounds, equivalent to $49 billion.

33.3 Billion Annual Cost of teh EU's Top 100 Regulations on U.K. Businesses

3. 11 Reasons Why Everyone Wants to Move to Texas

As a “Tex-Can”—born in Canada, living in Texas for the past 26 years—I am so blessed to call Texas my home. Although we are global investors, often focusing on macro-economic issues and government policies, I enjoyed writing this piece highlighting 11 reasons why Texas is truly a remarkable place to live. Did you know if Texas were its own nation, its economy would be about the same size as Canada’s?

The Global Scale of America's Economy
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4. Did OPEC Just Cry Uncle?

Back in October, the Organization of Petroleum Exporting Countries (OPEC) tentatively agreed to a production cut at its meeting in Algiers. Officials announced a “plan” to limit daily production, but I warned investors not to get too excited over OPEC’s decision at the time, since nothing was set in stone. Some OPEC members were already wavering, with Iraq questioning output numbers and Nigeria moving to boost production.

Fast forward to December. For the first time since 2008, OPEC has agreed to a crude oil production cut, renewing hope among producers and investors that prices can begin to recover in earnest after a protracted two-year slump.

5. Use This Tax Strategy Like the Top 1 Percent

Many people might have the impression that the top 1 percent of society—those making over $521,411—deal mainly in exotic investments such as derivatives, fine art and rare French wines. The truth is actually a lot less exciting—they invest in munis. Muni bond income, after all, is entirely exempt from federal and often state and local taxes—a feature that should appeal not just to money-saving, high-net worth individuals but to all investors.

 

 

 

Wealthiest U.S. Households Own an Increasing Share of Municipal Debt
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6. Romania Did This, And Now It's Among the Fastest Growers in Europe

In July I wrote a piece highlighting a country I don’t always discuss—Romania. At the end of last year, and after years of tepid growth, Romania’s government moved to revise its tax code. The country reduced the value added tax (VAT) rate from 24 percent to 20 percent, lowered the income withholding tax rate, nixed a controversial “special construction” tax, simplified deductibles and exempted certain dividends from corporate income tax.

The changes have worked much faster than expected. In the first quarter of 2016, Romania grew 4.3 percent year-over-year, beating the 3.9 percent analysts had expected, and up 1.6 percent from the fourth quarter of 2015.

Keep Calm and Invest On

I want to end on one final point. Trump recently responded to the Berlin Christmas Market massacre—the perpetrator of which was just shot dead by police in Italy last week—saying the event validates his past support of banning Muslims from entering the country and creating a Muslim registry for those already in the U.S.

I’ve said before that people too often take President-elect Trump literally but not seriously, and I think this is one of those cases. I don’t believe he will literally ban all 1.6 billion Muslims from coming into the country, nor does he literally mean it. More likely such a ban would resemble President Jimmy Carter’s temporary cancellation of Iranian visas in response to the hostage crisis, but that’s mere speculation. The issue of Shia-Sunni relations alone is far too complex, with the schism as deep and nuanced as when Protestants broke from the Catholic Church in the 16th century.   

But let’s say for a moment that Trump somehow succeeds in implementing a complete ban and creating a registry. These plans would not come cheap. One team of researchers estimated a ban would cost the U.S. economy at least $71 billion a year in lost spending on tourism, education and more. As for a registry, the similar National Security Entry-Exit Registration System (NSEERS)—created in response to 9/11 and dissolved this month by President Barack Obama—cost taxpayers about $10 million a year.

New rules, laws and regulations associated with a ban and registry would also add to our already bloated list of rules, laws and regulations. Trump has said he is committed to axing regulations. I’m all for limiting the regulatory burden, but I wonder what Trump (and incoming Homeland Security secretary John Kelly) would need to cut and streamline to offset the additional rules and costs.

This is the very definition of the law of unexpected consequences, and it’s important to be cognizant of “the negatives of Trump’s anti-globalization ideas,” in the words of billionaire money manager Bill Gross. It’s for this reason that investors should remain diversified, in gold, equities and tax-free municipal bonds.

To all of our readers around the world, I wish you robust health, buckets of wealth and tons of happiness in the New Year!

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

The J.P. Morgan Global Purchasing Manager’s Index is an indicator of the economic health of the global manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

The NYSE Arca Gold Miners Index is a modified market capitalization weighted index comprised of publicly traded companies involved primarily in the mining for gold and silver.

The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.

A basis point, or bp, is a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001).

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What Are the Risks of a U.S.-China Trade War?
December 19, 2016

What Are the Risks of a U.S.-China Trade War?

Risk is one of my all-time favorite board games. It’s among the very few that’s equal parts strategy and luck, and the stakes can’t get much higher than total world domination. It wasn’t uncommon for games between my friends and me to last for hours, sometimes deep into the night.

Today a real-life game of Risk is unfolding on the world stage, with major players moving their pieces into place.

As you probably recall, President-elect Donald Trump recently took a call from Taiwanese President Tsai Ing-wen, a decision that flies in the face of 40 years’ worth of U.S.-China diplomacy. Since 1978, the U.S. has had no diplomatic relations with Taiwan after acknowledging the “One China” policy—a policy Trump says the U.S. is not necessarily bound to.

His phone call and comment follow tough talk on the campaign trail about China manipulating its currency and stealing American manufacturing jobs—though bringing them back might be hard, as we’ve steadily been losing such jobs since the Second World War.

Manufacturing Jobs as a Percentage of Total U.S. Workforce
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Trump has also threatened to impose an unrealistically high 45 percent tariff on Chinese imports, prompting U.S. companies operating in the Asian country to fear “retribution.”

For their part, the Chinese say they have “serious concerns” about Trump’s position on Taiwan and international trade, with one state-run newspaper describing the president-elect as “ignorant as a child” in the field of diplomacy.

China’s “retribution” could be coming sooner than we expect. Last week, a top Chinese official visited Mexico to strengthen ties with the Latin American country, which has also frequently found itself caught in Trump’s crosshairs. Both countries—our number two and number three trading partners, after Canada—have expressed interest in lessening their dependency on the U.S., especially given the strong possibility that Trump could raise certain trade restrictions.

In the fight for American jobs, we could be “risking” a trade war with China right on our southern doorstep. Though the stakes might not be as high as total global domination, they come pretty close. With rates moving up and the world resetting to less quantitative easing, inflation might accelerate. To avoid a global recession, Trump will need to make streamlining regulations a top priority.

Gold Sidelined as Trump Rally Continues and Yields Surge

For only the second time since 2008, the Federal Reserve raised interest rates last week, surprising no one. Although the 25 basis point lift was in line with expectations, markets took some time to digest the news that three rate hikes—not two, as was earlier expected—were likely to happen in 2017. Major averages hit the pause button for the first time since last month’s presidential  election, but the Trump rally quickly resumed Thursday morning.

The two-year Treasury yield immediately jumped to a nominal 1.27 percent after averaging 0.80 percent for most of 2016, an increase of 58 percent. In real, or inflation-adjusted, terms, the yield is still in negative territory, but it’s clearly heading up following the U.S. election and rate hike. Thirty-year mortgage rates, meanwhile, hit a two-year high.

Real 2-Year Treasury Yield Heading Up Following Election and Rate Hike
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Gold retreated to a 10-month low. As I’ve explained many times before, gold has historically had an inverse relationship with bond yields, performing best when they’re moving south.

It’s worth pointing out that the most recent gold bull market, which carried the yellow metal up 28 percent in the first six months of 2016, was triggered last December when the Fed hiked rates.  

Will Gold Respond Similarly to Fed Policy?
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Again, as many as three rate hikes are expected in 2017—unlike the one this year—with Fed Chair Janet Yellen commenting that economic conditions have improved well enough to warrant a more aggressive policy. If true, this should accelerate upward momentum of Treasury yields and the U.S. dollar—currently at a 14-year high—which could dampen gold’s chances of repeating the rally we saw in the first half of this year.

More Than $10 Trillion in Negative-Yielding Bonds

Other gold drivers still remain in place, though, including negative-yielding government bonds elsewhere around the world. The value of such debt has dropped considerably since the election of Donald Trump, but it still stands at more than $10 trillion, supporting the investment case for the yellow metal. And as I mentioned previously, many of Trump’s protectionist policies—opposition to free trade agreements, imposition of tariffs on Chinese-made goods—are expected to heat up inflationary pressures in the U.S., which could serve as a gold catalyst.

What’s more, gold is looking oversold, down two standard deviations for the 60-day period, which has historically signaled a good buying opportunity. With prices off close to 12 percent since Election Day, I believe this is an attractive time to rebalance your gold position. I’ve always recommended a 10 percent weighting, with 5 percent in gold stocks and the other 5 percent in bullion, coins and jewelry.

 

Will Trump Tear Up Dodd-Frank? The Market Is Betting on It

The top beneficiary of the Trump rally so far has been the banking industry, with bets driven by the potential for higher lending rates and stronger economic growth in the coming months, not to mention the president-elect’s pledge to reject any new financial regulations.  

Betting Big on Banks
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I wouldn’t call this rally “irrational exuberance” just yet, but according to Bank of America Merrill Lynch’s monthly survey, fund managers have built up the largest overweight position ever in bank stocks—31 percent above their benchmarks on average.

This phenomenal run-up implies investors have confidence Trump can make good on his promise to unleash the U.S. economy and dismantle Wall Street regulations.

As I’ve made clear in previous commentaries, regulations are usually created with the best of intentions, and they’re sometimes necessary to establish a level playing field. But all too often, they end up impeding financial growth, hurting not just businesses but also consumers.

Take Dodd-Frank. What was intended as a set of policies to prevent another financial meltdown has dramatically limited consumer choice, shrunk the number of retirement options and squeezed out smaller banks and credit unions. The 2,300-page act, signed in 2010, places a monumental burden on financial institutions, from banks to brokers to investment firms, which we have felt indirectly. Even former Fed Chair Ben Bernanke had a hard time refinancing his house in 2014, one of Dodd-Frank’s unintended consequences.

Before 2010, about 75 percent of banks offered free checking accounts. Only two years later, that figure had fallen to less than 40 percent. Since the law went into effect, the U.S. has lost one community financial institution a day on average. This hurts credit-seeking small businesses and startups, not to mention consumers in the market to buy a new home or vehicle.

Changes in Number of U.S. Banks Since Passage of Dodd-Frank
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In House Speaker Paul Ryan’s “A Better Way” initiative, several solutions to runaway regulations are proposed. One that stands out is a “regulatory budget,” which would limit the number and dollar amount of rules federal agencies can impose every year. My hope is that Ryan and Trump can set aside their differences to streamline the ever-growing mountain of rules that weighs on American businesses and restricts the flow of capital.

 

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Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.

The MSCI World Financials Index captures large and mid-cap representation across 23 Developed Markets countries. All securities in the index are classified in the financials sector as per the Global Industry Classification Standard (GICS). The Dow Jones U.S. Financials Index, a member of the Dow Jones Global Indices family, is designed to measure the stock performance of U.S. companies in the financials industry. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.

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These Factors Show Why Buffett Likes Airlines Again
December 14, 2016

Last month we learned that Warren Buffett bought shares of American Airlines, Delta Air Lines and United Airlines, according to Berkshire Hathaway’s third-quarter regulatory filings. He also confirmed that he purchased Southwest Airlines stock as well. If we look at the Dow Jones U.S. Airlines Index year-to-date, these allocations appear to have been well-timed.

Buffett Bought at Airline Bottom
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Buffett is universally recognized as one of the most influential investors of all time, so his decision to book a flight on airlines, after blasting the industry for years, is worth examining more closely.

Protected by an Economic Moat

We can mention a couple of things upfront. Most everyone knows Buffett is a value investor. He seeks equity in companies that the market has undervalued—including airlines. As I’ve pointed out before, if we use price-to-earnings as our valuation metric, airlines are among the least expensive in the industrials sector.

He also likes companies that are protected by what he calls a “moat,” the “something” that prevents new competitors from disrupting the industry, giving the veteran players a clear advantage in the marketplace. This is why Buffett has always been attracted to railroads. Because rail is prohibitively capital-intensive, the barriers to entry are high and competition is limited, giving companies greater market power.

Why Buffett Likes Airlines: Protected by a Moat

We see a similar moat protecting U.S. airlines. Since the industry consolidated a decade ago after a wave of bankruptcies, a vast majority of the market share is now concentrated in the big four carriers. In 2015, American, Delta, United and Southwest controlled about 77 percent of U.S. airline revenue.

These are pretty high-level factors to consider. When we delve deeper into the factors Buffett uses to assess equities, the airlines group becomes even more attractive.

Airlines Crushed the Broader Market

What you see below are the top 10 U.S. airlines compared to the S&P 500 Index, using four of Buffett’s favorite financial metrics:  return on equity, cash flow return on invested capital, net income margin and free cash flow per share. As of the third quarter, the airlines group trounced the broader market in all four areas for the 12-month period. This might have contributed to Buffett’s decision to rotate back into a space he spent a couple of decades deriding.

Buffett's Favorite Factors Applied to Airlines and S&P 500
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You can find the definitions of these factors on Investopedia, but they’re pretty self-explanatory.

Return on equity (ROE) measures how much profit a company generates with shareholders’ money. Whereas the S&P 500 returned about 14 percent during the 12-month period, airlines returned 36 percent of equity.

Cash flow return on invested capital (CFROIC) tells investors how much cash flow a company produces as a percentage of its total capital. CFROIC was 35.60 percent for carriers, 14.90 percent for blue-chip stocks.

Net income margin, simply put, is the percent difference between a company’s sales and its net profits. In the past, airlines were notorious for having razor-thin margins. That’s all changed thanks to industry consolidation, restructuring of businesses and the addition of new revenue streams. The top 10 airlines saw margins of more than 12 percent, while S&P 500 margins were 9.8 percent.    
Finally, free cash flow per share is exactly what it sounds like. It’s sometimes used as a proxy for earnings per share, but it specifically measures a company’s ability to pay back loans, taxes and other expenses on a per-share basis. Airlines beat the S&P 500, $4.1 per share to $3.3 per share.

Airlines have definitely come a long way since Buffett invested in—and lost money on—US Airways back in 1989. If you’re interested in learning more, I invite you to join me during my next webcast. I’ll be discussing how airlines reversed their fortunes from near-bankruptcy to record profitability, and where they might go from here.

I hope you’ll join us!

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

Dow Jones U.S. Total Market Airlines Index is constructed and weighted using free-float market capitalization and the index is quotes in USD.

The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.

The price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings. The price-earnings ratio can be calculated as: market value per share / earnings per share.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. The following securities mentioned in the article were held by one or more accounts managed by U.S. Global Investors as of 9/30/2016: Alaska Air Group Inc., Allegiant Travel Co., American Airlines Group Inc., Delta Air Lines Inc., Hawaiian Holdings Inc., JetBlue Airways Corp., Southwest Airlines Co., Spirit Airlines Inc., United Continental Holdings Inc., Virgin America Inc.

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Net Asset Value
as of 05/22/2017

Global Resources Fund PSPFX $5.40 0.02 Gold and Precious Metals Fund USERX $7.15 0.05 World Precious Minerals Fund UNWPX $6.29 0.02 China Region Fund USCOX $8.85 0.10 Emerging Europe Fund EUROX $6.41 0.03 All American Equity Fund GBTFX $24.19 0.17 Holmes Macro Trends Fund MEGAX $19.12 0.05 Near-Term Tax Free Fund NEARX $2.23 No Change U.S. Government Securities Ultra-Short Bond Fund UGSDX $2.00 No Change