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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.

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
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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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Inflationary Expectations in 2017 Keep the Polish on Gold
December 12, 2016

Inflationary Expectations 2017 Keep Polish Gold

Inflation can be understood as the destruction of a currency’s purchasing power. To combat this, investors, central banks and families have historically stored a portion of their wealth in gold. I call this the Fear Trade.

The Fear Trade continues to be a rational strategy. Since President-elect Donald Trump’s surprise win a month ago, the Turkish lira has plunged against the strengthening U.S. dollar, prompting President Recep Erdogan to urge businesses, citizens and institutions to convert all foreign exchange into either the lira or gold. Most obliged out of patriotism, including the Borsa Istanbul, Turkey’s stock exchange, and the move has helped support the currency from falling further.

Gold Save Turkish Lira
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Venezuela, meanwhile, has dire inflationary problems of its own. Out-of-control socialism has led to an extreme case of “demand-pull inflation,” economists’ term for when demand far outpaces supply. Indeed, the South American country’s food and medicine crisis has only worsened since Hugo Chavez’s autocratic regime and the collapse in oil prices. The bolivar is now so worthless; many shopkeepers don’t even bother counting it, as Bloomberg reports. Instead, they literally weigh bricks of bolivar notes on scales.

“I feel like Pablo Escobar,” one Venezuelan bakery owner joked, referring to the notorious Colombian drug lord, as he surveyed his trash bags brimming with worthless paper money.

Because hyperinflation has destroyed the bolivar, the ailing South American country sold as much as 25 percent of its gold reserves in the first half of 2016 just to make its debt payments. Venezuela’s official holdings now stand at a record low of $7.5 billion.

Trump-Carrier Deal a Case Study in U.S. Inflation

visited Bloomberg TV studio today rates gold

The U.S. is not likely to experience out-of-control hyperinflation anytime soon, as the dollar continues to surge on bets that Trump’s proposals of lower taxes, streamlined regulations and infrastructure spending will boost economic growth. But I do believe the market is underestimating inflationary pressures here in the U.S. starting next year.

As I explained to Scarlet Fu and Julie Hyman on Bloomberg TV last week, inflation we might soon see is largely caused by rising production costs, which is different from the situation in Turkey and Venezuela.

Nevertheless, it still serves as a positive gold catalyst for 2017.

Consider Trump’s recent Carrier deal—the one that saved, by his own estimate, 1,100 jobs from being shipped to Mexico. We should applaud Trump and Vice President-elect Mike Pence for looking out for American workers, but it’s important to acknowledge the effect such interventionist efforts will have on consumer prices.

Trumps jobs Carrier indicative protectionist policies

As I see it, the Carrier deal is indicative of the sort of trade protectionism that could spur inflation to levels unseen in more than 30 years. The Indiana-based air conditioner manufacturer has already announced it will likely need to raise prices as much as 5 percent to offset what it would have saved by moving south of the border.

We can expect the same price inflation for all consumer goods, from iPhones to Nikes, if production is brought back home. That’s just the reality of it. Prices will go up, especially if Trump succeeds at levying a 35 percent tariff on American goods that are built overseas but imported back into the U.S. The extra cost will simply be passed on to consumers.

What’s more, Trump has been very critical of free trade agreements, threatening to tear them up after blaming them—NAFTA, specifically—for the loss of American jobs and stagnant wage growth. There’s some truth to this. But trade agreements have also helped restrain inflation over the past three decades. This is what has allowed prices for flat-screen, plasma TVs to come down so dramatically and become affordable for most Americans.

International Trade Deals Slowed Inflation
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In its 2014 assessment of NAFTA, the Peterson Institute for International Economics (PIIE) calculated that for every job that could be linked to free trade, “the gains to the U.S. economy were about $450,000, owing to enhanced productivity of the workforce, a broader range of goods and services, and lower prices at the checkout counter for households.”

Additional tariffs and the inability to import cheaper goods are inflationary pressures that could result in a deeper negative real rate environment. And as I’ve pointed out many times before, negative real rates have a real positive effect on gold, as the two are inversely correlated.

Inverse Correlation Between Gold Real Fed Funds Rate
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Macquarie research shows that last year, ahead of the December rate hike, gold retreated about 18 percent from its year-to-date high. Afterward, it gained 26 percent in the first half of 2016. The decline so far this year has been about 15 percent from its year-to-date high. Gold, according to Macquarie, is setting up for another rally in a fashion similar to last year.

Central Bank Demand Could Accelerate on Growing Federal Debt

The U.S. government is currently saddled with $19.9 trillion in public debt. Since 2008, federal debt growth has exceeded gross domestic product (GDP) growth. And according to a Credit Suisse report last week, Trump’s tax proposal, coupled with deficit spending, could cause federal debt to grow even faster than under current policy.

After analyzing projections from a number of agencies and think tanks, Credit Suisse “estimates a federal debt-to-GDP of 92 percent by 2026, including a GDP growth offset from the lower tax tailwind, and 107 percent excluding the GDP growth offset.”  

Higher US Budget Deficits Debt Spur Banks Increase Gold Buying
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The U.S. dollar accounts for about 64 percent of central banks’ foreign exchange reserves. With the potential for higher U.S. budget deficits and debt risking dollar strength, central banks around the globe could be motivated to increase their gold holdings, says Credit Suisse.

Waiting for Mean Reversion

As I mentioned last week, gold is looking oversold in the short term and long term, down more than two standard deviations over the last 20 trading days. Statistically, when gold has done this, a return to the mean has often followed. This has been an attractive entry point for investors seeking the sort of diversification benefits gold and gold stocks have offered.

In a note to investors last week, ETF Securities highlighted these diversification benefits, writing that a gold allocation has “historically increased portfolio efficiency—lowering risk while increasing return—compared to a diversified portfolio without an allocation to precious metals.”

As always, I recommend a 10 percent weighting: 5 percent in gold bullion, 5 percent in gold stocks, then rebalance every year.

Learn Why Warren Buffett Changed His Mind

When I visited New York in the spring, the media was negative on airlines because Warren Buffett didn’t like the industry. Now, the Oracle of Omaha has changed his mind about airlines, having invested $1.3 billion in the big four American carriers—but the media’s still down on the group.  I was in New York all week, and they were saying airlines have gone up too much.

I’m afraid they’re missing a great opportunity here. Today, the industry is surrounded by what Buffett calls a “moat,” meaning the barrier to entry is too high and restrictive for new competitors. President-elect Trump’s victory means that industry regulations could be streamlined and the Federal Aviation Administration (FAA) brought into the 21st century. Since the group bottomed in late June, it’s rallied a phenomenal 46 percent.

If you’re getting your market news from the mainstream media, you could be at risk of missing out on this opportunity as well. I urge you to learn the real story about the airline industry by registering today for our webcast event, to take place this Thursday, December 15. I’ll be discussing how airlines have reversed their fortunes from near-bankruptcy to record profitability, and where they might go from here.

I hope you’ll join us!

Higher US Budget Deficits Debt Spur Banks Increase Gold Buying

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.

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.

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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Manufacturing Activity in Europe Surprises to the Upside
October 26, 2016

Manufacturing activity in the eurozone strengthened sharply in October, beating expectations, according to “flash,” or preliminary, purchasing manager’s index (PMI) data. The region is growing at its fastest pace so far this year, having climbed to its highest reading since April 2014.

Premilimary Eurozone Manufacturing PMI
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The news follows positive September readings in emerging European countries that we track closely, an encouraging sign that the continent’s economy might finally be picking up steam after an extended period of sluggish growth.

Hungary, volatile as always, was the largest gainer last month, leaping ahead 5.3 points to a nearly three-year high. Historically, the Central European country has bumped up when the transport sector, which represents a big share of production, gets a new large order.

Hungary Manufacturing PMI
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I’ve written numerous times on why we monitor PMI. Unlike gross domestic product (GDP), which is a backward-looking indicator, PMI gives us a foreshadowing of manufacturing activity three and six months out. This is important for investors because as manufacturing accelerates, so too does demand for commodities and natural resources, helping to support prices.

Poland Manufacturing PMI
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Czech Republic Manufacturing PMI
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Czech Republic Manufacturing PMI
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Not only do we like to see the monthly reading come in above 50—the threshold separating industry expansion from contraction—but it’s exceptionally positive when the reading appears above its three-month moving average.

This was the case for all countries except Greece and Turkey, both of which shrank slightly in September.

Greece Manufacturing PMI
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Turkey Manufacturing PMI
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All in all, I’m encouraged by the eurozone’s positive October PMI, even if it is preliminary. Whether you like it or not, ours is a global economy, and it’s impossible for any country, even one as strong as the U.S., to do all the heavy lifting alone. What we need now is synchronized global growth, and this is definitely a step in the right direction.

 

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

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

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Apple Gets a Shakedown from the EU. Is Ireland Next to Bail?
September 6, 2016

$5,009 Apple Stores' sales per square foot per year--the most of any store

“Total political crap.”

That’s how Apple CEO Tim Cook described the European Commission’s ruling that the iPhone maker must pay 13 billion euros ($14.5 billion), plus interest, in back taxes to Ireland, its longtime European host. Meanwhile, the island-nation is being accused of giving Apple an “illegal” sweetheart deal in exchange for jobs.

Political crap, indeed. I hate to say it, but I told you so.

June’s Brexit referendum, I’ve argued, was about so much more than immigration. U.K. citizens and businesses are fed up with mountains of rules and regulations from unelected bureaucrats in Brussels, controlled by French and German socialists, that trample on basic personal freedom. There are ludicrous laws on the books legislating everything from the kind of lightbulbs you can use to the wattage of your vacuum cleaner to the curve and length of your bananas and cucumbers to the color of your olives.

Now, Ireland is learning a similarly hard lesson on Brussels’ policies of envy.

It’s a plotline that should be reserved for the Theater of the Absurd: Party A is forced by Party B to pay Party C, in a transaction that neither Party A nor Party C had a hand in creating.

Apple insists it has no outstanding taxes. “We never asked for, nor did we receive, special deals,” Tim Cook wrote in an open letter last week. And yet an authoritarian, nontransparent “Commissioner of Competition” is ordering the company to shell out an arbitrarily exorbitant amount to the government of Ireland—which doesn’t even want Apple’s money.

And why would it? As you might imagine, Ireland fears risking a stain on its tax advantaged status that has succeeded in attracting hundreds of billions in foreign direct investment.

Eurocrats Envious of Ireland’s Competitive Advantage and America’s Ingenuity

Over the last 50 years, the country has carved out a reputation as a prime destination for multinationals seeking a competitive corporate tax rate. At 12.5 percent, Ireland’s rate is much more attractive than the U.S. rate, 35 percent, one of the highest in the world. (Other countries with similarly high rates include Argentina, Brazil and Venezuela—not exactly model examples of business-friendly regimes.)

Corporate Tax Rates in Select OECD Countries
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Consider what Ireland has achieved: PricewaterhouseCoopers (PwC) ranks it “the most effective country in the EU in which to pay business taxes.” For five years in a row, the country has topped IBM’s Global Location Trends report for its “continued ability to attract high-value investment projects in key areas.” The most recent IMD World Competitiveness Yearbook names Ireland first in the world for “investment incentives” and “financial skills.” According to the World Economic Forum, it’s the fastest growing European economy (followed by Romania, which I wrote about in July). The list goes on.

For these reasons and more, nine out of the top 10 global information and communications technology (ICT) companies have locations in Ireland, not to mention nine out of the top 10 global pharmaceutical companies and nine out of the top 10 global software companies, according to Ireland’s Industrial Development Agency.

The country’s relationship with American-based companies has been particularly beneficial to its economy and workforce. U.S. companies account for three quarters of Ireland’s inward investment, which totaled nearly $116 billion in the years from 2008 to 2014. That’s more than U.S. investment in the four BRIC countries combined over the same period. About a fifth of all private sector jobs in Ireland are in some way linked to American multinationals. Apple alone employs 6,000 Irish citizens, most of them in Cork, where Steve Jobs originally opened an Apple factory in 1980.

Ireland Most Favored Nation US Foreign Direct Investment 2008 2014
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Thanks to low corporate taxes that attract big multinationals, youth unemployment in Ireland is today among the lowest in the EU. Restrictive, labyrinthine labor laws elsewhere in the 28-member bloc have immobilized the jobs market, especially for young people, many of whom have little choice but to seek work abroad. In May, the Financial Times reported that the number of EU nationals working in the U.K. had climbed to 2.1 million, accounting for close to 7 percent of its workforce—a new high.

youth unemployment in ireland lowest among select european countries
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Both Apple and Ireland vow to appeal the European Commission’s ruling, a process that will likely take years.

Next Up: Irexit?

The real question now is whether the Apple incident will motivate Ireland to follow the U.K.’s lead and pursue its own “Irexit” from the European Union. In June, I asked if we’re nearing the end of the EU experiment. If officials continue to oppose competition and restrict member states from conducting business on their own terms, entrepreneurial countries such as Ireland will increasingly feel the pressure to file for divorce

Remember, Britain will soon be free to do what it pleases to attract foreign investment—possibly away from Ireland. London already sees an opening with Apple following the tax ruling. On Tuesday, Prime Minister Theresa May’s spokesman said the tech giant is welcome to relocate to the U.K. if things don’t work out between Ireland and the EU.

This would be a high price for Ireland to pay to retain its EU membership status.

Apple by the numbers infographic

Apple Just the Beginning

American multinationals are likewise in a difficult position, as they face mounting pressure from EU regulators and tax officials. Europe doesn’t have its own versions of Apple, Facebook and others, so its only course of action is to legislate them into being noncompetitive.

Successful US Companies Under Fire European Regulators

I previously shared with you the European Commission’s proposal to require streaming services such as Netflix and Amazon Prime Video to meet a content quota. Under the plan, at least 20 percent of all programs offered in their libraries would need to be produced in Europe.

Like Apple, Starbucks was ordered in October 2015 to pay up to $33 million in back taxes to the Netherlands, a ruling the Dutch government has already appealed. McDonald’s and Amazon’s tax arrangements in Luxembourg are also being scrutinized, and Google could be added to the list.

Speaking of Google, its Madrid office was raided in June by Spanish tax inspectors, who are accusing the search giant of tax avoidance.

In yet another case, Google and Facebook could both end up having to pay licensing fees to European newspapers, magazines and other publications every time their content ends up in their search results.

WhatsApp, the most-used messaging app in the world, and its parent company, Facebook, are both currently being investigated by EU privacy regulators.

This is just a sampling of what American companies must put up with in order to do business in Europe.

The question stands: Instead of attacking American innovation and ingenuity, why don’t Europeans develop their own competitive alternatives?

 

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.

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 6/30/2016.

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Romania Did This, and Now It’s Among the Fastest Growers in Europe
July 27, 2016

Romania cut taxes last year and is now enjoying some of the strongest growth in Europe.

In 1974, the American economist Arthur Laffer, then a professor at the University of Chicago, was having dinner with his friend Jude Wanniski, an associate editor of the Wall Street Journal. They were joined by Donald Rumsfeld and Dick Cheney, both of whom worked at the time in the Gerald Ford administration. The topic at hand was President Ford’s Whip Inflation Now, or WIN, initiative, which included proposed tax increases.

The Laffer Curve. U.S. Global Investors According to Wanniski’s version of the story, which he recounted years later in a WSJ article, Art grabbed a napkin and sketched out what Wanniski dubbed “the Laffer curve.” Put simply, the Laffer curve illustrates what happens when the government raises taxes too much—theoretically, it ends up bringing in less revenue than before the tax hike. Why? Taxpayers feel less incentivized to work if everything they earn is handed over to the government. Small businesses can no longer compete. The flow of capital is squeezed, and business growth slows to a trickle.

The Laffer curve says that tax revenue at both 0 percent and 100 percent is the same: zero. But somewhere in between those two values is the “optimal” tax rate, one that maximizes both government revenue as well as employment, productivity and output. (In the chart above, it looks as if 50 percent is the ideal rate, but the peak could fall anywhere. In fact, it varies year-to-year.)

Art is known today for being the architect of President Reagan’s supply-side economics policies, which emphasize free trade, spending restraint, fewer regulations and low taxes. According to the Laffer Center, these policies “contributed to the longest boom in United States history.” More wealth was created between 1982 and 2007 than in the previous 200 years, when adjusted for inflation.

Ronald Reagan laying out his proposal to reduce taxes in a 1981 televised address. The chart is clearly inspired by the Laffer curve.

These are policies that apply overseas as well. Part of why the U.K. voted to leave the European Union last month was to escape punitive taxes and regulations—indirect taxes—imposed by unelected officials in Brussels. British voters recognize the fact that policies of envy have stifled growth and innovation.

Romania Slashes Taxes, Speedy Growth Ensues

Another country that “gets it” is Romania, the mountainous, Central European nation and home to roughly 20 million people. After years of tepid growth, Romania’s government moved to revise its tax code. At the end of last year, it 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, 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. This places the country among the fastest growing EU economies, with the European Commission now expecting it to be the second fastest growing country in the 28-member bloc, behind only Ireland.

Romania Among the Fastest Growing EU Economies
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What’s more, investment bank Wood & Company sees country GDP growing 5.1 percent this year and 5.8 in 2017. Much of this growth, Wood writes, will be driven not just by tax cuts but also low borrowing costs, restructured balance sheets and loose fiscal policy. Private consumption is healthy and investor confidence is up.

The country is also getting back to work. Romania’s unemployment rate in May fell to 6.6 percent, compared to 10.1 percent on average for eurozone countries. Its youth unemployment rate, while worrisome at 21 percent, still significantly trails levels found in several other EU countries, including Italy (36.9 percent), Spain (43.9 percent) and Greece (47.4 percent).

Bucharest is home to a booming tech industry.

A Tailwind for Romania’s Tech Industry

This is good news for Romania’s economy as a whole, specifically Bucharest’s important information technology sector, which has grown tremendously in recent years. In the first quarter, IT contributed 6.1 percent to the country’s GDP and is expected to exceed 10 percent this year or next. For years, Romania has promoted itself as a place to find reasonably priced software development by coders who speak English. Today, many of the world’s top tech companies, including Adobe, Microsoft, IBM, Intel and Oracle, operate in Bucharest, where consumer prices are dramatically lower than in London. (Rent is 84 percent cheaper in the Romanian capital than in the U.K. capital.)

In a previous post, I asked the question: Where’s Europe’s answer to Silicon Valley? Romania is the likeliest answer.

I’ve also been asking for months how Europe can jumpstart its economy, and again, Romania might very well have the answer. It all comes back to the Laffer curve. Since the financial crisis, we’ve relied too heavily on monetary policy to accelerate growth. But quantitative easing, helicopter money and negative rates have done all they can. Meanwhile, punitive taxes and burdensome regulation continue to hinder growth. It’s time we follow Romania’s lead and shift our focus to reforming our fiscal policies.

 

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Net Asset Value
as of 01/13/2017

Global Resources Fund PSPFX $5.54 0.03 Gold and Precious Metals Fund USERX $7.85 0.06 World Precious Minerals Fund UNWPX $6.95 0.14 China Region Fund USCOX $7.62 0.02 Emerging Europe Fund EUROX $6.00 -0.01 All American Equity Fund GBTFX $23.72 0.03 Holmes Macro Trends Fund MEGAX $18.77 0.08 Near-Term Tax Free Fund NEARX $2.22 No Change U.S. Government Securities Ultra-Short Bond Fund UGSDX $2.00 No Change