From the December 2002 issue of Investment Advisor • Subscribe!

Return of the Gold Bug

With bullion ebullient once again, U.S. Global In

Frank E. Holmes lives and breathes gold. Ask him a question about the precious metal and the veteran money manager will rattle off Toronto Stock Exchange gold index figures going back five decades. And with gold finally coming back from the dead amid concerns over war, terrorism, and ailing equities, Holmes is once more feeling his oats.

Chairman and CEO of San Antonio-based U.S. Global Investors Inc.--its ticker is GROW--Holmes is responsible for $1.2 billion in assets, about $150 million of that in gold. After a disastrous performance during the late 1990s, Holmes returned to the trading floor, instituted new procedures for U.S. Global and its in-house managers, and took personal control of the 28-year-old Gold Shares Fund (USERX) and slightly younger World Precious Minerals (UNWPX) fund.

"Gold is an emotional asset class," Holmes concedes. But, he maintains, "when you put it in a portfolio, you enhance overall performance because of gold's countercyclical nature." This, more than an emotional attachment to gold, is Holmes' prime argument for giving it a weighting of 5% to 12% in a diversified portfolio.

Holmes argues that over the past 50 years, shares of mining companies have tended to strengthen when the overall equity market is weakening, and vice-versa. This year, that argument has certainly held true: Although Gold Shares fund has seen losses in eight of the past 10 years, Morningstar Inc. estimates that through Nov. 15 it had gained 48%, against a 20% loss for the S&P 500. U.S. Global shares, meanwhile, are up 24%.

I spoke with Holmes in Dallas recently during a TD Waterhouse Institutional advisor conference. Here are some of his thoughts on investing in gold as well as on changes at U.S. Global:

Gold responds to geopolitical events. What's driving it now? 9/11 changed everything. You also have deficit spending and a weaker dollar. Still, if there is no war [in Iraq], gold could come back to $300 [Gold closed at $320/ounce on Nov. 15].

How about supply? [Partly owing to environmental concerns], it is becoming tremendously difficult and costly to spur production and replace reserves. The cost of getting gold out of the ground is more than $300 an ounce. You don't make much profit with gold around $320. So we are going to see a tremendous contraction among mining companies and a 60% drop in production over the next 10 years.

Do you only invest in mining issues? No. We own Tiffany & Co. It controls the richest diamond mine in Canada and moves more with consumer sentiment than with gold.

Morningstar has called Gold Shares "one of the world's worst mutual funds." What's your reaction? The costs of maintaining small gold fund accounts--many of them under $1,000--were killing me. So our gold funds had huge expense ratios. I told the small shareholders that unless they were cost-averaging, they'd have to pay $6 a quarter. So a lot of them bailed out. We are back down to 100 basis points in management fees.

What prompted the Royce mutual funds to become U.S. Global's largest shareholder? They own 14.99% of U.S. Global. After 9/11, they went 10% into gold. We were a value play with a huge leverage to gold.

How are you turning around U.S. Global? I fired people all over the place. I instituted price-risk management of our stocks. I want a control sheet--like a Value Line report--for every time we buy a stock. All the metrics, who the analyst talked to, and so on. I created standardized controls for macro analyses and company earnings. And we now use a SWOT model--for strength, weakness, opportunity, and threat. We look at strengths and weaknesses [of stocks] over 5, 20, and 60 business days, and one year. We update our earnings model every morning. Every Monday, we do a top-down analysis of the 11 sectors in the S&P. And we look for correlations. For example, we download DRAM [computer-memory] valuations every day and put them into our pricing model.

Editorial Director William Glasgall can be reached at bglasgall@ia-mag.com.

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