'Fear and Love Make Gold Strong'

An interview with Frank Holmes, by Jeff Clark, BIG GOLD

For the BIG GOLD annual gold forecast survey published in January, Jeff
Clark surveyed seven gold experts and nine top economists and fund
managers, along with Doug Casey himself, to provide their best insight on
what to expect in 2011 and how to invest.



One expert he interviewed was Frank Holmes, head of U.S. Global Investors,
which manages 13 no-load mutual funds, many of them recognized for
consistently high performance by Lipper Fund Awards. Last year, Frank’s
Gold & Precious Metals fund returned 36.8% – more than triple the Dow –
and the World Precious Minerals fund gained 45.4%, outgunning the S&P
almost four-fold.

Read on for Frank’s thoughts on gold and precious metals stocks…

BIG GOLD: Gold was up 30% in 2010; to what do you attribute its rise?

Frank Holmes: Investors have to look at gold demand as both the fear trade
and the love trade. What most media focus on is the negativity of
government policies to drive gold prices. I characterize this as the fear
trade — deficit spending and negative real interest rates for the G7
countries.

More significant is the love trade – where more than 60% of the world’s
population is in emerging countries averaging over 6% GPD growth and 8%
rising personal income, and they believe in giving gold as a gift for
birthdays, weddings, religious holidays, etc. This love trade is
entrenched, and it is not going away.

Fears over the European debt crises were a big driver of gold in the first
half of the year, as investors bought both gold and the dollar for
safety. However, by mid-year, the dollar started to break down as
smoldering budget woes in the U.S. began to reignite concerns over the
fiscal situation here.

Gold got a second lift by October as both the fear and love trade showed
up together. We had the season of Diwali lights in India and we had QEII,
so gold went to new highs. By year end almost all the gains made by the
dollar were eroded away, while gold finished the year with a respectable
rise of 29.5%.

BG: What forces will move gold this year? And what's your price projection
for 2011?

FH: U.S. equity strategists are way too complacent and so are risk
measures such as the VIX, which is back to pre-Lehman lows despite
government debt levels at even higher levels. The broad view is that there
will be no inflation in the U.S., as labor markets are slack, with 10%
unemployment; however, rising commodity prices, which are controlled by
international demand, will remain strong.

A second wild card will be whether the German public will go along with
the "transfer society" concept. European woes are not over.

Third, U.S. lawmakers will have a bitter potion to swallow, as the vote on
raising the U.S. debt ceiling will be a rallying point for the Tea Party
this year. And if inflation, such as rising oil prices, starts to sap
spending, wages in the U.S. may have to rise, and then the cat would be
out of the bag.

It’s been a great ten years for gold, which was fully justified due to the
explosion in consumer credit and debt, but gold may still have a very
important role to play going forward. I believe in the next five years the
price of gold will double from current levels, and that means it has the
potential to have a 15% annual compounded rate of return.

BG: How volatile do you expect gold to be?

FH: What is really key in understanding and managing expectations in the
capital markets is that over any 12-month period, it is a non-event for
gold to go plus or minus 15% in a year. This happens 68% of the time. The
stocks of gold producers can go plus or minus 40% over any 12-month
period, so they have greater risk but can also provide substantial
returns. It is thus important to respect and look at volatility as an
opportunity.

BG: Gold stocks as a group did not outperform gold in 2010 – does that
change in 2011? And if the broader markets sell off, do gold stocks fall
along with them or trade on their own?

FH: Actually, 2010 may have been a turning point, as major gold-producing
companies, measured by the Gold Bugs Index (HUI), gained 34.1%. This
hopefully has reversed the trend of the last couple years where bullion
outperformed the stock. Junior gold mining companies, on average, returned
roughly twice the gain of gold bullion, but some of those names were
fairly silver rich, and we know how well silver did last year.

In the scenario of a market sell-off, gold stocks are still equities and
can get pulled down with any surge towards liquidity. However, the price
action since the 2008 credit crises showed us that gold stocks did very
well for investors relative to the broader markets. In addition, while
those of us in the gold business are very close to the story, there are a
lot of people that are still coming around to investments in the precious
metals sector.

When one looks at what has been some of the best-performing stocks over
the last 10 years, gold and gold stocks may very well trade on their own
as a preferred asset class.

BG: Silver was up 81.9% in 2010, but is still below its 1980 nominal high.
What's your outlook for silver in 2011?

FH: Silver may have gotten ahead of itself a bit. In the coin market, for
instance, it is not uncommon to see certain gold coins sell for a 30%
premium to the spot price, but in the last quarter we saw some collectable
silver coins with asking prices as much as a 300% premium.

Silver does offer exceptional leverage to gold, almost 2 to 1. Right now,
while it looks like the economy is getting stronger, silver could continue
to benefit from a pick-up in industrial uses.

BG: What's your best advice for precious metal investors in 2011?

FH: Investors should consider buying gold as insurance. We recommend
having about 10% of their portfolio in gold and gold stocks, and
rebalancing every year.

Two stocks that we like at current prices are Randgold (GOLD) and
Silvercorp (SVM). Both companies focus on high-quality ore deposits that
will be economic at prices substantially below current spot prices.

In Randgold’s case, their share price has fallen about 20% since the
presidential elections in the Ivory Coast became locked in a stalemate.
The company’s Tongon mine is their newest project and is currently being
commissioned, but news flow has been slow and hasn’t drawn much attention.
Look to see this issue resolved over the next couple of months.

Silvercorp is one of the few companies that has successfully navigated in
China, and our models indicate there is much more upside available from
these assets than where the stock is currently priced. SVM also has a very
attractive relative valuation to its North American peers, where in some
cases we have seen 5% of their market capitalization turn over fairly
consistently everyday over the last month – those shareholders are
obviously not around for the long term.