A Strategy To Win With Gold

By Sree Vidya Bhaktavatsalam
Bloomberg News
Sunday, April 23, 2006

Frank Holmes, manager of the best-performing U.S. metals mutual fund of the past five years, says gold is heading to $700 an ounce.

The U.S. Global Investors World Precious Minerals Fund has risen 46.5 percent so far this year, as gold prices climbed above $600 for the first time since 1981. The advance will extend for at least another year, as countries including Russia increase reserves, Holmes said.

"We're in a very secular bull market for commodities," the 51-year-old money manager said in an interview from his office in San Antonio. "All of a sudden, this is the flavor of the month."

U.S. Global's $685 million fund rose at an average rate of 50 percent during the past five years, the most of 16 metals funds tracked by Bloomberg. In the past 12 months, the fund jumped 122 percent. The No. 1-ranked fund was U.S. Global Investors' Gold Shares Fund, also managed by Holmes, followed by Midas Fund, overseen by New York-based Midas Management Corp.

"Many of the funds in this category have had a recent run because of the gold rally," said Karen Wallace, an analyst at fund research firm Morningstar Inc. in Chicago. "The price of the metal is so volatile, investors should keep such funds on the margins of their portfolios, not as core holdings."

Metal prices rose as more investors searched for a hedge against inflation. Gold for June delivery climbed to $623.30 an ounce on Tuesday on the Comex division of the New York Mercantile exchange. Prices are up 45 percent in the past year. Copper and zinc also soared as China's booming economy spurred demand for raw materials needed for houses, appliances and cars.

Some countries are buying gold to keep as reserves, Holmes said. Russia, for instance, doubled to 10 percent the amount of foreign reserves it invests in gold, he said.

Holmes is buying Canadian mining companies including Goldcorp Inc., Northern Orion Resources Inc. and Silver Wheaton Corp. Shares of Toronto-based Goldcorp, the country's fourth-largest gold producer, doubled since last April, and Vancouver-based Silver Wheaton, which gets all its earnings from silver, almost tripled in value in the same period.

Holmes, who serves as both chief executive and chief investment officer of U.S. Global Investors, mainly invests in warrants that can be converted into shares at a later date for a set price. That strategy gives him leverage to earn higher returns.

U.S. Global uses mathematical models to find stocks that Holmes views as inexpensive relative to competitors. Holmes and analysts Ralph Aldis, 48, and Jordi Dominguez, 28, compare companies' reserves, production rates and cash flow.

"We like to buy laggards," said Holmes. Holmes was raised in Toronto, whose main stock exchange is dominated by natural-resources companies. He attended the University of Western Ontario in London, Ontario, where he majored in economics and natural science.

Seven of the fund's top 10 holdings as of Dec. 31 were gold exploration and mining companies. Gold-mining stocks accounted for half of its assets. Three-quarters of the companies in the fund are based in Canada.

The World Precious Minerals Fund's largest holding is Goldcorp, which has gold mines in Canada, Mexico, Brazil, Argentina and Australia. A year ago, Holmes bought four warrants for the price of each share, giving the fund four times the exposure for the same amount of money. As Goldcorp's share price has doubled since then, the fund's investment payoff was eight-fold.

Northern Orion, which runs a gold and copper mine in Argentina, is the fund's second-largest holding. The Vancouver-based company's share of operating cash flow from its Alumbrera mine was $75.5 million last year, up from $58.2 million in 2004 and $23.6 million in 2003.

The World Precious Minerals Fund also had a 4 percent stake in Silver Wheaton, whose shares have been buoyed by silver's increase to a 23-year high of $13.50.

Some fund managers are betting that prices are peaking. ProFunds Advisors LLC of Bethesda opened the Short Precious Metals ProFund in January, giving investors a chance to profit from a decline in gold, silver and platinum prices. The fund fell 7.6 percent in the three months ended April 17, according to data tracked by Bloomberg.

Whichever way prices move, Holmes said hedging with warrants insulates the fund from swings in the commodity markets. The fund also may invest as much as 20 percent of its assets in cash. He now has about 8 percent in cash.

"We recognize that there is a strong cyclical market for commodities, but we bring a strong disciplined approach to this that gives us a competitive advantage," Holmes said.

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