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By Jeremy Glaser | 07-15-2010 10:49 AM

Portfolio Insurance With a Golden Shine

U.S. Global Investors' Frank Holmes thinks no one will get rich holding gold but that investors should still allocate 10% of their portfolios to the precious metal as an insurance policy against fiscal and monetary imbalances.

Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser. I'm joined today Frank Holmes, CEO and Chief Investment Officer of U.S. Global Investors to find out his take on the global economy and how he thinks investors should allocate their portfolios.

Frank, thanks for joining me today.

Frank Holmes: It's great to be here.

Glaser: So, I guess the first just overarching question is, have we reached a sustained economic recovery or do you think that the U.S. economy is going to sputter back into recession?

Holmes: I don't think it's going to sputter back into recession, but we have to just look back at history. In the past 400 years, there have been 47 of these currency/credit crises and they seem to come every decade. So, then you go back and you say okay, how long do they last?

Whenever a country goes through a huge credit contraction, the banks, the currency goes through this volatility, it takes about four to five years to repair that and that's just what we are living with when China – sort of the Asian crisis of '97 took four years.

When we had the S&L crisis, it took four years for the southern belts, the countries, states to sort of rebound. This is just the factors we are dealing with. We are going to have extreme volatility, governments are going to try to do everything, they to try to create jobs, but we'll not sputter because they are going to come in and print a lot of money.

Glaser: So with all that money being printed, there is a lot of people worried the potential for inflation, is that something you are worried about or is there deflationary pressures that were actually seeing on the ground right now is something that's more of your concern?

Holmes: My thesis for as a gold fund manager has been that we will see gold rise in a deflationary cycle, and gold actually performs well and so do a lot of commodities whenever there is an imbalance in monetary and fiscal policies. And what's so different today than in 1971 is that China and India had no global footprint. They were 1% of the global GDP.

Now you are pushing 10 and you go back in the history books, in 1840, they were 40% of the world's economic activity. So there is a super cycle going on, and it's very, very different and that's a big part of that that people don't capture and it's a deflationary cycle until the very end. So I think we are going to wrestle this deflation for the next several years.

Glaser: So you are not too worried about your kind of runaway price levels, but if you are thinking about allocating part of your portfolio to commodities, how would you suggest – people think about that exposure, should it be a huge part of the portfolio, should it be a relatively minor one?

Holmes: Roger Gibson has done research on this on asset allocation and same with your group has some spectacular asset allocation and do regressional studies and we saw the opinion that 25% international investing is appropriate, 25% in resources, 25% equities and 25% fixed income.

But the magic there is to rebalance, because you'll have these huge runs in international funds and stocks et cetera, and then they go through this correction phase. And by rebalancing your portfolio, you'll capture those opportunities, and if they are in a correction phase, you'll be able to buy them in the correction.

Glaser: So when you're looking at kind of that resource allocation, I think it's one that some people maybe struggle a little bit more with because you don't know. Should I invest in ETF that's buying futures contracts for oil, or should I buy gold miners, there are so many different options there. How would you suggest investors weigh those different options that they have?

Holmes: When it comes to gold, I have always advocated 10% waiting, and so you don't buy gold to get rich just like you don't have a car, you don't want to have car insurance to get an accident. You want to make sure in case you have one. And having a 5% in bullion, in a bullion ETF or bullion itself, and having 5% of unhedged gold equities and a good active fund manager, I think is a smart move, but you got to – once again you got to rebalance that portfolio and capture that inherent volatility and apply that law of mean reversion.

Glaser: So you talked about asset allocation, I have these booms and you want to make sure that if you have the big boom, that you are bringing your allocation down to size. The price of gold has obviously run pretty spectacularly over the last year. Are you worried about the current price level of gold to just being too high?

Holmes: Now what people have to recognize for gold is that gold has not gone through its 1980 inflation adjusted prices like almost every other commodity has. If it was to go through that 1980 price, it would be at $2,300 an ounce today.

Two, is that there is a seasonality to gold and the seasonality is impacting right now and usually in the summer months, is the best time to buy. It's when these stocks and gold actually declines. And the big run starts to take place with religious holidays starting in September, October, right through and that drives the next phase. That's the jewelry demand which is about 70% of the demand side for gold.

The other part is investing and that moves around on government policies. Are they going to print a lot of money, how much they are going to print, how they are going to bail out this institution versus that institution and you will see waves come in regarding – and the ones I believe is you are going to see a slow devaluing of currencies to create jobs, so we can get exports going out. That's the thesis on this deflationary battle.

Glaser: So the gold could help battle that a little bit?

Holmes: Gold will perform whenever you get instability. Either big deflation or big inflation, gold starts to perform.

Glaser: Great. Frank, thanks so much for talking with me today.

Holmes: Thank you.

Glaser: For Morningstar.com, I'm Jeremy Glaser.

 

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