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Anti-Establishment Forces Rise; Real Interest Rates to Fall

Frank Holmes Exclusive: Oil, Gold, and Silver to Rally on Better-Than-Expected Nominal Growth

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Welcome to this week's Market Wrap Podcast, I'm Mike Gleason.

Coming up we'll hear from Frank Holmes of U.S. Global Investors. Frank weighs in on the turbulent market action thus far in 2016 and discusses some of the positive signs he sees ahead for gold and silver. Don't miss another great interview with Frank Holmes, coming up after this week's market update.

Volatility continues to rattle markets and raise fears of what could be in store for the rest of the year. The stock market sold off hard on Wednesday, driving the S&P 500 back near its August lows last year. The market seemed to find some support there and rallied strongly Thursday. However, the equity markets are getting hammered again today as the whipsaw action continues.

Precious metals, meanwhile, got hit, with gold giving back some of its gains from last week. Gold and silver prices fell Thursday, moving in the opposite direction of stocks. As of this Friday recording, gold trades at $1,090 an ounce, down 1.4% for the week. Silver is recovering a portion of yesterday's losses and comes in at $13.94, essentially flat now week-over-week.

Turning to the platinum group metals, platinum is showing the most weakness, down 4.8% since last Friday's close and currently trades at $839 an ounce. Meanwhile palladium is swinging wildly after getting trounced last week, with prices gaining Thursday to reach break-even on the week. As of this Friday morning recording, palladium is unchanged on the week and trades at $497.

And in Washington on Tuesday, the U.S. Senate voted on a bill to audit the Federal Reserve. The good news for monetary reformers is that is that a majority of Senators voted for Audit the Fed. The bad news is that they fell short of the 60 votes needed to prevent the Fed's Big Government allies from blocking the bill. In short, Audit the Fed won't be heading to President Obama's desk.

Senator Rand Paul did much of the heavy political lifting to finally get the Audit the Fed bill to a vote. He vowed to continue the fight after the election in the next Congress, even as he expressed frustration that the Federal Reserve intervened in the legislative process to ensure the bill went down in defeat.

Rand Paul: The biggest lobby against auditing the Fed is actually coming from the Federal Reserve. This has made me so mad that the government created the Federal Reserve. Sure, they're quasi private, but they were created by the government; it's a conglomeration of private banks, but they should not be allowed to lobby against their own oversight. They come to Washington, they write OpEds, they called every senator in advance and lobbied them to say, "We don't want more oversight." I'm going to keep up the fight if it takes me another 5 years. I'm going to get a vote on Audit the Fed, and we're going to win.

Only two Democrats broke ranks to vote for the bill. One was presidential candidate Bernie Sanders. Senator Sanders, an avowed socialist, is on the opposite side of the political spectrum as Senator Paul. But like Rand Paul, Ted Cruz, Ben Carson, and Donald Trump on the Republican side, Bernie Sanders is tapping into rising anti-establishment sentiment among the public with tremendous success.

Just a few months ago, virtually no one in the elite media thought Bernie Sanders would threaten Hillary Clinton's presumed cakewalk to the Democrat nomination. Now polls show Bernie has a good chance of knocking off Hillary, increasingly dogged by allegations of corruption and enabling of a notorious sex offender, in both Iowa and New Hampshire.

On the Republican side, the party establishment has nearly been sidelined so far in the primary process. The Jeb Bush campaign has spent tens of millions of dollars with nothing to show for it. Much to the chagrin of party figureheads, Donald Trump continues to lead in the polls, followed by Ted Cruz. The more the establishment attacks them, the stronger their anti-establishment credentials get.

GOP leaders are in a bind and they don't know what to do. They tapped South Carolina governor Nikki Haley to give the Republican response to President Obama's State of the Union address on Tuesday. Instead of hitting the President's policy agenda, Governor Haley reiterated and amplified Obama's criticisms of Donald Trump and his supporters. The White House even went out of its way to praise the Establishment Republican's speech.

Regardless of who ultimately becomes the Republican nominee, tensions will persist between the disaffected public and the entrenched elites in Washington, the media, Wall Street, and the Fed-backed banking system. The upcoming election could well deal a blow to the powers that be. But they aren't going to let go of their grip on things as important as the monetary system – at least not without a fight. We've seen now how the Federal Reserve can block a public audit of its books even when there is majority support for it.

The country's problems won't be solved by any single candidate. But this election has already opened up the parameters of political discussion to areas that the establishment won't be able to close back up.That's an encouraging sign for proponents of fundamentally reforming the monetary system and restraining the government's ability to spend and borrow in unlimited amounts.

Well now, without further delay, let's get right to this week's exclusive interview.

Mike Gleason: It is my privilege now to be joined by Frank Holmes, CEO and Chief Investment Officer at US Global Investors. Mr. Holmes has been named Mining Fund Manager of the Year by the Mining Journal. He is the co-author of the book The Goldwatcher: Demystifying Gold Investing, and is a regular guest on CNBC, Bloomberg, Fox Business News, and the Money Metals Podcast. And you can find his company as well as his renowned Frank Talk blog at USFunds.com.

Frank, it's good to have you back. Happy New Year, and thanks for joining us again.

Frank Holmes: Well, Happy New Year to you.

Mike Gleason: Well, to start out here, Frank, I want to ask you about your "Frank Talk" blog piece from earlier this week where you wrote about How Gold Got Its Groove Back. The beginning of the New Year brought us a noticeable divergence between the stock market and the yellow metal, as gold rose about 4% while the equities fell 6% in the worst January start on record. So gold appears to be getting a bit of a safe-haven bid, as you wrote there. What is the reason for this market action in the early stages of 2016 here, and what did the first week in particular tell you, Frank?

Frank Holmes:Well, it showed that gold is important as an asset class. With the Chinese stock market being skittish and North Korea announcing that it detonated a hydrogen bomb and rising tensions between Saudi Arabia and Iran, those three factors come together and gold responded and rising for it. I don't think it's critical for a long, sustainable move, but it does go to show that the yellow metal is the safest of all forms of money.

Mike Gleason: I know you follow the entire commodities sector very closely and certainly slumping oil prices are making lots of headlines here lately. It seems that the conventional wisdom out there is that now that we've fallen below a key technical level on the chart, I guess around $34 a barrel, that we could see crude drop all the way back to the teens. But in the face of this continued sell-off in the energy sector, we're seeing gold hold up quite well. What do you make of that.. is gold starting to trade more like a currency and less like a commodity? And if it does do that, is that helpful for gold moving forward?

Frank Holmes: Well, I think they're great observations and I think the headwinds for gold have to do with US real interest rates. There's a fear trade, that creates sustainable moves in gold and either positive or negative. Then the love trade is basically how economic prosperity is for Chindia and the Middle East. Chindia is a faction for China and India, which is 40% of the world's population. So falling oil prices is a boom for ... and it takes at least 12 months before it truly ripples through the economy. It's an estimated a $500 billion global tax break, and it will start to impact, as we've seen in some of the parts in the U.S. it has, and China. However, it does impact negatively, countries like the Middle East, Saudi Arabia.

There is a sort of thirst for buying gold for gift giving, it sort of slows down. They are going to buy you 8 grams for this anniversary, not 22. That's what we are going to see that's sort of a headwind. But for India, it's very significant. India is a major oil importer in a huge consumption economy with a real affection for gold as an asset class for giving as love. I think that's the other offset. I think what we have to deal with is this global growth and currency devaluations, and I think we are seeing a bit of a currency war, with China letting it's currency slowly fall, and what we saw last year that, it's in my visuals, was showing that gold was off 10% for the third year in a row. But if you look at some of these other countries, like at Brazil, gold was up almost 40%.

There is some of the best performing gold stocks in Australia. If you look at their numbers, I think companies like St Barbara is up 900%. What's happening for countries like Australia, is they're paying locals in a weaker currency, and at the same time energy prices have come down, so diesel energy, which is used a lot in the gold industry, its costs for producing and for mining gold, it's climbed dramatically for them. So they in fact have profit margin expansion, and these stocks are starting to reflect that. So I think that in the U.S., it's more difficult with the strong dollar for gold stocks, such as the Newmonts of the world, but I do think for other countries, their gold producers, there could be big benefits.

Mike Gleason: Certainly we're seeing real threats of price deflation out there among many asset classes, crude oil prices seems to be at the forefront of that. With that in mind, do you envision the Fed following through on their interest rate raising campaign this year? Because to me it seems they can't have it both ways, meaning it's going to be tough for them to maintain their goal of jacking up prices that everyone pays for things at an annual rate of about 2%, and, at the same time, raise interest rates. You'd think that raising rates would strengthen the dollar versus other global fiat currencies. What are your thoughts on the Fed there, given the economic data we're seeing?

Frank Holmes: Well, what I think is important to recognize, and in March of ‘09, when Obama came in with a massive economic stimulus, $700 billion was injected into the economy, and then they removed the FASB 157 called Mark-to-Market rules, which was a big part of the financial meltdown – the interpretation of those government policies – the market started to take off. And what we're seeing right now that's on a positive note, is that Congress, which is Republican, but more balanced in negotiating with the Democrats, pushed through huge business deals of the magnitude of over $700 billion for this year. There are lots of tax concessions and considerations, which are going to help small businesses across the country. I think that raising of interest rates without that fiscal stimulus would have basically destroyed any economic growth, and would have taken us down like Asia has been going down.

I think that that balancing act is one has to just be cognizant that rates went up 25 basis points, and they may go up another 25 basis points, but the fiscal stimulus is always a bigger money multiplying effect than cheap money by the government. Cheap money by the government doesn't mean everyone gets a loan. There is so much fiscal drag. Even a former Federal Reserve Chairman, Bernanke wanted to go refinance his mortgage, had great difficulties with all the rules, etc. So I think the tax stimulus would be an important part that will mute any raising of interest rates for the U.S. domestic economy. But it will impact a stronger dollar for exports, and that will hurt the manufacturing, the heartland of America more so than it will other places.

Mike Gleason: When it comes to gold prices, a major driver is real interest rates, not nominal rates, as you have said many times, and a moment ago. Positive real interest rates have certainly been a major headwind for gold over the last several years. As the economy begins to possibly rollover what do you think the central banks response is going to be, and how will that affect gold? Could we see real interest rates dip into negative territory to provide that much needed boost that metals investors are looking for?

Frank Holmes:There is no doubt we could see that, because we've seen that from inflation. Let's say the CPI number picks up like the PPI number, it picks up in the U.S. in the next quarter, but rates, the 5-year and 10-year government bonds are lower than they were a year ago. So if rates stay the same in that space because I'm worried about a weak economy, but inflation starts to pick up its head, then we're going to negative interest rates scenario. Gold starts to rally with that. It's well documented. That would be a catalyst for it. Now, if they raise interest rates 25 basis points, and inflation goes up only 10 basis points, then that's a positive grow rate of rate of return differential, and that's not bullish for gold.

But I don't see where they can really raise rates dramatically because when we look at the real interest rate world, we have already seen a 500 basis points rate hike, and any time we've had that, over 30 years of data points, the global economy slows down, and that's what we're witnessing today. What do I mean by that for your listeners, if we go back to September of 2011, when gold hit $1,900, well, we forget that was the summer that the rating services downgraded the U.S. dollar, and real interest rates back then, the 10-year government bond, were minus 3%.

Earlier in 2015, they hit plus 2%. You went from minus 3 to plus 200 basis points on a 10 year government bond because inflation had fallen so greatly, it was a key factor. That means that rate hikes is that you already had it, and anytime you've had that 500 basis points positive swing, global growth starts to slow down. So I think that if anything the odds favor for negative interest rates to start to grow.

Mike Gleason: You cited in your piece earlier this week, and just a moment ago as well, about the huge physical demand for the metals that come from outside the U.S., specifically China and India. As we do see the Chinese stock market taking a major hit, do you envision gold being a safe haven over there? You spoke a little bit about India, but will the appetite for physical metal remain strong in China in the face of this liquidation of stocks that is going on?

Frank Holmes:I think that it's really fascinating to me that this meltdown in gold for the third year in a row, off 10%, which was a lot less than most other currencies against the U.S. dollar. So gold coming on sale, and silver, people in the U.S. and Australia have been record buyers of the precious metals. So I think that's an important part because we are seeing the physical delivery in China in the Shanghai Exchange, that is massive physical delivery, which you don't see in the U.S. 97% of the U.S. is just settles, futures, trade-in, buy, and sell, and close out the book business, only 2% take delivery. It's the inverse of that in Shanghai.

But also what has really surprised me this past year was Russia. Russia's currency is highly correlated to Brent. Brent fell, the price of oil in Brent terms, it fell dramatically, and so did the currency. However, Russia continued to be a net buyer of gold. So you have central banks like China, like Russia, etc., continuing to be net buyers of gold, and that to me is pretty positive constructive for gold. At the same time you're seeing retail investors buying the physical metal. There has been redemption out of the GLD's and the ETS, and I think the best place, and what I've always recommended is 5% in bullion, and 5% in a managed gold fund, like ourselves. Speaking from a very biased position, but it is important when you take a look at that active money management aspect of it.

Mike Gleason: Gold seems to get more interest in the face of uncertainty. Do you think that we'll see the potential for increased interest in gold as investors get more and more uneasy about the stability of the world? You mentioned some of those economic or geopolitical events; North Korea getting nuclear, the tensions with Iran and Saudi Arabia, and so forth.

Frank Holmes: I think so. I think there will always be that trigger point that people buy it, but I think it's important that people continue to buy silver coins (2 oz New Zealand Silver Hawksbill Turtle) and take physical delivery. I think it's important that people own some, and give it as gifts. I give silver coins to all my employees as gifts every year, and it's something they always keep and cherish. So I think that's an important part, and we will get these little blips. But they're not sustainable. You know, what's really important for long term investing, for investors, is when you have that global growth. And we don't have global trader growth.

But here's what's positive. I mentioned earlier over $700 billion of tax breaks have come to Americans, which is passed by Congress for this year, is this TPP, that's the Trans Pacific Partnership. If that goes through, that is going to be very significant in 2016 for global growth. Any time we've had global growth, we get oil rallying, the demand for oil, and we get gold and silver and platinum and palladium rallying. I'd rather bet on that because if the TPP goes through, you're going to have 16,000 tariffs removed. That takes away a lot of excessive regulations, which are non-growth to the overall economy, and you're talking about 25% of the world's GDP. Canada, America, Mexico, Chile, Peru, Australia, New Zealand, Singapore, Japan, Vietnam... Vietnam will be a big beneficiary of that. It leads to this tremendous amount of growth, and that's what's going to really drive higher commodity prices.

Mike Gleason: Earlier this week we got a “sell everything” warning from banking giant RBS, which certainly created some financial waves. They're calling for a 10-20% drop in global equities this year. What did you make of that? Obviously they are seeing a reason to get defensive.

Frank Holmes: Well, there's two thoughts on that. One is the 4th year of a presidential election cycle historically for over 100 years of data points has been up, except for it gets challenged in the second term, the lame duck, of the President's term, so the 8th year. People have been coming out and commenting that usually the markets are down in this year. So those things are always useful to look for seasonal patterns, etc. But we've always written that government policies are a precursor to change, and the governments have two ways of monitoring the economy; one is monetary and the other is fiscal. Any form of deregulation will be good for global economic growth, and if that goes through, as I mentioned earlier, the TPP and Congress gets through all these other tax breaks for Americans, we are going to have better growth than is expected.

Mike Gleason: Well, as we begin to wrap up here, Frank, do you have any closing thoughts for our listeners? Is there anything else they should be watching or thinking about in 2016?

Frank Holmes: Yeah. Just be thankful. We all woke up today. We're all listening and talking with each other, and that's the most blessed part of life. And there's lots of great research that when we are grateful, we are being mindful, and that thoughtfulness allows us to see opportunities. I think that's really key if you want to be able to capture opportunities for 2016 is just be grateful. You know, we've lived through these past three years that we've been in the gold cycle. It's been really challenging, but we're alive, and we're going to continue to seek more opportunities for 2016.

Mike Gleason: Well, very good advice, and wonderful insights as usual, Frank. It's great talking to you again. We certainly appreciate your time, and look forward to check in with you in the not too distant future as we watch the year unfold. Now, before we let you go, tell our listeners a little bit more about your firm and your services, and then the aforementioned fantastic Frank Talk blog, and how they can get that on a regular basis.

Frank Holmes: It's so kind of you to mention the Frank Talk blog. It's my thoughts of travelling around the world, and basically views of behavioral finance. The bigger article, you need to go to USFunds.com. We've won many awards for education, and we have the Investor Alert, which is read by tens of thousands in over 170 countries. It's a SWOT analysis, it comes out every Friday night. So go to USFunds.com, and sign up for Frank Talk and Investor Alert. I think that's important. Remember, buy some silver coins, and give them for gifts, when you're thinking of the next present you want to give, and give some nice gold jewelry for the ones you love, and that will keep this commodity cycle very attractive.

Mike Gleason: Well, excellent stuff as always, Frank. Thanks for your time. I know you've got to run and you're travelling. Thanks very much. Have a great weekend.

Frank Holmes: Take care.

Mike Gleason:Well that will do it for this week. Thanks again to Frank Holmes, CEO of US Global Investors. The site is USFunds.com, and be sure to check out the Frank Talk blog, get signed up for that in order to get some of the very best market commentary you'll run across anywhere. Again, you'll find that at USFunds.com.

And check back here next Friday for our next Weekly Market Wrap Podcast. Until then, this has been Mike Gleason with Money Metals Exchange. Thanks for listening, and have a great weekend everybody.

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