As an investor, you probably get a lot of advice and don’t know which to follow: there are conflicting reports, Fed announcements, figures that tell only half the story. In this interview with The Gold Report, Ralph Aldis, senior mining analyst with U.S. Global Investors, helps investors parse these many information streams, explains what seasonal gold pricing patterns could mean for investors who await greater leverage to a gold price recovery.

The Gold Report: The CEO of U.S. Global Investors, Frank Holmes, recently told gold investors to “keep calm and invest on.” I hope you have the T-shirt royalties for that. What advice do you have to help investors do that?

Ralph Aldis: We like this phrase because it reminds investors not to let their emotions get the best of them. Instead, investors need to plan an investment strategy and make sure it includes all their assets. Investors need to think about what the weightings are in those assets, track quarterly performance numbers to make sure assets aren’t correlated with each other, make sure there is diversification and rebalance the portfolio every year.

TGR: What’s a good asset allocation mix through at least the end of the year?

RA: The asset mix will be a function of age, investment objectives and how soon liquidity is needed. Generally, a maximum of 5–10% in gold and gold stocks, 50% in equities, 30% in fixed income and the balance in some other asset, such as real estate or home value.

TGR: U.S. Global Investors recently reported that gold has 30% upside potential over the next 18 months. What do you believe will specifically move the gold price?

RA: A 30% rebound is well within the normal volatility swings of gold for a given year. Right now, we have the seasonal rally in the gold market. Buyers, like jewelry manufacturers, return to the market usually in late July or August and start restocking to get gold into the pipeline.

Another factor is the employment data that recently came out. It beat expectations, and people got excited. But most of the gains came from part-time jobs, which were up 360,000, and we lost 240,000 full-time jobs. The full U6 unemployment rate actually climbed to 14.3%, up from 13.8% in May. The quality of the employment numbers was dismal, but people saw the headline number and thought “Woohoo, go long equities!” Macquarie Research released a study on July 11 that said the Federal Reserve tapering is much further out than expected—Q4/16 not Q4/14.

TGR: Can a climbing gold price and a strong U.S. economy coexist?

RA: Yes. Some economic growth and a little inflation could get the gold price and the economy growing in sync. But you need the dollar to weaken, which is a function of U.S. interest rates going down. The Federal Reserve doesn’t want a rising interest rate because that stifles some of the economic activity and makes the U.S. debt burden greater.

TGR: What about central bank buying by emerging market countries? If their economies are stronger, will some of the spoils go into gold?

RA: We’ve had seven months in a row of central banks buying gold. The U.S. dollar isn’t as significant to official holdings as it used to be. It has lost a lot of influence, and emerging markets don’t feel they need to own dollars instead of gold.

TGR: But if the American economy is rolling, chances are the global economy is doing well. If these emerging market economies buy more gold, won’t that put pressure on the gold price?

RA: That would be the hedge that I would want to be making, too, trying to diversify some of that risk as some countries, like China, probably have way too many dollars in their official reserves.

TGR: What are some signs for investors that it’s safe to return to the precious metals sector?

RA: We look at the year-over-year changes in the gold price to indicate whether the price has moved up two standard deviations from its mean, which means that gold may soon correct, or whether the metal has moved down two standard deviations from its mean, in which case, gold is due for a rally.

Also, look for the exhaustion of money flows out of the gold sector, which is happening now. We’re just beginning to see positive money flows come into some of our gold funds now.

We’re also seeing gold analysts capitulate. These people get paid to love stocks, and they capitulated. When analysts do that, I believe it’s a sign to buy.

TGR: Has the slide in precious metals prices and the recent selloff exposed some of the flaws in precious metals exchange-traded funds (ETFs)?

RA: If you’re a U.S. citizen, the biggest drawback is a tax liability issue. The SPDR Gold Trust ETF  is taxed as a collectible, so if you recently sold and made a gain, you actually have to make twice as much than you would on a gold stock investment. It’s liquid and gives you exposure, but it’s just not tax efficient.

TGR: You said investors should have 5–10% of their portfolios in gold and gold equities. Why should they hold Canadian or American gold equities versus gold futures or gold ETFs?

RA: Tax efficiency is a consideration. Plus gold equities can move two to three times the magnitude of the underlying metal price. And our research has found that a small weighting of gold stocks in a portfolio of U.S. companies historically increased return with the same amount of risk.

TGR: But some of the names you’re following have limited liquidity. How do investors deal with that?

RA: Sometimes people look at our mutual fund holdings and marvel that there are 150 names there. But we want to have enough liquidity to adjust positions. Maybe we’d like to have a bigger position, but if investment conditions change for that particular stock, you could compromise your liquidity. If we can build a portfolio out of 10 or 20 junior names that meet our criteria, then we’re insulated from some of the extreme price moves.

TGR: What is price leadership?

RA: We look at price performance over a period of time and for statistical significance of outperformance relative to others in that model. When the market knows more than you do, you can see it through price leadership. Ask why a stock is outperforming and see if it makes sense.

TGR: Do you have some parting thoughts for us, Ralph? Maybe something to bolster the hopes of the retail crowd?

RA: Gold investors are seeing two newer trends in gold. One has to do with a move out of paper gold to the physical holding of gold. Chinese gold imports from Hong Kong have more than tripled since 2012 and premiums for gold physical delivery in Shanghai jumped above $30/oz. In addition, the U.S. Mint suspended sales of its smallest American Eagle gold coin after it sold off its entire inventory.

The second trend is the extreme pessimism toward gold, with speculative short positions hitting a record level. As of the beginning of July, the number of outstanding gold short contracts was close to 140,000. I think investors will see some higher gold prices later this year.

TGR: Thank you for your insights.

Ralph Aldis, CFA, rejoined U.S. Global Investors as senior mining analyst in November 2001. He is responsible for analyzing gold and precious metals stocks for the World Precious Minerals Fund (UNWPX) and the Gold and Precious Metals Fund (USERX). Aldis also works with the portfolio management team of the Global Resources Fund (PSPFX) to provide tactical analyses of base metal, paper, chemical, steel and non-ferrous industries. Previously, Aldis worked for Eisner Securities, where he was an investment analyst for its high net-worth group and oversaw its mutual fund operations. Before joining Eisner Securities, Aldis worked for 10 years as director of research for U.S. Global Investors, where he applied quantitative skills toward stocks, portfolio tilting, cash optimization and performance attribution analysis. Aldis received a master’s degree in energy and mineral resources from the University of Texas at Austin in 1988 and a Bachelor of Science in geology, cum laude, in 1981, from Stephen F. Austin University. Aldis is a member of the CFA Society of San Antonio.

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In volatile financial markets what has gone down like a stone can rebound like a rocket. Gold and silver investors should not forget that this summer after the recent price rout.

The financial markets have turned far too heavily against the precious metals, piling up wildly leveraged short positions that have driven the price down and down in the futures market. Once these positions come off then there will be an equally powerful reaction in the opposite direction.

Wall Street Crash

Why should that happen this autumn? There is only one obvious answer: Wall Street’s long rally against a very poor US economic recovery will finally end with a crash.

Where it will be different to 2008 this time is in the precious metals market. Gold and silver have already been through their correction and this time will be an oversold safe haven in a crisis.

Given the recent bond market squeeze there will be less confidence in treasuries as a safe haven this time round. Remember it used to be the Chinese who were buying all the bonds and now they just can’t get their hands on enough gold.

The Shanghai Gold Exchange settled an amazing 1,098 tonnes of physical gold in settlements compared with just 161 tonnes in the New York Comex in the year to end of June. To put this in perspective that is an eighth of all the US Treasury’s gold reserves in Fort Knox and 40 per cent of global gold production.

The Chinese really are turning their treasury bonds into gold now. ArabianMoney has explained this on many occasions (click here). Rumors that they might go the whole hog to a gold backed yuan currency are less credible (click here).

Put simply the gold price fall this year is an artificial construct of the gold futures market. That is paper gold. The hard stuff’s price is being artificially held down by the price of futures being traded by speculators.

Price mechanism

However, it just cannot stay down in the face of this huge growth in demand for physical gold from China. And it won’t for much longer because the physical gold backing the Comex futures paper is actually running out (click here).

In less than three months the price setting mechanism for gold will have to move from the Comex to the physical metal itself and that price-setting revolution will give the gold price a massive boost.

Buying what is cheap is a part of the contrarian investment philosophy. The other part is to have a cast iron case for believing a rebound is at hand. We have that now with gold and silver.