Position Updates (June 23, 2010)
June 23, 2010
The Macro Trumps All Else
July 2, 2010

Index Fund Shopping Day

Billions of dollars are invested in index funds. The index funds follow strict guidelines on what companies can and cannot be included in the index. These funds are rebalanced from time to time. When the guidelines say it’s time to sell—they sell. Index funds have grown to be so large that they move markets when they need to get out. It’s mechanical and sometimes this selling can create some really amazing bargains.

On Friday, the Russell indices were forced to sell shares of US Global Investors (GROW: Nasdaq). Over a million shares were sold from the indexes—which is extreme when you consider that there are less than 10 million shares in the float. I think this is why the shares have dropped in half over the past two months. This also creates opportunity. On Friday, I bought quite a few shares of GROW.

US Global is the manager of mutual funds primarily focused on commodities and Eastern European equities. Over the years, their funds have had phenomenal performance and attracted plenty of investors. At the end of May, 2010, assets under management (AUM) stood at $2.44 billion. There are four key funds that make up the majority of the fee earning assets.


US Global Assets Under Management
Fund Name Ticker AUM $Million (May, 2010)
Eastern European Fund EUROX 394
Global Resources Fund PSPFX 665
World Precious Minerals Fund UNWPX 635
Gold And Precious Metals Fund USERX 230
Total 1,924


AUM is down by half since the peak in late 2007 because of redemptions and losses suffered by their commodity funds when the global economy collapsed in 2008. While many asset classes have recovered, most commodity producer shares have not. This is ironic because the prices of the commodities themselves have recovered. I think it is only a matter of time before the shares catch up with their respective commodities. However, the decline in AUM is certainly a concern.

During the quarter ended March 31, 2010, the company had $2.629 billion in average assets under management. This produced $9.4 million in revenues and $1.5 million in income. This would annualize at 40 cents a share. At a current price of 5.40, the shares are trading at 13.5 times income. That’s not terribly expensive. It actually could be quite cheap.

Let’s look at gearing. Fund managers like US Global earn a management fee based on their AUM. When their AUM increases, so do their revenues. Expenses are somewhat fixed. When revenues go up quicker than expenses, you can have some powerful gearing. A few years back, US Global was a case of gearing in practice. I made nearly ten-fold on my investment in the company. Let’s just say that I’ve been waiting a long time for a chance to buy back in. Asset management can be a really great business. The key is to watch changes in AUM. I think US Global is currently in the sweet spot for gathering assets.

The concept of investing in gold is about to go mainstream. This should funnel assets towards the best performing funds in the sector. The World Precious Minerals Fund was first in total return among all US gold-oriented funds for 2009. Commodities should be beneficiaries of money printing. The Global Resources Fund also has a very good track record. The Eastern European Fund has underperformed lately. Eastern Europe has been out of favor for a while now. However, the fund is mainly comprised of Russian energy companies. I’m scared to own them myself, but these companies should do quite well as energy prices continue to increase. In summary, US Global has 4 funds that are in the sectors that should outperform over the next few years. Hot sectors attract inflows. Inflows mean earnings growth.

When investing, you always have to watch your downside. At 5.40 a share, the market cap is $85 million. However, net tangible assets are $36 million or nearly $2.35 a share. Cash and securities make up $31 million of this figure. The company owns its headquarters. It’s on the balance sheet for an insignificant number. I’ve been there. It’s worth at least another fifty cents a share and probably closer to a dollar a share. Let’s just say there isn’t much downside to this investment as long as it remains profitable.

I think it will remain profitable. CEO Frank Holmes owns 14% of the fully diluted equity. He’s a very smart and capable executive. Frank has a great track record as an investor in resource stocks and it gives me a lot of comfort that he has personally been buying shares of US Global over the past few weeks.

In summary, you are getting a great business that is churning out a dime a share in income each quarter at current AUM levels. I think AUM should increase considerably in the next few quarters which should rapidly grow income. You are protected by a solid balance sheet which is mostly made up of cash and investments. Finally, the company does pay a nice dividend of nearly 5%. It is cheap because it has just been kicked out of the index funds. Their silly rules have created the opportunity for me to get back into US Global at about a quarter the share price of when I sold it a few years back. I love index fund shopping day.


Disclosure: My partnership owns shares of US Global. I may buy or sell shares without further notice.

Categories: Current Investments
Positions Mentioned: GROW

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