A Greek Drama and a Gold Disconnect…

Greek debt has been an increasing global concern. Those countries holding significant amounts of its debt, notably France and Germany, face the prospect of Greece failing to meet its financial obligations.

Greece has only 2% of Eurozone GDP and 3% of its debt, but its significance is as a member of a group of economic laggards known ironically, and perhaps appropriately, as the “PIIGS” (Portugal, Italy, Ireland, Greece and Spain). These omnivores all suffer, in varying degrees, from overconsumption and sovereign debt indigestion!

Germany and France have both affirmed Greece’s place in the Eurozone, making clear their commitment for a bail out program to calm fears of a contagion. For its part, Greece committed to abide by conditional austerity measures, whilst Italy, the largest of the PIIGS, faces a decisive vote on budget cutting measures of its own.

A more solvent group of nations with their own acronym – the “BRICs” (Brazil, Russia, India and China) meet next week in Washington to discuss what role they might play.

The Greek drama will continue to play out over the next several weeks. Is there enough political will to rescue Greece from default or let it fail? More importantly, can European and world leaders steer the region toward sustainability?

Recent days have seen signs of that leadership emerging with quieter markets. Any positive moves should send strong signals to restore lost confidence. What does this mean for our resource-based fund?

The gold “disconnect” is a result of this uncertain environment. Investors have preferred physical gold, the traditional safe haven and currency hedge, to gold-based equities. Indeed, the price of gold has almost doubled since early 2008 while the HUI index, measuring unhedged gold equities, rose by just 22%. Proven reserves of gold have been available for c. US$500/oz - a quarter of the physical price!

This pattern now seems to be reversing. For example, on August 10th, the DOW dropped 4% with gold stocks rallying 3%, and on September 7th gold lost over 3% while gold stocks actually rose by 0.33%. We expect this pattern to strengthen, with a number of funds and institutions beginning to transfer from bullion into equities, with the best leverage in the smaller cap “junior” stocks.

The gold commodity/equity disconnect is nothing new and historically the subsequent reversion tends to be swift and dramatic. Notwithstanding appreciation in the precious metals sector, we believe investors should maintain significant exposure to this asset class.

We will continue to buy well-priced junior to middle-market companies with significant exposure to precious metals, looking for strong near term price appreciation.