Tocqueville Gold 2010 Year-End Investor Letter – Tocqueville

December 17, 2010

Tocqueville Asset Management L.P.

Two significant developments boosted the gold price in 2010. First the Greek debt crisis in the spring contributed to doubts as to the safety of the euro. In our opinion, many investors who took refuge in the euro to escape from the U.S. dollar learned a tough lesson—-that no paper currency deserves safe haven status. As investors dumped their euro holdings, the dollar appreciated and gave the appearance of strength. Dollar strength has usually been associated with a weak gold price. However, in this instance, the gold price rallied in both in U.S. dollar and euro terms. More important, gold broke out to an all time high in euro terms. As a side note, it is remarkable but unsurprising that the European sovereign debt crisis remains unresolved. At the moment, finance ministers in Europe are scrambling to rescue Ireland, while spreads for Greek sovereign debt have widened to levels that exceed those when Greece was front page news in May. In our opinion, permanent resolution of the credit woes afflicting the weaker European economies (PIIGS-Portugal, Italy, Ireland, Greece, and Spain) will remain elusive. Bailouts and rescues resolve nothing and have only bought time while potentially fueling inflation by further undermining confidence in the euro.

The second key development was the launch of a second round of quantitative easing (QE2) by the Federal Reserve. While economists debate whether additional money printing by the Fed was necessary or will have a positive effect on economic activity, the rationale put forth by Chairman Bernanke and other Fed officials was quite disturbing to foreign holders of U.S. dollars. That rationale unequivocally stated that the purpose of QE2 was to create inflation. Such statements coincided with a new upward leg in the gold price, which rose from $1,308.35 at the end of September to an all time high of $1,431.25 on December 7, 2010. On the day after the Fed officially announced that it would proceed with QE2, the gold price rallied 3% in a single day. The action was met with a storm of criticism from academia, former Fed officials, and ministries of our trading partners claiming Fed actions would result in dollar debasement.

While many observers feel that the gold rally has been overdone, is too crowded, resembles a bubble or whatever, the simple fact remains that central banks of the Western democracies appear on course to debase paper currencies. On the one hand, currency debasement is the path of least resistance to grapple with the seemingly intractable fiscal issues of record deficits and unchecked growth in entitlements. On the other hand, persistent economic weakness translates into political pressure for central banks to pursue extremely lax monetary policies. Under these circumstances, it is hard to argue against the notion that some exposure to gold offers protection against monetary damage still to come.

Our Tocqueville Gold investment strategy remains consistent with practices since the inception date of June 1998. Our research team has travelled over 500,000 miles since 2003, to remote sites around the world to visit the mining and exploration activities of smaller companies. We seek to invest in companies at an early stage of development which can generate growth through exploration success or new mine construction. In this way, we have invested earlier than most of our peers and well before investment banks and brokerage firms commenced research coverage. This strategy is reflected in the fact that our average market cap is 60% of our peer group average. It is also exhibited in our low turnover of less than 10% in 2010. The success of our approach is manifest in having numerous acquisitions of our positions by large cap mining companies. Two notable examples of this in the past year were the acquisition of Red Back by Kinross and the acquisition of Andean Resources by Goldcorp.

We believe that mining stocks remain cheap relative to gold bullion. As evidence, we point to the chart below which depicts our benchmark, the XAU Index, as a fraction of the gold price. At its current level of 16%, it remains well below its historical norm of 20%-25%. What investors seem to be forgetting is that the business of producing gold has suddenly become quite healthy, unlike the lean years leading up to 2008. This is reflected in strong earnings reports, much improved returns on capital, and a multitude of dividend increases. Unlike gold bullion, successful gold mining companies are capable of generating internal growth, returning capital to shareholders in the form of dividends, and participating in potentially accretive merger activity. We believe that investment in gold mining shares, given the current level of profitability, is capable of producing acceptable investment returns even if the price of gold were to hypothetically remain range bound for a period of a few years.

Finally, I am pleased to report that the Tocqueville Equity Gold Strategy was named as the top performing strategy over the past one and five years by Pensions & Investments magazine. This
designation was not only in comparison to other precious metals funds, but applied to the entire universe of Morningstar’s Separate Accounts’ Composite U.S. stock.

John Hathaway
Portfolio Manager and Senior Managing Director
© Tocqueville Asset Management L.P.
December 16, 2010

This article reflects the views of the author as of the date or dates cited and may change at any time. The information should not be construed as investment advice. No representation is made concerning the accuracy of cited data, nor is there any guarantee that any projection, forecast or opinion will be realized.

References to stocks, securities or investments should not be considered recommendations to buy or sell. Past performance is not a guide to future performance. Securities that are referenced may be held in portfolios managed by Tocqueville or by principals, employees and associates of Tocqueville, and such references should not be deemed as an understanding of any future position, buying or selling, that may be taken by Tocqueville. We will periodically reprint charts or quote extensively from articles published by other sources. When we do, we will provide appropriate source information. The quotes and material that we reproduce are selected because, in our view, they provide an interesting, provocative or enlightening perspective on current events. Their reproduction in no way implies that we endorse any part of the material or investment recommendations published on those sites.

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