MAY, 2005

This month’s interview is with Derrick Van Eck who is one of the owner/operators at the Van Eck Funds. Derrick is the Chief Investment Officer and Portfolio Manager and head of the investment team on the Van Eck Global Hard Asset Fund.

Legend: Derrick, can you provide us with some background information on the Global Hard Asset, the types of hard assets you invest in as well as the outlook for each of these assets?

Van Eck: The Fund was started back in 1994, so it’s been around for a fairly long period of time. The key reason we started the fund was because we thought that hard assets were oversold. They had a very difficult period for approximately two decades. Prices were significantly below normalized levels and had been so for a long period of time. To us, that was setting you up for a great supply-side picture from a commodity price perspective. In other words, companies weren’t building or spending the amount of capital that they had historically been on different commodity projects. It was a period of very low growth of supply. Combined with the emergence of virtually every emerging market country in the world, which is now pretty well documented in the press, it was obvious that the leadership was in China’s hands. As a result, the last couple of years have been quite tremendous. That has fed demand virtually across the entire commodities sector. In answer to your immediate question, what do we invest in? We invest in both commodities as well as commodity stocks. If we need a little bit more color on that, we’ll invest in the energy complex, which will range from crude oil all the way down to the equity side, upstream, downstream, midstream and everything in between all the different value-added sectors. We’ll do that in gold or precious metals, base metals which are copper, tin, zinc, etc. We’ll invest through some agricultural shares. We do not invest in agricultural commodities themselves in the Fund, but we do invest in the stock shares. Our investment universe takes us across all of the commodities sectors, again, leaving out the agriculture part of it, which is a very minor part of the commodity world. In other words, we invest in the entire spectrum of commodities and commodity-related equities. We do that on a global basis, not just from a U.S. perspective.

Legend: What do you think the outlooks for all those different commodities are?

Van Eck: That’s an easy question. Last year was kind of an anomalous year in that you had strong global growth throughout the world combined with awesome supply-side stuff. The commodity world will differentiate itself more and more as it has in the last couple of months. We continue to be most excited about the energy complex. We think that the value in the energy complex remains in the equity piece (in energy securities). We don’t think energy company valuations are discounting nearly what the crude forward curve on the commodity side is telling them for the next five to ten years or so. We see strong value in the equity component of the energy universe. That’s where we have most of our capital in the Fund. From there, you kind of drop down. There are some interesting base metal commodities and stocks. Stuff like nickel, which we have a tremendously strong outlook on. Stuff like zinc, which we also have a very strong outlook on. Then we would go down to the copper markets, which we are less and less excited about as time goes on as we continue to plot out additional supply-side additions to the mix. We think, more or less, that it may well be likely that copper, for example, has peaked for this cycle. We’ve therefore put all our capital into nickel stocks and some zinc stocks that we own. We actually own the commodity in the case of zinc in the Fund as well. I would say that the base metal complex is probably the next area of large interest for us. I would say on the equity side again, the value is there. There has been a lot of consolidation activity in that space in the last year or so and we think there will be additional acquisitions to come. All of this has been accomplished at premium pricing. We see that aspect, that optionality to emanate growth continuing as well as these companies continue to earn these massive amounts of free cash flow. Some of these companies have free cash flow yield of something like 20% to 30% based on our numbers this year. Awesome numbers! The market doesn’t seem to want to pay up for it. So we think there’s value there.

Over the course of the last year, I would say, we have taken some capital out of the precious metals arena. This has particularly occurred in the last six months or so, during which the dollar was close to peaking on an interim basis. Gold was therefore likely to underperform some of the other commodity sectors. We still have that view, but I can tell you, we spend a lot of time in our shop talking about how that may well be priced into the market. You’ve seen some tremendous underperformance by the gold shares in recent months. We are actively talking in our shop about getting up and taking a hard look at that stuff. Gold shares today are trading at unprecedented valuation levels compared with bullion. We’re looking hard at gold mining companies. We haven’t really upped our exposure in recent months, but are looking very hard, thinking that there will be more corporate acquisition activity at these price points. At the moment though, you’re getting some unbelievably good value in some of these gold mining stocks. I would place that area as the third largest area. Relatively, it’s about 10% to 12% of capital in the Fund right now. I would say, if we have this conversation three months from now, we’ll probably be a little bit higher.

On the negative side of things, we’re not super enthusiastic at the moment about agricultural commodities. There are just huge stockpiles of soybeans and wheat now. Crop reports are showing that crop yields this year will be extraordinarily healthy again aside from reports of some Asian countries. We’ve kept our capital out of that sector and really put our monies in the three sectors I mentioned earlier.

One other sector of interest, that hit the press on Friday, we have about 10% of capital in timber-related shares. We own companies like Timber West. It is a big company in western Canada. We have owned the stock for a number of years. We still think the stock has attractive valuations from a timberland perspective. We have a piece of Weyerhauser in the Fund. We still think, in other words, there is huge value creation potential and realization potential in some of these forestry companies. You haven’t just seen the kind of people like the Franklin Templeton folks which own a 6% or 7% stake in Weyerhauser trying to increase the stock’s value through corporate actions. You’ve seen a lot of financial engineers come in, such as Carl Icahn. You’ve had some private equity firms like Maddox and Dearborn Partners come in and take runs at some of these companies. They really have been able to create and realize value in some of their timberland by spinning those operations out. We see that formula continuing as well. Hopefully that gives you a pretty broad stretch of what we think might be going on.

Legend: When you say you own some of the physical commodities as opposed to shares, how are you buying those physical commodities? Are you buying the actual physical metal or are you buying futures?

Van Eck: We’re not buying physicals at all. We’re not allowed to do that by virtue of the 1940 Act. We have to buy paper assets. We’re buying futures and/or structured notes which are effectively securities that Wall Street offered to get around some IRS restrictions and some 1940 Act restrictions. These are notes levered to various commodity prices. Basically, we are acquiring ownership positions through futures and structured products.

Legend: Where do you see the most potential and what kind of asset classes? Is it energy at this point?

Van Eck: It is most clearly energy to us. Particularly in the last couple of weeks, there’s been an interesting sell-off. With respect to underlying crude prices. Underlying crude prices are something like 10% to 12% off their highs. These companies, particularly some of the oil service and drilling companies, have reported outstanding results for the first quarter. Being already excited about the expected numbers but beating them handily to the extent which has never occurred before. They have beaten the commodity numbers to this extent only once in the course of the last 10 to 20 years or so. Activity levels and fundamentals are phenomenal, yet you have this kind of stock sell off in the last couple of weeks. We’re trying to step up here. We think the value in that space is outstanding, and the potential returns are astronomical. We have expected returns on some companies that we like and own in the portfolio of 30% to 40% or so, without heroic assumptions.

Legend: That’s the companies themselves obviously you’re buying as opposed to the actual different ways to buy energy, correct?

Van Eck: We don’t see tremendous value in owning crude oil at $50 a barrel. I’d rather own the stocks which are probably discounted. By the way, some upstream companies have tremendous upside, and frankly I think the biggest anomaly in the energy markets today is in the upstream. Some of these Production companies could go out and hedge out their production to the end of the decade and take out virtually all of their commodity price risk and earn returns on that kind of portfolio of something like 10% to 80% depending on what kind of properties they’re taking over. There are a lot of private guys who are looking at this by the way. You’ve got just a clear anomaly that people are just waiting to take advantage of. Or they could structure some of our investments to do that as well. I think there’s basically a lot of skepticism of the structured commodity partnership, particularly in energy.

Legend: Have you tried to play the royalty trusts out of Canada at all? We keep running into individuals looking to play that game.

Van Eck: We have not. We think that is not a space that we want to put any capital in, just given the decline curves that are going on in that space and given the kind of euphoric nature some of the valuations of those companies. Our Energy and Production guy, Sean Reynolds, has taken a hard look at that space. He used to own the firm in Denver called Petri Partners. They have done a lot of work, not so much in Canadian royalty trusts, but on understanding how to unlock value in Energy and Production companies. That’s been the core arbitrage up in Canada. Petri Partners took a hard look at that stuff and just decided that’s a pretty temporary game that they don’t want to get involved with. We have chosen to avoid the royalty trusts in the Fund.

Legend: At one time, did you not have REITs in this particular Fund?

Van Eck: Yes, we did. I think at the beginning and inception of the fund that we had REITs. We still own some REITs but it’s 4% to 5% of capital. The reason we put REITs in the fund was, I think, for portfolio stability and to add some risk management. The correlation of REITs to some of the other commodity universes is pretty low. You get pretty low standard deviations and pretty high yields on some REITs when we first put them in the Fund. We’re much less excited by the valuation on the REITs today. REITs didn’t provide the kind of total stability and the value added from a return perspective that we wanted so we minimized the exposure in recent years. Although that’s been wrong. That’s how we felt. We still believe that REITs are a little bit overvalued. We like the value in some of the commodity stocks much better.

Legend: Do you see this as a viable concept, basically a commodity-related type theme, even 10 years from now?

Van Eck: Absolutely. I don’t understand why this marketplace has not leapt onto this concept of commodities as a separate asset class. If you look at the return features, the risk features, the draw-down features and the low correlation coefficient, there is no way you can explain to me why the concept would not fit into a diversified portfolio. We’ve calculated the numbers on that. We have also had Ibbotson and Associates provide the number crunching on that. We’ve looked at I don’t know how many different studies that have proven this concept. By the way, this concept is clearly being accepted in the institutional world. We’re just not quite sure why it hasn’t crept into the retail space that much yet. I clearly think that the story has legs not only from a return perspective, but that it has awesome diversification characteristics. I think you’re getting paid to have diversification in your portfolio in this case. You certainly have been in the last couple of years. We think that the return profile continues for a while.

Legend: You mentioned a study performed by Ibbotson Associates. Could you elaborate a bit?

Van Eck: The study was prepared by Ibbotson and they created a hypothetical index of hard assets where they go back and study the effects of adding hard assets to an otherwise well-diversified portfolio dating back to the early 1970s. The net result is, depending on the characteristics of the portfolio, being conservative, moderate or aggressive, you get a varying mix between risk and improved return. The long and short of it is, building hard assets into a portfolio over time enhances return and reduces risk to one extent or the other, again depending on whether it’s a conservative, moderate or aggressive portfolio.

Legend: Our studies have found also that it makes a lot of sense, especially when you’re in a portfolio of stocks and bonds, that the hard asset or commodity-based type investment really drops the risk levels substantially. Actually, if you run correlation analysis including REITs, especially if you equally-weight them, you will be pleased. When you already have a low-risk portfolio, meaning that the standard deviation is very low like 4 or 5 already, sometimes we’ve found when you add a commodity piece into it, it really doesn’t reduce risk at all and it doesn’t necessarily add return, either, believe it or not. When you’re going from a typical portfolio, our studies have also shown that commodities are a way to drop down risk levels pretty substantially, is to add commodities.

Van Eck: I think that’s more or less exactly what the Ibbotson numbers bear out as well. We’ve done some other asset allocation studies I think which would suggest the same thing. I think the other piece is that it would be certainly lower risk and depending on how you want to structure the stuff, you can either increase your returns as you are well aware for the same level of risk or just drop your risk down for the same level of returns. To us, it clearly has excellent diversification characteristics. I would just layer on top of that, that I think the return characteristics are not as attractive as they have been in the last couple of years, but still remain very attractive.

Legend: Your Fund has outperformed the S&P 500 over the last 10 years by about 1% per year, yet your risk level has been about the same. This has resulted in the standard deviation being about the same yet when those two asset classes are combined, the risk level drops down quite a bit, correct?

Van Eck: That’s exactly what we’re saying.

Legend: Tell us about the Fund itself. What’s unusual about the Fund? Why should we use this fund versus a fund like a PIMCO commodity fund or something along those lines?

Van Eck: A couple of answers to that. One is, I think The Van Eck Global Hard Asset Fund has more flexibility. We have the ability to buy not just underlying commodities but underlying commodity stocks as well. I think if you look at the basic returns (pre-tax returns) on our strategy versus the PIMCO fund, you’ll find that it’s reasonably attractive. On an after-tax basis, it’s particularly attractive. I would say, one, returns, two, flexibility in investment approach. I just think we’ve got a much broader mandate. Three, probably the most important thing is that you’re investing with a group of seven people. When I say seven people, we’ve got a team, I’m one of the seven, so there are six other guys that spend all their time looking at hard asset investments. The team that we’ve put together I think is a fairly interesting team. It’s worked pretty well for us. On the one hand, we combine the skill sets of a petroleum engineer and mining engineer with our gold expert who used to run a mine out in Nevada. Our petroleum engineer, Sean Reynolds still looks at a lot of properties and works on a number of properties that are now part of the Fund in some way shape or form. That’s one skill set which I think is appropriate and it has been helpful in actually two respects. One, just for idea generation, but secondly, for risk management. We tend to stay out of the situations that are pretty iffy. There are a lot of promoters and guys who tell a good story but may not back that story up with solid resources in the ground. Having that skill set really allows us to understand that aspect.

The other skill set we marry that with is a recognition of market tactics and trading fundamentals. We’ve got a bunch of traders. Two of our traders have worked with us for probably an average of 15 years or so. I think they’re the best in the business from a commodity perspective. These guys are much more shorter term but have a very good understanding of their area of the marketplace. I think there’s a tremendous value added in kind of tactical movements that we might be making such as when we’re hearing that a company might be issuing a secondary or something like that, we’ll tend to stay away from that company for a while. Or that some Commodity Trading Advisor (CTA) is getting involved in the gold sector which has traditionally been either a very healthy thing or a very unhealthy thing. Having our traders with that kind of skill set brings a lot of value to the table as well. I would say once again, given our historical numbers (pre and after-tax returns), the flexibility in our investment options, the investment flexibility, to actual commodities and/or commodity stocks, and invest on a global basis is what makes our Fund an excellent option.

What also makes our Fund different is our research approach. As you’re well aware, China’s been THE story behind commodities in the last couple of years. We have had someone over in China virtually once a month. I am headed over in a couple weeks. We had our energy analyst there a few weeks ago. We also have the ability to invest in emerging markets resource stocks that are a very attractive value to us right now. There are some other Chinese stocks that we have the ability to invest in such as iron ore stocks. That is a unique attribute that we have. I would say investment flexibility and again the people are key strengths.

This is the heart and soul of this company. The legacy of the company was the International Investors (Gold) Fund and the hard assets was a brand extension off of that capability and the it’s the heart and soul of what we do. Our Fund allows for active management. That fund that you mentioned is based on the AIG Index as I recall. They are therefore hamstrung, if you will, or required to maintain high correlation to that index. They have to be invested in what that index is invested which in part includes soft assets actually if you go in and you drill in and you look to see what the AIG Index is comprised of, there are a variety of things, vegetable oil among them, that are probably a little bit off the radar screen. These items that are off the radar screen are in effect soft commodities. The active management is another advantage of ours. We would suggest that you compare the after-tax returns and see. I think there’s a great misperception about the differential between before tax and after-tax returns and I can just tell you that the numbers are quite different when you look at it on an after-tax basis of course. In a deferred tax this is irrelevant but in a currently taxable account, after-tax returns are something that I think people find meaningful. Another significant issue is the one that would pertain to the TIPS component that is in that fund that you named. It’s there of course for the obvious reasons, as collateralization for the derivative products and whatnot. Of course, there’s a little bit of interest rate risk there, but the other thing that has been suggested more recently is that simply because of supply and demand, the supply and demand imbalance over TIPS, that TIPS may be a tad overvalued and therefore adding an interest rate risk component.

Legend: Your response is all very logical in terms of our questions. The tax situation is obviously better in the case of your Fund because you won’t have that ordinary income component.

Legend: Your fund has a small asset base at this point in time. According to Morningstar, as of March 31, 2005 you had $110 million in the Fund. Is that still true?

Van Eck: That would probably be the A shares which I am guessing at their close of business last Friday. We have just under $130 million in the A shares and there’s an additional $35 million in the C shares.

Legend: Do you run this same strategy in any private accounts?

Van Eck: We do not. Not a long-only strategy. Let me take that back. We do have an insurance clone fund. We’ve got the Worldwide Hard Assets Fund which is effectively a clone fund that we run in various insurance products for Nationwide, Pacific Life, New York Life, etc. It’s a variable insurance trust that we run for Nationwide, Pacific Life, New York Life and a number of others. The total would be an additional $265 million.

Legend: So you’re still altogether under $500 million.

Van Eck: Yes.

Legend: Do you have any similar strategies? Obviously you have the gold funds and things like that. Are there any similar strategies to the Hard Asset Fund?

Legend: Is there anything else you would like to tell us?

Van Eck: From an investment perspective, I think it’s actually a very interesting time. I was over visiting some guys in London a couple of days ago and the talk over there was all about revaluation and what that number is going to be. That’s been a fairly hot topic over the last four or five days or so. We’re seeing some kind of interesting crosscurrents going on with the Dollar and the Euro with growth moderation. There is obvious growth moderation here in the States and some degree of growth moderation in China. We’ve got all kinds of interesting crosscurrents going on in the commodity space which in my opinion has resulted in some investors taking profits in some energy shares and some other mining shares etc. We are using this sell-down to our advantage. We’ve had some cash in the Fund for the last month which we are now able to put back into the marketplace. I think it’s actually a very interesting time from a tactical perspective. I think there are some really interesting return profiles that are being generated, at least in our opinion, given all these crosscurrents that are going on. We’re pretty optimistic.

On a different note, we have placed an expense cap on this Fund. When it was smaller a couple of years ago, we also put a cap on it. In fact, effective May 1st of 2004 we put a cap on it of 1.75% on the A shares. I think if you look at audited annual numbers for the total of 2004, it blended to 1.85%. Starting January 1st then of this year, it’s been at 1.75%. We have further reduced it effective May 1st to 1.50% so that investors May 1st and forward will be paying an annual operating expense ratio of 1.50%.

Legend: Is that permanent or just temporary?

Van Eck: It’s per year. It’s a year at a whack. It’s locked in at 1.50% contractually. It’s stated in the prospectus through April 30th of next year. At this point, we’ve put the fund into a competitive expense ratio and that’s where we’d like to keep it.

Legend: Thank-you Derrick.

Van Eck: You’re welcome!

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