Should you join the gold rally? Are you a masochist? Do you love to mix the joy of making money with the pain of losing it?
Gold-mining stocks (hence gold mutual funds) typically anticipate movements in gold prices, which anticipate price inflation. So far this year, the markets have obediently followed the script.
Gold mutual funds started moving in January, and are now up by nearly 50 percent. Gold stirred in April, rising 8.5 percent to $368 an ounce last week. Scattered inflation reports coalesced in early May, with a 0.4 percent rise in the consumer price index.
This apparently ends a 13-year bear market in gold and four to five years of underperformance in gold mutual funds. Last year, the average gold fund dropped 15.2 percent. It’s not unusual for some of these funds to gain more than 50 percent, or lose more than 20 percent, in a single three-month period.
That’s what I mean by masochism. Are you willing to risk the downside pain to bet that even richer gains still lie ahead?
Two investment arguments
There have always been two arguments for holding some percentage of your money permanently in gold. The first is Armageddon. If inflation rages, currencies collapse and governments totter, gold will endure. That’s generally a concern of the rich. They can afford to hedge against Armageddon while the rest of us are worrying about the interest rates on our CDs.
The other argument is diversification. Gold tends to go up when other investments are going down. If you hold some gold (or gold mutual funds), your total investment portfolio is supposed to do better, with less overall risk, than if you hold no gold at all.
That’s the theory anyway. In practice, it depends on the time period you look at. Gold helps if measured from December of 1971, when the price was only $43 an ounce. It hurts if measured from December of 1979, when prices stood at $526 an ounce, says Bill Martin of the Benham Gold Equities Index Fund in Mountain View, Calif. So the diversification case is suspect.
At the request of Louise Nameth, a reporter for this column, Morningstar Inc., in Chicago compared a balanced portfolio (45 percent stocks, 45 percent bonds, 10 percent cash) with a portfolio containing gold mutual funds (40 percent stocks, 40 percent bonds, 10 percent cash, 10 percent gold funds), starting in January of 1981. Gold did indeed reduce the portfolio’s risk; the monthly price swings were a little narrower than in the portfolio without gold. But gold also lowered total returns by about 1 percent annually.
The bull case for gold no longer rests principally on inflation but on rising demand for investment gold jewelry in newly prospering China and elsewhere in Asia.
“Mine production isn’t keeping up,” says Dan Leonard, manager of Financial Strategic Gold Portfolios, one of the Invesco Funds in Denver. The gap has been filled by central banks that are selling gold. But if current levels of demand continue, prices should have farther to run up.
As for inflation, it ought to ease off, given the deflationary tax increases ahead. But the weak dollar and threats of trade protection are pushing up prices on some key imports such as cars, which permit competing American firms to raise prices, too.
S. African stocks riding high
South African gold stocks are the most volatile of all, heightening the risk for funds that buy them heavily, such as U.S. Gold Shares (from United Services Funds in San Antonio). The South African mines pay dividends that are highly sensitive to costs (both operating costs and gold prices), as measured by their own currency. Last year, these stocks were in the pits; this year they’re riding high.
Opinions are split on the future of silver, up 16 percent since the first of the year, to $4.52 an ounce last week. Leonard thinks it will do better than gold, as industrial demand picks up. But Malcolm MacNaught, who runs Fidelity’s American Gold Portfolio in Boston, thinks the overhanging supply is too large to let prices rise by very much.
A special risk with any precious-metals fund is that there aren’t many gold and silver mines in the world. A huge influx of money into their shares inflates their prices-heaven on the upside, hell on the down. Market timers might consider taking a flier on Benham’s Gold Equities Index: It lets you place limit orders, to sell when prices drop to a certain level and buy when they rise again.
