Pluses, Minuses of Gold-Related Investments

Thanksgiving is the traditional time to pick on turkeys, which explains why this column deals with gold mutual funds.

Few mainstream investments have been so frustrating for so long as the roughly three dozen portfolios that invest in gold-mining stocks.

These inflation hedges have been shut out of the long stock and bond market rallies that commenced in the early 1980s, when inflation and interest rates began to recede.

As of Nov. 19, gold mutual funds were off about 18% for 1992, according to Lipper Analytical Services. That’s following losses in five of the previous eight years.

Gold has been so disappointing that even when prices drop to apparent bargains--such as the current level of about $335 an ounce--it doesn’t attract much attention.

“While gold is near a 10-year low and thus might be interesting from a contrarian perspective, we just don’t see inflation being a problem over the next several years,” says Russ Hill, a senior vice president with Stratford Advisory Group in Chicago. Stratford, like many money management firms, doesn’t have holdings in gold funds, gold stocks or the metal itself.

Even if inflation were to accelerate, some fund watchers say they would go with other types of investments instead. Greg Schultz, a principal at Asset Allocation Advisors in Walnut Creek, likes the T. Rowe Price New Era Fund as a substitute purchasing-power hedge. The Baltimore-based fund invests in mining companies along with a more diverse array of energy, chemical and lumber stocks. In addition to natural-resources plays, the fund owns a few stocks such as Wal-Mart whose earnings are expected to rise faster than the inflation rate.

Natural-resources funds such as New Era tend to lag the market during disinflationary periods, but they’ve still done much better than gold portfolios in recent years.

One selling point gold funds enjoy is a diversification edge. Mining stocks don’t move in sync with the broad stock or bond markets--which means that they sometimes rise when financial assets are falling.

“If you feel you can’t predict crises and want some added diversification, you will want to use some gold funds,” says Tom Connelly of Keats, Connelly & Ritchie, a financial planning firm in Phoenix.

Of course, gold investments also tend to decline when stocks and bonds are rallying. For this reason, Connelly recommends that you treat any gold-fund holdings as a type of insurance that should be limited to no more than 5% of your investment assets.

Gold funds are actually more volatile than the metal itself because of the high operating leverage in the mining business. Because so much of the industry’s costs are fixed, an uptick in the metal’s price tends to result in proportionately higher profits for mining companies.

A move from, say, $350 to $385 an ounce would represent a 10% gain for the metal. But for a mining outfit that breaks even at $315 an ounce, that same $35 rise to $385 an ounce would result in a doubling of profit.

At current prices, gold is selling near $330 an ounce--where it has successfully bounced back on four occasions this year, says Victor Flores, who manages two gold mutual funds for United Services Funds in San Antonio, Tex.

Flores concedes that gold prices are being hurt by heavy selling by the central banks of Canada, Brazil and Russia. But he’s encouraged that jewelry demand for gold continues to climb and will likely reach a record in 1992 for the third year in a row.

He also figures that at current depressed prices, less money is being spent on exploration--a factor that could result in lower supplies down the road.

Perhaps the most pithy observation on gold investments is articulated by Bob Doll, director of equity research for Oppenheimer Management in New York. His company runs a gold fund that has performed well relative to its peers but poorly compared to stock and bond investments. Doll wants to see more of the same. “We view gold funds as a hedge that can be an appropriate part of a person’s portfolio,” Doll says. “But we hope they don’t do too well because that would mean higher inflation--and bad news for financial assets.”