Time to invest in gold?

While some experts think the yellow metal is ripe for a turnaround, most warn against heeding the siren song of "Goldfinger."

By Leslie Kane
Senior Editor

Gold is like the ugly duckling that's supposed to turn into a swan—but we're still waiting for the transformation. The price of an ounce, which peaked at $850 in 1980, has sunk to around $280. And the 36 precious-metals funds followed by Morningstar, a mutual fund tracking service, have one- and five-year average annualized returns of ­8.5 and ­13.3, respectively.*

Never mind, say fans of these investments, who shrug off losses as temporary results of a good economy. "Demand for precious metals has suffered because of the strong dollar, low inflation, and the exceptional performance of the US equity market in recent years," says Paul Bateman, president of The Gold Institute, a trade association in Washington, DC. "Investors now fear the economy may worsen. If it does, metals should do better."

Sure enough, 29 of those 36 precious metals funds followed by Morningstar had positive returns in late April and early May, a period of wild and mostly downward stock market gyrations based on concerns about technology stocks and the economy overall.

Besides, say metals' proponents, even if returns don't improve, these investments make a reliable inflation hedge. "A few hundred years ago, one ounce of gold was sufficient to buy a man's suit of clothing, and the same can be said today," notes Richard Scott-Ram, chief portfolio strategist with the World Gold Council, based in London.

Fans also point out that in the event of a total economic collapse, owning gold would provide a safety net. "Between Nasdaq volatility and the threat of inflation, many people feel they'd sleep easier with some gold to diversify their assets," says Graham E. French, portfolio manager for Vanguard Gold and Precious Metals Fund. "Gold's value is internationally recognized, and if the stock market crashed or our economy weakened, gold would retain that value."

Be aware, though: Most investment experts consider the arguments for investing in gold or other precious metals to be weak, at best.

For one thing, while gold has indeed kept up with inflation over centuries, you're probably more interested in keeping up over 20 or 30 years. In recent times, gold hasn't come close to matching the inflation rate over such periods. "There are much better ways to hedge against inflation, such as with real estate," says Alan P. Weiss, an adviser with Regent Retirement Planning in Woodbridge, CT.

Other metals haven't done so well lately, either. Granted, platinum is increasingly used in catalytic converters for cars and is heating up as the luxury material for jewelry. It's also used in the production of data storage discs and fiber-optic cables. Growth in its price, though, has been less than spectacular: In 1992, platinum averaged about $360 per ounce; it's now at about $575. That's an annualized gain of 6 percent, not nearly on a par with what stocks have delivered since 1992.

Silver, meanwhile, has languished. In 1985, its price hovered around $6 an ounce. Although it enjoyed a brief spike in 1998, it's now down to about $5. The Lexington Silver Fund, the only mutual fund focusing on silver, generated a one-year return of ­15.5 percent and a 10-year annualized return of ­5.8 percent.

One exception to the general downtrend in metals has been palladium, which is related to platinum. Palladium is used in the production of electronic components for cellular phones, personal computers, fax machines, and dental alloys. Its price has shot from $80 per ounce in 1992 to over $750.

Most experts don't expect a turnaround for metals anytime soon. "People have been saying for years that gold is ready to rise, but it hasn't happened," says Ronald J. Paprocki, an adviser with Mediqus Asset Advisors in Chicago. "It's difficult to get enthusiastic about an investment with such a horrible track record."

Although metal investments in general would indeed rise in value if the entire economy went down the drain, that scenario is highly unlikely. "People who built bunkers or stocked up on canned goods to prepare for a millennium disaster are the ones who would buy bullion," says Paprocki. "There are advantages to holding gold in times of political and social turmoil and high inflation, but I don't see those scenarios as likely in the near term."

Perhaps, though, you're more optimistic than most experts about the prospects for metals prices—or more pessimistic about the economy overall. If so, you might want to put up to 5 percent of your portfolio in precious-metal investments.

If you're in the camp that thinks metals prices will rebound, consider investing in mining-company stocks or—for greater diversification—in mutual funds that own shares in such companies (see page 120). Keep in mind, though, that the funds probably won't give you a pure gold play. Although the price of gold is a major factor in most precious-metals funds' performance, the fortunes of other metals, such as platinum, often also play a role. Moreover, metals funds have steep expenses: The average expense ratio of 2.1 percent is higher than the 1.4 percent average for mutual funds in general.

Owning the metals themselves has drawbacks, too. Unlike stock and fund owners, metals owners get no dividends. You'll also sacrifice the growth advantage of investing in a business, which can reinvest earnings to spur future profits. A company could use earnings to open more branches, buy affiliated businesses, or boost online customer services; metals themselves have only their intrinsic value to offer.

Still, if you want to hold gold in case of economic chaos, intrinsic value may be just what you're after. In that case, your best bet is bullion, coins, or certificates of ownership, rather than mutual funds or individual stocks. Then the value of your stash will be based solely on gold prices, instead of on the value of other metals or on mining company profitability, which is affected by management performance.

Bullion isn't the most practical option. Gold is measured in troy ounces, which are slightly heavier than avoirdupois ounces, our usual standard of measurement. A gold bar weighs 400 troy ounces (27.47 pounds), which makes it too expensive—not to mention clumsy—for most investors. You also have to keep it safe, which could mean storage and insurance costs.

It's easier to buy certificates of ownership for gold or other precious metals. That way, you don't need to take physical possession, and you can phone in your order to sell. You'll pay commissions of about 1 to 3 percent when you buy, and 1 to 2 percent when you sell.

If you'd rather have the metal in hand, though, consider buying coins. For example, if you want gold, you might choose the US Mint's American Eagle, which comes in sizes from a tenth of an ounce to one ounce. Besides being easier to store, these have a slight edge in value over gold bullion: "The one-ounce coin has a $50 face value, so no matter how low the price of gold drops, the coin is worth at least that much," says Bateman. Granted, that may not be much consolation if you've paid $280 per coin, but even a small advantage is better than none. Other gold coin possibilities include the South African Krugerrand and the Canadian Maple Leaf.

One disadvantage of buying coins rather than bullion: "You'll pay a bit more for coins, because of manufacturing costs," Bateman says. The premium for a small order of one-ounce gold coins, for instance, ranges from 3.5 to 6 percent over the gold price, and you may pay shipping, sales tax, and sales commission on top of that. Silver and platinum coins also sell at premiums above the metal weight.

Generally, you can't buy coins directly from a mint; you must get them through wholesalers, brokerages, precious-metal firms, coin dealers, or participating banks. One major source—Kitco, a leading precious-metal firm and dealer—has an Internet site (www.kitco.com).

Coin prices vary based on a variety of factors, including dealer markup and shipping costs. So shop around.

*All returns in this article are through June 30, 2000.

Precious-metal mutual funds: The best of a lackluster bunch

Returns for precious-metal mutual funds are nothing to rejoice over. But if you’ve decided that investing through funds is your best option, consider the following ones, which are among the best performers, based on a one-year return.

All figures as of June 30, 2000. Source: Morningstar

 

Leslie Kane. Time to invest in gold?. Medical Economics 2000;16:117.