Investor's Business Daily
Is This A Time To Grab Gold's Glitter?
Friday September 14, 7:00 pm ET
Donald Jay Korn


Gold and gold stocks are up. But is this a good time to invest in gold?

Back in 1999, the price of gold hit a 20-year low of around $250 an ounce. For the next two years, it stayed below $300.

A bull run began in the first half of 2001. Gold reached $720 in 2006. It remains over $700 an ounce.

Gold may have more upside potential. The price is still well below its 1980 peak of $850.

Gold can play a role in a diversified portfolio. The price of gold is usually not correlated to the price of stocks. When they're disconnected, gold commonly moves in the opposite direction of equities. So gold often rises when stocks sink.

Still, both gold and U.S. stocks are rising. But the U.S. dollar has been weakening. That makes the metal, typically denominated in dollars, cheaper to buy in other currencies. Gold is also a haven from weakness in other assets -- like the dollar.

Yet gold should not be a big part of your portfolio. That's because gold can be very volatile, says Katherine Yang, an analyst at Morningstar.

To help you decide whether to own some gold, you should understand frequent reasons for the metal's strength in this century:

Weakness in the U.S. dollar. The price of gold historically has risen when the dollar ebbs.

Inflation fears. Gold is used as an inflation hedge. Its 1980 peak followed an inflationary decade.

The 2000-02 bear market in stocks. Fleeing equities, many investors sought alternatives like gold.

That helped trigger gold's rebound, beginning six years ago. Now five years into a bull market, some investors worry that stocks' gains will slow, stop or reverse.

Geopolitics. Gold is seen as a safe harbor in times of crisis.

The emergence of China and India is also playing a role. Rising wealth is increasing their demand for gold.

You can hold the metal itself. Or you can hold gold mining stocks.

If you choose stocks, you can select individual mining companies. Or you can invest in a mutual fund that holds many gold mines.

Not In Sync

The metal and gold stocks don't always move in sync. In July, bullion's price rose. But many gold stocks and funds lagged. Many mining companies were hurt by rising prices for commodities like diesel fuel, steel and rubber.

If you prefer the metal, you can buy gold coins and bars from a dealer. That's been legal since 1974.

You'll have your gold on hand in case of a catastrophe. But in the meantime, you'll have to find a place to keep the coins and bars. And you may want to pay for extra insurance.

You might pay a big premium over the posted per-ounce price, too, due to middlemen.

Another way to hold gold bullion is via an exchange traded fund.

"Generally, gold ETFs track the price of bullion rather than companies," Yang said. So they provide direct exposure to gold prices.

StreetTRACKS Gold Shares (NYSE:GLD - News) and iShares Comex Gold Trust (AMEX:IAU - News) are two examples.

ETFs trade like stocks, so they offer easy liquidity. Both ETFs charge expenses of 0.40% a year.

Tax impact can be a surprise. If you sell a gold ETF at a long-term gain, you won't owe the bargain 15% tax rate you'd owe on a stock -- you'd owe 28% on that gain.

That's because gold ETFs are taxed as collectibles, which have special rules.

You can also hold gold mining stocks or mutual funds that own those stocks.

Morningstar lists 20 precious metals funds, which mainly hold gold mines.

Mining stocks and funds can be very volatile. The fund group lost nearly 41% in 1997.

And there were losses in 1998, 2000 and 2004 as well. In July-August 2007, these funds lost over 3%.

But fund gains can be spectacular. In 2002 and 2003, the category returned about 64% and 58%, respectively.

For the past five years going into Friday, the average annual return of precious metals funds was 24%.

If you think this decade's rise in gold prices will continue, stocks and funds are likely to outperform bullion and bullion-linked ETFs. Historically, stock-price moves have been three to five times as much (up or down) as gold-price moves.

That's because gold-price movements create larger moves in the profitability of companies like mining firms, due to their largely fixed costs.

Don't Overload

You shouldn't overload in gold or gold stocks, Yang says.

You should not put more of your portfolio into gold than you would into any other volatile asset.

Volatility is a concern. And the long-term returns haven't been great, considering the price decline from 1980 to 1999.

Yang urges investors who want an allocation to gold to look carefully before buying. "Search for factors like seasoned management and low costs," she said.

On average, precious metals funds have expense ratios of 1.50%. Expense ratios of U.S. diversified stock funds tracked by Morningstar average 1.39%.