How to Be Gold Bug Without Holding the Metal

RUSS WILES <i> is editor of Personal Investor, a national consumer-finance magazine based in Irvine</i>

Recession. Bank failures. The federal deficit. War in the Persian Gulf. Everywhere you look, the world seems headed for disaster. With all these problems, you might think that investors would be scurrying to buy gold, the traditional safe haven against economic and political crises. Yet nothing of the sort has happened.

In fact, gold made headlines by plunging $29.60 an ounce on Jan. 17, the first trading session after the Gulf War began. That’s on top of a 2% decline in 1990 and a long-term bear market for the metal that has spanned more than 10 years.

All of which should have you wondering whether it makes sense to have any exposure to precious metals. Many advisers say yes, since this can add an extra layer of diversification to a well-balanced portfolio. However, it’s wise to keep your holdings small--no more than 5% of your total investment assets.

Gold mutual funds offer one way to invest in the metal. The funds buy common stock of mining companies, hoping to capitalize on share appreciation as well as dividend income. Unlike gold coins or bars, with a fund you don’t have to worry about storing, safeguarding or insuring your investment. And compared to an individual mining stock, you get diversification, professional management and other benefits.


“I prefer the mutual fund route for gold because of the convenience, the ability to buy or sell quickly and the dividend payments,” says James S. Hatcher, a certified financial planner with IDS Financial Services in Irvine. However, he recommends limiting your gold holdings to 5%--or less, if you have a modest portfolio or a low appetite for fluctuations.

One major disadvantage of gold funds is that they’re volatile--certainly more so than the metal itself. Here’s why: For any increase in gold prices above a mining company’s break-even point, the firm’s profits will usually climb at a much higher rate. The reverse happens when gold falls.

Mining stocks thus fluctuate sharply whenever gold makes a significant move up or down, and so do the funds. In 1987, for example, the average gold portfolio surged 36% on a 20% rise in gold prices. By contrast, last year’s 2% drop in the metal pushed down the funds by 22%.

Another argument against gold mutual funds is that they don’t offer an ultimate safeguard. If you’re truly worried about a disaster striking, paper assets won’t be of much help. “Physical gold is still the best way to own,” says Bruce L. Kaplan, president of Kaplan & Co., a precious-metals consulting firm in Santa Monica. He prefers coins such as the one-ounce U.S. Eagle, Canadian Maple Leaf and Australian Kangaroo Nugget, since they’re portable, widely traded and virtually counterfeit-proof.


But over the long haul, the funds seem to have a performance edge over the metal itself. From 1986 through 1990, for example, gold rose 20%, but the average gold fund tracked by Lipper Analytical Services gained nearly 48%.

Dividends help explain the differential. A coin or bar yields nothing, but many mining companies pay dividends--which accrue to the funds that invest in them. In addition, some portfolio managers keep a portion of their assets in money market instruments--another income source.

Lipper currently counts 36 gold funds; most major fund groups have one in their arsenal. When shopping among gold portfolios, check the performance record, the size of fees, the investment approach and other factors.

“The main thing is to have good geographical diversification,” says Martin Wiskemann, portfolio manager of Franklin Gold Fund, the total-return leader for the past 15 years. Most gold portfolios, including Franklin’s, invest in mining stocks based in several countries--primarily the United States, Canada, Australia and South Africa. A handful avoid South African mining shares because of the apartheid controversy.

Of course, you shouldn’t put money into any gold investments if you think that they don’t have much profit potential. Here are some of the key arguments against the metal:

* Since gold wasn’t able to rally in recent months--despite some serious, largely unforeseen problems, ranging from the banking crisis to war in the Persian Gulf--it’s unlikely to increase when some of these difficulties get sorted out. Major selling by the Soviet Union or Middle Eastern investors--a constant threat--would further depress prices.

* Gold is a traditional inflation hedge, yet the recession will probably push down the inflation rate.

* Stocks and stock funds probably offer better long-term protection against inflation anyway. “In the ‘90s, I think an equity-driven portfolio will deliver much greater returns,” Hatcher says. He recommends building your investment plan around equity funds, and he cautions against trying to capitalize on short-term movements in gold prices.


* Treasury bills and money market funds offer an alternative to gold when it comes to safe havens. While you’re waiting for disaster to strike, you at least can be earning interest.

On the other hand, several arguments can be made for committing a small portion of your portfolio to gold or gold mutual funds. They include:

* Favorable supply. “Global gold production has peaked because current prices don’t warrant aggressive mining,” Kaplan says. If gold fell to $300 an ounce, most mines would shut down, he contends. Wiskemann points out that South African mining has become less profitable because of rising labor costs, while Australian producers were hit with a new tax at the start of the year.

* Increasing demand, especially for jewelry. In addition, Kaplan thinks that Eastern Europeans will emerge as a new source of gold investor now that they’re allowed to hold the metal.

* Lower interest rates. If the recession pushes down rates, as many people expect, that would reduce the allure of Treasury bills and money market funds compared to gold, Kaplan says.

* Turnaround potential. Nothing stays down forever, yet gold has been depressed for more than a decade. Besides, there appears to be buying support at around $350 an ounce, not far from the current price. Gold hasn’t traded significantly below the $350 range since mid-'86.

Assuming you agree with these arguments, you might want to commit a small portion of your portfolio to gold. Mutual funds offer a good way to invest in the metal because of their better long-term performance and convenience. However, it’s important to keep your allocation small, because nobody knows if there ever will be another Golden Age for gold.



Gold mutual funds are riskier than other fund categories. As such, they make most sense for aggressive investors, and then only in small doses. Gold funds do offer a diversification benefit when combined with other types of stock and income portfolios. They also have the potential for explosive upside growth when gold prices rise. The following funds are among the performance leaders over the past one and five years.

Total Return Sales Initial Fund 5 years 1 year Fee Amount Phone Oppenheimer Gold & Special Minerals +151% -27% 8.5% $1,000 800-525-7048 Franklin Gold +102% -20% 5% $100 800-342-5236 Vanguard Specialized Gold & Prec. Metals +87% -20% None $3,000 800-662-7447 IDS Precious Metals +72% -24% 5% $2,000 800-328-8300 Freedom Gold & Govt. +47% +0% None* $1,000 800-225-6258 Gold fund average +48% -22% General equity fund average +54% -6% Gold +20% -2%

* Freedom Gold & Govt. charges a maximum 3% back-end load and a 0.75% annual 12b-1 fee.

Performance numbers for periods ending Dec. 31, 1990, provided by Lipper Analytical Services.