Diversifying Investors Turn to Gold Funds
Gold-oriented mutual funds combined hold just $2.7 billion in assets--less than one-tenth of 1% of the total in all stock funds, according to Morningstar Inc.
But there was nothing puny about the performance of precious-metals stock mutual funds in the first quarter: They soared 35.6%, on average, leading all stock fund categories.
The average domestic stock fund, by contrast, was essentially flat in the period, up a minuscule 0.4% as the broad market struggled after the fourth-quarter’s surge.
With precious metals, natural resources funds (up 12.2% on average) and real estate funds (up 8.1%) among the top-performing stock mutual fund categories in the quarter, it might seem that investors are signaling that they fear the re-emergence of inflation. All three of those sectors are viewed as classic inflation hedges.
But analysts and money managers say it may not be inflation fear that’s driving these fund sectors so much as a simple desire by some investors to better diversify their holdings.
“There is definitely an interest in physical assets in some way, shape or form,” said John Hathaway, manager of the Tocqueville Gold fund, which rocketed 45.9% in the quarter. “Returns on stocks have been lousy for a while, so investors are discouraged and looking for insurance. People always come to gold in difficult markets--it’s the epitome of an alternative asset class.”
Gold funds, which have been in an uptrend for the last 12 months, tend to lure the so-called hot money of active traders when returns are strong. And because the sector is relatively tiny it doesn’t take much cash to provide a big boost, Hathaway said.
But he also believes the gold sector now is gaining more attention from serious long-term investors.
“In the 1970s everyone thought it was prudent to have 5% of one’s portfolio in gold, whereas now people think it’s prudent to have nothing in gold. But that seems to be changing,” Hathaway said.
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Gold Companies’ Shares Outperform the Metal
Although gold bullion itself posted only a single-digit rise in price the first quarter--up 8.5%, to $302.60 an ounce as of March 29--shares of gold mining companies “act like options,” tending to far outperform the metal on the way up and underperform it on the way down, Hathaway said.
Precious metals funds typically own mining shares, but some also can invest directly in gold, silver and platinum, or in metals futures contracts. The funds also may use borrowed money to juice their bets.
Other factors also contributed to the best quarter for gold-oriented funds since the fourth quarter of 1993, said Andrew Clark, analyst at Denver-based fund tracker Lipper Inc. He said gold investors profited from industry consolidation; Japanese investor interest amid ongoing weakness in that nation’s economy and concerns over new limits on bank deposit insurance; Middle East tensions; and the prospect of global economic recovery and its promise of increased demand for industrial and jewelry use of the metal.
Despite gold’s run-up to two-year highs, Hathaway, perhaps not surprisingly for a gold-fund manager, said he believes it could be in just the early stages of a multiyear climb. Among his reasons: “Stocks remain overpriced, and the U.S. dollar is overvalued.”
Gold funds are rebounding from a dismal period in the late-1990s. The average annualized return on gold funds over the last five years is a negative 4.7%, despite the gains of the last year, according to Morningstar.
As for inflation, though there’s little evidence that a general surge in prices is brewing, could the market be foreshadowing its return?
It’s possible, said Lipper analyst Don Cassidy. “You could make the case that the market always sees ahead, and maybe it sees something that nobody else does at the moment,” he said.
But natural resources and real estate funds may have attracted investors for other fundamental reasons in the quarter, analysts say.
Natural resources funds posted their first back-to-back double-digit quarterly gains since 1980, profiting from a spike in crude oil prices. The escalating Middle East conflict continues to propel oil prices, Cassidy noted.
Real estate funds, which own shares of real estate investment trusts, remained strong as investors were attracted to the sector’s seemingly sound earnings prospects, reasonable valuations and high dividend yields.
Real estate shares also tend to have little performance correlation with the stock market overall, so the sector has benefited from increased attention to portfolio diversification by investors who fear Wall Street’s rebound since Sept.21 may not be long-lasting.
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Highlights in Other Fund Sectors
Among other fund-sector highlights in the first quarter:
* The sizzling small-cap value fund category--up 8.7% in the quarter and an annualized 20.2% in the last three years--benefited from a relatively heavy weighting in consumer stocks, such as homebuilders and restaurant chains, analysts said. Consumer-related stocks have been among Wall Street’s favorites this year as investors bet that consumer spending will continue to power the economy’s recovery.
A net cash inflow from investors of nearly $20 billion in the last 14 months also has helped boost the small-cap value category, Lipper said. Value stocks--which typically sell for lower prices relative to earnings, assets and other measures than the average stock--have led the market for the last two years, as the crash in once-high-flying growth shares has turned more investors cautious about stock valuations.
But the cash infusion into the small-cap value sector has led several fund firms to close their small-cap value portfolios to new investors to avoid becoming inundated with more cash than they can put to good use.
* Among foreign stock funds, optimism about such economies as South Korea, Taiwan and Mexico in a global economic recovery fueled gains of 9.7% for Pacific Rim /Asia (excluding Japan) funds and 8.7% for Latin American funds.
Diversified emerging markets funds surged 11.9%, powered by bargain hunting as well as the strength of oil and gold stocks in those countries, Lipper said.
By contrast, Japanese funds rose 2.8% in the quarter and European funds added 1.1%.
Overall the average stock fund that invests overseas gained 3.9%, outperforming the average U.S. stock fund even though the strong dollar hurt foreign returns for U.S. investors, particularly in Europe.
* Technology funds slumped 7.5% as the sector, which got a hefty bounce with the market rebounding from its Sept. 21 low through early January, succumbed to profit-taking. With $55 billion in assets, tech still is the largest sector fund category, according to Morningstar.
Tech stocks’ continuing troubles weighed on large-cap growth funds: That sector’s 2.7% loss in the quarter was the worst of any diversified equity fund category. Tech bellwethers Cisco Systems Inc. and Microsoft Corp., which have a combined weighting of nearly 6% in the average large-cap growth fund, both lost ground during the quarter.
Meanwhile, the quarter’s worst-performing sector was communications. Those funds slumped 16.9%, on average, as corporate bankruptcies in the overbuilt telecom industry rose further.
* Health-care funds sank 7.7% in the quarter, hurt by a plunge in many biotech stocks. Investors have become more skeptical about steeply valued biotech issues amid a stream of Food and Drug Administration decisions rejecting new drug ideas, according to fund analysts at New York-based Standard & Poor’s.
