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Will Gold Add Some Shine to Your Portfolio?

For those interested in investing in gold, many options are available.

Sumit Desai, CFA, 02/28/2014

The roller-coaster ride experienced by gold investors during the past year shows no signs of stopping. Still, many investors consider gold a safe haven from inflation or a hedge against financial calamity, and consider a small allocation to gold as a prudent diversification tool. This article will explore a few different vehicles that investors can use to gain exposure to gold.

Two Views on Gold
There are generally two schools of thought when it comes to investing in gold. None other than Warren Buffett suggests staying away from gold investments, as he prefers assets that generate cash flows for him to reinvest:

"When we took over Berkshire, it was selling at $15 a share and gold was selling at $20 an ounce. Gold is now $1,600 and Berkshire is $120,000. Or you can take a broader example. If you buy an ounce of gold today, you can go to it every day and you could coo to it and fondle it and a hundred years from now, you'll have one ounce of gold, and it won't have done anything for you in between. You buy 100 acres of farm land and it will produce for you every year. You can buy more farmland, and all kinds of things, and you still have 100 acres of farmland at the end of 100 years. You could buy the Dow Jones Industrial Average for 66 at the start of 1900. Gold was then $20. At the end of the century, it was 11,400, and you would also have gotten dividends for a hundred years. So a decent productive asset will kill an unproductive asset."

Not all investors see it like Buffett though, including some value-investing heavyweights. Jean-Marie Eveillard probably agrees with Buffett on most things, but he and his team at First Eagle believe strongly in the use of gold as a safety net against runaway inflation and other unforeseen events. First Eagle argues that gold bullion is not tied to any specific currency nor is it dependent on the health of any one government. Also, since gold has very few industrial uses, its price is not tied to economic cycles. Ironically, gold's lack of industrial use is part of the reason Buffett shuns the metal. 

First Eagle invests a small portion of each of its funds in gold bullion and launched a dedicated gold fund, First Eagle Gold SGGDX in 1993. The First Eagle managers are quick to point out, though, that they do not make any attempts to forecast the price of gold, staying true to its use as a hedge against financial calamity rather than a speculative investment. They also note that gold probably shouldn't take up more than a 5% to 10% allocation in a well-diversified portfolio, and I tend to agree with this advice.

Options
For those that do want to add gold to their portfolios, there are a wide variety of open- and closed-end funds and exchange-traded funds focused on the asset. Some people also purchase gold directly in the form of gold bars or jewelry, for example. As my somewhat traditional Indian mother would tell you, gold jewelry carries significant cultural importance both as a store of value and for its aesthetics.

Even across similar investment vehicles, different funds may employ different strategies, and investors should understand these differences before putting money to work. Some funds, like the SPDR Gold Shares GLD and iShares Gold Trust IAUETFs and the closed-end fund Sprott Physical Gold Trust PHYS,  invest only in physical gold bullion. Other funds, like ASA Gold and Precious Metals ASA and Market Vectors Gold Miners ETF GDX invest directly in the stocks of gold miners. Finally some funds, like the First Eagle Gold, Vanguard Precious Metals and MiningVGPMX, and Fidelity Select Gold FSAGX, invest in a combination of both the bullion and equities. Coincidentally, both First Eagle Gold and Vanguard Precious Metals and Mining experienced manager changes at the end of 2013, causing us to lower our Morningstar Analyst Ratings of both to Neutral. That said, we like the process employed at both funds and would consider upgrading these ratings once the new managers get situated.

Recent Trends
Last year was one of the roughest years in recent memory for gold investors. Gold prices, as measured by SPDR Gold Shares, dropped 28% last year, following a massive five-year runup in price. As we mentioned earlier, many invest in gold as a hedge against inflation and declining stock prices, factors which helped gold prices increase 14% annually between 2008 and 2012. In 2013, despite historically low interest rates, the runaway inflation that many feared never materialized. What's more, domestic growth has been on the uptick, boosting stocks significantly and causing gold investors to second-guess their need for a hedge against calamity. Most funds that invest in gold or gold miners fared terribly, as the typical open-end fund plunged just more than 48% last year and the average closed-end precious-metals fund declined almost 34%. In this difficult environment, the funds that turned in better relative performance in 2013 were those that owned more gold bullion and stayed away from less-established junior and exploratory mining firms. The top performing open-end precious-metals fund in 2013, Vanguard Precious Metals and Mining, beat its peers not because of its investments in gold, but rather because it held other nongold industrial firms like Umicore UMICY and Johnson Matthey.

Sumit Desai, CFA is a senior stock analyst with Morningstar.

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