Gold Bugs: Some Mutual Funds Move Into Gold

The yellow metal is gaining popularity among some unlikely subjects.

You may have heard: The spot price of gold has risen above $1,100 an ounce, a rise of more than 20% so far this year. In fact, it's been reaching record highs over the past 20 months or so, passing through its previous high of about $850 an ounce, first reached in January 1980 then not again until early 2008.

It's not just commodities funds or investors, however, who are interested. More than a handful of diversified-stock mutual funds have added the metal, both in the form of gold bullion and gold exchange-traded funds (specifically  SPDR Gold Shares (GLD) and  iShares COMEX Gold Trust (IAU)). Sure, many funds have dabbled in gold miners from time to time, but the ownership of physical bullion is unusual.

Business as Usual, Kind Of
For some of the diversified fund managers that own gold bullion, it's business as usual. Take First Eagle. Legendary value manager Jean-Marie Eveillard had owned gold forever during his multidecade career. Although Eveillard retired at the end of March 2009, his successors have continued to own gold in all of the First Eagle funds run by advisor Arnhold & S. Bleichroeder:  First Eagle Global (SGENX),  First Eagle Overseas (SGOVX), and  First Eagle U.S. Value (FEVAX). Here, the managers generally keep between 5% and 10% of assets in gold bullion, primarily as an insurance policy against any sort of market catastrophe (that is, a sharp drop in stock prices, like 2008).

 IVA Worldwide  and  IVA International , run by former First Eagle folks Charles de Lardemelle and Charles de Vaulx, also fall in this boat and have maintained roughly 7% gold positions in the IVA portfolios, which were launched in October 2008.

Meanwhile, moderate-allocation funds  Leuthold Core Investment (LCORX) and  Leuthold Asset Allocation  are more tactical in their exposure to gold and other metals, as well as to other asset classes, sectors, and geographies, relying on quantitative models that use historical relationships to determine the attractiveness of different investments. While the funds have at times in the past owned other metals derivatives, manager Steven Leuthold has added physical gold to these portfolios for the first time in their histories, as well as to Leuthold Global (GLBLX). Each fund has a roughly 2% position in gold.

 Ivy Asset Strategy (WASAX) and  Waddell & Reed Asset Strategy (UNASX), both run by same team in same manner, aggressively adjust their portfolio compositions based on macroeconomic trends and currently maintain a midteens weighting in gold. Those stakes are roughly in the middle of the historic range over the past three years, which has run from 8% of assets at the end of 2006 to 30% of assets at the end of 2007.

A Looming Danger, Say Others
The bulk of the other funds somewhat new to investing in gold, though, have more-ominous reasons for owning the metal--specifically, worries about rampant inflation and a weak dollar. Inflation and a weak dollar are related: The more rapidly prices rise in the United States, the less purchasing power the dollar has. Meanwhile, to the extent that interest rates remain lower than those of other nations, there's less demand from foreign sources for U.S. government bonds and dollars. Finally, for these and other reasons, such as a ballooning government debt, there's the risk that the U.S. dollar loses its claim as the world's reserve currency, which could prompt a wave of supply of dollars in global markets, putting pressure on the dollar.

For some mutual funds that are comfortable holding cash, such as Queens Road Value (QRVLX) and  First Eagle of America  (run by subadvisor Iridian Asset Management, completely separate from Arnhold & S. Bleichroeder), the dollar thus isn't an attractive store of value. Iridian's Harold Levy has therefore maintained a roughly 4% position in SPDR Gold Shares, noting that the U.S. government is "in the process of destroying our currency" and lamenting the U.S.' "lack of discipline" on a spending front. Queens Road Value's Steve Scruggs has 3% in iShares COMEX Gold Trust (and still 21% in cash).

Other mutual funds are thinking of gold as less a substitute for cash and more a part of the investment portfolio.  Sentinel Capital Growth's  Elizabeth Bramwell has a 3.4% investment in SPDR Gold Shares, as a play on the falling U.S. dollar. Similarly,  Presidio  has more than 6% combined in SPDR Gold Shares and Central Gold-Trust, a Canadian trust that owns gold bullion. Presidio manager Kevin O'Boyle wrote in his April 2009 semiannual report that while he has spent most of his career focused on buying individual stocks, there are times when macroeconomic trends "almost becomes the over-riding consideration before investigating the merits of individual companies."

 Appleseed (APPLX) sees something of a double-whammy. That fund is currently keeping more than 10% of assets in gold. Not only is the management team concerned about inflation and the dollar, it is also having a tough time finding attractive valuations among stocks after taking profits in stocks as the market has run this year. For Appleseed, with already more than 20% of assets in cash, gold seems the best option.

Gold's Benefits and Risk
There is much gold can do for a portfolio, specifically diversify a stock-heavy portfolio, preserve capital, and hedge against inflation and a falling U.S. dollar. Indeed, gold's permanent spot in First Eagle's diversified funds has served its purpose: Although all three lost a bit more than 20% last year, for instance, they sat at the top of their respective categories and well ahead of broad-market indexes.

Still, gold is hardly risk-free. Most notably today, the biggest risk seems to be its record-high price. If the demand for physical gold turns out not to be as expected--part of the longer-term case among gold bulls is new demand from emerging markets--the investment won't pan out (no pun intended). And remember that it took more than 25 years for gold's spot price to return to its January 1980 level. Even First Eagle, which also offers a gold-specific fund,  First Eagle Gold (SGGDX), says that gold's "insurance premium," or price, is less attractive today and is one of the reasons that the managers have marginally reduced the funds' exposure to gold since the end of 2008.

Conclusion
Most of the diversified funds investing in gold today aren't doing so in a speculative or careless way. The stakes could provide meaningful cushion in a tumultuous market, but they are modest enough such that they're not drastically altering the funds' strategies. A small position in gold isn't the kind of thing that should necessarily alarm shareholders, particularly for those funds that maintain some level of flexibility--as those noted above do. Provided the managers have earned your trust, it's precisely the kind of leeway that investors should afford their portfolio managers.