Time to Hop on the Gold Wagon?

Prices for the yellow metal have been climbing again, and some pros see its strength continuing

The gold bugs are swarming again. On Nov. 27, spot prices for the yellow metal climbed to their highest level since late summer. While prices pulled back a bit the following day, some analysts say factors are aligning for the precious metal to continue its rally. Gold investors, so often burned in the past, have more reason to smile these days.

With a spot price of more than $630 on Nov. 28, gold has gained about 20% on the year. It has fallen, however, since May when it topped $700 per oz., heights not seen for more than two decades. But amid ongoing political instability worldwide and concerns over the U.S. economy, gold prices could continue to climb.

Traditionally, investors have flocked to gold as a safe haven from currency gyrations and geopolitical strife. The U.S. dollar's continuing weakness against the euro—as well as violence in the Middle East—provide an obvious incentive for some investors to move into the metal.

"Stealth Bull Market"

And gold enthusiasts see more good times on the horizon. True, the metal is still well below past glories. In 1980, the price reached about $850 per oz.—far more, when accounting for inflation, than its current value.

But a number of factors may keep the shiny stuff in investors' good graces. With the weak greenback, countries with vast dollar holdings, such as big Asian exporters like China and Japan, may want to diversify their currency portfolios. "As those dollar reserves are redeployed, gold is going to get some share," says Standard & Poor's analyst Leo Larkin.

Larkin says there's been a "stealth bull market" in gold for about five years. "I don't think the public is in on this in any meaningful way," he says. "This isn't like the tech boom of the late 1990s." Even though public attention has been enraptured with outperforming stock indexes, he thinks gold will continue to climb.

Volatile Smaller Miners

Besides the likelihood of Japan and China shuffling their assets, the price could get a boost from weakening financial markets, lower interest rates that "lower the opportunity cost to owning gold," or even something as simple as declining supply confronting growing demand. With this is mind, Larkin has buy ratings on Barrick Gold (ABX) and Newmont Mining (NEM), the world's largest gold-mining outfits.

Joseph Foster, portfolio manager at Van Eck International Investors Gold Fund (see BusinessWeek.com, 4/19/06, "A Deep Knowledge of Gold"), prefers smaller miners not covered by S&P like Agnico-Eagle Mines (AEM), Kinross Gold (KGC), and Randgold Resources (GOLD). "They can discover a deposit that's 1 million to 2 million oz. and it's meaningful to them," he says. By contrast, Barrick had gold mineral reserves of 139 million oz. at the end of last year and expected to produce more than 8 million oz. this year.

As yields from major gold-producing regions in Nevada, South Africa, and western Australia decline, Foster notes that "nature didn't make gold in the sorts of deposits that the majors need to grow." Gold miners aren't too different from companies in other commodity industries. The small players tend to be more volatile and, with fewer reserves, are probably less able to weather a price drop. (Foster says his portfolio's holdings, spread over a variety of gold assets, reflect a similar bias for the small gold producers.)

ETFs Worth a Look

Not everyone is as excited about the metal's near-term future. Parvathy Krishnan, an analyst at Morningstar, writes in an e-mail that gold is "trading at historically high levels, so there is more downside potential than upside [potential] over the next year, in my mind."

Though their stocks often travel with gold prices, investing in mining companies is quite different from investing in gold. Each outfit has its own management, mine holdings, and financial structure that will affect how it can benefit from higher metal prices.

For an investment more closely tied to gold prices, investors might want to look to exchange-traded funds such as iShares COMEX Gold Trust (IAU) and StreetTRACKS Gold Shares (GLD). The funds track each other very closely; both are up more than 25% for the last 12 months. The investors who got in early have found their plays have panned out nicely.
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