Gold Keeps Looking Shinier

There are plenty of reasons to think the rally will continue.

Gold bugs, rejoice: Prices broke $330 per ounce on Dec. 13, further fueling the yearlong bull run in gold-mining stocks. Those smart enough to invest in gold and precious metals funds at the start of 2002 have earned an average 56% return--the best performance of any mutual fund category in the period. "People just don't believe it," says Morgan Stanley's gold analyst, Michael Durose. But that's because they may not understand the dynamics. On average, every 1% increase in the price of gold leads to a 3% increase in the value of mining stocks, he says. "You get that kind of leverage because costs are fixed, and reserves are more valuable," says Durose. Ultimately, the industry's profits are enhanced."

There are technical reasons why gold prices spiked, say enthusiasts. Hedge-fund managers, who make bets on geopolitical and economic changes, are buying en masse, propping up prices. Also, as gold-mining stocks soar, short-sellers who had bet on price declines are scrambling to cover their positions.

Skeptics say the rally won't last. Spikes are nothing new: Gold last reached $338 in October, 1999, when 15 central banks signed a pact to limit their lending and sales of metals for five years. Prices also shot up after the terrorist attacks of September 11, as investors fled to safe, tangible assets.

But the industry has gone through a metamorphosis that bodes well for the long term. Twenty-year lows in gold prices forced mining companies to streamline operations. Some are now earning their first profits in years. Rampant consolidation and lack of money for exploration have cut supply, boosting prices. That's not all: The threat of war and other uncertainties have added to demand from speculators. The weakening of the U.S. dollar will also help to keep prices aloft. As it stands, most analysts expect gold to reach $350 in the first half of the year. "I don't think it's too late to buy gold stocks," says equity metals analyst Leo Larkin of Standard & Poor's.

Once a rally starts, watch out, says Frank Holmes, CEO of San Antonio's U.S. Global Investors Inc. He runs two gold-related funds, which are among the best performers of all U.S. diversified stock funds. The U.S. Global Investors World Precious Minerals Fund, which buys North American mining companies, is up 64% so far this year. In stimulative cycles, after the economy turns bad, with low interest rates, deficit spending, and a weakening currency, "the gold stocks take off," he says. "We're more than a year into it, but we think 2003 is going to be another bull market in gold stocks. Gold shines when everything else falls apart."

Word to the wise: Don't try to time the gold market and chase returns. Holmes advises stashing 5% of a portfolio in physical gold or stocks, rebalancing every six months. If you don't, you risk tarnishing an otherwise bright investment move.

By Mara Der Hovanesian

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE