Golden No More

The shine is starting to dim on investments in gold. True, bullion rose about 20 percent in 2003, and gold stocks improved more than twice as much (42 percent), thanks to a sliding dollar's burnishing of the precious metal's safe-haven status. And, yes, many current macros seem bullish. Interest rates are low enough to make saving seem thankless, the greenback scrapes the bottom of its range against

The shine is starting to dim on investments in gold.

True, bullion rose about 20 percent in 2003, and gold stocks improved more than twice as much (42 percent), thanks to a sliding dollar's burnishing of the precious metal's safe-haven status.

And, yes, many current macros seem bullish. Interest rates are low enough to make saving seem thankless, the greenback scrapes the bottom of its range against the euro and the world suffers a double case of nerves from terrorism and U.S. foreign policy. Factor in those deficits — both budget and trade — and you end up with a script guaranteed to lift the spirits of gloomster and goldbug alike.

But make no mistake: Gold is poison right now.

A quick check of Internet-based gold offers provides some compelling circumstantial evidence of this fact. For starters, the Web sites proffering gold boast electronic come-ons usually reserved for porn sites. Typical is Swiss America, which backs its claim of “a new bull market in gold” with a laundry list of woes, including the dollar's drop, the rise in the Commodity Research Bureau gold index, corporate scandals, poor mutual fund performance (now somewhat dated), terrorism and an “exacerbation” of the shortfall of physical gold.

Though it's obvious that the world is full of instability right now, the site's rhetorical question — “Can you afford not to own gold?” — sure smells like a hard sell.

There are softer peddlers, Frank Holmes notable among them. Holmes is chief investment officer of U.S. Global Investors, a mutual fund company that placed three funds on the Wall Street Journal's top 50 list for 2003, in part because of their hefty gold commitments. Holmes rests his bull case on cycles, terrorism and the weak dollar. “Cycles give us perspective,” says Holmes, pointing to the 60-year Kondratieff, 20-year construction and four-year Presidential cycles, all of which currently register positive for commodities.

For Holmes, a deficit-inducing war on terrorism, a weakened dollar and a fed funds rate lagging inflation differentiate gold's current move from its price spikes of the 1990s, when investors had attractive alternatives. (Interest rates at that time were returning “about 300 basis points above inflation,” he notes.)

Looking Backwards

Still, history tells us it can be costly to enter an asset class too late, and even U.S. Global's historical chart shows gold to be a class of extreme performance. Over the past 20 years, gold has been the best performer four times and the worst performer eight times, which suggests that getting the entry point right means everything.

So is now the right time? Let's have a look backwards.

Since being decoupled from the U.S. dollar during the Nixon years, gold topped $400 an ounce four times during the 1980s and 1990s (in 1989, 1990, 1993 and 1996), and made large moves forward during 1979-80 and 1982 (topping $700 per ounce), and in 1987-88 (clearing $500). In the late 1970s, gold's spike was driven by inflationary energy costs and soaring interest rates. In the late 1980s, it was the stock market crash and dollar drop.

The current situation borrows from both earlier periods, given our higher (but noninflationary) energy prices and weak dollar. Interest rates are chintzy, which is bullish for gold, though stocks are in an uptrend, which is bearish.

Among gold's indicators, the dollar is key. A recent Merrill Lynch study showed that for the past 10 years, the negative correlation of gold to the dollar is 84 percent. So, whether gold is or isn't a safe haven during crisis, it works pretty darned well as an antidollar. But the dollar-inversion thesis exposes a nasty truth about gold: Priced in an ascending currency, like the euro, gold's big move of 2003 gets whittled down to practically nothing. Euro-holders, relative to dollar-holders, got to buy the metal at a discount. According to The Leuthold Group, gold priced in euros ended 2003 almost exactly where it began, at 329 euros per ounce.

Jeff Christian, managing director of CPM Group, who calls himself “a very cautious long” on gold after it recently hit his target price of $425, sees gold “moving more against the whole currency complex, rather than just against the dollar.” In Christian's view, “investors tend to like currencies, but when there's no longer a clear choice, they go to gold.”

In other words, when the dollar stops being hopeless, the dollar-for-gold trade might hit the wall. And that could well happen soon.

As Christian notes, the dollar has been heading south for two years and has only once faced a three-year bear market since 1971. To Christian, those heavily sold dollars seem undervalued, and euros seem overvalued. In addition, the Parmalat scandal might set off a round of investor skepticism toward Europe while the ECB might lower rates “as early as tomorrow.”

Nor does Christian see gold undergoing anything like the massive moves that capped the 1970s. Recalling the American hostages in Tehran, Soviet troops in Afghanistan and interest rates approaching 20 percent, Christian says, “1979-1980 makes the current period seem like a picnic.” Plus, hedges readily available today, like S&P puts, were not available during the Jimmy Carter era, when “silver and gold were practically the only hedges out there.”

Shiny Happy Equities

Despite all this, there are still likely to be investors who cannot resist the allure of the precious metal. Such gold diggers might consider buying gold coins or a bullion-based stock. Pending SEC approval, a new exchange-traded fund (ETF), called Equity Gold Trust, is expected to begin trade on the NYSE during 2004. The trust will let investors trade an equity backed by physical gold. Approval rests upon whether the shares will be considered equities or gold by the IRS.

Another safer way to buy gold would be through U.S. Global Investors, which keeps a hefty chunk of funds in alternative asset classes like gold. Though the company's shares are at record levels, they arguably remain cheap. The company's cash flows come to about 10 cents per share for every $100 million under management and deserve a multiple of 8 to 10 times, claims Holmes. On that metric, the value of U.S. Global is over three times current share prices — and even cheaper were the shiny metal to rise to $440 per ounce in 2004, as Holmes believes it will.

Says Holmes: “Wall Street has been calling for the gold rally to end for the last two years, but it just keeps going.”

But remember: Nothing lasts forever.

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