Precious metals funds were golden in 2010. The mutual funds in this category typically load up on the stocks of gold mining companies such as Randgold Resources and Goldcorp. The price of gold peaked at $1,432 an ounce on Dec. 7, while the companies held by precious metals funds enjoyed rising profits and the fund category gained 41.7%, according to Morningstar.
Why the big gain in 2010? "Some big miners took off hedges," explains Janet Yang, an analyst who covers the equity precious metals fund category for Morningstar. That is, they stopped entering into contracts to sell their gold at a preset price. Without the hedges, Yang explains, these mining firms' stock prices move more closely with gold prices, so they enjoyed hefty returns in last year's run-up.
What's more, the precious metals fund category's 10-year annualized return jumped to a startling 25% after a strong 2010. At that rate, a $10,000 investment grows to around $93,000 in 10 years. To put that in perspective, the best 10-year record for large-cap stocks (the S&P 500 and a predecessor index) occurred in the post-World War II boom of 1948-1957, according to Morningstar's Ibbotson subsidiary. That annualized return was just over 20%, so $10,000 would have grown to about $62,000.
Precious metals funds have had a run during this century that topped anything recorded by blue-chip stocks in the last century. Are they still worth buying? Perhaps, for planners who have not held gold or diversified precious metals in clients' portfolios. Longtime investors, though, might want to take some winnings off the table, rebalancing back to target allocations while this sell-high opportunity exists.
FROM FEAR TO FONDNESS
Gold advocates insist that prices may rise from current levels, especially after a 7% pullback from last year's peak. Nevertheless, it's unrealistic to expect another decade of 25% annualized returns. From 2001 to 2010, gold went from $256 to $1,431 per ounce, a gain of over 450%. Even if gold reaches $2,500 an ounce in the next 10 years, the gain would be less than 100%. A reprise of the last 10 years is unlikely.
Of course, mutual funds don't have to return 25% a year to be good investments. As long as gold prices keep rising, the funds probably will stay in positive territory, and supporters point to many reasons why this may be the case. Frank Holmes, CEO of U.S. Global Investors in San Antonio, says that both a "fear trade" and a "love trade" exert upward pressure on gold prices.
As might be expected, the "fear trade" refers to investors' purchases of gold to protect their portfolios in case of a catastrophe. Gold prices ascended in the 1970s, a decade when the term "misery index" was coined. (That index, the sum of the unemployment and inflation rates, peaked at 21.98 in June 1980, the same year that gold peaked at $850 an ounce.)
Holmes says the fear trade is driven by negative real interest rates-where inflation is greater than the nominal interest rate-and increased deficit spending. Gold tends to rise whenever these two are coupled together.
In Holmes' view, gold rose in the 1970s because people were afraid of inflation, which averaged 9.2% from 1973 through 1982. Even though inflation is nowhere near that level now, the fear trade still exists.
"We're in the middle of an extended period of negative real interest rates that will likely last through the year," he says. "Deficit spending is also a concern. Gold investors worry that currencies might be devalued, as governments in developed nations pay for social welfare programs."
Such anxieties are well-told tales, but a new chapter has recently been added to the gold story: the love trade. "The love trade is unique to gold," Holmes says. "People buy gold out of love, especially in the emerging markets." He explains that it's customary in most emerging markets, particularly Asian countries, to give gold as a gift to friends and relatives for birthdays, weddings and to celebrate religious holidays.
For example, Holmes says that China becoming a global presence has added enormously to the demand for gold. In India, the world's largest gold market, jewelry consumption rebounded in 2010, according to the World Gold Council. "I don't believe the drivers pushing up the price of gold will evaporate," Holmes adds.
Believing that gold prices will go higher might not be the only reason to buy a precious metals fund. Diversification can also be a selling point. These funds definitely deserve a position in your portfolio if you want an investment that is not correlated to other asset classes, says Dan Denbow, co-manager of the USAA Precious Metals & Minerals Fund. "A precious metals fund often will act differently than other holdings."