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Gold investing: Beware the global risks

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Some advisors believe that gold mining stocks or precious metals funds belong in clients’ portfolios.

Indeed, there have been periods of excellent results. In the nine calendar years from 2002 through 2010, for instance, Morningstar’s precious metals category returned 23% or more seven times, including 64% and 57% in 2002-2003. (In the other two years the category lost 8% and 30%, followed by more downs and ups, so these funds can be extremely volatile.)

Besides the risks inherent in any equities, and those of gold price fluctuations, mining stocks may be subject to geopolitical threats. The companies might be based in and/or operating in nations where expropriations or other unwelcome events can occur. Is there any way to screen for such risks and focus on “safe” gold mining stocks?

“That can be difficult,” says Jeff Waters, managing member at OFC Financial Planning in Short Hills, N.J. “A mining company may be domiciled in countries such as the U.S. or Canada or Australia yet the mines themselves might be in places that are vulnerable to political upheaval. Unless an advisor wants to act as a securities analyst, determining a company’s exposure can be challenging.”


Waters, who formerly was a securities analyst on Wall Street, says that the best way to minimize country risk in gold mining stocks is to diversify. “If you invest through a fund,” he points out, “you’ll get companies with different domiciles and different countries of operation. Assuming that markets are reasonably efficient, there will be an extra risk premium for the stocks that have more exposure to these concerns, which should be built into their trading prices.”

With an actively managed precious metals fund, advisors are relying on the manager for an in-depth evaluation of each stock’s risk and potential rewards. Alternatively, “an ETF that tracks an index of major mining stocks will have more of its assets in the large gold miners that have been around for decades,” says Waters. “Such companies probably have a portfolio of mines in different areas.”


Many of Waters’ clients have a 5% allocation to gold but he is not enthusiastic about the mining stocks. Theoretically, he notes, investors who want to own gold for the long term should hold mining stocks to profit from the operating leverage: a rise in the price of gold can cause a disproportionate increase in the company’s profit margin and stock price. “That hasn’t been true lately,” he says, “with gold prices rising much more than mining stock prices.”

Consequently, Waters uses bullion ETFs for gold positions. “If you own the commodity through an ETF,” he says, “you don’t have to worry about whether an election in some frontier market will impact the prospects for a stock you own.”

Moreover, Waters’ penchant for diversification extends to gold bullion ETFs. “If you believe, as we do, that the dollar may strengthen while other major currencies will fall, there’s a case for using some of the newer bullion ETFs, which offer gold denominated in other currencies,” he says. “We’re currently putting more dollars into yen- and euro-based gold bullion ETFs than into the traditional dollar-based gold bullion ETFs.” Deciding among yen- and euro- and pound- and dollar-based bullion ETFs for a gold allocation adds yet another dimension to global investing.

Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.

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