An age-old standard, gold, was one of the most touted alternative investments at the Morningstar 2010 Investment Conference in Chicago last month.

But gold may not be that original of an idea. “Some say it’s been in a 6,000-year bubble,’’ said Morningstar ETF Strategist Paul Justice.

On July 6, gold closed at $1,194.80 a troy ounce, with a 52-week high of $1,265. Before the credit crisis exploded in fall of 2008, gold had traded below $1,000 an ounce.

In the wake of the worldwide credit crisis and lingering recession, stock price movements remain volatile. This is driving retail and institutional investors, including hedge funds, into gold. One big gold bull is Rudolph Riad-Younes, head of international equities at Artio Global Investors, a New York investment manager that says it takes an unconventional approach to global equity and fixed income.’

For Riad-Younes, gold is simply “an insurance option, a safe boat.”

Likewise, other hedge fund and alternative managers at the Morningstar conference concurred that they, too, have moved into ultra-conservative plays such as dividend-paying stocks, utilities, real estate investment trusts, commodities swaps—and gold.

Then there are exchange-traded funds which track gold prices using futures contracts. Traditional gold ETFs have merely invested in indexes tied to companies related to gold production and mining. Now there are funds that specialize in indexes based on gold itself.

The Morningstar “Hot Topics in ETFs” presentation focused primarily on the May 6 Flash Crash nosedive that tore the cover off the many risks and complications of ETFs—but it also covered the rising fascination with gold, including gold ETFs, and their risks and rewards.

David Einhorn, who runs the Greenlight Capital hedge fund, recently moved all of his gold investments into physical gold ingots because he believes it’s a more certain way to invest in the metal, than a fund based on gold price movements.

“We know for sure that they’re there and numbered, said Einhorn, speaking of his gold bars. He is among a growing number of fund managers moving big positions into gold, silver, palladium, platinum and other metals.


The emphasis on tangible investments raised the specter of investors moving into cash in 2008, amid news reports of people buying safes to store their wads of cash.

There are a handful of ETFs, for instance, that track indexes of gold actually stored in vaults.

One is the $608 million ETFS Physical Swiss Gold Shares fund, launched Sept. 9, 2009 by ETF Securities. Its gold bars are stored in a Zurich, Switzerland bank. The biggest gold ETF, the $50 billion SPDR Gold Trust, which is second only to the No. 1 ETF, the SPDR 500, has its underlying holdings stored in HSBC’s London vault.

“Investors like physical underlying holdings because they’re uniform, they’re easy to store, and they don’t spoil,” agreed Ben Johnson, a European ETF strategist at Morningstar, adding: “A long-only commodity investment can produce equity-like returns.”

However, due to “fundamental changes in futures contracts, the commodities category is a victim of its own success,” Johnson warned.

For instance, the day before a gold or economics “roll,” or rolling report, is announced, Johnson said, investors can pour funds into puts or calls on gold as easy as “ringing the cash machine. That’s a pretty easy front run and way to distort the market, and it’s not efficient.”

For instance, Scott Burns, ETF research director at Morningstar, noted that “on the May 6 Flash Crash, there was a swing of 16 points in the value of ETFs that could be arbitraged. If you’d called that play correctly, you could have packed it in and retired to your own island,” Burns said.

Gold Selloff

On a broader level, investors’ increased interest in gold and gold ETFs comes at an unusually unpredictable time for the market. Despite the prevailing belief among institutional investors that interest rates will rise, which would further support gold prices, volatility and price fluctuation in the international gold bullion market is rising.

A footnote in a recent report from the Bank for International Settlements, also known as the central bank of central banks, showed a remarkable spike in central banks’ offloading of their bullion in the first four months of 2010. Normally, they sell four million ounces a month, according to the International Monetary Fund. In January 2010, that rose to just over 10 million ounces, and then to nearly 12 million in February and 15 million in both March and April.

Driving the selloff, according to metals experts, was the bailout of Greece and other European nations saddled with sovereign debt.

Meanwhile, among hedge funds that invest in gold, there is a nascent fear that governments could ban private ownership of the metal. That’s happened once before, on April 5, 1933, when President Franklin D. Roosevelt banned private hoarding of gold worth more than $100.

Of course, the IMF data concerning the Bank for International Settlements is a three-month lagging indicator. By autumn, this movement may prove to be nothing more than an aberration.

However, should the lack of transparency and fair valuation in the gold and bullion market increase—or particularly as investors continue in their flight to safety and quality—then countries may find it difficult to liquidate their holdings through BIS, metals consultant Philip Klapwijk, executive chairman of GFMS Ltd. of London told The Wall Street Journal. That could mean price depreciation for gold.

The important lesson for investors to remember in this unpredictable market, investment leaders told the Morningstar conference, is how all asset classes except gold uncharacteristically and unpredictably fell in 2008.

Those who’ve been bitten by the “gold bug” must know that gold could be just as unpredictable in 2011 and 2012.

Whether it’s a gold or other commodities ETF or mutual fund, Justice suggested, find out “how liquid is the underlying market. Protect yourself with stop orders and puts.”

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