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Gold is booming, but for how long?

November 20, 2010

For the past three years, Indianapolis investment adviser Jeffrey S. Cohen has recommended that his clients at Stifel Nicolaus have some gold in their portfolio.

Physical gold, money invested in an exchange-traded fund, a piece of a gold-mining company—it doesn’t matter what form, and it doesn’t have to be more than a small percentage of total holdings.

But buy gold.

“I met with five foundation endowments this week,” he said in late October, “and every one of them has had precious metals in their account for two years. So I do advise people to own precious metals in their portfolio and as a hedge against the decline of the dollar.”

Cohen, who owns gold (but doesn’t want to disclose how much), has plenty of company in dispensing that advice. And clearly, investors large and small are listening, sending gold soaring to more than $1,300 an ounce compared with about $1,090 at this time last year and $466 five years ago.

To appreciate how much money is being poured into gold, just look at GLD, the largest exchange-traded fund, which owns gold stored in London. The fund, run by SPDR Gold Trust, grew from $35 billion in assets in September 2009 to $55 billion this year. Its price has risen to around $132 a share, up about 21 percent for the year.

That’s a substantial return anytime, but especially when many traditional investments are paying out something close to zero.

For years, many investors considered gold the choice of doomsayers and crazies.

“If you have 30 percent of your portfolio in gold,” said Timothy Strauts, an exchange-traded funds analyst covering precious metals for Morningstar, “you must think something bad is really going to happen.”

But with so much global uncertainty, potential currency deflation and some countries teetering under crushing debt, advisers and their clients think gold is worth holding.

“Gold does well when people have less confidence in currencies,” Strauts said, pointing out that with all the talk of quantitative easing—that is, flooding financial institutions with capital to promote lending and liquidity—long-term bond yields have been coming down and the dollar has been falling. “As the dollar falls, it’s positive for gold because if your paper currency is losing value, you want to store it somewhere. Gold can be used to store value.”

‘Still a Wild West’

The current version of a gold rush has become so notable that in mid-October, Indiana Secretary of State Todd Rokita felt the need to warn investors “to be cautious about buying into the hype surrounding the precious metal.” He noted that “it’s still a Wild West out there, and dangers abound for prospective gold investors.”

Rokita was passing along advice he received from the North American Securities Administrators Association, an organization his office is part of. His spokesman, Jim Gavin, said the warning was particularly directed at individual investors, rather than sophisticated commodities traders, who may be tempted to invest in gold coins or other products being pitched through cable TV, newspaper ads and the Internet.

“While we’re not saying all of this recent gold promotion activity is directing investors toward illicit schemes,” Gavin said in an e-mail, “it is safe to say that with gold prices at record highs, unsophisticated investors are being exposed to more gold-related investment opportunities. Con artists tend to follow the headlines.”

Andreas Hauskrecht, clinical associate professor of business economics at Indiana University’s Kelley School of Business, said the run-up of gold prices is based on several overlapping factors: institutional investors and central banks taking a position in gold, inflation fears (however unfounded), volatility of the dollar, and traditional safe investments now yielding next to nothing.

“When interest rates are very low,” Hauskrecht said, “it’s rational to go into gold, which has a value in itself.”

But as he also noted, just as gold is a real asset, so is real estate. “But would you really invest in the real estate market? Not now.”

Hauskrecht said what we’re witnessing now is a “gold bubble” and, like all investment bubbles, it will eventually burst.

“If I knew when,” he said, “I would be a multi-billionaire, probably.”

His best guess: In 2012, when, he expects, the U.S. economy will normalize, the Federal Reserve will raise interest rates, short-term markets will rise, and yields will be re-established for nominal assets. Then people will invest in nominal assets like currency.

Timing is crucial

Morningstar’s Strauts said investing in gold five years ago would have been smarter than it is today, since fewer people had foreseen the run-up in price.

“When everyone’s talking about it, it may be near its end,” he said. “It feels like it’s a growing bubble, but the imbalances in the global economy are so strong right now that I think the bubble could last. That doesn’t make it a great investment necessarily. It’s up 21 percent this year. Sometimes it does best in the last year.”

He added: “Anyone can make a great case to buy gold and anyone can make the opposite case to not buy gold,” he said. “I can’t really disprove either one.”

Then there’s Cohen, the Stifel Nicolaus managing director. He noted the rewards—from August 1971 to January 1980, investments in gold returned 43 percent per year—and the risks—that gold was at $850 an ounce in January 1980 and $252 in August 1999.

He also acknowledged the reputation that gold investments sometimes carry.

“I’m getting crazy as I get older,” Cohen, who turns 47 next month, said with a laugh. “Because there’s a lot to be said for some of that crazy thought process.”•

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