From the November 2008 issue of Research Magazine • Subscribe!

November 1, 2008

Has Gold Lost Its Mojo?

After breaking the $1,000 an ounce barrier during the spring, gold's seemingly invincible run has hit a brick wall. Has gold lost its mojo?

The price of this storied yellow metal has been steadily sliding over the past few months. Since touching all time highs, exchange-traded funds tracking the price of gold have been all over the place. After falling around 20 percent into bear market territory, gold has recently recovered.

The two gold-focused ETFs are the iShares COMEX Gold Trust (IAU) and the more heavily traded SPDR Gold Trust (GLD). Through mid-September, both ETFs are up around 3.5 percent year-to-date.

Despite gold's choppy year-to-date performance, it's still outperforming broad equity indexes. Over the same year-to-date time frame, the S&P 500 (SPY) has fallen 20.2 percent, the Dow Industrials (DIA) is down by 19.5 percent and international stocks (VEA) are off by 27.6 percent.

Is the bull market in gold over?

Even factoring in recent declines, gold's price has still managed to double since the start of 2005.

Some analysts remain convinced that gold's multi-year gains aren't over. They point to gold's recent weakness as mere consolidation and argue that long-term fundamentals remain intact.

Recent data reveal a slowing world economy, which has trickled down from the slumping U.S. During the second quarter the economy in Japan and Europe contracted. A worldwide economic recession could boost demand for tangible assets like gold.

One of gold's most outspoken advocates is James Turk.

He's called for gold prices to reach as high as $8,000, which has led some observers to scoff at Turk's forecast. True, it may be a while before gold reaches those levels, but Turk was accurate in forecasting gold passing the $500 barrier in 2005.

Why has gold fallen?

One of the reasons for the recent weakness in gold performance has been a rebound in the beaten down U.S. dollar. Recently, the greenback has been gaining against competing currencies. The better the dollar does, the worse gold is likely to perform.

Other factors may be hedge funds repositioning assets out of commodity-based investments like gold into other areas of the market that have performed poorly.

Still, gold's decline has been far less dramatic than the energy-heavy iShares S&P GSCI Commodity Index Fund (GSG). The fund is up one-half percent for the year, but has given back roughly 40 percent of its gains over the past few months because of spiraling crude oil prices. GSG follows a basket of 24 different commodities including crude oil, gasoline and natural gas futures. Gold is also represented inside GSG, but it has a very small weighting.

Gold's recent fall has translated into healthy gains for gold ETFs that provide inverse performance.

Since their debut in February, the PowerShares DB Gold Double Short ETN (DZZ) is ahead by a sizzling 26.8 percent and PowerShares DB Gold Short ETN (DGZ) is up by 11.8 percent. Both ETFs are built to increase in value when gold prices fall. The duos are bank notes issued by Deutsche Bank that charge annual expenses of 0.75 percent.

Why do people invest in gold?

Gold is typically used as a hedge against inflation and lately there's been plenty.

July data showed the Consumer Price Index (CPI) was up 5.6 percent year-over-year, mainly because of elevated food and energy costs. The figures exceeded forecasts and were higher compared to June.

Another looming wild card that could boost gold is more unexpected economic shocks or even a political event. Such a scenario would likely translate into gains in gold.

Both GLD and IAU represent fractional ownership in gold. Their ETF share prices are designed to reflect one-tenth the per ounce price of gold bullion. Each fund charges annual expenses of 0.40 percent.

Technically, the two funds aren't ETFs because they're registered as grantor trusts under the Securities Act of 1933, but they're usually referred to as ETFs for simplicity.

Another aspect of gold investing to consider is taxes.

Long-term gains made in gold are taxed as collectibles or at a maximum rate of 28 percent. This is a higher tax rate compared to gold equities. Also, investment products that utilize gold futures are typically taxed at a blended tax rate of 60/40 which amounts to a maximum rate of 23 percent.

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Ron DeLegge is the San Diego-based editor of www.etfguide.com.

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