From the April 2009 issue of Research Magazine • Subscribe!

Gold: Ready for $1,500?

As global economies around the world sputter and world central banks search for the answers, an ancient measure of value appears ready to rise. What is it? Gold.

While it's still early in the going, 2009 has been (until the recent equity jump) shaping up to what may become a banner year for gold. The ounce price of gold matched last year's previous high of $1,000, and $1,500 was thought to be just around the corner. "Compared to a basket of major world currencies, except the U.S. dollar, gold has appreciated handsomely," states gold trader Andrew Djukanovic. Put another way, investors searching for stable and relative value have found it in gold.

So far in 2009 (through mid-February), gold as measured by the SPDR Gold Shares (GLD) gained 13 percent before pulling back. That's nearly as much as gold's performance return for all of last year. In 2008, gold rose 4.32 percent as calculated using Kitco's London PM Fix prices.

[EDITOR'S NOTE: For an update on the performance of gold ETFs, see http://www.etfguide.com for Gold's-Bluff---Is-A-30-Percent-Drop-Next?]

From Deflation to Inflation?

While the deflation in major asset classes from stocks to real estate has been one of the principal themes over the past year or so, hidden inflationary forces may already be at work. In February, bailout 2.0 (also known as the "American Recovery and Reinvestment Act of 2009") was passed into law. It amounts to a $787 billion U.S. government plan for job preservation and creation, infrastructure investment, energy efficiency along with state and local fiscal stabilization. The cost of paying for these large spending programs is creating what some economists are calling the "Perfect Storm."

In many respects, the U.S. government finds itself in a fiscal Catch 22. If it pays for massive bailout and stimulus packages with borrowed money, it drags a deeply indebted nation into deeper debt. If it pays for the packages by printing more money, it creates other problems like unwanted inflation, not to mention devaluing the dollars already in circulation.

John Williams, an economist who publishes the Shadow Government Statistics newsletter, has a dim view of the future prospects of the dollar and foresees U.S. inflation that could reach double digits by the end of the year. "Over the long-term, I think gold is your best hedge, along with having assets outside of the U.S. dollar." Williams also suggests holding other assets like real estate that have tended to hold their value in the face of economic chaos and inflation.

While nobody knows exactly how any of these events will play out, having some gold exposure in your clients' portfolios may be a good hedge.

Most mutual funds only offer gold exposure by investing in gold stocks, but not in gold itself. Investing in gold is easily accomplished with gold ETFs. Some products are designed to track the price of gold bullion, whereas others are tied to the performance of publicly traded stocks that mine or produce gold. Other ETF products invest in commodity futures or options tied to the price of gold.

Let's analyze a few key gold ETFs:

-SPDR Gold Shares (GLD): State Street Global Advisors introduced GLD back in 2004 as the first exchange-traded trust linked to the price of gold bullion. The share price reflects one-tenth the price of one ounce of gold bullion. The trust is backed by physical gold, which is stored in the form of London Good Delivery Bars (400 oz.) in a secured vault. GLD has a mammoth $30 billion in assets making it the largest gold ETF in the world. The iShares also offer a similar version of GLD under the ticker symbol of IAU.

In 2008, GLD had a modest gain of 2.99 percent compared to a 37.38 percent decline in the SPDR S&P 500 ETF (SPY). GLD's annual expenses are 0.40 percent.

-Market Vectors Gold Miners ETF (GDX: This Van Eck Global ETF follows the Amex Gold Miners Index. The underlying index contains 32 mining stocks, and Barrick Gold (13.90 percent), Goldcorp (10.17 percent), and Newmont Mining (8.60 percent) represent the three largest holdings. GDX was one of the first gold mining ETFs and it currently has $2.6 billion in assets.

In 2008, GDX fell 26.65 percent compared to a 4.32 percent rise in the value of gold bullion. GDX's annual expenses are 0.59 percent.

-ProShares Ultra Gold (UGL): This ProShares ETF aims to deliver twice (200 percent) the daily performance, before fees and expenses, of gold bullion as measured by the U.S. dollar fixing price for delivery in London. This ETF is structured as a partnership and it uses a combination of forward and futures contracts to execute its investment strategy.

UGL was launched in December 2008 and its annual expenses are 0.95 percent.

-PowerShares DB Gold Fund (DGL): DGL follows the Deutsche Bank Liquid Commodity Index - Optimum Yield Gold Excess Return Index. The index is rules-based and composed of futures contracts on gold and is intended to reflect the performance of gold. Selection of contracts is determined based on the best possible implied roll yield for each eligible futures contract. Like the other PowerShares DB commodity and precious metal products, DGL is structured as a grantor trust.

In 2008, DGL rose 2.83 percent. The fund's annual expense ratio is 0.50 percent and it has an additional 0.04 percent in estimated brokerage costs associated with rolling futures contracts.

-PowerShares DB Precious Metals Fund (DBP): DBP follows the Deutsche Bank Liquid Commodity Index - Optimum Yield Precious Metals Index. The index is composed of futures contracts on just two precious metals: gold (80 percent) and silver (20 percent). The selection of contracts is determined based on the best possible implied roll yield for each eligible futures contract. Throughout the year the precise weighting of each commodity in the index will change based upon price changes. The index is rebalanced annually to the base weights every November.


In 2008, DBP declined 2.99 percent. The fund's annual expense ratio is 0.75 percent and it has an additional 0.04 percent in estimated brokerage costs associated with rolling futures contracts.

-PowerShares DB Commodity Index Tracking Fund (DBC): While not a pure gold ETF or trust, DBC has a larger percentage of its portfolio's exposure to gold compared to other diversified commodity index funds. The index is composed of futures contracts on six commodities and weighted as such: light sweet crude oil (35 percent), heating oil (20 percent), gold (10 percent), aluminum (12.5 percent), corn (11.25 percent) and wheat (11.25 percent).

In 2008, DBC fell 30.77 percent compared to a 4.32 percent rise in the value of gold bullion. DBC's annual expenses are 0.75 percent.

Gold for Diversification

The performance of gold stocks and gold itself don't always correspond with each other. In 2008, gold mining stocks (GDX) lost 26.65 percent compared to a rise of 4.32 percent in gold. For this reason, some advisors have opted for investing in ETF products linked to gold the asset. "We own GLD because it is the most efficient and liquid way to buy gold," said James Shelton, CIO at Kanaly Trust in Houston. "GLD is easily traded and represents true ownership of gold, which can provide protection in uncertain times."

Shelton's investment firm manages $2.2 billion in assets.

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. In 2009, investors in the two lowest tax brackets will pay zero capital gains on long-term equity investments and investors in the 25 percent to 35 percent brackets will pay just 15 percent. 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.

Not Just Physical

Beware of the financial extremists that tell you the only way to benefit from rising gold prices is by investing in physical coins, bars or jewelry. It's not true. Gold ETFs allow you to have an ownership stake tied to physical gold, gold futures or gold equities. In many cases, the cost of acquiring gold exposure through gold ETFs is substantially less than taking physical delivery of gold. Also, the acquisition costs may be less with gold ETFs than dealing with middlemen peddling physical gold. Do the math! Also, keep in mind that gold ETFs allow your clients to avoid the expense and inconvenience of storage and insurance.

People that made the strategic mistake of investing in gold at its peak in 1980 sat on dead money for more than two decades. This is a valuable lesson for your clients, especially the ones with an urge to overdose.

It's also important to communicate to your clients that gold supply and demand is a two-way street. It's true that investor demand for gold ETFs can drive up the price of gold because products like GLD and IAU must acquire gold bars to back the shares they're issuing. But what happens when gold demand dries up? Gold ETFs would be forced to sell their gold holdings to pay investors that don't want to own their gold shares. This could have the opposite impact by driving gold prices down.

In the context of a diversified portfolio, gold may stabilize your clients' portfolios during these unstable times. It may even help them to reach their financial goals.

Speaking of the Gold Rush in the 1850s, historian H.W. Brands wrote, "The Gold Rush established a new template for the American dream. America had always been the land of promise, but never had the promise been so decidedly material." While the gold rush of the past may not be exactly duplicated in the future, anything close should keep gold's investors more than satisfied.

Are you ready for $1,500 gold?

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

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