How Fund Investors Can Spread Gold Bets

Gold has been whipsawing investors lately, as well as shareholders of precious metals funds have special factors to feel disappointed.

And so far this year, gold prices have climbed 14% to $1,662, while precious metals money have dropped 15.7%, according to Morningstar.

The performance is unusual because most often the funds rise along with bullion prices. Fund portfolio managers provide several theories regarding exactly what has caused the bad returns.

The funds invest in stocks of mining companies. Those have faced increasing costs for fuel as well as steel. In addition, many companies have struggled to find new reserves.

But the biggest cause of the weak showing could just be that investors expect gold costs to sink in the next couple years. If that happens, mine profits could drop sharply.

"People are afraid that mining stocks can be at the top of the cycle," says Stephen Land, portfolio manager of Franklin Gold as well as Precious Metals(FKRCX).

Under typical conditions, the precious metals money outperform bullion during bull markets as well as trail in downturns.

This happens due to the fact mining stocks are leveraged to the price of gold.

To appreciate how the leverage works, consider that it costs some miners regarding $700 to produce an ounce of gold.

Say the price of gold is $1,000; a mine then earns a profit of $300 an ounce. If the price climbs to $1,300, the mine's profits would increase 100%. But investors in bullion would only record 30% gains.

In a downturn, leverage works in reverse, and mining stocks suffer big losses when gold falls.

During the past decade, gold prices have climbed regarding 18% annually. Leverage has boosted precious metals money, which have returned 23.5% annually and ranked as the top-performing category tracked by Morningstar.

If you such as gold, should you purchase a precious metals fund or hold bullion directly?

Some analysts claim that the funds have an edge mainly because mining stocks look cheap. Many of the stocks have usually sold at price-to-earnings ratios of 20 to 30. But after the bad performance this year, the P/Es have slipped into the 10 to 20 range. Naturally the multiples could fall more if gold prices plunge, as many analysts predict.


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