Go for the gold, cautiously

If you can stomach a bit of initial volatility, now is a good time to start building a long-term allocation to gold. Despite some palpable near-term risks associated with the precious metal’s historically lousy second-quarter performance, the broader economic picture looks bright for gold.

“The economic uncertainty and the printing of money that we’re seeing is all good news for gold,” said William Rhind, director of ETFS Marketing LLC, the marketing agent for ETF Securities USA LLC, which has $17.5 billion under management.

He and other “gold bugs” are looking beyond the immediate reality of gold trading at near record levels of more than $1,100 an ounce to longer-term drivers such as inflation.

Gold, generally viewed as a safe hard asset during times of inflation, trades in an inverse relationship to the dollar, the value of which declines during an inflationary period.

“With mounting debt in the U.S. and Europe, one way out for the government is by raising taxes, or an easier way is to just inflate its way out of debt by letting inflation creep into the economy,” Mr. Rhind said.

A third option, beyond raising taxes and devaluing the dollar through inflation, is to renege on the debt, but that is considered a highly improbable alternative for the U.S. government.

“Historically, when countries have been faced with staggering debt, the strategy has always been to devalue the currency,” said Thomas Winmill, president of Midas Management Corp. and manager of the $120 million Midas Fund (MIDSX).

“That’s when gold rallies as inflation protection,” he said. “And everybody wins, except for the savers.”

Mr. Winmill, whose fund gained more than 82% last year and is currently more than 80% allocated to the gold-mining sector, sees inflation as the force that will more than double the price of gold over the next 10 years.

In the meantime, there is a near-term wrinkle: Where will the price of gold go over the next few months?

The second quarter of the year represents the off-season for the gold manufacturing and fabrication industries in China and India, which represent huge consumers of gold jewelry.

Mr. Winmill, an openly enthusiastic fan of gold, concedes that now is a time to be cautious with regard to gold investing.

Learn the most common types of gold investments here.

Because the marginal cost to produce an ounce of gold is currently below $850, he sees that price as the potential low point.

“In the short term, people should be cautious, but longer-term gold is one of the great asset classes to be in,” Mr. Winmill said. “If the price of gold suddenly nose-dives, people should consider whether they can handle that kind of volatility.”

But even the traditionally weak second quarter is being tempered this time around, due largely to the latest evidence that several European countries are acting in concert to stabilize Greece’s economy.

These latest developments have strengthened the euro, which tends to be highly correlated to the price of gold.

“The historical second-quarter dips for gold might apply in a normal environment, but we’re in such a different time now that all bets are off,” Mr. Rhind said. “Gold’s principal relationship is opposite the direction of the U.S. dollar, and that’s why the wind is definitely at the back of gold.”

Three simple and efficient ways to gain exposure to gold without buying bullion are the SPDR Gold Shares ETF (GLD), ETFS Physical Swiss Gold Shares (SGOL) and iShares Comex Gold Trust (IAU).

Asset size is the main distinction among the three exchange-traded funds.

The SPDR fund, sponsored by the World Gold Council and marketed by State Street Global Advisors, has nearly $41 billion under management.

The iShares fund, offered by BlackRock Inc., manages about $3 billion, while the ETFS fund, managed by ETF Securities, manages about $360 million. The latter imposes a 39-basis-point management fee, while the other two charge 40 basis points.

Not surprisingly, the three ETFs move in virtual lockstep.

Year-to-date through last Tuesday, gold ETFs had gained 5%, compared with a 7.4% gain for the S&P 500.

Last year, the SPDR and iShares funds gained 24%, compared with a 23% gain by the index. The ETFS fund was launched in September.

One other way to play a gold rally is to tap into the operating leverage of mining companies.

But according to Mr. Winmill, finding the best value in mining stocks requires “moving down the food chain” to smaller and riskier companies.

One exception might be Newmont Mining Corp. (NEM), the only gold-mining company in the S&P 500 and a stock with a forward price-earnings ratio of 11, which is down from a high of 35.

“That valuation should attract some value investors,” Mr. Winmill said. “With a stock like that, you can get twice the bang for your buck, because if the price of gold goes up, it doesn’t cost Newmont any more to produce it.”

Questions, observations, stock tips? E-mail Jeff Benjamin at [email protected].