The case for staying in gold

Many investors have been pulling their money out of gold ETFs, seeking better returns. Some advisers, however, say that strategy could backfire. They point out that gold could bounce back if there is a sudden jump in inflation, a flare-up of the European debt crisis or a stock-market correction at home.

By Ian Salisbury
March 26, 2013, 10:31 a.m. EDT

Over the past decade investors have poured billions into exchange-traded funds that track the price of gold. Now with gold prices falling, many are yanking some of that money back out — a move investing pros say misses the whole point of owning the shiny metal in the first place.

Gold’s recent slump — down 4% so far this year — has turned many former gold bulls into bears. In the first two weeks of March, investors pulled $1.6 billion from gold ETFs, according to data compiled by BlackRock, the largest ETF provider. That follows outflows of more than $5.6 billion from the funds in February, the largest monthly outflow ever.

Many of these investors are simply seeking better returns: The decade-long gold rally may have stalled (or be over), but stocks are on a tear. So far this year, the Dow Jones Industrial Average has returned 11% and is hovering near an all-time high. “Some people chase momentum,” says Russ Koesterich, BlackRock’s global chief investment strategist.

But some advisers say that strategy could backfire. For starters, they point out that gold could bounce back if there’s a sudden jump in inflation, a flare-up of the European debt crisis (perhaps tied to the Cyprus crisis) or a stock-market correction at home. But more importantly, they say owning gold isn’t about buying low and selling high, but about owning an insurance policy for the long term: Investors that aren’t willing to swallow losses in good times won’t be in a position to reap the offsetting profits gold can deliver during a crisis, says Herb Morgan, chief executive of Efficient Market Advisors, an investment firm that specializes in ETFs. “Nine times out of 10 you should lose money” on gold, he says. “It’s like any other form of insurance.”

In recent years, however, gold investors have been able to have their cake and eat it, too, in large part because the financial crisis sent investors scrambling to safe havens. The SPDR Gold Shares—the oldest and largest U.S. gold ETF, with $63 billion in assets—posted gains in each of its first eight years on the market, including 2008, when it returned 3% while stocks lost more than a third of their value. An investor who bought $10,000 worth of SPDR Gold Shares in late 2004, when it first appeared, would have a stake worth nearly $34,800 today. In contrast, an investment in the S&P 500 would have grown to just $15,200.

It wasn’t necessarily supposed to be this way. Investing in gold was once the province of speculators and conspiracy theorists, but gold ETFs came with a seductive sales pitch that broadened the customer base. Fund marketers pointed to academic studies showing that a small amount of commodities like gold can smooth returns of a stock-and-bond portfolio over time. “It’s the ultimate diversifier,” says Jason Toussaint, managing director at the World Gold Council, the gold industry trade group behind SPDR Gold Shares.

And this year’s gold slump shouldn’t alter that thesis, say advisers. After all, an investor who owned a small amount of gold alongside a larger portfolio of stocks would still see overall returns smoothed, just as advertised. But it remains to be seen whether investors will stick around when gold provides a drag, rather than a boost, to performance. “It’s easier to buy into the story when you see an asset go up every year,” says BlackRock’s Koesterich.

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