Gold's long-term outlook positive despite short-term dip

Many fund managers say that gold will resume its rise as central banks pump more money into the economy in order to avoid a recession. Gold fares well when individuals loose faith in paper currencies and many investors believe that is where the US economy is heading.

By John Waggoner, USA TODAY
October 6, 2011
ABC News

People betting on a dead dollar or red-hot inflation were disappointed in the third quarter, as the average gold fund posted a 6.4% loss. But managers say gold could resume its rise as central banks pump more money into the economy to avert a recession.

Gold bullion fell to $1,624 an ounce at the end of the third quarter, up from a high of $1,895 on Sept. 6. Despite that tumble, gold bullion was up for the quarter. Most gold funds, however, invest in gold-mining stocks, which tumbled more than the yellow metal and turned the group negative for the quarter.

Gold traditionally fares well when people lose faith in paper currency. And for the past decade, gold funds have rewarded investors amply. Gold closed at $292.10 in September 2001, and has soared 456% since then. The top mutual fund for the past 10 years, USAA Gold fund, has soared 937%, according to Lipper, which tracks the funds.

Recession fears and worries of global financial meltdown prompted the gold sell-off at the end of the third quarter. Gold thrives on inflation, and a recession generally causes a drop in prices.

The prices of most base commodities, such as copper, tumbled as traders worried about the debt crisis in Europe. Gold came along for the ride.

And, says Dan Denbow, manager of USAA Gold, traders simply wanted to take their profits and move to cash as worries about another global meltdown mounted. "Gold was overbought and had run up too far," he says.

But managers remain optimistic about gold, because central bankers are likely to keep injecting money into the economy to avoid recession. The Federal Reserve has said it will keep interest rates low through mid-2013, which makes loans cheaper for businesses and consumers. Currently, short-term interest rates are negative, once adjusted for inflation, which ran at a 3.8% pace through August.

"The Fed's monetary policy is the obvious lever for gold," says Caesar Bryan, manager of Gamco Gold.

Managers expect that European central banks will also lower rates to combat recession. "We're standing aside and waiting for the Europeans to come up with their plan of attack," says Robert Cohen, manager of Dynamic Gold and Precious Minerals fund. "Ultimately, that translates into more printing of money."

Cohen expects gold to ultimately rise above $2,000 an ounce.

For investors, the choice is whether to buy funds that invest in the physical metal, or funds that invest in gold-mining stocks. Normally, gold-mining stocks fare better than the metal itself. Consider a gold mine that can produce gold for $1,000 an ounce. When gold rises from $1,400 to $1,600 an ounce, a gold investor has gained 14%. But a gold miner's earnings have soared 50%, to $600 from $400.

Some gold miners are also increasing their dividends. "They have great cash flow," USAA's Denbow says.

If you're considering a fund that invests in gold, be sure to consider the tax consequences. Long-term gains from funds that invest in gold-mining stocks are taxed at a maximum 15%. Gains from funds that invest in the physical metal are taxed at the same rate as collectibles — 28%.

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