Fed Is Creating Golden Opportunity

The gold fund manager believes the Fed's "reflation" efforts will exacerbate the dollar's decline and ultimately result in higher interest rates, eroding the appeal of equities as well as Treasuries. Loose fiscal policies -- and accompanying high federal and current account deficits -- will also contribute to the dollar's weakness and accompanying inflationary pressures.

Hathaway didn't discuss this, but others believe gold will also benefit if the Fed is unsuccessful in combating deflation, because investors' faith in the central bank will be decimated.

Golden Bullets

Other factors Hathaway cited for his optimistic view include:

Negative sentiment: In 1998, The Financial Times declared "Gold is Dead," which Hathaway said is analogous to Business Week's infamous "Death of Equities" cover in August 1979. Sentiment about gold has improved, especially in the past 18 months, but most on Wall Street still dismiss it as a relic.

Supply: Even as gold prices tumbled from 1987 until 2001, the supply of gold production expanded by about 5%, Hathaway observed. Currently, mine supply is declining because of the closure of older mines, environmental obstacles to permitting for new mines and industry consolidation. He also believes central bank selling, which persistently pressured gold in the late 1990s, will decline going forward as policymakers realize they were selling at the bottom. Notably, a common theme among conference presenters was how companies are getting rid of hedging programs in order to increase their leverage to gold prices.

Demand: The three-year bear market in stocks heightened investor demand for so-called alternative assets. Ultimately, asset allocators will move more toward tangible assets and view gold in the same regard as timber and/or real estate, Hathaway forecast. Because the market cap of the gold industry is so small, even marginal demand by pension funds and others of that ilk will have a huge impact on the sector.

A crucial element in the demand story is the World Gold Council-sponsored exchange-traded gold fund, which will allow investors to purchase a proxy for physical gold and "bring gold into the mainstream," Hathaway said. Trading in the gold ETF -- officially the Equity Gold Shares (GLD Quote) -- is pending Securities and Exchange Commission approval. Assuming that occurs, individuals will be able to trade gold as easily as, say, shares of Cisco (CSCO Quote). China's liberalization of laws that had prevented citizens from owning gold is another key source of demand.

Bottoms-Up

Although many gold shares had huge runs in 2001 and 2002, gold stocks -- as represented by the Philadelphia Stock Exchange Gold & Silver Index -- have lagged the metal. In the past 12 months, for example, gold is up 10% vs. 2% for the index. Hathaway believes that trend might soon "flip-flop" and the shares will outperform the metal, which has fallen swiftly since exceeding $370 per ounce in late May. On Thursday, gold futures fell 0.5% to $353.70.

Hathaway cited Barrick Gold (ABX Quote) as a favorite, even if only as a contrarian play. Barrick has outperformed the XAU this year, but underperformed its peers by a wide margin for some time prior because of disappointing earnings, a large hedging program (which the firm says it is unwinding and simplifying) and its ouster from the S&P 500 last year. (Hathaway's fund is long Barrick.)

Barrick has been anathema to gold bugs because of its hedging program, while Newmont Mining (NEM Quote) has been their favorite big-cap. Richard Russell, editor and publisher of Dow Theory Letters, is long Newmont shares and observed a close above $33 would establish a breakout from a "huge ascending triangle-type" base. Such a breakout could send Newmont "into the stratosphere," he wrote.

Newmont rose 0.6% to $31.68 Thursday, when RealMoney.com contributor Gary B. Smith made a similar observation about its ascending triangle.

Finally, Freeport McMoran Copper & Gold (FCX Quote) was the suggestion of John Burbank, managing partner at Passport Capital, a San Francisco-based hedge fund that is long the stock. Burbank's firm manages $100 million and was up 6% year to date after gaining 22% in 2002, both net of fees.

Because it is the world's largest copper producer, Freeport McMoran is often overlooked by gold investors. Its shares have also traded at a discount to peers because its main operations are in Indonesia, not exactly a bastion of political stability.

But if investors can look past those concerns, "this is a great way to be long for basic business reasons -- free cash flow [over $500 million annually] and good leverage to higher gold prices," said Burbank, who believes Freeport McMoran may soon increase its dividend.

On the most basic level, Freeport McMoran is the world's lowest-cost producer of both copper and gold. That makes it an intriguing play for those who see commodities being at the beginning of a long-term bull cycle, regardless of recent action in financial assets.