Fool's Gold? Precious Metal Funds Are Up, But Prospects Aren't

If this week's stock market jitters have made you think about investing in something "solid" like gold, think again. Although precious metals funds were up about 2.4% on the year as of Wednesday while the stock market plummeted -- as is often the case with precious metal mutual funds -- all that glitters is not gold.

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The category has been looking up of late, but analysts say much of the move is due to technical market factors and that investors should not mistake what could be a momentary blip for a comeback. Furthermore, a look at the long-term track record of precious metal funds is about as dismal as it gets. Even some of the better-performing funds have long-term returns in the red, making this area one of the worst performing in the mutual fund world.

"If you are going to invest in a precious metal offering, it should be no more than 5% of your portfolio," says Morningstar equity fund analyst Kelli Stebel. "It can be a very volatile area, and you certainly wouldn't want to build your portfolio around this area."

Precious metal funds, which invest both in mining companies and the metals themselves, typically have been a place for investors to sock money as a defensive play in a down market or as a hedge for bullish bets. But the funds have been hampered in recent years by lackluster gold prices, a lengthy bull run and investors' forays into other defensive alternatives.

Heavy Metal Leading Precious Metal Funds Year-to- Date*
Fund Name	Year-to- Date	One- Year	Three-Year Annualized	Five-Year Annualized
(SGGDX Quote)First Eagle SoGen Gold	12.12%	-3.53%	-5.88%	-12.64%
(RYPMX Quote)Rydex Precious Metals	7.83	-4.13	-10.96	-17.64
(MNTGX Quote)Monterey OCM Gold	7.51	-9.68	-9.67T	-15.25
(LEXMX Quote)Pilgrim Goldfund A	6.64	-4.04	-6.69	-15.38
Invesco Gold C	5.70	3.15	N/A	N/A
(SCGDX Quote)Scudder Gold S	5.34	6.71	-5.27	-12.57
(BGEIX Quote)American Century Global Gold Inv	5.00	-10.31	-12.75	-19.89
(EKWAX Quote)Evergreen Precious Metals A	4.94	0.36	-7.33	N/A
(OPGSX Quote)Oppenheimer Gold & Special Minerals A	4.28	-0.22	-1.28	-8.03
Franklin Gold & Precious Metals B	4.12	7.79	N/A	N/A
Category Average	2.43	-5.87	-8.87	-16.70
*Data through 3/14/2001 Source: Morningstar

Investors historically have turned to gold as a hedge against inflation, because its value increases during times of inflationary pressure. Gold and other precious metals are also sometimes used as an alternative to the stock market, since their prices often get a boost when there is turbulence in the equity markets.

Predictably, the bull market of the late '90s made investing in gold about as interesting as watching C-SPAN. In the past three years, the average monthly spot price for gold has hovered anywhere from $261.80 to $298.90 an ounce, a range not seen since 1979, according to figures from the New York Mercantile Exchange. Gold prices throughout the '80s and much of the '90s, meanwhile, fluctuated anywhere from a high of $672 in January 1980 to the $300 to $400 range.

"Gold has been trading at 20-year lows for quite some time," says George Gero, senior vice president of investments at Prudential Securities in New York. "As the stock market has been booming, gold has been dragging." Morningstar's Stebel adds that central bank selling of gold into the markets over the years has flooded the market with supply, further diluting the value of the gold.

Lackluster metal prices also have conspired to make life miserable for mining companies, the results of which are highly dependent on commodity prices.

"There's no question that the sector hasn't been performing well, largely because of the commodity prices," says Barry Cooper, precious metals analyst for CIBC World Markets. "In essence, that's eliminated 50% of the operating margin of all of these mines, hence virtually all of their earnings."

So what's up with the solid performance of late? Prudential's Gero says some short-covering in the gold market is occurring as lease rates, or the prices paid to borrow gold, have been increasing steadily. The one-month lease rate for gold last week jumped as high as 6.2775%, compared to 2.0325% on March 1. While lease rates as of midday Friday are back down to 2.3575%, that's still a jump from the rate of 0.7875% at the beginning of this year. Market-watchers say higher lease rates could be a sign that central banks want to make gold more difficult to borrow, which in turn, should increase the value of gold by making supply scarce.

The stock market's volatility is also seen helping the sector somewhat, although Morningstar's Stebel notes that assets such as real estate, natural resources and small-value stocks are steadily replacing gold's role as an inflationary hedge.

In order for gold and other precious metals to experience a sustained rally, the economic or political situation would need to be pretty dire for a while, say analysts, who note that events in the past year that should have helped gold, like the U.S. election debacle, higher oil prices and the renewed bombing in Iraq, have not.

"There's been plenty of opportunities for gold to perform well in the past, and it's never lasted more than a week or two," Cooper says.

Still, if you are expecting economic Armageddon and want to give yourself some exposure to gold and precious metals, Morningstar's Stebel says investors should stick to funds with a lot of assets in North American mining companies, which she says have cheaper costs and tend to weather drops in commodity prices better.

She also suggests that investors look at funds that invest in the commodities themselves, which she says are less volatile than holding the mining companies. Among Stebel's top precious metal picks are the (VGPMX Quote)Vanguard Gold & Precious Metals and (OPGSX Quote)Oppenheimer Gold & Special Minerals.