With gold headed back toward its highest level in decades, why are so many gold fund managers holding so much cash?
Take Frank Holmes, chief investment officer at U.S. Global Investors in San Antonio. His $250 million
Gold Shares (USERX) held 16.4% in cash as of Dec. 31, while the $1 billion
World Precious Minerals (UNWPX) had 14.5% of its assets in cash at year's end.
While it might seem like a fund with that much money on the sidelines would have missed out on gold's rally of 20% from its low of around $560 an ounce last October, Holmes says it has provided much needed flexibility.
"What happens is that when the stocks really get clobbered, I have the money to buy them," the fund manager says.
In particular, when prices fell back in the second quarter of last year, he used the funds to increase his stake in miner
, currently the top holding in both funds. He also bulked up on
Holmes' cash levels have actually come down from the end of the second quarter of last year, when they reached 28% for Gold Shares and 20% for World Precious Minerals. Because investors tend to chase performance and buy at the top of the market, he had a lot of new money to put to work at exactly the wrong time. In May of last year, U.S. Global Investors was raking in up to $50 million a day from both retail and institutional investors, most of it into the two precious metals funds.
So Holmes let the cash pile up.
He's not alone in his penchant for cash. Other specialty
also seem to hanker after the green stuff as much as the yellow, albeit to a lesser degree.
The Fidelity Select Gold Fund (FSAGX) held 11.9% of its $1.5 billion in cash at the end of 2006, down from almost 15% in March.
Other than cash, the fund's top holdings at year's end included
And as recently as June, the $1.1 billion
First Eagle Gold Fund (SGGDX) had 14% of its holdings in cash and other short-term, cashlike securities, although that figure had dropped to 5% by year-end.
The fund's largest holding by far is bullion, at 26% of total assets, followed by
at 10% and Barrick at 8%.
To put these figures in perspective, the average diversified U.S. equity fund holds 3.94% cash, according to Morningstar.
Fund flows aren't the only determinant of how much money Holmes keeps in cash. Gold, as he sees it, is a currency, and just as there are times when the dollar or the euro are overvalued or undervalued, the same is true for gold.
The fund manager uses proprietary algorithms to determine when the different instruments have diverged meaningfully from a trend. "We are not Koala bears hugging an index," he says, referring to penchant of some fund managers to try to replicate the performance of a benchmark.
This strategy has helped Gold Shares and World Precious Minerals log five-year annualized returns of 35% and 42%, respectively, as of Thursday's close, according to Morningstar.
By comparison, the 44 precious metals funds tracked by Morningstar have five-year annualized returns of 29%, on average.
Market-timing may not sit well with all investors, however. For one thing, you need to have faith that a fund manager can make the right calls. "It's very hard to do well that way," says Marc Lipson, professor of finance at the Darden graduate school of business administration.
Moreover, funds that have a lot of cash may not perform as intended in your portfolio. It's widely accepted that keeping a small portion in commodities, say 5% to 15%, can reduce a portfolio's volatility. But investors who put 10% of their assets in a gold fund that has 30% of its assets in cash would have only a 7% exposure.
"If my objective is to have exposure to a particular asset, I might not want them to be timing the market," adds Lipson.
Investors may also wonder why they're paying an investment manager. Morningstar estimates the average expense ratio for specialty precious metals funds at about 1.4%, compared to the mean cost of 0.62% for all money market funds.
"If you leave a lot of money in cash, then sooner or later someone says, 'I could have done that'," says Jeff Christian, managing director at New York-based specialty consulting firm CPM Group. "Fund managers can take a lot of criticism."
At the other end of the spectrum, there are some gold fund managers who are quite happy hugging an index.
"Our stance is that gold is in a bull market and most human beings are not clever enough to catch all the twists," says John Hathaway, portfolio manager of the $900 million
Tocqueville Gold Fund (TGLDX). "I don't think any investor is paying me to be a market-timer."
He says that, as of the end of December 2006, his fund held just 1% in cash. It has logged respectable 31% annualized returns over the past five years, according to Morningstar.
Tocqueville Gold's largest holding was physical bullion at 7% of total assets, followed by
and Goldcorp, which each accounted for about 5% of the portfolio.
Simon Constable has a stake in the Fidelity Select Gold Fund.