First, let me assure, you I'm no gold bug. I haven't fallen for any of the micro-rallies that have punctuated gold's long descent to a near-20-year low of $252.80 an ounce in July. But I've got to admit -- even though I'm a little afraid to -- the powerful rally of the past two weeks is compelling.
I don't quibble with the fact that much of the uptick (do you still call a 30% increase an "uptick?") is explained by the two s-words that every bear dreads: short squeeze. After 15 European central banks announced two weeks ago that they will limit gold sales as well as gold lending for the next five years, those who had bet against gold had to scramble to cover short positions -- and many are scrambling still. Even the mining companies themselves, which had set up hedges to protect themselves against a further drop in gold prices, faced margin calls when the metal surged unexpectedly and they couldn't unwind their positions.
Investors can expect weeks -- maybe even months -- of volatility while the shorts and the hedgers sort themselves out, says Joseph Foster, portfolio manager for the
Van Eck Gold/Resources fund. When gold finds its equilibrium again, he predicts it will be in a trading range somewhere north of $300.
gold fund outlook
story last week, several skeptical analysts said they thought the European banks' agreement was much ado about nothing. But the gold watchers I spoke to feel otherwise. Without the pressure of the central banks on prices, they say, gold is free to move on fundamentals. And that direction is likely to be up.
"Is this the embryonic stage of a bull market in gold? I say yes," says James Bianco of
in Chicago, who isn't afraid to go out on a limb. "The dirty little secret is that the fundamentals have been positive for years."
Demand for gold, mostly jewelry, has exceeded the supply from mines and scrap by 500 to 1,000 tons a year in recent years -- a staggering gap that central-bank selling has nonetheless filled, year in and year out. Weakened demand from Asia last year cut the gap to a mere 200 tons, but jewelry demand worldwide rose 35% in the first quarter of this year, a rate of increase the
World Gold Council
expects to continue.
Here's another dirty little secret about gold: You don't have to be an inflationist to believe in it. Gold, always considered a hedge against inflation, is the latest in a long line of commodities to show signs of life in today's robust economy, even though inflation has been nil. Says Bianco: "It's demand-driven. Those big SUVs
sport utility vehicles we're buying are pushing up oil prices just like jewelry sales are pushing up gold. Is inflation coming back? I'm not so sure. Commodities can come back without inflation coming back."
Or maybe inflation
back and we just haven't noticed. Ray DeVoe, a portfolio strategist at
Legg Mason Wood Walker
, argues that inflation is alive and well -- it's just hiding in financial assets. Adding stocks to the basket of goods reflected in the
Consumer Price Index
in 1990 would have meant an annual inflation rate averaging 4.4% instead of 2.9% for the past nine years. Instead of running at a 2.3% increase this year, a "financially enhanced" CPI would stand at 3.8% -- enough to get folks thinking about protecting themselves.
DeVoe also keeps track of price hikes on little-ticket items -- a paper at the newsstand or a haircut. And while he hasn't updated what he calls his Trivia Index in about four years, he's starting to think it might be time.
The New York Times
costs him 75 cents now, up from 60 cents, and the barber in Spring Lake, N.J., is charging $10 a clipping, up from $8. And DeVoe swears he paid $2 more to see
Star Wars I -- The Phantom Menace
than he did to see
Time for an inflation hedge? You could buy some Treasury Inflation Protection Securities, or TIPS, the new inflation-indexed bonds. But after checking the table of total returns, below, why would you?
Gold-mining stocks, and hence gold funds, are leveraged investments. Production costs are fixed, so any increase in the price of bullion flows straight to the bottom line. Stocks will go up -- or down -- three to five times the change in bullion. It might seem easy to pick a gold stock -- after all there aren't many and their collective market value is less than that of
. But last week's hedging casualties --
got knocked down 25% in the midst of a gold rally -- proved that picking gold stocks is a lot more complicated than selecting a pair of earrings or a bracelet. "You have to be aware of a company's hedge position and whether it can meet margin calls," warns Van Eck's Foster.
The diversification of a mutual fund and the expertise of a good manager can make a difference. But is it enough to attract the attention of investors who've been antigold for so long? Foster's Gold/Resources fund rose 22.6% last quarter, ranking it well within the top-half of gold funds. And while he's seen some new money coming in, "it's not as much as you'd think." Now that the central banks are out of the picture, any uptick in inflation or political upheaval will bring investors back, Foster predicts.
Maybe. But I doubt I'll be one of them. Like I said, I'm no gold bug -- at least I'm not ready to place a big bet on gold yet. But for me and plenty of others, I suspect it's no longer just a four-letter word.
Anne Kates Smith is a senior editor at U.S. News & World Report in Washington. At time of publication, Smith had no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds.