Should Investors Buy Gold, Stocks or Both?

BOSTON ( TheStreet) -- Investors may be dumping gold, but they certainly don't appear to be putting the proceeds to work in equities.

Gold prices are down more than 10% this month from its all-time high, while the S&P 500 has slipped more than 2%, dispelling the notion that gold is the best safe-haven for investors in tough times. Instead, U.S. Treasuries have been the go-to place for worried investors, even with yields at record lows.

Gold was considered the perfect portfolio hedge against the threat of inflation, while others (most notably billionaire investor George Soros) said gold had become the ultimate speculative bubble. Before last week, gold prices had held up as equities fell apart under the weight of uncertainty from the European debt crisis. Central banks around the world were joining the gold frenzy, becoming net buyers of the precious metal for the first time in two decades.

However, gold for December delivery fell to nearly $1,500 an ounce this week from a high above $1,920 earlier this month. Late Friday, the CME Group announced a 21% increase to margin requirements on gold, which went into effect Monday. The increased margins were one of the big reasons gold fell sharply during Monday's session.

"The recent price decline in gold is likely related to margin hikes that occurred in the gold market, which forced people to sell out of overleveraged positions," says Adam Strauss, a co-portfolio manager of the Appleseed Fund ( APPLX), which has been a holder of gold exchange traded funds, or ETFs, like the Sprott Physical Gold Trust ( PHYS).

The plunge in the yellow metal put a hurting on even the most successful fund managers. In a recent blog post, Tsachy Mishal, portfolio manager at TAM Capital Management, highlights a circulating rumor that hedge fund manager John Paulson is liquidating as nearly everyone of Paulson & Co.'s largest positions has blown up. Paulson is the biggest holder of the SPDR Gold Trust ETF ( GLD), which had been Paulson's best-performing holding until it dropped about 10% in September.

Paulson's situation shows how tough it can be in this market for even the most successful investor. After reportedly booking a record profit of $5 billion in one year thanks to smart bets on housing and financial stocks, Paulson's Advantage Plus was said to be down 34% this year through August.

If Paulson and others are cutting exposure to gold, they aren't alone. Michael Pento, president of Pento Portfolio Strategies, said that when countries are under duress, they will dump whatever they can. "And there just isn't any asset that has performed better in the last dozen years than gold and commodities," he writes of gold.

Though investors may be liquidating their gold holdings, it's not because there is better value in equities. Fund managers who own gold, like Strauss, aren't eager to put the cash to work now in equities that appear expensive.

"In recent weeks, we have been buying equities very selectively, but we are still keeping a lot of our powder dry," Strauss says. "Europe is a mess, the global economy is slowing down, and most stocks are still priced too high to provide us with any kind of margin of safety. We had been buying some equities. But if you're looking to ask whether we have substantially reduced our gold position to buy stocks, the answer is no."

The price decline in gold actually makes it an even more attractive investment now, given the 2% jump in the S&P 500 since Thursday. Pento argues that it's positive for gold that the commodity is now moving from weak hands to a diffused group of strong ownership. "That will be beneficial for gold prices in the long run and this recent selloff should be a welcomed opportunity for investors to accumulate a more substantial position," he adds.

Strauss says the fundamental factors that make gold an attractive investment now haven't changed at all.

"First of all, gold is more attractive today than it was a week ago," Strauss says. "In our opinion, the investment thesis for gold remains intact. It makes sense for most investors to consider an allocation to gold. However, it is a volatile asset class and you have to be willing to hang on despite the volatility. "

-- Written by Robert Holmes in Boston.

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