Can Gold Regain Its Shine?

NEW YORK ( TheStreet) -- Gold ETFs have been sinking. During the past 12 months, SPDR Gold Shares ( GLD) and iShares Gold Trust ( IAU) each lost more than 25%, according to Morningstar. This year shareholders withdrew $21 billion in assets from SPDR Gold, a huge outpouring for a fund that now has $37 billion, according to IndexUniverse.com. Rising interest rates have propelled the flight. When yields climb, bonds become more attractive, and investors tend to dump gold, which produces no income.

Is this a time to stay away from gold? No, argued panelists who spoke last week at the Morningstar ETF Invest Conference in Chicago. While gold may be an erratic performer, a small stake can help to diversify portfolios, the speakers said. Investors should keep from 2% to 10% of assets in gold, said Juan Carlos Artigas, head of investment research for the World Gold Council, an industry group. "For most investors, the rationale for holding gold should be capital preservation," Artigas said.

John LaForge, who heads the commodity team of Ned Davis Research, cautioned that gold may not provide large returns any time soon. He said that gold bull markets typically last 16 years. The current cycle has now been running for 12 years. "In baseball parlance, we are in the 7th or 8th inning," said LaForge.

After hitting a low of $255 an ounce in 2001, gold soared, reaching a high of $1,855 in 2011. Since then the price has settled to $1,304. The bull market performance was particularly notable in the turmoil of 2008. For the year, the SPDR gold ETF returned 5.0%, while the S&P 500 lost 37%.

Much of the sharp decline in gold prices this year can be traced to selling by hedge funds and other investors. In the second quarter this year, global demand for gold dropped to 856 tons, down 12% from the year before, according to the World Gold Council. But the outlook for gold is not completely gloomy. Sales remain steady from industrial customers who use gold for components of smart phones and other products. Demand from consumers in the emerging markets has been skyrocketing. Sales in China increased 54% in the second quarter, while demand in India grew 51%. The growth in the emerging markets should help to prop up prices over the long term, said Artigas of the World Gold Council.

Consumers in India have long bought jewelry for wedding presents. This year sales accelerated as prices dropped and jewelry seemed to be a relative bargain. In addition, many Indians bought gold to preserve their assets at a time when the rupee has been plummeting. "In many countries, gold is for adornment and also a savings mechanism," said Artigas.

Central banks have been another major buyer of gold, purchasing 71 tons in the second quarter. That represents a major shift from earlier in the decade when the banks were net sellers. As confidence in the dollar slips, banks have been selling dollars and buying gold. "Banks in the emerging markets need to diversify their holdings," said Artigas.

LaForge of Ned Davis said that investors should hold gold as part of a diversified basket of commodities. During periods of inflation, commodities of all kinds tend to rise. But there are often times when gold does not move in lockstep with other commodities. During recessions, prices of energy and other commodities can decline as demand falls. At such times, prices of gold may remain firm as nervous investors seek stability.

LaForge said gold often does not track prices of base metals, such as copper and zinc. The base metals tend to track the outlook for China, since it is the biggest purchaser. But gold does not necessarily rise and fall along with China's GDP.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.

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