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Wall Street Journal's lead story: Investors rush to gold
Investors Rush to Gold
Metal Hits New High;
Fans in the Mainstream
By E.S. Browning
The Wall Street Journal
Thursday, January 31, 2008
The new gold rush is on.
As inflation has picked up and the stock market has tumbled, investors seeking a safe haven have piled into gold, driving the metal to all-time highs.
Since mid-August, New York gold futures have risen more than 42%. After finishing down at the early-afternoon close yesterday, they shot above Monday's record of $927.10 in later electronic trading. The peak occurred after the Federal Reserve cut its target lending rates, which sent the dollar -- gold's big competitor -- lower.
Historically, the world's most enthusiastic buyers of the metal have been catastrophe-fearing "gold bugs" in places like India, where banks aren't always trusted and currencies can be unstable.
Today, a different class entirely is powering gold's rise: mainstream investors and money managers who once shunned it. They hope adding gold to their portfolios will help soften the blows of inflation, possible recession, the sagging dollar and gyrating stock prices.
"What we have seen in the last few years is a fundamental shift in attitudes toward the gold markets" by Western investors, says Paul Walker, chief executive at London precious-metals research firm GFMS.
Investors from Wall Street to Main Street are betting on what had long been a losing investment. After hitting $847 an ounce in January 1980, gold futures fell for almost 20 years, grinding down to $253 in August 1999, a 70% drop. Gold remained dull until 2001. Prices have more than tripled since then, but didn't exceed the 1980 record until this year.
The precious metal has been a horrible hedge against inflation. To keep pace with inflation going back to 1980, gold futures would need to be above $2,228 today. Believers see that as a sign that gold has a lot of room to rise, and predict that it will surpass the $1,000 mark this year.
Gold's renewed luster shows the extent to which unease has replaced optimism since 2000. The 1990s marked a period of hope about the information-technology revolution, declining inflation and easier global money flows -- all in a peaceful, U.S.-dominated world.
Today optimism is clouded by terrorism, war, declining U.S. prestige, a technology-stock bubble followed by a real-estate bubble, and the emergence of China and India as economic juggernauts. Investors' affection for gold perhaps reflects their shaken faith in the U.S. financial system and a strong dollar -- historically bedrock beliefs -- as the housing debacle spreads.
One advantage of gold, says Marc Stern, chief investment officer of Bessemer Trust, a New York institution that oversees $52 billion for wealthy families, is that it isn't regulated by any central banker who might be tempted to print money and thus debase its value. "Gold doesn't have a policy, gold doesn't have a central banker, gold doesn't have a printing press," he says, adding, "It is a form of insurance."
...Increase in Demand
There's also talk about gold prices benefiting from the difficulty of finding new metal deposits, and the likelihood that demand in developing countries will increase as their populations become wealthier.
Gold's backers are believed to include government-run investment pools called sovereign-wealth funds in China, Russia and the Middle East, seeking to diversify away from dollars and weather the market storm.
U.S. money managers think they can track gold's latest surge with some precision. They point to Aug. 17, when credit markets were seizing up amid defaulting low-quality mortgages. That is the day the Federal Reserve stopped signaling a desire to hold the line on interest rates, announcing the first cuts in the base rates it uses to regulate whether money is cheap or expensive. It cut the discount rate, the rate at which banks can borrow money from the Fed.
Some investors rightly concluded that the Fed would lower rates much more in later months, causing worry that the dollar would keep falling, adding to inflation pressures. Investor reaction was swift: On Aug. 17, gold began its latest sharp leg up.
That same day, a trio of managers at the mutual-fund group Waddell & Reed huddled. The Overland Park, Kan., firm oversees about $63 billion, mainly for individual U.S. investors. Soon, Michael Avery, Dan Vrabac and Ryan Caldwell, the three men who manage the $13.6 billion Asset Strategy Fund, Waddell's largest investment pool, were buying more gold.
"Dan, Mike, and I got together and said, there has been a clear change in Fed policy," Mr. Caldwell recalls. "It was around the time of the flip-flop from the Fed that we decided we needed to get the bullion holdings up."
At the end of June, the fund held 2% gold. Disappointing profit reports from major banks and brokerage firms then led the managers to boost gold holdings to 3%. After the Fed's August decision, they began buying more bullion -- in the form of hundred-ounce gold bars stored at a bank in New York -- and exchange-traded funds that track gold's price. By autumn, the fund was 10% gold. The fund today holds $1.51 billion in gold.
Its defensive approach has been attracting new money. Since early December, Mr. Caldwell says, the fund has taken in $2.3 billion, 10% of which it poured into bullion and gold exchange-traded funds, or ETFs.
It wasn't just the Fed that made the Waddell managers move more heavily into gold. They also point to troubled credit markets, developing-world prosperity and U.S. public and private debt that weighs on the dollar. They have made other bets against the dollar, investing in the currencies of China, Russia, and the United Arab Emirates. They are tilted toward Asian stocks over U.S. stocks.
The managers had been as much as 20% invested in gold in 2003, but cut that back heavily around a year ago. They noticed that, after the creation of ETFs made it easy to invest in gold, the metal became more closely correlated with stock movements, which wasn't what they wanted. As the credit crunch deepened last summer, the correlation faded, which boosted their interest in gold again.
...Change of Approach
The long bear market for stocks from early 2000 to October 2002 made many investors change their approach. They began looking for what they call "noncorrelated assets" -- investments that wouldn't track stocks and bonds but would show independent strength. They put money into things like real estate, timber, private-equity investment pools, hedge funds, industrial commodities -- and gold.
ETFs and other instruments that track gold's value have made it easy for money managers to invest in a commodity that was once cumbersome to own. In the past, investors had to buy bars, coins, futures, or shares in gold-mining companies. Now, they can buy gold as simply as shares of stock.
Doubters view gold's failure to keep pace with inflation as evidence of its risk. While gold is used in jewelry, dentistry, and electronics, the main reason for its recent rise is speculation and fear. Unlike companies, loans, or land, gold bars owned by investors produce nothing. They don't pay dividends. They sit in bank vaults collecting dust. Their owners rarely visit, and must pay for storage. They can be melted down to make jewelry, but lately gold has become so expensive that many consumers are looking for cheaper ways to adorn themselves.
It is highly unusual for traditional investors such as mutual funds and trust companies to invest so much in a commodity they once viewed as a nonproductive asset. Until recent years, central banks around the world were selling their gold holdings, at prices far below today's prices. Now some central banks are buying.
Three years ago, Bessemer Trust had no money invested in gold. It has about $300 million today, due partly to new purchases and partly to investment gains, and plans to buy 10% more over the next few weeks. Its managers say they believe the firm's gold stockpile is the greatest in its 100-year history, in either dollar or percentage terms. That period includes the Great Depression, two world wars, and the 1970s oil crisis.
Mr. Stern, Bessemer's chief investment officer, says his firm's burgeoning gold purse dates from a decision three years ago to create a portfolio dedicated to hard assets that will do well even if inflation surges. He recognizes that gold won't necessarily be a good investment forever, and can foresee a day when Bessemer would cut back. But not now.
Bessemer's hard-asset fund includes energy investments, industrial materials, agricultural grains, commercial real estate, inflation-protected Treasury bonds, and precious metals. Precious metals, mainly gold, have been growing as a percentage of that fund.
Bessemer isn't projecting a deep recession. Mr. Stern isn't too worried about inflation right now either, figuring that global competition will keep overall inflation in check. But he believes lower interest rates mean a lower return from bonds and a weaker dollar, which should help gold. And, he says, "You just need to look at the cost of production, the [small] number of new mines coming on, the difficulties meeting demand, and the varied sources of demand."
Other gold investors are unhappy with central-bank policy.
"I am not a fan of what central banks have been doing," says Brett Gallagher, who helps oversee about $63 billion in international investments as deputy chief investment officer at Julius Baer Investment Management, a New York subsidiary of Zurich's Julius Baer Holdings. "Central banks have created rolling bubbles from technology to housing" by providing too much money to the financial system over the years, Mr. Gallagher says.
Because of the Fed's easy-money policies, "global investors in general are saying, 'We don't feel the dollar is a good store of value,'" and they are diversifying into other assets, he says. His fund holds gold-related stocks as well as other commodities-related shares that he thinks will benefit from a weak dollar. "Our interest in tangible assets such as gold increased in the fourth quarter" of 2007, he says.
There are signs that ordinary investors are following the suits. OppenheimerFunds has a $2.2 billion fund called the Gold and Special Minerals Fund that is 85% invested in gold-related stocks, notably mining companies. Its manager, Shanquan Li, believes that dollar weakness, tight supplies, and world-wide demand could push gold to $1,100 or more this year, although he predicts the average 2008 price to be around $900.
That isn't too optimistic, given that gold is above $900. But his caution isn't holding back the fund's investors, almost all of whom are ordinary individuals. In 2005, his fund had less than $40 million in net inflows. In 2006, net inflows were above $250 million and in 2007, more than $600 million.
What could tarnish the gold bet? Waddell's Mr. Caldwell thinks the biggest short-term threat would be a coordinated international push to lower interest rates world-wide. "That would help the dollar against other major currencies," he says, and could hurt gold.
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