Small investors are hoarding gold

By Larry Light
The Wall Street Journal
Thursday, July 9, 2009

http://online.wsj.com/article/SB1000142405297020357730457427595335541288...

Worried about a harrowing, inflation-ridden future, Scott Van Steyn has found the answer in a batch of glittering one-ounce gold coins. In fact, they make up a large chunk of the physician’s assets.

"There's 2,000 years of history to show that gold is the best thing to own during bad inflation," says Dr. Van Steyn, a 45-year-old orthopedic surgeon in Columbus, Ohio. "People used to laugh at me for buying gold. They don't anymore."

More and more investors are acquiring physical gold, or bullion, in the form of small bars the size of iPhones or coins like American Eagles and South African Krugerrands. Individuals' bullion purchases almost doubled last year, amid apocalyptic panic over the financial system, to 862 metric tons.

Lately, that panic-driven demand has given way to a more subdued, yet still potent, fear that stocks will suffer as the recession grinds on for a long time, so gold makes sense. At the same time, there's a rising anxiety about inflation among people like Dr. Van Steyn, resulting from the Obama administration's massive stimulus spending.

"When you're in uncharted economic waters, people buy gold," says Shawn Price, manager of the Touchstone Large Cap Growth fund, which holds several hundred ounces of the stuff.

Certainly, holding bullion carries its own risks, such as keeping it safe. And you also run the risk that gold, as it has in the past, will disappoint investors lured by the storied metal’s special gleam.

Although gold buying by investors has fallen from it 2008 peak, it is still high. The first quarter's 130 metric tons is 50% higher than this decade's average quarterly volume, and analysts say sales for the rest of this year should remain strong. (A metric ton is 10% heavier than a standard U.S. ton.)

While gold use for industrial and jewelry purposes is way down because of the recession, robust investor demand has kept prices aloft. In April, when talk of inflation resurfaced, gold prices climbed over $900 per ounce, hitting $983 in early June. It has since drifted down to $909, thanks to such factors as India's recent doubling of import taxes on gold. For much of the last decade, though, gold has been on a tear, with prices tripling since 2002. Over that time, the Dow Jones Industrial average is down 10%.

The U.S. Mint, the federal agency that makes America's coins, has had to step up its gold-coin production. This year's sales through June are just shy of the 794,000 American Eagles it peddled in all of 2008. A few months ago, it had to freeze sales of some of its gold items due to an order backlog.

All this comes at a time when the supply of newly mined gold is dwindling. Fresh discoveries of deposits are on the wane, and numerous cash-for-gold businesses have sprung up to feed demand. Some employ a Tupperware-party format, where people hold gatherings at home to sell dealers their jewelry and other gold items that can later be melted down.

Many mainstream financial advisers, however, are leery about owning gold in its physical form. "If we get total chaos, are you going to chip off a piece of your gold to buy milk at the store?" says Michael Goodman, president of Wealthstream Advisors in New York.

And while they often recommend putting 10% of your portfolio into commodities such as gold for the long term, a number of advisers think that no gold should be included, physical or held in other vehicles such as exchange-traded funds. The thinking is that gold performs best during times of unrest, and not so well at other times.

Over the past four decades, gold has been one-third more volatile than the Standard & Poor's 500-stock index, and yet has delivered a lower return: an annualized 8.4%, versus 9.1% for the S&P index, says Steve Condon, director of investor advisory services at Truepoint Capital in Cincinnati.

As an inflation hedge, gold's record isn't perfect either. After reaching a record high of $850 per ounce in January 1980, gold’s price fell almost 44% in two months. It didn't reach $850 again until January 2008, meaning it was flat while inflation rose 175%, Mr. Condon calculates. Indeed, today's gold price is far below its 1980 apex when inflation is factored in: That $850 is worth $2,206 in today's dollars.

Gold as a store of value has been getting a bad rap from some quarters at least since the days of economist John Maynard Keynes, who once sneeringly called it a "barbarous relic." Contemporary gold lovers bridle at such slights. "Owning bullion," says gold investor Chris Martenson, 46, a scientist from Montague, Mass., "is buying insurance against the unknown."

Gold's tangible quality is reassuring to its owners. Gold owner Richard Dempsey, 63, a vice-president at Bank of New York Mellon, keeps some of his 60 gold coins in a safe at his Point Pleasant, N.J., home and some in a safe-deposit box. "I like to know it's there," he says.

The biggest threat to bullion, aside from a price collapse, is theft. "The only way to lose gold is if someone steals it," says Dan Deighan, president of Deighan Financial Advisors in Melbourne, Fla., who advocates that his clients own some bullion.

To its fans, bullion brings a feeling of stability that evokes the days when monetary systems were based on it. But there's no need to own the actual metal in order to invest in it. Among the alternatives: funds dedicated to bullion or gold-mining companies, or stock issued by mining companies. Some advisers say investors should opt for gold exchange-traded funds that hold actual gold, because they are less of a hassle and easier to trade.

Gold-mining stocks often don't correlate well with ETFs dedicated to physical gold, and sometimes lag the price of gold. SPDR Gold Shares, which holds gold, returned 4.9% last year and 5.4% in 2009. Meanwhile, Market Vectors Gold Miners, owner of mining stocks, lost 26% in 2008 and is up 11.6% this year. One problem is that miner stocks track the broader stock market, and gold prices don't. Another is that the miners have capital costs and can waste money on fruitless digs.

The truest gold buffs, though, want nothing to do with ETFs or mining stocks. Mr. Martenson, who runs an investing Web site, dismisses them as creatures beholden to untrustworthy managements and financiers. "I've lost faith in how Wall Street does business," says Mr. Martenson, who keeps more than half his portfolio in bullion.

Another way to play gold is via the commodity futures market. You can buy a 100-ounce contract for August at $909,000, putting 10% down. But as with all futures, you run the risk of a huge wipeout if ever-jumpy prices drop.

Owning bullion has its own challenges. You have to worry about storing, securing and insuring it. Under a standard homeowner's policy from Allstate Corp., for example, gold kept in the house is covered only up to around $200 in value. Special riders are available: Allstate will ensure $20,000 worth of household gold for an annual premium of $684, with a $250 deductible, for example.

Several dealers will store gold for customers, employing high-tech security measures reminiscent of the movie Ocean's Eleven. FideliTrade Inc. has a vault in Wilmington, Del., with seven sets of steel doors. FideliTrade charges 0.75% of your gold assets annually for storage. Unlike most other goods, gold is impervious to water damage. An intense fire would melt gold, but couldn't destroy it.

Buying the stuff is not cheap. Markups on bullion are around 5%. Since the Internal Revenue Service considers gold a collectible, not an investment, it is ineligible for the 15% maximum federal capital gains tax -- the rate for gold is 28%.

Unlike stocks and bonds, gold pays no dividends or interest. You can keep gold in an individual retirement account, but must forfeit the joy of holding the metal. IRA gold must be sequestered in trust by a bank, where you can't mess with it for nonretirement purposes.

Despite renewed investor interest, most gold is still dedicated to ornamental or industrial purposes. According to the World Gold Council, a trade group, there are 163,000 metric tons of gold in human hands, with 51% of it in jewelry and 12% used for such practical applications as electronic circuitry and dentistry. That leaves 16% for private investments, with much of the rest held by central banks.

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