By Matt McCall
The momentum in the gold market continues to build as the yellow metal rallies to new all-time highs. The strength in gold is not a short-term trend; it is on pace to close out 2010 with big gains, its tenth consecutive year of positive returns.
The big question now is: Is buying gold a viable investment strategy? Some argue the gold market will be the next bubble to burst. I, on the other hand, believe the long-term trend will continue for the foreseeable future.
Positive Factors Driving Gold Higher
For starters, gold has become an asset class added to the portfolio construction for the individual investors as well as the ultra-wealthy. In the past, gold would only be considered a useful investment during times of uncertainty and inflation. But today, gold has proven its ability to rise during both bull and bear markets and even in the face of deflationary fears.
The introduction of gold exchange-traded fund has made it easy for the individual investor to gain exposure to the metal and it has spurred the growth of the related ETFs. More on that in a moment.
There is no doubt that we live in uncertain times, and the ownership of gold as a hedge against geopolitical issues or any related governmental or terrorism problems is still alive and well. What's more, future inflation fears help fuel gold purchases, as investors grow worried that the US government is printing money like there's no tomorrow. My opinion is that inflation in the coming years is inevitable, and gold will be one of the top performers as the value of the US dollar plummets.
With investors losing confidence in the value of the US dollar, it's not a surprise to see money flowing into gold as a currency alternative. And average investors aren't the only ones moving their money; the central banks and IMF sold the lowest amount of gold over the last year since an agreement that was signed in 1999. Eurozone banks sold just 6.2 tons of gold; this is 96 percent below the amount sold last year.
Finally, momentum builds in gold with each passing high. The technical breakout will attract buyers who are willing to purchase the metal based solely on the charts and nothing else. This, in combination with all the factors mentioned, would be enough to push gold to $1500/oz by early 2011 — and possibly much higher — depending on the economic and political situation around the globe.
Picking Among the Gold ETFs
Investors who want to invest in gold without the hassle of buying gold coins or bullion can turn to gold ETFs. There are currently three choices for investors in the US. The SPDR Gold ETF (GLD) is the largest by assets and was the first to begin trading, in late 2004. The iShares COMEX Gold ETF (IAU) launched in early 2005, but greatly lags GLD in assets under management. The newest addition is the ETFS Physical Swiss Gold ETF (SGOL), which launched during the third quarter of 2009.
All three gold ETFs are backed by physical gold kept in vaults, but the major difference between SGOL and its two competitors is that SGOL keeps its gold in vaults located in Switzerland. The theory behind the move is that if war or some other geopolitical situation arises, the gold will be safer in Swiss vaults versus others in Europe or the US. Personally, I believe this is a useless selling point, because if vaulted gold worldwide is in danger, then Switzerland will likely have its own issues as well.
Even though GLD is the largest gold ETF by assets and the second-largest ETF in the US, its expense ratio is the highest of the three, at 0.40 percent. SGOL has an expense ratio of 0.39 percent and IAU comes in at a low 0.25 percent.
So which gold ETF is right for your portfolio? It comes down to expense ratios and liquidity. Both GLD and IAU average several million shares traded each day and the bid/ask spread is typically one penny. SGOL has sufficient liquidity, but it's not as good as its two competitors.
Based on these two criteria, IAU appears to be the better choice, due to its lower expenses. That being said, I own shares of both GLD and IAU for clients based on the timing of our purchases.
The Future of Gold
Naturally, there's great debate over the longevity of gold's current trend. As I mentioned above, there are several factors that could help push gold higher, and it will only take a few of them to continue fueling the bull market.
That being said, when bubbles burst, they really burst and the selling comes swiftly and quickly. A three-week sell-off that began in December 2009 sent shares of GLD lower by 11 percent. This was the end of the gold bull market in the mind of many, but we were lucky enough to hold onto our shares and ride the ETF to new highs in 2010.
The best strategy for playing gold is to use a stop-loss price on an ETF to protect your gains if you already own, or to limit your losses if you plan on buying in the near future. The 200-day moving average has been a key support level that both GLD and IAU have held above since January 2009. Several times the ETFs have pulled back close to the indicator, only to rally again to new highs.
But if the 200-day moving average is breached, it will be the ultimate sell signal for the gold bugs. The moving average is currently 10 percent below the latest close on the gold ETFs. My strategy for our clients will be to let the money ride on GLD and IAU as we watch the 200-day moving average closely.
Disclosure: No positions