Stock Crash Has Put Gleam Into Eyes of Gold Investors

The stock market crash and heightened fears of a recession have spurred many small investors into a mini-gold rush.

Sales of gold bullion coins--a popular method for small investors to test their mettle in metals--are up sharply since Black Monday two weeks ago. Sales of the American Eagle gold coin, for example, have doubled in two weeks, reports a spokesman for the U.S. Mint, which produces the popular coin.

Investors are buying, experts say, as part of classic “flight to quality� away from stocks. They see gold--traditionally a favorite hedge against inflation and international economic crises--as a security blanket against possible bad economic times ahead.

But will the metal’s price continue to glitter? Should you join this gold rush?

While gold remains a good long-term investment, investors hoping to make a short-term profit may be better off delaying gold purchases until the outlook for the metal becomes clearer, many experts say.

There is no clear consensus about whether gold prices in the short run will continue their strong performance of the past two years, in which they have risen 65% to a close of $469 an ounce Friday from $284 in February, 1985.

That price rise was accomplished largely because of investor fears of renewed inflation. But since the stock market crash, opinions have become widely split about whether higher inflation is still in the cards. No one knows for sure whether the Federal Reserve and other foreign central banks will fight inflation or fight a possible recession that could result in part from the stock crash.

“The inflation-deflation picture is sufficiently unclear that it warrants waiting,� said John H. O’Connell, senior metals analyst for Refco Inc., a leading commodities and futures brokerage based in New York. “We just don’t know what these guys (central bankers) are going to do.�

Bulls Encouraged

Experts who are bullish on gold argue that recent sharp declines in the U.S. dollar, spurred in part by the Fed’s recent move to pump money into the financial system, could spur inflation. Gold bulls also argue that the crisis in the Middle East could worsen. Also, output from South Africa, by far the world’s biggest gold producer, continues to drop due to strikes and racial unrest at its mines.

Bulls also are encouraged by the fact that gold prices increased in the past two weeks despite reported heavy selling of the metal from wealthy stock market investors facing margin calls, which are demands by their brokers for cash or securities to replenish the collateral backing loans to buy stock. There also has been heavy selling of gold held by some securities firms that needed cash to cushion losses from the stock crash, said Jeffrey A. Nichols, president of American Precious Metals Advisors, a New York investment advisory firm.

But pessimists on gold argue that the threat of a recession within the next year or so will reduce pressure on inflation, despite the Fed’s easy money policies. Gold bears also note that investors who lost large sums from the stock crash may cut back on gold purchases. They also worry about reports that central banks have been selling gold in exchange for U.S. dollars to stop further declines in the greenback.

Good Long-Term Investment

Another bearish argument: Gold prices already have run up quite considerably in the past two years. Most of the big profits, at least for the short term, may have already been made, bears say.

But while there is no clear consensus on the short-term outlook for gold prices, most experts agree that gold is still a good long-term investment that should represent between 5% and 10% of a diversified investment portfolio that also includes bonds, money-market funds, savings and possibly stocks, real estate and other investments.

Gold prices have consistently beaten inflation over the past 15 years, particularly in the inflationary 1970s, according to data compiled by the Wall Street firm of Salomon Bros.

A big mistake that small investors make in gold investing “is to try to predict the short-term future of gold prices,� said Margaret Welch, a Washington financial planner. “But if you look out 10 to 15 years, there is a possibility that all those inflationary conditions (of the 1970s) can return again.�

Investors who want to go ahead and buy gold now, despite the unclear outlook, should consider using dollar-cost averaging. This is where you divide up how much you want to invest into installments and buy over time--for example, once a month for six months. This is a good way to hedge your bets in case gold prices go down instead of up. Later installment purchases can be made at cheaper prices.

If you are more willing to gamble on higher gold prices, consider buying gold mining stocks or, better yet, mutual funds that invest in mining stocks.

Mining stocks and gold funds are more volatile than the price of the metal itself, since a small increase or decrease in the gold prices translates into a much bigger increase or decrease in profits of mining firms.

Mining stocks and funds fell sharply in the stock crash along with the rest of the market. But gold mutual funds are still the top performers so far this year among major mutual fund groups. They rose 20.19% this year through Thursday, compared to a 3.38% decline for all stock mutual funds, according to Lipper Analytical Services, a New York firm that tracks mutual funds. Of course, that does not guarantee future results will be as good.

What about silver and platinum?

Stay away for now, many experts say. Their prices are more dependent on industrial demand, since the biggest use of silver is in photographic chemicals and the biggest use of platinum is in catalytic converters in automobiles, investment adviser Nichols said. Neither will have good growth prospects in a slowing economy or recession, he said.