ANALYSIS: Ailing Gold Market Presents a Puzzle to Investors

Two years ago, when gold hit a historic high of $1,910 an ounce, some analysts predicted that an ounce of the stuff might someday fetch more than $2,000.

Heads up, investors – we’re not in 2011 anymore.

Gold prices have fallen more than 20 percent this year, to $1,213 an ounce as of Friday. Now, some forecasters think that number could dip below $1,000.

As the precious-metal market turns from bull to bear, the big question remains: Will this trend persist?

There is no definitive answer. What is certain is that gold has always had some intrinsic value. That’s why its most conventional use is as a hedge against inflation.

“That’s what 90 percent of our customers are buying precious metals for, is to protect their cash,” said Mark Mamelian, a salesman at Scotsman Coin and Jewelry in the St. Louis area.

By that logic, it makes sense that gold began its three-year run up the price charts in 2009, as the recession deepened and just after the Federal Reserve began pouring cash into the economy via quantitative easing.

Three rounds of cash injections later, however, not much has come of the inflationary fears that drove investors to gold in the first place. So when Fed chairman Ben Bernanke announced a soft end to his loose monetary policy following the most recent Fed meeting, gold took a significant hit, tumbling more than $200 an ounce – or more than 10 percent – in the days that followed.

While that spells trouble for those already invested, new investors have the opportunity to capitalize.

“It’s a buyer’s market,” Mamelian said, estimating that lately, sellers have accounted for 1 in every 100 transactions at his store.

There are several options for gaining exposure to gold, each with its own pitfalls and benefits.

Physical gold, for instance, is less volatile in price than the indexes that track it.

“In my opinion, that’s the only way to buy gold is to take physical delivery, that way you know you have it,” Mamelian said.

Tom Shearburn, store manager at Crestwood Coin in St. Louis, said the most popular investment pieces among his customers are gold coins. His top picks are the 21.6-carat United States Gold Eagle and South African Krugerrand, which are alloyed with copper and silver, or the 24-carat, pure gold Canadian Maple Leaf.

“When you have a (gold) bar, you have to rely on an individual company to verify its authenticity,” Shearburn said. But since a coin must be issued by a country, “its integrity is beyond reproach.”

On the downside, short of burying it in the backyard, gold requires further investment to store and insure. Shearburn recommends a safe-deposit box; the cost will vary depending on how much needs to be stored.

There’s no immediate return on gold, either. In the recent past, low interest rates have kept the opportunity cost of investing in precious metals close to zero. That is to say, investors weren’t missing out on much by holding gold instead of an asset that accrues interest.

However, rates have risen steadily in recent weeks. The U.S. Department of the Treasury recorded on Friday a 2.7 percent return on the 10-year Treasury bond. Assuming Bernanke moves forward with ending quantitative easing, bonds could become more attractive.

For the short-term investor, an exchange-traded fund, such as SPDR Gold Shares, offers some attractive features, not least of which is relative liquidity. Essentially a basket of various securities, ETFs give investors exposure to a sector while protecting against the rise and fall of individual assets. They’re bought and sold like shares of stock.

But insulation from the market comes at a premium. Units of an ETF are not wholly backed by gold, with critics estimating that some bullion banks own only 1 percent of the metal they’ve contracted to investors.

Wistar Holt, a partner at Holt & Shapard Capital Management in St. Louis who has a penchant for precious metals, wouldn’t advise entering the paper market. He instead antes up to bet on the mining industry, though its performance is currently on a downswing.

“Most mining companies cannot make money at this price per ounce (of gold),” Holt said. “The sector has been absolutely annihilated.”

For his part, Holt predicts the layoffs and project cuts in the mining industry will contribute to the eventual stabilization of the gold market. As supply drops, he said, higher demand will prop up price.

That’s already begun in India, the world’s largest consumer of gold, where demand for the metal could jump as much as 150 percent this quarter, The Wall Street Journal reports.

Although import penalties will likely curb demand in India, Holt pointed to China, the world’s second-largest consumer of gold, as another driver of recovery.

“Physical demand will ultimately determine the price of the metal,” Holt said.