Gold glowed when stocks dimmed.

Gold is suddenly glowing again. And this time, one can't call it a one-year fluke or blame it on high gold prices or runaway inflation rates. That's because precious metals funds, which in the past have generally been one-year wonders and the target of endless jokes on Wall Street Week, have suddenly achieved good long-term numbers.

Precious metals funds, for example, were up 36.3% annualized over the three-year period that ended September 30, according to Morningstar. But these funds can go farther out than that and still show strong numbers. Indeed, in the five-year period through September 30, the median performance of precious metals funds was plus 14.9% on an annualized basis. Those numbers were decidedly better than the average domestic stock fund. General domestic stock funds, in the same five-year time frame, were ahead on average only 3.9%.

"We are experiencing a natural resources global bull market," says Frank Holmes, chief investment officer for U.S. Global Investors, which runs several gold funds. Typical is U.S. Global Gold Shares, which was up 42.6% for the year ended September 30. The three-and five-year numbers were also impressive-plus 36.2% and 10%.

Nevertheless, precious metals skeptics abound. "I would say a three-year period of viewing these funds is just tomfoolery and a five-year period also isn't enough," says Gary Greenbaum, a certified financial planner licensee in Old Tappan, N.J. Greenbaum will not use precious metals funds.

Nevertheless, another advisor concedes that, regardless of the debate over their effectiveness, precious metals funds have become popular. "I've been getting lots of phone calls about them recently," says Gary Schatsky, a financial advisor who heads his own firm in New York. This kind of investment-no matter the approach to precious metals, whether a fund uses just one or multiple metals-has been racking up big numbers across the board, notes one fund observer.

"Even the worst of these funds, over a five-year period, was up about 8%," comments Gregg Brewer, a fund analyst with Value Line. The category obviously has benefited in part from this year's run-up in the price of gold, which has gone from about $320 an ounce earlier this year to about $380 recently.

U.S. Global Funds' Holmes says "it feels like $400 an ounce by the end of the year." And he adds that the price will likely be $500 in two years. Holmes' rationale? With the United States on a war footing, with new strong demand from China and with the overregulation of the U.S. economy because of new environmental factors, the re-creation of the high inflation of the 1970s is now "inevitable."

Other precious metals funds executives, citing the weakness of the dollar along with the poor performance of the stock market in a three-year span through last year, argue that gold and precious metals are proving their case as an insurance policy against hard times. "Gold is simply a good diversifier. It is a diversifier that, if conservatively used and put in the right portfolio, will give an investor great protection," says Joseph Brennan, an executive vice president with the Vanguard Group, overseeing its Vanguard Precious Metals fund. That fund was closed earlier this year, but its five-year number is outstanding: up 18.2% annualized over five years through September 30, which puts it about 3.5 percentage points ahead of the average fund in this group.

But even though the group numbers have been great, the way in which these funds have turned in this performance is as noteworthy as the numbers themselves. This kind of investing is not for those with high blood pressure or sensitive stomachs.

For example, at the beginning of this five-year period, in 1998, precious metals funds were down 10.4% for the year. In the following year they gained 6.7%; both numbers trailed the S&P 500 by a wide margin. In 2000, it was another disappointing year for precious metals funds. They lost 16.6%. Jokes about these funds were rampant.

But in 2001 and 2002, when equities were suffering through the height of a dreadful bear market, precious metals funds were up 18.7% and 63%, respectively. Invariably, however, volatility comes with the territory, and this year started out as a rough one for precious metals funds. In the first quarter, this group lost 12.7% on average, and in the second quarter they remained mired in negative territory, too. However, in the third quarter, these funds led the fund industry pack. No category was even close, as technology placed a distant second at 10.3%. Precious metals funds returned on average 24.6% and, for the year through September, they gained 26.4%.

That roller coaster performance means precious metals funds are in first place over the past five years in the major categories tracked by Morningstar. And their margin of victory is large. The great precious metals numbers happened in the same period in which the average U.S. stock fund had an annual return of 3.9%. That means the average precious metals fund beat the average domestic stock fund by a little over a thousand basis points.

Gold fund advocates say this has been the key factor in their strong performance-precious metals funds have almost no correlation with the S&P 500. When investors are howling with pain on Wall Street, precious metals investors are yawning or laughing with delight. The average beta of a precious metals fund is 0.20 and their R-squared is microscopic number. Therefore, Schatsky says he uses this group of funds on a limited basis to achieve diversification. But he warns that clients can be misled by their performance.

"Of course, noncorrelated assets will outperform from time to time, and then clients may pressure advisors to put too much money into these things. Now a lot of them are going to hear the noise of short-term performance, of clients who want to jump onto the latest strong-performing category," he adds. Schatsky says he will allow no client to have more than 5% of a portfolio in a precious assets component.

Greenbaum, the precious metals fund critic, agrees that this kind of investing could be used as an insurance policy or as an inflation hedge, or as protection against the possibility of "New York getting nuked. But the funds are not the way to carry out this strategy," he says. That, he says, requires an investor to own the precious metal itself.

Traditionally this kind of investment has been viewed as a form of insurance against a return of high inflation, the kind experienced in Western nations in the 1970s, which was disastrous for the stock market. (In an 18-month period of 1973-74, the U.S. stock markets lost close to 50%, a performance that was not repeated until the 2000-2002 period.)

Precious metals advocates, in making their cases, have traditionally argued that high inflation rates are inevitable. At some point, they say, governments will run huge deficits and print too much money to pay for government warfare programs. The dollar will be under attack in this scenario. Yet that is not what happened in this recent glowing period for gold.

There is another way this kind of investing can flourish. Precious metals funds, because of their complete non-correlation with the major stock market, can also clean up when there is a protracted bear market, such as the 2000-2002 market. Those three disastrous years are at the heart of the sizzling performance of this category.

"For 20 years, in the 1980s and 1990s, every man, woman and child seemed to think we had a God-given right to receive an annual 20% return. It made no sense. It had to end," says Jean-Marie Eveillard, the manager of First Eagle Global A (up 34.1% for a one-year period through the end of September and 15.6% a year for five years).

"Investors," he continues, "finally realized that we were in a post-bubble economy." Eveillard adds that if the bear market returns, precious metals funds will start turning in more great performances.

Moreover, he argues that a well-run precious metals fund should be considered as part of an institutional or individual portfolio. "We should be seen as a legitimate option, as a minor, alternative asset, just as oil or real estate or private hedge funds are viewed," he says. "This is insurance that many people should have."

First Eagle is a pure play. It owns gold bullion and very little else, rather than a more diversified approach such as owning the gold mining stocks. Some of the latter, Eveillard explains, are often "involved in exploration, but not yet production."

Vanguard's precious metals fund, for example, is more diversified because it invests in more than one metal and focuses on more liquid, long-term companies. First Eagle invests primarily in gold and on producers who don't hedge their exposure to gold prices. The contrast between these two funds can be seen in their betas. First Eagle has one of 0.02, while Vanguard Precious Metals is 0.47.

Both approaches have been shining over the past five years. Still, Brennan argues that the five-year numbers have been "an optical illusion" because the last three years have been the biggest part of these numbers. Whichever end of the precious metals spectrum a manager uses, it has been happy days for this sector for several years.

So does that now mean that the precious materials fund is now more than a form of speculation? And does it mean that advisors should now take another look at precious metals funds for a part of their client portfolio?

"I don't think so. These funds, to me, remain more a kind of speculation than investment," warns Lynn Russell, an analyst with Morningstar. She added that the ten-year numbers of these funds are "not nearly so good as the five-year numbers."

Here the precious metals critics have their strongest arguments. These funds lag the S&P 500 by about2% on a ten-year, annualized basis through the end of September 30 (2.48% versus some 10%). Greenbaum cautions that 15-and 20-year numbers will be even worse. Russell's argument is the same. She says that precious metals funds are inevitably going to underperform and start providing more comic material for "Wall Street Week."

Eveillard agrees that precious metals can be seen by some as a speculation, but he stresses there are many ways of looking at this kind of investing. Ultimately, precious metals funds are a hedge, he argues. But they are less a hedge against runaway inflation as against something else: "A post-bubble economy that takes many years to recover, more than any of the central bankers predicted."

Value Line's Brewer, who says his company recommends precious metals on a very limited basis and for no more than 2% of a portfolio, cautions that this kind of investment is at a dangerous point. "Their performance over the last few years has been very good. That is precisely why you could get misled by how dangerous these funds can be," Brewer says. "There are few investors who I would recommend these funds for, because of how streaky they can be. There are other ways of hedging against the market."

The funds are only appropriate for those who can handle the most volatile of investments, Brewer says; REIT funds would be a better alternative for those seeking a hard asset alternative to standard equities.

But Vanguard's Brennan counters that REITs often are correlated with small-cap stock performance. And precious metals advocates believe that the funds will always be needed as long as there is potential for bear markets, high inflation or weak dollars.

"You can also look at it as insurance. That is what we do," Eveillard says. "We look at gold as the ultimate hedge, just in case we get what Peter Bernstein calls an extreme outcome. That's a fancy way of saying Mr. Greenspan [is] falling flat on his face."