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.