Is there a glimmer of hope left for gold, which all too recently had been hailed as a potential savior for client portfolios?

The Wall Street big boys, including Goldman Sachs, Merrill Lynch, Societe Generale, Barclays, Credit Suisse and Deutsche Bank, have dramatically cut gold price forecasts over the next year. The investment banks cite a strengthening dollar, declining investor sentiment, low inflation and an improving U.S. economy for their negative outlooks.

But the big boys have been wrong before. Those bullish on gold recommend that investors rebalance portfolios by increasing their precious metal positions. They argue that investment bankers’ forecasts are short-term calls based on trends and an optimistic outlook for corporate earnings.

So who’s right?

In April 2013, gold was trading around $1,500 per troy ounce. By April 2014, Goldman Sachs expects that price to decline 7%, settling at $1,390 per troy ounce, while Deutsche Bank expects a 12% drop to $1,320.

In fact, suggests Goldman Sachs analyst Damien Courvalin in an April company report, “The fall in prices could end up being faster and larger than our forecast. Despite resurgence in euro-area risk aversion and disappointing U.S. economic data, gold prices are unchanged over the past month, highlighting how conviction in holding gold is quickly waning. While higher inflation may be the catalyst for the next gold cycle, this is likely several years away.”

Despite gold’s zero correlation to other financial assets, David John Marotta, a Charlottesville, Va.-based CFP, does not recommend gold. He prefers to invest part of his client portfolios in natural resource company stocks as an inflation hedge.

“On average, gold [bullion] appreciates just at the rate of inflation,” he says. “On the other hand, gold is very volatile. Combined, that means that gold is not near the efficient frontier, and the correct asset allocation is 0%. We ask that clients limit their purchases of gold coins or bullion to 3% to 5% of their net worth if they must buy gold.” 
Nor is gold still considered a safe haven. John Rothe, the CEO of Riverbend Investment Management in Tysons Corner, Va., says several things are driving gold prices lower: concerns that the Fed will stop monetary easing; the selloff of gold by hedge funds; and the sale of $500 million in gold by Cyprus to bail out its economy.

Robert Wiedemer, manager of the new Aftershock Strategies Fund, says the negative investor sentiment has him concerned about the gold market. But in the longer term, he says, U.S. and Japanese monetary policies are highly inflationary, and his fund is designed to limit volatility by investing in gold, commodities and foreign currencies, as well as stocks and bonds, and it carries a low beta value.

“The bottom line is that I am worried about the [gold] market,” he says. “We have seen a quick downturn and the market could go down in the future. But the fundamentals long term are even better due to inflationary monetary policies here and abroad.”

Wiedemer recommends that advisors take a near-term cautious stance toward gold by dollar-cost averaging through the bear market. He also thinks battered mining stocks, such as the Market Vectors Gold Miners ETF (GDX), are a good long-term buy.

Greg Womack, a planner in Edmond, Okla., has a stake in gold because he is concerned about Uncle Sam’s printing press working overtime. “The fundamentals for owning gold have not been stronger,” he says. “Paper currencies are becoming less valuable every day. The potential for a crisis of confidence in the dollar is growing larger. Paper gold, futures and shares held in exchange-traded funds have been selling off. But the physical metals markets have been in high demand.”

On the mining stock side, share prices may rebound along with bullion prices in the next upswing. Mining stocks have underperformed bullion over the past few years because of the industry’s rising costs and shrinking cash flows and a series of bad acquisitions by mining companies. Companies here also made poor decisions to stop hedging gold to lock in prices. This cost them dearly when gold prices dropped this year.

On the bright side, many major mining companies are selling below historical price-to-cash and price-to-forward earnings ratios. Frank Holmes, manager of the U.S. Global World Precious Minerals Fund, says new managers at mining companies are finally focusing on cost controls and shareholder value.

As long as real interest rates on Treasury securities are negative, gold has historically been a good investment. But if interest rates rise, all bets are off.

Holmes expects the price of gold bullion to rise from its cyclical low because there is a rising demand for legal tender gold coins, because there is demand for gold in Asia and because central banks around the world are making bullion purchases. The central banks invested $236 billion in gold last year—up 17% from 2011. And through the first quarter of 2013, the banks have been adding gold and alternative investments to diversify U.S. dollar and euro reserves.

Holmes forecasts a 15% rise in the price of gold—or about $220 per ounce—over the next year. That bodes well for mining stocks, which have lagged behind the return on bullion over the past few years.

Mining companies’ total costs are running about $1,500 per troy ounce because they are reporting the cost of extraction, including depreciation and operating expenses. This has lowered their government taxes and royalties. In the past, companies only reported the cost of taking ore out of the ground, which runs about $1,000 per troy ounce, so got hit with big taxes.

Today, a 1% rise in the price of gold results in a 2% rise in company earnings. So a 15% increase in the price of gold should translate into a 30% increase in mining company earnings.

“Mining companies have stopped making dumb acquisitions, are buying back shares and increasing their dividends,” Holmes says. “Supply is contracting and companies that have their costs under control will perform well.”

For those reasons, he favors companies such as Alamos Gold, Royal Gold and Franklin Mining. His fund’s five largest holdings include Agnico-Eagle Mines, Silver Wheaton Corp., Gran Colombia Gold Corp., NGEx Resources Inc. and Virginia Mines Inc.

Holding the middle ground is Juan Carlos Artigas, investment research manager at the World Gold Council in New York. His research shows that the recent drop in gold prices is in line with historical norms. Over the past 25 years, gold has had a negative correlation to stocks, bonds, the U.S. dollar and systemic events. So it is no surprise that the price of gold is dropping while stock prices are rising.

In the long term, however, even a 2% to 5% position in gold can improve the risk-adjusted rate of return in a portfolio, according to Artigas’s research. The bottom line in his findings is that investors can’t take a short-term perspective on gold. Forecasters often just take the United States and European perspective on the economy. They are bearish because of the fundamentals, yet don’t take into account the fact that the emerging market demand for gold is strong. India and China are responsible for 50% of the investment and jewelry demand for the metal.

“Because changes in the price of gold do not correlate with changes in the price of mainstream financial assets, the yellow metal fulfills the diversification investment criteria,” Artigas says. “Importantly, it is a relationship that holds both across markets and over time.”

His study on hedging against tail risk using gold as a diversifier shows that from 1987 through 2010, a period that included four bear markets in stocks, gold improved the risk-adjusted rate of return on a portfolio that included stocks and bonds. Gold performed well during stock and bond bear markets brought on by problems with the value of the U.S. dollar, brought on by inflation or by crisis. It performed poorly during stock bull markets when the economy was growing.

“We find that portfolios which include gold are not only optimal in the sense of delivering better risk-adjusted rates of return, but they can help reduce the potential loss,” he says.

Artigas’s study, Gold: Hedging Against Tail Risk, found that gold can decrease the “value at risk” of a portfolio. Value at risk is a measure of the worst expected loss over a given period at a given confidence level under normal market conditions. Allocations between 2.5% and 9% to gold helped reduce the weekly 1% and 2.5% value-at-risk measurement from 1987 through 2010.

Value at risk is measured in three variables: the amount of potential loss, the probability of that amount of loss, and the time frame. For example, a financial advisor may determine that a client has a 2.5% weekly value at risk of $10,000. So there is a 2.5% chance that the client could lose more than $10,000 in any given week.

“Looking at past events considered to be tail risk, such as Black Monday, the Long-Term Capital [hedge fund] crisis and the recent 2007-2009 recession, we find that in 18 of 24 cases, analyzed portfolios which did include gold outperformed those which did not,” Artigas says.