The economy is gaining momentum.  The government revised its estimate of 3Q GDP from 3.7% to 3.9% on November 30, following growth of 3.3% in the 2Q.  Consumer spending jumped 5.1% in the 3Q, the highest in almost three years, even though the consumer confidence index fell for the fourth month in a row in November.  This doesn’t make sense - spending up but confidence down - but I suspect it had a lot to do with the nasty presidential campaign that is now behind us.

Still troubling, however, is the Index of Leading Economic Indicators (LEI) which fell for the fifth month in a row in the latest report.  The Bank Credit Analyst downplays the decline in the LEI and forecasts that the US economy will continue to expand at a rate of 3½% or better for the next year or so.  BCA feels that government changes in the makeup of the LEI report make it less predictive than in the past. 

The stock markets rallied immediately after the election and Bush’s win, and most of the major market indices have broken out to new highs.  I continue to look for the stock markets to trend at least modestly higher in the months ahead, especially if oil prices continue to ease lower.  Our equity Advisors have done well over the last month.  The Treasury bond market has done well this year as long-term rates have moved lower once again.  However, with the Fed intent on raising short-term rates several more times at least, long-term rates are likely about as low as they are going in this cycle, and the next move may be up.  High yield bonds, on the other hand, still have the potential to do well in this growing economy. 

This month we take an indepth look at gold, which has recently topped $450 per ounce for the first time since 1988.  We will analyze the yellow metal, the new bull market, a new way to own gold, and I’ll give you my thoughts on what you should do now.

This month marks ProFutures’ 20th anniversary.  As we cross this milestone, I want to thank all of you for your loyalty.  See page 8.

Introduction

On Monday, November 29, December gold futures broke the $450 per ounce mark for the first time since 1988.  Gold’s recent strength, coupled with the dollar’s continued weakness, is driving many investors to evaluate gold as a potential investment.   In fact, investors are now pouring money into all types of gold and metals-based investment products.

But is now the time to be jumping into this very volatile market?  As I wrote last month, BCA is predicting a multi-year bull market in resource commodities, including gold.  And, our futures funds have profited handsomely from the rise in gold this year.  So, is it time to jump onboard? 

In the pages that follow, we’ll look at some of  the pros and cons for gold and try to decide.  I will also tell you about a new way to invest in gold that is taking the market by storm.  It’s the new exchange-traded gold fund which just opened on November 18.  I will tell you how the new gold ETF works and if I think this new fund is a good deal.

Is It Time To Buy Gold?

With the recent breakout over $450 per ounce, gold has become an even hotter topic among individual investors.  As long-time clients and readers of this newsletter will recall, I have not been a huge fan of gold since the late 1970s.  Since the price of gold skyrocketed to above $800 briefly in late 1979, the price trended lower for the next 20 years, reaching a low near $250 per ounce in 1999.

In early 2002, when gold was in the $300 range, we produced a SPECIAL REPORT entitled “Should I Invest In Gold?”  In that Special Report, we discussed many of the supply and demand factors in the gold market, and we concluded:

“As discussed in this Special Report, there are some very encouraging signs that gold prices will trend higher in the next few years.  We actually think that is what will happen, barring any new bearish developments.”

Our timing was good.  Since then, the US dollar price of gold has been in a steady climb, reaching $450 per ounce on Monday of this week for the first time since 1988.  Gold is up almost 80% from the low in 1999. 

Gold is definitely in a bull market.  As I discussed in these pages last month, The Bank Credit Analyst now predicts a multi-year bull market in gold and other resource commodities.  BCA continues to believe that many commodity prices will move significantly higher over the next several years due to increased demand and other factors.

But the question is, should you buy gold NOW?  Now, after an 80% jump in prices?  Now that the new gold fund, which is all the rage, has contributed to the latest spike to $450?  I will answer that question below, but first let’s quickly review the pros and cons for gold today.

Reasons To Be Bullish On Gold

As we pointed out in our Special Report in early 2002, there is still no shortage of reasons to be bullish about the price of gold.  Just a few good reasons include the following:

1.  Gold is a good store of value during times of uncertainty, and there is definitely no shortage of uncertainty in the world today.

2.  Gold is a hedge against inflation.  If you believe, as I do, that the economy will continue to do well and possibly lead to a rise in the rate of inflation, then gold may hedge that risk. 

3.  Although I do not believe that gold reacts to supply and demand in exactly the same way that other commodities do (see #4 below for more about this), you cannot discount the fact that exploration was down during the period of low gold prices and gold mining companies are now having to play catch-up.  This could possibly lead to a supply/demand squeeze and push up the price of gold.

4.   As I have written before, another reason why gold does not always react to supply and demand forces the same way that other commodities do is because gold has a hybrid nature.  While it is a commodity used by many industries, it is also a currency maintained in vast reserves by many countries, central banks and individual investors.  As a result, the price of gold is often dictated more by its relative value to currencies rather than on a strict supply/demand basis.

Accordingly, the recent slide in the value of the US dollar has been very bullish for the price of gold.  For those who believe that the economic recovery can’t last and we’re eventually going into the abyss, this would mean an even greater decline in the dollar, and thus additional upside potential for gold.

Actually, there are many, including BCA, that believe the US dollar will continue to fall even if the economy continues to expand. Recent comments by Alan Greenspan seem to support this view, and the Bush administration's apparent policy of “benign neglect” in relation to the dollar seems to add even more support for this argument.

Obviously, these are not all of the reasons to be bullish on gold, but they are some of the major factors that I keep on my radar screen in relation to the yellow metal, in addition to the supply/demand fundamentals.  The point is that there are many factors that are favorable for a continued increase in the price of gold. 

Reasons To Be Cautious

Just as there are reasons to be bullish about the price of gold, there are equally valid reasons to be cautious about running headlong into a major gold investment at this point in time.  As it is always the case with all commodities, there is another side to the story.  Let’s take a look at some of the negatives:

1.  As noted above, gold prices in the US have risen almost 80% since the low, and prices have moved virtually straight up since September.  That means the market is ripe for a pullback at any time.  Furthermore, gold has heavy overhead resistance (a technical term for selling pressure) from $450 to $500.  Gold prices spiked to near $500 in 1982 and 1987 and both times, the market then cratered.

And that’s another negative.  Gold prices typically fall off a cliff after a sharp run-up, rather than gently trending downward.  This extreme volatility can be disconcerting to many investors.

2.  Most analysts that I respect, including BCA, believe that the US dollar will fall only another 10-15% before it stabilizes.  This expectation (and more) is already factored into the price of gold today.  The dollar could reach those levels relatively soon.  This could take a lot of the wind out of gold’s sails.  Yet many people buying gold today believe the dollar is going to plummet another 50% or more.  That is not likely to happen.

3.  Another thing to keep in mind is that the recent run-up in gold prices is largely a US phenomenon.  If you look at gold prices in Euros, you will see that European gold prices have been generally flat during the big rise in US gold prices because the Euro has strengthened relative to the dollar.  So, the relative value of gold as an investment sometimes depends in part on what kind of money you have in your pocket.

4.  Contrary Opinion.  More often than not, I am a contrarian, meaning that I don't like to buy when everyone else is buying (or short when everyone else is shorting).  Right now, the bullish consensus on gold is very high, as evidenced by the stampede into the new gold fund discussed below.

5. At prices above $400, gold producers have begun to ramp-up production.  As noted above, they may be playing catch-up at present, but at some point increased supplies will adversely affect gold prices. 

6. As I have written in recent weeks, there is a recession in our future.  While BCA and others believe that the recession will not come until late 2005 or even later, this is a risk that will almost certainly be negative for gold prices.

Given the pros and cons discussed above, I would NOT recommend buying gold today. I would wait for a meaningful correction, which may or may not happen.  Given the recent sharp spike in prices, I consider the risk too high at this point. 

On the other hand, if you already own gold at much lower prices, I would hold on for now.  But I would also strongly recommend that you determine a “stop-out” point to protect profits - and stick to it.

Be Careful How You Invest, If You Do

As I have written before, I have concerns regarding the various methods of investing in gold, as they relate to the average investor.  The physical purchase of gold in its various forms (coins, bullion bars, etc.) involves not only significant bid/ask price spreads, but also the additional expenses of insurance and storage, unless you want to risk keeping it at home and hope you are not robbed. 

In the case of numismatic coins, which have a value higher than the spot price of the metal based on rarity and condition of the coins, you really have to know what you’re doing.  While there are a few very reputable numismatic dealers out there, there are still differences of opinion on the value, and the condition, of many rare coins - even among the good guys.  And there are plenty of bad guys in the field of numismatic coins.

Even non-numismatic coins have large spreads between their bid and ask prices.  Examples of the bid/ask spreads can be found by going to www.kitco.com.  On Monday, November 29 for example, the asking price for a one-ounce American Eagle gold coin was just over $478, while the bid price to anyone wanting to sell the same gold coin to Kitco was $450.90.   That’s a lot of ground to make up if you are a buyer!  Gold bars have smaller bid/ask spreads, but they are still significant and there is still the matter of storage to be dealt with. 

I have recently received direct-mail ads (also on the Internet) offering a “secret currency” investment that was “outlawed for 41 years,” but is now graciously offered to you.  Hint: whenever you see this kind of hype, look for the trash can!

This particular investment turns out to be nothing more than numismatic gold and silver coins.  This investment not only has the normal problems associated with physical gold, but adds the requirement that you be able to identify and evaluate the numismatic qualities that provide the extra value.  Again, my advice regarding these hyped solicitations is to just say NO to these investments.

When I have written about gold before, I have had readers ask why I didn't include a new opportunity called “E-Gold.”  The reason I didn’t is because this is fairly new and, it appears to be more geared toward using gold as a method to conduct business on the Internet, rather than as an investment.  The E-Gold website describes it as “an electronic currency” backed by physical gold held in storage, thus making international Internet trade more feasible.  While this might sound like a great new opportunity using the bold new frontier of the Internet, I’m going to reserve judgment for a while. 

Remember the rule: If it sounds too good to be true, then it probably is.   Caveat Emptor.

On the following pages, I am going to discuss the new exchange traded gold fund that is taking the financial world by storm.  It may be a better way to invest in gold than any of the ways discussed above. 

A Better Way To Own Gold?

The SEC recently approved the sale of a new form of gold ownership.  This new investment vehicle is known as the StreetTracks Gold Trust (NYSE: GLD), and it has taken the market by storm.  In its market debut on November 18, the Gold Trust  raked in over $550 million in new investment from investors eager to participate in gold ownership without the hassles of physical possession of the yellow metal.

The StreetTracks Gold Trust is sponsored by the World Gold Council, and is marketed by Boston-based State Street Global Markets.  The major difference in this investment and other gold-related “paper investments” is that each share represents a physical quantity of gold that is held in a custodial account in the London vault of HSBC Bank, USA.  The Gold Trust invests virtually all of its assets in physical gold bullion.   As the fund grows in size, more and more physical gold is purchased, and vice-versa if the fund declines in size.  I will discuss more about this below.

The Gold Trust is structured as an “exchange traded fund,” or ETF for short.  In a nutshell, an ETF is a basket of securities (or other assets) that tracks a specific market and can be traded all day on a stock exchange, much like individual stocks.  While most ETFs are geared toward mimicking the major market indexes, the Gold Trust holds physical gold, and its share price should closely follow the spot price of gold.  Shares of the Gold Trust are priced at 10% of the spot price of gold, less expenses of the Trust, currently around $45 per share.

A second US-based gold ETF has been submitted to the SEC for approval by Barclays Global Investors.  If approved, their product will be known as the iShares Comex Gold Trust and will be listed on the American Stock Exchange under the symbol “IAU.”  Like the StreetTracks Gold Trust, the iShares Trust will invest virtually all of its assets in gold bullion, and its share price will be equal to 10% of the spot price of one ounce of gold.

While the gold ETF is a brand new entry in the United States, several similar programs have been available on exchanges in England, Australia, and South Africa for some time.

Gold ETF Advantages And Disadvantages

One of the most obvious advantages of the new gold ETF is that it solves the shipping, insurance and storage problems associated with investments in physical gold bullion or coins.  Some of the other advantages of this new way to invest in gold are as follows:

1.   Dealer markup is no longer a problem, in that there is no spread between bid and ask prices.  There may be transaction costs associated with purchasing and selling the ETF, but there is no premium to be paid.

2.   The gold ETF is listed on the New York Stock Exchange, so it is liquid and can be traded any time the market is open.  In addition, the new gold ETF may be “shorted” if an investor believes the price of gold will fall.

3.   Some institutional investors were precluded from owning gold because of the costs related to buying, selling, and storing the physical gold.  The new gold ETF allows these investors to have an undivided interest in gold, but without all the hassles.

4.   Gold mining stocks, a popular way to play the gold market, are often significantly overvalued or undervalued, relative to the price of gold for various reasons, and are typically extremely volatile.  This is why I have never recommended gold stocks in all these years.  Because the gold ETF closely tracks the price of gold over time, it is becoming a popular alternative to gold mining stocks.

Disadvantages To The Gold ETF

Unfortunately, there are still some disadvantages to investing in the new gold ETF.  Perhaps the most obvious is that it is not physical gold.   For those investors who want to own gold as a store of value in case of international chaos, having an undivided interest in gold sitting in a London vault will provide no comfort.  Those investors who want to run their fingers through their gold hoard will still have to buy physical gold, and deal with the storage and other hassles involved.

Other disadvantages of the new gold ETF are:

1.   As I have written a number of times, the price of gold is very volatile and can move suddenly and without warning.  You will lose money if gold falls after you purchase shares.  The gold ETF will not change this characteristic of gold, but it does offer a way to quickly trade out of a gold position without the hassles of selling physical coins or bars.

2.   The success of the new gold ETF may be a self-fulfilling prophecy, at least for a while.  The demand for the gold ETF is strong, requiring the Trust to purchase more and more gold on the open market.  This buying has contributed to the upward pressure on the price of gold since the fund opened, and may continue to do so, as long as the gold Trust continues to grow in size.

To illustrate, in anticipation of the launch of the Gold Bullion Securities ETF on the London exchange on March 31, 2004, the price of gold spiked to over $420 per ounce partly as a result of increased demand.  However, only five weeks later, the price of gold was back down to $375 per ounce.  A similar spike and subsequent decline occurred in 2003, shortly after the launch of the Australian gold ETF. 

Some believe that the latest price spike to $450 is largely due to the wave of gold-hungry investors gobbling up the new gold ETF, and that prices will fall, perhaps sharply, once the initial feeding frenzy is over.  I would not be surprised to see this happen, even if gold manages to rise more in the long-term.

3.   While the expenses of the gold ETF will be kept to a low 0.4%, the Trust will have to sell part of its gold stores to pay these expenses.  Thus, over time, the fractional amount of physical gold represented by each share will decrease.

4.   While the form of the gold ETF investment will be similar to a stock, the IRS will still classify these shares as a “collectible” for tax purposes.  This means that long-term gains will be taxed at a higher 28% rate reserved for collectibles, rather than the 15% rate for other types of investments.

I like It, But Not Now

All in all, Ilike the new StreetTracks Gold Trust.  While it is certainly not suitable for all investors, I think it is an excellent alternative to owning physical bullion or coins (other than an emergency stash).  If you merely want to participate in a rise in gold prices, I think the new gold ETF is certainly a better way to go than buying gold mining shares (extremely volatile) or numismatic coins (hard to evaluate and sell).

The new gold ETF may also be a better alternative than many of the mutual funds that invest in mining shares.  Many of these funds have gained far more in percentage terms than gold has recently.  This is because the mining shares they own have exploded in value, far more than the price of gold.  And that simply means that they will plunge harder if gold prices retreat.

While I do like the StreetTracker Gold Trust, I would not buy it today with gold at the highest price in over 15 years.

Finally, I should also point out that most investors who buy this fund, or others like it,will not know when to sell their shares.  This is a risk with any investment in precious metals.  Knowing when to sell is always the hardest part.

Conclusions

The new gold ETF appears to be an excellent way to participate in the gold market without all the hassles of owning physical gold.  But the question is, should you be buying into this market at this time, after a rise of almost 80% over the last few years? 

Gold has had a very nice run, the strongest uptrend since 1986 to 1987 when prices climbed to $500 per ounce before falling to near $250 over the next 13 years.  Do I think gold will fall back to $250 again?  No, I do not, especially in light of BCA’s latest forecast for a multi-year bull market in resource commodities.

There is certainly the chance that gold will continue to move higher, and it is even possible (maybe likely) that gold will rise above the $500 barrier at some point in the future.  But there is certainly also the possibility that gold will fail to breakout above the magic $500 resistance mark, and a nasty selloff could follow.

There is also a good chance that gold prices will experience a significant downward correction at some point, especially when the ETF buying frenzy subsides.  That indeed was the case following the introductions of other gold ETFs in London and Australia.

For this and other reasons cited above, I believe the risks in the gold market are too great to be buying at this time.  I would wait for a meaningful pullback, which may or may not happen. 

If you already own gold at lower prices, you may want to hang on a bit longer, but consider having a profit stop at some level.  Gold has a nasty habit of falling off a cliff after strong run-ups like we’ve seen recently.

And most of all, don’t believe all the hype that is now out there regarding gold investments.  This always happens in a bull market.

Chicago Mercantile Exchange
Introduces Gold TRAKRS Futures

Earlier this year, the Chicago Mercantile Exchange (CME) introduced a new type of futures market in gold.  Gold futures have long been traded on the NY COMEX exchange and elsewhere, but the new CMEgold “TRAKRS” (Total Return Asset Contracts) are an interesting new twist on the gold market. 

The CMEgold TRAKRS are designed as an index to track not only the spot price of gold, but also a total return component that reflects an accrual at a rate apprx. equal to the one-month lease rate for gold.  In other words, these contracts are designed to pay the buyer the income that comes from lending gold (like Central banks and major bullion dealers do).  The lease rate is intended to represent the compensation an owner of gold would receive in return for lending gold for a period of one month.

As noted above, it is an interesting concept, but these are very complicated contracts.  Although they carry an income accrual, they still have all the price risk that traditional futures have.  In fact, most brokers who offer these contracts require individual investors to deposit 100% of the contract’s market value at the time of purchase.  The CME has various other TRAKR contracts on several different markets.  If this is of interest to you, more information may be found at www.cme.com .

I mention the gold TRAKRS only as a matter of general information to you.  I do NOT recommend that you trade in this market, or any other futures market, on your own.  The failure rate in trading futures on your own is reportedly as high as ever.  Like the TRAKRS, many of the new markets introduced in recent years are very complicated and were actually designed for use by professionals - typically companies within the particular industry.

It’s amazing how many new futures markets there are today.

20 years ago this month, Debi and I and a handful of brokers and staff left the ranks of the big brokerage firms and established ProFutures, Inc. in an effort to better serve our clients.  The very best thing about the large firm we left was that I met Debi Benson there when I first joined the firm, and in 1986, she became Mrs. Debi Halbert, and later the mother of our two kids.

Back in 1984, our main business consisted of “hedging” for commercial grain firms, feedlots, etc.  I also had a nightly futures trading advisory service called the Hotline Update, a recorded message with specific trading advice.  In 1985, I discontinued that service, and we began to use Commodity Trading Advisors (CTAs) to manage our clients’ investment accounts.

In 1986, I met Aladin Abughazaleh, the founder of ATAResearch, Inc.  ATA had a large database of CTAs, and I frequently consulted with Aladin regarding CTAs to recommend to our clients.  In 1987, ProFutures and ATA launched the ATAResearch/ProFutures Diversified Fund, our flagship fund which continues to operate today.  In conjunction with the Diversified Fund’s launch, we formed ProFutures Financial Group, Inc., a broker-dealer and a member of the NASD.  In 1990, ProFutures opened the Alternative Asset Growth Fund.

Over the years, clients frequently asked us to expand our money management services to include more than professionally managed futures funds.  I resisted the idea until 1994 when I read the Dalbar Study which illustrated that most mutual fund investors earn paltry returns, much less than the average mutual funds, because they switch funds so often, frequently buying high and selling low.  Upon learning that news, we surveyed our clients to see if they would like us to expand our services into mutual fund selection and timing.  We were overwhelmed at the response.  So we then formed ProFutures Capital Management, Inc. and registered the company with the SEC as a Registered Investment Advisor.

In 1995, we introduced our AdvisorLink program which features successful market timers.  We continue to search for successful market timers and asset allocators to this day.  We have over $55 million of client assets (and my own) in these programs.

In 1996, we introduced the  ProFutures Global Reserve Fund, a private offshore fund that deals primarily in foreign currencies.  In 2000, we introduced the ProFutures Strategic Allocation Trust, which is managed exclusively by Campbell &Company, one of the oldest and largest CTAs in the world.

We currently manage over $130 million in client assets in our programs.  We have a staff of 12 great employees (actually more like family members).

Over the last 20 years, the one thing that stands out the most is the fact that we have GREAT clients.  Most of our clients are likeminded politically (conservative), successful in their respective fields, interesting, courteous, patient and very loyal. 

Few people that I know in the investment world would describe their clients in that way.  Demanding, impatient and rude are words I often hear from others.  So, above all, I am thankful for our clients, and that is why I have always made myself available to speak with clients who wish to talk with me personally.  That is also something you don’t find at a lot of   firms.  Many heartfelt thanks to you all!  I am truly blessed to have such great clients and staff.

           MERRY CHRISTMAS &     

             HAPPY HOLIDAYS EVERYONE!