Gold Metal Performance

December 18, 2011

First, we'll check on the tarnishing gold market, and then we'll review year-end fund taxes (or lack thereof.)

Gold is set to deliver an astonishing 11th straight calendar year gain in 2011, a dramatic reversal of an equally astonishing 20-year slide that began in 1980 when the gold bubble collapsed. For 13 of the calendar years between 1981 and 2000, gold was a loser, in contrast to the S&P 500, which rose during 17 of those same 20 years.

This stark comparison doesn’t do justice to the real money implications of sharply diverting ways. A thousand dollars invested into the Vanguard 500 Index Fund at the end of 1980 (even without 1980's 30%+ gain) grew to $17,524 by the end of 2000 (incidentally, a down year for stocks, with a 9.06% slide). The same investment in gold crumbled to $465.

No wonder so much attention was given to stocks, and so little to gold, by the end of the bull market in stocks. Way too much attention. The next decade was the Gold Boom 2.0. From the end of 2000 to the end of November 2011, gold zoomed up 536% compared to the S&P 500’s (with dividends) lackluster 15% total return. Of course, the original $1,000 invested in stocks at the end of 1980 is now worth $20,152, as opposed to gold’s $2,961, but if the trend is your friend, it's just a matter of time before gold beats paper investments even in the long run (or so gold bugs will tell you.)

Gold’s appeal to the non-financial Armageddon crowd (i.e., the traditional investment community) has mushroomed in recent years, not just due to gold’s remarkable performance, but because of its apparent properties to cure all that ails your portfolio.

Although its very long-run returns are worse than any major asset class, it's hard to deny gold’s luster during  bear markets for stocks. There hasn't been a bear market in stocks since 1972 (Nixon stopped dollar convertibility to gold in late 1971, and real gold trading began after) that gold didn’t go up. Not during the 1970s bear market, the 1987 crash, the tech crash of 2000, or the 2008 financial crisis.

Except for one. December 1980 to July 1982 was the last bear market before the  golden era in stocks started. It was also several months into the slide off the gold bubble peak in January 1980 (when gold was about $875 an ounce.) 

The takeaway for the rational gold investor is that gold offers illusive portfolio diversification –unless gold itself is in a bubble, in which case, don't expect any help from the shiny metal when trouble hits stocks. This diversification benefit is key, because professional investors are scared that all asset classes have begun to converge into lumps of different risk pools. Owning 20 different global asset classes doesn’t help much when they all fall at the same rate.

Enter the latest gold mini-collapse. The end of the magic may have been September 6, 2011. Gold was near $1,921 an ounce, and going up while stocks were going down. Since then, gold has fallen about 17% in just over three months, just shy of a bear market 20% drop.

The trouble is that global stocks are down nearly 4% from September 6th (down even more since earlier this year, when gold was going up). In other words, gold went down when it should have been going up. Gold fell harder during a short drop in 2008, but stocks fell a bit more, and more importantly, gold was up by 4% in 2008, while the S&P 500 dropped 37%.

The Euro crisis was custom tailored for a gold rally, but gold didn’t rally. We have an entire currency, the Euro, that may fall apart and require massive paper money creation by governments. You can’t GET a better financial panic story than a global government collapse! And yet, gold slid along with the Euro – to a psychologically important 200-day moving average low this past week . Okay, perhaps it's only important to somewhat crazy technical analysts…but then you don’t have fundamentals with gold. Just technicals and magic.

Professional investors may say we've already experienced the gold rally leading up to the peak of the Euro crisis – the roughly 70% run in gold over the year leading up to the early September peak of $1,921, the classic “Buy the rumor, sell the news” Wall Street cliché. 

Dyed-in-the-wool gold bugs will tell you not to worry, that gold is still up 11% for the year, despite its recent slide, while the S&P 500 is down around 1%, and that gold's winning streak is only two weeks away from extending into its eleventh year. The U.S. dollar is also going up while the Euro sinks, and gold is first and foremost supposed to do the opposite of the U.S. dollar. 

Perhaps this pullback in gold will lead to the much higher prices that gold bugs predict, prices that'll make gold a clearly superior investment to stocks (although gold mine production is climbing, and the cost of getting new gold out of the ground isn’t keeping up with prices). But gold’s fundamentals went bad years ago. Stock investors may look forward to the next decade-plus of stocks beating gold – the natural state of things for the universe. This won’t be the first time we thought the great gold rally was going to end. Yet the higher it goes, the harder it'll fall.

Last up – taxes. Those with funds in IRA or 401(k) accounts can ignore this section.

The end of the year is traditionally the time stock mutual funds deliver Christmas presents in the form of year-end taxable distributions to shareholders. Unlike real presents, the bigger they are, the crummier you feel, at least on April 15th.

Mutual funds generate income during the year from dividends, and pass most of it on to shareholders. This isn’t unique to mutual funds. If you owned the stocks directly, you’d also be liable for the dividend income. 

Mutual funds are often labeled tax-inefficient investments due to the way they handle capital gains. Mutual fund cap-gains usually arise from the fund manager realizing gains during the year, sometimes as a result of shareholders exiting a fund, which requires the manager to sell stocks, and sometimes in excess of what you would have realized owning and trading the stocks yourself. This can be especially strange if you buy a new fund near the end of the year, and in essence receive someone else’s gains (although the fund price will fall, lowering your eventual selling price and future tax liability). 

In some cases, funds with high turnover of portfolio holdings incur short-term capital gains and are taxed at higher income rates. These are the gains (if they're high enough) you want to try to avoid. Frankly, long-term capital gains and dividend tax rates are generally so low  you don't need to avoid them or push them off to the future. Consult your tax professional to determine what makes sense in your specific case. Note our own mutual fund rating system ‘prefers’ funds with low turnover, which coupled with the fact we tend to like out of favor funds that have experienced losses in the past, means year end distributions are not usually a huge problem for us.

We keep an eye on the funds in our model portfolios here (which are also in many MAXadvisor Private Management accounts). 

You can usually ignore traditional ETFs as being largely tax favorable structures compared to open-end funds, the exception being inverse or other leveraged ETFs. Another exception –Exchange Traded Notes (ETNs) or other products that treat investors like partners and generate K1s, not that this would lead to a large tax bill, but it could lead to extra tax work.

That said, we’re not seeing any significant short-term capital gains brewing in the portfolios this year, probably because we own mostly ETFs and low turnover mutual funds, and because stocks were weak this year, which led to minimal realized capital gains for managers. 

Keep in mind that funds don’t always know or say in advance what the distributions will be, but this year is basically one you can ignore, with high tax rate distributions typically in the 0%-2% of the fund price ($200 on a $10,000 investment). Taking steps to avoid a distribution can cost you, so unless the distribution is more than 5%, it probably doesn’t make sense to sell just to avoid the gain. If you're going to add money to a fund in one of our portfolios, consider checking the fund’s website or consulting with a phone rep before you invest taxable (non-IRA) money before January 1st, and confirm the date you can own the fund without receiving the 2011 distribution.