Investor Question: Invest In Gold or Gold Miners? (IAU, GDX, GDXJ)

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April 16, 2012 11:34pm NYSE:GDX NYSE:GDXJ

Russ Koesterich:  The Federal Reserve may be the best friend gold investors ever had.

The most important factor for gold is actually not inflation or the dollar, but rather the level of real interest rates. In fact, the relationship between gold and real rates is so critical that since 1990, the level of real rates explains roughly 60% of the annual performance of gold.

Gold generally does best in an environment in which real rates are low to negative as this means no opportunity cost to holding gold. Since 2003 – when gold began its long-term outperformance – we have been in just such an environment. Real long-term yields have averaged 1.3%, half of their long-term average, and over the past year, real rates have fallen into negative territory.

And given that the Fed has made it clear that monetary conditions will remain accommodative for the foreseeable future, the low to negative real rates that have supported gold for most of the last decade will likely stay in place.

So what does this mean for investors? It’s important to keep in mind that despite gold’s expense and the current cheap valuations of gold mining company stocks, gold miners are not a good substitute for physical gold from an asset allocation perspective.

First, while it’s true that miners and gold tend to be highly correlated, these are different asset classes. As a commodity, gold is diversifying to a portfolio. Second, over the long term, gold has been a much better inflation hedge. Third, while many investors believe that miners are due for a spell of outperformance given their recent under performance versus the metal, miners have actually been trailing gold since 2003. Finally, real rates have historically had little to no impact on equity returns.

As such, I wouldn’t advocate selling gold to buy gold miners, and I continue to advocate maintaining a strategic allocation to gold through funds that access the physical metal such as the iShares Gold Trust (NYSEARCA:IAU).

Source: Bloomberg

ETFDN Notes Tickers: Market Vectors Gold Miners ETF (NYSEARCA:GDX), Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ).

Written By Russ Koesterich From The iShares Blog

Russ  Koesterich, CFA, is the iShares Global Chief Investment Strategist as well as the Global Head of Investment Strategy for BlackRock Scientific Active Equities. Russ initially joined the firm  (originally Barclays  Global Investors) in 2005 as a Senior Portfolio Manager in the US Market Neutral Group. Prior to joining BGI, Russ managed several  research groups focused on quantitative and top down  strategy. Russ began his career at Instinet in New York, where he occupied several  positions in research, including Director of Investment Strategy for  both US and European research. In addition, Russ served as  Chief North  American Strategist for State Street Bank in Boston.

Russ holds a JD from Boston College Law School, an MBA from Columbia Business School, and is a holder of the CFA designation. He is also a frequent contributor to the Wall Street Journal, New York Times, Associated Press, as well as CNBC and Bloomberg Television. In 2008,  Russ published “The ETF Strategist”(Portfolio Books) focusing on using exchange traded funds to manage risk and return within a portfolio.

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