Time to buy gold

Markets held up surprisingly well in April, especially given the looming bankruptcy of Greece. My model portfolios of exchange-traded funds, and of a mutual fund-based 401(k), did even better than the domestic stock market.

But U.S. stocks are getting riskier and riskier. In just the last month volatility, as measured by the VIX, or “fear” index, has surged 35%. Bonds are dicey, since interest rates are more likely to rise than fall. Foreign markets are in a shambles. What remains?

Gold. And thanks to the strength of the U.S. dollar, we Americans can buy it at a discount. Its price in dollar terms is up only 8.8% in the last six months. That’s half the 16.6% rise in terms of the British pound, and a fraction of the 20.1% surge in euros.

We can afford to buy it because we have cash on hand. I’ve been worried about the increasingly fragile rally in U.S. stocks for several months. So my model portfolios are so well diversified they have outperformed the S&P 500 index.

Here is how the model ETF portfolio finished the month of April.

Small caps, energy and property lead the way

The model outpaced the U.S. stock market’s 1.5% return in April thanks to its overweight position in small-cap stocks and in alternative asset classes, namely energy and commercial real estate. So I’m taking 4% of assets and putting them into yet another alternative class, precious metals.

SPDR Gold Shares is a pure play in bullion. Each share represents one-tenth of an ounce of gold, less the ETF’s expenses. Those fees are not immaterial–currently the shares are worth only 98% of 1/10th the price of gold. But that’s unavoidable; gold pays no dividend but is so valuable it must be locked in a vault, so its carrying costs are a tangible pain.

My model 401(k) portfolio owns mutual funds, not ETFs, and there is no mutual fund that corresponds to GLD. Gold mutual funds tend to invest in the stocks of gold mining companies. One of the best of these is Toqueville Gold, and I’m allocating 4% of this portfolio’s assets in that fund.

What's new here is Tocqueville Gold

Speaking generally, gold stocks provide more bang for the buck than the metal itself. A 10% change in the price of the metal could produce a 100% change in the profits of a mining company. So in the last year the ETF is up 32.2%, whereas Tocqueville Gold has surged 92.1%.

Warning: Chances are your 401(k) does not offer a gold fund. The industry is very paternalistic, rightly terrified that it could be hauled in front of Congress if any of its investment options turned sour. This is why you need to have an IRA in addition to your company plan, or even a taxable investment account, to own the stuff Mommy Government tsk tsks.

Why gold? For inflation protection. The United States is in the catbird seat right now, because Europe is going broke and Japan already is. Our dollars are recognized worldwide as the only reliable store of value among currencies. But our dollars are only a currency, backed by nothing except Uncle Sam’s smiling face, and we have flooded the world with them to avert financial disaster in the late near-depression.

Inflation is always and everywhere a monetary phenomenon. The Federal Reserve has shown amazing dexterity in managing the financial crisis, and is already sopping up some excess dollars through its management of a mortgage-bond portfolio. But it can’t sop up dollars so easily in China and India, not to mention Athens, Rome and Madrid.

The gold price is rising strictly because of investment demand; fundamentals in that marketplace are actually weak. A rising number of investors regard inflation as inevitable. Let’s own some protection against it.

As you look over these model portfolios, one question you might ask yourself is why the ETF model continues to own SPDR Barclays Capital International Treasury Bond (BWX).

This fund is down 2.7% this year, entirely because of fallout from the Greek debacle. The euro is an exercise in elitist political fantasy that has been pole-axed by reality. The Greeks are not like the Germans, thrifty and honest on their taxes; no other Europeans are. Monetary union will not survive the horror The Economist has dubbed Acropolis Now. Greeks will renege on their current fiscal promises in three years or so; the austerity they demand will be too cruel. Italy is also likely to go bankrupt within a few years, and maybe Portugal. Even Spain, where unemployment is already 20%, faces a horrible fiscal future.

But …

Markets do not look ahead three years. They have trouble looking ahead six months. And six months from now Europe’s financial woes will seem less immediately pressing than they do right now. At the moment they appear to be “solved.”

So I expect a rebound in European bonds in coming months, and I will look forward to selling this fund into that rally.

As for everything else: There’s a market axiom that preaches, “Sell in May and go away.” Markets are more likely to go down in the summer than up. This year I think that’s particularly true. We are due a correction in stocks, and it could become ugly.

But I am already light on stocks in these portfolios. If we get a correction, I’ll become a buyer. But meanwhile I’m content to sit back and relax. I always have a mint julip when I watch the Kentucky Derby, and this year I forgot to, despite having a robust crop of mint sprawling around in my garden. I think I’ll make up for that oversight this afternoon.