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Rob Carrick

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Yesterday's hero?

Rob Carrick

OTTAWA (GlobeinvestorGOLD)—Long before technology funds came along, precious metal funds were the bane of many an investor's portfolio.

You probably know of precious metals funds as the mutual fund world's star performer of 2002, when the average fund in this category made 76.2 per cent and the top-ranked fund, Royal Precious Metals, surged 153.1 per cent.

Outsized gains like this will sound familiar if you owned science and technology mutual funds in the late 1990s. In 1999, the average tech fund made 113 per cent while the best of the bunch, AIM Global Technology, made 200.3 per cent. You know what happened next: massive destruction in the tech sector, and in the portfolios of investors who partook too enthusiastically.

AIM Global Technology vs. S#38;P/TSX Composite

Are precious metal funds headed in this direction? We'll address the outlook for these funds shortly, but first let's take a look at some of their antics in past years.

To start, history shows that these funds are wildly volatile and badly suited to buy-and-hold investing. Performance depends on what the price of gold is doing. When gold prices languished in the later 1990s, precious metal funds turned in four straight years of negative returns on average (1997-2000).

All told, there were seven down years for this fund sector in the past 15. The worst was the average 38.2-per-cent loss of 1997, followed by the average 18.8-per-cent drop of 1988.

No, these declines aren't as severe as what technology funds have gone through. But they make the point that precious metals funds can turn some of the windfall gains of the previous year into dust, and we're not talking gold dust.

Beginning of the end, or end of the beginning?

The way to protect yourself against this eventuality is to understand that precious metal mutual funds are a speculative investment that you trade in and out of. When the party for gold is over, it's time to bail.

This brings us to the question of what might be ahead for precious metals funds in 2003.

The old cliché about gold is that it's a shelter in uncertain times—no question, there's a lot of uncertainty in the investing world right now.

For one thing, there's the global instability caused by tensions between Iraq and the United States. In mid-January, gold prices hit a six-year high on war fears sparked by the discovery of empty chemical warheads in Iraq by United Nations weapons inspectors. A U.S.-Iraq war could easily drive gold prices higher.

Gold has also fed off the weak stock market in the past year. Insofar as the stock market has shown no definitive signs of taking off, this factor could continue to work in gold's favour.

Obviously, it's possible to construct a positive outlook for gold in the months ahead. Still, think hard before jumping into precious metals funds at this point because the hot fund sector of one year often turns out to be the laggard of the following year. Remember the tech fund example here.

If you owned a gold fund through the previous year or two, think about taking some profits. A rule of thumb when investing speculatively is to sell half when your investment doubles. This might work well if your precious metals funds have come anywhere close to doubling.

Something else to look at in assessing the role of these funds in your portfolio is the rule stating that a specialty fund, especially one as volatile as a precious metals fund, should not account for more than 5 per cent of the typical portfolio (10 per cent for super-aggressive types).

After the past year, you may well find that your precious metals fund has taken a more dominant position in your portfolio than you expected. If you're reluctant to trim your holdings, just remember what happened to tech funds after the fun was over.

Rob Carrick has been writing about personal finance, business and economics for more than 12 years.

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