Gold has been regaining its luster this year. Strong gains in bullion are propelling sky-high returns in mutual funds that focus on precious metals.

Despite a 13% decline for precious metals funds in August, according to research from Toronto-based Morningstar Canada, the category was up by 86% year-to-date as of Aug. 31, far ahead of the 12% gain shown by Canadian equity mutual funds.

The trends that lifted gold out of its slumber after a three-year slump remain in place, and investors can still join the party, says Ani Markova, vice president and portfolio manager with AGF Investments Inc. in Toronto and lead portfolio manager of AGF Precious Metals Fund.

“The catalyst is insufficient global [economic] growth,” she says, “and most of the world is on pause in raising interest rates.”

Low or negative interest rates mean bonds and other interest-paying securities offer little competition to gold. From a bottom of US$1,046 an ounce in December 2015, gold bullion traded as high as US$1,375 in July before falling back as investors took profits.

“Small increases in the bullion price can lead to huge increases in the cash flow of gold-producing companies, assuming costs stay where they are,” says Markova. “Companies are showing good momentum in earnings, and I expect a positive environment for the next few quarters. “

Investors may be best served by committing 5%-10% of a diversified investment portfolio to precious metals over the long term, rebalancing by selling a bit when the holding overshoots and adding during down periods, says Achilleas Taxildaris, head of portfolio manager research at Morningstar Canada.

“Short-term movements are hard to pinpoint, but there’s a case to be made for investors to have a small exposure to the precious metals category,” he says. “Precious metals are volatile, but they’re not correlated to the general equities market – and that creates diversification benefits, such as reduced volatility overall.”

The biggest risk to the gold bullion price would be a solid pickup in economic growth and subdued inflation the U.S., Japan and Europe. This scenario would result in upward moves in real interest rates and would be poisonous for gold. Although the number of jobs created in the U.S. in August was stronger than expected, the fragile state of most economies and high levels of government debt make a significant rise in interest rates unlikely.

Gold-linked equities have risen significantly more relative to bullion, as precious metals companies tend to be more volatile than the underlying commodity. After sharp gains for precious metals companies across the board this year, being selective in choosing the most profitable mining firms with the best properties and management teams is important.

Although there could be an uptick in interest rates in the U.S. at some point this year, the hikes anticipated in 2016 have not yet materialized. And global economic growth may weaken further, making any significant interest rate increases unlikely anywhere in the world. Currently, US$13.4 trillion of global sovereign debt, or 30% of outstanding bond issues, is sporting negative yields.

“There’s no yield anywhere on bonds, and that leads to rising demand for long-term real assets, such as gold, high dividend- paying stocks and real estate,” says Markova.

The flood of negative-interest bonds is unprecedented, and that situation is making investors uneasy about the state of capital markets, says Paul Wong, senior portfolio manager and lead portfolio manager of Sprott Gold & Precious Minerals Fund, sponsored by Toronto-based Sprott Inc.

“Governments want lower interest rates and they want to see growth and inflation rise. But, so far, there’s no strong evidence that their quantitative-easing programs and negative interest rates have worked,” he says. “I’m still pretty bullish on the gold trade because the primary drivers remain there.”

Other signs of a precious metals bull market also remain intact, such as small-cap equities outperforming large-caps, and silver bullion outperforming gold, says Wong, who holds about 28% of the Sprott fund’s assets under management in silver stocks, near his maximum of one-third.

Precious metals stocks and mutual funds could receive a further boost if portfolio managers of broad Canadian equity funds that are underweighted in their precious metals exposure, relative to the S&P/TSX composite index’s 8% weighting, decide to increase their exposure.

“There’s a lot of potential demand on the sidelines that, in past cycles, has come in later, leading to big moves,” Wong says.

With 2016 being an election year in the U.S. and elections coming up in 2017 in Germany, Italy and the Netherlands, Onno Rutten, vice president, investment management, global resources team, at Mackenzie Financial Corp. of Toronto, and portfolio co-manager of Mackenzie Precious Metals Class Fund, expects government policies to be accommodating. In addition, he says, Japan is struggling with low growth and China’s high rate of growth is slowing.

“It’s possible that some governments will move from monetary to fiscal stimulus to spur growth and jobs,” he says. “That’s the next frontier: some kind of government-managed form of ‘helicopter money.’ [That strategy] would raise questions about where the money would come from and the expanding size of the monetary base. Gold is the ultimate hard asset.”

In addition, gold can store value during a crisis, says Jon Case, portfolio manager with Sentry Investments Inc. of Toronto and manager of Sentry Precious Metals Fund: “Brexit was an unexpected wildcat event, and gold responded positively.”

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