All that glitters is gold: despite a lackluster 2008, Joe Sterling sees gold stocks regaining their sparkle in 2009.

IF YOU THINK THE FINANCIAL MARKETS THREW FOLKS for a loop last year, imagine how gold investors felt. Gold has long been known as an asset that retains its value--even when the world is in turmoil.

That's not how it appeared last summer, when both bullion and the mutual funds that bet on gold dipped sharply. After a long climb the precious metal pulled an about-face midyear, coinciding with the decline in the global economy. Gold fell roughly 23% from its high of a little more than $1,000 per ounce in March to about $775 in December. Gold mutual funds took an even greater hit because they invest mainly in mining companies whose labor and fuel costs increased at the same time that gold prices fell. Those funds dipped an average of more than 40% through early December. Joe Sterling, co-manager of the American Century Global Gold fund, offers a glimmer of hope for gold fans, however. Some costs are beginning to turn in the miners' favor. For instance, the drop in oil prices means operating costs should decrease in 2009.

Sterling's strategy raises an immediate question: If gold is so great, why not invest directly in the metal itself, rather than in related stocks or mutual funds? The answer is simple. Certainly, gold is a tangible asset and a store of wealth when all other alternatives--stocks, bonds, cash--have scared investors away. But there are several problems associated with owning gold bullion or coins. It's difficult to store and to guard. Later on, gold isn't so easy to trade.

Gold funds are set up to provide investors some clear advantages. They provide a more liquid way to tap into the metal's ability to weather a storm. First, they invest in companies that mine gold and other precious metals. Their value rises and falls along with the stocks the gold funds hold. Investors can jump in or out with a call to their broker. Gold funds can, however, be just as volatile as holding real gold.

Sterling's fund typically has from 75 to 100 positions in global gold mining companies. Even so, two-thirds of American Century's portfolio is invested in North American firms. The fund takes a long-term approach to investing, and annual turnover is low--usually the managers rotate no more than 10% to 35% of their portfolio each year. Like other precious metal mutual funds, Global Gold (BGEIX) often endures volatile twists and turns posting huge gains and losses. Even so, after its 29% drop in 2008's third quarter, the fund's average annual 10-year return as of Dec. 15, 2008 was 10.6%.

So what happened in 2008 to shake things up?

Several macroeconomic events affected the price of gold. In midsummer, the dollar bottomed. One reason is that the financial crisis took front and center stage worldwide and investors started seeking safety in U.S. Treasuries. A stronger dollar brought the price of bullion down. Meanwhile, producers were hurt by higher costs for much of 2008. Oil prices were steep the first half of the year, and that took a cut out of mining companies' bottom lines. Higher labor and equipment costs brought expenses up. And as a result of both events--a stronger dollar and higher costs--mining shares took it on the chin.

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What is your forecast for 2009?

We're cautiously optimistic. For one, mining outfits were taken by surprise when costs ramped up last year. This time around, they should manage better. Besides that, we're getting signals from gold producers that costs should come down anywhere from 25% to 30% this year. A better operating environment should help them close the gap between mining returns and the price of gold.

And what about gold prices in 2009?

We don't forecast target prices for gold, but we do think there's a good chance gold could trade in a range of $1,000 to $1,500 an ounce over the next 12 to 24 months.

How's the overall economy going to affect the stocks you track?

The macroeconomic factors are uncertain, but let's look over the possibilities. We know that gold tends to do very well when there is inflation. During the fall of 2008, there was talk among economists that the U.S. might teeter into a deflationary period and that asset prices, including that of gold, would fall across the board. I'm not so sure that deflation will necessarily hurt gold, especially this time around. Remember that investors flock to gold when the dollar is weak. Right now, we're seeing the federal government heap money into bailouts and stimulus packages. There's a possibility that we might see prices fall for the short term, but in the long run there's a good chance that a ballooning U.S. budget deficit will weaken the dollar and drive the price of gold back up. So on one hand, there's uncertainty and a lack of confidence, and on the other hand there's a chance for inflation to pick up strongly.

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Just how do you assess the value of gold mining companies?

First, we look at the value of the assets and just how productive each mine will be over time. Then, there are costs. We want to see that an operation can effectively extract the gold and other precious metals at a cost that will allow management to make a profit.

Give us an example of a stock that balances the two.

We see Goldcorp Inc. (GG) as something of a development project. They have mines in Mexico and Canada that have strong growth profiles and, as a result, the company should see production grow from just under 2.3 million ounces in 2007 to somewhere close to 2.4 million this year. At the same time, Goldcorp is one of the lowest cost producers around. The company actually saw production costs drop to around $300 an ounce this year from between $450 and $500 in 2007.

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Kinross Gold Corp. (KGC) is much the same story. The company has been managing costs well while production out of its mines in Russia has been strong. Kinross should see growth from the 1.6 million ounces of gold the company extracted in 2007 to 1.8 million last year. Management, meanwhile, says it sees costs coming down to around $400 an ounce from $450 this year.

So is the gold business as easy as keeping costs down and production up?

Yes, but there are different ways to keep costs down. One way is to leverage the other precious metals that are extracted from its properties. AgnicoEagle Mines (AEM) is an example of just that. The company has a good stable of mines in Mexico, Finland, and Canada that are coming on line this year to drive production growth. They've got a low cost structure at about $240 an ounce. At the same time, management has done well selling byproducts such as zinc and copper, another benefit to Agnico-Eagle's bottom line.

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