By Claudia Assis
SAN FRANCISCO (MarketWatch)--The bloom is off the golden rose.
Investors who have recently jumped on the gold bandwagon will need plenty of patience this year, as the anemic global economy and better prospects for the U.S. dollar combine to dim gold's allure.
While buyers are likely to see their gold holdings rise in value for a 12th consecutive year, any advance is expected to be more modest than in recent years.
Muted returns from gold would test short-term traders. Yet those who own gold as a long-term answer to currency concerns and for portfolio diversification could find their patience is rewarded. Investing in gold-related companies is also a reemerging trend.
"I don't think (gold) will be the slam dunk that it has been," said Jay Feuerstein, chief investment officer at 2100 Xenon Group, a Chicago-based managed futures fund. Short-term gold speculators are likely to have a tougher time with the metal this year, he added.
The absence of catalysts to drive buyers to gold is affecting both demand and price.
Gold ended at a record $1,891.90 an ounce last Aug. 22 as talk of additional quantitative easing from the Federal Reserve reached a fever pitch. But gold is down about 15% since then, closing Thursday at $1,647.70 an ounce. Prices fell 10% in December alone.
Still, gold managed a 10% gain for 2011, much better than the Standard & Poor's 500-stock index, which finished the year flat on a price basis.
Large and small investors alike have cut gold positions over the past year. Holdings in SPDR Gold Trust (GLD), the largest exchange-traded fund backed by gold, offer a good picture of the fund liquidation that has taken place in recent months.
The ETF's gold holdings have remained around 1,250 metric tons for most of December and so far this year, but that's still a 2.4% decrease from December 2010, when the fund had 1,281 metric tons. Holdings jumped 13% in 2010.
Gold investors have seen no signs that the Fed will ease anytime soon, while the euro zone debt crisis has taken the euro down several notches.
European headlines still impact gold futures, to be sure, but increasingly the metal has traded on U.S. dollar moves.
The dollar is seen as firming this year as the U.S. economy shows strength relative to other developed nations.
If significant short-term gains are not in the cards, gold still has a supporting role in a balanced portfolio, Feuerstein said. Gold is a hedge against inflation and currency fluctuations, he added, though he recommended having no more than 5% of one's portfolio tied to gold.
Feuerstein sees gold ending 2012 not much beyond $1,700 an ounce, with some peaks and valleys along the way but mostly staying under the dollar's thumb.
That said, support for higher gold prices is rooted in Europe's unresolved debt situation and ongoing concerns about the heath of European banks, Feuerstein said.
One of the most optimistic forecasts for gold comes from Michael Widmer, a metals analyst with Bank of America Merrill Lynch in London, who sees gold approaching $2,000 an ounce by year-end.
The same forces that pushed gold close to $1,900 last year are still evident, some analysts say, offering support for the metal. Moreover, gold serves other purposes including being a way to offset currency risk, to insulate a portfolio from global economic uncertainty, and as protection against "black swan"-type geopolitical upheaval.
"We still have low growth in a lot of countries, and we still have high debt in a lot of countries," Widmer said. He added that gold could trade in a wide range in 2012, possibly testing lows of around $1,450 an ounce, and he noted that he'd be a buyer at that level.
Gold's massive run has left a cloud on gold-related stocks. Shares of gold miners have greatly underperformed the metal itself, as the companies were weighed down by rising production costs. But investors might want to give the miners another chance.
Newmont Mining Corp. (NEM) has started a trend likely to be followed by more companies this year. Newmont was the first to offer gold-linked dividends, a move widely viewed as a response to criticism that miners have been hoarding cash at the expense of their investors.
"You will see others do it," said Rick de los Reyes, a portfolio manager with T. Rowe Price Group in Baltimore. Even if a company's dividend is not directly linked to prices, dividend payouts will increase, he added.
De los Reyes manages a fund with about $800 million in equities related to base- and precious metals mining. He's looking to buy more shares of smaller companies rather than the safer, but less compelling, major gold miners, he said. Smaller companies are likely acquisition targets and offer the best upside potential, he noted.
De los Reyes cited three companies that share the virtues of having good management and strong production growth prospects.
Eldorado Gold Corp. (EGO) is a "premier" mid-tier gold company, he said. "It is a very well managed company with a pristine balance sheet," Unlike many of its competitors, Eldorado has a long history of "underpromising and overdelivering," he added.
The others are smaller Agnico-Eagle Mines Ltd. (AEM) and Osisko Mining Corp. (OSKFF).
Agnico-Eagle made a series of missteps recently, and it is expected to offer lower earnings guidance next month, but de los Reyes said the market has already priced in this event and is likely to reward Agnico going forward - not least because most of the company's assets are in lower-risk countries such as Canada, Mexico and Finland.
Osisko also had its share of operational issues and the stock has suffered accordingly, but it is expected to ramp up production, de los Reyes added.
Claudia Assis is a San Francisco-based reporter for MarketWatch.