Gold prices jumped to a two-week high on Friday after the US central bank left the key rates unchanged. As gold reached $1,142 per ounce last week, it also snapped a three-week losing streak. Gold had been trading higher right ahead of the outcome of the FOMC meeting last Thursday as many traders had predicted no rate hike. A rate hike decision would have made it difficult for the non-yielding commodity to attract investors away from Treasury bonds. Higher rates would have also led to a surge in the dollar, making dollar-denominated gold more costly.

However, it is not certain yet if the rally would continue and help gold funds. Major growth countries, particularly China, have been suffering dismal economic conditions. The outlook in general is also bearish. This may hurt gold as demand in these regions remains the key indicator of buying trends.

Gold & Interest Rates

Gold has a negative correlation or inverse relationship with interest rates. Opportunity costs of holding gold increases amid higher interest rates. Gold is viewed often as capital preservation asset and a currency that has no yield. So if there are higher yields elsewhere, the cost of holding gold goes up. The yellow metal offers no yield and thus the price declines. A surging dollar, a result of higher rates, also has an inverse relationship with gold prices.

Gold moves higher amid ultra-loose policy and is also employed as a hedging strategy during inflation. A low rate environment pushes demand higher for gold, as quantitative easing measures subdue inflation.

Rate Hike Delaying the Inevitable?

After concluding the two-day policy meeting, the Fed decided last week to keep the short-term interest rate unchanged at a near zero level. Sluggish global economic growth, an increase in volatility in financial markets and a low inflation level held the Fed back from hiking rates. Nine out of 10 policy makers voted in favor of keeping the rate at the near zero level.

However, out of 17 committee members, 13 indicated that a rate hike may be possible this year. On that note, it will be difficult for gold to sustain the rally. A hike in December is possible, and that would turn the tide again for the yellow metal, which nevertheless is under extreme pressure. In fact, Bloomberg generic pricing showed gold for immediate delivery had dropped 0.3% at 11:16 a.m. in Singapore after indications from some policy makers that rate hike may come this year. The Federal Open Market Committee will meet on Oct 27-28 and again on Dec 15-16.

Gold Output Relatively Unaffected

On the other hand, the fortunes of gold miners are closely interlinked to gold prices. Recent data on gold production in the U.S. paints a grim picture. Output slumped 14% in May to 14.9 tons from 17.3 tons in the same period last year. However, production on a global basis continues to increase. Analysts at the CPM Group, GFMS and Metals Focus have projected that output will continue to increase this year and may stabilize next year. A substantial near-term reduction in output seems unlikely.

There are several reasons for this situation. First, prices surged from 2008 to 2011, when the economic crisis led to a flight toward gold. This created a bloated sector which means that there is enough room for cost reductions in the industry. Such initiatives will allow companies to create favorable bottom lines despite falling prices.

Gold Prices for Other Countries

Interestingly, gold prices for the U.S. may have declined this year, but a completely different picture is emerging in certain other countries. The reason for this is the appreciation of the dollar against other currencies. Since the cost of mining is accounted for in the currency of the relevant country, it is this metric which should be taken into account when evaluating foreign gold producers.

In fact, a situation has emerged where gold prices have actually increased in the local currency. This is particularly relevant when it comes to those countries with established stock exchanges with important listed gold miners, South Africa, Canada and Australia.

Of course, local exchanges continue to use U.S. gold prices to determine the fate of local producers. But this is fundamentally counterintuitive and the health of these producers is ultimately dependent on local costs over the longer term.

Gold Funds in Focus

Given the current scheme of things, is it a good idea to start offloading funds from your portfolio? Or is it a good idea to wait? The funds we will discuss below have gained in the 1-week period, but they continue to have massive negative returns for the other long-term periods. Nonetheless, the sustainability is indeed debatable. Uncertainty again prevails about whether a rate hike will actually take place this year. On that note, below we present 2 funds for investors who are ready to take the risk and buy Precious Metals funds, and also 2 funds that should be avoided now.

Our selection is also backed by Zacks Mutual Fund Rank. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.

Funds to Buy

Franklin Gold and Precious Metals A (FKRCX - MF report) invests heavily in companies engaged in operations related to gold and precious metals. FKRCX mostly invests in non US companies irrespective of their market capitalizations. FKRCX may also invest in ADRs and other depositary receipts.

Franklin Gold and Precious Metals currently carries a Zacks Mutual Fund Rank #1 (Strong Buy). FKRCX has a 1-week return of 8.3%. However, the 3 and 5 year annualized returns are negative 30% and 21.4%. Annual expense ratio of 1.07% is lower than the category average of 1.44%.

Fidelity Select Gold Portfolio (FSAGX - MF report) invests heavily in companies whose principal operations are related to gold as well as in gold bullion or coins. A maximum of 25% of its assets are invested in precious metals via a wholly owned subsidiary. FSAGX invests mostly in firms involved in exploration, mining, processing, or dealing in gold, or to a lesser degree, in silver and other precious metals.

Fidelity Select Gold Portfolio carries a Zacks Mutual Fund Rank #2 (Buy). FSAGX has a 1-week return of 7.6%. However, the 3 and 5 year annualized returns are negative 31.4% and 21%. Annual expense ratio of 0.90% is lower than the category average of 1.44%.

Funds to Sell

Tocqueville Gold (TGLDX - MF report) seeks long-term capital growth. TGLDX invests a large share of its assets in companies related to gold and other precious metals located worldwide. Investments are also made in developed and emerging markets. While most of the assets are invested in Gold related securities, a maximum of 20% of the assets can be invested directly in gold bullion and other precious metals.

Tocqueville Gold carries a Zacks Mutual Fund Rank #4 (Sell). TGLDX has a 1-week return of 6.9%. However, the 3 and 5 year annualized returns are negative 29.4% and 18.5%. Annual expense ratio of 1.36% is however lower than the category average of 1.44%.

Oppenheimer Gold & Special Minerals A (OPGSX - MF report) invests almost all its assets in equities of firms that are engaged in mining, processing or dealing in gold or other metals or minerals. The fund has no limit on foreign investments. Apart from investing in domestic companies, it may also invest in developing or emerging markets.

Oppenheimer Gold & Special Minerals A carries a Zacks Mutual Fund Rank #4 (Sell). OPGSX has a 1-week return of 7.3%. However, the 3 and 5 year annualized returns are negative 33% and 22.5%. Annual expense ratio of 1.16% is however lower than the category average of 1.44%.