Gold has fallen 5% so far in January

While Gold rose 29.6% in 2010 for its 10th consecutive annual gain, it has performed poorly so far in 2011.  On Thursday, gold fell 1.7% to US$1,346.5/ounce.  Today, it fell again to $1,342.7.  So far in 2011, gold has fallen 5%, while silver has dropped 11%.

This correction is primarily due to the improving economic data from the US.  The same data has also caused US stock markets to return to their September 2008 levels.  Rising inflation and increasing interest rates in China has also caused investors to feel concerned, since a higher interest rate increases the opportunity cost of holding gold.  Hedge fund manager Dennis Gartman has sold 2/3 of his gold position.

However, improving US economic data may not continue for much longer.  While the US economy is currently receiving a boost from the extension of the Bush tax cuts, economist David Rosenberg believes the US economy will slow in the second quarter and beyond.  He believes that some current estimates for 4% GDP growth in 2011 are too high.

In addition, the euro zone debt crisis is far from over.  Portugal is paying 6.7% on 10-year government bonds despite purchases by the ECB, which makes a bailout imminent.  After Portugal, more nations may need to be bailed out.

Yesterday, news emerged that the Spanish government is raising money to bail out its regional savings banks, called Cajas.  The Cajas were the centre of attention back in May 2010 when Greek crisis erupted, since the bankruptcy of the savings banks would devastate the entire financial sector in the euro zone.

Thus, economic worries from the US and the euro zone are far from over.  Charles Morris, who manages HSBC's US$2.5 billion Absolute Returns fund, has retained half of his gold position.  He believes the long term prospects for gold are good.  In addition, it is far safer to hold gold company stocks than the bullion through ETFs such as GLD.  While bullion-backed ETFs do not pay a dividend, many gold mining stocks do.

In addition, with a gold mining company that is increasing production, the shares will go up even if the price of gold remains flat.  For example, Kinross Gold Corp (TSX: K) is expected by TD to increase its production by 104% over the next 5 years.  Thus, I expect the shares to rise considerably even if the price of gold remains flat or decreases slightly.  In fact, I expect the price of gold to continue to rise in 2011 to $1,750/ounce and peak in 2012 at $2,000/ounce.  I currently hold Kinross and Goldcorp (TSX: G) in my porfolio and other portfolios I manage.