(MONEY Magazine) – War jitters, terror alerts, stagnant stock prices, a fragile economy and a weak job market.... Hey, with news items like these topping the headlines, it's no wonder nervous investors have been gravitating toward gold. After all, throughout history gold has held a special place not just in our portfolios, but in our psyches. We see it as a rock of stability in uncertain times, an insurance policy of sorts that offers financial shelter during political and economic crises. But most of all, it's an investment we know we can depend on to keep our money safe.

But can we really? True, gold has glittered recently, with bullion prices surging from less than $280 an ounce early last year to $385 in February. And the funds in Morningstar's precious-metals category--which concentrate mainly in gold-mining stocks--were up 26.1% for the 12 months through early March, while stocks overall lost 25%. The question is this: If you go for gold now, are you buying security and the possibility of robust returns--or are you simply setting yourself up for a big emotional disappointment and even bigger losses?

Considering all the attention that gold has been getting, I thought we'd take a look this month at its value to investors. We'll begin by examining whether gold deserves its reputation as a safe haven. After that, I'll move on to what I see as the two very different ways that individual investors might consider playing the gold market--although I have to say up front that I have serious doubts about whether most people can actually make these strategies pay off. Which, of course, is all the more reason for you to read on if you're giving even the slightest thought to joining the latest gold rush.

GIMME SHELTER There's no doubt that gold can be a refuge in times of turmoil. Its performance during the uncertain post-Sept. 11 world has shown that. But paradoxically for an asset renowned for security, gold is also one of the most flighty investments around. Gold stocks, for example, are nearly three times as volatile as the overall stock market. One reason is that gold is driven not just by economics but also by emotion--our fear of geopolitical instability, for example, or concerns about the declining U.S. dollar. Another fundamental fact that contributes to gold's volatility: It's not that big an asset class. The market value of all gold stocks is roughly $60 billion, or less than that of Dell Computer alone. So it doesn't take much of a flow of money into or out of the sector to drive prices up or down.

That volatility is wonderful when it works in your favor, but it can also quickly turn against you. Indeed, after precious-metals funds racked up spectacular gains through the end of 2002, they did an abrupt about-face in the first few months of this year, actually losing 6.3% in February alone. It's unclear whether that means this rally in gold is already over. Gold advocates point to a variety of factors that argue for even higher gold prices in the future, including a weak U.S. dollar, deficit spending that could lead to inflation and a rising global demand for gold in the face of a supply that's been limited because of years of depressed prices. Citing these and other factors, U.S. Global Investors chief investment officer Frank Holmes predicts that gold could rise from its recent level of $345 an ounce to as high as $600 over the next couple of years. Jean-Marie Eveillard, manager of the First Eagle Gold fund, which gained 107% last year, also believes we're in the early stages of a bull market for gold, although he also knows that much depends on investors' perceptions. "If in 12 to 18 months we're back to genuine peace and prosperity," says Eveillard, "forget about gold. Gold will be dead."

Which brings us to what I see as one of the major downsides to gold. If you buy after a big run-up in price, you may have to suffer through a long period of subpar performance. Even after its recent run, at $345 an ounce gold bullion is still below its 1996 price of more than $400--and isn't even within shouting distance of its high of $850 an ounce in January 1980. Similarly, as the chart of trailing returns for precious-metals funds shows (see page 77), gold stocks can go through decade-long stretches when they generate very low or even negative returns. So whether you consider gold a refuge depends on what kind of protection you're looking for. If you want shelter during a specific time of crisis, chances are that gold can provide some security. However, if you think of gold as an asset that will protect the value of your money over long periods of time, then its record is much spottier.

VIRTUOUS VOLATILITY Even if you don't want to own gold for protection, there are other ways you may be able to play it to your advantage. One is to make a virtue of one of gold's most prominent shortcomings, its volatility. Even when gold is in one of its prolonged periods of stagnation, it will occasionally break out of its slumber with short but very strong rallies. For example, although gold was in a horrible slump from 1997 through 2000, in September 1998 gold stocks jumped more than 50%, largely because of turmoil in the Russian equity and bond markets. If you are smart or lucky enough to buy gold or gold stocks before such spikes occur or get in at the early stages of a run, you can reap huge returns.

The question is whether it's realistic for you to expect to perform such a feat of exquisite timing. I know I can't do it, and I doubt most individuals can. But maybe you're one of those rare savants who got out of tech stocks and into bonds in early 2000 when the Nasdaq was over 5000. Or maybe you had the prescience to buy gold stocks in late 2001 right before they zoomed to a 30% gain in the first four months of 2002. Just remember, if you buy in late, you may face some tough going. In the three years following their explosive gains in September 1998, gold stocks posted an annualized return of negative 6%. And even if you held on for the gold-stock rally in 2002, you would still be sitting on a small loss. In short, the cost of poor timing can be high.

THE DIVERSIFICATION EFFECT The other way to invest in gold is to exploit another of its remarkable attributes--namely, its low correlation with the stock market. Although gold returns jump around much more than stock returns do, the fact that they don't move up and down in unison with the broad stock market gives gold a unique advantage. It means that by adding some gold stocks or funds to your stockholdings, you stand a chance of boosting your returns while lowering the overall volatility of your portfolio. Over the 32-year span from the beginning of 1971 through 2002, for example, the S&P 500 index returned an annualized 11.2% while gold stocks gained an annualized 8.8%. But research by U.S. Global Investors shows that a mix of 90% S&P 500 stocks and 10% gold shares over that period would have gained 11.5%--more than the S&P 500 alone--and simultaneously reduced volatility below that of either gold or S&P 500 stocks alone.

I don't doubt that this "more gain, less pain" effect is theoretically possible. But again, the question is whether you're likely to pull it off in real time as opposed to seeing in retrospect how it would have worked. Getting this diversification benefit requires that you periodically rebalance your holdings--buy gold and sell stocks or vice versa--to restore your portfolio to its original proportions. "This requires enormous emotional energy," says William Bernstein, author of The Four Pillars of Investing. "You've got to be willing to buy gold when everyone says it isn't something you should own and then be able to sell it when all the gold bugs in the world are saying buy."

Frankly, I'm not sure it's worth the effort when I can get plenty of diversification by adding an asset like real estate investment trusts (REITs), which also have a low correlation to the stock market, to my portfolio. And with REITs, I get diversity without gold's volatility, so it's easier to follow a rebalancing strategy.

BOTTOM LINE I believe gold is overrated as a safe harbor and requires more discipline than most investors have for it to pay off as an investment. So I'll sit out this latest gold rush. And unless you've got a golden touch for predicting gold prices or nerves of, uh, steel when it comes to rebalancing, I suggest you do the same.