Pimco Adds to Gold Holdings on Inflation Concerns

--Gold holdings increase to 11.5% of assets in Pimco Commodity Real Return fund

--Betting inflation will soar beginning next year

--Also recommending REITs

The world's biggest bond-fund manager, Pacific Investment Management Co., is buying gold futures as it bets that global inflation rates will pick up over the next three to five years.

The Pimco Commodity Real Return Strategy Fund, which has about $20 billion in assets, has increased its gold holdings to 11.5% of total assets recently, from 10.5% two months ago, and has been adding to the position when gold prices dipped toward $1,500 a troy ounce, says Nic Johnson, the fund's co-portfolio manager.

The money manager predicts global inflation rates will run higher, on average, over the next three to five years than what the world had witnessed over the past 25 years. However, the risk won't arise for another 12 months, during which inflation should be subdued.

Inflation--the erosion in money's purchasing power that is typically measured by the increase in the price of goods and services over time-- plays a key role in debt markets, where Pimco, a unit of Allianz SE (ALIZF, ALV.XE), has made its name.

Pimco has aired its concerns about inflation in the past and moved to avoid longer-dated Treasury bonds in favor of inflation-protected securities. But the move toward gold is recent and reflects an escalation in the fund manager's concern.

In the face of such risks, "broadly speaking, we prefer owning real assets as opposed to financial assets," Mr. Johnson told Dow Jones Newswires in a recent interview.

Three of Pimco's portfolio managers, including the head of the commodities group Mihir Worah and Mr. Johnson, have been on a 17-city U.S. tour since June to raise awareness among institutional investors and larger financial advisers.

Their message: the trifecta of loose monetary policy, persistently high levels of sovereign debt and rising commodity prices will drive inflation higher.

Pimco expects currency devaluation to remain a central theme in the market as global liquidity swells thanks to continued easy-money efforts from the world's central banks. Interest rates, meanwhile, will need to stay low as government debt runs at a high proportion to the overall economy.

"Gold is the currency without a printing press," Mr. Johnson says.

Moreover, investors should purchase gold before inflation rates rise, as "it's the process of going from 2% inflation to 4% inflation that's going to drive gold higher," he says.

Inflation rates will also get a boost from rising commodity prices, as increased prosperity in China and other developing and emerging markets bolsters demand for raw materials. China is in the process of bringing more than 1 billion people into the middle class as it strives to catch up to many of its neighbors, Mr. Johnson says.

"To put it simply: as people become richer, they consume more stuff," Mr. Johnson says.

To guard their wealth against the "silent tax," as inflation is often called, Pimco recommends investors stock up on store-of-value commodities like gold and platinum, and hard assets like real-estate investment trusts.

Gold prices have rallied sharply over the past decade, rising more than fivefold from $279 a troy ounce at the end of 2001 to $1,566.80 at the end of 2011.

While some have come to question gold's ability to extend this rally, Pimco says the precious metal, as well as the rest of the commodity complex, has more to go.

"We think the outlook for commodities is still positive and we think we're still in the midst of this super cycle," Mr. Johnson says, adding that commodity prices are set to rally for another decade.

Pimco's call on gold and inflation sees it join ranks with Wall Street giants John Paulson and George Soros, who have made similar bets on the precious metal in recent years.

However, what distinguishes Pimco's wager on gold is the money manager's prowess in debt markets, which have a close tie-in to inflation. The steady stream of interest income paid on government and company bonds can lose its value over time if inflation rates tick higher.

Last year, Pimco proved its mettle with getting inflation bets right when the company made about $50 million on a wager that 30-year Treasury Inflation Protected Securities would rise in value.

--Gregory Zuckerman contributed to this article.

Write to Tatyana Shumsky at [e-mail]

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