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Invest In Gold As A Hedge Against Inflation, Recession, and The Weakening Dollar

Published 1/8/08 (Modified 3/9/11)
By MoneyBlueBook

Most ordinary investors know about the general wisdom of investing in the stock market and the importance of portfolio diversification, but have you ever considered investing in gold? Admittedly, the very concept of investing in gold is strange to begin with. After all you're paying money to buy a shiny piece of metal dug from the ground that is more commonly associated with jewelry meant to adorn the body. With all the technological advancements and investment vehicles out there today like stocks, bonds, currency exchanges, and options, why would any sophisticated investor choose to include this physical asset as part of his or her investment portfolio?

The answer lies in how gold has been regarded and used throughout history. Since the beginning of time, gold has been prized as a measurement of wealth due to its rarity and unique functional qualities. From ancient China to the ancient Egyptians, to pre- modern day United States, gold has been used to stabilize and back currencies. Even our United States currency remained on the gold pegged standard until 1971 when President Nixon suspended the convertibility of U.S. dollars into gold. Since then, world currencies including the dollar have operated on a float fiat money system where currency value comes not from the underlying intrinsic value of the paper itself, but from supply and demand driven by exchange traders.

Gold Performance Vs. Stocks

Because they are from two completely different asset classes, investors value gold and stocks quite differently. As a precious material, gold has always had the ability to retain its value over time and has historically moved inversely with the U.S. dollar. This means historically whenever the value of the dollar has dropped or become extremely weak, as it is now, the value of gold has increased. While gold can store its value due to its durability and limited quantity, the value of stocks is based on the perceived rate of return due to growth, performance, and dividends. Thus while stocks tend to perform extra well during periods of political and economic stability, due to its intrinsic value gold tends to be more desirable and perform better during periods of bank turmoil, falling interest rates, and times of political crisis or war. In fact, many gold bug investors track the price of gold today to gain insights into the health of the overall economy, and to forecast where it is headed as well as the likelihood of future instability and pullbacks. Some also preach the value of investing in hard assets like gold as an important component to weathering and surviving a recession.

The current rise in the value of gold can be attributed to recent geopolitical instability as well as the continued dollar depreciation. This has caused assets not tied to the value of the dollar to become much more appealing. The continued U.S. recession talks, problems in Iraq and Iran, the flattening credit markets, and increased demand from places like India and China, have caused the value of gold to rise. However, keep in mind that prices do waffle and fluctuate significantly.

Options For Buying Gold and Investing In Gold Operations

I don't think gold should be seen as a replacement for stock investments. In the long run, stocks have much higher growth potential, but gold can complement a diversified portfolio and help hedge against some risk. Thus, having gold comprise 1-5% of your portfolio would probably be sufficient. Here are a few ways to invest in gold assets.

1) Gold Bullion - The most direct way to invest in gold is to simply buy the real thing in the form of gold coins or gold bars from a broker. Of course, unless you are Scrooge McDuck, you probably don't have a large money bin to stash your loot, so storage may be a concern. Also, when you want to sell, you'll likely need a gold appraiser to calculate the value. Another downside is that the Internal Revenue Service treats gold bullion as a collectible and the sale of it as a gain taxed at rates up to 28%, well above the 15% capital gains for stocks and mutual funds.

2) Exchange Traded Funds (ETF's) - For those of you who don't have the money to buy or rent large warehouses to store your gold doubloons, you may consider investing in a gold ETF that does all of the gold buying, storing, and insuring for you. That way you can avoid the hassle of owning the physical asset itself, while still getting needed direct exposure to gold. Shares of popular gold ETF's include StreetTracks Gold Shares (GLD) (up nearly 40% in the last year or so) and iShares Comex Gold Trust (IAU). Both can be traded like any stock. Keep in mind that there are usually management fees to cover storage cost. Unfortunately, long term capital gains for gold based ETF's are taxed the same way as owning the physical asset itself. However, if you held the ETF in a retirement tax-free account like a Roth IRA, the gains would be completely tax-free. Certainly something to think about and consider.

3) Mutual Funds - Mutual funds offer exposure to mining operations and companies that primarily mine gold while offering some semblance of diversification. Rather than relying on the success of one mine alone, you get to invest in a pool of related mines and companies. Here are a few high performers to consider - (link).

4) Stocks Of Gold Mining Operations - Another roundabout way to invest in gold is to buy stock in a company that mines gold. However, such an investment is also subject to the usual corporate risk associated with a going concern pegged according to the perceived rate of return of the company. Stocks that you may want to take a peek at include the two biggest mining companies - Newmont Mining (NEM) and Barrick Gold Corp. (ABX). Both have been performing quite well recently.

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