Gold Investing - How To Hedge Against Inflation and a Weak Dollar

Gold investing is now deemed a must for many investors, even if it comprises a small portion of a portfolio. Precious metals act as a hedge against inflation and concerns over a weak currency. Gold has more than tripled over the past several years while stocks have barely gained any ground in the past decade. While this trend is not expected to continue forever, there are certainly some reasons gold may outperform other asset classes moving forward, as well as provide an important hedge against inflation and a weak currency.

First off, gold is denominated in US Dollars. While the US dollar continues to fall against foreign currencies, that alone forces the price of gold to rise. We saw this in 2008 and 2009 and surely you recall $140 oil which exhibited a similar phenomena until the global economic crisis quelled demand while the dollar rallied.

Another driver for gold prices is inflation. In essence, when hyperinflation takes hold, physical assets with tangible value become more valuable (relatively speaking) while paper currency declines in value. Recall some economic disasters overseas (like Zimbabwe) where people were taking entire wheelbarrows full of paper currency to the local store for bread just to survive. Meanwhile, can you imagine what a bar of gold was worth at that time in terms of currency? While this doomsday scenario is unlikely to unfold in the US, the principal holds. We saw rampant inflation in the 1980s and given the increasing deficits, borrowing and runaway entitlement programs the administration is passing, it's not out of the realm of imagination that in the coming years, the US will see higher inflation than the low single digits we've become accustomed to.

Multiple Gold Investing Options

There are various ways to exploit the rise in gold prices. Much depends on your particular objective.

First, there are gold ETFs that allow investors to benefit from a rising gold price. Popular ETFs include (GLD) which holds physical gold bullion, (GDX) which is comprised of gold mining and exploration stocks, and (GDXJ) which is a more volatile gold miner "Juniors" ETF since it holds smaller companies.

Next, some people prefer to take physical custody of their own gold. While some refer to these people as conspiracy theorists and doomsday enthusiasts, there have actually been recent reports of investment firms claiming to have physical custody of gold bullion for their investors when the vaults were actually deficient in the amount on record. Some feel it's only a matter of time before there's a run on gold. Additionally, in the event of an extreme catastrophe, some people feel the key reason to even buy gold in the first place is so that they'd have physical custody of this "currency" in such event and would have no use for an online account for instance, that claims to be holding gold on their behalf.

Gold Investing Tax Implications

There are some key tax implications for holding gold though. It is treated as a collectible. As such, profits derived from gold bullion or the ETF GLD are treated as a "collectible" and taxed at a higher tax rate than capital gains on stocks that comprise a gold miner's index for instance. Taxed profits can be easily calculated using online tax tools. In looking back historically, roughly, GLD and GDX track pretty closely together and GDXJ tends to be more volatile. So, on the way up, GDXJ would be expected to outperform while on the way down, GDXJ would be likely to underperform.

Whichever method you prefer, many financial experts advise investors hold anywhere between 3%-10% of their portfolios in gold for the inflation and currency hedge.

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