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Investing in the 79th Element

July 12th, 2009 by 
PK

Gold, the 79th element in the periodic table, is perhaps the most controversial of any investments.  Every investor seems to have an opinion on the metal.  Some people, particularly enamored with the constitution, read into it the necessity for the government to only issue gold (and silver) coins.  So, investing in gold... is it a good idea in your portfolio?

Regardless of your viewpoint on the legality of fiat currency, perhaps you have decided to take the plunge and invest some of your hard earned funds into the stuff.  There are many ways to approach investing in gold; I will lay out a few approaches to gold investing in this article.

A Brief, Contentious Historical Summary of Investing in Gold

The United States has historically altered between being backed by gold at a fixed rate or a constant rate. Two major events in the history of our currency are pointed at as the most controversial laws our nation has passed with regards to gold and silver backed currency.  The first is the "Gold Confiscation Act", or Executive Order 6102 under President Franklin D. Roosevelt.  That act banned the 'hoarding' of gold over the amount of $100 for private investors.  The second was the August 15, 1971 act by President Richard Nixon to depeg the $35 / oz. gold standard due to excessive spending on Vietnam and President Lyndon Johnson's 'Great Society'.  Since 1971, currencies of the world have been fiat currencies, and the rate of gold exchange is set by the market.

Widely Held Beliefs on Investing in Gold

Just because beliefs are widely held doesn't mean they accurately reflect reality.  Yes, there is a correlation between the devaluation of the dollar and the increase in the price of gold (it is not 100%, stocks are a better inflation hedge).  However, gold tends to perform even better in times of deflation (see here and here).  Gold's highest performance potential would seem to be linked to an emotional event rather than a monetary one.  Gold has historically been used as currency, and its perception as currency might keep it valuable in times of great emotion.

Whatever The Reason...

Investing in gold isn't like investing in copper pennies...

Picture of copper... I guess it's similar to gold

Regardless of the reason why you want to purchase gold, you have decided to take the plunge.  The next step you have to consider is how, exactly, you are going to go about that.  There are a few options for you to invest in the metal, which I will highlight shortly.  It is important to note, that for whatever reason, gold is considered a 'collectible' by the IRS.  This means that no matter your holding period, physical gold capital gains you receive will actually be taxed at your marginal rate.  See a tax professional for more details... I am not one.

Pick a Door

  1. Physical Bullion - Depending on your risk tolerance, (and possibly, paranoia) physical gold is an option.  You can buy gold coins, such as the popular American Eagle or the South African Krugerrand, for your own personal storage.  You're going to want a safe... theft is probably the greatest risk to your gold holdings, not confiscation.  Alternatively, you could store it in a bank safety deposit box or off site in a vault like with Bullion Vault.
  2. Gold ETFs - A much simpler solution is to invest in a gold exchange traded fund such as IAU and GLD.  You can even go long 2x the spot price of gold with an ETF such as [[UGL]].  There are a number of other options, check them out.  An ETF like GLD will hold physical gold somewhere.  Commodity ETFs are an interesting approach to investing in commodities in general, not just gold.
  3. Gold Stocks - Gold miner stocks, such as companies like Freeport McMoran FCX and Gold Fields, Inc. GFI are another way to play gold.  Gold stocks will not correlate perfectly with the spot price of gold, but will realize a benefit.  The nice thing about gold stocks (other than the reduction in tax if held in a taxable account for a sufficient duration vs. the 'collectible' tax of gold) is they won't lose as much money on the way down if gold loses its luster.
  4. Derivatives - For a more exotic approach (where you can also apply leverage) to investing in gold you can check out the derivative market.  You can buy or sell options on gold, and invest in futures contracts.

Finishing it Off

All of these options are a solid bet for investing in gold.  Various options have their own advantages and disadvantages.  In a true crisis environment, physical gold would probably be better than any of the other options.  However, that sort of situation seems unlikely.  In a taxable account, ETFs are the most accessible way to invest in gold.  Take a look at CEF, which is the Central Fund of Canada (note CEF also holds silver).  In a taxable account, you can save money over the other options.  Of course, you could stick it in a retirement account and not worry about taxes.

Full Disclosure: That's what I did; I'm invested in a mutual fund that invests some of its assets in physical gold in a tax-free account.  Consult a financial advisor if you have any questions.

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