Gold: A Possible Hedge for Hard Economic Times

Written by
David Mully
Read Time: 3 minutes

Gold is the world's most under-owned asset now...but will that continue? As economic concerns rise, some financial gurus believe that more investors will start allocating a larger portion of their portfolios to gold.

The hike towards financial well-being is tough enough. But add inflation concerns to the mix, and the road to wealth seems virtually impossible and impassable. Is gold the answer to weathering economic storms without losing financial ground?

Coattailing on commodities in inflationary times

Relative to stocks and bonds, commodities react differently to economic conditions. When there's a rapid increase in an economy's money supply, commodities are likely to go up in value, while stocks and bonds are more likely to go down. For this reason, many investors turn to commodity buying as a means of hedging their portfolios against the ravishing effects of inflation. This is because value increases in commodity holdings can offset some of the inflation-driven declines in equity and debt holdings.

Panning for gold

Gold has long been a commodity of choice among investors. It's perceived as having inherent value, which differentiates gold from stocks, bonds, and paper currencies. Governments in debt trouble can print money to pay off their debts, but they can't fabricate gold. Also, because gold's worth isn't as affected by worldly events, investors view it as a safe haven of value during times of economic or political turmoil. This aspect makes gold an attractive complementary investment to the traditional asset classes.

Current macroeconomic conditions warrant a closer look at making a gold investment. Consider these factors:

  • Rapidly declining interest rates increase the threat of inflation by loosening the money supply. Since September, 2007, the Fed has cut the federal funds rate by 3.25 percentage points.
  • The value of gold rises when the value of the dollar falls. The U.S. dollar has been in an uneven decline against other currencies for years.
  • Real interest rates are getting pulled down by rising inflation around the world. Gold's return under these conditions can be on par, or sometimes better, than stocks and bonds.
  • Investment companies are offering new ways to buy gold, giving investors better options than hiding away jewelry or trading gold futures. Gold can be purchased by way of exchange traded funds, mutual funds, or mining stocks.

Investing in gold does have its risks, however. History has shown that gold can realize huge gains in short periods of time. But if you time it wrong, gold tends to underperform relative to stocks and bonds over the long haul. Further, an investment in gold pays no dividends and offers no guarantees. If the demand doesn't out pace the supply, the value of your investment might just tread water.

When you decide to go for the gold, heed the risks and be conservative by using it as a small percentage of your portfolio. If inflation spikes, gold holdings will rise too, evening out the path that leads you to financial well-being.

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