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Heavy Metal Jacket For Defensive Investors

Published: Monday, 31 Aug 2009 | 2:22 PM ET

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By: Barbara Chai,
Special to CNBC.com

Given the uncertain economic climate, is gold a sound investment?

Gold Bricks
AP

“Gold has a place in almost every investment portfolio as a hedge or safety mechanism,” says Burton Rothberg, Ph.D., a former senior trader with Commodities Corporation, who has invested in the gold markets for decades.

In February, gold briefly pierced the $1000-an-ounce mark before retreating, and while prices have been volatile this year, they have mostly hovered above $900. Since gold is used as a hedge against inflation, prices have moved inversely to the dollar.

Metals
Rothberg recommends the average investor buy some gold purely for safety's sake. “If worse comes to worse—and I don’t just mean the economy in a recession, I mean if really bad things happen—gold is what you want to own because people will move away from paper currency.”

Bars, Funds And Contracts

He suggests buying solid gold bars at wholesale prices—the retail market brings a significant markup-and keeping it tucked away in a bank safe-deposit box. For smaller amounts, there are also gold coins, though these carry a mark-up for the expense of producing them.

Slideshow: From Coins to Commodities And Beyond

Alternative Investing - A CNBC Special Report - See Complete Coverage

“I would recommend the average investor, if they want to get into hard assets, put 3 percent to 5 percent of their money in gold and hope they never have to use it.”

Other experts encourage different ways to invest in precious metals.

“A mutual fund is probably more conducive for the average investor,” says Douglas Lockwood, CFP, of Harbor Lights Financial Group in Manasquan, N.J. “These invest in hard assets and mining companies, and transporter companies as a combination. Sometimes more money is made in the underlying companies.”

Mutual funds that fall into this category include USAA Precious Metals and Minerals [USAGX Loading... () ], Van Eck Intl Investors Gold [USAGX Loading... () ], and Evergreen Precious Metals [INIIX Loading... () ].

“I think when we talk about precious metals, there’s a reason why they’re called ‘precious’,” says Lockwood. “Precious metals are a good thing to have for diversification, but I’d recommend a 2%-to-5% range. Any more than that is just dangerous.”

Mark Johnson, vice president of equity investments at USAA Precious Metals & Minerals Fund, agrees: “I think if one buys a well diversified mutual fund with some established track record, it’s appropriate for the small investor at maybe the 3%-to-5% level. You don’t want to put too much into this category because it is an inherently volatile category.”

According to Johnson, the disadvantage of a precious-metals mutual fund is that it doesn’t offer a direct play on the price of metal; while they generally move with the metal, there are periods when they align more with the stock market.

Gold Rules

Johnson adds that of all the precious metals, gold is the best for investment because it is used more as a currency.

“The other metals have industrial aspects to them and consequently are more economically sensitive,” he says. “They’re not as well situated to protect an investor from currency debasement, inflation, and just the overall portfolio insurance aspects.”

Rothberg says metals such as silver and platinum are trickier because they are also industrial metals. He notes that platinum prices are down sharply because—aside from jewelry, the metal is used primarily in the auto industry, which has been in a serious slump.

He sees palladium a “good businessman’s risk” for speculators, because there is a limited supply in the world.

Another avenue of investment exchange traded funds. Two of the most-often cited are US SPDR Gold Trust [GLD Loading... () ] and iShares COMEX Gold Trust [IAU Loading... () ].

“A gold ETF allows you to avoid the premium and storage cost [of owning physical gold], albeit there’s a small fee with an ETF,” Johnson says.

He cautions that since the IRS has determined gold to be a collectible, owning physical gold would subject the investor to the special long-term capital gains tax rate of 28 percent, not the normal 5-percent or 15-percent ones. (For less than one year it is 35-percent.) Owning shares of an ETF that holds gold or silver makes you subject to the higher rates.

ALTERNATIVE INVESTING SLIDESHOWS

“I’m not a big fan of ETFs because they can be thinly traded, which makes price and volatility harder than a mutual fund,” Lockwood says.

In addition, there is the gold futures market, in which you can open an account at an exchange such as the Comex.

Another option is to use online platforms to buy, store and trade gold. Web sites such as BullionVault.com and GoldMoney.com allow customers to purchase gold bullion and have it stored in a vault, usually in Zurich or London (BullionVault also uses a vault in New York).

One last note: the potential value of gold doesn’t extend to jewelry, which carries significant mark-ups after the gold has been fabricated and designed. Jewelry purchased for pleasure or as a gift holds a different kind of value. But don’t expect to get a return on your money if you try to sell a ring to “Gold for Less”, which pays only for the value of the gold, melted down.