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With Inflation Fears Rising, Consider Physical Gold as a Hedge

A financial advisor on three potential future scenarios where gold could provide some protection.

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For the last 10 years, as it averaged less than 2 percent annually, inflation has not been a problem. However, due to recent events of stimulus and an ever-rising national debt, investors would be wise to prepare for that possibility.

Like the crisis itself, the federal government’s response to the COVID-19 pandemic and ensuing economic collapse has been unprecedented. Congress has passed massive stimulus bills and the Federal Reserve is printing lots of money. And while those drastic measures have helped mitigate the economic impact of the crisis, eventually, the bill for all that borrowing is going to come due and that could mean high inflation.

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During the last financial crisis, most of the money that the Fed was handing out through TARP and other programs went to the banks. This time around, the government’s stimulus relief program is lending money to businesses to keep workers’ paychecks coming as well as putting cash directly into the hands of consumers through IRS payments. When consumers start spending that money, there’s a good chance that inflation will follow diminishing the dollar’s buying power due to increasing the money supply. To hedge against rising inflation, I often tell clients that they should consider a combination of equities, real estate and gold. Hedging with equities is a more complicated subject than we can address here, and for most people, the primary real estate investment is their home, so we’ll look at the last item on the list—gold.

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Throughout history, gold has been considered the standard of wealth. And since Richard Nixon took us off the gold standard in 1971, gold has, for the most part—with some ups and downs along the way—held its value with inflation. On the other hand, a dollar today only has about 17 percent of the purchasing power it had in 1971. By comparison, gold closed out 1971 with an average price of $250 per ounce. On June 1 of this year, the spot price of gold per ounce was $1,709.

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The reason I’m focusing on gold rather than other precious metals in general is because platinum and silver have not been able to maintain their value in recent years. For example, in 2011, silver was trading at around $35 per ounce, and today, it’s less than $16; while platinum was over $1,700 per ounce then and less than half that now.

Buying Gold Stock Is Not Buying Gold

For investors looking to invest in gold as a hedge against rising inflation, I always recommend buying actual, physical gold. But before explaining the reasoning behind that advice, it’s important to stress that the gold investment should be considered as a sort of insurance policy. Like any other asset in a balanced portfolio, gold should be considered in the context of other holdings and the long-range desired outcome.

Those who already have investment portfolios may be tempted to buy a gold mutual fund or ETF or even gold mining stock, because that’s something they already know how to do, but that may not be the best solution.

Buying a gold mutual fund is not the same thing as buying gold. The mutual fund doesn’t actually own any gold; it owns gold mining company stocks, and those don’t correlate to the actual price of gold. When you buy a gold fund, you’re betting that the value of the gold mining companies’ stocks is going to increase at the same rate as actual physical gold. However, there have been instances when the value of mining company stocks will move in the opposite direction of the actual metal due to factors other than the price of the gold itself.

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A gold ETF gets one a little bit closer to gold—but just a little. In this case, the investor owns shares in an ETF that owns the actual gold, which is supposedly held in a secure facility and regularly audited.

When it comes to physical gold, there are basically two ways to own it—in coin or in bullion. With the coin, you’re going to have to pay a little more than the actual value of the gold in the coin. For example, on June 1 when the spot price of gold was $1,709, a one-ounce gold Krugerrand was priced at $1,846. The other bullion option in the form of one-ounce assayer bars which generally sell for the spot price plus a commission charge of around 3 percent.

Why You Should Consider Holding Gold

I see three potential future scenarios where gold could provide some protection. The best case, and one that most of us are hoping for, would be that despite all the money the Fed has pumped into the system, the dollar remains strong and inflation stays at recent levels. In that scenario, gold should retain its value or even decline slightly, in which case it’s like an insurance policy you never have to file a claim on. The second, and I think most likely future scenario, would be slow-rising inflation with the dollar remaining the world’s exchange currency and the price of gold slowly rising from $1,700 to $3,000 or $4,000 per ounce over the course of time. Finally, and good for no one, is a hyperinflation scenario in which the dollar is no longer the international reserve currency, and the world reverts to an asset-backed monetary system. In that scenario, owning physical gold would be best because gold should fly up and with a supply-demand issue, the price of gold would multiply.

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Before mid-March, our economy was slowly growing and hopefully will get back on that trajectory soon. But our debt was growing substantially at a higher rate even before all the stimulus, which is worrisome and causes concern about inflation peeking its head up. Granted, we are in unprecedented times, but based on historical precedent, unless we have a balanced budget and reduce debt to a level that’s sustainable with our level of growth, we can expect inflation; and normally, the price of gold correlates with the rate of inflation.

My final word on the subject is not a call for everyone to go out and buy a lot of gold. It’s likely that inflation is coming sometime soon, and investors should look to assets that will give some protection, including gold.

Evan Mayer is a financial advisor in Boca Raton, Fla. and a regional partner at Concurrent, an advisor-owned partnership of elite independent advisors affiliated with Raymond James Financial Services, Inc.  

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