On August 15, 1971 something very interesting happened in the world of currency – the United States, under President Richard Nixon, removed the dollar from the gold peg. Foreign traders were able to redeem their dollars for gold at a rate of $35 per ounce. Nixon dropped the gold peg in the face of rising inflation and in response to other nations also leaving the gold standard set up in 1944 at the Bretton Woods meeting in New Hampshire. The event, known as the Nixon Shock, instantly devalued the debt and left the dollar as a fiat currency – with nothing backing it up. However, the dollar also found itself in a unique position as the reserve currency which other nations used to back up their own currency.
The Price of Gold
As I write this, gold is trading at a price of $1,782.20 an ounce, a nifty increase from the $35 an ounce peg back 40 years ago. Gold has had an impressive run lately, trading in the mid $700 an ounce range as recently as 2008. Gold, however, is usually a trade of fear or tradition – uncertainty in the value of currencies or expectation of massive debasement will cause shocks in the price of gold. Traditionally, since gold and other precious metals were treated as currency, people will invest in them when they lose faith in other currencies.
That said, gold has a number of disadvantages. Other than a very small amount used in industrial and computing processes, the vast majority of gold is purchased for jewelry and investment. Gold doesn’t have a special rate for capital gains – as of right now gains on gold are taxed at a rate of 28% as it is considered a collectible. Physically, it is also a security risk to store your gold.
How to Invest in Gold?
If you believe gold’s record run will continue and it is not a bubble, consider the benefits of investing in a gold fund (for the physical metal) or the stocks of gold mining companies. Although they don’t offer the benefit of being able to hold the metal in your hand, both offer superior security and convenience. Consider funds if you are convinced of the prospects of gold – they correlate better with the spot price of gold than gold-related company stock, even though stock has better tax treatment.
Is gold a bubble? It may only be possible to tell for certain in hindsight, but it has certainly enjoyed an unprecedented run-up in the recent past. Here at DQYDJ we started asking that question in 2009 – and gold’s run has continued. Take that as a warning – make your own decision on gold’s prospects, and if you choose to devote some of your portfolio to it consider the issues of taxation, convenience and security. Full disclosure: I own some gold stocks in a fund.