Four Ingredients to Create the Ultimate Gold Portfolio

Amongst those of us who agree that the economic downturn in the United States is far from over, the inflation vs. deflation debate is at the center of determining how to preserve wealth and profit in this environment. It is with this in mind that I've focused on this a good bit in my contributions to SeekingAlpha.

Regardless of what side of the inflation vs. deflation debate you fall on, there's one thing almost all of us can agree on: gold. Inflationists view gold as a hedge against currency devaluation; deflationists for the most part agree that gold is not as good as legal tender, though expect it to fall less than other assets, and thus gain purchasing power.

With that in mind, here are my thoughts on creating the ultimate gold portfolio:

1. Physical gold. Yes, I'm referring to accepting delivery, and developing a nice coin collection. To what extent you want your gold portfolio to be in physical gold should be proportionate to how bearish you are. If you are very, very, VERY bearish, I would expect you to want 50%+ of your gold portfolio in physical gold. Personally, I'm looking to get to around 10%.
2. Vault gold. Services like BullionVault and GoldMoney are ways where you can get receipts for gold stored in vaults. Thus it is just like owning physical gold, though the gold is not in your possession; instead a secure vault is holding it for you. These services also make it convenient for you to sell your gold in exchange for legal tender. Moreover, some of these services have vaults overseas, the importance of which I'll get to shortly.  The only question with these services is their trustworthiness.
3. Gold futures. Perhaps the most common way of profiting from gold is through exchanges like the New York Mercantile Exchange, which will let you speculate on the futures price of gold. While I recommend having gold positions on exchanges, it is worth noting that there have been many, many reports of price suppression via short selling and naked short selling of gold on exchanges.
4. Gold stocks. Stock traders can purchase gold via exchange traded funds (ETFs); GLD and IAU are two such ETFs. However, reports of price suppression and naked short selling are even more pronounced for the ETFs than they are in the futures market. While a diversified portfolio would probably benefit from having a position in these ETFs, I would consider gold mining stocks to be a better bet. GDX is an ETF traded on AMEX that tracks gold mining stocks.

Other Factors to Consider

Gold bugs everywhere fear the resurrection of something like Executive Order 6012, an order issued in 1933 by President Franklin D. Roosevelt that forbade the hoarding of gold coins, gold bullions, and gold certificates, and required all Americans to hand over such gold products to the Federal Reserve. If such government actions were to return, there might be some security in having gold stored abroad in foreign vaults (as well as in collector coins and in jewelry). Of course, whether or not this is true depends on how exactly the government's response will be enforced.

Disclosure: I am long gold.

Comments

[Leif Peterson:]

These are good comments. "Printing Press" Ben will soon start dropping money from helicopters -- so get ready for a large pop in the price of gold and other precious metals (PM's). Historically, almost all of the bull markets for gold have lasted 10-14 years -- and we are in about midway in the current growth cycle.

With the lowering of the Fed lending rate to 1% this week, it now costs less to borrow money. Any time money costs less to borrow, the value of the dollar goes down. Unemployment is also rising quite quickly, so there is a stronger need to start hoarding. The inflation vs. deflation effects on gold is chaotic at present; however, this should stabilize in next few weeks.

Also important is the fact that China is not overleveraged to the extent the US/EU are, and in fact has less gold in its central banks than Germany! If China starts buying gold in gangbusters, you wouldn't want to be on the sidelines watching. You can purchase bullion and certificates online at the (offshore) Perth Mint (Perth Australia). Happy investing.

2008 Oct 31 09:55 AM