While economic recessions usually draw many comparisons to The Great Depression, so far there has been little (if any) historical precedent to the monetary and fiscal stimulative policies that our country embraced in the fall of 2008. For many investors, gold has never been seriously considered as a long-term investment. (To learn about the factors that led to the Great Depression, see What Caused The Great Depression?)
Yet in investing, to completely dismiss an idea simply based on reasons that are ultimately based on pre-existing views is not an intelligent idea. If anything, one should examine the situation for his or herself and come up with an independent reason as to whether or not an investment is to be made.

The Gold Conundrum
The topic of investing in gold came to the forefront of many investors' minds during the 2008-2009 recession. The most obvious reason for this is due to the rise in the price of gold. Market watchers love to sensationalize any stock or asset class that is experiencing a rise in price as the next possible investment to latch on. Yet the rise in the price of gold happened largely due to people buying physical gold or betting on the shiny metal through various investment options, such as ETFs or gold miner stocks.

Problems with Gold as an Investment
Before jumping on the gold bandwagon, I often find it instructive to first examine reasons why investing in gold holds fundamental problems. Only by realizing these issues will you be able to make an intelligent decision with regards to gold investing.

The main problem with gold is that, unlike other commodities, gold does not get used up. Once gold is mined, it stays with you. A barrel of oil is turned into gas and other products that are used up. Grains are used to feed us. Gold on the other hand is turned into jewelry, used in art, or stored in vaults. Jewelry can be melted to make other things, but gold's chemical composition is such that it cannot be used up. The only way gold disappears from our society is if it lost or buried.

Because of this, the supply demand argument that can be made for commodities like oil, copper, grains, and so forth doesn't hold up for gold.

History Overcomes This Problem
However, unlike other commodities, gold has been with human societies since the beginning of time. Empires and kingdoms were built and destroyed over gold. As societies developed, gold was universally accepted as a satisfactory form of payment. In short, centuries of history have given gold a power unlike any other commodity on the planet. Peter Bernstein's book "The Power of Gold" offers a wonderful look at gold's hold on societies over the centuries.

And that power has never really disappeared. The U.S. monetary system was based on a gold standard until the 1970s. Proponents of the gold standard argue that this monetary system effectively controls the expansion of credit and enforces discipline on lending standards since the amount of credit created is linked to a physical supply of gold. It's hard to argue with that line of thinking after nearly three decades of a credit explosion in the U.S. led to the financial meltdown in the fall of 2008. (Learn about the gold standard in The Gold Standard Revisited.)

In investing, you can't ignore the effect of human psychology when it comes to gold. Gold has always been a go-to investment during times of fear and uncertainty. Periods of fear and uncertainty go hand in hand with economic recessions and depressions. The Great Recession of 2008 is set to have profound effects on our economic system for many years to come. These periods of market uncertainty tend to benefit gold.

From a fundamental perspective, gold is generally viewed as a favorable hedge against inflation. Gold functions as a good store of value against a declining currency.

Investing in Gold
The easiest way to gain exposure to gold is through the stock market, in which you can actually invest in actual gold bullion or gold mining companies. Investing in gold bullion won't give the leverage that you get from investing in gold mining stocks. As the price of gold goes up, miners' higher profit margins can boost earnings exponentially. Suppose a mining company has a profit margin of $200 when the price of gold is $1000. If the price of gold goes up 10% to $1100 an ounce, the operating margin of the gold miners goes to $300, a 50% increase.

Of course, there are other issues to consider with gold mining stocks namely political risk (since many operate in third world countries), and maintaining gold production levels.

The most common way to invest in physical gold is through the SPDR's Gold Shares (NYSE:GLD) ETF, which simply holds gold. When investing in ETFs, pay attention to net asset value (NAV) as sometimes the purchase can exceed NAV by a wide margin, especially when folks are optimistic.

Gold mining companies include Barrick Gold (NYSE:ABX), Newmont Mining (NYSE:NEM), Goldcorp (NYSE:GG), and Anglogold Ashanti (NYSE:AU). Passive investors who want great exposure to the gold miners may consider the Market Vectors Gold Miners ETF (NYSE:GDX) which includes investments in all the major miners.

Alternative Investment Considerations
While gold is a good bet on inflation, it's certainly not the only one. Commodities in general benefit from inflation, since they having pricing power. The key consideration when investing in commodity-based businesses is to go for the low-cost producer or producers. More conservative investors would consider inflation-protected securities like TIPS. The one thing you don't want is to be sitting idle in cash thinking you're doing well when inflation is eroding the value of your dollar.

For younger investors, the best investment is to invest in yourself. Anything that increases your earnings power is a wonderful hedge against inflation.

Conclusion
Gold certainly matters, especially during times of uncertainty surrounding government monetary and fiscal policies. Monetary policies that depreciate the dollar and lead to high inflation will always benefit gold.

For related reading, take a look at 8 Reasons To Own Gold and Does It Still Pay To Invest In Gold?

Related Articles
  1. Mutual Funds & ETFs

    The Top 5 Large Cap Core ETFs for 2016 (VUG, SPLV)

    Look out for these five ETFs in 2016, and learn why investors should closely watch how the Federal Reserve moves heading into the new year.
  2. Economics

    The Delicate Dance of Inflation and GDP

    Investors must understand inflation and gross domestic product, or GDP, well enough to make decisions without becoming buried in data.
  3. Investing Basics

    The Importance of Commodity Pricing in Understanding Inflation

    Commodity prices are believed to be a leading indicator of inflation, but does it always hold?
  4. Retirement

    Shopping the New Retirement Products

    There are more options than ever for retirement portfolios these days. Choosing the right product comes down to your needs, time and management style.
  5. Economics

    India: Why it Might Pay to Be Bullish Right Now

    Many investors are bullish on India for all the right reasons. Does it present an investing opportunity?
  6. Mutual Funds & ETFs

    Top 3 PIMCO Funds for Retirement Diversification in 2016

    Explore analyses of the top three PIMCO funds for 2016 and learn how these funds can be used to create a diversified retirement portfolio.
  7. Options & Futures

    What Does Quadruple Witching Mean?

    In a financial context, quadruple witching refers to the day on which contracts for stock index futures, index options, and single stock futures expire.
  8. Economics

    Industries That Thrive On Recession

    Recessions are not equally hard on everyone. In fact, there are some industries that even flourish amid the adversity.
  9. Retirement

    How Much Should You Have In Your 401(k) To Retire?

    Determining how much money should be in your 401(k) when you retire depends on several variables, many of which are uncertain.
  10. Retirement

    Retiring in Thailand: The Pros & Cons

    It's a lovely land, but before relocating, get the skinny on this Southeast Asian kingdom.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is comparative advantage?

    Comparative advantage is an economic law that demonstrates the ways in which protectionism (mercantilism, at the time it ... Read Full Answer >>
  3. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  4. Am I losing the right to collect spousal Social Security benefits before I collect ...

    The short answer is yes, if you haven't reached age 62 by December 31, 2015. The Bipartisan Budget Act of 2015 disrupted ... Read Full Answer >>
  5. How does the Wall Street Journal prime rate forecast work?

    The prime rate forecast is also known as the consensus prime rate, or the average prime rate defined by the Wall Street Journal ... Read Full Answer >>
  6. What is the maximum I can receive from my Social Security retirement benefit?

    The maximum monthly Social Security benefit payment for a person retiring in 2016 at full retirement age is $2,639. However, ... Read Full Answer >>
Hot Definitions
  1. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  2. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  3. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  4. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  5. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  6. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center