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Uncertainty in stocks can jump the gap into the other capital markets. Traders will often look for ways to diversify riskier bets in a falling or volatile equity market with bonds, which may drive yields down or in safe-haven commodities like gold.

As a diversification tool, gold is important not only as a way to hedge falling stocks but also as a potential protection against inflation. In these two respects, learning to invest in gold is a great way to add a powerful tool to your investing portfolio.  

In the past, investing in gold was difficult for individual investors. You could buy the actual spot commodity in the form of coins and bullion or you could speculate in the futures market. Both alternatives were unpopular and expensive for most individual traders. However, investors now have access to gold investments through ETFs like the SPDR Gold Trust (GLD).

GLD is one of the largest ETFs on the market in terms of asset value because the fund actually holds positions in gold bullion itself. As of this writing, the fund holds more than 34,000 ounces of gold bullion.

Because GLD is an ETF, you can trade it like a stock. This means that the minimum investment is a single share rather than a full ounce or multiple ounces. GLD even has options available for traders looking for additional leverage.

As an investment, gold is considered a hedge against inflation because it is inversely correlated to the value of the dollar. That means that if the U.S. dollar falls in value through inflation, gold prices will rise because it takes more, weaker dollars to buy an ounce.

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Conversely, if the dollar is rising in value gold prices will fall because it takes fewer, stronger dollars to buy an ounce of gold.

Historically speaking, inflation is not only likely but a certain level of US dollar inflation is considered desirable. As the current banking bailout proceeds and the Fed’s “money printing” activities continue and the massive fiscal deficit work their way through the financial system, higher than historical levels of inflation seem likely. That should increase the value of gold in dollar terms over the intermediate future.

It is also important to consider gold as an alternative store of value. This means that traders consider gold a shelter during periods of extreme uncertainty.

For example, during the global stock market collapse of late 2008 through early 2009, gold and the dollar both increased in value at the same time. This period was beneficial for gold because it is a considered a form of money and like the dollar itself it is a place to hedge against uncertainty in other currencies and investment types.

The fact that gold is a hedge against both inflation and uncertainty seem to make it an ideal investment. However, like all investment types, gold contains risk. If economic fundamentals improve significantly or the U.S. economy begins dealing with deflation, gold prices could collapse.

When evaluating gold, we suggest traders consider the needs of their entire portfolio. Gold can be a great source of diversification and can be easily added to an investment strategy through an ETF without the danger of becoming overweight in the asset.

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