5 Ways Gold Will Protect Against the Fiscal Cliff

The Washington politicians and the Federal Reserve are teaming up to roil your portfolio.  Gold is the one investment that can settle the waters. 

The politicians are making like difficult in their reluctance to address the fiscal cliff – media shorthand for the combination of federal tax increases and spending cuts that are scheduled to go into effect January 1, 2013. 

If we hit the fiscal cliff full throttle, the Congressional Budget Office (CBO) estimates gross domestic product (GDP) will shrink 0.5% over the next 12 months and unemployment will rise above 9%. 

That's a recession, folks, which would surely be accompanied by a stock-market sell-off. 

A low-priced stock market would also be a lower-income stock market – even if many companies are able to maintain and increase their dividends. 

Here's why: the fiscal cliff includes higher dividend taxes.  If nothing is done – and there is no assurance anything will be done – taxes on dividends will rise as high as 39.6% from 15% today.  That's a 164% increase. 

Concurrently, the Federal Reserve is working to ensure a diminished income stream will also be a stream of diminished purchasing power. The Fed, through QE3 and pressuring China and Brazil to allow their currencies to appreciate versus the dollar, is actively working to impoverish investors. 

What the Fed is doing is not only foolhardy, but criminal.

So your investment portfolio is under a two-prong attack: one from the federal government, the other from the Federal Reserve. No wonder so many investors are in wealth-preservation mode. 

Gold is the wealth-preservation asset of choice, and for good reason. Gold has intrinsic characteristics that ensure it will continue to preserve wealth no matter what the Fed or the Washington politicians do. 

1. Inflation Hedge.  Every “crisis” sends the Fed scrambling to speed up the money printing press. (Actually, it takes nothing more than a few keystroke these days.) Growth in the money supply is inflation in its purest form.

Money inflation leads to price inflation, because more money chases the same number of goods and services. With the Fed adding more money each month to the money supply, you can be assured each dollar unit will buy and less and less in the future. 

Gold is a stable good in comparison, which means each dollar will buy less gold in the future. That means gold will continue to be an excellent inflation hedge.

2.  Store of Value. Inflation also erodes the value of dollar-denominated assets, which means investors lose by saving. Gold serves as a savings vehicle because it will hold its value by appreciating against a depreciating dollar.  Gold allows you to store your wealth without fear of losing value. 

3.  Maintained Purchasing Power. Gold enables consumers to buy the same quantity of goods over time.  For instance, over the past 50 years, an ounce of gold has, on average and with some variation, bought roughly 14 barrels of oil. Today an ounce of gold buys around 19 barrels of Brent crude on the spot market.

Nearly everyone needs to maintain purchasing power. Unlike the U.S. dollar, gold is proven to maintain its purchasing power.  

4. Scarce Good.  Like land, no is making more gold.  Even with growing worldwide demand, production remains consistent. Only 1% to 2% of new gold production is added to the stockpile annually.  Consistent production year after year means the gold market is immune to supply shocks.

5. Portfolio Diversification. Gold is a diversifying asset. Owning more than one asset class and owning securities with exposure to more than one industry reduces risk because of the unique correlations between different assets and different business sectors.

The lower the correlation, the better.  Gold is correlated with the U.S. dollar at negative 0.48, which means it's an excellent ballast against dollar depreciation.  What's more, gold offers similar benefits when paired with other asset classes, including stocks.  In 2008, when the S&P 500 lost 37% of its value, gold was up nearly 6%.

The Washington politicians and the Federal Reserve governors will downplay gold's value, but don't let their words persuade you. If gold were an ineffective asset, why, then, are central banks themselves net buyers of gold? Most likely for the reasons I mention above.

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