With all the money the Feds have pumped into the economy, many economists and analysts anticipate a dramatic increase in the inflation rate within the next few years. Traditionally, when threatened with higher inflation, investors have turned to gold as a hedge, and in the past, gold indeed, has proven to be a good hedge. Gold holds its value in times of rising prices and for this reason has earned the moniker “the crisis commodity.”

Before you run out and buy a few gold bars, however, there are a few reasons to reconsider. First, gold is not easy to buy in large quantities, but if you do, you must factor storage and insurance costs into your return on this investment. Most investors will instead opt to purchase mutual funds and exchange-traded funds (ETFs.) The SPDR Gold Shares ETF is the seventh largest holder of physical gold in the world. The size of the fund is itself problematic. If the fund needed to, or was forced to sell a large portion of its holdings, it would prove difficult to find buyers, considering that they are one of the largest buyers themselves. And if they are selling, it’s likely others are too. The inability to sell could result in a marked decline in price – like a fire sale. This may seem unlikely, but we’ve seen this type of crisis hit hedge funds and mutual funds over the past year and decimate their returns.

Another important consideration is that, unlike stock, profits from trading bullion are considered “collectibles” to the IRS. That means you don’t get the advantage of long-term capital gains rate if you hold bullion for more than 1 year. Instead it’s taxed at 28%.

In addition there are other means to fight inflation that didn’t exist 10 or 20 years ago, and these alternate investments could limit the attraction of gold, thus reducing its potential march in lock-step with inflation. Now investors can buy Treasury Inflation Protected Securities (TIPS), currencies (through ETFs) and commodity ETFs, products that didn’t exist in the early 1980’s, which was the last time we experienced high inflation. These alternatives, such as TIPS, may be more stable than gold, which has had higher volatility than stocks over the past 40 years.

When we see high inflation become a real threat (and we don’t see this now) we will explore the various options for client portfolios. Gold ETFs may be one of them, but it won’t be the only one.