Why Gold Matters: Everything You Need To Know

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 our country embraced in the fall of 2008. (To learn about the factors that led to the Great Depression, see What Caused The Great Depression?)

Many investors have never seriously considered gold to be a long-term investment, but the topic of investing in gold did come to the forefront of many investors' minds during the 2008–2009 recession. The most obvious reason for this was due to the rise in the price of gold. Market watchers love to sensationalize any stock or asset class experiencing rising prices as the next investment to latch on to. Yet the rise in the price of gold happened largely due to people purchasing physical gold or betting on the metal via various investment options, such as ETFs or gold mining companies' stocks.

As does any major economic or political event, the Great Recession of 2008 will likely have profound effects on our economic system for decades to come. An example of this was seen more recently, in 2016, after the UK vote to leave the EU led gold prices to soar, reflecting the widespread view of Britain's economic future as highly uncertain.

Before jumping on the gold bandwagon, let us first examine the reasons why investing in gold holds fundamental problems. 

The main problem with gold is that, unlike other commodities, it 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 expended. Grains are consumed. Gold, on the other hand, is turned into jewelry, used in art, stored in vaults, and given to a variety of other uses. Still, regardless of gold's final destination, its chemical composition is such that the precious metal cannot be used up.

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

Unlike other commodities, gold has held the fascination of 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, history has given gold a power surpassing that of any other commodity on the planet, and that power has never really disappeared. The U.S. monetary system was based on a gold standard until the 1970s. Proponents of this standard argue that such a 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. 

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.

The easiest way to gain exposure to gold is through the stock market, via which you can invest in actual gold bullion or the shares of gold-mining companies. Investing in gold bullion won't offer the leverage you would 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 rises 10%, to $1100 an ounce, the operating margin of the gold miners goes up 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 the difficulty of 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 the purchase can at times exceed NAV by a wide margin, especially when the markets are optimistic.

A list of gold-mining companies includes 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. (See also: Top 5 Gold ETFs for 2017)

While gold is a good bet on inflation, it's certainly not the only one. Commodities in general benefit from inflation, since they have pricing power. The key consideration when investing in commodity-based businesses is to go for the low-cost producer(s). More conservative investors would do well to 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, while inflation is eroding the value of your dollar.

You can't ignore the effect of human psychology when it comes to investing in gold. The precious metal has always been a go-to investment during times of fear and uncertainty, which tend to go hand in hand with economic recessions and depressions.