Fed Chairman Ben Bernanke can't create a 100 million new ounces out of thin air whenever he wants to buy more bad mortgages. He has to print dollars... and the more dollars he circulates, the more it takes to buy gold ounces.
While lots of hard assets will rise in value for the same reason, gold is the ultimate option for protecting wealth. Solid gold bullion is one of the easiest commodities to buy and sell. Gold bullion should not be our only gold play, however.
From May 13, 2005 to May 12, 2006, the price of gold rose 71% – a nice 12-month return for any investment and a huge move for the metal. But consider that over the same period, the AMEX Gold Bugs Index (which tracks the major gold mining stocks) went up 105%.
That was no fluke. The movement in gold stocks is always more exaggerated than those of the metal. They are said to be "leveraged" to the gold price. That's why to make a lot of money in gold, you must own gold stocks.
Here's why it happens: The share prices for mining companies are driven by their profits. And those profits are based on the gold price because their costs are (relatively) fixed. So let's say a company spends $400 per ounce to mine gold. When gold sells for $700 an ounce, the company books $300-an-ounce profits. If gold prices shoot to $1,000, its profits jump to $600 an ounce. So while the metal has appreciated about 43%, the company's profits (and market value) rocketed 100%.
That's leverage. And that's how investors get rich in gold.
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