Hard asset stocks are a hedge

- Alan Lavine and Gail Liberman

David Marotta, a Charlottesville, Va.-based money manager, recommends putting some money in "hard asset stocks." These are companies that own and produce an underlying natural resource.

Examples of these natural resources include oil; natural gas; precious metals, like gold and silver; base metals, such as copper and nickel; and resources like diamonds, coal, lumber, and even water. "We recommend broadly diversifying your hard asset stocks by resource type, by geographic location of a company's reserves, and by company size," he has said.

Is this the same as investing in commodities? No, Marotta says.

"Buying gold bullion or a gold futures contract is an investment directly in raw commodities or their volatility, whereas buying gold mining company is a hard asset stock investment."

Buying these types of stocks has two advantages. Commodities generally maintain their buying power. Meanwhile stocks typically appreciate over inflation when dividends are reinvested.

Marotta cites research based on the past 200 years that shows that gold, on average, maintains its value over time. Meanwhile, over the long term, stocks have returned 6.5 percent over the rate of inflation.

Hard asset stocks often do not move with the overall stock or bond markets. But they also tend to increase in value when stocks and bonds decline.

Here is why hard assets stocks often act as a hedge against inflation.

Consider a gold mining company whose expenses and overhead allow it to pull gold out of the ground for $290 per ounce and sell that gold for $300 per ounce, making the company a $10 per ounce profit. As gold jumped 33 percent from $300 per ounce to $400 per ounce, the company's profit jumped from $10 an ounce to $110 an ounce--a 1,000% jump in profit--which then caused the company's earnings and stock price to soar. Of course, the current price level of gold stocks is much higher than it was in that example.

Be advised that there is no free lunch when you invest in hard assets. These investments are riskier than other types of stocks. So there may be times when your hard asset stocks lose money--particularly when stocks and bonds are gaining in value. So these types of investments require patience.

How should you best invest in hard asset stocks? You can own individual stocks in companies with strong balance sheets and low mining costs compared with other companies. You also can invest in precious metals mutual funds that invest in all types of mining companies.

Financial gurus increasingly are recommending exchange traded funds over mutual funds. Reasons: Generally lower costs, tax-effectiveness and the fact that you hold the asset directly. If you already own a lot of U.S. stocks, an exchange traded fund can provide greater diversification. The largest gold exchange traded fund is StreetTRACKS Gold Shares.

Consider, though, that while exchange traded funds invest in the actual asset, mutual funds largely invest in companies with earnings.

Beware that exchange traded funds that invest in gold are relatively new and generally, more volatile than stock mutual funds due to intra-day trading. They are not subject to U.S. regulations for investment companies. So you could have a tough time obtaining recourse if something goes wrong. An additional risk may include loss or damage to the actual asset. Exchange traded funds overall often are touted as more tax-effective than most mutual funds. But you need to consider that gold is subject to the 28 percent long-term U.S. capital gains tax on collectibles--even if it's in exchange traded funds, confirms the IRS. Precious metals stocks and stock mutual funds, by contrast, generally are subject to the 15 percent long-term capital gains tax.

Regardless of what type of gold investment you select, how much should you invest? Most experts agree that a good rule of thumb is 5 percent to 10 percent of your assets.

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Spouses Gail Liberman and Alan Lavine are syndicated columnists. You can purchase Alan Lavine & Gail Liberman's latest book Quick Steps to Financial Stability (QUE Publishing 2006) online at www.moneycouple.com or at your local bookstore. E-mail them at MWliblav@aol.com.