Not All Gold Shines

Stocks shimmer, but gold shines; or do they? In recent years, investors have become enamored with Exchange Traded Funds (ETF), but they have fallen head over heels in love with gold ETFs. While equity ETFs tied to major indexes are just starting to show signs of life, the SPDR Gold Shares (symbol: GLD) has returned an eye-popping 33.45 percent in one year (ending July 31, 2010) and 23.71 percent in three years. Investors turn to gold in times of uncertainty and the threat of inflation. Therefore, it’s no surprise that investors have flocked to gold ETFs for all their advantages. ETFs have gained in popularity because of their low costs, high liquidity, transparency, and tax efficiency. However, not all ETFs are tax efficient and gold ETFs, which are considered collectibles by the IRS, are subject to different tax rates.

Under current tax laws, capital gains are taxed depending on the holding period of the investment. Assets held less than a year are taxed at the investor’s ordinary income tax rates while assets held greater than a year are taxed at long-term tax rates of 15 percent (unless Congress lets the Bush tax cuts expire in 2011). Unfortunately, the IRS considers investments in gold, including gold ETFs, as collectibles. Under IRS rules, gold ETFs held over a year are taxed at the maximum rate of 28 percent. If the investment is held less than 1 year, the same income tax applies as ordinary income tax rates which can be as high as 35 percent (39.6 percent if tax cuts are left to expire).

Of course taxes should never be a reason to purchase or sell an investment, but they should be factored into any investment decision making process. Investors seeking to circumvent the ordinary tax treatment of gold ETFs by investing in individual gold mining stocks such as Barrick Gold (symbol: ABX) don’t come out ahead. Because of several factors, including hedging and leverage employed by mining companies, the returns of gold mining stocks are not perfectly correlated with the gold ETFs. For example, the 1 year return for ABX was 12.61 percent versus 33.45 percent for GLD. Gold remains the investment of choice for those fearing inflation or another catastrophic market event, but investors should be cognizant of its tax implications.

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