Although it lagged the broader market rally over the past three months, gold proved its worth during the deflationary selloff last fall. The yellow metal has underperformed during periods of economic stability, such as 1980-2000, but it has shown itself to be a good asset to hold during periods of extreme inflation or deflation.

Recently, gold has started to outperform once again. Be it fears of inflation or the depreciating dollar, investors have turned to the "barbarous relic" for protection. During the month of May,

SPDR Gold Shares

(GLD) - Get Report

returned 10%. That compares to a 5% return for the

S&P 500

. Meanwhile, shares of gold mining companies have been strong for three months, benefiting from the stock market rally as well as stable gold prices. The

Market Vectors Gold Miners

exchange-traded fund

(GDX) - Get Report

, which tracks these shares, increased 32% over the past three months, vs. a 25% gain in the S&P 500.

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Because of gold's recent strong performance and its use as a safe haven at times of crisis, it's important for investors to understand the many options out there for investing and speculating in this precious metal. That's why we're providing you with this introduction to the types of investment vehicles, as well as their tax implications and risks.

Physical Gold ETFs

These funds hold physical gold in storage. They are taxed as collectibles, with a 28% long-term capital gains rate.

  • SPDR Gold Shares (GLD)
  • iShares COMEX Gold Trust (IAU) - Get Report

The only difference between these two funds is that the SPDR Gold Shares have thirty times the assets and volume of the iShares COMEX Gold Trust.

Gold Futures ETFs

The following funds hold gold futures contracts and are organized as partnerships. They are taxed as futures, with a 60% long-term capital gains rate and a 40% short-term capital gains rate. Each investor in these funds is responsible for paying annual taxes and receives a Schedule K-1 form every year reporting his or her share of the fund's income.

PowerShares DB Gold uses Deutsche Bank's Optimum Yield Index, which aims to maximize gains from backwardation (a situation where futures prices are lower than spot prices) and minimize losses from contango (when futures prices are higher than spot prices). The ProShares funds are leveraged and deliver twice the daily change in prices.

Exchange-Traded Notes

Exchange-traded notes are debt instruments that track an index. These have more favorable tax treatment than the ETFs we discussed because they are taxed as stocks and subject to the 15% long-term capital gains rate. However, they do expose the investor to the credit risk of the issuer.

The PowerShares DB Gold ETNs use the Optimum Yield Index, just like the PowerShares DB Gold ETF does. The leveraged ETNs, meanwhile, deliver twice the

monthly

change in gold. Lastly, the E-TRACS CMCI Gold ETN, issued by UBS, tracks a basket of futures spread across five maturity dates and "is designed to be representative of the entire liquid forward curve of the gold contracts."

Stock ETFs

  • Market Vectors Gold Miners ETF (GDX)

We've already mentioned this ETF and its robust recent performance. This fund mimics the

New York Stock Exchange

Arca Gold Miners Index, which tracks companies primarily engaged in gold mining. The fund currently holds 31 stocks, and top holdings include

Barrick Gold

(ABX)

,

Goldcorp

(GG)

,

Newmont Mining

(NEM) - Get Report

and

Compania de Minas Buenaventura

(BVN) - Get Report

.

Choosing Your Weapon

Investors with tax-sheltered accounts would be wise to avoid the ETNs because they would not capture the tax advantages, and also because the ongoing financial crisis increases the credit risk inherent with these products. The physical ETFs offer lower fees than the futures ETFs and, therefore, offer more value.

Leveraged ETFs and ETNs are generally unsuitable for all but the most sophisticated or aggressive investors. Because they reset at the end of each period, ProShares "daily doubles" are best for short-term trading measured in hours or a single session, while PowerShares "monthly doubles" are better suited for trades measured in days or weeks.

Gold miners perform best when the price of gold rises relative to the cost of inputs. Since the November 2008 lows, for example, the Market Vectors Gold Miners ETF has logged a 159% return. That's because after last year's market crash, gold prices held up and then increased, while a general deflationary trend lowered input costs for the miners. The combination left their shares undervalued.

Following is a table listing each instrument's fees and average volume.

Dion Money Management currently holds both IAU and GDX in both newsletter and client portfolios.

Don Dion is the publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers. Dion is also president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years� experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.