This month, one sector outshines the rest: Precious metals.

They rose to the No. 1 spot in TheStreet.com Ratings' aggregate sector rankings of closed-end mutual funds, which in our model includes ETFs. On a risk-adjusted return basis, no other sector looks more attractive right now, and we have a couple of fund ideas that could add some luster to your portfolio.

The classic reasons to add precious metals like gold to your portfolio still hold true: They act as a hedge against inflation and help diversify your portfolio.

Inflation has been increasing. The consumer price index -- which tracks the prices of a specified group of consumer goods and services -- has trended higher for the past four years. In addition, the inflation rate accelerated from 1.1% in June 2002 to its current level of 3.8%.

Precious metals also help provide diversification, because they tend to move independently of -- or modestly in the opposite direction from -- U.S. common stocks.

The Dollar-Gold Relationship

Those reasons for investing in precious metals, especially gold, involve a common element: the U.S. dollar. Industrial and jewelry demand aside, the value of the dollar has the greatest impact on the price of the metal.

Because gold is priced in dollars, when the purchasing power of the greenback rises, the price of gold falls, and when the purchasing power of the dollar erodes, gold prices go up, as the chart below shows.

The dollar has fallen 29.1% since July 2001, as measured by the Dollar Index, which compares the greenback to a basket of six major currencies, including the euro, the Japanese yen and the British pound.

Over the same period, gold has risen 126.5%. These long-term trends are still in place, which is why we recommend that investors have exposure to the metal.

An Inverse Relationship

Click here for larger image.

Source: Bloomberg

There are many ways to get exposure to gold, and each has its own risks and rewards.

Traders who play in the gold-futures markets make substantially leveraged bets on the minute-to-minute movements in the yellow metal. If the precious-metals market moves against them, they can lose more than they have.

You could visit coin dealers to buy bullion coins or bars, which are usually sold at marked-up prices -- known as premiums -- over the spot price (the current market price at which the commodity is being bought or sold). After paying to store your gold, when you decide to sell it, a dealer will offer to buy it back from you at a discount to the price of the metal.

A Golden Plan

There is no reason to lose at both ends of the trade when there are two exchange-traded funds that let you buy and sell gold within a few cents of the spot price.

The funds are the

iShares COMEX Gold Trust

(IAU) - Get Report

and the

streetTRACKS Gold Shares

(GLD) - Get Report

. TheStreet.com Ratings model has buy ratings for these investment vehicles of A+ and A, respectively.

However, the two funds are so similar that it would not make sense to hold both.

What do they have in common? Both sell at a price equal to the value of one-tenth of an ounce of gold, have expense ratios of 0.4% and own gold bars stacked from floor to ceiling in their custodian banks' vaults.

In addition, there are no stocks in either fund, just gold bullion. Buyers of these ETFs become fractional owners of the gold, so the IRS treats gains and losses under the rules for collectibles, not financial securities.

How are the funds not alike?

Size is the biggest difference, as IAU's market capitalization of $804.5 million is dwarfed by GLD's $7.3 billion, which grabbed the first-mover advantage by launching its fund two months prior to the premiere of IAU, in November 2004. With nine times as many shares outstanding, GLD averages a daily trading volume of 7 million shares, compared to just 210,000 for IAU.

Although not a concern for long-term investors, daytraders favor GLD because its spread -- the difference between the ask price to buy and bid price to sell -- is routinely as tight as 1 or 2 cents, while IAU's spread is a bit looser.

Ground Rules

Although both IAU and GLD are good choices, there is no need to wait for the gold to be mined, refined and minted.

With the

(GGN) - Get Report

Gabelli Global Gold, Natural Resources & Income Trust, you can gain exposure to the metal while it is still in the ground. TheStreet.com Ratings has a buy rating of B on this fund.

As of June 30, the closed-end fund holds a who's who list of mining shares, including

Gold Fields

(GFI) - Get Report

,

Newmont Mining

(NEM) - Get Report

,

Agnico-Eagle Mines

(AEM) - Get Report

,

Glamis Gold

(GLG) - Get Report

,

Randgold Resources

(GOLD) - Get Report

and

Barrick Gold

(ABX)

.

The fund's allocations break down as follows: gold-mining shares constitute 50%; energy and related services, 39%; nonprecious-metal companies, 9%; and paper and forest products, 2%.

Kevin Baker became the senior financial analyst for TSC Ratings upon the August 2006 acquisition of Weiss Ratings by TheStreet.com, covering mutual funds. He joined the Weiss Group in 1997 as a banking and brokerage analyst. In 1999, he created the Weiss Group's first ratings to gauge the level of risk in U.S. equities. Baker received a B.S. degree in management from Rensselaer Polytechnic Institute and an M.B.A. with a finance specialization from Nova Southeastern University.