Hoard Gold Stocks

LONDON -- "Gold Set to Soar by 20%!" "Beware the Next Gold Crash!"

On most days, new investment articles with such titles abound, pitching either the bull case or the bear case for gold. Confused? So am I.

I buy into the long-term story for gold. But what worries me about the gold price is how volatile it can be and how quickly sentiment can change. I prefer gold miners, which offer upside if the bull run is sustained, but a softer landing if the bears win.

Shares that provide diversification, some downside protection, and also the prospect of growth have a place in any portfolio, whatever your financial objective may be. The Motley Fool's free report "10 Steps To Making A Million In The Market" offers more tips on how to grow your wealth. You can download it for free right here.

Bull case
The bull case for gold rests on three sources of demand. First and foremost is the burgeoning wealth of the East, where the middle classes in countries such as China and India buy gold for both cultural and financial reasons. Those two countries are the world's largest markets of physical gold. Culturally, gold jewelry is a significant purchase. And the middle classes have a tendency to use gold as a form of savings and hedge against inflation, as both countries lack sophisticated savings products.

Second, Western buying is also driven by those who fear the newfound enthusiasm of authorities for printing paper money.

And finally, demand has been bolstered by central bank buying, particularly from emerging nations. That in turn says something of those authorities' view of the West's reserve currencies.

If you buy into the bull case, there are a multitude of ETFs that enable retail investors to buy and sell readily. For U.K. investors, there are ETFs such as ETFS Physical Gold or SPDR Gold Shares, while U.S. investors have SPDR Gold Trust, for example. Gold accounted for three of the top 10 most popular London-listed ETFs last year.

Bear case
The very popularity of these funds is a central plank of the bear case. Buying gold has become easier and has drawn in a broad swath of new private investors as investing in gold becomes fashionable -- but that makes it just as easy for gold to fall out of fashion again.

And gold seems to have lost its safe-haven status. As the recent financial turmoil has led markets to oscillate between "risk on" and "risk off" appetites, gold has been squeezed out by U.S. Treasuries, U.K. gilts, and similar assets. Perversely, gold now falls on bad economic news and vice versa.

Historically, mining shares are correlated with the gold price, though the correlation is far from perfect. And generally the miners stocks have not kept pace with the bull market in gold. That offers the prospect of further upside as they catch up, with the downside cushion if the yellow metal itself goes into freefall.

The economics of miners is driven by the price of gold and the cost of extraction. As with all natural-resource companies, the size of their reserves is a factor in valuation. Often as not, they operate in difficult or hostile territories, introducing an additional dimension of risk.

A fine example is Randgold Resources (ISE: RRS.L) , the only FTSE 100 gold miner. In March its shares were hit by a coup in Mali, the West African state where two-thirds of its production is based. Though the coup has left the north of the country lawless and at the mercy of Islamic militants who have desecrated the ancient city of Timbuktu, Randgold's operations in the south and west of the country have largely been unaffected.

That looked like a buying opportunity to me. The one ingredient missing was the sign of directors piling in. That happened in May with CEO Mark Bristow buying 650,000 pounds' worth of stock and nonexecutive Graham Shuttleworth spending 142,000 pounds. At 5,825 pence, the shares are up around 10% from their post-coup levels, but they're still an attractive buy.

Other interesting gold stocks include Russia-focused Petropavlovsk, which recently increased 2012 production targets, and Egyptian miner Centamin, whose share price has suffered from the political instability in the country. Both could reward patient investors.

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At the time thisarticle was published Tony has shares in Randgold Resources, Petropavlovsk, and Centamin. He holds no interest in any of the other companies mentioned. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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