As good as gold: but will the bull-run continue?

Gold is a volatile asset class, and this can be unnerving for investors. For example if you bought in summer 2004 at $455 an ounce you then had to wait almost a year to see your money back, and then things got really interesting in autumn 2005 and into the New Year.

Indeed, that has often been the pattern for the average gold investor. You wait until the price has run-up and your confidence grows, only to find that you have bought at the top and then prices head downwards. So where is gold today?

Geopolitics and gold

If it was not for the geopolitical uncertainties surrounding Iran and oil supplies from Nigeria, then gold would probably be due for a major correction, if not necessarily a change from its five-year uptrend.

But gold is the classic hedge in uncertain times and it is really anybody's guess what will happen when rather than if Iran fails to respond to UN calls to halt its nuclear program at the end of this month.

A showdown of some kind looks inevitable, and the more dangerous it proves the higher gold prices will go. Conversely a swift diplomatic solution would send gold into its customary correction pattern.

How then should investors buy into the positive gold story? The safest option is to take delivery of the physical metal and store it securely; but for most people exchange traded funds like GLD on the NYSE are the most convenient way to own gold; ETFs are a proxy for real gold and buy and store it as money comes in.

Gold stocks

The alternative is to buy gold stocks. It is tempting to see the gold sector as narrow and undervalued: at $150 billion it has a total market capitalization less than half of Coca-Cola. But price-to-earnings ratios of gold stocks are in the Nasdaq boom years' range; in short they are already discounting gold at $1,000 an ounce.

Now momentum buying is likely to keep gold stocks moving upwards. But it has been noticeable in recent months that the larger gold stocks have not shown the sort of increases in price that you might expect with gold prices leaping daily.

A better option might be the junior gold exploration companies which have shown high gains over the past quarter in many cases, but could have much higher to go.

Again to use the Nasdaq metaphor these are like the dot-com start-ups, companies of great hope but little track record, which might fare best in a gold price explosion, and offer the highest investment leverage. Perhaps the intelligent gold investor will diversify within the sector and allocate capital according to perceived risk.

Certainly keeping a small percentage of a gold portfolio in the junior exploration companies might be advisable, just in case gold prices really soar in which case these neglected stocks could advance by huge multiples; but equally a high proportion of these firms may prove worthless in the long-run, so there is no need to get carried away.