How Arabian investors can use stocks to leverage the gold price

Buying gold futures on a market like the new Dubai Gold and Commodities Exchange is one way to leverage a rising gold market. Futures are an option to buy gold at a future date for a specific price.

The future contract costs a fraction of the cost of the gold to be purchased and the buyer can sell immediately the contract is due pocketing the difference between the agreed and current price, or earlier if desired.

This sounds a perfect deal, except that gold prices are notoriously volatile, and thus investors may find themselves in a loss-making position and forfeit the entire cost of the option. Investors who have seen the price of gold swing violently from $725 an ounce down to $570 in 2006 will know this sinking feeling.

Alternative options

However, there are plenty of investors who believe gold is locked in a long-term cyclical upward trend, linked to the gradual devaluation of the US dollar. One way to trade this trend successfully is to buy physical gold in cash and wait, riding out the ups and downs of the gold price.

But there ought to be a way to leverage an uptrend, especially one that many blue-chip commentators feel is firmly established and unlikely to go away anytime soon. Apart from a weakening dollar, gold is a hedge against financial crises and possible geopolitical events like an attack on Iran or the impeachment of George W. Bush.

Gold shares are the answer. For as the gold price rises, the profits of gold producers rise by an even greater amount because of their relatively fixed operating costs.

And to avoid the uncertainties of choosing individual stocks many professional investors choose the HUI Index of the top 15 gold stocks to gain from this leverage. Indeed, over the past five years of rising gold prices the HUI Index has gone up five-fold while physical gold has doubled in value.

But the HUI Index is a mirror of the performance of the biggest gold companies, and can not hope to touch the performance of some of the more junior gold companies. So spotting the likely winners among this pack has become a profitable hobby among expert investors looking for the greatest leverage against the gold price.

Spotting winners

Their advice is to be taken seriously as this sector attracts some dubious characters whose approach is similar to the rip-off artists of the dot-com era, in the sense that they are hyping asset values for personal gain. But as in the dot-com era, the biggest gains in the gold boom will be found among the smaller stocks if you can spot the right ones.

For the record, here is a selection of recent junior gold company tips offered by serious commentators (Google search these names for more information): AuEx Ventures (Casey Research); Galahad Gold (Jim Slater); Linux Gold (Khandaker Partners); Seabridge Gold (Matein Khalid); and Teuton Resources (Joe Granville).

Will some of these names prove to be an Amazon.com or EBay.com for investors? You might hit lucky if the gold bull market moves into phase three shortly.