Not to sound alarming, but this is a good time to invest in gold.

Stock picks that offer leverage, not just exposure

Not to sound alarming, but this is a good time to invest in gold.

Then again, it’s hard not to sound alarming as looming inflation and currency devaluation have investors wondering how to protect the value of their portfolios. As it has in the past, gold is emerging as a go-to currency. At the same time, the supply of gold cannot keep up with demand and there is a commonly held view that in the next 12 months, gold could crack the $2,000 mark.

There are a number of ways to own gold – bullion, gold-backed exchange traded funds, and equities. If you can find well-managed companies operating in stable countries with a clear path to growth, stocks provide the most leverage. But before we zero in on a number of equities, it’s useful to understand why it’s a good time to go for the gold.

Let’s start at the top. Frank Giustra, the Vancouver-based entrepreneur who founded Wheaton River, which evolved into Goldcorp Inc. (G-T45.20-0.24-0.53%), the world’s number two gold producer by market value, recently revealed why investors should own gold.

“Think of gold as the chicken soup for all the world’s ills,” he told Forbes magazine.

Mr. Giustra still produces gold through a number of companies, including New Gold Inc. (NGD-T6.61-0.04-0.60%)and Etruscan Resources Inc. (EET-T0.370.024.23%) , which is drilling on the new gold-mining frontier -- the West African nation of Burkina Faso. He outlined the factors influencing gold’s strength: supply and demand, stock market performance, interest rates and geopolitics. But he zeroed in on two: the high level of bank reserves that will drive inflation, and high levels of sovereign debt caused by record budget deficits. Historically, he said, both outcomes have been a boon for gold prices.

FOR OPTIMISTS, TOO
Mr. Giustra’s outlook is based on a relentlessly pessimistic outlook. But you don’t have to be a pessimist to like gold. Carmel Daniele is the London-based founder of CD Capital and launched the CD Private Equity Natural Resources Fund in 2006 to take advantage of the “commodity super-cycle”, her term. She’s a former group executive at Newmont Mining (NEM-N56.110.410.74%), and was involved in the $24-billion (U.S.) merger between Franco-Nevada, Newmont and Normandy to create the world’s largest gold company.

In a recent interview with The Gold Report, she explained her belief that this super-cycle is driven by the urbanization and industrialization of 3 billion people in Asia, is 10 years in and has at least 20 years to run. Look at what China and India are doing, she suggested: “Securing limited resources around the world in order to continue to build out their empires”. She dismissed the current gloom as an annual thing. “Basically most people sell in May and go away.”

During this spring of uncertainty, however, she likes gold as much as Mr. Giustra, and believes that gold could get “really, really high”. “It could easily break through $2,000” if China , for example, starts to buy.

Ms. Daniele called gold a “psychological metal”, driven by more than supply and demand dynamics. “Basically when economies aren’t doing very well, and people aren’t feeling very optimistic, they tend to flock to gold.”

While people can always buy gold bullion, the storage problem always presents itself, prompting images of stuffing gold coins into mattresses. Other, more portable means of acquiring gold, are gold-backed ETFs and equities.

PICKS
Ms. Daniele likes equities because of the multiplier effect. “You see, if the gold price goes up, the leverage you get is just so much higher than just holding the gold bar itself,” she said.

Ms. Daniele recommended several companies operating in Colombia: “one of the richest places in the world for gold at the moment”, starting with Vancouver-based Greystar Resources Ltd. (GSL-T4.85-0.05-1.02%) currently trading at $4.87. Greystar is sitting on 15 million ounces of gold in its Angostura project, and will produce 500,000 ounces at $391 an ounce annually once it gets started. The project has been delayed pending the company’s appeal of a retroactive application of new environmental standards, but on May 28, received word from the Colombian government that its appeal has been successful.

In the same Colombian patch are two other Vancouver-based operations Galway Resources Ltd. (GWY-X0.89----%) and Ventana Gold Corp. (VEN-T9.220.030.33%). It is Ms. Daniele’s belief that the three companies will have to consolidate to benefit from a single processing operation and economies of scale.

Another theme that bolsters gold’s value is the growing realization that gold is getting harder to find. Sean Broderick is a natural resources analyst for Weiss Research Inc, and a columnist for Dow Jones MarketWatch and Uncommon Wisdom Daily. He predicts the price of gold will hit $1450 by the end of the year, and has been saying that we’ve already hit peak gold.

“The ore bodies being discovered now are smaller and lower-grade than in the past,” he said in a recent interview. “The amount of gold we can produce in any one year is probably hitting a peak, so the price is just going to go higher.”

As Ms. Daniele is big on Colombia, Mr. Broderick likes Mexico, and has recommended a number of Mexican silver mines, which he thinks are undervalued. But now that the world is more focused on rare metals, he thinks the Mexico miners will become better known.

Mr. Broderick has been to the Timmins Gold Corp. (TMM-X1.320.021.54%) San Francisco mine in Sonora, which began commercial production in April. The mine is expected to yield 80,000 ounces a year at $412 an ounce. Like so many of these companies, Mr. Broderick thinks it will either merge or acquire other companies. As Ms. Daniele says, there’s a lot of consolidation in the sector, because companies begin to shrink as soon as they start production—every ounce of gold they produce, they have to replace, either though discovery or acquisition.

The new gold rush takes place in the boardroom as well as in the field. One company that has been successful in that realm is Franco-Nevada Corp. (FNV-T33.050.040.12%)the gold-focussed royalty company. Credit Suisse analyst Anita Soni recently recommended Franco-Nevada with an “outperform” rating, commenting that Franco-Nevada provides a leveraged alternative to gold-backed exchange traded funds, yet has less risk than mine operators.

“Gold ETFS lack leverage,” she said in a letter to clients. “Franco-Nevada provides one-to-one leverage to gold and additionally provides exposure to exploration upside, which the ETF does not.”