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A hedge of gold

Australian listed gold stocks are notoriously volatile. One explanation is that many day traders use them as a proxy for trading the yellow metal. The larger volumes and bigger daily ranges are both a product of trader participation, and a cause of that participation. In a year where event risk is elevated, investors may consider adding gold stocks to the portfolio as hedge against market disruption.

The all-time highs of the US markets appear to reflect optimism that the new administration will both stimulate and support economic growth. Many of the measures foreshadowed will do exactly that. Corporate tax cuts are one example. However other policies could have a negative impact. Any moves that curtail trade are likely to hurt the country enacting them as well as the countries targeted.

At a PE of 20 the US markets can be compared to an overinflated balloon, and no-one can say with certainty whether the balloon will slowly deflate, or pop. Policy announcements that lower growth forecasts could do either.

Heightened political risk is an issue in Europe as well. Elections in the Netherlands take place next week. French voters will go the polls in the next two months, and German officials face a ballot in September. The rise of populist parties means ambitious would be politicians may be tempted by policies with strong electoral appeal, regardless of known potential economic consequences.

Given the potential for politics to roil markets, gold is on the radar. Some may prefer to trade gold directly, using instruments such as CFDs. Others may prefer to buy coins or bullion. The appeal of assets that can be held in the hand is well established.

Investors with significant portfolios could turn to the listed gold mining and producing stocks, while staying out of the junior explorer space. There is a risk that even gold producing stocks may not rally if there is a market meltdown and spot gold prices rocket higher. There are no guarantees.

Bearing in mind the risks, two stocks are high on my list. Newcrest (NCM) is the largest listed gold stock on the ASX. With market capitalisation around $16 billion and operations in Australia, Africa and across the Asia Pacific region, some may see it as the safer play:

Given the volatility of the sector a good entry level is more important than usual. My plan is to wait for a move back to the zone between $16.35 and $18.00.

One stock that reported better prospects is Northern Star (NST). An all in cost of production between $1000 and $1050 make it profitable at current prices, and the company said it is on track to produce 485,000 to 515,000 ounces this year. Some analysts expect the production to come in at the top of that range:

Once again I’m cautious on entry. I’d prefer to see NST somewhere between $2.97 and $3.50 before stepping up to the plate.

My view is that the most probable scenario is the modestly positive economic prospects will see markets higher by year end. Further, a strengthening US economy will bring Fed rate rises, a stronger USD and therefore a lower spot gold price. It may seem strange to buy stocks and hope to lose. But that’s exactly where I’m at with gold stocks. I’m adding these to my list “just in case”, not because I like the outlook. If there are no market disruptions my portfolio overall should prosper, and if something does come from left field my gold stocks will help.

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