How to Invest in Gold

With gold prices high, gold companies can make more for every ounce of gold they produce, but their net profits depend on their cash costs; how much it costs them to produce an ounce of gold. Those factors vary from company to company and are subject to currency issues, energy costs and geopolitical factors.

Adam Graf, director of emerging miners for Dahlman Rose & Co., models 50 companies on a forward basis using forward curves. "On a theoretical basis, if gold moved up $100 an ounce, what does the change in the current value do based on what the forward looking cash flow should do."

Another factor to consider when picking gold stocks is how quickly the company will benefit from higher prices. Randgold Resources(GOLD), a miner in Africa, is almost 100% correlated to gold prices. CEO Mark Bristow says that the company benefits from gold prices in almost two days.

You also have to buy the right amount of gold stocks. J.C. Doody, editor of goldstockanalyst.com, bets on 10 gold stocks because it allows him to take some risk with explorers or junior miners as well as get the safety from a major.

"Frankly there aren't 30-40 stocks in the gold space worth buying," says Doody who would rather be heavily invested in 10 than over invested in 2 and under invested in 40. "If you've got too many the best you're going to be is a mediocre mutual fund and if you have too few you're just taking on too [much] risk."

If you do go the gold stock route, you have to be prepared for the rollercoaster ride.

Leverage swings both ways so if the gold price drops 10%, gold stocks can plummet 20%-30%. Investors often get too spooked too fast and wind up selling out of gold stocks at the wrong time.

"It inhales and exhales 20-30% at least once or twice a year," says Pratik Sharma, managing director at Atyant Capital who urges investors to not get spooked by volatility. "Ultimately what you have to realize 5-6-7%... these things are meaningless when you have a sector that moves 20-30% several times a year on the downside."

There is always time to buy gold, you just have to know your ABCs before you start.

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How to Invest in Gold

--Written by Alix Steel in New York.

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