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Analyst: Top 2 Stocks for High Gold Prices

Stocks in this article: SA VGZ

NEW YORK ( TheStreet ) -- With gold prices up 20% for the year, finding the next big gold stock ripe for a breakout is tough.

Mining stocks can have as much as a 3-to-1 leverage to gold's spot price to the upside and downside. Gold miners are risky because they trade with the broader equity market.

Some tips to consider when picking gold stocks are to find companies with strong production and reserve growth. Make sure they have good management and inventory supported by either buying smaller companies or by maintaining consistent production.

Global gold production has been declining since 2001 and big miners are keeping their gold reserves flush by buying or partnering with small-cap companies, which are in the exploration or development stage.

As gold prices rise, gold companies can make more for every ounce of gold they produce, but their net profits depend on their cash costs, i.e. 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.

You also have to take into consideration how the company grows. There is a finite supply of gold in the ground. According to reports, gold discoveries have been falling by 4 million ounces each year for the past 30 years. Companies, in order to meet growing demand, either have to invest in an active exploration unit in hopes of striking gold, or have enough cash to buy a smaller company.

In the World Gold Council's recent Gold Demand Trend report, gold mine supply rose 3% to 702 tons in the third quarter from a year ago as producers hustled to ramp up supply. Global identifiable gold demand rose 12% to 921.8 tons.

This trend makes junior miners a risky but potentially explosive investment. They are doing the actual exploring and digging for gold but often have no cash flow and must wait 5-10 years before a mine goes into production. Juniors are oftentimes forced to hedge, lock in gold sales at a low price, which limits profits, in order to secure project financing.

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