Market volatility commonly drives investors toward gold as an investment safe haven — and the current severe downturn is no exception. The price of gold has climbed and, with signs of global economic recovery still sparse, analysts expect gold to retain its lustre for some time.

So, the question is not “Why gold?” but “How much is appropriate for clients’ portfolios, and in what form?”

Many industry watchers expect gold to continue on its upward trajectory. In fact, the price could hit US$2,000 an ounce, more than double its recent level of about US$890, say such economic bears as Eric Sprott, CEO of Toronto-based Sprott Asset Management Inc.

Martin Murenbeeld, chief economist with DundeeWealth Inc. in Victoria, is also bullish on gold: “Gold bullion prices are likely to go up over the medium and longer term.”

Murenbeeld points to two factors that are triggering the increase: declining levels of gold production worldwide and the fact that gold is priced in U.S. dollars. The U.S. government’s recent efforts to boost liquidity by buying U.S. Treasury bills, he explains, have heightened expectations that the value of the greenback will deteriorate.

“There is the potential for the US$ to decline in value quite dramatically,” adds John Hogarth, senior wealth advisor with ScotiaMcLeod Inc. in Toronto.

Because any devaluing of the US$ tends to strengthen the value of gold, Hogarth believes gold could reach US$1,500 an ounce as the US$ sinks. As a result, he has boosted his exposure to gold as a hedge.

But there are risks to holding the precious metal. Like any commodity, gold tends to fluctuate widely in price. And because its price often moves in a direction opposite to that of the stock market, a return of confidence in the financial services sector and a recovery in stock prices could depress the price of gold in the months to come. So, anyone holding gold has to be able to stomach volatility.

Despite the risks, investors have been showing plenty of interest in the precious metal. A recent report by ScotiaMocatta, the precious metals division of Bank of Nova Scotia, found that investor demand drove up gold holdings in exchange-traded funds by 315 tonnes in the first two months of 2009 — more than the 283 tonnes that ETFs accumulated in the whole of 2008. And the ScotiaMocatta report expects that trend to continue: “People seem to be turning to gold as a hedge against money and economic disorder.”

So, how much gold should your clients hold in today’s environment? That is open to debate.

Some gold bugs encourage investors to increase the amount of gold in their portfolios while they wait for the economic turmoil to pass. James Turk, founder and chairman of GoldMoney — a British Channel Islands-based company that sells gold to investors — recommends that investors hold 25% of their portfolios in gold.

“In this kind of environment, you want to have safety in your assets,” he says. “When you own gold bullion, you achieve that safety, because gold is the only money that doesn’t have someone’s promise attached to it.”

David Chapman, an investment advisor and technical strategist with Vancouver-based Union Securities Ltd., also recommends a 25% allocation to gold, but as a long-term core holding. Even if signs of market recovery appear, he does not recommend reducing exposure to gold. “This crisis has many more years to run,” he says. “We may not have seen the bottom in the market.”

But other industry players advise against such large holdings. Frank Wiginton, a certified financial planner with Toronto-based Tri-Delta Financial Partners, says the standard rules of portfolio diversification should apply to gold: a single asset should never represent more than 10% of a portfolio.

“The problem is the risk factor and the volatility factor that comes with gold and investing in gold stocks and physical gold itself are far beyond most people’s tolerance,” says Wiginton. “That risk of investing in gold needs to be mitigated through diversification, through proper asset allocation.”

Hogarth agrees: a portfolio should have no more than 5%-10% exposure to gold. “Make sure the portfolio is balanced,” he says, “that you don’t get too lopsided in the portfolio in case you’re wrong.”

Here are ways for your clients to gain exposure to gold.

@page_break@> Physical Gold Or Certificates. The only way to avoid counterparty risk entirely is to hold physical gold, Chapman says: “It’s no one else’s liability, unlike a company. It’s not a piece of paper; it’s a hard asset.

Investors can purchase physical gold in the form of bars or coins. For instance, the Royal Canadian Mint produces Gold Maple Leaf bullion coins that are 99.9% pure gold. In addition, bullion is available in bars ranging from one ounce to 400 ounces. But investors should be aware that premiums on purchases of physical gold can be very high, says Turk, particularly on smaller transactions.

Safe storage can also be challenging. Some companies eliminate this concern by storing the gold for investors. GoldMoney, for instance, allows investors around the world to purchase bullion online, storing it in vaults in Zurich and London.

Another option to eliminate storage concerns is gold certificates, which represent gold ownership without the transfer of physical gold. But unlike physical gold, certificates involve some counterparty risk, Chapman warns, because they are dependent on the credibility of the banks that sell them.

Also, clients need to keep in mind that gold and gold certificates are “non-producing assets” that do not produce income. Turk cautions that gold should be considered cash, not an investment.

> Gold Stocks. Clients seeking growth potential can invest in the stocks of gold producers. Because any movement in the gold price can have a dramatic impact on the profitability of gold producers, these stocks tend to be sensitive to movements in the price of gold.

“Clearly, equities have a real kick to them when the gold price goes up,” says Murenbeeld.

But these investments also involve greater downside risk when the price of gold falls. In addition, many gold producers are exposed to risks such as geopolitical risks and volatile production costs.

> Exchange-Traded Funds. ETFs have recently soared in popularity among investors seeking an accessible way to invest in gold. A number of ETFs, including iShares COMEX Gold Trust, sponsored by Barclays Global Investors International Inc. and traded on the Toronto Stock Exchange, hold physical gold and seek to correspond to its daily price movement.

“ETFs are a very convenient vehicle for trading in and out of bullion,” says Nick Barisheff, president and CEO of Toronto-based Bullion Management Group Inc.

But, he cautions, ETFs do not involve the same level of security as owning physical bullion. The liquidity of an ETF and its ability to maintain its net asset value per unit is dependant on its size and daily trading volume rather than on the liquidity of the underlying bullion market, he says: “They shouldn’t be confused with holding fully allocated, segregated bullion.”

Other ETFs, including iShares Canadian Gold Sector Index Fund from Barclays Global Investors Canada Ltd. , offer investors exposure to a diversified range of gold stocks.

> Precious Metals Mutual Funds. Mutual funds represent another means of investing in gold without storage concerns. For example, Sprott recently launched Sprott Gold Bullion Fund to invest primarily in unencumbered gold bullion, gold certificates, and closed-end funds based on an underlying interest of gold. Another option, Bullion Management’s BMG Bullion Fund, invests in equal proportions of unencumbered, fully allocated gold, silver and platinum bullion.

Many other precious metal funds invest in mining equities rather than physical bullion and, says Barisheff, it’s crucial to distinguish between the two types. IE