Before the most recent sell-off, gold had set an all-time high, lifting with it the Canadian market and the Canadian dollar. But analyst opinion varies on where gold goes from here.

The bulls see it at US$2,000 an ounce, while the bears see it languishing in a range between US$800 and US$1,000 an ounce. In the end, it’s the same old story: gold has value as a commodity and generates enthusiasm as a currency hedge. More specifically, that usually means hedging against a decline in the U.S. dollar.

Ultimately, for gold to rally, you have to believe that paper currency is losing credibility. Of course, you also have to believe that the world would be willing to accept gold as a currency to transact business.

Personally, I have never been able to line up those positions and therefore, have never been a big, long-term fan of gold. In my view, if you believe the world is facing a catastrophe, you should buy a farm. (You could even argue that farm property has become a decent investment lately.) The point is: we all have to eat, and currency — whether paper or bullion — is nothing more than a medium of exchange.

In general, the gyrations in the gold market follow movement in the US$. Or, specifically, the anticipated movement in the US$. Think about it this way: gold is valued in US$. If the US$ is weaker and gold simply retains its core value, then, by definition, gold’s price will rise.

We also know that the price of gold has less to do with supply and demand fundamentals and everything to do with sentiment. At US$1,000 an ounce during the height of the credit crisis, sentiment was painting a worst-case scenario for the US$. At less than US$900 an ounce, one could argue that gold traders believe the US$ is grossly undervalued.

The bottom line is that gold is not a growth story.

From time to time, it does have value as a trading vehicle, as we have seen with some Canadian gold stocks — namely, Vancouver’s Goldcorp Inc. and Barrick Gold Corp. of Toronto.

Understanding that dynamic gives us an appreciation for the role that gold plays within a portfolio.

Typically, gold moves counter to the general trend in the economy.

A robust economy means weaker gold prices, and vice versa. As such, gold plays a role as a diversifier within a broader portfolio. Which is to say that gold can dampen portfolio volatility, but it will not likely enhance long-term performance.

If you accept that position, then you need to ask whether one should diversify with gold bullion — as in gold exchange-traded funds such as Streettracks Gold Trust, which is listed on the American Stock Exchange — or gold stocks.

Choosing one over the other depends on whether you believe that what is good for gold will be good for gold stocks. The answer to that is twofold.

On one side, there will always be a speculative bump in gold stocks as traders weigh the short-term potential for bullion prices. We have already seen that over the past 12 months, when Barrick traded above $54 a share.

On the other side, if Canadian gold stocks are to rally, more has to happen. For one thing, there is the relationship between the US$ and the C$ that has an impact on the bottom line of Canadian gold-mining companies.

The past three years have demonstrated that a decline in the US$ has a positive impact on the value of the loonie that is exponential.

This is critical, because profit for Canadian gold companies, as it relates to Canadian investors, comes down to a bottom line valued in C$.

In that sense, a Canadian gold-mining company may end up selling a commodity (gold) that is rising in US$ terms, but declining in price relative to the currency investors are trading in. That dynamic is at play here. How much it affects gold-mining companies in the weeks and months ahead remains to be seen.

The ideal scenario, if you are playing gold companies, is to have the US$ show signs of weakness against all world currencies — except the C$.

In that light, the weaker US$ will positively impact the price of gold, and a stable C$/US$ relationship will enhance the bottom line of Canadian gold companies.

@page_break@In fact, that is exactly the scenario that some believe will play out in the weeks ahead. If it does — that is, if the US$ remains weak against other currencies, but with a stable relationship between the US$ and C$ — then this is an excellent time to diversify your clients’ portfolios with gold stocks rather than gold bullion.

The other factor at play is understanding what gold companies actually do. Aside from currency-related issues, their bottom line is influenced by the spread between what it costs to get gold to market and what they can sell it for.

In that sense, gold stocks have an economic model that is similar to say, banks and oil companies. Both of those sectors profit from the spread between the cost of money or a barrel of oil and what they can get on their loan portfolio or at the gas pump.

From a portfolio perspective, gold is a diversifier. From my perspective, the best way to add that diversification today is with gold stocks or gold stock ETFs, such as iShares CDN S&P/TSX Global Gold Index Fund, which is listed on the Toronto Stock Exchange.

But these securities should be added only to the extent that they are used as a diversifier. Which is to say, limit the exposure to gold to no more than 10% of the total value of a portfolio. IE