Like many commodities, gold stock prices are unpredictable. So if you plan to invest in this industry, here are some tips

The best gold stocks have strong reserves, low production costs and are already producing gold. They also have a range of development projects, but their strong base of production cuts the risk of relying on new developments alone.

If you want to invest in gold, we think the best way to do it is through gold mining stocks or ETFs that hold those stocks. We recommend staying away from gold bullion, certificates representing an interest in bullion, and other gold bullion alternatives. The best gold stocks will generate positive cash flow even with low gold stock prices—and also offer rising production outlooks.

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Gold stock prices influence the shares of gold firms—but so do other factors

The best gold stocks operate in secure locations. We generally stay away from mining companies that operate in insecure and politically unstable regions like the Congo, Venezuela and Colombia. We also avoid those in countries with little respect for property rights and the rule of law, such as Russia or Mongolia. Mining is particularly vulnerable to political instability. You can’t move the mine to another country, and local citizens may sometimes get the impression that a foreign mining company is robbing them of their birthright, even though the foreign company’s capital and expertise would appear to be the best way to get any value out of the ground.

Stocks in the best gold companies will generate positive cash flow even with low gold prices

Some of the most highly promoted gold mining stocks are penny stocks that have yet to produce an ounce of gold. Many must still add to their reserves, invest in mine feasibility studies, and raise a lot of money before they go into production. The prospects for most of these penny-mine properties, even though they may be in areas with production from existing mines nearby, are far from certain.

However, the best gold stocks have strong finances with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests. The best junior golds often have a major partner who has agreed to pay for the drilling or other exploration or development, in exchange for an interest in the property.

Remember, the very best gold stocks all have strong balance sheets and low debt—and above all, generate positive cash flow even when gold prices are low.

Gold stock prices do not tell the whole story of gold investing

Gold is different from other commodities due to its scarcity, its special physical characteristics like freedom from tarnishing, malleability (the ability of a metal to be hammered into thin sheets), its unique suitability for use as a medium of exchange, and its place in the world’s financial history.

But keep in mind that no matter how appealing they look, you should limit gold stocks, like penny stocks in gold, to a modest part of your portfolio.

Gold investing is a poor choice for most investors. For one thing, it involves a lot more guesswork than other aspects of investing.

The markets for widely traded goods like gold are inherently unpredictable. These markets are so big that there is no practical limit to how much you can trade in them. It follows that if you could predict them, you could wind up acquiring a measurable proportion of all the money in the world. Nobody ever does that.

One special risk to gold investing is that some investors take it to extremes. They invest too much capital, and some use options, futures or margin loans to gain leverage. This magnifies their losses when they are wrong on gold-price trends.

If you want to invest in gold, we think you should limit your gold exposure to a portion of what you would otherwise devote to the resources sector of the economy.

Six guidelines we use to pick gold-mining stocks

1. To profit in gold stocks, look for well-financed companies with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests.
2. High-quality gold stocks should have strong balance sheets with low debt. Junior mines should have a major partner who can finance a mine to production.
3. Another key ingredient is an experienced management team with a proven ability to develop and finance a mine.
4. We think you should avoid stocks that trade “over the counter,” where such things as regulatory reporting are lax.
5. We also recommend avoiding stocks that are trading at unsustainably high prices as a result of broker hype or investor mania.
6. Compare the market caps of the stocks with the estimated value of their assets or future earnings streams. Some need to quickly find a mineral deposit and begin production to justify the current share price and avoid collapse.

Gold stocks are often perceived as being a “safe harbour” when markets drop. Have you ever invested in gold as a safe harbour?

Gold has an emotional appeal, but there can be financial appeal at times, too. How do you look past the allure of gold and focus on the practical aspects of gold as an investment?