One of the lessons learnt from the global financial crisis was that all economies and their stock markets are highly interconnected. So we may assume that the Australian stock market may be negatively impacted by recent falls on overseas markets.
In Friday night's trade, U.S. stocks saw their biggest drop since last June, capping the worst week for indices since 2012, as a selloff in developing nation currencies created concerns for global stock markets.
Gold tends to outperform in uncertain times. So the rising gold price over past weeks, when the slide in currencies began, should come as no surprise. Gold closed at US$1,270 in Friday night's trade in America, continuing its rise from recent lows of US$1,187.
Gold also thrives under scenarios of inflation and deflation. In my opinion, deflation is more likely and would be detrimental for all but the precious commodities. This would inevitably result in a falling Australian dollar. Thus, the right Australian gold shares would receive a boost from both the rising gold price and falling dollar.
The good news is that while holding gold shares is a long-term protection strategy for a portfolio of shares, it also allows the shareholder to sell their holdings at a later stage to fund purchases of beaten-down industrial and mining shares. During deflationary times cash is king, as the majority of asset classes become cheaper to buy.
Which gold shares to buy?
Significant gold producers are the most likely to rally before the smaller end of the market. They include Regis Resources (ASX: RRL), Newcrest Mining (ASX: NCM) and Beadell Resources (ASX: BDR).
I would prefer not to rely only on investment trends, so I also seek out companies that have positive fundamentals or recent good news. On this basis I have excluded my favorite gold stock, Beadall Resources. Last Friday, it released a quarterly activities and cash flow report that had a negative impact on its shares. To be conservative, I will await a more detailed explanation for this reaction. Thus, I have selected the following two stocks.
1. The woes afflicting Newcrest Mining over the course of 2013 have been well documented and resulted in a loss of nearly three-quarters of its market value. One worry for Newcrest is that it has been rated a high-cost producer. However, signs were beginning to emerge from its mid-January production update that costs are beginning to decline, with potentially more declines to come. Rising production figures were also a feature for gold, while guidance was maintained for full-year copper and gold production.
Should market turmoil be ongoing, and gold continues its rise, such a beaten-down stock could potentially rally very hard. Having been as high as $13 in September and then plummeting to a low of $6.96, it is currently at $9.48.
2. Regis Resources is one of the lowest cost producers and recently had a significant resource increase at its Moolart Well operations, better than expected production from the Edikan resource and lower than expected capital expenditure at its Rosemount mine.
It has not been beset by the myriad troubles of Newcrest such as boardroom departures and a mediocre FY2013 financial result. In the event of a good rally in the gold price, its own rally will be likely be less than that of Newcrest, but substantial nonetheless.
Foolish takeaway
Gold may well afford some protection during a period of general market volatility. In particular, holdings of Australian gold stocks, with an additional bonus of a falling Aussie dollar, may help offset some losses in other industrial and mining shares.
