Investment bright spots have a habit of emerging in the market’s darkest places. Amid unrelenting resource-sector gloom, the iron ore price bounced in April, the Australian-dollar gold price has rallied and gold equities are outperforming the broader market this year.

Resource bears will argue this is a bear-market rally that attracts and destroys fresh capital. That may be true of iron ore, but there is more substance to the gold sector’s near-term outlook, and the case for modest portfolio exposure to the precious metal is strengthening.

Although still off a peak of US$1900 reached in early 2011, the good news is the Australian gold price, which matters most for local producers, has rallied from A$1,333 an ounce in November 2014 to around A$1,500. With further Australian-dollar weakness likely this year as interest rates are cut and as the US dollar rises, a higher A$ gold price is a reasonable bet, assuming a stable US$ gold price.

That should underpin further gains in local gold stocks, which are collectively coming off several years of heavy losses. The All Ords Gold index’s total return of 31% so far this year compares with an 11% gain in the S&P/ASX 200 Accumulation index, which assumes dividend reinvestment.

A rally in sector heavyweight Newcrest Mining partly explains the index gain. After being hammered in recent years, Newcrest has delivered a one-year total shareholder return of 41%. But at $14.84 a share, it remains well down on its $41.45 peak in early 2011.

Reasons to buy gold

Some prominent forecasters have become more bullish on the outlook for gold. British commodities researcher Metals Focus said in late March that 2015 was likely to mark the end of the bear cycle for gold.

Macquarie Group is also positive on gold’s medium-term outlook. Its global commodities team has a long-term forecast gold price (2019+) of US$1,500, with an average of US$1,255 in 2015 and US$1,363 in 2016. Like Metals Focus, Macquarie expects further gold-price volatility in the near term, before the metal stabilises and gradually improves in the next few years.

Lower interest rates are another reason to buy gold. Unlike most other assets, gold bullion does not provide yield. But with interest rates at record lows, the return on bank term deposits is 3-4%, less in real terms after adjusting for inflation. Another one or two rate cuts this year would further reduce the gap between bank deposit rates and gold’s zero yield.

Gold, it seems, is in a tug-of-war between the prospect of rising US interest rates and a rising Greenback, and the potential for another bout of global financial-market volatility, which would spur demand for safe-haven investments. Greece’s potential exit from the European Union could be a trigger.

These market machinations will provide fuel for gold speculators to get in and out of the market. However, long-term investors, such as SMSFs, should view gold for its portfolio-diversification benefits rather than as a tool for quick gains.

There is a good argument that long-term investors should consistently allocate a small portfolio weighting, arguably no more than 3-5%, to gold. The allocation could be higher in periods of extreme volatility, such as the 2008 Global Financial Crisis, and lower when global equity markets are booming, as is the case in the US now.

Because gold has a different relationship to shares and bonds, it can protect wealth when other assets are going backwards. Gold was the best-performing asset during the 20 worst days for the US S&P 500 index since 2000, according to Macquarie Equities Research last year.

How to gain exposure

The question, then, is how to rebuild gold exposure in portfolios, knowing the precious metal should only ever have a small allocation in a balanced portfolio, and does not suit investors, who need income-producing assets to live off. There are three main options.

The first is buying Australian gold equities. They provide more leverage to rises and falls in the gold price, and a rising Australian share market is a much-needed tailwind for the gold sector. Analyst opinions on gold stocks, however, are mixed. For Newcrest, for example, there are four buy recommendations, five holds and six underperforms.

Macquarie Group’s preferred gold picks are Evolution Group, Regis Resources, Saracen Minerals Holdings, Doray Minerals and Gold Road Resources.

Option two is using exchange-traded products (ETPs) for gold exposure. They eliminate company and market risk inherent in investing in gold equities, and offer purer better exposure to gold bullion. The ASX-listed ETFS Physical Gold ETP, from ETF Securities, has rallied from $130 in late 2014 to $145.

The ETFS Physical Gold ETP (ASX Code: GOLD), one of the market’s largest, is unhedged for currency movements. Investors seeking hedged currency exposure could use the Betashares Gold Bullion ETF – Currency Hedged.

Option three is owning gold bullion directly, a strategy more SMSFs are adopting, according to anecdotal reports from the Australian Bullion Company and other gold-bullion providers.

Owning gold bullion means being able to take physical delivery of the metal – something ETPs cannot offer. Also, transaction and storage costs for gold bullion compare favourably with annual management fees for gold ETPs over time, argue gold-bullion providers.

Gold ETPs are best bet at this stage

Of the three options, I favour using unhedged gold ETPs for portfolio exposure. It is too early to get bullish about gold equities in this market given poor sentiment towards resource stocks and the likelihood of the commodity-price rout having further to run.

The best time to buy resource stocks is when the sector has stopped investing, or when small mining-service companies and explorers are going bust by the day – conditions not yet seen in this market, but getting closer.

The ETFS Physical Gold ETP (ASX Code: GOLD) should benefit from medium-term gains in the gold price and be cushioned by further modest weakness in the Australian dollar in the next 18 months. It is also a simpler way to add gold to a portfolio compared with gold equities or owning gold bullion.

I understand the appeal of owning gold bullion for self-directed investors. But investing via regulated listed, liquid share markets usually makes more sense than over-the-counter markets in commodities, when retirement income is at stake.

Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at April 28, 2015.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.