Though the price of gold has tumbled since peaking in late 2011, it’s still much higher now than was 10 years ago.

Some advisors may suggest an allocation to gold, either in an ETF that holds gold bullion or in a fund that holds mining stocks. True gold bulls likely will prefer mining stocks, because miners may have operating leverage: a company that produces gold at $1,200 an ounce, for example, would see profit margins rise by 20%, from $250 to $300 an ounce, if the price of gold goes up about 3.4%, from $1,450 to $1,500. Higher margins, in turn, may be reflected in stock prices.

Of course, investing in a fund holding mining stocks is not the same as investing in a bullion fund. Clients effectively own company shares, and many gold mining companies are based outside the U.S., operate internationally, or both. Thus, country risk may be a factor for advisors attempting to choose among precious metals funds for clients.

“Country risk is certainly pertinent for investors and advisors,” says Andrew Clark, manager of alternative investment research at Lipper. “Holdings of South African firms such as AngloGold are common.”

While South Africa might seem to offer some country risk, perhaps from labor disputes, Australia may not be considered in the same category. Yet a few years ago, a “punitive” tax on Australian mining companies was proposed, notes Tim Knepp, CIO of Genworth Financial Asset Management. “Mining stocks there took a hit,” he says. “The mining companies pushed back and the proposed tax law was watered down. Clearly, though, those events hurt investment flows.”

Advisors should know which mining companies are included in precious metals funds, and where they operate. “North American reserves are diminishing,” says Knepp, “so gold companies are exploring new territories. Some are operating in places such as Argentina, Brazil, Ghana, and Peru, where there may be some form of political risk.” Beyond the emerging markets, even developed countries such as Australia may pose political risks, as noted above.

Country risk will grow over time as Africa is mined for its resources, according to Clark. “Country risk tends to manifest itself as liquidity risk,” he says. “There are risk premiums in emerging markets, but they are not stable. That is, you can't count on them being there for the same stocks all the time.”

Some emerging countries, such as Nigeria, have liquid markets where exits from a given stock are typically available at a fair price, Clark notes. “Exchanges elsewhere in Africa are only beginning to approach Nigerian standards,” he says, “so country risk in the form of liquidity risk will be something investors will need to pay attention to. The same is true for Chinese firms, especially those that trade only on a mainland exchange, such as the ‘B’ shares.”

Knepp says his firm invests in Market Vectors Gold Miners Index ETF, which tracks the NYSE Arca Gold Miners Index. “This index is heavily weighted towards companies operating in North America, which helps to moderate the country risk. Even so, as new discoveries in North America tail off, some of these companies are becoming more exposed to newer frontiers.”

Clark asserts that country risk from political exposure is a judgment call. “There is no way to ‘sell off’ or contain such risk,” he says, “so each investor needs to make choices about political risk. Clearly, the safest way of not having liquidity or political risk is to stay in the developed world, but illiquid assets can have the greatest profit potential.”

Donald Jay Korn

Donald Jay Korn is a New York-based financial writer who contributes to Financial Planning and On Wall Street.