Worried About a Market Correction? Invest in Gold With Franco-Nevada Corp.

It has been a wild ride for gold investors with the precious metal peaking at $1,379 per ounce in mid-March of this year and now down by 12% since then. But there are growing indicators this could represent a buying opportunity for investors, with global stock markets in turmoil, the TSX having dropped to its lowest point in three months, and declining demand for crude and other commodities.

Global economic uncertainty continues to grow

The outlook for the global economy is becoming increasingly uncertain, with slowing industrial activity in China, Germany, France, and Italy, along with lower than expected economic growth weighing heavily on the price of crude. Already for the year to date West Texas Intermediate is down 4% and Brent, which is predominantly purchased in European refining markets, down a massive 12%.

There are also emerging signs China’s $23 trillion credit bubble is set to burst, with housing prices in its overheated property market tumbling for the fourth consecutive month. This alone could cripple China’s economy with mortgage defaults rampant. Any such collapse would see demand for commodities such as crude, coal, iron ore, and base metals fall even further.

The Eurozone is facing the specter of deflation with economic growth slowing and in some economies, contracting along with industrial activity. This is already hitting the price of Brent hard and deflation would see real asset prices like stocks, business assets, and real estate fall.

There’s also the upheaval in the Middle East. The uncertainty around all of these issues will have a significant impact on Canada’s energy patch and commodity miners.

Is a market correction in the future?

Surprisingly, investors continue to push markets to new heights despite the volatile economic and geopolitical outlook. It was only a month ago that the TSX hit a record high, and last week both the S&P 500 and Dow Jones Index hit new highs. However, it is now projected the U.S., Chinese and Canadian economies will not grow as strongly as expected in 2014, leading some to claim we’re seeing the start of a market correction, and pushing some risk averse investors to hedge their bets with gold.

The likes of billionaire George Soros has taken significant positions in gold miners Goldcorp Inc. (TSX: G)(NYSE: GG), Yamana Gold Inc. (TSX: YRI)(NYSE: AUY), and Agnico Eagle Mines Ltd. (TSX: AEM)(NYSE: AEM). Hedge fund managers John Hussman and John Paulson have also been hedging their bets by investing in gold. The former has substantial positions in Goldcorp, Barrick Gold Corp. (TSX: ABX) (NYSE: ABX), and Agnico Eagle Mines, while the later has taken a massive position in the world’s largest gold ETF, the SPDR Gold Trust (NYSE: GLD).

The three miners, Goldcorp, Yamana and Agnico Eagle, are solid bets to hedge against a market correction and an ensuing gold rally because of their portfolios of quality mining assets, low all-in-sustaining-costs of $852, $844, and $990 per ounce respectively, and attractive valuations with enterprise values times EBITDA of 15, 13, and 10 respectively.

But it is precious metals and commodities streamer Franco-Nevada Corp. (TSX: FNV)(NYSE: FNV), that continues to attract my attention. While it may appear more expensive than the miners with an EV of 20 times EBITDA, it operates with a far lower cost structure because it is a royalty and streaming company.

It does not operate any mines and does not have to make the same intensive capital expenditures to develop mines or meet the expenses associated with operating mines to sustain production. This allows Franco-Nevada to generate a solid operating margin, which for the second quarter 2014 was 81%. As such even a slight increase in the gold price will create a significant improvement in the company’s financial performance providing investors with the best leveraged exposure to gold.

Clearly there are signs of a growing disconnect between ever-better market performance and rising stock prices and the global economic outlook. The big end of town has already hedged its bets appropriately and now it’s time for investors to protect their portfolios as a market correction looms large.

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Fool contributor Matt Smith has no position in any stocks mentioned.

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