Factors Align in Gold's Favor

Other analysts point to the spate of mergers in the gold-mining industry as a bullish development for gold stocks. AngloGold(AU Quote) has offered to buy Ashanti (ASL Quote); Harmony(HMY Quote) is in the process of buying ARMGold; and Placer Dome(PDG Quote) recently acquired East African Gold Mines.

Michael Dudas, an analyst at Bear Stearns, said investors should overweight the entire group, because he believes gold prices could move to $390 by year-end. But other analysts say investors should be careful about blindly jumping into gold stocks.

"Gold stocks have been performing particularly well over the past couple of months; in fact, they've outstripped the performance that you would expect given the rise in gold prices," said Stanley. "On most measures of valuation, they're looking a little expensive."

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The Gold Bugs index of unhedged gold stocks is up 30% so far this year. Several analysts say investors should steer clear of Newmont Mining(NEM Quote), in particular. While the stock is largely unhedged against fluctuations in the price of gold, it does have a high net-asset-value multiple.

Other producers such as Barrick Gold(ABX Quote) or Placer are more attractive, they say.

Credit Suisse First Boston analyst David Gagliano thinks Barrick will outperform its peers going forward, noting that it trades at just 2.1 times net asset value, compared with the group's average of 2.6 times. Still, he is cautious on the sector overall, saying higher operating costs and a deterioration in asset quality could hurt earnings.

"In our opinion, the same fundamentals that support the current strength in the gold price are negatively affecting the earnings of the major producers," he said.

Meanwhile, there are risks to the outlook for gold prices. Some analysts warn that if the economy picks up steam over the next few months, the dollar could get stronger. Others say higher interest rates pose a threat to gold because the Treasury market is a big competitor for investment capital flows.

Also, with so many people expecting a rise in gold, some believe the market is at risk of falling. "Historically, as the speculative crowd built large long positions in this market, the market has proved very vulnerable to a sharp decline in price," said Canaccord Capital analyst Brian Christie.