A confluence of fundamental and monetary factors has the gold bugs licking their chops again.

Gold, which has traditionally been a safe haven for investors in times of financial turmoil, has posted net gains this year, though it's been a bumpy ride. After a 25% rally in 2002, gold started this year at $344.8 an ounce and has swung both up and down by double-digit percentages, recently settling at about $360.

Analysts attribute the net 4.6% rise in 2003 primarily to a drop in the U.S. dollar. When the dollar falls, gold often rises, because investors lose confidence in paper currency.

Dusted on Cool

Even though the greenback has rebounded over the past couple of months, some pundits believe there's a decent chance it will weaken through the end of the year, as investors react to the budget deficit and huge current account gap. That, and an uptick in inflation, could lend support to gold prices and by extension gold stocks.

"From 1989 to the present, each 1% shift in the spot price of gold has meant a 1.9% shift in the S&P 500 gold index," said David Kerans, an analyst at Argus Research.

Kerans said he is expecting gold to climb to about $380 an ounce by the end of the year, partly because he feels the supply of gold will be constrained going forward. He is looking for gold production to decrease by 3% per year until at least 2007.

"There's not enough money being spent on exploration to maintain current production levels in the longer term," agreed Geoff Stanley, an analyst at BMO Nesbitt Burns.

Yellow Yellow

Analysts also note that demand for gold continues to be strong, particularly in India, where jewelry makers have been stepping up their gold purchases.

Merrill Lynch, which is looking for bullion to rise to $370 an ounce by October, also noted that demand in China is likely to increase from both the public and private sectors.

"Continued gold market reform is expected to enhance China's gold demand," the firm said in a recent report. Merrill and Goldman Sachs now recommend a 5% weighting of gold in client's holdings.

Other analysts point to the spate of mergers in the gold-mining industry as a bullish development for gold stocks.

AngloGold

(AU) - Get Report

has offered to buy

Ashanti

(ASL)

;

Harmony

TST Recommends

(HMY) - Get Report

is in the process of buying ARMGold; and

Placer Dome

(PDG)

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."

Favored Names

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) - Get Report

, 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)

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.