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Gold's Deceptive Glitter

By Isabelle Sender With gold prices at 17-year highs -- and up more than 5% since Friday, Aug. 26, before Hurricane Katrina hit the U.S. Gulf Coast -- investors are weighing whether gold stocks can head even higher. On Sept. 19, December gold futures reached a high of $471.05, and spot gold jumped to $474.90.

Valuations suggest that investors can find better buying opportunities, especially since gold stocks tracked by Standard & Poor's have climbed approximately 20% since Aug. 26. "Since we see little upside potential at this point, we do not recommend adding to holdings," says Leo Larkin, S&P's gold equity analyst, who follows outfits such as Barrick Gold (ABX

; ranked 3 STARS, or hold; recent price: $29), Newmont Mining (NEM

; 3 STARS; $46), and Placer Gold (PDG

; 3 STARS; $17).

Similarly, S&P recommends against investing in gold directly. "In general, we think gold is a bad investment because it's very seldom that gold outperforms any other investment, like stocks or bonds," says David Wyss, chief economist at S&P.

BLACK GOLD. The price of gold has risen lately for a few reasons. Erratic returns in other asset classes may be driving some investors to gold this year. Plus, demand is outstripping supply, leading to higher prices, a refrain echoed by close observers of oil prices. "We believe the low level of gold prices in the late 1990s led to sharply reduced exploration, which we think will result in flat to lower production even if the metal price rises dramatically," Larkin says.

Gold prices tend to move in tandem with crude oil prices. Crude futures jumped 7% on Sept. 19, settling at $67.39, on fears of another hurricane barreling down on the already-strapped oil production and refining capabilities in the Gulf of Mexico area.

However, few market observers see either of these commodities' high prices as sustainable. Wyss believes current gold prices are susceptible to fall because of the historic influence of oil on gold. Wyss cites some evidence that oil producers appear to be taking profits to buy gold. He expects this gold-buying trend to halt as oil prices likely reverse and momentum in other asset classes, such as currencies, likely gain investors. S&P sees a yearend oil price of $62 a barrel, falling to $52 by the end of 2006.

NO HEDGE NEEDED. Doug Groh, senior investment analyst at Tocqueville Asset Management, the company behind the $500 million-asset Tocqueville Gold mutual fund (TGLDX), sees gold's future support level at around $439 an ounce, or pre-Hurricane Katrina prices. He says he doubts gold prices would go much below that.

An investment in gold is traditionally used as a hedge against inflation, Groh notes. However, S&P isn't forecasting a big increase in the inflation rate. And Groh believes that investors don't want to be gold buyers in this environment. "If you believe inflation is in front of us, you probably want to buy against that hedge, but it may be too late now," he says, because of the high valuation.

Meanwhile, gold stocks have many risks at this point, Groh says, due to the rise in operating costs for miners. These include labor, heavy-duty equipment, fuel, and imports such as steel to build mines or chemicals to process the gold ore. Mining equipment is now in relatively short supply on a worldwide basis, Groh says.

Though gold and shares of gold producers may have luster among speculative traders, individual investors may be better off sitting out this time around.

Sender is a reporter for S&P MarketScope

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