Gold stocks: Few gems left to unearth

NEW YORK (CNNMoney.com) -- Gold has been on a tear that few other investments can boast of - and gold mining stocks have gone along for the ride in recent months.

The price of gold - approaching $800 an ounce - is up more than 20 percent year-to-date. Several large mining companies have soared nearly as much as the metal. Many miners are trading at or near their 52-week highs.

With the dollar sagging, some analysts think now is a good time to grab an investment that historically has been immune to market downturns and currency fluctuations.

Gold is often viewed as a safe haven during a time of turmoil since, like oil, it is a "hard" asset that can help investors mitigate the risk of inflation.

One analyst sees higher oil prices and a weak dollar as evidence that rising gold prices are here to stay.

"I believe we're in a multi-year bull market for gold," said Leo Larkin, Standard & Poor's metals and mining analyst.

But others are concerned that the bull run for gold could be nearing an end.

"Gold is a bit frothy, both the bullion and the value of stocks in the sector," said Vahid Fathi, an equity analyst with research firm Morningstar. "We have seen a lot of speculative buying recently. We still see some values in gold miners, but we're not recommending that investors jump in with both feet."

So how can investors find the best bets? This week will be an eventful one for gold stocks and a good chance for investors to sift out the winners from the losers: Several miners, including No. 1 gold producer Barrick (Charts), third-largest producer Newmont (Charts, Fortune 500) and the smaller Eldorado Gold (Charts) will report earnings.

Investors will be watching closely to see if there are any deals left to dig up in the sector.

Analysts say the biggest problem facing gold miners, especially the largest producers, is the difficulty of replenishing supplies during surging demand.

"It's better to be nimble than big in the gold sector," said Fathi. "Once you become a mega-producer, it's a burden to replace your production constantly."

Newmont, for instance, has lagged its competitors in replacing reserves, and its stock is the worst major performer in the gold sector over the past two years. But analysts say that this problem isn't isolated.

"Gold mine supplies are going to continue to be flat for the next two to three years," said Larkin. "During the 1990s, there was a lot of cutback in spending for exploration. Even as spending has picked up, there aren't a lot of large deposits being found."

One of the companies that has weathered this storm is Barrick, which didn't pull back on exploration expenditures nearly as much as the other firms did in the late '90s.

"Barrick has been in a much better position than Newmont, because they have a more robust pipeline of growth projects," said Larkin.

Indeed, Barrick has actually outperformed the StreetTracks Gold ETF (Charts), an exchange-traded fund which is designed to mimic the price movement of the actual commodity.

Barrick's stock has gained nearly 43 percent compared to a 23 percent increase for the gold ETF. Unfortunately, that might make the stock a bit more of a risk for investors.

While most analysts say gold assets - either the commodity itself or shares of gold producers - can serve as an important inflation hedge in a portfolio, they stress that it's important not to overdo it.

Katherine Yang, a mutual fund analyst with Morningstar, advises that gold should make up no more than 5 percent of a person's investments.

The commodity's amazing rise over the past 10 months underlines its volatility. But gold is still historically less volatile than most financial instruments, said S&P's Larkin.

Nonetheless, financial planners advise caution.

"We think there are better ways to hedge against inflation than investments in pure gold," said Jane Newton, a wealth manager and certified financial planner with Regent Atlantic.

"We are very bullish on the demand for commodities, though, so we have created some custom structured investments with exposure to commodities including gold," she added.

Planner Richard Martin of Columbus, Ohio, also says he's found other ways to hedge against inflation. While he believes it's important that clients have a portion of their portfolio set up to counter inflation, he says TIPS (Treasury Inflation Protected Securities) provide more stability in volatile times than gold.

But if you are still interested in investing in gold, what's the best way to do it?

Fathi said that No. 4 producer Gold Fields (Charts), Newmont and the smaller Harmony Gold (Charts) are better bets than Barrick since they have not performed as well as the high-flying Barrick.

He said Gold Fields is undervalued but is still risky because of cutthroat competition.

Fathi likes Newmont because it has begun to react to its supply problems with aggressive exploration. Newmont also announced earlier this month that it was buying Canada's Miramar Mining (Charts) for $1.5 billion in order to increase its reserves.

And Harmony has been successful in pushing down costs with a broad restructuring program, he said.

Gold Fields trades at about 20 times next year's earnings estimates, a relatively low valuation for a mining stock. Newmont and Harmony are more expensive, trading at 27 times and 32 times 2008 earnings estimates, respectively.

For investors looking to not gamble on one stock, the world of exchange-traded funds offers several options. The StreetTracks Gold ETF and iShares COMEX Gold Trust (Charts) are for investors who'd rather bet on the metal itself.

"Even as the price of gold has gone up, the cost of producing has climbed just as fast - labor, materials and energy," said Larkin. "Actually investing in the commodity itself by way of an ETF is probably a bit more rewarding."

There's also an ETF that tracks a group of mining stocks, the Market Vectors Gold Mining ETF. But Morningstar's Yang said if you're looking for diversity, two actively managed sector mutual funds are attractive.

Vanguard Precious Metals & Mining (Charts) is a standout fund of commodities producers, says Yang. Its manager, Graham French, has one of the best-diversified products on the market, with 51 percent of its assets in metals and 49 percent in materials like copper and coal.

"Because it's so diversified, the volatility is relatively low," said Yang.

She also likes American Century Global Gold (Charts) for its low costs and heavy exposure to gold - around 95 percent of its portfolio has gold-related firms.

"It's a very good way to get a play on gold, but it's still quite diversified," she said.

The gold market has seen tremendous growth in recent months and values are hard to come by. So don't get greedy. A well-balanced mutual fund is probably the best way to harness some of gold's gleam without taking on as much risk.

Fathi and Yang do not own any shares of the products they cover, and Morningstar doesn't do any investment banking business with firms. S&P's Larkin has no affiliation or ownership of any company discussed, but his company may provide services to the companies that were discussed.