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Gold Is Hot — Should You Buy?

October 10, 2009 – by Richard Band

Gold surged to another all-time high this week — above $1,060 an ounce. So is now a good time to buy gold?

In a word, no. Bullion is expensive; gold mining shares, equally so.

That doesn’t mean you can’t keep a modest cache of the precious yellow for insurance against financial Armageddon, or hold onto some gold-mining shares that you bought earlier as an inflation hedge. But don’t count on the big gains to continue. In fact, a painful shakeout is more likely.

Back in 1913, an ounce of gold was freely exchangeable for $20.67 in U.S. currency. Today, gold at $1,054 is trading 136% above its 1913 price, adjusted for inflation. That’s the highest premium over the “gold standard” price since February 1983.

Could bullion go even higher? Sure it could. It did during the 1979-80 inflation mania. However, prudent investors don’t bet on the recurrence of mass hysteria. Gold is stretched right now.

Ditto for the mining shares. Right now, the five largest gold-mining stocks (by market value) are quoted at a median 16 times cash flow (enterprise value to EBITDA).

That’s far above the typical industrial stock. It’s also more than double the 5.7 times reading for defense contractor Lockheed Martin (LMT), one of the handful of stocks I’ve continued to buy, even with the market rallying to heady levels in recent days.

Yes, gold could still go to the moon, and carry the universe of mining shares with it. When the speculative sap is running high, though, as it is now, I prefer to put any new money into businesses that are clearly undervalued, not overvalued. Lockheed’s 3.3% dividend yield seals the deal.

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