With gold currently trading at over $1,500 per ounce, the price of the precious metal has increased by 600% following the peaks of the tech bubble. Despite the recent rise in prices, fundamentals continue to suggest that the trend is unlikely to reverse.

TUTORIAL: Choosing Quality Mutual Funds

Increasing Demand
According to the World Gold Council "gold demand in the first quarter of 2011 totaled 981.3 tonnes" as more of the physical commodity was required for jewelry (primarily in India and China) and gold bars/coins for investment purposes. Bullion ETF holdings have increased from approximately 7 Moz in 2005 to over 60 in 2011. Last year's 11% increase in global demand outpaced the 7% rise in total mine production, forcing the prices to appreciate. As a result of the continuing pattern the SPDR Gold Trust (NYSE:GLD) ETF, which tracks the price of bullion, rose by 23% within the last year.

Low Interest Rates
Interest rates are another primary factor that drive gold prices, as an investor's willingness to hold the commodity depends on the potential rate of return on alternative investments. Although gold is considered a relatively safe asset, holding the commodity does not generate an investment yield. The inverse correlation between interest rates and gold prices has clearly persisted since 2001, reflecting a similar historical pattern to the 1970s. As part of the Quantitative Easing program, interest rates in the United States have remained extremely low at 0.25% and the Federal Reserve has indicated that it does not have any immediate expectations of increasing rates.

Economic Uncertainty
Barrick Gold Corporation (NYSE:ABX), the largest international gold producer, sites other major macroeconomic indicators such as sovereign debt concerns and trade imbalances to support a bullish gold outlook. Gross debt as a percentage of GDP has been drastically increasing in the PIIGS nations, leading to foreign bond uncertainty. Spain's debt-to-GDP ratio is expected to increase from 40% in 2008 to 70% in 2012, while the Greek GDP/Debt multiple will be on the verge of 140% next year. Furthermore, with the latest monthly $21.6 billion trade deficit with China, investors are looking for protection against inflationary pressures.

Gold Is Not in a Bubble
Unlike the characteristics of most unsustainable bubbles, the price of gold has been increasing at a relatively slow and stable pace throughout the last decade, suggesting a long term change in fundamentals rather than a case of irrational exuberance.

The initial steps of a bubble include a displacement of an established paradigm followed by a rapid price spike leading to unreasonable valuations. Gold price trends are neither reflective of the Dutch Tulip Mania, the Dot.com bubble, nor United States housing boom, all of which displayed the typical characteristics of an overheated market. (Bubbles are deceptive and unpredictable, but by studying their history we can prepare to our best ability. See 5 Steps Of A Bubble.)

Bottom Line
In addition to strong fundamentals driving gold prices, there are other valuable purposes to investing in the commodity. Primarily, gold prices are typically uncorrelated with overall stock and bond market movements. Therefore, ETFs such as GLD, ProShares Ultra Gold (NYSE:UGL) and iShares Gold Trust (NYSE:IAU) offer much needed portfolio diversification benefits.

Major corporations such as Barrick Gold, Goldcorp (NYSE:GG) and Newmont Mining (NYSE:NEM) offer other alternatives to play the industry.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraPro Nasdaq Biotech

    Obtain information about an ETF offerings that provides leveraged exposure to the biotechnology industry, the ProShares UltraPro Nasdaq Biotech Fund.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Europe Financials

    Learn about the iShares MSCI Europe Financials fund, which invests in numerous European financial industries, such as banks, insurance and real estate.
  4. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Insurance

    Learn about the SPDR S&P Insurance exchange-traded fund, which follows the S&P Insurance Select Industry Index by investing in equities of U.S. insurers.
  5. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Emerging Markets Small Cap

    Learn about the SPDR S&P Emerging Markets Small Cap exchange-traded fund, which invests in small-cap firms traded at the emerging equity markets.
  6. Mutual Funds & ETFs

    ETF Analysis: ETFS Physical Platinum

    Learn about the physical platinum ETF. Platinum embarked on a bull market from 2001 to 2011, climbing to record prices along with other precious metals.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Turkey

    Learn about the iShares MSCI Turkey exchange-traded fund, which invests in a wide variety of companies' equities traded on Turkish exchanges.
  8. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  9. Mutual Funds & ETFs

    ETF Analysis: Guggenheim Enhanced Short Dur

    Find out about the Guggenheim Enhanced Short Duration ETF, and learn detailed information about this fund that focuses on fixed-income securities.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares US Oil&Gas Explor&Prodtn

    Learn about the iShares U.S. Oil & Gas Exploration & Production ETF, which provides an efficient way to invest in the exploration and production sector.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  4. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  5. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  6. Lion economies

    A nickname given to Africa's growing economies.
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  4. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!