As the gold prices soar to new levels the question still remains whether the gold is worth the price.  Is this the right time to invest in gold. Will gold prices continue to rise in future or is it another asset bubble.

To answer these questions lets understand the dynamics of gold market. Like any other commodity gold price is determined by the forces of demand and supply. The supply of gold is more or less constant. It may increase slowly in the long run as new mines become operational and new technologies are developed to unearth gold. Hence the increase in the price of gold is entirely due to increase in demand of gold.

So why is it that the demand for gold has suddenly increased? Demand for gold has increased cause other investments have lost their glitter. People are choosing to buy gold because they are looking for an investment that will not suffer when the alarm bells next ring. Investors want something that will go up in terms of purchasing power. Gold is fitting in that role perfectly. Even at current levels gold is being perceived by investors to be better than other alternative investments such as equities and bonds which are seeing decline day by day.

Weaker US dollar and inflation fears have also helped the yellow metal. Gold is being held as an hedge by investors against inflation and a depreciating dollar. But why is it that investors accumulate gold when dollar depreciates. Investors perceive that gold will function as money when there is an ultimate loss of confidence in money. In the current economic scenario of deflation, the fed is pumping in more liquidity in the system by printing more money. The impact of this is the loss of confidence in paper money. The excessive printing of money has fuelled fears of hyperinflation.  This has increased demand for gold among investors which given the fixed supply has increased its price.

However this trend cannot continue forever. When the inevitable liquidity contraction occurs, gold price will fall as well. But when can we expect liquidity contraction given the current scenario of recession. There are clear cut signs of recovery in the global and US economy. The U.S. economy shrank slightly less in the first and second quarter than initially estimated. Also corporate profits seem to be rebounding. Overall it seems that the recession is moderating.   Consumer confidence also seem to be showing signs of recovery as can be seen by increase in retail sales compared to last year.  China, the second most critical factor in a global recovery is pumping up its economy and trying to switch to local growth from primarily export growth and succeeding.   Manufacturing in China is climbing.   Overall the global economy is showing convincing signs of growth starting up.   But is this enough to change the climate for gold?   Will this stall the gold price?   Analyst don’t think that this will stall the gold price cause gold price did not rise simply because of dropping consumer confidence, but because of the fears and uncertainties coming out of systemic failures and dropping value of $. An economic recovery and boosted consumer confidence is not expected to repair the global monetary system at least in the short run.   They are not restoring confidence in the $.   There is little evidence that a recovery accompanied by potentially explosive inflation will encourage investors to turn from gold to $ investments.

In conclusion gold is expected to continue on its upward path until there is substantial and convincing evidence that we have a monetary system that can withstand the potential systemic failures on the horizon now. In the short run there may be pull back as dollar recovers. However over the long run gold is expected to continue on its upward path.