9/13/11

For years, skeptics have warned of an imminent drop in the price of gold as the bubble bursts. The recent downswing in the price of gold has led many of these so-called pundits to declare it just the beginning of a steep fall.

This fear demonstrates a misunderstanding in the way bubbles work. A bubble generally ends after days of sharp price increases, not sustained growth like we have seen in recent years. That gold continues to climb, in spite of some wariness, is an indicator that it is still in a bull market.

Looking beyond gold's performance as an independent asset, there are several indicators that gold is still in a bull market and could potentially rise to unseen heights. As global currencies continue to depreciate in value and purchasing power, gold becomes an even more attractive asset to invest in. Fiat currencies lose their purchasing power when the market is flooded with additional currency; gold, because of its finite supply and the difficulty of extracting it, cannot be artificially multiplied. Most instances of hyperinflation have stemmed from governments flooding the market with excess currency in an attempt to counteract slow economic growth.

In addition to currency devaluation and inflation, there are several other factors that positively impact the price of gold. Two of the more significant factors are central bank buying and the movement away from the U.S. dollar. In the last two years, central banks have transitioned from selling gold to purchasing it; a clear sign that even governments are wary of fiat currencies.

In addition to central bank buying, many private investors are moving away from the U.S. dollar as fears rise that the U.S. government will need to further devalue its currency in order to pay off existing debts. Investors across the world are snapping up gold in an effort to convert their currency holdings into something more concrete.