Has the gold price peaked

We have gold because we cannot trust governments", said President Herbert Hoover's statement to Franklin D Roosevelt in 1933. 75 years later gold is still viewed in the same way.

Gold was in great demand as soon as the threat of recession and decline in the purchasing power of dollar was visible to investors in 2007.

People are buying gold as they cannot trust governments to protect the purchasing power of money.

Gold as a hedge

For 5,000 years, gold has captivated mankind like no other metal. The demand and supply dynamics of the market underlines the precious metal's appeal as an ornament and its function as an investment.

But the sharp rise in gold prices in the last two years has not been due to demand supply dynamics alone. The fear of decline in value of paper currencies, especially the dollar, saw the parabolic rise in the price of gold. Investors who made investments in gold in mid-2007 are now making 70 percent returns in just 20 months.

In 2010, gold rallied 30 percent due to escalating US and European debt. Gold investors are now wondering whether gold can give a repeat performance third year in a row.

Low correlation to equity

Gold gives better returns only in times of uncertainty, strife and stressful times like war. If you look back, gold gave 300 percent returns from 1970-75 when the world suffered recession and America went through depression.

In 1971, US President Nixon 'closed the gold window' - America stopped exchanging dollars for gold. After 1975, till 2007, gold stayed stable and gave very minimal returns to its investors. The sub-prime crisis followed and turned Wall Street upside down, and brought gold back to the limelight.

Future based on resolution of crisis

Going forward, the performance of gold depends on resolution of the debt crisis in Europe and US. Gold's superlative performance will continue if there are sovereign defaults in Europe and US continues with its printing policy. The Euro zone debt crisis is moving at a fast a pace.

Now, financial markets are creating pressure via rising bond yield spreads on Portugal, Spain, Belgium and Italy all at once.

It will require all the dexterity available at the disposal of the institutions in Europe to avert the debt defaults. The 16 Euro zone countries have 750 billion euros at their disposal to combat the crisis. With at least 650 billion euros still available, the Euro zone countries should be able to handle a bail-out of Portugal and possibly even Spain.

Investors should be careful and study the underlying macros

In the US, the positive news of falling unemployment rates is giving a sense of confidence that the economy will continue to grow. A steady dollar will entice investors to return to risky assets. This could imply that gold prices have already seen the peak.

Investors should be careful and study the underlying macros before venturing to invest in gold at the current prices. Any asset class will revert to its mean performance after a period of outperformance. That applies even to gold.