According to a report recently issued by Windsor-based Dan Hallett & Associates, gold investors need to be aware that, potentially, much of the demand for gold is being driven by the financial markets rather than substantial shifts in supply and demand. Gold has a unique position with an almost 1:1 inverse correlation with the U.S. dollar, so institutions and retail investors alike have loaded into the asset class for a number of diversification reasons. According to Dan Hallett,CEO of the firm and the author of the report, this does not necessarily make gold a great investment from a valuation perspective.

"If you're buying gold today, (at around $1,000 an ounce) you have to have some view at least in broad terms about how far the commodity is going to go above that," he says. "One of the risks that you run, particularly with a popular hot asset class, is valuation risk at the time you buy. You're reasons for investing in gold could be well thought out but if you're buying at a very high price, you're going to suffer some downside."

Hallet says data from the World Gold Council, an industry that tracks gold usage, shows more than a doubling in demand from investment instruments like exchange traded funds (ETFs gold during the second quarter of 2009. Meanwhile there have been actual decreases in some physical demand channels, like jewelry demand. Subsequently, Hallet points out Canadian investors in un-hedged bullion products have seen nearly a 50% diminishment of returns, due the drop in the U.S. dollar versus the Canadian dollar.

"True, buying gold at the height of fear last year would have worked well, but a falling U.S. dollar would have clipped gains. Buying stocks (as we advised) has worked out much better. So, we present this analysis to warn of the irrational trends we are noticing that could disappoint today’s gold buyers," Hallet says. Hallet also points out that investors may not be willing to stomach the volatility that gold investing has historically exhibited. Back in March he conducted a study that looked at gold prices over the last four decades.

"I looked at gold in the context of why people recommend it. One is as an inflation hedge, another is to diversify portfolios and a third reason is to have it as kind of disaster protection portfolio insurance," he says. "I found that it delivered on all three of those goals, but it did so in a very volatile fashion. You're looking at 19% to 20% a year in annualized volatility. That is well above what you'll get with most stock markets."

Jon Nadler is Senior Analyst, Kitco Metals Inc.