With gold now trading above $1,100/oz, many investors are starting to wonder if the fundamentals really support the yellow metal's seemingly unstoppable upward rise. But it's not just a weak dollar and inflation fears driving gold upward, says precious metals expert Adrian Ash; it also depends on "hot money" from leveraged players—who might very soon decide to move on.

Adrian Ash is the editor of Gold News and the head of research at BullionVault, the world's fastest-growing online gold service for private investors. Formerly head of editorial at Fleet Street Publications, Mr. Ash now regularly contributes to 321gold, GoldSeek and Whiskey and Gunpowder, and his views on precious metals have been sought by the Financial Times, the Economist, Bloomberg and others.

HAI Associate Editor Lara Crigger recently caught up with Mr. Ash to discuss the primary drivers behind today's gold markets, including the real reasons behind gold's rise, why gold is actually a terrible inflation hedge and whether we're nearing a gold bubble.

Lara Crigger, associate editor, HardAssetsInvestor.com (Crigger): Gold has been on a real tear lately, and analysts often point to the falling dollar and inflation fears as the reasons behind its rise. But is that really all that's going on here?

Adrian Ash, head of research, BullionVault (Ash): I think there are several elements behind gold going so much higher. Firstly, the attitude toward the dollar is a really big part of that, because gold is priced in dollars. It's really quite mechanical to say dollar down, gold up.

But you'd have to look further, though. Gold has done nominally well against all major currencies. It's up three times over against the euro; it's done very strongly against the Japanese yen. Against a global basket of the major currencies of the world, it's made all-time highs. Currency appreciation is a main concern, driving a lot of money toward gold over the last decade.

But then there also was the government response to this crisis. People think of gold as being an inflation hedge, but you can't deny the studies that show that gold was actually a terrible inflation hedge for the best part of the 20^th century. It was a great inflation hedge during the 1970s, and during a genuine currency collapse, like Mexico in the ‘80s and ‘90s, or Southeast Asia in the late ‘90s or Weimar Germany. Then, certainly it was a fantastic store of wealth. When inflation reaches hyperinflation proportions, a lump of rare precious metal is a useful way of defending against that. But in everyday inflation, it was a terrible inflation hedge.

But gold has been a good defense against deflation. If you look at the last couple of years, we had deflation in asset prices. Again, gold has done very well in defending its value over those times, because people move to gold when businesses and banks are failing. They want that physical security that gold offers.

Crigger: So gold will do well regardless of whether we have runaway inflation or catastrophic deflation on the horizon.

Ash: It comes down to this: Gold tends to do well in times of financial stress. And inflation or deflation—they're two manifestations of the same thing, which is the destruction of wealth. High inflation destroys bond investors, cash savings. But then deflation does the same thing, but kills debtors indiscriminately, meaning cash holders and bond holders are destroyed. The net effect is the same: A loss of wealth. Gold's appeal steps forward there, as it's rare, physical, tangible property.

Crigger: Even though spot prices have shot up lately, investments in the gold ETFs have remained relatively flat lately. Why is that?

Ash: In the past three months, really since the end of summer, the move has been driven by leverage. If you look at the exchange-traded funds or businesses such as ours—yes, we're still doing very well, but we're not seeing the same kind of flood of new business that we saw months ago. That's not the game at the moment.

It's very much about institutional traders using the very cheap money they can now access: hedge funds, prop desks at the banks and so on. These guys are basically leveraged up on everything. That's why we see correlations getting very strong again between emerging markets, non-U.S. currencies, precious metals, and equities across the board. It's very much the reflation rally of 2003-2007 replayed. The broader markets have wanted to get back to that trend. So many financial players have been looking to get back to a world they understand—dollar down, everything else up—that's why I think you've seen such huge gains across the board between September and October.

It's not a different gold market in nature. Obviously, you've got to accept that a lot of hot money has come into gold, and it's coming in through the futures market, so the chances of a sharp correction are much greater than if you had a bulwark of cash buying the physical bullion.

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