The gold bugs were ecstatic. On Tuesday, the price of bullion leapt to a record high at US$1,048.43 an ounce. It must have seemed to the bulls as if all their predictions were coming true, and that the price of gold was finally heading for the massive rally they have long been forecasting. Invest in gold, they screeched. Invest now or you will miss out big time. At first glance, it seems as if the enthusiasts have a point. So far this year, gold has risen 21 per cent. On closer examination, however, the run-up looks rather less glittering than it seems at first. For a start, 21 per cent might sound like a robust performance, but it pales in comparison to the returns generated by equities. Over the same period, Hong Kong's Hang Seng Index has climbed 48 per cent, while the H-share index is up 56 per cent. And if you measure from the starting point of bullion's latest rally, its 2008 low in late October last year, the contrast is even more stark. Whereas gold is up 45 per cent, the Hang Seng Index has risen 93 per cent and H shares 147 per cent (see the first chart below). Still, gold's poor relative performance as an investment doesn't discourage the metal's true believers. They can cite a list of reasons to invest as long as your arm. Typically, these range from buying gold in order to piggy-back on a rally driven by rising demand for jewellery from newly wealthy Indian consumers, to investing in bullion as a hedge against runaway inflation, which they believe must be an inevitable consequence of quantitative easing by the world's major central banks. These sound like plausible arguments, but there are some big problems with them. Although it is possible that some of the rally has been driven by seasonal demand for jewellery before this month's Diwali festival, Indian buyers are typically highly sensitive to price, cutting back their purchases as gold gets more expensive. In fact, by far, the biggest driver of the recent run-up has been financial speculation. If you doubt that, take a look at the second chart below, which shows how net speculative long positions in gold futures and options on New York's Comex have risen fivefold from last year's low. If those buyers are going long gold as a play on future inflation, they are likely to be disappointed. Gold is a dubious inflation hedge at best. Research by the National Bank of Canada shows that if you had bought gold in the early stages of its last big rally in the late 1970s, when US inflation was running at double-digit rates, your hedge would only just have broken even in real terms - about 30 years later. Over the same period, an investment in the US stock market would have risen 700 per cent, again in real terms. Moreover, inflation is not inevitable. As Japan proved in the early years of this decade, quantitative easing does not necessarily lead to higher prices. In fact, with many industries suffering heavy overcapacity, and with developed world consumer demand likely to be subdued for years, many economists are far more worried by the prospect of deflation, which is likely to be negative for the price of gold. Finally, it is not clear that there even has been a genuine rally in the gold price. It all depends on your perspective. Although gold has climbed 21 per cent this year in US dollar terms, it has risen only 15 per cent in euros, and has actually fallen 6 per cent in Australian dollars. In reality, the recent rise in the price of gold reflects the fall in the US dollar rather than any fundamental strength in bullion. And the slide in the dollar has been propelled largely by speculators taking advantage of low US interest rates to sell the currency short in order to fund long positions in higher-yielding currencies; the classic leveraged carry trade. If we have learned anything over the past year or so, it is just how rapidly investors can bail out of leveraged trades when things go wrong. So investors eyeing the gold market should be warned, if anything happens to spook the markets, wholesale unwinding could push the US dollar sharply higher and precipitate an abrupt sell-off in gold. At these prices, bullion is a high-risk investment.