The most famous series of bear market rallies happened after the stock market crashed in 1929. Between the years of 1929 and 1932, the market kept surging up, only to tumble back down further than its previous lows.

The graphic above illustrates how the stock market kept trying to retrace its highs over a period of three years. The current stock market, too, is showing ominous signs that it might not be a recovery we’re experienced, but rather, a powerful bear-market rally.

As evidence, a lot of newsletter writers (and, less so, mainstream journalists) are pointing to the large out-flow of cash in small-cap ETFs. The logic goes like this: small-cap stocks are the first to hit in a downturn, and that means they’ll be the first to recover. Conversely, if things start to look bad again, small-cap stocks will be the first to tumble.

That’s what seems to be happening. In October, fully $1 billion flowed out a single small-cap ETF, the iShares Russell 2000 Index Fund (NYSE:IWM). “If this trend continues, it would be a very bad sign for the continued strength of the rally,” writes Andrew Mickey of Q1 Publishing. “It signals investors are getting nervous and want the perceived safety (that’s a topic for another day) of large-cap stocks.”

Indeed, small-cap stocks are a barometer of investor sentiment. If investors get even slightly nervous, they ditch their riskier investments, and hold onto stalwart large-cap stocks. If things get even worse, they’ll ditch the large-cap stocks, and the bear rally will begin in earnest.

The demand for gold as an investment has helped drive up the value of the commodity more than $250 since Jan. 1. And there are a whole lot of people arguing that it’s just the beginning of a powerfully rally that might look a whole lot like 1980 – a time when gold spiked to $850 per ounce.

Some investors have postulated that gold might spike to $5,000 or even $10,000 per ounce. While we’re not that over-the-top, we do think gold has an excellent chance of breaking the $2,000 barrier. Here are seven reasons why:

1) Gold closed at $226.80 on Jan. 1, 1979. It hit $850 per ounce barely a year later on Jan. 21, 1980. That’s a gain of 375 percent in just over a year. In the current market, gold has gained 45 percent since Jan. 1. That’s a lot, but it’s nothing like 1979.

2) Gold is still a long way off from its all-time highs. When we compare today’s dollars with the dollar in 1980, we’d have to see gold at $2,300 to break the all-time record.

3) Gold jumps in price when inflation is at its peak. The threat of inflation is everywhere right now; not just in the U.S. but in other countries as well, including Europe, China and Japan. As government’s flood the world’s economy’s with cheap cash, gold doesn’t have to go up, it just looks like it is since currencies are losing “real” value.

4) Other central banks would need to start becoming net buyers of gold. Central banks have been net buyers of gold this year, even at the metal’s current prices. Some of the biggest surprises have included India’s purchase of 200 tonnes of gold from the IMF in October. Others? How about Sri Lanka, Russia and China.

5) Mining output would need to fall. And, in fact, a lot of gold investors are already talking about gold production nearing or passing its peak. Even disruptions in mining output at a single mine (like the one being experienced by DRDGold, ticker DROOY on the NASDAQ) could cause significant price movements in gold.

6) The more people who invest in gold ETFs, the more the price of the commodity will rise. Since gold ETFs aren’t backed by notes (like ETNs), managers of the funds actually have to buy gold to protect the price of their ETFs. That means when more money flies into ETFs, more gold gets pulled off the open market. This causes a sort of echo-chamber in which the only direction is up for gold prices.

7) Finally, the simplest way for gold to hit $2,000 an ounce would be for a euphoric buying frenzy to take place. As the number of net sellers decreases, the price will rise to meet demand for the precious metal. A lot of people are saying we’re already in a buying frenzy, but, trust me, there will be a whole lot more buyers if another major bank closes, unemployment tops 15 percent or the country’s GDP turns negative again. The holiday season should give a good glimpse of what’s to come in the U.S., and, consequently, around the world.

Gold’s powerful rise bodes ill for the future of the dollar and the economy. In all, the metal’s up 46 percent in 2009, after setting another all-time record high price on Monday, Nov. 23, 2009. Around 10 a.m. EST, gold rose to $1,174. That makes the fourth week in a row that the yellow metal has surged to record prices.

Metal buyers are creeping out everywhere: central banks, individual investors, and massive hedge funds led by vocal investing icons like Paul Tudor Jones and John Paulson.

In a recent letter to investors, Paul Tudor Jones pointed to several reasons for gold’s rise beyond just the threat of inflation:

    •  Record holdings by gold ETFs (which are required to own the underlying asset they represent).
    •  Net buying by central banks for the first time since 2000.
    •  Decreased output at gold mines worldwide.

“Any incremental demand for gold must be met through sales from current owners,” the letter said. “They just aren’t making that much of it anymore.”

In all, Jones directs about $11.6 billion in his hedge fund, and gold is one of his fund’s largest holdings.

“The historical drivers of investment demand for gold seem to have simultaneously come together in 2009,” he concludes.

I’ve talked a lot about exchange traded funds (ETFs), but less about exchange traded notes (ETNs). Let’s start with some definitions:

Exchange traded fund (ETF): Similar to a mutual fund, ETFs trade on stock exchanges. The fund’s hold a basket of underlying securities such as other stocks, gold or currency, and the price of the ETF mirrors the value of those underlying assets minus administration fees.

Exchange traded note (ETN): A senior debt note issued by a major bank that tracks an underlying index such as the Dow Jones Industrial Average. The note’s value tracks the index minus administration fees.

ETFs and ETNs both have unique advantages and disadvantages. ETFs, for example, tend to trade more actively, which means you won’t get as bad of a spread when you’re selling your stock at market. ETNs on the other hand are often thinly traded, which means price movements aren’t as dramatic.

The biggest difference, though, is the fact that ETFs might not necessarily reflect the value of the underlying index or commodity they’re trying to track. Since ETNs are structured products issued as debt, they more accurately reflect the value of the underlying index they’re tracking.

From a trader’s perspective, though, they trade much like any other stock, and they’re a great way to hedge some of your riskier investments. Rather than concentrating on a particular company, you’re concentrating instead on an entire industry or sector.