How did the word "gay" become associated with homosexuals?

I think it may have had something to do with the supposedly positive upbeat, and maybe flighty, attitude of so many homosexual men. Since the word meant happy as you said, it sounded like a better label than 'homosexual.' I think.

It started almost a hundred years ago. If a homosexual wanted to know where to go to meet other homosexuals, he would ask if there were any gay nightclubs. People who knew what this meant would direct them to the right place. Then when people figured it out, gay became a pejorative. In the 70s the homosexual community decided to embrace the word as a euphemism.

This isn't definite, but probably an insult to describe the flamboyancy of gay men. Usually, in colloquial language gay is referred as stupid man or something~ A.k.a Flamboyancy.