SERIOUS MONEY:GOLD HAS captivated humankind throughout history. Indeed, there are more than 400 references to the precious metal in the Bible and the explorer Christopher Columbus wrote in 1503 that "by means of gold, one can even get souls into Paradise", writes CHARLIE FELL

However, the allure of gold has been lost on an entire generation of central bankers and investors who have been schooled to believe that gold is a “barbarous relic” and nothing more than a commodity.

A confluence of events emanating in particular from the United States, including increased anti-inflation resolve on the part of central banks, the greater fiscal responsibility of governments, and reduced geopolitical tensions with the collapse of the Soviet Union, all served to undermine the precious metal. The price dropped from a record high of $850 a troy ounce in early 1980 to little more than $250 in 1999.

However, a gold renaissance is under way as the yellow metal has registered gains in each of the past seven years. The price recently closed above the psychologically important $1,000 level and, with it, the pressure on poorly diversified investors to consider the virtues of gold.

Gold is typically misunderstood. The precious metal is not simply a commodity; it is a monetary asset.

Indeed, it is the only form of money that cannot be debased by the authorities that print paper currency. It is both rare and durable. It has been discovered on every continent, yet all the gold ever mined amounts to less than one week’s aluminium production.

Roughly 80 per cent, or circa 158,000 tonnes, of gold still exists today, most of which could come back to the market under appropriate conditions. The annual flow of newly mined gold – 2,400 tonnes – adds little to the existing stock. Consequently, the price of gold, just like paper currency, is determined by the outstanding stock and not the annual flow.

The role of gold as a monetary asset means that it competes directly with foreign currencies, most notably the dollar, the euro and the yen.

As gold pays no interest, investors must compare gold’s return with that available from investing currencies in short-term monetary instruments.

As the real interest rate falls, the opportunity cost of holding the precious metal declines and consequently its relative appeal rises.

Negative real interest rates in the 1970s were an important factor behind gold’s strong performance during that period when annualised gains materially outpaced the dismal returns from stocks and bonds.

The precious metal’s role as a monetary asset was consistently undermined for more than three decades. Its official role as an anchor for the international monetary system ended on August 15th, 1971, when Richard Nixon announced that the gold window was closed – the dollar was no longer exchangeable into gold.

Persistent central bank sales of their gold reserves every year since the late-1980s further undermined the precious metal. Blow after blow was delivered to the market, including Gordon Brown’s sale of more than half of Britains reserves at just $275 an ounce.

Some semblance of order was brought to the market with the signing of the five-year Washington Agreement on September 26th, 1999, and its subsequent renewal in 2004, which limits the collective sales of 15 European central banks – including the ECB and those of Switzerland, France and Ireland.

Signatories to the agreement, combined with those countries and official institutions that are known to be opposed to gold sales, account for more than 80 per cent of the official sector’s holdings of some 28,000 tonnes.

Although central banks still account for a large percentage of total annual supply of gold, official sector sales have dropped considerably in recent years as central banks outside the western world have increased their holdings.

Indeed, China recently announced that it had increased its gold holdings from 600 to 1,054 tonnes since 2003 and it is not alone. Other major buyers include India and Russia.

However, gold holdings as a proportion of official foreign exchange reserves remain relatively low at less than 2 per cent in China and little more than 4 per cent for both India and China.

Central banks outside the western world are purchasing gold in an effort to diversify their foreign exchange reserves away from the beleaguered US greenback.

Gold is the ultimate hedge against economic and political uncertainty and its relative appeal has increased as the zero interest rate policy adopted by the Federal Reserve has reduced the opportunity cost of holding gold.

Growing concern over large and persistent fiscal deficits has served to undermine the dollar, which recently dropped to a record low on a trade-weighted basis.

Given that the greenback accounts for roughly two-thirds of central banks’ foreign exchange reserves, it is certain that monetary authorities will seek to protect the value of their reserves and the natural hedge to the dollar is gold.

Debate rages among investors as to whether Ben Bernanke’s monetary experiment will lead to inflation or whether the debt-laden US economy will succumb to malign deflation. Gold’s appealing diversification properties jump to the fore under both scenarios.

The precious metal’s role as a store of wealth beyond compare would see it outpace most competing assets during an inflationary period, just as it did in the 1970s, while its role as a risk-free monetary asset would see it perform admirably during a deflationary period, just as it did in the 1870s and 1930s when individuals hoarded gold over paper currency.

Charles de Gaulle once said: “There can be no other criterion, no other standard than gold . . . which has no nationality and which is externally and universally accepted as the unalterable fiduciary value par excellence.”

Investors should take note and buy gold.