GOLD is human desire in the form of a soft yellow metal. We call it precious because it is imbued with almost human like qualities. A signifier of all our dreams and desires.

Over the millennia gold has occupied top spot on pyramid of our desires, being fought over, died for but never tired of.

It may have several practical uses, but above all it has served us best as an enabler of trade and development and today as the most favoured store of wealth.

So as we look back at the wreckage of the worst financial disaster in living memory should we be surprised that its price continues to set new records? Maybe, but then again maybe not. The problem is that while gold has functioned well as a store of wealth, as an investment its record is somewhat patchy. And to complicate matters the global financial paradigm is changing, placing new demands on and creating new demand for the precious metal.

So while the gold market exhibits some signs of a bubble about to burst, there are plenty of reasons for thinking otherwise.

As the price of gold continues to break records, investors have been looking back over the history books in a bid to understand what comes next. Is the current gold run a classic bubble or a more fundamental shift in the market, one which may protect investors against the dramatic collapse in prices which overtook the market back in 1980?

To reinforce the point, gold prices took a wobble this week, reminding investors that they are dealing in a volatile market, one which can be influenced not just by supply and demand, but a plethora of factors from the value of the dollar to the price of oil.

It is not just the big investors who have been bitten by the bug, all social classes are being invited to get in on the action. This has eerie parallels with the great stock market crash of 1929. Back then John F Kennedy's father Joe was said to have realised what was coming when his shoe-shine boy started giving him stock tips. His quick conclusion was "it's time to bail out".

TV adds have appeared asking viewers to raid their attics for old jewellery, promising handsome payments in return. Harrods is selling gold bars to casual shoppers. The precious metal is very much the flavour of the day.

Instability

"Gold always plays an important role as a protector of wealth, and in these current times of financial instability, that role has taken on a newfound prominence," World Gold Council chief Aram Shishmanian says.

This year gold prices have surged by 35pc from $750 an ounce back in January with the market driven primarily by growing fears over inflation and the decline of the US dollar. For investors around the world the greenback's decline has increased the relative appeal of physical assets, particularly gold, to protect against further devaluation.

Gold bulls -- investors who have been buying the metal consistently in recent months and years -- were frothing at the mouth last week as the yellow metal hit an all-time high near $1,226 an ounce last Thursday.

But their euphoria was short-lived and at the start of this week gold tumbled down on news of an unexpected fall in the US unemployment rate. On Monday, the metal traded as low as $1139 -- a decline of $87 or about 7pc before recovering a little later in the day.

Meanwhile, the US dollar has rallied to a five-week high on the same news, news that some believe raise the odds of a reversal of Federal Reserve interest rate policy sooner than previously thought.

For gold buyers, any move in the value of the dollar is crucial, as a rise in the US currency will almost always be accompanied by a drop in gold prices.

Rosland Capital gold analyst Jeffrey Nichols is not perturbed by the latest volatility. "We've been consistently warning that gold's advance would be marked by high volatility and occasional sharp reversals that would lead some to believe the long bull market in gold has ended -- and we will continue to hold this view even if the metal falls back yet another $100 an ounce.

"Gold had risen some 32pc so far this year up to its latest historic high and since piercing the $1,000 level in September it rose another $226 in the space of just two months.

"I suspect that once the market moved down a few dollars, some traders and hedge funds, with handsome gains in gold so far this year, were keen to cash in some of their long positions and lock in profits on their end-of-year accounts.

Moreover, he adds, recent fears about Dubai's debt situation and possible default had helped propel the market skyward in recent weeks -- but by last week it no longer seemed much of a threat to world financial markets.

So despite these symptoms of overheating, there is good reason to believe we are not at the end of the run. Gold prices have been climbing relentlessly since 2001, but with good reason -- demand continues to outstrip supply.

One of the principal drivers of this soaring demand are the major central banks, whose appetite for gold can be traced back to a decision in 1999 by then UK Treasury Secretary Gordon Brown to offload most of Britain's gold reserves.

With no crystal ball to consult, Mr Brown gave the order to liquidate most of these reserves -- at the bottom of the market. Starting in May 1999 the UK auctioned approximately half of its reserves, at an average price of around $280 an ounce.

Reserves

The UK's gold reserves were worth about $6.5bn at the time and the advance notice of the sale naturally put the short sellers on alert. Over subsequent months the price fell by over 10pc, much to the annoyance of central bankers from Frankfurt to Washington. Their response came in the shape of the Washington Agreement on Gold which limited gold sales to 400 tonnes a year. Initially set to run for five years, it has been renewed twice since, including earlier this year.

By limiting such massive sales, the central banks have put an absolute floor under the gold price. Since The Washington Accord was signed the price has soared, reaching $675 in 2007 and almost doubling over the past two years.

And they are likely to play an even greater role in the market over coming years, buying more gold as a hedge against declines in the value of their foreign currency reserves. China is a case in point -- its foreign currency reserves amount to almost $1trn.

Thirty years ago China held 95pc of its foreign reserves in gold. Today, China's gold reserve only accounts for 1.3pc of total reserves. This is well below the average minimum between 3pc and 5pc adopted in many other countries. China with an estimated gold reserve of 600 tonnes has a fraction of that believed held in the US which holds around 8,500 tonnes, so obviously it has a long way to go.

India, the world's biggest gold consumer, purchased in early November some 200 metric tonnes of the metal from the International Monetary Fund, which is selling an eighth of its reserves.

Other governments, from Russia to Sri Lanka, have also been buying. The large creditor nations -- notably China and OPEC members -- who are sitting on massive dollar reserves are understood to be increasing their reserves of gold. Meanwhile, western central banks, including those in Germany and the UK, are selling much less.

Apart from the action of the central bankers, other factors are at play, including a claim by some producers that like the oil market, gold has now passed the point of "peak gold".

It is a difficult analogy to sustain. Unlike oil, almost all of the gold produced in the world's mines is still with us. While the precious metal has several industrial uses, most of them do not involve the destruction of the metal, so whether or not peak gold is a reality, it is largely an irrelevance.

Of far more importance is the demographics of the emerging economies, notably China and India. Their growing wealth is certain to raise demand in coming years, analysts believe.

While financial and political upheaval has always been at work when it comes to fixing the price of gold, population growth and economic development are relative newcomers. Gold has been the traditional store of wealth for rich nations and individuals for centuries, but it is now being adopted by a wider community generating an increased demand for real assets, in particular, for the traditional safe havens of gold and silver.

A recent report from the World Gold Council suggested that the emergence of newly industrialised economies led by the BRIC nations (Brazil, Russia, India and China) will generate new demand for the precious metal.

From a current global population of 6.5 billion, United Nations demographers forecast it will reach seven billion by 2013, eight billion by 2028, nine billion by 2054, and 10 billion by 2200. The bulk of this growth will come from Asia led by China, India and the Middle East and is likely to have an immense impact on global precious metals demand. For instance it is only in recent years that the gold market in China was liberalised, allowing its citizens to buy gold for the first time since 1949 and opening up a pool of more than a billion potential investors.

A third major driver of gold has been the low interest rate climate which has forced investors to look for protection against inflation. The impact of low interest rates in the US, UK and the euro zone have been exaggerated by the huge stimulus packages introduced by governments. These funds, which amount to the printing of new money have stoked inflationary fears among many investors, encouraging them to keep a good portion of their assets in the form of gold.

But whatever floor the shifting fundamentals have put under the gold market, they have failed to remove one consistent feature of the market -- extreme volatility.

While we are undoubtedly in a bull market, prices have seen some dizzying peaks and troughs, with the price moving in huge swings since the economy started to crack in 2007.

The price closed above $1,000 for the first time on March 14, 2008, just before Bear Stearns was sold to J.P. Morgan, then fell to near $700 last November in the wake of the Lehman collapse. It has recovered back above $1,000 since then, but even this year volatility has been a consistent feature of the market.

Some analysts suggest this volatility presents opportunity. "Some investors will use it as a good opportunity to buy on dips," Andrey Kryuchenkov, a VTB Capital analyst in London said in a report this week. He describes the current slide as "very healthy" and one that will enable gold to build "a good base for further growth in 2010."

The last great bubble in gold prices was brought to an end by then Federal Reserve chairman Paul Volcker who in January 1980 announced that the Fed was switching its policy from controlling interest rates to controlling the money supply. By then turmoil in Iran, soaring oil prices and the Soviet intervention in Afghanistan had driven gold to a record peak of $850 an ounce.

But soaring interest rates, a direct result of Volcker's new policy, brought this bull run to an abrupt end.

Adjusted for inflation the $850 peak experienced in 1980 would be equivalent to around $2,200 in today's money. On this basis the current spike in prices could have some way to go.

Irish Independent