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“You can’t print more gold,” says Daniel Sacks, manager of the £37m Investec Global Gold fund. This says it all. When the alchemy of structured finance is exposed as a con, investors buy cash. When inflation picks up, they lose faith in cash and buy gold. Bullion represents an old world of certainty and transparency. It is the one investment everyone understands. Or do they?

Somewhat surprisingly, only 20 per cent of global gold demand is stored away in vaults for jittery investors. Most – 68 per cent – is used for making jewellery, while one 10th goes towards industrial processes. Public confidence in banks is a major driver of gold prices, but it is not the only one.

After nearly 20 years of steady decline, the gold price started rising in 2001, back when inflation was well under check. According to Natalie Dempster, investment research manager at the World Gold Council, this was due to supply-side shortages as well as rising demand.

Gold can be found through three channels: the sale of government reserves, scrap metal and mining. At 60 per cent, mining is the most important of these, and it is here blockages have arisen. “Because gold is so hard to find, production lead times are very long. As prices fell through the 80s and 90s, exploration was scaled back. Spending has picked up since 2003 in reaction to the rising price, but no major reserves have been found,” she says.

Tight supply has coincided with a booming luxury market, particularly in the developing world. India has long been the single largest consumer of the asset globally, as 24-carrot gold is traditional in dowries. With a burgeoning middle class, India’s share of the bullion pie rose to 27 per cent last year. Meanwhile, China is, predictably enough, the fastest-growing consumer.

Industry dynamics may be largely responsible for the steady escalation in gold prices from mid 2001 to 2007. But there is no denying that deteriorating economic conditions have fuelled the surge since last August. Gold prices hit their recent peak of $1011 an ounce on 17 March – the day the US Federal Reserve announced the Bear Stearns rescue.

“Jewellery doesn’t so much drive the price as provide a base,” says Ms Dempster. “Investor behaviour accounts for the marginal demand, so it has the greatest impact on prices.”

Gold is different from most assets because it is a store of value, rather than a return on value. The fact it does not offer a yield makes it unattractive in a stable economic climate. As the US economic system has gained credibility over the past 200 years, gold’s value relative to the Dow Jones Industrial Average has steadily declined. This, along with over-supply, was the major reason why gold prices fell throughout the '80s and '90s. The dollar became the new gold standard.

There have been times when the world has lost faith in the dollar, however, and the price of gold soared – 1980 was one. Now is another. “The current spike is driven by the parlous state of the US trade and current account deficit,” says Ian Henderson, co-manager of the £1.7bn JPM Natural Resources fund. “The beneficiaries of the high oil price are unwilling to keep their petrodollars in dollars because of the perceived currency risk. They’re going into gold instead, which is seen as a non-fiat currency.”

Gold, like all commodities, is also seen as hedge against inflation. When real interest rates fall below zero, the absence of yield becomes immaterial. For some doomsayers, gold – unlike oil – also has the advantage that it can be locked up at home. If investors believe the entire banking system is on the brink of collapse, this is a unique advantage.

But the most compelling long-term reason to invest in gold is diversification. The academic evidence suggests gold has a low correlation with almost all other asset classes, as its fundamental drivers in the luxury goods market and mining sector are very particular. As global equity and bond markets converge, the case for gold becomes more and more compelling.

Mr Henderson believes gold prices are unlikely to fall back below $850. “Mining costs have been rising at over 30 per cent. The floor is likely to be much higher than in the past. Gold is cheap if you consider the effort of finding the stuff,” he says. On the upside, he points out that if you take inflation into account, gold prices are still at only half their 1980 peak price."

Retail investors interested in buying gold can chose between coins and bars, ideal for a financial apocalypse, ETFs, for those who don’t have a reinforced concrete safe in their cellar, and funds which invest in gold mining stocks, which tend to offer geared exposure to fluctuations in the gold price.