According to a December 7 Bloomberg report, the SPDR Gold Trust (NYSE: GLD) now holds more bullion than Switzerland’s central bank.

This massive accumulation by the biggest bullion-backed exchange-traded fund has been driven by a sinking US dollar and concern that the USD12 trillion of government stimulus unleashed to combat the global recession will result in out-of-control inflation.

In November the US Mint suspended production of some American Eagle coins made from precious metals because of depleted inventories. The UK’s Royal Mint more than quadrupled production of gold coins in the third quarter. And Harrods, the London department store, began selling gold bars and coins for the first time in October.

Those sales contributed to a 31 percent rally in gold this year, beating the 24 percent gain in the S&P 500 and a 2.4 percent drop in Treasuries.

Meanwhile, Barrick Gold Corp (TSX: ABX, NYSE: ABX) completed a previously announced plan to eliminate its entire book of gold hedges well ahead of schedule. Barrick now has now has full leverage to the gold price on the industry’s largest production and reserves.

Said Barrick CEO Aaron Regent, “Our positive view on the gold price led us to accelerate the elimination of these contracts ahead of the schedule we had established. With their elimination we no longer have any gold price related mark-to-market exposure and will now fully benefit from increases in the gold price.”

According to the World Gold Council, total identifiable gold demand for the third quarter 2009 reached 800.3 tons, or USD24.7 billion in dollar terms–a 15 percent increase from the second quarter, as gold’s long-term store of value and wealth preservation qualities continued to attract investors and consumers. Jewelry and investment demand in non-western markets rebounded from very low levels seen in the first quarter, while industrial demand started to recover in response to an improvement in economic conditions.

Initial buying was spurred by worries that the global economy would collapse–the apocalyptic scenario that makes hard currency worth holding seemed to be unfolding a less than a year ago. The venerable investment case for gold is essentially this: If the world falls into an abyss, gold is a store of value.

Whether you believe in “apocalypse, now” or not, the view that 1970s-style inflation is right around the corner has taken hold in the market, pushing the yellow metal to new all-time, nominal highs. Since the S&P 500 peaked in October 2007, the index is down 25 percent. Holders of Treasuries are up 16 percent during the same time frame. Gold buyers are up 64 percent.

Looking back a decade–to a time before out-of-control spending trashed the US federal budget and sent the fiscal deficit spiraling again, those who bought gold when it reached a two-decade low of USD251.95 in August 1999 have enjoyed a 387 percent return, more than four times the 82 percent gain in Treasuries. An investment in the S&P 500 lost 0.4 percent through the end of last month.

One of the main arguments against gold pays no interest. This ignores the “sleep easy” qualities: Gold, in the words of Oakley R. Bramble, the first editor of the Inflation Survival Letter, the progenitor of CE sister letter Personal Finance, “is the time-honored, preferred, infallible hedge against all of the perils of runaway inflation, depression and deflation…and because the value of gold coins rise with the increase of commodity gold…investors will pay scant attention to the fact that they draw no interest. (Interest is paid on bank deposits, mortgages, etc., in paper ‘money,’ widely discredited and being devalued at the rate of 10% – 15% every year.)”

Inflation is still tame–US consumer prices will rise 2 percent next year, the smallest expansion since 2002, according to the median estimate of 63 economists surveyed by Bloomberg.

Actually, these same economists forecast prices will shrink 0.4 percent this year, i.e., we’re seeing deflation. But, as Mr. Bramble suggested in 1974, there’s an argument that gold is a useful hedge against this calamity as well.

During periods of deflation, when spending shrinks and savings (in anticipation of lower consumer prices) rise, households hoard cash and cash-equivalents such as short-term US Treasuries, bank deposits, and money-market instruments. Gold (and silver) are considered cash equivalents, and some will choose to hold more of their savings in these metals, particularly during times of stress and economic uncertainty when gold just feels safer.

Moreover, deflations are also characterized by very low interest rates, both in nominal and real (inflation-adjusted) terms. Demand for credit is low–no one wants to borrow and, if they do want to borrow, the banks are loathe to lend–savings are high, and the US Federal Reserve and other central banks will push rates down to encourage economic recovery. The opportunity cost of holding gold and silver–the interest foregone by holding these metals rather than an interest-bearing asset–is extremely low, further encouraging some investors to favor the metals over alternatives.

The essential truth is that gold is money. It is unlike other commodities used mostly in production, consumption etc. One of money’s main functions is to store wealth. We therefore earn money, we hoard it, we guard it and then we exchange it for assets when needed. Gold is the premier store of wealth that this world has known for the last 3,000-plus years. Even the fact that gold isn’t the official currency in the countries of the world hasn’t changed this fact. It is especially during an economic crisis that one needs an effective preserver of wealth or buying power.

It can be argued that inflation of asset prices is no different than deflation of asset prices because when inflation runs its full course–that is, the end of hyper inflation–the only things left standing are tangible assets. Gold shines even brighter.

If the Federal Reserve and other central banks manage to avoid deflation of asset prices, we’ll have high asset-price inflation, which will push gold prices extremely high.