I've seen this from both angles--I was required to take gym (with a grade) up to my junior year. I have absolutely NO athletic ability and I'm awful at team sports, but I dressed every day, gave it my best, and aced the tests. I hated every minute of it.
DD, on the other hand, is a natural athlete and LOVES gym. Oddly enough, after elementary school, gym is an elective. So, to take gym she has to give up another elective (they only get 2). Since she takes choir and a foreign language, she's had to forget gym class. She still plays on school sport teams (basketball and volleyball).
The thing I find odd is this: with so many overweight children--why is gym no longer required in so many schools? I realize that it's a budget thing, but I worry about these kids that get NO exercise. I was not athletic but I still ran around and played as a kid. Most of these kids don't even walk to school. The school parking lot is a big traffic jam before and after school even when the weather is nice.
My rant--sorry about that. To answer your question--gym SHOULD be pass/fail!