Gold heads north on demand from the east

Gold may have risen in price by 21 per cent in 12 months, to more than $1,100 per troy ounce – but interest in the metal is not fading in Beijing. A report from the World Gold Council this week suggests that demand from China – for gold jewellery as well as bullion – will double within a decade.

Chinese consumption has grown in line with the country’s gross domestic product (GDP) and population, according to the report – and if gold is bought at the same per capita rate as it currently is in India, Hong Kong and Saudi Arabia, demand could increase by up to 4,000 tonnes in the jewellery sector alone.

At the end of last year, China’s gold market was valued at about $14bn – which is equivalent to 11 per cent of global gold demand. Jewellery still accounts for almost 80 per cent of all gold buying there, according to the World Gold Council.

Eily Ong, author of the report, says: “Our analysis shows that if gold demand were to continue to increase so markedly, domestic supply would be unable to keep pace. Whatever the outcome, China will almost certainly have implications for the global gold market.”

But while some investors see this as further reason to hold gold as a hedge against economic risks, Simon James, partner with Gore Brown Investment Management, argues that its price is due for a correction.

He says: “By the end of 2009, everyone had a reason for owning gold . . . but when everyone has a reason to buy, the market becomes overbought. We believe the dollar will strengthen in the short-to-medium-term, and act as a catalyst for gold to retreat from its highs.”

Over the longer term, bulls claim the case for gold remains strong – particularly if inflation returns.

“The price of gold may have risen a long way recently but, in real terms, it is still well below the real price high of $2,300 per ounce achieved in 1980,” argues Ted Scott, director of UK strategy with F&C. “Technically, the gold price has had a very strong tailwind behind it, even though it has become a crowded trade with overwhelming positive sentiment.”

Supply constraints are also cited as a support to the price. Last year, production from gold mines rose 6 per cent to 2,553 tonnes, and scrap gold was up almost 27 per cent to 1,541 tonnes, according to metals consultants GFMS. But Adrian Ash, head of research with the market maker BullionVault.com, says miners still face difficulty replenishing reserves. “You haven’t seen any ‘elephant’ finds – of more than 1m ounces – in a long time,” he notes.

Renewed buying by central banks is another factor. Last year, central banks bought gold at the fastest pace since 1965, according to the World Gold Council, with total ownership by governments reaching 30,190 tonnes at the end of January 2010.

Private investors have also been building up positions through exchange-traded funds (ETFs) backed by physical gold holdings, as well as metals funds, bullion-backed certificates, mining shares, and physical coins and bars.

Online exchanges have opened up the market for smaller amounts of gold to be traded as well, with groups such as Bullion Vault (www.bullionvault.com) and ATS Bullion (www.atsbullion.com) acting as marketmakers.

However, Meera Patel of advice firm Hargreaves Lansdown argues that funds investing in undervalued mining stocks – such as BlackRock Gold & General and Smith & Williamson’s Global Gold & Resources fund – look a better bet for longer-term investors.