(Kitco News) -Gold is entering the time of year when it historically draws support from physical demand tied to a series of major gift-giving holidays around the world, although analysts caution that this impact may not be as great as in the past since physical buying such as jewelry is now a smaller percentage of the market due to rising investment demand.

Analysts say the level of investment, based on macroeconomic factors, will be the most important influence for gold in the coming months. But nevertheless, they also look for physical demand to offer some support, although much of this may tend to come in the form of buying on price dips that helps limit any corrections.

Autumn is the time of the so-called “wedding season” and the Diwali festival in India, historically the world’s largest gold consumer. This is followed by Christmas in Western nations, then the Lunar New Year celebrations in China, which has become the world’s second-largest gold consumer. Gold is part of the cultural tradition in India, in particular, with jewelry having high karat content and often viewed as an investment that is readily convertible to cash.

“Our base scenario is for physical demand to remain robust,” said Robin Bhar, senior metals analyst with Credit Agricole CIB. “One feature of the run-up over the last 12 to 18 months is that physical demand doesn’t seem to be severely dented by the high prices.”

Still, several analysts said, even though the physical demand has held up so far, it may be hard for it to keep growing at a time of historically high prices. The World Gold Council’s second-quarter trends report said second-quarter jewelry demand of 442.5 metric tons was 5% higher than in the same period a year ago. This demand from India, China and Turkey generated combined growth of 16%.

In fact, some analysts suggested the jewelry sector may carefully pick the times to buy, so that demand may most pronounced on pullbacks.

“Any dip in prices may be limited by restocking on the part of jewelry manufacturers,” said Anne-Laure Tremblay, precious-metals strategist with BNP Paribas.

Bhar expressed doubt that jewelers would heavily “chase” prices on a surge.

“That won’t be the trigger. I think it will still be speculative and investment buying,” he said. “But they (physical buyers) will certainly support the dips.”

In fact, he said, this appeared to occur last week when gold fell from above $1,900 an ounce toward $1,700, before bouncing again. “There were reports of good physical offtake,” Bhar said. “Premiums for small bars in Singapore and Hong Kong have risen and are a good indicator that demand is out there.”

The physical demand could oscillate and be dependent upon price levels in the months ahead, suggested Carlos Sanchez, director of risk management for CPM Group.

“While demand will probably be in an uptrend, it is likely to going to be mixed and choppy,” he said.

“As you see prices head to record highs, (physical) demand has wavered. As prices have fallen to support levels, demand has picked up.”

However, he added, there also have been some times when the demand has risen along with prices. This tends to occur on breakouts when buying emerges on ideas that gold will be even more expensive down the road, Sanchez explained.

India had good monsoon rains that should be constructive for physical gold demand, said HSBC analyst Jim Steel and Bhar.

“It provides farming income, which supports rural demand for gold in India, which is the largest consumer or hoarder of gold,” Steel said.

With rural Indian incomes likely to be “strong,” Bhar looks for Indians to keep giving gold as a traditional wedding gift despite the rising price for the metal. “In fact, because the price is so strong, it may be seen as a good omen for prices going even higher.”

However, physical demand for jewelry might not be as strong in Western nations such as the U.S., Europe and Japan, where the economies are soft, Sanchez said. Gold jewelry tends to be purchased in developed nations as a quality fashion item, but there is less of a cultural tradition than in say India, Sanchez said.

“In the developing world, it is also fashion, but also a savings-oriented investment as well,” he said. In fact, worries about inflation are one of the factors driving gold-jewelry demand in India and China, he explained.

Analysts: Investment, Rather Than Physical Jewelry Demand, To Be Key Influence

Still, some observers that caution that ultimately investment demand—rather than jewelry for gifts around holidays—will be the most significant factor for gold.

“The seasonality has gone more and more out of the market over the years as more players have entered the market who are not influenced or governed by the seasonality,” Steel said. “But it’s still a factor.”

Tremblay also commented that the seasonal impact of gold-jewelry demand on the price has “faded somewhat” over recent years.

“This seasonality was notably due to Indian consumption, tied to festivals and the wedding season,” she said. “However, the wedding season seems to be more spread through the year. Perhaps more importantly, physical investment gold demand has risen quite rapidly over the past years, blurring seasonal patterns linked to jewelry demand.

“Economic and financial developments should be the main drivers of the gold price for the rest of 2011.”
In particular, the biggest focus will be the debt burdens of the U.S. and European nations, fears of currency de-basement, inflation and deflation worries, as well as interest rates, Bhar said.

“When real interest rates are negative like in the (United) States for the foreseeable future, that’s going to be a huge boost to gold,” Bhar said. “The opportunity cost, among other factors, is negligible…Nothing has really changed in terms of the appetite (among investors) for diversifying into and holding gold as a form of insurance.

“But the seasonal demand helps to support the market when it does sell off, because you’ve got the backstop of physical buying…If it comes off $150 or $200, they’re going to think it’s manna from heaven.”

By Allen Sykora of Kitco News; asykora@kitco.com

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