Physical gold buyers have adjusted to strong prices above $600 an ounce after a price rally last year hit demand, forcing everyone from jewellery makers to industrial users to bite the bullet.
"A few years ago if you had said, 'If gold goes to $600, what's going to happen to demand?' you would say, 'Well, there wouldn't be any physical demand'," said Jeremy East, head of metals trading at Standard Chartered Bank. "And here we are at $650 and there is big demand," he added.
Gold fabrication demand, including the metal used for coins, jewellery and industrial applications, fell 11 percent from 2005 to 2,919 tonnes in 2006, when prices hit a 26-year high of $730 an ounce before shedding about $200 or 25 percent in a month. But demand rose four percent in the first quarter of 2007 from a year earlier, according to the World Gold Council.
At its peak last year, gold was twice as expensive as it was three years earlier. Gold traded around $650 on Thursday. Demand for gold for fabrication purposes declined from a peak of 3,855 tonnes in 1997 to 2,919 tonnes in 2006, despite rapidly growing economies in some parts of the world.
But electronics demand for gold grew by nine percent to more than 300 tonnes in 2006 from the previous year and is forecast to rise further this year. While demand has rebounded, analysts generally agree that price volatility, while of benefit to some speculators, is hard on physical gold users.
"Volatility is still a bad thing for the market," said Michael Widmer, director of research at Calyon Corporate and Investment Bank. "As volatility rises, people try to delay purchases and wait until the view on price direction is clearer," he added.
Analysts also have mixed views on the impact of rising incomes in developing countries such as China and India on gold demand, but agree that investment tools like exchange-traded funds and gold's industrial applications will be important going forward. "Actually there is no evidence to this thesis that as we get richer, we spend more money on gold," Stephen Briggs, economist at SG Corporate and Investment Banking, said.
"You can make a case saying that gold is attractive in undeveloped countries and as they develop, it becomes less relevant. And that's the experience of Europe over the last 200 years," he said.
China grew 10.7 percent last year and is likely to expand at more than 10 percent this year. India's economy rose 9.4 percent in the year to March, its fastest rate in 18 years and second only to China among major global economies. "Chinese demand for aluminium is growing at 20 percent a year, Chinese demand for gold is not," Briggs said.
But some analysts say that growing incomes should translate into higher metal demand. "In five-to-10 years time, I would imagine that global income will not only be higher, but will also be significantly higher in much of the emerging world," James Steel, precious metals analyst at HSBC Bank, said. "And that you would literally see many millions of households enter a level where they could purchase gold. So I would imagine physical demand could be substantially higher."