Singapore, 9 September 2011: Reuters

One of the oft-cited reasons for gold's strong rally this year has been investor concern over the European sovereign debt crisis and fears of renewed global recession, but this argument doesn't stack up. Demand by what could be termed professional investors has been largely unchanged, as shown by holdings in exchange traded funds and futures contracts.

The real demand growth for gold has largely come from consumers in China and India and from central banks. It's impossible to know exactly why consumers in Asia have been buying gold, but I suspect that it has very little to do with concerns that Greece may default on its national debt, sparking another banking crisis.

More likely, Chinese and Indian buyers of gold are concerned about the prevailing high inflation in their countries and are seeking a hedge. It is also likely that rising wealth in those two countries creates additional demand as owning gold can be seen as a status symbol.

If the above is true, surely it means that if gold is going to extend its nearly 30 percent gain this year inflation in China and India must remain elevated, as should consumer confidence in two of the world's fastest-growing major economies.

And a corollary question also arises, if professional investors in the Western world are worried about recession and European debt, why is more money not flowing into the vehicles that provide easy access to gold exposure?

The world's largest gold ETF, the SPDR Gold Trust , has actually seen the net tonnes its holds decline this year, showing that overall there isn't much demand from portfolio managers and retail investors in developed countries. The fund started the year with 1,280 tonnes, it climbed as high as 1,309 tonnes on Aug. 8 but slipped to 1,232 tonnes by Sept. 7. Overall, it has been largely steady in the 1,200 to 1,300 tonne range over the year.

Investor interest in the SPDR fund was actually much stronger last year, when the net tonnes held rose from 1,133 at the end of 2009 and spent several months above the 1,300-tonne level. Likewise, the open interest on COMEX 100-ounce gold futures  has been largely stable over the year, in a range anchored around 330,000 contracts.

This too is down from the peak of around 385,000 contracts in August and open interest was stronger last year with around 450,000 contracts being the peak in October. While the 27 percent hike in August in the margins required for gold futures may have reduced investor appeal, there is little evidence of a flight to the safety of gold in either COMEX futures or the ETFs.

So where is the gold demand coming from? Well, it has been slipping slightly in the first half of this year compared with 2010, but it is still strong by historical trends, according to data from the World Gold Council. And much of the growth in demand comes from two categories, jewellery and bar and coin demand.

In the year to June, bar and coin demand rose 37 percent to reach 307.7 tonnes, while jewellery use gained 6 percent to 442.5 tonnes. Together, these categories represent about 82 percent of total gold consumption, so any change in their demand profile will certainly impact the overall gold outlook and price.

India and China are also the key drivers of these two categories, with India's demand jumping 38 percent in the second quarter of 2011 from the same period a year earlier and China's by 25 percent. Breaking it down further it shows that India's demand for bars and coins leapt 78 percent and China's by 44 percent, which seems to be prima facie evidence that consumers in these countries are stocking up on the yellow metal as an inflation hedge.

India's inflation has stubbornly remained above 9 percent this year despite the central bank raising interest rates 11 times since March 2010. However, the Reserve Bank of India expects inflation to start moderating by November, and here's the key part for gold demand, by a moderation in domestic demand.

Similarly, China's government has been tightening monetary policy in a bid to cool inflation, which reached a threeyear high of 6.5 percent in July. Again, expectations are that consumer prices will start to come down, with August expected to come in at 6.2 percent, according to a Reuters poll.

If inflation in India and China does start to slow, will that remove a pillar of gold demand? Probably not, but it may serve to trim buying of the precious metal in those countries in 2012. Similarly, if investors aren't flocking to gold futures and ETFs now, when the storm clouds of doom are gathering over Europe, it's hard to see why this part of gold demand will rise much next year.

For now, as long as Chinese and Indian consumers fret about inflation, and the global economy remains under threat, there are no real reasons to expect gold prices to decline. But maybe gold bugs should keep an eye on inflation data in Asia's emerging titans.

Ends --

By Clyde Russell, Reuters market analyst – for Commodities Now.

The views expressed here are his own.