Singapore, 21 November 2011: Reuters

There were two surprising elements in the World Gold Council's third quarter report: the leap in Europe's gold demand and the slump in India's. The trick is working out whether these are the start of some significant new trend or once-off phenomena that can be explained away by temporary factors.

Europe's demand for gold bars, coin and investments surged 135 percent to 118.1 tonnes in the third quarter from the year-earlier period. This was the major contributor in the 6 percent overall gain in gold demand to 1,053.9 tonnes in the quarter, the highest level since the three months ended June last year.

Europe's demand also outweighed a decline in top buyer India's jewellery consumption, which dropped 26 percent to 203.3 tonnes in the third quarter. It's perhaps no surprise that gold reached its all-time high of $1,920.30 an ounce during the third quarter on the back of European demand.

If you break down the European picture, German buying was the main factor, accounting for half of the region's total bar, coin and investment demand, with the council attributing the gain to large-scale investors increasing their existing holdings.

In retrospect, this makes sense as investors in Germany, probably the most economically healthy part of Europe, look with increasing concern at the carnage being wrought by the sovereign debt crisis in the continent's southern mendicant states.

What also speaks volumes about Europe's situation is the fact that jewellery demand in the region was too small to be recorded, according to the council. Since stores would still be selling gold jewellery, what this means is that the sale of used gold was enough to meet demand for new jewellery.

To my mind, this shows high levels of economic stress as people sell family heirlooms to prop up finances, while at the same time the professional investors stock up. So, will Europeans continue to buy gold for investment, or is the decline from the recent record high a sign that the yellow metal is also vulnerable to the gloomy headlines?

It depends on what you expect to happen in Europe. If Greece, Italy and Spain can stay in the euro currency and convince markets they have a viable plan to resolve the debt crisis, then safe haven flows into gold should be reduced.

However, a doomsday scenario of a messy breakup of the common currency and the associated financial carnage should boost gold. As long as the situation remains unresolved, investors will be tempted to increase gold exposure. But whatever happens in Europe, the longer term picture for gold demand is still an Asian story, notwithstanding the decline in India's jewellery use.

Gold for jewellery in India dropped 26 percent to 125.3 tonnes in the third quarter from the year-earlier period, according to council data. This was below China's jewellery demand of 131 tonnes, the first time this has happened since early 2009.

Two factors may account for India's poor showing, namely the drop of the rupee against the dollar and a traditionally inauspicious time for buying gold. The rupee has slumped 14.4 percent against the dollar since the start of the third quarter, and this coupled with a higher gold price, drove a 36 percent increase in the rupee price of gold between July 1 and the recent peak of just over 90,000 rupees an ounce reached last Tuesday.

This scale of price increases will no doubt curb India's appetite for the metal, and even the arrival of some auspicious days for buying in October may not have been enough to boost demand back to the levels of prior quarters, although it should have been enough to ensure that some gains are recorded.

For both India and China, as long as inflation remains high, there should be demand for gold as a hedge, especially if other investments such as shares, which already look ropey, and property become less attractive.

But, as the sharp drop in India's jewellery use shows, even demand in Asia's gold powerhouses can be affected by higher prices, and the risk has to be that if the precious metal does break above $2,000 an ounce, as some analysts forecast, that buying in Asia will fall away.

Ends --

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

The views expressed here are his own.