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Jewelry demand helping gold price

Consumption on rise in developing countries

By Bina Brown

Jewelry accounts for almost 70 percent of total demand for gold.


Financial Markets

(CNN) -- Along with higher inflation and global instability, one important driver of the gold price this year is expected to be the increasing demand for jewelry in developing countries.

Gold has already had a sensational run, with a 45 percent rise in gold prices in the last 12 months.

That may be dampening immediate demand for jewelry, but key social and cultural events later this year are expected to put extra shine on the precious metal.

According to the World Gold Council, jewelry already accounts for nearly 70 percent of total demand but the emancipation of women in developing countries is leading to enormous growth in potential markets for gold jewelry.

A recent WGC report found that women in the developing world have gained both greater responsibility for the way they dress and more disposable income, which has led to many more women falling into gold jewelry's target groups.

More affordable

Citigroup analyst John Hill believes that increasing wealth in developing nations has also made gold more affordable to women who see jewelry as both a fashion item to enhance emotional well being and as an intrinsically valuable investment.

He says the most recent quarterly figures on jewelry demand suggest the sharp gain in gold prices is significantly reducing tonnage this year but that enthusiasm should pick up.

September and October are key holiday periods in China - the mid-autumn festival -- and India -- the revival of the wedding season -- and precede Christmas purchasing in the OECD countries.

Even without the growing interest in jewelry the outlook for gold remains positive, thanks largely to expectations of higher global inflation, rising interest rates on account of strong economic growth, rising oil prices and ongoing tension in the Middle East.

It is not hard to find predictions for gold to advance to $800 an ounce in coming months.

One of the most bullish outlooks has come from the new chief executive of one of Australia's largest gold companies, Newcrest Mining. Ian Smith said recently that if current trends acted as an indicator for future price movements, it was "not beyond the realms of possibility" that a price of $1,000 an ounce was achievable.

As Mark Skousen, the chairman of investment adviser Investment U, explains, gold is an inflation hedge. When the gold price declines, it means less inflation down the road. When gold goes up, it means more inflation ahead.

Skousen also predicts that the price of gold and inflation still have some way to run, based on war being inflationary.

Investment rationale

The reasons for investing in gold have remained much the same throughout history. As well as being a hedge against inflation, gold is a safe haven in times of economic and financial instability. It is also a proven asset-diversifier that, when included in domestic portfolios, reduces the portfolio's overall risk.

There are a number of ways investors can gain some exposure to the gold price including buying gold bullion in the form of bars or coins. Then there is trading in gold or gold futures electronically, or investing in gold mining or refining companies.

Australian investment bank Macquarie Bank says the asset classes most frequently bought include:

• Investment in physical gold, including buying into Exchange Traded Funds (ETFs), which track the gold price. ETFs are vehicles which issue shares that are backed by physical gold;

• Investment in equities, either small or large gold producers.

The risks and returns an investor is exposed to will depend on the option chosen.

Macquarie says the small gold listed producers provide the biggest potential gains but they also carry the greatest risk.

According to Macquarie, some of the reasons why gold equities provide higher returns in the medium-term than gold itself include the revenue stream of mining companies being influenced by metals prices as well as gold production volumes which have been expanding over the past few years.

A further reason may be that companies are also usually leveraged; that is, they finance part of their operations through debt. Financial leverage has a direct impact on equity valuations. For instance, the interest rate charge is generally not affected by the gold prices, so in an environment of higher gold prices, any incremental revenue accrues to shareholders.

However, although equities generally outperform gold in the long term, this is not necessarily the case in the short run.

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