Reality check: who is still buying gold?

Bullion-hungry Asian consumers are often touted as the fundamental support for gold prices. But India’s demand for gold has weakened as the combination of high inflation and a weakening rupee sap the country’s collective buying power. China seems to be stepping in to fill the gap.

China’s gold appetite rose 20% in 2011. But even though the country imported $46 billion in gold — roughly 770 metric tons of bullion — it still trailed India, which absorbed 933 metric tons or $56 billion in precious metal.

Overall, worldwide gold demand rose 0.4% to 40,671 metric tons worth $205.5 billion.

The World Gold Council said it’s “likely that China will emerge” as the world’s largest consumer on 2012.

The world’s second-largest economy has a population blessed with a rising income, providing a direct link to the demand for gold jewelry and other luxury goods. China became the world’s largest gold jewelry consumer in the second half of 2011. 

Helping to fuel the demand for gold bars and other gold investments in China is the lack of other domestic investment options.

Couple China’s appetites for both gold jewelry and investments with gold’s popular status as a hedge against both inflation and “the sky is falling” economic dread, and it is no surprise gold hit a record high of $1,891.90 in August.

If that wasn’t enough demand for gold, enter the central banks of developing economies as they seek to diversify their growing piles of foreign currency reserves.  Central banks of these developing economies bought 439.7 metric tons of gold in 2011, up 77 metric tons in 2010 — and the highest amount since 1964.

If traders read only the World Gold Council annual report they couldn’t help but be bullish. So what is the big picture driving gold?

1. The sky is falling, at least in the euro zone. Europe is still in a crisis as Greece, the European Union and policy makers continue to delay the Greek bailout up to the edge of the March 20 deadline. Until we get resolution here, the outlook for European banks remains clouded — and Portugal and Italy are not looking great either. Meanwhile, the contagion spreads.

2. Global inflation remains strong. U.S. policy leaders continue to take food and energy out of the inflation numbers to only mask the increasing amount of American earnings going toward necessities. Go to your grocery store and marvel at the products that have been reduced in size with either price staying flat or in many cases increasing. 

I maintain the best bet against inflation and a great way to hedge portfolios from disaster risk is through physical gold — either gold coins and bars, or via the SPDR Gold Shares Trust (GLD, quote).

Although the miners (GLDquote) seem cheaper at times, many factors can move against individual companies and would require a more hands-on approach.

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