Chinese buying puts a floor under gold prices even when worry about Libya and oil supplies start to ebb

03/03/2011 12:09 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

China is buying gold at a faster pace than last year.

Gold purchases in China climbed to 200 metric tons in the first two months of the year. Last year gold purchases in China totaled 580 tons. An example of just how hot demand for gold has become in China: The Industrial and Commercial Bank of China, started physical-gold linked savings accounts only last December. Since then the bank has opened 1 million accounts that hold 12 tons of gold.

For gold prices--$1424 an ounce as I write this--the reasons for the buying are as important as the buying itself.

Some of the buying—as is the case around the world—is a reaction to fear produced by the uprisings in the Middle East and the threat to global oil supplies and world economic growth. Demand driven by this fear would, logically, taper off if and when the Middle East retreats to its normal level of instability. Gold buyers should be worried about the price of gold dropping as the fear reading goes down.

But part of the buying is being driven by fears of rising inflation inside China. And those fears—and the gold buying that goes with them—won’t go away when the violence in Libya does.

Inflation at the consumer level rose to a 4.9% annual rate in January 2011. The government is forecasting 4% inflation for 2011. That would bring inflation below the official 4.5% target for the year—a target the government raised for 2011. The forecast is almost certainly a mix of wishful thinking and bureaucratic self-preservation. Private forecasts are looking for inflation to climb to 5.2% in February. Economists note that wholesale prices rose at a 6.6% annual rate in January, up from a 5.9% rate in December. That’s evidence of a lot of inflationary pressure in the pipeline that will eventually make its way to consumer prices.

So you can think of inflation-based buying in China as a kind of safety net under the current record gold prices that will prevent a drop on the end of violence in Libya from turning into much more than a temporary correction.

That said, Wall Street isn’t looking for a repeat of last year’s 30% rise in gold prices. For example, UBS is predicting gold to hit $1500 an ounce within the next six months. Casimir Capital is calling for $1600 an ounce in 2011.

Neither of those forecasts are outlandish leaps from today’s $1424 an ounce. If those forecasts are right, that would make Chinese buying a reason not to sell yet, but they don’t suggest that investors should rush now to add a ton of new gold to their portfolios.

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