By Clyde Russell
SINGAPORE (Reuters) - The gold bulls have been at it again, talking up the demand prospects for the precious metal in 2012, but there are reasons to believe that some of the factors that drove gains last year are waning.
The World Gold Council expects 2012 to be a stronger year than 2011, which saw physical demand rise 0.4 percent to 4,067 tonnes, the highest of the current 11-year bull run.
It's no surprise that the council, which represents producers, will focus on the positives, but it's worth examining if the logic still stacks up or whether there are holes in the thinking.
A considerable amount of faith is being put in demand from China in 2012, both from consumers and the central bank.
It does appear the People's Bank of China has been a significant buyer, but official figures aren't available so it's impossible to know exactly how much has been purchased.
What is known is that shipments from Hong Kong to China, one of the main ways imported gold reaches the mainland, grew more than three times in 2011 from the prior year.
The World Gold Council expects China will surpass India as the top buyer in 2012, but for this to turn out to be the case, it will require large purchases by the central bank.
This is because consumer demand in China may not grow much in 2012, especially if the rate of economic growth slows as expected, and inflation continues its downward trend.
China's gold demand was stagnant in the fourth quarter of last year from the same period in 2010, a change from strong growth in the earlier quarters of 2011.
The council acknowledges that Chinese consumers prefer to buy into a rising trend, and gold prices have tracked largely sideways in recent weeks.
Also, as inflation cools, there is less incentive to buy gold, especially if other asset classes, such as equities, continue their positive start to the year.
Spot gold dropped to a low of $1,521.94 an ounce in December, and while it has since recovered to around $1,731, it is still well shy of its record $1,920.30 hit in September last year.
Gold's volatility in the fourth quarter of last year may help explain why Chinese demand was lacklustre, and it's possible that consumers won't return to buying until a clear uptrend in prices is re-established.
What of the other major gold consumer, namely India?
Even the council acknowledges that it may be a tougher year for gold demand in the South Asian nation this year.
Fewer auspicious days for buying in the Hindu calendar, according to the council, together with the weakness in the rupee and the economy in general is likely to crimp demand.
The rupee has recovered from the 2011 low of around 54 to the dollar to trade around 49.2, but this is still way weaker than the levels around 45 that prevailed in the first half of 2011, and it's no coincidence that this was when Indian demand was strongest.
As the rupee plunged and gold prices rose in dollar terms, so Indian buying plummeted, with fourth quarter demand dropping 42 percent from the same period in 2010.
Indian inflation is also moderating, undermining another bullish leg for the gold story.
The council, and investors such as hedge fund guru John Paulson, also cite concern about global inflation as a reason to buy gold, especially since most Western countries continue to keep interest rates low while printing money in order to try and stimulate economic growth.
The theory is that ultimately inflation will rocket up, debasing currencies and boosting gold as a store of value.
Coupled to this view is that gold is a buy because of the ongoing financial crisis in Europe that will encourage investors to seek a safe haven.
However, the new year has brought progress on the European debt crisis and the most likely scenario is still the muddling through to an eventual resolution, a process that has been happening for the past year.
The U.S. economic picture has also brightened recently and investors may well start feeling more comfortable about switching back into riskier assets such as equities and liquid, bulk commodities such as oil and copper.
The fears of rampant inflation also assume that Western central banks will be so irresponsible to start a process that will run out of control.
It also assumes that they cannot, or will not alter policy directions should economic circumstances change.
I would think it's pretty naive to think that the Federal Reserve's pledge to keep interest low for several years is so ironclad it cannot ever be modified.
The pledge was made to boost confidence that businesses and consumers could borrow and not have to worry about rising interest rates.
But if economic growth roars back to life and inflation pressures start to build, it's more likely that the Fed will change course rather than feel beholden to a promise made some time ago and under very different circumstances.
So, if Chinese and India gold demand looks constrained, especially at the retail level, and Western investors may be feeling happier about the general outlook, what remains for the bullish case for gold?
It basically comes down to central bank buying, particularly among developing nations.
The World Gold Council said in its report on Thursday that central bank holdings have risen by more than 500 tonnes over the last two years, and it expects this to continue as developing nations seek to diversify their reserves.
However, there may well be limits as to how much diversification is necessary and how far along this road the central banks have already travelled.
If central banks do repeat the buying patterns of the previous two years, then, yes, that's a major bullish factor for gold.
But even they might be tempted to buy other assets, especially if a European resolution becomes more assured and the United States continues to surprise on the economic upside.
While it definitely is too early to become bearish on gold, the risks to the bullish case are probably rising more than the gold bugs acknowledge.
Editing by Himani Sarkar