Demand for physical gold has been rocketing this year – up by more than a quarter in the first three months. That is according to the latest quarterly review of gold supply and demand from the World Gold Council (compiled by GFMS) which reports that gold offtake was up by 26% in tonnage terms in the first quarter of this year when compared with demand in the first quarter of 2004. In dollar terms the increase was 32%.

This was driven particularly from the jewellery sector, bar and coin purchase and from investment in gold-backed exchange traded funds, further stimulated by an undercurrent of political and economic unease, which favoured gold investment. This demand absorbed additional supply coming onto the market, especially from increased central bank sales, and sustained dollar prices that were 5% higher than in the first quarter of 2004. With consumers accustomed to the higher price range, dips towards the lower end of the $420-$440 range were seen as buying opportunities and anecdotal reports suggest that buying rose strongly when the price fell towards the lower end of this range.

James Burton, Chief Executive of the WGC commented that while gold advertising and marketing campaigns are hitting the right note, there is "still a lot to do to regain levels of demand that past experience has indicated can been achieved, against a backdrop of an increasingly competitive luxury goods market with large marketing budgets".

In the jewellery sector the upward trend witnessed over the past two years was sustained in the first quarter of 2005, with jewellery offtake increasing by 19% in tonnage terms and 25% in dollar terms over the first quarter of 2004. Indian demand shot up by 72% and the only areas that did not register an increase were Europe and Japan. The industrial sector saw a slight dip in demand in tonnage terms with electronics, which is the largest demand category, registering a drop of six per cent as the electronic sector slowed from the boom conditions of a year earlier and inventories were run down.

Decorative and other industrial uses continued to grow strongly. Buoyant economic conditions in India, which accounts for over 25% of the "other industrial and decorative" uses, was a supportive factor – this category includes "jari", the gold thread used in ceremonial and other saris. In the western world current fashion is favouring gold-coloured accessories and this has contributed to decorative demand.

Chinese gold demand was up by 13%, with chuk kam ("24 carat "yellow gold") benefiting from the slight decrease in the gold price while K-gold (18-carat) enjoyed strong increases, resisting the usual winter dip. Net retail investment was 36% higher in tonnage terms than the previous year, reflecting the deregulation of the gold market as well as concern over the sluggish performance of the Shanghai stock market.

Investment demand for coins and bars was vibrant in the four major markets of India, Japan, Vietnam and Turkey, aided by unease over the economic and political backdrop. Turkey established new records for jewellery and for investment, with jewellery rising by 28% and investment up by 31%, with nine tonnes sold in March alone.

In the US, jewellery demand rose by 3% and net retail investment was sup by 5%. Poor economic conditions in Europe constrained purchases and demand slipped.

Gold-backed ETF's and similar products contributed 89t to overall demand while trends in the rest of the non-retail investment market were neutral over the quarter as a whole. Initial disinvestment was neutralised by later net purchases.

The difference between the two sectors is largely a function of differing investor horizons with the ETFs attracting many investors who are new to gold along with those taking a long-term view. The investment environment, including the geo-political and economic background along with concerns over the medium-term outlook for the US dollar were all conducive to longer-term gold investment. The shorter-term environment was the other way around, however, with the recovery of the dollar and the debate over possible IMF sales.

While demand was up by 26%, supply increased by 23% against the first quarter of 2004, driven by an increase in central bank sales and a reduction in de-hedging form the mining sector. Mine output itself increased fractionally as the Grasberg mine in Indonesia returned to normal levels after the disruption in 2004, although to a large extent this was offset by the mining of lower grades in North America and Australia.

Net central bank sales were more than double the level in the first quarter of 2004, largely due to the timing of sales under the new Central Bank Gold Agreement, which came into force in September 2004. By April 1st 2005, CBGA signatories had disposed of a combined 346 tonnes from the 500 tonnes maximum imposed for any one CBGA year (ends late September). The first quarter of 2005 saw the final tranche of selling from Switzerland, which has now completed its 1,300 tonnes sales programme (and which falls under the auspices of the CBGA).

The outlook for the second quarter is essentially positive, with factors supporting increasing gold demand remaining largely in place. The Council submits that any deterioration in the dollar will be supportive of the price, although any sharp rises in price will constrain jewellery demand. A notable positive factor is the likely reduction over the next two quarters in central bank sales due to the timing of the Central Bank Gold Agreement sales.