While the global gold market may be hotter than ever, the world's best-known precious-metal consultancy is warning that investment demand is going to have to stay at massively high levels to keep prices from falling back down.

London-based GFMS Ltd. said yesterday world investment demand in gold more than doubled in 2009 to almost US$57-billion, an unprecedented level, as investors sought a reliable store of value amid the economic turmoil.

This surge in investment demand more than made up for a 23% decline in jewellery fabrication demand last year, which plummeted in response to rising prices. (Gold prices rose 24% in 2009.)

Speaking in Toronto, Philip Klapwijk, GFMS executive chairman, warned that the gold market is "like a junkie" in that it is relying so much on investment demand. When that demand declines, he said it could have a major effect on the gold price.

"If that investment demand doesn't materialize for some reason, you're back to the bread-and-butter [ jewellery] demand, which will need much lower prices to be stimulated," he said in an interview.

"And that, to my mind, means something closer to US$700 or US$800 an ounce than US$1,000-plus."

In the short term, this may not be an issue: GFMS expects that implied net investment in gold will be "markedly higher" in the first half of 2010 than it was in the last six months of 2009, as it expects the global economy to recover more slowly than the market consensus.

Additionally, there is the backdrop of zero interest rates and a potentially weaker U.S. dollar in the short term. And while US$57-billion is a huge amount of investment in gold, it is still tiny compared to other asset classes, and Mr. Klapwijk said that number could easily increase if more investors are drawn to the precious metal.

But he does not expect these conditions to last forever. "At some point, you'd imagine governments would have to start cutting spending and balancing their books," he said.

"If investors see that world government finances are being brought into order and interest rates being raised, gold becomes a lot less attractive."

For the first half of 2010, GFMS projected an average price of US$1,175 an ounce, roughly in line with current levels. It is expected to be a volatile road, however, as the consultancy predicted prices will trade in a wide range of US$990 to US$1,230 an ounce.

Among GFMS's other findings, one of the most surprising was that mine production actually increased 6% last year to 2,553 tonnes. That is a sharp turnaround from recent history, as production was flat to declining from 2001 to 2008.

But Mr. Klapwijk said the increase is not the sign of a new trend, and that production might turn down again in 2012.

pkoven@nationalpost.com