Rise and rise of gold: Will prices hit $2,500 on 'insatiable' Chinese demand?

The Chinese are complaining that the U.S. Federal Reserve policies effectively result in exporting America’s inflation to China. And they are finding that gold is arguably the best hedge against the runaway costs in the domestic market.

And then there is the Chinese government's intention to diversify from dollar-based currency reserves ad focus more on gold servers. This makes sense considering that China ranks pretty low in a list of countries with gold-backed reserves.

What is really happening is that Chinese are buying gold on an institutional level to hedge away from the dollar and build in diversification, Seeking Alpha quoted Investment Strategist Keith Fitz-Gerald as saying.

China had a big role to play in the astounding gold rally the world witnessed last year. Demand from China and India accounted for a whopping 41 percent of the total global demand increase last year.

Analysts estimate that China is poised to overtake India as the world's biggest gold consumer. It is expected that Chinese demand for gold investments could spike to the tune of 40 to 50 percent this year.

China has already surpassed South Africa as the world's largest gold producer. Chinese gold output stood at a stupendous 340.9 tons of last year, which was an increase of 8.6 percent from the previous year. But its insatiable demand for the yellow metal meant that the country imparted an additional 209 tons in the first ten months of 2010.

The reasons are not far to seek. The Chinese government is decidedly moving in the direction of solidifying its gold-backed assets. The new found love for the bullion runs against the grain of Chin's previous policy of discouraging, and sometimes even prohibiting people from owning gold assets.

The Chinese gold rush is also aimed at preventing a fatal overhearing of the country's housing sector. The government has unleashed a variety of policies to prevent a housing bubble, which it fears would set off a massive economic collapse and the onset of social unrest.

The gargantuan demand from China can cause the yellow metal's prices to skyrocket, analysts feel. If the Chinese buying trend is ably supplemented with a fall in the value of dollar, this could result in a skyrocketing of prices, according to Fitz-Gerald.

They could send gold prices to $2,500 per ounce or higher in the near future. And investors who continue to sit on the sidelines during this gold boom will miss out on a massive amount of potential profits, argues the Seeking Alpha article.

Over the past five years, China's gold consumption has grown by whopping 84 percent, points out Stansberry Research. The Chinese are rightly thinking now that gold investment is the only route they can take now while holding a massive 2.6 trillion foreign reserve stockpile. Currently only a small fraction of 1.6 percent of this stockpile is held in gold. And that's a tricky situation. While 70 percent of Germany's reserves are in gold, the United States holds 74 percent of its reserves in gold.

Juxtaposing China's recent gold craze with the yawning gap the country has in terms of gold backed assets reveals one thing. China can unleash a lot more fierce gold buying spree, which can technically result in the prices of the yellow metal go through the roof.

However there is also a sobering line of thought. Analysts have highlighted the reversals suffered by gold and silver in the last week, suggesting that the rally may not just last forever.

In the commodity carnage last week, gold performed much better than silver. However, while silver lost a whopping 25 percent, gold did not breach any major support levels on the downside. Reflecting this, there was no rush among long-term gold investors to exit.

Last week's sell-off was indicative of something more important in play -- the commodity markets are beginning to price in a global industrial slowdown, and that combined with the likelihood that the U.S. dollar had put in at least an intermediate low, Reuters quoted James Dailey, portfolio manager of the TEAM Asset Strategy Fund, as saying.

In New York, spot gold rose 1.2 percent to $1,512.20 an ounce on Monday.