High and volatile prices will continue to scare physical gold buyers in most parts of the world, but some markets such as China and Japan will remain strong, bullion dealers said.
Analysts say a majority of buyers are still not ready to cope with the wide price fluctuations that lowered global demand in the past quarters, especially in price-sensitive markets like India - the world's largest consumer.
Then there are issues related to credit, with high prices forcing jewelry manufacturers in Europe and the United States to borrow less gold and in the process, feed lower volumes into the pipeline ahead of the Christmas buying season.
Paul Walker, chief executive officer of consultancy firm GFMS Ltd, said a lot of purchases were taking place with a great deal of caution due to dramatic price moves in the past months.
The absolute price levels have a big impact on the European manufacturers and those supplying the U.S., whereas volatility is probably more of an issue in the Indian market.
Different markets have responded differently to price changes that lifted gold to a 26-year high of $730 a troy ounce in mid-May. Prices retreated even faster to fall 26 percent in a month to a three-month low of $543, but jumped again in the past days to $650 an ounce.
Buyers in India, Singapore and Indonesia were largely absent from the market. On the other hand rising incomes in China kept demand robust, with jewelry consumption rising two percent in the first quarter of 2006 from last year, dealers said.
Gold markets have just opened in China in the last few years and economic growth has been so fast. The effect of high gold prices has been limited, said Cui Lin, analyst at metals consultancy Antaike in Beijing.
LEAN SEASON IN INDIA
Indian purchases have been lukewarm as farmers, who account for about 65 percent of the country's total demand, are busy farming the winter harvest in the monsoon season that started in June and runs through to October.
Dealers said a good harvest stimulates incomes and boosts gold demand in the country of one billion people. Rains have been satisfactory so far and good winter crops in September and October should lift buying, but not everyone is convinced.
Demand has been depressed in the first half of the year and might continue to be so in the rest of the year, if the markets remain choppy or turn irrationally high, said Mukul Sonawala, president of the Bombay Bullion Association.
Some dealers said the buying appetite was there as jewelry makers would need bullion to prepare for the next demand season that will begin in mid-August and peak in November.
But Indians generally allocate a fixed amount to buy gold for gifts during festivals and marriages, and higher prices means lower quantities.
Other major gold buying centers echoed this view.
I guess jewelers will reduce the weight to match the customers' needs. The price will be the same but the weight will be lighter, said Ronald Leung of Lee Cheong Gold Dealers in Hong Kong.
In Italy, high and volatile prices, export duties and a strong euro hit the gold industry at the start of this year.
Ivana Ciabatti, managing director of Italy's leading metal bank Italpreziosi, said demand would be sharply down despite the first timid signs of recovery at the start of the third quarter.
Italy used to dominate the world's gold jewelry sector but has recently bowed to competitive pressure from India, which has boosted its jewelry sector thanks to lower labor costs.
CHRISTMAS ORDERS MAY BE HIT
Dealers said volatile prices might force retail firms to delay Christmas orders given to wholesalers and manufacturers until later this year.
Should Christmas sales perform poorly, early next year could see a concerted period of stock liquidation, analysts said.
There has been some demand for retail bars in Europe, but I haven't heard anything of substance going on in North America, said Bruce Dunn, a trader at Auramet Trading in New Jersey, U.S.
Some markets remain largely unaffected by gold's rally and are expected to continue attracting physical buyers.
An official at Tanaka Kikinzoku Kogyo K.K., Japan's largest bullion house, said Japanese demand was likely to remain brisk from the industrial sector, thanks to economic expansion.
Turkish gold jewelry demand rose in the last two months and the revival was seen continuing in the rest of the year.
Cetin Binatli, board member of Turkey's only listed gold jewelry producer Goldas, said that demand, which shrank about 40 percent in the first four months, was recovering.
Dubai, which is a favorite destination of tourists, also showed strong demand for the metal.
We see higher demand for gold in this region in the coming quarters and this will continue for the rest of the year, Asim Khan, director of Trust Securities in the Middle East said.
(Additional reporting by Richard Dobson in Taipei, Lucy Hornby in Shanghai, Miho Yoshikawa in Tokyo, Lewa Pardomuan in Singapore, Ruchira Singh in Mumbai, Humeyra Pamuk in Istanbul, Zach Howard in New York, Dayan Candappa in Dubai and Svetlana Kovalyova in Milan)