Inflation risk is driving "explosive" buying of physical gold in China, putting the country on a path to becoming the world's number one gold consumer and driving demand for the yellow metal to a 10-year high.
And the country's insatiable yearning for the precious metal could send gold prices to $2,500 in the next six months.
Chinese demand for gold bars and coins reached 180 tons last year, up a whopping 70% from the year before.
Chinese demand for gold jewelry hit an all-time high of 400 tons.
The country's gold demand nearly tripled in the last 10 years, and it could easily double again in less than a decade.
Currently, India is still the biggest market for gold, with total demand rising by 66% to 963 tons last year. But buying may slacken this year. The government is likely to increase import duties on gold in the forthcoming budget.
Gold imports by India climbed to a record of 918 metric tons last year, with Indians continuing to buy jewelry as a store of value.
Inflation Drives Demand Higher
Investment demand for gold in China was especially hot in the fourth quarter of last year, rising 84%. And the surge was mainly due to concerns about inflation.
The significant increase in demand seen in China, India and around the planet is reflective of the uncertainty facing consumers. People are buying gold to protect themselves from macroeconomic risks and rising inflation.
Increases in commodity costs are beginning to filter through the global economy. And that means the extended period of tame inflation we've been experiencing is officially over.
The"ultra-loose" monetary policy of Ben Bernanke and the Federal Reserve in the U.S. is exporting the country's inflation to China, India and other emerging markets, increasing commodities prices and wages.
The problem with exporting inflation is that it always comes back, and usually sooner than expected. (The inflation America has been exporting to countries like China isn't going to stay there. It will soon come roaring back onto U.S. shores. And that inflation has the potential to knock out any economic recovery we're currently seeing)
In China, core consumer prices increased 2.6% year-over-year in the last month, after posting a 2.1% rise the month before.
And China's broader consumer price index increased 4.9% year-over-year last month, exceeding the official government inflation ceiling of 4% for the fourth month in a row.
Gold is an excellent hedge against all of the rising costs the Chinese are currently experiencing. But could the surging investment demand in China also be a reflection of the ongoing internationalization of the Chinese yuan?
We don't think so. Money Morning Chief Investment Strategist Keith Fitz-Gerald sees the Chinese government's desire to move away from dollar-based currency reserves as a more important reason for the gold fever sweeping China.
The global investing expert, who splits his time between the U.S. and Asia, said the increase in gold demand will have "very little to do with yuan appreciation." He has not seen any evidence the two are linked, yet.
What is really happening is that Chinese are buying gold on an institutional level to hedge away from the dollar and build in diversification," Fitz-gerald said. "This is a conscious part of the yuan decision. The government definitely wants at least a partially hard asset-backed global currency."
Demand for Gold a "Global Phenomenon"
The price of gold soared nearly 30% last year, reaching a record high of $1,431.25 an ounce, as the dollar dropped and investors sought a store of value against the currently loose monetary policies of Western governments.
Global demand for gold rose 19% year-over-year to a 10-year high of 3,812 tons. Demand in India and China accounted for about 41% of that total.
The increase in investment demand for gold in a global trend and is set to remain strong throughout 2011.
And in particular, China's appetite for the yellow metal will remain robust this year, making it a significant force in global gold prices.
In fact, China's demand for gold investments could grow 40%-50% this year, with gold jewelry increasing a more moderate 8%-10%.
Despite being the world's largest bullion miner - after it toppled South Africa from the perch in 2007 - China's demand for gold has begun to outpace is supply significantly.
China produced a record 340.9 tons of gold last year, up 8.6% year-over-year. But that was not nearly enough to meet demand as gold imports into China soared, turning the country into a major overseas buyer for the first time in its modern history.
China imported 209 tons in the first ten months of last year, up almost 500% from the total brought in the previous year. And its imports for the entire year could nearly equal its domestic gold production.
Government Pushing Gold in China
There's a secret behind China's sudden demand for gold that's rarely mentioned in the Western media: The Chinese government is strongly encouraging its citizens to buy physical gold bullion.
China actually banned its citizens from owning gold from 1950-2003. And now it's promoting the practice. Times have certainly changed.
This turnaround in government policy is coming as part of an effort to cool off China's real estate and housing sectors, which are in the middle of a red-hot boom.
The Chinese government is so afraid of a housing market bubble burst like the one we just experienced in the West that it's using any means necessary to draw investors away from the real estate markets. It's even encouraging its largest banks to come up with easy, creative ways for investors to buy gold or gold-backed investments.
The Industrial and Commercial Bank of China (ICBC) started offering physical-gold linked savings accounts late last year. More than one million such accounts have already been opened, and the bank is now storing over 12 tons of gold on behalf of its investors.
In the first few days of this year, ICBC has managed to sell 1 billion yuan ($151 million) in gold-price-linked term deposits. That's equal to the total amount sold last year. Investors are predicted to deposit more than 5 billion yuan ($759 million) in gold-linked accounts this year.
Last week, the bank launched its second physical gold investment product, which sells gold bars to investors. They can then be resold for cash through ICBC, based on real-time gold prices.
The Chinese stock market will be choppy at best this year. Rising interest rates and inflation "imported" from Western countries could affect property markets. And the government-backed banks like ICBC are making it easy for investors, and your average savings-account holders, to buy into the gold market. Record numbers of Chinese will buy into gold, either in physical purchases or in gold-linked savings accounts, this year.
Action to take: The insatiable Chinese demand for the yellow metal can do nothing but continue to drive gold prices higher.
According to China investment expert Fitz-Gerald, Chinese buying programs are going to drive prices a lot higher before this is done, especially if the dollar gets worse.
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.
But you don't have to buy bullion to take advantage of the possible gains in the gold markets.
If you want some leverage on the price of gold, then one of the preferred ways is to own a group of elite gold miners. One simple vehicle to gain this kind of exposure is through shares of the Market Vectors Gold Miners ETF (NYSEARCA:GDX). Gold-mining powerhouses Barrick Gold Corp. (NYSE:ABX), Goldcorp Inc. (NYSE:GG), Newmont Mining Corp. (NYSE:NEM), and AngloGold Ashanti Ltd. (NYSE:AU) account for nearly 50% of the current weighting in this ETF.
It's important to note that gold stocks typically offer an average leverage ratio of about 2:1 on the performance of the price of gold. On a five-year basis, gold shares have lagged. Despite an increase since the 2008 market crash, the ratio is still about 20% below that 2:1 level. This is a "limited-time offer" we don't expect to last long. Buy your gold miners now before the market corrects, bringing prices for miners up to historic norms.
Gold is not the only commodity that's booming on Chinese demand. China may be willing to go to war to protect its monopoly on one vital natural resource. These scarce metals are in everything made today - from kids' pajamas to cellphones and night vision goggles.