gj1Jewelry purchases have historically made up the majority of annual gold demand. With record high gold prices and a worldwide economic slowdown, jewelry demand has plummeted by over 50% in some countries and 24% overall during the first quarter of 2009. Industrial demand has declined even more sharply during Q1, posting a 31% drop from year ago.

With consumers cash-strapped, plenty of “cash for gold” companies have emerged encouraging people to send in their old, unwanted, unused or damaged jewelry in return for cash. While they are only getting a fraction of the true market value for their gold, unprecedented amounts of jewelry have surfaced and contributed to a 55% increase in scrap supply.

With a massive increase in supply and a sharp drop in the primary source of demand, gold investors have been understandably concerned about the price direction of gold. But some relief was found in the recent numbers released by the World Gold Council.

A record level of investment into ETFs led to a 540% increase in demand versus year ago. The world’s largest gold-backed ETF, the SPDR Gold Trust, commonly called GLD, said it held a record 1,041 tonnes of bullion as of March 12, replacing Switzerland as the world’s sixth-largest holder of gold.

This contributed to an increase in investment demand of 248% to 596 tonnes and an overall increase in total demand for gold in Q1’09 of 38% to 1,016 tonnes. This is bullish news for gold investors as increasing investment demand has more than made up for the decline in jewelry/industrial demand.

But investors should not celebrate prematurely, as the sharp increase in scrap sales led to a situation where total gold supply during the first quarter (1,144 tonnes) exceeded total demand (1,041 tonnes). Scrap sales jumped by 55% to 558 tonnes, helping total gold supply surge by 34%.

Also contributing to the increased supply was a sharp slow down in the levels of producer de-hedging (from -129 in Q1’08 to -10 in Q1’09). Mine production was relatively stable, increasing by just 3% to 560 tonnes while lower levels of central bank sales, which fell 54% to 35 tonnes, had a dampening effect.

Moving forward, I anticipate that scrap sales will decrease, while investment demand continues to increase sharply. The short term surge in supply from individuals selling jewelry will likely recede. I also expect both the dollar and the stock market to continue lower into the back half of 2009. This will push the price of gold back above $1,000 and to new highs as the inflationary effects of the recent bailouts finally hit the market. A currency crisis could be the next major shoe to drop and in this environment you will want to hold precious metals and shares of the companies that mine these metals.

The Gold Stock Bull portfolio includes junior miners that we believe are undervalued by the market relative to their peers. These companies experienced the greatest price appreciation during previous uplegs and I expect they will produce the greatest returns this time around as well. To view the portfolio, receive trading alerts and get the monthly newsletter become a Premium Member.