* Net demand at 4-year low as physically backed funds sold
* Heavy liquidation of gold funds easing off in Q1
* Jewellery demand rose by most since 1997 last year
* Heavy restocking seen in China, some gold scrap seen
By Jan Harvey
LONDON, Feb 18 (Reuters) - Net gold demand fell 15 percent in 2013 as huge outflows from physically backed investment funds outweighed record consumer demand but that disinvestment is tailing off this year, the World Gold Council said on Tuesday.
Massive liquidation of bullion-backed exchange-traded funds returned 881 tonnes of gold to the market last year, part of a 51-percent slump in investment demand to 773.3 tonnes, the WGC said, citing data from Thomson Reuters GFMS.
Expectations of a tapering in the U.S. bond-buying programme, which had boosted gold by holding down interest rates while stoking fears of inflation, helped drive prices to their biggest annual loss in 32 years.
That, in turn, drove demand for gold jewellery, coins and bars, which rose 21 percent to its highest ever at 3,863.5 tonnes, the WGC said, while overall demand slid to a four-year low of 3,756 tonnes.
With consumer demand expected to hold firm, gold prices might recover this year as selling from ETFs tails off, it said. Already this year, the largest gold ETF, New York's SPDR Gold Trust, has reported a small inflow.
"You're seeing a significant change in the behaviour of those ETFs," the WGC's managing director for investment, Marcus Grubb, said.
"Notwithstanding that the year is yet young, you are certainly going to see a much better year for investment and ETFs than you did last year," he said.
"The market is getting back to balance. Futures sentiment is improving too, with the increase in net longs back to nearly 10 million ounces. Overall, it leads us to think this will be a better year for gold than last year ... we expect to see a positive return this year," Grubb said.
"Unprecedented" amounts of gold flowed from Western vaults to Eastern markets, via refiners in North America, Switzerland and Dubai, the WGC said.
China overtook India as the world's biggest gold consumer, with overall demand of 1,065.8 tonnes, largely driven by a 29-percent rise in Chinese jewellery demand and a 38-percent increase in coin and bar buying.
Signs are that demand may match those levels this year.
"Demand post-new year is remarkably high," Grubb said "We had a 29-tonne delivery from the Shanghai Gold Exchange last week in one day, and a consistent premium in Shanghai - we expect on balance that China will be close to the same level of demand in 2014 as last year."
He said the difference between the amount of gold going into China and measured demand suggested that a lot of metal remained in the inventory chain, ready to meet demand.
JEWELLERY DEMAND HITS HIGH
China bucked the trend in developing markets for lower scrap supply - which fell 14 percent globally to 1,371.4 tonnes, its lowest since 2008 - to show an increase in recycled gold returning to the market.
"The surge in demand (in China) seen in 2013, with consumers making opportunistic purchases at lower prices, does increase the prospect of a resurgence in recycling should prices rebound with any conviction," the WGC's report said.
Globally, gold jewellery demand rose to a five-year high of 2,209.5 tonnes, the largest volume increase since 1997 and in India demand for jewellery rose 11 percent to 612.7 tonnes, while buying in the United States rose for the first time since 2001, to 122.8 tonnes.
Grubb expects the gradual improvement in Western jewellery demand to continue in 2014 as long as economic recovery keeps strengthening and lifting consumer's earnings.
Demand for smaller gold investment products such as coins and bars also rose 38 percent in China and 16 percent in India last year, with buying also rising sharply in Thailand, South Korea, and the Middle East, particularly in Egypt. Turkish coin and bar demand more than doubled to 102 tonnes.
Central bank buying fell to its lowest in three years, down by nearly a third to 368.6 tonnes. This was driven in part by the last year's price volatility, Grubb said.
"Effectively one of the reasons the slowdown happened was the increased volatility of the gold price, which is certainly looking better this year so far," he said. "That did affect these longer-term programmes last year."
"Overall we still think you'll see a strong year for central banks (in 2014), probably similar to last year."
On the supply side of the market, mine supply rose again by about 5 percent to 1,968.5 tonnes, a record high.