By Clara Denina and Jan Harvey
LONDON (Reuters) - When Western investors dumped gold en masse in April they set up a situation bullion traders have not seen for years, a market where normal commodity fundamentals might just determine prices.
Buying for investment powered the metal's 12-year bull run, during which price movements were dictated more by macroeconomic and geopolitical factors than supply and demand drivers.
Since the start of this year, investors have turned away from gold, liquidating holdings of physically-backed exchange-traded gold funds and cutting long positions in U.S. gold futures. But the impact of this on prices has been cushioned by the emergence of another type of buyer.
"If investors are less interested in buying gold, you won't have such a bull market, but it doesn't mean prices won't go anywhere," Bank of America-Merrill Lynch analyst Michael Widmer said.
"It just means that someone else is regaining some clout - jewellery buyers, and traditional physical buyers," he said. "It'll be proper ounces being purchased by emerging markets, genuine offtake of gold that we haven't had in the last ten years."
Since 2003, sophisticated investors have been able to access new investment tools, notably ETFs, which issue securities backed by physical metal. These absorbed 2,691 tonnes of gold in the following ten years.
ETF buying surged when gold prices rocketed to record highs at $1,920.30 an ounce in 2011, as central banks slashed interest rates to record lows and adopted ultra-loose monetary policy that investors felt could spark rampant inflation.
The upward trajectory of prices came to an halt this year, however, when the U.S. Federal Reserve started to question the longevity of its stimulus programme, aimed at boosting its economy after the 2008 global crash.
Gold dropped $200 an ounce in two days in its sharpest slide in 30 years in April, and investors started to dump gold as a result, unwinding around 600 tonnes of ETF holdings so far.
Lower metal prices have made gold more affordable, prompting a sharp increase in physical demand for bullion coins and bars to 900 tonnes in the first six months of the year, against 630 tonnes in the first half of 2012, the World Gold Council says.
Jewellery demand also rose by 24 percent to 1,126 tonnes in the first half, led by India, China and the Middle East. Stronger demand for physical metal has helped prices recover more than 20 percent from their lows of the year.
"When you look at the rise in bar and coin demand, and jewellery demand, and also the decline in recycling, this is a market that is getting back to balance very quickly," WGC investment managing director Marcus Grubb said.
As prices have fallen, gold supply has also come under the spotlight. A raft of gold miners, including Barrick Gold and Gold Fields, have announced restructurings and lower profits since bullion prices fell earlier this year, leading companies to scrap exploration and investment plans.
Recycled bullion supply, another key element balancing the market, also looks likely to fall as prices slide, as scrap holders have less incentive to sell.
Gold recycling, which accounted for 40 percent of total supply over the last five years, could drop around 20 percent from last year's 1,591 tonnes, the World Gold Council said.
"If there is less material coming from the supply of recycled gold, which is related to lower gold prices and lower availability of metal, it will be positive for prices," Commerzbank analyst Eugen Weinberg said.
The sensitivity of the gold market, which since the collapse of Lehman Brothers in 2008 has tended to take its cues chiefly from U.S. monetary policy and moves on the broader financial markets, to underlying fundamentals is already increasing.
"Definitely there is more interest in fundamentals, and they will have more impact on prices," Mitsui Precious Metals analyst David Jollie said, adding that tighter money means investors are going to have examine supply and demand basics more closely.
While Western investment is becoming more informed by perceptions of supply and demand, these in turn are being driven in part by the appetite Asian buyers.
The high-carat jewellery sold in China, India and the Middle East, for instance, is often seen as much an investment there as the purchase of a gold future might be in the United States.
"An investor in China might be the same person who's owning a piece of jewellery," Jollie said. "The separation between investment and jewellery demand is much less clear than may be suggested by the conceptual investor you may have in mind."
The World Gold Council believes gold demand from China could break through 1,000 tonnes this year, with current world number one buyer India expected to consume a similar amount. In the current environment, this bodes particularly well for prices.
(Editing by Veronica Brown and Keiron Henderson)