The ongoing rally in the world gold market above $700, much earlier than expected, indicates that the effects of the crisis in global financial markets have begun reflecting in the gold market, according to a GFMS report.

The gold rally can be attributed largely to fears of further losses in traditional investments that are highly leveraged on a problematic subprime mortgage market, pushing investors towards safe assets such as gold. In fact, losses in other markets have forced investors to move out of liquid assets in order to raise cash and minimise exposure to risk, leading to bailouts in gold, the report further says.

Going forward, investor sentiment towards the yellow metal will generally remain positive during the rest of the year and through 2008. GFMS estimates gold price to average above $690 in the second half of the current calendar year.

However, in the short term, liquidation is certainly possible, particularly as continued crises in global markets could once again force speculators out of long positions in gold. In the medium term, nevertheless, continued revaluation of the risk-return trade-offs of traditional investments, tension in West Asia and good underpinning by gold fundamentals are expected to continue to attract investors with a longer-term outlook to the metal, providing essential fuel for a continued bull run and eventually to a fresh 26-year high.

Consumers continued to rely on jewellery, primarily on greater price stability, particularly in the second quarter, when price volatility fell to 12 per cent from 31 per cent a year ago. The most important response in the price-sensitive markets was the surge in Indian jewellery demand, which rose by nearly 80 per cent y-o-y in the first half, accounting for a majority of the global jewellery offtake.

Not all was merely a price response as offtake was further aided by robust economic growth. West Asia recorded a rise of 17 per cent in jewellery consumption driven largely by demands from Turkey, Egypt and Saudi Arabia. In contrast, concerns over subprime debacle led to a fall of 13 per cent in the US jewellery imports.

Looking forward to the year-end, GFMS has forecast that jewellery fabrication can grow by 6 per cent y-o-y in the second half.

The firmness will largely be supported by the estimated decline in mine output, especially in Indonesia. Mitigating the rise in Asia, other continents, including Africa and Latin America, showed a decline in gold production, the latter cutting the output by almost 25 tonnes in the first half compared with that of in 2006.

Output in the second half may prove more muted, possibly recording a modest decline, due to an expected fall in Indonesian production. Nevertheless, GFMS expects the mine output for the full year to grow moderately. China, which has established itself as the world's second largest producer after seven years of strong, continued growth, looks set to become the new world leader, as South Africa continues to decline.