Gold demand fell 34 percent in the third quarter as high prices weighed on investment flows and led to a slump in jewelry buying in key markets like India and the Middle East, a World Gold Council report showed on Thursday.

But speculation in gold futures and expectations for more official sector bullion buying are keeping prices elevated despite a dearth of physical demand, according to the WGC's investment research manager Rozanna Wozniak.

For most of last year, the buying was very physical, said Wozniak. (Now), it seems to be more financial market-driven, by some of those other less visible instruments -- derivatives, futures, over-the-counter transactions.

In terms of why it is happening, we have had some good news coming out from the central bank sector, as well as the fall in the U.S. dollar, she said. That says something about potential future demand.

A 200-tonne gold purchase by India's central bank pushed gold prices sharply higher in early November. Prices hit a record above $1,150 an ounce on Wednesday as momentum buying pushed prices through key technical resistance levels.

But high prices have pressured physical offtake this year as consumers shied away from the metal, even as large investors and central banks bought gold as a portfolio diversifier.

Indian jewelry demand tumbled 42 percent to 111.6 tonnes in the third quarter from a year earlier, though it inched up from extremely low levels earlier in the year. In the Middle East, jewelry buying was down 34 percent at 69 tonnes.

Greater China, however -- which comprises China, Hong Kong and Taiwan -- saw a 10 percent rise in overall demand to 128.6 tonnes, while jewelry demand rose 7 percent.

Chinese consumers have seen less of an impact on local gold prices from currency fluctuations, and their economy has been more resilient than many. The market also remains relatively immature in terms of consumer buying, Wozniak said.

The Chinese market was regulated for some time, so the Chinese consumer is still very much in the process of accumulating (gold), said Wozniak.

INVESTMENT SLIPS

Investment demand for gold also slipped from high levels in the third quarter of 2008. Retail investment in products such as coins and bars was down 31 percent year-on-year, while ETF inflows tumbled 72 percent to 41.4 tonnes.

Levels of ETF buying were exceptionally high in the third quarter, the World Gold Council said, with a dip in prices boosting interest in gold in all its forms.

Total gold supply edged down 5 percent in the third quarter, meanwhile, the WGC said. Mine production rose, but a dearth of sales from central banks -- which turned net buyers of gold in the quarter -- and producer dehedging cut into total supply.

Central banks bought 15 tonnes of gold in the third quarter, their second straight quarter as buyers. In the third quarter of last year, they sold 13 tonnes of gold.

Supply of recycled gold to the market rose 31 percent to 283 tonnes, but was still significantly down on the 569 tonnes it hit in the first quarter of 2009 as prices powered through $1,000 an ounce.

Scrap does tend to come in waves, and it appears that for another wave, we would need a higher price to generate it, Wozniak said.

(Editing by Sue Thomas)

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