April 7 (Bloomberg) -- Gold may reach a record this year as demand for a hedge against inflation outpaces an expanding scrap supply and weaker usage by jewelers, researcher GFMS Ltd. said.

Bullion could “easily” reach $1,000 an ounce because central-bank spending is fueling speculation that inflation will accelerate, London-based GFMS said today in a report. Scrapping will gain this year after jumping 27 percent to a record 1,218 metric tons in 2008 as higher prices encouraged sales. Jewelry fabrication may extend last year’s decline, GFMS said.

“You can’t just increase supply of money like that and not expect there to be some consequences in terms of its value against a yardstick such as gold, the supply of which is increasing by about 1 percent a year,” GFMS Chairman Philip Klapwijk said in an interview in London. “That’s going to start to worry investors as much or more than the security of their banks or financial instabilities.”

The Federal Reserve has cut interest rates close to zero and last month said it would buy as much as $300 billion in Treasuries and step up purchases of mortgage bonds to combat the worst financial crisis since the Great Depression. The European Central Bank last week said it may use new tools to revive lending.

Low interest rates may mean “investors, who currently are sitting on record amounts of cash, will be looking for a secure inflation hedge,” GFMS said in the report. “An investor-led rally to well above $1,000 this year is quite probable and a breach of $1,100 cannot be discounted.”

Game Not Over

GFMS forecast in January that gold may climb to a record in the first half. The metal surpassed $1,000 on Feb. 20, an 11- month high, and has since dropped as much as 13 percent. Gold traded at $880.22 as of 4:03 p.m. in London. It reached a record $1,032.70 in March 2008.

“The price may have pulled back a fair bit from the February highs but that was largely just the market’s reaction to jewelry demand crumbling and scrap booming,” Klapwijk said in a separate statement. “It’s far from game over for investors and it will be that crowd which sets the price alight.”

Still, gold may fall to the low $800s in the short to medium term, which will likely be the low for the year and encourage “short bursts of demand,” Klapwijk said today at a presentation in London.

Red Lights

U.S. inflation will return in the fourth quarter of this year, and accelerate through the second quarter of 2010, according to a Bloomberg survey of economists.

“I don’t think that you’re going to see inflation in this calendar year appear at levels that get the red lights flashing, but people will start to act before it does that,” Klapwijk said in the interview. “We could see much higher inflation perhaps in 2010.”

The precious metal, down 0.3 percent this year, may also gain for an unprecedented ninth year because of concern that the global economy won’t recover any time soon, GFMS said. U.S. stimulus plans may weaken the dollar, increasing gold’s appeal as an alternative investment, Klapwijk said.

Gold in the SPDR Gold Trust, the largest exchange-traded fund backed by bullion, has overtaken Switzerland as the world’s sixth-largest gold holding. The fund’s assets reached a record 1,127.44 tons on April 2.

ETF, bar and coin purchases climbed 52 percent to 927 tons last year, GFMS said. Official coin minting rose more than 40 percent to a two-decade high and bar hoarding increased 62 percent. Total fabrication, which includes jewelry, fell 7.3 percent to 2,850 tons.

Turkey, India

“So far this year we’ve seen times when major fabricating countries like Turkey have been exporting bullion because jewelry demand collapsed and scrap was so strong,” Klapwijk said in the statement. “There’s no way that’s sustainable even in the medium term and I’d argue that’s the main reason the rally this year failed.”

Turkey, the world’s third-largest manufacturer of gold jewelry in 2007, imported 40 kilograms (1,286 troy ounces) of gold last month, and none in January or February, according to the Istanbul Gold Exchange. Imports dropped almost 29 percent last year to 165 tons, the lowest since 2002, GFMS said.

Imports by India, the world’s biggest buyer, have dropped to near zero in the past two months, according to the Bombay Bullion Associated Ltd. Gross imports fell about 16 percent to 720 tons last year, as prices in the local currency advanced, GFMS said.

Central Banks

Global scrap supplies probably surpassed jewelry fabrication volumes in the first quarter of this year, Klapwijk said.

Global supply fell 40 tons to 3,880 tons last year as mine production fell to its lowest in 12 years and central bank sales slumped. A 51-ton slide in Indonesian production, mainly because of the Grasberg mine, accounted for most of the decline, while output was also constrained in South Africa because of accidents and power outages. Mine production may add between 20 and 30 tons this year, the first increase since 2005, Klapwijk said.

Central bank sales fell 49 percent to 246 tons last year, the lowest since 1995, and should decline further, GFMS said.

To contact the reporter on this story: Nicholas Larkin in London at nlarkin1@bloomberg.net

Last Updated: April 7, 2009 12:05 EDT