Gold consumption in India, the world's largest market for the precious metal, has shot up by 50% in the first half of the year to 508 tonnes, only a little less than the 642 tonnes consumed during the whole of last year, the World Gold Council says.
The price of gold surged to an all-time high of 6990 rupees ($156) per 10g ($442 an ounce) in India this week, although it dropped marginally later.
However, the prices are likely to start climbing again with the wedding and festival season starting among the population of 1.1 billion, brokers said.
"There is a new-found confidence in gold. Whoever has invested in gold has made extra money. People are also turning to it as a hedge against the high oil prices," said Jatin Mehta, head of gold trading firm Suraaj.
Two successive increases in petrol prices since June have stoked India's inflation rate, which crept above 4% in the week ending 1 October. India's central bank has predicted inflation will range between 5% and 5.5% this fiscal year.
The income of middle class Indian families has been going up with the economy growing at a robust 7% to 8%, but putting their savings in banks is yielding little as the interest rate of 4% to 5% is barely on a par with the inflation rate.
Traders said the price of gold was likely to rise another 5% to 10% by the year-end as more people invest their savings and demand for jewellery soars during the October to February festival and marriage season.
"The demand in India is also because of increasing income levels, due to the rising economic growth rate"
Sanjeev Agarwal, World Gold Council Indian office head
The yellow metal rose to a new near-18-year high in Europe on Monday and was seen hitting the next big level of $480 to $500 an ounce amid buying by funds over inflation worries.
"The linkages between international prices and Indian gold are very close. The demand in India is also because of increasing income levels, due to the rising economic growth rate," said Sanjeev Agarwal, head of the Indian office of World Gold Council.
India's economy expanded 8.1% in the three months to June, compared with 6.9% over the last financial year ended March.
Indian consumers said their decision to buy was not just influenced by economic factors, but traditional preference for gold on special occasions.
"I am buying for my daughter's marriage. Gold prices have risen, but they will keep on rising. And one really has no choice but to buy gold when an occasion like marriage is happening in the family," said Deepa Ray, a housewife, visiting a New Delhi jewellery shop.
Indians traditionally prefer gold
to other metals such as silver
Mehta said a large portion of the buying demand was coming from smaller Indian cities and towns, where people are not comfortable investing in stock markets, mutual funds or government saving instruments.
The buying trend in gold has seen a subtle shift in preference for lighter and different designs of jewellery so that they can be worn on various occasions and not just marriage, industry officials said.
"Indian women are looking for lighter-weight jewellery. They wear it after asking themselves 'where I am going', 'what I am doing'," said Agarwal. "But their preference for the metal remains intact."
He said the rise in prices was also because the gold supply had remained at the same level in the domestic market although consumer demand had shot up.
"People are holding on to their stocks of gold. They don't want to release them now as the maximum buying in the metal takes place between September to January. Therefore, they expect prices to rise in the months ahead," said Sanjay Kothari, a leading trader.
Traders said some of the demand in the market is also coming from international customers in the United States and the Middle East, where Indian-made jewellery is finding greater acceptance as quality improves.