Gold may hit $1,250/oz if fear returns to markets Tue Sep 8, 2009 12:43pm EDT LONDON (Reuters) -

Gold could rise as high as $1,250 an ounce next year, after surging to 18-month highs this week, if faltering appetite for risk sparks fresh buying of the traditional safe-haven asset, a London-based fund manager said. Nick Bullman, managing partner of hedge fund Bullman Investment Management, said on Tuesday that gold is benefiting from its status as a safe store of value as improved financial market sentiment could give way to risk aversion toward the end of the year.

"Equity markets have had a huge bull run, they are probably 20 percent overvalued and are discounting two years of earnings growth, which may or may not come through," he said. "From a dynamic perspective, you have credit markets, which have been very good indicators of real risk, indicting that risk is increasing, equity markets ignoring any bad news... and inflationary pressures still remaining very strong."

"As a backdrop for that, people have turned to gold, and certainly the hedge fund community and the exchange-traded fund market have been increasingly positive on gold in the last six months." As a result, spot gold is set to build on gains that have taken it to 18-month highs on Thursday of $1,007.45 an ounce, he said. "I think we can get to $1,100 by year end and that we can get to $1,250 over a year's view," he said.

Gold rallied this week after breaking out of the narrow range it stuck to over the seasonally quiet summer period, surging toward the psychologically key $1,000 an ounce mark. Momentum buying sparked by the weaker dollar pushed the metal through that level early on Thursday.

Analysts say prices could now be set to target all-time highs above $1,030.80 an ounce, set in March 2008. INFLATION FEARS As well as benefiting from rising fears over the stability of the financial system, gold could also gain in the longer term from its status as an inflation hedge, Bullman said. Investors are buying gold on expectations inflation will eventually result from measures taken by governments to stabilize the financial system through hefty cash injections -- or "quantitative easing" -- over the last year, he said. "Quantitative easing is ultimately very inflationary," he said.

"At the moment we're still in the deflationary cycle, but ultimately it is very inflationary, and people are going to want to be ahead of that curve." "People want to hold something that will protect them and have a store of value, and I think gold, rightly or wrongly, has that position in the market." But unusually, gold is also benefiting from the current period of deflation, he said.

"It is a very interesting dynamic in the market at the moment that gold is acting as a hedge both against inflation and a deflationary environment," he said. He said that on the inflationary side, paper currencies were weakening and risks were emerging from use by governments of quantitative easing to stimulate economies.

"On the deflationary side, (you have) the fear of deflation, plus if interest rates are at zero, there is no holding cost for gold." Bullman expects the dollar -- weakness in which has been a key factor driving prices higher on Tuesday -- to continue its decline for the foreseeable future, although a sharp slide in the currency is unlikely, he said.

"It doesn't help anyone to see the dollar collapse." Meanwhile he said downside risks to the gold price are limited. The weak physical demand seen in the market this year has already been discounted, he said, while the risk of central banks selling gold is relatively small.

(Reporting by Jan Harvey; Editing by Anthony Barker)