1. Central Bank Buying

The biggest secular trend for gold is that central banks have become net buyers of gold over the past two years rather than net sellers.

Grubb says that central banks have imported 198.4 tons of gold in the first half of 2011 whereas two years ago they were selling 450 tons a year.

Central bank buying is widespread. In the second quarter, Russia bought 26 tons, South Korea bought 25 tons and Mexico added 5.9 tons to its 100 ton purchase back in the beginning of the year.

"Some banks," says Natalie Dempster, head of government affairs for the World Gold Council, "have been rebalancing as the percentage of gold in total reserves has fallen over time. Others are looking to diversify away from dollar-based assets, and with sovereign debt concerns continuing to grow around the world, gold's attractiveness as a reserve asset that bears no credit risk continues to grow."

The U.S. has 74% of its reserves in gold compared to some emerging market economies like China, which owns 1,054 tons of gold, but it only makes up 1.6% of its reserves. India now holds 8.7% in gold reserves, but that figure is still considerably lower than the 20% of gold reserves it held in 1994.

Dempster says that if China in particular were to reallocate its holdings to 3%, it would need to buy 1,000 tons of gold. China is the world's largest gold producer and vies with India for title of largest gold consumer.

Nigel Moffett, head of Treasury at Gold Corp. says, " China is the world's number one producer, producing 340 tons of gold a year. You don't see any of that coming out of China. You see a lot of gold going into China." Moffatt believes that its central bank is a prominent buyer.

The rumor is that China is trying to beef up its currency, the yuan, to make it a more viable player on the international stage. Not a gold standard, but a gold kicker.

Central banks, in general, regard reserve allocation as an ongoing government policy. Although the governments consider fundamentals like dollar weakness and the sustainability of gold as money, they don't trade gold; they buy it as an investment. They will buy gold when they feel gold reserves are too low when compared to its other holdings.

Central banks tend to be price agnostic, but are heavy buyers.

Gold prices are volatile currently there is no denying that, but there are fundamental reasons that underscore gold's appeal as a"safe" investment.

-- Written by Alix Steel in New York.

>To contact the writer of this article, click here: Alix Steel.

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