(Kitco News) - Gold purchases by South Korea and Thailand this summer continue a trend in which central banks are net purchasers of the metal as they look to diversify their foreign-exchange reserves.

“So far in 2011, central banks in the emerging markets have already bought more than double the gold they bought in all of 2010, and we’ve got almost five months to go for the rest of the year,” said Jeff Clark, senior precious-metals analyst with Casey Research.

This buying has occurred despite historically high prices. “So apparently, central banks don’t regard the gold price as too high,” Clark said.

For the year to date, net purchases by the world’s central banks are 203.5 metric tons, which already is a 168% increase from 76 tons for all of 2010, said Natalie Dempster, director, government affairs, with the World Gold Council.

Most of the data is gleamed international financial statistics released by the International Monetary Fund at the beginning of each month. Additionally, some central banks—such as South Korea—make their own announcements.

The buying is coming from emerging-market nations that are accumulating foreign-exchange reserves, Dempster reported.  For the year to date, the biggest buyers have been Mexico, 98.8 tons; Russia, 48; Thailand, 26.3; and South Korea, 25.

During just the first five months of the year, the central-bank buying amounted to 15% of global mining production during the same period, said a research note this week from Commerzbank.

“The central-bank buying is coming on top of speculative buying and creating a Perfect Storm for gold,” said Ross Norman, chief executive officer of Sharps Pixley.

Central Banks Buying To Diversify And Manage Risk

The net purchases by central banks are a reversal from the not-too-distant past. Until recent years, European central banks collectively were selling a few hundred tons of gold annually, resulting in net annual sales. Those sales have dried up while purchases have increased from emerging-market nations.

Some of the central-bank buying is due to a rebalancing of portfolios, Dempster said. As emerging-market nations increase foreign-exchange reserves, the percentage from existing gold holdings gets smaller.

“The tonnage was constant but the percentage was declining,” Dempster explained. “So they wanted to rebalance it (the percentage) back up to what they believed was the appropriate strategic level.”

Further, the strategies of reserve managers have changed in the last couple of years since the global financial crisis.

“There is much more emphasis now on risk-management strategies, as opposed to yield enhancement,” Dempster said. “And obviously, if gold is anything, it’s a tool to manage risk.”

Also, gold has become more attractive due to worries about other traditional reserve assets such as bonds, particularly with high debt levels in many European nations and the U.S., analysts said.

“They feel the sovereign-debt risk is high, therefore they’re buying gold even though the price is high,” Clark said. “They are viewing gold as a necessity now and not just one way to diversify, in my opinion.”

Dempster pointed out that the guidelines on which assets that some central banks can buy can be restrictive. “They may not have the option of diversifying into the equity market or diversifying into hedge funds. For a lot of them, it is fixed income and gold,” she said.

Some reserve managers have looked toward the bonds of nations such as Australia and New Zealand. “But they don’t really have sufficiently deep debt markets to offer meaningful diversification, and gold does,” Dempster said. “It’s a deep and liquid market.”

Further, reserve managers are turning to gold for many of the same reasons as private investors, such as concerns about inflation and U.S. dollar weakness, Dempster said.

Sharps Pixley’s.Norman commented that the buying is tending to come from nations that are either rich in resources or perceive themselves as “overly extended” in the U.S. Treasury market. Often on gold-price dips, he said, good support has emerged, suggesting large buyers that just might be central banks.

“I wouldn’t be surprised to find central bank on the other side of any good selling at the moment to acquire a little bit of metal on the dip,” Norman said.

Analysts Anticipate Continued Central-Bank Purchases

Dempster said she anticipates more “meaningful” buying from central banks,  “driven by the need to rebalance, the deterioration in the quality of other reserve assets, and a continued emphasis on risk management.”

Clark cited a UBS survey of 80 central bank reserve managers earlier this summer predicting that there would be a further build-up of gold reserves over the next decade. The extent of further central-bank buying could hinge on how they view the sovereign-debt risk, he said.

“If they think the sovereign-debt risk is going to not let up or increase, they are not going to let up on their gold buying,” he said.

Meanwhile, there is an assumption that China is continuing to add gold to its reserves. The country reports its gold holdings less frequently than most.

“You could say it’s a predictable surprise,” Clark said. “At some point, they are going to announce they’ve been buying gold again, just like they did a few years ago.”

The debt-ceiling agreement in Washington this week enabled the U.S. to avoid a technical default by increasing the Treasury Department’s borrowing authority. But it also means still-higher deficits that may become worrisome to investors and other central banks alike.

“The ratings agencies may be holding off on re-rating America, but nevertheless central banks are looking at their risk portfolio and wondering to what extent they want to extend (holdings) in U.S. Treasurys,” Norman said. “I would be surprised to find many seeking to extend their position in U.S. debt. With that being the case, they need to find other reserve assets….There are relatively few things they can move into, and gold is one of them.”

By Allen Sykora of Kitco News; asykora@kitco.com

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