Gold retreated after rising above 1800 amid profit-taking and CME's increase of trading margins. However, as global economic outlook deteriorates and central banks are expected to implement additional easing measures, investors will continue to find gold as the ultimate safe-haven assets. We believe buying on pullback remains a valid strategy for now as the yellow metal may extend gains to 2000.

The CME Group said it raised the initial margin requirement to 7425 per contract from 6075 while the margin for hedging was also increased to 5500, up +22.2% from 4500. While gold retreated after the announcement, it should not reverse the metal's long-term uptrend. Gold has risen more than +26% since the beginning of the year but almost 80% of the gain was made over the past 6 weeks. Macroeconomic conditions has worsened drastically since mid-July when sovereign debt crisis in the Eurozone escalated, the US had heated debate regarding the debt ceiling and the global economy showed more evidence of a slowdown. The root problems of these issues remain. While the governments have implemented 'contingency' plans, they failed to restore market confidence.

Central banks have been trying to diversify their foreign reverses these 2 years as USD sought to depreciate itself through quantitative easing. With US debts losing its triple A rating and heightening speculations of QE3, the trend to shift away from USD-linked assets should be more prominent. The best candidate that reserve managers look for is gold due to its lack of credit risk and hedge against inflation. The latest report from the 3rd Central Bank Gold Agreement (CBGA3) showed that sales for gold from European central banks were minimal. In the second year (Sep 27, 2010-Sep 26. 2011) of CGBA3, gold sales recorded so far were only 53.3 tons of which 52.2 tons was sold under IMF's limited sales program. The amount was tiny compared with the limit of 400 tons per year and 136.2 tons last year. We expect the trend will continue as central banks prefer holding gold rather than currencies.

Emerging markets are also getting more aggressive in buying gold as a means to diversify their huge USD holdings. We have seen Korea and Mexico join the purchases in recent weeks, despite elevated price levels. Last week, the Bank of Korea bought 25 tons of gold over the past 2 months. While the amount was too small to move the market, it signaled gold purchases in official sectors remained robust as central bankers sought to diversify their assets away from the US dollar. Before the announcement, South Korea, Asia's 4th largest economy, ranked number 56 in the world's official gold holdings with its 14.4 tons of reserve. Its ranking will be risen to number 45 after addition of the 25-ton holding. Yet, at 0.4%, the proportion of gold in total foreign reserve remained small when compared with 74.4% in the US and over 60% in the Eurozone. Indeed, gold holding as % of total foreign reserve have been insignificant when compared with international average. China is the world's 6th largest gold holder, yet it only represents 1.6% of total foreign reserve as of July, according to IMF's data. India ranks number 6 in the world's official gold holdings but it represents 8.7% of total foreign reserve. Mexico's net buying of gold reached 98.8 tons in the first 5 months of the year while Russia also bought 41.8 tons during the period. Given the fact that these purchases were made before the current turmoil, we believe more official sector buying will be seen later in the year as market conditions weaken further.

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