Don't count on central banks to fuel the gold rush. Ask South Korea

Gold bugs readily cite plenty of reasons why they think the precious metal's price will keep climbing. One argument gaining prominence lately is that the world's central banks will rush into gold, pushing the price ever-higher. But apparently the central bankers haven't gotten the memo.

On Tuesday, the Bank of Korea -- the world's sixth-largest central bank -- became the latest one to pour cold water on the notion that it would buy gold to diversify out of the dollar. "There's an illusion in gold," Lee Eung Baek, the head of the bank's reserve-management department, told Bloomberg News in an interview. "We follow the big trend. Gold isn't the trend. Out of more than 200 nations, how many countries have bought bullion?"

South Korea's disparagement comes on the heels of suggestions by Chinese central bank officials that gold prices may be in a bubble. And rather than diversifying out of the dollar, Japanese officials were recently mulling snapping up greenbacks in an attempt to weaken the yen against the dollar and boost Japan's export sector.

Speculation that the world's central banks would pile into gold helped fuel a massive rally in gold prices in November after small central banks like India's and Sri Lanka's picked up relatively minor sums. Gold bugs became confident that the moves were just a prelude to bigger pile-ons. But their reasoning is fuzzy. Buying gold would make barely make a dent in terms of diversification for major banks and the ballooning price may make any entry prohibitive.

Gold Buyer Beware

Still, news that high-profile hedge fund manager John Paulson -- fresh off making a killer bet against the subprime sector -- would launch a fund focused on gold added more fuel. But Paulson may be using his newfound fame to raise more money and charge hefty fees -- a familiar play for hedge fund managers who come into the limelight. And given that Paulson is already trailing his peers this year -- returns in his flagship fund are 15%, compared to 17% for the industry -- that seems like an increasingly likely scenario.

As gold piles up losses on Tuesday for a third day and the dollar shows signs of strengthening, investors should take note of what they're getting into when buying the precious metal.

Without the prospect of big central banks willing to purchase the shiny metal for ever-higher prices, gold seems like a very risky bet. It has a history of volatile moves, is questionable as a hedge against inflation -- though actual income-generating assets like stocks and real estate tend to be -- and has a terrible track record. Over the past 30 years ago, simply leaving money in an interest-bearing checking account would have outperformed an investment in gold.

Indeed, the illusion in gold that Bank of Korea's Baek is referring to may well be that central banks like his are about to pile into the precious metal.

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