South Korea, holder of the world's fifth-biggest foreign exchange reserves, is considering expanding its small holdings of gold to diversify its dollar-heavy portfolio."We need to give careful consideration to the matter of increasing gold volumes in the foreign reserves," Kim Choong-soo, governor of South Korea's central bank, told a parliamentary committee on Monday.Such a move would have a powerfully bullish effect on the gold market. With just 14 tonnes of gold -- or 0.2 per cent of $290 billion reserves -- Seoul is one of the smallest holders of gold among large economies. The world average is about 10 per cent, according to the World Gold Council, while countries such as the US, Germany, and France hold well over 50 per cent of their reserves in gold South Korea would join other Asian countries including China, India, Thailand, and Bangladesh in adding gold to its reserves. With emerging market countries buying gold and central banks in Europe halting their programmes of sales, central banks are set to become net buyers of gold this year for the first time since 1988, according to GFMS, the precious metals consultancy.

That trend is one of the most important changes in the gold market in recent history, and has helped drive the metal's rally to a series of fresh highs. On Thursday it touched $1,387.10 a troy ounce, an all-time nominal record.

South Korea's central bank stressed any moves would have to be "cautious" and "prudent" because of the high gold price. One person familiar with the Bank of Korea's stance on the metal said it was "receptive to the idea" of buying gold but stressed that there remained "differences of views" within the central bank.

Historically, Seoul has favoured Treasury bills over commodities because they are more liquid and can be used as a weapon to control the notoriously volatile won.

However, this reliance on the dollar, which makes up 63 per cent of reserves, has attracted widening criticism in recent years as commodity prices have soared. The rest of Seoul's reserves are in euros, sterling, and yen.

Lee Ji-pyeong, senior researcher at the LG Economic Research Institute, said South Korea should have started building up gold stocks last year. Increasing its holdings now would be difficult but worthwhile, he said.

"The bank is likely to remain hesitant, waiting for gold prices to come down, which is unlikely," he said. "Although gold prices have risen sharply in recent months, the upward trend is likely to continue for now as the dollar is likely to remain weak, with Ben Bernanke talking about additional easing measures and central banks worldwide likely to keep buying gold amid ultra-low interest rates."

Another issue for central banks looking to diversify into gold is the size of the market. Relative to the size of foreign exchange reserves, the gold market is tiny, meaning any large purchases could drive up the price. An increase in Seoul's gold holdings of just a few percentage points would translate into 100-200 tonnes of purchases -- a significant additional source of demand compared to annual production from mines of just 2,500 tonnes.

As one of the world's leading reserve holders and this year's president of the G20 leading economies, Seoul has advocated a system of global financial safety nets that might encourage many countries, South Korea included, to hold smaller reserves.

Many economists are sceptical that this proposal, which is steered by the International Monetary Fund, could help reduce reserves, which they argue are at a level far beyond what is needed to defend against financial shocks.

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