GLOBAL - Pension funds should have at least five percent invested in gold funds if they want to take advantage of the increasing demand for gold, says Merrill Lynch Investment Managers.

Graham Birch, head of MLIM’s natural resources team, said institutional investors - including pension funds – are the main investors in MLIM’s 2.5 billion-dollar (2.25 billion-dollar) gold funds.

“We would say pension funds should have an allocation of one percent. But more typically they will hold between one and two percent. Some will hold zero.”

Birch said that the gold market had suffered from a legacy of depressed returns in the mid 1990s. Since then supply-side discipline had firmed prices, and prospects for next year looked good. “The market for gold is definitely increasing. Investment demand is now the key factor that is driving the gold price. Investors are now looking for wealth preservation through diversification.”

Interest rates pose the greatest risk to an gold market upturn, he said. “We expect some rises, but nothing aggressive.”

China represents a huge potential market for gold, he said, and will overtake India as the world’s large consumer of gold within a few years.

Growth in China will be driven chiefly by demand from private investors, he said, following the People’s Bank of China’s decision to relax restrictions on the retail trading of gold. “The Chinese gold market has been heavily regulated for years, but now it is possible to trade on an individual basis,” he said.