UBS suggests gold has potential US$2,500/oz upside

Despite the worst global recession in 70 years, UBS has upgraded commodities from underweight to a small overweight, especially in precious metals.

RENO, NV - 

UBS Investment Research has moved gold to overweight from neutral, citing the "broad uncertainties in the current macroclimate."

In their Q-Series: Gold research,  analysts Daniel Brebner and James Luke, strategist John Reade and economist Larry Hatheway said they have determined that "future returns on gold are likely to be positively asymmetric, with potential upside US$2,500/oz."

The team also suggested that the current environment as "having a ‘low margin of error' for central bankers."

"We would characterize the prospects for deflation/inflation as becoming more extreme, and have illustrated this concept as a wider than usual probability cone for inflationary outcomes. The higher potential for policy error is generating considerable interest in certain assets that are perceived as ‘stores of values', including gold," they said.

In their analysis, UBS forecast downside risks up until the year 2015 being limited to a probability cone of caUS$500/oz (down ca50% from current levels) vs. upside risks of a probability cone of caUS$2,5000/oz (ca160%).

The "opportunity cost"  that investors experience in holding gold bullion is declining, UBS asserts, which is generating some capital inflows into the commodity; "furthermore, given the current deflationary pressures it is possible that this cost could continue to decline over the near term."

UBS also suggests that central banks are not likely to sell much gold. "With the cost of fixing the global financial system likely to run into the multi-trillions of dollars, the utility of gold fixing this gaping hole needs to be seriously questioned, at least in the sense that selling reserves would not bring sufficient revenues to make a difference."

Furthermore, the analysts advise, "if a central bank were to sell gold in large quantities there would potentially be the risk that, despite the recognition that its currency was not backed by gold, confidence could deteriorate further."

"Even more dangerous for a central bank being a large seller would be the appearance of a large buyer," they added. "If, for instance, an Asian or Middle Eastern central bank were to bid for a large tonnage of gold, the implications would potentially be: (1) highly supportive for the gold price; and (2) a potential political powder keg for the seller."

Meanwhile, although there is a possibility the IMF could sell gold to fund economic bailouts, UBS asserts "a potential sale is likely to be well flagged to the market, thus not significantly impacting the gold impart."

Although investors question if a new gold standard will be adopted to support flagging currencies, UBS analysts also do not believe that proponents of a return to the gold standard have made much headway due to institutional, economic, and political reasons. 

GOLD EQUITY IMPACT

In their analysis, UBS states "gold equities have suffered underperformance as a function of five important factors, which have meaningfully truncated equity performance and may continue to do so in the future." 

1. Poor volume growth:

Much leverage comes through the conversion of ounces in the ground to sales. "Over the past four years in particular, this leverage has been disappointing. ...Poor volume growth has been a function of rising capital intensity, aging mines and a small number of quality deposits to choose from." 

"We also believe that it is also a function of affordability: the gold sector is not very cash generative and hedging is frowned upon (clearly this diminishes the leverage aspect of owing a gold equity in the first place); thus financing large gold projects is a challenge." 

2. Earnings variability:

Earnings associated with the global gold industry "hasn't exactly been consistent with the gold price." 

3. Valuation:

"Many investors remain uncomfortable with the premium valuations at which gold equities trade relative to other mining companies. While there is a theoretical justification for this valuation, in our view, investors generally remain averse to paying a high multiple for a company which produces a commodity, the value of which is in itself questionable..." 

4. Other risks:

Gold mining companies have other risks which investors avoid including gold hedging, assets located in risky countries, or assets exposed to potential environmental liabilities. 

5. Alternatives:

"One of the most serious challenges to gold equity performance, in our view, is the development of a relatively new instrument, the gold exchange-traded fund (ETF). These vehicles allow investors to gain exposure to gold without the risks which come with owning a gold mine." 

"Given the performance challenges facing gold equities and the availability of attractive alternatives, we expect that gold mining equities may at best, perform in line with the gold price over the next several years," the analysts advised.

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responses to this article

GOLD FUTURES I READ YOUR ARTICLE WHICH STATES THAT GOLD PRICES CAN GO TO AN UPSIDE OF $2500. I AM NOT AN EXPERT IN PREDICTING GOLD PRICES BUT I STILL DO NOT THINK THAT PRICES CAN REACH THAT LEVEL. OVER THE PAST 12 MONTHS WE CAN SEE THAT GOLD PRICES HAVE RISEN . .more ABOVE $1000 AN OUNCE AND THEN WE ALSO SAW A DECLINE. BUT BECAUSE THE US CURRENCY IS VERY STRONG AT THE MOMENT IS CAUSING GOLD PRICES IN THE UK TO REMAIN VERY HIGH. IN MY OWN OPINION I THINK THAT SOME TIME IN THE FUTURE GOLD PRICES WILL WALL SHARPLY TO AROUND $750. HOWEVER THIS CAN POSSIBLY HAPPEN ONCE WE SEE ANY IMPROVEMENTS IN THE GLOBAL RECESSION. . .less by SHAHJAHAN AHMAD on March 12 2009, 04:28 Find this comment inappropriate? Report it

$2500. Gold NOT! W/O more jewelry demand, $2500. gold is a pipe dream, as is usual from the Euros! Pawn shops around here are already seeing more foot traffic. Why two unsustainable gold spikes in over 30yrs causes this much attn. & folly just proves how . .more gullible the public still is, God Help Them! . .less by SageNot on March 12 2009, 08:17 Find this comment inappropriate? Report it

Funny - did you read UBS's predictions last year for... Platinum, Nickel and Copper ? lolol. Where is that now ? If the crash taught us 1 thing (only), it's that absolutely nobody can predict.the future. Stop even trying "clever people". by Dave on March 13 2009, 01:53 Find this comment inappropriate? Report it

india demand I AM EXTREMELY SCEPTICAL OF GOLD PRICES EVER REACHING 2500$ MARK. THE BIGGEST CONSUMERS OF GOLD IN THE WORLD ARE INDIANS. THEY CONSUME ALMOST 30% OF THE OVERALL SALES WORLDWIDE. IN THE LAST 6 MONTHS THIS SALE HAS DROPPED BY MORE THAN 75%. INFACT . .more THIS QUARTER OVERALL NOS HAVE BEEN AN IMPORT OF BARELY 5 TONNES AGAINST 200 TONNES. INDIANS ARE EXTREMELY PRICE SENSITIVE ON THIS ASPECT AND HENCE OVERALL THERE HAS BEEN A LOT OF SCRAP COMING IN THE MARKET.. . .less by mitesh on March 13 2009, 06:13 Find this comment inappropriate? Report it

$2500.00 gold I think the comments to this article,fall short of the truth of the value of real money(gold silver) if the U.S. $ goes into hyper inflation we could see $10,000 gold , it would not be gold rising but the value of the dollar falling , with the . .more deficits and massive govt spending together with falling revenue due to the resession we will see the printing presses running 24-7 = hyperinflation.. . .less by leo on May 13 2009, 17:07 Find this comment inappropriate? Report it

Thumb Rule 1 oz of gold buys you a good suit. Still true today as it was in 1935. by Rule of Thumb on May 13 2009, 17:30 Find this comment inappropriate? Report it

anyone notice what China is doing? Perhaps you should because they are quietly buying gold.. ask yourself why? by Brennan on May 14 2009, 05:53 Find this comment inappropriate? Report it

Rule of thumb Then I should stock up on good suits. They seem to hold their price well by Richard on May 14 2009, 06:55 Find this comment inappropriate? Report it

China Yes, China is buying gold, and at a fast pace. Silver on the other hand is in short supply, unlike gold silver is used for many reasons. Right now the spot price is around $14, but try to buy an oz of silver on e-bay, $20 oz or so. The markets . .more are fixed, fraud. . .less by Guru on May 14 2009, 11:25 Find this comment inappropriate? Report it

Only way gold will reach $2,500 is if world goes back to gold standard Now that UBS has shelved their metals desk we're expected to believe this 'research'. Who does John Reade talk to nowadays? Their wealthy Swiss clients getting out of those suddenly all too transparent Swiss bank accounts. Sounds like they talking . .more their book here. China is stocking up on gold from their own production. Imagine if they weren't stocking up and that gold had to go onto the market. Imagine when China starts selling their gold surplus... India also has massive second hand (scrap) gold willing to be dumped onto the market at anything above $1,000. As long as gold lease rates remain low banks will sell spot gold to raise USD funding. No, the world would have to be in armageddon for gold to fly. Then what would be the point anyway? . .less by CONTANGO on May 14 2009, 13:19 Find this comment inappropriate? Report it

Evil men in power = High gold Gold prices are significantly tied to people's emotions, plus the natural factors of supply and demand.. As long as large portions of humanity are distressed about the future, gold will hold it's value. Gold remains strong due . .more to the long lasting worldwide economic damage caused by the warmongering criminal and torturer GEORGE W. BUSH (republican).. . .less by Truthseeker on May 14 2009, 14:55 Find this comment inappropriate? Report it

2500 is a low estimate Gold is the only true money. The printing presses are running 24/7 cranking out fake money all over the world. You people who think in the box are going to be very surprised. The day of having confidence in the U S dollar is past. It is a new day. . .more Do you remember playing monopoly as a child? Do you remember how often the kid acting as the banker would just eventually start taking money out of the bank? That kid is now in charge of the government and the real bank and the money is the same as that monopoly money. Tick tock, the clock is running and the end of another fiat experiment is upon us. . .less by Michael on May 14 2009, 19:06 Find this comment inappropriate? Report it

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