Saturday, May 16, 2009

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

GOLD EQUITIES UNDERPERFORMANCE TO CONTINUE 

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

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. 

By Dorothy Kosich

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