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."

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."

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
  2. Earnings variability
  3. Valuation
  4. Other risks: Gold hedging, geopolitical risk, 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."

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