Gold News

UBS's Gold Price Strategy

What the Swiss bank sees in inflation, bond yields and stocks for gold prices...
SENIOR strategist Brian Nick at Swiss investment, private and bullion bank UBS shares his views on the commodity markets with Sumit Roy of Hard Assets Investor...
Hard Assets Investor: What are your current thoughts on inflation and gold?
Brian Nick: I don't think they're necessarily closely related. If you look at the periods during the financial crisis and since the financial crisis when gold has done the best, there's almost no correlation between gold and inflation. In fact, there might be a negative correlation.
It's not that when inflation is higher, the price of gold increases. What you typically see is when there is a dramatic downward revision to growth prospects – as there was in the US in 2008 and again in 2011 – you tend to see gold do a bit better. Because what that means is your return on yield-producing assets, like fixed income and assets that have a risk premium associated with them like US equities, tend to go down.
A very extreme example would be a savings account in a bank. As your expectation for what you will earn on your savings account in a bank goes from 5 percent to 2 percent to zero, as it's been for many years, the cost of owning gold goes down. Because you're basically saying, "Well, I can either let my money sit in the bank and probably lose its value, because the rate of inflation is higher than the rate of interest it's earning...or I can put some money in gold, which I have some sense will do a better job of preserving its real value."
That's been the story. When you've seen gold do well – including the period earlier this year – it's usually because it's associated with falling real interest rates in the US And because we seem like we're on a path now where interest rates aren't going to continue falling in the US – if anything, we think they'll probably rise – that's going to be a negative for the demand for gold.
HAI: It's interesting you brought up the interest rates. The consensus seems to be that the Fed's going to start hiking short-term rates next year. Yet we've seen a notable decline in long-term yields.
Brian Nick: It's not an anomaly. We don't have a great handle on why it's happened, but there are a couple of plausible explanations. We've been talking to pension funds; people who look at pension funds have seen some rebalancing that's gone on since the beginning of the year. As pension funds become closer to being fully funded, they can afford to hold more fixed income. That could be one factor.
You also saw a weaker economic story in the first quarter, which probably caused interest rates to fall back a bit as we await more certainty in terms of whether the economy is actually growing at the 2.5 or 3 percent rate that we think it is, as the first quarter was negatively impacted by weather.
And another reason for the rate decline is that the Fed has been a little bit clearer in terms of the path it sees for unwinding its quantitative easing policy and eventually moving to actually raise interest rates next year. As that uncertainty around that event has gone down, the premium that may have been built in for investors to hold longer-duration bonds has gone down as well.
You also have the Fed saying that this is going to be a gradual process and it may only raise rates to a somewhat lower level when all is said and done than the markets had initially anticipated.
It does make sense that as we get closer to when we actually see the first interest rate hike from the Fed some time in the middle of next year, that long-term rates do move up in accordance with that. It's going to be more gradual than what we saw last year, but we do think interest rates are going to eventually move up. 
That's going to be bad for gold. The last time you saw gold prices have a huge run-up in nominal terms, comparable to what's happened since the mid-2000s, was during the 1970s and 1980s. When interest rates normalized after that from very high levels, you saw a pretty severe drop in the real value of gold, as there was just more of a demand on the part of investors to hold bonds and to hold other types of assets.
HAI: What's your outlook for economic growth? Are you bullish on the US? And how about China and the rest of the world?
Brian Nick: Yes, I guess you could call us bulls on the US if you think that 3 percent growth in the US is bullish. That puts us ahead of consensus for the year. It's going to depend a lot on what we see in the second quarter data.
It's going to depend on how much of the growth in the quarter we're in right now is real, versus just a bounce from things that were on back-order or had a backlog from the weather disturbances in the first quarter. We probably won't know until later in the summer/early fall what kind of year this is really shaping up to be. The first two quarters are going to be kind of funny.
But we're also now starting to see more confidence on the part of businesses to hire workers and to undergo acquisitions. And increasingly businesses are ready to invest in themselves. They're ready to undertake some of these capital expenditures that they've been sitting on or delaying for a number of years – partially because of the policy environment, partially because they were able to extract so much additional productivity out of their existing capital and existing workforce.
Those things have been largely absent from the US economy since the financial crisis ended. They're going to have a bigger impact this year, and the consumer should stay more or less about as strong as it has been, which means higher growth overall. Especially if you have the government no longer a negative factor for growth.
If you look outside the US, the story isn't quite as good anywhere else. I think Europe's got a decent trajectory. Germany's certainly growing. Spain is out of recession. But the level of growth is still slow in the continent as a whole, compared to the US
China is obviously going to grow more in terms of its actual growth rate than the US and Europe this year. But they have a different bar to clear. If they're growing at less than 7 percent, there's something amiss happening in China. And right now, we think the chances of a hard landing there – which we would quantify as less than 6 percent growth in 2015 – have gone up. We think that there's about a 30 percent chance that we'll see that next year.
The risks are definitely growing in China. We're seeing some pretty troubling real estate and housing market data, with prices falling and construction falling. That's been such a huge component of Chinese growth the last couple years that it's hard to see where they make that up.
We're more cautious on China. We've moved to neutral on Chinese asset classes. We're still overweight the US and we're overweight Europe.
HAI: In that context, do you see US stocks rallying even more from here, even after they've risen 29 percent last year?
Brian Nick: Yes, we do think that the S&P 500 still has upside from here. But our six-month forecast is only 1,965. That's not a huge increase from here. It's going to be largely earnings driven, not multiple driven. It's hard to get a 29 or 30 percent 12-month return for the S&P 500 without some upward multiple reweighting. We saw a lot of that last year.
Now stocks look fairly valued, so the growth from here is going to have to come from earnings, not as much from further multiple expansion. That's why we think it's going to be somewhat slower.
HAI: While we're on that topic, do you have any views on diversions between the S&P 500 and the Russell 2000 this year?
Brian Nick: It's interesting, because we've been big supporters of small-cap. The earnings outlook is still better. In a world where the US is the best economic story, it should make sense that the Russell should outperform. We've been a bit surprised this year by small-cap's underperformance.
One of the reasons for that could be that when we did have that momentum reversal in March, the sectors that got hit and the companies that got hit – some of the best performers from last year – tended to be disproportionately located in small-cap.
When you look at some of the technology stocks, or even the financials that tend to do less well when interest rates are falling than when they're rising, they've gotten hit this year. That's hurt the sector makeup of small-cap.
But we're still bullish. Small-cap valuations were probably getting a little bit overextended compared to large-cap. But now we're much more comfortable with the trade from here. It's already started to pick up a little bit of steam just in the last week or so.
HAI: Finally, I know you don't think the outlook for gold is too rosy, but are there certain commodity sectors that can do well? Maybe the economically sensitive ones, like energy?
Brian Nick: We're neutral on commodities in the asset allocations that we recommend to clients. That doesn't mean we're at zero; we're recommending between a 3-5 percent allocation to broad commodities for our wealth management clients. If our commodity analysts could pick one sector that they're bigger fans of than the rest, it would be base metals.
The dispersion of base metals performance has been pretty striking. You've seen copper get hit pretty hard earlier this year by the fact that it's kind of uniquely tied in to the China story. At the same time, you've seen a metal like nickel do quite a bit better because there's been export restrictions on it coming out of Indonesia, and it's even had a little bit of levering into the Russia/Ukraine conflict.
Base metals have been underperforming for quite a long time, even as commodities as a whole underperformed. But we think there are enough different drivers out there right now to give us confidence. That makes it our favorite sector right now. is a research-oriented website devoted to sharing ideas about investing in the natural resources sector. Published by Van Eck Associates Corporation, the site offers an educational resource for both individual and institutional investors interested in learning more about commodity equities, commodity futures, and gold – the three major components of the hard assets marketplace.

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