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UBS worries that gold may be losing its luster

While other investment firms have recently lauded gold, the UBS Investment Research group was far more pessimistic in its most recent report, noting that UBS clients are “increasingly questioning the role of gold in a portfolio.

RENO, NV - 

In its latest analysis published Thursday, UBS Investment Research questions if gold has lost its luster, citing the breakdown of the relationships between oil and gold, and between the U.S. dollar and gold.

"Overall, we are growing more concerned that North American gold equities may have lost their relative multiple advantage over other commodity producers and may offer less portfolio protection in the event of a broader equity market downturn," the analysts said.

Noting that gold has long held an advantage to other metals due to its role as a reserve currency and an inflation hedge, UBS analysts claimed that gold is no longer a reliable portfolio hedge for generalist investors.

"More recently, gold bullion has underperformed oil and has not shown its typical negative correlation to the U.S. dollar or the broader markets," the analysts said. "Political risks premiums are also at records lows which has eroded gold's role as a safe haven investment."

"Consequently, many of our clients have been increasingly questioning the role of gold in a portfolio."

Meanwhile, UBS also raised the question of whether gold equity valuations have become permanently impaired? "While bullion has underperformed its traditional relationships, gold equities have significantly underperformed bullion since February 2007," according to their analysis.  Golden Star is the only gold equity that outperformed bullion over the last three months, according to UBS.

"The underperformance of gold equities versus bullion can be explained by a) the emergence of the gold ETF and its cannibalization of investment flow; b) the better equity performance recently available in base metals; c) strong gains from some of the fringe metals such as molybdenum; d) there have also been fewer gold discoveries made which has minimized the optionality of gold equities."

UBS asserted that gold margins have eroded, claiming that "operating and capital costs have increased more rapidly than the gold price if one excludes by-product credits." They attributed poor cost performance to the lack of new mine development and an aging asset base. "New development projects are generally inferior in quality to existing assets and new growth is coming at the expense of free cash flow."

"Why pay a premium valuation for operational underperformance, execution risk, the potential for dilutive acquisitions for the sole purpose of growth, and most importantly a more opaque supply and demand balance?"

Noting that Barrick Gold Chairman Peter Munk recently admitted that Barrick may have to eventually expand further into non-gold precious or base metals production if its share price continues to underperform, UBS suggested that perhaps "all gold companies should pursue base metal or platinum acquisitions while they still have a multiple advantage."

Despite today's trend of producer de-hedging, UBS asked if "perhaps gold companies should also pursue hedging if gold optionality is no longer superior to base metal optionality?

Although North American gold equities on average are at an 11% discount to forward curve NAV valuations, UBS suggested that "base metal equities still look even more inexpensive," which are at a 24% discount.

Despite their misgivings about the value of gold equities to a portfolio, UBS still remains bullish about North American gold producers Kinross (KGC), Agnico-Eagle (AEM) and Goldcorp (GG), "whether using our traditional multiple approach or the forward curve pricing scenario."

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