UBS on Gold
Americas Precious Metals
Mining Update
Gold Price Revised
* UBS recently revised USD/EUR forecast:
UBS has cut the end 2004 forecast to USD/EUR to 1.32 from 1.40, while
maintaining the 1.40 USD/EUR rate for 2005.
* UBS updates forecast gold price:
As a result of UBS changing its USD/EUR exchange rate, UBS gold analyst John
Reade has updated the UBS gold price forecast. In annual terms the new UBS
gold price forecast that gold will average US$422/oz in 2004, compared to
US$447/oz before; for 2005 we forecast US$455/oz, compared to US$430/oz
before.
* Outlook for gold still positive:
UBS continues to forecast that gold will trade higher from the current
level, however, due to the change in our economists' forecast for USD/EUR,
we now forecast that the peak in gold will occur in the first quarter of
2005 rather than the fourth quarter of 2004.
* Equity ratings unchanged:
The Gold Equities in our coverage universe remain rated at Buy 2, although
there have been some changes to our EPS estimates. Target prices have also
declined by approximately 11% on average. Details on a company-by-company
basis can be found in Table 2 and 3 contained herein.
Introduction
As a result of UBS changing its US/EUR exchange rate, UBS gold analyst John
Reade has updated the UBS gold price view. The report outlines the rational
for UBS's changes to its gold commodity price forecast.
Gold Price Update: Attenuation
Gold rallied, not without interruptions, from a 22-year low of US$252/oz in
the first quarter of 2001 to a 16-year high of US$430.50/oz at the start of
April. Since the start of April, however, the metal has retreated and at last
weeks low of around US$378/oz, was down more than US$50/oz from its highs.
Three factors were behind the fall:
Firstly, the trend weakening of the US dollar paused for breath in the first
quarter of 2004. Verbal intervention from the ECB and European national
central banks saw the USD/EUR retreat from highs around the 1.2900 level and
the euro traded as low as 1.1760 in late April before edging higher over the
past week.
Secondly, speculators built up large net long positions in March despite a
generally stronger tone to the US dollar. With more than 22 million ounces of
net longs on Comex and more in the over the counter (OTC) market, a USD
related decline in the dollar-denominated gold price triggered the first phase
of the sell-off in gold.
Finally a combination of fears of rising US interest rates and a slow-down in
China saw widespread weakness in metal prices in late April.
The dollar gold price and the size of the Comex-trading speculative gold
positions are shown on Chart 1 below:
Speculators built up all-time high net long positions in gold before the
recent bout of profit taking
The recent sell-off in gold is clearly shown, together with the liquidation
from speculators that drove it.
Commodity cycle possibly attenuated, not over
The broad outlook for commodities remains positive according to Peter Blight,
global mining and commodity analyst at UBS. While the magnitude of the recent
sell-off indicates that there is more hot money in the metals market than we
had expected. US growth is meeting our expectations of around 5.5% average
industrial production growth for the year - and even if strong US growth leads
to higher interest rates, as seems inevitable, comments from Chairman
Greenspan after the May FOMC meeting indicates that increases will be steady
rather than rapid.
China remains, as usual, the main area of uncertainty. We had already forecast
a considerable slowing in Chinese GDP growth this year - from 11.5% in 2003 to
9.6% in 2004 and 7.4% in 2005 and there is nothing in the recent moves by the
Chinese government to slow growth to suggest that the landing will be harder
than we are expecting. China's direct impact on the global gold market is
limited at the moment as China produces and consumes around 200 tonnes of gold
per annum.
Gold consumption has not grown over the past few years despite the rampant
increases in demand for other commodities including base metals and platinum;
consequently we do not fear a slow-down in underlying demand from any landing
in China, hard or soft. But any diminishing of the Chinese growth story would
affect broader investment in physical commodities, including gold.
We do not believe that the commodity cycle is over but it may have changed
shape, becoming more attenuated than we had previously expected as US business
inventories are not growing strongly and capacity utilization is low by
historic stands.
US dollar adjustment to be prolonged
Our economists continue to believe that the US dollar has further to fall
although they have changed the profile of the USD forecast. Instead of the
USD/EUR rising to 1.40 by the end of the year, we can and should now allow for
a slightly more complicated and longer period of currency adjustment. Now
therefore, we have cut the end 04 forecast to USD/EUR 1.32 while persisting
with the 1.40 rate in 2005. (A more complete extract of UBS' Global Economic
Focus, 22 April 2004, George Magnus appears on page 11 in Appendix 2).
Implications for the gold price forecast
Regular readers of UBS gold research will note that we base our forecasts on a
model derived from two variables. The most important factor that drives the
dollar denominated gold price is the strength or weakness of the US dollar;
the other factor is the level of speculative and investment money positioned
in gold. We use the USD/EUR exchange rate as a barometer of the strength of
the US dollar with a strong euro equivalent to a weak USD. Whilst it is
impossible to estimate the size of investment and speculative positions in
gold, the commitment of traders report of Comex gold futures and options
position appears to give us a good proxy for overall investment in gold. Work
undertaken in conjunction with Simon Kendall, UBS gold equity analyst in
Johannesburg, South Africa demonstrates that there is a better than 95%
correlation coefficient between XAUUSD, EURUSD and the Comex net long
position. The formula from this work, together with our USD/EUR forecasts and
our predications of speculative long positions in gold are the basis of our
determination of our forecasts for the dollar-denominated gold price.
Clearly the change in forecast of the global economics team to draw out their
forecast dollar weakening has resulted in a similar change in our gold price
forecasts.
We continue to forecast that speculators will hold and indeed rebuild their
net long positions in gold - with positions growing as the euro weakens and
the gold price moves higher. Our quarterly profile of forecasts is shown
below:
Table 1: Prior and Revised Gold Price Forecast
Source: UBS
We continue to forecast that gold will trade substantially higher from the
current level around US$395/oz however due to the change in our economists'
forecast for USD/EUR, the peak in gold occurs in the first quarter of 2005
rather than the fourth quarter of 2004. The peak of US$470/oz is lower than
the previous peak of US$480/oz because of our forecast for higher US interest
rates, which will prevent gold hitting the highs that we previously expected.
Increasing interest rates will also contribute to the sell-off in gold that we
expect for 2005 and 2006.
In annual terms we forecast that gold will average US$422/oz in 2004 compared
to US$447/oz before; for 2005 we forecast US$455/oz compared to $430/oz
before; and for 2006 we forecast US$398/oz, compared to US$388/oz before.
The chart above shows the relationship between the gold, the euro and the
Comex speculative long positions. The X-axis shows the EURUSD exchange rate;
the Y-axis shows the dollar denominated gold price and the parallel lines
represent various levels of Comex speculative long positions. As well as a
graphical representation of the model, it also allows alternative forecasts to
be generated for different assumptions of EURUSD and speculative long
positions.
Equity Implications
As a result of the gold price change, we have updated our 2004 and 2005 EPS
forecasts as well as our NAVs. A summary of these changes and our target
prices are given in tables 2 and 3 below.
Table 2: Earnings estimates for the NA senior and intermediate gold producers
Source: UBS estimates
Overall, our EPS forecasts for the NA gold equities declined in 2004, with the
lower expected average gold price for the year. Conversely, we also now expect
2005 EPS to be higher given our revised gold price for that period.
The table below highlights the net asset value assumptions, target prices and
potential return for the NA gold companies under coverage.
Table 3:Net asset value and target price revisions and potential returns
There were relatively minor adjustments to our net asset value assumptions
using UBS' long term gold price of US$325/oz. The lower gold price assumption
in 2004 was offset be the higher price assumption in 2005. We also highlight
our net asset value estimate for each company generated using a UBS's average
gold price assumption in 2004 as a long-term price. We utilized UBS' explicit
gold price forecast of US$422/oz (revised lower from US$450/oz) for 2004 to
derive our net asset values on the premise that gold stocks tend to price in
prevailing gold prices. We then applied a multiple to our net asset value
estimate based on a number of company specific factors (see research: "North
American Gold Equities," 12 February 2004) to derive our target prices.
Overall, the target prices declined between 6% and 17%, with the more levered
producers such as Agnico-Eagle and Bema Gold the most impacted. Overall, the
senior producers fared better than the intermediate producers. All our ratings
remained Buy 2 to reflect our assumption that gold prices will rise over the
coming quarters and average US$422/oz in 2004.
Of the intermediate producers, Wheaton River and Bema Gold have the highest
returns to target. Of the senior producers, Freeport McMoRan and Placer offer
the greatest upside over the next 12 months in our opinion.
Appendix 1
Gold
Table 4: Gold supply and demand balance
Source: GFMS; UBS estimates
Gold rallied to a 16 year high of $431/oz in April 2004 driven by dollar
weakness and speculative buying
The bear market that saw gold fall from US$418 to US$252/oz between 1996 and
1999 appears to have ended in early 2001. Gold rallied steadily from the first
quarter of 2001 reaching a high of $430/oz in the early January 2004 and again
at the start of April before succumbing to long liquidation prompted by dollar
strength and increasing US interest rate expectations.
Gold has performed much less impressively in other currency terms
While fundamental supply and demand factors have had a role to play, the
weakness in the US dollar has been the major factor behind the move higher in
the dollar-denominated gold price. The performance of the gold price in other
major currencies has been much more subdued, broadly sideways in euro and
Swiss franc terms over the whole period and unexciting in yen terms in 2003
after large moves higher in 2001 and 2002.
Speculators amassed record long positions in January and February 2004 before
cutting positions in April
Speculative and investment buying has also contributed to the move higher in
the gold price. Comex-trading speculators amassed a record 22.56 million
ounces of net long position in April 2004 - much higher than the previous
all-time high of 14moz in February 1996 - but profit taking has subsequently
seen this position reduced to around 10 million ounce. Similar patterns have
been noted in the over-the-counter market.
Supply and demand fundamentals have weakened as the gold price has climbed
Higher gold prices have seen supply and demand fundamentals for gold
deteriorate as physical demand is hit by higher prices and scrap supply has
increased. Thus the gold price is being supported at the current levels by
speculative and investment flows, rather than fundamental factors.
Further US dollar weakness will likely drive gold higher peaking early in 2005
before declining.
The risks of short-term liquidation has passed, we believe and we forecast
that further weakening of the US dollar will see the dollar-denominated gold
price rally over the remainder of 2004 and into early 2005. We forecast that
gold will average US$422/oz in 2004 and US$455/oz in 2005, peaking in the
first quarter of 2005 at an average of US$470/oz before declining through the
balance of 2005 and into 2006.
Gold has traded higher this year, hitting a level not seen since 1988 on
dollar weakness and speculative buying before heading lower on long
liquidation
Speculators built up all-time high net long positions in gold before the
recent bout of profit taking
We forecast that primary gold mine supply will decline further in 2004-2006
Central bank sales remain steady around 550 tonnes per year. We believe the
risks are of surprise buying of gold by the official sector rather than shock
sales
Gold mining companies have been reducing the size of their hedge books. We
expect this to continue, albeit at a slower rate
Jewellery demand, in decline since 1997, should fall further in 2004 although
we forecast a modest recovery in 2005-2006
One of the faster growing applications for gold, electronics demand, was hit
by the tech slowdown and is only slowly recovering
Higher gold prices have hit physical demand for gold while boosting supply,
especially from scrap. This has brought the market into a large surplus,
before investment and speculation
We forecast that gold will trade higher on expected weakening of the US
dollar. We forecast that gold will average US$422/oz in 2004 and US$455/oz in
2005
Appendix 2
Global Economic Focus, 22 April 2004, George Magnus
US Dollar view, small shift, imbalances still rule ok:
Reflecting in the main the downgrade to Eurozone economic forecasts and the
incorporation of an ECB rate cut in Q4 04, we have changed slightly the
profile of our USD forecast. Instead of the USD/EUR rising to 1.40 by the end
of the year, we can and should now allow for a slightly more complicated and
longer period of currency adjustment. Now therefore, we have cut the end 2004
forecast to USD/EUR 1.32 while persisting with the 1.40 rate in 2005. There
are three other factors we should cite.
While moderating the end-2004 EUR rate to 1.32, we keep with 1.40 for next
year and shed a new focus on JPY with forecast extended now to USD/JPY95 in
2005
First, there has been renewed focus on the JPY, not least because after the
massive intervention in Q1-04, the authorities seem to have backed away. Not
that they've needed to be obvious because the hiatus about US interest rate
expectations has been clearly helping to either drive some "hot" money into
the USD or cause investors to unwind many carry trades based in USD, where
foreign currencies or commodities were the beneficiary. None of this can enter
the 2005 currency call configuration but it reminds us that the JPY can
probably stand on its feet now at higher levels in view of the preceding
comments about Japan. Our JPY forecast still stands at JPY100 for the end of
2004 and has been extended to JPY95 for the middle of 2005.
Second, we have no new specific currency regime changes to note for 2005.
Which is not to say they won't happen, but at the time of writing we still
think that the China and Asian foreign currency regimes will change only
moderately and without any obvious timing.
Plenty of noise over trade data and Fed expectations
Thirdly, in general, we still believe that the most likely medium-term path
for the USD is down. It's possible that, as now, periods of US export
strength, will lead to temporarily better trade deficit numbers, even a more
stable current account deficit. And in turn, this could be compatible with
improved USD sentiment. For choice, though, we fancy that it's the brouhaha
over Fed policy and the market implications of the shift that are causing all
the noise in the currency.
Medium term, imbalances still key. The fiscal and private sector imbalances
won't improve enough on our forecasts to allow major CAD reversal
But over the medium term, when noise and flows fade in importance, it's those
imbalances that still represent the main reason for the USD's expected decline
and overshoot. We should probably avoid an ad nauseam repetition of the
current account arithmetic here but suffice to say the following.
First, if the fiscal deficit is going to be of the order of 4-5% of GDP and
the private sector's financial balance remains around "in balance" to -1% of
GDP, the external deficit is not going to improve.
But eventually tighter monetary policy will allow the private and external
imbalances to improve. Imprecise timings however
Secondly, as monetary policy tightens into 2005 and nominal and real rates
start to firm, there is every possibility that the private sector's financial
balance will improve, returning on a more durable basis into a more
sustainable surplus.
First, USD will drop as domestic demand slows further, but around the second
corner, the seeds of USD reversal will have been sown. To be dealt with when
the time comes!
Note though that this will comprise bad and good news with impossible timings!
Initially, the bad news is that the private sector's improvement must be the
other side of the coin that reads "slower domestic demand" and is part of a
wholly desirable adjustment process. The USD would likely fall further as
markets take this on board. The good news though is that a USD turnaround and
revival awaits sustainable improvements in the current account deficit, which
should flow from the private sector's financial adjustment as described. That
though may be to look around the second corner before we have negotiated the
first.
Market Data 
Markets 
AI
