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Precious metals Gold (25 Jun): USD 1,573/oz (last month: USD 1,573/0z) UBS View (gold) 6-month target: USD 1,650/oz ¢ The price outlook for gold is largely tied to quantitative easing by the Fed. Although the probability has increased on weak US data, our base case still calls for no QE. Hence, current prices run on thin ice, in our view. In the absence of any monetary stimulus, the gold market is likely to be oversupplied by more than 400 tons this year. e Physical demand out of Asia remains lackluster. With the USDINR trading at a record high, the world's second-largest gold market, India, is likely to witness a steep decline in jewelry consumption and a rather firm increase in scrap supply. Central bank buying, estimated at 300 tons (7% of total demand) in 2012, will not be enough to clear the market. Right incentives — i.e. temporary price setbacks — are needed to motivate enough demand, before prices should manage to rebound towards USD 1,650/oz in 6 months. ¢ The negative stance from a absolute return perspective, should not overshadow the relative attractiveness of the yellow metal. The higher probability of QE3 by the Fed poses an upside risk to the gold price. Hence, we maintain our neutral position. A Positive scenario 6-month target: USD 1,920/oz e Additional quantitative easing measures by the US Fed and the ECB are implemented, or inflation accelerates sharply in emerging markets. This would drive the gold price towards USD 1,920/oz again. & Negative scenario 6-month target: USD 1,250/oz ¢ A liquidity crisis would curtail financial demand and weigh on the gold price. A similar impact would come from deflationary pressure (positive real rates), or a combined Chinese and Indian hard landing. What we're watching Why it matters Physical demand/supply from India. The health of coin and bar demand should be visible in the World Gold Council mid-August release. After the drop in PGM production, keeping an eye on South African PGM output is a must. Flows & rates To judge gold-related financing deals, we track gold export/import between Hong Kong and China. In addition we follow the latest uptick in ETF gold holdings and futures positions in gold to proxy investment demand strength. From an opportunity-cost perspective (real interest rate standpoint), we also look at the upcoming meetings of the ECB on 5 July and Fed on 1 August. 36 UBS Further INR weakness in the coming months should determine jewelry demand For further information please contact CIO's asset class specialists Dominic Schnider, dominic.schnider@ubs.com or Giovanni Staunovo, giovanni.staunovo@ubs.com Preference: neutral Recommendations Tactical (up to 6 months) e In case of a conversion into gold, investors should hold the position and target re- conversion at the original strike level. Over three months, we regard strike levels around USD 1,460-1,520/oz as attractive. With option volatility on the rise, the risk reward for selling volatility has improved. Strategic (1 to 2 years) ¢ The risks for debt monetization in the developed world and double-digit wage growth in China and India, the two largest gold markets, should ensure a steady rise in demand for gold and platinum over time. Physically backed ETF positions allow investors to participate effectively in higher prices. Positive real interest rates present a threat to this view. Gold in INR terms and Indian gold demand 3 ‘Standardized to 100 250 200 150 100 ap 50 0 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Mi India's gold quarterly demand - in tons (rhs) —Gald in USD terms (Ihs) Gold in INR terms (Ihs) Source: WGC, Bloomberg, UBS CIO, as of 19 June 2012 Note: Past performance is not an indication of future returns. 35 Please see important disclaimer and disclosures at the end of the document. HOUSE_OVERSIGHT_024170