>GOLD: Macro and financial factors driving gold returns over the past three years should remain in place for 2012.

Goose with the Golden Eggs

 Gold holds a unique historical status as a non-consumable commodity universally

recognized as a medium-of-exchange. Given the large amount of non-perishable

inventory overhang, traditional demand-and-supply dynamics do not apply in the short

term. In times of macroeconomic stress, financial factors may drive gold prices well

above physical costs of replacement for extended periods of time, thus exhibiting

“bubble-like” characteristics.

 There is a high probability that macroeconomic and financial factors which have

propelled gold prices over the last three years will continue for the next 12 to 18

months. We look at three major macro-financial drivers of nominal and real gold price

returns: denomination effects from inflation and currency adjustments, followed by real

interest rates, and finally financial demand for gold as a safe haven.

 Denomination — Nominal gold prices quoted against the US dollar must reflect

changes in the value of the denominator. Common measures of changes in the

purchasing power of the US dollar include consumer price inflation and currency

exchange rates against a weighted basket. This has accounted for some but not all of

the appreciation in nominal gold prices.

 Real Interest Rates — Once adjusting for denomination effects, real interest rates

serve as a useful proxy of the value of holding purely financial as opposed to physical

assets, thus capturing the opportunity cost of investing in gold. Given the weak

economic outlook, we expect central banks to keep nominal and real interest rates low,

providing the impetus to drive gold prices higher.

 Financial Demand — Lastly, gold has seen an unprecedented amount of financial

demand from both retail investors and central banks seeking a safe-haven against

other asset classes. Given the high level of market uncertainty and continued turmoil

from the euro-zone crisis, this financial demand should continue into 2012.

 Gold Price Outlook — We forecast nominal gold prices, which averaged $1220/t oz in

2010, to average $1575 in 2011 and $1950 in 2012.

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