MS 2012 Outlook: Precious Metals

MS 2012 Outlook: Precious Metals Gold and silver are our preferred exposures given the heightened risks of a DM recession. Ongoing uncertainty surrounding the European sovereign debt crisis should be positive for safe haven investments. Moreover, an ongoing threat to the value and integrity of a major fiat currency (the euro), the renewed prospect of QE3 in the US and negative real interest rates are good news for gold/silver investment demand and prices in all currencies. Gold We remain bullish on price prospects over the medium term. Beyond the safe haven items noted above:1) The gold to oil ratio highlights that, on a long-term real purchasing power basis, gold is close to fair long-term value; 2) The prospect of sustained negative real interest rates reduces the opportunity cost of holding non-yielding assets. 3) Current USD strength is a headwind to USD gold prices, but our expectation of aggressive Fed easing and the adoption of QE3 in 1H12 is expected to boost golds performance materially. Silver Following a sharp correction in 2Q11, silver remains an attractively priced safe haven commodity relative to gold. However, silvers well attested volatility, its vulnerability to weakening industrial demand, and weaker supply credentials make it a less fundamentally supported market than gold. Platinum /Palladium We are less bullish on the Platinum Group Metals. Platinum lacks safe haven status and has limited investment demand. With jewelry and the automotive industry as key end markets, slowing global GDP and lower discretionary spending put demand at risk. Palladium is less exposed to the demand consequences of weakening EU auto demand. However, palladiums jewelry and investment demand base is even more limited offering little protection in a slowing growth environment. Gold: Preferred Metals Exposure Getting defensive: Gold remains our preferred exposure heading into 2012. Gold, and silver to a lesser extent, are viewed as safe havens and stores of value, as well as the closest thing to a global reserve currency. Not surprisingly, in analyzing commodity performance around previous US recessions, we find precious metals (especially gold) tend to outperform other commodities. Given the lack of progress in the Eurozone and US and our economists bearish economic forecasts, we feel it is prudent to position defensively, making gold an attractive investment option. Beyond macro weakness, heightened risk aversion and policy uncertainty should continue to benefit gold in 2012. We expect ongoing market uncertainty regarding the ability of European policy makers to deliver a credible shock and awe solution to the sovereign debt crisis will continue to be positive for gold investment demand over the coming year. Gold is once again close to long-term fair value, creating an attractive entry point. The fall in the goldto-oil price ratio highlights that on a long-term real purchasing power basis, gold is once again close to fair value, which should attract bargain hunters. We arent deterred by the recent sell

off as temporary price corrections are a normal occurrence during a bull market. The corrective price action since September has stalled the uptrend in gold, but has not reversed its primary direction. Such non-trend reversing price corrections are healthy and have been evident throughout the 2001-2011 bull market, especially since the acceleration in the uptrend from 2009. USD strength likely to be offset by aggressive Fed easing. Projected USD strength should be a headwind to short-term gold price performance. However, we expect an aggressive easing of financial conditions by the Fed in 1H12, including a heightened probability of QE3, to provide an offset. QE in its earlier manifestation was positive for gold and silver prices.

Gold: Uncertainty Over Macroeconomic Trends Is Key To Support Demand Risk aversion boosting investment demand. The lack of progress on the Eurozone debt crisis and US deficit reductions provided a major stimulus to investment demand for gold as a safe haven asset for much of 3Q11. Threats to major fiat currencies should drive additional buying.

With the Eurozone sovereign debt crisis moving from the periphery to the core (Italy, Spain), an ongoing threat to the value and integrity of a major fiat currency is positive for gold investment demand and prices in all currencies. Negative real interest rates increase appeal. The prospect of a long period of negative real interest rates is bullish for investment demand as it reduces the opportunity cost of holding a non-yielding asset. Supply Limited central bank selling. Central banks are sending strong positive signals to the gold market. Global net purchases of 100 tonnes in 1H11 accelerated the net buying trend that emerged in 2010. Despite the protracted crisis, European central banks have been notably absent as sellers, notwithstanding very elevated prices. Emerging market central banks continue to be net buyers, accelerating purchases during the course of 2011, despite persistently rising prices. Insufficient new production. Mine production is increasing once again, rising 6.2% YoY in 1H11. However, this new supply is insufficient to keep pace with the combined effects of investment demand, central bank buying and only modest growth in secondary supply

Silver: Safe Haven Status Should Reemerge, but Volatility Likely to Continue Higher volatility here to stay. The high level of volatility in silvers 2011 price performance has been nothing short of dramatic. The sharp rise in the silver price between late March and May caused the gold:silver ratio to narrow sharply, reaching its lowest point since October 1980 at 30:1. Following successive increases in the Comex margin requirements, the gold:silver ratio stabilized until the third week of September when a 23.4% fall in silver prices pushed the ratio back to the long-run average of 54:1 despite an 8.5% fall in gold prices. Silvers industrial exposure has jeopardized the gold-silver ratio. Silvers precious metal status and, therefore, its links with gold have traditionally been reinforced by investors preference to hedge systemic financial risk, rising inflationary pressures, and resurgent political risk through a cheaper vehicle with similar value storing characteristics as gold. However, mounting concerns about slowing industrial demand, a key end market, put silvers traditional links to gold under increasing pressure. Safe-haven status should be reinstated in 2012. Despite silvers relative underperformance vs. gold in 2H11, we expect the implied erosion of silvers status as a precious

metal safe haven to be temporary. 1) The recent weakness in silver prices should attract bargain hunters. If sovereign debt concerns persist, silvers potential as a cheap store of value is likely to overwhelm demand concerns, which appear to be mostly priced in. 2) Low opportunity cost. As with gold, an expected lengthy period of negative real interest rates should reignite investment demand for silver as a non-yielding asset, even in the absence of a renewed round of QE. 3) Slowing outflows from physically backed ETFs. An extended period of negative real interest rates will also be critical for quarantining the risk of large outflows of silver from physically backed ETFs. To date, recent evidence suggests that long liquidation pressures have been stronger in the paper silver market than in the physical investment market. Gold Silver Ratio

Platinum: Any Recovery Must be Led by Demand Supply While operational constraints remain a feature in the South African mining landscape, supply discipline is not on the agenda. Many of the large, medium and small cap platinum companies have near and mediumterm growth projects under active development. While slippage is likely, the lack of appetite for active supply discipline is a concern in a risky demand environment especially given the political constraints to cutting high-cost production.

Demand As industrial demand for platinum correlates to global GDP growth, we believe demand-side risk is skewed to the downside. Critically, European autos account for 22% of gross platinum demand, making this segment the single largest regional driver of demand. The nonauto global industrial segment represents 24% of platinum demand , and faces similar nearterm headwinds from slowing global GDP growth and industrial production. Jewelry demand a relative positive, but not enough to support prices. We expect jewelry demand in China to account for 22% of gross platinum demand in 2011and to remain a key price-elastic support for platinum demand. However, we do not think this component can drive up the price. A weaker supply and demand balance and a stronger USD potentially impair investor interest in platinum. Platinum could see some marginal investor buying given the increased appetite for precious metals as a safe haven asset. However, we expect any defensive buying to be limited and more than offset by poor fundamentals. Needless to say, we view gold as a far superior safe-haven asset, as demonstrated in 2008.