Gold could surge to $2,500 a troy ounce in the next five years because the prospects of either deflation or inflation were “becoming more extreme”, UBS said on Tuesday. The Swiss bank told investors to overweight gold in their portfolios.

The Swiss bank’s warning is the most radical among mainstream institutions and comes as some hedge fund investors who made money last year by betting against investment banks are now buying gold as a way of betting against central banks.

“The current environment is one which can best be characterised as having a ‘low margin of error’ for central bankers, with the prospects for deflation or inflation becoming more ex­treme,” said Daniel Brebner, analyst at UBS in London.

A bet on gold is considered by some as essentially a bet against all paper currencies.

“Given the broad uncertainties in the current macro climate we believe investors should look to gold, given its historic tendency to act as a hedge,” the bank said.

The bullish forecast failed to lift gold prices, depressed on Tuesday by lacklustre jewellery demand, traditionally the backbone of gold consumption, some profit-taking and an early rebound in financial stocks.

Spot gold in London was $896.5 a troy ounce in late afternoon trading, down from the previous days’ closing quote in New York of $920.95 an ounce. Gold prices hit a high of $1,030.8 last March and last month traded briefly above $1,000.

UBS, one of the biggest bullion dealers in London and Zurich, said the downside risks to gold prices were limited to about $500 an ounce, or less than 50 per cent below the current price, while the potential upside was $2,500.

Hedge funds that bet last year against investment banks are now betting against their ability to wea­ther the crisis without triggering a jump of inflation or letting the economy fall into deflation. Gold bulls include David Einhorn, founder of the hedge fund Greenlight Capital, who last year came under the spotlight for short selling shares in Lehman Brothers. Others looking at gold include Eton Park and TPG-Axon, investors said.

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