UBS Securities Canada Inc. is underweighting the hot energy sector. Resource stocks have become expensive, it suggests in a new report, and the firm counsels taking a more defensive approach.

“The bottom line is that we believe a more defensive tack is warranted for three reasons: stock prices have moved noticeably higher in relation to their underlying commodity prices in recent months; global growth is slowing and commodity prices tend to follow; and, non-energy commodities had largely ignored the [U.S. dollar’s] rise prior to its recent weakness,” it says.

UBS argues that the, “recent rebound in resource stocks has moved them to neutral or expensive territory when compared to the performance of their underlying commodity prices. This higher valuation, coupled with commodity prices that are still vulnerable to an eventual deceleration in global growth, suggests a more cautious stance for resource stocks is warranted.”

The firm admits that recent commodity price strength reflects the unwinding of fears of an economic “soft patch”. However, it notes that while it expects near-term economic data to continue to be firm, “the broad cycle remains that global growth is still decelerating towards trend”.

Within the resources, metals appear relatively attractive, UBS adds. “Sectorally, the surge in energy stocks has catapulted them to their highest levels since 1998 relative to oil and gas prices. Metal stocks, however, have only moved just above neutral relative to underlying commodity prices, and tend to perform well even after commodity prices peak,” it says. “Gold stocks look relatively attractive, but are particularly vulnerable to rising bond yields.”

Overall, it’s underweighting energy, while overweighting industrials, technology, health care and consumer discretionary stocks. It’s neutral on materials, financials, telecom, utilities and consumer staples.

“Energy stocks will react more symmetrically to fluctuations in energy prices, as the downside buffer they enjoyed for the last two or three years is no longer there,” it says. The firm is predicting that energy prices should moderate — with the oil price expected to average US$54 this year, US$48 next year and $42 in 2007 — leading to an underweight recommendation.

“Looking at the metals and gold outlook together, recognizing that their performance tends to counterbalance each other, and considering that they represent 75% of materials, leads to our neutral rating for this sector,” it explains. “On a temporal basis, we would rank metals, energy and golds in terms of relative attractiveness in the short run, while on a 12-month view it would move to golds, metals and energy.”