CITIGROUP: Macro, supply/demand forecasts mix could send gold soaring to $1,000/oz

From Mineweb:

Citigroup suggests that $1000/oz gold could become a reality if a mix of macro and supply demand forecasts sufficiently gel to send gold soaring beyond its historic ceiling of $850/oz.

Dorothy Kosich
RENO, NV -

Citigroup metals analysts said Monday they are positive on gold "based on a mix of macro and supply/demand forecasts," that could send gold beyond its historic ceiling of $850/oz to as much as $1,000/oz or higher under certain circumstances.

Noting that 2007 is running $62/oz above the 2006 average of $605/oz, analysts John H. Hill and Graham Wark declared that "we would not be surprised to break its historical highs of $850/oz."

The analysts theorized that the policy resolution to the current credit crunch may be "an extended ‘Re-flationary Rescue,' in a new cycle of credit creation and competitive currency devaluations that should be inherently positive for pro-cyclical basic materials, hard assets, oil and gold."

"This could take gold to $1,000/oz or higher," they predicted.

Citigroup hiked gold forecasts for 2009/2010 to $800/$820/oz and long-term valuation to $700/oz. "Within this, a test of $850-$1000/oz is likely," they advised.

Investment Returns with a Vengeance

Citigroup's research suggests that gold is entering a new investment-driven phase as gold market drivers "tend to oscillate between bouts of eastern physical/fabrication demand and western investment demand."

The analysts asserted that "the handoffs back and forth between these demographically distinct buyers, typically over six- to nine-month intervals, continue to define gold's stair-step ascent over the past five years. Investment driven-upside, typically featuring retail investors responding to macro jitters, tend to be violent and shorter-lived. Fabrication support tends to play off in a more muted manner."

Nevertheless, Citigroup feels that "investment has returned with a vengeance. This was driven first by safe-haven demand during the credit crunch and now by greater awareness of gold's critical role in the ‘re-flation trade'. Investment patterns in physical gold are mirrored by the equities."

Gold Equities Looking Good

In Citigroup's research, Hill and Wark noted that a powerful resurgence in investment demand has coincided with seasonally strong fabrication offtake, which "may extend the move to the upside." However, the Indian/Asian holders who would normally be selling aggressively into the current rally are limited by pre-buy ahead of the western holidays, Indian festivals in November, and the Chinese New Year in early February.

The September close of the central bank sales year also brings relief to the pressure to sell gold, according to the analysts. "As a result, there is a good chance that the gold rally will continue through year-end, followed by a correction in early 2008 when Indian/Asian holders have more latitude to sell," they advised.

Meanwhile, Citigroup noted that gold ETFs have set a new high of 759 T, up 21% since the end of June and valued at $18 billion.

‘The behavior of gold equities closely mirrors action in the physical market," Citigroup noted. "It is no accident that the equities awakened simultaneously with investment demand for bars, coins and ETFs."

The good news, Citigroup suggests, is that gold stocks are finally outperforming gold, as investment demand rekindles. "After early signs of life in 2Q/07, our broader-based gold composite has tacked on +28.4% in the second half of this year to date. This is notable because the stocks have lagged gold since 2H/05. In 3Q, star performers were Barrick and Agnico Eagle."

Citigroup's analysis also indicates that stocks are showing leverage to the gold price. "Longer term it is reasonable to assume that growth companies with superior executive can deliver betas of roughly 1.5x the gold price."

Supply/Demand Considerations

Hill and Wark claimed that central banks "have been forced to choose between global recession, or sacrificing control of gold, and have chosen the perceived lesser of two evils. We expect sales to continue to run in the 400-500 TPY range and see this as a normal, recurring feature of the gold market. Long-await official sector accumulation in dollar-overweight/gold-underweight countries like China and Saudi Arabia could provide a catalyst."

Citigroup believes that growth in the Chinese market and western ETF demand can easily absorb central bank gold sales and de-hedging from gold miners, particularly since the global hedge book standards at 1,064 T or roughly 8.5 months of mine production, the lowest since 1995.

Company Earnings

The analysts raised EPS estimates for the second half of this year and 2009.

Barrick Gold (ABX) remains Citigroup's favorite as the analysts hiked the target price from $43 to $48 a share, citing "higher long-term gold assumption." Possible catalysts include the advancement of the Pascua/Lama project; day-lighting non-gold assets; buying the minority interest in the Cortez operation; buying back shares; and reduction of what the analysts called "the increasingly unwieldy project hedge book."

The analysts also praised the hidden value of Barrick's non-gold portfolio. "While there is no need to immediately monetize them, we see asset value gains as offsetting mounting MTM losses on the project hedge book, which was about $4.1 billion at the end of Q3."

Hill and Wark admitted that they were disappointed with Newmont's announcement concerning higher unit costs and lower reserve replacements. To achieve financial and operational improvements, Citigroup suggests that Newmont needs to return to normal production at Batu Hijau; have the new Leeville underground mine achieve commercial production; and achieve better power availability in Ghana. Nevertheless, problems remain with higher diesel and Australian-dollar costs, start-up issues at Phoenix and the closure of Midas due to a fatality.

Citigroup remains positive on Freeport McMoRan Copper & Gold (FCX), raising the share target price from $120 to $122/sh. Nevertheless, the analysts warned Freeport investors to be prepared for three "false negatives" including so-called falling production, royalty rumblings in Indonesia, and delays/cost escalation at the Tenke project.

Nova-Teck?!?!

The analysts raised the target price for NovaGold Resources (NG) from US$18 to $23/sh, and upgraded it from "Hold/Speculative" to "Buy/Speculative" with an expected share price return of 38.3%. Citigroup cited a possible 50-50 settlement with Barrick in the battle over Donlin Creek, and a consensus that values NovaGold at 30% of Donlin.

In fact, Citigroup believes that "Canadian major Teck could potentially create an innovative, negotiated solution to the Donlin impasse with Barrick. This might involve contributing Donlin, Galore, and Teck's large Pogo gold mine to ‘Nova-Teck', with Barrick taking a minority shareholding in exchange for some/all of its Donlin stake plus the Grace claims near Galore."

"In this way, expensive, time-consuming litigation might be avoid, while providing investors with an exciting new mid-tier North American-based gold/copper miner," they suggested.