Citigroup forecasts the gold price to reach $1,000/oz

Noting that gold had broken through $900/oz with relative ease and citing various economic factors that are regarded as friendly to the gold market, Citigroup's analyst John H. Hill said he expected the gold price to test $1,000/oz. Citi has raised its price forecast by roughly 20% to the range of $900-1,000/oz between 2008 and 2010.

The latest Citigroup North America Mining & Precious Metals report indicated that physical selling pressure and flows of recycled scrap had been light. This suggests that Asian markets are becoming acclimated, and that much of the available scrap was flushed out in 2003-2006.

Gold has been driven above $900/oz by a "potent push" of investment demand, the report said, noting that in the near term scrap flows should increase, given that it is price-elastic, and for core fabrication demand should ease.

"Gold is coming into its own: With discourse dominated by credit crisis, derivatives dislocations, currencies, inflation and self-reinforcing financial negatives, we believe gold is entering friendly macroeconomic territory," said the report. "Investment dominates demand ... with Western macro-driven investment demand taking prices higher, and Eastern jewelry/fabrication filling in during periodic pullbacks."

In boosting its price forecast, Citi cited the record highs reached after gold scaled the $900/oz mark, and added: "We believe gold has entered a new investment-driven phase, amid a much more hospitable macro environment. While gold prices have been rising since 2002, this was largely due to the pull from pro-cyclical basic materials and oil in a benign if unbalanced macro environment."

The report said the gold market is now being driven mainly by the credit crisis, derivatives dislocations, currency debasement, inflation and self-reinforcing financial negatives threatening US recession and synchronous global slowdown and that the market is entering friendly territory.

"We remain positive on gold, based on a mix of macro and supply-demand drivers; the forces that have propelled gold for the past five years are in place, and intensifying," said the report. "Appreciation remains muted relative to other metals and oil, with prices barely regaining long-term constant-dollar averages .... Corrections are expected along the way, and buying on weakness is recommended, which seems to be the central lesson of the past five years."

The report continued: "Within the pulse of investment demand, catalysts [for the gold market rally] have shifted from safe-haven demand during the early stages of the credit crisis in August-September 2007, to currencies as the US dollar plummeted, to the broader reflation trade on display in oil. Coordinated Fed and central bank action to thaw credit markets and boost liquidity should be positive for hard assets and gold."

Gold has been attracting new groups of powerful investors, institutional asset allocations to commodities, and Citi expects this trend to continue.

"With equity and fixed income [markets] facing stiff headwinds, we expect weightings toward gold to increase especially as it has been rising in multiple currencies," said the report. "This could be amplified by petro-dollar flows and sovereign investment funds.... We continue to see gold as a small market with motivated buyers (India, China, Russia, petro-players), and few sellers of size."

According to the report, they key supply/demand factors to be considered for the market are: The pace of scrap selling in response to the rally, which has been running at roughly 1,000 mt/year; physical investment for coins and bars in the East versus industrial demand and paper gold trading in the West; the level of sales by central banks; de-hedging by mining companies and a likely wave of new mining taxes, royalties, asset expropriations and delays in mine development.

Given the fact that a new wave of investment demand has been pushing gold prices higher (an estimated 30% year-on-year increase in 2008), "the key variables will be the extent to which jewelry demand slips and the amount of new scrap becomes available," said the report. "The last major price push was the 2006 gain (+36%) that cut jewelry demand by 16% and inspired 25% more scrap supply. We believe a similar pattern is likely in 2008, although more muted due to dollar depreciation and less available scrap."

While the official sector narrowly met its 500 mt/year quota under the CBGA II agreement in 2007, sales are likely to be less than that target in 2008 and 2009, according to the Citi report. "We believe the likelihood of IMF sales are low. We regard central bank sales as a normal, recurring feature of the gold market that has faded from relevance as a price determinant," said the report.

Regarding de-hedging, the report noted that less than 1,000 mt of gold remained on the books of mining companies at the end of the third quarter, down from more than 3,000 mt when hedging was at its peak in 1999.

"We expect the de-hedging to continue, particularly from the two major companies that hold over half the remaining contracts," said the report. ""The pace of de-hedging is likely to slow given smaller aggregate positions. This will modestly increase available physical supply."

Created: Feb 13, 2008

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