From the August 2008 issue of Research Magazine • Subscribe!

Lifting Forecasts

Gold and other metals are in favor thanks to a variety of secular and seasonal factors that are supporting commodities in general, equity analysts say.

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Daniel Brebner, CFAUBSDaniel.Brebner@ubs.com+44-20-7568-3451The first three months of 2008 saw precious metals trade very strongly with gold, platinum and rhodium setting nominal all-time highs and silver and palladium posting strong performances too albeit both peaking well short of all-time record levels.

Precious metals were all helped by further weakness of the U.S. dollar, with the strength of crude oil and very positive performance of other commodities -- base metals and especially agricultural commodities -- helping sentiment towards commodities as an asset class. But specific factors also helped platinum group metals and the monetary metals -- gold and silver.

Gold benefited a little from South African supply issues, but following the decline in the proportion of gold production from this country -- China overtook South Africa as the largest gold miner in 2007, a far cry from 1970 when South Africa produced about 70 percent of the world's gold. Gold benefited more from buying from clients wishing profit from a weaker dollar and to protect themselves from the impact of the credit crunch and the possibility of stagflation.

All five precious metals are above our average price forecasts for 2008.

We like platinum's fundamentals the most out of all five precious metals. Stocks are low, investment positions relatively small, we believe, and demand driven by a mixture of Chinese jewelry appetite and particularly autocatalyst demand for diesel powered vehicles. Supply is very concentrated amongst a small number of South African and Russian producers and the evidence of the past twelve months is that production has and will continue to disappoint. As we argue above we suspect the platinum market has reached a tipping point where the price will have to trade sharply higher to bring the market back closer into balance.

Rhodium's ongoing strength is as much a function of strong demand as it has been to the disappointments that have marred South African platinum production. We expect thrifting/substitution together with slower global economic growth to slow rhodium demand growth this year but the market will probably remain in deficit in 2008, although a small but growing surplus looks likely in 2010 and beyond. There is a clear risk that rhodium will remain very strong in 2008, but also that it will decline in price in following years.

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John Hill, CFACitigroupJohn.h.hill@citi.com415-951-1714Gold has weathered a series of thematic negatives related to the end of the Fed rate-cutting cycle and a "floor in the dollar," with minimal damage. Macro catalysts have rotated from credit concerns, to currencies, to intensifying inflationary pressures worldwide.

We see wealth creation in Asia and petro-dollar flows in the Mid-East as secular drivers amid a supply-constrained gold market. We remain positive on gold, based on macro and supply/demand factors. The forces that have propelled gold for five years are firmly in-place. We see gold as well-positioned heading into autumn, when fabrication tends to tighten the market.

Gold is likely to regain $1,000/oz by end-'08 and to work higher through 2009-10. Longer term, we believe gold is capable of doubling or tripling from current levels.

During 2Q '08, gold has averaged $896/oz (-3 percent quarter over quarter and +34 percent year over year). The low was $853/oz on May 1, down from a high of $945 on April16. Following a series of downside fundamental tests, gold appears to have found a floor, and quietly climbed back to $917/oz.

Longer term, we would not be surprised to see gold double from current levels as the global policy prescriptions for the credit crunch remain powerfully and uniformly re-flationary. Citi's gold forecasts are $906/$950/$1000 in 2008/2009/2010. December '09 futures are above $924/oz.

Aluminum seems poised to finally participate in the supercycle after lagging for four years. Elements of structural change include a steeper cost curve due to disproportionate power cost impacts, China shifting to neutral/importer, and the pronounced upward pivot in the long-dated futures. Our new forecasts are aggressive at $2.00/lb and $2.20 in 2009-10.

Copper has corrected below $3.80/lb as investors digest bumpy macro data following the end of a contractors strike at world No. 1 producer Codelco. Exchange inventories have fallen 20 percent year to date. Big outflows in Europe and the U.S. have more than offset builds in Asia ex-China. We see copper as best-positioned among the non-ferrous metals.

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Jeffrey SautRaymond JamesJeffrey.Saut@RaymondJames.com727-567-2644I have advocated gold and some base metals since the fourth quarter of 2001. I did cut back on these recommendations and rebalanced those positions when gold got to about $1000 in November/December of last year.

I believe that gold is in a secular bull market and that over the next five years they should be higher than where they are now. This is more of a macro-[economic] story than it is about gold. We are bringing three billion people into their own economic viability. As these people become economically viable, their consumption of stuff -- including gold, for instance, which is not just used in wedding bands but also in electronics, as well -- drives the demand.

To my knowledge, we have not brought a lot more sourcing of gold onto the markets. We have recently brought on some, due to the [high] prices. And gold prices should go higher. After $1000 an ounce, a good round number, and a big rally, this market could go sideways for a while ... and could need to pause. That said, gold has been firming at around $938 [on July 3].

Inflation has put the wind at the back of precious metals in the aggregate, and inflation should torque up. This seems to be another argument in gold's favor.

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