METALS COMMENTARY (July 21, 2008)

In the next 12 months, Citigroup Global Markets thinks Alcoa is going to move to US$50 per share from US$32.78 on the back of stronger aluminum prices.

“It’s Ally’s turn,” Citigroup asserts in a July research report.

“After lagging badly,” aluminum is “primed to participate” in the supercycle, it maintains.

Prices will likely climb to US$1.70 per lb. aluminum this year from their current US$1.43 per lb. range and to US$2-2.20 per lb. in 2009-2010, the bank says.

Since late January, aluminum has traded at between US$1.27 and US$1.44 per lb., up from US$1.07 at the end of 2007.

Slower global production and the possibility that China will shift to net importer status are two tailwinds that will lift aluminum higher.

Another is likely to come in the form of tax increases in emerging markets that are designed to slow energy-intensive exports, the bank predicts.

Disappearing surpluses, the possibility that China will move to a “neutral/importer status,” higher cost curves due to rising energy prices, as well as gains in metal substitution, will all contribute to a revival in aluminum prices.

“The threat of Chinese capacity is overstated and aluminum is winning the substitution battle with other metals,” the research states.

While exchange inventories are up 24% year-to-date, the total stock ratio for aluminum is at about 26 days, a “near record low.”

In addition, Citigroup calculates that about 2% of estimated production in 2008 has been lost due to power disruptions and high energy costs.

In the United States, Alcoa cut production in mid-June at its Rockdale smelter in Texas because of power supply problems. In Brazil, the Valesul smelter slashed output by 20% due to rising spot power prices and in the United Kingdom, a fire at the Anglesey smelter reduced output to about one third, Citigroup says.

Meanwhile, in Western Australia, a gas pipeline explosion on Varanus Island has cut gas supply by about 30%. In China, the power disruptions in the first quarter of the year resulted in an estimated loss of about 600 kilotons and in South Africa, aluminum production has been reduced by about 150 kilotons per year. Citigroup believes the cutbacks will last several years.

Citigroup forecasts a net deficit of aluminum of about 211 kilotons this year and 495 kilotons in 2009 and 2010. It predicts supply will grow 4.5% this year, 7% next year and 8.1% in 2010.

In terms of Alcoa and its share price, Citigroup notes that the Pittsburgh, Pa.- headquartered alumina and aluminum producer is focusing investments on high-margin bauxite/alumina and Greenfield smelters “while shaving downstream underperformers.”

It argues that Alcoa is one of the few major metals companies “with a deep bench of development projects capable of driving organic growth for the next five to ten years.”

As for gold, its rise has been relatively muted compared with surging base metal and oil prices, Citigroup Global Markets argues in another recent report.

But mounting wealth in Asia, surging petrodollar flows in the Middle East, and a supply-constrained gold market are all likely to push gold prices back up to the US$1,000- per-oz. mark by the end of the year.

Citigroup’s equity research team forecasts gold will “work higher through 2009-2010” and longer term “is capable of doubling or tripling from current levels.”

Gold averaged US$896 per oz. in the second quarter of this year, with a low of US$853 per oz. on May 1 — down from a high of US$945 per oz. on April 16.

Citigroup cites a number of reasons for its favourable view on the gold price. For one thing, fabrication demand will tighten in the fall, it says, and fabrication makes up 76-82% of the physical gold market. (By contrast, net investment demand for gold has amounted to just US$11-14 billion in recent years.)

Citigroup also maintains that negative real interest rates will continue to favour hard assets like gold. Systemic financial problems that have taken root in the U. S. and are now spreading to Europe and emerging markets will also support the gold price going forward.

Citigroup’s favourite gold stocks: Barrick Gold, Peter Hambro, Lihir Gold and Newmont Mining.