Short gold in '08, Goldman says

Globe and Mail Update
November 29, 2007 at 3:03 PM EST

Gold bugs have mostly had it all their own way this year, but that won't be the case next year, Goldman Sachs Group Inc. believes. In fact, the big brokerage firm recommends in its top 10 trades list for 2008 that investors short gold next year.

Goldman had recommended investors go long gold in its top 10 trades list for 2006 and bullion went from around $500 (U.S.) an ounce to $650 at the end of that year. Bullion has continued to climb since. This year it rose from $636 at the beginning of the year to as high as $845 on Nov. 7 and is currently changing hands at aound $795 on the London Metal Exchange.

But the 2008 top trades list, drawn up by Goldman's global markets team, suggests investors short gold priced in U.S. dollars in order to capitalize on a gradual relaxation of credit concerns in the financial sector over the coming months and as an avenue to benefit from the prospect of the U.S. dollar stabilizing. Bullion has been one of the main beneficiaries of the financial turmoil that began in August as investors sought alternative stores of value to the weakening U.S. dollar.
(A short sale occurs when the seller borrows a stock, commodity or currency and sells it, expecting the price to fall. If it does, the seller buys it at the lower price to replace the commodity that was borrowed.) The team anticipates that the greenback, which had a tough time in 2007 against global currencies including the Canadian dollar and the euro, will find its footing next year as the U.S. Federal Reserve Board cuts interest rates and thereby lowers the risk of a recession, and the U.S. trade balance improves further.

The team also makes its argument for shorting bullion on the basis of technical analysis. That, the team says, suggests that gold is topping out and that longer-term momentum indicators are turning lower. “We see scope for acceleration through $770 to re-test the $600-650 levels prevailing ahead of the summer,” the team said.

The team also suggests investors short small capitalization stocks and go long large caps and opt for stocks from a variety of countries, given the risk of choosing stocks from just one country.
Another of the top 10 trades for next year is to short 10-year Canadian bond futures and go instead for 10-year Swiss franc bond swaps as the rate differential between the two has gotten out of whack.

A further one is to go short the British pound and long the Japanese yen to capitalize on the expected slowing of the British economy.

“Sterling remains one of the most overvalued major currencies” in Goldman's trade-weighted valuation metric while the yen is comparatively cheap, the team said.

“On top of this, the narrowing of interest rate differentials between Japan and other major industrialized countries, including the U.K., make Japanese yen funded carry trades less attractive,” the team added.

4 picks from 2 top fund managers

Thomas Winmill of the Midas Fund (MIDSX) and Frank Holmes of the U.S. Global Investors World Precious Minerals Fund (UNWPX). Winmill's fund is the No. 1-ranked fund for total returns this year, and Holmes' fund topped the charts last year.

Winmill suggests sticking with mining companies with assets in countries whose legal systems make it harder to wriggle out of contracts. He puts the U.S., Canada, Mexico, Finland, Sweden and Australia on this list.

Next, you want to go with mining companies that have huge, undeveloped deposits that will rise in value as gold crosses over $1,000. "There is scarcity value. As gold prices go up, the value of these deposits can go up enormously," he says.

Winmill puts NovaGold Resources (NG, news, msgs) at the top of the list for both criteria. It owns the rights to a huge gold deposit in Alaska called Donlin Creek, which could hold as much as 33 million ounces of gold. "That is one of the biggest deposits in the world, and the biggest in all of the politically safe countries in the world," says Winmill.

Donlin Creek also contains big copper deposits. NovaGold Resources has a joint venture agreement with Barrick Gold to develop Donlin Creek, which adds credibility to its story. NovaGold has three or four other significant gold fields in Alaska and British Columbia.

"The company has successfully pursued a strategy of tying up large deposits when commodity prices were low and is now bringing these toward production," says Citigroup's Hill, who has a buy rating on the stock. Even before that happens, NovaGold Resources could get taken over because its holdings are so attractive, says Winmill.

Winmill also likes Northern Dynasty Minerals (NAK, news, msgs), which has a huge gold, copper and molybdenum project in Alaska called Pebble. The chairman of Northern Dynasty is Robert Dickinson of Hunter Dickinson, a private Vancouver, British Columbia, mining company that has a good record for finding developing precious metal assets, says Winmill.

Northern Dynasty has a joint venture with Anglo American (AAUK, news, msgs) to develop Pebble. And the mining company Rio Tinto (RTP, news, msgs) has a 19% stake in Northern Dynasty. Close ties with both of those companies suggest either one could buy out Northern Dynasty to get full control of its assets, believes Winmill. "My instinct is someone is going to acquire the company, and it would be good fit with Anglo American and Rio Tinto," he says.

Raymond James Financial (RJF, news, msgs) analyst Tom Meyer describes Northern Dynasty as an "ideal way" to get exposure to precious metals, in part because its shares look cheap compared with peers.

Two favorite gold mining picks of U.S. Global Investors' Holmes are Yamana Gold (AUY, news, msgs) and Goldcorp (GG, news, msgs). Yamana Gold operates several mines in Brazil. The biggest is a cash cow called Chapada where production is growing so fast that the mine helped gold production at Yamana increase by 48% in the past quarter. The company also has several exploration projects in Brazil, Argentina and Nicaragua which it believes will more than double its gold production to 2.2 million ounces a year in five years. Yamana Gold recently agreed to purchase Meridian Gold (MDG, news, msgs) at a price that was low enough so that the merger will add substantially to earnings over time, says Holmes.

Holmes favors Goldcorp because it has stakes in big gold and copper mining projects in Canada and Argentina whose growth contributed to 28% production growth at the company in the last quarter. Goldcorp also has about the lowest costs among the major gold producers. It recently forecast that it will produce gold at an average cost of $150 per ounce in 2007, once credits for the sale of copper and other mining byproducts are factored in. Holmes also believes Goldcorp has a lot of upside potential because it is developing a large gold, silver and zinc project in Mexico called Peñasquito.

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