Roberto Mancini has already moved to strengthen his midfield by signing former Arsenal star Patrick Vieira from Inter Milan.
With the 33-year-old France international only guaranteed a deal to the end of the season, new Eastlands boss Mancini could see Gago as providing bite to the City midfield in the longer term.
Battler: Real Madrid growler Gago could be heading to Eastlands
Madrid are prepared to listen to offers for the 23-year-old as they try to recoup some of the £265million they spent in the summer.
Bernabeu boss Manuel Pellegrini is reluctant to let the Argentina international go, but Gago is unhappy at falling behind the likes of Lassana Diarra and Esteban Granero in the pecking order.
Gago played 90 minutes in Madrid's 2-0 win against Mallorca on Sunday, but that was only his third start of the season in La Liga.
It is believed that his agent Marcelo Lombilla has tried to engineer the holding midfielder's return to Boca Juniors, where Gago came through the ranks before securing a £13.7m move to Madrid three years ago.
Lombilla has reportedly told Boca coach Alfio Basile that Gago would be keen on a return to Buenos Aires, but Madrid'd demands could scupper a deal.
The Spanish giants are believed to want £7.5m and are reluctant to accept a short-term deal, while Boca are unlikely to be able to commit to anything other than a loan deal up to the World Cup finals.
Reinforcements: City chief Mancini has already signed Vieira
Gago fears for his place in the Argentina team while he is on the fringes at Madrid and it is said that a return to his homeland is his preferred option, despite the reported interest from City and Juventus.
Neither Mancini's high-fliers nor the Italians have made formal approaches, but they are both said to be sounding out Madrid.
Everton have also shown an interest in taking Gago on loan.
Chelsea lead Arsenal and Manchester City in chase for Sergio CanalesMancini delivers clear message to underachieving striker RobinhoManchester City 4 Blackburn 1: Don't look now Sir Alex. Manchester United old boy Carlos Tevez fires City into title race Carlos flies high again: Tevez hat-trick fires City into the top fourVeron sensation: United flop claims to have snubbed Manchester City MANCHESTER CITY FC