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Gold: China Inc.

Metal trading giant, China Minmetals Corp. bid for Canada's biggest mining company, Noranda Inc., reflects less China's voracious appetite for commodities and more China Inc.'s arrival on the world's stage as the world's financier. Nationalist and xenophobic fears are being raised because China Minmetals is a state-owned enterprise. What can people be thinking? All of China, until recently was owned by the state, but that is changing as reforms, privatization and liberalization policies take hold. Those wrapping themselves in the flag, don't complain when state-supported Bombardier takes over an Irish plane company or when once nationalized PetroCanada acquires resources in Egypt. China is simply flexing its financial muscles.

China has become one of the world's locomotives, becoming the world's third biggest exporter. China's boom has sparked an unprecedented expansion in world commodity markets. China produces two-thirds of all DVD players, microwaves, and over half of all digital cameras. It has become the world's largest consumer of aluminum, copper and cement and the world's second largest import of oil.

China is the Saudi Arabia of the Capital Markets
Unlike the Japanese, who bought Van Goghs and golf courses with their surpluses, the Chinese appear to be more sophisticated in spending their almost $500 billion of foreign exchange reserves. In the past, China seemed content to replace Arab investors as purchasers of U.S. treasury bills. Asian central banks were active in the foreign exchange markets by buying up U.S. dollars to deter their currencies from appreciating further. China is to the US financial markets what Saudi Arabia is to the world oil markets - the primary provider of capital. Chinese companies to date have invested about $33 billion throughout more than a 160 countries, but the Noranda purchase is the biggest, so far.

Prompted by this prudent desire to diversify and the recognition that the U.S. dollar is vulnerable, China has also bought euros, Canadian dollars, and even gold last year. But now, instead of settling for more low-yielding dollars, China has bought dollar assets or proxies with their surplus dollars lessening their dependence on the dollar. The Chinese central bank likely lost $10 billion due to the drop in the US dollar, and no central bank can do that for very long. Increased protectionist measures by Americans and the nationalist outcry against Chinese companies exposes America's vulnerability. Americans must realize that the rules of the game have changed. He who owns the gold, makes the rules. Investors should adjust accordingly. The Chinese subsidization of the American economy is over.

China has one of the highest savings rate in the world, and in recognition has liberalized the ownership of gold. China's central bank governor estimated that Chinese citizens currently have 1.2 trillion yuan or $145 billion of savings, which contrasts sharply with the spent savings of the Americans. Historically, the Chinese have an affinity to gold and the government's recent move to allow individual ownership has prompted the World Gold Council to predict "the rise in demand for gold in China from the current 200 tonnes to an annual 600 tonnes over the next few years." We believe Chinese demand will surprise even the World Gold Council. Already five banks jumped the gun and queues were formed, similar to the long lineups outside the Bank of Nova Scotia in the late 1970s. The Chinese have one of the lowest grams per capita usage, at 0.1 grams per capita in contrast to 0.73 in India and 1.41 in the United States. China's official gold reserves are less than 2 percent at only 600 tonnes. The central bank is expected to boost its holdings in line with the more industrialized nations. To achieve a level of the Europeans at 15 percent of reserves, China would need to consume all of the gold produced in the next two years.

The Big Risk
For sometime now, we have warned about America's financial imbalance and vast accumulation of domestic debt, which are the dollar's Achilles heel. To date the dollar has lost over twenty percent of its value and appears poised to slide another 10 percent. Without the largesse of foreign investors, the Americans must somehow attract more than $50 billion of net investment each month. Foreigners bought $39 billion in net purchases of US securities in August, less than the $64 billion bought in July.

The big risk lies on the United States whose debt load threatens to endanger the world's economy. The US has become the world's biggest debtor. Every day, the superpower is looking more like another big Latin American debtor. For the past decade, America has been living beyond its means. The US government has increased spending while cutting taxes, causing a swing of $700 billion of red ink. America's households have also spent more than they earn, subsidizing their lifestyle against the illusory value of their home. We believe a potent cocktail of twin deficits will lead to a collapse of the dollar, exacerbated by $55 oil prices and continued geo-political uncertainties.

America's bubble was spawned by a huge reliance on debt and its way of life is unsustainable. Unlike the Chinese whose boom is built on traditional wealth creation, America's boom is built on debt and the false illusion of "asset wealth". Since 2001, a potent mixture of leveraged assets, deficits at 10 percent of GDP, $7.3 trillion of government debt, negligible savings and the opiate of artificially low interest rates have contributed to a huge U.S. credit binge, which will be passed on to the next generation. The United States today has over $53 trillion in government debts and liabilities that start to mature in four years when the first of the baby boomers begin to retire. The average household's personal debt today is about $85,000, and if you include Medicare and social security, this increases five times to $475,000. A mixture of spent savings and huge fiscal deficits, financed largely by foreigners, has ruined many Latin American economies. The US is poised to follow, but just how big a crash, we don't yet know (almost half of the US government debt is currently held by foreigners). And in this quarter, this appetite for American assets appears to be waning along with interest in the greenback. Gold will be a good thing to have.

Fannie Enron Mae
Falling rates are also a problem for "too big to fall" Fannie Mae. Fannie Mae with $1 trillion of assets is the second largest financial company after Citicorp and among its biggest derivative players. Fannie's accounting practices and misuse of "generally accepted accounting rules" are the focus of an interim scathing 211-page report by The Office of Federal Housing Enterprise Oversight (OFHEO). The regulator of America's giant mortgage company recounts how Fannie Mae improperly expensed half of $400 million so that the company could meet its earnings guidance allowing top management to receive the maximum bonus payouts. Fannie Mae deferred the other $200 million of prepayment losses or expenses following the collapse of interest rates in the third quarter of 1998. Last year, its top executive, Franklin D. Raines was paid $20 million. The report was searing, it stated "the misapplication of GAAP are not limited occurrences, but are pervasive and are reinforced by management" and, "the Enterprise was making preemptive adjustments for the sole purpose of managing prospective earnings". Indeed the OFHEO report also revealed billion of dollars of derivative losses. Fannie improperly recorded $12.2 billion in deferred losses relating to cash flow hedges that if adjusted, Fannie would be undercapitalized. Just how undercapitalized was Fannie Mae? We don't know. The company subsequently agreed to boost its reserves by 30 percent, as an interim measure but must raise billions of new funds or liquidate assets.

As private companies with a government charter that guarantees its debt, Fannie and its smaller cousin Freddie were able to borrow huge sums of money. Today, Fannie Mae and Freddie Mac owns or guarantees nearly half of the United States $7.9 trillion of residential mortgages outstanding. Like Enron, the roles and responsibilities of the key executives are being questioned as well as executives from the Controller's department. Key management may be replaced, and congressional hearings have begun. The Justice Department has also launched a criminal probe.

Even Alan Greenspan issued warnings that there was a danger in this concentration of mortgage risk and suggested the privatization and removal of the contentious government guarantee. The International Monetary Fund also waged in, warning that both Fannie and Freddie's "bias" concentrated interest-rate risks and the hedging of which would amplify interest-rate movements."

Last year, Fannie Mae's retained earnings only stood at $24.5 billion, against a derivatives book of $1.04 trillion. And the other mortgage company? Freddie Mac recently restated $4.5 billion of earnings, removed key executives and settled with federal regulators. Foreigners today hold more than 12 percent of outstanding US agency securities and nearly half of its debt. The question then to ask, who bails out the bag holder? Gold is a good thing to have.

We continue to expect gold to post a new high this year, driven by dollar weakness, high oil prices, strong investment demand and continued geo-political tensions. Gold will average $450 next year with an interim target of $510 per ounce. Gold stocks have outperformed bullion and volume has also increased. Joe Ismail, our technical analyst, notes that many of the intermediates and junior producer charts display long bases and the stocks have recently broken above their short and intermediate term moving averages. There have been few "hot plays" other than Guyana Gold and the Cortez Hill discovery, and thus the junior exploration stocks are lagging. Gold stocks need a discovery.

Among senior producers, we like Kinross, Placer Dome, and Newmont. The Harmony/Gold Fields/Iamgold ménage á trois signals a resumption of the industry's consolidation and if harmony is successful expect the next round will include the big cap players this time. Among the intermediate producers we continue to recommend Bema, Meridian, Agnico-Eagle, and Goldcorp. The junior and emerging producers are still lagging but Eldorado, Northgate, Crystallex, and Miramar look interesting here. Until a discovery, we would stay with the junior producers.

Cambior Inc.
Cambior acquired 55.3% in Minera Poderosa SA, a private Peruvian gold producer from two of the Arias sisters for $25 million in cash, 2.2 million common shares and a contingent payment of $6 million. The Poderosa mine has been in production since 1982 with an average of 75,000 ounces produced annually over the last five years from a series of high-grade veins but reserves are limited. Cambior paid more than double our valuation and it is noteworthy that the other two sisters did not sell but instead swapped their interest for shares of another non-producing Canadian gold producer, raising questions about the valuation. Cambior has refinanced this acquisition with a $110 million stock issue putting a lid on that stock. The acquisition and dilutive stock issue distracted investors from the operating problems at the Doyon mine in Quebec, masking the good news of the successful start-up at Gros Rosebel in Suriname, which boosted Cambior's production to over 700,000 ounces in 2004. We believe the stock dilution together with the expensive acquisitions makes Cambior a sell at current levels.

Crystallex International Corporation
Crystallex is expecting the final permit (Permit to Impact Renewable Resources) shortly, which will allow physical construction to begin. Crystallex has completed engineering and drilled 18 infill holes, which is expected to add about 2 million ounces to its reserves by yearend. We expect the company to pursue its 40,000 tonnes per day model but will first begin production at 20,000 tonnes per day, producing 300,000 ounces by first quarter 2006. Upon receipt of permitting, financing arrangements could then be arranged; although this project could also be financed outside the usual or traditional bank financing. Crystallex shares remain undervalued and the company remains a tasty takeover candidate particularly when compared to other 10 million ounce deposits. Unlike other projects, there is no technical risk, strong government support and with Chavez winning the referendum, no political risk. We continue to recommend the shares here and expect the stock to outperform its peers.

Eldorado Gold Corporation
Eldorado received all permits and approvals to build the heap leach Kisladag mine in Turkey. The long awaited construction permit was granted and Eldorado completed the roads and utilities work. Kisladag should be in production late next year, producing 240,000 ounces over the next fourteen years. Eldorado should produce 90,000 ounces at Sao Bento in Brazil as the shaft sinking continues and about 10,000 ounces are expected from Kisladag late in the year as the mine starts up. Permitting is continuing at the other Turkish site, the Efencukuou project, a mine capable of producing 90,000 ounces per year. Eldorado shares have lagged and thus we recommend purchase here.

Gabriel Resources Ltd.
Gabriel Resources received a lifeline $25 million investment from Newmont, which gave Gabriel much needed cash and credibility to pursue the Rosia Montana project, a large 10 million ounce undeveloped gold/silver deposit in Romania. While Newmont's arrival is welcome, we believe the Rosia Montana development is still difficult from a social and permitting standpoint - Gabriel is still considered a junior in the eyes of the government. Newmont's purchase gives it a stake in a potential major producer, but we believe the difficulties that plague the project remain and we would avoid Gabriel here.

Goldcorp Inc.
Goldcorp shocked the Street when Rob McEwen offered to relinquish the CEO spot. Rob McEwen has been the main driver behind making Goldcorp a much admired intermediate sized gold producer and was a major part in the identification, exploitation, and expansion of the Red Lake mine. Rob's desire to bring in a new manager to finish the Red Lake expansion is unselfish and will likely put Goldcorp into play. The big problem was that Rob was too successful and Goldcorp is so richly valued that many producers cannot pull of an accretive transaction. However, under a $500 gold scenario, the Red Lake mine is an attractive asset for many of these senior producers, who are lacking a premium deposit and sitting with bloated hedge books. As such, we continue to recommend the shares of Goldcorp, particularly on any weakness.

Newmont Mining Company
When it rains, it pours. Newmont has had a run of bad karma. In Indonesia, Newmont has been unfairly accused of environmental damages and its workers have been "detained". At Yanacocha, Newmont has been hit with a workers' strike where water is a big issue and production has been adversely affected. Ironically little has been written about Newmont's royalty business and oil & gas interests, which were inherited from Franco-Nevada. Little attention is being paid to those assets, but those assets are an effective hedge. Newmont's dilemma in the near term is the replacement of depleting reserves. For too long, the Street has been abuzz that Newmont would acquire Placer Dome. Even though such an acquisition might excite the Street but such a merger would bring little benefit to either company and frankly would not solve both companies' problem, the need to replace of reserves. We continue to like Newmont as a core holding, particularly for its' strong balanced sheet, lack of hedges and strong core asset, at Yanacocha and Nevada. A $10 change in the gold price causes a $50 million bottom line improvement to Newmont's earnings. Buy.

Placer Dome Inc.
Placer Dome hosted an analyst tour at the Cortez Hills in Nevada in September. Placer's new president noted that the Cortez Hill discovery is open at depth in at least two directions and we expect further news. We should also expect news from the joint venture with White Knight on the Indian Ranch project. Placer has allocated $10 million for Cortez. Placer has also completed a mineral resource model at Pueblo Viejo in the Dominican Republic, which completes the test work. Placer is expected to make a positive decision and put this project into production. With a resource of 18 million ounces, Pueblo Viejo is expected to be a solid producer if they solve the metallurgical puzzle (Placer could use the BioteQ process). We upgraded our opinion of Placer in the last quarter because of Cortez Hill and on expectations that Pueblo Viejo will offset the negatives of Placer's South Deep albatross in South Africa. We continue to recommend Placer's shares here for Cortez, Timmins and Pueblo Viejo.

Meridian Gold Inc.
Meridian gold has finally started to perform, due in part to a new discovery at crown jewel El Penon in Chile. The Dorada discovery extends Meridian's production profile beyond 2006 and El Penon should produce 310,000 ounces this year at a paltry cash cost of $55 per ounce. Meridian has more than $200 million in cash and no debt. And like Goldcorp, Agnico-Eagle and Kinross production is unhedged. The high-grade Dorada discovery is exciting and reflects our view that El Penon has much more reserve potential ahead. The Dorada has 800 meters along strike and 150 meters dip defined so far. Three rigs are working on the vein. At Esquel in Argentina, there has been little progress but then, little was expected by investors. We believe that any movement on Esquel would be positive for Meridian since there is little discounted in the stock price. We continue to recommend Meridian here.

Northgate Minerals Corporation
Northgate has benefited from the upturn in the copper price, which has helped reduce the cost of the Kemess South mine in north-central British Columbia. Kemess South produces 300,000 ounces of gold at a cash cost of $150 an ounce plus 75 million pounds of copper at a cost of $0.90 per pound. Management has done a good job with a tough project and will now focus on developing nearby Kemess North, which contains 4.1 million ounces and 1.5 billion pounds of copper. The project capital is estimated at only $160 million and technically the project is feasible. However, while close by, Kemess North is on the other side of the mountain, it requires permitting and public information sessions together with agreements from First nation groups. Kemess North is not yet a slam-dunk but any improvement in the permitting process would assist the shares. Northgate is in need of a third leg but to date has been unsuccessful in looking for another 100,000 ounce producer. Northgate shares are undervalued and we recommend them here. Brascan sold its 41.5 percent interest via a secondary in November 2003.

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