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The first round of earnings…

Gold: Seismic Events

Geopolitical shockwaves have fractured along fundamental fault lines. The hostilities in the Middle East intensified on two fronts. The Israeli-Palestinian conflict spread to Lebanon and now has drawn in Iran, through its proxy Hezbollah. To be sure, nobody can claim the moral high ground here but the undercurrent is that as long this festers there will be no progress on other fronts, making investors more worried, particularly when oil prices hit a new record. The growing hostilities also increased market volatility and the rollercoaster ride caused oil and gold to hit higher levels.

The West has been reduced to passive observers. The rise of Hezbollah, a Shiite organization, armed and bankrolled by Shiite-led Iran is causing alarm in Sunni-led Saudi Arabia, Jordan and Egypt. Iran is also backing the Arab Shiite majority in Iraq. Iran has replaced the US as the dominant power in the region. The Americans and Israelis are caught in a sectarian split that threatens to engulf all the Middle East. Israel and America appear poised to repeat the mistakes of the past in Vietnam and Lebanon in 1982. Hezbollah's 34 day conflict with Israel exposes not only longstanding hostilities but also the sectarian differences among the Arabs, exposing centuries of enmity between the Sunni and Shia branches of Islam. Democracy in the Middle East is paper-thin and the radical movements have hijacked this process. The West and Israel are caught up in not only a regional battle but a religious one as well and to a large extent unable to stop the erosion of democracy.

Although 90 percent of the world's Muslims are Sunni the radical Shia Islamist groups fear that America and Sunni Arab interests will ultimately coalesce against them and the struggle inside Islam is the competition to carry the flag for Arab nationalists. Shiite Iran is the common denominator supplying the resources and arms. Iran holds the ultimate card - a nuclear stockpile? No, Iran is the world's fourth largest exporter of oil, exporting a critical 2.4 million barrels of oil a day - the swing producer. Iran also straddles the Straits of Hormuz - source of one fifth of the world's oil needs. Indeed it's that concern that will drive oil and gold prices higher. The problem is not a shortage of oil but the geo-political fear of the disruption of oil supplies. Gold will be a good thing to have.

Top 15 Countries with Highest Proportion of
Shiites in the Population
Country Number of
Iran 61,000,000 93
Oman 948,750 75
Bahrain 400,000 65
Azerbaijan 4,700,000 61
Iraq 11,000,000 55
Lebanon 1,370,000 40
Yemen 3,170,000 36
Kuwait 550,000 30
Pakistan 26,700,000 25
Syria 1,300,000 17
United Arab Emirates 400,000 16
Turkey 6,000,000 15
Afghanistan 3,560,000 15
Saudi Arabia 620,000 15

NOTE: This list is not based on the proportion of Muslims which are Shiite, but on the proportion of Shiites in the total population.

Gold is the Currency of the Realm

In "Pirates of the Caribbean: Dead Man's Chest", a greedy pirate hunter, barks "loyalty is no longer the currency realm". What is then, "the currency of the realm"? The US dollar might have been the currency of the realm but that too is fading in use. We believe that the new currency is gold. Gold was the currency of the realm then, now and in the new future.

The United States, the sole global superpower has become the world's largest debtor and its current account deficit was the second largest on record last month. They are simply consuming more than they produce. America's credit card is tapped out, running up another huge bill (almost 7 percent of American GDP), using borrowed foreign money to pay for it every month. That debt has grown at twice the rate of the United States' GDP. America, however has exceeded its limit and is too deep in debt and despite the increase in interest rates, foreigners are putting their money elsewhere.

China Provided Cheap Financing

China has provided cheap financing to Americans by buying huge amounts of their treasury bonds allowing them to finance their mammoth twin deficits. By unpegging the yuan, the Chinese will need fewer dollars, thus American interest rates must rise as they attempt to replace foreign creditors. Unfortunately, the Americans cannot finance the debt internally because they have zero savings. America's problem is "made in America" and not a "made in China" problem. Following the internet bust of the late nineties, Fed policymakers concluded that since it was too hard to identify bubbles as they were inflating, it was best to wait until they popped, then clean up the mess. That happened as the Fed dropped interest rates from 6 percent to 1 percent. This encouraged a borrowing binge and the resulting excess liquidity flowed into prices of assets such as homes, rather than the traditional inflation hedges. Fed policy simply replaced the internet bubble with the housing bubble. But seventeen interest rate hikes later, all has changed.

In May, foreign central banks became net sellers of long term securities for the first time in a year. There now appears to be a shift away from American treasuries to eurodollars. Alternatives are available. For example, the Bank of Italy lowered its US dollar holdings from 84 percent to 63 percent, shifting to sterling which now makes up about 24 percent of Italy's reserves. The Chinese, an emerging superpower, might not be so ready to recycle their dollars should Senators Schumer and Graham reintroduce their tariff bill to Congress by September 30. And just when everybody forgot the March controversy over the Dubai Ports World takeover, the United Arab Emirates reminded us of their political clout by moving 10 percent of the UAEs' $229 billion foreign exchange reserves into euros. Indeed, many of the Gulf countries have proposed to drop the dollar peg and move to a floating exchange rate which would further weaken the US dollar. America's Achilles heel is the massive transfer of wealth from the developed world to superpower wannabes, the oil-rich Middle East and Russia.

America's Insatiable Appetite Leaves It Vulnerable

In a further sign of the dollar's diminished role as a reserve currency, the United States has quietly ended its 10 year opposition to the establishment of an Asian currency similar to the European currency (EU). Since Japan, China and Taiwan hold the bulk of the world's reserves, the establishment of an Asian currency unit is inevitable. In April the Treasury department reported that foreign investors bought only $58.5 billion worth of US securities, the lowest level in a year.

Russia has bought more gold and has been piling up petrodollars, making Russia the third largest holder of foreign exchange in the world. By the end of July, Russia had gold and foreign exchange reserves of $277 billion up from $180 billion at the beginning of the year. China once had a balance of payment surplus of $100 billion in 2005 and today holds $975 billion. Saudi Arabia expects to have $203 billion by the end of this year. Saudi Arabia is enjoying record oil revenues of $20 billion a month. The petrodollars are now piling up and rival the Asian cash hoard. According to the IMF, the current account surpluses of Kuwait and Norway are $311 billion this year up from $242 billion, while Asia's surplus will be down to $253 billion versus $263 billion last year. The IMF also reported that from 1999 through 2005, revenues of OPEC nations plus Russia totaled $2 trillion as the price of oil doubled during this period. Indeed, Russia has been able to use those petrodollars to repay $22 billion of debt owed to the Paris Club.

The problem, however is not the piling up of petrodollars, it is America's insatiable appetite for energy and cheap financing. By saving too little, and consuming too much, Americans have become too dependent on foreign investors, and ironically on Iran.

Inflation Is Back

Gold has doubled in two years. When the dollar loses value, gold will resume its uptrend. However, we believe the main driver of gold beyond $850 an ounce this year will not be geo-political events but the return of inflation. Despite Ben Bernanke's pronouncements, inflation is not a by-product of housing starts or ebbing oil prices. Those are symptoms of inflation as is the rising cost of mortgages, food, rents and taxes. While inflation has been subdued for the last decade at 2.6 percent, the spike in ever-climbing oil price has resulted in a jump in core inflation (ex: food and energy) to levels not seen in eleven years.

With the May stock market meltdown, investors are looking who to blame? Rather than a grand conspiracy among central banks, we believe the meltdown was simply due to investor recognition of a new sea change in the marketplace. Investors are recognizing a new problem. For some time, we cautioned investors about the inflation in stock prices which came about from too much money chasing too few stocks. Today the attendant liquidity created by the central banks has gone into hard assets like commodities and into gold. With "real" interest rates even now at relatively low levels, investors can still take advantage of the "carry trade", particularly highly leveraged hedge funds that have been going in and out of various markets. Indeed, the hedge funds are not the problem, they are just a reflection of the problem and a product of the flood of easy money.

To no surprise, base metal prices also moved in line with China's explosive growth. Last year, global stainless steel production increased dramatically. Stainless steel production accounts for about 70 percent of annual nickel demand. Nickel stockpiles have fallen from 35,000 tonnes in February to less than 6,000 tonnes or one day's supply. The price of nickel hit a record and has increased about 56 percent from mid-January. Copper is at two days supply. The explosion of China and India has reshaped the global economic order changing the pace of not only the financial markets but now the commodity markets.

Get Ready for the Food Inflation Bubble

Despite Ben Bernanke's reassuring words, inflation is back. Overall prices rose by 0.2 percent in July, despite a temporary drop in energy prices. While economists will play around with the numbers, prices increased to an annual rate of 4.3 percent over the last twelve months and 5.2 percent for the last three months. In fact, the US Bureau of Labour Statistics' calculation of the consumer price index (CPI) is flawed as a leading indicator and more of a backward looking indicator. Indeed the CPI is of little value as an oracle of how markets interpret inflation data.

The real lead indicators are gold, commodities and currency markets. Gold has risen 50 percent while the dollar has fallen 6 percent. Inflation is a monetary phenomenon. And, more inflation allows the Fed to repay its indebtedness with cheaper dollars. The Fed quietly ended the release of important M3 data in March, removing a more accurate indicator of inflation. While investors will not be able to study M3 anymore, the price of commodities and now agricultural or "soft" commodities will more accurately reflect money inflation. Get ready for food inflation.

SUVs or a Meal

Low inventories, strong demand and the highest prices in ten years. Yet another base metal? No. The global heat wave and low stocks have pushed wheat prices to ten year highs. Corn, soybeans, and barley are also increasing in prices. And the US Agricultural Department (USDA) warned that the US spring wheat crop was the worst in eighteen years because of the lack of moisture. US wheat stocks are the lowest in eleven years. Soft commodities are moving in line with inflationary expectations. And for those of us who are old enough, the warming of the ocean has caused the anchovies to go missing off the coast of Peru, again. The last time the anchovies went missing was in the seventies. Those missing anchovies were a prelude to a double digit run in inflation as consumers replaced the missing anchovies with soybeans and the inflation dominos fell after that. The spike in oil and subsequent rise in commodities were blamed for the inflation of the 70s. This time not only are the anchovies missing but the explosive growth in biofuels has resulted in big increases in grain consumption which is the main ingredient to make ethanol in Europe and Brazil.

While the May meltdown was sparked in part by central bank jawboning, we believe that the next new worry is not the deficit, but inflation. Investors are concerned about the increase in the core rate of inflation. The collapse of the Doha trade round will ensure even higher farm prices and the potential return of the protectionist policies of the thirties. We believe that like the current bull market in hard commodities, higher energy prices and the changing weather has resulted in a rundown in inventories and agricultural prices have edged up. We might be able to switch from our SUVs, but we cannot skip a meal. Gold is the ultimate hedge against inflation and is likely to outperform most other assets.

Gold Stocks' Lack of Performance

Traditionally, gold stocks and bullion have moved together for much of the economic cycle. But in this bull market, gold stocks have been the poor cousin failing to keep pace with bullion's long run. Gold stocks provide not only leverage but protection on the downside through diversification particularly during bear markets. In the past three years bullion has increased 71 percent while gold stocks have only gone up 52 percent during the same period. The explosion of gold exchange-traded funds (ETFs) is thought to be one of the reasons for gold stocks' lack of performance. Another reason for gold stocks' lack of performance is that for much of the bear market, gold companies were interested more in survival than exploration and thus exploration budgets were cutback. Since there were no drill turnings during the bear market, there were no new discoveries.

Finally, gold stocks' lack of performance has frustrated both retail and institutional investors alike. We believe that the chief factor is the lack of organic growth and new discoveries. To date gold companies have harvested previous discoveries and the cost of a discovery today has sky-rocketed. At one time the price tag to bring the average 100,000 ounce discovery into production would cost about $200 million. Today, most "100,000 ounce" projects would cost in excess of $1 billion, which is very difficult to justify even at a $600 an ounce price deck.

Consequently, in the last few years, the industry has instead consolidated - takeovers the key driver instead of discoveries. Gold companies have taken advantage of the low stock prices and there has been a major consolidation in the gold industry (ounces are cheaper on Bay Street). While an important variable for relative performance between bullion and gold stocks are the gold companies' growth prospects, the consolidation means that there are just even fewer investment vehicles today. We believe that the period of equity underperformance will end when gold surpasses the $800 peak. Only then, will CNBC and Business Week herald the new dawn of gold stocks' arrival. Consequently we would buy a package of junior and mid-cap gold stocks.


Agnico-Eagle Mines Ltd
Agnico-Eagle's LaRonde mine in Quebec reported a great quarter due in part to strong base metal prices. If one includes the byproduct credits for zinc and silver, Agnico-Eagle produces gold at zero cost. Agnico's cash balance now stands in excess of $400 million, which is sufficient to finance the development at Kittila in Finland, Goldex and Lapa project in Quebec, and the fast track funding of Pinos Altos in Mexico. Agnico-Eagle expects these projects will boost the current production rate of 250,000 ounces to somewhere around 750,000 ounces in the next 3 to 4 years. We have no doubts that Agnico can achieve these levels, thus the company's shares are undervalued and should be purchased at current levels. Buy.

Barrick Gold Corporation
Barrick reported second quarter results of $0.53 per share, which was more than the company earned all of last year. Equity gold production was 2.1 million ounces and Barrick should produce 8.7 million ounces this year at a cash cost of $285 per ounce. Barrick also continued the consolidation trend by making an all cash hostile bid for NovaGold Resources Inc and Pioneer Metals Corporation in order to consolidate the ownership of Donlin Creek and add Galore Creek. Of note, rather than purchase production ounces, Barrick has acquired ounces in the ground, presumably to offset the loss of South Deep in South Africa which we believe will be sold. Barrick also eliminated Placer Dome's hedge book of 7.7 million ounces at a total cost of $1.8 billion. Barrick thus holds 2.8 million ounces corporately but another 9.5 million ounces is allocated to Pascua-Lama and Pueblo Viejo. The mark-to-market loss on Barrick's hedges is a whopping $4.3 billion at the spot gold price $614 per ounce. While Barrick has accelerated the reduction of its hedge book, the hedges remain its Achilles heel, and we expect Barrick to further accelerate either deliveries or buybacks.

Barrick's other problem is showing a growth trend and thus we expect the company to fast track the exciting development at Cortez Hill in Nevada. Barrick is focusing on the Cortez Hill property and has allocated additional funds and Cortez may rival Goldstrike in size. Barrick has two other major projects in addition to Cortez Hill. Pueblo Viejo in the Dominican Republic is a tough metallurgical problem and the company expects to spend in excess of a $1 billion for autoclave and power plant facilities. Donlin Creek in Alaska is a massive project and infrastructure will be the question mark. While Barrick has the management and balance sheet, all of these projects will likely cost in excess of $1 billion each to develop, thus Barrick's problem is like all the others, how to fill the growth gap between now and when these mines come on stream. Consequently, we expect Barrick to continue its acquisition trend, preferring to buy ounces on Bay Street rather than spend the time and money to find the next big deposit.

Bema Gold Corporation
Bema raised additional funding for its flagship, high-grade gold-silver deposit, Kupol in northern Siberia. Bema's results were disappointing in the quarter, producing almost 80,000 ounces for a drop of almost 9,000 ounces due to shortfalls at Petrex in South Africa and Refugio which just came on stream this year. Bema is expected to offload Petrex and concentrate its efforts by developing up Kupol's 5 million plus ounces. While Cerro Casale in Chile is one of the world's largest underdeveloped copper/gold deposits, the price tag and modest IRR relegates it as a "hidden asset" at this time. We continue to recommend Bema shares for its growth profile and suitable acquisition tidbit for one of the majors.

Centerra Gold
Centerra's results were weaker than expected. In addition, the company is only now releasing the damage at the key flagship Kuptor deposit in Kyrgyzstan where a pit wall collapsed, resulting in a drastic cutback of next year's production. Centerra's main mine will have to undergo new development plans and thus next year's production is iffy. We would switch Centerra into Agnico-Eagle or Kinross where the growth prospects are better defined. Centerra has a great balance sheet but until the development plans are better known, it is dead money.

Crystallex International Corporation
Crystallex floated a small share issue which should be enough funds until March of next year. Crystallex has been waiting for the all important final Environmental Permit which is somehow caught up in Venezuela's bureaucracy. We expect that the permit will be granted and the noise about the new Mining Act has no applicability to Crystallex since it already enjoys a concession already signed with the Venezuelan government. Thus the new mining law, will not have an impact on Crystallex. Crystallex's key asset is the almost 14 million plus ounce gold deposit in Las Cristinas in Bolivar State. We believe that this is one of the few remaining world-class deposits left to be developed. As such, we continue to believe that once the permit is granted, there will be a heated auction for Crystallex at a takeout double the current price.

The current production plans remain that Crystallex should produce 300,000 ounces a year, and could begin production within 12 to 18 months of being granted the permit. Crystallex has already ordered equipment, the runway is paved and the company is dressed up and waiting for the party to begin. Crystallex shares have been depressed as investors have become impatient and frustrated with the lack of permit. We believe that the current weakness affords an excellent purchasing opportunity and continue to recommend purchase.

Kinross Gold Corporation
Kinross reported an excellent quarter, producing 385,000 ounces in the second quarter. Profits in the quarter was a whopping $0.19 a share or $65.6 million up from a loss of $16.4 million a year. More important, Kinross continues to accelerate development by allocating an additional half a billion dollars to the Paracutu gold project in Brazil. Kinross' Paracutu's annually gold output is expected to increase from the current 200,000 ounces to approximately 550,000 ounces by 2009. Acquired by Bob Buchan, Paracutu is Kinross' major asset. Recent development drilling continues to show excellent growth in potential resources and reserves. Meanwhile, production at the Refugio joint venture in Chile, achieved its target rate, and that mine was a contributor in this quarter. Kinross should produce 1.4 million ounces this year at a cash cost of $305 per ounce. At long last, Kinross has filed documentation to take in Crown Resources and the Buckhorn deposit will add to Kinross' results. Kinross will produce almost 1.5 million unhedged ounces next year. We continue to believe that the company will be an attractive tidbit for one of the majors and/or Kinross could be a major player in the consolidation game with its array of assets. While the shares have done well recently, we continue to recommend purchase. We caution however, that the company has reviewed just about every deal on Bay Street and has yet to pull the trigger. While the company has been overly cautious, we believe that it is just a matter of time before the company takes its first big step (since the alternative is for Kinross to be gobbled up).

Newmont Mining Corporation
Newmont should produce between 5.9 and 6.2 million ounces this year plus a quarter of a billion pounds of copper. Newmont too doubled its profits in the second quarter to $161 million. Newmont however has not had a good year, with government problems in Uzbekistan, Indonesia and South America. Newmont must feel as if someone is putting a pin through a Newmont voodoo doll as it fights governments in various jurisdictions. Newmont last year sold 123,000 ounces of gold from the Zarafshan/Newmont joint venture in western Uzbekistan, but this June, the government declared the joint venture bankrupt over the failure to pay $48 million in back taxes. This comes after Newmont had environmental difficulties in Indonesia, problems with Gabriel in Romania and headaches in Peru. Newmont has been very successful through the merchant banking (Franco-Nevada) side of the business and the sale of Harker Holloway is expected shortly. However with $1.5 billion of cash Newmont is in need of additional development prospects and Aquarius in Nevada does not fit the bill. Newmont has been cautious, and the company appears to be more interested in harvesting rather than growing. We like the shares here, but we prefer the growth of the midcaps.

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Analyst Disclosure
Company Name Trading Symbol *Exchange Disclosure code
Barrick Gold ABX T 1
Bema Gold BGO T 1
Crystallex KRY T 1,5
St. Andrew Goldfields SAS T 5
Disclosure Key: 1=The Analyst, Associate or member of their household owns the securities of the subject issuer. 2=Maison Placements Canada Inc. and/or affiliated companies beneficially own more than 1% of any class of common equity of the issuers. 3=<Employee name> who is an officer or director of Maison Placements Canada Inc. or it's affiliated companies serves as a director or advisory Board Member of the issuer. 4=In the previous 12 months a Maison Analyst received compensation from the subject company. 5=Maison Placements Canada Inc. has managed co-managed or participated in an offering of securities by the issuer in the past 12 months. 6=Maison Placements Canada Inc. has received compensation for investment banking and related services from the issuer in the past 12 months. 7=Maison is making a market in an equity or equity related security of the subject issuer. 8=The analyst has recently paid a visit to review the material operations of the issuer. 9=The analyst has received payment or reimbursement from the issuer regarding a recent visit. T-Toronto; V-TSX Venture; NQ-NASDAQ; NY-New York Stock Exchange


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