" The good news is we have Iraq. The bad news is we have Iraq." - David Letterman

So that was war. In only its third week, the markets declared victory and celebrated. And so the conventional wisdom goes, the return of confidence, the economy and the markets. Investors also unwound their safe haven bets sending gold and oil lower.

The launch of the war was so smooth leading the market to expect that the Baghdad " 500" would be over by the first weekend. Then reality set in as casualties rose and the market reacted negatively. Exposed supply lines, Iraqi resistance and Saddam's "bob and weave" strategy quickly demolished the "shock and awe" campaign. While the market senses the end, the fog of war has obscured what is going on underneath. After all the war was not the cause nor the cure for the massive balance of payments deficit, the budget deficit and slowing economy. Indeed, after the war, these imbalances can only get worse as the geo-political risk has increased.

Always volatile in times of trouble, gold can be a fickle animal. In 1991, when Iraq invaded Kuwait, gold rocketed from $270 an ounce to $410 an ounce only to slump seven per cent in a seven-day period. Gold hit a 6-year peak at $390 an ounce this February on similar war jitters before falling sharply to support levels at $320 in the next month. Yet there is more to gold than war.

Victory In Iraq Is Not The Market's Panacea

The celebration was a short-lived emotional relief rally but does not take into account the real risks that earlier plagued the market mired in the aftermath of the bursting of the largest asset bubble in history. Indeed, the open-ended price tag of war and the inevitable reconstruction costs together with huge tax cuts will cause deficits as far as the eye could see. Before the war, the budget deficit was projected to exceed a record $300 billion this year. Only three years ago the budget was in surplus of nearly $240 billion. The twin deficits, the budget and current account deficit, leaves little choice for the Fed dependent on foreign capital to keep a savings-short economy going. And should the financial outlook turn darker, gold's brief debut as the market's darling will last longer, with or without the war. We believe that, America's indebtedness and stagnating output represents a more pervasive threat to financial values than the Victory in Iraq. This time investors may be "shocked and awed" into submission.

Gold Is A Financial Asset

The key driver for gold is its return as a financial hard asset. Gold is often held in anticipation of an investment or speculative return. Having lost confidence in fiat money and financial assets, investors have sought gold as a hedge against monetary depreciation. Negative returns, ongoing accounting scandals (HealthSouth), and record levels of debt continue to depress stock prices. The three-year demise of the stock market and other asset classes has caused a reluctance to remain in financial assets. Hence the return to hard assets and the emergence of talk of a return to some sort of a gold standard in order to regain price and asset stability. Even Fed Chairman, Alan Greenspan hinted of a return to the gold standard. In a recent speech to the Economic Club of New York, Greenspan said, "Although the gold standard could hardly be portrayed as having produced a period of price tranquility, it was the case that the price level in 1929 was not much different, on net, from what it had been in 1800. But in the two decades following the abandonment of the gold standard in 1933, the consumer price index in the United States nearly doubled. And, in the four decades after those prices quintupled. Monetary policy unleashed from constraints of domestic gold convertibility had allowed a persistent over-issuance of money."

Tide Of Red Ink

Greenspan's concerns come when the Americans are deeply in debt. The Americans have become the world's largest debtor. Consumer, government and corporate debt as a percentage of gross domestic product are at higher levels today than in 1929. So now, the US requires a continuous inflow of $2 billion a day just to fund its current account deficit which will easily surpass a half trillion dollars this year - or 5.5 percent of GDP. The twin deficits have become unmanageable, a duo that has not been a worry since the late 1980s. If the inflow slows a bit, returns on US investments will decline further, so attracting sustained foreign capital will become even harder. With savings at minimal levels, financing America's twin deficits becomes problematic. The dollar must fall.

The United States has been using other people's money to finance its domestic and international deficits. Thus far, foreigners own more than 40 percent of the government's debt, 26 percent of corporate debt and at least 15 percent of equities. With a lower dollar, Greenspan and others are questioning whether the United States should live within its means. Historically, the decline in the value of its currency was the market's way of adjusting for a country that spends beyond its means. Gold Is Money Prior to gold's demise in 1971, money was backed by a country's gold reserves. Gold was used to settle a country's balance of payment accounts. When a country ran a temporary balance of payments deficit, it shipped gold to its creditors, and in doing so, reduced the growth rate of its gold-backed money. To do otherwise, the paper money's value would exceed the value of the gold held by that country's central bank. The same would apply when wars were fought. Countries fought wars and repaid each other with gold.

The global monetary base grew by 55 percent between 1949 and 1969 - an average of 2.2 percent per year. Since then, reserve assets have grown by almost 1900 percent, or about 9.7 percent per year. In 1971, President Nixon severed the final link between the dollar and gold because foreigners were claiming gold instead of dollars. The US dollar became the world's dominant world currency, which saw the major currencies float against the dollar. The greenback is now the linchpin in a US-centric world with America becoming the world's bank and economic locomotive.

Without a gold backing there was no discipline enabling Americans to finance their endless deficits with fiat money. The Fed conveniently placed much of this debt with foreigners. As long as foreigners were willing to hold US dollar denominated debt, the Americans would be able to consume more than they produced. Until now.

Today's budgetary problems have their roots in Bush's tax cuts and the War on Terrorism. Like President Johnson who fought the Vietnam War and financed the Great Society at the same time, the government deficit could only get larger. In the first weeks of the war, Bush asked Congress for $75 billion and no one knows whether this is a down payment or installment. While there is no doubt that the $10 trillion economy can absorb much, the whopping big deficits and spending programs limit both the Fed and policymaker's options. After all, every dollar the government has to borrow to pay is a dollar less for manufacturers, new business, education or new technology. The twin deficits will force the Fed to generate more credit and liquidity, which in turn will further weaken the dollar and strengthen gold.

Gold's Bull Market Is Intact

We remain bullish on gold and expect a near term consolidation between $320 and $340 an ounce, the breakout level before gold's run to $390. This correction is normal and needed. After reaching our interim target at $375 an ounce in February, we continue to believe gold will hit $510 an ounce this year. Indeed, the war and its costs ensures that the target will be exceeded. The bull market was intact with or without Victory in Baghdad. It ain't over, till it's over.

The US dollar is poised to correct another 15 percent. We believe foreign investors have lost confidence in the dollar as a store of value in the wake of ballooning budget deficits and ever-widening current account deficits. And now, the dollar is simply not as good as gold. The massive issuance of dollars to pay for both twin deficits and the Iraqi War will cause a new round of currency debasement not seen since the seventies when the dollar lost 70 per cent of its value. Gold rose during this period from $50 to $850 per ounce.

Will Central Banks Sell More Gold?

The big risk today is whether the higher gold price will cause central banks, the world's largest holders of gold to review their stance regarding gold. In the past thirty years, despite much publicity, the central banks have only reduced their holdings by less than 10 percent. Because gold doesn't pay any interest, central banks have been selling gold from their huge stockpiles to earn modest income in a "portfolio management approach" to their reserves. That the return has been miniscule is lost on these central bankers who are supposed to be stewards of our money.

Nonetheless the decline of the US dollar, the dominant asset class in their reserves is raising eyebrows. Currently, the central banks have voluntarily capped their sales under the 1999 Washington Agreement, which limits gold sales to 400 tonnes until September 2004. The central banks found that gold sales without the Agreement depressed gold prices, which ironically hurt not only their own reserves (since gold is the second largest reserve asset held by the central banks), but also the gold sales of their colleagues in the Third World who utilized gold not only as an asset but key foreign exchange source. And, many central bankers are re-thinking gold sales in the wake of the Bank of England's sale of gold close to the bottom at $275 an ounce, leaving over a quarter billion dollars on the table.

We expect an extension of the Washington Agreement with sales from "old world countries" like Italy, Germany and maybe France. This time, the "new world" buyers are likely to come from the Far East who have bought the majority of gold as they attempt to build up their holdings in line with the West who hold eleven percent of their reserves in gold. In December, China bought about $1 billion in gold, increasing its bullion reserves to 2.5 percent, far below the world's average holdings.

Hedges- Financial Weapons Of Mass Destruction

But not only are the central banks receiving modest returns on their gold holdings due to the collapse in interest rates, but their sales were central to the development of the huge derivative market. Central banks leased or loaned out their gold holdings to bullion banks that used the borrowed gold to settle the hedging contracts of their client gold producers. The proceeds would be reinvested in higher yielding instruments and when the gold producer delivered gold against the contract, the bullion bank would return or repay the gold to the central bank. To hedge the risk, bullion banks used options or forward contracts. Derivatives became the fastest growing market during the eighties and nineties as the bullion banking industry exploded at the expense of the gold price, since much of the paper gold was dumped on the market. This worked until the gold price moved up and interest rates came down.

Central banks may have let the genie out of the bottle but are now scrambling to recork the bottle. The creation of these exotic derivatives or Warren Buffett's "financial weapons of mass destruction" served to undermine the fragile nature of the gold business and almost killed the gold market. The lack of contango and investor desire for 100 percent of the upside forced the gold industry to dehedge. To date, the industry has bought back only 10 percent of the estimated hedges outstanding. Importantly, noone has replaced those hedges. We expect continued buying back of the hedges, which ironically will be a powerful demand influence to an already tight market, with or without Victory in Baghdad.

Placer Dome, Canada's second largest producer announced that it had reduced its hedge book by 1.1 million ounces to 11.5 million ounces or 22 percent of reserves versus 12.6 million ounces or 24 percent of reserves. Placer having acquired heavily hedged AurionGold has been scrambling to unwind its hedges, because both companies were heavily hedged (See Table). It is important to note however that all hedges are not equal. Indeed, from an accounting point of view, forward sales are considered definitive contractual obligations whereas written calls are contingent commitments. While Placer has reduced committed hedge ounces, it did so by converting 920,000 ounces committed under forward sales to "put" options through the purchase of offsetting call options at a cost of $9.4 million or approximately $10 per ounce. In the last quarter, Placer only reduced 170,000 ounces by delivering into existing contracts. Placer simply used another derivative to offset a derivative. This is not what investors want. Meanwhile Cambior zigged again and reduced its hedges after increasing its hedges at yearend. Nonetheless, both Cambior and Placer, despite their widely advertised reduction still have more than three years of production hedged - that is not what investors want.

Newmont on the other hand, aggressively reduced its hedge book by repurchasing 804,000 committed ounces and delivering 449,000 ounces committed for the year. Newmont inherited much of its hedge book from its acquisition of Normandy and Newmont has been unwinding most of these latent time bombs. The Yandal gold hedges are still out of whack but they are nonrecourse to Newmont. Newmont will be hedge free by the end of this year.

Gold Is The Ultimate Hedge Fund

The debasement of the US dollar and the longest bear market in 60 years has forced investors to look elsewhere for safe havens. Devalued markets are sending investors in search of alternatives from jukeboxes to fine wines and from antiques to stamps. But such investments are fraught with risk. Liquidity or lack thereof is important. And of course, wine can always go sour. The worsening stock market picture has made hedge funds an attractive alternate investment class and a major part of the asset management business. A recent survey of institutional investors revealed that hedge funds have grown by double-digit rates, but in total are still less than Fidelity's Magellan fund. While the growth rate has been astronomical, the returns have been more surprising in that the average hedge fund gained 4 percent last year in contrast to a 25 percent drop in the stock market.

Indeed, gold is the ultimate hedge fund. While hedge funds have performed well on both an absolute and relative basis, they have actually lagged gold, which rose 25 percent last year. Gold represents diversification to risk other than simple market risk. With the recent decline in traditional asset classes, gold has emerged as a separate asset class. Gold has an inverse relationship to the stock market, commodities and currencies. We believe that a gold-based strategy can increase diversification and reduce portfolio risk. Unlike other asset classes, gold is liquid and there is little credit risk. Its performance both on an absolute and relative basis, can be back-tested on more than a few hundred years of history. Good portfolio performance comes through diversification based on assets exposed to different risks. Gold as an alternative asset class can provide this difference.

Recommendations: The Fundamentals Remain Strong

In the latest period, the performance of the mid-tier producers has been disastrous. Meridian's new project, Esquel became embroiled in a fight with local residents and the project will be delayed. Agnico-Eagle's shares were hurt following a rockfall, which will result in a shortfall of 75,000 ounces, hurting this year's production profile. Goldcorp had a terrific quarter but it too came down when the tide went out, despite announcing the Red Lake mine expansion plans. Our top picks remain in the mid-tier category which give investors the best risk/reward leverage to the gold price. We particularly like Agnico-Eagle, Meridian Gold and Goldcorp on this pullback. Among the Seniors we continue to like Newmont and Kinross.

The fundamentals of gold remain strong. Gold mining production has slumped to 2500 tonnes while demand has been growing twice as fast to a level of 3,900 tonnes. The difference has been made up from sales from central banks, short sellers and scrap. The cost of production has been increasing as mines have run out of high-grade ore. Meanwhile gold exploration has fallen from a high of $2.9 billion in 1996 to an estimated $900 million last year. As a consequence mine production continues to fall and there have been no major new discoveries.

The decade of high gold prices during the 1980s spurred exploration and the development of the gold mining industry, causing a peak in 1991 of newly mined gold supply. Most mines take from 5 to 10 years from discovery to production. Since then, the direction has been down due in part to the twenty year slump in gold prices, to the point that mine production actually fell last year widening the gap between supply and demand. The problem for the mining industry was best explained by Barrick's Senior Vice-President of Exploration, Alex Davidson at the Prospectors and Developers Association (PDAC) meeting who said, "That the current state of affairs in exploration is untenable for the health of the industry." Alex added that more money was urgently needed for junior mining companies, which traditionally have been a pipeline for new projects. Alex also warned that today's gold reserves will run out in ten years unless there is a dramatic increase in exploration spending.

The industry is faced with a dilemma. Notwithstanding the recent rally in gold prices, an even higher price is needed to stimulate exploration. Mining is a capital-intensive business and successful gold mining companies have grown either through exploration or acquisition. The last couple of years have seen a major industry consolidation to the extent that there are fewer players today than there were ten years ago. Consequently, we believe that in order to replace fast depleting reserves, the industry must either boost exploration or eventually acquire one of the few 6-10 million ounce undeveloped deposits. For sometime now we have featured our Top Ten list of junior producers many of which possess mega-ore bodies that were found much earlier and have been waiting for financing or a higher gold price. We expect this group to be a beneficiary of the industry's inevitable appetite for large-scale new projects. As such, our top picks include Eldorado for Kisladag, Crystallex for Las Cristinas, Northgate for Kemess North, Bema for Cerro Casale, Miramar for Hope Bay and Philex for Boyongon.

Bema Gold Corporation
We added Bema Gold, which is an evolving gold producer. Bema produced 117,000 ounces last year at a cash cost of $121 per ounce due to production from the Julietta mine located in Far East Russia, which produced almost 109,000 ounces. Modest output from 50 percent owned Refugio in Chile is expected from residual leaching. Kinross and Bema still hope to reopen that mine. This year production will increase to 270,000 ounces due to the company's recent acquisition of the Petrex mine in South Africa, which is expected to produce 155,000 ounces this year. Bema has a number of exploration targets and development-type situations, which could be potential mines for example. Bema has an interesting play in the Kupol gold and silver property located in northeastern Russia and owns 24 percent stake in the huge Cerro Casale project in Chile, which is a large undeveloped gold/copper deposit, partially owned with Placer Dome. The development price tag is over a billion dollars so that project is still an inventory play. We like Bema shares and recommend purchase.

Cambior Inc.
Cambior will go ahead with its share of the $7 million shaft-deepening project at the 50 percent owned Sleeping Giant mine in Quebec, which will extend the life of the 60,000 ounce facility by another two years. Meanwhile, Cambior's Doyon mine will lose 4,000 ounces of production and almost $1 million of cash flow as a result of the breakdown of the mine's production hoist. Feed will be stockpiled until the hoist is repaired. Meanwhile, Cambior reversed course again, repurchasing 189,000 ounces of its hedge program at an average price of $342 per ounce, offsetting in part the poorly thought decision to increase its hedge position. Cambior should more aggressively reduce its hedge positions since it still has almost two years of production hedged and, with declining Omai production and the uncertainties of the startup at Gros Rosebel, the company is vulnerable. Cambior is a poster child of why companies should not hedge. We continue to believe the shares should be sold, particularly since we do not believe the company has learned much from its near death hedging experience.

Claude Resources Inc.
Claude Resource's Madsen project in the Red Lake area of northwestern Ontario is developing with Placer Dome spending $2 million last year. The results focused on three target areas following almost 35,000 feet of drilling. Grades were excellent but with typical narrow intersections. The company plans to spend $3 million this year adding a second diamond drill. Placer Dome has a right to earn a 55% interest in Claude Resource's 10,500 acre property by spending $8.2 million prior to the end of 2004 and delivering a bankable pre-feasibility study. We like this play and recommend Claude here.

Crystallex International Corporation
Crystallex shares corrected following its removal from the S&P/TSX composite index only months after joining that index. Maison recently participated in a $4 million financing of Crystallex and we continue to view the company favourably. Las Cristinas in Venezuela is one of the world's largest gold deposits with measured and indicated resources of over 15 million ounces plus calculated by highly respected Mine Development Associates (MDA) of Nevada. A feasibility study by SNC Lavelin is expected in September and we expect news about the feasibility and mine plan this summer. Las Cristinas will produce 275,000 ounces initially increasing to 500,000 ounces per year from a open pit. Crystallex plans a 20,000 tpd facility with a capital cost of $225 million and $250 million. We continue to recommend Crystallex since Las Cristinas is the most under-valued, undeveloped deposit around, which will eventually be exploited.

Eldorado Gold Corporation
Eldorado posted a modest profit last year of $2.1 million and boosted its reserves by 40 percent to 5.8 million ounces. The company should produce about 105,000 ounces this year at a cash cost of $185 an ounce from the Sao Bento mine. More importantly, the company continues to advance the 7.8 million ounce Kisladag project in central Turkey and a bankable feasibility study prepared by Hatch Associates suggests an initial production of 143,000 ounces from the oxides and about 230,000 ounces later from the sulphides. The study suggested an open pit with a capital cost of $130 million and a payback of 2.6 years for a mine life of 15 years. Phase II calls for producing 230,000 ounces from the sulphides with a lower recovery factor. Eldorado submitted an environmental impact assessment and anticipates approval by July. The feasibility study paves the way for financing and with a solid balance sheet, construction is expected to begin by yearend. Eldorado is a producer with a debt free balance sheet, solid management, $48 million in cash, and two excellent gold projects in Turkey.

Gabriel Resources Ltd.
Gabriel Resources surprised the Street with a 70 percent boost in the capital costs at its 80 percent owned Rosia Montana gold project in Romania. The Basic Engineering study program by SNC Lavalin calls for a whopping US$181 million increase to US$437 million which follows the appointment of yet another president, Robin Hickson, who joined the company last summer. Oyvind Hushovd formerly of Falconbridge was made Chairman and Chief Executive Officer. The new plan calls for 500,000 ounces annually at a cost of $155 an ounce. Gabriel hopes to be in construction in 2004 with production anticipated in late 2006. While there is no question that the 10.6 million ounces of proven and probable reserves of the Rosia Montana mine is there, the rising price tag, village relocation agreements and financing are question marks. As such, we prefer Crystallex or Eldorado at current levels who are also in a similar development phase, but further along with their projects. Switch.

Kinross Gold Corporation
Followng the three-way merger, Kinross shares fell back due in part to its sensitivity to the gold price. Kinross is the seventh largest gold producer in the world with annual production of almost two million ounces at a cash cost of less $200 per ounces. The company's cash flow is in line with Placer Dome and we expect a revaluation of Kinross shares in line with Placer Dome's valuation. Kinross has an excellent management group, strong free cash flow and virtual unhedged status. The company has a "book" on most of the major producers and continues to look for more acquisitions. Ironically, Kinross is one of the few companies with the patience and wherewithal to takeover problem-ridden companies such as Placer Dome. We continue to recommend the shares here.

Meridian Gold Inc.
Meridian Gold has been under pressure due to concerns that the company will be blocked from developing its three million ounce resource at Esquel in the Pantagonia region in southern Argentina. Esquel is a $100 million dollar project and was to produce 300,000 ounces per year by 2005. However, the project has stirred up every environmentalist in the country and permitting will be an arduous process so the timetable may be extended. Nonetheless, this is a viable project and the reality today is that every mine must go through these hoops. In fact, a mine is not a mine unless it has either a lawsuit or a local town in opposition. We believe the price correction is an excellent opportunity since Meridian's El Penon mine continues to produce low cost ounces. Since the sale of Jerritt Canyon fell through we expect Meridian to produce 500,000 plus unhedged ounces this year and with there is little in the stock price for Esquel. The shares are an excellent buy here with.

Miramar Mining Corporation
Miramar Mining continues to develop its Doris North on the Hope Bay project in Nunavut. The company plans to spend $17 million in exploration to boost the development prospects at Doris. The feasibility study was completed and the development plans for Doris North include a 690 tonne per day operation to mine, mill and recovery of about 310,000 ounces over a two-year period at a cash cost of $109 per ounce. Doris is a few kilometers south of tidewater on Roberts Bay. The capital cost is estimated at only $40 million. Miramar plans about 43,000 metres of additional core drilling. The Hope Bay area is a classic greenstone belt, host to at least another two or three deposits. We expect news shortly from this drilling program. Meanwhile mining operations at the Giant and Con mines in Yellowknife continues to produce 115,000 ounces and the operating life of these mines has been extended 2005. Miramar has $41 million in its treasury and no long-term debt. We like the shares here.

Newmont Mining Corporation
Newmont mining reported a strong fourth quarter, ahead of expectations, resulting in earnings of $0.41 a share versus a loss of $0.16 a share last year. The big story is Newmont's reduction in hedges, which are now down to five million ounces. Overall the market value of the hedge book is a negative $433 million but over sixty percent of the hedge book is related to the Yandal operation in western Australia which have been "ring fenced". The Yandal hedges are offside and there are more hedges than there is reserves, so the bullion bankers are faced with a classic dilemma since the Yandal contracts are non-recourse to Newmont. Newmont is expected to be hedge free by yearend. With a much stronger balance sheet, estimated production at 7 million ounces this year and reserves in excess of 82.3 million ounces, the senior company is well placed to benefit from the rising gold price. Newmont has set aside almost $90 million for exploration but the core assets remain Yanacocha in Peru, Kalgoorlie in Australia and Batu Hijau in Indonesia. We expect Newmont will tap the equity markets sometime this year and continue to recommend this senior holding for its gold leverage.

Northgate Exploration Ltd.
Northgate a gold/copper producer in northeastern B.C., posted a profit in the fourth quarter due to better prices and higher throughput. Northgate produced 275,000 ounces of gold equivalent ounces from the large open-pit Kemess South mine from an inferred resource of almost 5.7 million equivalent ounces. The company is working on a feasibility study of Kemess North, spending $3.5 million last year. Kemess North material can be processed at Kemess South, with a tunnel purveyor system since the deposit lies on the other end of the mountain. The Kemess mine is located about 250 kilometers north of Smithers and Kemess North is 7 kilometers north of Kemess South. Northgate shares are a buy here for its steady production and the potential to add ounces at Kemess North. Moreover, Northgate would be an excellent tidbit for a company looking for ounces and future ounces at a reasonable cost.

Wheaton River Minerals Ltd.
Wheaton River continues its consolidation move, by bumping up its 25 percent interest in the Alumbrera gold/copper mine in Argentina. The increased stake gives Wheaton a 37.5 percent stake in the Alumbrera project and Wheaton should produce 450,000 (gold equivalent) ounces. Wheaton financed its initial stake with equity and the latest purchase will be financed with debt. Wheaton has grown exponentially acquiring the Luismin gold/silver mine for cash and shares. With the most recent acquisition there has been a quantum leap in shares outstanding and our view is that there is a need for a consolidation period. The market might wait for Wheaton to show that it can not only grow ounces but also grow profits.