A Devalued Dollar Will Do Little To Fix The Deficit

However these policies are largely ineffective. After all, the $320 billion tax cut is over an eleven year period and the near-term impact is negligible. A lower US dollar will definitely help American manufacturers by cutting the prices of their products, but American exports as a percentage of GDP is much smaller than its neighbours. Further a lower dollar will do little to correct either twin deficit. In the mid-80s, a 10% correction in the dollar reduced the current account deficit by 1% of GDP, but it took years. To achieve equilibrium, Americans would need at least a 50% correction in their dollar and a few years.

It's Not About Deflation

The high level indebtedness of the consumer and banking sector, makes deflation an impossibility in the United States. Deflation is more than falling prices. It destroys debt, transferring resources from debtors to creditors. But, deflation like inflation is a monetary phenomenon. Too little will translate into deflation, too much translates into inflation. The corporate sector has recovered from the bubble years of false prosperity but there is simply too much capacity and too much debt. Monetary base is growing at a 9% annual rate this year. A look at the Commodity Research Bureau Futures Index, a harbinger of inflation, shows that inflation should be a bigger concern than deflation and what we are experiencing is not deflation but instead disinflation. Since the October 2001 low, the CRB Index, which does not include energy is up 28%. It's not about deflation. It's about keeping the economy afloat with subsidized interest rates until at least next year's election. But why is Greenspan worried about deflation? Simply, the Fed has a vested interest in ensuring its securities are financed. The bond rally is well into its seventeenth month, spurred recently by Greenspan's musings about the threat of deflation. The market believes that under deflation, interest rates can't go up, but down. The stock market on the other hand should be going down in a deflationary world but instead it too has rallied. Fed-speak surely can't be good for everyone. An apparent reason for this contradiction is that Greenspan's warnings are simply typical Fed jawboning and an excuse to reopen the money spigots. Rates are low because of the tremendous liquidity unleashed by an expansive Fed policy not deflation. However, this wave of liquidity, which has flowed into the bond and stock market will stay only as long as the Fed can keep rates down. That can't last.

The Americans Need Outside Capital

It's bound to happen. Sooner or later, foreign investors would demand a higher price for agreeing to hold onto US debt. Today amid heavy currency losses and strained geo-political relations, foreigners correctly question the relative attractiveness of US assets and the dollar particularly with interest rates at near zero rates. The world's currency of choice has now become the currency to avoid. Foreign demand for dollar denominated assets is tepid, except for Asian countries, which have been buying to prevent their own currencies from strengthening further.

The United States has never been more dependant on the rest of the world for critically needed capital. Greenspan warned that if foreigners would not buy their debt, the Fed would instead underwrite America's debt by printing more money. A savings short economy is sucking up all available funding from overseas and with a fixed pool of domestic savings, crowding out will eventually raise rates, which is also inflationary. History shows that the debasement of a currency's value is a symptom of incipient monetary inflation.

Freddie Mac A Casualty

Not surprising, one of the casualties of Greenspan's low interest rate policy is Freddie Mac. With rates at near-zero, spreads are too narrow, raising derivative risks concerns. Not only is the bubble-like housing sector affected but the markets will be hurt by the problems at the giant mortgage company Freddie Mac. The top executives were recently fired, sending shivers through the financial markets at a time when the markets were just recovering from the HealthSouth and Martha Stewart scandals. With a $1.29 trillion loan portfolio or 16% of outstanding mortgages, the No. 2 government agency was the main pillar of the housing market. Freddie has been a huge player in the trillion dollar derivative market as a way to hedge interest rate risk. Derivative concerns and accounting issues apparently are behind the investigation, threatening confidence in one of America's largest lending institutions. With near zero rates, Freddie Mac may have exposed itself and the market to too much risk.

It's All About Debt

But the real damage is in Washington where the budget deficit for the current fiscal year, is projected to reach a record $500 billion, up from $158 billion last year. At 5% of total economic output, the unsustainable deficit is approaching the mid 1980s crisis level, which sparked a 70% drop in the US dollar in the last dollar bear market. Between 1985, after the Plaza Accord and 1987, the US current account rose 35% to $168 billion but it took two years of a low dollar to correct back to $128 billion. Meanwhile the other deficit, the current account is also pegged at a record $500 billion with America's imbalance with its trading partners getting even bigger. As we have said before, deficits must be financed. America's dollar devaluation strategy is a high-risk gambit to not only revive the economy, but reverse the massive current account deficit. Never in history, have the Americans owed so much, the current account been so big and never before has the United States been more dependant on foreigners for money.

Competitive Currency Devaluation- Gold For Gold

Competitive currency devaluations are an age-old weapon used successfully in the last decade by the Chinese and before them the Japanese. Today, the US is the world's largest debtor. The United States requires an inflow of over $2 billion a day to finance its record current account deficit and keep the dollar up. Foreign demand of US assets is insufficient to finance the widening deficits. Yet the huge US trade deficit has flooded the world with debased dollars. Rarely in U.S. history has there been so much liquidity, with so much massive monetary and fiscal stimuli in the pipeline. America's interest rates are among the lowest in the world. The United States requires an even lower dollar to assist its export sector. But the problem, given the global slump, to whom can they export? The other problem is that unlike China or Japan, exports are a relatively small part of the US GNP.

Of greater concern is that if America's trading partners cannot afford to ship its goods that they too might follow an easy money policy to cheapen their currency in a deathly series of competitive currency devaluations, reminiscent of the thirties. The ECB's recent rate reduction reflects an attempt to fight back. Capital controls are next. Gold will go higher under this scenario because historically these policies don't work. We believe the policy of a debasement and a move towards competitive devaluation is by far a bigger potential threat to the economy than the much-ballyhooed threat of deflation. The real issue is not the devalued dollar, but America's devalued creditability. The dollar is no longer as good as gold. Gold is an effective hedge against a world of competitive devaluations.

Gold's Stealth Bull Market

Gold has recently jumped about $55 on the back of the depreciation of the US dollar. Last year gold outpaced the stock market, bond market and most every major industrialized currency in the world. This year, bullion has appreciated almost 6% but the index has fallen 17%. Investors and pundits are complaining of gold's sluggish performance. We believe that we are in a stealth bull market and the main drivers for our $510 per ounce price target are: a collapsing US dollar, falling mine output, producer de-hedging and yes, increased investment demand.

Gold's main role is as a store of value. For much of the world, gold is still used as a medium for hoarding. When one looks at gold denominated in other currencies, it has not only appreciated but importantly maintained its value in a period of volatile currency moves. Gold has an inverse relationship with the US dollar and stock market. A weaker dollar spurs buying of dollar-denominated gold by making it cheaper for foreigners, while falling stock prices raises gold's safe-haven status. Gold is simply an elegant alternative to all those "cheap" dollars in the world. We continue to believe that we are in the early stages of another bull market for gold, beginning the second upleg which will see gold at least at $510 an ounce this year.

But Why Are Gold Stocks Lagging?

But, why are gold shares lagging gold bullion? The major reason is that during the first upleg, gold producers replenished their balance sheets and ever-efficient Bay Street flooded the Street with paper. High River Gold Mines has gone from 35 million shares to over 100 million shares. While balance sheets were replenished, many gold producers also made acquisitions financing those acquisitions with paper. Wheaton River Minerals has gone from 52 million shares to over 240 million shares. Kinross Gold has gone from 81 million shares to over 300 million shares following the Echo Bay and TVX mergers. It takes time for this paper to be digested.

Hedging, like smoking Has Become Unacceptable

Another reason for gold shares' disappointing performance is that many senior producers were ardent hedgers. With gold near the $360 per ounce level, the major producers are scrambling to unwind their hedge books because virtually every hedge book is underwater. And, the lack of a contango, nervous regulatory agencies and investor desire for 100% of the upside are causing mines to unwind their positions, supporting the physical spot market. Investors appear to favour those unhedged producers giving them more credit to unwind their ounces than hedging those ounces. Placer Dome and Barrick still have to buyback hedges in comparison to the better placed unhedged mid-cap producers such as: Goldcorp, Agnico-Eagle and Meridian.

The non-hedgers have doubled the performance of the hedgers. Born-again anti-hedger Newmont recently offered $219 million to buy back all of Yandal's gold hedges for fifty cents on the dollar. Yandal only has proven and probable reserves of 2.1 million ounces against hedge contracts of 3.5 million ounces. To date, six of seven bullion banks have agreed to take 50 cents on the dollar to liquidate their claims, exposing the risk and lender liability of the counterparties' hedge book. Hedging is only practical in a declining market and the Street is quickly finding out that the world has changed. Producers have so far dehedged less than 10% of their hedge books and thus so are expected to be a big part of demand. Much has been said that producers' dehedging won't have much of an influence on the market because the paper derivative market is so much bigger than the physical market. Balderdash. The paper derivative market is based mostly on physical gold that has been swapped, lent or leased by the central banks. In our view, the buybacks tighten an increasing illiquid market since the gold must eventually be returned to the central bank. Investors today want the upside and are willing to take the commodity risk. The bullion banks and central banks ironically are the one with the risk.

North American Producers' Premium To Widen Over South Africa

The weakness in the US dollar also had a material impact on non-American gold producers. In South Africa, the rand has increased 40% against the US dollar over the last year and half. The rand's increase has outstripped the gains in the dollar price of gold during the same period. The strengthening rand raises costs, increasing the risks of production curtailments. South African mines are already producing at 50-year lows. In Canada, the dollar has also strengthened stoking mine costs in the first quarter. This comes at a time when the gold industry is faced with a declining production profile due to deepening mines and lack of exploration. The industry consolidation has narrowed the number of mining companies. Today the top ten producers account for sixty-two percent of the world's production. We continue to expect further mergers, acquisitions and corporate consolidations. The North American producers are well placed in contrast with their South African cousins who are hurt by the rand, a nationalistic government and increased taxes. We thus expect more money to be focused into the North American producers and that the premium will widen.

New World Central Bankers Are Buyers Of Gold

Central bankers are expected to be buyers and not sellers of gold. Not only is the supply of gold constrained because of the Washington Agreement but central bankers appear to be curtailing their activity because of concern over the recent dollar weakness. We thus expect the Washington Agreement to be extended next year as many of the new world countries have discovered the merits of gold in their reserves, particularly with the U.S. dollar losing so much value. Kazakhstan recently announced their intention to double their reserves of gold purchasing up to 57 tons of gold. China is also diversifying its billions by buying euros and gold instead of dollars. China has not only bought gold as a reserve asset but also liberalized gold ownership allowing its people to own gold. China is currently the world's third largest consumer, and is likely to become the largest consumer. Not only has the Shanghai Gold Exchange traded more than 700 tons since its inception but the central bank has given producers and retailers a license to enter the gold business. With the largest savings in the world, China is well positioned to show that gold is money.

Gold's Role As A Store Of Value And Reserve Asset Intact

But what of the hand wringing by the bears who are disappointed that gold is still a "fringe" investment lacking in investment demand. Much is made of gold's lack of yield relative to bonds or stocks by the bears. However, they conveniently overlook that while gold does not pay a penny of interest it has historically maintained its value against fiat money. With interest rates at forty-five year lows and a debased dollar, investors should be more concerned about the preservation of capital, not yield. Gold does well during financial periods of stress as it rises when times are bad. Last year, for example, gold rose twenty five percent, the largest gain since the 1970s, while the Dow Jones fell sixteen percent, the Standard and Poors index fell by twenty four percent and the dollar fell by nine percent.

Gold Has A Negative Correlation To The Dollar

The Street's myopic analysts seem to be suffering from attention deficit disorder (ADD). They have lost sight that gold has risen over $100 per ounce from its lows on the backs of a lower US dollar. For two decades the strong dollar was the world's currency keeping gold down. That has changed. The dollar is still overvalued and its expected revaluation will keep gold up. Gold in yen has not only maintained its value for Japanese investors but has kept its value in dollar terms. Gold is still the second largest reserve asset held by central banks with the euro backed by 15% of members' gold holdings.

New Products To Revive Investment Demand

The industry is devising new initiatives to broaden gold's appeal which could easily double investors demand. ETF or exchange traded funds based on gold have been created to revive investment demand. Gold Bullion Limited, a gold-backed security listed on the Australian Stock Exchange last month, has already sold more than three tons of gold and should account for fifty tons of demand this year. The World Council has unveiled a low cost Gold Equity Share, which will be listed on the NYSE and other exchanges. The ETF will be backed by gold bullion and provide simple access to bullion. Unlike coins, there will be no sales tax and importantly more liquid. We expect that this Gold Equity Share will be hugely popular and attract mainstream investment. Lost on these myopic analysts is that ETFs and bullion funds represent a huge potential source of investment demand for gold. In Canada, a new bullion closed-end fund, Central Gold-Trust sponsored by highly respected Central Fund of Canada and Sprott Asset Management is expected to attract investor appeal. By turning cash into gold, we believe these funds will open up gold investment to a wider audience including retail investors and pension funds.

Company Recommendations

Agnico-Eagle
Agnico-Eagle reported a loss of $0.07 per a share or $6.9 million reflecting a lower output of 55,000 ounces compared to 60,000 ounces of the first quarter of last year. The main reason for the production shortfall was due to a rock-fall at the company's main La Ronde gold mine in northwestern Quebec. The rock-fall was attributable to a localized stress from a production blast immediately below the caved area. The company immediately began remedial work and changed the mining sequence, which will result in reduced tonnage. The La Ronde mine has recovered well and the operational problems experienced in the first quarter will not be repeated. Normal underground operations are expected to resume in the third quarter. Consequently Agnico-Eagle will produce 300,000 ounces or 20% less than the previous target of 375,000 ounces. The Street was obviously disappointed, but we believe the rock-fall is a temporary setback. Average daily mill throughput increased almost 7,000 in the first quarter with the mill and mine averaged 7,978 tonnes per day in April. The company continues to aggressively explore and has nine drill rigs operating in the La Ronde area. Further, the company has begun a $2.5 million exploration program on the recently acquired Lapp property with five drills in operation. Agnico-Eagle has assembled a land package, which has expanded to 2,467 hectares. With an excellent physical plant, this planned assembly makes sense. At Goldex, the company is continuing technical studies and a feasibility study should be announced shortly. We believe that Goldex will be Agnico-Eagle's next mineral production and is not reflected in Agnico-Eagle's share price. As such we maintain our buy for the rising producer profile, strong balance sheet and more importantly for its potential to add significantly to its long life reserves. At quarter-end, Agnico-Eagle had cash of $141 million while working capital was $174 million.

Barrick Gold Corporation
Barrick reported another disappointing quarter of $0.05 per share compared with $0.09 a year earlier. The drop in earnings was attributable to an accounting change and lower gold production. First quarter gold production slipped 100,000 ounces to 1.3 million ounces from a year earlier. Increased costs at Barrick's Betze-Post operation in Nevada was due in part to autoclave problems. Barrick is expected to recover production at Betze-Post once the autoclave problems are sorted out. Barrick's plum Eskay Creek in British Columbia produced 84,230 ounces of gold at a cash cost of $69 per ounce. Barrick expects to produce 5.4 million this year, down from 5.7 million ounces last year. Barrick has been hit with a fourth class action lawsuit alleging that its earnings guidance last September was misleading. A fifth lawsuit is currently being heard. This one concerns the GATA allegations of a grand conspiracy among Barrick, the bullion dealers and central banks. JP Morgan and Barrick argued for a dismissal of the case on the grounds that the courts did not have jurisdiction over the central banks and bullion dealers - that argument was rejected. This suit should not to be taken lightly. It is still too earlier to gauge the performance of newly appointed president Greg Wilkins. However it is obvious that the hedge program will be reviewed and simplified. At the end of the quarter, Barrick had 17.3 million ounces of gold hedged at an average of $337 an ounce. Barrick intends to deliver against its hedges, but we believe that the company must aggressively reduce its hedges to recapture investor interest. Hedging has become a lightening rod for Barrick's nonperformance and with the hedge book about $500 million underwater, Barrick must surprise a skeptical Street. Meanwhile the company intends to spend part of the $1.1 billion cash hoard by buying back about 7% of its shares. We think that the buyback is a good idea since it both shows management's belief that the shares are undervalued and it will restore Barrick's rising earnings profile due to fewer shares.

Crystallex Inc.
Crystallex reported a reserve update at its 100% owned Las Cristinas gold project in Southeastern Venezuela. An independent study by Reno-based Mine Development Associated showed the deposit holds proven and probable reserves of 9.5 million ounces, grading 1.33 grams per tonnes. Crystallex has hired SNC Lavalin, to complete a feasibility study of Venezuela's largest undeveloped deposit is expected this fall. Current plans call for an initial 20,000 tonnes per day operation, capable of producing oxide and sulfide ores with a capital expenditure between $225-$230 million. The first phase should produce 275,000-280,000 ounces of gold. Deutsche Bank has been selected as project finance advisor and despite earlier ownership questions, we believe that Las Cristinas does not have any of the political problems or lack of economics of other major projects. Crystallex will not have to move villages, cemeteries or change their processing facilities to mine Las Cristinas. The government is Crystallex's partner and with power, water and abundant labour, this is an excellent project. We continue to recommend purchase since Crystallex has one of the lowest market cap per ounce of production with respect to other major underdeveloped projects. As such the longer the shares drift down here, the more likely the company will become a takeover candidate. Maison has assisted the company in recent financings.

One of the biggest myths is that Crystallex does not own the rights to Las Cristinas. Las Cristinas was awarded to Crystallex on September 17, 2002. This exclusive operating agreement was signed with Coporacion Venezolana de Guyana (CVG) a multi-billion state owned company that was given authority to contract with third parties over the Las Cristinas property from the Ministry of Energy and Mines, as the executing authority under the Mining Law. Following the cancellation of the Placer Dome contract due to a notice of default (no gold was produced) the property was repossessed on behalf of the Republic of Venezuela under Venezuelan mining law. The contract was cancelled in early November 2001 and the assets were repossessed November 16, 22001. The contract was gazetted and the copper concessions were cancelled on March 6, 2002. Crystallex owns the rights - fact.

Glamis Gold Ltd.
Glamis reported a disappointing quarter of $0.02 per share compared with $0.04 last year due to a production shortfall at the San Martin mine in Honduras. Glamis will produce 245,000 ounces of gold at a total cash cost of around $175 per ounces. Glamis boosted its exploration spending $2.4 million as part of feasibility at its 3 million ounces resource Marlin project in Guatemala. More work is needed at this $100 million project. Glamis' 100 percent-owned El Sauzal project in Mexico is not expected to be in production until 2005, at the earliest. El Sauzal should produce at a rate of 190,000 ounces at $190 per ounce cash cost. Engineering has been completed and Glamis expects to start building the mine next year following permitting. We think Glamis' shares are ahead of themselves and given uncertainties of bringing two major projects on stream, we believe the shares are expensive and view these shares as a source of funds.

Goldcorp Inc.
Goldcorp reported a slightly lower quarter with earnings of $0.08 a share on gold production of 133,000 ounces. Goldcorp's high-grade crown jewel Red Lake mine in northwestern Ontario produced almost 118,000 ounces but a drop in recovery rates offset the improvement in head grades. Red Lake should produce 510,000 ounces this year and Goldcorp will produce in total 610,000 ounces including the Wharf mine output in South Dakota. Importantly Goldcorp has begun sinking its new shaft at Red Lake, which will enable the company access to other areas, allowing a 40% increase in production to 740,000 ounces by 2006. Goldcorp has an excellent balance sheet with working capital of $300 million, bullion holdings of over 200,000 ounces and remains debt free. Goldcorp is also withholding 10% of its production from the market and from time to time purchases gold on the open market. We continue to recommend the shares for its production profile, balance sheet and management's astute read of the gold market. Buy.

Iamgold Ltd.
Iamgold reported earnings of $0.03 versus $0.05 in the first quarter last year and should produce 430,000 this year. The results include the production from the Tarkwa and Damang Mines in Ghana, which was part of Repadre Capital. Iamgold's Sadiola (38% owned) open pit mine in Mali, produced 104,000 ounces but the head grade was lower in the current quarter. The 40% owned Yatela Mine was another disappointment producing 12% lower production at 53,000 ounces in the quarter. Offsetting the production shortfall was the increase in production from 18.9% owned Tarkwa gold mine operated by Goldfields. Tarkwa will be expanded and annual production should increase to 650,000 ounces from the current 600,000 ounces. Iamgold has an excellent balance sheet with $110 million in cash and gold, we continue to recommend the shares particularly since they have not reflected fully merged Repadre Capital. Iamgold also holds royalties, including a 1% royalty in the Diavik Diamond project in northern Canada.

Kinross Gold Corporation
Kinross reported a disappointed quarter in part due to problems at Musselwhite and Lupin. Kinross, however, only had one full quarter under its belt. At the main Fort Knox deposit in Alaska, exploration continues at the True North and Gil deposit and Fort Knox should produce over 410,000 ounces this year. At 50% owned Round Mountain, this epithermal deposit generated 19% of the production and about 27% of Kinross' cash flow. In Russia, the Birkachan deposit will add three years to the mine life of Kubaka. Kinross plans to reopen 50% owned Refugio in Chile with additional reserves found within the Verde pit at Refugio. Kinross also hopes to revive the Kettle River Mine in Washington State. Kinross has consolidated the various inherited mines from TVX Gold and Echo Bay. We believe the market has penalized the company and the Street has not yet appreciated the wisdom of combining the three companies. Not only will there be cost savings but the inherited inventory of mines and almost 2 million ounces of unhedged production makes Kinross an appealing company. On a valuation basis the company is trading at a huge discount of at least two thirds to other senior producers. With $123 million in cash, the company is expected to continue its acquisition/consolidation model later this year to extend its mine life beyond the current 6.5 years. Buy.

Meridian Gold Corp.
Meridian Gold has suspended plans to build the Esquel gold project at this time. The local community has opposed the mine development and the company has finally admitted they may have played the wrong cards. Meridian wants to build an open pit using carbon and leach cyanide processing circuit to recover the gold. While a feasibility study had been completed, local opposition to the 300,000 ounce gold project caused the reassessment. Meridian shares have been beaten up, to levels where but we believe that the shares do not reflect anything for Esquel. Given that El Penon continues to produce low cost gold of 320,000 ounces this year from surface and underground, Meridian shares are attractive here. Esquel will eventually be developed and with a strong balance sheet, the shares should be held.

Northgate Exploration Ltd.
Northgate reported a disappointing quarter due to lower production resulting from higher stripping at the Kemess mine in north central British Columbia. Northgate lost $0.02 per share or $4.4 million compared with a bigger loss last year of $0.15 per share. The Kemess mine produced 62,000 ounces of gold and 17.1 million pounds of copper down from 68,193 ounces of gold and 18.5 million pounds of copper. Kemess is a large open pit operation and the lower production was due to the mining of lower grades from the eastern section of the pit. For the balance of the year, the mill is expected to process higher grades and thus Northgate will be on track to produce 290,000 ounces of gold and over 75 million pounds of copper this year. Cash flow was positive, amounting to $4 million in the first quarter or $0.02 per share, reflecting lower interest expense. At the Kemess North project, the company continues to do engineering work and a prefeasibility study is anticipated by the end of month. Kemess North would require a higher gold price to be put into production. We continue to recommend Northgate as an ideal takeover candidate because the Kemess deposit and infrastructure is an attractive production base in that part of the world.

Placer Dome Inc.
Placer Dome was one of the few producers to report a strong first quarter of $0.16 per share up from $0.11 per share due in part to unrealized non-hedge derivative gains. With fourteen gold mines, Placer produced a total of 903,000 ounces of gold at a cash cost of $205 compared to its 666,000 ounces a year earlier, reflecting the acquisition of AurionGold. Placer reduced its hedge book by 1.1 million ounces to 11.5 million ounces, which is still too large. Placer's problem remains a flat production profile even with the acquisition of AurionGold. Placer hopes to salvage the $1 billion Getchell acquisition by reopening Turquoise Ridge in Nevada. Placer plans to spend $80 million on a smaller phase I scale operation to generate 700,000 ounces from the smallish 2 million ounces reserve. This is planned as part of an eight-year plan. Placer also finally announced a widely known new gold discovery at Cortez Hills. Six drills are delineating the new discovery and there are expectations that this could be the first bit of good news for Placer (the gold resource has doubled from 2.1 million ounces to 4.5 million ounces). Meanwhile, Placer continues to develop the South Deep operation in South Africa. While production is up, cash and production costs have also increased due to the appreciation of the rand against the US dollar. Placer is sinking a shaft with this operation, and in our view will prove to be a sinkhole for Placer's cash. Overall Placer should produce about 3.5 million ounces of gold and 400 million pounds of copper this year. We view the shares as a market perform particularly since the intermediate term prospects are modest in contrast to its quickly depleting mine life. Mega projects such as Donlin Creek, Pueblo Viejo and Cerro Casale are too far off in the future to be included in our valuation. Indeed, if one strips out the reserves of South Africa, Placer's reserve picture is somewhat precarious.

Southwestern Resources Corp.
The Boka gold project in northcentral Yunnan province in China has been widely followed. Gold mineralisations were discovered in 1999 through stream sediment and soil geo-chem by Team 807 of the Yunnan Ministry of Geology and Mineral Resources. For the record, we have been skeptical about this play not because of the lack of gold but our belief that the lack of drilling results did not support the stock price. The most recent results for example include a section of 81.44 meters of 3.22 grams per tonnes of gold in Hole B03-04. However, that hole was part of a series of holes and the results are sporadic. Metallurgy has not been disclosed but there are some hints of sulphide mineralization. Continuity would appear to be a problem and a simple leach may be difficult to recover the gold. While the grades are described as uniform, they are anything but, ranging from 1.9 gram at 5.5 gram per tonne in one section for example. And, an attempt to match those holes with the tunnels suggest an envelope much smaller in ounces than the mega ounce expected by the Street. Much has been made of the shallowness of the deposit but it appears that there is nothing to support this speculation based on the drill hole information released to date. Speculation of dip or undulating also has yet to be supported by drill hole results. The Boka deposit appears to down dip 30% and appears heavily faulted. Further, based on press releases it would appear that the geology is complex and the highly faulted rock might make mining difficult. Most outrageous is the speculation that the waste-to-ore ratio is 1:1 which defies imagination given that the drill play appears to be on the side of a steep mountain. Comparisons to Barrick's Pierina Mine is further misleading since that deposit is a flat lying deposit and had many times the holes drilled into before calling it a deposit. The climate is even different. Pierina has a different physical setting and the dry climate is conducive for low cost heap leaching. While we are reluctant to throw cold water on a developing play and we believe that there is gold in them hills. The question, however, is that with the economics of mining in that part of the world, information to date and the lack of drill results (less than 3,000 meters of drilled so far) makes the stock vulnerable. Management of Southwestern Resources is considered professional and seasoned and the work to date appears highly competent. However, drilling is slow and assays take a long time. In the interim, the investors caught up in the enthusiasm of a rising stock are confusing a high stock price with results. Simply, we are early days into this play, and given the lengthy time between assays and information, we believe that it is better to play elsewhere. SELL.

John R. Ing
416-947-6040

21 June 2003