'Not the same thing a bit!' said the Hatter. 'You might just as well say that "I see what I eat" is the same thing as "I eat what I see"'- Quote from the Mad Hatter in "Alice In Wonderland" - Lewis Carroll.

"I know you believe you understand what you think I said, but I am not sure you realise that what you heard is not what I meant" - Alan Greenspan.

Confused? While reassuring the markets, Greenspan noted that the flat yield curve either suggested a slowing economy or instead was attributable to "new forces" such as Asian central banks, a savings glut or a labour glut. Historically, when long term yields fall as short term rates increase, it flattens a steep yield curve, indicating that the economy is heading for a serious slowdown. And it is not only a made-in US phenomenon since 10 year German bond yields are only 2 percent.

Greenspan's Conundrum

Like Alice at the Mad Tea Party, Alan Greenspan is puzzled. The interest rate "conundrum" in which 10-year Treasuries continues to fall despite an increase in short rates is confusing investors and central bankers alike. Although Alan Greenspan has moved interest rates up nine times, he hints that there are more to come. The Fed chairman worries that the economy is too strong and points to looming bubbles such as hedge funds and real estate. However, the bond market seems to be ignoring Mr. Greenspan's warnings of higher interest rates and appears to be on a path of chicken with the central bank.

Greenspan just doesn't get it. We believe that the answer to the bond market puzzle is that Greenspan and other central banks have flooded the financial markets with liquidity, resulting in too much money chasing too few goods. At the heart of this debate is that Bush has gone on the biggest spending spree since Lyndon Johnson. America has become the world's largest debtor. The Fed's requirement to finance America's burgeoning trade and budgetary deficits kept rates at ridiculously low levels in order to keep the consumer spending to avoid the very recession or slowdown that the bond market is expecting.

The recent rate increases are a reflection of the need to attract foreign monies, since Americans have outsourced the financing of these deficits. Either way, we believe that the market is vulnerable to a major reversal of sentiment since this excess liquidity could disappear quickly, particularly if investors were to be spooked from benign events such as a build-up of inventories, another shift in the US dollar or an increase in rates.

What is at issue is that America's indebtedness has left it exposed, threatening the world's financial stability. The US savings rate is near-zero, matched equally by a large increase in the savings rate of foreigners. The Americans are pumping out so many billion of dollars that it has been calculated that it needs to attract about eighty percent of all the world's savings just to maintain the dollar's value.

China Inc.

For too long, America has been living on borrowed time and borrowed funds. Those funds have been supplied by Asians who now own $1.1 trillion of US Treasuries. China with the world's biggest population and fastest growing economy is awakening economically. While we can understand China's quest for securing its energy sources, left unsaid is the huge power that China has come to wield. That power comes from its mammoth cash reserves. That the Chinese are no longer content to invest their money in US government bonds is a reflection of not only their attempt to diversify but a logical objective to seek a superior return. Also it has become cheaper to buy reserves on Wall Street than the drill bit.

As the US current account deficit climbed above six percent of gross domestic product (GDP), China accumulated over $200 billion of US Treasuries and $711 billion of foreign exchange reserves. Until recently, China was content to be a passive investor but America's profligacy caused an economic-awakened China to take a more active stance.

China is exercising its right to manage its economy, its assets and security of resources. China's currency and exchange rate are matters for the Chinese, not John W. Snow or anyone else. The Americans lost control over their currency in 1971-1973 after the Bretton Woods breakdown when currencies floated without an anchor. It's not about a more flexible renminbi, it's about the devaluation of the world's last reserve currency.

Today the world is awash with dollars. China has become the most vital creditor of the debt-laden US. China has more dollar reserves than it needs and the depreciation of the dollar lowers asset values in their own currencies. China holds the cards. But what if China revalues its currency? All those goods made in China would become more expensive. US rates would go up since Beijing would have less to spend. Inflation would ensue, coinciding with rising rates and the bursting of America's remaining bubbles. Americans should be careful what they wish for.

War of The Words

"Take more tea, " the March Hare said to Alice very earnestly. "I've had nothing yet, "Alice replied in an offended tone, "so I can't take more." "You mean you can't take less", said the Hatter, "it's very easy to take more than nothing." from Alice In Wonderland - Lewis Carroll.

And that is like the Americans who are reluctant to wean themselves from the easy money policies that piled on debt on a horrific scale. The foreign appetite for US debt is waning. Americans should listen to the message and fix their own balance sheet, fix their own currency and fix their own businesses. While China-bashing is quickly becoming the rage - it is a red herring.

China National Oil Corp's (CNOOC) bid for Unocal Corp set off a geo-political debate as Congress and others in a xenophobic knee jerk reaction wrapped themselves in the flag of nationalism. This comes following Chinese computer firm, Lenovo's acquisition of IBM's personal computer division and now Haier, China's largest appliance maker, bid for US appliance giant Maytag Corp. The bids are an important shift in China's investment activity. At the end of April, China held $230 billion in US treasury securities and by diversifying, China is using its cash hoard to acquire expertise from developed companies.

Rather than buy golf courses and Hollywood film studios, the Chinese are simply acquiring under-achieving industrial assets with global brands. Yet the Chinese are actually proceeding cautiously with their investments. For example, the National Development and Reform Commission acts as gatekeeper and studies oversea investments and their approval is needed before final consent is granted by China's cabinet.

Though 70 percent of CNOOC is indirectly state-owned and thus not directly funded by the government, politicians were quick to raise concerns about national security and its parenthood. Missing is that Americans are non-plussed in dealing with Aramco owned by the government of Saudi Arabia. Missing is that China and the United States have become deeply interdependent. China has become America's third-largest trading partner (Canada is number one). China needs a market for its exports and the Americans need funding for its growing trade and budgetary deficits. In addition, the US consumer keeps buying cheap Chinese goods and US manufacturers depend on China for the production of those goods. Indeed about half of China's exports are by companies that are wholly or partly owned by foreigners.

Despite the rhetoric, America with its mountain of debt is not in a position to stop future purchases. The use of China's economic muscle provides an early warning sign for the Americans. The debate over the yuan, pegged to the US dollar is simply a proxy over China's emergence as an economic superpower. Threats to impose tariffs or telling the Chinese to change their internal monetary policy will not only fall on deaf ears but make them no friends.

Enter the Dragon

The implications of China's emergence as a superpower is going to have bullish implications for commodities. According to Zhang Jian, president of the China Non-Ferrous Metal Mining Company, China may have to import 57 percent of its iron ore, 70 percent of copper concentrates, and 80 percent of alumina by the end of the decade. The statistics are mind numbing. By now we know China is the world's largest consumer of steel, iron ore, copper and aluminium. Then there are the agricultural commodities where China has already displaced Japan in consumption.

In the past, the foreign policies of Britain and the United States were governed by their need for commodities and now so will China's need force those countries to develop new strategies for foreign policy and security of resources. Oil shaped much of America's foreign policy in the last forty years as did the Boer War for Britain. The U.S. went to war with Iraq twice because of concern over the control of two of the world's largest oil reserves. In our view, China's emergence is at the very inflection point to have a major influence on global geo-political environment. The centre of influence in global and monetary policies has tilted from a US-centric world to the Middle Kingdom.

China has already developed a foreign policy and military strategy to protect its access to raw materials. In August, China and Russia have scheduled the largest military exercise ever with 8,000 troops. From Sudan to the Caribbean, the Chinese have become masters of influence by negotiating agreements filling the vacuum left by the Americans. China has independently developed trade ties with those not friendly to the United States. China is in Kazakhstan building pipelines and acquiring reserves to protect its supply. Chinese state-owned companies are making direct foreign investments in Venezuela, Africa, Indonesia and Australia. And recently the Chinese has started knocking on the doors in Canada for access to our resources.

This growth and new role for our commodities has occurred so quickly that policymakers have not yet looked at the implications. Canada is well placed to benefit. Canada exports 80 percent of the minerals produced or refined here and is well poised to benefit from China's voracious appetite. At the current rate of growth, China will be a bigger influence than America and thus Canada is in a position to be an influential player in the early decades of the 21st Century. Indeed, we believe that Canada's role as a provider of resources will eventually be overshadowed as a provider of capital.

Fiat Money

The euro took another pounding in the wake of the French and Dutch rejection leading to fears of economic paralysis as the Community sorts out what to do without a constitution. As Canada discovered, a constitution does not make country, since it took more than a hundred years to repatriate our constitution. The European Community was created to promote trade, provide stability and establish a common currency. Although the euro had a near-death birth, it enjoyed a huge rally to record levels but has now collapsed following the rejection by the French and Dutch. Notwithstanding this "up and down" performance, underlying the value of a currency is the economic fundamentals.

Here the Europeans have been woefully undisciplined. Germany, Italy. Portugal and France could not rein in their budgetary deficits and all have exceeded the three percent of GDP cap. Spending was not kept in check and there has been a common lack of discipline. Thus the euro has become like any other currency, not worth the paper its printed on.

After Buying Companies, They Will Buy Gold

With Asian central banks awash with billions of reserves, what else could they do with their billions. Not only are they buying real assets, they're diversifying by buying Canadian dollars and other currencies than the US dollar. The Chinese have become the fourth largest gold buyer in the world. Gold is going to play a much bigger role. China's central bank has less than two percent of its reserves in gold. Japan too is light. This will change. In our view, the lack of faith in currencies will result in a move to gold, the ultimate currency.

Gold in US dollars has seen a near 80 percent rally from $255 an ounce to an almost seventeen year high of $455 an ounce last December as gold marched in lockstep to the US dollar collapse. Gold was a classic hedge for investors and a beneficiary of the greenback's three-year plunge through the end of 2004. Early this year, the greenback rallied and gold sank to $410 an ounce. But the dollar has strengthened in the past month and gold has risen $25 an ounce decoupling from the dollar. The pattern is changing.

With the euro sinking to a fourteen month low, gold priced in euros has broken out from a four-year range. Gold has also broken out against the Japanese yen. Like the seventies when gold broke out in Swiss franc terms, gold provides a hedge not only for Europeans but against all currencies. Historically, when people lack confidence in currencies, gold has been an alternative and now with both the dollar and euros appearing less credit-worthy, gold is expected to retest its seventeen year high with an interim target at $510 an ounce. Gold is an effective hedge against fiat currencies. We believe that gold's hedge qualities will underpin the second major upleg.

John R. Ing
Maison Placements Canada
130 Adelaide St. West - Suite 906
Toronto, Ont. M5H 3P5
(416) 947-6040

jing@maisonplacements.com

22 July 2005

The information contained herein has been obtained from sources which we believe reliable but we cannot guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell for the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that Maison Placements Canada Inc. is to be under no responsibility whatsoever in respect thereof. Directors, shareholders or employees of this company may be beneficial owners of the securities referred to herein.