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January 20, 2004

January 20, 2004

I know I just wrote to you a few days ago, but at the risk of being boring, I want to share some new developments with you about the Indian and Chinese stock markets and also to reiterate that I believe gold and base metals are ready to move higher in coming weeks.

I am a buyer of gold and base metal shares at this time. As the gold shares topped out and started to pull back before physical gold, the shares are likely to bottom out before the physical metal. Our strategy is to buy gold shares on every correction and to wait for much higher prices ahead.

As we have written, we expected a decline in the Euro and other currencies. It came earlier this month and may not last much longer. From the recent trough to peak, the dollar rallied 4% against the Euro. Is this enough for a short-term rally? I am fond of pointing out the U.S. has done nothing to correct the dollar’s problems. So perhaps this pullback in the currencies was enough to start

As I wrote recently, India has been rethinking its approach to government control of the economy. Recently, the world was shocked to see that the Indian GDP growth rate for the last quarter was 8.4%. This is just shy of the 9% growth rate China experienced.

It has finally dawned upon the leaders of the Indian ruling coalition that rapid economic growth will garner them votes in the elections of 2004. Recently, the ruling coalition put two and two together and came to realize that privatization has increased GDP growth and attracted foreign capital. This has led to a stock market boom and a higher standard of living for many city dwellers.

India had been operating for fifty years under a Fabian Socialist economic doctrine. Fifty years of socialism, with its built in inefficiencies and the requirements to receive permission to operate and change many aspects of ones business, has led to a psychology among government and business employees that it is ok to slow things down and work slowly. The perception being that there is not enough work to go around. In addition, there is the unalterable fact that employees of regulating and licensing bodies whose responsibility it is to approve licenses and changes in people’s business operations, is well situated to demand favors.

Gradually these old strictures are being loosened by politicians who have come to realize that the patronage of the License Administration is beneficial to a relative few. It only helps employ a few supporters who make a very good living while the mass of Indians are left behind. Economic growth, on the other hand, has a much more far-reaching and powerful economic benefit.

Late last week the ruling coalition decreased the requirements for ownership by Indians of two important economic sectors. In energy, foreigners may own up to 100% of new companies, up from 51%. In banking, foreigners are now able to own up to 74% of a bank, versus 49% previously. Obviously, the Bharata Janata Party (BJP) has decided to add an economic growth plank to their political platform. This is a change from the past when elections have been decided primarily on caste and communal issues.

For example, due to India’s long colonization by the Moguls and the British, votes could be garnered by pressing for an anti-foreigner platform. Now, the Indian political establishment has recognized that foreign investment is important enough to admit to the electorate that it is required. Secondly, the rapid growth of the Chinese economy has not gone unnoticed by the powers that be in India.

China is India’s neighbor, and a competitor for regional influence. India can not sit and watch China become an economic power while they remain a backwater. There are numerous political and economic consequences if this is allowed to happen.

Our reading of these events is that India will encourage foreign investment. As a result, the Indian GDP will grow rapidly, although not as rapidly as China, for the next several years.

China has an admitted GDP growth rate of 9%. The economists I speak to, who are active in China, on average believe that it is more like 11% currently. The Chinese like to manage news and statistics, so they will try to keep China’s admitted growth rate between 5 % and 9% for the next several years. It may of course actually be greater or lesser than is admitted.

China’s banking system is deeply troubled. There is a shortage of experienced bankers who know how to judge the creditworthiness of borrowers, and there is a system of payoffs that local political operatives enjoy that allows them to ration credit to their friends. Currently, there are probably several hundred billion dollars in bad loans with more being made every day.

China needs western help in solving the quality-of-borrowers problem. First, however, they must get control of the lending apparatus, which is often in the hands of local politicians and is a source of power and income. The recent scandal about the political influence of local politicians was highlighted when a brave entrepreneur named Sun dared to point out the corruption in a speech at Beijing University. He was subsequently jailed. Yet at his trial he was let off with a wrist slap due to the fact that many agreed that the problem he exposed is truly out of control.

I share this information in order to explain that China is not a one way street. All Chinese stocks will not rise. Many are poorly run companies built to employ people not to earn a profit.

When we investigate Chinese companies we stick with those that have management who were educated or experienced working in the west. They should be individuals who know and agree with the western concepts of a profit making company and financial transparency.