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February 12, 2004

February 12, 2004

THE CURRENT SITUATION
The correction in gold and metals and currencies has drawn to a close.

Both Fed Chairman Greenspan and Treasury Secretary Snow have spoken out for a weaker dollar, in both direct and subtle ways. World market players, especially in the currencies, have been trained by decades of experience to listen to the pronouncements of powerful economic figures. When the pronouncements are congruent with the obvious economic realities, the pronouncements are acted upon. When the pronouncements are not congruent with underlying economic realities, financial market participants listen politely, weigh the degree of power (intervention) at the command of the speaker, and act accordingly. Yesterday, Greenspan endorsed a weaker dollar and a few days ago Snow did the same.

Some say the dollar will rally. Look at all the articles being floated in the world press saying China will revalue their currency, Yuan, or even let it float. This is not a realistic probability. The Chinese will revalue the Yuan (which is pegged to the dollar) only when they are forced to. Having a weak dollar and a correspondingly weak Yuan relative to other global currencies is to their distinct advantage. It allows the Chinese to export more goods and thus to provide employment for more farm dwellers as they move into urban areas.

Analysts and economists working for western investment banks, who wish to curry favor with the Chinese government, are hammering the party line. I read an article by one of these banks today saying that China does not need to revalue the Yuan. Their argument is that the reason China is a large exporter is that wage rates are low and that raising the value of the Yuan will not change cost advantages that much. This is the line the Chinese government wants to promulgate. It is also very true. Still, U.S. politicians are trying to make the Yuan a political rallying cry as they posture for the support of the American worker. It shows their enormous lack of economic knowledge, their cynicism in proposing an ineffectual economic policy, or both.

Remember, the Chinese have hundreds of millions of people living in the countryside that are underemployed and who would love to find jobs in the cities at higher wages. In our opinion, the Chinese government believes that they have to find work for these people or risk the danger of political upheaval as the have-nots look at the success and prosperity of the haves. Historically, a bifurcated society is seldom a stable society.

OUR FAVORITE AREAS FOR INVESTMENT
We believe that the US dollar is going down and precious metals, base metals and possibly energy are going to rise in price. I say possibly energy because we are in the season when energy prices typically fall. The cold winter weather is drawing to a close and the summer driving season is months away. Usually, you would sell energy stocks now and repurchase in the fall. We believe that the normal pattern will develop this year. We also believe energy prices will rise a great deal in the next few years. Temporarily however, we see better opportunity in other areas. We continue to like growth stocks in the developed countries and are purchasing these when they meet our research criteria.

We like copper stocks because we believe supply and demand events have conspired to drive copper to at least $1.50 per pound, and possibly much higher. We continue to believe that steel, iron ore, as well as some aluminum stocks remain attractive. Silver stocks are cheap in our opinion and we favor the high quality established companies in this area.

We further believe China and India remain good areas for investment. Oil refining companies in Asia remain attractive due to strong demand in China and neighboring countries. US, Canadian and some European growth stocks, especially in medical and high tech areas also appear attractive. We are only buying those companies whose P/E ratios are low versus their growth rates.

GOLD
In our opinion, the recent correction in the gold price and in gold shares supports our buy on dips and hold strategy. We have been at this for a long time and have seen many bull and bear markets. For those of you who trade more actively than we do, Jim Sinclair has once again proved to be a master of gold buying and selling tactics. He has consistently advised holding the core position and adding to positions as prices reach attractive technical levels.

Those traders who sold their metals to lock in trading profits may not have seen the current rally coming and now have lost their positions. This is not something that we want to happen to us. We are buying gold shares at current prices for new accounts and holding our long positions for other clients.

INDIA
India is having elections in the next few months and we expect the ruling Bharata Janata Party to maintain control of the parliament. The bigger question is: Will India once again shoot itself in the foot? Or will they be able to enjoy prosperity and stock market success? The privatization program has gone very well, the outsourcing industries are booming, domestic consumer demand is rising, and India is a strong supplier to China and the region in certain industrial areas.

ECONOMICS
The following article explains in a concise way how the U.S. and world economies are expanding without the expected rise in the monetary aggregates in the U.S. In addition to this article, Jim Sinclair very cogently explained what was happening in his www.jsmineset.com website a few days ago. You might want to take a look at it to get further information about the mechanics of the transactions.

COMMENT: Japan’s monetary alchemy may not yield gold By Richard Duncan
Financial Times; Feb 10, 2004

The most aggressive experiment in monetary policy ever conducted is now under way. Japan is printing yen in order to buy dollars in such extraordinary amounts that global interest rates are being held at much lower levels than would have prevailed otherwise. In essence, the Bank of Japan is carrying out the unorthodox monetary policy that the US Federal Reserve intimated it was considering in mid-2003. In other words, the BoJ is creating money and buying US Treasury bonds, which is helping to drive down US interest rates and underwrite US economic growth – and, by extension, global growth.

It is inconceivable that economic policymakers in Tokyo and Washington do not understand the impact that this unprecedented act of money creation is having on global interest rates and economic output. The amounts involved are staggering. Since the beginning of 2003, monetary authorities in Japan have created Y27,000bn with which they have acquired approximately $250bn – that amount is equivalent to more than 4 per cent of Japan’s gross domestic product. It also represents $2,000 for every person in Japan. In fact, it would amount to $40 per person if divided among the entire population of the world. Most importantly, it is also enough to finance almost half of America’s $520bn budget deficit this year.

The amount of new yen that Japan “printed” and converted into dollars during January 2004 alone was enough to finance 13 per cent of the US budget deficit. The investment of those dollars into dollar-denominated debt instruments clearly explains why the yield on the 10-year US Treasury bond fell last month in spite of the 10 per cent upward revision in the Bush administration’s budget deficit projections.

By accident or by design, Japan is carrying out the most audacious endeavour to conjure wealth out of nothing since John Law sold shares in the Mississippi Company in 1720. So far, the results have been impressive. Japan’s monetary alchemy has been the most important factor in allowing the US government to finance a $700bn deterioration in its budget over the past three years without pushing up US interest rates to levels that would pop the wealth-creating property bubble there.

US tax cuts have fuelled domestic consumption. In turn, growing US consumption has shifted Asia’s export-oriented economies into overdrive. China has played an important part in this process. With a trade surplus vis-à-vis the US of $125bn, equivalent to 9 per cent of its 2003 GDP, China has become a regional economic growth engine in its own right. China has used its large trade surpluses with the US to pay for its trade deficits with most of its Asian neighbours, including Japan. This recycling of China’s US dollar export earnings explains the incredibly rapid “reflation” now under way across Asia. Even Japan’s moribund economy has begun to show signs of export-oriented growth.

These developments highlight a fundamental question that has been debated over centuries: can governments create money and make the population richer without setting in motion a chain of events that ultimately ends in monetary chaos? We may be about to find out as Japan tests the hypothesis on an unprecedented and global scale. If this experiment in unorthodox monetary policy succeeds, then we have arrived at a new international monetary paradigm. Governments will have discovered how to finance limitless deficits through the creation of paper money, and we all can look forward to an age of great prosperity. If it fails – as have all past attempts to create wealth from thin air – then the world may not be able to avoid a severe and protracted economic slump as the extraordinary imbalances in the global economy (caused by the explosion of fiat money in recent years) begin to unwind.

In mid-2003, economists at the US Federal Reserve published a paper explaining why the Fed was not “out of bullets” despite having cut short-term interest rates to 1 per cent. That paper stated that “the Fed could even implement what is essentially the classic textbook policy of dropping freshly printed money from a helicopter,” if necessary, to stimulate the economy.

Today, that helicopter is in the air. But, strangely, it is not the Stars and Stripes that is painted on its side, but rather the Rising Sun. That much is clear. What still is not quite discernible, however, is who is actually in the pilot’s seat.

The writer is a financial analyst based in Asia and author of The Dollar Crisis: Causes, Consequence, Cures (John Wiley & Sons, 2003)