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Bill Haynes
President
CMI Gold & Silver, Inc.

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The Case for Physical Gold

October 11, 2002

CMI is biased. We admit it. We prefer physical gold to gold shares because there is less risk with physical gold. Over the years (primarily via our client newsletter, Monetary Digest), we have discussed the risks that come with owning mining companies’ shares. The demise of Sunshine Mining Company stands as a quintessential example. Management borrowed more than it could repay, and the debtors took over the company, diluting the public shareholders to next to nothing.

Now comes the South African Mining Charter, which threatens the efficacy of all mining companies operating in South Africa. The Charter, which is expected to be passed into law in a few months, will mandate that 15% of South African mine assets be black owned within five years and 26% black owned within ten years. Companies that fail to effect the ownership transfer will lose their mining licenses.

Considering that South Africa is predominately black, the Charter’s demands may seem equitable. However, as the old saw goes, the devil is in the details.

The Charter requires the mining companies to arrange financing for the blacks’ acquisition of the 15%, up to R100 billion. Funds must come from outside South Africa. The mining companies will cosign or guarantee the loans. A recent addition to the Charter calls for the black empowerment groups (the politically correct term for the privileged blacks who will get to buy the assets) to arrange their own financing for the 16% to 26% interest, which is to come within ten years. SA’s minister of minerals and energy has said that she hoped black companies would have established their commercial credentials sufficiently after five years to secure their own financing.

The really detrimental effect of the Charter is that to the mine assets are to be transferred. The black empowerment groups will not receive shares in the companies. The blacks who will receive title will bring nothing to the operation in the way of mining knowledge. They simply have to be "politically connected," which probably means membership in or be a strong supporter of the African National Congress, which rules South Africa. In effect, the mines in South Africa will see their ownership assets diluted, which means less money will flow to shareholders.

Determining the value of the assets will be a major issue. Undoubtedly, the mining companies will see their assets as having higher values than will the buyers. The hope is that the "transfers will take place at market value." Yet, one analyst noted, "If the transfers were going to be at market value, you wouldn’t need a Charter in the first place."

Gold stock analysts have mixed assessments of the Charter. According to an interview in Mineweb (www.miningweb.com), John Hathaway, manager of Tocqueville Gold Fund, believes that a rising gold price will make investors forget all about the issue. "This is life in South Africa, let’s get on with it now," he said. Other analysts are less optimistic.

Goldman Sachs analyst Dan McConvey: "Our first reaction from a North American perspective is not positive. The North American market may be less prepared for the complications involved in this charter than UK and South African markets. It will not likely help the appetite for South African gold mining stocks in the US." McConvey sees "a lot of uncertainty."

Bill Belovay, a fund manager for the Toronto-based Jones Heward group, fears complications. "I do not see any undertaking to prevent cronyism, which is a criminal offence in the developed world. Why not just distribute the empowerment quotas in a lottery and the winner becomes the owner of a mining company."

Belovay believes that all "the cheerleading" by the SA analysts and mining companies underscores the real fears of the black empowerment movement: full nationalization. "That’s why the Charter was done so quickly; you’ve never seen anything like it." (For more analysis and comments by these and other analysts, visit www.theminingweb.com and click on Fund managers, analysts mixed on Charter.)

Perhaps the most critical view on the future of South Africa and SA mining stocks is held by Dr. Frank Lucas, head of the small New York banking firm Loeb Aron. At the New York Institutional Gold Conference in September, Lucas issued a blunt sell on South African gold shares and laid out a case for "quitting" the country itself. He said that his firm was "very long physical precious metals and lightly exposed to SA," a position that would be sold down in coming weeks.

Lucas noted that the African National Congress’ own characterization of the transfer of power from white to black in South Africa was revolution. Revolutionary goals, Lucas said, are always redistributionist. (For a summary of Dr. Lucas’ talk at the Gold Conference, visit www.theminingweb.com and search for Selling South African golds, a September 24, 2002 article by Tim Wood.)

South African mining executives, while extolling the virtues of the Charter, have voted with their pocketbooks. SA executives own vastly smaller proportions of stock than do their Canadian or American counterparts. The same is true for lower management.

The rise of SA’s black empowerment movement, which resulted in the Charter, is only one instance where the risks of stock ownership have surfaced. Investors need to be aware of those risks when allocating their investment funds. CMI likes Dr. Frank Lucas’ position of being "very long physical precious metals." We think it makes sense for these times.

Call CMI at 1-800-528-1380 for answers to any questions or clarifications.  Our hours are 7:00 a.m. to 5:00 p.m. Mountain Standard Time, Mondays through Fridays.  Our offices are in the middle of the Phoenix, Arizona financial district.  CMI has had the same bank account since its inception in 1973.  References available on request.  http://www.certifiedmint.com

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