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China's Golden Age

Bob Moriarty
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October 25, 2004

"Always arrive first to the empty battlefield to await the enemy at your leisure. After the battlefield is occupied and you hurry to it, fighting is more difficult."
-So said Sun Tzu.
The Art of War

I returned recently from a two week trip to China. While there I visited several gold projects for two different Canadian juniors. While different in style and business model, each of them realizes a fundamental precept of both war and business. The best time to occupy a hill is before anyone else realizes it's even there.

This was my first trip to China and boy was it an eye opener. 'New countries' isn't any big deal for me. For fifteen years I delivered US-built airplanes all over the world. So a visa from another country is just another visa. But China was different and special.

I flew into Beijing in the evening so couldn't see anything on the 30 minute drive to the hotel. But the service was nothing short of incredible. The hotel had a greeter meet me, literally, as I walked off the plane. And she took me straight through the lines of officialdom and had me in a limo 20 minutes after I got off the plane. Throughout my visit, I would find the service prompt, efficient, and courteous.

When I woke the next morning I pulled the curtains back to see what I could see of Beijing. From my 18th floor window, in a hotel matching or exceeding any in New York or Vancouver or San Francisco (but a lot cheaper,) I saw a clear China morning with a flock of China's new national bird, the building crane. Without straining my neck, I could see 20 cranes, all working like busy little beavers.

China can only be under described. The pace, the energy, the hustle and bustle of the people is unmatched and I lack the words to fully describe what I saw. Words don't suffice. China is on the move.

In the next two weeks, I would see architecture which would rival the best Chicago ever dreamed of; hotels and shops as grand as any in New York or London; construction on a scale unparalleled in history.

I've underestimated the impact of China on demand for raw materials. In ten short years, China has moved from a net exporter of commodities to a net importer. And Chinese demand is going to continue for the next fifty years. Fortune magazine just did a special on China and came up with some interesting numbers. In the next 25 years, China plans on moving 400 million people from farms into urban areas, this is the largest mass migration in history.

Without question, China faces problems. The primary limit on demand in China today is energy. China has increased oil imports by 39% in the first eight months of this year yet most areas in China face increasing shortages of electricity. Experts suggest the Chinese banking system is your garden variety disaster area yet demand continues to increase and growth goes on. They will face problems but I suggest they will overcome them. If the 20th Century belonged to the United States, the 21st Century is going to be Chinese.

Americans tend to wear blinders which prevent them from seeing what is going on in the rest of the world. The average cab driver in London or Rome has more of a clue as to world economics than does the average college graduate in the US. Our ignorance knows no limits and we soon shall pay a giant price as a result.

And all the kids are learning English.
Everywhere I went in China, when I came across a 4-5 year old child, he/she would run up and smile shyly before saying in perfect English, "Hello, how are you." I guess hairy barbarians give them the opportunity to try out their English.

I suspect that somewhere in every school is a document asking the teachers to tell their young students to practice their English on every foreigner they see.

They also are fascinated by arm hair. The little critters would reach up and pluck a few hairs from your arm just to see if we really are hairy barbarians.

China is your typical garden variety 800 pound gorilla. And we all know where an 800 pound gorilla sleeps. But China is an 800 pound gorilla chimp. With lots of growth yet coming. We aren't prepared, the world isn't prepared and there will be constant supply dislocations for many years to come.

The key to commodity prices is no longer going to be American demand. It's going to be Chinese demand. We had best learn to live with far higher prices for commodities, especially oil, because the sleeping giant has awakened.

Dynasty Gold
A year ago I came across a gold company starting operations in China: Dynasty Gold [DYG-V $.465 Canadian 28 million shares outstanding, 38 million fully diluted.
Website].

Dynasty had a compelling story. Basically they were in the process of acquiring Terrawest Minerals which had a joint venture with Xinjiang NonFerrous Metals Co. which is one of China's leading mining companies.

Dynasy's deal requires exploration commitments of $12.1 million US over a three year period to earn a 70% interest in the JV. The joint venture properties included 1600 square kilometers in the Hatu Gold Belt, 600 square kilometers in the Baogutu Mineral Belt and an additional 300 square kilometers in the Hami Gold Belt.

Some of the top analysts in the mining business participated in the Dynasty Gold tour. We began by flying to Urumqi in Xinjiang province in far northwest China and then driving 5 hours to Karamay. In each stop, I was amazed at the level of the activity and the volume of construction.

Dynasty didn't provide us with briefing books and I suspect that was a mistake. On most of the tours I've been on, the company provides a briefing book with a general statement of their goals, maps of all the properties and a detailed brief of how they are proceeding to meet their goals.

When I get back from a trip, I think about what I saw for a few days and then do a thorough review of their website and materials provided to produce what I write. Basically, the company provides the story and writers do a critique. Not having a briefing book complicated my job. I don't create stories, I just report them.

When I talked to Dynasty management a year ago, their theory was that prior Chinese mining had concentrated on mining narrow, high grade structures. Dynasty believed prior mining had ignored lower grade but far higher tonnage formations. The Chinese only mined underground which means they missed a lot of lower grade ore not economic in underground mining. And they simply failed to even sample anything but the vein structure.

Dynasty brings a western approach to exploration. Dynasty wants to consider the economics of open pit bulk mining which allows for a much lower cutoff grade for ore.

Drill results to date tend to prove their theory. Dynasty released the results from eight holes in September including a 64.7 meter intersection of 5.1 gram gold. The market snored at the news and the stock did nothing. But if that near-surface intersection represented a cube of the same grade and dimensions, a 65 meter cube of 5.1 grams is about 45,000 ounces of gold. And that's better than a read-hot stick in the left eyeball.

A few more holes like that and Dynasty will be well on the way to proving their theory.

On the first day of the mine tour, we saw Dynasty's work at Baobei. As with most projects, the early work consists of a lot of trenching and soil samples. They had done some drilling to follow up on tentative drill targets but have been so far disappointed. While it's not covered on their website in any detail at all, the Baobei project was not part of the deal with Terrawest, it was a hole in their property which was privately owned and operated.

In late spring, the opportunity came up to bid on the project and Dynasty signed an option. To date they have committed and spent about $440,000 Canadian. Some soil samples looked promising but they have not yet been able to confirm ore grade through drilling.

I will make one interesting point here. Since they were taking over a Chinese project, they took over the tools the Chinese were forced to drill with. And in the case of drilling, the Chinese used these 50 year old Russian designed drill rigs which could only drill vertical holes. So they could angle at 10 degrees from the vertical, but they couldn't do the 45 and 60 degree holes Canadian juniors are far more comfortable with. Dynasty made it a major project to bring in an angle drill so they could better locate vertically aligned structures. It makes a world of difference. With a vertical drill, you could miss a 1000 meter structure by two inches for the entire length and might never know it.

We saw a bit of drill core from Baobei and it didn't look very juicy. One of the alternatives Dynasty has is to not complete their option on the property. I got the feeling that unless they came up with a lot better drill results than they had gotten to date, they might walk away from that particular project. It probably was a necessary move on their part to at least consider the project. The worst thing possible would be for that part of the structure to end up in the hands of another mining company. Dynasty did what they had to do.

Qi2 is another story. It is part and parcel of the first Hatu Area project and drill results have been very encouraging. Qi2 was a mine in the past, the area has been mined for 200 years. It surprised me that Dynasty hadn't sampled the dumps to get a feel for the background level of gold but until we visited Qi2, they hadn't sampled the dumps, it didn't occur to them.

We did see drill core from several holes, some split and some not. We compared the drill core with the 5.1 gram gold and if looks aren't deceiving, they should be announcing very good results shortly. The drill core I saw a lot of was identical in appearance to the very positive drill core of the 64.7 meter, 5.1 gram per tonne intersection.

More results will be out any day and should they meet or exceed the 64 meter intersection, I would expect the market to respond in a far more positive way. While the senior mining companies are making new highs, the juniors are still snoozing. One day soon they will wake up and when they do, you want to have your dance card filled out.

I do want to add one minor bit of trivia. My best friend in Miami happens to be the grandson of the world famous Colonel Sanders. He's not rich, the old story of shirtsleeves to shirtsleeves in three generations is accurate. But eating in China, let me say simply, was a challenge. Trig Adams would have enjoyed one of our meals...

We were honored guests everywhere we went and the Chinese wanted to serve us the very best and most expensive food possible. I went through 7 straight 40-course meals. A lot of the food you didn't even want to identify, much less consider eating. At least I didn't. But on our last day at Karamay, when we were in the midst of sorting through the core shed for goodies, Dynasty rewarded us with lukewarm Kentucky Fried Chicken which their driver had driven 40 miles to pick up. The 20 or so of us doing the work leaped into the greasy boxes to scarf up the chicken. It was pure heaven.

We had a short brief of the the second major property in the Dynasty stable, that called the Red Valley Project in Qinghai Province. Dynasty has yet another JV covering a 1000 square KM region. They received their business license in April and have to date spent about $110,000 US in trenching, soil samples and mapping. An area next to where they are testing was the home of 5,000 placer miners for the past 15 years. Anything which would support 5,000 placer miners for 15 years is a pretty good indication that the mother lode is around. The gold came from somewhere.

Dynasty's third major project, Wildhorse, is located in Gansu Province and totals about 3000 square KM. Dynasty expects the business license soon, exploration won't begin until spring of next year. Dynasty must spend $1 million US on exploration in the first year.

Dynasty isn't a slam dunk. They have one of the largest land positions in China and are running, not walking, in their quest to be the biggest and best foreign junior in China. They have made deals which require a lot of money over the next three years and that means they are under the gun. They need results now. But even with few holes already announced, they have shown the validity of their theory. They will either succeed grandly or fail grandly, this isn't your average mining company with two full time geos and a secretary with a three line phone system.

Dynasty is acting like a big mining company and that can be a little dangerous. What I saw seemed to reflect a lack of control, a lot of simple things like taking samples of the dump, even as simple as splitting core, were running behind. Dynasty needs to get management under control. They were on the edge of chaos in a lot of ways. That's good, the best work is always done on the edge of chaos. But it's dangerous to become long-time comfortable with chaos.

China is beginning a golden age. Those foreign companies who offer technical help and access to investment capital will be welcomed. I cannot fully explain how impressed I was with China. Dynasty saw the opportunity early and has a two-year head start over most Canadian juniors. They are completing a drilling season when most companies are only just thinking about drill targets. If they can get management coordinated and everyone working in the right direction, I think they will become one of the leading juniors.

Dynasty will be announcing drill results for the next two months and expects to release a 43-101 resource during the winter. 1-2 million ounces would not be impossible and that makes the stock pretty cheap at $.465.

Goldrea Resources
The last part of my trip to China was a visit - along with my favorite traveling companian, Rick Langer of Canaccord - to Rushan City in Shandong Province to look at a gold project of Goldrea Resources [GOR-T $.215 Canadian, 19.5 million shares, 25.5 million fully diluted.
Website].

Goldrea has entered into a JV with China Rushan Gold to earn a 74% interest in a 650 square KM property near Rushan City in eastern China. Shandong province produces 26% of all the gold produced in China today.

Chairman Larry Reaugh of Goldrea has pulled a near slam dunk. He negotiated the contract in Canadian Dollars, a first as far as I know. Which should also give viewers an idea of what the Chinese think of the US Dollar.

The contract calls for Goldrea to invest $2 million Canadian over a four year period for 74% of a 650 square KM region. The package comes with a Chinese resource of 707,000 ounces (not 43-101 compliant) which won't mean anything until Goldrea reviews the data and brings it up to 43-101 standards. But China Rushan operates a 65,000 ounce per year mill and has granted an option to Goldrea to buy the existing mine and mill based on a mutually-agreed appraisal price.

The Daye Gold Mine, currently in operation with 4 years of reserves, operates the 2,300 TPD capacity mill at a rate of 1750 TPD so there is excess milling capacity available immediately. Also once Goldrea takes over the mill, it would be dead easy to expand production capacity.

We walked some of the area covered by the JV. One major deposit already identified lies beneath a small village. In most areas of the world, that would be a killer to at least that portion of the deposit. But China intends to build new living facilities for 400 million people over the next 25 years and it's not all that difficult to build new homes over an area with no gold.

It's fairly unusual to find sulfide ores at the surface but this project contains a sulfide ore at the surface. It has gold associated with pyrites and chalcopyrite. When we visited the existing pit and looked at the mining going on, it was easy to pick out the ore grade rock visually. When we walked around the village, you could pick up the identical rock type.

Developing a 43-101 resource of some quantity isn't going to be difficult. The rock being mined today grades between 3-5 grams per tonne. The ore bodies are near surface and that makes for cheap drilling. This is not a greenfields project where some scatterbrained geo thinks there may be some gold. There is an existing mine, there is a producing mill with up-to-date equipment, there is a resource which at least the Chinese believed and there are trained and qualified workers available at once.

The Daye Gold Mine does both open pit and underground mining. The existing pit doesn't have much expansion capability until they move the pit wall back and it's right next to a highway. They report about 3.5 grams from the underground mining which wouldn't be much by western standards in most mines but works for the Chinese. Larry Reaugh wants to explore the idea of finding a larger but low grade bulk mineable resource at the surface.

There is a lot of work already done by the Daye Gold people. If I had to guess, I'd say the Chinese showed us maps and drill results which would have cost a lot more than $2 million Canadian.

There will be problems, there are with any new project. Management of any company is in the business of solving problems. The first problem is that the most accessible gold is right under a village. That may be an easy problem to solve.

The JV has the rights to the gold under the existing pit and that may require moving the road. A high priority will be developing a reserve quickly and coming to an agreement on purchase of the existing mill. The mill had equipment with a replacement value of $25 million which will be worthless once the existing mine runs through its reserves in 4 short years.

I hate picking numbers on gold potential, it is like walking through a minefield with a blindfold. But I also think I owe it to our readers to give them as honest an appraisal as possible.

At $.20 a share, the company has a market cap of about $4 million Canadian. Goldrea has just completed a placement. They wanted to raise $600,000 which would have gotten them through the next year and were overwhelmed with demand and increased the placement to $1.2 million which will give them a lot of operating space.

There aren't many companies out there with an agreement of this value who are priced at such a low market cap. Goldrea is cheap. Shandong is in a reasonable moderate climate and I know Larry Reaugh will be arranging for a drill rig as I write. He's going to hit the ground running and the company could easily have a 1-2 million ounce 43-101 resource by late summer of 2005. They know where the gold zones are, all they have to do is drill.

Ounces in the ground vary all over the place. On the low side, $10 an ounce is really cheap for an operating junior. The average I saw on a recent report was $68. You can work out the math, I won't bother. But this is about as low risk, high potential as you will ever come across.

Especially if you like either China or the future of gold. I like both.

These two companies represent two totally different approaches to mining gold in what is a new frontier. There is risk in China but there is risk walking across the street. You can get run over walking across the street but you can't get rich.

Investing in new frontiers can make you rich. I believe the future - the next 50 years at least - will belong to China. While I recognize there is a very real risk of a Boom-Bust in their banking and construction industry, the Chinese have built enormous production capacity over the last ten years and at the end of the day what we produce is what we are. And, on a side note, the Chinese recycle everything.

Dynasty is batting for home runs. They have the largest and in my so humble opinion, one of the best land positions of any gold junior in China. They were one of the first five in the country and I suspect they will all be rewarded for their vision. But Dynasty has some giant financial commitments which almost certainly will require substantial dilution of their stock. It's going to take a major management effort to succeed and I'd like to see them shore up management. It wasn't the most organized company I've ever had dealings with. But should they succeed, they will succeed grandly.

Goldrea on the other hand is going to be hard to screw up. Larry Reaugh has negotiated an excellent package and price. I fully expect him to exercise the option to buy the mill as soon as reasonable. He will have a resource next year and it will be worth reading. My meeting with his Chinese partners was memorable if for no other reason than the fried bumble bees, silkworm larva, jellyfish and sea slug dinner. The Chinese can not only mine gold and build buildings at a rapid rate, they drink like fish and smoke like chimneys.

Both companies are advertisers. We own stock in both companies. I am biased. I like them and I like the opportunities I saw in China. We try our hardest to be both balanced and complete but everyone is biased. I wouldn't have bought the shares in the first place if I wasn't biased.

I suspect the Chinese will go to a gold backed currency, certainly articles over the past month have seemed to me to indicate they have a realistic view of the future of the US dollar. If and when China goes to a gold backed currency, every country in the world who intends to compete on the world market will be forced to do the same or see their currency turn to something with the rough value of used toilet paper.

Owning a piece of a gold mine, especially in China, might be real handy about that point in time.

And FYI there are gold shops everywhere. I bought Barb a small gold bar and a 24kt miniature sword for her 60th Birthday, that I missed because I was on this trip. Gold is sold by the gram and costs about $15 per gram. That reflects about a 10% premium over the value of the gold which as good a price as I've found anywhere in the world.

Note: On Wed October 27th I am packing my bags once again, and leaving for Kazakhstan via Frankfurt. I will be back on Tues. November 2nd, so PLEASE don't send me email.

October 24, 2004
Bob Moriarty
President: 321gold Inc
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