**UNITED
      STATES**





**SECURITIES
      AND EXCHANGE COMMISSION**




**Washington,
      D.C. 20549**




**FORM
      10-Q**




x
            QUARTERLY
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934




For
      the
      quarterly period ended June 30, 2008




OR




o
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934




For
      the
      transition period from to




Commission
                file number 000-51076




**WESTERN
      GOLDFIELDS INC.**


(Exact
      Name of Issuer as Specified in Its Charter)




Ontario
            98
                – 0544546(State
                of other jurisdiction of
            (I.R.S.
                Employerincorporation
                or organization)
            Identification
                No.)







Royal
      Bank Plaza, South Tower, 200 Bay Street, Suite 3120, PO Box 167


Toronto,
      Ontario, Canada M5J 2J4


(Address
      of Principal Executive Offices)




416
      324
      6000


(Issuer’s
      Telephone Number, Including Area Code)





2
      Bloor
      Street West, Suite 2102


Toronto,
      Ontario, Canada M4W3E2


(Former
      Address of Principal Executive Offices





Check
      whether the issuer: (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the registrant was required to file such reports), and (2) has been subject
      to such filing requirements for the past 90 days.  Yes x  No o




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, a non-accelerated filer, or a smaller reporting company.
      See
      the definitions of “large accelerated filer”, “accelerated filer” and “smaller
      reporting company” in Rule 12b-2 of the Exchange Act.


Large
                  accelerated filer
              o
              Accelerated
                  filer
              xNon-accelerated
                  filer
              o
              Smaller
                  reporting company
              o





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act)





Yes o No x





State
      the
      number of shares outstanding of each of the issuer's classes of common equity
      as
      of the latest practicable date: Common Shares of no par value – 136,731,919
      shares outstanding as of
      July 31, 2008 .










INDEX




**PART
                I.**
            **FINANCIAL
                INFORMATION**
            3Item
                1
            **Financial
                Statements (unaudited)**
            3Cautionary
                Note Regarding Forward Looking Statements
            3Consolidated
                Financial Statements: (unaudited)
            4Consolidated
                Balance Sheets
            4Consolidated
                Statements of Operations and ComprehensiveIncome
                (Loss)
            5Consolidated
                Statements of Shareholders’ Equity
            6Consolidated
                Statements of Cash Flows
            7Notes
                to the Consolidated Financial Statements
            8Item
                2.
            Management's
                Discussion and Analysis of Financial Condition and Results of
                Operations
            23Item
                3
            Quantitative
                and Qualitative Disclosure about Market Risk
            36Item
                4
            Controls
                and Procedures
            37**PART
                II.**
            **OTHER
                INFORMATION**
            38Item
                1.
            Legal
                Proceedings
            38Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            38Item
                3.
            Defaults
                Upon Senior Securities
            38Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            38Item
                5.
            Other
                Information
            38Item
                6.
            Exhibits
            38




2


**PART
      1 – FINANCIAL INFORMATION**





**CAUTIONARY
      NOTE REGARDING FORWARD LOOKING STATEMENTS**





We
      have
      included in this Form 10-Q filing, and from time to time may make in our public
      filings, press releases or other public statements, certain statements that
      may
      include forward-looking statements that reflect our current views with respect
      to future events and financial performance, including, without limitation,
      those
      under “Management’s Discussion and Analysis of Financial Condition and Results
      of Operations” in Part I, Item 2. In some cases these statements are
      identifiable through the use of words such as “anticipate,” “believe,”
“estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,”
“may,” “should,” “will,” “would” and similar expressions. You are cautioned not
      to place undue reliance on these forward-looking statements. In addition, our
      management may make forward-looking statements to analysts, investors,
      representatives of the media and others. These forward-looking statements are
      not historical facts and represent only our beliefs regarding future events
      and,
      by their nature, are inherently uncertain and beyond our control.





The
      nature of our business makes predicting the future trends of our revenues,
      expenses and net income difficult. The risks and uncertainties involved in
      our
      business could affect the matters referred to in such statements and it is
      possible that our actual results may differ materially from the anticipated
      results indicated in these forward looking statements. Important factors that
      could cause actual results to differ from those in the forward-looking
      statements include, without limitation:





·
            the
                effect of political, economic and market conditions and geopolitical
                events;·
            the
                actions and initiatives of current and potential
                competitors;·
            our
                reputation;·
            investor
                sentiment; and·
            other
                risks and uncertainties detailed elsewhere throughout this
                report.




Accordingly,
      you are cautioned not to place undue reliance on forward-looking statements,
      which speak only as of the date on which they are made. Additional information
      regarding these factors and others that could cause our actual results to differ
      materially from our expectations is included in our Annual Report on Form 10-KSB
      filed with the Securities and Exchange Commission (the “SEC”) on March 28, 2008.
      We undertake no obligation to update publicly or revise any forward-looking
      statements to reflect the impact of circumstances or events that arise after
      the
      dates they are made, whether as a result of new information, future events
      or
      otherwise except as required by applicable law. You should, however, consult
      further disclosures we may make in future filings of our Annual Reports on
      Form
      10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, any
      amendments thereto, and in the corresponding documents filed in
      Canada.





3




**PART
      I – FINANCIAL INFORMATION**


**Item
      1.**  **Financial Statements (Interim)**




**WESTERN
                      GOLDFIELDS INC.****CONSOLIDATED
                      BALANCE SHEETS****(In
                      thousands U.S. dollars)****(Unaudited)**
  June
                      30,
                  
                  December
                      31,2008
                  
                  2007**ASSETS
                      (Note 13)**CURRENT
                      ASSETSCash
                      and cash equivalents
                  
                  $
                  26,549
                  
                  $
                  43,870Restricted
                      cash (Note 4)
                  
                  
                  7,500
                  
                  
                  7,500Receivables
                  
                  
                  940
                  
                  
                  298Inventories
                      (Notes 2, 5)
                  
                  
                  25,134
                  
                  
                  11,201Prepaid
                      expenses
                  
                  
                  800
                  
                  
                  887Current
                      portion of deferred income tax asset
                  
                  
                  3,498
                  
                  
                  755TOTAL
                      CURRENT ASSETS
                  
                  
                  64,421
                  
                  
                  64,511Plant,
                      and equipment, net ofaccumulated
                      amortization (Note 6)
                  
                  
                  98,454
                  
                  
                  77,951Construction
                      in progress (Note 7)
                  
                  
                  10,246
                  
                  
                  21,864Investments
                      - reclamation and remediation (Note 8)
                  
                  
                  8,803
                  
                  
                  8,661Long-term
                      deposits
                  
                  
                  357
                  
                  
                  348Long-term
                      prepaid expenses (Note 9)
                  
                  
                  1,469
                  
                  
                  1,555Deferred
                      debt issuance costs, net of accumulated amortization (Note
                      10)
                  
                  
                  2,997
                  
                  
                  3,227Deferred
                      income tax asset (Notes 2, 11)
                  
                  
                  45,497
                  
                  
                  36,379TOTAL
                      OTHER ASSETS
                  
                  
                  167,823
                  
                  
                  149,984**TOTAL
                      ASSETS**
                  
                  $
                  232,244
                  
                  $
                  214,495**LIABILITIES
                      & STOCKHOLDERS' EQUITY**CURRENT
                      LIABILITIESAccounts
                      payable and accrued liabilities
                  
                  $
                  5,673
                  
                  $
                  8,781Current
                      portion of mark-to-market loss on gold hedging contracts (Notes
                      2, 12,
                      17)
                  
                  
                  8,969
                  
                  
                  1,935Current
                      portion of loan payable (Note 13)
                  
                  
                  15,109
                  
                  
                  6,882TOTAL
                      CURRENT LIABILITIES
                  
                  
                  29,751
                  
                  
                  17,598LONG-TERM
                      LIABILITIESMark-to-market
                      loss on gold hedging contracts (Notes 2, 12, 17)
                  
                  
                  82,753
                  
                  
                  56,966Loan
                      payable (Note 13)
                  
                  
                  71,230
                  
                  
                  69,581Reclamation
                      and remediation liabilities (Note 14)
                  
                  
                  5,235
                  
                  
                  5,061TOTAL
                      LIABILITIES
                  
                  
                  188,969
                  
                  
                  149,206COMMITMENTS
                      AND CONTINGENCIES (Note 19)
                  
                  
                  —
                  
                  
                  —STOCKHOLDERS'
                      EQUITYCommon
                      stock, of no par value, unlimited shares authorized;136,731,919
                      and 135,049,685 shares issued and outstanding,respectively
                      (Note 15)
                  
                  
                  135,250
                  
                  
                  133,725Stock
                      options and warrants (Note 16)
                  
                  
                  7,695
                  
                  
                  7,551Accumulated
                      deficit
                  
                  
                  (99,670
                  )
                  
                  (75,987
                  )TOTAL
                      STOCKHOLDERS' EQUITY
                  
                  
                  43,275
                  
                  
                  65,289**TOTAL
                      LIABILITIES AND STOCKHOLDERS' EQUITY**
                  
                  $
                  232,244
                  
                  $
                  214,495




The
        accompanying notes are an integral part of these consolidated financial
        statements.




4




**WESTERN
        GOLDFIELDS INC.**
 **CONSOLIDATED
          STATEMENTS OF OPERATIONS**
 **AND
            COMPREHENSIVE LOSS**
 **(In
              thousands U.S. dollars)**
 **(Unaudited)**


Three
                  Months Ended June 30,
              
              Six
                  Months Ended June 30,2008
              
              2007
              
              2008
              
              2007REVENUESRevenues
                  from gold sales
              
              $
              20,347
              
              $
              1,546
              
              $
              29,602
              
              $
              2,779EXPENSESMine
                  operating costs
              
              
              12,122
              
              
              3,466
              
              
              21,209
              
              
              5,674Royalties
              
              
              340
              
              
              59
              
              
              605
              
              
              105Cost
                  of sales
              
              
              12,462
              
              
              3,525
              
              
              21,814
              
              
              5,779Amortization
                  and accretion
              
              
              2,290
              
              
              377
              
              
              4,384
              
              
              752Cost
                  of goods sold
              
              
              14,753
              
              
              3,902
              
              
              26,198
              
              
              6,531GROSS
                  PROFIT (LOSS)
              
              
              5,594
              
              
              (2,356
              )
              
              3,404
              
              
              (3,752
              )EXPENSESGeneral
                  and administrative
              
              
              1,197
              
              
              1,138
              
              
              2,308
              
              
              2,222Stock
                  based compensation
              
              
              289
              
              
              820
              
              
              658
              
              
              1,289Exploration
              
              
              591
              
              
              749
              
              
              814
              
              
              1,0322,077
              
              
              2,707
              
              
              3,781
              
              
              4,543OPERATING
                  INCOME (LOSS)
              
              
              3,517
              
              
              (5,062
              )
              
              (377
              )
              
              (8,295
              )OTHER
                  INCOME (EXPENSE)Interest
                  income
              
              
              289
              
              
              525
              
              
              673
              
              
              1,042Interest
                  expense and commitment fees
              
              
              (1,320
              )
              
              (242
              )
              
              (2,019
              )
              
              (242
              )Amortization
                  of deferred debt issuance costs
              
              
              (115
              )
              
              (110
              )
              
              (231
              )
              
              (110
              )Unrealized
                  gain (loss) on mark-to-market of gold forward sales contracts (Note
                  12)
              
              
              (8,708
              )
              
              759
              
              
              (32,820
              )
              
              759Gain
                  (loss) on foreign currency exchange
              
              
              250
              
              
              124
              
              
              (770
              )
              
              205(9,605
              )
              
              1,056
              
              
              (35,167
              )
              
              1,655LOSS
                  BEFORE INCOME TAXES
              
              
              (6,088
              )
              
              (4,006
              )
              
              (35,544
              )
              
              (6,640
              )INCOME
                  TAX RECOVERY
              
              
              (2,029
              )
              
              —
              
              
              (11,861
              )
              
              —NET
                  LOSS
              
              
              (4,059
              )
              
              (4,006
              )
              
              (23,683
              )
              
              (6,640
              )OTHER
                  COMPREHENSIVE LOSSForeign
                  currency translation adjustment
              
              
              —
              
              
              (3
              )
              
              —
              
              
              (8
              )NET
                  COMPREHENSIVE LOSS
              
              $
              (4,059
              )
              $
              (4,009
              )
              $
              (23,683
              )
              $
              (6,648
              )BASIC
                  AND DILUTED NET LOSS PER SHARE
              
              $
              (0.03
              )
              $
              (0.04
              )
              $
              (0.17
              )
              $
              (0.06
              )WEIGHTED
                  AVERAGE NUMBER OFCOMMON
                  SHARES OUTSTANDING
              
              
              136,406,008
              
              
              113,641,025
              
              
              136,035,903
              
              
              108,240,372




The
      accompanying notes are an integral part of these consolidated financial
      statements.




5





**CONSOLIDATED
                  STATEMENTS OF STOCKHOLDERS' EQUITY****(In
                  thousands U.S. dollars)****(Six
                  months ended June 30, 2008 and year ended December 31, 2007)****(Unaudited)**
  Common
                  Stock
              
              Stock
                  Options
              
              
              
              Accumulated
                  OtherNumber
              
              
              
              and
              
              Accumulated
              
              Comprehensiveof
                  Shares
              
              Amount
              
              Warrants
              
              Deficit
              
              Income
                  (Loss)
              
              TotalBalance,
                  December 31, 2006
              
              
              78,452,876
              
              
              32,885
              
              
              7,674
              
              
              (25,678
              )
              
              (2
              )
              
              14,879Common
                  stock and warrants issued under prospectus supplement
              
              
              44,646,000
              
              
              92,608
              
              
              —
              
              
              —
              
              
              —
              
              
              92,608Common
                    shares issued on conversion of common stock warrants
              
              
              10,248,052
              
              
              4,508
              
              
              —
              
              
              —
              
              
              —
              
              
              4,508Common
                    shares issued on exersice of common stock options
              
              
              1,702,757
              
              
              1,040
              
              
              —
              
              
              —
              
              
              —
              
              
              1,040Options
                  issued for directors' services
              
              
              —
              
              
              —
              
              
              482
              
              
              —
              
              
              —
              
              
              482Options
                  issued for officers' services
              
              
              —
              
              
              —
              
              
              998
              
              
              —
              
              
              —
              
              
              998Options
                  issued for employees' services
              
              
              —
              
              
              —
              
              
              1,027
              
              
              —
              
              
              —
              
              
              1,027Options
                  issued for consultants' services
              
              
              —
              
              
              —
              
              
              54
              
              
              
              
              
              —
              
              
              54Exercise
                  and expiration of warrants & options
              
              
              —
              
              
              2,684
              
              
              (2,684
              )
              
              —
              
              
              —
              
              
              —Net
                    loss for the year ended December 31, 2007
              
              
              —
              
              
              —
              
              
              —
              
              
              (50,309
              )
              
              —
              
              
              (50,309
              )Other
                  comprehensive income
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              2
              
              
              2Balance,
                  December 31, 2007
              
              
              135,049,685
              
              $
              133,725
              
              $
              7,551
              
              $
              (75,987
              )
              $
              —
              
              $
              65,290Common
                    shares issued on conversion of common stock warrants
              
              
              750,001
              
              
              338
              
              
              —
              
              
              —
              
              
              —
              
              
              338Common
                    shares issued on exersice of common stock options
              
              
              932,233
              
              
              672
              
              
              —
              
              
              —
              
              
              —
              
              
              672Options
                  issued for directors' services
              
              
              —
              
              
              —
              
              
              103
              
              
              —
              
              
              —
              
              
              103Options
                  issued for officers' services
              
              
              —
              
              
              —
              
              
              261
              
              
              —
              
              
              —
              
              
              261Options
                  issued for employees' services
              
              
              —
              
              
              —
              
              
              295
              
              
              —
              
              
              —
              
              
              295Exercise
                  and expiration of warrants & options
              
              
              —
              
              
              515
              
              
              (515
              )
              
              —
              
              
              —
              
              
              —Net
                    loss for the period ended June 30, 2008
              
              
              —
              
              
              —
              
              
              —
              
              
              (23,683
              )
              
              —
              
              
              (23,683
              )Balance,
                  June 30, 2008
              
              
              136,731,919
              
              $
              135,250
              
              $
              7,695
              
              $
              (99,670
              )
              $
              —
              
              $
              43,275




The
      accompanying notes are an integral part of these consolidated financial
      statements.


6
 
  **WESTERN
            GOLDFIELDS INC.**
 **CONSOLIDATED
              STATEMENTS OF CASH FLOWS**
 **(In
                  thousands U.S. dollars)**
 **(Unaudited)**


Three
                  Months Ended June 30,
              
              Six
                  Months Ended June 30,2008
              
              2007
              
              2008
              
              2007**CASH
                  FLOWS FROM OPERATING ACTIVITIES**Net
                  loss
              
              $
              (4,059
              )
              $
              (4,007
              )
              $
              (23,683
              )
              $
              (6,641
              )Adjustments
                  to reconcile net loss to net cash provided (used) by operating
                  activities:Items
                  not affecting cash:Amortization
                  of plant and equipment
              
              
              2,219
              
              
              298
              
              
              3,030
              
              
              592Amortization
                  of deferred debt issuance costs
              
              
              115
              
              
              110
              
              
              231
              
              
              110Accretion
                  expense (Note 14)
              
              
              87
              
              
              84
              
              
              174
              
              
              169Deferred
                  income taxes
              
              
              (2,029
              )
              
              —
              
              
              (11,861
              )
              
              —Interest
                  net of reimbursed costs - reclamation and
                  remediation
              
              
              (80
              )
              
              (87
              )
              
              (142
              )
              
              (170
              )Stock
                  based compensation
              
              
              289
              
              
              820
              
              
              658
              
              
              1,289Mark-to-market
                  loss on gold hedging contracts
              
              
              8,708
              
              
              (759
              )
              
              32,820
              
              
              (759
              )Changes
                  in assets and liabilities:Decrease
                  (increase) in:Restricted
                  cash
              
              
              —
              
              
              (7,500
              )
              
              —
              
              
              (7,500
              )Accounts
                  receivable
              
              
              (720
              )
              
              174
              
              
              (642
              )
              
              76Inventories
              
              
              (7,894
              )
              
              31
              
              
              (12,732
              )
              
              (40
              )Prepaid
                  expenses and deposits
              
              
              87
              
              
              (369
              )
              
              173
              
              
              (547
              )Long
                  term deposits
              
              
              (6
              )
              
              (6
              )
              
              (9
              )
              
              (9
              )Increase
                  (decrease) in:Accounts
                  payable
              
              
              810
              
              
              (154
              )
              
              (529
              )
              
              (955
              )Payroll
                  and related taxes payable
              
              
              —
              
              
              —
              
              
              (1,562
              )
              
              —Accrued
                  expenses
              
              
              (287
              )
              
              (795
              )
              
              764
              
              
              201Accrued
                  interest expense
              
              
              (59
              )
              
              241
              
              
              (230
              )
              
              241Net
                  cash provided (used) by operating activities
              
              
              (2,817
              )
              
              (11,917
              )
              
              (13,539
              )
              
              (13,943
              )**CASH
                  FLOWS FROM INVESTING ACTIVITIES**Purchase
                  of property & equipment, including constructionin
                  progress
              
              
              (5,920
              )
              
              (25,662
              )
              
              (14,669
              )
              
              (31,377
              )Increase
                  in reclamation and remediation investment
              
              
              —
              
              
              (2,090
              )
              
              —
              
              
              (2,090
              )Net
                  cash provided (used) by investing activities
              
              
              (5,920
              )
              
              (27,752
              )
              
              (14,669
              )
              
              (33,467
              )**CASH
                  FLOWS FROM FINANCING ACTIVITIES**Loan
                  payable
              
              
              2,017
              
              
              —
              
              
              9,877
              
              
              —Deferred
                  debt issuance costs
              
              
              —
              
              
              (521
              )
              
              —
              
              
              (850
              )Common
                  stock issued for cash
              
              
              —
              
              
              1
              
              
              —
              
              
              59,191Exercise
                  of options to purchase common stock
              
              
              440
              
              
              356
              
              
              672
              
              
              501Exercise
                  of warrants to purchase common stock
              
              
              —
              
              
              1,436
              
              
              337
              
              
              1,816Net
                  cash provided by financing activities
              
              
              2,457
              
              
              1,272
              
              
              10,887
              
              
              60,658Change
                  in cash
              
              
              (6,280
              )
              
              (38,396
              )
              
              (17,321
              )
              
              13,248Cash
                  and cash equivalents, beginning of period
              
              
              32,829
              
              
              57,147
              
              
              43,870
              
              
              5,503Cash
                  and cash equivalents, end of period
              
              $
              26,549
              
              $
              18,750
              
              $
              26,549
              
              $
              18,750**SUPPLEMENTAL
                  CASH FLOW DISCLOSURES:**Interest
                  paid (received), net
              
              $
              933
              
              $
              1
              
              $
              1,346
              
              $
              1**NON-CASH
                  FINANCING AND****INVESTING
                  ACTIVITIES:**Stock,
                  options and warrants issued for services
              
              $
              289
              
              $
              820
              
              $
              658
              
              $
              1,289Equipment
                  purchases included in accounts payable
              
              $
              (180
              )
              $
              11,832
              
              $
              334
              
              $
              11,832Deferred
                  debt issuance costs included in accrued expenses
              
              $
              —
              
              $
              2,328
              
              $
              —
              
              $
              2,328Non-cash
                  component of inventories
              
              $
              (2
              )
              $
              2,328
              
              $
              1,201
              
              $
              2,328




The
      accompanying notes are an integral part of these consolidated financial
      statements.




7




**WESTERN
      GOLDFIELDS, INC.**


**NOTES
      TO THE CONSOLIDATED FINANCIAL STATEMENTS**


**(all
      tabular data in US $ thousands unless otherwise stated)**





**1.**  **ORGANIZATION
      AND DESCRIPTION OF**  **BUSINESS**





Western
      Goldfields Inc. (hereinafter “the Company” or “WGI Ontario”) and its wholly
      owned subsidiaries are engaged in the exploration for, development and
      extraction of precious metals, principally in North America. The Company’s four
      wholly owned subsidiaries are: Western Goldfields USA Inc. (a holding company),
      Western Goldfields (Canada) Inc. (a management company), Western Mesquite Mines,
      Inc. (an operating company), and Calumet Mining Company (an exploration
      company).





On
      June
      19, 2007 the shareholders of the Company’s predecessor, Western Goldfields,
      Inc., an Idaho corporation (“WGI Idaho”), approved an agreement and plan of
      merger effective June 29, 2007 whereby the Company’s place of incorporation was
      changed from Idaho, USA to Ontario, Canada, and its name was changed from
      Western Goldfields, Inc. to Western Goldfields Inc. (the “Reorganization”). For
      accounting purposes, the Reorganization has been treated as a reorganization
      of
      entities under common control which has not resulted in any changes in the
      consolidated carrying amounts of assets, liabilities and stockholders’ equity.
      As used herein, the term “the Company” refers to WGI Ontario and its predecessor
      WGI Idaho.





The
      Company was in the exploration stage until late 2003. With the acquisition
      of
      the Mesquite Mine in November 2003, the Company exited the exploration stage
      and
      became an operating mining company. Until June 2007, the Company’s operations
      were restricted to the production of gold from material that was placed on
      heap
      leach pads by previous owners of the mine. In June 2007, the Company commenced
      active mining operations and in December 2007 commenced leaching new
      ore.





The
      Company, through its wholly-owned subsidiary, Western Mesquite Mines, Inc.
      (“WMMI”), entered into a term loan facility with a syndicate of banks, dated
      March 30, 2007 as amended and restated on May 31, 2007, under which facility
      WMMI can borrow up to $105 million in connection with the development of the
      Mesquite Mine. Of this amount, $87.3 million is available until Completion
      of
      the project and $17.7 million is available until 12 months after Completion.
      The
      agreement, in conjunction with the equity financings of 2007, completed the
      financing requirements for Mesquite. At June 30, 2008, $86.3 million had been
      drawn under the facility.





The
      Company’s year-end for reporting purposes is December 31.





**2.**  **BASIS
      OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES**





The
      consolidated financial statements include the accounts of Western Goldfields
      Inc. and its 100% owned subsidiaries: Western Goldfields USA Inc., Western
      Goldfields (Canada) Inc., Western Mesquite Mines, Inc., and Calumet Mining
      Company (collectively “Western Goldfields”). The consolidated financial
      statements include the assets and liabilities of Western Goldfields as at June
      30, 2008 and December 31, 2007 and its results of operations and its cash flows
      for the three and six month periods ended June 30, 2008 and 2007. All
      significant inter-company accounts and transactions have been eliminated on
      consolidation.





The
      classification of certain items in these financial statements differs from
      that
      adopted in prior periods as a result of revised groupings or allocations.
      Comparative figures have been reclassified in the financial statements of the
      prior period to conform to the revised basis.




8




The
      preparation of consolidated financial statements in conformity with accounting
      principles generally accepted in the United States of America requires
      management to make estimates and assumptions that affect the reported amounts
      of
      assets and liabilities and disclosure of contingent assets and liabilities
      at
      the date of the financial statements and the reported amounts of revenues and
      expenses during the reporting period. Significant areas requiring the use of
      management estimates relate to the determination of mineral reserves,
      reclamation and remediation obligations, impairment of assets, useful lives
      for
      depreciation and amortization, measurement of heap leach, metal-in-process
      and
      finished goods inventories, value of options and warrants, and valuation
      allowances for future tax assets. Actual results could differ from these
      estimates.





The
      accounting policies followed in preparing these financial statements are those
      used by Western Goldfields as set out in the audited financial statements for
      the year ended December 31, 2007. These interim statements should be read
      together with Western Goldfields’ audited financial statements for the year
      ended December 31, 2007. In the opinion of management, all adjustments
      considered necessary for fair and consistent presentation of interim statements
      have been made. The financial statements and notes are representations of the
      Company’s management which is responsible for their integrity and objectivity.
      These accounting policies conform to accounting principles generally accepted
      in
      the United States of America and have been consistently applied in the
      preparation of the financial statements.




**3.**  **RECENT
      ACCOUNTING PRONOUNCEMENTS**





In
      September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
      No.157, “Fair Value Measurements”. The Statement defines fair value, establishes
      a framework for measuring fair value in generally accepted accounting
      principles, and expands disclosures about fair value measurements. The Statement
      does not require any new fair value measurements. The provisions of the
      Statement are effective for the Company’s fiscal year ending December 31, 2008.
      In February 2008, the FASB amended SFAS No. 157 to exclude leasing transactions
      and to delay the effective date by one year for non-financial assets and
      liabilities that are recognized or disclosed at fair value in the financial
      statements on a non-recurring basis. Effective January 1, 2008, the Company
      adopted SFAS No. 157 as it relates to financial assets and liabilities. The
      new
      disclosures are included in Note 17.





In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities - Including an amendment of FASB
      Statement No.115”. The Statement permits entities to choose to measure many
      financial instruments and certain other items at fair value. The objective
      is to
      improve financial reporting by providing entities with the opportunity to
      mitigate volatility in reporting earnings caused by measuring related assets
      and
      liabilities differently without having to apply complex hedge accounting
      provisions. The Company adopted SFAS No. 159 effective January 1, 2008 but
      this
      has had no impact on the Company’s financial position, financial performance and
      cash flows.





In
      December 2007, the FASB issued FAS 141(R), “Business Combinations”, which will
      replace FAS 141 prospectively for business combinations consummated after the
      effective date of December 15, 2008. Under FAS 141 (R), business combinations
      will be accounted for under the “acquisition method”, compared to the “purchase
      method” mandated by FAS 141. Significant changes will result from applying the
      acquisition method, including: more acquisitions will be accounted for as
      business combinations rather than as asset acquisitions; acquisition related
      costs of the acquirer will be expensed as incurred , whereas under FAS 141
      these
      costs are capitalized as part of the business combination; and the assets
      acquired and liabilities assumed are recorded at 100% of fair value even if
      less
      than 100% is obtained, whereas under FAS 141 only the controlling interest’s
      portion is recorded at fair value. In the event of the Company being involved
      in
      a future business combination, the Company will evaluate the application of
      FAS
      141(R).





9




In
      December 2007, the FASB issued FAS 160, “Non-Controlling Interests in
      Consolidated Financial Statements” which is effective for fiscal years beginning
      after December 15, 2008. Under FAS 160, non-controlling interests will be
      measured at 100% of the fair value of assets acquired and liabilities assumed.
      Under current standards, the non-controlling interest is measured at book value.
      For presentation and disclosure purposes, non-controlling interests will be
      classified as a separate component of shareholders’ equity. In addition, FAS 160
      will change the manner in which increases/decreases in ownership percentages
      are
      accounted for. The provisions of FAS 160 are to be applied prospectively with
      the exception of the presentation and disclosure provisions, which are to be
      applied for all prior periods presented in the financial statements. In the
      event of the Company being required in the future to prepare consolidated
      financial statements including a non-controlling interest in another entity,
      the
      Company will evaluate the application of FAS 160.





In
      March
      2008, the FASB issued FAS No. 161, “Disclosures about Derivative Instruments and
      Hedging Activities – an amendment of FASB Statement No.133”, which is effective
      for financial statements issued for fiscal years and interim periods beginning
      after November 15, 2008, with early application encouraged. The statement
      requires enhanced disclosures about an entity’s derivative and hedging
      activities and thereby improves the transparency of financial reporting. The
      statement changes the disclosure requirements for derivative instruments and
      hedging activities. Entities are required to provide enhanced disclosures about
      (a) how and why an entity uses derivative instruments, (b) how derivative
      instruments and related hedging items are accounted for under Statement 133
      and
      its related interpretations, and (c) how derivative instruments and related
      hedged items affect an entity’s financial position, financial performance and
      cash flows. The Company is currently evaluating the implications of the enhanced
      disclosure requirements in respect of its forward gold sales contracts.





**4.
      RESTRICTED CASH**





The
      Company, through its wholly-owned subsidiary, Western Mesquite Mines, Inc.
      (“WMMI”), entered into a term loan facility with a syndicate of banks, dated
      March 30, 2007 as amended and restated on May 31, 2007 (note 13). Under the
      terms of this facility the Company has set aside $7.5 million (2007 - $7.5
      million) in a Cost Overrun Account until completion of the Mesquite Mine
      development project, which occurs on satisfaction of physical and economic
      completion tests as set out in the credit agreement. At completion, unused
      funds
      will be applied to fund a Debt Service Reserve Account established to hold
      an
      amount equal to the debt service amounts payable on the next Repayment Date
      as
      set out in the credit agreement, and thereafter any surplus funds may be
      returned to the Company. Interest earned on restricted cash is for the account
      of the Company.





**5.**  **INVENTORIES**





Inventories
      consist of the following:





**June
                30,**
              **2008**
            
            **December 31,**
              **2007**Ore
                on leach pads
            
            $
            19,877
            
            $
            7,724Metal-in-process
            
            
            2,738
            
            
            847Bullion
            
            
            103
            
            
            994Supplies
            
            
            2,416
            
            
            1,636Total
                inventories
            
            $
            25,134
            
            $
            11,201





Inventories
      are valued at the lower of cost or net realizable value (“NRV”).





At
      June
      30, 2008, new ore placed on leach pads has been valued at cost, based on current
      mining costs, including depreciation, amortization and depletion, since this
      is
      lower than NRV. At December 31, 2007, ore on leach pads was valued at NRV.
      The
      estimated 44,120 ounces (2007 – 12,080 ounces) of recoverable gold on the leach
      pads is calculated from the quantities of ore placed (based on measured
      tonnage), the grade of ore (based on assay results), and a recovery percentage
      (based on ore type), less transfers into metal-in-process inventory.




10




At
      June
      30, 2008, metal-in-process inventory has been valued at cost, based on the
      average cost of gold-in-solution fed into the process from the leach pads plus
      further processing costs, including depreciation relating to processing
      facilities, since this is lower than NRV. At December 31, 2007, metal-in-process
      inventory was valued at NRV. The estimated 5,649 ounces (2007 – 1,086 ounces) of
      gold-in-solution and in carbon is based on assays and projected recoveries
      from
      the refining circuit.





Bullion
      represents gold held for our account by refiners pending sale. At June 30,
      2008,
      bullion has been valued at cost, based on the average cost of the in-process
      inventory plus refining costs, since this is lower than net realizable value.
      At
      December 31, 2007, bullion was valued at NRV. At June 30, 2008, 213 gold ounces
      were held at a refiner (2007 – 1,196 ounces).




**6.**  **PLANT AND EQUIPMENT**





The
      following is a summary of plant and equipment, and accumulated amortization
      and
      depreciation as at June 30, 2008 and December 31, 2007:





**June 30,**
              **2008**
            
            **December 31,**
              **2007**Buildings
            
            $
            4,703
            
            $
            4,215Equipment
            
            
            78,278
            
            
            74,633Leach
                pad expansion and other processing equipment
            
            
            22,937
            
            
            2,684Mine
                development
            
            
            3,864
            
            
            3,517109,782
            
            
            85,049Less
                accumulated amortization and depreciation
            
            
            (11,328
            )
            
            (7,098
            )Net
                plant and equipment
            
            $
            98,454
            
            $
            77,951





Capitalized
      interest expense for the six month periods ended June 30, 2008 and June 30,
      2007
      was $0.1 million and $nil, respectively, based on the interest attributable
      to
      borrowings incurred to finance the construction of assets intended for the
      Company’s own use. For the year ended December 31, 2007 capitalized interest was
      $0.5 million. Capitalization of interest ceases when an asset is ready for
      its
      intended use.





Mine
      development as at June 30, 2008 and December 31, 2007 includes $1.4 million
      in
      respect of fauna relocation costs and
      $2.3 million
      in respect of capitalized development drilling costs.





Amortization
      and depreciation expense for the three month and six month periods ended June
      30, 2008 was $2.2 million and $4.2 million respectively (2007 - $0.3 million
      and
      $0.6 million).





**7.**  **CONSTRUCTION
      IN PROCESS**





The
      following is a summary of the major components of construction in process at
      June 30, 2008 and December 31, 2007:





**June
                30,**
              **2008**
            
            **December 31,**
              **2007**Leach
                pad expansion
            
            $
            -
            
            $
            12,837Building
                construction and site infrastructure
            
            
            10,426
            
            
            9,027$
            10,426
            
            $
            21,864




11




Construction
      in process is accumulated and carried forward at cost until completion of
      construction or until the equipment is substantially complete and ready for
      productive use, at which time the cost is transferred to property, plant and
      equipment and is amortized over the asset’s expected useful life.





Cumulative
      spending on the two phases of the leach pad expansion have been capitalized
      and
      depreciated effective January 1, 2008 and May 1, 2008, respectively.





**8.**  **RECLAMATION
      AND REMEDIATION INVESTMENTS AND BONDS**





The
      Company has a bonding and insurance program, primarily with American
      International Specialty Lines Insurance Company (“AIG”), in respect of the
      operations and closure liabilities of the Mesquite Mine. Under the program,
      the
      Company initially paid $6.0 million into a reimbursement account with AIG,
      representing the net present value of expected reclamation costs. As a result
      of
      increases in proven and probable reserves in August 2006 and March 2007, which
      increased the estimated life of the mine by two years, the Company agreed with
      AIG and the regulatory agencies to revisions in its reclamation cost estimates.
      As a consequence, in May 2007 the bonding program was increased from
      approximately $8.7 million to approximately $11.3 million and the Company was
      required to place an additional $2.1 million in the reimbursement account with
      AIG. In addition, changes were made to the insurance program as described in
      note 9.





During
      the second half of 2006 and first quarter of 2007, the Company carried out
      closure procedures in respect of the Vista heap leach pad. Related costs of
      $0.3
      million were reimbursed by AIG.





The
      following is a summary of cumulative activity in the reimbursement account
      as at
      June 30, 2008 and December 31, 2007:




**June
                30,**
              **2008**
            
            **December 31,**
              **2007**Original
                deposit to reimbursement account
            
            $
            5,999
            
            $
            5,999Additional
                deposit to reimbursement account
            
            
            2,091
            
            
            2,091Interest
                earned from inception
            
            
            1,062
            
            
            9209,152
            
            
            9,010Reclamation
                costs reimbursed
            
            
            (349
            )
            
            (349
            )Closing
                balance
            
            $
            8,803
            
            $
            8,661





The
      following bonds have been issued by AIG and approved by regulatory agencies
      under the bonding component of the insurance program:





**Bond**
              **Number**
            
            
            **Inception**
              **Date**
            
            
            **Value**
            
            
            **Obligee(s)**ESD
                7315360
            
            
            11/7/2003
            
            $
            1,218
            
            
            Imperial
                County, CaliforniaCalifornia
                Department of ConservationU.S.
                Bureau of Land ManagementESD
                7315361
            
            
            11/7/2003
            
            $
            1,468
            
            
            Imperial
                County, CaliforniaCalifornia
                Department of ConservationU.S.
                Bureau of Land ManagementESD
                7315362
            
            
            11/7/2003
            
            $
            62
            
            
            Imperial
                County, CaliforniaCalifornia
                Department of ConservationU.S.
                Bureau of Land ManagementESD
                7315363
            
            
            11/7/2003
            
            $
            550
            
            
            California
                Water Quality Control BoardESD
                7315358
            
            
            11/7/2003
            
            $
            6,978
            
            
            U.S.
                Bureau of Land ManagementESD
                7315359
            
            
            11/7/2003
            
            $
            50
            
            
            California
                State Lands CommissionESD
                7315533
            
            
            5/30/2007
            
            
            977
            
            
            Imperial
                County, CaliforniaCalifornia
                Department of ConservationU.S.
                Bureau of Land ManagementCalifornia
                State Lands Commission





12




**9.**  **LONG-TERM
      PREPAID EXPENSES**




The
      Company has paid advance premiums in respect of insurance policies to cover
      environmental risks at the Mesquite Mine. In late 2007, the insurance program
      was re-evaluated in light of the increase in reserves and forecast mine life
      at
      Mesquite.





The
      insurance program covers closure and reclamation risk in excess of the amount
      on
      deposit in the Investment - Remediation and Reclamation account ($8.8 million
      at
      June 30, 2008), to an aggregate limit of $17.5 million (December 31, 2007 -
      $17.5 million), and expires November 7, 2020.





The
      program also covers pollution and remediation risk up to $10.0 million and
      includes coverage for pre-existing conditions and new conditions. The terms
      for
      these two aspects of coverage expire on November 7, 2013 and November 7, 2008,
      respectively.





The
      premium cost is being amortized over the terms of the policies and is summarized
      below.





**June
                30,**
              **2008**
            
            **December 31,**
              **2007**Original
                Policy Premiums
            
            $
            1,643
            
            $
            1,643Additional
                Policy Premium
            
            
            724
            
            
            724Amortization
                to date
            
            
            (727
            )
            
            (641
            )Unamortized
                Premium Cost
            
            
            1,640
            
            
            1,726Current
                Portion
            
            
            (171
            )
            
            (171
            )Long-Term
                Prepaid Expenses
            
            $
            1,469
            
            $
            1,555




**10.**  **DEFERRED
      DEBT ISSUANCE COSTS**





Debt
      issuance costs, primarily bank fees and professional fees and costs associated
      with the term loan facility (note 13) incurred to June 30, 2008 and December
      31,
      2007, were $3.6 million. These costs are being amortized on a straight line
      basis over the term of the facility to December 31, 2014. Amortization for
      the
      three month and six month periods ended June 30, 2008 was $0.1 million and
      $0.2
      respectively (2007 – $nil and $0.1).




**June 30,**
              **2008**
            
            **December 31,**
              **2007**Debt
                issuance costs incurred
            
            $
            3,570
            
            $
            3,570Cumulative
                amortization
            
            
            (573
            )
            
            (343
            )Closing
                balance
            
            $
            2,997
            
            $
            3,227




13




**11.**  **INCOME
      TAXES**





**Income
      Taxes Recoverable**





**June 30,**
              **2008**
            
            **December 31,**
              **2007**Current
            
            $
            3,497
            
            $
            755Deferred
            
            
            45,497
            
            
            36,379Income
                taxes recoverable
            
            $
            48,994
            
            $
            37,134





**Deferred
      Taxes**





The
      Company records deferred income tax assets and liabilities where temporary
      differences exist between the carrying amounts of assets and liabilities in
      the
      balance sheet and their tax bases.





The
      significant components of the deferred tax asset at June 30, 2008 and December
      31, 2007 are as follows:





**June 30,**
              **2008**
            
            **December 31,**
              **2007****Current
                deferred tax assets**
            
            $
            3,497
            
            $
            755**Long-term
                deferred tax assets**Unrealized
                loss on mark-to-market of
              gold
                forward sales contracts
            
            
            32,274
            
            
            22,217Net
                operating losses
            
            
            24,765
            
            
            19,131Mining
                property
            
            
            1,265
            
            
            1,265Reclamation
                cost
            
            
            1,948
            
            
            1,948Exploration
                cost
            
            
            453
            
            
            453Stock-based
                compensation
            
            
            1,450
            
            
            1,335Total
                long-term deferred tax assets
            
            
            62,155
            
            
            46,349**Long-term
                deferred tax liabilities**Fixed
                assets
            
            
            (7,584
            )
            
            (2,370
            )Total
                long-term deferred tax liabilities
            
            
            (7,584
            )
            
            (2,370
            )**Net
                long-term deferred tax asset**
            
            
            54,571
            
            
            43,979**Valuation
                allowance**
            
            
            (9,074
            )
            
            (7,600
            )**Net
                deferred tax assets**
            
            $
            48,994
            
            $
            37,134





At
      June
      30, 2008 the Company had income tax loss carry-forwards of approximately $65.0
      million. These losses expire from 2022 to 2028. The ability to utilize these
      loss carry-forwards is dependent upon a number of factors, including the future
      profitability of operations and other tax limitations. The future tax benefit
      of
      $24.8 million less a valuation allowance of $7.4 million, resulting in a future
      tax benefit of $17.4 million, has been recognized in the consolidated financial
      statements with respect to these income tax loss carry-forwards.




14




**12.**  **MARK-TO-MARKET
      LOSS ON GOLD HEDGING CONTRACTS**





Under
      the
      terms of the term loan facility dated March 30, 2007 and amended and restated
      on
      May 31, 2007 (note 13), Western Mesquite Mines Inc. was required, as a condition
      precedent to drawdown of the loan, to enter into a gold hedging program
      acceptable to the banking syndicate. On June 14, 2007 the Company announced
      that
      all requirements needed to make the facility available for drawdown had been
      met
      and that it had executed flat forward sales contracts for 429,000 ounces of
      gold
      at a price of $801 per ounce. The hedging contracts represent a commitment
      of
      5,500 ounces per month for 78 months commencing July 2008 with the last
      commitment deliverable in December 2014.





The
      Company has not designated these contracts as cash flow hedges. Accordingly
      the
      hedge accounting rules of SFAS No.133 are not being applied and the period-end
      mark-to-market adjustment related to these contracts is immediately reflected
      on
      the income statement of the Company as unrealized losses on gold forward sales
      contracts and the cumulative effect is reflected as an asset or liability on
      the
      balance sheet.





The
      contracts were marked-to-market as at June 30, 2008 using a spot price of gold
      of $930. The cumulative unrealized pre-tax loss of $91.8 million (2007 - $58.9
      million) has been disclosed as a liability as at June 30, 2008 and the Company
      has recorded an unrealized loss of $8.7 million and $32.8 million for the three
      month and six month periods ended June 30, 2008 respectively (2007 unrealized
      gain – $0.8 million and $0.8 million respectively).





**13.**  **LOANS
      PAYABLE**





**Term
      Loan Facility**





The
      Company, through its wholly-owned subsidiary, Western Mesquite Mines, Inc.
      (“WMMI”), entered into a term loan facility with a syndicate of banks, dated
      March 30, 2007 as amended and restated on May 31, 2007, under which WMMI can
      borrow up to $105 million in connection with the development of the Mesquite
      Mine. The facility expires December 31, 2014 and comprises a multiple-draw
      term
      loan of which $87.3 million is available as required for the development of
      the
      Mesquite Mine; the remainder is available for up to 12 months after completion
      for corporate purposes.  The facility is secured by all of the assets of
      WMMI and a pledge of the shares of WMMI owned by the Company. In addition,
      until
      completion, the facility is guaranteed by the Company.





Interest
      on the term loan is charged at U.S. LIBOR plus 2.2% prior to completion and
      U.S.
      LIBOR plus 1.75% after completion.  Completion occurs upon the satisfaction
      of certain technical and financial criteria as defined in the credit agreement.
      As at June 30, 2008, WMMI had drawn $86.3 million under the facility at a rate
      of approximately 5.5%.  As at December 31, 2007, WMMI had drawn $76.5
      million under the facility and incurred interest at a rate of approximately
      7.25%. Repayment of the project facility will be on a semi-annual basis,
      commencing December 31, 2008 through December 31, 2014 according to an agreed
      schedule of percentages of the loan outstanding on the final day of the
      availability period. On the basis of the loan outstanding at June 30, 2008,
      the
      initial repayment on December 31, 2008 would be $9.9 million or 11.5% of the
      loan, and the second repayment on June 30, 2009 would be $5.2 million or 6%
      of
      the loan, which amounts have been recorded as a current liability.  In
      addition to the scheduled repayments, mandatory prepayments are required
      semi-annually based on excess cash flow from the Mesquite
      Mine.




15




**14.**  **RECLAMATION
      AND REMEDIATION LIABILITIES**





Federal,
      state and local laws and regulations concerning environmental protection affect
      the Company’s operations. Under current regulations, the Company is required to
      meet performance standards to minimize environmental impact from operations
      and
      to perform site reclamation and remediation activities. The Company’s provision
      for reclamation and remediation liabilities is based on known requirements.
      It
      is not possible to estimate the impact on operating results, if any, of future
      legislative or regulatory developments. The Company’s estimate of the net
      present value of these obligations for the Mesquite mine is based upon existing
      reclamation standards as at June 30, 2008 and is in conformity with SFAS No.
      143. The increase in the net present value of the liability is recognized for
      accounting purposes as accretion expense during the period under
      review.





In
      May
      2007, the Company announced an increase in its mineral reserves which is
      reflected in an increase of $0.1 million in the provision for reclamation and
      remediation as at December 31, 2007.





The
      following table sets out the activity for the Company’s reclamation and
      remediation liabilities for the six month period ended June 30, 2008 and the
      year ended December 31, 2007:





**June 30,**
              **2008**
            
            **December 31,**
              **2007**Opening
                Balance
            
            $
            5,061
            
            $
            4,805Accretion
            
            
            174
            
            
            337Reclamation
                costs incurred
            
            
            -
            
            
            (148
            )Increase
                (reduction) in the present value of obligations
            
            
            -
            
            
            67Ending
                Balance
            
            $
            5,235
            
            $
            5,061





The
      estimated amount payable within the next 12 months included in the above balance
      as at June 30, 2008 is
      $0.2 million
      (2007 - $0.1 million).





**15.**  **COMMON
      SHARES**





**Reclassification
      of Additional Paid In Capital**





Following
      the Reorganization, the Company’s authorized share capital, as an Ontario
      corporation, comprises solely an unlimited number of common shares of no par
      value. Prior to the Reorganization, the Company’s authorized common stock, as an
      Idaho corporation, was 500 million common shares of $0.01 par value. The impact
      of the conversion from shares of $0.01 stated value to shares of no par value
      has been reflected in the financial statements on a retroactive basis.
      Accordingly, amounts recorded as credits in the Additional Paid-In Capital
      component of Stockholders’ Equity as at June 29, 2007 and December 31, 2006 have
      been reclassified as Common Stock.





**Public
      Offerings of Common Shares**





In
      January 2007, the Company issued 33,330,000 common shares at a price of $1.91
      per share (Cdn. $2.25 per share) under a prospectus supplement to the Company’s
      shelf prospectus dated October 27, 2006. Net proceeds to the Company, after
      expenses of $4.5 million, were $59.2 million.





In
      October 2007, the Company issued 11,316,000 common shares at a price of $3.13
      per share (Cdn.$3.05 per share) under a Short Form Prospectus dated October
      2,
      2007. Net proceeds to the Company, after expenses of $2.0 million, were $33.4
      million.





16





**Other
      Issuances of Common Shares**





During
      the six month period ended June 30, 2008, 932,233 options were exercised for
      cash consideration of $0.7 million.





During
      the six month period ended June 30, 2008, 750,000 shares of common stock were
      issued for cash consideration of $0.3 million upon the exercise of 750,000
      warrants to purchase common shares.





During
      the year ended December 31, 2007, the Company issued 1,702,757 shares of common
      stock for cash consideration of $1.0 million upon the exercise of options to
      purchase common shares. Of the shares issued, 103,125 were issued under the
      cashless method under which option holders receive that number of shares
      calculated by dividing the amount by which their options are “in the money” by
      the share price at date of exercise.





During
      the year ended December 31, 2007, the Company issued 10,248,052 shares of common
      stock for cash consideration of $4.5 million upon the exercise of 10,248,052
      warrants to purchase common shares.





**16.**  **STOCK
      OPTIONS AND WARRANTS**





**Options**





The
      Company has a stock incentive plan which is intended to provide an incentive
      to
      officers, employees, directors and consultants of the Company. The option price
      is determined by the Compensation Committee of the Board of Directors at its
      sole discretion but shall not be less than the closing price of the Company’s
      common stock on The Toronto Stock Exchange two trading days after the date
      of
      the grant. The term of each option granted shall be for a period of not
      exceeding ten years from the date of the grant. Except as expressly provided
      for
      in the option holder’s employment, consulting or termination contract, the
      option holder may exercise the option to the extent exercisable on the date
      of
      such termination at any time within three months after the date of
      termination.





The
      plan
      is a non-qualifying stock option plan for U.S. income tax purposes. For awards
      made before and after the reorganization of the Company effective June 29,
      2007,
      the price of options granted is expressed in terms of U.S. and Cdn. dollars,
      respectively. The aggregate number of shares of the Company’s common stock for
      which option awards may be granted under the plan shall not exceed 5,000,000.





The
      Company estimates the fair value of options and warrants using the Black-Scholes
      Option Price Calculation. Some options and warrants may be exercised by means
      of
      a “cash-less exercise” to receive a number of shares of common stock equal in
      market value to the difference between the market value of the shares of common
      stock issuable under the option or warrant and the total cash exercise price
      of
      the option or warrant being exercised.





During
      the six month period ended June 30, 2008, 932,233 options were exercised for
      cash proceeds of $0.7 million and 36,666 options were forfeited.





During
      the year ended December 31, 2007, 1,749,632 options were exercised for cash
      proceeds of $1.0 million, and 10,000 options expired. Of the options exercised,
      150,000 were exercised in exchange for 103,125 common shares under the cashless
      method under which option holders receive that number of shares calculated
      by
      dividing the amount by which their options are “in the money” by the share price
      at date of exercise.





On
      December 10, 2007, the Company issued 300,000 options to an employee with an
      exercise price of Cdn $3.74 per share. The options vest in three equal annual
      installments beginning on December 10, 2007, and were fair valued at $0.7
      million.





On
      August
      2, 2007, the Company issued 395,000 options to employees and to a director
      with
      an exercise price of Cdn $2.80 per share. The options vest in three equal annual
      installments beginning on August 2, 2007, and were fair valued at $0.9
      million.




17




On
      June
      29, 2007, the Company issued 50,000 options to an employee with an exercise
      price of $2.46 per share. The options vest in three equal annual installments
      beginning on June 29, 2007, and were fair valued at $0.1 million.





On
      April
      4, 2007, the Company issued 655,000 options to employees with an exercise price
      of $1.96 per share. The options vest in three equal annual installments
      beginning on April 4, 2007 and were fair valued at $1.1 million.





The
      value
      of each option award is estimated on the date of the grant using the
      Black-Scholes option-pricing model. The model requires the input of subjective
      assumptions, including the weighted-average risk-free rate of return, expected
      term of the option award, and stock price volatility. During 2007, these
      assumptions were adjusted to reflect prevailing interest rates, plan experience
      and stock market performance of the Company’s shares, respectively. These
      estimates involve inherent uncertainties and the application of management
      judgment. In addition, we are required to estimate the expected forfeiture
      rate
      and only recognize expense for options expected to vest. As a result, if other
      assumptions had been used, our recorded stock-based compensation expense could
      have been different from that reported. The Black-Scholes option pricing model
      used the following assumptions:


**December 31,**
                **2007**Weighted-average
                  risk-free rate of return (%)
              3.9%
                  - 5.0%Dividend
                  yield
              -
                  %Expected
                  life in years
              4
                  and 7Volatility
              91%
                  - 98%





The
      following is a summary of stock option activity for the six month period ended
      June 30, 2008 and the year ended December 31, 2007:




**Weighted
                Average****Shares**
            
            **Exercise**
              **Price**
            
            **Fair**
              **Value**Balance
                January 1, 2007(1)
            
            
            13,661,250
            
            $
            0.61Granted
            
            
            1,400,000
            
            
            2.60Exercised
                / Expired
            
            
            (1,759,632
            )
            
            0.65Outstanding
                December 31, 2007
            
            
            13,301,618
            
            
            0.82Exercisable
                at December 31, 2007
            
            
            9,403,291
            
            $
            0.72Fair
                value of options as at December 31, 2007
            
            
            
            
            
            
            
            $
            0.55Balance
                January 1, 2008
            
            
            13,301,618
            
            $
            0.82Granted
            
            
            -
            
            
            -Exercised
            
            
            (932,233
            )
            
            0.72Cancelled/forfeited
            
            
            (36,666
            )
            
            1.96Outstanding
                June 30, 2008(1)
            
            
            12,332,718
            
            
            0.81Exercisable
                at June 30, 2008
            
            
            11,512,720
            
            $
            0.68Fair
                value of options as at June 30, 2008
            
            
            
            
            
            
            
            $
            0.56




(1)
      Includes options granted under predecessor plan




18




The
      following table summarizes information about the stock options outstanding
      at
      June 30, 2008:


**Awards
                  Outstanding by Range****Exercise
                  Price**
                **$**
              
              **Awards
                  Outstanding**
              
              **Awards
                  Exercisable****Low**
              
              **High**
              
              **Quantity**
              
              **Weighted**
                **Average**
                **Outstanding**
                **Contractual**
                **Life**
              
              **Weighted**
                **Average
                  Exercise Price**
                **$**
              
              **Quantity**
              
              **Weighted**
                **Average**
                **Remaining**
                **Contractual**
                **Life**
              
              **Weighted**
                **Average**
                **Exercise Price**0.01
              
              
              0.50
              
              
              7,784,117
              
              
              4.48
              
              
              0.34
              
              
              7,784,117
              
              
              4.48
              
              
              0.340.51
              
              
              1.00
              
              
              2,420,000
              
              
              3.85
              
              
              0.88
              
              
              2,420,000
              
              
              3.85
              
              
              0.881.01
              
              
              1.50
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —1.51
              
              
              2.00
              
              
              508,601
              
              
              5.76
              
              
              1.96
              
              
              326,935
              
              
              5.76
              
              
              1.962.01
              
              
              2.50
              
              
              925,000
              
              
              5.09
              
              
              2.18
              
              
              750,001
              
              
              5.06
              
              
              2.152.51
              
              
              3.00
              
              
              395,000
              
              
              6.09
              
              
              2.74
              
              
              131,667
              
              
              6.09
              
              
              2.743.01
              
              
              3.50
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —3.51
              
              
              4.00
              
              
              300,000
              
              
              6.64
              
              
              3.66
              
              
              100,000
              
              
              6.44
              
              
              3.6612,332,718
              
              
              4.55
              
              
              0.81
              
              
              11,512,720
              
              
              4.46
              
              
              0.
                  68




**Warrants**





The
      following is a summary of warrant activity for the six months ended June 30,
      2008 and the year ended December 31, 2007:





**Six months ended
                June 30,**
              **2008**
            
            **Year ended**
              **December 31,**
              **2007**Balance,
                start of period
            
            
            6,806,180
            
            
            17,054,232Issued
            
            
            -
            
            
            -Expired
            
            
            -
            
            
            -Exercised
            
            
            (750,000
            )
            
            (10,248,052
            )Balance,
                end of period
            
            
            6,056,180
            
            
            6,806,180





Warrants
      outstanding to acquire common shares of the Company at June 30, 2008 are as
      follows:





**Warrants Outstanding**
            
            **Exercise** **Price**
            
            **Expiry Date**6,056,180
            
            
            0.76
            
            Note
              (1)





(1)
            Newmont
                Mining Corporation (“Newmont”) received warrants as part of the purchase
                price for Mesquite in November 2003. Under the anti-dilution provisions
                of
                the warrant, the exercise price was reduced from $1.00 to $0.76 upon
                the
                issuance of common shares and warrants by way of private placement
                on
                February 13, 2006. The warrants expire between June 9, 2011 and June
                9,
                2012




19




**17.**  **FAIR
      VALUE OF FINANCIAL INSTRUMENTS**




As
      discussed in Note 3, effective January 1, 2008, the Company adopted SFAS 157
      as
      it relates to financial assets and liabilities that are being measured at fair
      value on a recurring basis. Although the adoption of SFAS 157 did not materially
      impact its financial condition, results of operations, or cash flows, the
      Company is now required to provide additional disclosures as part of its
      financial statements. In accordance with FSP 157-2, the Company deferred
      adoption of SFAS 157 as it relates to nonfinancial assets and liabilities
      measured at fair value on a non-recurring basis.




SFAS
      157
      defines fair value, establishes a framework for measuring fair value in
      accordance with GAAP, and expands disclosure about fair value measurements.
      The
      statement is intended to enable the reader of the financial statements to assess
      the inputs used to develop those measurements by establishing the hierarchy
      for
      ranking the quality and reliability of the information used to determine fair
      values. The statement requires that assets and liabilities carried at fair
      value
      be classified and disclosed in a three-tier fair value hierarchy. These tiers
      include: Level 1, defined as quoted market prices in active markets for
      identical assets and liabilities; Level 2, defined as inputs other than Level
      1
      that are observable, either directly or indirectly, such as quoted prices for
      similar assets or liabilities; quoted prices in markets that are not active;
      model-based valuation techniques for which all significant assumptions are
      observable in the market; or inputs that are observable or can be corroborated
      by observable market data for substantially the full term of the assets or
      liabilities; and Level 3, defined as unobservable inputs that are not
      corroborated by market data.




The
      following table sets out the Company’s financial assets and liabilities at June
      30, 2008 at fair value by level within the fair value hierarchy. As required
      by
      FAS 157, liabilities are classified in their entirety based on the lowest level
      of input that is significant to the fair value measurement.





**Fair
                Value at June 30, 2008****Total**
            
            **Level
                1**
            
            **Level
                2****Assets******Cash
                and cash equivalents and restricted cash
            
            $
            34,050
            
            $
            34,050
            
            $
            -**Liabilities**Bank
                debt
            
            $
            86,339
            
            $
            86,339
            
            $
            -Derivative instruments – forward gold sales
            
            
            91,721
            
            
            -
            
            
            91,721




The
      Company’s cash and restricted cash is represented by account balances and short
      dated deposits with major Canadian and U.S. banks. Canadian account balances
      and
      deposits are converted to U.S. dollars at the closing exchange rate on March
      31,
      2008 and accordingly are classified within Level 1 of the fair value
      hierarchy.




The
      Company’s bank debt represents the current and long-term portions of advances
      under the Company’s term-loan facility. This indebtedness is a financial
      liability and as such its fair value equals its historic cost. Accordingly
      it is
      classified within Level 1 of the fair value hierarchy.




The
      Company’s forward gold sales contracts are valued using pricing models which
      require a variety of inputs, including contractual terms and yield curves,
      and
      correlation of such inputs. The Company utilizes the market approach to
      measurement of fair value for these derivative instruments. This approach uses
      prices and other relevant information generated by market transactions involving
      comparable liabilities. Such derivative contracts trade in liquid markets and,
      as such, model inputs can generally be verified and do not involve significant
      management judgment. Such instruments are typically classified within Level
      2 of
      the fair value hierarchy.




20




**18. 
        RELATED PARTY TRANSACTIONS**





In
      March
      2006, the Company concluded a cost sharing agreement with Silver Bear Resources
      Inc. (“Silver Bear”) under which half of certain of Silver Bear’s office
      overhead costs is charged to the Company. The Company is related to Silver
      Bear
      because certain senior executives and a director of Silver Bear also serve
      as
      senior executives and as a director of the Company. During the three months
      and
      six months ended June 30, 2008 overhead costs of $0.1 million and $0.1 million,
      respectively, were charged to the Company under this agreement (2007 - $0.1
      million and $0.1 million). At June 30, 2008 and December 31, 2007, $18,204
      and
      $31,150, respectively, was payable to Silver Bear. The Company anticipates
      renewing an agreement in August 2008 with the result that the Company will
      pay
      for costs, including office rental, in the first instance and will then invoice
      Silver Bear for its share.





**19.**  **COMMITMENTS
      AND CONTINGENCIES**





**Mining
      Industry**




Although
      the minerals exploration and mining industries are inherently speculative and
      subject to complex environmental regulations, the Company is unaware of any
      pending litigation or of any specific past or prospective matters which could
      impair the value of its mining claims.





**Contract
      with the County Sanitation District of Los Angeles**





During
      its ownership of the Mesquite Mine, Hanson Natural Resource Company, a prior
      operator of the mine, entered into an agreement with the County Sanitation
      District of Los Angeles County, which then developed and permitted a plan to
      create a 100 year landfill at the Mesquite Mine.





Under
      the
      agreement with the County Sanitation District of Los Angeles County, the Company
      has the right to explore, mine, extract, process, market and sell ore, and
      otherwise conduct mining and processing activities, anywhere on the property
      for
      an initial period through 2024 with automatic extensions until 2078. Much of
      the
      infrastructure at the property is likely to be retained by the landfill after
      mining operations are completed and the Company has met certain reclamation
      standards. Construction operations are now underway and landfill operations
      are
      expected to begin in 2008.





**Mesquite
      Expansion**





The
      Company is in the final stages of completion of the mine expansion program
      at
      Mesquite. As at June 30, 2008, planned and committed capital spending on the
      program is approximately $3.0 million. In addition, the Company has committed
      capital spending of $3.4 million for an additional loading unit.





**Lease
      Agreement**





The
      Company has entered into a lease for head office premises for the ten year
      period commencing June 1, 2008. Estimated rental and operating costs over the
      first year of the lease are approximately $530,000 and over the ten year term
      are approximately $5.4 million. The Company anticipates that Silver Bear will
      initially share 50% of these costs (see Note 18).





**Congrove
      Construction Matter**





The
      Company, through its subsidiary, Western Mesquite Mines Inc. (“WMMI”), entered
      into a Management Representative Agreement dated August 7, 2007 (the
“Agreement”) with Congrove Construction (“Congrove”) of Yuma, Arizona, in
      respect of certain construction activities associated with the Mesquite
      expansion project. WMMI terminated the Agreement on the grounds of bad faith
      demonstrated by Congrove in the carrying out of its contractual duties. On
      July
      3, 2008, legal counsel acting for Congrove filed a complaint and demand for
      jury
      trial with the United States District Court, Southern District of California,
      asserting that WMMI materially breached the Agreement by failing to provide
      complete plans in a timely manner, by wrongfully terminating Congrove’s services
      on the construction project, and by failing to pay monies owing to Congrove
      under the Agreement. Congrove is seeking relief in the amount of $0.6 million
      plus interest thereon. WMMI has not yet been served with the
      complaint.





21




The
      Company does not believe these claims have merit and intends to vigorously
      defend against such claims.





**20.** **SUBSEQUENT
          EVENTS**





Effective
      July 31, 2008, the Company settled in respect of the first delivery of 5,500
      ounces of gold under its hedging contracts (see Note 12).




22


**Item
      2.**  **Management’s
      Discussion and Analysis of Consolidated Financial Condition and Results of
      Operations**




The
      following discussion provides information that management believes is relevant
      to an assessment and understanding of the consolidated financial condition
      and
      results of operations of Western Goldfields Inc. and its subsidiaries and
      including its predecessor, Western Goldfields, Inc. (collectively “Western
      Goldfields” or the “Company”). **This
      item should be read in conjunction with our unaudited consolidated financial
      statements for the three and six month periods ended June 30, 2008 and the
      notes
      thereto. The information is presented as of August 6, 2008. All amounts in
      this
      discussion are expressed in U.S. dollars, unless otherwise
      specified.**





The
      following discussion contains forward-looking statements that involve numerous
      risks and uncertainties. Actual results of the Company could differ materially
      from those discussed in such forward-looking statements as a result of these
      risks and uncertainties, including those set forth in our Annual Report filed
      with the SEC on March 28, 2008 under Item 1. Description of Business - “Risk
      Factors.”




**Overview**





We
      are an
      independent precious metals production and exploration company with operations
      focused in North America. Our principal asset is the Mesquite Mine (“Mesquite”
or “the Mine”) which we acquired from Newmont Mining Corporation (“Newmont”) in
      November 2003. Until late 2007 Mesquite provided us with residual gold
      production from ore that was placed on the heap leach pads by Newmont and
      previous owners of the property. We completed a positive feasibility study
      in
      August 2006. Subsequent equity and debt financings have enabled us to undertake
      a capital expansion program and resume mining operations at Mesquite. We started
      to place new ore on the new heap leach pad during the second half of 2007 and
      this started to be reflected in our gold production and inventories by late
      2007. We attained “steady state” production from the new leach pad during the
      second quarter of 2008 (“Q2/08”). We are fully permitted and fully funded and we
      expect gold production of 135,000 – 145,000 ounces of gold in 2008. Western
      Goldfields Inc. is listed on the Toronto Stock Exchange and trades under the
      symbol WGI, and is listed on the American Stock Exchange under the symbol
      WGW.





**Overall
      Performance**





Our
      first
      gold pour from new production occurred on January 15, 2008. Our primary goals
      during the first half of 2008 were to meet the mining productivity objectives
      of
      our mine plan and to achieve “steady state” production from the new ore being
      placed on the leach pad that we have constructed over the past year. Although
      tonnage of ore mined and ounces of gold placed on the leach pad during the
      first
      quarter of 2008 (“Q1/08”) was in line with our projections, gold sales were
      lower than projected. The
      start up of leach pad operations involves numerous assumptions that can only
      be
      validated over time, and the initial recovery curve was several weeks slower
      than expected because of gold being tied up in solution inside the heap. By
      late
      May solution flow to the leach pad had been significantly increased as our
      new
      process equipment came on stream, the leach pad had become saturated, steady
      state pregnant solution flow had been achieved, and production rates had
      stabilized. Production for Q2/08 of 28,524 ounces was at the high end of our
      forecast range of between 20,000 and 30,000 ounces. Production benefited from
      the commencement of mining ore in the Rainbow 1 pit which produced higher grade
      material than previously obtained from the Big Chief pit. The
      selling price for gold in world markets continues to be strong and more than
      offsets the escalation in production costs, notably for fuel and haul truck
      tires.





23




**Term
      Loan Facility and Related Hedging**





Our
      wholly-owned subsidiary, Western Mesquite Mines, Inc., has a term loan facility
      with a syndicate of banks for $105.0 million. The facility comprises
      multiple-draw loans maturing December 31, 2014, of which $87.3 million is
      available for the development of the Mesquite Mine, and the remainder is
      available for up to 12 months after completion for other corporate purposes.
      Achieving completion will require the satisfaction of financial, production
      and
      technical criteria and is expected to occur in late 2008. Repayment of the
      facility will be on a semi-annual basis commencing December 31, 2008, with
      mandatory prepayments being made from excess cash flow. Interest on each advance
      is charged at U.S. LIBOR plus 2.2% up to completion and at U.S. LIBOR plus
      1.75%
      after completion.





As
      at
      June 30, 2008 we had drawn approximately $86.3 million. Based on our current
      plans, we do not anticipate making further draws.





In
      connection with the term loan facility which required us to sell certain
      quantities of gold forward, on June 7, 2007 we executed flat forward sales
      contracts for 429,000 ounces of gold (the “Hedging Contracts”) at a price of
      $801 per ounce. The Hedging Contracts represent a commitment of 5,500 ounces
      for
      78 months commencing July 2008, with the last commitment deliverable December
      2014. We expect to produce on average between 160,000 and 170,000 ounces
      annually during the term of the Hedging Contracts, of which 66,000 annually will
      be covered by the Hedging Contracts, leaving approximately 100,000 ounces
      leveraged to the price of gold. Since we have not designated these forward
      sales
      contracts as cash flow hedges, they are being marked-to-market at the end of
      each quarterly period for financial reporting purposes. We have recorded an
      unrealized pre-tax loss of $8.7 million and $32.8 million for the three and
      six
      month periods ended June 30, 2008, respectively, and $58.9 million for the
      year
      ended December 31, 2007. The cumulative unrealized pre-tax loss of $91.7 million
      has been disclosed as a liability as at June 30, 2008. The first delivery of
      5,500 ounces occurred on July 31, 2008.





**Capital
      Program - Construction Activity**





During
      the first half of 2008, the remaining aspects of our capital program, launched
      in late 2006, were substantially completed. The expanded leach pad became fully
      operational in Q1/08 and the retrofit of the process plant was completed. During
      Q2/08, new carbon columns for the processing circuit were brought on stream
      and
      construction of the new truck repair shop, warehouse and mine administrative
      office was substantially completed. Our
      latest forecast for spending on the expansion capital program is $109.9 million,
      of which $95.4 million was incurred in 2006 and 2007 and $14.5 million will
      be
      incurred in 2008. Spending on the expansion program in 2008 YTD was $11.6
      million. In addition, a purchase order for $3.4 million was placed for an extra
      front-end loader to be delivered during the third quarter of 2008. This third
      loader will provide flexibility in haul truck loading so that mine production
      is
      maintained at the required level.





24




**Selected
      Financial Information**  *(all
      tabular information in $000s unless otherwise stated)*




Three months ended June 30,
            
            Six months ended June 30,**2008**
            
            **2007**
            
            **2008**
            
            **2007**Cash
                flows from operating activities
            
            
            (2,817
            )
            
            (11,917
            )
            
            (13,539
            )
            
            (13,943
            )Cash
                flows for investing activities
            
            
            (5,920
            )
            
            (27,752
            )
            
            (14,669
            )
            
            (33,467
            )Cash
                flows from financing activities
            
            
            2,457
            
            
            1,272
            
            
            10,887
            
            
            60,658


**June 30,**
                **2008**
              
              **December 31,**
                **2007**Cash
                  and cash equivalents
              
              
              26,549
              
              
              43,870Restricted
                  cash
              
              
              7,500
              
              
              7,500Working
                  capital
              
              
              34,671
              
              
              46,914Property,
                  plant and equipment, net of depreciation
              
              
              98,454
              
              
              77,951Construction
                  in progress
              
              
              10,246
              
              
              21,864Shareholders’
                  equity
              
              
              43,275
              
              
              65,290


Three months ended June 30,
              
              Six months ended June 30,**2008**
              
              **2007**
              
              **2008**
              
              **2007**Revenues
                  from gold sales
              
              
              20,347
              
              
              1,546
              
              
              29,602
              
              
              2,779Gross
                  profit (loss)
              
              
              5,594
              
              
              (2,356
              )
              
              3,404
              
              
              (3,752
              )Mark-to-market
                  on forward sales
              
              
              (8,708
              )
              
              759
              
              
              (32,820
              )
              
              759Net
                  loss
              
              
              (4,059
              )
              
              (4,007
              )
              
              (23,683
              )
              
              (6,641
              )Net
                  loss to common shareholders
              
              
              (4,059
              )
              
              (4,010
              )
              
              (23,683
              )
              
              (6,649
              )Net
                  loss per common share, basic and diluted
              
              $
              (0.03
              )
              $
              (0.04
              )
              $
              (0.17
              )
              $
              (0.06
              )Gold
                  ounces produced
              
              
              28,524
              
              
              2,304
              
              
              37,590
              
              
              4,240Gold
                  ounces sold
              
              
              22,760
              
              
              2,350
              
              
              32,720
              
              
              4,225Average
                  price received per ounce
              
              $
              894
              
              $
              658
              
              $
              905
              
              $
              658Cost
                  of sales per ounce(i)
              
              $
              548
              
              $
              1,500
              
              $
              667
              
              $
              1,368





(i)
            Cost
                  of sales per ounce is defined as cost of sales per the Company’s financial
                  statements divided by the number of ounces
                  sold.





25




**Consolidated
      Financial Results / Overall Performance**





The
      Company’s net loss to common shareholders for the six months ended June 30, 2008
      (“2008 YTD”) was $23.7 million, or $0.17 per share, compared with $6.6 million,
      or $0.06 per share, for the six months period ended June 30, 2007 (“2007
      YTD”).




The
      net
      loss for 2008 YTD includes $32.8 million non-cash, pre-tax expense arising
      from
      the mark-to-market of contracts for the forward sale of gold which were taken
      out as a requirement of our term loan facility. These contracts are in respect
      of 429,000 ounces of gold at a forward price of $801 per ounce spread evenly
      over the period of 78 months (5,500 ounces per month) commencing July 2008. The
      loss reflects the fact that the spot price for gold increased from $836 to
      $930
      during the period and the upward movement in long term interest rates. These
      higher interest rates translate into an increase in the discount rate applied
      in
      the valuation of these contracts and hence a greater mark-to-market
      adjustment.





Results
      for 2008 YTD reflect our first two quarters with Mesquite as a producing mine,
      and as such are not comparable with results for 2007 YTD when Mesquite was
      a
      residual leaching operation based on ore production several years previously.
      Revenues for 2008 YTD are up by $26.8 million over the previous year. Of this
      total, $18.7 million relates to increased gold ounces sold. Although ounces
      sold
      increased from 4,225 in 2007 YTD to 32,720 in 2008 YTD, sales in the early
      months of 2008 were at the low end of the range that we had initially forecast.
      There are numerous variables and unknowns in commissioning a new leach pad
      operation. It took us several weeks longer than anticipated to reach “steady
      state” solution flow and planned performance. $8.1 million of the revenue
      increase relates to the increase in the average selling price from $658 to
      $905
      per ounce. Cost of sales per ounce for 2008 YTD, based on mine cost of sales
      less non-cash depreciation, amortization and depletion, was $667, as compared
      with $1,368 per ounce in 2007 YTD .
      Unit costs for 2008 YTD are still running higher than the projected estimate
      for
      full year 2008 of $470 - $490 per ounce, mainly due to higher fuel prices which
      have increased from a projection of $3.55 per gallon to an average of $3.99
      per
      gallon in Q2/08. Higher fuel costs are also being reflected in the cost of
      other
      items with a high energy content, such as explosives and chemicals. Tire
      costs continue to run higher than originally forecast. In common with many
      mining companies, we are adversely effected by a world-wide shortage of
      radial-ply truck tires. We have mitigated the impact of this shortage by
      sourcing improved quality bias-ply tires, but nevertheless usage is up and
      haul
      trucks are operating at less than planned speed. To compensate for this, during
      March 2008 we hired an additional crew and mining operations were carried out
      on
      a 24 / 7 basis during Q2/08.





Other
      operating expenses for 2008 YTD were $3.8 million compared with $4.5 million
      in
      2007 YTD. General and administrative expenses of $2.3 million were slightly
      higher than the previous year, but several cost elements have changed. Non-cash
      stock based compensation for 2008 YTD of $0.7 million was significantly lower
      than the $1.3 million expense the previous year. The higher expense in 2007
      primarily reflects grants of options to our new management team in early
      2006. Exploration expense in 2008 YTD of $0.8 million relates to a drilling program
      to
      explore for oxide resources to the south of the Brownie Hill area at Mesquite.





Other
      income (expense) for 2008 YTD was $(35.2) million compared with $1.7 million
      in
      2007 YTD. The major negative factor was the non-cash expense relating to the
      mark-to-market of our gold forward sales contracts. The spot price of gold
      at
      the time the hedging contracts were entered into was $660-675 per ounce as
      compared with a price of $930 at June 30, 2008 and $836 at December 31, 2007.
      We
      have recorded an unrealized loss of $32.8 million for the six month period
      ended
      June 30, 2008 and $58.9 million for the year ended December 31, 2007. The
      cumulative unrealized pre-tax loss of $91.7 million has been disclosed as a
      liability at June 30, 2008.





Other
      income (expense) for 2008 YTD also included $0.7 million of interest income
      as
      compared with $1.0 million in 2007 YTD, reflecting the higher cash balances
      in
      2007 immediately after the January 2007 equity issue, which generated cash
      of
      $59.2 million. Interest expense and commitment fees for 2008 YTD was $2.0
      million reflecting advances under the term loan facility in the range of $76.5
      -
      $86.3 million. The loss
      on foreign currency exchange of $0.8 million for 2008 YTD relates to our holding
      significant cash balances in Canadian dollars during periods when that currency
      generally weakened in relation to the U.S. dollar.





Prior
      to
      2007, we did not recognize the recoverability of any part of our deferred tax
      assets, including operating losses carried forward. At year-end 2007, we
      determined that it was more likely than not that we would realize the benefit
      of
      a substantial amount of the deferred tax asset that we have accumulated.
      Accordingly, at December 31, 2007 we recorded a tax recovery of $37.1 million,
      principally arising from net operating loss carry forwards for income tax
      purposes and timing differences arising from the recording of the accounting
      loss in respect of the mark-to-market of gold forward sales contracts. For
      2008
      YTD we have recorded an additional $11.9 million of deferred taxes.




26




Three months ended June 30,
              
              Six months ended June 30,**2008**
              
              **2007**
              
              **2008**
              
              **2007**Gold
                  sales revenue
              
              
              20,347
              
              
              1,546
              
              
              29,602
              
              
              2,779Average
                  price realized per ounce
              
              $
              894
              
              $
              658
              
              $
              905
              
              $
              658Increase
                  (Decrease) in revenues
              
              
              18,801
              
              
              (558
              )
              
              26,823
              
              
              (2,100
              )Change
                  in revenues attributable to ounces sold
              
              
              13,428
              
              
              (639
              )
              
              18,744
              
              
              (2,417
              )Change
                  attributable to average selling price
              
              
              5,373
              
              
              81
              
              
              8,079
              
              
              317








Revenues
      from gold sales for Q2/08 and for the six months to June 30, 2008 increased
      by
      $18.8 million and $26.8 million, respectively, compared to the same periods
      in
      2007, reflecting attainment of steady state production from the new leach pad
      during Q2/08 and higher average selling prices.




Three months ended June 30,
              
              Six months ended June 30,**2008**
              
              **2007**
              
              **2008**
              
              **2007**Cost
                  of goods sold
              
              
              14,753
              
              
              3,902
              
              
              26,198
              
              
              6,531Increase
                  (Decrease)
              
              
              10,851
              
              
              1,229
              
              
              19,667
              
              
              823Gross
                  profit %
              
              
              38
              %
              
              n/a
              
              
              13
              %
              
              n/a







Cost
      of
      goods sold for Q2/08 and for the six months to June 30, 2008 increased by $10.9
      million and $19.7 million, respectively, compared to the same period in 2007.
      Prior to Q2/08, cost of goods sold exceeded revenues. Gross profit for Q2/08
      was
      38%, reflecting the ramp up of mining production, the attainment of steady
      state
      ounce flow from the leach pad and progress towards a normal cost structure
      for
      ongoing operations. Gross profit for the six months to June 30, 2008 was 13%,
      reflecting the higher cost structure of Q1/08 when the new leach pad was in
      start-up mode and when a relatively high volume of waste material was moved
      to
      access the ore body. The higher costs in 2008 as compared with 2007 also reflect
      increases in several cost inputs, notably fuel, tires, blasting and mining
      fleet
      maintenance. Mine site administration costs have also increased as we now have
      a
      full management team in place. Costs also reflect substantially higher
      amortization charges for the new plant and equipment that was placed in service
      during 2007.




A
      comparison of the major components of cost of goods sold is as
      follows:




Three months ended June 30,
              
              Six months ended June 30,**2008**
              
              **2007**
              
              **2008**
              
              **2007**Mine
                  operating costs
              
              
              10,824
              
              
              2,777
              
              
              18,980
              
              
              4,550Mine
                  site administration
              
              
              1,285
              
              
              682
              
              
              2,205
              
              
              1,113Amortization
                  and accretion
              
              
              2,290
              
              
              377
              
              
              4,384
              
              
              752Royalties
              
              
              340
              
              
              59
              
              
              605
              
              
              104





27




Other
      operating expenses for Q2/08 are $2.1 million, compared with $2.7 million in
      Q2/07. Although general and administrative expenses overall are slightly higher
      at $1.2 million, the components are different; business development costs are
      higher reflecting our examination of investment opportunities, and audit fees
      are also higher, reflecting our engagement in late 2007 of a major international
      accounting firm as auditors. These increases were offset by lower legal fees,
      which were relatively high in Q2/07 as a result of the reorganization activities
      at that time. Stock based compensation in Q2/08 is $0.5 million lower than
      the
      prior year primarily because of higher initial amortization relating to options
      awarded to the new management team in 2006. Other operating expenses for the
      six
      months to June 30, 2008 are $3.8 million, compared with $4.5 million for the
      same period in 2007. General and administrative costs are slightly higher,
      reflecting increased business development activity and audit fees and lower
      legal fees. In addition, salaries, travel and recruiting costs are higher than
      in the previous year. Stock based compensation is $0.6 million lower than the
      previous year because of the higher initial amortization of options awarded
      to
      the new management team.




Three months ended June 30,
              
              Six months ended June 30,**2008**
              
              **2007**
              
              **2008**
              
              **2007**General
                  and administrative
              
              
              1,197
              
              
              1,138
              
              
              2,308
              
              
              2,222Stock
                  based compensation
              
              
              289
              
              
              820
              
              
              658
              
              
              1,289Exploration
                  - Mesquite
              
              
              591
              
              
              749
              
              
              814
              
              
              1,032








Other
      expense for Q2/08 was $9.6 million compared with income of $1.1 million the
      previous year. The major contributor to this cost increase was the $8.7 million
      charge in respect of the unrealized mark-to-market loss on our gold forward
      sales contracts. The loss reflects the fact that, although the spot price of
      gold was little changed during Q2/08, long term interest rates increased during
      the period. These higher interest rates translate into an increase in the
      discount rate applied in the valuation of the contracts and hence a greater
      mark-to-market adjustment. Interest income for Q2/08 was $0.3 million compared
      with $0.5 million the previous year. Cash balances were still relatively high
      in
      Q2/07 after the equity issue in January of that year. Interest expense and
      commitment fees of $1.3 million in Q2/08 reflects term loan advances in the
      range of $84.3 - $86.3 million during the quarter. In addition, in Q2/08 we
      recorded a foreign exchange gain of $0.2 million as a result of our holding
      net
      Canadian dollar cash balances at a time when that currency was generally
      strengthening in relation to the U.S. dollar.





Other
      expense for the six months to June 30, 2008 was $35.2 million compared with
      income of $1.7 million the previous year. The unrealized mark-to-market loss
      on
      our gold forward sales contracts during the period was $32.8 million. The loss
      reflects the fact that the spot price for gold increased from $836 to $930
      during the period and the upward movement in the long term interest rates.
      These
      higher interest rates translate into an increase in the discount rate applied
      in
      the valuation of these contracts and hence a greater mark-to-market adjustment.
      Interest income for the six months to June 30, 2008 was $0.7 million compared
      with $1.0 million the previous year. Cash balances were relatively high during
      2007 after the equity issue in January of that year in advance of the expansion
      project. Interest expense and commitment fees of $2.0 million during the six
      months to June 30, 2008 reflects term loan advances in the range of $76.5 -
      $86.3 million during the period. In addition, for the six months to June 30,
      2008 we recorded a foreign exchange loss of $0.8 million as a result of our
      holding net Canadian dollar cash balances when that currency was weakening
      in
      relation to the U.S. dollar.





A comparison of the major items included in other income (expense) is as
      follows:




Three months ended June 30,
              
              Six months ended June 30,**2008**
              
              **2007**
              
              **2008**
              
              **2007**Interest
                  income
              
              
              289
              
              
              525
              
              
              673
              
              
              1,042Interest
                  expense and commitment fees
              
              
              (1,320
              )
              
              (242
              )
              
              (2,019
              )
              
              (242
              )Amortization
                  of deferred debt issuance costs
              
              
              (115
              )
              
              (110
              )
              
              (231
              )
              
              (110
              )Gain
                  (loss) on mark-to-market of gold hedging contracts
              
              
              (8,708
              )
              
              759
              
              
              (32,820
              )
              
              759Gain
                  (loss) on foreign exchange
              
              
              250
              
              
              124
              
              
              (770
              )
              
              205




28




**Results
      of Operations**





**Six
      Months Ended June 30, 2008 (”2008 YTD) compared to Six Months Ended 30, 2007
      (“2007 YTD)”.**




Gold
      production for 2008 YTD was 37,590 ounces compared with 4,240 ounces for 2007
      YTD. During 2007, production at Mesquite derived from residual gold contained
      in
      ore placed on the leach pads several years previously. Mining of new ore at
      Mesquite started in July 2007 and the first pour of gold from new ore occurred
      in January 2008. Ore production has been building up steadily since that time but production
      is
      still constrained by the fact that haul truck speeds are restricted by the
      type
      of tires currently available in the market place. A pproximately
      22.9 million tons of waste and 3.3 million tons of ore were mined in 2008 YTD
      at
      an average grade of 0.029 ounces per ton. The low production in Q1/07 reflects
      the almost total depletion of the recoverable gold ounces from ore placed on
      the
      leach pads prior to our acquisition of Mesquite. Gold sales for 2008 YTD were
      32,720 ounces at an average selling price of $905 for revenues of $29.6 million
      compared with 4,225 ounces at an average selling price of $658 for revenues
      of
      $2.8 million for 2007 YTD. In both periods, all sales were made on a spot basis.





Mine
      operating costs were $19.0 million in 2008 YTD , compared to $4.6 million in
      2007 YTD. 2008
      costs represent the first two quarters of full mining operations; operating
      labour, contracted services and fuel and tire costs are the largest cost items. Mine
      site
      administration costs for 2008 YTD were $2.2 million compared with $1.1 million
      in 2007 YTD, reflecting the increase in staff and associated costs to support
      the capital program and full mining operations. Depreciation, amortization
      and
      accretion expense for 2008 YTD was $4.4 million compared with $0.8 million
      in
      2007 YTD, reflecting mining fleet additions from May 2007 onwards and the new
      leach pad addition in 2008.





During
      2008 YTD we have increased our gold inventory under leach and in process from
      13,166 ounces to 49,769 ounces. Inventoried costs associated with this build
      up
      were $13.2 million compared with $nil million in 2007 YTD. For much of 2008
      YTD
      the new leach pad was in start up mode. We attained the steady state of solution
      flow and gold production rates that we are planning on in late May 2008. As
      a
      result, unit production costs are still high and are not yet representative
      of
      anticipated future costs. Inventories are valued at the lower of cost or net
      realizable value (“NRV”); cost basis applied at June 30, 2008. In 2007, no value
      was attributed to gold ounces in the leach pad.





The
      foregoing factors resulted in a gross profit of $3.4 million for 2008 YTD
      compared with a gross loss of $3.8 million in 2007 YTD.





General
      and administrative expense of $2.3 million for 2008 YTD was little changed
      from
      2007 expense. Listing expenses and legal fees were substantially higher in
      2007
      as a result of corporate financing and reorganization activities. These
      reductions were offset by higher audit and taxation fees, reflecting our
      engagement of a major accounting firm and the increasing complexity of our
      activities, and corporate development spending as we explore investment
      opportunities.




Stock
      based compensation represents the non-cash costs of options, as calculated
      under
      the Black-Scholes option pricing model, granted to directors, officers and
      employees. The lower cost in 2008 YTD reflects the fact that options granted
      to
      the new management team in 2006 are now fully expensed. Exploration activities
      at Mesquite during 2008 YTD totaled $0.8 million and relate primarily to a
      drilling program to explore for oxide resources south of the Brownie Hill area
      at Mesquite. Costs of $0.6 million in 2007 relate to a similar drilling program.
      The 2007 program resulted in an increase in proven and probable reserves of
      reserves and resources of 0.4 million ounces and an increase in the mine life
      of
      approximately 2 years.





Other
      expense for 2008 YTD was $35.2 million compared to $1.7 million in 2007 YTD.
      The
      increase primarily reflects the $32.8 million charge in respect of the
      unrealized mark-to-market loss on our gold forward sales contracts, as a result
      of the spot price of gold during the period and the upward movement in long
      term
      interest rates. In 2007 we recorded a gain of $0.8 million, reflecting a
      decrease in the spot price between early June 2008, when the contracts were
      entered into, and June 30, 2007. Interest income for 2008 YTD was $0.7 million
      compared with $1.0 million the previous year. Cash balances were relatively
      high
      during 2007 YTD after the equity issue in January of that year and pending
      outlays on the expansion program. Interest expense of $2.0 million in 2008
      YTD
      reflects the term loan advances in the range of $76.5 - $86.3 million during
      the
      period. There were no loans outstanding during Q1/07. In addition, in 2008
      YTD
      we recorded a foreign exchange loss of $0.8 million relating to our holding
      Canadian dollar bank deposits at a time when that currency was strengthening
      in
      relation to the U.S. dollar.




29


At
      year-end 2007, we determined that it was more likely than not that we would
      realize the benefit of a substantial amount of the deferred tax asset that
      we
      have accumulated. Accordingly, at December 31, 2007 we recorded a tax recovery
      of $37.1 million, principally arising from net operating loss carry forwards
      for
      income tax purposes and timing differences arising from the recording of the
      accounting loss in respect of the mark-to-market of gold forward sales
      contracts. For 2008 YTD we have recorded an additional $11.9 million of deferred
      tax recovery.





The
      above
      were the major factors in our reporting a net loss to common shareholders for
      2008 YTD of $23.7 million or $0.17 per share, compared with a net loss of $6.6
      million or $0.06 per share in 2007 YTD.





**Three
      Months Ended June 30, 2008 (“Q2/08”) compared to Three Months Ended June 30,
      2007 (“Q2/07)”.**




Gold
      production for Q2/08 was 28,524 ounces compared with 2,304 ounces in Q2/07. Ore
      production continues to build, but is still constrained by the fact that haul
      truck speeds are restricted by the type of tires currently available in the
      market place. A pproximately
      11.8 million tons of waste and 2.0 million tons of ore were mined in Q2/08
      at an
      average grade of 0.036 ounces per ton. The relatively high grade during the
      quarter relates to the shift of mining activities to the Rainbow 1 pit from
      the
      Big Chief pit as called for in our mine plan. Gold sales for Q2/08 were 22,760
      ounces at an average selling price of $894 for revenues of $20.3 million
      compared with 2,350 ounces at an average selling price of $658 for revenues
      of
      $1.5 million for Q2/07.





Mine
      operating costs, after adjustment for inventory changes, were $10.8 million
      in
      Q2/08, compared to $2.8 million in Q2/07. The mining cost component continues to be adversely affected by escalating fuel costs
      and
      by our inability to operate the mining fleet at rated speeds because of the
      type
      of tires being used. To compensate for this, mining operations were carried
      out
      on a 24/7 basis throughout the quarter. We are focused on increasing fleet
      availability and continuous improvement of mining productivity. Mine processing
      costs in the quarter started to reflect the benefits of the new carbon columns
      that come on stream during April. We expect further processing cost reductions
      from increased solution pumping capacity that was installed during the quarter. Mine
      site
      administration costs for Q2/08 were $1.3 million compared with $0.7 million
      in
      Q2/07, reflecting the increase in staff and associated costs to support the
      capital program and full mining operations. Depreciation, amortization and
      accretion expense for Q2/08 was $2.3 million compared with $0.4 million in
      Q2/07, reflecting the substantial completion of the expansion program.





During
      Q2/08 we have increased our gold inventory under leach and in process from
      19,654 ounces to 49,769 ounces. Inventoried costs associated with this build
      up
      were $7.4 million compared with $5.8 million in Q1/08 and $0.1 in Q2/07. We
      attained the steady state of solution flow and gold production rates that we
      have been planning on in late May 2008 and the continuing build up of leach
      pad
      gold ounces is in line with our projections based on leach curve modeling.
      Inventories are valued at the lower of cost or net realizable value (“NRV”);
      cost basis applied at June 30, 2008. In 2007, no value was attributed to gold
      ounces in the leach pads.





The
      foregoing factors resulted in a gross profit of $5.6 million for Q2/08 compared
      with a gross loss of $2.4 million in Q2/07.





General
      and administrative expense of $1.2 million for Q2/08 was little changed from
      2007 expense. Legal fees were substantially higher in 2007 as a result of the
      activities leading up the reorganization in late June 2007. This reduction
      were
      offset by higher audit and taxation fees, reflecting our engagement of a major
      accounting firm and the increasing complexity of our activities, and corporate
      development spending as we explore investment opportunities.





Stock
      compensation expense for Q2/08 was $0.3 million compared with $0.8 million
      in
      Q2/07. The lower cost in Q2/08 reflects the fact that cost amortization relating
      to the grant of options to the new management team in 2006 is substantially
      complete.





Exploration
      activities at Mesquite during Q2/08 were $0.6 million and relate primarily
      to a
      drilling program to explore for oxide resources south of the Brownie Hill area
      at Mesquite. Costs of $0.7 million in Q1/07 relate to a similar drilling program.





30


Other
      expense for Q2/08 was $9.6 million compared to income of $1.1 million in Q2/07.
      The increase primarily reflects the $8.7 million charge in respect of the
      unrealized mark-to-market loss on our gold forward sales contracts. Although
      the
      spot price of gold was little changed during Q2/08, long term interest rates
      increased during the period. These higher interest rates translate into an
      increase in the discount rate applied in the valuation of these contracts and
      hence a greater mark-to-market adjustment.





Interest
      income for Q2/08 was $0.3 million compared with $0.5 million the previous year.
      Cash balances were relatively high in early 2007 after the equity issue in
      January of that year and pending outlays on the capital program. Interest
      expense and commitment fees of $1.3 million in Q2/08 reflects term loan advances
      in the range of $84.3 - $86.3 million during the quarter. Expense of $0.2
      million in 2007 YTD represents commitment fees in advance of initial draws
      under
      the credit facility. There were no loans outstanding during Q2/07. In addition,
      in Q2/08 we recorded a foreign exchange gain of $0.3 million relating to our
      holding Canadian dollar bank deposits at a time when that currency was generally
      strengthening in relation to the U.S. dollar.




During
      Q2/08 we recorded a tax recovery of $2.0 million, principally arising from
      the
      operating timing differences arising from the recording of the accounting loss
      in respect of the mark-to-market of gold forward sales contracts and differences
      between accounting and tax depreciation charges. For Q1/08 we recorded $9.8
      million of deferred tax recovery.





The
      above
      were the major factors in our reporting a net loss to common shareholders for
      Q2/08 of $4.1 million or $0.03 per share, compared with a net loss of $4.0
      million or $0.04 per share in Q2/07.




**Liquidity
      and Capital Resources**




The
      financing activities in 2007 enabled the Company to fund the completion of
      the
      expansion program at Mesquite and the inventory build associated with the ramp
      up of production until we achieved the generation of free cash flow during
      Q2/08. We started 2008 with available cash balances of $43.9 million, restricted
      cash of $7.5 million, and working capital of $46.2 million. In addition, we
      had
      unutilized credit facilities of $28.6 million of which $10.9 million was
      available for the Mesquite Expansion project and $17.7 million was available
      for
      general corporate purposes.




During
      2008 YTD we drew down a further $9.9 million under the term loan facility and
      we
      raised $1.0 million through the exercise of warrants and stock options.





Cash
      required for operating activities in 2008 YTD was $13.5 million compared with
      $13.9 million (including $7.5 million transferred to restricted cash under
      the
      terms of the credit facility) in 2007 YTD. The net loss for 2008 YTD was $23.7
      million, including the non-cash impact of the $32.8 million mark-to-market
      loss
      on forward sales contracts and the non-cash recovery of deferred income taxes
      of
      $11.9 million. Other non-cash expense items were: depreciation and accretion
      expense of $3.2 million, amortization of deferred debt issuance costs of $0.2
      million, and stock-based compensation of $0.7 million. Changes in the
      composition of non-cash working capital items during 2008 YTD required $14.8
      million. The largest single item in this requirement was the increase in
      inventories of $12.7 million, reflecting an increase of approximately 36,603
      ounces in recoverable gold on the leach pads and in process during the period.
      A
      reduction in accrued payroll of $1.6 million was also a contributing factor.




Cash
      required for investing activities in 2008 YTD was $14.7 million compared with
      $33.5 million in 2007 YTD. The spending in 2008 was on several process related
      projects forming part of the Mesquite expansion program, notably the new leach
      pad, new carbon columns and the retrofit of the process plant.




The
      foregoing factors resulted in a decrease in our cash position of $17.3 million
      in 2008 YTD.




At
      June
      30, 2008, we had available cash balances of $26.5 million, restricted cash
      of
      $7.5 million, and working capital of $34.7 million. In addition, we had
      unutilized credit facilities of $18.7 million of which $1.0 million was
      available for the Mesquite Expansion project and $17.7 million was available
      for
      general corporate purposes. At present we do not anticipate making further
      draws
      under the credit facility. We expect to spend an additional $3.0 million in
      completing the expansion related projects during the third fiscal quarter of
      2008. In addition, we have placed an order for an additional loader to be
      delivered during the third quarter of 2008, at a cost of $3.4 million.




31




With
      these moderate capital expenditures, and having reached steady state production
      in Q2/08, we expect consistent generation of operating cash flows in coming
      quarters.




**Critical
      Accounting Policies**




Listed
      below are the accounting policies that we believe are critical to our financial
      statements due to the degree of uncertainty regarding the estimates or
      assumptions involved and the magnitude of the asset, liability, revenue or
      expense being reported.





*Derivative
      Instruments*





The
      Company accounts for its forward sales of gold in conformity with the following
      statements issued by the Financial Accounting Standards Board (“FASB”):
      Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for
      Derivative Instruments and Hedging Activities,” as amended by SFAS No. 137,
“Accounting for Derivative Instruments and Hedging Activities - Deferral of
      the
      Effective Date of FASB No. 133,” SFAS No. 138, “Accounting for Certain
      Derivative Instruments and Certain Hedging Activities,” and SFAS No. 149,
“Amendment of Statement 133 on Derivative Instruments and Hedging Activities”.
      These standards establish accounting and reporting standards for derivative
      instruments, including certain derivative instruments embedded in other
      contracts, and for hedging activities. They require that an entity recognize
      all
      derivatives as either assets or liabilities in the balance sheet and measure
      those instruments at fair value.





A
      derivative may be specifically designated as a hedge of financial risk exposures
      of anticipated transactions if, both at the inception of the hedge and
      throughout the hedge period, the changes in fair value of the contract
      substantially offset the effect of commodity price changes on the anticipated
      transactions and if it is probable that the transactions will occur. Pursuant
      to
      such a designation, the income effect of the change in derivative values may
      be
      accounted for in other comprehensive income based upon the Company's valuation
      of the associated financial gain or loss. Any change arising from the
      determination of the derivative's effectiveness is accounted for as a charge
      to
      current operations.





In
      applying SFAS No. 133, the Company has not designated its contracts for the
      forward sales of gold as cash flow hedges. Accordingly the hedge accounting
      rules of SFAS No.133 are not being applied and the period-end mark-to-market
      of
      these contracts is immediately reflected on the income statement of the
      Company.




*Depreciation
      and Amortization*




Expenditures
      for new facilities or equipment and expenditures that extend the useful lives
      of
      existing facilities or equipment are capitalized and depreciated using the
      straight line method at rates sufficient to depreciate such costs over the
      estimated useful lives of such facilities or equipment.




We
      expensed all mine development costs prior to our establishing proven and
      probable reserves upon completion of the feasibility study in August 2006.
      Development costs incurred subsequent to that date are capitalized and deferred
      and are amortized on a units-of-production basis.




The
      expected useful lives used in depreciation and amortization calculations are
      based on applicable facts and circumstances, as described above. Significant
      judgment is involved in the determination of useful lives, and no assurance
      can
      be given that actual useful lives will not differ significantly from the useful
      lives assumed for purposes of depreciation and amortization.




*Carrying
      Value of Long-Lived Assets*




We
      review
      and evaluate the carrying value of our long-lived assets for impairment when
      events or changes in circumstances indicate the carrying values may not be
      recoverable. Our long-lived assets comprise the fair values allocated to the
      plant and equipment acquired upon completion of the Mesquite acquisition and
      subsequent additions. Annually, we review the present value of future cash
      flows
      to determine if the amounts carried under plant and equipment are
      recoverable.




32


Material
      changes to any of these factors or assumptions discussed above could result
      in
      future impairment charges.





*Deferred
      Taxes*





The
      Company accounts for income taxes using the liability method, recognizing
      certain temporary differences between the financial reporting basis of the
      Company’s assets and liabilities and the related income tax basis for such
      assets and liabilities. This method generates either a net deferred income
      tax
      asset or liability for the Company, as measured by the statutory tax rates
      in
      effect. The company derives its deferred income tax benefit or charge by
      recording the change in either the net deferred income tax asset or liability
      balance in the year .





The
      Company’s deferred income tax assets include certain future income tax benefits.
      A valuation allowance is recorded against deferred tax assets if management
      does
      not believe the Company has met the “more likely than not” standard imposed by
      SFAS No. 109 to allow recognition of such an asset.





*Ore
      on Leach Pads and Metal-in-Process Inventories*





*Ore
      on Heap Leach Pads*




Prior
      to
      July 2007, the Company placed no value on the mineralized material that had
      been
      placed on the leach pads at the Mesquite Mine prior to the acquisition of the
      property by the Company on November 7, 2003. The reserve estimates reported
      by
      the Company in August 2006 and March 2007 support the recoverability of
      inventoried production costs. Accordingly, since resumption of mining operations
      in July 2007, new ore placed on the leach pads has been valued at the lower
      of
      average cost or net realizable value. Costs are added to ore on leach pads
      based
      on current mining costs, including applicable depreciation, amortization and
      depletion relating to mining operations. Costs are removed from ore on leach
      pads as ounces are recovered based on the average cost per estimated recoverable
      ounce of gold on the leach pad. The estimates of recoverable gold on the leach
      pads are calculated from the quantities of ore placed on the leach pads (based
      on measured tonnage), the grade of ore placed on the leach pads (based on assay
      results), and a recovery percentage (based on ore type).





*Metal-in-Process
      Inventories*




Under
      the
      heap leaching process, ore on leach pads is treated with a chemical solution
      which dissolves the gold contained in the ore. The solution is further processed
      in a plant where the gold is recovered. Metal-in-process inventories represent
      metal in solution or in subsequent stages of the refining process. In-process
      inventories are measured based on assays of the solution and projected
      recoveries from the refining circuit and are valued at average production cost
      or net realizable value. Average production cost is based on the average cost
      of
      material fed into the process from the leach pads plus the in-process conversion
      costs, including applicable depreciation relating to the process
      facilities.





Although
      the amount of recoverable gold ounces placed on the leach pads, based on tonnage
      and grade of ore, is reconciled to the gold ounces actually recovered, the
      nature of the leaching process inherently limits the ability to precisely
      monitor inventory levels. As a result, the metallurgical balancing process
      is
      constantly monitored and estimates are refined based on actual results over
      time. The determination of both the ultimate recovery percentage and the
      quantity of metal expected over time requires the use of estimates, which are
      subject to revision since they are based upon metallurgical test work. The
      Company expects to continue to process and recover metal from the leach pads
      until no longer considered economically feasible.




*Reclamation
      and Remediation Liabilities*




Our
      mining and exploration activities are subject to various laws and regulations
      governing the protection of the environment. In August 2001, the Financial
      Accounting Standards Board (“FASB”) issued Statement of Financial Accounting
      Standards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations” which
      established a uniform methodology for accounting for estimated reclamation
      and
      remediation costs. The statement was adopted in July 2003 upon the acquisition
      of Mesquite when we recorded the estimated present value of the reclamation
      and
      remediation liabilities. Our estimates of reclamation and remediation
      liabilities are reviewed and adjusted from time to time to reflect changes
      in
      the estimated present value resulting from the passage of time and revisions
      to
      the estimates of either timing or amount of reclamation and abandonment
      costs.




33


Accounting
      for reclamation and remediation liabilities requires management to make
      estimates at the end of each period of the undiscounted costs expected to be
      incurred. Such cost estimates include ongoing care, maintenance and monitoring
      costs. Changes in estimates are reflected in earnings in the period an estimate
      is revised.




Accounting
      for reclamation and remediation liabilities requires management to make
      estimates of the future costs we will incur to complete the reclamation and
      remediation work required to comply with existing laws and regulations. Actual
      costs incurred in future periods could differ from amounts estimated.
      Additionally, future changes to environmental laws and regulations could
      increase the amount of reclamation and remediation work required. Any such
      increases in future costs could materially impact the amounts charged to
      earnings for reclamation and remediation.





*Stock
      Options and Warrants Granted to Employees and Non-employees*





The
      Company accounts for grants of stock options and warrants in terms of SFAS
      No.
      123 (R), “Share Based Payment”, which revises SFAS No.123, “Accounting for
      Stock-Based Compensation”. Accordingly, the Company measures all employee
      stock-based compensation awards and awards to non-employees in exchange for
      goods and services, using a fair value method and records such expense in its
      financial statements over the service period. In its application of the
      Black-Scholes model for valuation of stock options and warrants, management
      is
      required to make estimates based on several assumptions, including: risk-free
      interest rate, volatility rate, and the expected life of the options and
      warrants. Actual results could differ from these estimates.




**Recent
      Accounting Pronouncements**





In
      September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
      No.157, “Fair Value Measurements”. The Statement defines fair value, establishes
      a framework for measuring fair value in generally accepted accounting
      principles, and expands disclosures about fair value measurements. The Statement
      does not require any new fair value measurements. The provisions of the
      Statement are effective for the Company’s fiscal year ending December 31, 2008.
      In February 2008, the FASB amended SFAS No. 157 to exclude leasing transactions
      and to delay the effective date by one year for non-financial assets and
      liabilities that are recognized or disclosed at fair value in the financial
      statements on a non-recurring basis. Effective January 1, 2008, the Company
      adopted SFAS No. 157 as it relates to financial assets and liabilities. The
      new
      disclosures are included in Note 17 to the Company’s financial
      statements.





In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities - Including an amendment of FASB
      Statement No.115”. The Statement permits entities to choose to measure many
      financial instruments and certain other items at fair value. The objective
      is to
      improve financial reporting by providing entities with the opportunity to
      mitigate volatility in reporting earnings caused by measuring related assets
      and
      liabilities differently without having to apply complex hedge accounting
      provisions. The Company adopted SFAS No. 159 effective January 1, 2008 but
      this
      has had no impact on the Company’s financial position, financial performance and
      cash flows.





In
      December 2007, the FASB issued FAS 141(R), “Business Combinations”, which will
      replace FAS 141 prospectively for business combinations consummated after the
      effective date of December 15, 2008. Under FAS 141 (R), business combinations
      will be accounted for under the “acquisition method”, compared to the “purchase
      method” mandated by FAS 141. Significant changes will result from applying the
      acquisition method, including: more acquisitions will be accounted for as
      business combinations rather than as asset acquisitions; acquisition related
      costs of the acquirer will be expensed as incurred , whereas under FAS 141
      these
      costs are capitalized as part of the business combination; and the assets
      acquired and liabilities assumed are recorded at 100% of fair value even if
      less
      than 100% is obtained, whereas under FAS 141 only the controlling interest’s
      portion is recorded at fair value. In the event of the Company being involved
      in
      a future business combination, the Company will evaluate the application of
      FAS
      141(R).





In
      December 2007, the FASB issued FAS 160, “Non-Controlling Interests in
      Consolidated Financial Statements” which is effective for fiscal years beginning
      after December 15, 2008. Under FAS 160, non-controlling interests will be
      measured at 100% of the fair value of assets acquired and liabilities assumed.
      Under current standards, the non-controlling interest is measured at book value.
      For presentation and disclosure purposes, non-controlling interests will be
      classified as a separate component of shareholders’ equity. In addition, FAS 160
      will change the manner in which increases/decreases in ownership percentages
      are
      accounted for. The provisions of FAS 160 are to be applied prospectively with
      the exception of the presentation and disclosure provisions, which are to be
      applied for all prior periods presented in the financial statements. In the
      event of the Company being required in the future to prepare consolidated
      financial statements including a non-controlling interest in another entity,
      the
      Company will evaluate the application of FAS 160.





34




In
      March
      2008, the FASB issued FAS No. 161, “Disclosures about Derivative Instruments and
      Hedging Activities – an amendment of FASB Statement No.133”, which is
      effective for financial statements issued for fiscal years and interim periods
      beginning after November 15, 2008, with early application encouraged. The
      statement requires enhanced disclosures about an entity’s derivative and hedging
      activities and thereby improves the transparency of financial reporting. The
      statement changes the disclosure requirements for derivative instruments and
      hedging activities. Entities are required to provide enhanced disclosures about
      (a) how and why an entity uses derivative instruments, (b) how derivative
      instruments and related hedging items are accounted for under Statement 133
      and
      its related interpretations, and (c) how derivative instruments and related
      hedged items affect an entity’s financial position, financial performance and
      cash flows. The Company is currently evaluating the implications of the enhanced
      disclosure requirements in respect of is forward gold sales contracts.





**Contractual
      Obligations**





The
      following table presents the contractual obligations outstanding as at June
      30,
      2008:


**Total**
              
              **Less than**
                **1 Year**
              
              **2- 3**
                **Years**
              
              **4- 5**
                **Years**
              
              **More than**
                **5 Years**Mesquite
                  expansion project and sustaining capital
              
              $
              6,405
              
              $
              6,405
              
              $
              —
              
              $
              —
              
              $
              —Reclamation
                  and remediation obligations (1)
              
              
              11,888
              
              
              206
              
              
              529
              
              
              85
              
              
              11,068Share
                  of office lease
              
              
              2,682
              
              
              249
              
              
              536
              
              
              532
              
              
              1,365Total
              
              $
              20,975
              
              $
              6,860
              
              $
              1,065
              
              $
              617
              
              $
              12,433





(1)
      In
      current dollars (undiscounted).





**Off-Balance
      Sheet Arrangements**





We
      had no
      off-balance sheet arrangements at June 30, 2008 and December 31, 2007 or at
      the
      date of this report.





**Outlook –
      balance of 2008**


The
        Mesquite Mine is expected to produce between 55,000 to 60,000 ounces of gold
        during the third quarter of 2008 as higher-grade ore from the Rainbow Pit
        is
        placed on the leach pad.  Cost of sales (1) is
        forecast at approximately $400 per ounce of gold. Gold production for 2008
        is
        projected to be 135,000-145,000 ounces of gold at an average cost of
        sales (1) of
        between $470-$490 per ounce of gold.
 
 Now
        that
        Mesquite is performing on plan, the Company continues to focus on adding
        value
        by pursuing the following opportunities:
 
 1)
            Sulfide
                resources: a sulfide gravity scoping study has been initiated to
                improve
                recovery rates for the property’s significant sulfide resources. 2)
            Continuous
                Improvement:  a continuous improvement program is underway for the
                mining fleet to further increase productivity.  In addition, we are
                completing a conveyor haulage study. 3)
            Increase
                Mining Rate: Mesquite has applied for a permit to increase its mining
                rate
                from 60 million tons per year to 75 million tons per year, with the
                outcome expected by the end of the year. 4)
            Increase
                annual gold production over the next four to five year period through
                a
                revised mining plan that will allow the Company to optimize its cash
                flow. 
 The
        Company is well-positioned to utilize Mesquite’s cash flow as a strategic
        platform for disciplined growth, through the acquisition of undervalued and
        overlooked assets in politically stable North America.
 
 (1)
              Cost
                  of sales per ounce is defined as cost of sales as per the Company’s
                  financial statements divided   by the number of ounces
                  sold.




35




**Item
      3.**   **Quantitative
      and Qualitative Disclosures About Market Risk**





In
      the
      normal course of business, we are exposed to market risk, including changes
      in
      interest rates and prices of certain commodities, notably gold and fuel. Changes
      in the market price of these commodities significantly affects our profitability
      and cash flow.





Gold
      prices can fluctuate widely due to numerous factors, such as: demand, forward
      selling by producers, central bank activities, the strength of the U.S. dollar
      and global mine production levels. We use forward gold sales contracts to manage
      a portion of our exposure to risk arising through changes in the price of gold.
      While we are exposed to credit risk in the event of non-performance by
      counterparties to these agreements, in all cases the counterparties are highly
      rated financial institutions and we do not anticipate non-performance. We do
      not
      hold or issues derivative financial instruments for trading
      purposes.





36


At
      June
      30, 2008, our forward gold sales contracts consisted of a series of contracts
      to
      sell 5,500 ounces per month at a price of $801 per ounce over a 78 month period
      from July 2008 to December 2014. The fair value of the contracts as at June
      30,
      2008 was $(91.7) million and at December 31, 2007 was $(58.9) million.





We
      monitor our hedge positions and perform sensitivity analyses on our forward
      contracts to determine the mark-to-market gain/loss at current gold prices;
      we
      estimate that a 10% change in the spot price of gold from the level of $930
      per
      ounce at June 30, 2008 translates into a mark-to-market fluctuation of
      approximately $25
      million .





Gold
      sales covered by the forward sales contract represent approximately 24% and
      47%
      of our forecast annual shipments for 2008 and 2009 respectively. The balance
      of
      our shipments will be sold in the spot market. We estimate that a 10% change
      in
      the price of gold from the level of $930 per ounce at June 30, 2008 translates
      into a $10.0 million increase/decrease in revenues from un-hedged production
      in
      2008 and $6.9 million in 2009.





Fuel
      costs are a significant cost element costs at Mesquite, currently representing
      approximately 33% of our mining costs. The market price of diesel and gasoline
      is unpredictable and can fluctuate significantly. World oil prices are currently
      at historically high levels and are being reflected in the price we pay for
      fuel. We estimate that a 10% change in the price of diesel fuel from the level
      of approximately $4.00 per gallon experienced during Q2/08 translates into a
      $0.9 million increase/decrease in mining costs.





At
      June
      30, 2008 we had $86.3 million of bank debt outstanding of which an estimated
      $15.1 million is current. This debt currently bears interest based on short-term
      U.S. LIBOR rates, generally for one-month periods, plus 2.2%. A 1% fluctuation
      in interest rates at current levels of indebtedness would translate into a
      $0.8
      million change in reported pre-tax income.





**Item
      4.**  **Controls
      and Procedures**




As
      of the
      end of the period covered by this report, our management, with the participation
      of our chief executive officer and of our chief financial officer, evaluated
      the
      effectiveness of our “disclosure controls and procedures,” as defined in Rules
      13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended.
      Based on that evaluation, these officers concluded that, as of the end of such
      period, our disclosure controls and procedures were effective. It should be
      noted that a control system, no matter how well designed and operated, can
      provide only reasonable, not absolute, assurance that it will detect or uncover
      failures within our company to disclose material information otherwise required
      to be set forth in our periodic reports.




During
      the period covered by this report, there were no changes in our internal control
      over financial reporting that have materially affected, or are reasonably likely
      to materially affect, our internal control over financial
      reporting.




37


**PART
      II. OTHER INFORMATION**




**Item
              1.**
            **Legal
                Proceedings.**




**Congrove
      Construction Matter**





The
      Company, through its subsidiary, Western Mesquite Mines Inc. (“WMMI”), entered
      into a Management Representative Agreement dated August 7, 2007 (the
“Agreement”) with Congrove Construction (“Congrove”) of Yuma, Arizona, in
      respect of certain construction activities associated with the Mesquite
      expansion project. WMMI terminated the Agreement on the grounds of bad faith
      demonstrated by Congrove in the carrying out of its contractual duties. On
      July
      3, 2008, legal counsel acting for Congrove filed a complaint and demand for
      jury
      trial with the United States District Court, Southern District of California,
      asserting that WMMI materially breached the Agreement by failing to provide
      complete plans in a timely manner, by wrongfully terminating Congrove’s services
      on the construction project, and by failing to pay monies owing to Congrove
      under the Agreement. Congrove is seeking relief in the amount of $0.6 million
      plus interest thereon. WMMI has not yet been served with the
      complaint.





The
      Company does not believe these claims have merit and intends to vigorously
      defend against such claims.





**Item
              1 A**
            **Risk
                Factors**





There
      have been no material changes to the risk factors disclosed in our 2007 Annual
      Report on Form 10-KSB filed with the Securities and Exchange Commission on
      March
      28, 2008.




**Item
              2.**
            **Unregistered
                Sales of Securities and Use of
                Proceeds.**




None.





**Item
              3.**
            **Defaults
                Upon Senior Securities**




None.




**Item
              4.**
            **Submission
                of Matters to a Vote of Security
                Holders.**





None





**Item
              5.**
            **Other
                Information.**





None.





**Item
      6. Exhibits**





31.1  Rule
      13a
      - 14(a) Certification of Principal Executive Officer*




31.2  Rule
      13a
      - 14(a) Certification of Principal Financial Officer*




32.1  Section
      1350 Certification of Principal Executive Officer *




32.2  Section
      1350 Certification of Principal Financial Officer *




*
      Filed
      herewith





38





**SIGNATURES**





In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      report to be signed on its behalf by the undersigned, thereunto duly
      authorized.




Date:August 11, 2008WESTERN
                GOLDFIELDS INC.By:
            /s/
                Raymond ThrelkeldName:Raymond
                ThrelkeldTitle:President
                and Chief Executive Officer




39