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 nine month periods ended September 30, 2008 and the notes thereto. The information is presented as of November 4, 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 residual gold production from ore that was placed on the heap leach pads by Newmont and previous owners of the property. A positive feasibility study was completed 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 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 have obtained all necessary permits and are sufficiently funded to complete the capital expansion program. We have revised our expectations to selling 117,000 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 NYSE Alternext under the symbol WGW.

Overall Performance

Our first gold pour from new production occurred on January 15, 2008. During the first half of 2008, we were focused on achieving "steady state" production from the new ore being placed on the leach pad that was constructed in the previous fiscal year. By late May, solution flow to the leach pad had become saturated, steady state pregnant solution flow had been achieved, and production rates had stabilized. During the third quarter of 2008, ounces produced and sold were 42,358 and 48,535, respectively. Production for the third quarter was lower than expectations and was mainly a result of a delay in the availability of replacement parts for one shovel in the mining fleet. Year-to-date, we have produced and sold 79,946 ounces and 80,255 ounces of gold, respectively. Of the ounces sold, 16,500 were delivered into a hedge program as a condition of the debt facility, at a fixed price of $801 per ounce. During the year, the Mine incurred escalating production costs, most notably for fuel and haulage truck tires. The selling price for gold in world markets continued to be strong and offsets the full impact of input cost increases.

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, 2012, 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 based on the new mine plan, is now expected to occur by March 31, 2009. Repayment of the facility will be on a semi-annual basis commencing December 31, 2008, with mandatory prepayments being made from 50% of excess cash flow. An estimate of the timing and amount of prepayments cannot be objectively determined, as these payments are based on the amount by which the Mesquite Mine's cash balance after scheduled repayments and interest payments, at the date of repayment, exceeds $4.0 million. Interest on each advance is charged at U.S. dollar LIBOR plus 2.2% up to completion and at U.S. dollar LIBOR plus 1.75% after completion.

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

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On June 7, 2007, we executed forward sales contracts for 429,000 ounces of gold (the "Hedging Contracts") at a price of $801 per ounce. These Hedging Contracts were a requirement under the term loan facility. The Hedging Contracts represent a commitment of 5,500 ounces per month for 78 months commencing July 2008, with the last commitment deliverable December 2014. We expect to produce on average approximately 166,000 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 gain of $31.4 million and loss of $1.4 million for the three and nine month periods ended September 30, 2008, respectively, and a pre-tax loss of $58.9 million for the year ended December 31, 2007. The cumulative unrealized pre-tax loss of $60.3 million has been disclosed as a liability as at September 30, 2008. The first deliveries into the hedge occurred during the third quarter of 2008. As a result of gold prices during the quarter being higher than the settled amount of $801, we realized pre-tax losses of $0.6 million for the three and nine month period ended September 30, 2008.

As a result of the change in life of mine plan, we have negotiated with the lenders to extend the date by which completion would be reached to March 31, 2009.

Capital Program - Construction Activity

During the first three quarters of 2008, the remaining aspects of our capital program, launched in late 2006, were substantially completed. In the first quarter of 2008, the expanded leach pad became operational and the retrofit of the process plant was completed. During the second quarter, 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 $110.0 million, of which $95.4 million was incurred in 2006 and 2007 and $14.6 million estimated for 2008. Spending on the expansion program in 2008 year-to-date was $13.0 million. The remaining planned expenditures of the capital program in 2008 are to complete the truck repair shop.

Selected Financial Information (all tabular data in US$ thousands unless otherwise stated)

Cash flows provided (used) by: