Cautionary Note Regarding Forward-Looking Statements

The discussion below contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act, and Section 21E of the Exchange Act. We have used words such as "believes," "intends," "anticipates," "expects" and similar expressions to identify forward-looking statements. These statements are based on information currently available to us and are subject to a number of risks and uncertainties that may cause our actual results of operations, financial condition, cash flows, performance, business prospects and opportunities and the timing of certain events to differ materially from those expressed in, or implied by, these statements. These risks, uncertainties and other factors include, without limitation, those matters discussed in Item 1A of Part I of our 2011 Form 10-K. Except as expressly required by the federal securities laws, we undertake no obligation to update such factors or to publicly announce the results of any of the forward-looking statements contained herein to reflect future events, developments, or changed circumstances, or for any other reason. The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing in our 2011 Form 10-K and Item 1A, "Risk Factors" for the year ended December 31, 2011.

Overview

Gulf Resources conducts operations through its two wholly-owned China subsidiaries, SCHC and SYCI. Our business is also reported in these three segments, Bromine, Crude Salt, and Chemical Products.

Through SCHC, we produce and sell bromine and crude salt. We are one of the largest producers of bromine in China, as measured by production output. Elemental bromine is used to manufacture a wide variety of brominated compounds used in industry and agriculture. Bromine is commonly used in brominated flame retardants, fumigants, water purification compounds, dyes, medicines, and disinfectants.

Through SYCI, we manufacture and sell chemical products that are used in oil and gas field exploration, oil and gas distribution, oil field drilling, wastewater processing, papermaking chemical agents and inorganic chemicals.

Our Corporate History

We were incorporated in Delaware on February 28, 1989. From November 1993 through August 2006, we were engaged in the business of owning, leasing and operating coin and debit card pay-per copy photocopy machines, fax machines, microfilm reader-printers and accessory equipment under the name "Diversifax, Inc.". Due to the increased use of internet services, demand for our services declined sharply, and in August 2006, our Board of Directors decided to discontinue our operations.

Upper Class Group Limited, incorporated in the British Virgin Islands in July 2006, acquired all the outstanding stock of SCHC, a company incorporated in Shouguang City, Shandong Province, PRC, in May 2005. At the time of the acquisition, members of the family of Mr. Ming Yang, our president and former chief executive officer, owned approximately 63.20% of the outstanding shares of Upper Class Group Limited. Since the ownership of Upper Class Group Limited and SCHC was then substantially the same, the acquisition was accounted for as a transaction between entities under common control, whereby Upper Class Group Limited recognized the assets and liabilities transferred at their carrying amounts.

On December 12, 2006, we, then known as Diversifax, Inc., a public "shell" company, acquired Upper Class Group Limited and SCHC. Under the terms of the agreement, the stockholders of Upper Class Group Limited received 13,250,000 (restated for the 2-for-1 stock split in 2007 and the 1-for-4 stock split in 2009) shares of voting common stock of Gulf Resources, Inc. in exchange for all outstanding shares of Upper Class Group Limited. Members of the Yang family received approximately 62% of our common stock as a result of the acquisition. Under accounting principles generally accepted in the United States, the share exchange is considered to be a capital transaction rather than a business combination. That is, the share exchange is equivalent to the issuance of stock by Upper Class Group Limited for the net assets of Gulf Resources, Inc., accompanied by a recapitalization, and is accounted for as a change in capital structure. Accordingly, the accounting for the share exchange is identical to that resulting from a reverse acquisition, except no goodwill is recorded. Under reverse takeover accounting, the post reverse acquisition comparative historical financial statements of the legal acquirer, Gulf Resources, Inc., are those of the legal acquiree, Upper Class Group Limited. Share and per share amounts stated have been retroactively adjusted to reflect the share exchange. On February 20, 2007, we changed our corporate name to Gulf Resources, Inc.

On February 5, 2007, we acquired SYCI, a company incorporated in PRC, in October 2000. Under the terms of the acquisition agreement, the stockholders of SYCI received a total of 8,094,059 (restated for the 2-for-1 stock split in 2007 and the 1-for-4 stock split in 2009) shares of common stock of Gulf Resources, Inc. in exchange for all outstanding shares of SYCI's common stock. Simultaneously with the completion of the acquisition, a dividend of $2,550,000 was paid to the former stockholders of SYCI. At the time of the acquisition, approximately 49.1% of the outstanding shares of SYCI were owned by Ms. Yu, Mr. Yang's wife, and the remaining 50.9% of the outstanding shares of SYCI were owned by SCHC, all of whose outstanding shares were owned by Mr. Yang and his wife. Since the ownership of Gulf Resources, Inc. and SYCI are substantially the same, the acquisition was accounted for as a transaction between entities under common control, whereby Gulf Resources, Inc. recognized the assets and liabilities of SYCI at their carrying amounts. Share and per share amounts have been retroactively adjusted to reflect the acquisition.

To satisfy certain ministerial requirements necessary to confirm certain government approvals required in connection with the acquisition of SCHC by Upper Class Group Limited, all of the equity interest of SCHC were transferred to a newly formed Hong Kong corporation named Hong Kong Jiaxing Industrial Limited ("Hong Kong Jiaxing") all of the outstanding shares of which are owned by Upper Class Group Limited. The transfer of all of the equity interest of SCHC to Hong Kong Jiaxing received approval from the local State Administration of Industry and Commerce on December 10, 2007.

As a result of the transactions described above, our corporate structure is linear. That is Gulf Resources owns 100% of the outstanding shares of Upper Class Group Limited, which owns 100% of the outstanding shares of Hong Kong Jiaxing, which owns 100% of the outstanding shares of SCHC, which owns 100% of the outstanding shares of SYCI.

On October 12, 2009 we completed a 1-for-4 reverse stock split of our common stock, such that for each four shares outstanding prior to the stock split there was one share outstanding after the reverse stock split. All shares of common stock referenced in this report have been adjusted to reflect the stock split figures. On October 27, 2009 our shares began trading on the NASDAQ Global Select Market under the ticker symbol "GFRE" and on June 30, 2011 we changed our ticker symbol to "GURE" to better reflection of our corporate name.

Our current corporate structure chart is set forth in the following diagram:

[[Image Removed]]

As a result of our acquisitions of SCHC and SYCI, our historical financial statements and the information presented below reflects the accounts of SCHC and SYCI. The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this report.

RESULTS OF OPERATIONS

The following table presents certain information derived from the consolidated statements of operations, cash flows and stockholders equity for the three-month and six-month periods ended June 30, 2012 and 2011.

Comparison of the Three-Month Periods Ended June 30, 2012 and 2011

                                 Three-Month Period      Three-Month Period
                                 Ended June 30, 2012     Ended June 30, 2011     % Change
Net revenue                     $       31,314,846      $       51,300,812    ?    (39 %)
Cost of net revenue             $      (21,389,651 )    $      (24,994,703 )  ?    (14 %)
Gross profit                    $        9,925,195      $       26,306,109    ?    (62 %)
Sales, marketing and other
operating expenses              $          (22,709 )    $          (23,733 )        (4 %)
Research and development costs  $          (62,526 )    $         (133,519 )  ?    (53 %)
Exploration cost                $                -      $       (3,867,286 )  ?   (100 %)
Write-off/Impairment on
property, plant and equipment   $         (911,995 )    $       (7,570,566 )  ?    (88 %)
General and administrative
expenses                        $       (1,370,866 )    $       (1,714,694 )       (20 %)
Other operating income          $           76,104      $          392,298    ?    (81 %)
Income from operations          $        7,633,203      $       13,388,609    ?    (43 %)
Other income (expense), net     $           30,660      $          (13,009 )  ?   (336 %)
Income before taxes             $        7,663,863      $       13,375,600    ?    (43 %)
Income taxes                    $       (1,975,189 )    $       (3,352,345 )  ?    (41 %)
Net income                      $        5,688,674      $       10,023,255    ?    (43 %)

Net revenue. Net revenue was $31,314,846 for three-month period ended June 30, 2012, a decrease of approximately $20.0 million (or 39%) as compared to the same period in 2011. This decrease was primarily attributable to the reduction of overall demand for all of our segment products, specifically, (i) revenue from the bromine segment decreased from $33,230,646 for the three-month period ended June 30, 2011 to $17,539,429 for the same period in 2012, a decrease of approximately 47%; (ii) revenue from the crude salt segment decreased from $5,994,384 for the three-month period ended June 30, 2011 to $3,779,658 for the same period in 2012, a decrease of approximately 37%; and (iii) revenue from the chemical products segment decreased from $12,075,782 for the three-month period ended June 30, 2011 to $9,995,759 for the same period in 2012, a decrease of approximately 17%.

                                             Net Revenue by Segment
                         Three-Month Period Ended              Three-Month Period Ended          Percent Decrease
                               June 30, 2012                         June 30, 2011                of Net Revenue
Segment                                     % of total                            % of total
Bromine             $      17,539,429             56 %    $      33,230,646             65 %             (47 %)
Crude Salt          $       3,779,658             12 %    $       5,994,384             12 %             (37 %)
Chemical Products   $       9,995,759             32 %    $      12,075,782             23 %             (17 %)
Total sales         $      31,314,846            100 %    $      51,300,812            100 %             (39 %)



Bromine and crude salt
segments                              Three-Month Period Ended                Percentage Change
product sold in tonnes          June 30, 2012          June 30, 2011         Increase/(Decrease)
Bromine (excluded volume
sold to SYCI)                            5,031                   7,670                 (34 %)
Crude Salt                             100,745                 124,809                 (19 %)



                                      Three-Month Period Ended                 Percentage Change
Chemical products segment
sold in tonnes                  June 30, 2012          June 30, 2011          Increase/(Decrease)
Oil and gas exploration
additives                                 3,057                  4,474                    (32 %)
Paper manufacturing
additives                                   771                    917                    (16 %)
Pesticides manufacturing
additives                                   830                    761                      9 %
Wastewater treatment
chemical additives                            -                    116                   (100 %)
Overall                                   4,658                  6,268                    (26 %)

Bromine segment
The decrease in net revenue from our bromine segment was mainly due to the decrease in both the sales volume and selling price of bromine. The sales volume of bromine decreased from 7,670 tonnes for the three-month period ended June 30, 2011 to 5,031 tonnes for the same period in 2012, a decrease of 34%. Despite an increase in the number of our bromine production plants in recent years which maintained our production capacity, sales volume of bromine decreased. The major reason for the decrease in the sales volume of bromine was mainly attributable to the drop in overall demand for bromine as a result of the recent macro-economic tightening policy imposed by the PRC government beginning in the second half of 2011 to slow down the economy, which has affected our customers' industries.

Due to the drop in demand of bromine, since the second half of 2011, we needed to offer competitive selling prices to our customers to compete with other bromine manufacturers. The average selling price of bromine decreased from $4,333 per tonne for the three-month period ended June 30, 2011 to $3,486 per tonne for the same period in 2012, a decrease of 20%. The average selling price for this quarter remained relatively stable as compared with the three-month period ended March 31, 2012 ($3,569 per tonne). We expect the average selling price of bromine will remain at current levels through the end of 2012 should the PRC government's macro-economic tightening policy remain in place. The table below shows the changes in the average selling price and changes in the sales volume of bromine for three-month period ended June 30, 2012 from the same period in 2011.

                                            Three-Month Period
                                              Ended June 30,
Increase / (Decrease) in net revenue of
bromine as a result of:                        2012 vs. 2011
Decrease in average selling price          $       (5,373,368 )
Decrease in sales volume                   $      (10,317,849 )
Total effect on net revenue of bromine     $      (15,691,217 )

Crude salt segment
The decrease in net revenue from our crude salt segment was mainly due to the decrease in both the average selling price and sales volume of crude salt. The average selling price of crude salt decreased from $48.03 per tonne for the three-month period ended June 30, 2011 to $37.52 per tonne for the same period in 2012, a decrease of 22%, and the sales volume of crude salt also decreased by 19% from 124,809 tonnes for the three-month period ended June 30, 2011 to 100,745 tonnes for the same period in 2012. Similar to the bromine segment, the decrease in both the average selling price and sales volume was a result of the macro-economic tightening policy imposed by the PRC government beginning in the second half of 2011 to slow down the economy. This policy resulted in, among other things, the decrease in the demand for crude salt for downstream production of chlorine alkali and use in chemical, food and beverage industries. The table below shows the changes in the average selling price and changes in the sales volume of crude salt for three-month period ended June 30, 2012 from the same period in 2011.

                                            Three-Month Period
                                              Ended June 30,
Increase / (Decrease) in net revenue of
crude salt as a result of:                    2012 vs. 2011
Decrease in average selling price          $      (1,185,440 )
Decrease in sales volume                   $      (1,029,286 )
Total effect on net revenue of crude
salt                                       $      (2,214,726 )

We noted a downward trend in the average selling price of crude salt since the first quarter of 2011 as we offered competitive selling prices to our customers in order to compete with other crude salt manufacturers. The average selling price decreased from $50.09 per tonne in the first quarter of 2011 to $37.52 per tonne in the second quarter of 2012. We expect the average selling price of crude salt will remain at current levels through the end of 2012 should the PRC government's macro-economic tightening policy remain in place.

Chemical products segment

                                           Product Mix of Chemical Products Segment                        Percent
                                Three-Month Period Ended               Three-Month Period Ended           Change of
                                     June 30, 2012                          June 30, 2011                Net Revenue
Chemical Products                                 % of total                             % of total
Oil and gas
exploration additives     $      5,569,089              56 %     $       7,994,967             66 %            (30 %)
Paper manufacturing
additives                 $        985,068              10 %     $       1,261,663             11 %            (22 %)
Pesticides
manufacturing
additives                 $      3,441,602              34 %     $       2,299,138             19 %             50 %
Wastewater treatment
chemical additives                       -               -                 520,014              4 %           (100 %)
Total sales               $      9,995,759             100 %     $      12,075,782            100 %            (17 %)

Net revenue from our chemical products segment decreased from $12,075,782 for the three-month period ended June 30, 2011 to $9,995,759 for the same period in 2012, a decrease of approximately 17%. The decrease was mainly attributable to the drop in demand for our oil and gas exploration additives and paper manufacturing additives. Our oil and gas exploration chemicals are the most popular products within the chemical products segment, which contributed $5,569,089 (or 56%) and $7,994,967 (or 66%) of our chemical segment revenue for the three-month periods ended June 30, 2012 and 2011, respectively, with a decrease of $2,425,878, or 30%. Net revenue from our paper manufacturing additives decreased from $1,261,663 for the three-month period ended June 30, 2011 to $985,068 for the same period in 2012, a decrease of approximately 22%. We believe that as result of the recent macro-economic tightening policy imposed by the PRC government to slow down the economy, the overall demand for chemical products was reduced, which resulted in a decrease in our volume of both oil and gas exploration additives and paper manufacturing additives sold, which decreased by 32% and 16%, respectively, for the three-month period ended June 30, 2012 as compared with the same period in 2011. Also, in June 2011 we stopped production of our wastewater treatment chemical additives and in July 2011 we successfully converted the production equipment to pharmaceutical and agricultural chemical additives which have higher profit margins.

However, the effect of the decrease in net revenue from our chemical products segment was partially offset by the increase in the average selling price of our pesticides manufacturing additives products due to the strong demand in the PRC market. The average selling price per tonne for our pesticides manufacturing additives increased by 37% for the three-month period ended June 30, 2012 as compared with the same period in 2011. The PRC government continued to support expansion of agricultural related products, which supported the growth in sales of our pesticides manufacturing additives. Also, we successfully converted the production equipment from wastewater treatment chemical additive to pharmaceutical and agricultural chemical additives, which contributed higher profit margins than other chemical products. The table below shows the changes in the average selling price and changes in the sales volume of major chemical products (excluded wastewater treatment chemical additives of $520,014 for three-month period ended June 30, 2011 as the production of such product line was stopped since July 2011) for three-month period ended June 30, 2012 from the same period in 2011.

Increase / (Decrease) in net
revenue,
for the three-month period ended      Oil and gas                                  Pesticides
June 30,                              exploration       Paper manufacturing       manufacturing
2012 vs. 2011, as a result of:         additives             additives              additives             Total
Increase / (Decrease) in average                                                                      $    943,199
selling price                      $      130,910       $       (82,889 )     $        895,178
Increase / (Decrease) in sales                                                                        $ (2,503,208 )
volume                             $   (2,556,788 )     $      (193,706 )     $        247,286
Total effect on net revenue of                                                                        $ (1,560,009 )
chemical products                  $   (2,425,878 )     $      (276,595 )     $      1,142,464

Cost of Net Revenue.

                                          Cost of Net Revenue by Segment                             % Change
                          Three-Month Period Ended               Three-Month Period Ended           of Cost of
                               June 30, 2012                          June 30, 2011                Net Revenue
Segment                                     % of total                             % of total
Bromine             $      11,969,325             56 %     $      15,518,035             62 %            (23 %)
Crude Salt          $       2,556,779             12 %     $       1,410,903              6 %             81 %
Chemical Products   $       6,863,547             32 %     $       8,065,765             32 %            (15 %)
Total               $      21,389,651            100 %     $      24,994,703            100 %            (14 %)

Cost of net revenue reflects mainly the raw materials consumed and the direct salaries and benefits of staff engaged in the production process, electricity, depreciation and amortization of manufacturing plant and machinery and other manufacturing costs. Our cost of net revenue was $21,389,651 for three-month period ended June 30, 2012, a decrease of $3,605,052 (or 14%) as compared to the same period in 2011. The decrease in overall cost of net revenue was mainly attributable to the decrease in volume of products sold and the decrease in purchase price of raw materials, as compared to the last comparable period, which was partially offset by the increase in depreciation and amortization of manufacturing plant and machinery and price adjustment fund, a levy imposed by the local PRC government to our bromine and crude segments since January 2011 for the purpose of enhancing the local PRC government's ability to adjust the price and stabilize the market price of daily necessities and other important commodities.

Bromine production capacity and utilization of our factories

The table below represents the annual capacity and utilization ratios for all of our bromine producing properties:

                                          Annual Production
                                            Capacity (in        Utilization
                                               tonnes)           Ratio (ii)
Three-month period ended June 30, 2011        41,547  (i)             81%
Three-month period ended June 30, 2012        44,547                  47%
Variance of the three-month periods
ended June 30, 2012 and 2011                   3,000  (iii)          (34% )

(i) Annual production capacity for the three-month period ended June 30, 2011 was adjusted with the appraisal report carried out by an international appraisal firm, Grant Sherman Appraisal Limited, in October 2011.

(ii) Utilization ratio is calculated based on the annualized actual production volume in tonnes for the periods divided by the annual production capacity in tonnes.

(iii) The increase in 3,000 tonnes production capacity represents the management's estimated capacity of Factory No. 10 acquired in late December 2011.

Our utilization ratio decreased by 34% for the three-month period ended June 30, 2012 as compared with the same period in 2011. The decrease in utilization and hence the sales volume of bromine was mainly attributable to the drop in overall demand for bromine as a result of the macro-economic tightening policy imposed by the PRC government to slow down the economy, which reduced our production volume since mid-2011.

In view of the trend of a decrease in the bromine concentration of the brine water being extracted at our production facilities as explained in 2011 Form 10-K, and in order to reduce the leakage rate and attempt to recover the annual production capacity of bromine and crude salt to a higher level in the future, we decided to carry out large scale enhancement work to replace all the eroded protective shells within a four year timeframe, which work commenced in the second quarter of 2011. In May 2012, we resumed the second phase enhancement works to our existing bromine extraction and crude salt production facilities, which are still under construction as of June 30, 2012. The total construction costs of the enhancement work to the extraction wells and protective shells to transmission channels and ducts in Factory No. 1 to 9 are approximately $12,806,910 and $8,139,503, respectively, which are expected to be completed by late August 2012.

Bromine segment
For the three-month period ended June 30, 2012, the cost of net revenue for the bromine segment was $11,969,325, a decrease of $3,548,710 or 23% over the same period in 2011. The most significant components of the costs of net revenue for the bromine segment were cost of raw materials and finished goods consumed of $6,616,505 (or 55%), depreciation and amortization of manufacturing plant and machinery of $3,423,638 (or 29%) and electricity of $799,502 (or 7%) for the three-month period ended June 30, 2012. For the three-month period ended June 30, 2011, the major components of the cost of net revenue were the cost of raw materials and finished goods consumed of $10,235,449 (or 66%), depreciation and amortization of manufacturing plant and machinery of $2,590,493 (or 17%) and electricity of $1,257,231 (or 8%), the cost structure changed as compared with the same period in 2012 where the contribution from cost of raw materials and finished goods consumed decreased by 11% and depreciation and amortization of . . .