Coxe Basic Points March 2011

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Basic PointsSlouching Towards Stagfation?

March 31, 2011

Published by Coxe Advisors LLP

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Don Coxe

THE COXE STRATEGY JOURNAL

Slouching Towards Stagfation?

March 31, 2011

published by

Coxe Advisors LLP

Chicago, IL


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March 31, 2011

Author: Don Coxe [email protected]

Editor: Angela Trudeau 604-929-8791

[email protected] Advisors LLP. www.CoxeAdvisors.com190 South LaSalle Street, 4th Floor

Chicago, Illinois USA 60603


5/401February 2011

OVERVIEW


The dramatic Page One stories this year were born in two cities lying worlds

apart:

A starving street vendor in Tunis set himsel afame, an immolation

which set deserts afame all the way to the Persian Gul;

An earthquake near Sendai spawned a tsunami, killing and

wounding thousands, and sending six nuclear reactors into

pre-meltdown mode, slashing electricity supplies across the nation

and orcing actory shutdowns, triggering supply chain shutdowns

worldwide; Japanese stocks plunged to new lows.

This month we chronicle these stories and suggest their important investmentimplications. We also discuss two Page 16 storiesthe problematic pension

situation in the US and the implications o a NASA-sponsored committees

recent prediction o the lowest-activity sunspot cycle in nearly two

centuries.

All these topics relate to an over-arching investment question: is the world

slouching erratically toward a revival o stagfationa condition in which

commodities and commodity stocks become core investment priorities?

We are modiying our Recommended Asset Mixes and Recommended Sector

Weightings in Commodity Stocks to refect the impacts on investment

strategies rom these challenges.


6/40

THE COXE STRATEGY JOURNAL2 February 2011


7/403March 2011


Our title comes rom Yeatss The Second Coming, which includes the ollowing

lines:

Things all apart; the centre cannot hold;

Mere anarchy is loosed upon the world,

The blood-dimmed tide is loosed, and everywhere

The ceremony o innocence is drowned

When a vast image out o Spiritus Mundi

Troubles my sight: a vast waste o desert sand;

A shape with a Lion body and the head o a man

And what rough beast, its hour come round at last,

Slouches towards Bethlehem to be born?

What do the Arab revolutions and the Japanese earthquake and tsunami-

driven nuclear crisis have in common?

They were unexpected:

1. Mere anarchy is loosed upon the world

A vast waste o desert sand. A shape with a Lion body and the head o a man.

No oreign aairs expert predicted that Tunis would be the site o riots that

would depose an obscure autocrat; nor did anyprominent pundit predict,

as Tunisians began rioting, that the orces unleashed would switly depose

the rulers o Egypt and then trigger a civil war in Libya which would become

the 4th war o our time in which hastily-cobbled western alliances attack

entrenched autocracies in-or-adjoining the Middle East.

The last time this part o the world launched a campaign that enguled much

o Mediterranean civilization was in 217 B.C., when Hannibal let present-day

Tunisthen known as Carthagecrossed the Alps, and annihilated Romes

legions in three great victories that panicked Rome. He atally hesitated beore

marching on Rome. As he rebuilt his supplies and pondered his climactic

assault, the Senate sent Scipio to attack Carthage, orcing Hannibal to return.Scipio had analyzed his oes battle strategies, and won a decisive victory. He

then destroyed Carthage, and sowed it and its environs with salt.

This years Tunisian eruption also set o tumult and, in some cases, threats

o civil war, in Jordan, Bahrain, Oman, and Yemen: it even managed to scare

the brutal Bashar al-Assad in Syria. The Saudi rulers also respondedwith

generous payouts to local residents and army support or besieged Bahrain,

where King al-Khalia was beset with large-scale Shia protests.

Things all apart;

the centre cannot hold


8/404 March 2011



2. The blood-dimmed tide is loosed, and everywhere the ceremony o innocence is

drowned.

Obviously, no one predicted a Force 9 earthquake and a horrendous tsunami

in Japan. But, even ater the seismologists proclaimed the scale o the quake,

ew investors immediately realized the world-wide energy implications o a

major nuclear accident.

Global capital markets have been reacting almost daily to the news rom

Japan, and many short-term traders have been rushing intoand then out

oJapanese stocks. Many hedge unds and trading shops sustained huge

losses. However, ew investors seem to believe that these events could, within

months, have major long-term bullish implications or Japanese equities.

Many investors see the Japanese crisis primarily as a disaster or the global

nuclear power industry, which had nally begun to build momentum decades

ater Three Mile Island and Chernobyl.

Already, the psychological eects have been elt on the other side o the

world. In Germany, Angela Merkel, who is nuclear-savvy, was orced to

announce a delay in her program to deer German nuclear shutdowns, but

was still burned in Baden-Wrttembergs regional election last week. Yes, her

pro-euro policies were her biggest problem, but the Greens' gains in that vote

were driven by their insistence that all German nukes must be permanently

decommissioned.

Is there any good news out o all this bad news? We think that investors could

eventually conclude that the Japanese earthquake and tsunami may have

marked the end o the 21-year Triple Waterall Crash or Japanese equities,

and discuss this possibility on page 12.

...ew investors

seem to believe that

these events could,

within months, have

major long-term

bullish implications

or Japanese

equities.


9/405March 2011

I. The Arab Awakening

George W. Bush justied his invasion o Iraq on two grounds: stopping SaddamHussein beore he built up an arsenal o weapons o mass destruction, and

ridding the Mideast o an evil despot, replacing his regime with a democracy

which would eventually be seen to be an expression o Iraqi aspirations,

thereby encouraging the development o democracies across the Arab

world.

When it switly became apparent that Justication #1 was based on bad

intelligence work, criticsparticularly those or whom nuance is an

intellectual liestyleattacked Bush or equally naive thinking about this

supposed underlying Arab urge or democracy. Werent the people in all

those autocraciesbenevolent and otherwisesatised with their lot? Theynever did anything about booting their rulers out and replacing them with

democratic systems. The Arab Street devoted its outbursts o rage to Israel

and the US, not to their dictators.

Bush characterized such criticisms as the sot bigotry o low expectations.

He was enjoying the semi-obscurity o Craword when, seemingly out o

nowhere, Arabs almost everywhere took to the streets and demanded

political reedom. (The most deant demonstrations tended to bewith the

exception o Libyain the least vicious dictatorships.)

Those o us who watched asnight ater nightall those young, warm, tech-

riendly Egyptians demonstrated in Cairo were naturally rooting or them.

Hosni Mubarakthe best Arab riend Israel and the US have in the region

gave in to pressure rom his youthul citizens and rom his erstwhile good

riendObama, and departed without ring a shot. Nothing became him in

his long rule as the leaving o it.

What kind o regime will take power in the June elections? All observers

agree the Muslim Brotherhood is the only nationally-organized group.

The Administration has advised Congress through a spokesman that this

is a secular group. This is an odd appraisal. According to the Council onForeign Relations, The Egyptian Brotherhood is the ounding member o a

world-wide network o organizations that include establishing Islamic states

with Shariah law among their goals. The Council notes that, because it has

branches across the globe, local groups convictions and strategies may vary.

The Egyptian branch has more than three hundred thousand members, and

has consistently rejected violent activity as it has sought to move into the

mainstream. As or what it will do i it achieves power, many riends o Egypt

... "the sot

bigotry o low

expectations."


10/406 March 2011



abroad will probably look on its intentions according to the Reagan Rule:

Trust, but Veriy.

Perhaps coincidentally, last week, a Christian church in Cairo was torched

and 13 people were murdered.

Investors primal ears are that revolutions could spread to the oil-rich

statesKuwait, Algeria, Qatar, Oman, the Emirates, and even Saudi Arabia.

Already, the cuto o Libyan exports has driven the price o prized light oils

to bigger premiums over West Texas and Brent.

Benchmark oil prices fuctuated during the early phases o the alling o the

desert dominos, but they remained restrained until the pain spilled into the

plains o Libya, and WTI leapt rom $97 to $106.

We believe that investors should now be adding to their crude oil producer

exposures on at least a tactical basis, because the momentum or change

continues to build across the Maghreb and Middle East, and the worlds

comort level with oil supplies will doubtless be subject to shocks as new

crises erupt.

Libya

No pundit expected a civil war in Libya. Indeed, a ortnight ater the Egyptian

revolution began, the eminent American commentator Robert Samuelson

wrote a column in Newsweek that Americans were in denial about the

implications or global oil prices i the revolution spread. He listed ve

oil-producing states that could possibly be at risk, but did not include Libya on

the list.

Muammar Gadda has ruled this tribal kingdom since 1969, and has, along

the way, made many riends abroad.

Why?

For decades, as other leaders came and went, he was a sustained voice and

terrorist instigator in support o what a large number o members o the UN

General Assembly have wanted to hearthat Israel is an illegal state, and is

the cause o nearly all Mideast misery, that the US is the next greatest evil in

the world, ollowed by all the ormer imperialist powersBritain, France,

Germany and Italy. When he spoke beore the General Assembly in 2009, he

demanded thatthe imperialists pay Arica $7.7 trillion or past colonial

crimes.

Trust, but Veriy.


11/407March 2011

He was widelyand accuratelyblamed or bloody anti-US terrorist

strikesthe Lockerbie Pan Am crash and the murder o American soldiers

in Germany. (For that latter assault, he was bombed at Reagans orders, and

narrowly escaped thank to French reusal to authorize use o its airspace to

American bombers, a non remembered in the Pentagon.)

For his rousing speeches and support o the enthusiasms and bigotries o the

global Let, he and his nation have been routinely lionized by anti-Western

nations. Libya was named Chairman o the UNs Commission on Human

Rights in 2003, joined the Security Council in 2007, and Gadda was named

Chairman o the Arican Union in 2009.

Ater decades o scorn rom the US and many o its allies, Gadda was

declared partially rehabilitated by Bush, because, ater the deeat o Saddam,he renounced his program o nuclear weapons development. Condoleezza

Rice cited the wisdom o his policy in 2005 in discussions with Iran. In 2008,

she became the rst in her position to visit Libya since 1953. Ater meeting

with Gadda, she said, Were o to a very good start. It is only a start, but

I think, ater many, many years, its a very good thing that the United States

and Libya are establishing a way orward.

Why, then, have so many nations suddenly turned against this Third World

Titan?

And why is Libya under attack rom a group o nations that claim their warplans do not include capturing or killing him?

President Obama is emphatic that Gadda must go, but that is not the

stated objective o all those Tomahawk missile attacks and B-2 airstrikes.

The senders agree that the objectives are limited to protecting civilians rom

attacks by Gadda. Hillary Clinton and the chairman o the US Joint Chies

o Sta both state that Gadda could well survive.

In his typically impressive speech to the nation on Monday, President

Obama explained how a limited allied response can save lives and eventually

convince Gadda he should go. He did not review the week-long wrangling

about who would have command and control o the program, simply noting

that a Canadian General [Lt. Gen. Charles Bouchard] is now in charge.

Nor did he explain the implications o a struggle in which American troops

and weaponry have been the crucial components o the response to date, but

can somehow ade into a support role without Gadda moving back into

attack mode against the ill-armed and ill-trained rebels. Nor did he address

Libya was named

Chairman o the UNs

Commission on Human

Rights in 2003...


12/408 March 2011



the possibility that, thanks to allied attacks on Gaddas armor and possible

deections among his mercenaries and allies, the rebels could roar on to the

attack and begin killinghis supporters. Does humanitarianism choose sides

permanently?

The operation got o under quasi-chaotic conditions when Sarkozy insisted

that this was a partnership o individual states, and not a NATO exercise, a

stance that would have pleased DeGaulle, in whose ootsteps he has long

claimed to walk. But NATO has the command systems and logistics needed

to maintain a no-fy zone and embargo. Furthermore, NATO stalwart Turkey

insisted that NATO must not embark on a war to capture or kill Gadda or

even to protect rebels i they regroup and challenge Gaddas entrenched

positions.

The President, who long ago eliminated the phrase War on Terror rom

all discussions o the Administrations geopolitical policies, naturally does

not call this a war. As Ross Douthat noted this week in The New York Times,

In press briengs last week, our Libyan campaign was euphemized into a

kinetic military action and a time-limited, scope-limited military action.

(The online parodies were merciless: Make love, not time-limited, scope-

limited military action!Let slip the muzzled canine unit o kinetic military

action!)

To us, and to a growing number o critics, this is not the way to win a war.

Why is its objective preventing Gadda rom using armor against his people

because he is such a bruteyet to leave him on the throne, a bruised brute

acing no allied boots on the ground, and who would, unleashed, most

certainly be bloody mad? Will a wounded beast be more solicitous o the

welare o his citizens who opposed him, and less o a threat to the rest o the

world? Will there be new Lockerbies, to be resolved with new compassion

or the murderers?

Never beore have American troops been committed to a war that is not called

a war, with no real agreement among the partners as to its goals, and without

rsthand knowledge o the aims and capabilities o the rebels who created

the crisis. Already there are reports that Al Qaeda elements are prominent

in some o the rebel groups. As Thomas Friedman wisely notes, There are

two kinds o states in the Middle East: real countries with long histories in

their territory and strong nation identities (Egypt, Tunisia, Morocco, Iran);

and those that might be called 'tribes with fags' or more articial states with

boundaries drawn in sharp straight lines by pens o colonial powers that

have trapped inside their borders myriad tribes and sects whohave never

Make love, not time-

limited, scope-limited

military action!


13/409March 2011

ully melded into a unied amily o citizens. They are Libya, Iraq, Jordan,

Saudi Arabia, Syria, Bahrain, Yemen, Kuwait, Qatar, and the United Arab

Emirates.

Pity the Pentagon. It resisted this mission. Now it is allocating its already-

overstretched resources in a confict but not war, without any reasonable

chance o accomplishing something decisive that would allow it to declare

victory...and with the already-discussed prospect that it would need to

commit boots on the ground to stabilize Libya were Gadda to go.

2. The Arabian Peninsula

The revolutions in Tunisia and Egypt are major human and historical events,but are likely to have little investment impact.

On the other hand, because Libya is a signicant producer o light crude, the

military activity (the war that dare not speak its name) and rebellion have

had a denite impact on oil prices and on perceptions o risk in the global

economy.

But i Saudi Arabias regime were threatened, the eect on global stock

prices could be near-existential or the global economy. The surprises and

shocks to date have taken WTI rom $85 to $106, with immediate impact on

economic growth across much o the worldincluding the US, where most

o the recently-announced growth in consumer spending came rom higher

gas prices.

A Seventies-style shock rom oil remains, thankully, a remote contingency,

but it is ar less remote than it was three months agowhen nobodyworried

about it.

What makes the Saudi situation tenuous at the moment are the rapidly-

escalating riots and tumults in neighboring Bahrain and Yemen.

(a) Bahrain

In Bahrain, the al-Khalias amilys longand historically benevolentgrasp

on power is at risk. From personal experience in travels there, the local Shia

population has long been subjected to signicant propagandizing rom rabble-

rousing Iranian imams. Although one should not, on the evidence, argue that

a majority o the Shias are in rebellious mood, there is no reason to doubt that

most Shias are resentul o the distribution o power and wealth in the island

kingdom between the ruling Sunnis and themselves (75% o the populace).

Pity the Pentagon.


14/4010 March 2011



This month, the ruler o Bahrain and the King o Saudi Arabia publicly

denounced the intervention oa oreign power in Bahrain. Saudi Arabia

sent some o its crack soldiers across the causeway rom their country to

Bahrain.

Most observers seem to believe that the two kingdoms are well able to handle

the Shia unrest and the daily fow o Iranian propaganda.

We agree. Iran will doubtless continue to oment unrest in Bahrain, but it

will not be able to bring down a Saudi-backed regime.

What would change the worlds perception o the risks to Saudi oil production

would be a new, jihadist radicalization o resident Shias just across the

causeway connecting Bahrain with Saudi Arabia.

To date, most o the jihadists who have sacriced themselves in Aghanistan,

Pakistan, America and Israeland in other parts o the worldhave been

Sunni.

Al Qaeda is Sunni, and, indeed some o Al Qaeda-driven jihadism has been

aimed at Shias. The religious war between Sunnis and Shias has been more

or less continuous or 18 centuries.

Jihadists are able to carry out mayhem precisely because they are not

uniormed soldiers ghting on battleelds, (although most terrorists

captured by Americans demand the privileges accorded to combat soldiers).Jihadists go into crowded markets, mosques, restaurants, girls schools, and

other civilian milieus, and try to take as many people as possible with them

into the next world or, i in doubt about the alleged rewards o Paradise, they

merely leave bombs behind as they depart.

In close proximity to Bahrain is a large part o Saudi oil operationsin an

area heavily populated with Shias. Given the eectiveness o Saudi security

orces, we doubt that any open attacks on Saudi Arabia could be more than

a minor nuisance.

But a ew jihadist employees o the oil installations could have signicant

impact on the reliability o Saudi oil output.

World leaders worst nightmare must be Shia Shock in Saudi Arabia.

(b) Yemen

The reign o Ali Abdullah Saleh o Yemen is beset by the most earsome

rebellion in its thirty-year history.

World leaders worst

nightmare must be Shia

Shock in Saudi Arabia.


15/4011March 2011

Yemen has long harboredunwillinglyArab terrorists, including Anwar

al-Awlaki, the ex-American whose website whipped up the jihadist ervor o

such headline-makers as Major Hassan at Fort Hood, the would-be bomber

o Times Square, and the would-be Christmas bomber o Detroit. (That Army

intelligence knew that Hassan was routinely visiting the Yemeni website and

was giving passionate speeches against American involvement in the Mideast,

yet never warned the authorities at Fort Hood, suggests political correctness

was at work in the Pentagon.)

The riots and ghting in Yemen have been widely scattered. However, now

that top ocials in the government and army have deected to the rebels, the

Saleh regime is probably doomed.

No one has more than a vague idea what kind o regime will ollow. Yemenlacks, as Friedman notes, the national bonds o which a consensus can be

orged.

Should we rejoice in another triumph o the human spirit, or should we

prepare or new waves o well-nanced and well-coached jihadists across the

West?

As in Libya and Egypt, the ultimate victors in some o these seeming

eforescences o political reedom could be rigid Islamists with a tendency

toward terrorismand suppression o women, Christians, and other

presumed perils or public purity.

Liberals (Girondistes and their allies) began the French Revolution. The

extremists (Jacobins) guillotined or expelled them and took over.

Liberals began the Russian Revolution. The extremists (Bolsheviks)

slaughtered them and took over.

Liberals began the Cuban Revolution against Battista. The extremists

(Communists) killed or imprisoned them and took over.

Liberals began the rebellion against the Shah o Iran, cheered on by, among

others, Jimmy Carter. The extremists killed or imprisoned them and took

over; thereater, they have had the time to torture their opponents beore

hanging themby the thousands.

Investors should assume that the Arab revolutions have only begun and the

potential or the kind o shocks, setbacks and disappointments that could

translate into impact on the global economy has only begun.

...the Arab revolutions

have only begun and

the potential or the

kind o shocks, setbacks

and disappointments

that could translate into

impact on the global

economy has only begun.


16/4012 March 2011



II. Japan: Was This the Tsunami That Ended Japans Triple Waterfall Crash?

The earthquakes and tsunami that hit Japan have caused the worst destructionsince Nagasaki, killed many thousands, and created the worst nuclear power

crisis since Chernobyl. The atershocks continue, with ve quakes o Force 6

or more within the past week. On Tuesday, Japans Premier summed up the

situation at Fukushima: We have no reason or optimism.

Faced with these continuing catastrophes, the Japanese daily display the

stoicism, sel-sacrice and unity that made the nation such a ormidable oe

in war, and, later, a ormidable global competitor.

The combination o a Force 9 earthquake and a gigantic tsunami has inficted

such widespread damage that investors can only guess at the costs. Thelatest published estimate o the reconstruction costs is at least $300 billion,

dwarng the nancial impact o any previously-recorded natural disaster.

The six nuclear plants that Tokyo Electric Power built so close to the ocean

whose ailure has transxed the world, are undergoing the long process o

being decommissioned and sanitized. There have been many setbacks, and,

as this is written, there are new radiation leaks and a new crisis at a reactor

that had been thought tamed.

And yet...

And yet, most likely, this disaster will ultimately live on mostly as the horrorstory that killed plans or atomic power plant construction in much o the

world.

However, the impact on the Japanese and global economy is severe. Reports

suggest that nearly 11% o all Japanese generating capacity is out o service.

According to The New York Times, the Greater Tokyo region that Tokyo Electric

Power serves represents one-third o the nations economic output. It quotes

an estimate that Japans 2nd Quarter GDP will contract by 3 %hal o

which comes rom the electricity shortageand that shortage wont end

soon. When summer air conditioning demand starts to build, blackouts

will intensiy. Astonishingly, an old rivalry between Tokyo and Osaka meansthat the two cities electric grids have diering requencies, so Osakas excess

capacity cant be used to ll the gap. Japanese industry uses less than one-third

o total Japanese demand. Manuacturers are getting together to pool their

demands, and one can be optimistic that the Japanese economy will muddle

through. The rage against Tokyo Electrics design and operating blunders that

have made a terrible situation worse will live long in a nation with amously

We have no reason or

optimism.


17/4013March 2011

long memories. (General Electrics share o the blame or design faws will

surely be considered in detail in the inevitable coming investigations. It was

cruel that GEs beleaguered CEO who has been presiding over the decay o

the House that Jack Built has been nicknamed Je Immeltdown. It doesnt

help his public image that the media are now publishing stories that GE pays

no US corporate taxes. The goodwill he built up with liberals or operating

the let o center MSNBC in a losing war with Fox News is evaporating.)

Investors seeking some potential opportunities amid all these calamities

might choose to look at these events in a dierent context: the tsunami came

almost exactly 21 years ater the Japanese stock market entered its Triple

Waterall Crash.

At the stock market peak, Japan seemed to many observers as a clear threatto the US rank as the worlds leading economy. But the 40-plus multiple on

earnings in an economy that had become the world leader in demographic

collapse was a mania that was destined to attenuate slowly and inexorably in

a seemingly endless bear market or equities and real estate. (Real estate and

stock values were interlinked: We recall asking clients in Tokyo in 1987 how

banks with tiny reported cash earnings were among the most highly-valued

in the world; the response was, that it was because o the value o their real

estate, which always rose in price.)

It was, in retrospect, a combination o the two manias that would devastate

the American economy rom 1997 to now, as Nasdaqs implosion was

switly ollowed by the real estate collapse that continues. (Last week, it was

announced that most US home prices were back to 2002 levels, with no sign

o bottoming.)

As readers o our book(The New Reality o Wall Street; 2005, McGraw-Hill)

know, we see Triple Wateralls as epic nine-year bull markets that eed on

themselves and keep rising to heights that would have seemed unimaginable

even in their mid-years. They are ollowed by a 21 year decline beore they

reach a new buying opportunity. By that time, virtually all the optimism and

shared belies o the inevitability o uture prots have been hammered into

the tur.

The commodity bull market began in 1971, and peaked in 1980, reaching

the depths o its Slough o Despond around the time o 9/11.

It was, in retrospect,

a combination o

the two manias that

would devastate the

American economy...


18/4014 March 2011



Tokyos P/E is roughly 8, an 80% drop rom its high. Last year, Japan lost its

multi-decade rank as the worlds second-largest economy.

Why should this be the bottom? Japans demography is vastly worse than it

was in 1989, and the compounding eect over the generations o its sustained

[in]ertility rate (1.3 babies per emale), combined with Japanese longevity

generates a sustained rise in what could be called its senility rate. (The rest

o the western world is closing the gap: Japans median age is 44.8 years,

Canadas 41, and the USAs 36.9. The gures or the emerging economies:

Indias 26.2, Chinas 35.5 and Brazils 29.3.)

Nikkei 225 Index

January 1, 2010 to January 28, 2011

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

Jan-81 Jan- 85 Jan- 89 Jan-93 Jan-97 Jan-01 Jan-05 Jan-09

9708.79

Crude Oil

March 31, 1983 to March 30, 2011

0

20

40

60

80

100

120

140

160

Mar-83 Mar-87 Mar-91 Mar-95 Mar-99 Mar-03 Mar-07 Mar-11

104.22

Gold

January 1, 1981 to March 30, 2011

0

200

400

600

800

1,000

1,200

1,400

1,600

Jan-81 J an-85 Jan-89 Jan-93 Jan-97 Jan-01 Jan-05 Jan-09

1424.50

Copper

Jan. 31, 1986 to March 30, 2011

0

50

100

150

200

250

300

350

400

450

500

Jan-86 Jan-90 Jan-94 Jan-98 Jan-02 Jan-06 Jan-10

427.15

... its sustained

[in]ertility rate (1.3

babies per emale),

combined with Japanese

longevity generates a

sustained rise in what

could be called itssenility rate.


19/4015March 2011

Japans governments have experienced, or most o the time during the bear

market, the kind o rapid turnover that made Italy a European embarrassment

during the decades beore Silvio Berlusconi entered politics. The one

interruption in this pattern o political utility was the Koizumi era: 2001-

2006. At the time, we wondered whether this uncharacteristically charismatic

leader would arrest the nations decline. But, like a meteor, he blazed and then

famed out, and the darknessand the stock market declineresumed.

The current regime is as uninspiring as its predecessors, and will soon

disappear, to be replaced by a cast o characters that will seem almost

undistinguishable rom their predecessors. The list o names o Japanese

premiers since the stock market peak is on the scale o the dramatis personae

o a production oThe Mikado. I there is to be a Japanese recovery that slays

the 21-year-old bear market, it wont be driven by the birth o a brand-new

political dynamism.

However, Japan is a nation o educated, energetic people who built their

economy on the basis o their competitive excellence. The nation is

commodity-poor, relying on imports o ood (other than rice), uels, iron ore,

and base metals, which means it is the most at risk among major economies

rom the commodities boom. Japans entry into World War II was, in large

part, driven by its leaders ear that the US Navy would choke o its imports

o natural resources, particularly oil.

So why should the bear die o old age?

Japans managerial and technological excellence, plus its reputation or the

high quality o its automotive, engineering and electronics products meant

that Japanese companies became erocious competitors in global markets

or consumer and capital goods, and much o that global perormance

survived the nancial and demographic declineand the rise o muscular

competition rom China and the Asian Tigers. With the rise o Taiwan, Korea

and China, leading companies adapted into the ad hocracy o Asian supply

chains. The importance o these hidden Japanese exports is being elt today,

as actories around the world slow down or shut down because o the cuto

o key Japanese intermediate goods.

The list o names o

Japanese premiers

since the stock market

peak is on the scale o

the dramatis personae

o a production o

The Mikado.


20/4016 March 2011



One obvious eect o the earthquake and tsunami is that the Bank o Japan

is injecting almost unimaginable levels o liquidity into the economyto

keep the nancial system intact and to oset the counterintuitive strength o

the yen:

Yen (vs. US dollar)

January 3, 2011 to March 30, 2011

78

79

80

81

82

83

84

Jan. 03 Jan. 17 Jan. 31 Feb. 14 Feb. 28 Mar. 14 Mar. 28

82.84

An economist noted last week that a side eect o the yens surge is that

the nations measured GDP increases in value. Since Chinas GDP growth

is slowing and Japans economic growth is bound to speed up during

reconstruction, he postulated that Japan might move backalbeit briefy

into the #2 slot in global GDP rankings. A statistical quirk, to be sure, but it

reminds us that Japan is still a big player globally.

At its peak, the multiple on the Nikkei was more than twice the multiple on

the S&P. Today, it is merely hal the S&Ps. That comparative multiple makes

sense only i one assumes that (1) Japan cant regain any o its past eminence,

and (2) the US has escaped rom its nancially-driven recession.

Although the problems besetting the Japanese economy are truly awesome, it

can be argued that, in comparison with the US, Japan has some advantages:

itspopulationis,onaverage,farbetter-educated.Exampleofeffectiveness

o education: in 2006, 126,800 Japanese patents were issued, whereas US

residents received roughly the same number as South Koreansaround

90,000.

...in 2006, 126,800

Japanese patents

were issued, whereas

US residents received

roughly the same

number as South

Koreansaround

90,000.


21/4017March 2011

after21years,itsrealestatebustisnolongeramajorchallenge,eitherto

the economy or the banking system, whereas the real estate bust in the

US seems to be in its middle phase, which means the US banking systems

pains and problems are likely to worsen substantially. Moreover, Japan

never got involved with mendacious collateralized mortgage products to

infate house values, while the balance sheets o major US banks still reek

rom those gigantic collections o rotting CDOs that cant nd buyers: the

supply o suckers to succor the big, bad bonused banks has run out. (As

this is written, demonstrators are picketing Bank o America across the

land demanding a halt to oreclosures. We share their disgust with the

complexand dangerousmortgage products inficted on uneducated

borrowers, and the near-raudulent roboloan oreclosure applications, but

wouldnt be prepared to bet on a satisactory outcome: Bank o Americamade the disastrous decision to buy Angelo Mozilos Countrywide, which

means large portions o its vast home loan portolio are at least as toxic

as the drinking water near Fukushima.)

JapanhasanagingproblemwhichtheUS(andEurope)willfaceincoming

decades, but its pension system is in vastly better shape, personal savings

are dramatically higher, and its public employee plans are in little danger

o becoming a painul burden or uture taxpayers.

theJapanesesuffertheproblemsarisingfromastrongcurrency,whereas

the US could very likely ace the problems arising rom a weak currency,as its economy struggles and its overall debt/GDP ratio deteriorates. One

oset to the problems o the strong yen: it somewhat osets commodity

price rises.

Japansnationaldebt/GDPratiois roughly twiceAmericas,but that

debtthanks to Japanese thritis nearly all held locally, whereas the

USthanks to its conspicuous lack o thritis dependent on large-

scale borrowings rom oreign governments. Washingtons debt strategy

recalls Blanche DuBois motto in A Streetcar Named Desire:I have always

depended on the kindness o strangers.

Insum,whenonecomparesthetwonationsonthebasisofpersonal,

business, nancial and governmental debts, Japans situation looks almost

bearable, but Americas doesnt.

So what is likely to happen to the Japanese economy ater the unerals are

nished, the nukes are nally sterilized and the national reconstruction

program gets under way?

Washingtons debt

strategy recalls

Blanche DuBois

motto in A Streetcar

Named Desire: I have

always depended

on the kindness o

strangers.


22/4018 March 2011



Thrit, Horatio, thrit: the uneral bakemeats urnished orth the wedding

supper.

That somewhat macabre appraisal sums up our view on what will happen

next to Japan. Its companies will recover and reprocess huge quantities o

scrap metals and building materials rom the rubble.

Hard work, national unity, stoicism, cooperation and quiet heroism will be

the bases o the post-unereal Japanese recovery.

Which leads to a strong argument or investing in Japan now: the image o

Japanese heroism and cooperation that is being shown daily on the television

screens o the world. Those pictures o the Japanese people under horrendous

pressures may be the best image o Japan ever broadcast across the world on

a sustained basis. Example: a US cartoon showed a man watching TV news.

He says, It will never happen again. His wie leans in and says, Another

nuclear disaster?Another nuclear disaster with no looting is his reply.

We have heard many Americans making similar comments. What we expect

next is benecial impact on the sales o Japanese consumer goods, along

the lines o, Gee, those Japanese are amazing! I used to think the Japanese

were pains in the neck. Now, I see how they work together under terrible

conditionsand wasnt it Washington that told me Chevys were saer than

Toyotas? For years, Consumer Reports kept giving Japanese cars great ratings,

but I kept Buying American. Maybe its time to buy a Japanese car.

Conclusion: when you can buy many o the worlds greatest companies at a

huge discount to the price o American companies, a value investor should

get very interested. A twenty-one year losing streak may be about to come to

an end. Ater all, when the 21-year commodity collapse ended, the ensuing

commodity bull market was tremendous. Yes, the comparison is a bit

stretched, to be sure, but Japan is coming backat least this year when that

$300 billion is spent on reconstructionand its selling at prices that assume

the Triple Waterall Crash will go on orever.

Why is 21 years so important in the Triple Waterall concept? It takes, we

believe, two decades to purge the economy o the excesses o major manias,

and a new generation o leaders must emerge, sworn not to make the mistakes

o their elders.

We do not argue that the end o the Triple Waterall means that the Nikkei

will soon be on its way back to 40,000. The population o workers, savers

and consumers o the Japan o 1989 has shrunk and that contraction will

Those pictures o the

Japanese people under

horrendous pressures

may be the best image

o Japan ever broadcast

across the world on a

sustained basis.


23/4019March 2011

continue. One actuarial orecast predicts that, based on recent trends, the last

Japanese will be dead by 2150.

All we suggest is that, with the Japanese stock market down 80% and, with

the earnings multiple o the companies that survived a record-long rout or

equities being at record lows compared to other advanced markets, Japanese

stocks have a good chance o entering a period o sustained outperormance

during the coming decade.

The earthquakes and tsunami that have come ater 21 years o an equity

bear market have surely added to the pessimism aficting Japanese equity

investors about the outlook or their own companies:

As each day we grow older,

And totter toward the tomb,

We fnd that we have lost all aith

That there could be a boom.

We fnd that we have

lost all aith

That there could be a

boom.


24/4020 March 2011



INVESTMENT ENVIRONMENT

The Pension Funding Problem

The US Pension Benet Guaranty Corporation, which insures private pension

plans, and the treasurers o most states in the union, have a similar problem:

ater a decade o zero returns on US equities, most pension plans are having

unding problems, and many will go bust.

Companies and state treasurers deend their plans by pointing out that no

one could have predicted such ghastly returnsthe previous two decades,

returns had been near 8% most o the time. Many plans still use those

duodecade returns in discounting their plans uture liabilities, as i the rst

decade o this millennium had never happened.

Some critics say that the plans should use Treasury yields to discount their

liabilities. That is out o the question: such pension puritanism would, in

most states, impose heavy, sustained burdens on local taxpayers, and would

be politically impossible.

Is the Lost Decade a fuke, or a harbinger o a coming Recession?

We think that the equity disasters o the past decade came rom the ailures

o the US business and economic models ater the Reagan boom. From

roughly 1992, the plunge in ertility rates had an increasing impact on the

population prole, as the US began to emulate the demography o Japan o

an earlier era. Secondly, by then, the impact o the long-term relative decline

in the perormance o the nations schools was beginning to impact the

nations competitive perormancea problem accentuated by the growth o

reer trade globally.

Americas glory years were, in considerable measure, due to the world-

beating perormance o its primary and secondary schools, which delivered

a well-trained population into the nations post-secondary systemand a

well-educated workorce.

Since 1975, American taxpayers costs or schools have skyrocketed, while the

relative perormance o their students in mathematics and science has steadily

declined. The New York TimesThomas Friedman and US Education Secretary

Arne Duncan routinely discuss the reality that, in an increasingly competitive

world, the economies o countries that educate their children better naturally

outperorm those whose educational systems dont deliver. (Friedman notes

that US schools couldnt even think o perorming at Singaporean levels,

although 40 years ago Singapore was poor and its education system was

nowhere near Americas.)

Many plans still use

those duodecade

returns in discounting

their plans uture

liabilities, as i the

rst decade o this

millennium had never

happened.


25/4021March 2011

To oset those two crucial components o American decay, the nation ell

back on (and ell with) two sadly misconceived boom strategies. First was

the tech boom that would supposedly make the economy grow orever and

deliver sustained double digit returns or investorsincluding pension

unds. Then came Techs Triple Waterall Crash, beginning in March 2000.

We have long reerred to the dot.com years between 1997 and 2001 as The

Years o Unmitigated Idiocy.

To our dismay and disbelie, a secondgreateridiocy was to ollow.

In the Bush era, the new engine o growth became home ownership.

Misunderstanding the nature o Margaret Thatchers brilliantly successul

program to transer ownership o council houses to their working class

tenants with modest government assistance, Bush went along enthusiastically

with Congressional Democrats like Barney Frank and their buddies Franklin

Raines and Jamie Gorelick at Fannie Mae, to pump up a real estate boom

that was bound to ail because the number o new qualifed home buyers

was, in percentage terms, well below that o earlier eras beore the baby

boom turned to bust. To make up or the inadequate number o rst-time

homebuyers with good jobs and educations, Wall Street and Washington

got together to create and nance millions o buyers who wouldnt have

qualied at any other time in the nations history. With such orce-eeding

o home hormones, the housing market became bloated with nancial

elephantiasis, rising to records both in absolute terms and in proportion

to personal incomes. Result: an even worse crash and a devastating blow to

pension unds investment returns. (As o last week, US house prices ell to

a nine-year low, and the supply o homes or sale and oreclosures climbed

anew.)

Even ater those two disastrous crashes, and amid evidence that the US economy

was losing ground globally, most pension und consultants kept advising

public und clients that their plans should continue to project uture earnings

at or close to 8%enough to keep the plans unding close to adequacy. Most

pension plans have been operated according to the Lake Wobegon ormula:

all o them will earn above-average returns in coming decades, so current

underunded levels would never be problematic. As David Brooks notes in

The New York Times, this smug complacency permeates much o American

society: most Americans, or example, rate their own public schools as above-

average (while giving poor marks to public education generally), and 94%

o American college proessors rate themselves as above-average lecturers.

(No wonder higher education costs rise remorseully in good times and bad:

With such orce-eeding

o home hormones, the

housing market became

bloated with nancial

elephantiasis...


26/4022 March 2011



there are only geniuses on sta, and they must get annual pay boosts above

the infation rateor they will deect to other universities!

Now that Congress has nally insisted on strict nancial reporting or states

or municipalities issuing new bonds, the ratings services and investors will

no longer have to rely on guesstimates. We expect a succession o horror

stories and nger-pointingand some disasters in the muni market.

The muni market, which sailed through the Crash, has been in tough

weather recently. Now that the media is reporting on the nancial problems

at the state and local levels, individual investors are exiting rom tax-exempt

bond unds. When this kind o herd ear takes over, even the best-managed

muniunds get hit with withdrawals.

Seventies Redux?

Last week, the US Producer Price Index reported the biggest jump in ood

prices since 1974, along with climbing uel prices.

Core infation remained subdued.

Nothing or anyone to worry about, right?

Except those with long memories.

Back in 1974, ood and uel infation set o serious infation, a recession anda deep bear market that took the Dow briefy to a 6 multiple.

The dierence between then and now is that those commodity costs were

passed through into the broad economy through automatic infation wage

boosts above those negotiated by the then-powerul unions, through Cost o

Living Allowances (COLAs).

This time the COLAs apply to government benets, such as Social Security, and

to some government union contracts, but not, in general, to compensation

packages across the economy. Since wage increases above productivity gains

constitute, (economists have long claimed), the major orce in cost o livingincreases, the $6.4 trillion question is, Will ood and uel infation be passed

through to wages?

We doubt that, and are thereore inclined to believe that infation isnt headed

or double-digit levels.

What about monetary infation? Is Milton Friedmans monetarism as dead

as its author?

Back in 1974, ood

and uel infation set

o serious infation, a

recession and a deep

bear market that took

the Dow briefy to a 6

multiple.


27/4023March 2011

The two Ayn Randian Pauls in Congress (Ron and his son, Rand) dont

think so, and they now have committee platorms to excoriate the Federal

Reservewhich they think should not exist. So they blame Ben Bernanke

and riends or $100 oil and $7 cornlet alone or $1400 gold.

They have a point: There is absolutely no doubt that excessive monetary

stimulus was a key ingredient in the runaway infation o the Seventies.

This time, the monetary expansions are vastly greaterand so are the scal

decits, which have the eect o putting money into peoples pockets that

tends to be spent ast.

In addition, the second-largest currency zone in the OECD is the Eurozone.

We have yet to see how the worlds rst currency to be issued not by a

government, but by a theory, will respond to todays infationary and

geopolitical stresses.

So why shouldnt infation be at Seventies levelsor worse?

1. Absence o COLAs.

2. Greater productivity gains: last year US productivity climbed 3.9% and

labor costs actually ell.

3. The success o WTO and other trade-expanding arrangements have reduced

global infationary pressures. In the OECD nations, the sustained growth in

imports rom lower-wage and more-productive economies has constrained

CPI growth.

4. Much weaker demography.

5. Todays and yesterdays deicits are yesterdays stimulus stories and

tomorrows defationary pressures as consumers and governments struggle

to meet the costs o past and present profigacy. In the words o Lady

Macbeth: Noughts had; alls spent.

ConclusionThe central bankers have enjoyed near-total reedom to print money at scary

ratesbecause o the scary recession and the ve actors listed above.

But we Friedman ollowers may have the last word. As he also said, Money

matters most.

But we Friedman

ollowers may have

the last word. As he

also said, Money

matters most.


28/4024 March 2011



The quantities o nancial heroin injected since mid-2008 have set the stage

or renewed stagfation.

And the big central banks are still reloading their hypodermics and rushing

to prevent their patients rom dropping over.

Add in ood and uel infationand rising prices or commodities

generallyand the likelihood o some wars somewhere, and you can count

on a CPI that reaches painul levels. It is unlikely to rise to a point within

view o the Seventies horror show14%but it will be serious enough to

crowd most other economic stories o Page One.

But theres another story that has potential infationary implications...

One youve heard rom us beore, but not or a while...

The Dark Side of the News About the Sun

As we have written many times in the past, the period o global warming

has been strongly benecial or production o most global crops. Why?

Because longer growing seasons almost always increase per-hectare yields,

and absence o rosts in the growing season means there are ewer shocks to

ood supplies.

That has been the case throughout human history. Modern seed technologies

can reduce the negative eects rom excess cooling, but total grain production

o the world has beneted hugely rom the recent decades o long growing

seasons.

I something happened to change the weather o the past 50 years and take it

back toward the growing conditions that prevailed or most o the years since

1300, then todays global ood crisis would look like a sustained picnic. As

clients know, we treated the sudden shrinkage o sunspot activity that began

in 2006 as the possible return to solar activity levels o much earlier times.

And, as we reported, those centuries were characterized by much colder

weather, killing rosts, and, in general, unreliable crop production.We have not been writing about sunspots recently, because the spots did

return ater a long absence, but their level o activity was so modest that we

werent sure whether that meant that we could expect urther global cooling

or wed be scooped by months o high-voltage solar activity.

Then, as the months went by and the sunspot score remained at pitiul levels,

we wondered how the scientic establishment would respond.

I something happened

to change the weather

o the past 50 years...

then todays global ood

crisis would look like a

sustained picnic.


29/4025March 2011

An international team o experts led by NOAA and NASA was convened in

2005 to predict sunspot activity going orward. The previous century had

been marked by the most vigorous sunspot activity on record, and scientists

expected yet another alltime peak in this cycle.

Based on centuries o data that meant the world was likely to get hotter,

because there has been a roughly 85% correlation between sunspot activity

and earth temperatures. Scientists are aware o the correlation, but they

decline to accept causality, because no expert has proved how sunspots aect

the climate. It may be coincidence, although they understand how they

can interere with electronic communications. The time-honored Farmer's

Almanac, on the other hand, has included sunspots in the actors they use or

their weather predictions, because whether scientists understand it or not,

the correlation exists.

Sunspot cycles last roughly 11 years, peaking in mid-cycle. The previous cycle

peaked in 2000, ending in 2008-9 with the longest stretch o zero spots in a

century.

The astronomers have been reworking their orecasts or this cycle in response

to the unexpected plunge in sightings. The shocker came on March 1 when

NASA announced, The predicted size would make this the smallest sunspot

cycle in nearly 200 years.

Two centuriesroughly the timespan used by the global warmists, who lay allthe blame on the human race or the temperature rise during that period.

As clients know, we have been skeptics about those doctrinaire claims and

projections. Why? Because we know a ew things about warmth and cooling

through history and they collectively suggest the sun itsel has more to do

with rising heat on earth than we do.

A new group o historians emerged late in the last centuryclimate

archaeologists. We are currently readingThe Little Ice Age, a splendid work o

history on Europe rom 800-1900. The author, an archaeologist at Berkeley,

recounts the remarkable change in European temperatures ater 800 A.D..

Temperatures rose smartly rom the mid-ninth century and stayed elevated

until 1300.

European populations nearly trebled in three centuries as growing seasons

lengthened, and more land was taken under cultivation. So rapidly did

economies improve that, or the rst time in the history o the Christian era,

there was substantial excess wealth generated routinely, along with rising


30/4026 March 2011



populations and urbanization. Result: the cathedral boom o the 11th to

13th centuries; during that time, most o the great cathedrals were begun.

Those public works programs created jobs or young men who were in excess

supply on so many peasants crots.

Ater that blessed period o history, the weather changed sharply. Seemingly

endless rains during the growing seasons year-ater-year destroyed or weakened

crops. As the population became weakened by starvation and disease, its

resistance to epidemics collapsed. The Black Death hit Europe our decades

into the cold, wet era, but typhoid and other killers kept coming too.

One o the ew pleasant aspects o those cold, low sunspot centuries: winter

skating parties on the Thames became the rage until the sunspots came back

in orce, and, by coincidence or not, the world warmed up again in the 19thCentury.

We have included charts or those who are interested in this subject and have

more material on our website.

Our take: based on uncontradicted evidence over a millennium, this collapse

in present and projected sunspot readings suggests that we may have entered

a prolonged period o global cooling. We may not know whether it is a

serious threat to agriculture in northerly climates or a ew years. We can

certainly predict that winters will be colder and wetter than the average o

the 1990s, and the threat o late and early rosts in northern growing areaswill intensiy.

The investment thesis is that unexpectedly cold weather during the growing

season in any o the major crop-producing regions would unleash one o the

most dramatic bull markets in history or corn, soybeans, and wheat.

The outlook or the agricultural stocks is splendid anyway. But unexpected

global cooling would destroy the amber waves o grain, while turning

agriculture stock portolios golden.

...unexpected global

cooling would destroy

the amber waves o

grain, while turning

agriculture stock

portolios golden.


31/4027March 2011

Allocations Change

US Equities 19 -2

Foreign Equities:

European Equities 3 unch

Japanese and Korean Equities 4 +4

Canadian and Australian Equities 6 -1

Emerging Markets 13 -1

Commodities and Commodity Equities* 13 unch

Bonds:

US Bonds 15 -2

Canadian Bonds 6 unch

International Bonds 3 -2

Infation Hedged Bonds 12 +4

Cash 6 unch

Recommended Asset Allocation

Capital Markets InvestmentsUS Pension Funds

Years Change

US 4.00 -0.50

Canada 4.25 -0.50

International 3.80 -0.45

Infation Hedged Bonds 5.5 unch

Bond Durations

Change

Agriculture 31% unch

Precious Metals 28% 1

Energy 24% +5

Base Metals & Steel 17% -4

Global Exposure to Commodity Equities

We recommend these sector weightings to all clientsfor commodity exposurewhether in pure commodity

stock portfolios or as the commodity component ofequity and balanced funds.

RECOMMENDED ASSET ALLOCATION


32/4028 March 2011



RECOMMENDED ASSET ALLOCATION

Allocations Change

Equities:

Canadian Equities 20 unch

US Equities 6 -2

European Equities 2 -1

Japanese, Korean & Australian Equities 7 +5

Emerging Markets 10 -2

Commodities and Commodity Equities* 13 unch

Bonds:

Canadian Bonds

- Market Index-Related 21 -1

- Real-Return Bonds 12 +4

International Bonds 3 -3

Cash 6 unch

Recommended Asset Allocation

Capital Markets InvestmentsCanadian Pension Funds

Years Change

US (Hedged) 3.90 -0.85

Canada:

Market Index-Related 4.00 -0.75

Real-Return Bonds 5.50 -0.25

International 4.00 unch

Bond Durations

Global Exposure to Commodity Equities

Change

Agriculture 31% unch

Precious Metals 28% 1

Energy 24% +5

Base Metals & Steel 17% -4

We recommend these sector weightings to all clients

for commodity exposurewhether in pure commoditystock portfolios or as the commodity component ofequity and balanced funds.

Canadian investors should hedge their exposure to the US Dollar.


33/4029March 2011

INVESTMENT RECOMMENDATIONS

1. In global equity portolios, cease underweighting Japan and move to above

market weight, emphasizing the great global brands.

2. The all o the Harper-led Conservative government in Ottawa is a reason

or concern or global investors, i a minority Liberal government relying

on a coalition with the NDP or Bloc Quebecois were to take its place. The

best outcome or investorsand or Canadianswould be a majority

government.

3. The outbreak o revolutions across the south o the Mediterranean took

investors minds o the problems on the northern shores, and the euro

climbed rom $1.30 to $1.42. However, the challenges acing the northern

tier o the sea are ar rom resolved. Portugals Socrates drank the politicalhemlock, but his resignation may well make the situation worse. Greeces

situation is deteriorating rapidly, and Spains cajas nances continue to

erode, weakening banks inside and outside Spain. Italy aces the return

o its historic poisonous political merry-go-round i Berlusconis record

run ends. He is, in essence, an arresting actor with the bella fgura charm

that Italians love; yes, he is a laughing stock in many quarters, but he has

been able to sustain or a record time the theatrical illusion o making

Italy look governable. His successors will probably not provoke laughter.

But the convention ocommedia dellarte is that when the laughter stops,

the tears begin... and the euro will go back on the critical list. UnderweightEuropean nancial institutions and euro-denominated debt in global

portolios. Emphasize exposure to Swiss rancs and Canadian dollars.

4. Investors should prepare or the strong possibility that nearly all the good

news rom the Arab revolutions has already come. No one oresaw these

dramatic developments. We suspect that, in the intoxicating atmosphere

o the collapse o autocracies, ew investors are preparing themselves

or the strong possibility o a succession o disappointingor outright

tragicoutcomes. Revolutions, as history teaches, devour their children.

Precious metals had been strong or a decade beore the Maghreb awoke.

Remarkably, they have risen only modestly since then. When the risks

across a great swathe o the world turn rom modest to serious, and the

potential or existential risk goes rom near-zero to moderate, precious

metals basic values become more apparent. Overweight precious metals

in commodity stock portolios, and include exposure in all balanced

portolios.


34/4030 March 2011



5. Agricultural stocks remain the commodities group with the best balance

o risk and reward among all the possible outcomes o the current crises

in the Mediterranean region and the Arabian peninsula. Even without

the possible eects o global cooling, ood and uel infation already

besets most o the world. Perhaps the only strong argument against

overweighting companies oriented toward global ood production is that

it is so obvious.

6. Triple-digit oil prices have returned, and pricing o oil production is

becoming near-chaotic, with widening spreads in prices between sweet

and sour crudesand the day-to-day pricing o political risks. The US

has been remarkably insulated rom the worst o the price increases, due

largely to its imports o Canadian oil sands products. The latte liberals and

their riends who have sought to block US imports o dirty Canadian oil

have suddenly become remarkably silent. Investors should overweight the

oil sands companies, and, or now, continue to emphasize oil and coal

in North American energy portolios. We believe that industrial clients

should be hedging against the remote risk o catastrophe in the Mideast

through purchase o ar out-o-the money calls on crude.

7. The US governments Export-Import Bank is heavily invested in low-cost

lending to Brazilian companies developing the deepest oshore oilelds

in the Hemisphere. Obama exulted in this cooperation in his trip to

Brazil last week. At some point, he may have to explain why he remainsso obdurate against drilling deepwater o US shores, and yet is willing to

let American taxpayers guarantee loans to develop Brazilian oil at much

deeper depths than in the Gul. With an election campaign now only a

year away, we believe he will, within months, proclaim a cease-re and

issue licenses or big new projects. Overweight oshore companies that

do not ace continued litigation risk rom Macondo.

8. Cicero lamented, The peoples memory is short beore he was garroted.

The nuclear power industry wishes he were right. Memories o Three Mile

Island and Chernobyl have been remarkably durable, but they were nally

ading when Fukushima imploded. Continue to avoid uranium stocks.

9. The global economic outlook which looked so promising in January

has darkened. Food and uel infation are combining to shrink or erase

consumers discretionary incomes. The eurozones internal ault lines are

re-opening; big banks in Europe and the US are once again paying bonuses

and dividends, but the question whether the mix o diseases gnawing at

the tissues in their portolios is merely debilitating or is potentially atal


35/4031March 2011

is being questioned anew. Investors arent ooled: the BKX and KRE have

been sharply underperorming, although nancial rms accounted or

nearly one-third o total US corporate prots in Q4. I the Arab revolution

story turns rom triumph to tragedy, much o the investor optimism that

ueled strong equity markets outside Japan could ade ast.

11. Base metals stand to benet near-term rom the rebuilding o Japan, but

thereater we expect scrap to compete with virgin metal as the recovery

continues. Weakening economic prospects rom emerging economies beset

with ood and uel infation and, at the margin, rom the OECD, will trim

previously-expected strong demand or copper and steel. Underweight

base metal stocks.

12. Just because Stagfation o Seventies proportions is only a remote possibilitydoesnt mean that meaningul stagfation-style damage wont be inficted

on bond portoliosparticularly those denominated in currencies o

grossly overindebted countries. We think the risk o a real stagfationary

bond bear has now arrived, and have thereore reduced recommended

bond durations. Unless the stagfation risk recedes, we shall be reducing

those durations urther in coming months. So should you.


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Coxe Basic Points March 2011