6.0 Poseidon Perspective June 2010

8/9/2019 6.0 Poseidon Perspective June 2010

1/17

THE

POSEIDON

PERSPECTIVE

soundnavigationthroughperilouscrosscurrents

29June2010

DearInvestor,

EquitymarketreturnsinMaywerea

wakeupcallthatallisnotwellinthe

globaleconomy.

The

markets

are

forward

lookingandhavealreadydiscountedwhat

isonthefrontpageofnewspapers.

Nobodyknowsexactlyhoweventswill

transpirebuttheamalgamatedwisdomof

themillionsofbrightpeoplewhoare

intimatelyinvolvedinthefinancial

marketsdayafterdaycreatesaforward

lookingdiscountingmachine. Thismaster

processorputsitspricestampona

multitudeofsecuritiesonadailybasis.

Whiletheremaybemanydaytodaymis

pricingsandaplethoraofnoiseandmis

information,timeisthegreatsteamroller.

TheresultsinTableAindicatethatthe

equitymarketssenseaserioushurdle.

TABLEAMay10 3Year* 5Year* 10Year*

DJIA

(7.92)%

(9.39)%

(0.64)%

(0.37)%

S&P500 (8.20)% (10.7)% (1.78)% (2.62)%Nasdaq (8.29)% (4.66)% 1.76% (4.02)%MSCIEAFE (12.1)% (15.5)% (1.32)% (1.69)%MSCIEM (9.18)% (2.99)% 11.1% 7.93%SSEC (9.70)% (14.2)% 19.6% 3.19%Gold 2.99% 22.1% 23.8% 16.2%

*calculatedascompoundannualgrowthrate(CAGR)

WereadTableAtoindicatetheserious

reconsiderationofequityvaluations. This

processis

taking

place

across

global

markets. Historicperspectivedeemsthe

Mayreversalsasanecessarycorrectionto

thebroadandrapidrunupofequity

pricesoverthepast15months. Thereare

numerousfactorsbothfundamentaland

technicalwhichareatplayinthemarkets,

greaterturmoilinEurocreditmarkets,the

suddenriseintheUS$,andgrowing

deflationaryexpectations. However,the

currentpriceadjustmentshouldnotcome

asasurprise.

CHART1 MEANREVERSION?

Source:PSI;StockCharts


2/17

THEPOSEIDONPERSPECTIVE 29June2010

InChart1welookattheNewYorkStock

ExchangeCompositewithunderlyingbar

chartofvolume(LHS)overthepastyear.

TherisethrumidApril2010wasnothing

shortofspectacular. Note,also,thateach

stepofthewaytherehavebeenserious

dipsasthestockmarketclimbsawallof

worry. WhilethedownticksfromAugust

thruNovember2009werehesitationsto

fullcommitment,thejarringdropin

Jan/Feb2010wasapointoftemporary

adjustmentpriortoearningsreports. This

respitefrommarketmomentumwas

overcomewithfurtherhighsintoApril

2010.

Nowwe

must

contend

with

the

marketstruemessage. Wemustalso

reiteratethatduringthesecorrective

respitestherehavebeennumerous

distributiondayswhichindicate

institutionalselling. Thehighshavebeen

reachedonlighttradingvolumeswhilethe

downdraftshavebeendrivenbyincreased

sharevolume.

CHART2 ANOTHERWORLD


Meanwhile,theChineseequitymarket

continuestostruggleinthefaceof

spiralingrealestatespeculation. Chart2

exhibitstheSSECwiththeGoldmanSachs

CommodityIndex(GEMIX)as

background. Theseriousbreakdownin

equitypricesisaccompaniedbyconcurrent

uncertaintyincommodityprices. Both

indexeshaveshownconsiderablevolatility

overthepastfiveyears. However,we

believethatthelongtermpathforbothof

theseindexesisup. Afurthercorrectionin

Chineseequitiesisbeneficialandwill

provideanexcellententryopportunity.

Chinahashitatumultuousperiodamidst

alongtermriseindevelopmentbutthe

countrywill

continue

to

be

amajor

force

in

globalgrowth. Asaresult,all

commoditiesincludingoil,metals,and

agriculturewillcontinueavolatilerisein

prices. Chinasdependenceonoilmimics

thatoftheUSandJapan. Industrial

developmentdemandsbasemetals. Weall

havetoeat.

Page 2

Volatility

is

synonymous

with

commodity

pricesduetosupply,demand,and

derivativemisalignments. Yet,commodity

pricescanrapidlyaccommodateinflation.

Weknownotwhen,perhaps24years,

inflationwillreturnwithavengeance.

Therewillundoubtedlybesome

slowdowninmanufacturingasChinas

centralbankreducesmoneysupply.

However,theequitymarketsmaybenefit

fromaproposed

residential

property

tax.

Inthelongertermwebelievethatthe

resolutionoftheChinapropertybubble

willbenefitbothequitiesandgold. The

pictureforcommoditiesislessclear. With

anyslowdowninChinesegrowththe

energy,metals,andagriculturesectorswill


3/17


Page 3

reflectthisdeclineingrowth. However,

steadyanddurabledevelopmentwill

meancontinueddemandforbasic

commodities.

SOUNDINGS

Foranindicationofwhatmanymoney

managershavebeendoingduringthis

timeofduressweturntothefeargauge

inChart3wheretheVIXisunderlaid

withtheS&P500(LHS). Thecomplacency

ofearlyApril2010withtheVIXinthe$15

17rangewasshatteredasmanagersbegan

arunforS&P500insurancewhichresulted

inaMay

explosion

to

$45.95.

The

surge

in

theVIXfromlateAprilthruMay2010

shadowsthepanicseeninAutumn2008.

Wefoundthismove,194%inamatterof

days,evenwiththeS&Ptumbling,tobe

extraordinary. Thishyperactiveresponse

wasexcessive. Anormalcorrectionof10%

intheS&Pshouldhavebeenexpectedat

anygiventime. Thus,thereactionspoke

volumesaboutthelackofconfidenceinthe

marketsabilitytomovetofurtherhighs.

Itwastheitchyfingerquickonthe

trigger. However,webelieveequity

marketsaredestinedtomoveloweruntil

theFedunleashesitssecondroundof

quantitativeeasing(QE). Untilthen,

volatilitywillreignwithshortralliesand

dramaticdeclines. Allequityholdings

includinggoldstockswillbesubjectto

massivepressures.

Investors

who

were

previouslypronetobuyandholdforthe

longtermwillnowrealizejusthowlong

thelongtermmightbe.

CHART3 FRANTICOSCILLATIONS



4/17


Forawiderviewofinvestorsentiment

towardUSequitieswereviewChart4

fromtheInvestmentCompanyInstitute

(ICI),

a

primary

resource

for

statistical

dataandresearchoninvestorsand

retirementplans. Actually,theICIisan

associationinWashington,DCwhich

representstheinterestsofmutualfund

companies. Thischartdepictstheflowof

fundsintodomesticequityfunds(LHS)

superimposedontheS&P500(RHSx10).

Aquickandsimpleconclusionisthatthere

isadirectcorrelationbetweenmoney

inflow/outflowand

the

rise/fall

of

the

S&P

index. However,closerexamination

revealsthatmostoutflowsoccurinthe

midstorafteradeclineoftheindex. To

wit,wereferencetheweekofMay24,2010

duringwhichaccountedforthelargest

YTDwithdrawal($13,443). Thisfollowed

uponthe(11.9)%drop(from1,217to1,072)

intheS&P500fromApril23thruMay23.

Clearly,

these

investors

were

running

behindthepack. However,ignoringthe

S&Ppricelineonecanconcludethat

investorsarebecominglessenchanted

withdomesticequitiesandare,therefore,

limitingriskexposurebyshiftingfundsto

otherinvestments. Thisoutflowoffunds,

fearfulofequityrisk,mustgosomewhere.

Mostinvestorsdreadthereturnsofmoney

marketandshortdurationbondsand

thereforeseek

the

higher

expected

returns

oflongerdurationbonds,international

equities,emergingmarkets,REITS,

commodities,andpreciousmetals. There

areopportunitiesandtherearepitfalls.

CHART4 THEEBBINGTIDE

Page 4

Source:InvestmentCompanyInstitute


5/17


Chart5providestheyieldson10year

(RHS)and2year(LHS)Treasuries. We

lookataspanoftenyearsinwhich

demandincreases,pricesrise,andyields

fall. Inthreeyearsthe2yearriskfree

returnhascollapsedfromanannualreturn

of6%toameager0.65%. Accordingto

governmentstatisticsthisisanegative

realrateofreturn. Thus,itisacostto

investmoneyintheshortterm. Current

monetarypolicyandthefinancialsystem

penalizeprudenteconomicbehaviorand

endorsetheflighttoriskyassets.

Coincidently,whilethespreadallows

continuedrebuildingofbankbalance

sheets,shorttermratesmaybeasignof

systemicdeflation. Continued

deleveragingbyconsumersandbusinesses

mayeventuallydemandthecapitulationof

allmarginaldebtholdersincludingstates

andmunicipalities. Priortosuchadrastic

destructionofcreditthecentralbankwill

printmoney,inextremis.

CHART5

MAINTAININGTHESPREAD

Source:

PSI;

StockCharts

WEATHERWATCH

Page 5

OurcontentionisthattheUSeconomyhas

beensupportedoverthepast2yearsby

thetaxpayerthruthelargesseofFederal

governmentstimulusandFederalReserve

Systemmonetarypolicy. Theircombined

effortshavepumpedtrillionsofdollars

intothehandsofconsumers,bankers,and

corporations. Thefiscalmovesinclude

cashforclunkers,homebuyertaxcredit,


6/17


subsidiesforenergyefficientappliances,

andtheremainderofa$787billion

stimulusprogram. Monetarypolicyhas

providedtheliquidityandsubsidyto

supportmajorbanksandfinancial

institutions. Whilewewillnotdwellon

thefollyofthepastwearemostinterested

inthepathforward. Forthisexercisein

criticalprognosticationwelooktothe

thoughtsofthosewhoattendtothelevers

ofpolicyanddecisionmaking. Welook

firstforanewincreaseoffiscalstimulus

and,thenthetrajectoryofmonetarypolicy.

LawrenceH.Summers,Directorofthe

NationalEconomic

Council

(NEC),

spoke,

May24,2010atJohnsHopkinsSchoolof

AdvancedInternationalStudies. He

astutelynotesthatwearenearly8million

jobsshortofnormalemploymentand

about$1trillionshortoftheeconomys

potentialoutputandincome. These

conditionsconstituteaneconomic

emergency. However,thingsgrowmore

complex

as

the

economy

faces

a

liquidity

trapandwhentheFederalReserveis

constrainedbyazeroboundoninterest

rateswhenthefinancialsystemis

functioningimperfectlybecauseofcredit

problems.Becauseofoverleveraged

borrowersfiscalstrategyhastobedoing

everythingwecantoensurerecovery. In

thesefewwordswereadthatfurther

stimulusisontheway. Thedetailswill

onlybe

known

after

the

fact

but

the

intentionisclear. Inordertoresolvethe

argumentagainststimulusduringtimesof

astronomicalbudgetdeficitsSummers

reasonsthatwearecurrentlyinaposition

wheredeficitreductionwillstemfromthe

economysreturntogrowthandphasing

outofRecoveryActprograms. Thus,he

understandsthatwemustrecognizethat

thecurrentprojectionssuggestthe

preponderantprobabilitythatmajor

changesaffectingthewaygovernment

spendsandcollectsmoneywillbe

necessary Soheclearlyinvokesthe

solutionundertakenbyPresidentObama

whohasconvenedabipartisan

commissionwithamandatetoproduce

recommendationstocoverthecostsofall

federalprogramsby2015andto

meaningfullyimprovethelongrunfiscal

outlook.

Page 6

Weunderstandtheforcesatplayandwe

attempttoreadbetweenthelinesofMr.

Summersthoughtfulexpressionsonthe

importanceofthesituation. Our

understandingofintentisclear. The

DirectorNECclearlyintendstopursuethe

pathofleastresistancewhichinthe

continuingeconomiccrisisistospendas

much

and

as

long

as

possible

until

the

repercussionsandunexpected

consequencesbringthepoliticalprocessto

acompletestalemate. Thisisasadstateof

affairs. WhileSummersadvocates

spendingintheshorttermwitheconomic

prudenceandrestorationinthelongterm,

thegovernmentisverylimitedinhowit

willeventuallyfundtheincreasingand

untenabledeficits. Theoptionsare

taxation,continued

issuance

of

debt,

and/ormoneyprinting. Thus,sooneror

later,theUSeconomywillfaceasevere

slowdownduetoincreasedtaxes,

skyrocketinginterestratestoattract

necessarydebttocontinuefundingFederal

programs,and/orgrowinginflation,


7/17


potentiallyhyperinflation,asthedemand

forUS$sdropsduetoincreasingsupply.

Whilethetimingandamountofstimulus

havenotbeendetermined,thereislittle

doubtthatCongressandtheTreasurywill

feelcompelledtodosomethingtoalleviate

thehorrificunemploymentandlackof

economicgrowth.

TheFederalReserveSystemisnothobbled

byplebianpolitics. TheFedisabletoact

quicklyandforcefullyastheFedOpen

MarketCommittee(FOMC)seesfit. Yet,

traditionallytheFedhasbeenveryastute

inthe

political

arena.

For

years

their

purposefullackofregulatoryoversight

placatedCongressandtheabettedthe

growthatmortgagemoneymachines,

FreddieandFannie. Webelievethatthe

Fedisalsoquiteadeptatsignalingits

intentionsclearlytothemarketsinorderto

maintainorderlytransitionsalongthe

interestrateandmoneysupplycurves

except

during

the

most

tumultuous

markets.

WereviewarecentmissivebyGlennD.

Rudebusch,TheFedsExitStrategyfor

MonetaryPolicyinTheFRBSFEconomic

LetterdatedJune14,2010. Wesidenote

thatJanetYellenisPresident,Federal

ReserveBankofSanFranciscowhereMr.

Rudebuschisemployed. SheisPresident

Obamasleading

contender

for

Vice

ChairpersonoftheFedBoardof

Governors. Thiseconomicmissive

describesthevariousconsiderationsin

formulatinganappropriatepolicyexit

strategy. Thisexitisdeparturefromthe

Fedsunprecedentedmarketinterventions

andmonetaryactionsoverthepastthree

years. Thethreemostimportantactions

are1)theFedsprovisionofanenormous

amountofliquidityinordertocombat

panicanddislocationinthefinancial

markets,2)thereductionofthefederal

fundsinterestrateitsusualpolicy

instrumentessentiallytoitslowerbound

ofzero,and3)itsunconventionalpolicy

toolpurchasesoflongertermsecurities

whichledtoanenormousexpansionofits

balancesheet.

TheFedssuperabundanceofliquidityhas

ceasedas

banks

and

industry

have

been

rejuvenatedwithFedprogramsand

backstops. Endingtheseprogramshas

beenstraightforward. Thereductionof

interestratesisastickierproblem. In

Chart6weshowMr.RudebuschsFigure

3whichexplainsvariationsonthetheme

ofFedpolicy. HestatesthattheFeds

TargetRateisfoundfromtheSimple

policy

rule

regression:

Feds

target

=

2.1

+

1.3xInflation2.0xUnemploymentGap.

Asisclearlyshownthiswouldresultina

negativenumber. However,whiletheFed

cannottargetnegativeinterestrates,

prudentsaverssufferfromtheirexistence.

Anybasicmoneymarketaccountnow

payslessthantherateofinflation,thus

providingnegativerealrateofreturn.

Page 7

Thedash

line

reflects

the

FOMCs

median

economicforecasts(FOMC2010)which

predictslowlyfallingunemploymentand

continuedlowinflation. Thus,thegraph

isindicativeoftheFedsforwardlooking

policyguidanceandincludesinterestrate

policyofnearzeroratesuntillate2012.


8/17


Whileavarietyofcomplicationsare

ignoredinthesimpleanalysisthereexists

thegreaterriskassociatedwithraising

ratestooearlyand,therefore,suggests

postponinganinitialincreaseinthefunds

raterelativetothelinesinFigure3.

However,theFedsunconventional

monetarypolicyhasprovidedadditional

stimulustotheeconomy. Thisinhibitsthe

effectivenessofconventionalpolicy,which

istochangetheFedfundsrate. The

impactofchangesinthelongterminterest

rate,duetoQE,hasmuchlargereffects

thanequalsizedchangesinshortterm

interestrates.

After

consideration

of

these

factorspolicyshouldreflectthatthe

recommendedperiodofanearzerofunds

ratewouldendatthebeginningof2012.

CHART6 WHERESHOULDWEBE?

Source:Rudebusch,FRBSFEconomicLetter

RudebuschgoesontoaddresstheFeds

strategyforreturningtheleveland

compositionofitsbalancesheettopre

crisisnorms. Henotesthatamajorityof

theFOMCpreferredbeginningassetsales

sometimeafterthefirstincreaseinthe

FOMCstargetforshortterminterest

rates. Thisdegreeoflassitudewitha

balancesheetwhichisthreetimesits

historicalsizeissupportedbythelackof

inflation. WenotewellRudebuschs

secondreferencetoJapaninthisshort

essay. HestatesthatThisinsensitivityof

inflationtoanenlargedcentralbank

balancesheet

is

consistent

with

Japans

decadelongspellofpricedeflation.

Whilenotpursuingthepossibilityof

similardeflationintheUSeconomy,

Rudebuschaddressesthepotentialeffects

ofariseininterestratesontheenormous

amountandlongdurationofsecuritieson

theFedsbalancesheet. Theproblemof

Fedlossesduetoariseoflongterm

interest

rates

is

mitigated

by

access

to

an

indefinitestreamoffutureearningsfrom

assetsboughtwithcurrency(thatis,

seigniorage). Thisisaclearreflectionof

ChairmanBernankesprintingpress

stratagemforfightingdeflation. Weterm

itthemoneyprintingoption. In

summaryweread,Itseemslikelythatthe

Fedsexitfromthecurrentaccommodative

stanceofmonetarypolicywilltakea

significantperiod

of

time.

Page 8

ThisletterandotherFedspeechesand

publicationsdemandthecontinuationof

ZeroRateInterestPolicy(ZIRP). OnJune

23,2010theFOMCissuedthefollowing

statement:TheCommitteewillmaintain


9/17


thetargetrangeforthefederalfundsrate

at0to1/4percentandcontinuesto

anticipatethateconomicconditions,

includinglowratesofresourceutilization,

subduedinflationtrends,andstable

inflationexpectations,arelikelytowarrant

exceptionallylowlevelsofthefederal

fundsrateforanextendedperiod. We

alsobelievethattheFedwillnotshrinkits

balancesheetbutwillresumethepurchase

ofsecurities,moreQE,inauniquely

unconventionalmethodology. The

growingindicationsofdeflationarestrong

enoughthattheFedwithTreasurysupport

willnot

be

inhibited

in

their

effort

to

re

igniteinflation. Throughoutthisprocess

therewillbeanintenseefforttokeeplong

termrates,whichhavetraditionallynot

beenthebailiwickoftheFed,under

control.

CHART7 DRIFTINGDOWN

Source:St.LouisFed

Page 9

InChart7wenotethesuddengrowth,

peak,andincipientdeclineoftheAdjusted

MonetaryBase. Thepathisclear

affirmationoftheFedspolicyofQE. We

harbornodoubtthatitscontinuingdecline

willtriggermoremonetaryfuel. The

moneysupplymustexpandovertimeto

meettheneedsofagrowingeconomy.

Theboomingincreaseexceeding150%in

themonetarybasefrom2008untilrecently

wastheFedssuccessfulactiontoprovide

liquiditytothefinancialsystemand

maintaincommandofinterestrates. The

endofQEhasresultedinadropoffthe

monetarybase

as

can

be

seen

in

Chart

7.

TheUSeconomyisintheuniqueposition

where,inspiteofunprecedentedfiscal

deficitswhicharebeingmonetizedbythe

Fed,bankshavebeencontenttoholdthis

moneyasreserves. Theresulthasbeena

caponinflationandinflationary

expectations. However,accordingtothe

calculationsofShadowStatstheFedhas

not

been

successful

in

the

increase

of

the

broadermoneysupply,M3. InChart8,

weseethatthethreemeasuresofmoney

supplyareindecline. Thisisone

consequenceofretrenchmentby

consumersandbusinessafterthecredit

bubblecollapsein2008. Thebroadest

measureofmoneysupply,M3whichisno

longerreportedbytheFed,revealsthelack

ofdemandanddwindlingsupplyofcredit.

Thesimple

explanation

is

that

the

US

economyhasenteredaperiodof

deleveraging. Thisperiodofincreased

savingsanddebtreductionmayproducea

deflationaryspiral. Thenewfrugality

leavesthefederalgovernmentasconsumer

oflastresort. Evengovernment,atall
http://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASEhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASEhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASEhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASEhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASEhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASEhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASEhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASEhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASEhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASEhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASEhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=BASE


10/17


levels,islookingtobegincutbacksdueto

massivedeficits.

CHART8 PLUMBINGTHEDEPTHS

Source:ShadowStats

Thiscontinuingdeflationarysignalwillnot

betoleratedbyChairmanBernankes

FOMC. Webelievethistobefurther

evidencefor

our

thesis

that

the

QE

exercise

isnotover. Atsomepointinthenear

futuretheFedwillresumeitsmoney

printingoperations.

PROVISIONING

Werecapourcurrentmarketthesisin

threebriefstatements,1)theequity

marketscontinuetoshowextreme

vulnerability

and

little

potential

upside

for

theremainderof2010andinto2011;2)the

continuingeconomicslumpdemands

continuingfiscalstimulusinspiteofsevere

budgetandfinancialconstraints;3)since

theZIRPisnolongeraneffective

mechanismformonetarystimulus,a

renewedexerciseinQEinsomeformmust

resume. Thefightagainstdeflationary

forcesmaytake12yearsormorebut

eventuallyitwillleadtoseriousinflation.

Thebestprotectionagainstthedestruction

ofwealthbyinflationishardassets,real

estate,art,diamonds,commodities,and

preciousmetals. Forseveralreasons,at

thistime,weprefergold.

WebeginourgoldupdatewithTableB

whichsummarizesthetotalholdings,gold

reserves,andchangesfor10countries.

InformationisfromtheWorldGold

Council(WGC),

World

Official

Gold

Holdings,June2010andIMFInternational

FinancialStatistics,December2009. As

introductiontheWGCestimatesat3Q2009

thatthereareglobalfundsunder

managementofUS$81.5trillion. The

amountingoldisabout1%. Theyalso

estimatethatabout10%ofglobalcentral

bankreservesareasgold.Duringtherun

up

in

financial

paper

assets,

the

period

19952000,severalcentralbankschoseto

reducetheirgoldreserves. Wenotethe

followingexamplesintermsoftonnage,

Switzerlandfrom2,590.2to1040.1,a

reductionof59.8%;Britainfrom588.3to

310.3,areductionof47.3%;Netherlands

from911.8to612.5,areductionof32.8%.

Morerecentlywenotethepurchasesof

goldasreservesbyChina,Russia,and

India.

Thesecountries

have

very

high

and

growingTotalReserves;yet,rankamong

thelowestinGoldas%ofReserves.

Page 10

Thesepurchasesaresignificant;notdue

merelytotheirsizebuttheirexplication

whichrefutesthecommonlyassumed


11/17


Page 11

axiomthatcentralbankswouldnolonger

bebuyersofthisbarbarousrelic. With

theprofusionofmoneyprintingacrossthe

globethemostprudentcentralbankersare

nowbuyersofgold. Manycountriesin

additiontothelargebuyersofgoldhold

aninordinateamountofUS$sintheir

reserves. Theanomalyamongtheseis

Japan,forreasonsthatwedonotknow,

otherthanitslongtermeconomicsupport

fortheUSasexportmarketandmilitary

protector. Whencentralbankschange

reservestrategytogold,theimpactistwo

fold. Theincreasedemandisexacerbated

bydecreasingsupplyastheyarenolonger

sellersofbullion.

TABLEB CHANGINGRESERVES

Reserves Total Change Change

Gold Reserves GoldValue Gold% 1Q2008 1Q2008

(tonnes)* US$Million US$Million Reserves (tonnes) (%)

1.USA 8,133.5 $408,182 $291,702 71.5% 0 NA

2.Germany

3,406.8

$182,387 $122,182 67.0% (10.6)

(0.3)%

3.Italy 2,451.8 $133,105 $87,934 66.1% 0 NA

4.France 2,435.8 $135,416 $87,344 64.5% (132.5) (5.2)%

5.China 1,054.1 $2,501,346 $37,804 1.5% 454.1 132.0%

6.Swiss 1,040.1 $161,793 $37,302 23.1% (73.1) (3.4)%

7.Japan 765.2 $1,042,715 $27,444 2.6% 0 NA

8.Russia 663.8 $447,123 $23,806 5.3% 206.8 45.3%

9.India 557.7 $281,397 $20,003 7.1% 200.0 55.9%

10.SaudArab 322.9 $431,401 $11,581 2.7% 0 NA

Source:

WGC;

IMF;

PSI

*Troytonneis31,151troyounces;valuationsarebasedonpriceofUS$1,115;errorsareduetorounding

Themostinterestingcaseconcernsthe

activitiesofSaudiArabiawhichmadea

substantialpurchaseof180tonnesin

4Q2007. Thismoveincreasedtheir

holdingsfrom143to323tonnes,an

impressive130%. TheSaudiArabian

MonetaryAuthority(SAMA),thecentral

bank,reported

the

purchase(s)

of

180

tonnesfrom4Q2007and1Q2008. The

announcementbytheWorldGoldCouncil

andareportinthe21June2010Financial

Timesreflectanactivitywhichallegedly

occurredmorethan2yearsago. SAMA

refusestocommentandnotedinitsmost

recentreportthatthechangewasan

adjustmentofaccounts. Nomatterwhat

theactualfactsaretherevelationis

substantialevidenceofmarketinefficiency.

Withoutaccurateandtimelyinformation

thegoldmarketremainssubjecttothe

jurisdictionglobalplayersandopaque

operations.

However,these

attributes

availinvestorsanopportunityforout

sizedgainsinatruestoreofwealth. We

believethatthefunctionofgoldasa

reserveassetisonemajordriverfor

increasingdemand. However,giventheir

conservativenatureandbureaucratic


12/17


structurethisisaslowprocesswhichmay

takeyearstoplayout. Additionally,asin

thecaseofSaudiArabiasaccumulation,

theflowofinformationislikeanoilslick,

slowandopaque.JohnHathaway

manageroftheTocquevilleGoldFundin

aninterviewwithKingWorldNewsstated

thatThekeytothewholestoryisthatthe

capacitytoabsorbcapitalflowsbyphysical

metalisextremelyconstrained. He

expandedbynotingthatgoldisavery

limitedmarketwithexplosiveprice

potential.

CHART9 GOLDVSSPX,ORROCKVSPAPER


Ifapictureisworthathousandwords,

thenChart9isworthafewminutesof

study. Theredblackline(RHS)istheratio

ofgoldpricetoS&P500Index(GOLD:

SPX)andthesolidblackline(LHS)isthe

S&P500.Hereweseethedemiseofgoldin

relationtothestockindexover20years,19812001. Fromitspeakpriorto

ChairmanVolkerbreakingthebackof

inflationtheratiodroppeddramatically

until1988. Thiscollapsewasfollowedbya

continuingdeclineuntil2001. Thisperiod

wastheprosperitywhichblossomedunder

theeasymoneypoliciesoftheGreenspan

greatmoderationalsoknownasthe

goldilockseconomy. AftertheTMT

collapsein200001goldbeganastealthy

riseinrelationtoequities. Thishas

continuedthruanotherstockmarketcollapseandtheendofthelargestreal

estatebubbleinUShistory.

Page 12

Sowhereisthelongtermmeanforgoldvs

USequities? Itisnot7.0andcertainlynot

0.5. Ataconservativeestimate,theratioof


13/17


2.5,pricesmustadjustfromthecurrent

baseline. EithertheS&P500mustfallto

502.3(1,255.7/2.5)orgoldmustriseto

2,691.8(2.5x1,076.8),orbothpricesadjust

withinthisrange. However,sincewe

assignavery,verylowprobabilityofthe

S&Pdroppingbelow600,wearriveata

baseforgoldof1,500(2.5x600). Onemay

arguethatourchosenratioistoohigh. We

adjusttoaverymoderate1.7,thelowest

ratiopriortoMr.GreenspanasChairman

oftheFed. InthisinstancetheS&P500

mustfallto738.64(1,255.7/1.7)orgold

mustriseto1,830.49(1.7x1,076.76),or

onceagainpricesadjustwithinthisrange.

Thesimplefactisthatgoldwhenpricedin

relationtotheS&P500iscertainlynotina

bubblephase. Secondly,thesearelong

termcycles,eventsunwindslowly. We

willreconsidervaluationparameterswhen

thegold/S&Pratiosurpasses2. Doingthe

mathissimpleandstraightforward.

CHART10 ELEVATEDBYCHEAPMONEY


Page 13

InChart10wereviewthe20yeardecline

inyieldfromthe10YearTreasury(solid

blackline,LHS)inconjunctionwithgold

prices. ThebullmarketinTreasurieshas

followedthejaggeddownwardpathof

yieldfromabove8%in1990tothecurrent

3.12%.Eventhisabsurdreturnonaten

yearcommitmentallowsfora2s/10s

spread,withthe2yearTreasuryat0.65%,

of247basispoints. Thus,banksborrowing

attheevenlowerFedFundsRateareable

toarbitragesteadyreturnsofalmost3%.


14/17


Thisinterestrateenvironmentisvery

supportiveofgold,preciousmetals,and

hardassetsingeneral. Shorttermreal

interestratesarenegative. Lookatthe

risingpricesforlargediamondsand

Picassopaintings. Thecostofcarryfor

goldandcommoditiesisatitslowestin20

yearsexceptforthebriefpaniccausingthe

creditfreezein200809.

Whiletherearenumerousmetricsinthe

pricingofgold,partofthevaluationis

sweptupwardbythegeneralcarrytrade

usingUS$s. Ultralowinterestratesfor

longperiods

will

accelerate

the

rise

in

gold

asseeninthepricerisefrom2003,at

$320/ounce,tothecurrent$1,255. There

willbecorrectionsalongthewaybutuntil

theinterestrateonthe10yearbondis

above5%goldwillprosper.

Lastly,welookattheAugust1999price

surgeingoldwhichexceeded20%. This

was

brought

about

by

the

announcement

thatsixteencentralbankscommittedto

newlimitationsingoldsales. Thisnews

hadaswiftandsubstantialimpacton

prices. Thisisanotableindicationofwhat

canhappenonnewsofchangeincentral

bankandsovereignfundreservepolicy.

However,inthiscasethenewswassoon

forgottenandthegoldpricedriftedlower

toreachadoublebottominearly2001.

However,from

that

point

gold

began

its

longtermrise.

Normally,thepriceofgoldfollowsan

inverserelationtothestrengthoftheUS$.

Chart11surveys10yearsofgoldprices

(solidblackline,LHS)incomparisontothe

US$Indexonaweeklybasis. Since

December2009goldhascontinuedto

climbinthemidstofaUS$rally. We

believethatUS$devaluationisessentialto

risingequityprices,easingofdebt

burdens,andcontinuingsupporttoUS

moneycenterbanks. Thus,theFedwill

supportaweakerUS$. TheFedZIRPis

essentiallyapolicyoffreemoneywhich

supportsavarietyofalgorithmdrivenand

profitablecarrytradesfundedinUS$s.

Additionally,therearenumerousother

worldeconomies

which

hide

under

the

wingoftheUD$fromthosewithpegs,

suchasHongKongandChina,tothose

withactiveUS$blackmarketssuchformer

Communistbloccountriesandpartsof

LatinAmerica. Thecultureofthese

countriesvaluesgoldasastoreofvalue,

yettheypreferUS$sasacurrency.

Obviously,theyareabletoseverthe

connection

that

one

artifact

must

serve

bothfunctions.

Theriseingoldoverthepastfiveyearsisa

reflectionofthepotentialdiminutionofthe

US$astheinternationalreservecurrency.

HoldingsofUS$foreignreserveshave

grownfrom$2trillionto$8trillion. This

growthof14.8%(CAGR)astheprimary

reserveassetreflectsthegrowthinthe

priceof

gold,

16.2%

Table

A,

over

the

past

10years. Weopinethatthereserveroleof

theUS$willcontinuetodeclineascentral

bankspursueadiversificationprocess

whichincludesgold.

Page 14


15/17


CHART11 CHOPPYWATERS


Webelievethattheunsustainabledebt

growthwillreachaninevitableconflict

withthedemandfornewausterity. This

willoccur

in

the

US

at

both

the

state

and

federallevelsofgovernment. Asaresult

theFedwilloptforthesteadyinflation

optionfordealingwithgovernmentdebt

burdens. UnderthisscenariotheUS$

maintainsitsvalueasmediumof

exchange;however,itisnolongeravalid

storeofvalue. Whiletheriseingold

overthepast10yearsat16.2%perannum

(see

Table

A)

is

substantial,

we

believe

that

duringthenextdecadethisrapid

appreciationwillbeexceededwhenthe

goldmarketentersthethirdstageofthe

currentcycle. Thecontinuingriseofgold

willbedrivenbyaconfluenceoffactors

whichincludethefollowing1)the

continuinglossofvalueintheUS$,2)

continuinglowinterestrates,3)increased

volatilityandweaknessintheequity

markets,4)

increased

volatility

in

currency

markets,5)increasedpublicrecognitionof

goldasanalternativestoreofvalue,thusa

viablecurrencyandinflationhedge,6)a

decliningsupplyofbulliontomeet

increasingdemand,and7)increasing

sovereignclaimsoverresourcesextraction.

Lastly,wemustalsoponderthedownside

of

owning

gold.

Where

is

the

risk?

We

noteseveralbasicfactorswhichnegateor

alleviatetheinvestmentrequirementfor

preciousmetals.

Page 15

1)Goldproducesnocashflow. Thus,

thereisacosttocarryandproblematic


16/17


valuation. Theonlyreturnoninvestment

ispriceappreciation.

2)Duringtimesofstablemoneyand

economicgrowththereturnsongoldwill

berelativetosupply,costofproduction,

anddemand. Hence,returnsmayonly

tracknominalinflationwhilethecarry

costscontinue.

3)Substantialriseininterestrateswould

bedetrimentaltogoldasalternatives

financialassetsprovidegreaterrelative

returns.

4).Generalpeaceandprosperityare

detrimentaltogold. Unfortunately,gold

prospersunder

uncertainty

and

fear.

Duringtimesofgrandelationandrising

equitymarketssuchastheroaring90s(see

Chart7),goldstaggersinneglect.

5)Astrongandstablebankingsystemis

anathematopreciousmetalsandhard

assetsingeneral. Whenpapermoney

retainsitvalueasastoreofwealthandis

notsubjecttodestructionbyinflation

preciousmetalsbecomebaubles.

6)Finally,therearetaximplications. Gold

isconsideredacollectibleandtherefore,

gainsongoldinvestmentaretaxedat

regularincomerates.

Ourcurrentinvestmentregimeisa

modifiedbarbellstrategy. Thebellsconsist

of30%cashand30%goldwithsilver;and

the40%

bar

is

built

with

diversified

bond

funds. Thefundsaredistinguishedby

managementexpertise,diversified

holdings,andlowduration.

OnJune11,2010wesatdowninfrontofthecomputertocatchthemorningopenoftheUS

equitymarkets. IthadbeenagoodweekastheS&Pstruggledbackfromthesmackdownof

thepreviousweek. Wewerelookingatthepotential4%gainovertheweek. WasMaya

fluke? Weturnedtogoldanditwasbouncingoff1,220. ThemovetoBloombergforNews

resulted

in

trivial

noise;

so,

another

click

takes

us

to

Bloomberg

Worldwide

which

we

quickly

desertfortheUKIndependentWorld. Funnyhowthemindwillwanderwhennotfully

engaged. Wereadthatayoungwomanaged16,solosailor,hadbeenfoundinthesouthern

IndianOcean2,000milesoffthewestcoastofAustralia. Herboathadbeendismasted

duringanattemptatsolocircumnavigation. Whilethiswasagrandspectacleandfab

bloggingforyoungwomanaloneagainstthesea,aveteranAustraliansailorstatedthatthe

voyagewaspoorlyplannedandfoolhardy.

Thisfiascobroughttomindanotherfailedpassage,thesinkingofthemightyliner,Titanic.

Inaccordwithhernameshewasacolossalandspectacularship,atotallengthof883feetand

46,328gross

tons.

As

the

photo

indicates

she

was

as

grand

as

she

was

large

and

powerful.

However,shewasnomatchforthebitterNorthAtlanticOcean. TheendeavorsoftheWhite

StarLinewereasgrandioseinexpectationastheTitanicwasinhermassivedeportment.

Bothordinationswerereflectedinthepretensionsofthearistocraticpassengers. Profits,

esteem,andfamewerethequintessenceoftheresolutepursuitforarecordbreakingAtlantic

crossingonthemaidenvoyage.

Page 16


17/17


THEGRANDSTAIRCASE

Source:MaritimeQuest.com

Sucharetheexploitsofmodernmanthat

theyhavegrownintotherealmof

obsessiveandhubristicfantasiesbuilton

wealthandpower. InAmericawearenow

confrontedwithatrioofmotleydisasters.

Theyaretheunrivaledecocatastrophicoil

blowoutintheGulfofMexico,abanking

systemgivenswaytoexploitthefruitsof

worthyenterprise,andaquagmireofwar,

corruption,andreligiousterrorisminthe

Iraqi/Afghanaxis. Thecommonthread

whichweavesthroughtheseruinous

calamitiesisthetriageoffailedleadership,

densetechnology

past

the

point

of

controlledproductivity,andmisguided

andsurrealisticexpectations.

Wehavedevelopedahubristicsenseofentitlementandconsumption.

TheGreekspropagatedacontrapowertohubrisandshewasNemesis,thespiritofdivine

retribution. Shewasgoddessofvengefulfate,justice,andpunishmentforoverconfident

prideandchallengesagainstthegods. Sheanswersourcriesofextremearrogance.

Sincereregards,

BrianE.Shean,CFAPRINCIPAL

POSEIDONSTRATEGICINVESTMENTS

_________________________________________________________________________________

Theviewsexpressedinthiscommentaryarethoseoftheauthoratthetimeofcomposition. Theassumptions,analysis,and

conclusionsaresubjecttochangeinconjunctionwithchangesinthesecuritiesmarketsordiscoveryofadditionalor

conflictinginformation. Allinformationconveyedhereinhasbeendeduced,compiledorquantifiedfromsourcesthoughtto

beconsistentlyreliable. Thisinformationalreportisproducedforgeneralcirculationandisnottobeconstruedasa

solicitationto

buy

or

sell

securities,

financial

instruments,

or

investment

products.

Prior

to

entering

any

transactions

for

investmentproductspleaseconsultacompetentfinancialadviserandundertakeproperduediligence. AMDG

Page 17

Documents

6.0 Poseidon Perspective June 2010