Basic Points June 2009 BMO CM

8/14/2019 Basic Points June 2009 BMO CM

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Basic PointsSummer Issue

Who Will ReallyLead the Global Rescue?

June 8, 2009

Published by Coxe Advisors LLC

Distributed by BMO Capital Markets


2/43

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Company Name Stock Ticker Disclosures Company Name Stock Ticker Disclosures

Alcoa AA 3,4 Goldman Sachs GS 3,4

Aluminum Corporation of China ACH Google GOOG 2

American International Group AIG 3,4 Imperial Oil IMO

Anadarko Petroleum APC 4 Intel Corp. INTC 2Apple Computer AAPL 2 Magna International MGA 1

Bank of America BAC 4 Microsoft MSFT 2

BHP Billiton BHP 2 Morgan Stanley MS 3,4

Canadian Oil Sands COS.UN 1,4 Potash POT 1,3,4

Citigroup C 3,4 Research In Motion RIMM 1,2

Companhia Vale do Rio Doce RIO Rio Tinto RIO 2,4

ConocoPhillips COP Suncor SU 1,3,4

ExxonMobil XOM Teck Resources Ltd. TCK.B 1,4

Fannie Mae FNM Wells Fargo WFC 4

Freddie Mac FRE


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Don Coxe

THE COXE STRATEGY JOURNAL

Summer Issue


June 8, 2009

published by

Coxe Advisors LLC

Chicago, IL


4/43


Summer IssueWho Will ReallyLead the Global Rescue?

June 8, 2009

Author: Don Coxe [email protected]

Editor: Angela Trudeau [email protected]

Coxe Advisors LLC. www.CoxeAdvisors.com

190 South LaSalle Street, 4th FloorChicago, Illinois USA 60603


5/431June

OVERVIEW


Judging by the stock market performance since March, the green shootsshould be as high as an elephants eye by the time this text reaches you. The

longest-sustained rally in decades caught bears unaware. We hear from clients

that the rally is driven by professional investors fear that the Pelosi-Obama

stimulus might work almost instantly and theyd miss out on the move that

would put their clients back on side after the 50% meltdown.

Paradoxically, as fund managers fly from fear into stocks, insiders fly from

fear to cash. The insider trading reports suggest that corporate bigwigs

stockholdings are being managed by acolytes of Nouriel Roubini, Nassim

Taleb, and David Rosenbergwho were so right for so long about the extent

of the housing disaster. Bulls who saw green shoots at a time insiders weregreen around the gills said, We have nothing to fear but fear itself. Problem

for bulls: which fear should they fear more: fund managers fear of missing

The Recession-Ending Mega-Rally or the insiders fear that their companies

miseries are far from ended? The fear that is winning proclaims, Happy Days

Are Here Again! The opposed fear growls, That song came out in 1929.

And whatever happened to Greed? Has it been repealed?

This has been one of the few times in most institutional clients lives when

theirbusiness is the first order of business for media and governments and

social conversationsday-after-day, week-after-week, month-after-month.Everybody wants to know what professional investors think. And nearly

everybody wants to hear that the Obama optimism which spread across the

land and across the sea is fully justified.

As hard as it may be for clients to tear their attention away from screens and

screaming front-page stories, we believe this is a time to step back and reflect.

This lengthy summer issue is meant to be used along with suntan lotion and

gin-and-tonics.

Our theme this month is that this one of those rare moments when history is

being made without most of its leading participants recognizing that they arecollectively reading from the wrong script.

With the industrial world in its first serious deflationary downturn since the

Depression, the acknowledged leader of the rescue brigade is Barack Obama.

That title goes with the lease to the White House. Had John McCain managed

to hold his pre-Lehman lead in the polls, then he would now be the Hope

of the World.


6/43

THE COXE STRATEGY JOURNAL2 June

But Mr. Obamas personal claim to leadership is one that would not have

been accorded to McCain. He is the most popular American Presidentabroad

since Roosevelt. On his European tour, he showed he could draw crowds that

were both larger and more enthusiastic than local leaders could pull. (Indeed,

even the Germansthe Germans!have been gripped by Obamamania: the

new hot toy there is a stuffed animal that looks like the White House dog.)

His domestic poll ratings remain highand are as high at this stage as G.W.

Bushs, which, thanks to the crisis that followed 9/11, stayed so lofty that

Congress backed not only the invasion of Afghanistan but of Iraq. Obamas

the man, and the image he projected of cool centrist as crisis manager was

exactly right.

But what if Americas economic problems are so seriousand the Pelosi-

Obaman remedies are so seriously wrongthat he will not be able to pull

his nationlet alone the rest of the industrial worldout of the bog and

back into sustained non-inflationary growth?

Ourfear is that the Presidents past enthusiasm for reshaping America from

the top down by summoning statist changes from the ground up will push

himand Americainto a new adventurism that will ultimately lead to the

shift of global economic leadership abroad.

We are continuing to reduce the share of US assets in our Recommended Asset

Mix. The next stage of the dollar bear market has begun. Have a rewarding

summer. Our next issue comes out in 3 months.


7/433June


Since 1943, the US has been the dominant military and economic power in

the world. Although the barefoot Krushchev told the UN he would bury the

capitalist world, his successors were unable to keep pace with the dynamism

of America and resurgent Europe, and Reagan and Thatcher were able to bury

Communism alive.

In each postwar recession, it was the US that pulled the rest of the industrial

world out of its downturns. Not only was the US economy so much larger

than any others, including what would become the Eurozoneit remained

the centre of innovation, risk-taking and productivity gains. Meanwhile,

powerful trade unions were able to retain their stranglehold on most

Continental economies even after Thatcher had broken their power in Britain.

Trade union veto power on US economic progress waned during the 1970s

and shrank dramatically thereafter, as capitalist vitamin content flourished

in Americas bloodstream.

The technology boom of the 1990s was, in retrospect, the high-water mark for

American capitalism. As new billionaires were being anointed each month,

and outsized productivity gains became accepted as inevitable, US equities

value soared to more than 60% of total global equities.

But what was glittering wasnt, as Greenspan believed, a new Golden Age. As

Nasdaq soared through 5,000 and Baby Boomers were planning luxurious

retirements for their forties or fifties, investors who had feared that the

Millennium would bring Y2K shock, found that it brought something much

scarier: reality. They learned that Tech company earnings were vastly inflated,

due to failure to account for stock options (which were the main form of

compensation for top execs), and that Asian-based companies were rapidly

gaining global market share in terms of employees, profits, and patents. What

would become the stars of this decadeGoogle, Apple and RIMwere either

not public during the boom, or had proprietary products based onbrand-based

profit margins that were no longer available to the established manufacturers

of the defining commodities of the 1990schips and bandwidth.

America retained its stock market leadership until 2007 because of the

new centre of high-margin innovationWall Street. At the peak, financial

companies were reporting 41% of US corporate earnings.

Except that their overstatement of earnings turned out to be on a scale that

made the Nasdaq cheaters look like pusillanimous Puritans. Those new tech-

spawned financial products that created trillions in reported profits after

paying hundreds of billions in unearned bonuses turned out to be frauds

designed to fool investors, US ratings agencies and financial institutions at

home and abroad.

At the peak, financial

companies were

reporting 41% of US

corporate earnings.

Except that their

overstatement of

earnings turned outto be on a scale that

made the Nasdaq

cheaters look like

pusillanimous

Puritans.


8/434 June



Those who do not learn from history

The sudden implosions of Long-Term Capital and Enron came from marketvolatility that the Myron Scholes model said was of a rarity that could occur

only once since mammals replaced dinosaurs as the masters of the universe.

How did Wall Streets biggest, boldest and brightest respond to those late

1990s debacles? By imitating LTCM and Enron! They levered up LTCM style,

using hidden off-balance-sheet entities Enron-style, with risk probabilities

calculated on models used by both LTCM and Enron.

Should anyone have been surprised that Wall Street got the same results?

The bosses expected sustainably black earnings statements from following

those models. Instead, they created Black Swans on a scale that devoured theavailable supplies of junk financial foodwith predictable results for the

consumers financial health.

There is talk of criminal prosecutions against the big names that got the big

payouts and spawned the big disasters. However, apart from insider selling

prosecutions such as have finally been launched against Countrywides

Angelo Mozilo, we predict few prosecutions and even fewer convictions. Wall

Streets accused could win acquittal on the grounds of insanity. A well-known

proof of insanity is trying the same experiment over and over, expecting to

eventually achieve a different result. What they did in creating trillions in

AAA-rated illiquid products out of financial sewage should be enough to

trigger insanity diagnoses from Park Avenue psychiatrists with sterling records

in testifying on behalf of the tarnished rich. The accused would surely be let

off on pledges to continue their treatment programs with their psychiatrists,

and at their golf and bridge clubs.

Last month, we asked, Where Will America Go to Grow?

Were America, once again, relied on to pull the global economy out of

recession, what would be its Comparative Advantagesin terms of trade in

goods and services?

A new book by Robert C. Allen (The British Industrial Revolution in a Global

Perspective) seeks to explain why Britain was the first home of the Industrial

Revolution. It argues that cheap, abundant energy was the key factor. Britain

had a huge comparative advantage in terms of carbon-based energy. Its coal

reserves were Europes largest, and its early emphasis on converting coal

and iron into steel gave it a lead that was crucial in the formation of the

British Empire, which was based on the Navys power to sustain free trade

in commodities, food, and industrial goods. Britain prospered by importing

commodities from its colonies and selling them its manufactured goods.

How did Wall Streets

biggest, boldest and

brightest respond

to those late 1990s

debacles?

By imitating LTCM

and Enron!


9/435June

The first century of American industrial prowess was also energy-based.

After Spindletop launched the US oil industry, America powered ahead to

global leadership based on oil for transportation and coal for electricity and

steeland by benefiting from global free trade enforced by the British Navy.

America replaced Britain as world leader, in part because the British had

dwindling supplies of cheap coal, negligible supplies of oil and gas, and world

leadership in entrenching the power of industrial and transportation unions

that could bring the economy to its knees, thereby reducing its international

competitiveness in each new cycle.

Chris Patten observed that, for the first eighteen centuries of the Christian

(or Common) Era, the two largest economies were China and India. They

didnt experience the Industrial Revolution and therefore ceded leadership to

America and Europe. In the first half of this century, he predicted, the world

would revert to normalcy.

Although few forecasters publicly dispute this long-term prediction, even

fewer suggest that this global recession would put the world into fast-forward

into the future.

Consider a few developmentsat home and abroadsince Obama and his

party swept to dominance:

1. The recessions in the US and Europe have been far more severe than

consensus forecasts predicted.

2. After two decades in which economic growth was positively correlated to

nations reliance on capitalist principles, the industrial world has suddenly

accorded to governments and central banks the entire responsibility for

saving the global economy. Capitalism is widely blamed for the Crash,

and government is now the savior. (A recentNew Yorkercartoon sums up

the new consensus: it shows a king with his head on the chopping block,

with the headsman holding high the axe; a man is rushing in, shouting,

Stop! Wait! Governments no longer the problemits the solution!

3. As Chryslers bailout was proceeding, President Obama appeared on TV

to denounce the speculators who were insisting that their ownership of

secured bonds gave them priority in the bankruptcy. This was not the calm,

cool, compromise seeker who had reassured the business community that

he would respect its claims to full participation in the economic rescue

program. He shouted, (like the Marxist Labourites who kept the party

out of power until Tony Blair cowed them), I stand with the workers!

In the outcome, the UAW, whose benefit programs were unsecured

creditors, was awarded a 55% ownership share in the company, and the

[Obama] shouted,

(like the Marxist

Labourites who kept

the party out of power

until Tony Blair cowed

them), I stand with

the workers!


10/436 June



secured bondholders were given only pennies on their holdingsand

threats of the kind of personal retaliation suffered by AIG officers.

Only later did we learn (on Page 16) that the speculators included public

pension funds in Indiana. The state funds had, (despite the investment

rules in ERISA), invested heavily in the secured debt of Chrysler, which

was, directly and indirectly, a major economic power in Northern Indiana.

In GMs bankruptcy, a large percentage of the secured debt was held by

yield-seeking individual investors, and leading law firms announced their

willingness to protect their rights from White House assaults. Result: this

bankruptcy is now, thankfully, proceeding according to the law, and GM

executives need not fear being harassed in their homes by ACORN radicals

paid, (at least in part), by Washington.

4. The Pelosi-Obama budget that swept through Congress with Indy speed

will, according to the non-partisan Congressional Budget Office, double

the national debt within five years and treble it in teneven assuming that

the President is right that US economic growth in the coming decade will be

far above its average level of recentcapitalist-drivendecades. The growth

will come from millions of jobs in clean energy, new techniques in health

care management, and public (read unionized) education. Offshore

drilling bans will ensure that none of the nations vast untapped oil and

gas reserves will compete with switch grass bio-fuel and other expensive

new forms of energy. (Mr. Allen would presumably be astonished.)

5. The Fed has been transformed into a Fast-Feeding operation. Its balance

sheet has doubled, and it keeps finding new classes of assets to buy. Apart

from its newfound willingness to lend against some of Wall Streets pet

products, it is buying longer-dated Treasurys to try to ensure that interest

ratesparticularly mortgage ratesstay low. Like other aspects of the

stimulus programs, results of this unprecedented initiative are somewhat

disappointing: yields on the Ten-Year Note (the basis for first mortgage

rates) have climbed 85% since year-end. Among those holders of Treasurys

who have expressed public alarm at quantitative easing and other novel

programs are the Chinesethe biggest gluttons in what Bernanke oncecalled The global saving glut. (When Tim Geithner spoke to a Beijing

audience last week, student laughter greeted his claim that the dollar would

remain strong and the Administrations policies would protect the value

of Treasurys. Those students are already learning how to act like tough,

arrogant creditors to yesterdays #1 economy.)

6. Indian voters went to the polls at a time of a global economic crisis, and

civil wars in two of its neighboring statesPakistan and Sri Lanka. Defying

predictions that the next Parliament would be even more hamstrung

The Fed has been

transformed into a

Fast-Feeding operation.


11/437June

by excessive leverage from Communist and other intransigent minority

parties, voters gave Manmohan Singhs Congress resounding support.

Nor were these gladsome results due to an unexpectedly high percentage

of stay-at-homes: 58.5% of eligible voters cast their ballots. So much for

the theory that only the Chinese can make modified capitalist principles

work. Then, India rather suddenly became a beneficiary of the defeat of

the terrorist Tamil Tigers, and Sri Lanka was no longer one of the two

neighboring threats to regional stability.

7. China chose not to emulate the strategy of Obamas rescue package: Sino-

Stimulus was aimed at immediate results, not in entrenching vast new

government programs designed to lock in a far bigger share for the state

in the economy of the future. Yes, Chinas growth has slowedto 7%at

a time the US and European economies have been decliningby almost

equal percentages.

8. Commodity prices, which suffered their greatest two-month decline since

records began, have been rebounding. No thanks to the US and Europe:

large-scale Chinese purchases of oil, soybeans and metals have been major

contributors to the rebound.

RJ-CRB Futures Index

June 1, 2008 to June 4, 2009

150

200

250

300

350

400

450

500

Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09

259.79

Baltic Dry Index

June 1, 2008 to June 4, 2009

0

2,000

4,000

6,000

8,000

10,000

12,000


4,093

Sino-Stimulus was aimed

at immediate results,

not in entrenching

vast new government

programs designed

to lock in a far bigger

share for the state in the

economy of the future.


12/438 June



Crude Oil

June 1, 2008 to June 4, 2009

30

50

70

90

110

130

150


69.50

Soybeans

June 1, 2008 to June 4, 2009

7.00

9.00

11.00

13.00

15.00

17.00


12.30

Copper

June 1, 2008 to June 4, 2009

1.00

1.50

2.002.50

3.00

3.50

4.00

4.50


2.33


13/439June

9. Commodity stock prices have responded:

Coxe Commodity Strategy Fund (COX.UN) relative to S&P 500

June 1, 2008 to June 4, 2009

60

7080

90

100

110

120

130


106.33

MS Commodity Related Equity Index (CRX) relative to S&P 500

June 1, 2008 to June 4, 2009

60

70

80

90

100

110


98.36

Gold Stocks (TTGD) relative to S&P 500

June 1, 2008 to June 4, 2009

60

80

100

120

140

160


142.90

(Readers please note: we cite as the example of commodity stock performance

the fund in which we are Advisors, because it includes all four main

commodity sectors, with weightings approximating those that have been

Commodity stock prices

have responded.


14/4310 June



recommended from time-to-time in this publication. We are not aware of any

other exchange-traded company that has investment policies that reflect those

discussed each month in Basic Points. If any readers are aware of comparable

products, wed be pleased to be informedand will include them in a future

issue. Citing the Fund herein does not constitute a recommendation to buy its units

or warrants.)

The US Claim to the Title The Global Economic Rescuer

It is widely taken for granted that the US has been the driver of the world

economy since World War Iwhich so devastated the economies of Britain,

France and Germany that the US succeeded The Old World as industrial

and military leadersand has stayed in that role ever since.

We suggest that, as is so often the case, investors with inadequate knowledge

of history are nonetheless among the most dogmatic in citing it to justify

their conclusions.

It is an oft-cited fact that the US has pulled The Old World out of each

recession since 1921; that record, we are told, means it is the worlds only

hope for exit from this deep recession.

Since World War I, there have been three great recessions, two of which were

deflationary and one inflationary. The Great Depression and this one have

been the deflationary downturns; the first of the 1970s recessions was the

sole inflationary recession. (No less an analyst than Niall Ferguson says (New

York Times Magazine, May 17th) the 197375 recession was every bit as severe

and protracted as the one were in now.)

Yes, the US pulled the world out of all the recessions since World War II, but

it was the Old World that pulled the US out of the Great Depressionby

engaging in World War II.

Yes, yes, we know that its an American article of faith that Roosevelt and

the Democratic Congress saved America and the world from the Depression

caused by Herbert Hoover and the Republicans.

Roosevelt did a splendid job of restoring American faith in itself, and he was

a great leader during World War II. Perhaps, without Roosevelt, there would

still be Prohibition, Hollywood wouldnt have experienced its Golden Age,

Fred Astaire would have continued to avoid movies in favor of Broadway and

vaudeville, and Victor Fleming wouldnt have had the unique opportunity to

directGone With the Wind while he was completingThe Wizard of Oz.

...as is so often the case,

investors with inadequate

knowledge of history

are nonetheless among

the most dogmatic in

citing it to justify their

conclusions.


15/4311June

Give Roosevelt credit for any or all of the above, but be cautious about

crediting him with ending the Depression. In actuality, Hitler, Hirohito

and Stalin did more than Roosevelt to slash US unemployment rates by

80%. Despite the Rooseveltian alphabet soup of government programs,

including NRA, WPA, and Social Security, and the brief mid-decade recovery,

US unemployment was still 17% by 1938. Then, as Continental European

leaders at last realized that Hitler was a greater threat to peace than Winston

Churchilland launched large-scale rearmament. As many scholars have

noted, the net benefit to the economy of Roosevelts job-creation programs

such as WPA sidewalk painting was largely offset by the unforeseen effects

of the Wagner Act and other Rooseveltian programs to magnify trade union

power. As Charlie ChaplinsModern Times (1936) showed, staging strikes as

soon as the workers finally had jobs after years of large-scale unemploymentmay have been good for union power, but what workers needed most was

jobs. The powers granted to union leaders under these programs ensured that

the minority of private sector workers with unionized jobs ultimately made

major gains in real income, but they actually prevented overall employment

growth for Americans because the products they made were too expensive

for much of the population. Worse, major industries became even less

competitive with factories abroad, forcing intensification of Smoot-Hawley

protectionism that had the inevitable effect of overseas backlash that shut

America out of major overseas market. That process was exacerbated by the

strength of the dollar as the worlds gold flowed into Fort Knox and currencydevaluations became routine across the world.

Ironically, the federal nature of the US would turn out to be its ace in the hole in

post war era, compared with European economies in which employment rules

were mostly set at the national level. Flexible employment arrangements

became (apart from seemingly endless supplies of low-cost coal, oil and gas)

Americas greatest competitive offset to the new industrial challenges from

Europe and Japan. Right to Work laws, which banned compulsory union

membership, undergirded the Souths strong recovery and powerful job

growth since 1960, as the former, seemingly-all-powerful big businesses in

the North succumbed to competition from abroad and the South, and theindustrial states became Rust Belt states.

Roosevelts panoply of programs and preferences might actually have worked

to end the Americanbut not the globalrecession, had he and the Fed

understood monetarism and the futility of beggar-thy-neighbor trade policies.

(Of course, there wouldnt have been anything worse than a recession had

Hoover and the Fed understood monetarismand the futility of beggar-thy-

neighbor trade policies.)

In actuality, Hitler,

Hirohito and Stalin

did more than

Roosevelt to slash

US unemployment

rates by 80%.


16/4312 June



By the time FDR took office, US M2 was down one-third from its 1929 peak.

Needed: rapid growth of Fed credit. However, existing laws limited monetary

expansion that was not backed by growth in gold holdings. Roosevelt did

in fact address this challenge by (1) raising the price the Fed would pay for

gold from $20.67 an ounce to $35, and (2) making private holdings of gold

bullion and coins illegal. However, monetary policies during the rest of the

decade were hopelessly inadequate to the challengeand no amount of

increase in the supply of WPA sidewalk painters would be able to offset the

Feds failure.

The reality is that the Old World, (with help from Japan) in its final

collective act of madness, pulled the US out of the Depression by 1941.

Marx had said that capitalism needed war to survive. A large body of leftist

economic thinking drew that lesson from Roosevelts failed efforts to end

the Depression, and how waging war set US factories hummingand put

millions of unemployed Americans into military uniforms. The economists

concluded that Big Government would be needed in the postwar era to

ensure sustained growth in jobs once Rosie the Riveter and her colleagues

switched from producing weaponry to producing babies.

The rebuilding of shattered economies and expectations in Europe and Japan

took decades, and the US trade balance gradually turned from permanent

surplus into permanent deficit, as European and Japanese manufacturers

began to take advantage of the demise of Smoot-Hawley and the complacencyof US manufacturers, in an era of large-scale featherbedding, and annual

growth in union wages and benefits regardless of productivity. The European

and Japanese factories built after the bombing ended used the best-available

technologies, and, (apart from Britain, where 19th Century labor attitudes

on the shop floor and among Labour politicians in Parliament prevented a

sustained postwar industrial renaissance), the fast-reviving economies relied

on welfare state programs, and Value-Added Tax regimes to redistribute actual

production costs away from factories to taxpayers at large.

The post-Depression US consumer, who hadnt experienced the horrors of

bombings, came to believe that prosperity was his/her birthright. Because USfactories had to price not only outsized wages, but health care and pension

costs into their output, their competitive position against European and

Japanese competitors weakened by the year, and Americans began finding

more and more bargains that werent Made in the USA. Until the dollar bear

market that began in 1971 with Nixons closure of the gold window, the

dollar was still so overvalued relative to European currencies that the best-

selling book for American tourists was Frommers Europe on $5 a Day.

in 1971...the dollar

was still so overvalued

relative to European

currencies that the

best-selling book for

American tourists was

Frommers Europe on

$5 a Day.


17/4313June

Result: the US consumer of goods, services and holidays became the industrial

worlds buyer of first and last resortand thesine qua non rescue force for

minimizing and ending postwar recessions across the industrial world.

Until American mortgage and credit card lenders finally realized that they

had run out of credit-worthy first-time home buyers and qualified borrowers

a few trillion dollars back on the roadand until a meaningful percentage of

the credit-worthy borrowers finally discovered there was a peril heading their

way that was much more immediate than global warming.

That shock was a long time coming.

Although some US economic analysts began to predict a peak in American

households willingness to increase their acquisition of goods and services

decades ago, for nearly all the time we have been managing money, the word

to the wise was Wall Street is littered with the bones of analysts who said the

US consumer was tapped out.

Which means that America and the rest of the world are finally going to have

to find a new set of buyers for their output.

Were Roosevelt to return to the USA from his eternal home, hed

recognizeand presumably applaudone-third of the Washington response

to this recession, but would be amazed byand presumably applaudthe

other two-thirds.

By now, if hes been in Heaven, hell have learned from Milton Friedman of

the importance of stimulating money supply growthand will be mentally

fitting out Ben Bernanke for angel wings.

When he considers the Pelosi-Obama programs, hell recognize that theyve

been reading from his script. Their priorities are (1) expanding union

power, because an economy based on strong unions should be a prosperous

economy, and (2) making government(s) the consumer of first and last resort

until the household sector has rebuilt its finances and saved something for

its retirement costs.

Under Goal (1), the Democrats are pledged to legislate Card Check, the

AFL-CIOs top legislative priority. This law would take away workers rights to

secret ballots when a union is trying to organize an employer. The decision

to join a union would hereafter be made at the employees kitchen table,

with eager assistance, one assumes, from hearty, husky union organizers, and

from those in the employees work unit who have already joined the union.

Until American

mortgage and credit

card lenders finally

realized that they had

run out of credit-worthy

first-time home buyers

and qualified borrowers

a few trillion dollarsback on the road...


18/4314 June



Included in this bill is a brand-new provision that, once a company is

organized on the basis of signed cards, if the employer is unwilling to meet

the unions demands, it cant just shut down and go where it believes it can

produce competitively. Those big, brotherly people in Washington will send

in an arbitrator, who will declare what future wages, work rules and benefits

must be. The great advantage of this new system is its simplicity: instead of

competing arguments about the economic value of an employees work, it

will be decided by one of the well-trained people in a great new make-work

program for well-trained people who may not otherwise have great jobs with

great paychecks. The President has promised to create millions of new jobs,

and, since programs like carbon tax and banning offshore oil drilling will kill

vast numbers of private sector jobs, why not hire people in the Department

of Labor to say what American workers should be paid and how many hoursthey should work?

So, a returned Roosevelt would be delighted. Yes, a returned Ford, Rockefeller,

Edison, Kroc, or Carnegie would be appalled, but they believed in creating

jobs and wealth in the private sector by competitively producing products

people at home and abroad wanted and bought. That is so passthese days.

As the scope of Washington bailouts proceeds, our sympathy for the pressures

on the President grows. Somehow, he will have to take out time from

deciding which models of cars Chrysler and GM must produce, to dealing

with Ahmadinejad, Kim Jong Il, the Taliban and other tiresome people. Dontthey understand that all thats needed is for us to talk together? Dont they

know that Bushthe biggest global threat to peaceis gone?

Even if the Pelosi-Obama stimulus program succeeds in generating modestly

positive US economic growth, it wont do much for the rest of the world.

The Buy-America provisions that bespangle the stimulus bill have already

kicked off mini-trade wars with Canada and Mexico, and Europe is mulling

over potential retaliation. No, they wouldnt strike a returned Roosevelt as

a worthy substitute for Smoot-Hawley, but at least they have what might be

called by sophisticates asoupon of Smoot-Hawleyism.

That said, American politicians might try to justify these Smoot-Smart

evasions of WTO rules by pointing out that Americas allies have mostly

confined their involvement in the globalstrategic crisis to criticizing the US.

Apart from Canada, Britain and Australia, Americas allies have not only

done almost nothing to help crush the jihadists in Iraq and Afghanistan, but

theyve done squat in Swat and virtually everywhere to its South and West.

Nor, after Obama wowed crowds in their homelands by announcing closure

of Guantanamo, are they stepping up to take those victims into their own

...since programs

like carbon tax and

banning offshore oil

drilling will kill vast

numbers of private

sector jobs, why not

hire people in the

Department of Laborto say what American

workers should be paid

and how many hours

they should work?


19/4315June

prisons. (How many prisoners were subjected to aggressive interrogationthe

euphemism Bushies used for water-boarding? According to a Page 16 story we read

recently, three Gitmo inmates were water-boardedSheik Khalid, who organized

the 9/11 massacres, the self-confessed beheader of Wall Street Journal reporter

Daniel Pearl, and one other.) As Obama is learning, a global policemans lot

is not a happy one.

Obama spent weeks abroad apologizing for Americas past sins dating back

to the A-Bomb. Until he attended the D-Day anniversary, he never once

mentioned the hundreds of thousands of US military corpses in European

cemeteries or the sacrifices America made to prevent a Soviet takeover of

Germany and France. Mr. Obama must be wondering, with allies like these,

who needs enemies?

Among the few prominent academic economists to challenge Obamas long-

term stimulus programs is Stanfords John Taylor, the renowned thinker

who devised Taylors Law for setting economically-successful fed funds rates.

Writing in the Financial Times last week, he observed:

The federal debt was equivalent to 41 per cent of GDP at the end of 2008;

the Congressional Budget Office projects it will increase to 82 per cent of

GDP in ten years; with no change in policy it could hit 100 per cent of GDP

in another five years.

He cites Obamas defense: We have an unprecedented financial crisis and wemust run unprecedented deficits, and he replies, While there is debate about

whether a large deficit today provides economic stimulus, there is no

economic theory or evidence that deficits in five or 10 years will help to get

us out of this recession. Such thinking is irresponsible. If you believe deficits

are good in bad times, then the responsible policy is to try to balance the

budget in good times.

He rejects Obamas pledge to cut the deficit in half, citing the CBOs projection

that the deficit in 2019 is the same percentage of GDP as the Administrations

estimate for the deficit in 2010a zero per cent cut.

Finally, he dismisses Obamas justification, We inherited this mess. The deficit

was 41 per cent of GDP at the end of 1988, President Reagans last year in

office, the same as in 2008, President Bushs last year in office. If one thinks

policies from Reagan to Bush were mistakes does it make sense to double-

down on those mistakes?

We have quoted so extensively from Mr. Taylor, because he is both eminent

and wiseand we believe that, if his view of the future is even close to being

accurate, America will not be #1 for long.

As Obama is learning,

a global policemans

lot is not a happy one.


20/4316 June



So, unless Mr. Obama reverts to being the cool, charismatic leader whose

public policies synthesize the dynamic aspects of American economic process

with the expansion of governments new roles, the global rescuers torch will

be passed at some point soon. As clients are aware, we were enthusiasts for

him when he was elected and in the early months of his work thereafter.

We are not yet willing to assume that he cannot yet be the great unifier and

sensible visionary who swept the nation at the polls. But we do believe

investors should have a new caution that the recent Obama will strive to

carry out his statist programs in ways that will be deleterious both to the

economy and to investment returns. Watchful cautionnot Panglossian

enthusiasmis in order. There is a world of opportunity outside the USA.

Capital that survives and prospers is a coward, not a lover.

When will the new global leadership emerge?

Maybe as soon as the early years of the next decade, if the US economy has

become so solipsistically engaged in snaring itself in Laoconesque coils that

it has neither the resources nor the prestige to sustain its position of global

economic leadership.

If not us, who?

The New Best Hopes for the World

Shanghai Stock ExchangeJanuary 1, 2008 to June 4, 2009

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

6,000

Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09

2,764.83

Capital that survives

and prospers is a

coward, not a lover.


21/4317June

Bombay Sensex

January 1, 2008 to June 4, 2009

7,500

9,500

11,500

13,500

15,500

17,500

19,500

21,500


15,116.27

Morgan-Stanley Emerging Markets


400

500

600

700800

900

1,000

1,100

1,200

1,300


781.76

Brazil Bovespa


25,000

30,000

35,000

40,000

45,000

50,000

55,000

60,000

65,000

70,000

75,000


53,764.98


22/4318 June



Positions Open: Rescuers for The Global Economy

Applications requested to fill slots for two or more large economies which each meet

allor most ofthe following criteria, and show likelihood of being able to continue

to meet these tests over the next five years.

Qualifications

1. Capitalist-oriented economies that are continuing to be driven primarily

by risk-taking in the private sector and are not reliant on sustained new

forms of large-sale government intervention.

2. Respect for the rule of law in commercial transactions, particularly

bankruptcy, where the commercial rules in the Anglo-Saxon economies

have evolved slowly over three centuries.

3. High household savings rates.

4. Demonstrated competitiveness in international trade.

5. A record of fair trade cooperation with neighbors where regional trade

agreements are in force.

6. A banking system that has passed the open market stress test of survival

and growth in recent months, (not a backdoor analysis) and has not

been subject to bailouts amounting to more than 1% of GDP.

7. A public educational system in which students at Grade Eight level andhigher grades rank in the top 25 in the world in mathematics, science

and literacy.

8. If not a net creditor globally, then not a net debtor to foreign investors

of more than 2% of GDP.

9. 9.Average per capita real GDP growth rates in the previous five years of

at least 3%.

10. Positive demography, such that each new generation of first-time

homebuyers is larger than its predecessor.

Likely claimants: China, India and Brazil.

(Canada and Australia meet most of the tests, but their populations are too

small to give them the global clout as Rescuers. Their economies and stock

markets are the most obvious winners among the industrialized nations

from the sustained growth in commodities demand that will occur if those

three heavyweight emerging economies continue to grow strongly.)

Canada and Australia

meet most of the tests,

but their populations

are too small to give

them the global clout

as Rescuers.


23/4319June

There are obvious caveats:

1. China is only non-democratic nation in the select circle, and proclaimsitself as being ruled by the inheritors of Maos branch of Communist

theories. It remains to be seen how long it can achieve its astonishing rate

of progress to the status of advanced industrial nation if it continues as

the oxymoronic Communist free economy.

2. Indias southeast is more secure now that the Tamil rebellion in Sri Lanka

has been quashed. However, its problems from Pakistans vulnerability

to the Taliban and other Islamic extremists remain. There has been some

good news in recent days, with the governments new commitment to

challenging the Taliban with the full power of its well-regarded army.

Jihadist terrorism cannot be eradicated in open military combat, but thecitizenry will justly conclude that democracy is doomed and defect to

the cutthroats if they are able to defy the national army successfully. This

is one military campaign that absolutely must be won. Even those who

ritualistically oppose all American military involvement abroad might have

second thoughts if the Taliban and Al Qaeda gain control of Pakistans

nuclear arsenal.

3. Brazils wise, benign ruler, Lula, is nearing retirement, and the nation has

a record of more than a century of disappointmentsbeing the most-

often cited candidate for title of Tomorrows Great Global Success Story.

As Margaret Thatcher observed, when asked whether Thatcherism would

survive, It will continue if the next Labour government is elected on, and

continues, the elements of what you call Thatcherism. Tony Blairand

even Gordon Browndemonstrated that Labour had learned from the Iron

Lady, and the party wasnt going to revert to the sterile socialist policies

that had been the Tory partys greatest electoral assets.

4. Now that Kim Jong Il has proved that one of the poorest nations on earth

can develop workable atomic weapons and inter-continental ballistic

missiles, Asia faces frightening new challenges to its plans to continue

its drive to prosperity. North Korea cooperates openly with Iran, and the

mullochracy is probably only months away from having both nuclear

bombs and long-range missiles. Dick Morris, former Clinton advisor, says

that an unchecked Iran will attempt to carry out its threat to wipe Israel

off the map. It will not be done with missiles, but by giving suitcase

bombs to terrorists. Although Hezbollah failed to win at the ballot box

in Lebanon last weekend, it still has a large brigade of jihadists on its

staff, eager for action. But since Ayatollah Khomeini took power (while

Jimmy Carter stood aside and waxed eloquent about democratic progress

Even those who

ritualistically oppose

all American military

involvement abroad

might have second

thoughts if the Taliban

and Al Qaeda gain

control of Pakistansnuclear arsenal.


24/4320 June



as Americas allythe Shahwent down), Iran has never failed to

make clear that it regards America as The Great Satan, which, in its

interpretation of Shia prophecies, means America must be dislodged

from its global throne. So any American city could, in theory at least, be

the first victim of a suitcase bomberand destruction of any major city

would, if only because of insurance and rebuilding costs, wipe out the

American economy.

We only mention these geopolitical challenges because Planet Earth is

probably the riskiest it has been since the day before the meteor landed

in the Yucatan and wiped out most life. No investment thesis can protect

private wealth from a cataclysm of those proportions. We can only hope that

Obama and his military advisors are seriously pondering the implications of

the suddenly-changed situation. Unfortunately, were the CIA to learn that a

catastrophe looms, it could lack the credibility to convince the Administration

that desperate measures must be planned, because Ms. Pelosi, major architect

of the stimulus program, has repeatedly charged the agency with misleading

Congress and serial lying.

So What Should Investors Do Now?

After having made passing reference to the (thankfully) still-remote possibility

of The End of the World As We Know It, we resume consideration of what a

peaceful transformation of global economic leadership means to investment

policymakers.

If, in fact, over the next year or so, global investors gradually come to conclude

that the Third World, as led by China and India, is the key to global economic

recovery, then this is one of those Hinges of History that dictate changes to

investment policies.

We sum it up as The Old, Old World Has Come To Redress the Balance

of the New.

Among the basic investment axioms that have underlain concepts of portfolio

construction in our lifetimes are:

1. US Equities will always be the global standard, and the US stock market

will always have the greatest liquidity and highest capitalization.

2. The US bond market will always be the global standard, and will always

have the greatest liquidity and highest capitalization.

3. The dollar will remain the global store of valueperhaps not for always,

but certainly for the foreseeable future.

...this is one of those

Hinges of History that

dictate changes to

investment policies.


25/4321June

4. Global equity markets will continue to follow the lead from Wall Street

and the US economy.

5. Commodities share of global wealth and GDP will, across most economic

cycles, continue their two centuries of decline, because industrialized

societies commodity content declines as the values of manufactured goods

and services increase. Commodity stocks investment outperformance will

occur during periods of rapid inflation (such as the stagflationary 1970s),

but otherwise will be seen as mere aberrations and will be short-lived.

If, however, the Obama rescue programs do not produce the gaudy results he

has predictedand which voters have come to believethen the probability

exists that investors will reduce their exposures to US equity and debt products

relative to those from the economies that are demonstrating global leadership.If a parade is proceeding along a street, one can choose to watch it or join it:

standing in front of it yelling Stop! is not, for most of us, an option.

As the Chinese, Indian and Brazilian economies were booming, and stock

markets in those countries were solidly outperforming the S&P, and as the

dollar was underperforming most major currencies, and as commodities and

commodity stocks outperformed, many respected investment commentators

said, knowingly, Dont join this parade. Its about to come to an end.

After The Midnight Massacre of July 13th, those experts wereat last

vindicated. Emerging Markets equities were savaged more severely than thenon-financial sectors of the US stock markets, Emerging Markets bonds were

savaged as severely as US junk bonds, and commodities had their quickest and

most brutal collapse since 1930. The parade ended quickly and ingloriously

and the spectators dispersed.

But then, the pattern began to shift back toward what had been normal for

most of this decade:

US Dollar Index (DXY)

July 1, 2008 to June 4, 2009

70

75

80

85

90

95

Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09

79.41

...yelling Stop!

is not, for most of us,

an option...


26/4322 June



Morgan Stanley Emerging Markets Index

July 1, 2008 to June 4, 2009

400

500

600

700

800

900

1,000

1,100


781.76

Shanghai Stock Exchange

July 1, 2008 to June 4, 2009

1,500

1,700

1,900

2,100

2,300

2,500

2,700

2,900

3,100


2,764.83

Bombay Sensex

July 1, 2008 to June 4, 2009

8,000

9,000

10,000

11,000

12,000

13,000

14,000

15,000

16,000


15,116.27


27/4323June

We see this shift as more than a blip. We think it heralds an emerging reappraisal

among globally-oriented investors to go back to the future. From 2002 until

The Midnight Massacre, the S&P significantly underperformed most of the

stock markets of two kinds of economies: those (such as Australia or Brazil)

in which commodity exports are large or major components of GDP, and

those (such as China) in which commodity imports are large components

of GDP. In the first category can be some industrial or newly industrializing

economies; in the second are newly industrializing countries.

It was these nations stock markets sustained outperformance from 2002

through June 2008 that, in retrospect defined the real growth of the global

economy. The S&Ps performance from March 2002 to July 2007 was, we now

know, heavily based on heavily-overstated earnings of the financial stocks,

which reported 41% of total S&P profits. If one adjusts the US stock markets

performance for all the financial frauds and folly, the outperformance of

economies linked by growth in commodity trade becomes even clearer.

We believe that relationship is about to return, and will be the leitmotifof

the music of the markets over the next five years.

We also believe that it will have especial impact on the prospects of the

important commodity-oriented companies

Which prospered so mightily as soaring commodity prices made these

producers the scarcity stories on stock exchanges this decade

And which could soon be acquiring a rather different kind of scarcity value.

RJ-CRB Futures Index

July 1, 2008 to June 4, 2009

150

200

250

300

350

400

450

500


259.79

We believe that

relationship is about

to return, and will be

the leitmotifof the

music of the markets

over the next

five years.


28/4324 June



Are Private Sector Commodity Companies CapitalismsNext Endangered Species?

Since last summer, we have been reporting (with growing concern) on the

tragic fall of free market capitalism from prestige and leadership in the global

intellectual and economic pantheons. Romes fall was due, in great measure, to

the failure of Augustuss successors to live up to his ethical standards. Roman

soldiers and citizens lost faith in the system. (We know just how decadent

many of them were because of Suetoniuss classicLives of the Twelve Caesars,

which, with its enthusiastic reporting on the emperors sexual proclivities,

has been delighting prurient history students for nearly two millennia.)

Similarly, many of our modern Masters of the US Financial Empire have

betrayed their capitalist heritage, collectively undermining not just their owncompanies and the global financial system, butmost tragically of allthe

strategic and moral justification for letting large capitalist companies function

in privileged positions at the core of the financial system.

Taxpayers across major Western countries are being hit for trillions of dollars

in bailout funds for companies whose leaders had previously been as rich and

haughty as Tiberius (although not, as far as we know, as personally appalling

as Caligula). Each week, one reads new commentaries arguing that the

neo-capitalist models most countries adopted after the collapse of Bolshevik

Communism are being rejected in favor of statism in various modes.

What text can capitalists use to defend themselves?

Oddly enough, the Chinese government is publicly suggesting that the

OECD nations should go back to Adam Smith. Chinese premier, Wen Jiabao,

spoke at Davos of Smiths bookTheory of Moral Sentiments, saying it was a

guidebook for the rulers in Beijing.

Who would have thought 20 years ago that China would be the third biggest

economy in the world by 2010?

And who would have thought that a red-hot favorite book in of Asias

communist leaders would be written by the father of the Westerncapitalism.

We live in wondrous times.

...trillions of dollars

in bailout funds for

companies whose

leaders had previously

been as rich and

haughty as Tiberius

(although not,

as far as we know,as personally appalling

as Caligula).


29/4325June

The best-known modern American book praising the glories of unrestricted

capitalism and denouncing socialism is probably a novel published fifty

years agoAyn RandsAtlas Shrugged. It describes an American dystopia of

the future run by politicians, pundits, union bosses, and leftist foundations.

Ms. Rand was a better pamphleteer than novelist, and the book was panned

by critics for its Castro-length speeches by capitalists, and the simplicity of

its characterizations of public and private figures who were either glorious

heroes or despicable villains. Belletristic merit, and subtlety it lacks, but it

was an enormous hit and has never gone out of print.

We havent re-read it in decades, but we thought of it as we watched President

Obama declare war on Chryslers secured bondholders.

Mr. Obama, whose only paid job other than being a community organizer(whatever that may be) was as a law professor, overturned bankruptcy

preference rules which have been on the books here since the Constitution,

part of English Common Law for a century before that, and a strictly-

enforced part of European lawsfrom the Hanseatic League to Renaissance

Switzerland and Italyfor centuries before that. But such an uncontested

legacy of business practice could not be allowed to get in the way of satisfying

the demands of the UAW.

In the same week, he announced that he would withhold Californias $14

billion in federal emergency funds unless the tarnished Golden State restored

the full wages, benefits and work rules of state employee locals of the Service

Employees International Union. The Governator had imposed some work

hour cutbacks and unpaid holidays on many state employee groups as part

of crisis measures to deal with a $20 billion deficit.

In his Chrysler speech, Obama seemed to have stepped right out of the pages of

Atlas Shruggedan America ruled by leftist demagogues (called looters) who

were strongly influenced by enlightened socialists and strongmen abroad.

Her tale begins with a story of the looting of a commodity-producing company

by a Latin American Marxist dictator. The scion of a family (loosely modeled on

the story of the Patinos) arranges to have the familys great copper-producingoperation blown up rather than handing it over to a Latinstalinist.

What dates Atlas Shrugged most is its view of the major strengths of the

American economy of her era, which was dominated by heavily unionized

basic industriescommodity-producing companies, auto companies, and

railways. The economic progress that has defined America since the Reagan

Revolution made capitalism respectable has been led by newer, non-unionized

industries.

In his Chrysler speech,

Obama seemed to have

stepped right out of

the pages of

Atlas Shrugged

an America ruled by

leftist demagogues

(called looters)...


30/4326 June



(We exempt the construction industry from this comparison, because that

industry has long been led by companies which have pension and benefit

funds jointly managed with the construction trades unions. From long

personal experience working with clients in those fundsin Canada and

the USand from speaking at the jointly-managed conventions of the

International Foundation for Employee Benefits, we can attest that this is

a model that works for the industry, its employees and the economy. The

old-style adversarial labor relations of the auto companies and airlines

operate in an outdated, Randian mode.)

Were Rand alive today, she would be shocked at what had happened to the

oil industry, which was then the biggest and most profitable of the goods-

producing industries. Back then, The Seven Sistersthe transnational

Supermajorsdominated the global oil industry, and, from the fruits of

their worldwide exploration, owned most of the worlds proven oil reserves.

Although reviled by fashionable politicians, pundits and moviemakers, they

kept finding new oil and gasand the postwar economic boom was based

on cheap, reliable energy.

Today, analysts estimate that the surviving supermajorsExxon-Mobil,

Shell, Chevron, ConocoPhillips, BP and Totalown only 3% of total known

conventional reserves. State-owned or controlled enterprises are collectively

the owners of most of the known oil and gas deposits.

What about the other commodity industries?

Despite such Randian robberies as the looting of Freeport-McMoRans nickel

mines in Cuba, the mining industry still remains largely in private hands,

subject to royalties and other income-sharing contracts with nations and

states. Notable exceptions: (1) Codelco, the Chilean government company,

is the worlds foremost copper producer and a respected industry leader; (2)

after Yeltsin-era privatization and a decade of stockholder control, Norilsk,

the Stalin Gulag nickel giant, has reverted to Kremlin controlbut remains

a public company.

However, the mining industrys era of private ownership is now threatenedby the emergence of a new trend in the commodity world: the desire of

commodity-short new industrializing economies to gain controland

ownershipof important commodity production facilities.

The miners first experience with this brave new world in which the biggest

commodity buyers would try to use their financial muscle to control

their access to resources came with Chinalcos (China Aluminum Co.)

dramatic intervention into the takeover battle of Rio Tinto by BHP Billiton.

Despite such Randian

robberies as the looting

of Freeport-McMoRans

nickel mines in Cuba,

the mining industry

still remains largely in

private hands...


31/4327June

With the notably insipid Alcoa as front man and junior partner, and with

the approval of the Chinese government, Chinalco bought 12% of Rio Tinto

in a matter of hours. That effectively blocked BHPs bid. Chinalco thereafter

entered into negotiation to acquire outright some of RTPs major mineral

properties in Australia.

As we were preparing for publication, RTP stunned the financial markets

with the announcement that its deal with Chinalco was off, and that it was

entering into a partnership with its former foeBHP Billitonto develop

major iron ore properties in Western Australia. Chinalcos consolation prize

is a $195 million breakup fee. Heavily-indebted RTP will rebuild its finances

with a $15.2 billion rights offering, and a $5.8 billion payment from BHP for

its share of the joint venture.

This multi-billion-dollar deal has two strategic elements that suggest that

other attempts to buy major commodity producers are inevitable: (1) to buy

enough of a commodity-producing company to have real influenceor even

a vetoon its major decisions and investments, and (2) to buy particularly

desirable properties owned by the company, develop and manage them,

and ship their production to the investing country. Had this deal succeeded

China would have become a large-scale producer of metals and minerals

abroad, and acquired major influence on global pricing of those metals and

minerals. (China has, in fact, been trying to open mines in some of the parts

of the globe with the most noxious rulers, and, to its disappointment, hasenjoyed only modest success. The rebels in the Congo, for example, didnt

show any more respect for the Chinese than they had for capitalist investors.

That may be another reason why it decided to switch its strategy to investing

in proven superstars with global reach.)

Why didnt China just buy Rio outright?

We believe that the American response to the CNOOCs bid to buy Unocal

showed the Chinese that domestic politics could bedevil the best-laid plans of

mice and Maoist men. Chevron was able to win the bidding war without having

to pay an excessive price because of threats by some Congresspersons against

a Chinese takeover of a national treasure. (Unocal was hardly a national

treasure, and its biggest appeal for CNOOC was its hydrocarbon reserves in the

South China Sea, which should hardly have concerned politicians whose energy

policies have been mostly directed toward banning offshore drilling. But the

Chinese Peril publicity worked. This wasnt as disgraceful a Congressional

intervention as its cover-up and connivance in the corruption at Fannie Mae,

and it wasnt even low comedy: it was just low.)

...the American

response to the

CNOOCs bid to buy

Unocal showed the

Chinese that domestic

politics could bedevil

the best-laid plans of

mice and Maoist men.


32/4328 June



What was supposed to distinguish the Rio Tinto-Chinalco deal from

CNOOCs setback was that it was merely a business venture between two

mining companies. Beijing spokesmen denied that the government was

behind the bid.

However, the outraged response from RTP shareholders and Australian

politicians showed that the market believed Beijing was deeply involved.

Chinalcos chances of having its offer judged solely on financial merits

evaporated quickly when its Chairman and CEO, Xiao Yaqing, was named to

the State Council, Chinas cabinet, shortly after the deal was announced.

The Chinese doubtless also learned of the political perils in outright takeovers

from what happened to Inco when it negotiated a merger with Falconbridge.

Because the two companies together had such a sizable share of world nickelproduction, anti-trust bureaucracies in Washington and the EU had to sign

off. Swiss-controlled XStrata also wanted to buy Falconbridge. Washington

granted approval fairly quickly, but the Brussels snouts kept rooting around

trying to find a threat to the competitiveness of European steel manufacturers.

A tie-up period of stock control expired as Inco frantically tried to complete

the deal. XStrata leapt in, bought Falconbridge, and, hey presto! No problems

with Eurocrats! Control shifted from Sudbury to Zugthen the home of that

fine, principled capitalist, Marc Rich.

(We cannot help but suspect that some Eurocrats may have had personal reasons

for gloating about the victory of a Continental company (even if it isnt in the

EU). Brussels is, after all, an expensive city to live in. What can we do next? Hey,

those guys at Intel have been displaying the kind of arrogance you expect from

Yanks. Lets see whether theres something we can nail them with.)

China Inc. is now zero-for-two in takeovers of Western mineral giants. Does

that mean that commodity companies should breathe easier?

We strongly believe that the Chinese will lick their wounds, learn from what

went wrongand will be even more forceful the next time. Beijing will not

be content to continue its policy of reducing its acquisition of Treasurys

through purchase of commodities. It has powerful reasons to become anowner of major resource properties.

It showed it could move with lightning speed in blocking BHPs takeover and

becoming the largest holder of RTP shares. Next time, it will doubtless be more

selective in its choice of partners, and will be more willing to pay up. Better

to own a significant share in production of what you need to buy to grow,

rather than holding an extra quarter-trillion-or-so of bonds denominated in

the currency issued by the most profligate big nation on earth.

China Inc. is now zero-

for-two in takeovers of

Western mineral giants.


33/4329June

If the worlds economic power has shifted, then managements of none of

the major diversified companies except Teck can feel secure about their

futures. (Tecks multi-vote share structure precludes a takeover unless the

controlling stockholders approve.) These companies are worth more to the

Chinese (and, for that matter, the Indians) than they are to open market

investors. Why? Because ownership of strong minority interests allows China

to intervene in pricing decisions on products subject to long-term contracts,

such as iron ore and metallurgical coal. As the worlds biggest buyer of both

those bulk products, China has powerful reasons for wanting to break open

the producers group that sets global prices.

If effective control of major mining companies is going to be acquired

by government-controlled companies for purposes other than profit

maximization, then we could well be seeing a dramatic shrinkage in supply

of commodity equities as the next cycle unfolds.

Apart from coal and iron ore, what other mined mineral of great concern to

China and India is subject to such contractual pricing formulas?

Non-nitrogen fertilizerparticularly potashmight be the most obvious.

Rumors that BHP would make a bid for Potash Corp. have been titillating

underemployed investment bankers for years. They resurfaced after BHP

floated a large bond issue for general corporate purposes. At its annual

analyst day, CEO Bill Doyle was asked outright about the possibilities of atakeover, and he was suitably dismissive. [Full disclosure: We were there to

give the luncheon speech, not as analysts or as stockholders.] Now we know

that BHP had enough cash on hand to be able to leap back into bidding for

RTP propertiesto the tune of $5.8 billionon what seemed to be a few

days notice. Potash management and its shareholders can relaxfor now.

Remarkably, there is one major agricultural stock subject to 90% control

that just might become controlled by open-market investorsthereby going

against the trend we think will come in the next cycle. That is CNH Global,

the worlds second-largest manufacturer and distributor of farm equipment.

FIAT owns 90% of the stock and there had been rumors it might make adivestiture to concentrate managements full energy on the manufacture of

cars if its grandiose plans to merge its operations with Chrysler and GMs

Opel divisions were approved. Canadas Frank Stronach (of Magna fame),

seems to have won the Opel auction, so at the moment it looks as if CNH

will continue in its role as the most reliable cash flow producer in the FIAT

organization.

As the worlds biggest

buyer of [iron ore and

metallurgical coal]

China has powerful

reasons for wanting

to break open the

producers group that

sets global prices.


34/4330 June



However, the trend is already rapidly becoming global in agricultural land.

As we often noted, one factor which made this global food crisis different

from past occasions of soaring grain prices was the appearance of widespread

state intervention among grain-producing countries to control grain exports.

For decades, governments of grain-producing countries across the world had

competed with each other to promote grain exports.

What had changed?

First, almost unnoticed by consumers, politicians and policymakers alike, the

grain surpluses which had been at the core of farm policies quietly shrank

until observable supplies of corn, wheat and rice were down to levels that

would mean that almost any crop failure anywhere could raise prices above

government support levels.

Second came the first serious outbreak of global food inflation since the

stagflationary 1970s, and prices of all grains skyrocketed.

Result: governments began to taxcontrolor even ban exports of grains

and oilseeds. Two motivations appeared: (1) the rebirth of autarky among

nations , which hadnt been seen since World War II; it reappeared in a few

countries where food scarcity among urban residents suddenly became a

hot political issue; (2) keeping food at home to suppress domestic inflation,

even if it meant that local farmers were forced to sell their output at prices

far below world levels.

The major food-importing nations that had the money to buy food werent

initially frightened as grain prices climbed. What got their attention was the

threat that food might not be available at almost any price because of export

controls abroad.

Their response has been astonishing. Saudi Arabia, South Korea, China,

Egypt, Kuwait, Qatar and Bahrain have been making deals to buy or lease

farmland to grow grains that must be sent to the investing nation. According

to The Economist, at least 5.4 million hectares have already been acquired

by foreign government agencies in such countries as Sudan, Cambodia,

Ethiopia, Mozambique and Turkeyand the process is still proceeding

rapidly. The International Food Policy Research Institute told The Economist

that between 15 and 20 million hectares have been subject to transactions or

talks involving foreigners since 2006That is the size of Frances agricultural

land.

What got their

attention was

the threat that

food might not be

available at almost

any price because

of export controls

abroad.


35/4331June

Some of these deals (such as Saudi Arabias with Ethiopia) involve production

of grain for delivery to the foreign investors from poor countries that are

receiving emergency food aid from the UN. (When Joseph agreed to supply

Egyptian grain for delivery to Jacobs family in modern-day Israel, he wasnt

taking it out of the mouths of poor residents of Egypt: they were already

well-looked after, thanks to excellent long-range crop forecasting, and major

expansions of grain storage facilities.)

If deep-pocketed food-importing nations are going to pour billions into

irrigating and farming in grain-producing nations abroad, how will this

affect the share prices of the great input stocks, such as Monsanto, Deere,

Syngenta, Potash and Mosaic?

We suspect that investors who spend time pondering this question willconclude that, over the long run, it should help to prevent sudden grain price

spikes such as corns runup from $2.50 to $7. We believe it will significantly

increase sales of fertilizers, seeds and high-end farm equipment, because the

new owners (or lessors) are spending heavily to produce gobs of grain. To

the extent that this massive inflow of capital does make vast stretches of

under-utilized land rich and productive, this could do more to prevent a

truly disastrous global food crisis than all the food aid one could imagine.

So we are, in principle, in favor of this trend.

We conclude this discussion by raising the following overall question about

growing government ownership in commodities.

In the last cycle, once commodity prices began to climb, the producers stocks

soared, and were the pre-eminent sector of many global stock markets until

The Midnight Massacre. Will they be even more valued this time because

sovereign wealth funds and other emanations of governments will, from time

to time, choose a more appetizing investment alternative than Treasurys?

And will the whooping crane-sized population of high-quality publicly-

traded non-oil-producing commodity companies become an endangered

species?

To us, the likely answers to these questions suggest strongly that the great

commodity companies should be at or near the top of most investors short

list of Buy And Hold stocks.

...will the

whooping crane-sized

population of

high-quality

publicly-traded

non-oil-producing

commodity companies

become anendangered species?


36/4332 June



INVESTMENT ENVIRONMENT

Back in the Sixties, there was a saying in some intellectual circles. Learn aforeign language! If youre an optimist, learn Russian! If youre a pessimist,

learn Chinese!

That reflected the fashionable feeling that capitalisms best days were behind

it. And a very good thing, too, because most of the history of capitalism was

of robber barons, exploited workers, raped environments, and wars.

Even a few months before the Wall fell, liberal elitists thought that the USSR

was an economically successful society, albeit undemocratic, and with a

regrettable tendency toward building dreary housing developments in dreary

cities.

We cite those perceptions from the past as evidence one must be wary

about assuming that the economic system that has, for two centuries, been

the source of most of the worlds progress, is about to cede leadership to

the self-proclaimed heirs to a Communist fanatic responsible for more

deaths among his own people than either Hitler or Stalin. We are, of course,

delighted that the current Beijing politburo reads Adam Smith. That gives

China an automatic advantage, because we doubt that Smith is standard

bedtime reading in the White Houseor in leading economics departments

other than the University of Chicagos.

The remarkable paradox of our time is that China since Deng Xiaoping has

achieved its longest continuous politico-economic program in at least two

centurieswith dazzling successwhile the new US leadership is in the

process of dismantling the model developed by Reagan, and continued

mostlyby his successors. During that time US GDP climbed far faster

than Continental Europes, which managed its economic torpor brilliantly:

it offset that underperformance by convincing most of the most powerful

American liberals thatits model was better than Americas.

Now that it is President Obamas job to get the economy performing the

way it did between Reagans First Term and the Recession of 1999, the multi-

trillion-dollar smorgasbord of policies on offer seems to be a mixture of

Depression-Era Roosevelt and Modern-Era France and Belgium.

With one conspicuous exception: the only Rooseveltian initiative that

not only created jobs and economic gains almost from Day One was the

Tennessee Valley Authority (TVA). This became, over the years, one of the

worlds most successful energy development programs and was a big factor

in fulfilling the classic defiant cheer from Dixie: The South will rise again!

...the multi-trillion-dollar

smorgasbord of

policies on offer

seems to be a mixture of

Depression-Era Roosevelt

and Modern-Era France

and Belgium.


37/4333June

But, apart from a few windmills and a lot of research into converting hay

into electricity, there is nothing in the Obama program that creates jobs

nowand continuously into the futureand finances them TVA-stylein

public debt markets based on cash flow generated from electric power plants

and other contributions to economic renaissance. TVA became a big producer

of nuclear power, which somewhat tainted it in the eyes of the True Left.

What about the hundreds of thousands of real jobs fixing the worn-out

highways and bridges across America that would be at the core of the Obama

recovery program?

We lost the roads and bridges somewhere along the way.

The numberand dollar valueof new US highway and bridge contracts

has actually plunged since the stimulus was announced. So much for all

those shovel-ready projects that were going to create jobs and improve

transportation.

Obamas vision of creating economic progress through millions of jobs in

governments, universities and NGOs is doubtless a hit in Brussels. Following

those policies has meant that the unemployment rate in Continental

European countries in this decade has for many years been roughly at the

levels America is experiencingnowand twice the rate it experienced under

the horrors of the Bush Administration.

We think the likeliest outcome of our current discontent is a recovery that will

disappoint both bulls and bearsby making neither much richer. Obama

could have stimulated large-scale immediate job creation in the private sector

in California and other coastal states by authorizing and promoting offshore

drilling. Instead,

Documents

Basic Points June 2009 BMO CM