BMO CM Basic Points April 2009

8/14/2019 BMO CM Basic Points April 2009

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Basic PointsWhere Will America Go to Grow?

April 21, 2009

Published by Coxe Advisors LLC

Distributed by BMO Capital Markets


2/42

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Company Name Stock Ticker Disclosures Company Name Stock Ticker Disclosures

Aluminum Corporation of China ACH Freddie Mac FRE

American International Group AIG 3,4 Goldman Sachs GS

Anadarko Petroleum APC Google GOOG 2

Apple Computer AAPL 2 Imperial Oil IMO

Bank of America BAC Microsoft MSFT 2

BHP Billiton BHP Morgan Stanley MS 3,4Canadian Oil Sands COS.UN 1 Potash POT 1

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

Companhia Vale do Rio Doce RIO Rio Tinto RIO

ConocoPhillips COP Suncor SU 1,3,4

ExxonMobil XOM Wells Fargo WFC

Fannie Mae FNM

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Don Coxe

THE COXE STRATEGY JOURNAL

Where Will America Go to Grow?

April 21, 2009

published by

Coxe Advisors LLC

Chicago, IL


4/42



April 21, 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


5/421April

OVERVIEW


The economic news in North America and Europe is as bad as the most pessimisticbears predicted, and seems to get worse each month.

Yet New York and most global stock markets have been rallying powerfully. The

S&Ps six-week Spring rally was a percentage record-breaker.

Equity investors who have been rushing back into the market point to the stock

markets historic pattern of bottoming just before the recession does, and rallying

while the recession fades. Pollsters report that investors are now more optimistic

than at any time since Lehmans collapse.

President Obama, who became Fear-Merchant-in-Chief to overtake and win

against McCain, and stayed in that role until his Stimulus Package passed, thenappropriately became Cheerleader-in-Chief. More than 60% of voters support him

and want to believe in his newfound optimism. Many are doubtless putting their

money where his mouth is.

We have been arguing that those investors who didnt sell last fall shouldnt give

up now.

Although we have reluctantly come to believe that the Presidents Stimulus

Package may vie with the AAA Mortgage CDO for the title of most mislabeled

nancial offering of our time, we retain our condence in Ben Bernanke, and still

hope that the gargantuan liquidity injections from the Fed and most other majorcentral banks will be enough to reoat the sinking US and global economies.

This month we revisit that counsel from a different perspective. All past bear

markets and recessions were nearing their ends when some sector or sectors of

the stock market and the economy began to take off, eventually providing the

leadershipand musclethe overall economy needed to get growing again. In

other words, shrewd equity investors who took a bet on buying stocks, primarily

because they saw opportunities for outsized prot gains in those industries, not

only got their timing right, but outperformed for years.

We are leaving last months Recommended Asset Mix unchanged. Cautious though

we are, we are not re-issuing Aprils time-tested advice for equity investorsSell

in May and go away. Although we suspect that an increasing number of voters

will become less credulous about the relevance of President Obamas policies to

the realities of the nations present and future challenges in coming months, we

doubt that the downside from here is either deep enough or certain enough to

validate a timing-based sale now.


6/42

THE COXE STRATEGY JOURNAL2 April


7/423April


Is the stock market a good predictor of 1) the timing of the next recovery and (2)

the nature of that recovery?

The answer to (1) is Yes, but it usually takes a few false rallies before it gets its

forecast right. The trick for investors is in guring out whetherthis rally is the right

one, or just another Come on in, the waters ne! call that fails to warn of the

sustained profusion of sharks.

The markets record in answering (2) is considerably better. In fact, its been

spot-on since 1974.

The story line for each new economic and nancial cycle included some new

winners and some new losers in its plot. Those shifts in shares of GDP and corporate

prots gave each new cycle its stamp.

The stock market senses these shifts before they become vindicated by nancial

performance. While the bad news from big companies in high-prole industries

dominate Page One, on Page Sixteen are brief accounts of the improving outlook

for companies in industries whose growth should be particularly robust in the next

cycle.

Heres how that process worked in the recessions weve lived through:

Apart from Japans demographically-driven Triple Waterfall Crash that begin in

1990, there have been three recession-powered Mama Bears since World War

II.

As the Mama Bear Market of 1973-74 was bottoming out in late November,

mining and oil stocks were moving up, led by gold miners. Those stars through

the gloom of what was then the worst bear market since the Depression became

investors favorites through the turbulent ups and downs of the rest of the decade,

prospering through the ensuing stagation that crippled the economies of the

industrial world.

Their powerful outperformance would turn out to be the up-leg to a Triple

Waterfall Crash that would begin when stagation was terminated by Volcker

and Reagan, launching a sustained disinationary bull market that was wondrous

for virtually every stock group except commodities.

By February 1976, the S&P had climbed by a third from its December 74 low,

but its returns thereafter to the end of the decade were substantially below Cash.

But the returns to holders of gold, silver and oil stocks remained great.

The trick or investors

is in guring out

whether this rally is

the right one...


8/424 April



However, to stay on the winning side, they had to cash out those prots in 1980,

because a two-decade ination-hedge Triple Waterfall collapse was dawning.

The winning trade became shorting gold and silver, and going long T-Bonds.

Then came the brutal Mama Bear Market of 1981-82, with the S&P down 48%.

As it was beginning to bottom out, defense stocks began to surge in response

to the Reagan arms build-up, and high-grade consumer stocks began to show

improving relative strength, as investors concluded that a powerful economic

recovery was inevitable once Volcker declared victory over ination and 16%

interest rates were no more. The leaders in those industries led the bull market

that began August 13, 1982, as the Dow nally burst through 1,000 to stayand

then kept rising, interrupted briey by the Greenspan Baby Bear Crash of

1987.

Coming out of that Baby Bear, bank and brokerage stocks led, correctly

anticipating further Fed easing and a continuation of the Reagan boom.

The recession of 1990 that doomed the Presidency of the rst George Bush

ended as a major new bull market in technology stocks was beginning. What

would later send it to previously-unimaginable valuation peaks was Greenspans

panicky ooding of the economy with liquidity after the Long-Term Capital

crash in 1998, and the appearance of Y2K Terror in 1999.

The most recent Papa Bear market arrived in 2000, forecasting the recession

that hit seven months later just as Bush was elected.

The Commodity Triple Waterfall Crash that had begun in 1980 nally ended

just as 9/11 proclaimed a new kind of war. The drastically-reduced population

of Defense stocks joined the ranks of US stock market leaders again. Base metal

stocks bottomed out right after 9/11, as some shrewd investors realized that the

metal miners miseries (which had been more severe than the suffering in other

commodity groups) had been, in signicant measure, due to the major event

of 11/9the day in 1989 when the Berlin Wall fell, signifying the coming end

of the Cold War. Since military procurement spending had, during the Reagan

buildup, been the major source of non-cyclical metal demand, the coming of

peace was terrible news for copper, zinc, nickel, aluminum and steel. Once theUSSR imploded, the great Gulag mines and other metal production facilities

across Russias 11 time zones suddenly faced zero demand from the military,

which had been more than 35% of Soviet GDP. (The Leftin the US and

across the worldhad been reviling America for spending 6% of its GDP on

Defense, but studiously averted its gaze from the epicenter of Socialism, where

the USSR armament spending was six times that percentage of GDP.) Many of

The winning trade

became shorting gold...


9/425April

the mines that managed to stay in production after Communisms crash became

formidable price competitors with capitalist companies by making desperate

deals with Marc Rich to sell their output in world markets.

We proclaimed in February 2002, that what would become The Greatest

Commodity Bull Market of All Timea new super-cyclehad already begun.

By that time, oil and mining stocks were already on wheels. The problem for

most US investors was that there were almost no US gold or base metal stocks

left, and nearly all of the S&Ps commodity capitalization was represented by

the big integrated oil stocks. As splendid as these stocks would be in coming

years, none of them had what would become the dening characteristic of value

in this decadelong-duration reserves in politically-secure regions of the world.

(Indeed, a painful percentage of Exxon Mobils and ConocoPhillips reserves

were located in Russia, and had to be written down as the KGB came back from

the dead to become Russias new ruling class, and began settling old capitalist

scores on terms to their liking.)

Yes, there were a few US agriculture-related stocks in the S&P, but it would be

four years before grain prices entered major rallies, sending the seed, fertilizer

and farm equipment stocks into powerful bull markets.

However, the force that propelled the Dow and S&P to new peaks was the astounding

rally in nancial stocks. The US had discovered a new export industry to participate

in the global trade boomWall Street-created derivatives. The sharp increase in

jobs in this new export sector made up for the jobs lost to foreign competitors in

the goods-producing industries. By 2006, 41% of US corporate prots were being

booked by banks, brokers, mortgage companies, insurers, hedge funds, and private

equity rms. (The nancial sectors share of prots was in the 20% range during

the 1970s and 80s and the 25% range during most of the 1990s.)

Congresss vast interventions into the housing market to promote trillions in

mortgage lending to impecunious individuals, (with emphasis on non-Asian

minorities having low or no credit ratings) was fueled by Wall Streets record

panoply of unconscionable excesses. Washington and Wall Street justied

themselves to critics of the debasement of mortgage-lending principles as being

high-minded donors of The American Dream to the unjustly disadvantaged. The

array of new products rewarded politicians connected with Fannie Mae and Freddie

Mac (F&F) who promoted them, the Street that fashioned them, and investors who

rushed for the higher interest rates on these pseudo-scientic confections. Step

right up! Everybody wins!

The US had discovered

a new export industry

to participate in the

global trade boom

Wall Street-created

derivatives.


10/426 April



Without the surging growth in newly-spawned CDOs and CDSes, and their bastard

brethren, the US economy and US stocks might have passed a placid decade. There

would have been no recession, because economic growth would probably have

been just enough to keep unemployment from rising to worrisome levels, and there

would have been, apart from LBO loans, no big bankruptcies that would threaten

the nancial system.

But the nancial and housing booms were such stuff as dreams are made on. The

real growth in economic activity was mostly elsewhere.For the rst time, global

economic growth and trade driven by booms in China and India far outpaced US

GDP growth. The US trade decit kept climbing, as US factories share of US

consumption kept falling. The outsourcing of US production for US consumers to

producers in China, Taiwan and South Korea swelled global gures at the expense

of US jobs and US GDP.

US-oriented equity investors were missing out on the fundamentally-driven booms

across the Pacic:

Toronto Stock Exchange (TSX Composite)

January 1, 2002 to June 30, 2008

5500

6500

7500

8500

9500

10500

11500

12500

13500

14500

15500

Jan-02 Oct-02 Jul-03 Apr-04 Jan-05 Oct-05 Jul-06 Apr-07 Jan-08

14010.39

Australian Stock Exchange Index (ASX200)


2500

3000

3500

4000

4500

5000

5500

6000

6500

7000


5082.1

...the nancial and

housing booms were

such stu as dreams

are made on.


11/427April

Shanghai Stock Exchange (SSE Composite)


500

1500

2500

3500

4500

5500

6500


2669.89

South Korea Stock Exchange (KOSPI Composite)


500

700

900

1100

1300

1500

1700

1900

2100

Jan-02 Sep-02 May-03 Jan-04 Sep-04 May-05 Jan-06 Sep-06 May-07 Jan-08

1577.9

Taiwan Stock Exchange (TWSE)


3500

4500

5500

6500

7500

8500

9500


7228.41


12/42


13/429April

Moreover, star investment bankers in the big, bloodied rms which have been

the biggest recipients of TARP funds have been migrating en masse to brand-new

boutiques which seek to grab market share in advisory fees from the big banks.

Citi is little more likely to return to its former glory than Pompeii. As for Vikram

Pandit, the only way hell make the kind of money he was being paid is to win

a Mega Millions lottery. (The odds of winning over the years by buying lottery

tickets week after week may well exceed those from buying CDOs at face value

week after week.)

We doubt that the stock market has fully priced in the doleful data about household

wealth destruction. Last week, The Financial Times reported a McKinsey Global

Institute study that reminds us of the scale of the challenge. From 2003 until the

third quarter of 2008, US households sucked $2,300 billion of equity from their

dwellings. About $890 billion was used for personal consumption or for home

improvementsa sum exceeding the Obama Administrations emergency stimulus

package.Since its peak in 2007, household net worth has fallen by $13 trillion,

almost equivalent to one year of US output.

It could be a long slog back to traditional American consumer exuberance.

We remain of the view that this bear market, like all other nancially-driven

bears, can only end when nancial stocks have not only stopped falling, but have

demonstrated sustained relative strength. No economic recovery and no true

bull market will arrive until the nancials are strong enough to make a positive

contribution to the economy and to nancial market activity. In past cycles, the bank

stocks came back from disaster largely on their ownand those recoveries helped

kick-start recoveries in the stock market and the economy. This time, the shares of

the big banks collectively have bounced back big, but only because of trillions of

subsidies in various forms from the taxpayers and the Fed. Although neither their

stock prices nor their CEOs compensation will once again attain the stratospheric

levels they achieved in this decade, they must cease to be voracious consumers of

taxpayer funds before the stock market can believe in their sustainability and the

real economy reasserts itself.

Which other equity groups are showing good relative strength?

Most prominent are two sectors which are heavily-levered to growth in world

tradetechnology and commodities.

Citi is little more likely

to return to its ormer

glory than Pompeii.


14/4210 April



Relative Strength of Technology and Basic Materials to S&P:

These two groups have not traded together historically, because their basic business

models are opposed. Basic materials companies earnings gains have historically

been based on rising price levels for units of output of commodities whose

reserves are limited and whose supply cannot be expanded rapidly. Conversely,

tech companies earnings have been based on rapid growth in output of units of

products whose prices are under near-continuous downward pressure from global

competition.

So why should they trade together now and into the next recovery?

Nasdaq 100 relative to S&P 500

November 1, 2008 to April 20, 2009

90

95

100

105

110

115

120

3-Nov 23-Nov 13-Dec 2-Jan 22-Jan 11-Feb 3-Mar 23-Mar 12-Apr

111.99

BHP BIlliton (BHP-NYSE) relative to S&P 500


80

90

100

110

120

130

140

150


131.16

Technology and Basic

Materials...have not

traded together

historically, because

their basic business

models are opposed.


15/4211April

CVRD (RIO-NYSE) relative to S&P 500


80

90

100

110

120

130

140

150


129.45

Potash Corp. (POT-NYSE) relative to S&P 500


60

70

80

90

100

110

120

130

140


113.96

Imperial Oil (IMO-NYSE) relative to S&P 500


85

95

105

115

125

135


116.59


16/4212 April



Probably because the leading info-tech companies are, more than most other

major American industries, now tied directly into growth of economies abroad.

The overinvestment in productive capacity that helped trigger the Triple Waterfall

collapse has been largely worked off through obsolescence. Now, the same new

Third World middle class which created the commodities boom is also the driving

force behind the growth in sales of cell phones and other tech hardware, along with

the supporting software. Nasdaqs Big Ten info-tech companies now derive most

of their earnings from industrial and commercial expansion abroad.

However, Nasdaq is still in the mid-stage of its Triple Waterfall, which meansshakeouts of weaker companies will continue, and margins of the stronger

companies will be under sustained pressure; it can rise signicantly, but will not

return to its peak. That doesnt mean there wont be some strong rallies, and that

some superlative performers wont be great investments in absolute and relative

terms for the next recovery. But among techs brightest stars, such as Research in

Motion and Apple, the only certitude is that the more success they achieve, the

more certain is newand potentially toughercompetition. Even Google may not

be immune to new challenges to its dominance. Microsoft, the PC monopolist, is a

special case, but the fact that it trades at a mere nine or ten times earnings suggests

that investors have begun to worry that the next generation of handheld devices

may hold something it has not had to face: real competition.

Suncor Energy Inc. (SU-TSX) relative to S&P 500


75

85

95

105

115

125

135

145155


117.69...the leading ino-tech

companies are, more

than most other major

American industries,

now tied directly into

growth o economies

abroad.


17/42


18/4214 April



The data for year-over-year percentage decline of exports in February are of

Draculate horror proportions:

China 41%

Taiwan 41%

Japan 38%

Canada 33%

France 33%

Germany 32%

Britain 32%

Brazil 25%

USA 22%

India 22%

Note that this list is not distorted by the collapse in oil prices. Only one oil-exporting

nationCanadais included, and Canada is an industrialized nation. Therefore,

the potent pummeling to those other economies exports far offsets the benets to

their trade balance and consumers living costs from the plunge in oil prices.

Norris quotes Barry Eichengreen of the University of California, who says trade is

collapsing more severely than in 1929-30.

With global trade so sickly, most commodity producers should, in theory, have

outlooks appropriate for a factory whose biggest prots last year came from

producing McCain-Palin buttons.

There is no questioning the savagery of the impact on the prices of their output:

RJ-CRB Futures Index

January 1, 2007 to December 31, 2008

200

250

300

350

400

450

500

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08

229.54

The CRB fell faster in late 2008 than during the onset of the Great Depression.

The CRB ell aster in

late 2008 than during

the onset o the

Great Depression.


19/4215April

So why have commodity stocks been outperforming major stock marketsand

commodity pricesfor the past six months?

Several factors are worth considering:

1. Commodities and commodity stocks kept rising for eight months after the

Dow and S&P had entered their bear markets. As the last-remaining protable

asset class for long-only hedge funds and other levered players, they doubtless

attracted a disproportionately-large percentage of fast money before The

Midnight Massacre of July 13th triggered panic liquidation. Perhaps long-term

investors were waiting until the effects of the Lehman bankruptcy on the $65

billion of hedge fund assets had been worked off and now believe the commodity

stock hammering was overdone.

2. The unprecedented scale of reliquication and bailouts from Washington,

London and Europe argues that this will continue to a recessionnot a

Depression. Although the economic forecasters who have the responsibility

for proclaiming the beginning and end of recessions informed the world late

last year that the US recession had begun in December 2007, the vertiginous

plunge in the global economy was anticipated by only a handful of long-time

bears. The power and suddenness of the collapse made at least a few long-term

investors conclude that the global economy might also snap back quicker than

the born-again bearish consensus is predicting. Therefore, commodity prices

should turn upward before most experts become convinced the economy has

touched bottom.

3. Quantitative Easing became the new term for monetary policies in Washington

and abroad. Many sophisticated investors consider this a euphemism for

seriously inationary monetary growth. The last time excessive monetary

growth was launched to ght a global recession came in the 1970s. Although

the rapid monetary expansion then was tortoise-paced compared to even a dull

month for the Bernanke Fed, it unleashed stagation, majestic gold and silver

Triple Waterfall run-ups, and years of outperformance by commodity stocks.

Why couldnt commodity investments be even bigger winners this time?

...monetary expansion

[in the 1970s] was

tortoise-paced

compared to even a

dull month or the

Bernanke Fed...


20/4216 April



4. Last years plunge in raw materials prices triggered panicky production

cutbacks and major slashes in exploration and development in the mining and

oil industries. It didnt take long for analysts to crawl out from under their

desks and opine publicly that commodity prices could go back quite swiftly to

their former peaks once the global recession ended. Example: Daniel Yergins

Cambridge Energy Research Associates, which had persistently underestimated

oil price gains from 2003 through 2008, recently raised its estimates for oil

prices sharply for the next decade, because of the abandonment or delay of so

many big-ticket oil projects.

5. High-prole bids for commodity production assets emerged amid the carnage.

Most notable was Chinalcos bid for Rio Tinto facilities in Australia, which

investors believe has Beijings backing. Since these bids came at a time that

China announced it was rebuilding its strategic reserves of oil, foods and

metals, investors began to reconsider analysts forecasts for Depression-style

collapses in raw materials prices.

6. Remarkably, the strong commodity stock performance came against the

backdrop of the strongest rally in the value of the dollar in this decade. Almost

every commodity investor knows that, for decades, the most reliable of inverse

correlations has been of the performance of commodities compared with the

dollar. Commodity stocks should therefore have continued to lead the stock

market down noisily, instead of quietly rallying. What happens to commodity

stocks when the dollar bear re-emerges?

7. As one country after another fell into recession, various gloomsters began

predicting a full-scale retreat from free trade to protectionism. Although

President Obama, goaded by a reactionary Democratic Congress, has on occasion

been a publicized sinner on trade, and has thereby provided convenient excuses

for backsliding among such long-time agnostics on free trade as France, the

percentage of global trade subject to outright protectionism remains (rather

surprisingly) quite small. The G-20 Meeting in London did more than repeat

pious platitudes against protectionism: it lined up huge nancing for Third

World economies in order to arrest the decline in global trade. Those of us those

who think the recession should be over within a year predicate this vestigialoptimism on the hope that protectionism will not gain a renewed stranglehold

on the global economy.

8. Adding these considerations up, this looks like a good time to search for values

among the raw materials producers.

The G-20 Meeting in

London did more than

repeat pious platitudes

against protectionism...


21/4217April

We realize that readers may be smiling: weve had such a lengthy love affair with

commodities, were suddenly and furiously rebuffed, and yet were eager to come

back for more?

Answer: we fell in love with commodities because we believed that China and

India would, in the coming decades, regain their multi-century status as the worlds

largest economies. That means their demand for raw materials will put continuous,

powerful pressure on global commodity supplies. We arent economists, and hadnt

anticipated the sudden onset of the worst recession since the Depression. On the

assumption that this downturn will end, then the commodity story will be more

relevant than ever. Moreover, we have growing doubts that the US economy will

regain its characteristic global leadership, so most US stocks lack the attractive

long-term fundamentals of the leading commodity stocks.

There remains the question whether wishing makes it so. If stock market prices

are rm, and shares of basic materials companies are outperforming, does that

mean the global recessions lifetime, in comparative terms, now approximates

that of a Somali pirate who grabs a breath of fresh air while SEAL snipers are

watching?

More than one economist has cited the powerful stock market rallyand

particularly the outperformance of bank stocksas a good reason to believe the

recession will end sooner, rather than later. They point out that rising stock prices

lead to rising levels of equity offeringsthe rst step in redressing the perilous

position of global debt to global equity. Goldman is, once again, out in front, with

a $5 billion equity sale that could permit the rm to repay its TARP nancing (and

free the rm to pay its top performers what it thinks theyre wortha privilege not

available to banks subsisting on government nancing).

Some economists have begun to cite the good performance of commodities as

evidence that the collapse in global trade may be over, and that an economic

pickup could occur within a few months. In particular, reports that Chinas stimulus

program (which, unlike Obamas, is the real thingtargeted and temporary) is

already working, have sent buyers into metals futures and metals stocks.

History says that the stock market could be somewhat premature about thetiming of the upturn in global trade, but has not erred in its choice of stock

market leadership in the next economic cycle.

So the next thing for investors to ponder is

Chinas stimulus

program...

unlike Obamas,

is the real thing

targeted and temporary


22/4218 April



Which Sectors Will Be Hiring Heavily When the US Recession Ends?

GDP is simply output per worker multiplied by the number of workers, minus the

trade decit. So which sectors will soon be hiring again?

1. Can State and Local Governments Create New Jobs?

During this decade, state and local governments budgets soared along with real

estate prices. Employees unions had little difculty extracting hefty increases

in wages and benets. In particular, many states found that an excellent way to

disguise the generosity of their sweetheart union contracts was to increase pension

and other retiree benets that would not show up in actual spending until later.

(Illinois is now $50 billion in debt, and its biggest problem is its underfunded

pension and retiree health benets. Because so many collective bargaining

agreements provide for retirement at young ages, Medicare is not an offset for

ballooning health costs.)

Now, the many loose-spending states and municipalities are nding that those years

of boosting expenditures even beyond the bubble-driven increases in property taxes

have them in a bind. California, a particularly conspicuous proigate, is asking for

a federal rescue, and the line forms to the left.

So states and municipalities are raising taxes, asking employees to work four

days a week for several months, and, in some cases, threatening to open the jails,

even for felons convicted of violent crimes. (This latter stratagem seems to be a

new version of the justly cherished Washington Monument strategy. When a

Republican President threatened to impose deep cuts on the budget sent up by

a Democratic Congress, the immediate response within the bureaucracy was to

recommend shutting down the Washington Monument.)

Last week, Moodys downgraded the debt of nearly all states and municipalities,

citing serious decits almost everywhere.

Municipalities already face taxpayer wrath because the house values they use for

todays property tax bills come from those golden days when everybody knew that

house prices never go down. Most states and municipalities are constitutionally

forbidden to budget for decits. Raising taxes now will not only trigger ratepayerfury, but will, according to published calculations, seriously offset the Obama

stimulus package.

Therefore, looking to the early years of the next cycle, we believe that states

and municipalities will not be contributing to the solution of the unemployment

problem by rapid rebuilding of their staff complements.

Caliornia, a particularly

conspicuous profigate,

is asking or a ederal

rescue, and the line

orms to the let.


23/4219April

Doubtless, one of their responses to budget crises will be to cut payrolls by

offering incentives for earlier retirement. Since state and local pension plans in

the aggregate are already Cadillacs compared with the Chevrolet models in private

plans in the aggregate, enriching benets can only cut current costs by degrading

states balance sheets even further. The next actuarial valuations of their plans will

hit future state budgets hard.

True, states will be boosting spending on infrastructure without imposing extra

taxes on their residents using Congressionally-generated funds. But the states only

function as pass-throughs on federally-funded projects, and those funds do nothing

for states straitened nances. The Stimulus Package may only offset the cutbacks

on roads and bridges nanced locally. So far this year, state and municipal highway

contract projects offered for bidding are down 24%.

Conclusion: the sector that was a signicant help to the economy in recent decades

by its steady gains in middle class payroll employment is already becoming a drag

and threatens, in some cases, to become an anchor. (California is now experiencing

out-migration, as businesses and individuals ee to states with sounder scal

situations and lower taxes. What was once the nations leader in attracting

inward migration has joined such other high-tax population losers as New York,

Pennsylvania and Illinois. But the national economy cannot move forward based

on the relatively sound nances of Utah, Idaho and Wyoming.)

2. All Those Beautiful Jobs From Clean Energy

The Obama budget calls for hundreds of billions in government spending on

alternative fuels and other forms of clean energy.

This will be nanced, in part, by cap and trade taxes on carbon-generated energy,

such as coal, oil, and natural gas-generated electricity.

When the President spoke to the press after meeting with his economic team, he

spoke of some optimistic signs in the economy. Specically, he cited new jobs in

alternative and clean energy. These jobs are already coming, he said, as we reduce

our dependence on foreign oil.

He naturally made no mention of the thousands of jobs lost in the oil and gasindustry because of low current prices for natural gas, and because he overruled

Bushs repeal of the ban on offshore drilling for oil and gas. (We had predicted last

year that offshore exploration would be a key growth sector for the US economy

during the recession and well into the next cycle. We had not expected ideology

to triumph over pragmatism during an economic crisis. We now understand the

Audacity of Hypewhen that hype comes from the Ruling Class.)

We now understand

the Audacity o Hype

when that hype comes

rom the Ruling Class.


24/4220 April



When Congressional Republicans suddenly found last summer that they had a

hot political issue in offshore drilling, and chanted Drill, baby, drill! at their

convention, it looked for a few weeks as if liberal elitists were at bay. Nancy Pelosi

managed to prevent a vote in Congress on repealing the ban on offshore drilling.

When she was challenged, she replied, Im just trying to save the planet.

Joe Biden contributed his characteristic wisdom to the debate. He said the oil

industry wants to rape the Continental Shelf.

That the oil and gas drilling industry is losing tens of thousands of workers doesnt

seem to upset the latte liberals as long as people in white coats get more jobs in

non-prot institutions in the North and on the Coasts doing research on schemes to

replace oil, a commodity that has a deeply Texan taint.

In assessing the Obama budget, it becomes immediately clear that the full-scale

ght against global warming is The Cause scheduled to (1) create new jobs and new

investment to stimulate the economy, (2) give Washington new, permanent control

over a wide range of private sector capital investment programs, including mining,

rening, the design of automobiles, setting energy-saving design specications

for buildings, and intervening in banking to promote nancing for fashionable

projects, (3) win friends in Europe to get help for Americas military operations

abroad, so that ghting the Taliban will not prove to be Obamas millstone, as

Iraq was for Bush, and, (4) generate automatic, gigantic stealth tax revenues that

operate independently of annual budget reviews.all while saving the planet (and

its polluting people) from otherwise-inevitable catastrophe.

The driving force behind this program came from a long-awaited excuse for

expansion of federal power over the economy: the Environmental Protection

Administration last week decreed that Carbon Dioxide is a pollutant. That puts it

right up there with Chlorine Gas, Sulphur Dioxide, Hydrogen Sulphide, Ozone,

and other products of industrial and transportation activity that have long been

subject to regulation because of their serious impact on human and plant health.

Fighting air and water pollution is a cause we can all support. We were among the

many Canadians who, for years, tried to get American Presidents and Congresses

to take Acid Rain seriously. Living in Southern Ontario, we were downwind fromnumerous toxic coal-red electricity plants that were having devastating impact

on our hardwood forests. (Because of the location of the plants and wind patterns,

Canadian forests suffered more than American forests, so it was hard to get

Congressional attention to a Canadian problem. Eventually, real progress was

made, and Ontarios forests recovered. So we believe strongly in using the power

of the state to protect the air we breathe and the water we drink.)

...oil, a commodity

that has a deeply

Texan taint.


25/4221April

But putting Carbon Dioxidepart of the air we actually and naturally breathe in

and, with extra CO2outon the same list with those industrial-generated toxins?

Isnt that somewhat like amending an anti-noise bylaw aimed at motorcycles and

huge trucks to include a potent penalty for belching?

The Obama Answer: Weand the planetare doomed unless we cut back on

CO2. That is now the unanimous opinion of all respectable scientists, as proven

by decades of data showing escalating global temperatures. The Nobel Prize

Committee ended what was left in the debate by awarding its Peace Prize to Al

Gore.

The time has come, the leader said,

To talk of warming things:

Let Business pay a climate taxAnd folks, by using things

That make the sea grow boiling hot,

As CO2

takes wings.

James Hackett, Anadarkos CEO, has had the guts to emerge from the oil industrys

foxhole on this topic, inviting enemy re. He says the global warming-driven policy

of preventing development of US oil and gas in favor of massive spending on research

in wind and other alternatives, backed by hundreds of billions in taxes on businesses

and consumers through cap and trade schemes will cripple the US economy in two

ways: it will prevent the creation of hundreds of thousands of good-paying jobs in the

oil exploration and development sectors, and will impose huge burdens on Americas

industrial economy, at a time China and other nations will be merrily adding new

oil and coal-red plants, generating low-cost electricity to make their factories even

more competitive. (In three years, China constructs as many megawatts of cheap

[3 cents per kwh] coal-red electrical generation as the US has in operation, and a

new plant starts adding to global pollution every week.)

Peter Huber, writing in City Journalnotes, The roughly 1.2 billion citizens of the

industrialized countries are expected (under Kyoto) to reduce their emissions. The

other 5 billion, including China and Indiaarent. Windmills are now 50-storey

skyscrapers. Yet one windmill generates a piddling 2 to 3 megawatts; Google is

building 100 megawatt server farms. Meeting New York Citys energy demand

would require 13,000 of those skyscrapers spinning at top speed, which would

require scattering about 50,000 of them across the state to make sure you always

hit enough windy spotsEven if solar cells themselves were free, solar power

would remain very expensive because of the huge structures and support systems

required to extract large amounts of electricity from a source so weak that it takes

hours to deliver a tan.

The roughly 1.2

billion citizens o the

industrialized countries

are expected (under

Kyoto) to reduce their

emissions. The other 5

billion, including China

and Indiaarent


26/4222 April



Such science-based objections cut no ice in the crusade to impose on the economy

a whole new structure of controls, subsidies and taxes to offset a global climate

change on which scientists disagree.

Last week, the President rejected the growing demands to postpone cap and trade

until the economy recovers. He reiterated his convictionthat drew such cheers

across Europethat ghting global warming is our top priority, and must not be

delayed.

The air war is on, and it threatens to make the Battle of Britain look like a quaint

exercise.

A few observations:

1. As the Cato Institute noted in a full-page ad, President Obama was just plainwrong when he asserted the science of global warming was beyond debate. The

ad was signed by 116 scientists from around the world. (http://www.cato.org/

special/climatechange/)

2. The cooling that has already occurred in this decade has driven global

temperatures down to 1980s levels.

3. As many climatologists admit, the long-term temperature statistics showing

rising temperatures in the worlds cities have an inherent bias: urban records

tend to be based on data from airports, and the more tarmac is created, and the

more grass disappears, the more heat is generated. Moreover, Michael Crichtondemonstrated, long-term data from weather stations located far from major cities

generally failed to conrm the temperature increases shown for cities.

4. Finally, we have many centuries of data to show a close correlation between

sunspot activity and recorded temperatures. The correlation is so close that

even a one-year cessation of rapid activity has generally shown cooling effects

globally. As scientists have routinely noted, in the 25 years leading up to this

decade, we experienced the most intense, sustained sunspot activity for which

we have recordsand global temperatures rose. In the past two years, we

have experienced the lowest level of sunspot activity in nearly a centuryand

temperatures have fallen sharplyand North Pole ice coverage has climbeddramatically.

Since we have been commenting on this for nearly two years, we obviously have

staked out our claim for what we call history-based skepticism about a popular

new theory. Since the cooling began, the global warmists have retitled their cause

Climate Change.

Since the cooling began,

the global warmists

have retitled their cause

Climate Change.
http://www.cato.org/special/climatechange/http://www.cato.org/special/climatechange/http://www.cato.org/special/climatechange/http://www.cato.org/special/climatechange/


27/4223April

We agree with that: all the records show that the worlds climate is in constant

change. Greenland was a grape-growing region a thousand years ago. Saving

the planet is a quixotic rallying cry if it means trying to keep Earths climate

and topography frozen to Sixties levels, no more than saving Earths Art means

banning all post-Sixties music and art.

Freeman Dyson, of the Institute for Advanced Study in Princeton, was the subject

of a recent cover story in The New York Times Magazine. He has a long career as a

distinguished scientist routinely active in liberal causes, so his vehement rejection

of the global warming thesis has attracted considerable attention from leaders in

both sides of the debate. In a recent essay, he writes about the prospects of a New

ice-agethe burial of half of North America and half of Europe under massive ice

sheets. We know that there is a natural cycle that has been operating for the last

eight hundred thousand years. The length of the cycle is a hundred thousand years.

In each hundred-thousand year period there is an ice-age that lasts about ninety

thousand years and a warm interglacial period that lasts about ten thousand years.

We are at the present in a warm period that began twelve thousand years ago so the

onset of the next ice-age is overdue..Do our human activities in general, and our

burning of fossil fuels in particular, make the onset of the next ice-age more likely

or less likely?

Dr. Dyson deals with a threat to humanitybut not to the planetthat is more

predictable than global warming. We cite him only to point out how little about the

earths climate future truly serious scientists know.

The sunspot debate deals with data for the last 800 yearsa twinkling of the

geological eye. Nevertheless, sunspots could prove to be of signicance for a ve-to-

fteen year time horizon, which is why we discuss them in an investment journal.

As the sunspots became nonespots and stories of extra-cold weather became

commonplace, we have heard from more and more clients, Why dont more

scientists agree with you, since your evidence is based on incontestable data over

many centuries, and theirs is based on computer models of recent decades and

projections into the future?

The biggest reason is that even those scientists who admit that the evidence ofcorrelation between global temperatures and sunspot activity is powerful, they feel

they cannot accept it as conclusive because the relationship could, in theory come

purely from coincidence.

...all the records

show that the

worlds climate is in

constant change.


28/4224 April



Thats why we were so interested last week in reading the report of an interview

with Harvard (and Smithsonian) astrophysicist Dr. Willie Soon. (http://www.

thecrimson.com/article.aspx?ref=527650)

In brief, he says high levels of sunspot activitysuch as the earth experienced

during the past centuryincrease the volume of water vapor, the greatest of all

greenhouse gases, warming the earth in two ways: First, when vapor condenses,

it increases cloud cover and that prevents terrestrial heat from escaping into the

atmosphere. Secondly, it also increases the density of ultra-high cirrus clouds (5-8

km) that prevent heat from escaping into space.

He concludes, if sunspots dont return by year-end, global warming scientists will

probably be forced to recalculate their forecasts.

Dont bet on thattriumph for science-based science. Al Gore has another mega-

money-making book coming, and that means nearly all the media and politicians

will be warning of warming. Moreover, the United Nations has scheduled a

December conference in Copenhagen on the global warming crisis. Like the

UNs sequel to the Durban anti-Israeli bashfest, there can be little doubt about the

conclusions from that cool Yule Conclave of the Correct.

Are the American Banks Really Back On Track?

The Bank stocks led the market coming off the March low, helped by good news.

Those rallies made it look as if happy days were here again.

But skepticism is in order.

KBW Bank Stock (Large Cap) Index (BKX)

January 1, 2007 to April 20, 2009

10

30

50

70

90

110

130

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09

31.48

...skepticism is in order.
http://www.thecrimson.com/article.aspx?ref=527650http://www.thecrimson.com/article.aspx?ref=527650http://www.thecrimson.com/article.aspx?ref=527650http://www.thecrimson.com/article.aspx?ref=527650http://www.thecrimson.com/article.aspx?ref=527650


29/4225April

Goldmans prot announcements last week suggest that at least one of the biggest

of what used to be pure investment banks is back in business. They help explain

why Goldman stunned the markets last month by nancing a Japanese theme

park.

That Goldman plans to repay its $10 billion TARP nancing so it can resume its

bonus-based compensation system is supercially reassuring. But even if it does

pay back the loans, it will continue to benet big from Washington aid because

its deposits and short-term borrowings remain government-backed. It was a big

winner at taxpayer expense when AIG paid 100% of its CDS liabilities. All that

glitters on the Street is not Goldman, but it didnt take long to return to regain itsshiny status.

Wells Fargos pre-announcement the previous week was superbly timed to send

bank and other stocks sharply higher. However, most of those splendid prots

came from fees for renancing mortgages at the new, low rates. We can only

assume that these mortgages were not among those that were poisoning its balance

sheet, and were in fact among the best loans on its books. (We note that, among

the long list of neologisms the imaginative Administration has been introducing,

toxic assets have become legacy assets, and Decit Budgets have become

Investments.) The rebranding of nancially friendless CDOs as legacies will,

in theory, make them treasures the private sector will eagerly buy. Legacies usedto be real assets that got taxed on death. Now they include the assets which have

been killing banks.

The still-huge spreads in the corporate debt market are attracting more commentary

from equity strategists. Why are stocks so robust, led by the new vigor of the

banks, when the corporate debt markets remain tuberculous?

SPDR KBW Regional Banking Index (KRE)

January 1, 2007 to April 20, 2009

10

20

30

40

50

60

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09

20.06

...toxic assets

have become

legacy assets...


30/42


31/4227April

We watched the scenes on TV of Acorns busload of protestors that toured the

homes in Connecticut of the AIG bonus recipients, stufng insulting messages

in mailboxes and screaming threats on front doorsteps. (Acorn, which was

a conspicuous promoter of subprime loans to non-Asian minorities, and the

nationwide leader among community groups that rounded up inner-city voters

for Democrats, triggering vote-fraud challenges in several states is, according to

reports among the recipients of funds from the Obama stimulus program to assist

community groups. Great OKs for funding from Acorns grow?)

Those weeks of banana-republic-style ochlocratic excesses on Capitol Hill may

be fading among some voters memories. But in the beleaguered investment

community, the memory could prove indelible.

We do not blame President Obama or Secretary Geithner, who conductedthemselves with distinction under extreme duress. In particular, Mr. Geithner

displayed in interviews on the Sunday talk shows the kind of cool professionalism

and knowledge that showed why the President was so eager to not only recruit him,

but then to stand by him during the embarrassment of the unfolding stories of his

years of tax evasions.

However, it remains unclear whether the daily scenes of rage from Barney Frank

and his ilk have permanently poisoned the programs that were the Administrations

best hope for resolving the nancial crisis.

We hope for the healing of time. But nancial markets may not show sustainedpatience.

By far the most encouraging sign in the nancial data is the rapid escalation in

the growth of M-2, which suggests that not all the monetary creation and federal

bailout money is being vaporized by toxic assets, or remaining immured in the

banking system as ornaments on otherwise ugly balance sheets.

We thought of The Cabaret song in the tawdry Berlin nightclub at the dawn

of the Hitler era, Money Makes the World Go Round. It was a sadly ironic

number reecting the weltanschauungof that tragic era. A few years after the

monetary madness of the Weimar era, Hjalmar Schacht had restored value to the

Deutschemark, but the Depression meant that the money did not in fact move

around and neither did the economy. As dubious as we may be about the Treasury

measures and the Obama Stimulus Package, we take consolation in this shard of

evidence that what the Fed is doing may actually be working.

The stock market has certainly taken notice of this green shoot of the green

stuff.

After a record rally, we think equity investors who did not buy at the March bottom

should resist the temptation to rush back into US stocks.

...equity investors

who did not buy at

the March bottom

should resist the

temptation to rush

back into US stocks.


32/4228 April



The Importance of the Durability of the Oil Contango

Oil stocks tend to trade off spot prices.

But, as clients are well aware, we have consistently advised investors to rank

producers based on the value of unhedged reserves in the ground (or undersea)

in politically-secure regions of the world. Why, for example, should Suncor and

Canadian Oil Sands, who have reserves lasting through this century, trade on the

basis of todays spot prices?

Are those futures prices sheer speculation, or are they the collective best judgment

of those who have the most at stake?

Crude Oil SpotJanuary 1, 2008 to April 20, 2009

30

50

70

90

110

130

150

Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09

48.35

Crude Oil Futures (at April 20, 2009)

June 2009 to December 2016

45

55

65

75

85

Jun-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16

77.48

Are [oil] utures prices

sheer speculation, or

are they the collective

best judgment o

those who have the

most at stake?


33/4229April

We believe that those distant month contracts primarily reect the intersection of

the beliefs of major producers and consumers about oils future. The population

of oil speculators has shrunk drastically since The Midnight Massacre. What

is particularly interesting about the steep slope of the contango is (1) that the

producers, at a time of tremendous stress on their budgets, have not rushed en

masse to drive down the prices of out months to lock in such attractive prices,

and (2) that consumers are willing to pay up so consistently for futures contracts

to assure themselves of supply at prices they are willing to include in their own

long-term business forecasts.

As important as those concepts are, there is another aspect to the oil futures curve:

as long as oil stays in such sharp contango, investors in most commodity funds will

nd to their surprise that their holdings of barrels of oil are shrinking, month by

month when oil enters its next sustained bull market.

Why is that?

The typical commodity fund, such as the Goldman Sachs fund, rolls its investment

in each asset as the spot month expires, buying the next months offering. It doesnt

for example, switch between some out months into spot and then back again.

Heres a simplied version of the process. Suppose an investor holds, through a

fund, 100,000 barrels of oil which, at contract expiry, trades at $51 a barrel and

rolls it into the next month, which trades at $53 a barrel. The value of the sale is

$5.1 million, which is invested in next months crude. The investor now owns96,226 barrels. In other words, as long as the contango lasts, the investor cannot

expect to prot from a long-term investment in the commodity. This is precisely

what happened to the big funds when oil swung from backwardation to contango

on its rush from $75 to $145. Some shocked pension funds moaned about capital

destruction.

We make this point to illustrate one reason why we argue that pension funds

should not treat commodity investing as an alternative investment that must

be conducted by investing in actual commodities through the best-known funds.

Owning the shares of commodity producers is a far more reliable way to participate

in a commodity boomparticularly the shares of those companies which are ableto expand their output at a time of rising prices through having politically-secure

reserves: the investor wins two ways at once.

The population o oil

speculators has shrunk

drastically since The

Midnight Massacre.


34/4230 April



That said, commodity funds have their place in pension investing, because most

commodities stayed in backwardation during the decades of commodities Triple

Waterfall, and most commodities are in backwardation today.

However, ifor whenination 1970s style returns, then most commodities will

surely swing into contangos, as speculators buy out month contracts as bets on

future ination. Thats the way commodity bettors made their bucks back then.

But as long as deation remains the over-arching fear, commodity fund investors

should get reasonable returnsbut probably not as rewarding as those earned by

investors in strong commodity-producing companies.

The Worlds Troublemakers Challenge The President

We wrote last fall that the unfolding tragedy in Pakistan could become a global

disaster. While most policymakers and pundits focus on the fast-emerging nuclear

threats from Iran and North Korea, the government of the most populous Mainland

Asian Muslim nation looks helplessly at the fast-rising power of the Al Qaeda-

backed Taliban. Its army has ceased to be controlled by the government, and remains

preoccupied with its traditional enemyIndia. Now that control of Swat has been

handed over to the Taliban, the Dark Ages are returning rapidly. Already, 131 girls

schools have been closed, and pictures of public oggings of young women who

displayed what these pious people call public indecencywhether in displaying

bare arms or in leaving their homes for even a few minutes unaccompanied by

their husbandsare being published daily.

President Obama and his Asian negotiator, Richard Holbrooke, have been publicly

forceful that the war against Al Qaeda and the Taliban in Afghanistan cannot be

won unless Pakistans government reins in the Taliban in its frontier regions.

In recent weeks, the Taliban has grown bolder, extending its bombings into the

cities, even including Lahore. The terrorists who took over the Taj Mahal and other

hotels in Mumbai (ve days after we and our clients left), came from Pakistan,

were directed by a Kashmir-based group, and may have been actively aided by

the ISI, the powerful state-within-a-state that controls the army, the intelligence

servicesand the nations nuclear weaponry.

Meanwhile, India is embarked on its month-long national Parliamentary elections.

Prime Minister Manmohan SinghIndias Deng Xiaopingat age 78 enters a

bitter campaign just weeks after his second experience with open-heart surgery. His

main opponent is the Hindu Nationalist Party (BJP), which, in its term in ofce,

continued the liberalizing policies Singh had introduced as Finance Minister in the

Congress Partys previous term in power.

...ior when

infation 1970s style

returns, then most

commodities will

surely swing into

contangos...


35/4231April

Mr. Singhs health, and the Congress Partys often-weak control over its fractious

coalition, have meant that India has not been moving forward as rapidly on

liberalization since 2004 as most external observers seem to assume. The

government has responded to the global crisis with some protectionist measures

designed to appeal to key voting groups. Moreover, as readers of Aravind Adigas

Booker Prize-winning The White Tigerhave learned, the Singh government made

scant progress in controlling the pervasive corruption that the multi-party political

process fosters. What would doubtless most reassure global investors would be

a fairly decisive win for either of the two leading parties, so that the government

would not be dependent on support from Communists, Maoists or notably corrupt

regional factions. Another worry: the Mumbai massacre and the Talibans rise in

Pakistan may be giving respectability to extremist Hindu groups, which oppose

government programs designed to help the Muslim minority, and have beenresponsible for persecution and murder of Christians.

Despite those concerns, we are still cautiously optimistic that the worlds largest

democracy will somehow once again demonstrate that it remains a largely-tolerant

and largely-progressive beacon of political and economic freedom in a Continent

that boasts pathetically few true democracies.

We were talking to an Indian friend at the Grant Conference. He is now deeply

concerned. He thinks that investors should be downgrading India in their portfolios,

because the collapse of the Zardari government in Pakistan could unleash a

catastrophe that would engulf the subcontinent.

Joe Biden predicted just after the election that the new President would be tested

by some foreign challenger within his rst six months in ofce. For once, Mr.

Biden got it right. The challenges from Iran, North Korea, Afghanistan, and now

Pakistan will test Obamas coolness and determination.

The Somali pirate dramaa TV spectacularwas good news for Obama, because

the risk was contained in a small space, there were only three pirates holding

Captain Phillips, and this was the kind of confrontation made to order for the

SEALsthe worlds premier seaborn operations force. The way the President

managed the situation was textbook-perfect, and Americans got a chance to rejoice

in a victoryand found a new hero in Captain Phillips just as the story of Sully,

the peerless USAir Captain (and, inconveniently, a staunch Republican) was fading

from the mainstream media.

The challenges rom

Iran, North Korea,

Aghanistan, and

now Pakistan will test

Obamas coolness and

determination.


36/42


Last month, we criticized the President for riding madly off in all directions. This

month, we commend him for displaying on his European tour what he does better

than anybodycampaignand for his insistence that the war in Afghanistan is not

just a good war but a war that must be won. Those enemies of America across

the world who may have thought he was too callow and ideologized to be a serious

challenge may now have to rethink their assumptions. Mature democracies seem

to have the abilityor good luckto produce real leaders just when the going gets

tough. Obamas clumsy mishandling of the British le (sending back the bust of

Churchill given by Tony Blair, giving Gordon Brown 25 DVDs that dont work on

British TVs, and not bowing to the Queen while apparently bowing to the Saudi

prince) could have precipitated sneering and cynicism in the nation that has been

Americas key ally for a century. However, he and Michelle still wowed the Brits

with their panacheand the alliance is, thankfully, still intact.

We remain worried that his belief that he should take advantage of the deep

recession to fashion the statist society of the future will not only prolong the

recession, but weaken the American economy for at least a decade. We are unhappy

that Paul Volcker has been marginalized, and remain disappointed with Obamas

willingness to defer to Nancy Pelosi, who, though smart and experienced, is not

conspicuously endowed with either pragmatism or a desire to build a consensus at

a time of crisis.

We decline to join those who have reawakened the Far Lefts assault on Larry

Summers. Like most geniuses, he can be erratic, and he doesnt suffer foolsgladlya real liability for a political gure. However, he is as smart and well-

informed as any American economist since Milton Friedman, and hes likely to be

an excellent interpreter of the economys challenges to a President who must deal

with big economic and nancial problems while beset with so many challenges

abroad.

Besides, with the wise and experienced Volcker receding into the background, hes

all weve got and he could be taking Bernankes place at the Fed next year.

Mature democracies

seem to have the

abilityor good

luckto produce real

leaders just when the

going gets tough.


37/4233April

Allocations Change

US Equities 18 unch

Foreign Equities

European Equities 6 unch

Japanese and Korean Equities 2 unch

Canadian and Australian Equities 9 unch

Emerging Markets 11 unch

Bonds

US Bonds 8 unchCanadian Bonds 5 unch

International Bonds 11 unch

Long-Term Infation Hedged Bonds 10 unch

Cash 20 unch

Years ChangeUS 4.00 unch

Canada 4.25 unch

International 3.75 unch

Recommended Asset Allocation(for U.S. Pension Funds)

Bond Durations

Change

Precious Metals 35% unch

Agriculture 33% unchEnergy 22% unch

Base Metals & Steel 10% unch

Global Exposure to Commodity Stocks

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

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

RECOMMENDED ASSET ALLOCATION



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INVESTMENT RECOMMENDATIONS


1. F. Scott Fitzgerald had it wrong, at least for American stocks: you do get a second,and even a third chance. Stocks leading that six-week rally looked down, couldnt

see the bottom anymore, and promptly retreated to lower levels. Think about

what youll most want to own when The Real Thing arrives, and accumulate

them at leisure, while the market tries to decide whether the economic recovery

is a month, a quarter, or a year away.

2. Larry Summers adroitly brushed off a question about future levels of

unemployment by saying, Economic forecasters are divided between those who

know they dont know, and those who dont know they dont know. Galbraith

said the function of economic forecasting has been to make astrology look

respectable. We know we dont know, but we know we didnt feel comfortablewith the speed of optimisms return. Those last two deep Mama Bear recessions

didnt end with such alacritynor did optimism return so speedily.

3. We do believe that the stock market is giving the correct signals that techs and

commodities will lead the next recovery.

4. The other winner will be (sound of trumpets) commodity stocks. They were

heavily outperforming the S&P until the late stages of the recent rally. We think

theyll move back to #1 slotat least on relative strength.

5. Gold has been a bitter disappointment to its boosters in recent weeks. Bullion

is down 4.6% this year, and most of the leading stocks are down far more than

that. These setbacks came at a time when gold was getting more publicity as a

haven investment than it has received in decades. Gold has been hurt by two

ralliesrst the dollar, then the bank stocks. More recently, investors have been

spooked by the deal for the IMF to sell 403 tonnes of gold, at a time Indians,

traditionally the most reliable buyers, are on strike. That 500 tonnes of scrap

gold has come to the markets this year is a bad news/good news story: its a huge

amount for markets to absorb, but it proves anew that gold is a precious asset

in tough times. Gold stocks remain core investments within equity portfolios,

reducing overall portfolio volatility. They will be superstars when the dollar

nally falls, and people begin to get genuinely worried about inations return.The stocks will outperform bullion on the upside.


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6. Coppers remarkable performance (up 48% in three months) worries us. Yes,

China is coming back, but the industrial world is looking as bleak as a group

of paid mourners at a funeral. We do not recommend adding to base metal

exposure.

7. Within the energy group, we believe the bookendsreners and oil sandsare

most attractive. Why reners? (1) Most oil analysts despise them; (2) They

have to continue to ret their reneries to provide for greater percentage

usage of that great nuisance, ethanol; (3) Americans are driving less; however

(4) Reners should hold up better than other oil sectors if theres one last oil

shakeout coming. Oil sands: You just possibly may never be able to buy oil for

the 2020s as cheaply as you can today by buying the oilsands stocks. These are

cornerstone investments for long-term oriented investors.

8. Its planting season as we write, and the snow is largely gone. Low corn prices

are discouraging farmers from planting as much corn as last year. Higher soybean

prices (and cold wet weather) are encouraging them to plant more beans. Both

these crucial crops are priced protably for farmers, so dont believe the talk that

theyll be cutting back dramatically on fertilizers. However, the extra emphasis

on beans is bad news for the nitrogen fertilizer companies. (Beans dont need

nitrogen.) Overall, we still think the agricultural stocks have the best risk/reward

prole.

9. The steep yield curve entices investors to buy long-term bonds and enriches all

those bankers who have any wiggle room for making real loans after succumbing

to the allure of all those fascinating, sophisticated ways to make ghastly bets.

However, what the market giveth, the market taketh away once the economy

begins to recover and ination begins to return. Stay below your duration

benchmark: give up yield now for performance later.


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Documents

BMO CM Basic Points April 2009