BMO Nesbitt Burns Basic Points Feb 2010

8/14/2019 BMO Nesbitt Burns Basic Points Feb 2010

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Basic Points

Hard Rocks and Hard Shocks

February 19, 2009

Published by Coxe Advisors LLP

Distributed by BMO Capital Markets


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Company Name Stock Ticker Disclosures Company Name Stock Ticker Disclosures

Barrick Gold ABX 1, 3, 4 Goldcorp GG 1, 3, 4

BHP Billiton BHP Goldman Sachs GS

BP BP International Business Machines IBM

Caterpillar CAT JPMorgan Chase JPM 1

Citigroup C 3, 4 Kinross Gold KGC 1, 3, 4

Companhia Vale do Rio Doce RIO Nasdaq NDAQ 2

ConocoPhillips COP Newmont Mining NEM 3, 4

Exxon XOM Potash POT 1, 3, 4

Fannie Mae FNM 1 Rio Tinto RTP 3, 4

Freddie Mac FRE 1 SPDR KBW Regional Banking KRE

Freeport McMoRan FCX Xstrata XTA

(1) BMO Capital Markets or its ailiates owns 1% or more o any class o common equity securities o the company

(2) BMO Capital Markets makes a market in the security

(3) BMO Capital Markets or its ailiates managed or co-managed a public oering o securities o the company in the past twelve months

(4) BMO Capital Markets or its ailiates received compensation or investment banking services rom the company in the past twelve months

(5) BMO Capital Markets or its ailiates expects to receive or intends to seek compensation or investment banking services rom the companyin the next three months

(6) BMO Capital Markets has an actual, material confict o interest with the company

BMO Capital Markets Disclosures

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Don Coxe

THE COXE STRATEGY JOURNAL


February 19, 2009

published by

Coxe Advisors LLP

Chicago, IL


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February 19, 2009

Author: Don Coxe [email protected]

Editor: Angela Trudeau [email protected]

Coxe Advisors LLP. www.CoxeAdvisors.com

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


5/501February

OVERVIEW


This is the month or the BMO Nesbitt Burns Resources Conerence, a majorevent or global mining companies, and or institutional investors in mining

stocks. It is our tradition to prepare an issue o our journal that will be o

particular interest to the attendees at that great gathering.

This meeting will also be the eighth anniversary o our keynote speech to the

2002 meeting (sparsely attended compared to this year, which should be a

record). Back then, we audaciously proclaimed The Birth o the Greatest-

Ever Commodity Boom.

As we began thinking about our keynote address or this years meeting,

we have been reviewing what we said at earlier meetings, and are struck by

how much the outlook has changed or the hard and sot rock industries,

because o the two great dramas o recent years: rst, the emergence o China

and India as the driving orces o the global economy, and secondly, the

international nancial crisis and recession.

We remain bullish on the longer-term outlook or commodities and the

shares o the commodity-oriented companies. But the ragile nancial state

o many major governments and banks means that we must consider the

implications or investment assets at a time when investorsand such basket

cases as Fannie Mae and Freddie Macare beginning to look orward with

trepidation to the time when the fows o what we call nancial heroin willslow down beore drying up.

We are leaving our cautious Recommended Asset Mix unchanged. The

powerul equity bull markets have, since last March, driven many valuations to

levels that make scant allowance or urther systemic shocks. Most commodity

stock prices are held back by the mixed messages o recovery in Europe and

the US, while China has switched rom expansionary to restrained liquidity

policies. Within the US, there are some hopeul recovery signsnotably the

recent strong perormance o the US regional banks in the KRE Index (despite

reports o rising problems with commercial real estate loans)but volatility,

as measured by the VIX, is rising anew.


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THE COXE STRATEGY JOURNAL2 February


7/503February

I The Base Metal Miners

When we spoke in 2002, the Canadiansand most o the Americansin

the audience were ocused primarily on the outlook or copper and nickel,

because Inco and Falconbridge were the core base metal investments in

Canadianand Canadian-orientedportolios.

Naturally, our enthusiasm was greeted with skepticism and, (we have since

learned) some outright scornparticularly rom the mining analysts and

rom mining executives.

We explained the importance o Triple Wateralls or macro-nancial analysis

by listing the three within our experience: in each case, a decade o bullishness

ended in mania, ollowed by two decades o collapse:

Commodities: The asset class o the Seventies, ending in January 1980,

ollowed by two decades o decline, disappointment, and despair.

Japan: The real estate and stock market stars o the Eighties, ending on the

last trading day o 1989; we predicted that Japans plunge still had many

years to run.

Technology: The asset class o the Nineties, ending March 2000. We

predicted that most technology stocks would be underachievers until late

in the ollowing decade. (Note: Google wasnt public at Nasdaqs peak.)


Copper

January 1, 1986 to February 18, 2010

50

100

150

200

250

300

350

400

450

Jan-86 Jan-89 Jan-92 Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10

320.25

Commodities: The asset

class o the Seventies,

ending in January 1980,

ollowed by two

decades o decline,

disappointment,

and despair.


8/504 February



My entry into portolio management in 1972 came just in time or the

horrendous stock market crash o 1973-75. Commodities then became an

infation hedge class, driven initially by gold, silver and oil, but later by base

metals when the big oil companies began redeploying into mines some o the

billions o dollars o their proceeds rom the nationalization o their major

Mideast oil elds. One o the historic Dow Thirty o that eraAnacondawas

bought by a member o the club still known as Big Oil. Its purchaser explained

that its skills in extracting wealth rom the ground were equally applicable

to metals. That was a sign o mania driven by desperation. (The investment

was later written o.)

The peak came in 1980. Commodities entered their Triple Waterall collapse,

and 20 years o despond and despair ensued, as the capex born o the mania

was slowly and painully absorbed or sold or scrap.

By 2002, with the mining industry shrunken and disbelieving, the stage

was now set or a boomwhich would be driven by demand rom Asian

industrialization.

China and, to a lesser extent, India, had embarked on what would becomethe

largest-scale eforescence o human economic liberty in the history o mankind.

Buy what China needs to grow, we had been telling investors since 1999.

By 2002, most investors seem to have orgotten their enthusiasm or the

new millennium, which had arrived with two shocks: the Technology Crash, which spread into an overall equity bear market, ollowed by 9/11, which

meant we were collectively at risk rom attackers based in some o the most

primitive regions o the world.

Yet, we were telling them their biggest investment opportunity was coming

rom nations that had not long ago been considered so economically

backward as to be mere ootnotes to any global investment strategy.

...the largest-scale

eforescence o human

economic liberty in the

history o mankind.


9/505February

A chance meeting in Australia months previously had conrmed our

suspicion that good times would soon be returning or the ravaged base

metals companies:

Ater touring the amous desert massi sacred to the Aborigines as Uluru,

our group was supplied a desert dinner. I asked the gentleman next to

me what he did, and he replied that until a ew weeks ago he had been a

mining executive. Since I had long been a ollower o that industry I asked

which one. I ran Rio Tintos operations in Australia.

I explained that I was an investment strategist and had been negative on

mining companies or years. Was the outlook changing?

He explained that, or twenty years, the industry was driven by men who

sought to prove their virility by opening bigger new mines than their

competitors. That strategy may have been good or their testosterone,

(he allowed), but it was terrible or shareholders. Stock prices were so

beaten-up that managements nally learned their lesson: rom here on,

they wouldnt be betting big on big new mines. (Refecting on that, I later

coined a maxim: Invest in an industry where Those who know it best, love it

least, because theyve been disappointed most.)

We asked, What could create the shortages that would get them to reopen

closed mines and open new ones?

China, he said. Theyre going to need a lot o metal to meet their growth

promises to their people, and they will soon have trouble getting it. Metal

prices will have to go up eventually.

That, I gured at the time, was the single most prophetic speech I was

likely to hear or years.

I knew rom having studied economic history that large-scale industrialization

created huge demand or metals, whereas mature economies modest annual

growth in consumption could be metin considerable measurerom

scrap.

By 2002, I was convinced the Prime Mover for the global economy in coming

decades would be Asianot Europe and North America.

Invest in an industry

where Those who know

it best, love it least,

because theyve been

disappointed most.


10/506 February



The Boom Begins, and Has Its First Pause

BHP Billiton (BHP)January 1, 2002 February 17, 2010

0

10

20

30

40

50

60

70

80

90

100

Jan-02 May-03 Sep-04 Jan-06 May-07 Sep-08 Jan-10

74.25

BHP Billiton relative to S&P 500January 1, 2002 February 17, 2010

0

100

200

300

400

500

600

700

800

900

Ja n- 02 J an- 03 Ja n-0 4 J an-0 5 Ja n- 06 J an-0 7 Ja n-0 8 Ja n-0 9 J an- 10

739.68

Rio Tinto (RTP)

January 1, 2002 February 17, 2010

50

150

250

350

450

550

Ja n-0 2 J an- 03 J an-0 4 J an-0 5 J an-0 6 Ja n-0 7 J an- 08 J an- 09 J an- 10

215.25

Rio Tinto relative to S&P 500

January 1, 2002 February 17, 2010

100

150

200

250

300

350

400

450

500

550

600

Jan -0 2 J an -0 3 J an -0 4 J an-0 5 J an-0 6 J an-0 7 Ja n- 08 J an-0 9 Ja n-1 0

284.23

Vale (RIO)

March 23, 2002 to February 17, 2010

0

5

10

15

20

25

30

35

40

45

50

Mar-02 Jan-03 Nov-03 Sep-04 Jul-05 May-06 Mar-07 Jan-08 Nov-08 Sep-09

27.78

Vale relative to S&P 500


0

200

400

600

800

1,000

1,200

1,400

1,600

1,800


1,336.96

Xstrata (XTA) (London)


0

500

1,000

1,500

2,000

2,500

3,000


1,062.50

Xstrata (XTA) (London) relative to S&P 500

(currency adjusted)


0

100

200

300

400

500

600

700

800

900


362.91


11/507February

These are the diversied base metal giants that operate around the world,

and their collective perormance is driven by demand and pricing or copper,

aluminum, iron ore, coal, nickel and zinc. (BHP has substantial oil and gas

production, and others have precious metal exposures in varying degrees,

but they trade on investors outlook or the key base metals and coal.)

CopperKing Copper serves a wide range o industrial markets, as

does aluminum. The others are tied directly into global iron and steel

production.

Copper


0

50

100

150

200

250

300

350

400

450


320.30

Aluminum


0.40

0.60

0.80

1.00

1.20

1.40

1.60

Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

0.83

These are the diversifed

base metal giants...

they trade on investors

outlook or the key base

metals and coal.


12/508 February



In 2002, and each speech thereater, we outlined the key nancial and

political principles or successul commodity stock investing:

First: invest in an industry that has completed its Triple Waterall Crash,

whose companies are led by battle-scarred executives and whose shares

are ollowed mostly by analysts who, like those executives, know it best,

and love it least, because theyve been disappointed most.

Secondly, invest in companies whose strength is unhedged reserves in the

ground in politically-secure areas o the world.As time went on and the stocks began to move, we added another maxim:

The Obesity Index.Avoid investing in stocks where the weight o analysts

on the Street is heavy in relation to that groups weight in the stock market,

In 1980, there were more oil analysts than tech analysts on Wall Street:

you should have sold oil and bought technology. Now the reverse was

true, even ater the rst stage o technologys Triple Waterall collapse. We

had, in eect the Anorexic Indexa ew analysts too scarred by years o

grim news to issue enthusiastic Buy stories.

ZincJanuary 1, 2002 to February 18, 2010

Nickel


0

10,000

20,000

30,000

40,000

50,000

60,000


20 066

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000


2,276.75

We had, in eect the

Anorexic Index

a ew analysts too

scarred by years o

grim news to issue

enthusiastic Buy

stories.


13/509February

By the late 1990s, most o the big base metal miners had virtually shut down

their exploration departments, ring their geologists, and hunkering down.

Why explore or new mines when youre losing money on the ones youre

operatingwhich are probably higher grade than what you might nd in

some bush, jungle or mountain topand ace strenuous opposition rom

local residents and global greens?

University geology departments had been shrinking or closing or more than

a decade, and many geologists had taken up careers outside their industry.

(A riend who was Chairman o Geology at a major university once told me

that one big reason they were able to keep the department going during the

bad times or exploration was demand rom students who had no intention

o working or mining companies. They wanted to learn about the industry

so they could get jobs with Greenpeace, environmental NGOs, and law

rms that sue to prevent mines rom operating. Some o these enthusiastic

demonologists doubtless got gloriously satisying work onAvatar.)

Such exploration as was being undertaken was mostly by the smaller

companies, who took advantage o the lack o competition rom the biggies

to stake claims around the world. That meant that the contract drillers which

had somehow survived the Triple Waterall Crash were getting more demand

or their services than they could ll.

Once the China story took hold with risk-oriented investors, smaller mining

and exploration companies were able to raise unds through equity oerings,

and they lled the gap let by the bruised biggies. Result: one o the great

winners rom the mining boom has been contract drillers:

Major Drilling Group


0

10

20

30

40

50

60

70


23.47

Why explore or new

mines ....which are

probably higher grade

than what you might

fnd in some bush, jungle

or mountain top...


14/5010 February



In keeping with Those who know it best love it least, big mining and oil

companies, having slashed exploration and capex to the bone, did not

boost their exploration budgets in line with rising revenues as metal

demand climbed. A study in 2005 reported that global mining exploration

expenditures were roughly equal to what the industry had spent a decade

earlier.

The managements o those companies and the ew surviving analysts who

covered them looked at each uptick in prices o their production as selling

opportunities.

It took a while or copper prices to respond to the rapidly-rising demands

rom China (and, to a lesser extent, South Korea). One big reason was the

determination o the management o Phelps Dodge, one o the worlds ourbiggest producers, to lock in higher copper prices by selling huge amounts

o production orward in what was (alsely) called hedging. At the 2005

Conerence, I was asked during Q&A, How high can metal prices go? I

had heard Phelps managements presentation that morning, in which they

insisted that analysts should use 85 cents per pound or their long-term

earnings estimates. I replied, Why not use $2.00 or copper and $9.50 or

nickel? The Phelps team got up, and noisily marched out. In contrast, Incos

CEO was quite complimentary about the speech, and grinned, I loved your

$9.50 nickel.

Phelps had locked in 85-95 cent copper on huge long-term contracts. They

doubled up with more sales in the $1.25 range. Insiders exercised stock

options and sold heavily with copper prices trading not ar rom $1. Result?

In 2006, with copper prices soaring to $3.00, the honchos o the Arizona

desert ound themselves under water and were bought outat a bargain

price or their superb assetsby Freeport McMoRan.

The management o BHP, led by the shrewd Chip Goodyear, had a dierent

view. The giant continued to expand production, eschewed hedging, and

shocked the industry by buying Olympic Dam, which had the largest known

undeveloped reserves o copper. At the Society o Economic Geologists

Convention in 2006, Rio Tinto people were smiling about the very large

sum BHP had paid or Olympic. In his speech the next morning Mr.

Goodyear noted, Yes, we paid a very large sum or those copper reserves.

But we also got the worlds largest known uranium reserves or ree. That is

the optionality that builds great mining companies. He urther explained

optionality with reerence to Freeports giant Grasberg minethe worlds

biggest gold deposit and one o the three biggest known copper deposits.

In 2006, with copper

prices soaring to $3.00,

the honchos o the

Arizona desert ound

themselves under water...


15/5011February

When the mine was being readied or production in 1988, its reserve lie was

estimated at 20 years, but the geology in the region was extremely avorable.

He said that its current estimated reserve lie was many decades.

That approach to optionality should, we elt, be used by investors in mining

stocks. Look or companies owning properties with great, unhedged, proven

reserves, and with indicated geologic potential or massive additions to those

reserves, includingin some casesthe likelihood o proving economic

quantities o other minerals.

The Crash: Was That The End of the Greatest-Ever Commodity Boom?

As the stock charts show, the big miners took bigger hits during the Crash

than most other big non-nancial companies.Naysayers who had dismissed the commodity boom as another 1990s bubble

were gleeul. So much or the China story! How will China continue to buy

copper and coal when its exports collapse and it alls into recession? Those

big mine expansions in Australia and Asia will probably go bust.

However, as those charts also show, the mining stocks came roaring back.

Their cash fows are once again robust, and the only one o the majors

with a modestly worrisome balance sheet is Rio Tinto, which leapt late

into the acquisition game, buying Alcan right at the top. But RTPs earnings

are powerul, and it is having no diculty in raising money. Meanwhile,

Freeport, which borrowed to expand Grasberg and buy Phelps Dodge, could

be debt-ree by next year, i copper and gold prices stay near current levels.

BHP announced its earnings or the rst hal o scal 2010 last week$6.1

billion, up rom recession trough $2.6 billion. O perhaps more importance

were its announced capex plansup 17% in this year, not including $5.8

billion or its joint iron ore venture with Rio Tinto that still awaits nal

government approval. The company had earlier advised the it was now

seeing strong price recovery driven by demand in China and restocking in

the developed world. This optimism was conrmed in a Wall Street Journal

report last week which asserted, The prices o ingredients to make steeliron ore and coalare rising sharply.

That approach to

optionality should...

be used by investors in

mining stocks.


16/5012 February



Contrast that powerul recovery in prices o minerals and stocks rom

recession depths with the anemic GDP outlook or the US and Europe.

On the evidence, The Greatest-Ever Commodity Boom remains intact.

What the Crash and subsequent events have demonstrated is that these

companies have ar less endogenous risk than most macro-analysts realize.

Many deep cyclical US stocks that rely on US economic activity have barely

recovered rom the Crash, and their utures depend on the success o the

Obama-Bernanke-Geithner programs. The miners are true global companies,

and the strong recoveries across Asia more than oset sparse demand rom

American and European customers.

Chinas Second Long March Goes Global

As metal pricesparticularly iron orecontinued to climb to record levels,

The China Story took a new turn. Stung by the iron ore cartelBHP, Rio

Tinto and ValeChina began sending its minions across the world looking

or metal reserves. When BHP tried to buy Rio Tinto, (which had recently

bought Alcan), the Chinese were alarmed that the merged company would

have the properties, production, and cash fow to have a lock on Australias

production o iron ore. Chinalco leapt in, buying sucient RTP shares within

24 hours to put a hold on the merger, which was already in trouble because

o anti-trust claims by Australia and the European Economic Community.

This year, China made its next move to lock in control o major Australianproperties that produce what Chinas steel mills need: the Export-Import

Bank o China is putting up $5.6 billion o the estimated $8 billion cost o

developing Clive Palmers huge Resourcehouse coal project in Queensland,

which will be built by Metallurgical Corp. o China.

China is investing almost everywhereincluding in Quebec, where Wuhan

Iron and Steel has taken a $240 million stake in Consolidated Thompson

Iron Mines. Stung by governmental intrusions into attempts to buy major

commodity companies such as Rio Tinto and Unocal, what is happening

is that Chinese state-owned or controlled companies are buying minority

and controlling stakes in companies with mineral properties across the

worldand opening mines in hellhole countries backed by their own

security personnel.

The Greatest-Ever

Commodity Boom

remains intact.


17/5013February

Although the Crash was devastating to the miners stockholders, it may

have accelerated the emerging competition or ownership o resources rom

government-owned mining companies and Sovereign Wealth Funds. These

cash-fow-rich organizations tried buying up mining and oil companies,

but ound that Western governments were unhappy about losing national

treasures. The situation was asymmetric: it was dicultor impossibleor

resource companies to buy control o Chinese, Brazilian or Indian companies,

but the government-controlled companies were able to hymn the virtues o

ree markets as they made major acquisitions abroad. Vale bought Inco, and,

(as we bitterly complained at the time), the Canadian government sat by

as the EEC bureaucrats took geologic time to consider the implications or

European steel mills o Incos planned merger with Falconbridge. That merger

would have prevented a takeover o Inco, and would have blended the giantSudbury operations o the companies. As a result o Brussels stalling, Xstrata

was able to pick up Falconbridge, while Inco was let virtually deenseless

against Vales big bid, at a time hedge unds were huge holders o Inco

shares.

We believe that the government-controlled companies and Sovereign Wealth

Funds will eventually dominate the worlds base metal industry unless

investors collectively revise their appraisals o minings risks and rewards,

and governments in the countries where the miners are incorporated change

their purist views about takeover rights by government-controlled companies.

Five years ago, or example, Falconbridge and Inco were jewels in Canadian

portolios and RSPs. Ater the dust had settled, a Brazilian-government-

controlled company owned Inco, and a company o shadowy origins that

was partially spun-o rom the Marc Rich group owned Falconbridge. Those

outcomes are dubious tributes to the glories o capitalism and ree markets.

Those outcomes are

dubious tributes to the

glories o capitalism

and ree markets.


18/5014 February



The Next Eight Years

What now?

The mining industry has long been loathed by environmentalists. It is relatively

riendless among G-7 governments as a polluter and a big contributor to

global warming.

Nobody wants a big smelter upwind.

Nobody wants any runo o toxic chemicals into local rivers and bays. The

industry, ortunately, has devoted billions to research and construction to

make it a clean air, clean water producer o what the world needs nowand

in the uture.Global warming is a dierent kind o challenge (as will be discussed in

the Investment Environment). Cleaning up air and water pollution rom

sulphuric and other acids and metal dust is something that is being done

at costs the industry can bear. But its smelters are CO2

producers, which the

warmists have been opposing with all their connections and might.

One reason why so many investors consider the mining stocks to be high-risk is

that resource companies still suer rom what could be called G-Sevencentric-

Evaluations. For the early years o the boom, skeptics regularly dismissed

these stocks as terrible investments: Theyve been that way or twenty years,

and, apart rom the infation boom, theyve been deep cyclicals that cant

deliver good long-term returns. They dont t the stable grower model made

amous by Warren Buett, and they have, in most cases, no control over the

prices o their output. They nally get around to opening big new mines late

in one cycle, and then a recession arrives, prices collapse, and they have to

keep pumping stu out or whatever they can get. They are their own worst

enemies.

Dare we say it? Its dierent this time.

Despite the worst Crash and recession since the Depression, prices o key

industrial commodities, such as copper and crude oil, are trading at highlyprotable levels or ecient producers. The S&P is up by one-third in eight

years but copper is up 192% and crude is up 130%.

...resource companies

still suer rom

what could be called

G-Sevencentric-

Evaluations.


19/5015February

One reason is that known economic reserves in politically-secure areas

have not increased, despite heavy capex in recent years. Costs o nding,

developing and producing are up sharply, which means the small and mid-cap

entrepreneurial companies that in earlier booms supplied substantial new

production (either by themselves or through being taken out by majors)

have not been able to ll those roles to the same extent this time.

Why?

Mostly because o politics.

Robert Friedland, a respected giant among mining promoters, is a modern

Gulliver, beset by Lilliputians. His superb Ivanhoe copper mine in Mongolia,

which could increase that poor nations GDP by one-third, is nally going

orward ater years o politically-driven delays. Just when it looked as i

he was on the verge o getting ull nancing, the Mongolian government

announced punitive new resource taxes. It has taken three years or him,

and his new partner, Rio Tinto, to get the government to repeal those mine-

killing levies, but investors are naturally wary that once many billions have

been invested and the ore fows, the cash-strapped government will enact big

tax increases. His vision, guts and smarts have outlined potentially gigantic

reserves in the Congo. They once looked secure because he had negotiated

rights with a government backed by the UN. Alas, as o now, his guts havent

brought glory. The Congo has reverted to its pre-Belgian pattern o bloody

tribal warare.

Where is it sae to bring on new mines?

I there arent major environmental challenges, and i local native tribes

dont claim veto powers while they sort out among themselves who has the

historic rights, then most provinces in Canadaand particularly Quebec

remain sae or miners. (Mining exploration in remote regions, as we have

been told by one o the leading contract drillers, is in Quebecoisgenes dating

back to Les Coureurs de Bois who lived, hunted and trapped in the wilds. Their

descendants are, he said, among the worlds best and most reliable workers

in the bush or jungle.)

Perhaps the best place or mining in North America is Nevada, because

the local governments are riendly and Congress has been unabledespite

decades o eortto come up with a royalty scheme or ederal lands. Result:

companies only pay regular corporate taxes. The miners have strong support

in Washington with Harry Reid as Senate Majority Leader, and he gets help

rom Senators in other states with substantial ederal lands.

Robert Friedland,

a respected giant among

mining promoters,

is a modern Gulliver,

beset by Lilliputians.


20/5016 February



Conclusion

The base metals and coal are the purest Chindia plays among the ourcommodity asset classes (base metals and coal, precious metals, energy, and

agriculture). Among those metals that trade on the exchanges, the China

infuence is powerul; or those steelmaking ingredients that trade by overseas

contractiron ore and metallurgical coalChina is the price-setter.

We underweight these stocks within our recommended commodity stock

portolio because they have the highest economic risk o the our classes,

and have the most to lose i the global economic recovery alters when the

nancial heroin supply dwindles. Chinas inventory policies are opaque,

and base metal contangos in the metal uturesmost notably in aluminum

stimulate speculative activity that makes valuations vulnerable to major sell-os.

However, the base metals may well have the best upside potential o any

group whenor ioverall global economic growth resumes and investors

no longer have reason to worry about metal price bubbles.

We expect to boost our recommended exposure to the base metals sharply

this year, as our concerns about a double-dip US economy ade.

China is the price-setter.


21/5017February

II The Latest Chapters in the Financial Crisis

The best moment or us, in our continuous coverage o the debate about the

nancial crisis was Obamas response to the Massachusetts Tea Party shock,

in which an obscure, centrist-conservative state senator named Scott Brown

won the Senate seat that had been under Kennedy amily control since 1952.

Within hours, Obama announced that he was endorsing Paul Volckers banking

reorm proposals (which we endorsed enthusiastically in our last issue). Then

we heard that Barney Frank and Chris Dodd would be proposing the reorms

in their respective committees. The surprise at being on the same page at the

same time with Obama, Frank and Dodd recalled or us the time we absent-

mindedly wandered into the wrong restroom at OHare.

The worst moment or us was to come two days later. Mr. Volcker appearedbeore the Senate Banking Committee, whose members are the objects o

Wall Streets tenderest attentions and most generous gits. The Democrats

were, in the words o Wodehouse not exactly disgruntled, but they werent

gruntled either.

The Republicans were more openly hostile. Republican Senator Richard

Shelby o Alabama became the Brutus in this latest Capitol drama. As The

Wall Street Journal described it, He questioned Mr. Volcker in a ashion that

suggested the utmost respect or a great hero o economic crises past and the

patronizing condescension one would give an 82-year-old suspected o being

out-o-touch with the modern nancial world and, perhaps, a bit senile..Mr. Shelby has taken $2 million rom nancial interests, more than double

the contributions rom the next leading industry.But thats how it is in

Washington these days. Unlike the Congress o the 1930s this body is more

beholden to politics than to reorming a broken system that has put the

American economy in a hole so deep the competitiveness o every American

industry is now in question.

Ater Shelby announced his opposition, other Republicans rushed, Gadarene-

Swinishly, to join him, and the Democrats quietly withdrew rom the scene,

unwilling to mount a ght that their biggest donors opposed.

Shelby may well be remembered as the Capitol killer who destroyed the

rescue program oered by the man who could reasonably be regarded as a

short-list candidate or the noblest American o them all. Prior to shating

Volcker, he was best-known or holding up 70 ederal appointments o all

kinds because he demands approval o a big tanker deal or his state.

Ater Shelby announced

his opposition, other

Republicans rushed,

Gadarene-Swinishly,

to join him...


22/50


23/5019February

Another o the central gures in the book, JP Morgans Jamie Dimon, who is

one o the most vocierous and powerul o the Wall Street barons, was upset

with Volckers proposals. He deended the Street, saying that a crisis comes

every ve to seven years.

Really?

Will that go into history as the Morgan equivalent o Chuck Princes

memorable, As long as the music is playing, youve got to get up and

dance?

The Crash wasnt some Seven-Year Hitch. And even ater nearly two years

o multi-trillion spending, 8.5 million Americans are unemployed, and the

stock market is where it was twelve years ago.

Nor was all this misery necessary. Had the B5 and their bankerly brethren

not pigged out on their ancy, impenetrable CDOs and CDSes, that Buett

and Volcker had routinely derided as socially useless and outright dangerous,

there would have been no Crash, and no recession.

In general, Wall Streets words o repentance and its acceptance o meaningul

reorm are as impressive and reliable as the investment quality o the average

sub-prime CDO that theyd love you to buy.

That doesnt bode well or the nancial recovery on which the nation

depends.

On the other hand, the KRE is looking better in recent weeks. I its relative

strength continues through a stock market correction, we would be looking

or the time to give the All Clear signal to investors.

Wall Streets words

o repentance and

its acceptance o

meaningul reorm

are as impressive

and reliable as the

investment quality

o the average

sub-prime CDO...

KBW US Regional Banking ETF (KRE) relative to S&P 500


50

60

70

80

90

100

110

Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10

69.25


24/5020 February



III Turning of the Tide?

When the nancial markets and economies imploded, Letist publicists and

politicians could barely conceal their satisaction: at last the era o greed that

began with Reagan and Thatcher and spread across the world so obscenely

ater the collapse o Bolshevism was over. Voters everywhere would now,

nally, demand socialist-oriented policies. Letist parties would transorm

the political landscapes o the world. Greed is dead! Government is no longer

the problem, it is the solution!

Except that it hasnt been turning out that way. Consider Europe: Apart rom

Greece and Spain, two o the Mediterraneans members in the Eurozones

amily o PIIGS (Portugal, Ireland, Italy, Greece and Spain), elections have

been going or center-right or conservative parties. Admittedly, in Latin America, the tide toward the dictatorial Let in Venezuela, Ecuador, and

Argentina, which began even as most o that region was turning to the Right,

is continuing. But even in those dens o political stench, the caudillos are now

having trouble holding down political discontent.

The most important conrmation o this trend toward normalcy came in

last years election in India, in which the center-right Congress party o

Manmohan Singh was returned with a larger majority.

We have commented on these reassuring trends previously. Now we must take

note o something that could be even more momentous: the tide in bondrisk appraisals away rom sovereign credits toward high-quality corporate

bonds. As voters seem to be moving away rom reliance on Big Government

and looking to the business community to revive their economies, bond

investors have begun to migrate rom the debt o hideously over-indebted

governments to the debt o well-managed companies that will be part o the

economic progress o uture years.

If, as we expect, this trend continues, it would be one of historys greatest sea

changes in bond investing.

Harvards Kenneth Rogo may have helped set o this swing among bond

investors with the publication o a remarkable history o debt deaults over

six centuries. He shows that the list o countries which have never deaulted

on their own debt is a handul. (Canada, by the way, is a member o that

virtuous group.) The record o European, Asian and Latin American countries

is enough to make a moralist weep and a sovereign bond investor consider

hemlock as an alternative acquisition. Rogo asks why sovereign credits are,

The record o European,

Asian and Latin

American countries

is enough to make a

moralist weep and

a sovereign bond

investor consider

hemlock as an

alternative acquisition.


25/5021February

according to banking system rules, always ranked higher than any corporate

credits. He shows that many o the biggest corporations have never deaulted.

He is, in eect, challenging the Basel rules which provide that a bank holding

Greek bonds does not need to allocate capital or that investment, whereas

i it holds Exxon Mobil bonds, it does. As Mr. Bumble would say: The law

is a ass.

The new doubts about sovereign credits are based on the rapidly-unolding

evidence that governments unionized employees salaries, pensions and

health care have created a huge new class o winnersand ew governments

can aord what previous governments promised to the privileged. Watching

the striking unionized government employees screaming threats in Athens,

we realized that those peoplewho retire as early as 58 or no later than 63

with great pensionsmay have more to argue about with most o their ellow

citizens than the Greeks had with the Trojans. (Our avorite rioter quote,

We gave the world democracy: now its time to pay us back.) Athenian

democracy disappeared 23 centuries ago, and only returned when Truman

intervened ater World War II to prevent the USSR rom taking over. Greeces

democratic perormance since then suggests that the genes o Pericles and

Solon are extinct.

In other words, manyi not mostgovernments are struggling under the

piled weight o all the sweetheart pension and union promises o the past,

while the economies on whose taxes they rely are orced to compete in thepresentand ace a uture o increasingly ormidable competition rom

economies that were deemed irrelevant when those costly promises were

made. To add injury to destiny, they have to bail out bad banks and insurers.

Why buy the paper o sovereign issuers that keep going deeper into debt and

have no realistic programs or doing better? (Although the dollar currently

benets rom the Greek-driven rush out o the euro, the IMFs calculation

o current decit to GDP ratios puts the US in Greeces league. Only the

USs reserve status allows Washington to keep boosting wages and benets

to government employees while the private sector languishes. According to

one study, the number o Federal employees earning more than $150,000per year has doubled in the past 18 months.)

I people are collectively beginning to mistrust Big Government and Zero

Interest Rates, then it should be no surprise that investment-grade nonnancial

corporate credits gain on governments almost every week.

Greeces democratic

perormance since

then suggests that the

genes o Pericles and

Solon are extinct.


26/5022 February



Until recent months, the United States seemed to be an exception to this

rule that governments were moving rom the Let toward the center-right.

Mr. Obama ran as a centrist against the record o a aux conservative who

had added a huge new entitlement (Prescription Drugs) and a major ederal

intrusion into school systems (No Child Let Behind), and drove the US into

a war based on botched intelligence about WMDs. Result: a big rise in scal

decits and the national debt. Bush also ailed dismally by kowtowing to

the Fannie Mae and Freddie Mac backers in Congress who kept legislating

reductions in down payments and credit ratings or mortgagors. Despite

strong support rom Congressional Republicans and Allan Greenspan, he

caved in to the Congressional Democrats who kept insisting that Fan and

Fred posed no risk whatever to the nancial system.

Inheriting this mess and a ull-blown nancial crisis, Obama proceeded

to surprise many o his supporters by introducing massive, costly new

ederal programs in health care and global warming. The result: decitsin

both the short and long-termar above earlier estimates and the kind o

rising political discontent that opens the doors to populists. As early as the

Midterm elections, i current polls hold, the US will have rejected dreamy

progressivism, and will, at least supercially, more closely resemble the

political trends abroad. (Whether the new winners in November will prove

to be sensible centrists and moderate conservatives remains to be seen, and

the auguries at this point are hardly encouraging.)

Obama has had one big stroke o luck recently. The Euro-turmoil about

Greece and the other PIIGS has orced China and other central banks to

reconsider their reduction in Treasury buying in avor o buying Eurozone

bonds. Major investors had been warning o a coming crisiswith sharply

rising interestas projections or US decits kept climbing. The White House

Budget oce minions kept grinding out reassuring gures about global

demand or Treasurys. Those geeks should thank the Greeks.

Conclusion

I the big bosses o the Big Government trend are losing public condence,then, at some point, private investors and pension unds will decide to build

some longer-term protection into their unds against worsening economies

and the rapidly-deteriorating quality o ederal and state bonds.

Theres a our-letter word or the clear alternative to all these machinations

and program and decits and bad bank paper: gold.

The White House Budget

ofce minions kept

grinding out reassuring

fgures about global

demand or Treasurys.

Those geeks should

thank the Greeks.


27/5023February

IV The Precious Metals

Gold


Silver


Platinum


200

400

600

800

1,000

1,200

1,400


1,120.10

0

500

1,000

1,500

2,000

2,500


1,609.80

0

500

1,000

1,500

2,000

2,500


1,537.10


28/50


29/5025February

Goldcorp (NYSE: GG)


0

10

20

30

40

50

60


38.65

Newmont (NYSE: NEM)


0

10

20

30

40

50

60

70


47.24

Kinross (NYSE:K)


0

5

10

15

20

25

30


18.50


30/5026 February



Among the biggest metal stories since the last Resources Conerence have

been the dramatic run-up in gold prices, and the announcement o Barricks

unwinding o its hedges.

Barricks hedging program was the right big thing during the years o golds

Triple Waterall collapseand the wrong big thing once gold had entered a

new long-term bull market. The Barrickvolte-ace helped drive gold prices to

new heights.

For decades, many gold companies executives and promoters spoke longingly

o the coming Golden Age when gold would trade at $1,000 an ounce. Gold

nally broke through that magic barrier last September, and has remained in

The Promised Land since then, but gold mining stocks (as measured by the

XAU) peaked out weeks ago.

As we wrote in December (Financial Heroin), when gold broke into Four

Digitland, it suddenly began to look less like a store o value and more like

a speculators plaything. Why was gold running wild? We cheekily suggested,

as historians, that this moment in metal history could be driven by dates o

the past. According to this dubious hypothesis, golds rst target should be

1066 (The Battle o Hastings), the next 1215 (Magna Carta), with a near-

term peak o 1258 (The Provisions o Oxord) and a one-year target o 1345

(Onset o The Black Death, which began to ade away by 1350). Bullion

bounced all the way to Magna Carta beore the mini-bubble burst and gold

plunged briefy back, bottoming outat 1066.

What converted so many skeptics into chrysophiles was (1) Barricks

capitulation to market orces, and (2) word that the Government o India

was buying 2,000 tonnes o gold rom the IMF or its oreign exchange

reserves. Analysts also noted that the list o European central banks who

were not taking advantage o their gold selling rights under the Washington

Agreement seemed to be gaining new members.

The new elixir or gold investors and gold bugs alike: what happens i (1) all

the central banks in the Washington Agreement stop selling and start buying

and (2) China and other heavyweights decide to put a meaningul percentageo gold into their orex reserves? As gold broke through $1,000, that kind o

buzz began to spread, and, ater thirty years in which gold bugs talked o

Gold at a thousand, suddenly the new target was $2,000. The wise Pope

(Alexander, that is), would understand:

Hope springs eternal in the human breast.

Man never was, but always to be blest.

Gold fnally broke

through that magic

barrier last September,

and has remained in

The Promised Land

since then...


31/50


32/5028 February



We have advised those who, terried by soaring global scal decits and

global liquidity, talk o a rush to cash by selling most or all their equities that

gold could be the optimal investment under both extreme outcomes.

Since we regard cash as an unattractive asset or investors who ear Depression

most (they should own long-duration high-quality bonds instead), we argue

that a holding o gold and gold stocks oers excellent protection under both

extremes, and attractive potential under a regime o moderate infation and

modest recovery.

Gold was the best investment during the Rooseveltian 1930s and the

Carteresque 1970s. Mr. Obama seems at times to be a blend o those two

Democratic Presidents. The rst was a condent, charismatic interventionist,

whose economy was actually rescued by World War II; the second was a well-meaning, yet inept, President who seriously weakened America at home and

abroad. Nothing became him in his Presidency as the leaving o itrst, by

giving the world the git o Paul Volcker, and then by losing to the reormist

Ronald Reagan. While on vacation, we spent some time watching Obama on

TV. We ound him even more impressive than we had thought previously.

What hes peddling may well be the wrong answers to our problems, but his

charm and energy are inectious.

Such bad news as there has been about gold recently has been conned

to disappointing news rom some o the major gold mining stocks that

unleashed big sellos.

We have held some o these recently-wounded companies in our Fund (The

Coxe Commodity Strategy Fund) because o our belie that long-duration

unhedged reserves in politically-secure ground meant they were better than

bullion in a bull market or gold.

Why? Because all mining (and oil) companies report reserves on the basic

o economically-recoverable minerals. I gold were back at $250, total

mineable gold reserves might be barely adequate to meet the collective bling

demands o all Grammy winners. Conversely, were it $2,000, new-mined

gold production would surge past current levelsbut it wouldnt double:There aint enough gold in them thar hills.

Miners report three kinds o mineral reserves: proven and probable reserves,

and resources. The latter category is generally lower-grade, has not been

drilled out in detail, and may have been estimated primarily by geophysical

and geochemical techniques.

I gold were back at

$250, total mineable

gold reserves might

be barely adequate

to meet the collective

bling demands o all

Grammy winners.


33/5029February

One reason a big boost in bullion prices has not meant a big jump in gold

productionbut was actually accompanied by declining outputis that

the kinds o mining companies in which you should invest are those who

recognize that each ton o ore taken out o the ground brings the mine closer

to closure. A mines closing is painul or stockholders and management, but

is usually a disaster or a community. Thereore, responsible mining means

mining some lower-grade ore during periods o high metal prices to expand

mine lives. This not only serves the community, it protects the value o the

companys biggest assetthe mine. This was illustrated a while back when

Freeport McMoRan announced a slight reduction in its copper and gold

output, which meant earnings came in modestly below the estimates o some

Street analysts. Some o these responded with criticisms o managements

ailure to execute, and argued that shareholders should reconsider theirapproach to the stock.

These criticisms bespoke not sophistication, but ignorance.

When copper and gold prices soared, that gave Freeport the chance to mine

some lower-grade sections o its Grasberg mine, thereby extending its lie

and smoothing its earnings growth.

The idea o steady, uninterrupted, and predicted growth in per-share

earnings is a construct o modern portolio theories about what makes good

investments. It doesnt work with commodity companies, because the prices

o their products are subject to wide swings over time. As applied to mines,

that valuation technique makes as much sense as giving the Academy Award

to the actress whose acial expressions are the most predictable.

Thats one reason why we do not recommend giving the highest recognition

to mining analysts who make the most accurate short-term earnings orecasts.

We rely most on those analysts who have real understanding o the nature

and challenges o each o the mines a company is operating or is planning to

open (or re-open), and the managements longer-term strategies.

Nevertheless, rising metal prices will almost always mean increased ore

reservesand in some cases, the results can be dramatic. There are hugeore-bodies in politically-secure areas o the world that are virtually worthless

at $1.25 copper and $600 gold but can be bonanzas at $3.00 copper and

$1100 gold.

...that valuation

technique makes as

much sense as giving

the Academy Award

to the actress whose

acial expressions are

the most predictable.


34/5030 February



We have argued that investors should overweight the gold mines and

underweight the bullion i they are bullish on the metal, and reverse the

strategy i they turn bearish on the metal. Quite simply, higher gold prices

not only mean more prots rom existing reserves, but likely mean major

additions to published reserves. You winor losetwo ways on a signicant

move in metal prices.

There is one other alternative orm o precious metal investing that we have

employed in the Coxe Commodity Strategy Fund: the royalty and streaming

companies. The pioneer in this eld was the original Franco-Nevada, which

was merged away, but has since been reincarnated. It has acquired some

imitators and competitors, but the eld doesnt yet look so overcrowded

that investors returns will shrink. These companies dont operate mines:

they buy percentage shares o the output, either on an overall basis, or one

component part o the productionusually a precious metal. A relatively

recent entrant to this entrepreneurial sectorSilver Wheatonillustrates the

most impressive eature o the concept: According to The Northern Miner, the

company has the highest market capitalization per employee on the New

York Stock Exchange23 employees or a $6 billion company.

...investors should

overweight the

gold mines and

underweight the

bullion i they are

bullish on the metal,

and reverse the

strategy i they turn

bearish on the metal.


35/5031February

Conclusion

The latest published estimates or global scal decits this year and last are$14 trillion. Dennis Gartman quotes a riend who explains a trillion by saying

that a pile o US $100 bills totaling a trillion dollar would be 800 miles high.

Conversely, all the gold on earth could be held within a ew bank vaults.

It is less than a century since all major currencies became non-exchangeable

into gold (or, the case o US, silver). That is, in human experience terms,

a brie interval. During that time there have been two World Wars, many

lesser wars, one Great Depression, many recessions, and many localized

depressions. The purchasing power o the greenbackthe global store o

valuedeclines year in, year out.

Since the invention o paper money and the development o oreign exchange

markets, there has never been a time when the central bank o almost every

industrial nation in the world that matters is pumping out money at near-

zero nominal ratesand government decits continue to explode, while

demographies in the G-7 countries continue to erode. Long beore the ty-

year bonds o some European countries mature, the workorces o their

issuing countries relative to retirees will have plummeted to levels that are

insupportable under almostanyeconomic theory.

When the sum o existing debts, present decits, and uture projected decits

is so ar beyond human experience, investors should go back to the OldReliable: There may never have been a time where Gold had a better claim to

inclusion in all portolios dedicated to wealth conservation.

What has long been the popular metaphor or a sure-re money-making idea

o almost any kind?

Its a gold mine.

Exactly.

What has long been

the popular metaphor

or a sure-fre

money-making idea

o almost any kind?

Its a gold mine.

Exactly.


36/5032 February



V Is a Fertilizer Producer a Mining Stock or an Agricultural Stock?Or Does It Matter?

For months there had been growing speculation that the big mining

companies were going to add ertilizer to their product mix.

Then, within weeks, Vale bought Bunges Brazilian ertilizer operations, and

BHP bought a small Saskatchewan ertilizer wannabe, Athabasca Potash.

BHP has long held rights to potash permit land around the main producing

properties o the giant Potash Corporation, and is developing a potash mine

(Jansen) that adjoins Athabascas leases.

(Not that the miners are the only buyers: the worlds biggest ertilizer

company, controlled by the Norwegian government, bought a US nitrogen

producer this week. Its not only a big deal, its positively poetic: Yara bought

Terra.)

Several brokers have been fatly predicting that BHP will buy Potash, a

company whose stock has recently languished in response to disappointing

earnings:

Potash (NYSE:POT)


The CEO o Potash, the messianic Bill Doyle, who is almost never rufed,

recently complained that BHP is trying to buy ertilizer companies on thecheap.

Why did BHP move into agriculture? Answer: its so big it has to think big.

Since BHP was rustrated in its attempt to buy Rio Tinto, it has what most

companies would consider a lovely challenge: how to reinvest its powerul

cash fow.

0

50

100

150

200

250


115.20

...its positively poetic:

Yara bought Terra.


37/50


38/5034 February



Canadas ederal Cabinet was only slightly more involved in the Falco-Inco

takeover battles than were the Commissioner o the National Hockey League

and the artistic director o the National Arts Centre. So Ottawa should not

be considered the premier player i Potash is the prey. The Saskatchewan

government, one o Canadas most quietly competent, should, in our view,

set up an inormal committee within the Department o Agriculture or the

Department o Finance to prepare a position paper on the provinces response

to any uture takeover bid.

We greatly admire the management and ethics o BHP, but we eel that the

people o Saskatchewan should be heard i Potash Corpa true national

treasure (even though its top management resides near Chicago)control is

at stake. A thousand years is a long time or remorse.

Canadas ederal Cabinet

was only slightly more

involved in the Falco-Inco

takeover battles than

were the Commissioner

o the National Hockey

League and the artistic

director o the National

Arts Centre.


39/5035February

INVESTMENT ENVIRONMENT

For investors worried about anemic growth in the G-7, industrial commoditiesand commodity stocks may look highly risky, ater their dramatic snapbacks

rom the Depression ears o a year ago.

We talk rom time-to-time with pension unds about the attractions o

commodities, and requently nd great willingness to consider new or

increased allocations to this sector despite all the worries about decits and

unemployment in the developed world.

In the US, many pension und managers and consultants cite a paper

recommending commodity investing published our years ago by two Yale

proessorsGary Gorton and Geert Rouwenhorst. The Financial Times last

week interviewed them about how their orecasts had worked out, given

that prices in the years ollowing the reports publication moved in tandem

with other asset classesAs stock markets plummeted worldwide in 2008,

commodities ared just as badly. The academics seemed unrufed, still

maintaining that Over a long period, commodity utures returns match

equities but with a negative correlation.

Their work tends to conrm our riend David Rosenbergs cogent analysis that

commodities and equities move in dierent long wavesand that equities

are still in a long-term bear market, whereas commodities are still in a long-

term bull market.

What does that imply or commodity stocks? Can they be in a long-term bull

market while the major equity indices are still in bear markets?

We believe that well-managed commodity companies oer investors the

opportunity to position themselves in the industries that are perorming

more strongly than the global economy, while under-exposing themselves

to shares in companies whose market caps refect the way the advanced

economies used to be when the industrial world was still industrializing

rapidlyas was its supply o citizens under age 25.

That was beore the combined impact o negative demographies, disastrouslyengineered nancial behemoths, and overburdened governments brought

the developed worlds global economic leadership to an end.

Car drivers drive by watching the road ahead, with requent checks to the rear-

view mirror. Northrop Frye, one o Canadas most renowned intellectuals,

argued that the best way to travel across Canada by train was to ride seated

backwardwatching where you have been.

...equities are still

in a long-term bear

market, whereas

commodities are

still in a long-term

bull market.



40/5036 February



The major equity indices oer that vistayou know the companies, you

know their competitive positions, and you know which products and services

have been their growth engines. This is ordinarily comorting, compared to

the neck strain rom trying to peer into the landscape ahead.

Commodity stocks are the asset class that should be priced mostly by appraisals

o the uture o the global economy. They are the pre-eminentglobal asset class

because the materials the companies produce are priced internationally, and

are tied to rising demand in the astest-rising economies. These economies

are the Global Olympiansyoung, competitive and optimistic. The advanced

industrial economies are rapidly becoming the equivalents o the high-end

gol and country clubs where the successul people whove already made

their wealth come to retire, play and drink with their own kindand where

they dont have to compete with aggressive young upstarts.

Governments debts are the accumulated buildup o cumulative spending

growth above GDP growththe underpayments made by earlier generations

or the rewards their politicians showered on them. They are an ever-present

reminder o past budget antasies.

Investors have begun the momentous process o re-evaluating the endogenous

risk in the pre-eminent backward-looking asset classOECD government

bondscompared with high-grade corporate debt, which is priced the

way drivers drive carslooking orward most o the time, with occasional

shoulder checks.

But, you ask, dont government bond prices refect perceptions o uture

decits? Yes, governments, economists and investment rms routinely

publish projections o uture public debt situations.

However, apart rom basket cases like Greece, those longer-term guesstimates

seem to have little or no eect on bond prices today. Else why would 30-year

Treasurys oer a nominal yield o just 4.6%, when the range o uture US

national debt estimates is rom the deeply worrisome to the utterly terriying?

Obamas own orecasts are or endless decits, even though they predict

strong economic growth orever, no real increase in infation, and only a onepercent rise in long Treasury yields. The nations debt/GDP ratio is widely

predicted to be heading within a very ew yearsinto the Mediterranean

Eurozonethe Twilight Zone or risk-conscious investors.

These economies are

the Global Olympians

young, competitive

and optimistic.


41/5037February

In contrast, blue-chip corporate debt sells based on the current balance sheet

and on assumptions about managements commitments to restrain uture

bond issues in line withor less thanactual earnings growth. Were IBM to

announce it expected to lose money or the next decade, but by then it would

dominate the computer service business, the yield on its outstanding bonds

would skyrocket, and it would be eectively priced out o the bond market.

So, what about the evaluations o commodity stocks?

The good mining companies should be priced three ways: the past, the

present, and the uture:

The past is there in the orm o the existing mines and reserves;

The present is there in the orm o earnings and new discoveries.

The uture is there in the orm o expectations about the growth o Chindia

and other emerged and emerging economies, and the companies abilities

to position themselves or even greater uture protability as hundreds o

millions o new consumers vie or the products that will come rom the

manuacture and use o commodities.

We place the greatest emphasis on the uture, whereas the Street tends to

downgrade it, posting long-term base metal price orecasts that plunge to

levels last seen in 2005 or thereabouts. We disagree strongly with those uture

earnings projections and question why any smart investor would want to payup or mining stocks that supposedly ace grim years later in this decade

and beyond. Peddling stock with a orecast o uture sustained gloom rarely

worksexcept or selling box seats or Wrigley Field.

The endogenous risk or the well-managed mining companies compared to

the broad stock market is much less than most backward-looking conventional

strategists assert, and the uture protability is greater than most analysts

dare to predict.

Peddling stock with

a orecast o uture

sustained gloom rarely

worksexcept or

selling box seats or

Wrigley Field.


42/5038 February



The Global Warmists Crisis

Global warming began to emerge as the new challenge to the economies

o the industrial world ater the Fall o the Berlin Wall and the subsequent

implosion o Bolshevism. The devastated global Let ound a new cause

that, by attracting support rom across the political spectrum, could give

Big Governments even greater power than they exercised beore Reagan and

Thatcher made capitalism ashionable.

Crucial to warmisms rapid rise to power was its insistence that the science

o global warming was settled. Dissenters within the scientic community

ound themselves marginalized and ridiculed, and their access to publications

restricted.

The Nobel Peace Prize awarded to the UNs Intergovermental Panel on

Climate Control (IPCC) and Al Gore sanctied the cause. The Copenhagen

Conerence was to be the occasion at which the industrial world would not

only pledge itsel to imposing strict controls on its practices, but would

pledge up to $100 billion in payments to the Third World in reparation or

the damages to emerging economies rom Western industrialization, and to

assist its members in achieving climate-sensitive economic growth.

Then the settled consensus began to become unsettled:

Firstcame Climategatethe thousands o hacked emails that showed

the extent to which the scientic dogmatists went to cover up embarrassingdata and discredit their opponents.

Secondwas Copenhagen. TV viewers across the world saw rioters in the

streets and socialists like Hugo Chavez getting standing ovations when

they demanded the end o capitalism. No deal was reached.

Third was the revelation that the IPCCs headline claim that the great

Himalayan glaciers would disappear within 35 years was as scientically

based as reports o conversations with a Yeti (The Himalayan Bigoot).

The one scientic paper used or that scary claim had actually talked o

the possibility they would disappear by 2350, but the basis o the IPCCassertion was anecdotal reports rom a ew enthusiasts at the World Wildlie

Foundation (WWF), which had long ago morphed rom saving pandas to

ghting warming.

Fourth came the report rom Swiss glaciologists that the Davos Glacier, the

most infuential ice sheet on world opinion, had not shrunk because o

global warming but because o eight years o ar-above-average sunlight.

...the IPCCs headline

claim that the great

Himalayan glaciers

would disappear

within 35 years

was as scientifcally

based as reports o

conversations with a

Yeti...


43/5039February

Fith came Amazongate. The IPCC had leapt into the cause to save the rain

orest by claiming that a huge percentage o orestland aced destruction

rom warming. Now it was revealed that the only basis or that scientic

alarmism was an article written by a pair o youthul global warmists with

scanty scientic credentialsone o whom worked or the WWF.

Sixth came the saving o Holland. The IPCC had reported that, because o

rising oceans, 55% o the Netherlands was below sea level. Dutch scientists

showed that the part o its landmass protected by dikes was a small raction

o the nationand it hadnt shrunk recently.

Seventh came the conessions o Phil Jones, the ormer head o the East

Anglia climate institute whose emails had been hacked. He had been put

on leave ater the scandal broke. He admitted that their studies showedno statistical evidence that the world had been warming since 1995, and

that the historical records showed the world was warmer 1,000 years ago

than now. He said that what was needed in coming years was a return to

peer-reviewed research.

More and more conessions and revelations come out each week.

This week, the big business alliance that had been backing Obamas Cap and

Trade bill began to unravel, as BP, Caterpillar and Conoco Phillips pulled out.

Its biggest remaining member is General Electric, which has built its business

model on building alternative energy devices. The legislation is stuck in theSenate, and it now looks as i that will be its tomb.

The record snowalls across the Southern and Eastern US cheered the

opponents o global warming, but the warmists point to the problems or

the Vancouver Olympics to argue that, as they said all along, warming meant

wild weather swings, so a snowbound Washington is actually proo o their

claims. On balance, those snowalls were urther bad news politically or

warmistsbecause o their impact on ordinary peoples perceptionsbut

they certainly werent decisive. What matters most is the week-to-week

accumulation o evidence that the science o warming has to go back to

the drawing boards. There is no chance now that voters in the developedworld will support governments that impose heavy burdens on their own

economies, while sending billions in reparations to the newly industrializing

nations that have become such ormidable competitorsand ormidable

polluters.

What matters most

is the week-to-week

accumulation o

evidence that the

science o warming

has to go back to the

drawing boards.


44/5040 February



The investment implications are immense:

Coaliscomingback,andWarrenBuffettsbetonBNSFwillpayoff. The Canadian oil sandswillprobablynever get supportfrom the

environmental elites, but the odds that the US will ban imports o

Canadian heavy oil now range between slim and none. Moreover, the

supposed global consensus demanding the shutdown o the oilsands

soon will be history. Suncor and the other producers can start breathing

more easilyand investors who dumped their shares to prove their green

virtues may begin to reassess their decisions.

TheUSEnvironmentalProtectionAdministrationscarte blanche to involve

itsel in business decisions across the economy will probably not outlive

the US Midterm elections. That is good news or the US economyand

particularly or transportation and industrial companies.

The businessmodelof Blood&Goremayhaveto undergo some

revisions.

No one has proved that man-made global warming does notexist.

But, week by week, more and more people across the world will come to

believe that no one has proved beyond reasonable doubt that it does.

The game has changed.

Is Bernanke Running Out of Heroin?

As we were going to press, Bernanke announced a boost in the Discount

Ratethe ee or short-term emergency loans to banks. He also announced

there would be no change to the ed unds rate. Commoditiesparticularly

goldwere hit hard. We see this as central bankers cosmetology---not

surgery. He doubtless would love to abort the commodity recovery, which

was conrmed by a big surge in the Crude Goods component o the PPI.

As an economic historian, he knows that indicator was the one that, in the1970s, rst fashed powerul evidence o the stagfation to come. The only

capital punishment open to him is closing down bad banks. He cant shoot

the infation messenger.

The business model

o Blood & Gore may

have to undergo

some revisions.


45/5041February

RECOMMENDED ASSET ALLOCATION

Allocations Change

US Equities 17 unch

Foreign Equities

European Equities 5 unch

Japanese and Korean Equities 2 unch

Canadian and Australian Equities 11 unch

Emerging Markets 14 unch

Bonds

US Bonds 12 unchCanadian Bonds 8 unch

International Bonds 11 unch

Long-Term Infation Hedged Bonds 10 unch

Cash 10 unch

Years ChangeUS 5.25 unch

Canada 5.00 unch

International 4.50 unch

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

Bond Durations

Change

Precious Metals 33% unch

Agriculture 30% 3Energy 22% unch

Base Metals & Steel 15% +3

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.



46/5042 February



INVESTMENT RECOMMENDATIONS

1. This is assuredly an inopportune time to increase equity exposureandan opportune time or prot-taking.

Major stock indices are breaking down. For the S&P, it would take only

an 8% retrenchment rom its current level to break the 200-Day Moving

Average, and take the index to late summer levels.

2. Maintain a strong overweighting in commodity stocks within equity

portolios.

3. Maintain high exposure to gold bullion and the gold miners whose

production comes rom politically-secure areas.

The core belie system or gold is that governments cant be trusted. Investing in

miners dependent on the sustained honesty and wisdom o conspicuously dubious

governments may work out or a time, but the principle behind that strategy is

oxymoronic.

4. Investors should overweight base metal miners within the cyclical

component o their equity portolios.

The base metal miners earnings have come back aster than all but the

most optimistic would have predicted when the worlds crisis managers

were engaged in panic-driven ad hoc strategies to avert a Depression. Few

investors grasped the signicance o the act that the new players on the

global blockChina and Indiawerent even in recession. Result: metal

inventories never mounted to levels that would have imperiled major

miners.

5. Here is a strategy or corporate clients to consider: borrowdont

buydebt denominated in euros.

The Eurozone, justly renowned or its liberal dispensations o pork, barely

emerged rom the Crash beore being aced with a big PIIGS (Portugal,

Ireland, Italy, Greece and Spain) problem. Germany has a veto on any

orm o bailout or the big spenders, and German voters were never givena chance to vote on whether they really wanted to swap their beloved

Deutschemarks or euros. Canada recently demonstrated its smarts by

borrowing heavily in euros.


47/50


48/50


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BMO Nesbitt Burns Basic Points Feb 2010

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