Slow Boat To China

Basic Points
A Slow Boat to China
April 16, 2010
Published by Coxe Advisors LLP
Distributed by BMO Capital Markets

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BMO Capital Markets Disclosures

Company Name Stock Ticker Disclosures Company Name Stock Ticker Disclosures
AIG AIG Freddie Mac FRE 1
Alpha Natural Resources ANR Monsanto MON
Arcelor Mittal MT Mosaic MOS
BHP-Billiton BHP Potash POT 1, 3, 4
Chesapeake CHK Rio Tinto RIO 3, 4
Citicorp C Sanderson Farms SAFM 2, 3, 4
CNH Global CNH Sinopec 554
Conoco Phillips COP Smithfield Foods SFD 3, 4
Deere DE Teck TCK 1, 3, 4
Devon Energy DVN Tyson Foods TSN
EOG Resources EOG 3, 4 US Steel X
Exxon Mobil XON Vale VALE 2
Fannie Mae FNM 1 XTO Energy XTO
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Don Coxe
THE COXE STRATEGY JOURNAL
April 16, 2010
published by
Coxe Advisors LLP
Chicago, IL
April 16, 2010
Author: Don Coxe 312-461-5365

DC@CoxeAdvisors.com
Editor: Angela Trudeau 604-929-8791

AT@CoxeAdvisors.com
Coxe Advisors LLP. www.CoxeAdvisors.com

190 South LaSalle Street, 4th Floor
Chicago, Illinois USA 60603
OVERVIEW
Our theme this month is the worldwide industrial recovery, which has sparked a new boom
in prices of industrial raw materials. Across most of the world, factories are humming tunes
of rebirth.
Lehman’s collapse was the final shock to an over-levered financial system, crashing prices of
equities, corporate bonds and commodities. However, while OECD economies survived on
life support from panicky politicians and stunned central bankers, China and India never
made it as far as hospital parking lots, let alone the triage desk. The quick stimuli in both
those economies kept banks and factories functioning, and GDP growth remained strongly
positive.
Thus history was made: The Old, Old World came to the rescue of the Old and New Worlds
in their worst economic collapse since the Depression, nearly drowning in the real estate
and financial engineering debts accumulated to finance the excesses and miscalculations
of the previous cycle.
We have been cautious since September about the runaway US and European equity and junk
bond markets because of their heavy dependence on astounding ingestions of what we termed
“financial heroin.” If there were a Financial World Olympics, the organizing committee would
have long ago disqualified them from further competition, and awarded the gold medal to
China, the silver to India, and the bronze to either Indonesia or Brazil—with a special award
of merit to Canada and Australia—whose economies and stock markets had been growing—to
great extent—based on the commodity price increases spawned in Asia.
In recent months, the global swing in inventory cycles from panic liquidation to modest
accumulation confirms that the industrial recovery has legs, even though house prices remain
weak and unemployment remains strong across most of the US and Europe.
We are therefore rebalancing both our Recommended Asset Mix (for US Pension Funds), and
our sector weightings for commodity stocks. Because we see the divergence between Canadian
and US financial assets as a longer-term phenomenon, we are introducing a new portfolio
for Canadian pension funds. We have added a new category “Commodities and Commodity
Equities” for all pension funds, financed, in the case of American pension funds, primarily from
bonds and cash. We discuss the background to this recommendation under “Recommended
Asset Allocation”, page 51. When those assets are added to the Funds’ stock investments, the
equity-equivalent weighting for pension funds has moved back to near-normal territory at
59%.
Those patients who barely survived a long stay in the Intensive Care Unit are back at work—
part-time. We expect major central banks to begin slowing the rate of their heroin injections
soon—and will watch anxiously to see whether the US and European economies are able to
stand on their aging feet when they discard the crutches provided by government financial
health care.
April 1
2 April THE COXE STRATEGY JOURNAL
Industrial recoveries are known by the symbols of their leadership. The brief
mid-1930s recovery was symbolized by the speedy new production lines,
with the hapless Charlie Chaplin (in Modern Times) frantically trying to
keep up. The wartime economy was symbolized by Rosie the Riveter. The
postwar recovery was symbolized by roaring blast furnaces and the noisy Melting your
assembly lines converted from manufacturing tanks and armored personnel heart of stone…
carriers to producing cars and trucks. The Seventies were the decade of Oil,
with the oil derrick its symbol. The Eighties were the decade of the Japanese
Miracle, symbolized by pictures and reports on those scarily smooth—
almost surreal—production lines in Japan, whose output of reliable products
challenged the very survival of factories in the West. The emblems of the
Nineties were the chip-machines churning out the brain cells and blood cells
of the information revolutionaries.
The “Noughties” were marked by the relentless outpouring of exports from

China, that were the stimulus of the most dramatic industrialization and
urbanization the world had ever seen. Its symbol: the TEUs (Twenty-Foot
Export Unit), the intermodal container that carried an increasing supply and
increasing range of products across the world.
Our theme comes from a Frank Loesser classic.
I’d like to get you

On a slow boat to China,
All to myself alone….
Melting your heart of stone…
In this decade, China’s global impact has, at the margin, switched from
exports to imports, as weak OECD economies can no longer absorb sustained
increases in purchases of Chinese products. China’s imports are mostly the
raw materials needed for infrastructure and urbanization. The symbol of
the second decade of the commodity boom is a ship going to, not from,
China—the bulk dry cargo ship carrying raw commodities, notably iron ore
and metallurgical coal.
April 3
Iron Ore
(Steel China Iron Ore Spot)
January 1, 2007 to April 13, 2010
1,400
1,300
“We will bury you!”
1,200
1,100
1,000 990.00
900
800
700
600
500
Dec-06 Apr-07 Aug-07 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09
Source: BMO Capital Markets
Hot Cold-Rolled Steel

1,200
1,100
1,000
900
800
700
665.42
600
500
400
Dec-06 Apr-07 Aug-07 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09
Source: BMO Capital Markets
The steel industry was a bastion of the American economy from the days
of Henry Clay Frick and Andrew Carnegie, but it grew complacent after
World War II, and, like its biggest customer—the auto industry—succumbed
routinely to union contracts whose generosity was based on the arrogance
that the rest of the world could never really compete with Pittsburgh. In
reality, the new global steel leader was the USSR, and its symbol was the
brawny Stakhanovite worker, whose heroism and productivity had been
so crucial in winning the war against Hitler and was now winning the war
against capitalism. Khrushchev’s famous taunt at the UN, “We will bury
you!,” accompanied by his boastful bang of his shoe, was the live geopolitical
version of the Stakhanov posters.

No such romance attaches to the iron ore and steel industries today. In
particular, the major iron ore deposits in Australia and Brazil owned by BHP,
Rio Tinto and Vale are mined with gigantic scoops that are more reminiscent
of Sauron’s monster machines launched in the assault on Gondor than the
tools of miners and steelworkers. No such romance
attaches to the
BHP Billiton (BHP)
iron ore and steel
100
industries today.
90
80 81.20
70
60
50
40
30
20
10
0
Jan-02 Nov-02 Sep-03 Jul-04 May-05 Mar-06 Jan-07 Nov-07 Sep-08 Jul-09
Rio Tinto (RTP)

550
500
450
400
350
300
250 241.00
200
150
100
50
VALE (RIO)
45
40
35 34.14
30
25
20
15
10
5
0
Mar-02 Jan-03 Nov-03 Sep-04 Jul-05 May-06 Mar-07 Jan-08 Nov-08 Sep-09
April 5
So the imagery in this iron age isn’t brawn, sweat and vigor, but a long ship
at sea loaded with sand—62% iron—or the metallurgical coal which will be
added to the iron ore in some Sino-version of “Satanic Mills.”
“But why,” the reader may ask, “Are you publishing this analysis now?
We remain of the
Haven’t those Chinese mills been pumping out steel with growing gusto for
view that the major
months while you were expressing caution about the financial system and
US and European
the economic conditions in the US and Europe? You kept talking about a
equity indices are
coming correction in the S&P from the time in September when it crossed
heroically priced
1,050 and it’s 1180, and now you tell us about the deep meaning of slow
on heroin...
boats to China?”
Good question.
We remain of the view that the major US and European equity indices are
heroically priced on heroin, and the health risks for those patients newly-
emerged from financial hospitals are under-priced.
However, we are now inclined to the view that the US and major European
economies should improve enough that they will not drag the global economy
into a new recession. We therefore recommend that investors orient their
equity and equity-equivalent portfolios to Oriental demand.
A roaring recovery in US stocks usually means many—or most—sectors

of the economy have regained pricing power. This time, the equity rally is
mostly based on hope for pricing power, and hype that investors must get
on the train before it leaves the station. Those who seem most conspicuous
in demonstrating pricing power include 3-D movies, ad rates on Fox News,
producers of copper, crude oil, iron ore and metallurgical coal, and members
of government unions, but collectively these do not seem the stuff of a robust
recovery.
We note that the famously slow National Bureau of Economic Research

remains unwilling to assert that the US is out of recession. Yes, these economists
are renowned for their desire to maintain their sublimely accurate record by
waiting until just before their caution becomes ridiculous. However, some
committee members still openly proclaim their fear of a double-dip recession
once the stimulus programs expire.
Nevertheless, we think both the strident pessimists and the starry-eyed

optimists could be wrong.

Here are three charts that argue that a US recovery that looked too tentative
and heroin-dosed to be worth Dow 10,000 (when we suggested clients might
well anticipate a correction) has recently moved from the Intensive Care Unit
to the recovery ward and is back to work, at least part-time:
KBW US Regional Banking ETF (KRE) a US recovery...
January 1, 2007 to April 13, 2010 has recently moved
55
from the Intensive
50
Care Unit to the
45
40
recovery ward and
35 is back to work,
30 at least part-time...
28.28
25
20
15
10
Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10
KBW US Regional Banking ETF (KRE) relative to S&P 500

110
100
90
80
70 65.49
60
50
KBW US Bank Index ETF (BKX) relative to S&P 500

110
100
90
80
70
60
56.81
50
40
30
April 7
These charts show how the BKX (dominated by the big, bad, bonused,
bailout banks, that we call the B5) and the KRE (the equally-weighted index
of fifty geographically-diverse commercial banks) signaled the coming crash
and how well they have been performing since then. The KRE has hugely
...the financial sector and consistently outperformed the S&P for nearly six months, with its
of the US economy is outperformance going to a new high last week. It is still outperforming the
in better health than BKX on a cumulative basis, although its outperformance peaked in January.
it has been since The thrust of these charts is that the financial sector of the US economy is
June 2008... in better health than it has been since June 2008, the last time Barney Frank
dismissed Republicans’ increasingly urgent concerns, insisting that Fannie
and Freddie were in sound shape, were no risk to the taxpayers and should
not be subject to increased regulation.
We now know that the bailout costs for F&F will be greater than all the
other financial bailouts combined, because the TARP program of bailing out
real financial institutions—rather than heavily-politicized bastard children
of government at its most venal—is getting refunds, with interest, at an
impressive rate, (with Citicorp and AIG the only remaining big holdouts,
and even they are looking better than seemed possible a year ago).
We have been insisting since we first warned in early 2008 of an apparent

breakdown of both the BKX and KRE that we would not be able to proclaim
a new bull market until those indices had outperformed the S&P for at
least six weeks, and the KRE—the index of banks behaving in the socially
useful ways most of the time, the way nearly all banks used to behave all
the time—had outperformed the BKX during that period. After the Crash we
said that six weeks wouldn’t be enough this time, because (1) this crash was
bigger than any we’ve had since WWII, and (2) the bailouts and financial
heroin that saved the banking system from large-scale implosion meant that
we had no precedent to use in evaluating endogenous risk within the banks
relative to the rest of the stock market. Citicorp went from $55 in 2007 to
$1 in 2009 and was rescued with the kind of money previously expended
only for victims of only the biggest hurricanes—Andrew and Katrina.

That it is up 400% from its low after all that cash is not necessarily evidence
that the banks are outperforming the broad stock market. That its top trio of
leaders included the once-magisterial Robert Rubin might possibly be reason
to take it seriously, but not to cite its survival after a $50 billion bailout as
an argument for buying US stocks generally. The leader who became the Messrs. Prince, Pandit
boss at the financial world’s biggest morass after Chuck Prince danced away and Rubin told
with a pay packet that could have financed four Fred Astaire movies—Vikram Congress they could
Pandit—is likely underpaid at his current rate of $1 a year; however, he was not have anticipated
paid more than $100 million to take the job, and is given stock options on the Crash and are
a penny stock that the government will not let fail. Messrs. Prince, Pandit therefore not to
and Rubin told Congress they could not have anticipated the Crash and are blame...
therefore not to blame: they are in company with the Best and Brightest
Banker, Alan Greenspan. Mr. Greenspan introduced a novel concept in his
defense: he admitted—sort of—that the Fed might have kept rates too low
for too long, but said the problem was in low mortgage rates and the Fed
doesn’t set those—the market does. Nobody challenged him on that assertion.
Presumably, Ben Bernanke has been given the all-clear to boost fed funds
rates soon, and no Congressperson will blame him when mortgage rates
rise.
April 9
The Iron Ore Oligopoly

Iron ore has been, for investors, for most of the past fifty years, the least
glamorous of the base metals. When we came into the business, we got to
know a veteran geologist who gave us one of the most useful maxims we ever
“An iron ore deposit is
learned: “An iron ore deposit is like a belly button—everybody has one.”
like a belly button—
everybody has one.” That saved us from betting on some big, undeveloped Canadian orebodies
that remain moose pasture today.
There were many reasons for this skepticism:
• Major steel companies built on the US Steel model of full backward

integration had their own supplies—such as the giant operations at
Wabush.
• The startup steel companies that were challenging the aging, heavily
unionized majors, were using a new technique that substituted readily-
available scrap for raw iron ore—or the 33% iron pellet products fabricated
out of low-grade ores.
• Steel was losing market share, year-by-year, to aluminum and plastics.

(The classic scene in The Graduate in which a drunk tries to convince the
anti-hero to seek a career in plastics was well-grounded: the American steel
industry hymned earlier by Ayn Rand was yesterday’s story and yesterday’s
career.)
• America’s progression from a no-car to a one-car, to a two-car family was

complete.
• The Cold War was, post-Vietnam, not really a shooting war, which
meant there was no inbred growth in demand for steel for weaponry;
the new, high-tech Pentagon sought specialty metals for its leading-edge
products.
• There were huge undeveloped ore bodies across the world—particularly

in India—that could meet such demand as might arise from the former
colonies.
The one constant we have experienced during the eight years since we
proclaimed the greatest-ever global commodity boom has been the regularity
of analyses from another growth industry—the China skeptics. The names
on the reports may change, but a month never goes by that we don’t receive
screeds from experts who’ve just been to China, or who’ve talked to important
insiders whose names they can’t reveal, that the China boom is about to

become a bust that will make the tech collapse look like something between
a hiccup and a belch. The allegations routinely include fraud in Chinese
GDP statistics, predictions of the coming collapse of Chinese banks, local
revolts that are precursors of a coming civil war, sheer incompetence among
government officials and Chinese industrialists, a real estate bust bigger ...the China boom is
than has occurred in any Western nation, massive overproduction, phony about to become a
statistics on metal consumption, gigantic hidden inventories of oil, copper bust that will make
and fertilizers, etc., etc. the tech collapse
look like something
There have been recent variations on these themes. The latest China expert
between a hiccup
is James Chanos, an American hedge fund operator who made a fortune
and a belch.
shorting mortgage-backed CDOs. Seeking the Next Big One, he proclaimed,
without even visiting China, that he just knew it was about to implode.
Alan Abelson, the witty, articulate super-bear of Barron’s, regularly publishes

these “devastating” insider reports of the coming China crisis, because they fit
so well into his doleful views that any bull market of our time faces castration
at best, slaughter at worst. That he has been right about the phony American
bull markets of our time may make his readers conclude that he has to be
right about China. Many of those who swallow these predictions of the
Great Fall of China are victims of wishthink: either they fear, on nationalistic
grounds, China’s growing challenge to US pre-eminence, or they’re upset
that they missed the commodities boom, or they’re just eager for the next
great short story.
And so to the iron ore story:
According to the Financial Times, the recent history of annual contracts for
iron ore prices is:
Price ($ per tonne)

2000 - 2001 17-18
2002 - 2003 17-19
2004 - 2005 19-22
2006 - 2007 38-46
2008 - 2009 50-90
2010 - Q1 and Q2 60-110
Last month, the system of annual contract prices set in negotiations between
leading Chinese, Japanese and Korean steelmakers fell apart. Hereafter,
quarterly prices will be set with reference to the still-small—but soon-to-be-
gigantic—spot market.
April 11
As metals analysts agree, this is a momentous event. With much of the global
economy still struggling to emerge from recession, the hottest of all major
commodities is the most basic of all metals—iron ore. That a product never
traded on any exchange is the new Wonder of the World argues against the
That a product conspiracy theorists who dismiss soaring prices in metals traded on public
never traded on any exchanges, such as copper, nickel, zinc and aluminum. All those investigations
exchange is the new into price manipulations through futures markets should soon become
Wonder of the World irrelevant.
argues against the
There is no argument that iron ore’s pricing and demand have been set by
conspiracy theorists...
China since the onset of the commodity boom. In 2000, China’s seaborne
imports were 72 million tonnes, less than half Western Europe’s. By 2005,
they were 276 million, with Western Europe buying 191 million. In 2009,
China’s estimated purchases from those slow boats were 615 million tonnes,
and the entire rest of the world drew only 289 million.
The collapse of the fixed contract system has produced chaotic iron ore
markets. Spot iron ore deliveries to China last week were priced as high as
$163 per tonne. Already, global steel prices have started to soar.
With iron ore uncapped and running wild, metallurgical coal could not be
far behind.
Metallurgical Coal Prices

January 1, 2005 to March 31, 2010
Met Coal 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E
Contract Price (US$/tonne) $108 $117 $101 $305 $129 $200 $200 $190 $180
Seaborne Supply 227 224 239 239 202 207 212 220 228
Source: IEA, BMO Capital Markets
As contract prices climb, so do prices of stocks levered to coking coal:

Teck Resources (NYSE: TCK)
April 13, 2009 to April 13, 2010
50
45 44.85
40
35
30
25
20
15
10
5
Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10

Alpha Natural Resources (NYSE: ANR)
April 13, 2009 to April 13, 2010
60
55 53.00
50
45
40
35
30
25
20
15
10
Remarkably, in recent weeks, so are steel stocks:

US Steel (NYSE: X)
April 13, 2009 to April 13, 2010
75
70
65 64.37
60
55
50
45
40
35
30
25
Arcelor Mittal (NYSE: MT)

April 13, 2009 to April 13, 2010
50
45 45.63
40
35
30
25
20
April 13
In other words, although China has almost single-handedly forced the biggest
cost increase in history on integrated steel companies, overall industrial
activity is at levels allowing significant cost pass-through.
Even the mini-mills relying on scrap—not ore—that compete with the major
It is different
integrated companies are facing painful cost increases. According to the last
this time...
two months reports of the US Producer Price Index, steel scrap has been the
star performer in the crude goods category.
The doubters—including some members of the National Bureau of Economic

Research—still warn of a double-dip recession.
To our knowledge, there has never been a recovery from recession marked
by (1) low overall CPI and (2) modest top-line GDP growth with (3) high
unemployment, when (4) no major shooting war was raging, yet (5) steel
scrap and finished steel prices were rising sharply driven by non-OECD
demand—that succumbed quickly into a new recession.
It is different this time, because this time the pulling power for global recovery
comes from Emerging and Emerged Economies—not the established
Industrial Economies.
We admit that skeptics might well reply, “When can you find a slow economic
recovery accompanied for more than a year by near-zero nominal interest
rates? Wouldn’t you expect the Crude Goods component of PPI to give the
first signal of higher prices in the economy? Besides, the overall economic
cost—and economic drag—from somewhat higher steel prices is trivial
compared with what’s been happening to crude oil.”
That, we believe, is a realistic concern.

NYMEXIFYING the Recovery?
Crude Oil
160 ...oil shock returned
140 with a vengeance.
120
100
80 84.09
60
40
20
0
When the economic recovery from the tech-crash-induced recession began in

2002, crude oil prices were still where they were in 1986. That was the year
the Saudis grabbed OPEC cheaters by their throats. This was the first time
since the Yom Kippur War shutdown of production that the Saudis chose to
demonstrate their power to control world oil prices.
The combination of slowly-collapsing oil capex across most of the world

during the 1990s, a slow recovery in Russian production from its depths
after the sudden defeat of Bolshevism, the collapse in Iraqi production, a
global economic recovery and, most importantly, surging demand from
China, yanked control from the Saudis and their OPEC colleagues, handing
it to the spot markets. By 2007, as Russian and Saudi output were finally
climbing toward record levels, and Iraq was returning to production, oil
shock returned with a vengeance.
Crude oil prices staged their wildest ride in three decades—soaring to $145
a barrel, followed by sudden financial and economic collapse across most of
the OECD, sending crude to as low as $35.
April 15
There are those who argue that the biggest US economic stimulus came not
from Obama, Pelosi et al but from Saudi-led OPEC, which did almost nothing
to halt the ski-jump plunge in crude prices, and thereafter cut production
only modestly, so that average oil prices in 2009 were roughly back to where
It sharply reduced they were in 2006. Result: US gasoline prices were briefly halved, and only
the Copenhagen recently have begun to climb back to levels that could in themselves constrain
kaffeeklatsch costs overall consumer spending. Arguably the only help the beleaguered airline
for those Greens industry received to avert disaster was cheap jet fuel. Even now, the airlines’
whose private aircraft fuel costs are well-covered by its ticket prices. (As for private jets, a sector
filled up most of the that was decimated by a financial collapse that wiped out so many of its
available airport owners and lessors, the plunge in jet fuel prices was Heaven-sent. It sharply
space... reduced the Copenhagen kaffeeklatsch costs for those Greens whose private
aircraft filled up most of the available airport space as they met to get global
agreement on carbon taxes and offsets on which so many of them expected
to receive revenues appropriate to their secular saintliness.)
If $45 oil was at least as big a stimulus as $2 trillion in Obama deficits (if not
as big as zero interest rates), then will $85 oil shoot the green shoots dead?
Our take: it is certainly bad news for consumers, who don’t need new bad
news. But we do not believe that it signals the onset of an economy-garroting
attack on the OECD from OPEC and Chinese consumers.
Energy prices could well remain reasonably subdued for the next few
years, and therefore act as a source of modest stimulus—not drag—on
the global economy.
Here’s why:
• Saudi Arabia believes $70-$80 oil is the “perfect price”—the Goldilocks

range that is high enough to encourage exploration and production, but
not high enough to choke the global economy, (or to stimulate massive
new high-cost non-OPEC production that could challenge the cartel’s
pricing power).
• Saudi Arabia claims to have 5mm b/d of excess capacity to enforce its
campaign for petroleum pricing perfection. Apart from Matt Simmons
and a few other prominent skeptics, that claim is widely respected.

• Triple-digit oil prices have left scars on the minds of governments and
consumers across the world. Energy conservation isn’t just something
that Greens applaud. Gasoline consumption has been falling across
the OECD and the next generation of low-consuming vehicles will be
hitting showrooms within two years. Airplanes keep becoming more fuel- Triple-digit oil prices
efficient. have left scars on the
minds of governments
• Iraq managed to get oil companies to agree to astonishingly onerous
and consumers across
pledges and astoundingly low pricing to develop its vast reserves—said
the world.
to be second only to Saudi Arabia. If Iraq does not dissolve into another
civil war, it could more than double its production within five years.
• Brazil’s giant offshore fields will begin producing later in this decade.
• Angola, a ghastly kleptocracy about which we seem to hear little, has quietly
taken in Chinese “supervisors” and joined Iran in the list of China’s top
three oil suppliers.
• One important—and rarely remarked—aspect of the functioning of the

oil futures curve is that it takes into account expected increases in future
production. In part, this is because oil companies help finance costly well
development by selling production forward to generate funds now. But
it is also because both producers and consumers make their estimates of
how much oil will be produced at various times in the future and make
their own guesses about how much will be consumed. So those big new
oilfield developments get plugged into oil price forecasts, and that tends
to drive prices downward in intervening years as well. Oil futures curves
don’t tend to have humpbacks…as do long bond yields at times investors
anticipate future declines in inflation.
April 17
We find it significant that the apparent upside breakout in spot oil has not
been confirmed in the futures curve. Indeed, the curve has been narrowing
for months. Not long ago the oil curve was almost as steep as the Treasury
yield curve, and was assigning a very high relative value to reserves in the
We find it ground compared to the Saudi-set spot prices.
significant that the
Not any more:
apparent upside
breakout in spot Crude Oil Futures (at April 13, 2010)
oil has not been December 2010 to December 2018
confirmed in the 120
futures curve.
110
100
95.42
90
80
70
Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18
Crude Oil Futures (at April 20, 2009)

December 2008 to December 2016
90
80
77.48
70
60
50
40
But there’s more….
Or should we say “less…?”

Cheap Gas
Natural Gas
16
Natgas...has long been
14 a boon supplying
12 lush pickin’s to oil
companies’ financial
10
reporting.
8
4 4.15
2
Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10
Natural Gas Futures (at April 13, 2010)

December 2010 to December 2018
8.5
8.26
8.0
7.5
7.0
6.5
6.0
5.5
5.0
Natgas may be the only commodity that trades at a far lower price today than
at year-end 2008.
Its coupling with oil, which was solemnized by the SEC in 1982, has long
been a boon supplying lush pickin’s to oil companies’ financial reporting.
However, this obscure accounting practice has gone from the subliminal to
the ridiculous.
April 19
It may soon be recognized as perhaps the most dubious financial distortion

since thousands of putrid mortgage packages got Triple “A” ratings from
fee-hungry rating agencies back in the days when Wall Street was still
respected.
...the most dubious
We have been complaining about this institutionalized overstatement of oil
financial distortion
company reserve life indices for five years. Perhaps we risk boring our loyal
since thousands of
clients by returning to discussion of this misleading practice. To date, no one
putrid mortgage
of prominence has joined our calls for fair reporting.
packages got
Triple “A” ratings... However, since it is part of the new, potentially huge, story about the likelihood
of sustained cheap gas prices, we need to allude to it again. Moreover, our long-
held view about gas prices seems to be confirmed by recent major strategic moves
among big oil and gas producers.
Here’s how the accounting has been handled:
• Oil companies generally produce both oil and gas. Most oilfields contain
both fuels. So oil companies use an industry formula to report their
combined gas and oil reserves in a single, simple, blended number in
their announced Reserve Life Indices.
• The Reserve Life Index is to oil companies what an actuary’s liability

valuation is to a life insurance company or pension fund. It discloses
how long the company can continue to produce at its current rate, based
on stated assumptions. The most important of these assumptions is that
natural gas reserves are included as oil equivalents based on 6 mcf of gas being
equivalent to a barrel of oil. The companies report their combined oil and gas
reserves in one number—the barrels of oil equivalent, or boe.
That is a scientifically-based law of industry accounting, because 6 mcf of

natgas produce as much energy as an average barrel of crude oil.
The formula worked well for many years.
But then, as oil prices kept climbing to new higher ranges and natgas stayed
lower-priced, it ceased to be pure science in the service of pure reporting.
Big Oil in general, and Exxon Mobil in particular, have always been comfortable
with this rule. Exxon bought Mobil in the 1990s primarily because of its
huge gas reserves and LNG operations in Indonesia that were supplying 34%
of Japanese gas imports a time Lee Raymond believed the Saudis would keep
oil prices below $35 a barrel for decades.

The supermajors’ liking turned to love of the SEC formula in recent years as
they failed to replace their oil production with major new discoveries, and
had big chunks of their published reserves looted by Chavez, Putin and other
such leaders with whom they had—naïvely—struck seemingly advantageous
deals in the 1990s. ...love has become
a perverted passion
That love has become a perverted passion in recent months, because US oil
in recent months...
and gas companies are finding so much shale and tight natgas, while their
the six-to-one
reserves of oil in the ground in politically-secure regions of the world continue
formula (which, in
to dwindle. So the six-to-one formula (which, in terms of financial window-
terms of financial
dressing might be better labeled “sex to one”) with oil at $84 effectively
windowdressing might
prices natgas reserves at $14 per mcf while the actual market price is around
be better labeled
$4. Since the only time natgas has ever sold at $14 was right after Katrina,
“sex to one”)
the oil companies would appear to be straight-facedly predicting Katrinas as
the norm for years to come. We await with interest Big Oil’s defense of this
accounting rule if, as some prominent bulls maintain, oil gets back to $96.
Its natgas in the ground will then be valued at $16 per mcf—a price it has
never experienced.
This audacious overvaluation of assets that will not be actually sold for years
recalls how Wall Street was valuing its subprime-laced CDOs before the
Crash. Those valuations were legal according to the SEC, and even according
to the rules of Basel II, because they were backed by Triple A ratings from the
supposedly clear-eyed and unbiased ratings services.
One reason we routinely recommend that clients overweight exposure to the

oil sands companies is that what they produce and sell is oil, and one of their
biggest production costs is natgas. To be long oil and short gas is a superb
business model—except in oil industry accounting models.
One reason we have never recommended Exxon Mobil (as efficiently managed
as it famously is) for commodity stock portfolios is that its Reserve Life Index
stated in barrels of oil equivalent (boe) is heavily weighted to gas, and its oil
reserves, (apart from the heavy oil and oil sands its owns in Alberta through
its 69% ownership of Imperial Oil) are dwindling, and include levels of
political risk ranging across the spectrum from low to absurd.
When geologists and petroleum engineers at companies such as Devon

Energy, Chesapeake and XTO cracked the code on producing vast quantities
of gas through fracking (fracturing of tight rocks) and horizontal drilling,
they transformed the outlook for energy prices.
April 21
We have been telling clients for more than a year to invest in oil producers,
and to avoid gas producers. The more we have learned about the humongous
quantities of natgas that exist in the Lower 48 states of the US and much of
Northern and Central Europe, the more we have been inclined to view natgas
How cold does it as a blessing for gas consumers in the US and Europe, and bad news for
have to get to absorb investors in natgas stocks—and for Messrs. Putin and Chavez. (Yes, Virginia,
all the gas being there is some good news in this story.)
developed?
Nothing we have written in the past two years has evoked such strong
opposition from clients—including some of the smartest investors we
know.
We start with the obvious:
• Investors in Natgas futures and the Natgas ETF have lost money during a
commodity bull market, while investors in oil have won handsomely. Why
should things get better for those who’ve been gas-bagged for so long?
• Seemingly the only constraint on putting more gas into storage is that
almost all the storage space is allocated.
• We are finally escaping from one of the roughest winters in decades, yet
natgas prices languish at $4. How cold does it have to get to absorb all
the gas being developed?
• The government, (which is, we admit, not necessarily the most reliable
source), estimates that recoverable reserves of natgas are enough to meet
the nation’s demand for the rest of this century, whereas oil reserves may
only last for another four decades.
• Perhaps the only thing that could get gas to go to profitable levels is for
some big players to go bust or slash their shale exploration budgets and
write down the value of their reserves.
The clients point out:
• Average decline rates of shale gas production are far above oil—roughly
70% in the first year.
• The well-managed companies which acquired big land spreads before

the operational challenges to horizontal drilling and fracking were fully
resolved are profitable at $7 gas.

• The US Energy Dept’s production statistics aren’t credible. A Wall Street
Journal story (April 5, 2010) reported that the Department now realizes
“it has been overstating output…The Energy Information Administration,
the statistical unit of the Energy Department has uncovered a fundamental
problem in the way it collects data from producers across the country—it They finally admitted
surveys only large producers and extrapolates findings across the that they hadn’t
industry…the EIA plans to change its methodology this month resulting bothered to research
in ‘significant’ downward revisions in some areas.” China’s consumption
carefully, “because
Some of the big gas producers, such as EOG Resources, argue that the EIA’s
it isn’t a member of
overstatements “helped push prices to seven-year lows in 2009….the EIA data
the OECD.”
showed that gas supply rose 4% in 2009 despite a 60% decline in onshore
gas rigs.”
The margin for error is said by industry people to be about 10%. “’It’s getting
ridiculously large,” said Ben Dell, analyst with Sanford C. Bernstein.”
We have read some of Bernstein’s well-researched and strongly bullish

studies on natgas and can understand why they would be upset about the
government’s sloppy work.
This recalls our oft-told tale about the OECD’s energy division, the Paris-
based International Energy Agency, which under-estimated oil consumption,
year after year. They finally admitted that they hadn’t bothered to research
China’s consumption carefully, “because it isn’t a member of the OECD.”
We have routinely characterized the staff of this agency as tax-exempt
boulevardiers living splendidly in Paris, luxuriating in enviable job security,
because, although they were always wrong, they still managed to live well in
an expensive and beautiful city.
We don’t know whether the Washington-based staff of the EIA are frères sous
la peau of those boulevardiers, (although Washington was built on a Parisian
model), but we aren’t surprised that those worthies find it pleasanter to make
a few phone calls to people they know at EOG, XTO and other biggies, rather
than trekking around Midland, Henry Hub, and other such oil centers to talk
to bosses of small operating firms who may lack a proper appreciation of the
intelligence and insight of experts from Washington, and may actually not
understand the nuances of Obaman energy policy.
April 23
But, just as those sustained UN faux pas didn’t hold back the oil boom, we’re
not sure that rectifying the EIA’s data will drive gas prices skyward. Natgas for
delivery during the prospective mid-December chills of yearend 2012 is only
priced at $6.20—a week after the release of the Wall Street Journal story—
But we like scarcity which had no apparent effect on gas prices.
stories, not surplus
What counts is gas in storage, and those numbers presumably aren’t fiddled,
stories where only
because that would constitute fraud.
the fittest and the
fibbers survive. What also counts is published industry estimates of how much gas that wasn’t
counted in the national inventory five years ago is now counted as probable
and possible because of technology breakthroughs—and it is huge.
Again, clients tell us all that gas won’t be hitting the market because so many
small operators will go bankrupt.
But we like scarcity stories, not surplus stories where only the fittest and the fibbers
survive.
From our perspective, the following tentative conclusions can be drawn:
1. Natgas will remain alluringly cheap relative to oil, and will gain market
share where substitution is feasible—such as in chemicals and plastics.
2. Natgas will gain market share in industrial heating from residual oil.
3. Those gigantic LNG projects in Qatar and Iran will not proceed as rapidly
as had been assumed.
4. There will be no further LNG deals that involve shipments into the US
east coast or California.
5. The native groups that managed to stall the various Arctic pipeline projects
have done a big favor to Big Oil, and have done great disservice to Sarah
Palin and the taxpayers of Alaska. Those projects will not proceed. If and
when the pipelines are eventually built, it will be because the Chinese
owners of the resources will have ordered the construction and obtained
compliance from any unruly natives.
6. If, as industry experts expect, there are huge shale and tight gas opportunities
in central Europe, that will be splendid news for the Eurozone and will
offset some of the economic problems from grunting and growling
PIIGS.

7. In that case, Putin’s power over pusillanimous politicians in Western Europe
will shrink sharply. This could turn out to be the best news for Western
European lovers of liberty since the Fall of Bolshevism in Russia.
8. If natgas remains plentiful and cheap, it will begin to invade oil’s dominance
Perhaps Washington
in transportation. Already, thanks to T. Boone Pickens-promoted subsidies,
will make natgas
it is attracting interest from government-related trucks and buses. Perhaps
the next ethanol,
Washington will make natgas the next ethanol, replete with subsidies,
replete with subsidies,
tariffs, and forced allocations—in which case demand would soar and
tariffs, and forced
prices would rise.
allocations...
As this was being written, we got some news about how EOG, a well-run oil
and gas producer and one of the shale kingpins, is rebalancing its strategies.
It is apparently not content to rely on the phantom valuation of reserves the
SEC accepts.
According to The Wall Street Journal, “It plans to boost production of crude
oil, particularly unconventional shale oil. Those plans require higher capital
expenditures of $5.1 billion this year. True, that is much more than the $3.5
billion Citigroup expects the company to make in operating cash flow. But
EOG plans to sell up to $1.5 billion of gas assets to help bridge the gap.”
Who will buy those assets and how will they be priced?
We have some personal experience with this process because the only
American shale gas-levered stock we held in the Coxe Commodity Strategy
Fund (TSX: COX.UN) was XTO Energy—our hedge against being completely
wrong about gas prices. We were pleased to be able to sell it very profitably
when Exxon Mobil made its first major corporate acquisition since it bought
Mobil. How profitable all that shale production will be for XOM remains
to be seen, but those assets will do wonders for the acquirer’s Reserve Life
Index, whose oil component has been falling almost as fast as the reserves in
the Social Security Trust Fund.
Sustained cheap gas and restrained oil prices are together good reason to
feel more confident about the pricing outlook for industrial metals—and
about the future profitability of some of the major gold mining companies.
It is also a reason to feel more confident about farmers’ net incomes—which
bodes well for the farm equipment manufacturers and fertilizer and seed
producers.
April 25
Greeks Bearing Gifts to Barack and Ben

Although the big mainstream media have been assuring us—day after day—that the best thing that has
happened to his Presidency was getting the health care entitlement bill passed, we are inclined to the
view that the best thing that has happened to his Administration—and to the Fed—is the sudden surge in
support for the dollar.
US Dollar Index (DXY) US Dollar – Yen

January 1, 2002 to April 13, 2010 January 1, 2002 to April 13, 2010
130 140
120 130
110 120
100 110
90 100
93.26
80.49 90
80
70 80
Jan-02 Nov-02 Sep-03 Jul-04 May-05 Mar-06 Jan-07 Nov-07 Sep-08 Jul-09 Jan-02 Nov-02 Sep-03 Jul-04 May-05 Mar-06 Jan-07 Nov-07 Sep-08 Jul-09
Euro – US Dollar Gold

January 1, 2002 to April 13, 2010 January 1, 2002 to April 13, 2010
1.7 1,200
1,152.40
1.6 1,100
1,000
1.5
900
1.4
1.36 800
1.3
700
1.2 600
1.1 500
1.0 400
0.9 300
0.8 200
Jan-02 Nov-02 Sep-03 Jul-04 May-05 Mar-06 Jan-07 Nov-07 Sep-08 Jul-09 Jan-02 Nov-02 Sep-03 Jul-04 May-05 Mar-06 Jan-07 Nov-07 Sep-08 Jul-09
Canadian Dollar – US Dollar

1.10
1.05
1.00 1.00
0.95
0.90
0.85
0.80
0.75
Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10

Since February 2002, when we announced at the BMO Resources Conference
the dawn of the commodity era, we have been counseling clients to minimize
their risks to the US dollar and to emphasize—in particular—Canadian
dollar investments and gold.
In its time of need,
For most of the intervening period, the dollar has been weak against major
the dollar is being
tradable currencies. The exception came during the financial crisis, when
rescued by the dramatic
overlevered players were forced to unwind exposure to American debt
revisions of global
instruments. That process, plus a general tendency in panics to rush to the
investors’ appraisals of
biggest of the alternatives, produced a powerful dollar rally.
Greeks and other PIIGS.
However, as the financial markets stabilized, and as publicity about the drastic
deterioration in US finances became a weekly event, the dollar resumed its
bear market.
In recent weeks, the dollar has been rallying powerfully, despite continuing
flows of negative reports about the Fed’s balance sheet, Washington’s deficits,
Washington’s spending, the likely cost of major new programs (such as health
care and cap and trade), and that the Social Security Trust Fund cash flow has
gone negative six years ahead of schedule.
In its time of need, the dollar is being rescued by the dramatic revisions
of global investors’ appraisals of Greeks and other PIIGS. That term covers
members of the Eurozone whose finances are as bad—or worse than—the
US, including Portugal, Italy, Ireland, Greece and Spain. But the greatest of
these is Greece, where the weekly news ranges from union leaders bewailing
a new kind of Greek tragedy or commentators across the world musing about
a new kind of Greek comedy. Greece’s fiscal deficit is listed at 12.5% of GDP,
whereas eurozone members’ deficit is supposedly capped at 3% of GDP and
its national debt is said to be near 130% of GDP. Those numbers would
not, in themselves, constitute disaster if there were any evidence that Greece
could, with short-term aid, become credit-worthy without reliance on the
productive eurozone members and the IMF.
But almost nobody believes that Greece can rein in its massive public sector
with its massive benefits—including early retirement. Nor does almost
anybody believe Greece can kickstart its economy by suddenly becoming
strongly competitive. On the macro level, Greeks are better known for their
charmingly casual approach to paying taxes and working efficiently. However,
they share space in the world’s largest free trade zone with such industrious
and thrifty people as the Germans, Dutch, and Austrians.
April 27
Greece has a storied past, as the founding culture of what would become the
West. But its record since Alexander the Great’s time is of 22 centuries in which
most of the news was bad, and heroes were few—or nonexistent. The rest of
Europe is willing to buy Greek art treasures and Aegean islands, but little
The yen is the else that is Greek. The Glory that was Greece lives on in our neighborhood:
zero-yielding currency atop the former Board of Trade Building that now houses the CME is a
of a country whose splendid statue of Ceres, the Greek goddess of agriculture. (Thankfully, those
demography is the atheist activists who rage against any public religious displays have tolerated
worst in human history. Ceres.)
Greece’s economy is tiny, so why is its seemingly hopeless and half-hearted

attempt to escape from its self-spawned Laocoönesque coils good news for
Washington?
Because, in foreign exchange markets, there are only three major trading
zones—the dollar, the yen and the euro. Roughly 80% of all trades involve
the dollar on one side. Until recently, investors wishing to escape from the
dollar’s highly-publicized problems could choose the yen or the euro.
Those escape routes are closing rapidly.
The yen is the zero-yielding currency of a country whose demography is

the worst in human history. Its population is set to fall by 50% by 2050—
the equivalent of two waves of Black Death in slow motion. By 2100, the
whole nation will resemble its Cabinets—average age over 65. This could, in
theory, be a time of bliss and harmony, because Japanese have traditionally
venerated the aged, who are assumed to be wise. However, it will not be an
economy that could service today’s level of debts, let alone the stratospheric
heights of the future. Soon the birth rate will be exceeded by the berth rate
for desirable storage slots of ancestral ashes. Anyone with a yen for long-term
Japanese bonds?
Eurobonds were obviously a better bet—no matter the name of the

borrower.
Until Greece went from the obscurity which allowed it to peddle its bonds
to investors abroad—and to the European Central bank—to Page One status
as the Wastrel of the Western World, the euro was the currency of choice for
currency traders and investors wishing to reduce their dollar risk.
Investors are now beginning to realize that Greece is just the first and most
malodorous of the eurozone’s PIIGS.
Result: more and more foreign exchange funds and institutional investors
are almost compelled to buy US-denominated debt.

Looking Ahead
The sad reality is that the eurozone outside the traditionally Protestant (and
therefore traditionally capitalist) northern industrial states and France is
uncompetitive. Apart from tourism, much of Europe has bad demography,
Apart from tourism,
bad public finances, and few competitive advantages.
much of Europe has
The US situation would surely be seen as grim by holders of Treasurys were it bad demography,
not being compared to the worsening situations in Japan and Europe. bad public finances,
and few competitive
Britain is not in the eurozone, but its demography and public finances are
advantages.
almost as pitiful as the average PIIG’s, and the country is in an election
campaign that matches a tired Labour government with whom the voters
are fatigued, against a young Etonian whose resemblance to Thatcher
is no greater mentally than it is physically. This callow candidate of great
ancestry and even greater ambitions has been known to praise Saul Alinsky,
the Marxist community organizer called “The Father of modern American
radicalism” who inspired ACORN and the young Obama. The voters do not
get to choose “None of the Above.” Tony Blair, driven from office by his
support of Bush in Iraq, looks better and better—but he is only slightly more
available as a rescuer than Churchill.
British Pound – US Dollar

2.2
2.1
2.0
1.9
1.8
1.7
1.6
1.54
1.5
1.4
1.3
Switzerland is not part of the EU, but even the classic haven Swiss franc
risks looking less and less Alpine and more and more like what Hannibal’s
elephants left behind. Its bailed-out banks are reporting robust trading
profits redeploying their government-guaranteed deposits, but much of the
economy is high-cost, and Swiss demography resembles the rest of aging
Europe.
April 29
Swiss Franc – US Dollar

1.05
1.00
0.95 0.95
0.90
0.85
0.80
0.75
0.70
So which tradable paper currencies are still stores of value?

Canadian Dollar – US Dollar
1.10
1.05
1.00 1.00
0.95
0.90
0.85
0.80
0.75
Australian Dollar – US Dollar

1.00
0.95
0.93
0.90
0.85
0.80
0.75
0.70
0.65
0.60
0.55

The only heavyweight among the tradable currencies is the Indian rupee:
US Dollar – Rupee
March 1, 2008 to April 13, 2010
53
...the US dollar is now
51
first among the worst
49 big alternatives to gold.
47
45
44.32
43
41
39
Mar-08 Jul-08 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10
We have no chart on the untraded renminbi, which is likely going to be

revalued upward modestly.
Conclusion: the US dollar is now first among the worst big alternatives to
gold.
The turnaround in the dollar has already had its effect on some Asian central
banks. They had begun unloading greenbacks in favor of euros—partly
because they have more trade with Europe than the US, but mostly because
the dollar’s highly-publicized problems scared them at a time when total
global forex reserves were roughly two-thirds in Treasurys. So we’ve seen
greater central bank participation in some recent Treasury auctions.
This must please Barack and Ben. When you know that in the next year you’re
going to be rolling over more than a trillion in outstanding Treasury paper
and adding another trillion to the supply, you’d like to think there are some
buyers other than local banks who are buying your stuff because they are so
financially emasculated they can’t make new loans.
April 31
A Commodity Bull Market Coexisting With a Dollar Bull Market?

The shrewd Jim Rogers was once asked why anyone should buy gold when
there was seemingly no inflation. He cited the current account and Treasury
deficits and said, “Just do the math.”
“Just do the math.”
As a general—and very useful—rule, the days the dollar is strong are days
commodities and commodity stocks are weak. History shows that the greatest
commodity bull market—the 1970s—was a time of severe dollar weakness,
and the Triple Waterfall Crash of commodities came during a long, strong
dollar bull market.
So, we are asked, can we have a commodity bull market coexisting with a
dollar bull market?
In a word: Yes.
We have come to believe that this Odd Couple can coexist if investors
conclude that bonds are no haven, and economic growth remains much
stronger in the key Asian economies than in the US or Europe.
Why?
Because the 1970s commodity boom was an inflation-hedge boom. US

inflation surged from 4% to 14% and there were three recessions within
a decade. That commodities other than gold performed well was because
investors learned that buying “out month” commodity futures was a hedge
against inflation. Result: base metals piled up in storage because of inflation
fears, while demand was erratic because of recessions.
We try to resist “New Era” thinking, but current conditions are collectively
unique:
1. OECD government fiscal deficits totaling more than $4 trillion.
2. Government bailouts totaling more than $1 trillion.
3. Debt/GDP ratios at unheard-of levels—both government debt/GDP and

total debt/GDP.
4. Global economic leadership now coming from China, India, Korea and
Taiwan, not from the US and Europe.

5. Housing bear markets across much of the OECD with government housing
price supports at unprecedented and unsustainable levels.
6. US State and local debt ratios at horrendous levels even before realistic
costing of liabilities under employee pension and medical plans. We live
A Stanford team
in Illinois, which ranks just behind California for the scale of its unfunded
recently costed out
employee pensions. A Stanford team recently costed out the unfunded
the unfunded portion
portion of California’s state pensions at $500 billion—which is roughly
of California’s
seven times the total amount of state general obligation bonds outstanding.
state pensions at
Illinois and California would need years of GDP growth at China’s rate
$500 billion...
to make their existing debts manageable—and many other states are in
similar crises.
One example of why the Canadian dollar is so strong relative to the

greenback:
Everyone has always known that Social Security was headed for trouble, but
we were told its cash flow wouldn’t turn negative until 2019; then 2016. It
goes negative this year and that means the “fund” is evaporating quite rapidly.
(Remember when the Democrats savaged Bush’s plans for Social Security
savings accounts by telling frightened voters that Bush would be taking their
money from its safe piggy bank where it was being kept for them? Great
politics.)
The Social Security Trust Fund, which is a mere bookkeeping entry, “invests”
in Treasurys at the approximate duration of the national debt. We appeared
before the US Senate Finance Committee in 1988 to testify about what was
wrong with the Fund. We criticized its investing strategy, pointing out that
any private plan with long-term liabilities that invested in what was then a
7-year duration would be shut down. We argued the Fund should be getting
the benefit of the high interest rates available on long Treasurys. Senator
Moynihan called our testimony “powerful,’ but told me he couldn’t rally
any votes for it because the Treasury was saving money by paying such low
yields into the fund, and if Social Security invested in long bonds it would
increase the reported fiscal deficit. Result: all those years of double-digit
and high-yielding Treasurys came and went and Social Security only briefly
prospered.
April 33
Compare that experience to the Canada Pension Plan, which for its early
years (until the 1990s) invested in 20-year provincial government bonds
whose blended real yields were high, then switched, as the bonds mature,
to investing in market instruments managed by skilled professionals at the
...what is the Canada Pension Plan Investment Board. The CPP isn’t fully-funded, but its
difference between market rate returns mean that its assets will keep growing for decades. Chile
a store of value and and Norway may be the only nations with better-financed public pension
an inflation hedge? systems.
We conclude that the US will continue to look somewhat attractive compared

to Europe, and so there will continue to be demand for Treasurys relative to
bonds issued by European governments other than the leading countries.
The commodity bull market in this decade will be driven by (1) industrial
demand for raw materials; (2) sustained demand for petroleum; (3) continued
protein upgrades in diets in emerging and emergent economies, and (4)
greater reliance on precious metals as stores of value—not necessarily as
hedges against actual inflation. Inflation could in fact come with a rush if the
global economy turns strong, government deficits stay high, and real yields on
government bonds turn sharply negative. At the moment, measured inflation
remains subdued because of heavy unemployment and large percentages of
unused capacity across the OECD.
Gold
What is the difference between a store of value and an inflation hedge?
Answer: a store of value at least maintains its market value under widely
varying economic conditions and widely-varying or steadily-rising inflation;
an inflation hedge is an asset bought and held to produce big profits when
inflation is high and rising—and investors think it’s going to rise even faster.
Gold ran from $38 to $850 when inflation ran from 5% to as high as 14%,
but annual inflation during that period averaged in the high single digits.
Once gold’s price was running far faster than inflation, it ceased to be a true
store of value and became a speculative hedge—ultimately against inflation
that Paul Volcker was about to terminate.

The Changing Scene on the Farms
We have made Agriculture an investment priority since 2006. One reason
it deserves inclusion in all commodity portfolios is that its drivers are not
closely correlated with those influencing prices of metals and energy.
...stock price changes
What drives agricultural stock price performance is farm incomes—notably are more closely
those of the producers of corn, wheat, and soybeans. Although farmers’ costs correlated to grain
can—and sometimes do—rise faster than grain prices, stock price changes prices than to GDP
are more closely correlated to grain prices than to GDP growth, employment growth, employment
data, overall corporate profits or the performance of the S&P. data, overall corporate
profits or the
Monsanto (MON) performance of the S&P.
140
120
100
80
67.75
60
40
20
Jan-05 Aug-05 Mar-06 Oct-06 May-07 Dec-07 Jul-08 Feb-09 Sep-09 Apr-10
Potash (NYSE: POT)

250
225
200
175
150
125
112.21
100
75
50
25
0
April 35
Mosaic (MOS)
180
160
140
120
100
80
60 56.78
40
20
0
Deere (DE)
100
90
80
70
60 61.54
50
40
30
20
CNH Global
70
60
50
40
32.84
30
20
10
0

Corn
850
750
650
550
450
350 350.50
250
150
Soybeans
1,700
1,500
1,300
1,100
968.00
900
700
500
Wheat
1,250
1,150
1,050
950
850
750
650
550
450 476.00
350
250
April 37
As the charts show, the world’s realization that its crop carryovers were
shrinking slowly took a while to translate into a bull market for grains. In
part, there was complacency: there’s always more corn and wheat than we
need; in part, there was investors’ multi-decade conviction that grain farmers
But what is good for were pampered by governments so outrageously that there would always
the human race and be surpluses; in part, there was sustained good weather: the kind of short
for investors in other growing seasons seen during the mid-1970s were rarely repeated.
commodities is bad
We said after our trip to India in 2006 that agriculture would be the next
news for investors in
commodity bull market. It was clear to us that steadily-increasing demand
agricultural stocks.
for higher protein diets was inevitable. Since total hectares under cultivation
worldwide were increasing almost imperceptibly, what was needed was
sustained increase in per-hectare output. Needed: genetically-modified seeds,
more fertilizer (and more precision in its usage), and greater use of advanced
farm machinery.
For a while, that concept became a financial cornucopia for clients. And then
came the Crash, and suddenly the surpluses were back. This year’s global
grain crop of corn, soybeans and wheat looks like a record, and it comes at a
time of carryovers reminiscent of the grim old days.
This is profoundly good news for the human race. The last thing we need
would be a major food crisis that sent prices of basic grains to levels that
drove millions into starvation and derailed the powerful economic recoveries
in China, India and Indonesia.
But what is good for the human race and for investors in other commodities
is bad news for investors in agricultural stocks.
We have been recommending in Conference Calls that clients reduce their

exposure to farm inputs (other than machinery), and invest in companies
which win from cheap grains—producers of beef, pork and chicken.

Tyson Foods (TSN)
21
20.07
19
17
15
13
11
5
Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10
Sanderson Farms (SAFM)

60
57.93
55
50
45
40
35
30
25
Smithfield Foods (SFD)

24
22
20 19.94
18
16
14
12
10
8
6
4
April 39
The ethanol story, which has long been a colorful tale of politics, mendacity
and greed, has recently taken a new twist. Look, Ma, it’s for real!
Ethanol’s profitability depends on the spread between gasoline prices—

which are driven by oil prices, and the cost of corn and natural gas. (This
...ethanol is The fuel
formula ignores the subsidies paid to refiners and the punitive tariffs against
that dare not speak
Brazilian cane sugar ethanol, which is in line with the rule that ethanol is
its cost.
The fuel that dare not speak its cost.) The Upper Midwest became dotted with
ethanol plants in the days of cheap corn, and many of them went bankrupt
when corn and natgas prices rose more than oil prices.
Our enthusiasm for agricultural stocks that collectively contribute to reducing

the global shortage of vegetable and animal protein has been reflected in
these pages and in our public involvement in conferences about global food
problems. For example, we wrote the analysis of the global food situation
used by the participants in the 2009 G20 meeting in Pittsburgh.
Because of our strong conviction of investing in companies whose products

and services alleviate hunger and promote health worldwide, we have
avoided investing in ethanol companies in our Fund. In our view, corn
ethanol contributes to the global shortage of food, and remains in the market
only because of the toxic combination of bad politics, bad science, and bad
propaganda.
However, we are modifying that view slightly. First, we realize that not all our
investors share our passionately-held views about the evils and false pricing
of ethanol. Secondly, low corn and natural gas prices now combine with
high oil prices to create a market for ethanol that is at least partly based on
honest economics—a remarkable novelty for ethanol.
So we have made an investment for the Fund in a large ethanol producer.

When we then read of Brazil’s retaliation against the US ethanol industry for
its punitive tariffs on Brazil’s sugar-based ethanol, we felt the first guilt we
have experienced in making investments for the Fund.
Nevertheless, we are forced to recommend these stocks to clients who believe

that “Conscience doth make cowards of us all.”

Jimmy Cartesianism?
The health care bill is now law, and the nation will soon be discovering the
true size of the bills it must pay. There was a long-felt national consensus that
no one should be denied health care through inability to pay, and that the
...the tort law system,
US must cease to be the only major industrial nation lacking universal health
which is unique in the
care. Those are commendable sentiments—and we share them.
world, and uniquely
As Canadians, we are well aware of the benefits and the limitations of that vile in the world.
nation’s universal system—depending in which province one resides and
which maladies one suffers. We also have several personal experiences with
the high quality of emergency services that system provides, and can attest
that it is a far, far better thing to visit an emergency room in downtown
Toronto than its counterpart in Chicago. We also find much of the Republican
oratory about the “horrors of socialized medicine” to be the kind of tired,
toxic demagogy we had long believed to be the preserve of the gaseous Left.
Nevertheless, what the sausage-making process in the Democratic-controlled

Congress finally excreted is execrable. Not only because—like Mitt Romney’s
Massachusetts Medicare program that he doesn’t want anyone to remind
Republican voters to think about—it encourages people with health
problems to take out health insurance just before seeing a doctor—and
lapsing it thereafter. And not just because of the deals done with doubting
Democrats to buy their votes—such as the Second Louisiana Purchase and
the Cornhusker Kickback. But because it not only failed to address the most
serious malignancy in the US health care system—but it built in provisions
that will make that horror far worse. We speak of the tort law system, which
is unique in the world, and uniquely vile in the world.
How?
By (1) failing to assign legal costs to losers in lawsuits, thereby stimulating

vexatious suits, and (2), by allowing judges’ election costs in the many
“hellhole” judicial districts to be financed largely by the plaintiffs’ lawyers who
practice in those courts, and (3), by requiring juries—rather than judges—to
make fact-findings on extremely technical medical questions in response to
seductive sob stories—the kind that made John Edwards a multi-millionaire.
Result: the system is shot through with extra costs for extra tests, and extra
costs for liability insurance for hospitals and doctors. We understand that,
April 41
next only to money from unions, the Democrats’ biggest funding support
comes from tort lawyers. Obama did nothing to cut off such a rich vein of
support for him and his party, and for health care’s contribution to making
America the most over-lawyered economy in the world, and its health care
...the Hollywood system the costliest in the world.
glitterati who
Actually, he did a lot to make the situation worse—by introducing hundreds
supported him...
of new rules and claim categories that will be fertile future fields for litigation
could doubtless have
against doctors, hospitals and health insurers. History may conclude that
warned him of a
this was among the more successful job-growth-creating laws he sponsored.
digital incompatibility
that could trigger Meanwhile, as fighting the health care battle was forcing the President to
some other kinds of cancel trips abroad to see allies fighting with his troops in Afghanistan, the
incompatibility. world was reviewing the President’s various foreign policy initiatives and
drawing its conclusions.
The clearest pattern, as so many critics have noted, is Obama’s urge to ignore,
rebuke and/or be openly rude to long-time friends and allies of America,
while playing up to nations that have been long-time problems to America.
His treatment of Gordon Brown and Britain has received the widest press
coverage. It began when Obama sent back to London the bust of Churchill
Tony Blair had presented to America. He didn’t offer it to any other
government offices—or even to any major universities or foundations. He
just sent it back. He made no attempt to rebut press reports that this was
because his Kenyan father, who may have had Mau-Mau connections, was
badly treated by British officials during the long Kikuyu-led rebellion.
When Brown visited the White House, and presented him with some well-
chosen gifts, Obama responded with 25 DVDs of popular American movies.
Brown returned to Number Ten and tried the first, and found they were
unplayable on British TV sets. Had Obama made any effort to contact any
of the 90% or so of the Hollywood glitterati who supported him, they could
doubtless have warned him of a digital incompatibility that could trigger
some other kinds of incompatibility.
In Central America, he backed the outgoing, unpopular leftist President

who proposed, Chavez-style, a referendum to overturn the constitutional
provision that he could not remain in power. The Supreme Court had
declared that challenge unconstitutional. The legislature had installed a

successor who agreed to run in the scheduled election in November. Despite
attempts by Venezuela and Cuba to intervene, Hondurans held firm, and
the temporary President, Porfirio Lobo, was resoundingly re-elected. Obama
was forced to accept the clear democratic decision in Honduras, which was
against the enthusiasm of the more vocal American Left who wanted to back ...Colombia, which
up the neo-Chavista. (These are the same people who continue to prevent is in bad odor with
Congressional ratification of the free trade deal with Colombia, which is the global Left for
in bad odor with the global Left for winning its long guerrilla war with the winning its long
Chavez-backed FARC Marxists.) guerrilla war with
the Chavez-backed
His relations with Israel’s Premier Benjamin Netanyahu rather rapidly
FARC Marxists.
deteriorated from cordiality to leaving him alone at dinner on a White House
visit. The issues were the building in Jerusalem of new housing for Ultra-
Orthodox Jews—who are known both for their un-Israeli fertility rates (vast)
and their un-Israeli attitude to military service (exempt). Netanyahu was
blindsided while Biden was in Jerusalem by the public announcement that
the controversial building project was approved: in his diverse and raucous
coalition, the various parties divide up the Cabinet posts and patronage and
power appurtenant thereto. Obama understood that Netanyahu had been
caught off guard, but chose to make this a full-scale confrontation.
The governments of Czechoslovakia, Eastern Europe and the Baltic region

were given no advance notice of his sudden decision to deny them the Bush-
promised protective coverage against attack through a US-developed missile
warning system. Not being an historian, Obama probably had not realized
that the date of his revocation of a US pledge of protection was 70 years
to the day that Germany invaded Poland. But the people in those nations
certainly did. Symbols sometimes count.
Other long-time friends and allies of the US have been complaining about
coolness or rudeness from Obama.
In sharp contrast, he has actively and almost slavishly courted some of the
most troublesome nations and odious leaders in the world. He nearly fawned
on Ahmadinejad of Iran and then stayed silent as the regime was beating,
gassing and torturing demonstrators against its brutalities and usurpations.
He was seen smiling with Russian Premier Medvedev, as they signed a nuclear
arms reduction agreement in which the US gave up far more than Russia.
April 43
It came after Obama announced an “historic” change in American nuclear

policies, including an announcement about limiting the kinds of attacks
with weapons of mass destruction that could trigger a US nuclear response.
(Investor’s Business Daily’s cartoonist summed up the revision with a sketch of
...at root, Obama denies a wall plastered with warnings of protection by powerful dogs. Right in the
what most Americans— middle was a sign saying “Welcome: we’ve locked up the dogs!”)
and most Presidents
Long-time members of the bipartisan foreign policy establishment have been
except Carter—
reacting with dismay to this unilateral reduction in America’s proclaimed
strongly believe in:
willingness to use—if necessary—its entire strategic arsenal to defend itself
American exceptionalism.
and its allies.
Their analysis is that, at root, Obama denies what most Americans—and

most Presidents except Carter—strongly believe in: American exceptionalism.
Reagan spoke powerfully to this deep conviction that America is different
because it has always stood for—and fought for—freedom.
Obama is a Kumbaya-style new-ager with a commendable belief in human

brotherhood and sisterhood. However he seems also to believe that appealing
to those instincts in “the people” can make the troublesome nations of
the world peace-loving, regardless of what the dictators in those nations
believe.
His eloquence and glamour make him a unique global force in transmitting
America’s peaceful intents and support for basic human values.
But then, during some of these gauzy and glorious effusions, he becomes
unable to resist overenthusiasm for inclusiveness, and mixes both his
metaphors and messages.
His Easter message was typical: he pointed out that Easter time has always
been an important part of American traditions, because of its Christian and
Jewish associations.
But then he said, “But Islam also always been part of American traditions.”
Head-scratchers searching to find Islam in American history found the

Barbary pirates, who could justly claim some credit for the creation of the
US Navy and Marines, but no Islamic Congressmen, Senators or Governors
or university or union presidents or Nobel or Pulitzer Prize-Winners until
very recent times. We would all have applauded him had he sent greetings
to Muslims at the time of this sacred season for Jews and Christians, but he
wasn’t content with the exceptionalism in American historical traditions. He
had to deny it.

More than one commentator has observed in the past week that the core
value of America to its allies since the founding of NATO has always been its
announced willingness to use, if necessary, all its power to protect itself and
them.
Being the unchallenged
Even the ban-the-bomb political leaders abroad surely slept better knowing
superpower who stands
that Russia would not feel free to invade a free ally of the US as it had Hungary
ready to protect its
and Czechoslovakia.
allies has always meant
Being the unchallenged superpower who stands ready to protect its allies has basic buying power for
always meant basic buying power for the dollar, even when the economic the dollar, even when
and financial fundamentals were less than benign. JFK, Nixon and Reagan the economic and
were, at times, explicit that those allies not making large troop commitments financial fundamentals
to NATO’s responsibilities were expected to—at the very least—offset the were less than benign.
balance of payments costs to the US of its troops and weaponry abroad,
and to make an indirect contribution for Pentagon nuclear research and
modernization by their purchases of Treasurys.
Part of Obama’s announcement of the drastic policy shift was abandonment

of the program of upgrading the nuclear arsenal through testing, research
and modernization—as Russia is doing, despite the likelihood that both
South Korea and Iran will have advanced nuclear weaponry.
It is no exaggeration to say that Obama’s increasing commitment to what

one wit called “Jimmy Cartesianism” will surely erode the fear component of
respect that so many nations unfriendly to America have long harbored.
That helps explain the uncharacteristically Russian smile on Medvedev, when

he proclaimed how much he approved Obama virtually unilateral offer. Not
even Danny Kaye could have flashed a bigger smile.
The frowns were left for friends.
Writing in the Washington Post, Charles Krauthammer delivered a broadside

against the new Obama nuclear policy. It asserts that if the US or any ally is
attacked with biological or chemical or other weapons of mass destruction
by a country that is compliant with the Nuclear Proliferation Treaty, the US
will not retaliate with nuclear arms.
He calls it “insane.” He notes that this is equivalent to a situation in which,

if a terrorist on US soil drives a vehicle at high speed into a crowd, killing
hundreds, he would face hanging unless his vehicle passed an emissions
compliance test, in which case 100 days of community service might be
allotted.
April 45
Conclusion
Obama’s policy of disarming hostile nations with his charm and with
apologies for everything “bad” the US has ever done, and his oft-repeated
protestations of peaceful intent have undoubtedly delighted many people
abroad who have been raised on the intellectual fodder that the US is to
...while Obama tries to
blame for all the misery in the world that hasn’t been caused by Israel and
make hostile nations
the former colonial powers.
see the light of sweet
reason, he is reducing He has, in his policies toward Iran and Syria, and, to a lesser extent, North
American strategic Korea displayed the faith in the sense and restraint of nations with long
arms, and cutting back records of hostility to the US that characterized Neville Chamberlain’s late-
on testing of missile 1930s policies toward Hitler’s Germany. Indeed, some of his most vocal
defense systems... American critics compare him to Chamberlain.
As is so often the case with the enthusiastically under-educated, the comparison

is faulty. The great difference between them is that Chamberlain was acutely
aware of how unprepared Britain was for war when he agreed at Munich
to the partition of Czechoslovakia, and was, in part, buying time while he
frantically bought planes and ships. Had war come in 1938, he would not
have had enough Spitfires, Hurricanes and cruisers to have withstood an
all-out German air attack, as precursor to a waterborne invasion. As it was,
his successor, Churchill, barely won “The Battle of Britain” with the increased
supply that another 15 months’ production had made available. In contrast,
while Obama tries to make hostile nations see the light of sweet reason, he
is reducing American strategic arms, and cutting back on testing of missile
defense systems—again, as evidence of good faith. Neville Chamberlain,
Lord Halifax and the rest of the appeasement wing in London would have
considered that policy unbelievably naïve.

Mr. Obama justifies the cutback in missile defense research and testing
because the systems haven’t proved themselves and may never work effectively.
He does not, however, apply that caution about wasteful spending to green
technology; he is willing to impose heavy taxes, and bet hundreds of billions
on finding and developing workable green technology because of the great Now that is a risk he
risks from global warming. Now that is a risk he takes seriously. You can’t takes seriously.
reason with Mother Nature.
Some people might think there is far greater evidence that Islamic terrorism
(a phrase he has banned from acceptable locution) and a nuclear Iran are
greater threats to American survival than “climate change.”
Are these thoughts relevant for investors, or just for foreign policy wonks?
Warren Buffett has said publicly that a successful terrorist attack on America
is almost inevitable.
We can presume that the insurance companies in his portfolio are factoring
in that probability.
April 47
INVESTMENT ENVIRONMENT
1. The Improved Global Outlook
The thrust of this essay is that the US is probably emerging from the black
India’s economy barrenness of recession into a relatively unknown territory, with hostile
keeps surprising on presences in the form of unmanageably high debt loads on Washington, the
the upside, as does states, many key corporations, and millions of homes and consumers.
Indonesia’s. There are other, more terrifying hostile presences, but there is little investors
can do to hedge themselves against a drastic US foreign policy and/or
homeland security breakdown.
What we do know is that China is no longer an Emerging Market dependent

on growing revenues in currencies stronger than its own. China actually ran
a small trade deficit last month, a sign that (1) its export accounts cannot
be expected to grow in the next few years—in percentage terms—as they
have in the past decade, because the flaccid OECD economies cannot keep
growing their purchases, and (2) that its own internal growth is proceeding
far more rapidly, and absorbing more and more of its fast-growing imports
of industrial raw materials. Doubtless the deficit was partly driven by heavy
anticipatory Chinese purchases of metals whose prices were rising rapidly.
(In addition, as reports from Long Beach show, more and more of the TEUs
from China that used to go back empty are returning filled with American-
made products. They aren’t likely to be DVDs that don’t work in China.)
India’s economy keeps surprising on the upside, as does Indonesia’s. Those

three nations—one largely Hindu, one largely Muslim, and the other largely
capitalist—are collectively crucial components of global growth forecast.
(Brazil is also large and growing, but commodity exports to China and India
are core to its economic expansion, so it, like Australia, needs them to keep
growing rapidly to expand its own economy.)
2. How to Play It
Clients may find it very hard to accept a revised investment strategy aimed at
participation in global economic growth that leaves exposures to US equities
at the minimal levels that we have been recommending right back to the
recession.
We missed the most recent leg of the S&P rally, but our commodity emphasis
has served investors well.

What we are doing now is expanding the cyclical component of our
investment portfolio strategy with the 12% allocation to commodities
and commodity stocks.
Pension funds have been building increasing exposure to commodities,

We continue to
mostly through the big, diversified funds that roll over their contracts as
believe that the
they near expiry. That program worked extremely well during the years of the
continuance
Commodity Triple Waterfall, because commodity futures were nearly always
of contangos
in backwardation.
is injurious for
That has not been the case for many commodities as a new bull market pension fund
unfolds: out months sell at higher prices than front months, in what is called commodity fund
the contango formation. investors...
We continue to believe that the continuance of contangos is injurious for

pension fund commodity fund investors, (who are classed by the regulators
as Large Speculators). As long as front-month oil contracts are priced at
a big discount to near-month contracts, speculators participating in the
traditional commodity funds used by pension funds will continue to lose as
their managers roll over the expiring contracts. We argue that the best way to
participate in rising commodity prices is through investment in well-managed
companies operating within one or more of the commodity sectors of global
stock markets. The underlying value of those with long-duration, unhedged
reserves in the ground in politically-secure regions rises as commodity prices
rise. In addition, well-managed commodity companies deliver the benefits
of other kinds of well-run companies, as their earnings gains will tend to rise
faster than commodity prices—and they can also pay dividends and buy back
stock. (Commodity companies resemble other kinds of business enterprises
except that they have little or no control over the prices of their products.)
3. Geo-Political Risk?
The combination of a strong rally in both the dollar and gold, accompanied
by a strong rally in spot oil, without follow-through in the distant years of
the futures curve, suggests to us that many investors and strategists have been
analyzing President Obama’s strategic policies and believe that he has made
Israel believe it’s alone facing Iran.
That would sharply increase the chances of a desperate Israeli strike.
Which would presumably be good news for holders of gold, crude oil, and
near-term oil futures.
April 49
And very bad news for most other asset classes.
We, for no particularly well-thought-out reasons, remain hopeful that there

will be no new military action involving Iran. But we would hardly be
shocked if the Israelis were to launch a defensive strike tomorrow.
For our story we just
need the US and We do not counsel hoarding oil and gold against purely geopolitical risks.
non-PIIGS Europe to Our advocacy of commodity stock investing is based on a best-case outcome
putter along. of mostly global peace and rising global prosperity, with the engines of that
growth located in Asia. Commodity stocks are still labeled “deep cyclicals”
and are widely considered appropriate investments only when the US is
experiencing very strong GDP growth and inflationary pressures are working
into pricing models.
For our story we just need the US and non-PIIGS Europe to putter along. The
global scarcity statistics, heavily driven by the double-digit growth of China,
will virtually guarantee good performance from well-chosen commodity-
oriented equities.
Stage #2 of the Great Commodity Bull Market—in which China and India
remain strong exporters but become even greater commodity importers—has
begun.
We recommend clients write tickets on slow boats to China.

RECOMMENDED ASSET ALLOCATION
Our New Category for Asset Allocation
In this issue, we have recommended that pension funds respond to the evidence of sustained
global growth without increasing their exposure to equities categorized by geography—a typical
way pension funds structure their portfolios.
Our Recommended Asset Allocation for US Pension Funds has always addressed capital
market assets, and not real estate or the growing diversity of real asset investments. Together,
globalization and technology have transformed the capital markets, and the traditional
approach to classifying pension assets no longer fits our investment outlook.
This month marks a dramatic shift—some might say a sea change—in the capital markets. We
needed a fresh approach to express the investment asset allocation—and opportunities.
We have added a new category “Commodities and Commodity Equities”.
Although commodities are regarded as “real assets” and commodity stocks as “financial
assets”, they have inherent commonality: like equities, commodities are publicly traded;
they are equity-equivalent investments in the same underlying asset: a resource.
Our new category brings these assets together to address an investment objective:
investment in the industrialization of emerging markets: the greatest efflorescence of human
economic liberty in history.
Our experience with managing the Coxe Commodity Strategy Fund, a global fund, is
that investors can add it to their existing equity portfolios and increase their exposure
to commodity-oriented stocks with a targeted approach, rather than merely increasing
exposure to Canadian and Australian indices and adding commodity subset ETFs from
some other markets.
We believe well-chosen commodity stocks will solidly outperform the traditional
commodity funds—most importantly and obviously—as long as contangos are in force
for key commodities such as oil. When one owns the shares of well-managed commodity
producers with unhedged reserves in the ground in politically-secure areas of the world,
one benefits more from a sustained commodity price increase than passive owners of that
commodity.
We shall be discussing the implementation of this strategy in greater detail next month. For
now, we are recommending that clients’ portfolios be upgraded for greater global growth
led by “Chindia” through this new category in the Asset Mix—rather than through simply
allocating more money to regional stock markets that may or may not capture favorable
commodity activity.
This month we are introducing a new portfolio for Canadian pension funds because we see
the divergence between Canadian and US financial assets as a longer-term phenomenon.
April 51
Recommended Asset Allocation

Capital Markets Investments
US Pension Funds
Allocations Change
US Equities 17 unch
Foreign Equities
European Equities 4 –1
Japanese and Korean Equities 2 unch
Canadian and Australian Equities 11 unch
Emerging Markets 13 –1
Commodities and Commodity Equities 12
Bonds
US Bonds 12 unch
Canadian Bonds 8 unch
International Bonds 6 –5
Long-Term Inflation Hedged Bonds 10 unch
Cash 5 –5
Bond Durations
Years Change
US 5.25 unch
Canada 5.00 unch
International 4.50 unch
Global Exposure to Commodity Equities
Change
Precious Metals 32% –1
Agriculture 25% –5
Energy 22% unch
Base Metals & Steel 21% +6
We recommend these sector weightings to all clients

for commodity exposure—whether in pure commodity
stock portfolios or as the commodity component of
equity and balanced funds.

Recommended Asset Allocation

Capital Markets Investments
Canadian Pension Funds
Allocations Change
Equities
Canadian Equities 20
US Equities 10
European Equities 3
Japanese, Korean & Australian Equities 3
Emerging Markets 14
Commodities and Commodity Equities 10
Bonds
Canadian Bonds
- Index-Related 18
- Long-term RRBs 10
International Bonds 7
Cash 5
Bond Durations
Years Change
US 5.25 unch
Canada 5.00 unch
International 4.50 unch
Global Exposure to Commodity Equities
Change
Precious Metals 32% –1
Agriculture 25% –5
Energy 22% unch
Base Metals & Steel 21% +6
We recommend these sector weightings to all clients

for commodity exposure—whether in pure commodity
stock portfolios or as the commodity component of
equity and balanced funds.
April 53
INVESTMENT RECOMMENDATIONS
1. Increase your equity-equivalent exposure through commodity stocks,
emphasizing the mining stocks at the expense of agricultural and oil &
gas stocks.
2. Canadian investors who use TSX-linked equity products should,

nevertheless, increase their total exposure to commodity equities to reflect
the better global outlook.
3. American investors who use S&P-linked products to participate in a

strengthening global outlook are underweight commodity exposure and
should adjust exposure upward accordingly.
4. Big Oil stocks are a blend of commodity companies and industrial

companies. They dominate the raw materials section of the S&P, giving
investors a false sense they have good commodity exposure. Underweight
integrated oil companies in commodity portfolios
5. The accounting wheeze that equates six units of natgas to one of crude
oil makes Big Oil in general and most oil and gas producers look like
better commodity investments than their true product mix would justify.
Overweight oil production and underweight gas production.
6. The oil sands companies are moving from open pit mining to Steam-
Assisted Gravity Drainage (SAGD) production methods, using natgas as
fuel for melting the bitumen. Result: they are long oil and short natgas,
which is a splendid strategy for investors. This week’s Sinopec purchase
of Conoco Phillips’ 9% interest in Syncrude confirms the strategic value
of that treasure trove that fashionable Greens love to deride. Continue to
overweight the oil sands companies.
7. The combined strength of the KRE and BKX is more than mildly reassuring.
We believe investors should feel quite safe in their equity commitments
as long as that relative strength holds. The test may come when Bernanke
withdraws the heroin, but most economists think that remains far off. This
is a good time to emphasize cyclical equities within US portfolios—and
to add to commodity exposure.

8. Within agricultural stock portfolios, emphasize the equipment and logistics
companies. Reduce exposure modestly to grain production, and increase
it to production of meat—poultry, pork and beef.
9. Gold and silver have held up well in the face of strength in the dollar.
Remain overweighted in the precious metals. The royalty and streaming
stocks offer special attractions, because relatively few investors understand
the companies’ beautiful business models, and the excellent execution of
those models by shrewd managements.
10. Within global bond portfolios, continue to emphasize Canadian bonds.

Within US bond portfolios, emphasize inflation-hedged TIPs. Within
retail portfolios holding high exposure to cyclical stocks, hold some
long-duration bonds as a hedge against a double-dip after the heroin is
withdrawn.
April 55
© Coxe Advisors LLP 2009. All rights reserved. Unauthorized reproduction, distribution, transmission or publication
without the prior express written consent of Coxe Advisors LLP (“Coxe”) is strictly prohibited. Coxe is an investment adviser
registered with the U.S. Securities and Exchange Commission. Nothing herein implies that the firm is recommended or
approved by the United States government or any regulatory agency.
Information, opinions, estimates, projections and other materials (referred to collectively herein as, “Information”) contained
herein are provided as of the date hereof and are subject to change without notice. From time to time, Coxe publications
may contain Information with regard to securities, commodities, derivatives or other investment assets (each referred to
herein as an “Investment,” or collectively, the “Investments”), or investment strategies. Due to staggered publication dates,
any Information contained herein may differ from Information contained in prior or subsequent publications. Information
discussed herein may have been obtained from various unaffiliated third party sources believed to be reliable, but has not
been independently verified by Coxe. Coxe makes no representation or warranty, express or implied, in respect thereof,
takes no responsibility for any errors and omissions which may be contained herein, and accepts no liability whatsoever for
any loss arising from any use of or reliance on such third party Information, whether relied upon by the recipient or user,
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Investments are subject to fluctuations in exchange rates that could have a positive or adverse effect on the investor’s
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No Information included herein constitutes a recommendation that any particular Investment or investment strategy is
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Published by Coxe Advisors LLP
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Slow Boat To China

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Basic Points

A Slow Boat to China

April 16, 2010

Published by Coxe Advisors LLP

Distributed by BMO Capital Markets

BMO Capital Markets Disclosures

A Slow Boat to China

April 16, 2010

April 16, 2010

Author: Don Coxe 312-461-5365

Editor: Angela Trudeau 604-929-8791

Coxe Advisors LLP. www.CoxeAdvisors.com

The “Noughties” were marked by the relentless outpouring of exports from

Our theme comes from a Frank Loesser classic.

I’d like to get you

Hot Cold-Rolled Steel

4 April THE COXE STRATEGY JOURNAL

Rio Tinto (RTP)

A roaring recovery in US stocks usually means many—or most—sectors

We note that the famously slow National Bureau of Economic Research

Nevertheless, we think both the strident pessimists and the starry-eyed

6 April THE COXE STRATEGY JOURNAL

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

KBW US Bank Index ETF (BKX) relative to S&P 500

We have been insisting since we first warned in early 2008 of an apparent

8 April THE COXE STRATEGY JOURNAL

The Iron Ore Oligopoly

There were many reasons for this skepticism:

• Major steel companies built on the US Steel model of full backward

• Steel was losing market share, year-by-year, to aluminum and plastics.

• America’s progression from a no-car to a one-car, to a two-car family was

• There were huge undeveloped ore bodies across the world—particularly

10 April THE COXE STRATEGY JOURNAL

Alan Abelson, the witty, articulate super-bear of Barron’s, regularly publishes

And so to the iron ore story:

Price ($ per tonne)

Metallurgical Coal Prices

Source: IEA, BMO Capital Markets

As contract prices climb, so do prices of stocks levered to coking coal:

12 April THE COXE STRATEGY JOURNAL

Remarkably, in recent weeks, so are steel stocks:

Arcelor Mittal (NYSE: MT)

The doubters—including some members of the National Bureau of Economic

That, we believe, is a realistic concern.

14 April THE COXE STRATEGY JOURNAL

When the economic recovery from the tech-crash-induced recession began in

The combination of slowly-collapsing oil capex across most of the world

• Saudi Arabia believes $70-$80 oil is the “perfect price”—the Goldilocks

16 April THE COXE STRATEGY JOURNAL

• One important—and rarely remarked—aspect of the functioning of the

Crude Oil Futures (at April 20, 2009)

But there’s more….

Or should we say “less…?”

18 April THE COXE STRATEGY JOURNAL

Natural Gas Futures (at April 13, 2010)

It may soon be recognized as perhaps the most dubious financial distortion

Here’s how the accounting has been handled:

• The Reserve Life Index is to oil companies what an actuary’s liability

That is a scientifically-based law of industry accounting, because 6 mcf of

The formula worked well for many years.

20 April THE COXE STRATEGY JOURNAL

One reason we routinely recommend that clients overweight exposure to the

When geologists and petroleum engineers at companies such as Devon