Coxe Basic Points March 2011

Basic Points
Slouching Towards Stagflation?
March 31, 2011
Published by Coxe Advisors LLP
Distributed by BMO Capital Markets

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Don Coxe
THE COXE STRATEGY JOURNAL
March 31, 2011
published by
Coxe Advisors LLP
Chicago, IL
March 31, 2011
Author: Don Coxe 312-461-5365

DCrosbie@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
The dramatic Page One stories this year were born in two cities lying worlds
apart:
A starving street vendor in Tunis set himself aflame, an immolation

which set deserts aflame all the way to the Persian Gulf;
An earthquake near Sendai spawned a tsunami, killing and

wounding thousands, and sending six nuclear reactors into
pre-meltdown mode, slashing electricity supplies across the nation
and forcing factory shutdowns, triggering supply chain shutdowns
worldwide; Japanese stocks plunged to new lows.
This month we chronicle these stories and suggest their important investment
implications. We also discuss two Page 16 stories—the problematic pension
situation in the US and the implications of a NASA-sponsored committee’s
recent prediction of the lowest-activity sunspot cycle in nearly two
centuries.
All these topics relate to an over-arching investment question: is the world

slouching erratically toward a revival of stagflation—a condition in which
commodities and commodity stocks become core investment priorities?
We are modifying our Recommended Asset Mixes and Recommended Sector

Weightings in Commodity Stocks to reflect the impacts on investment
strategies from these challenges.
February 2011 1
2 February 2011 THE COXE STRATEGY JOURNAL
Our title comes from Yeats’s The Second Coming, which includes the following
lines:
Things fall apart; the centre cannot hold;

Mere anarchy is loosed upon the world,
Things fall apart;
The blood-dimmed tide is loosed, and everywhere
the centre cannot hold
The ceremony of innocence is drowned…
When a vast image out of Spiritus Mundi

Troubles my sight: a vast waste of desert sand;
A shape with a Lion body and the head of a man…
And what rough beast, its hour come round at last,

Slouches towards Bethlehem to be born?
What do the Arab revolutions and the Japanese earthquake and tsunami-
driven nuclear crisis have in common?
They were unexpected:

1. Mere anarchy is loosed upon the world…
A vast waste of desert sand. A shape with a Lion body and the head of a man.
No foreign affairs expert predicted that Tunis would be the site of riots that
would depose an obscure autocrat; nor did any prominent pundit predict,
as Tunisians began rioting, that the forces unleashed would swiftly depose
the rulers of Egypt and then trigger a civil war in Libya which would become
the 4th war of our time in which hastily-cobbled western alliances attack
entrenched autocracies in-or-adjoining the Middle East.
The last time this part of the world launched a campaign that engulfed much
of Mediterranean civilization was in 217 B.C., when Hannibal left present-day
Tunis—then known as Carthage—crossed the Alps, and annihilated Rome’s
legions in three great victories that panicked Rome. He fatally hesitated before
marching on Rome. As he rebuilt his supplies and pondered his climactic
assault, the Senate sent Scipio to attack Carthage, forcing Hannibal to return.
Scipio had analyzed his foe’s battle strategies, and won a decisive victory. He
then destroyed Carthage, and sowed it and its environs with salt.
This year’s Tunisian eruption also set off tumult and, in some cases, threats
of civil war, in Jordan, Bahrain, Oman, and Yemen: it even managed to scare
the brutal Bashar al-Assad in Syria. The Saudi rulers also responded—with
generous payouts to local residents and army support for besieged Bahrain,
where King al-Khalifa was beset with large-scale Shia protests.
March 2011 3
2. The blood-dimmed tide is loosed, and everywhere the ceremony of innocence is

drowned.
Obviously, no one predicted a Force 9 earthquake and a horrendous tsunami

in Japan. But, even after the seismologists proclaimed the scale of the quake,
...few investors
few investors immediately realized the world-wide energy implications of a
seem to believe that
major nuclear accident.
these events could,
within months, have Global capital markets have been reacting almost daily to the news from
major long-term Japan, and many short-term traders have been rushing into—and then out
bullish implications of—Japanese stocks. Many hedge funds and trading shops sustained huge
for Japanese losses. However, few investors seem to believe that these events could, within
equities. months, have major long-term bullish implications for Japanese equities.
Many investors see the Japanese crisis primarily as a disaster for the global
nuclear power industry, which had finally begun to build momentum decades
after Three Mile Island and Chernobyl.
Already, the psychological effects have been felt on the other side of the
world. In Germany, Angela Merkel, who is nuclear-savvy, was forced to
announce a delay in her program to defer German nuclear shutdowns, but
was still burned in Baden-Württemberg’s regional election last week. Yes, her
pro-euro policies were her biggest problem, but the Greens' gains in that vote
were driven by their insistence that all German nukes must be permanently
decommissioned.
Is there any good news out of all this bad news? We think that investors could
eventually conclude that the Japanese earthquake and tsunami may have
marked the end of the 21-year Triple Waterfall Crash for Japanese equities,
and discuss this possibility on page 12.
4 March 2011 THE COXE STRATEGY JOURNAL

I. The Arab Awakening
George W. Bush justified his invasion of Iraq on two grounds: stopping Saddam
Hussein before he built up an arsenal of weapons of mass destruction, and
ridding the Mideast of an evil despot, replacing his regime with a democracy ... "the soft
which would eventually be seen to be an expression of Iraqi aspirations, bigotry of low
thereby encouraging the development of democracies across the Arab expectations."
world.
When it swiftly became apparent that Justification #1 was based on bad

intelligence work, critics—particularly those for whom “nuance” is an
intellectual lifestyle—attacked Bush for equally naive thinking about this
supposed underlying Arab urge for democracy. Weren’t the people in all
those autocracies—benevolent and otherwise—satisfied with their lot? They
never did anything about booting their rulers out and replacing them with
democratic systems. “The Arab Street” devoted its outbursts of rage to Israel
and the US, not to their dictators.
Bush characterized such criticisms as “the soft bigotry of low expectations.”
He was enjoying the semi-obscurity of Crawford when, seemingly out of

nowhere, Arabs almost everywhere took to the streets and demanded
political freedom. (The most defiant demonstrations tended to be—with the
exception of Libya—in the least vicious dictatorships.)
Those of us who watched as—night after night—all those young, warm, tech-
friendly Egyptians demonstrated in Cairo were naturally rooting for them.
Hosni Mubarak—the best Arab friend Israel and the US have in the region—
gave in to pressure from his youthful citizens and from his erstwhile good
friend—Obama, and departed without firing a shot. Nothing became him in
his long rule as the leaving of it.
What kind of regime will take power in the June elections? All observers
agree the Muslim Brotherhood is the only nationally-organized group.
The Administration has advised Congress through a spokesman that this
is a secular group. This is an odd appraisal. According to the Council on
Foreign Relations, The Egyptian Brotherhood is the founding member of a
world-wide network of organizations that include establishing Islamic states
with Shariah law among their goals. The Council notes that, because it has
branches across the globe, local groups’ convictions and strategies may vary.
The Egyptian branch has more than three hundred thousand members, and
has consistently rejected violent activity as it has sought to move into the
mainstream. As for what it will do if it achieves power, many friends of Egypt
March 2011 5
abroad will probably look on its intentions according to the Reagan Rule:
Trust, but Verify.
Perhaps coincidentally, last week, a Christian church in Cairo was torched

and 13 people were murdered.
Trust, but Verify.
Investors’ primal fears are that revolutions could spread to the oil-rich
states—Kuwait, Algeria, Qatar, Oman, the Emirates, and even Saudi Arabia.
Already, the cutoff of Libyan exports has driven the price of prized light oils
to bigger premiums over West Texas and Brent.
Benchmark oil prices fluctuated during the early phases of the falling of the
desert dominos, but they remained restrained until the pain spilled into the
plains of Libya, and WTI leapt from $97 to $106.
We believe that investors should now be adding to their crude oil producer
exposures on at least a tactical basis, because the momentum for change
continues to build across the Maghreb and Middle East, and the world’s
comfort level with oil supplies will doubtless be subject to shocks as new
crises erupt.
Libya
No pundit expected a civil war in Libya. Indeed, a fortnight after the Egyptian
revolution began, the eminent American commentator Robert Samuelson
wrote a column in Newsweek that Americans were in denial about the
implications for global oil prices if the revolution spread. He listed five
oil-producing states that could possibly be at risk, but did not include Libya on
the list.
Muammar Gaddafi has ruled this tribal kingdom since 1969, and has, along
the way, made many friends abroad.
Why?
For decades, as other leaders came and went, he was a sustained voice and
terrorist instigator in support of what a large number of members of the UN
General Assembly have wanted to hear—that Israel is an illegal state, and is
the cause of nearly all Mideast misery, that the US is the next greatest evil in
the world, followed by all the former imperialist powers—Britain, France,
Germany and Italy. When he spoke before the General Assembly in 2009, he
demanded that “the imperialists” pay Africa $7.7 trillion for past colonial
crimes.

He was widely—and accurately—blamed for bloody anti-US terrorist
strikes—the Lockerbie Pan Am crash and the murder of American soldiers
in Germany. (For that latter assault, he was bombed at Reagan’s orders, and
narrowly escaped thank to French refusal to authorize use of its airspace to
American bombers, a non remembered in the Pentagon.) Libya was named
Chairman of the UN’s
For his rousing speeches and support of the enthusiasms and bigotries of the
Commission on Human
global Left, he and his nation have been routinely lionized by anti-Western
Rights in 2003...
nations. Libya was named Chairman of the UN’s Commission on Human
Rights in 2003, joined the Security Council in 2007, and Gaddafi was named
Chairman of the African Union in 2009.
After decades of scorn from the US and many of its allies, Gaddafi was
declared partially rehabilitated by Bush, because, after the defeat of Saddam,
he renounced his program of nuclear weapons development. Condoleezza
Rice cited the wisdom of his policy in 2005 in discussions with Iran. In 2008,
she became the first in her position to visit Libya since 1953. After meeting
with Gaddafi, she said, “We’re off to a very good start. It is only a start, but
I think, after many, many years, it’s a very good thing that the United States
and Libya are establishing a way forward.”
Why, then, have so many nations suddenly turned against this Third World
Titan?
And why is Libya under attack from a group of nations that claim their war
plans do not include capturing or killing him?
President Obama is emphatic that Gaddafi must go, but that is not the
stated objective of all those Tomahawk missile attacks and B-2 airstrikes.
The senders agree that the objectives are limited to protecting civilians from
attacks by Gaddafi. Hillary Clinton and the chairman of the US Joint Chiefs
of Staff both state that Gaddafi could well survive.
In his typically impressive speech to the nation on Monday, President

Obama explained how a limited allied response can save lives and eventually
convince Gaddafi he should go. He did not review the week-long wrangling
about who would have command and control of the program, simply noting
that a Canadian General [Lt. Gen. Charles Bouchard] is now in charge.
Nor did he explain the implications of a struggle in which American troops

and weaponry have been the crucial components of the response to date, but
can somehow fade into a support role without Gaddafi moving back into
attack mode against the ill-armed and ill-trained rebels. Nor did he address
March 2011 7
the possibility that, thanks to allied attacks on Gaddafi’s armor and possible
defections among his mercenaries and allies, the rebels could roar on to the
attack and begin killing his supporters. Does humanitarianism choose sides
permanently?
‘Make love, not time-
The operation got off under quasi-chaotic conditions when Sarkozy insisted
limited, scope-limited
that this was a partnership of individual states, and not a NATO exercise, a
military action!’
stance that would have pleased DeGaulle, in whose footsteps he has long
claimed to walk. But NATO has the command systems and logistics needed
to maintain a no-fly zone and embargo. Furthermore, NATO stalwart Turkey
insisted that NATO must not embark on a war to capture or kill Gaddafi or
even to protect rebels if they regroup and challenge Gaddafi’s entrenched
positions.
The President, who long ago eliminated the phrase “War on Terror” from
all discussions of the Administration’s geopolitical policies, naturally does
not call this a war. As Ross Douthat noted this week in The New York Times,
“In press briefings last week, our Libyan campaign was euphemized into a
‘kinetic military action’ and a ‘time-limited, scope-limited military action.’
(The online parodies were merciless: ‘Make love, not time-limited, scope-
limited military action!’ ‘Let slip the muzzled canine unit of kinetic military
action!’) ”
To us, and to a growing number of critics, this is not the way to win a war.
Why is its objective preventing Gaddafi from using armor against his people
because he is such a brute—yet to leave him on the throne, a bruised brute
facing no allied boots on the ground, and who would, unleashed, most
certainly be bloody mad? Will a wounded beast be more solicitous of the
welfare of his citizens who opposed him, and less of a threat to the rest of the
world? Will there be new Lockerbies, to be resolved with new compassion
for the murderers?
Never before have American troops been committed to a war that is not called
a war, with no real agreement among the partners as to its goals, and without
firsthand knowledge of the aims and capabilities of the rebels who created
the crisis. Already there are reports that Al Qaeda elements are prominent
in some of the rebel groups. As Thomas Friedman wisely notes, “There are
two kinds of states in the Middle East: real countries with long histories in
their territory and strong nation identities (Egypt, Tunisia, Morocco, Iran);
and those that might be called 'tribes with flags' or more artificial states with
boundaries drawn in sharp straight lines by pens of colonial powers that
have trapped inside their borders myriad tribes and sects who…have never

fully melded into a unified family of citizens. They are Libya, Iraq, Jordan,
Saudi Arabia, Syria, Bahrain, Yemen, Kuwait, Qatar, and the United Arab
Emirates.”
Pity the Pentagon. It resisted this mission. Now it is allocating its already-
Pity the Pentagon.
overstretched resources in a conflict but not war, without any reasonable
chance of accomplishing something decisive that would allow it to declare
victory...and with the already-discussed prospect that it would need to
commit boots on the ground to stabilize Libya were Gaddafi to go.
2. The Arabian Peninsula

The revolutions in Tunisia and Egypt are major human and historical events,
but are likely to have little investment impact.
On the other hand, because Libya is a significant producer of light crude, the
military activity (the war that dare not speak its name) and rebellion have
had a definite impact on oil prices and on perceptions of risk in the global
economy.
But if Saudi Arabia’s regime were threatened, the effect on global stock
prices could be near-existential for the global economy. The surprises and
shocks to date have taken WTI from $85 to $106, with immediate impact on
economic growth across much of the world—including the US, where most
of the recently-announced growth in consumer spending came from higher
gas prices.
A Seventies-style shock from oil remains, thankfully, a remote contingency,

but it is far less remote than it was three months ago—when nobody worried
about it.
What makes the Saudi situation tenuous at the moment are the rapidly-
escalating riots and tumults in neighboring Bahrain and Yemen.
(a) Bahrain
In Bahrain, the al-Khalifa’s family’s long—and historically benevolent—grasp
on power is at risk. From personal experience in travels there, the local Shia
population has long been subjected to significant propagandizing from rabble-
rousing Iranian imams. Although one should not, on the evidence, argue that
a majority of the Shias are in rebellious mood, there is no reason to doubt that
most Shias are resentful of the distribution of power and wealth in the island
kingdom between the ruling Sunnis and themselves (75% of the populace).
March 2011 9
This month, the ruler of Bahrain and the King of Saudi Arabia publicly
denounced the intervention of “a foreign power” in Bahrain. Saudi Arabia
sent some of its crack soldiers across the causeway from their country to
Bahrain.
World leaders’ worst
Most observers seem to believe that the two kingdoms are well able to handle
nightmare must be Shia
the Shia unrest and the daily flow of Iranian propaganda.
Shock in Saudi Arabia.
We agree. Iran will doubtless continue to foment unrest in Bahrain, but it
will not be able to bring down a Saudi-backed regime.
What would change the world’s perception of the risks to Saudi oil production
would be a new, jihadist radicalization of resident Shias just across the
causeway connecting Bahrain with Saudi Arabia.
To date, most of the jihadists who have sacrificed themselves in Afghanistan,

Pakistan, America and Israel—and in other parts of the world—have been
Sunni.
Al Qaeda is Sunni, and, indeed some of Al Qaeda-driven jihadism has been

aimed at Shias. The religious war between Sunnis and Shias has been more
or less continuous for 18 centuries.
Jihadists are able to carry out mayhem precisely because they are not
uniformed soldiers fighting on battlefields, (although most terrorists
captured by Americans demand the privileges accorded to combat soldiers).
Jihadists go into crowded markets, mosques, restaurants, girls’ schools, and
other civilian milieus, and try to take as many people as possible with them
into the next world or, if in doubt about the alleged rewards of Paradise, they
merely leave bombs behind as they depart.
In close proximity to Bahrain is a large part of Saudi oil operations—in an

area heavily populated with Shias. Given the effectiveness of Saudi security
forces, we doubt that any open attacks on Saudi Arabia could be more than
a minor nuisance.
But a few jihadist employees of the oil installations could have significant
impact on the reliability of Saudi oil output.
World leaders’ worst nightmare must be Shia Shock in Saudi Arabia.
(b) Yemen
The reign of Ali Abdullah Saleh of Yemen is beset by the most fearsome
rebellion in its thirty-year history.

Yemen has long harbored—unwillingly—Arab terrorists, including Anwar
al-Awlaki, the ex-American whose website whipped up the jihadist fervor of
such headline-makers as Major Hassan at Fort Hood, the would-be bomber
of Times Square, and the would-be Christmas bomber of Detroit. (That Army
intelligence knew that Hassan was routinely visiting the Yemeni website and ...the Arab revolutions
was giving passionate speeches against American involvement in the Mideast, have only begun and
yet never warned the authorities at Fort Hood, suggests political correctness the potential for the
was at work in the Pentagon.) kind of shocks, setbacks
and disappointments
The riots and fighting in Yemen have been widely scattered. However, now
that could translate into
that top officials in the government and army have defected to the rebels, the
impact on the global
Saleh regime is probably doomed.
economy has only begun.
No one has more than a vague idea what kind of regime will follow. Yemen
lacks, as Friedman notes, the national bonds of which a consensus can be
forged.
Should we rejoice in another triumph of the human spirit, or should we

prepare for new waves of well-financed and well-coached jihadists across the
West?
As in Libya and Egypt, the ultimate victors in some of these seeming

efflorescences of political freedom could be rigid Islamists with a tendency
toward terrorism—and suppression of women, Christians, and other
presumed perils for public purity.
Liberals (Girondistes and their allies) began the French Revolution. The
extremists (Jacobins) guillotined or expelled them and took over.
Liberals began the Russian Revolution. The extremists (Bolsheviks)

slaughtered them and took over.
Liberals began the Cuban Revolution against Battista. The extremists

(Communists) killed or imprisoned them and took over.
Liberals began the rebellion against the Shah of Iran, cheered on by, among
others, Jimmy Carter. The extremists killed or imprisoned them and took
over; thereafter, they have had the time to torture their opponents before
hanging them—by the thousands.
Investors should assume that the Arab revolutions have only begun and the
potential for the kind of shocks, setbacks and disappointments that could
translate into impact on the global economy has only begun.
March 2011 11
II. Japan: Was This the Tsunami That Ended Japan’s Triple Waterfall Crash?
The earthquakes and tsunami that hit Japan have caused the worst destruction
since Nagasaki, killed many thousands, and created the worst nuclear power
“We have no reason for crisis since Chernobyl. The aftershocks continue, with five quakes of Force 6
optimism.” or more within the past week. On Tuesday, Japan’s Premier summed up the
situation at Fukushima: “We have no reason for optimism.”
Faced with these continuing catastrophes, the Japanese daily display the
stoicism, self-sacrifice and unity that made the nation such a formidable foe
in war, and, later, a formidable global competitor.
The combination of a Force 9 earthquake and a gigantic tsunami has inflicted

such widespread damage that investors can only guess at the costs. The
latest published estimate of the reconstruction costs is at least $300 billion,
dwarfing the financial impact of any previously-recorded natural disaster.
The six nuclear plants that Tokyo Electric Power built so close to the ocean
whose failure has transfixed the world, are undergoing the long process of
being decommissioned and sanitized. There have been many setbacks, and,
as this is written, there are new radiation leaks and a new crisis at a reactor
that had been thought tamed.
And yet...
And yet, most likely, this disaster will ultimately live on mostly as the horror
story that killed plans for atomic power plant construction in much of the
world.
However, the impact on the Japanese and global economy is severe. Reports
suggest that nearly 11% of all Japanese generating capacity is out of service.
According to The New York Times, the Greater Tokyo region that Tokyo Electric
Power serves represents one-third of the nation’s economic output. It quotes
an estimate that Japan’s 2nd Quarter GDP will contract by 3 %—half of
which comes from the electricity shortage…and that shortage won’t end
soon. When summer air conditioning demand starts to build, blackouts
will intensify. Astonishingly, an old rivalry between Tokyo and Osaka means
that the two cities’ electric grids have differing frequencies, so Osaka’s excess
capacity can’t be used to fill the gap. Japanese industry uses less than one-third
of total Japanese demand. Manufacturers are getting together to pool their
demands, and one can be optimistic that the Japanese economy will muddle
through. The rage against Tokyo Electric’s design and operating blunders that
have made a terrible situation worse will live long in a nation with famously

long memories. (General Electric’s share of the blame for design flaws will
surely be considered in detail in the inevitable coming investigations. It was
cruel that GE’s beleaguered CEO who has been presiding over the decay of
the House that Jack Built has been nicknamed Jeff Immeltdown. It doesn’t
help his public image that the media are now publishing stories that GE pays It was, in retrospect,
no US corporate taxes. The goodwill he built up with liberals for operating a combination of
the left of center MSNBC in a losing war with Fox News is evaporating.) the two manias that
would devastate the
Investors seeking some potential opportunities amid all these calamities
American economy...
might choose to look at these events in a different context: the tsunami came
almost exactly 21 years after the Japanese stock market entered its Triple
Waterfall Crash.
At the stock market peak, Japan seemed to many observers as a clear threat
to the US rank as the world’s leading economy. But the 40-plus multiple on
earnings in an economy that had become the world leader in demographic
collapse was a mania that was destined to attenuate slowly and inexorably in
a seemingly endless bear market for equities and real estate. (Real estate and
stock values were interlinked: We recall asking clients in Tokyo in 1987 how
banks with tiny reported cash earnings were among the most highly-valued
in the world; the response was, that it was because of the value of their real
estate, which always rose in price.)
It was, in retrospect, a combination of the two manias that would devastate

the American economy from 1997 to now, as Nasdaq’s implosion was
swiftly followed by the real estate collapse that continues. (Last week, it was
announced that most US home prices were back to 2002 levels, with no sign
of bottoming.)
As readers of our book (The New Reality of Wall Street; 2005, McGraw-Hill)
know, we see Triple Waterfalls as epic nine-year bull markets that feed on
themselves and keep rising to heights that would have seemed unimaginable
even in their mid-years. They are followed by a 21 year decline before they
reach a new buying opportunity. By that time, virtually all the optimism and
shared beliefs of the inevitability of future profits have been hammered into
the turf.
The commodity bull market began in 1971, and peaked in 1980, reaching
the depths of its Slough of Despond around the time of 9/11.
March 2011 13
Nikkei 225 Index Gold

January 1, 2010 to January 28, 2011 January 1, 1981 to March 30, 2011
45,000 1,600
40,000 1,400 1424.50
35,000
1,200
30,000
1,000
25,000
800
20,000
600
15,000
400
10,000 9708.79
5,000 200
0 0
Jan-81 Jan-85 Jan-89 Jan-93 Jan-97 Jan-01 Jan-05 Jan-09 Jan-81 Jan-85 Jan-89 Jan-93 Jan-97 Jan-01 Jan-05 Jan-09
Crude Oil Copper

March 31, 1983 to March 30, 2011 Jan. 31, 1986 to March 30, 2011
160 500
450
140
427.15
400
120
350
104.22
100
300
80 250
60 200
150
40
100
20
50
0 0
Mar-83 Mar-87 Mar-91 Mar-95 Mar-99 Mar-03 Mar-07 Mar-11 Jan-86 Jan-90 Jan-94 Jan-98 Jan-02 Jan-06 Jan-10
... its sustained Tokyo’s P/E is roughly 8, an 80% drop from its high. Last year, Japan lost its
[in]fertility rate (1.3 multi-decade rank as the world’s second-largest economy.
babies per female),
Why should this be the bottom? Japan’s demography is vastly worse than it
combined with Japanese
was in 1989, and the compounding effect over the generations of its sustained
longevity generates a
[in]fertility rate (1.3 babies per female), combined with Japanese longevity
sustained rise in what
generates a sustained rise in what could be called its senility rate. (The rest
could be called its
of the western world is closing the gap: Japan’s median age is 44.8 years,
senility rate.
Canada’s 41, and the USA’s 36.9. The figures for the emerging economies:
India’s 26.2, China’s 35.5 and Brazil’s 29.3.)

Japan’s governments have experienced, for most of the time during the bear
market, the kind of rapid turnover that made Italy a European embarrassment
during the decades before Silvio Berlusconi entered politics. The one
interruption in this pattern of political futility was the Koizumi era: 2001-
2006. At the time, we wondered whether this uncharacteristically charismatic The list of names of
leader would arrest the nation’s decline. But, like a meteor, he blazed and then Japanese premiers
flamed out, and the darkness—and the stock market decline—resumed. since the stock market
peak is on the scale of
The current regime is as uninspiring as its predecessors, and will soon
the dramatis personae
disappear, to be replaced by a cast of characters that will seem almost
of a production of
undistinguishable from their predecessors. The list of names of Japanese
The Mikado.
premiers since the stock market peak is on the scale of the dramatis personae
of a production of The Mikado. If there is to be a Japanese recovery that slays
the 21-year-old bear market, it won’t be driven by the birth of a brand-new
political dynamism.
However, Japan is a nation of educated, energetic people who built their

economy on the basis of their competitive excellence. The nation is
commodity-poor, relying on imports of food (other than rice), fuels, iron ore,
and base metals, which means it is the most at risk among major economies
from the commodities boom. Japan’s entry into World War II was, in large
part, driven by its leaders’ fear that the US Navy would choke off its imports
of natural resources, particularly oil.
So why should the bear die of old age?
Japan’s managerial and technological excellence, plus its reputation for the
high quality of its automotive, engineering and electronics products meant
that Japanese companies became ferocious competitors in global markets
for consumer and capital goods, and much of that global performance
survived the financial and demographic decline—and the rise of muscular
competition from China and the Asian Tigers. With the rise of Taiwan, Korea
and China, leading companies adapted into the ad hocracy of Asian supply
chains. The importance of these “hidden” Japanese exports is being felt today,
as factories around the world slow down or shut down because of the cutoff
of key Japanese intermediate goods.
March 2011 15
One obvious effect of the earthquake and tsunami is that the Bank of Japan
is injecting almost unimaginable levels of liquidity into the economy—to
keep the financial system intact and to offset the counterintuitive strength of
the yen:
...in 2006, 126,800
Japanese patents Yen (vs. US dollar)
were issued, whereas January 3, 2011 to March 30, 2011
US residents received 84
roughly the same
number as South 83 82.84
Koreans—around
90,000. 82
81
80
79
78
Jan. 03 Jan. 17 Jan. 31 Feb. 14 Feb. 28 Mar. 14 Mar. 28
An economist noted last week that a side effect of the yen’s surge is that
the nation’s measured GDP increases in value. Since China’s GDP growth
is slowing and Japan’s economic growth is bound to speed up during
reconstruction, he postulated that Japan might move back—albeit briefly—
into the #2 slot in global GDP rankings. A statistical quirk, to be sure, but it
reminds us that Japan is still a big player globally.
At its peak, the multiple on the Nikkei was more than twice the multiple on
the S&P. Today, it is merely half the S&P’s. That comparative multiple makes
sense only if one assumes that (1) Japan can’t regain any of its past eminence,
and (2) the US has escaped from its financially-driven recession.
Although the problems besetting the Japanese economy are truly awesome, it
can be argued that, in comparison with the US, Japan has some advantages:
• its population is, on average, far better-educated. Example of effectiveness

of education: in 2006, 126,800 Japanese patents were issued, whereas US
residents received roughly the same number as South Koreans—around
90,000.

• after 21 years, its real estate bust is no longer a major challenge, either to
the economy or the banking system, whereas the real estate bust in the
US seems to be in its middle phase, which means the US banking system’s
pains and problems are likely to worsen substantially. Moreover, Japan
never got involved with mendacious collateralized mortgage products to Washington’s debt
inflate house values, while the balance sheets of major US banks still reek strategy recalls
from those gigantic collections of rotting CDOs that can’t find buyers: the Blanche DuBois’
supply of suckers to succor the big, bad bonused banks has run out. (As motto in A Streetcar
this is written, demonstrators are picketing Bank of America across the Named Desire: “I have
land demanding a halt to foreclosures. We share their disgust with the always depended
complex—and dangerous—mortgage products inflicted on uneducated on the kindness of
borrowers, and the near-fraudulent roboloan foreclosure applications, but strangers.”
wouldn’t be prepared to bet on a satisfactory outcome: Bank of America
made the disastrous decision to buy Angelo Mozilo’s Countrywide, which
means large portions of its vast home loan portfolio are at least as toxic
as the drinking water near Fukushima.)
• Japan has an aging problem which the US (and Europe) will face in coming
decades, but its pension system is in vastly better shape, personal savings
are dramatically higher, and its public employee plans are in little danger
of becoming a painful burden for future taxpayers.
• the Japanese suffer the problems arising from a strong currency, whereas
the US could very likely face the problems arising from a weak currency,
as its economy struggles and its overall debt/GDP ratio deteriorates. One
offset to the problems of the strong yen: it somewhat offsets commodity
price rises.
• Japan’s national debt/GDP ratio is roughly twice America’s, but that

debt—thanks to Japanese thrift—is nearly all held locally, whereas the
US—thanks to its conspicuous lack of thrift—is dependent on large-
scale borrowings from foreign governments. Washington’s debt strategy
recalls Blanche DuBois’ motto in A Streetcar Named Desire: “I have always
depended on the kindness of strangers.”
• In sum, when one compares the two nations on the basis of personal,
business, financial and governmental debts, Japan’s situation looks almost
bearable, but America’s doesn’t.
So what is likely to happen to the Japanese economy after the funerals are
finished, the nukes are finally sterilized and the national reconstruction
program gets under way?
March 2011 17
“Thrift, Horatio, thrift: the funeral bakemeats furnished forth the wedding
supper.”
That somewhat macabre appraisal sums up our view on what will happen
next to Japan. Its companies will recover and reprocess huge quantities of
Those pictures of the
scrap metals and building materials from the rubble.
Japanese people under
horrendous pressures Hard work, national unity, stoicism, cooperation and quiet heroism will be
may be the best image the bases of the post-funereal Japanese recovery.
of Japan ever broadcast
Which leads to a strong argument for investing in Japan now: the image of
across the world on a
Japanese heroism and cooperation that is being shown daily on the television
sustained basis.
screens of the world. Those pictures of the Japanese people under horrendous
pressures may be the best image of Japan ever broadcast across the world on
a sustained basis. Example: a US cartoon showed a man watching TV news.
He says, “It will never happen again.” His wife leans in and says, “Another
nuclear disaster?” “Another nuclear disaster with no looting” is his reply.
We have heard many Americans making similar comments. What we expect

next is beneficial impact on the sales of Japanese consumer goods, along
the lines of, “Gee, those Japanese are amazing! I used to think the Japanese
were pains in the neck. Now, I see how they work together under terrible
conditions—and wasn’t it Washington that told me Chevys were safer than
Toyotas? For years, Consumer Reports kept giving Japanese cars great ratings,
but I kept Buying American. Maybe it’s time to buy a Japanese car.”
Conclusion: when you can buy many of the world’s greatest companies at a
huge discount to the price of American companies, a value investor should
get very interested. A twenty-one year losing streak may be about to come to
an end. After all, when the 21-year commodity collapse ended, the ensuing
commodity bull market was tremendous. Yes, the comparison is a bit
stretched, to be sure, but Japan is coming back—at least this year when that
$300 billion is spent on reconstruction—and it’s selling at prices that assume
the Triple Waterfall Crash will go on forever.
Why is 21 years so important in the Triple Waterfall concept? It takes, we

believe, two decades to purge the economy of the excesses of major manias,
and a new generation of leaders must emerge, sworn not to make the mistakes
of their elders.
We do not argue that the end of the Triple Waterfall means that the Nikkei
will soon be on its way back to 40,000. The population of workers, savers
and consumers of the Japan of 1989 has shrunk and that contraction will

continue. One actuarial forecast predicts that, based on recent trends, the last
Japanese will be dead by 2150.
All we suggest is that, with the Japanese stock market down 80% and, with
the earnings multiple of the companies that survived a record-long rout for
We find that we have
equities being at record lows compared to other advanced markets, Japanese
lost all faith
stocks have a good chance of entering a period of sustained outperformance
That there could be a
during the coming decade.
boom.
The earthquakes and tsunami that have come after 21 years of an equity
bear market have surely added to the pessimism afflicting Japanese equity
investors about the outlook for their own companies:
As each day we grow older,

And totter toward the tomb,
We find that we have lost all faith
That there could be a boom.
March 2011 19
INVESTMENT ENVIRONMENT
The Pension Funding Problem
The US Pension Benefit Guaranty Corporation, which insures private pension
Many plans still use plans, and the treasurers of most states in the union, have a similar problem:
those duodecade after a decade of zero returns on US equities, most pension plans are having
returns in discounting funding problems, and many will go bust.
their plans’ future Companies and state treasurers defend their plans by pointing out that no
liabilities, as if the one could have predicted such ghastly returns—the previous two decades,
first decade of this returns had been near 8% most of the time. Many plans still use those
millennium had never duodecade returns in discounting their plans’ future liabilities, as if the first
happened. decade of this millennium had never happened.
Some critics say that the plans should use Treasury yields to discount their
liabilities. That is out of the question: such pension puritanism would, in
most states, impose heavy, sustained burdens on local taxpayers, and would
be politically impossible.
Is the Lost Decade a fluke, or a harbinger of a coming Recession?
We think that the equity disasters of the past decade came from the failures
of the US business and economic models after the Reagan boom. From
roughly 1992, the plunge in fertility rates had an increasing impact on the
population profile, as the US began to emulate the demography of Japan of
an earlier era. Secondly, by then, the impact of the long-term relative decline
in the performance of the nation’s schools was beginning to impact the
nation’s competitive performance—a problem accentuated by the growth of
freer trade globally.
America’s glory years were, in considerable measure, due to the world-

beating performance of its primary and secondary schools, which delivered
a well-trained population into the nation’s post-secondary system—and a
well-educated workforce.
Since 1975, American taxpayers’ costs for schools have skyrocketed, while the
relative performance of their students in mathematics and science has steadily
declined. The New York Times’ Thomas Friedman and US Education Secretary
Arne Duncan routinely discuss the reality that, in an increasingly competitive
world, the economies of countries that educate their children better naturally
outperform those whose educational systems don’t deliver. (Friedman notes
that US schools couldn’t even think of performing at Singaporean levels,
although 40 years ago Singapore was poor and its education system was
nowhere near America’s.)

To offset those two crucial components of American decay, the nation fell
back on (and fell with) two sadly misconceived boom strategies. First was
the tech boom that would supposedly make the economy grow forever and
deliver sustained double digit returns for investors—including pension
funds. Then came Tech’s Triple Waterfall Crash, beginning in March 2000. With such force-feeding
of home hormones, the
We have long referred to the dot.com years between 1997 and 2001 as “The
housing market became
Years of Unmitigated Idiocy.”
bloated with financial
To our dismay and disbelief, a second—greater—idiocy was to follow. elephantiasis...
In the Bush era, the new engine of growth became home ownership.
Misunderstanding the nature of Margaret Thatcher’s brilliantly successful
program to transfer ownership of council houses to their working class
tenants with modest government assistance, Bush went along enthusiastically
with Congressional Democrats like Barney Frank and their buddies Franklin
Raines and Jamie Gorelick at Fannie Mae, to pump up a real estate boom
that was bound to fail because the number of new qualified home buyers
was, in percentage terms, well below that of earlier eras before the baby
boom turned to bust. To make up for the inadequate number of first-time
homebuyers with good jobs and educations, Wall Street and Washington
got together to create and finance millions of buyers who wouldn’t have
qualified at any other time in the nation’s history. With such force-feeding
of home hormones, the housing market became bloated with financial
elephantiasis, rising to records both in absolute terms and in proportion
to personal incomes. Result: an even worse crash and a devastating blow to
pension funds’ investment returns. (As of last week, US house prices fell to
a nine-year low, and the supply of homes for sale and foreclosures climbed
anew.)
Even after those two disastrous crashes, and amid evidence that the US economy
was losing ground globally, most pension fund consultants kept advising
public fund clients that their plans should continue to project future earnings
at or close to 8%—enough to keep the plans’ funding close to adequacy. Most
pension plans have been operated according to the Lake Wobegon formula:
all of them will earn above-average returns in coming decades, so current
underfunded levels would never be problematic. As David Brooks notes in
The New York Times, this smug complacency permeates much of American
society: most Americans, for example, rate their own public schools as above-
average (while giving poor marks to public education generally), and 94%
of American college professors rate themselves as above-average lecturers.
(No wonder higher education costs rise remorsefully in good times and bad:
March 2011 21
there are only geniuses on staff, and they must get annual pay boosts above
the inflation rate—or they will defect to other universities!
Now that Congress has finally insisted on strict financial reporting for states
or municipalities issuing new bonds, the ratings services and investors will
Back in 1974, food
no longer have to rely on guesstimates. We expect a succession of horror
and fuel inflation set
stories and finger-pointing—and some disasters in the “muni” market.
off serious inflation, a
recession and a deep The “muni” market, which sailed through the Crash, has been in tough
bear market that took weather recently. Now that the media is reporting on the financial problems
the Dow briefly to a 6 at the state and local levels, individual investors are exiting from tax-exempt
multiple. bond funds. When this kind of herd fear takes over, even the best-managed
munifunds get hit with withdrawals.
Seventies Redux?
Last week, the US Producer Price Index reported the biggest jump in food
prices since 1974, along with climbing fuel prices.
Core inflation remained subdued.
Nothing for anyone to worry about, right?
Except those with long memories.
Back in 1974, food and fuel inflation set off serious inflation, a recession and
a deep bear market that took the Dow briefly to a 6 multiple.
The difference between then and now is that those commodity costs were
passed through into the broad economy through automatic inflation wage
boosts above those negotiated by the then-powerful unions, through Cost of
Living Allowances (COLAs).
This time the COLAs apply to government benefits, such as Social Security, and
to some government union contracts, but not, in general, to compensation
packages across the economy. Since wage increases above productivity gains
constitute, (economists have long claimed), the major force in cost of living
increases, the $6.4 trillion question is, “Will food and fuel inflation be passed
through to wages?”
We doubt that, and are therefore inclined to believe that inflation isn’t headed
for double-digit levels.
What about monetary inflation? Is Milton Friedman’s monetarism as dead

as its author?

The two Ayn Randian Pauls in Congress (Ron and his son, Rand) don’t
think so, and they now have committee platforms to excoriate the Federal
Reserve—which they think should not exist. So they blame Ben Bernanke
and friends for $100 oil and $7 corn—let alone for $1400 gold.
But we Friedman
They have a point: There is absolutely no doubt that excessive monetary
followers may have
stimulus was a key ingredient in the runaway inflation of the Seventies.
the last word. As he
This time, the monetary expansions are vastly greater—and so are the fiscal also said, “Money
deficits, which have the effect of putting money into people’s pockets that matters most.”
tends to be spent fast.
In addition, the second-largest currency zone in the OECD is the Eurozone.

We have yet to see how the world’s first currency to be issued not by a
government, but by a theory, will respond to today’s inflationary and
geopolitical stresses.
So why shouldn’t inflation be at Seventies levels—or worse?
1. Absence of COLAs.
2. Greater productivity gains: last year US productivity climbed 3.9% and

labor costs actually fell.
3. The success of WTO and other trade-expanding arrangements have reduced

global inflationary pressures. In the OECD nations, the sustained growth in
imports from lower-wage and more-productive economies has constrained
CPI growth.
4. Much weaker demography.
5. Today’s and yesterday’s deficits are yesterday’s stimulus stories and

tomorrow’s deflationary pressures as consumers and governments struggle
to meet the costs of past and present profligacy. In the words of Lady
Macbeth: “Nought’s had; all’s spent.”
Conclusion
The central bankers have enjoyed near-total freedom to print money at scary
rates—because of the scary recession and the five factors listed above.
But we Friedman followers may have the last word. As he also said, “Money
matters most.”
March 2011 23
The quantities of financial heroin injected since mid-2008 have set the stage
for renewed stagflation.
And the big central banks are still reloading their hypodermics and rushing
to prevent their patients from dropping over.
If something happened
to change the weather Add in food and fuel inflation—and rising prices for commodities
of the past 50 years... generally—and the likelihood of some wars somewhere, and you can count
then today’s global food on a CPI that reaches painful levels. It is unlikely to rise to a point within
crisis would look like a view of the Seventies horror show—14%—but it will be serious enough to
sustained picnic. crowd most other economic stories off Page One.
But there’s another story that has potential inflationary implications...
One you’ve heard from us before, but not for a while...
The Dark Side of the News About the Sun

As we have written many times in the past, the period of global warming
has been strongly beneficial for production of most global crops. Why?
Because longer growing seasons almost always increase per-hectare yields,
and absence of frosts in the growing season means there are fewer shocks to
food supplies.
That has been the case throughout human history. Modern seed technologies
can reduce the negative effects from excess cooling, but total grain production
of the world has benefited hugely from the recent decades of long growing
seasons.
If something happened to change the weather of the past 50 years and take it
back toward the growing conditions that prevailed for most of the years since
1300, then today’s global food crisis would look like a sustained picnic. As
clients know, we treated the sudden shrinkage of sunspot activity that began
in 2006 as the possible return to solar activity levels of much earlier times.
And, as we reported, those centuries were characterized by much colder
weather, killing frosts, and, in general, unreliable crop production.
We have not been writing about sunspots recently, because the spots did
return after a long absence, but their level of activity was so modest that we
weren’t sure whether that meant that we could expect further global cooling
or we’d be scooped by months of high-voltage solar activity.
Then, as the months went by and the sunspot score remained at pitiful levels,
we wondered how the scientific establishment would respond.

An international team of experts led by NOAA and NASA was convened in
2005 to predict sunspot activity going forward. The previous century had
been marked by the most vigorous sunspot activity on record, and scientists
expected yet another alltime peak in this cycle.
Based on centuries of data that meant the world was likely to get hotter,
because there has been a roughly 85% correlation between sunspot activity
and earth temperatures. Scientists are aware of the correlation, but they
decline to accept causality, because no expert has proved how sunspots affect
the climate. It may be coincidence, although they understand how they
can interfere with electronic communications. The time-honored Farmer's
Almanac, on the other hand, has included sunspots in the factors they use for
their weather predictions, because whether scientists understand it or not,
the correlation exists.
Sunspot cycles last roughly 11 years, peaking in mid-cycle. The previous cycle
peaked in 2000, ending in 2008-9 with the longest stretch of zero spots in a
century.
The astronomers have been reworking their forecasts for this cycle in response
to the unexpected plunge in sightings. The shocker came on March 1 when
NASA announced, “The predicted size would make this the smallest sunspot
cycle in nearly 200 years.”
Two centuries—roughly the timespan used by the global warmists, who lay all
the blame on the human race for the temperature rise during that period.
As clients know, we have been skeptics about those doctrinaire claims and
projections. Why? Because we know a few things about warmth and cooling
through history and they collectively suggest the sun itself has more to do
with rising heat on earth than we do.
A new group of historians emerged late in the last century—climate

archaeologists. We are currently reading The Little Ice Age, a splendid work of
history on Europe from 800-1900. The author, an archaeologist at Berkeley,
recounts the remarkable change in European temperatures after 800 A.D..
Temperatures rose smartly from the mid-ninth century and stayed elevated
until 1300.
European populations nearly trebled in three centuries as growing seasons

lengthened, and more land was taken under cultivation. So rapidly did
economies improve that, for the first time in the history of the Christian era,
there was substantial excess wealth generated routinely, along with rising
March 2011 25
populations and urbanization. Result: the cathedral boom of the 11th to

13th centuries; during that time, most of the great cathedrals were begun.
Those public works programs created jobs for young men who were in excess
supply on so many peasants’ crofts.
...unexpected global
After that blessed period of history, the weather changed sharply. Seemingly
cooling would destroy
endless rains during the growing seasons year-after-year destroyed or weakened
the amber waves of
crops. As the population became weakened by starvation and disease, its
grain, while turning
resistance to epidemics collapsed. The Black Death hit Europe four decades
agriculture stock
into the cold, wet era, but typhoid and other killers kept coming too.
portfolios golden.
One of the few pleasant aspects of those cold, low sunspot centuries: winter
skating parties on the Thames became the rage until the sunspots came back
in force, and, by coincidence or not, the world warmed up again in the 19th
Century.
We have included charts for those who are interested in this subject and have
more material on our website.
Our take: based on uncontradicted evidence over a millennium, this collapse

in present and projected sunspot readings suggests that we may have entered
a prolonged period of global cooling. We may not know whether it is a
serious threat to agriculture in northerly climates for a few years. We can
certainly predict that winters will be colder and wetter than the average of
the 1990s, and the threat of late and early frosts in northern growing areas
will intensify.
The investment thesis is that unexpectedly cold weather during the growing
season in any of the major crop-producing regions would unleash one of the
most dramatic bull markets in history for corn, soybeans, and wheat.
The outlook for the agricultural stocks is splendid anyway. But unexpected
global cooling would destroy the amber waves of grain, while turning
agriculture stock portfolios golden.

RECOMMENDED ASSET ALLOCATION
Recommended Asset Allocation
Capital Markets Investments
US Pension Funds
Allocations Change
US Equities 19 -2
Foreign Equities:
European Equities 3 unch
Japanese and Korean Equities 4 +4
Canadian and Australian Equities 6 -1
Emerging Markets 13 -1
Commodities and Commodity Equities* 13 unch
Bonds:
US Bonds 15 -2
Canadian Bonds 6 unch
International Bonds 3 -2
Inflation Hedged Bonds 12 +4
Cash 6 unch
Bond Durations
Years Change
US 4.00 -0.50
Canada 4.25 -0.50
International 3.80 -0.45
Inflation Hedged Bonds 5.5 unch
Global Exposure to Commodity Equities
Change
Agriculture 31% unch
Precious Metals 28% –1
Energy 24% +5
Base Metals & Steel 17% -4
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.
March 2011 27
RECOMMENDED ASSET ALLOCATION
Recommended Asset Allocation
Capital Markets Investments
Canadian Pension Funds
Allocations Change
Equities:
Canadian Equities 20 unch
US Equities 6 -2
European Equities 2 -1
Japanese, Korean & Australian Equities 7 +5
Emerging Markets 10 -2
Commodities and Commodity Equities* 13 unch
Bonds:
Canadian Bonds
- Market Index-Related 21 -1
- Real-Return Bonds 12 +4
International Bonds 3 -3
Cash 6 unch
Canadian investors should hedge their exposure to the US Dollar.
Bond Durations
Years Change
US (Hedged) 3.90 -0.85
Canada:
– Market Index-Related 4.00 -0.75
– Real-Return Bonds 5.50 -0.25
International 4.00 unch
Global Exposure to Commodity Equities
Change
Agriculture 31% unch
Precious Metals 28% –1
Energy 24% +5
Base Metals & Steel 17% -4
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.

INVESTMENT RECOMMENDATIONS
1. In global equity portfolios, cease underweighting Japan and move to above
market weight, emphasizing the great global brands.
2. The fall of the Harper-led Conservative government in Ottawa is a reason

for concern for global investors, if a minority Liberal government relying
on a coalition with the NDP or Bloc Quebecois were to take its place. The
best outcome for investors—and for Canadians—would be a majority
government.
3. The outbreak of revolutions across the south of the Mediterranean took

investors’ minds off the problems on the northern shores, and the euro
climbed from $1.30 to $1.42. However, the challenges facing the northern
tier of the sea are far from resolved. Portugal’s Socrates drank the political
hemlock, but his resignation may well make the situation worse. Greece’s
situation is deteriorating rapidly, and Spain’s cajas’ finances continue to
erode, weakening banks inside and outside Spain. Italy faces the return
of its historic poisonous political merry-go-round if Berlusconi’s record
run ends. He is, in essence, an arresting actor with the bella figura charm
that Italians love; yes, he is a laughing stock in many quarters, but he has
been able to sustain for a record time the theatrical illusion of making
Italy look governable. His successors will probably not provoke laughter.
But the convention of commedia dell’arte is that when the laughter stops,
the tears begin... and the euro will go back on the critical list. Underweight
European financial institutions and euro-denominated debt in global
portfolios. Emphasize exposure to Swiss francs and Canadian dollars.
4. Investors should prepare for the strong possibility that nearly all the good
news from the Arab revolutions has already come. No one foresaw these
dramatic developments. We suspect that, in the intoxicating atmosphere
of the collapse of autocracies, few investors are preparing themselves
for the strong possibility of a succession of disappointing—or outright
tragic—outcomes. Revolutions, as history teaches, devour their children.
Precious metals had been strong for a decade before the Maghreb awoke.
Remarkably, they have risen only modestly since then. When the risks
across a great swathe of the world turn from modest to serious, and the
potential for existential risk goes from near-zero to moderate, precious
metals’ basic values become more apparent. Overweight precious metals
in commodity stock portfolios, and include exposure in all balanced
portfolios.
March 2011 29
5. Agricultural stocks remain the commodities group with the best balance
of risk and reward among all the possible outcomes of the current crises
in the Mediterranean region and the Arabian peninsula. Even without
the possible effects of global cooling, food and fuel inflation already
besets most of the world. Perhaps the only strong argument against
overweighting companies oriented toward global food production is that
it is so obvious.
6. Triple-digit oil prices have returned, and pricing of oil production is

becoming near-chaotic, with widening spreads in prices between sweet
and sour crudes—and the day-to-day pricing of political risks. The US
has been remarkably insulated from the worst of the price increases, due
largely to its imports of Canadian oil sands products. The latte liberals and
their friends who have sought to block US imports of “dirty Canadian oil”
have suddenly become remarkably silent. Investors should overweight the
oil sands companies, and, for now, continue to emphasize oil and coal
in North American energy portfolios. We believe that industrial clients
should be hedging against the remote risk of catastrophe in the Mideast
through purchase of far out-of-the money calls on crude.
7. The US government’s Export-Import Bank is heavily invested in low-cost

lending to Brazilian companies developing the deepest offshore oilfields
in the Hemisphere. Obama exulted in this “cooperation” in his trip to
Brazil last week. At some point, he may have to explain why he remains
so obdurate against drilling deepwater off US shores, and yet is willing to
let American taxpayers guarantee loans to develop Brazilian oil at much
deeper depths than in the Gulf. With an election campaign now only a
year away, we believe he will, within months, proclaim a cease-fire and
issue licenses for big new projects. Overweight offshore companies that
do not face continued litigation risk from Macondo.
8. Cicero lamented, “The people’s memory is short” before he was garroted.

The nuclear power industry wishes he were right. Memories of Three Mile
Island and Chernobyl have been remarkably durable, but they were finally
fading when Fukushima imploded. Continue to avoid uranium stocks.
9. The global economic outlook which looked so promising in January

has darkened. Food and fuel inflation are combining to shrink or erase
consumers’ discretionary incomes. The eurozone’s internal fault lines are
re-opening; big banks in Europe and the US are once again paying bonuses
and dividends, but the question whether the mix of diseases gnawing at
the tissues in their portfolios is merely debilitating or is potentially fatal

is being questioned anew. Investors aren’t fooled: the BKX and KRE have
been sharply underperforming, although financial firms accounted for
nearly one-third of total US corporate profits in Q4. If the Arab revolution
story turns from triumph to tragedy, much of the investor optimism that
fueled strong equity markets outside Japan could fade fast.
11. Base metals stand to benefit near-term from the rebuilding of Japan, but
thereafter we expect scrap to compete with virgin metal as the recovery
continues. Weakening economic prospects from emerging economies beset
with food and fuel inflation and, at the margin, from the OECD, will trim
previously-expected strong demand for copper and steel. Underweight
base metal stocks.
12. Just because Stagflation of Seventies proportions is only a remote possibility

doesn’t mean that meaningful stagflation-style damage won’t be inflicted
on bond portfolios—particularly those denominated in currencies of
grossly overindebted countries. We think the risk of a real stagflationary
bond bear has now arrived, and have therefore reduced recommended
bond durations. Unless the stagflation risk recedes, we shall be reducing
those durations further in coming months. So should you.
March 2011 31
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Basic Points

Slouching Towards Stagflation?

March 31, 2011

Published by Coxe Advisors LLP

Distributed by BMO Capital Markets

BMO Capital Markets Disclosures

Slouching Towards Stagflation?

March 31, 2011

Author: Don Coxe 312-461-5365

A starving street vendor in Tunis set himself aflame, an immolation

An earthquake near Sendai spawned a tsunami, killing and

All these topics relate to an over-arching investment question: is the world

We are modifying our Recommended Asset Mixes and Recommended Sector

Things fall apart; the centre cannot hold;

When a vast image out of Spiritus Mundi

And what rough beast, its hour come round at last,

They were unexpected:

2. The blood-dimmed tide is loosed, and everywhere the ceremony of innocence is

Obviously, no one predicted a Force 9 earthquake and a horrendous tsunami

4 March 2011 THE COXE STRATEGY JOURNAL

When it swiftly became apparent that Justification #1 was based on bad

Bush characterized such criticisms as “the soft bigotry of low expectations.”

He was enjoying the semi-obscurity of Crawford when, seemingly out of

Perhaps coincidentally, last week, a Christian church in Cairo was torched

6 March 2011 THE COXE STRATEGY JOURNAL

In his typically impressive speech to the nation on Monday, President

Nor did he explain the implications of a struggle in which American troops

8 March 2011 THE COXE STRATEGY JOURNAL

2. The Arabian Peninsula

A Seventies-style shock from oil remains, thankfully, a remote contingency,

To date, most of the jihadists who have sacrificed themselves in Afghanistan,

Al Qaeda is Sunni, and, indeed some of Al Qaeda-driven jihadism has been

In close proximity to Bahrain is a large part of Saudi oil operations—in an

World leaders’ worst nightmare must be Shia Shock in Saudi Arabia.

10 March 2011 THE COXE STRATEGY JOURNAL

Should we rejoice in another triumph of the human spirit, or should we

As in Libya and Egypt, the ultimate victors in some of these seeming

Liberals began the Russian Revolution. The extremists (Bolsheviks)

Liberals began the Cuban Revolution against Battista. The extremists

The combination of a Force 9 earthquake and a gigantic tsunami has inflicted

12 March 2011 THE COXE STRATEGY JOURNAL

It was, in retrospect, a combination of the two manias that would devastate

Nikkei 225 Index Gold

40,000 1,400 1424.50

Crude Oil Copper

14 March 2011 THE COXE STRATEGY JOURNAL

However, Japan is a nation of educated, energetic people who built their

So why should the bear die of old age?

• its population is, on average, far better-educated. Example of effectiveness

16 March 2011 THE COXE STRATEGY JOURNAL

• Japan’s national debt/GDP ratio is roughly twice America’s, but that

We have heard many Americans making similar comments. What we expect

Why is 21 years so important in the Triple Waterfall concept? It takes, we

18 March 2011 THE COXE STRATEGY JOURNAL

As each day we grow older,

Is the Lost Decade a fluke, or a harbinger of a coming Recession?

America’s glory years were, in considerable measure, due to the world-

20 March 2011 THE COXE STRATEGY JOURNAL

Core inflation remained subdued.

Nothing for anyone to worry about, right?

Except those with long memories.

What about monetary inflation? Is Milton Friedman’s monetarism as dead

22 March 2011 THE COXE STRATEGY JOURNAL