Thunder Road Report 16 1st September 2009 | Speculation | Ben Bernanke

report

1st September 2009

This issue:
Defence is sometimes the best means of attack Fed’s reflation policy about to be tested Chinese government is telling 1.3bn people to buy gold and silver Do India and China have enough wheat (redux)? Post script - the man in the Clapham health food store

Defence is sometimes the best means of attack
It’s official, the great recession of 2008-09 is over. The IMF told us that on the 18 August 2009 and Ben Bernanke said three days later that the “prospects for a return to growth in the near-term appear good”. Nomura’s economic team wrote on the same day: “The Great Global Recession is drawing to an end. Its uniqueness and the policy responses informed by Japan’s mistakes make a relapse unlikely.” While the debate about the sustainability of the recovery rages, the majority are ignoring the power of the giant wrecking ball heading our way – a sort of financial version of the legendary Nibiru/Planet X made famous in the writings of Zecharia Sitchin.

In a poll of economists by the Wall Street Journal earlier this month, the majority were in favour of Bernanke being re-appointed for a second term – an implicit approval of his policies. Obama duly appointed Bernanke for a second term and was gushing in his praise: Contact/additions to distribution: “Ben approached a financial system on the verge of collapse with calm and wisdom, with bold action and out-of-the box thinking…”

Paul Mylchreest paul@thunderroadreport.com

I’ll give him “bold”, but “out-of-the-box thinking”, do me a favour. It’s nothing more than an extreme version of the easy money policies which have been pursued since the late-1980s. Bernanke should have quit while he was ahead. Most mainstream criticism of Bernanke goes as far as arguing that he doesn’t have a well enough defined exit strategy and there could be a bit of an inflation problem down the track. Surely the lesson dished out by financial markets during the last decade is that prolonged periods of cheap money lead to inevitable, and severe, crises. The US Fed Funds remains at 0-0.25%, with no prospect of change, and Bernanke gets off almost scot-free in the mainstream media. Even Oliver Stone warned of the dangers in the opening scene on the trading floor in the movie, Wall Street. Hal Halbrook played Lou Mannheim, a kind of “elder statesman” in the markets: “The country’s going to hell faster than when that son-of-a-b*tch Roosevelt was in charge. Too much cheap money sloshing around the world. The worst mistake we ever made was letting Nixon get off the Gold Standard.” The National Association of Inflation nailed it: “President Obama reappointed Ben Bernanke as Federal Reserve Chairman on Tuesday and it is unbelievable how everybody in Washington and the mainstream media is praising Bernanke for helping prevent the next Great Depression, as if the economic crisis is already over. It’s unfortunate how forgetful Washington is and how the media fails to talk about how Bernanke has simply taken Alan Greenspan’s mistakes and made them bigger. Nobody has the foresight to see the disaster that lies ahead because of Bernanke…While Greenspan’s destructive actions gave our economy a high that lasted for a good five years, today there are no more asset bubbles in the U.S. left to inflate (Treasuries are the current bubble, Paul). All of the inflation being created will soon drive up the prices of gold, silver, agriculture, oil, and other commodities. Unfortunately, our country does not produce enough of these commodities to benefit from the upcoming boom. Most of our wealth will be transferred abroad and the only people in America who will benefit are those with the cash to purchase these commodities and the stocks of the companies that produce them.” When it starts to go wrong, my prediction is that he’ll be out fast and replaced by Larry “Gibson’s Paradox and the Gold Standard” Summers. The reality is that the liabilities in the financial and housing sectors didn’t just magically disappear, they were just transferred from the private sector to the public sector – with expenditure, commitments and pledges in excess of US$11trn for the US alone. Mark Zandi of Moody’s Economy.com published a chart back in June which Eric Sprott of Sprott Asset Management resurrected in his latest newsletter “Beyond the Stimulus”. This shows how the US$787bn stimulus programme in the US should have its maximum impact in the current quarter.

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As Eric Sprott argues “That’s right – this is as good as it gets”. In a similar vein, the “Cash for Clunkers” scheme is now over having run from 27 July 2009 to 24 August 2009. This mini bubble in the car market led to the sale of an additional 690,114 vehicles and is likely to have taken the SAAR (seasonally adjusted annual rate) for US car sales to 15-16m in August. The problem is that car sales were running below 10.0m in during the first six months and are likely to drop back sharply in September. GS has estimated that the incremental sales together with the inventory replenishment could add 0.8% to US GDP growth during H209. We’re only a month away from the fourth quarter now when, unless there’s more traction than I can see to this recovery, the Fed’s reflation strategy is going to be severely tested. Sprott again: “It is our view that the world’s combined government stimuli have completely distorted the global economy in the short term and have encouraged a false sense of hope in the stock market.” And then he asks a poignant question: “So what happens next? Will the Keynesian miracle take hold? Will the recovery be strong enough to pay back the increased debt load which was needed to jolt the economy back to life?” I don’t think so. In the meantime, the consensus of opinion is that the recovery will be sustained through 2010. I think that there is a real risk that many commentators are merely extrapolating current conditions into the future. This is far from new, as SocGen’s strategist, Albert Edwards, showed in a recent chart: Too often economists forecast the status quo on growth

Source: SocGen

As an aside, I was sent another SocGen strategy piece back in June with a proposed reading list for the Summer. On it where classics like Reminiscences of a Stock Operator (Edwin Lefevre) and Security Analysis (Benjamin Graham & David Dodd), modern stuff like Fooled by Randomness (Nassim Taleb) and Contrarian Investment Strategies (David Dremen) and some interesting left-field selections on psychology like Stumbling upon Happiness (Daniel Gilbert) and Robot’s Rebellion (Keith Stanovich). Like blogs linking to blogs, sharing reading habits (intellectual capital?) seems to be popular. Adam C. sent me a link to a reading list proposed by Blue Ridge Capital and I’ve noticed that Mike (Mish) Shedlock has one on the front page of his blog. I can’t walk into somebody’s house without looking at what books they have on their bookshelves. I’m a compulsive book buyer - a “neurosis” according to my wife. This is what I’ve been reading over the Summer: B The Unified Cycle Theory – how cycles dominate the structure of the universe and influence life on earth (Stephen J. Puetz):

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B Confidence Games – money and markets in a world without redemption (Mark C. Taylor); B The Mayan Code – time acceleration and awakening the world mind (Barbara Hand Clow); B Fashion Brands – branding style from Armani to Zara (Mark Tungate); B Bloody Good Winner – my life as a professional gambler (Dave Nevison); B Time and the Technosphere – the law of time in human affairs (Jose Arguelles); B The Rise and Fall of Marks & Spencer (Judi Bevan); B 2012 – the biography of a time traveller, the journey of Jose Arguelles (Stephanie South); B Allen Iverson – fear no one (John N. Smallwood Jr.); B Gnosis II – study and commentaries on the esoteric tradition of Eastern orthodoxy (Boris Mouravieff); B Licence to print money – a journey through the gambling and bookmaking world (Jamie Reid). On reflection, the biggest lesson for investing was probably confined to a couple of pages in Dave Nevison’s “Bloody Good Winner”. Nevison was a former City trader who left the financial markets to be a full-time gambler operating on British racecourses. Paradoxically, he started making money when he stopped backing the horses he thought would win and started backing horses which, in his view, had a better probability of winning than was reflected in bookmakers’ odds. If I’d read this at the start of the year, I might (only might, unfortunately) have bought some rubbish banks back in the Spring, but no such luck. Anyway, back to the outlook. When San Diego-based portfolio manager, Jim Puplava, said recently that his source is telling him that the Obama Administration is already working on a second stimulus plan, it’s easy to believe. The question is will the markets and US creditors still be permitting the US government to pursue reckless financial policies that would be deemed insane by any other commercial enterprise down to the lowliest street vendor? The chart shows how the US dollar index is hovering around the 78 level: US dollar index (5-years)

Source: timingcharts.com

My brokerage account is in New York and just in case there’s a black swan event this month, like an unplanned bank holiday, in the US (as the likes of Harry S. Schultz, Bob Chapman and Jim Willie have warned as being a possibility), I sold the majority of my non-gold/silver and food stocks. This basically consisted of technology stocks and my holding in LVMH acquired about a month ago - I turned a modest profit on the latter after positive comments from Swatch pushed up share prices in the luxury sector.

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I repatriated most of the cash back to the UK, so I’ve got some funds here “just in case”. I know I’m being hyper-cautious, but as Gordon Gekko commented after agreeing to sell his shares in Anacott Steel to corporate raider, Sir Larry Wildman (Terence Stamp), in Wall Street: “He’s right, I had to sell. The key to the game is your capital reserve. If you don’t have it, you can’t p*ss in the tall weeds with the big dogs.” The message is just as powerful even if the weeds are shorter. I’m also moving my account out of the US to Luxembourg. My portfolio now is 90% gold, silver and food/agriculture, but I’m hoping that defence will be the best form of attack - especially if the market rally starts to lose momentum. Besides using the sale of the technology stocks and LVMH to ensure I’ve got some cash, I used part of the proceeds to buy Krugerands and also bought more exposure to Food/Agriculture via the DB Power Shares Agriculture ETF (sugar, soybeans, corn and wheat) which I mentioned in the last Thunder Road. The premium on Krugerands last Friday from ATS Bullion (near the Savoy Hotel) was about 6.5% compared with about 11% on small bars. I got the impression from ATS that all those adverts around in the UK at the moment encouraging people to sell their gold jewellery for cash are pushing up the price of getting scrap gold refined into bars. My sense is that those adverts are a reflection of the strong demand for gold and the operation of Gresham’s Law, i.e. bad money (paper) drives good money (gold and silver) out of circulation with the latter being hoarded. As an aside, if you buy gold from ATS, the company will send it in a plain package through the post (while insuring it obviously). A London portfolio manager, who also uses ATS, answered the door to the postman one morning who joked as he laboured to pass over a heavy package: “What have you got in here then? Gold?” The Obama administration has “fessed” up on the horrific prospects for the Federal Government’s deficits during the next ten years, raising the estimate from US$7.14trn to US$9.05trn. Eric Sprott, mentioned above, also wrote a good piece, “The Solution…is the Problem” (here) explaining the essentially mathematic impossibility that the US can fund its deficits going forward. The current quantitative easing policy has been extended to the end of October 2009 and Bernanke and Geithner have stated that there will be no more monetisation (i.e. buying debt with money created out of “thin air”). While this seems unrealistic, China has made it clear that it would disapprove of additional monetisation. We could face a crunch point in a couple of month’s time. The argument put forward by many who assume the status quo for the dollar going forward is that it’s in China’s interest to keep on funding US deficits. In contrast, the historical precedent is the collapse of the London Gold Pool in 1968 when major US creditors converted their dollars into gold which led to the dollar’s devaluation. The latest Treasury International Capital (TIC) data of cross border financial flows for June 2009 shows that China reduced its holdings of US Treasuries in June by US$25.1bn to US$776.4bn. In the first six months of 2009, China increased its US Treasury holdings by US$49.0bn compared with US$192.3bn in the last six months of 2008. For the time being, these facts are being largely ignored. Overall, the TIC data shows a worrying trend of foreigners (central banks and private institutions) moving capital out of US paper assets to the tune of US$345bn leaving the country in the first six months of 2009: Treasury Interntional Capital flows for the US US$bn Private Official Total
Source: US Treasury

Jan -152.2 8.2 -144.0

Fed -98.6 7.7 -90.9

Mar 13.7 13.4 27.1

Apr -45.2 5.2 -39.9

May -81.3 15.6 -65.7

Jun -27.7 -3.5 -31.2

Ytd -391.3 46.6 -344.7

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There is a good chart from the St Louis Federal Reserve which captures the reversal in the long-term trend With the Federal deficit exploding, this is extremely worrying and either the trend or the value of the US dollar is unsustainable. US net capital inflow

Source: St Louis Fed

The world’s largest bond fund, PIMCO, and the world’s wealthiest investor, Warren Buffet, have both come out with bearish calls on the dollar. PIMCO argued that the dollar will lose its status as the world’s reserve currency. Buffet, writing in the New York Times, praised Bernanke and Obama for their handling of the crisis while warning, at the same time, that the side-effect of the deficits will eventually be reduced purchasing power of the dollar. While they are merely stating the obvious, the point is that both Buffet and PIMCO are “connected”, which makes these public comments all the more curious. Buffet is far from the savvy “hick” from Omaha which he is often portrayed. Buffet’s father was a Congressman, but his big leap into the power control hierarchy came in the 1970s when he became the close companion of Katherine Graham, proprietor of the Washington Post (and confidant of Kissinger, which is just one step away from David Rockefeller). As an aside, Bob Woodward of Watergate fame wasn’t just a reporter on the Washington Post who got lucky, having formerly worked for the Office of Naval Intelligence. Buffet said of Katherine Graham in Alice Schroeder’s biography of him: “She didn’t change my behaviour as change what I knew and saw. Everywhere she went, she was treated just like royalty. I saw a whole lot of interesting things that I wouldn’t have seen in the world. I had a lot of things explained to me. I picked up a lot around her. Kay knew so damned much about everybody that she would give me insights on people in the political arena.” PIMCO is a monitor of the New York Fed’s TALF (Term Asset-Backed Loan Facility) programme, is one of four asset managers implementing the NY Fed’s US$1.25trn MBS purchase programme and is the asset manager of the NY Fed’s Commerical Paper Funding Facility. Black is white and white is black – have you ever checked out the address of the NY Fed, both number and street? How they must have laughed. Gary Gensler, formerly of Goldman Sachs, (of course) and now Chairman of the Commodity Futures Trading Commission, is proposing to limit speculation in commodities. This looks to me like a pre-emptive strike against the prospect of rising commodity prices - which would be the very visible corollary of reduced US dollar purchasing power and inflation. Gensler was interviewed on CNBC’s Closing Bell on 25 August 2009. Intriguingly, the “Money Honey” introduced the slot as: “Low prices and low volatility, this is the Commodity Futures Trading Commission’s goal as it moves to curb excessive speculation in energy and commodities markets.”

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Nothing like telling it like it really is, Maria. Samuel Johnson said that “Patriotism is the last refuge of a scoundrel” and there was Gensler peppering his short interview with concern for the average American, rather than his real desire to support the dollar and the patriarchy: “We do think that the regulatory system of America failed the American public…What I think we need to do first, and most importantly, is to make sure the American public benefits by more consistent regulation where it’s appropriate…The American financial system and the financial regulatory system failed the American public so now the test is are we really going to cover the gaps that were so obvious in this last crisis?” He “doth protest too much” - he’s clearly inexperienced in the art of disinformation in my opinion. But let’s get to the crux of what he proposed during the rest of the interview which is to limit “concentrated or large market positions”. Maria asked him point blank “Do you think there is market manipulation?” which was amusing because the biggest manipulators in the commodity pits are his bosses in the US government. Dodging the direct question, he replied: “We as an agency protect against fraud and manipulation, but also Congress has asked us to protect against the burden that might come from outsize or excessive speculation, so we’re really just making sure that not one party so concentrates in a market that they put a burden on those markets.” The problem Gensler faces is bringing in position limits without addressing the existing massive short positions in silver and gold on COMEX which have been used to suppress their prices. The very latest Bank Participation Report from the CFTC shows that two US banks have a short position equivalent to 30.0% of all the open interest in silver and 27.1% in gold. The extreme concentration in these markets, pointed out by silver analyst, Ted Butler, in his “Smoking Gun” report of 22 August 2008, led to the CFTC’s investigation into the silver market, which remains ongoing. The CFTC has invited comments from the public in relation to its current proposal to impose position limits. If you haven’t seen it, Butler sent the following letter:

August 10, 2009 Chairman Gensler, Thank you for the opportunity to comment on the issue of position limits in energy and other physical commodities of finite supply. The hearings you conducted were of great public service. I will confine my comments to one market – the COMEX silver futures market. I have excerpted the following passages from your opening statement of August 5th. You said: “I believe that position limits should be consistently applied across markets for physical commodities of finite supply.” “…, I believe that at the core of promoting market integrity is ensuring markets do not become too concentrated.” “The very important question becomes: how much concentration is too much? At what point of market concentration does a trader detract from liquidity instead of enhance it? I think we would all agree that if one party controls half the market, that party is more likely to lessen liquidity than enhance it. Position limits should enhance liquidity by promoting more market participants rather than having one party that has so much concentration so as to decrease liquidity.” According to data contained in the most recent Commitment of Traders and Bank Participation Reports, both for positions held as of August 4, the level of concentration on the short side of COMEX silver futures would appear to meet or exceed the level you imply threatens market integrity and liquidity. After published non-commercial and imputed commercial spreads are removed, the net short position of one or two US banks exceeds 40% of the total net futures open interest. That same calculation indicates the net short

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position of the four largest traders exceeds 66% of total net open interest. Such levels of concentration do not exist, either on the long or short side, in any other market for physical commodities. The only effective means of ensuring market integrity and enhancing liquidity is for the Commission to impose legitimate speculative position limits. This will increase the number of traders on the short side of COMEX silver, as you stated. The level of the current accountability limit of COMEX silver futures (6,000 contracts), on an all months combined basis, is way out of line with any other commodity. Any reasonable method of applying position limits consistently across all commodities of finite supply, whether in relation to actual production or as a percent of total open interest, would dictate that the Commission impose a speculative position limit of no more than 1500 contracts in COMEX silver futures. I also strongly urge you to restrict any exemption from that speculative position limit to the bona fide producers or consumers of the actual commodity, and not to those engaged in financial trading through aggregation. I would respectfully remind you that while the thrust of the hearings involved the enforcement of position limits to guard against excessive speculation on the long side, commodity law requires you to guard against excessive speculation or manipulation on the short side as well. No other market comes as close to fitting the profile of a manipulated market than does COMEX silver on the short side. Once again, I urge you change that profile by establishing a speculative position limit of no more than 1500 contracts in COMEX silver and by restricting any exemption to that limit to the actual producers and consumers of the metal. Theodore Butler

Sticking with the theme of precious metals, the former member of the US intelligence services and anarcholibertarian (great phrase), Simon Black, had some very interesting insights to share on gold and silver a couple of weeks back: “I’ve been spending a lot of time this week talking to my sources in China, one of whom is inside one of the country’s sovereign wealth funds (SWF). He also indicated that the SWF analysts were working around the clock trying to put deals together… for China it’s a race against the clock for how fast they can convert their $2 trillion in US dollar holdings into strategic assets– namely oil and gold. At today’s deflated prices, putting together a really good billion dollar deal is a difficult thing to do. Putting together 2,000 of them is impossible. Doing it before the dollar collapses? No chance. And they know it. So as a hedge, the government appears to be pumping up demand for gold and silver among the public, possibly preparing them for an imminent dollar decline.” Here is a YouTube link to a news programme on China’s CCTV which highlights how easy it is for members of the Chinese public to buy silver. CCTV is China Central Television and is the main state broadcaster reaching over one billion viewers. This quote about CCTV comes from Wikipedia: “This station is one of the official mouthpieces of the Chinese government, and reports directly to high-level officials in the Chinese Communist Party’s Central Propaganda Department.” These are the words of the anchor on CCTV 9, the 24-hour English news channel: “China has introduced its first ever investment opportunity for silver bullion. The bars are available in 500g, 1kg, 2kg and 5kg with a purity of 99.9%. Figures show that gold was fifty times more expensive than silver in 2007, but now that figure has reached over seventy times. Analysts (like me! Paul) say that silver has been undervalued in recent years. They add that the metal is the right investment for individual investors and could be a good way to cash in.” Maybe counterfeit copies of Thunder Road have become cult reading in Beijing! Back to Simon Black’s blog, “The International Man” (here), and some comments from his China insider, Christine, after he asked her what was happening in the Chinese gold market:

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“It’s funny you ask, I just got off the phone with one of the key executives at the Shanghai Gold Exchange. You know, for the past 50 years, the Chinese government has controlled the distribution of all types of gold…The government is now taking radical measures to change that…The government is now trying to drum ‘gold/silver as an investment’ into their heads at every corner…In fact, Chinese have more precious metal investment options than Americans, and the statistics are alarming: In 1950, China had next to nothing in gold reserves. Today they rank 10th globally, and they are frantically mining for more on their own soil. For the past half a century, the Chinese had the lowest per capita consumption of gold in the world. Next year, Chinese gold demand will likely surpass that of India. This year, the government banned silver from being exported… and by July, it was being promoted as an “investment” to the Chinese public on the 6 o’clock news. You do the math– how does that affect global demand if just 10% of Chinese begin to perceive silver as an investment? Will the Chinese turn into goldbugs overnight? No. Over the next 5 years? Probably, yes. I like your long-term silver option strategy for this reason. Even the smallest shift in Chinese investor/consumer preferences can dramatically alter global demand and commodity prices. From what I’m seeing from the ground, the Chinese government is engaging in one of the most explosive financial marketing campaigns in history. Instead of Maoist propaganda, though, they are attempting to change the entire perception of gold/silver in the Chinese public. Simply put, the Chinese government is trying to trigger a national gold craze…and it’s working. The Chinese public now has gold trading platforms on steroids. You can buy silver bullion or gold bars at any Chinese bank in four different sizes. Wealth management products tied to gold are skyrocketing in popularity…Also, for the first time in history, Chinese investors can even trade gold abroad (in London) with the swipe of a ‘Lucky Gold’ card. I can’t even get Bank of America to open a foreign currency account.” I look at my position in junior silver company, ECU Silver Mining, now moving from an explorer to a producer but still very risky, and I think about Marv’s comment (one of my favourite lines from the movie) to Bud Fox on the trading floor in Wall Street: “This stock is going to Pluto”

Source: National Geographic It’s nice to dream, but the “only sure things are death and taxes”, as the sage elderly broker, played by Hal Holbrook, opined in the movie. Russia announced that it had increased its gold reserves by 600,000 ounces (18.7 tonnes) in July Adding this to the World Gold Council’s (WGC) latest (June 2009) figure, Russia now has 536.9 tonnes in aggregate. On its website, the WGC shows the monthly changes for every country back to the beginning of 2002 and

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this is by far the biggest monthly increase since then. And this is probably far from the whole story - from Jim Willie in his August 2009 Hat Trick Letter: “A gold banker contact with direct past experience inside Russia during the 1990s decade directed a comment after the Russian gold story emerged. He had contact with several of the Yeltsin cadre. He wished to elaborate on the much bigger story that comes from Russia pertaining to gold. A grand plan is in place, one to fill the vacuum when the inevitable collapse of the USDollar and USTreasury occurs. He wrote, ‘You need to understand and know that the Russians do not disclose their actual Pt (platinum, Paul), Au (gold), Ag (silver) holding at Gochran. It is safe to assume that the numbers mentioned are low-balling big time. Russia and the Gulf States will provide the required precious metal for the core of the new gold-backed currency that will emerge after the collapse of the dollar. This is all part of a larger strategy that is poorly or not understood by pretty much all so-called experts. There have been very few people who have had a chance to see what the Russians store at Gochran. It is mind bending. It is like the Kremlin and the White House. The White House is a shabby cottage compared to the Kremlin.” I wonder if Peter Hambro has had a shuftie round Gochran? Which reminds me of the comment from the first deputy chairman of the Russian central bank back in 2005 in which he said the bank would be: “buying gold on all markets on which it is available.” Back to the courageous Jim Willie who was threatened again: “Unfortunately, the Jackass got threatened again, this time clearly by a USMilitary guy out of uniform in an unmistakable warning given in a public park in San Jose Costa Rica here on a Saturday afternoon. He likely was dispatched to deliver a message from the syndicate, or had noticed monitors of my telephone calls. This is the first personal threat received in Costa Rica. The last threat came at a gold conference in Munich Germany in November 2006, one month before my arrival in this semi-paradise land. His message was to be careful about what is discussed and written regarding a certain very serious topic that is overarching in nature. This aggregate concept will not be discussed, but the individual pieces will be covered still. The syndicate is losing control, without a doubt. The longstanding US-UK alliance is breaking down in unmistakable fashion, even as creditor resistance is turning to multi-faceted global revolt. Foreigners react to US chronic broad hegemony, visible bank fraud, credit abuse, veiled aggression, and endless propaganda. The credit masters have moved in new defensive ways to protect their domains, which has the practical effect as offensive strikes on the global chess board. The opposition forces to the US-UK alliance are working to dismantle the vast control levers. The Jackass now has three forbidden topics to avoid in public and private writings. MESSAGE HEARD!!!” And what are some of Jim Willie’s themes? Stuff like the coming collapse of the US banking system, power control structures, etc. On a slight tangent, it reminded me of a comment from my then Head of Research, Dr. Stephen Carr, at Warburg (now UBS) when I downgraded the earnings of a corporate client, the chemical and fibre company, Courtaulds, in the mid-1990s: “Companies (or governments in Jim Willie’s case, Paul) only react like that when you’ve really got something on them.” My colleague back then, Michael Stone, was the only analyst in London (possibly anywhere) who had a relationship with Courtaulds’ main competitor in viscose fibre, an Austrian company, Lenzing. Viscose fibre was a big source of Courtaulds’ earnings – operating margins were over 20%. Lenzing told him that viscose profitability was falling rapidly, which obviously had a negative read across for Courtaulds. I arranged a meeting with Courtaulds’ investor relations manager who was as cagey as hell, but it was clear that things were going badly. The problems started when I got back to the office. Warburg had a very good/aggressive salesforce in those days (some of you will know/remember Howard Rankin, James Chancellor, Nigel Pears, Geoff King, George Granville, etc...yes and you Simon B.) and some of them would watch for your arrival back at the

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office after a company meeting if they knew you were expecting to come back with something significant. While you couldn’t say anything until you’d stood up and communicated your view across the firm, they could read body your language. Before the meeting, I’d already had a chat with Warburg’s market makers in Courtaulds about what was likely to come out of the meeting, as you were allowed to do in those days - the book was short half a million Courtaulds (at about £4-5/share). Before I’d even spoken, however, sell orders started to come in. The first sell order (I remember this clearly) being for half a million shares. The story started to get around and I hadn’t even got to the microphone yet. Someone I knew vaguely at another bank phoned up to say “I hear you are going to downgrade Courtaulds”. Warburg’s market makers were now having to support Courtaulds’ share price in the minutes before I could disseminate the news. So having been short, they were now long and the price was about to fall sharply. Anyway, I spoke to the salesforce, the stock fell and the market maker commented that he could have “bought the company”, the selling was so heavy. Unfortunately, Courtaulds’ CEO took the news that his bankers had downgraded the shares very badly. I was summoned to the Chairman of Warburg Securities’ office and thought my number was up – I’d been there less than a year. I explained what I’d done and off he went in a taxi to Courtaulds’ head office, having been summoned by its CEO. A couple of hour later I was asked to report to his office again. This is some of what he said: “Well I met with ******** (surname) and I have to say I wasn’t very impressed. Another ******* ****** ***** ****** (last two words = name of country deleted), if you ask me…Kept referring to Lenzing as a ‘tin pot little Austrian company’. One thing David Scholey (Warburg Chairman and protégé of Sigmund Warburg) taught me is never to criticise your competitors in public. It looks bad…” I kept my job and was immensely grateful. Ironically, Lenzing is still independent, while Courtaulds got swallowed up by the Dutch chemical major, Akzo Nobel, which also took over what was left of Britain’s onetime powerhouse in chemicals, ICI. I have the corporate histories of both ICI and Courtaulds on the shelves to my left, but I’ve never been able to bring myself to read them. Back to gold and silver and last week Bill Murphy, Chairman of the Gold Anti-Trust Action Committee, got a call from his “Stalker source”, the one which has provided very accurate information on the gold market in the past. “Our STALKER source called and has some input for us regarding that brilliant London trader. This is the latest…He has been instructed to keep 50% of his funds in physical gold at all times. Gold is in ‘no-man’s land’ at the moment, in a trading range between $920 and $970. He does not expect gold take out $920, but it if does he will lighten up … with the notion gold might then drop to $880. Should gold take out $970, the London trader will be an aggressive buyer…He expects gold to by flying in 4 to 6 weeks. Short term the London trader is not friendly to silver. In addition our STALKER source reports there is a good deal of discussion in Europe about a coming banking collapse in the US … by CHRISTMAS. While discussed over there, the media is ‘sitting’ on this talk in the US. Geez, now that’s a real surprise.” Following the World Gold Council’s (WGC) announcement of gold supply and demand for the second quarter of this year on 19 August 2009, , the Daily Telegraph carried a story on the front page of its business section “Losing its lustre – gold demand hits six-year low”. According to the data in the pictorial below this headline, the major components of gold demand - jewellery, dentistry/industrial, bar hoarding and coins/ medals, were all down in Q209 versus Q208 - only ETF and retail investment demand increased. Overall, the World Gold Council’s data (sourced from GFMS Ltd) showed that demand fell 9% year-on-year. On the back page of the business section, it discussed (I won’t say analysed) the data on gold demand in more detail and commented that: “Traders are still clinging to the commodity as a safe haven during the recession”.

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That comment, along with the headline about demand being at a six-year low, suggested that you’d better start worrying if you are invested in gold. However, as Bill Murphy, Chairman of the Gold Anti-Trust Action Committee, has said numerous times, gold is the worst reported market in the world. A quick look at the performance of the gold price during Q209 (and there was a chart in the newspaper article) was all you needed to realise that the impression given by the Telegraph and WGC was nonsense. The gold price at the end of June 2009 was US$935/oz which was about US$17/oz above the level at the end of Q109 and US$5/oz higher than at the end of June last year. Gold price US$/oz (2-years)

Source: timingcharts.com

If you knew that the price had actually risen in the face of demand falling to its “lowest level in six years”, it might have prompted you to check what the WGC data said about supply in Q209. One might have imagined that gold supply must have fallen even more sharply than demand to justify a higher price. Wrong. According to the WGC, gold supply actually rose 14% to 927 tonnes versus Q208. One view of gold supply and demand - but only part of the story (tonnes) Supply: Mined Hedging Official sales Scrap Total Demand: Jewellery Dental, etc Retail ETFs, etc Other Total Inferred Investment 475 116 89 73 9 762 90 532 118 143 4 5 802 10 695 112 213 149 57 1,227 -353 484 90 208 95 138 1,014 -39 355 79 42 465 93 1,034 163 416 93 127 57 39 731 195 -9% +1,815% -22% -21% -11% +1,315% 544 -129 77 359 851 589 -121 69 276 812 634 -53 77 216 874 648 -46 13 361 975 582 -3 52 566 1,197 622 -16 -14 334 927 +14% +6% Q108 Q208 Q308 Q408 Q109 Q209 Q209vQ208

Source: World Gold Council, GFMS Ltd.

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So demand fell 9%, supply increased by 14% and the price went up? Don’t people question things anymore? I’m very surprised at the Daily Telegraph letting this out because a senior reporter on the Daily Telegraph actually knows what’s “really” going on in the gold market, although (perhaps like the Bloomberg reporter implied to GATA when she met them in London a few months back) it’s probably difficult for him to write about it. Wonderful isn’t it. It’s hardly surprising that people are going to the internet more and more and the newspaper industry is slowly going to the wall. As you can see from the table above, to make the supply and demand numbers add up, the WGC has a balancing figure described as “Inferred Investment”. With retail investment, investment via ETFs and central bank buying and selling separately categorised, Inferred Investment refers mainly to institutional buying (if positive) or selling (if negative). According to the WGC, inferred investment reached a positive195 tonnes in Q209, the highest quarterly level since the sub-prime problems emerged during Q107. It should be crystal clear that the WGC’s data on gold supply and demand and the relationship to the gold price is completely implausible and that the Telegraph’s interpretation of the situation was poorly thought through. What the WGC, GFMS Ltd. and the Daily Telegraph need to grasp is that there is absolutely no way you can accurately model supply and demand for gold. Why? Because unlike other commodities which are “consumed”, almost all of the gold ever mined remains on the surface of the planet in the form of bars, coins or jewellery, etc, and can be re-sold back into the market relatively easily. Therefore, gold supply is “theoretically” almost all the gold ever mined - about 160-170,000 tonnes according to the WGC – it’s actually much higher, but has anybody else worked out why??? While inventories of copper, wheat and other commodities can vary according to supply and demand (consumption), the world’s gold inventory is always rising. Actual supply is not just the amount of gold mined each year, recycled scrap and central bank sales (if there are any). There is a much larger amount of supply coming from the sale of gold from the “existing stock” of bars and coins (apart from that held by central banks), some of which will be sold (and bought) many times over in the liquid bullion markets in London and Zurich. There was also no mention in the Telegraph’s report of the dramatic changes in central banks’ activity in the gold market. Firstly, the hugely significant announcement back in April that China had covertly increased its gold reserves by 75% to 1,054 tonnes since 2003. Not only had this completely blind-sided the WGC, but they have made no attempt to alter their historic demand estimates. As an aside, back in November 2007 I wrote in a Redburn Partners report: “According to the WGC, China has not purchased any gold since 2002 – during which time its foreign exchange reserves have increased by more than US$1trn. We find it inconceivable that some of this has not gone into gold. China has publicly declared that it has been building a strategic stockpile of oil since October 2006 and has created a Sovereign Wealth Fund. It would be naïve in our view, to believe they are not building a strategic reserve of gold at the same time.” That view was always shared by Bill Murphy, who had the “inside touch” from his “Stalker source”: “They have been discreetly buying up natural resources for at least the last five years…(we) have known for years how they have been accumulating gold via our Stalker source.” But as Gordon Gekko said: “If you’re not inside, you’re outside, okay?” Secondly, there have only been two quarters out of the last 37 when central bank holdings have increased – then only by about 7 tonnes each time, compared with 16 tonnes in Q209. If this carries on, maybe the WGC will have to change “Official Sector Sales” to “Official Sector Purchases” and move it from the supply side of its table to the demand side.

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In the last Thunder Road, I was talking about how I’d bought exposure to the Food/Agriculture space via the DB Power Shares Agriculture Fund – an ETF with exposure to the prices of sugar, soybeans, corn and wheat. I looked at wheat in some detail – with the help of Nogger (Dave Norris) from Nogger’s Blog (link here) - because I thought the price was going to bottom in the near future, despite the overwhelmingly bearish sentiment. So far, so good, although it’s early days. Wheat price

Source: timingcharts.com

As an aside, I don’t think I’ve mentioned in Thunder Road that two of the smartest people I know from the markets have substantial food reserves stored up – one has six months and the other three months. I bought a 7.5kg bag of rice just after Lehman collapsed last year and was ready to buy more rice, pasta, canned tuna and powdered milk, etc, in SIZE from south west London supermarkets, but thankfully it never quite came to that. Oh, and a chest freezer if they still make them? We used to have one in our garage when I was growing up, but you never see them these days. The crux of my short-term investment case is that I think that the consensus estimates for 2009/10 wheat production in China and India are too high given the bad weather conditions. In terms of individual countries, these are the two biggest producers and consumers, although they typically play very small roles in the international wheat trade. At the same time production from major exporting nations, like Argentina, Ukraine, US, Russia and EU-27, will be down this season. I’m also sceptical as to whether buffer stocks of wheat held in China and India are really as high as is generally assumed? Let’s consider how these arguments have developed since the last Thunder Road two weeks ago. Beginning with the level of Indian wheat stocks, Reuters reported 31.62m tonnes at the end of July according to official sources, while Nomura reported a level of 25.3m tonnes on 21 August 2009. With India consuming about 6.5m tonnes per months, these figures are at least “in synch”. However, the figures contrast sharply with comments from the Indian Finance Minister, Pranab Mukherjee, on the 21 August 2009. He said that in addition to the normal 4.0m tonnes buffer stock of wheat, India had an additional 3.0m tonnes – making only 7.0m tonnes in all. Which is true? We don’t know, but if it’s the latter, it would have very serious consequences. Other comments from Mukherjee on the same day are worth repeating: “We will go for imports. But we do not make announcements of import in a very big way because that has another cascading effect…The moment news spreads India is going for heavy dosage of imports, then it will automatically have an impact on market prices being jacked up…The decision is already there. Whichever commodity is in short supply, to meet the demand and supply mechanism, we shall go for imports.” Even if India had 31.62m tonnes of wheat in storage at the end of July 2009, it is likely that India will have to enter the market in a big way. Nogger did the maths – 31.62m tonnes at a monthly consumption of 6.5m tonnes means 4.9 months of supply, i.e. India could run out of wheat by Christmas time. With the

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next harvest not due until March/April, that could leave India needing to purchase about 2.5 months of consumption, or more than 16.0m tonnes. On 25 August 2009, Nogger reported: “And this morning I read a report on an Indian commodity website saying that ‘the government can still feed the entire country for at least 82 days,’ as if that’s in some way reassuring! Almost, three months, don’t worry there’s plenty of time for something to turn up!” That would imply a major problem by late November. Just to muddy the waters, however, India’s Commerce Minister, Anand Sharma, was quoted by the Bangkok Post as saying: “As of now, India has adequate food stocks that can last until the autumn of 2010 and this too despite the adverse impact of drought,” I’m struggling to believe that and, if it’s true, why did India remove import duties on wheat, pulses, edible oils and corn only a month ago? And why has it banned the export of wheat and non-basmati rice? And why have there been numerous media reports that the government is considering the release of 5.0m tonnes of wheat and rice from its reserves? Furthermore, here is part of a very distressing report I found on Huffington Post on 27 August 2009: “Dozens of impoverished farmers struggling with debt and poor rainfall have killed themselves in southern India in recent weeks, leaving behind families plunged even further into poverty, activists and politicians said. Nearly every day, newspapers report more farmer suicides in Andhra Pradesh, a state of 80 million people where 70 percent of the population depends on agriculture – and which has suffered badly this year from weak monsoon rains. Officially, the total number of suicides stands at 25 in the past six weeks. But opposition parties and farmers’ groups say the true total is more than 150. ‘The government is trying to hide the facts,” opposition leader N. Chandrababu Naidu said Wednesday in a speech before the state assembly. “I have a list of the names and addresses of 165 farmers who have ended their lives because of the distress caused by the drought’.” Another question mark regarding Indian wheat is the knock-on effect from the disastrous outlook for the rice crop. Even the slow coaches at USDA cut their forecast for Indian rice production in 2009/10 by 15.5m tonnes to 84.0m tonnes recently. Reduced rice consumption is likely to be compensated by wheat to some extent. Ned Schmidt commented on this a few weeks back: “Many do not understand that the global Agri-Food network is much like a Rubik’s Cube. A change of one block influences all sides of the cube. The same is true with global Agri-Foods. Any loss of rice production in India has an impact on the wheat market in North America. The current state of near euphoria in North America on the outlook for this year’s harvest may be premature, and ignoring the Rubik’s Cube nature of Agri-Food.” On a slightly more positive note, the monsoon rains have improved. From 1 June 2009 to 18 August 2009, rainfall was 27% lower than normal. During the last two weeks the deficit has declined to 25%. And there are those who take a very different view. For example, this is from a Reuters report on 20 August 2009: “I don’t see a big impact on world grain markets from this year’s monsoon failure in India,” said John Reeve, director of agricultural commodities at Standard Chartered Bank in Singapore…India has replenished its wheat stocks and world grain crops are also in good shape. But the impact on world markets will be big if there is a second erratic monsoon.” Looking at the global wheat picture, the International Grains Council (IGC) increased its forecast for 2009/10 production from 654m tonnes to 662m tonnes last Thursday – this is based on its expectations of better yields in the EU, US, Ukraine and China. Just like India, the subject of Chinese wheat production remains not only key to the direction of the wheat price, but a fascinating subject for study in itself. First USDA increased its forecast for China’s 2009/10 wheat production from 113.5m tonnes to 114.5m tonnes two

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weeks ago and now the IGC. Both agencies are now forecasting a record crop although, as I highlighted in the last Thunder Road, a severe drought hit China’s wheat growing regions in January and early February and severe storms disrupted harvesting in June. Here’s Nogger’s view after the IGC published its new forecast: “I find it all very strange that a country in the grip of a terrible drought in the middle of the growing season should ultimately bring in a record crop. A quick search on the blog throws up that on Feb 7, Henan province had its first rainfall for 110 days - and that was just 6 mm. So newly planted wheat in Henan had no rain at all for the first three months of it’s life, yet China brings in a record crop. Maintaining this nice steady upwards growth, no matter what, for the seventh year in succession. Now I ask you, how likely was that? I didn’t go to China to see how bad, or otherwise, things were at harvest time, and I don’t suppose you did either? But come on…They aren’t auctioning off any of their record wheat crop, and supposedly huge reserves, in their regular weekly sales are they?” Nogger also hails from “God’s country”, a city in the north west of England:

Source: www.visitliverpool.com

Despite my scepticism regarding the USDA and IGC forecasts for China, I was mildly disappointed by the latest data on Chinese wheat imports. May imports had more than doubled to 70,968 tonnes and June imports more than doubled again to 192,905 tonnes. In July, imports were 85,078 tonnes, albeit 22,701.26% higher than July 2008 according to China’s meticulous General Administration of Customs. In the last Thunder Road, I mentioned the longer-term threat to global wheat production from the Ug99 stem rust. Thanks to Simon Y. for passing on this other threat highlighted by Bloomberg – India’s “bread basket” is its north west region: “Orbiting satellites measuring the gravitational pull of water below the earth’s surface confirm what authorities in India suspected for more than 20 years: groundwater is shrinking in some of the nation’s driest areas. Three northwest Indian states lost a volume of water from underground supplies equal to more than twice the capacity of Lake Mead, the biggest U.S. reservoir, between August 2002 and October 2008, scientists said in the journal Nature yesterday. The findings suggest that pumping water from wells for irrigation is damaging India’s resources more than the government has estimated. Without measures to curb demand, dwindling groundwater supplies may cause drinking-water shortages and erode crop production in a region inhabited by 114 million people, the authors said.”

Post script – the man in the Clapham health food store
I went into the health food store on Northcote Road in Clapham, south west London to buy some supplements for my children. I was wearing a T-shirt with “Don’t Attack Iran” in big red letters on the front. The elderly proprietor looks at my T-shirt and comments how it’s sad these days because many people in Clapham have become “de-politicised”. He then goes on to tell me that his expectation is that Israel will attack Iran by October (and he’s Jewish, by the way). I’m absentmindedly trying to find various types of fish oil and vitamins which my wife has instructed me to buy and say that yes it’s possible because it would provide a

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convenient distraction to the US hierarchy if the economy has begun to deteriorate again. He then starts to complain about the unreliability of Chinese economic data and how the stock market keeps rising and that “it’s all due to Goldman Sachs”. Brilliant! Now whether this man has read into high frequency trading, the Plunge Protection Team, etc, I don’t know, but it really struck me how well-informed he was about contentious issues in the financial markets. It struck me that instead of the famed “man on the Clapham omnibus” being the barometer of public opinion, we now have the “man in the Clapham health food shop”. Local mothers, including my wife, already consider him to be a homeopathic guru and maybe his talents are multi-faceted. For some reason, it reminded me of this quote from Enrico Orlandini of Dow Theory Analysis from a while back: “I’ve lived in Latin America for the better part of twenty-five years and for the first time, people don’t want dollars. They actually prefer their own currency. Here’s my latest news flash for you. If a fellow with no education, a poor diet, and inadequate medical treatment living at 3,500 metres above sea level can figure out that the US dollar is undesirable as a store of wealth, how much longer do you think it can last as the world’s reserve currency.”

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Author: I started work the month before the stock market crash in 1987. I’ve worked mainly as an analyst covering the Metals & Mining, Oil & Gas and Chemicals industries for a number of brokers and banks including S.G. Warburg (now UBS), Credit Lyonnais, JP Morgan Chase, Schroders (became Citibank) and, latterly, at the soon to be mighty Redburn Partners. Charts: Thanks to timingcharts.com Wall Street movie - 20th Century Fox Disclaimer: The views expressed in this report are my own and are for information only. It is not intended as an offer, invitation, or solicitation to buy or sell any of the securities or assets described herein. I do not accept any liability whatsoever for any direct or consequential loss arising from the use of this document or its contents. Please consult a qualified financial advisor before making investments. The information in this report is believed to be reliable , but I do not make any representations as to its accuracy or completeness. I may have long or short positions in companies mentioned in this report.

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