report
6th September 2010
This issue:
Silver - the Call to Arms
Luxury Goods, the “Hemline
Indicator” and the stock market
Rare Earths - going to war
FREE Martin Armstrong
Imprisoned for financial analysis
Contact/additions to distribution:
Paul Mylchreest
paul@thunderroadreport.com
Silver, Luxury Goods and Rare Earths
I can’t remember a time in my 23 years in the market when there
was so much confusion and uncertainty about the outlook. As the
monetary catastrophe unfolds gradually, some days things look
a little brighter, then the sheer enormity of the problem becomes
only too apparent once again. Sentiment keeps flipping between
optimism and pessimism, but the debt bubble just gets bigger!
Noel Gallagher wrote “These are crazy days, but they make me
shine”, and that sounds like a good enough motto for trying to
invest right now (fingers crossed).
“The players are under so much duress it’s like Duressic Park out there”
Quote: Darts commentator Sid Waddell
The silver price has started to trade differently and it appears
that BIG MONEY is moving in to the metal (at long last) and
fighting the Cartel. There is evidence that the supply of physical
silver is getting tight and it could be the beginning of a major
upward move in the price. In the more ephemeral world of
luxury goods, if you’re following the emerging fashion trends,
you’ll know that there are some seismic changes moving into the
Autumn/Winter 2010 season. While not perfect, the link between
changes in fashion and economic prospects is long established,
most famously via the “Hemline Indicator”. It’s not for everyone,
but taken at face value, the current trends are overwhelmingly
bearish. However, there are also a few conflicting signals, which
seems to sum up the state of financial markets perfectly! Moving
 on to rare earths, China (which supplies more than 95% of world production) has slashed export quotas.
Rare earths elements are used in iPods, mobile phones, laptops and clean technology (e.g. wind turbines
and hybrid cars) as well as being critical to the US military. This could set the scene for a very serious trade
war between China and US, but the potential implications remain poorly appreciated. Rare earth prices
have spiked and the share prices of rare earth mining companies are responding. I’ve added Great Western
Minerals and a few shares in Avalon Rare Metals since the last TRR.

Silver – the Call to Arms

The Achilles Heel of the Cartel in the gold and silver markets (i.e. the US government, Federal Reserve and
their bullion banking agents) is almost certainly PHYSICAL SILVER BULLION. Just like gold, silver is money
(as well as being a vital industrial metal) - which scares the Cartel to death and is behind its attempts to
suppress the price going back more than a decade. Gold and silver not only compete with fiat currency but
also against Government bonds – the market for which is developing into one of the biggest bubbles in the
history of finance. That assertion is refuted by the majority, which is another classic indication of a bubble.
But back to silver:

BB Unlike gold, silver is no longer held as part of central bank reserves to any significant extent;

BB 76% of newly mined silver is consumed in non-investment applications (industrial, photography, etc)
thus further depleting above ground bullion stocks,

BB US banks (primarily the one whose name begins with the letter between i and k) are short 21.8% of all
of the outstanding contracts on the COMEX exchange in New York. These 26,855 contracts amount to
134.3m oz of silver or 4,176 tonnes. This is equivalent to 19% of all the silver mined in 2009 and 15%
of total silver production if we include the recycling of scrap. Let’s think about that a different way. If
one or two banks were long the entire annual oil output of Saudi Arabia and Norway combined, it would
be equivalent to 15% of the world’s 2009 oil production. Can you imagine the outcry from the public
and politicians about market rigging, greedy speculators pushing up the price of gasoline, etc? In terms
of wheat, it would be the same as a position in 100 MILLION tonnes, equal to the entire aggregate
production of agricultural giants the US and France;

BB Silver forms little or none of the Yamashita hoard of treasure which is hidden/protected in the Philippines
to the best of my knowledge; and

BB Because silver is such a small market, if “big money” started to accumulate physical silver in an aggressive
way, the Cartel could get into serious trouble. This seems to be what’s happening.

The silver price is just under US$20/oz so almost everybody (“tramps like us”) can afford at least a small
amount. I’ve bought a bit more physical silver from ATS Bullion which has an office next to the Savoy Hotel
in London (you can just phone them up and take some id when you go to pick up your silver). I even had to
pay more than a 20% premium to spot plus VAT, but that’s going to be irrelevant if I’m right and the silver
price goes to US$50-100/oz (note: I deliberately avoid silver and gold ETFs). This is part of my “Cascading
Defensive Strategy” in gold and silver, i.e. have a bit of physical CLOSE BY, buy some ALLOCATED bullion
at closer to the screen price (e.g. from the likes of BullionVault or goldmoney.com – which can also store
it overseas) and have some exposure to the EQUITIES, both the MAJOR producers and a few JUNIOR
exploration plays.

Buying some physical silver is an opportunity to send a powerful message to the corrupt interventionists
in the Cartel.

© Thunder Road Report - 6 September 2010 2

 In my two-part piece “Silver – the best investment of all?” back in January and February of 2009, I
characterised silver investors as being like:

“an underground movement – and one whose day in the sun is approaching”

I’m even more bullish on silver than gold and have the balance of my portfolio set up accordingly. In fact,
I sold some gold shares to buy the physical silver. My long-held view is that the gold/silver ratio will get
back to 30 from the current level of 62 - that would take it back towards its lows in the post-Bretton Woods
world. The gold/silver ratio was 12.5 in 323 B.C. when Alexander the Great died, was 12 during the Roman
Empire and was fixed at 15 during most of the 19th Century during the “golden era” of the Gold Standard.
According to the gold-eagle website, the median ratio since 1687 is 15.7.

Gold/silver ratio since 1975

Source: goldprice.org

Importantly, the silver price has started to trade DIFFERENTLY in the last couple of weeks - as everybody
who stands shoulder-to-shoulder with GATA and Ted Butler in the precious metals markets has noticed.

© Thunder Road Report - 6 September 2010 3

 The key was the price action in the run up to the recent COMEX (New York) option expiry on 26 August
2010. Time after time after time in recent years, the silver price has been blatantly taken down in the days
preceding option expiry to the benefit of the big shorts. This time was different. Dave in Denver put up a
chart on The Golden Truth blog showing the silver price action on the 23-24 August 2010:

Silver price - 23/24 August 2010

Source: The Golden Truth

Adrian Douglas of Market Force Analysis calculated the P&L for the shorts on this COMEX silver option
expiry:

“The option expiry for the cartel was an unmitigated catastrophe. The mining companies are not hedging so
we can consider nearly all the options, puts and calls, are being written by the commercials. If we consider
the whole option structure as just one book we can determine the optimal closing price to minimize the
payout on the options to speculators. When the commercials sell calls they want the price to go down to
make as many as possible expire worthless. When they sell Puts they want the price to go up to make as
many as possible expire worthless. Because they sell both puts and calls there is an optimal price to achieve
their best return or minimum loss.

Using yesterday’s open interest in the various strikes of the entire put-call option structure I charted the
payout over a range of closing prices for gold and silver. The minimum payout is the “optimal closing price”
for the commercials as a group if they own the entire book.

© Thunder Road Report - 6 September 2010 4

 The optimal closing price was $18/oz which would have been a payout of 5.5 Million USD (This would
probably not be a loss because to offset this is all the money they received from the purchases of the
options). The actual payout will be $14.5 Million USD. Almost triple the optimal. The cartel nearly ALWAYS
closes the metals at or near the optimal price month after month after month. This was a stunning change
and if the cartel could have prevented it they would have. In particular not only did silver finish at triple the
optimal payout but the cartel was struggling into the close to keep the $19 strike calls out of the money.
They achieved it by a mere 2 cents! (perhaps they will still be exercised!).”

James Turk of the Free Gold Money Report was almost prophetic in his comments just days before this
expiry:

“Let’s see if silver can hold this level, particularly with option expiry coming soon.

Given the strength we have seen in both precious metals, perhaps this option expiry will be the one I have
been waiting for – the shorts get overpowered by new buyers, and their getting squeezed results in a
moon-shot for the precious metals.  Everything remains in place for an upside explosion in silver.”

So what’s going on in the silver market? Several days ago, GATA’s Chairman, Bill Murphy, reported this from
their “Stalker” source whose track record is excellent:

“JUST IN: Heard from our STALKER source. He has picked up a new account which is a German
conglomerate of some sort. Nothing new to report on gold, however ‘THE London trader’ is
finally getting into silver and his reason is what is significant. His clients, which have had little
to no interest in silver in the past, now want to get onboard. Perhaps this is one of the reasons
silver is trading so differently these days. AND, if his clients (which have made so much money
because of the brilliant trading and market acumen of the London trader) now want in on silver,
other major newbie investors to silver most likely are doing the same thing.”

It sounds to me like BIG MONEY is starting to move in. After his emails to the CFTC’s Enforcement (joke)
Division on silver market manipulation were made public back in March, LBMA whistleblower Andrew
McGuire, had this to say in a subsequent interview on King World News:

“What’s going to happen if you’re an Asian trader, for example, or a non-western trader who has no loyalty
or care about homeland security or whatever else, who says ‘Hold on a minute, if I can establish this in my
mind that there is 100oz of paper gold, paper silver for example, for each ounce of real silver, then I’ve got
a naked short situation here that I can squeeze’ And they can go on to the spot market, which is basically
a foreign exchange transaction, short dollar, long silver to ANY amount they want, billions, trillions, any
amount they want and they can take this market, squeeze this market and blow it up.”

Is this what is beginning to unfold? Anecdotes from GATA supporters suggest that the physical silver market
is tightening. From Thomas:

“Just 3 hours before the silver price started to move up on the 08-24 I bought 2’000 silver eagles in
Switzerland for $23.68. The guy needs more than 10 days to get them. I believe, as last time, he had to
get it imported from a German supplier. I know, as before, some members will say they would have had a
cheaper source in Switzerland, but I’m used to working with and trust this company…and very very soon, I
really won’t care whether I bought silver at 15, 20 or 25$!”

And David:

“I visited the Canadian Mint in Ottawa, Canada on Saturday August 28. Very interesting tour. After the
tour we visited the boutique (gold and silver store). The mint had NO silver maple leafs for sale! The
sales girl said they wouldn’t have any for weeks! We are getting very close to a massive silver shortage!”
Finally this from Andy:

© Thunder Road Report - 6 September 2010 5

 “I started watching eBay when I started buying coins in Fall 2008. As we speak, silver coins are selling for
their highest prices that I’ve observed since that time. What is available is selling CONSISTENTLY at roughly
$21.50/oz. for 20 oz. rolls, and more for individuals. And, by the way, the price of ¼ and 1/10 oz. gold
coins, even at APMEX, have never traded at higher premiums to the paper spot price.”

There is the possibility of another positive catalyst coming down the pipe now that the Dodd-Frank Wall
Street Reform and Consumer Protection Act has become law in the US. Here is an email from the only
upstanding CFTC Commissioner, Bart Chilton, to a GATA supporter:

Hey Angelo
Here is the deal as I see it: There doesn’t appear to be any support (other than me) on the
Commission for metals position limits. We need 3 of the 5 of us. That’s the bad news. The good
news is that the financial reg reform bill has mandatory position limits in it. That means we
will implement them regardless of the lack of support at the CFTC (as long as the bill becomes
law).

The bill also contains what is called ‘disruptive trading practice authority’, so we will have
legal authority to go after trading that negatively impacts markets. We need this. For
example, currently our ‘manipulation standard’ under the law is weak...at best. We have to
actually prove intent. That means finding evidence of a trader’s intent (an email or wire tap
for example). We can’t simply say, as some suggest, that a trader has a large concentration
of positions and the price did this or that when the trader bought or sold, so therefore, they
manipulated that market. It doesn’t work that way under the law. In fact, we have only
successfully prosecuted one case in 35 years! The new law with disruptive trading authority, I
believe, will be most helpful.

Finally, we have an ongoing investigation. I meet with the staff and investigators all the
time. I did today. The work has been important and useful. I hope we will be able to discuss
that in public very soon. The thing about investigations is that we have to keep quiet during
the investigation. Most investigations, we simply don’t even announce, but I thought we
needed to on this one to let folks know we were looking at it. But, that means that now folks
are saying it has been too long, etc… I understand that frustration, but it is what it is. If we
weren’t making progress, I’d yell and scream.
All of these things will make for more efficient and effective markets in my mind.

Hope that helps somewhat.

B

The leading crusader to end the manipulation in the silver market has been the independent analyst Ted
Butler. As he explained:

“the new law mandates that the CFTC establish position limits in order to prevent market concentration.
Position limits in silver to break the stranglehold of concentration on the short side of COMEX silver has
been my mission for 25 years.”

Ted Butler deserves huge recognition for his hard work in exposing the manipulation of the silver market.
I agree with him on this:

“As to when legitimate position limits in COMEX silver should be enacted, the proper answer is yesterday.
That should always be the answer to a crime in progress…Therefore I suggest that you ask them (CFTC
commissioners – Paul) when legitimate position limits will be initiated and what the limits will be. It’s time
to stop stalling and for the CFTC to get specific.”

The chart below is a good illustration of how physical silver bullion was neglected as an investment vehicle
by US citizens for years – and how there has been a “sea change” since 2008. Demand for new American
Eagle silver coins from the US Mint during 1999-2007 was flat with, seemingly, a small number of believers

© Thunder Road Report - 6 September 2010 6

 quietly accumulating - then it changed. Note: the 2010 projection is the annualized number of the January-
August data.

US Mint - production of silver eagles in millions oz. (2010 annualised on Jan-Aug)

40

35

30

25

20

15

10

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010E

Source: US Mint

James Turk put up an interesting chart which shows were we stand in the silver market – breakout here
should signal a powerful phase in the bull market:

Source: Free Gold Money Report

© Thunder Road Report - 6 September 2010 7

 In addition, Dimitri Speck of the Seasonal Charts website shows how buying silver in early September has
usually been a good entry point during the last 37 years:

Source: Seasonal Charts

Luxury goods, the “Hemline Indicator” and the stock market

I used to buy Armani jeans and other “labelled” attire, even preppy stuff like Ralph Lauren. These days I
don’t really understand the desire for designer fashion, or is it just that I can’t afford it anymore? Not sure
on that one, but I’ve never (ever) “got” the concept of buying luxury cars. In my opinion, anybody who
buys a Porsche 911 or a Ferrari (except for a vintage model) should be tethered and pelted with rotten fruit
in public and twice if they are so stereotypical that they bought a red one. Just think how many books you
could buy instead. The usual defence when you ask them why is:

“It was only because I ALWAYS wanted one, since I was knee-high to an investment banker.”

But if there’s one person in the luxury goods and fashion world who REALLY annoys me it’s her:

© Thunder Road Report - 6 September 2010 8

 Despite my aversion to many luxury products:

BB I find the design, branding, retail and psychological aspect of the luxury goods sector fascinating (and
have many books about it!);

BB The top 10 luxury goods companies have a market capitalisation of US$165bn excluding Porsche.

Company Market Cap . (US$bn)

LVMH 61.348
Richemont 23.181
Hermes 20.291
PPR 17.809
Coach 11.630
Swatch 10.372
Polo Ralph Lauren 7.770
Burberry 5.848
Tiffany 5.440
Tod’s 1.934
Total 165.623

BB Fashion trends are symbolic of the collective conscious and often change with broader social, business
and financial market trends, the latter being incorporated in the once famous “Hemline Indicator” (see
below). Here is a quote from the French novelist and journalist Anatole France (1844-1924):

“If I should be allowed to choose one out of all the books published a hundred years after my death, I would
take a fashion magazine to see how women were dressing. Their fripperies would tell me more about the
society of the future day than all the philosophers and preachers.”

George Taylor was the first to develop the “Hemline Indicator” in 1926 arguing that the stock market
rises and falls with women’s hemlines. Hemlines got progressively shorter during the 1920s as the stock
market moved towards its peak and fell rapidly after the 1929 crash. The idea of hemlines predicting the
stock market was revived in the 1960s with empirical work done by Ira Cobleigh. In May 1967 with the US
brokerage firm, Harris Upham, publishing a chart of the “Hemline Indicator” (apologies but I couldn’t find
a colour version).

The Harris Upham “Hemline Indicator” 1917-1967

© Thunder Road Report - 6 September 2010 9

 Harris Upham was taken over by Smith Barney, which subsequently updated the chart:

Smith Barney “Hemline Indicator” 1917-1990

Paul Macrae Montgomery, these days CEO of Montgomery Capital Management, but writing in his “Universal
Economics” publication back in 1975 argued:

“The connection between hemlines and the stock prices has been painfully obvious since Cobleigh published
his findings in 1967. The micro miniskirt called the 1968 market top, and from the mini to the 1973-74
granny gowns and pantsuits, the Dow lost 480 points and the average stock was decimated.”

Take note of the word “granny” as it will come up again in relation to Autumn/Winter 2010 trends. Here is
Shirley Willet, of the Fashion Solutions blog talking in 2006 about the Hemline Indicator:

“I used this later in the 1980s when teaching about fashion marketing, production, and trends. I explained
that a lot of fashion trends have to do with ‘collective social emotions’. And those effect general business,
stocks, politics, etc, as well as fashion trends.”

It also seems that it may not just be about the hemline but the overall “look”. From a bit of background
reading, Christian Dior’s famous “New Look” was unveiled in 1947 – which coincided almost exactly with
the beginning of the upturn in the current long wave economic (Kondratieff) cycle.

After the uniforms and drabness of World War II, Dior commented:

“I wanted my dresses to be constructed, moulded upon the curves of the feminine body, whose sweep they
would stylize.”

© Thunder Road Report - 6 September 2010 10

 From my analysis, it does seem that hemlines tend to move in tandem with the economy and the stock
market. However, the stock market (which is what we are really concerned with) is often out of sync with
the economy. Generally, it’s a leading indicator although there are periods, like March-October 2007 as the
sub-prime crisis was unfolding and the market continued to rise, when it is a lagging indicator. Anyway, the
key question for me was whether hemlines are a leading/coincident indicator or lagging indicator for the
stock market. In not very scientific fashion, but from straining my eyes at the Harris Upham chart above, it
seemed to me that there were 6 occasions when it could be argued that hemlines were a leading/coincident
indicator versus 3 when they were a lagging indicator – which is a reasonably good track record.

I thought I’d see whether there was any message for the stock market from current fashion trends.
Having traded in and out of the luxury goods sector last year, via LVMH, I also revisited the luxury stocks
themselves.

It had nothing to do with hemlines at the time, but this was my bull case for the luxury foods sector in an
August 2009 Thunder Road Report:

“It struck me that a combination of the recent return of the ‘bonus culture’ to parts of the financial sector,
the possibility of a bubble developing in China and the likely response of the ultra-rich to the recent stock
market rally all bode well for this sector in the current quarter. At the same time, Japan, which is the biggest
market for luxury goods (>20% of the world market), should benefit from recovery in China, its largest
export market.”

I bought LVMH specifically because it was taking market share and had “numerous product launches” to
sustain the momentum through H209. LVMH is the world’s largest luxury goods play with brands such as
Louis Vuitton, Christian Dior, Marc Jacobs, Fendi, Donna Karan, Givenchy, Moet & Chandon, etc. At the time,
I was even reading the fashion industry’s leading “rag”…and as one portfolio manager said in an email:

“You reading Vogue in a Clapham coffee shop, legendary”

I quoted British Vogue’s August 2009 issue:

“The fashion gods have spoken: this autumn it’s all about the shoulder”

With hindsight, I suppose that big shoulders are reminiscent of the 1980s with yuppies and conspicuous
consumption. Hemlines were obviously still on the short side last year too. So although I wasn’t thinking
about the influence of fashion trends at the time, I guess that the omens were good for LVMH and its peers
back then. Indeed, LVMH’s share price surged and has made a new relative high:

LVMH price relative to EuroStoxx 300

Source: Redburn Partners

© Thunder Road Report - 6 September 2010 11

 The problem was that I lost my nerve on the prospects for the market as a whole and cut the LVMH position
in September 2009 – a big mistake as it turned out.

Below is the cover of the August edition of British Vogue which reviews the Autumn/Winter 2010 collections
– “First Look At Autumn” :

British Vogue - August 2010

Take note of some of the cover stories:

“The return of real clothes”

“Minimal make-up maximal impact”

In her editorial, Alexandra Shulman commented that the collections she saw on the catwalks represented
a:

“fantastic offering of clothes that I might actually be able to wear.”

Have the Martians landed? Catwalk clothes which you can wear, what’s going on? But the most insightful
comment was probably this one on page 104:

“Pared down, wearable, comfortable, ‘real chic’ - we are about to experience an extraordinary
shift in fashion, a moment when reality and desire collide and fantasy subsides.”

In fashion terms, this sounds like a shift of seismic proportions and apparently it is. By page 120, in an
article titled “Get real”, Vogue is in full flow:

“Fashion is undergoing one of those seismic shifts that reprograms how we think and feel about
the way we want to look…an altogether new avant-garde – the cult of the RESTRAINED (my
emphasis).”

And:

“Logical, hardworking, fit for purpose – these are the qualities resonating with women now.”

Then the Vogue writer relates this to financial markets (it just gets better!)

“The longest bull market ushered in a school of design that became consumed by theatrical
change, with dramatic mood swings between (what it’s only fair to describe as) prozzie dressing
and princess dressing.”

Unbelievable! She admits they admit they were living in “La La Land” as this roughly translates as Vogue
saying to the fashion industry:

© Thunder Road Report - 6 September 2010 12

 “IT WAS ALL B*LLOCKS”

And it’s hard to disagree.

Just like Greenspan and Bernanke with their easy money, obscene debt creation and bubble after bubble
for the last 20 years (and counting). While even the fashion industry is saying enough is enough, central
bankers and politicians march onwards towards monetary catastrophe. Here’s Vogue making more sense
than they do:

“It was quite a party with quite a hangover. But now designers have finally got their heads round a much
more cautious economic reality, we’re finally getting clothes that make sense.”

Obviously, just like any modern central banker, Vogue’s centre of gravity naturally resides in “La La Land”,
but let’s enjoy this while it lasts.

So big change is afoot, but what about those all-important HEMLINES? Here are a few sound bites from
the same Vogue issue:

BB “longer-length skirts” from the Editor’s Letter (after 34 pages of adverts)

BB “The gentle swoosh of a full skirt personifies the lady in 2010;

BB “Skirts from mini to full”

BB “Seventies Style - The longer skirt is big news”

BB “a new calf-length skirt needn’t look frumpy on the over-twenty fives”

I find these references to the 1970s interesting – does it send a message of austerity AND inflation! That’s
been my bet for the medium term…

Vogue asked London designer Roksanda Illincic, whoever she is, whether she would wear the new calf
length skirts:

“Yes, yes, yes! (OMG – Paul) With a fluorescent belt, big necklaces and maybe a three quarter length sleeve
to keep it youthful. The new length is probably the single thing that most excites me in fashion right now.
For ages, anything but short has been out of the question. But a new length changes everything.”

A cutting edge investment analyst has to crosscheck his sources (!), so I bought Grazia magazine whose
front cover had “Autumn’s Fashion Blockbusters” emblazoned on it (as well as “Gaga catches boyfriend
cheating – again”). Grazia supported everything Vogue had to say and possibly more. Here is a quote from
the “Runway to Reality” article:

© Thunder Road Report - 6 September 2010 13

 “Totally out there on the catwalk – and now totally wearable on you.”

But wait for this in a two-page spread titled “Let’s Grab a Granny”:

“Until now, only grandma’s wardrobe has been safe from us. But with Marc Jacobs, Daks, Marni,
Prada and Louis Vuitton all being inspired by the mid-calf skirts, bobbly jumpers, sensible
shoes and matchy-matchy accessories of our favourite cuddly relatives for their autumn/winter
runways, we’re sorry to report, Nana, but granny-chic is officially in.”

This could really spell economic disaster. We ARE in really big trouble (!) - it’s just that most people don’t
realise how much (although fashion designers seem to). Next to the text was a picture of this Louis Vuitton
creation (left hand side). On the right is an example of the new skirt length from Marc Jacobs’ collection:

Another major trend for A/W 2010 (as I now call it), is for “Aviator” jackets - Burberry are big here. I
don’t know whether there’s any subtle link here to the economy or the stock market, but I don’t see the
attraction of wives and girlfriends looking like Biggles.

© Thunder Road Report - 6 September 2010 14

 If they want to go with a flying theme, the answer is patently obvious:

Source: the recent Virgin Atalntic advert

“Air hostess chic”, it wouldn’t be a bad thing. That’s the problem with the “fashion gods”, sometimes they
just don’t get it.

I bet you didn’t know this, but according to the editor of Elle magazine, Lorraine Candy:

“An Elle girl stands out because she has an INNER BAD GIRL (my emphasis) who’s drawn to
clothes that make a spirited statement.”

The latest edition of Elle has a separate “Autumn/Winter 2010 – Style For Less” magazine. Here are a few
sound bites:

BB “Simple, and, above all, wearable – this is Autumn/Winter 2010”;

BB “Chiffon or silk blouses in soft colours will work the tonal and the 1970s trends”;

And it couldn’t get much clearer than this:

BB “We’re going down…Put your minis away, a new length of skirt has arrived. Less 1950s Mad
Men, more 1970s schoolmarm, the a/w hem should hit the centre of the calf.”

So more confirmation from the pages of Elle, but with my new found curiosity for the “inner bad girl”, I
found this blog entry from Elle’s Executive Fashion Editor, Stacey Duguid, on 3 September 2010:

“We are not teenagers, we are not easily marketed to, we are grown women and we will not be told to wear
colours that don’t suit us. Several hours later, having dismounted my high horse, a thought occurred; I’d
spent a month scouting for camel, khaki, and stone coloured blouses, I had become obsessed with finding
the ‘right’ coloured 70s denim skirt, I suddenly needed mustard in my wardrobe and I despise mustard.

© Thunder Road Report - 6 September 2010 15

 Where had this colour fanaticism come from and why was it suddenly OK to wear colour-draining camel
and stone?  So here I am, wearing all the colours I had never considered before thanks to Celine, Max Mara
and Tommy Hilfiger and I’m way over 30 by the way...The Camel Coat - they’re everywhere and yes, you
should own one and it probably should be by the king of the camel coat, Max Mara, and possibly styled in
the manner of a 70s mum.”

In shoes, the inspiration is slightly more recent according to Stacey:

“It’s goodbye unwearable, unwalkable, unbearable shoes and hello low-heel-height court shoes!  As worn
by office workers and police officers alike, the sensible court shoe has been off the fashion radar since the
eighties but it’s back for autumn”

Unfortunately, she was keeping her inner bad girl under wraps in the blog piece. But from Stacey to Sandy
and I reckon the latter was definitely an Elle reader:

Source: Grease, the movie from Paramount Pictures

I said to my wife that the most important items in her wardrobe are black boots, which come to just
below the knee, and a pair of black hold-up stockings and she could dispense with all the rest…literally.
Her dismissive comment was that “All men are amoebic” but I still don’t understand her point. Along with
flashbacks to my teenage years, however, I suddenly had a profound insight into the “inner bad girl” – any
time you try too hard to find it, you’ll be disappointed.

I hadn’t seen my former Warburg colleague, Russ M., for 13 years until I bumped into him at Killk & Co.’s
Summer party (thanks for inviting me guys…and thanks to NYC brokerage Dahlman Rose for an excellent
dinner with their clients). Russ’s wife is a fashion merchandiser for one of the leading UK high street
clothing chains and this is her summary of current trends:

COLOUR: Camel, lots of bright reds, yellows

SKIRTS: Generally long, full-length

TROUSERS: Making a big comeback but very short shorts big this A/W as well as the full length versions

I thought this was fascinating because it also suggests some CONFLICTS which I hadn’t considered while
reading through the fashion magazines. For example, the reds/yellows against the more staid camel and
very short shorts versus full length skirts (and the “leg-lengthening trousers as I now know they’re called).
And before anybody emails me, yes it did occur to me that I might taking this all a bit too seriously. I always
do.

I had a wander round the Bond Street luxury stores in London - I think paid up luxury goods and retail
analysts call them “store visits”. It was a Thursday morning about 11am, so not a time that you’d expect
lots of customers and they were very quiet. LVMH was clearly the busiest, but why a 8-foot giraffe with

© Thunder Road Report - 6 September 2010 16

 jewelled hooves wearing a neck scarf had pride of place in the shop window is somehow in keeping with
the brand, God only knows:

Sometimes I feel intimidated going into these stores and this time was no different. Some of the store
assistants look you up and down and not in a positive way. The security people in the big stores like LV and
Prada wear black suits and ear piece communications like they are members of the secret service.

I was walking round these shops in faded jeans and my “Abersoch Sailing School” T-shirt. Dogged by
insecurity, I had even purchased a copy of the Financial Times – for camouflage rather than any cutting
edge market insight obviously - hoping to pass myself off as a disaffected hedge fund manager. I suppose I
am…kind of…but trading my own (v. small) portfolio from sunny Balham instead of swanky Mayfair. In terms
of the fashion trends, the camel-coloured (the “new black”) clothes were in evidence and other 1970s-esque
stuff like long coats. But I didn’t see many of the calf length skirts on this occasion – presumably they are
coming to a store near you very soon as the A/W stuff displaces the previous season stock.

For what it’s worth, summing up the BIG PICTURE from this foray into the world of fashion and luxury
goods:

BB If we take the The “Hemline Indicator” at face value, it’s obviously indicating a decline in the economic
outlook and a better than average chance of a decline in the stock market.

BB There seems to be some trends which are in CONFLICT with one another. This seems to capture the
current debate in the markets perfectly, e.g. growth versus double dip, inflation versus deflation, etc.

BB I’m fascinated by the return of 1970s trends as it fits my view perfectly – bad economic performance
with inflation eventually prevailing over deflation thanks to the “monetary drug dealers” in governments
and central banks.

With regard to the European luxury goods sector itself, it strikes me that it is at an interesting juncture. If
you look at some of the share prices, Burberry, Richemont, LVMH, Hermes and Swatch are all close to their
highs. In contrast, US peers like Coach, Tiffany and Polo Ralph Lauren are c.10-15% off their May-June
peaks.

Bullish points include:

BB There was STRONG momentum in the first half of 2010 and results were generally excellent and beat
expectations, except for outliers like Hugo Boss. If we look at LVMH, it reported a 53% rise in net income
to Eur1.05bn, which was well above Bloomberg’s consensus of Eur 956m.

BB Taking LVMH as the example again, organic sales growth was 15% in Q209 and reportedly continued
at the same rate through July. Nomura is assuming organic sales growth of 10.6% for full year, which
already factors in a marked H2 slowdown. This is justified in part from tougher comparisons and less
benefit from inventory rebuilding. However, it strikes me that there might still be some room to upgrade
2010 estimates.

BB With stock markets holding up and bond markets surging, the VERY rich are in good shape to keep
spending…shame about all of us less fortunate souls!

On the bearish side:

BB A Nomura luxury goods report recently showed how the rolling 12-month forward PE multiple at 17x for
the European sector is down from the 20x seen a few months back. At a 70% premium to the market,
however, it remains very close to its all time high;

BB There is usually a reasonably good correlation between the global leading indicator, which is currently
turning down, and the relative performance of the luxury goods sector. Weakness in the important
Japanese economy doesn’t bode well either;

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 BB From a Reuters report on 24 August 2010: “The Spectrem millionaire investor confidence index fell
to its lowest level in more than a year in August as wealthy U.S. investors worried about politics and
unemployment, according to Spectrem Group…The move returns the index to mildly bearish territory
after 12 straight months in neutral…At the same time, the Spectrem Affluent Investor Confidence Index,
which measures the outlook of households with $500,000 or more in investable assets, fell 4 points in
August to -20, its third-straight monthly decline.”

BB I also have half an idea that if the “fantasy element” of the latest catwalk fashion is being ratcheted back
(as per Vogue comments), there will be less differentiation between the luxury brands and the better
quality high street brands going forward. Consumers (except for the ultra wealthy) might be less inclined
to pay substantial premiums when the outlook is so uncertain.

What I find most difficult to gauge, however, is the likely purchasing trends of affluent Chinese consumers
in the short-medium term. In fine wine, they seem to have bought up all the Chateau Lafite that’s been
offered for sale anywhere on the planet! The Liv-ex “Claret Chip Index” of top-rated Bordeaux first growths
is up over 40% in the last 12 months:

The Claret Chip Index (1-year)

Source: Liv-ex

If multitudes of rich Chinese suddenly decide that, say, Burberry for example, is THE must-have brand, the
prospects for a company could improve dramatically. On balance, however, I’m not going to put any new
money into this sector right now - even LVMH which remains my favourite and is the cheapest of the major
European stocks which are taking market share (the others being Burberry and Hermes). My guess is that
these stocks will see their price relative peaks around the time of the Q310 earnings season.

Rare Earths - going to war

If you throw enough darts, metaphorically speaking, one of them will inevitably land in the “Treble Twenty”
– and so it seems with rare earth stocks since the last Thunder Road Report (continued on next page).

© Thunder Road Report - 6 September 2010 18

 The world’s greatest sportsman, Phil “The Power” Taylor (15 times World Champion)

The timing was good, but I have to acknowledge the pioneering work of the “original rare earth bug”, the
one-and-only Jim Dines, who identified this sub-sector before most people knew what rare earths are. Rare
earth prices, which were already on a rising trend, have surged since China announced substantial cuts to
export quotas on 8 July 2010.

Rare earth prices 2008-10 (US$/kg)

Rare earth oxide Mount Weld 2008 2009 1Q10 21/6/10 6/9/10
Lanthanum oxide 25.5% 8.71 4.88 6.08 8.10 39.00
Cerium oxide 46.7% 4.56 3.88 4.46 7.00 39.00
Neodymium oxide 18.5% 31.90 19.12 27.56 34.50 75.00
Praseodymium oxide 5.3% 29.48 18.03 26.13 34.50 70.50
Samarium oxide 2.3% 5.20 3.40 3.40 3.40 32.40
Dysprosium oxide 0.1% 118.49 115.67 156.50 210.00 286.00
Europium oxide 0.4% 481.92 492.92 512.40 520.00 605.00
Terbium oxide 0.1% 720.77 361.67 478.90 506.00 620.00
Avge Mount Weld price 14.87 10.32 13.13 16.72 50.52

Source: Lynas Corporation

The Chinese Ministry of Commerce cut back its latest batch of export quotas for 2010 by 58%. For 2010 as
a whole, the export quota of 30,258 tonnes is a 39.7% reduction on the 50,145 tonnes level in 2009. At the
same time, the Chinese are taking steps to unify pricing and reduce competition by establishing “a unified
transportation and sales system and are expected to consolidate production into 3-5 conglomerates in the
long term.” Reuters quoted China Daily as saying:

“China’s central government plans to publish monthly prices for rare earth metals to avoid producers
engaging in cut throat competition.”

Dudley Kingsnorth of Industrial Minerals Company of Australia (IMCOA) outlined the consequences:

“Chinese rare earth export quotas are now significantly less than rest of the world consumption. The quotas
for 2010 total 30,250t REO (rare earth oxides – Paul) compared with ROW forecast demand of 50-55,000
t. Total ROW production capacity is currently 10-12,000 t at best, which indicates a shortfall this year of
10-15,000 t at least.”

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 According to China Daily, the plan for the unified pricing mechanism covers five provinces, Fujian, Jiangxi,
Guangdong, Hunan and Guangxi. What I thought was very interesting was Gareth Hatch’s (of Technology
Metals Research) point that the five jurisdictions to be combined into a unified pricing system are all in the
southern part of China. Industry estimates suggest that around half of the rare earth mines in southern
China are unlicensed and up to one third of export volumes from the region were smuggled out of the
country illegally. It is these regions which produce the majority of the “heavy” rare earths (like dysprosium,
europium and terbium), with most of the light rare earths being produced in Inner Mongolia in the north.
As Gareth noted:

“It would thus appear that the change is an attempt by the authorities to specifically control the prices of
the more valuable heavy rare earths.”

If this was the idea, it has backfired somewhat. While the prices of the heavy rare earths have also risen
sharply since the announcement, the price rises of the light rare earths have far outstripped them. It seems
that profit-maximising Chinese exporters have reduced sales of the light elements in favour of the higher
added value heavier rare earths. Responding to the Chinese action, the US lobbyist Jeff Green noted that:

“This is exactly the situation we’ve been warning the US government about for several years…and will very
likely lead to a strong political response from the US over the next 12-24 months.”

It didn’t take 12-24 months, the US and Japan are already whinging about the Chinese move. While China
now controls over 95% of world production, the US has only itself to blame for its cataclysmic decline
from being the world’s largest producer. During the China/Japan economic discussions in Beijing in the last
week of August, Japanese foreign minister, Katsuya Okada’s, protests were rebuffed according to the Daily
Telegraph (thanks Dylan G.):

“China’s commerce minister Chen Deming said that Beijing would not back down over the export quotas.
‘Mass-extraction of rare earth will cause great damage to the environment, that’s why China has tightened
controls,’ he said, repeating the official line.”

The US is trying to establish that China is breaching WTO rules by giving preferential treatment to domestic
companies. Even if the US gets some traction on this, the Rare Metal Blog made the following observation:

“Most outside of China believe that the environmental protection argument holds little credibility in the
defense of export controls, which only serve to create distinct price advantages for domestic end-users and
manufacturers. However, production controls, which limit the annual amount of rare earth production and
are also currently applied by the Chinese government, do not create the same unequal economic conditions
as export controls and have been recognized in other industries as acceptable under the WTO. Assuming
the dispute settlement panel does find China’s export controls to not be in accord with WTO rules, it is very
likely that China will shift towards greater reliance on production controls. Such a change would satisfy the
WTO by creating a more level playing field for domestic and international purchasers and allow China to
escape financial penalties or the imposition of countervailing duties. It would also allow China to maintain
control over the primary supply and global prices for many raw materials, including rare earths.”

My sense is that the Chinese have embarked on a trade war - and a very clever one indeed:

BB They have an almost total monopoly on both the mining of rare earths and downstream processing
capability. It’s going to take western nations years to catch up obviously;

BB Hypothetically, if China sought to benefit in the same way from an equally dominant position in something
like beer, bread or bras, all (fairly) vital to everyday life, billions of people would already be VERY p*ssed
off. There would be demonstrations, Obama would be droning on from his autocue and it would be all
over the media. In the case of rare earths, 99% of people don’t even know what they are, never mind
appreciating how vital they are in things we take for granted like iPods, mobile phones, laptops, flat
screen TVs, etc.
However, it seems that China’s intent to stiff the rest of the world on rare earths might be more longstanding

© Thunder Road Report - 6 September 2010 20

 than I realized. I’d read the alleged quote attributed to Chinese leader Deng Xiaoping that:

“There is oil in the Middle East, but there is rare earth in China”

Recently I read Cindy Hurst’s report “China’s Rare Earth Elements Industry: What Can the West Learn?”
published by the Institute for the Analysis of Global Security. Cindy’s day job is being an analyst for the
US Army’s Foreign Military Studies Office. Ms Hurst quotes the Deng comment and notes that he made it
in 1992 – so maybe it is true.

The report is also interesting because it puts an entirely different slant on Chinese oil company CNOOC’s
attempted US$18.5bn acquisition of US oil company, Unocal, in 2005. While the US blocked the deal on the
grounds of energy security, Ms Hurst speculates that the real motivation behind the takeover bid was to
take control of the Mountain Pass rare earth mine – then owned by Unocal (and recently listed as Molycorp
on the NYSE). Last year, China failed in an attempt to take a controlling 51.6% stake in Lynas Corporation,
but did take 25% in Arafura Resources – both Australian-based rare earth developers. On 9 August 2010,
the East China Exploration & Development Bureau took a 51% stake in Northern Uranium, a uranium and
heavy rare earth exploration company in…Australia (again). In military jargon, I think this is called “full
spectrum dominance”.

If China refuses to back down on exports, the question is how long a drawdown in inventories can persist
until we reach a “crunch point” in supply. According to industry consultant, Jack Lifton, there will be a
period of calm before what could be a storm:

“In the short-term, the end-users’ supply of rare earth metals and alloys from China will not be affected
because they have been building inventory in Japan, the majority (sic) direct user of rare earths outside
China.”

With tiny amount of rare earths needed for iPods, mobile phones, TVs and computers, I wonder if anybody’s
told Apple’s Steve Jobs what’s going on? When I was a mining analyst and there was a global shortage of
the huge tyres used on the giant trucks and earth movers back in 2006-08, I was told that BHP Billiton had
approached a reluctant Michelin and told its bosses that if they didn’t build new capacity their company
would be taken over. I wrote that last comment several days ago and then saw this on the Rare Metal Blog
on Sunday:

“I think we will be in the late innings of this story, when finally a tech company or a conglomerate
of tech companies finally (sic) reach upstream to secure their supplies of REEs. The lack of
vision that J. Lifton is always talking about really is astounding, but I guess that makes it a
good potential investment. They could have a 50 year secure supply of materials for a rounding
notation on a lot of these companies’ balance sheets, and yet it still goes unaddressed.”

In June, Alaskan senator Lisa Mekowski introduced a bill aiming to re-establish a competitive rare earths
industry in the US - the “Rare Earth Supply-Chain Technology and Resource Transformation (RESTART)
Act”. This is similar to legislation introduced to the House by Republican Representative, Mike Coffman, in
March this year. The US Government Accountability Office (GAO) published a report on 14 April 2010 which
highlighted the near-term need for a sustainable supply chain of rare earths in the US for critical American
national defense and industrial applications.

The two western producers with projects at an advanced stage both have deposits skewed heavily towards
light rare earths. Lynas Corporation’s Mount Weld deposit has a heavy-to-light rare earth ratio of 5%-
95% and recently IPO’d Molycorp’s has a 9%-91% ratio. For this reason, I bought some shares in Ucore
Rare Metals, which is a much earlier exploration play, but does have a heavy-to-light ratio of 50%-50%.
Its deposit is also on, or rather under, US soil in Alaska. Last Thursday, the company issued the following
announcement:

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 “the United States Geological Survey (USGS), a division of the US Department of the Interior,
has moved to increase its involvement at the Company’s Bokan Mountain Heavy Rare Earth
project in Southeast Alaska…the USGS has now sent a team of geoscientists to Bokan for the
purpose of advancing the US government’s understanding of the area’s unique Heavy Rare
Earth (HREE) mineralogy, believed to be the largest historically documented HREE deposit in
the United States…Of particular interest are terbium and dysprosium, which are among the
most scarce and valuable metals in the world, and which have been found in anomalously high
grades in the Bokan area. ‘The U.S. government is quite interested in these minerals because
they are of military importance,’ said Dr. Mariano. China has moved to decrease the export of
these essential metals to the U.S. and elsewhere, thereby increasing interest in securing short
and long term domestic supplies within the U.S.”

The timing of the Ucore announcement is interesting since we have the prospect of another positive
catalyst for rare earth stocks coming in September. The US Department of Defense is due to publish its
assessment of its dependency on these elements by the end of this month. For a country which spends
the same amount of money annually as the rest of the world combined, has 737 overseas military bases in
60 countries, and is at war, it’s hard to imagine it is going to take any risk with regard to supply. Two key
findings from the GAO’s study of rare earths were:

BB The use of rare earths in defense systems is widespread including precision-guided munitions, lasers,
communications systems, radar systems, avionics, night vision and satellites;

BB The US military began to recognise the rare earth supply issue as long as seven years ago, but did
nothing about it. The Air Force’s Materials and Manufacturing Directorate prepared a report in 2003
which raised concerns about the dependency on China. In 2006, the Navy considered funding Molycorp’s
Mountain Pass mine, but subsequently lost interest.

In broader terms, the GAO report also highlighted that mining rare earth ore is merely the first step in a
number of downstream processing steps:

BB separating the rare earth ore into individual rare earth oxides;

BB refining the rare earth oxides into metals; and

BB forming the metals into rare earth alloys.

In her report, Cindy Hurst remarked:

“Dr John Burba, Chief Technology Officer at Molycorp Minerals, the company that runs the only rare earth
mining operation in the US pointed out that, ‘a lot of people don’t quite understand why rare earth operations
are different (from other mining operations)’. Mining gold, for example, is a much simpler procedure than
mining rare earth elements. One method of processing gold ore, simply put, is to mix the ore with sodium
cyanide. The gold is then leached right out. Rare earth metals are far more complicated and costly to
extract…Each element has its own unique extraction steps and chemical processes and at times, these
elements will require reprocessing to achieve the ideal purity.”

According to the GAO “refined rare earth metals are almost exclusively available from China”. Lynas
Corporation, for example, is developing a rare earth processing facility in Malaysia and Molycorp is also
pursuing an integrated strategy. I searched for a junior rare earths play with reasonable exposure to the
more valuable heavy rare earths while also having downstream processing expertise. At the end of my
search, I bought some shares in Canadian-listed Great Western Minerals Group (GWG) and “as giraffes say,
you don’t get no leaves unless you stick your neck out”. In darts throwing terminology, the GWG purchase
is an “UNDERSTACKER”.

GWG has a fully diluted market cap of US$81m and owns the rights to 100% of the production from the
Steenkampskraal deposit in South Africa which should be in production in 2013. This project is a past-
producing mine and will only require about US$30m of capital expenditure – a VERY big positive in my

© Thunder Road Report - 6 September 2010 22

 view. Coming behind this deposit, CWG has four further exploration projects, three in Canada and one in
the US. Hoidas Lake, in Saskatchewan, Canada, is the most advanced of these and CWG estimates that
it will require c.US$115m of capital expenditure but could be onstream in 2015. Due to a combination of
high ore grade in the case of Steenkampskraal, for example, or due to very high levels of heavy rare earths
themselves in the case of the Douglas River deposit (also in Saskatchewan), the investor presentation
argues that GWG’s revenue per tonne of ore will compare favourably with its peers.

The President and CEO of CWG, James B. Engdahl, was interviewed on Jim Puplava’s Financial Sense news
hour a few weeks ago. He also emphasised the importance of processing the mined rare earth ore:

“There is a tremendous process downstream in this whole rare earth business and that’s one
of the things that the market also doesn’t understand. Most of these other companies outside
China, the only thing that they have is a deposit. They do not have the downstream processing
capacity, which is one the things which makes Great Western unique outside China. We have a
plant in England and we have a plant in Michigan, both of which are capable of processing oxides
into powders and making alloys and metal materials.”

And discussing the vision of the company’s Executive Chairman, Gary Billingsley, Engdahl commented:

“He also understood that you couldn’t just get into mining, because there was a high probability
that just mining itself wouldn’t make money. And that’s one of the things we’ve been focusing on,
a fully integrated mine-to-market model…the project we have in South Africa, Steemkamskraal,
it will produce only about 2,700 tonnes based on the historical resource calculation over the
next ten years, but we think there’s a high probability of expanding that…we will take that
material and separate it in South Africa and we’ll process it at our plant in England and we’ll
sell it then to the end users…from the mine to the market, to the end users, 2,700 tonnes will
generate for us about S$160m in revenue and about US$65m in cash flow. But only 15% of that
is attributable to the actual mining entity, the rest of it is all downstream.”

The fully diluted market capitalisation of GWG is currently US$81.4m (US$0.28 x 290.8m shares), net cash
is about US$2m, but the capital requirement for Steemkamskraal, is VERY modest as I emphasised.

I’m waiting to see what the US Department of Defense comes up with later this month. I can’t see how they
can disagree with the US military’s Cindy Hurst:

“With so much at stake, it is imperative that the US develop methods to acquire a secure, long-
lasting source of rare earth elements.”

© Thunder Road Report - 6 September 2010 23

 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.

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.

© Thunder Road Report - 6 September 2010 24