September 2010

Dear Investor,

The US stock market has been fluctuating higher and lower in a broad range for the past four months, after
declining from its high in April. In August the S&P 500 ended near the bottom of that range, and in early
September it rallied toward the upper end of that range. Most global equity markets are in a similar
position; there has been a partial recovery from the declines in the second quarter, but not a full recovery.

While stocks have remained range-bound, other markets have moved significantly in recent months. Gold
has continued moving higher, and silver has recently joined with a new uptrend. Grains and other
agricultural commodities have also moved significantly higher in recent months. However, despite these
positive trends in precious metals and agriculture, energy prices have remained relatively depressed. This
has kept the CRB Commodities Index in the negative so far in 2010.

Another market that has gained recently is the Treasury bond market. The yield on the 10-year reached 4%
in April, but by August it had fallen below 2.5%. The yield on the 2-year Treasury note dropped from a
high of 1.18% in April to below 0.50% in August. While longer-date Treasuries have risen modestly from
their lows in recent weeks, short-term Treasuries remain at their lows of the year.

With stocks off their highs, precious metals rising and Treasury yields falling, it’s clear the market has
priced in a softer economy in the immediate future. The economic data in recent months has confirmed a
deceleration from the growth rates seen in the latter half of 2009 and earlier this year, and there is a distinct
risk that the economy will soften further over the next year. Exactly how much further is the center of
much debate.

What isn’t up for debate is that we remain in the middle of the fallout from the bursting of the housing and
credit bubbles. Some of the effects from the ongoing structural adjustments in the economy have been
masked (or paused) during the past year and a half by government stimulus. However, considerable
imbalances remain, and some of these imbalances appear to be coming to the surface again now that
stimulus programs are fading. The markets continue to reflect this ongoing process.

However, managing investments through this deleveraging process is not as complex an endeavor as it
may seem. The key is to ignore much of the short-term noise and pay close attention to how these periods
have historically resolved themselves. In the following pages we’ll take another step along that path.

Stock Indexes August 2010 Market Indexes August 2010

S&P 500 Index -4.5% -4.6% HFRX Global Hedge Fund Index +0.2% +0.2%

MSCI World (ex USA) Index -3.2% -9.0% US Dollar Index +2.0% +6.7%

Amex Oil Index -5.4% -13.3% CRB Commodities Index -3.7% -6.8%

Gold and Silver Index +9.1% +10.0% Gold (Continuous Contract) +5.6% 13.7%

Sitka Pacific Capital Management, LLC 1 September 2010

 * * *

One of the more vigorous debates going on right now is the back and forth over the prospects for inflation
and deflation. Underlining this debate is the growing awareness that there is a large debt problem in the
US and other developed countries around the world, and there is no easy way out of it.

Unlike previous recoveries from cyclical post-WII recessions, where the economy emerged vigorous and
prepared to grow out of debt incurred during the preceding downturn, it is fairly clear the US economy
reached a pivot point in the first decade of the 21st century. The downturn in 2001 gave way to a
comparatively weak recovery. The downturn in 2007 through 2009 saw the beginning of significant
deleveraging in the private sector, something that hasn’t happened since the Great Depression.

Despite the efforts by the Federal Reserve to revive credit growth, overall credit continues to contract. And
despite the efforts of the federal government to stimulate the economy, it appears the effects of the stimulus
programs on growth will be short-lived. As it becomes clearer that the economy will not grow itself out of
the debt burden in the private and public sectors, there is a growing awareness that the public debt
situation is as unsustainable as the housing market was.

Going forward, the inevitable resolution of this debt issue is probably the most important issue facing
investors today. However, this is hardly a problem that has not been faced before. Societies and
governments have taken on too much debt many times in the past, and the result, often through much
political wrangling and market turmoil, has usually involved significant economic hardship or currency
debasement—or a combination of both.

Many investors today seem to think that the debt problem in the US will ultimately result in high inflation,
as the government attempts to lower the real cost of the debt through printing more money, thereby
causing prices to rise. As prices rise, the relative debt burden decreases.

That has certainly been the basic strategy of the Fed and the government since 1933, when President
Roosevelt first devalued the dollar against gold in an effort specifically intended to get prices rising again.
However, while the manipulation (i.e., devaluation) of the value of money has worked to stimulate the
economy and prices on many occasions since then, it has had much less of an effect this time around.

The reason lies in the amount of credit (i.e., debt) in the economy, which has been building up for decades,
and the fact that the amount of debt it is now decreasing. While the Fed has lowered interest rates to near
zero and offered vast sums to banks and other institutions, private sector lending and borrowing continue
to contract.

This trend of contracting credit is not solely the result of banks being unwilling to lend. Credit contraction
is also a rational response of tens of millions of people and businesses faced with high amounts of debt
backed up by assets that are now worth less than they were at their peak. They are not looking to borrow
more, regardless of the interest rate. Finally, credit contraction and deleveraging is an expected response of
a demographic population bulge headed towards retirement.

While the economy is currently in the grips of deflationary forces as credit continues to contract, this
process will not go on forever. At some point the deleveraging of the private sector will slow down, and
debt levels will stabilize. The main questions are “How far will the deleveraging process go?” and “Where
will the cost be felt?”

Sitka Pacific Capital Management, LLC 2 September 2010

 During the depression, most of this deleveraging process occurred while the dollar was fixed to gold.
Prices fell dramatically as demand for goods and services plunged, and defaults soared. Roosevelt
devalued the dollar in 1933 hoping to change consumer dynamics.

This time around, the cost of deleveraging is felt in the value of the dollar and the value of debt on the
balance sheets of banks and other creditors. The government’s activism in countering the recession has to
some extent blunted the impact of deleveraging by transferring some of the cost to the dollar. Other central
banks have joined in with various stimulus packages and currency debasement processes. This is the
reason gold has reached a new record high, not only as measured against the US dollar, but against many
other currencies as well.

However, just because the value of the dollar has absorbed some of the cost of deleveraging and declined
against gold, this does not necessarily mean inflation is just around the corner. Until the private sector
stops deleveraging, there is very little chance for significant price inflation and surging treasury yields.

Perhaps because we have a vivid collective memory of the 1970s, and because we have not experienced
anything close to deflation in more than 75 years, fears of inflation remain strong today. Adding to the
anxiety is the perception (which, as we’ll see, is not entirely correct) that investment strategies that have
done well in past inflationary periods are almost the polar opposite of those strategies that have done well
in deflationary periods.

During the late 1970s, when prices really started to rise, the value of bonds and the dollar fell precipitously,
and real assets like gold went into a parabolic rise. Although they maintained their nominal price level,
with the Dow Jones Industrial Average fluctuating below 1000, stocks fell dramatically on an
inflation-adjusted basis. Thus, gold did quite well during the inflationary 1970s, while investors in the
dollar and bonds were handed huge losses.

During the Great Depression, stocks fell 90% from their peak in 1929 to 1932, and remained depressed until
the late 1940s. Unlike the 1970s, Treasury bonds and high quality corporate bonds did quite well.

What is less well known is that when

Annualized Returns of Stocks and Gold during Bear Market Periods
you adjust for price changes, some of
the key differences between asset 1929-1948 1966-1982 2000-2010
classes during these different bear (Q2)

markets disappear. S&P 500 (nominal) -2.69% +0.98% -2.6%

This table to the right shows that the S&P 500 (real)* -4.40% -5.62% -4.88%

real return of stocks during the 1970s Gold (nominal) +2.86% +15.19% +15.12%
bear market was actually worse than
during the Great Depression, even Gold (real)* +1.15% +8.59% +12.84%
through nominal stock prices rose
slightly. It also shows that over the past Gold vs. S&P 500 +5.55% +14.22% +17.72%

10 years, the real return of stocks has *Real = Adjusted with CPI
been about the same as these past two
bear markets.

Another key piece of information shown in the table is that regardless of whether a long-term bear market
period is inflationary or deflationary, gold has risen versus stocks. During the deflationary period between
1929 and 1948, even while its price remained controlled by the government, gold rose an annualized 5.55%
a year relative to the S&P 500. Between 1966 and 1982, in the middle of which the price of gold was allowed
to float freely and inflation accelerated, it rose an annualized 14.22% per year relative to stocks.

Sitka Pacific Capital Management, LLC 3 September 2010

 When we look back and see how the markets have reacted in the past to what seem like very different
circumstances, such as a highly inflationary environment versus a highly deflationary environment,
sometimes the decisions we face as investors are simplified to some extent.

The key difference between the Great Depression and the inflationary bear market of the 1970s was not
whether stocks did well (they didn’t), whether the dollar did well (it didn’t), or whether gold did well (it
did), but whether interest rates rose or fell. Although there were certainly varying degrees of relative
performance among the major asset classes between these two periods, the basic relationships between
most of them, with the exception of interest rates, were more or less the same.

* * *

As your investment advisor, our main job is to recognize and remain aligned with these important
long-term market relationships. While we also adjust our allocation to different asset classes based on more
short-term opportunities and risks, these are done with long-term trends in mind.

Just as credit will not contract forever, we will not be in this bear market period forever. However, it is not
over yet, and until it is our overall investment approach will remain unchanged. That includes favoring
real assets that have historically done well during bear markets, such as precious metals, while being
relatively cautious on other asset classes that have historically done poorly, such as stocks.

One of the most interesting aspects of the rally from the March 2009 low has been the near constant
withdrawal of money from stocks by retail investors. Through July, over $33 billion had been withdrawn
from domestic equity mutual funds this year. It appears we have now reached the point where the broader
public is beginning to fall out of love with stocks, which is part of the normal progression of any bear
market.

Since peaking in April of this year, stocks have entered a bearish trend and there is a risk we’ll see more
declines before it is over. Volume has been light, which has allowed stocks to jump around quite a bit.
Moving forward, as more money is pulled out of stocks in the years ahead, we can expect volume to
continue to contract and short-term volatility to increase.

We hope you had a very nice summer this year, and are enjoying the early autumn. If you have any
questions about your account or topics discussed in this letter, feel free to contact us.

Sincerely,
Brian McAuley

Brian McAuley
Chief Investment Officer
Sitka Pacific Capital Management, LLC
investing@sitkapacific.com

The content of this letter is provided as general information only and is not intended to provide investment or other advice. This material is not to be
construed as a recommendation or solicitation to buy or sell any security, financial product, instrument or to participate in any particular trading strategy.
Sitka Pacific Capital Management provides investment advice solely through the management of its client accounts.

Sitka Pacific Capital Management, LLC 4 September 2010