David A.

Rosenberg December 1, 2009

Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

WHILE YOU WERE SLEEPING
IN THIS ISSUE
Global equity markets are back on track as the “constructive” Dubai debt
restructuring plan gets underway. The MSCI Asia-Pac index closed with a 1.4% • While you were sleeping —
gain and is now back at a five-week high. global equity markets are
back on track; positive
economic data overseas
Commodities are rallying too with oil up for the second day in a row and copper
strengthening on the back of some solid manufacturing PMI data overseas: • How can the recession be
China’s PMI is hot, at 55.7 from 55.4 in October, the best PMI reading in 18 over? Out of the 4
economic indicators that
months; Europe’s PMI is inching up, now at 51.2 from 50.7 — and raising hopes of the NBER uses, only 1
a similar lift today in the USA. looks to have remotely put
in a discernible bottom
On the economic data front, India just posted a ripping 13.9% annualized real
• Chicago! The Chicago PMI
GDP growth rate for Q3. Car sales in France soared 48% YoY in November on did improve in November,
the back of the country’s own version of argent-pour-voiture. Germany’s jobless but this diffusion index is
rate fell in November, to 8.1% from 8.2% in October and this came as a surprise spotty at best in terms of
too; and retail sales rebounded 0.5% in October (in line with consensus). U.K. predicting the ISM
home prices rose 0.5% in November (Nationwide survey) — the seventh gain in • Some major non-
as many months. Korean exports rose last month for the first time in over year. confirmations; railway
It’s a boom (not really)! carloadings, electricity
production, tax revenue,
Needless to say, the U.S. dollar is being sold off and the ‘carry-trade’ is back on and bank lending, just to
name a few are down
with the resource-based currencies, each with massive net speculative long
year-over-year
positions, rallying hard today (the New Zealand Kiwi is up 1.7%; the Aussie dollar
firming by 1.3% as the Reserve Bank of Australia hiked rates again, to 3.75% from • U.S. retail sales update —
chain-store sales in
3.50%). The mighty Yen is also being trounced along with the resumption of global
November did not look
risk trades, though the announcement from the Bank of Japan that it is going to that great and auto sales
provide $15 billion of basically free cash to the commercial banks as a response appear to be down on the
to the latest bout with deflation has also played a role (the Yen was looking very month
toppy going into today’s action). • Goldberg, not Rosenberg;
we remain long-term gold
Outside of JGBs (6bp rally today, to 1.18%), bonds are giving up a lot of ground this bulls, but we could get a
morning. The DXY index is down some 27bps and at 74.527 is closing back in on meaning correction at any
the nearby low; a break below 70 means there is no support for the U.S. dollar time
(one reason why gold has tacked on nearly $18/oz today as it pierced the • Not a bad time to be
$1,200/oz threshold). The latest tick down, however, in the Baltic Dry Index thinking income
provides one key source of non-confirmation to this latest upsurge in the
• Strong demand in Canada
commodity complex. We are bulls on the resource sector, but for the time being,
we are nervous bulls. • Producer deflation in
Canada continues

Please see important disclosures at the end of this document.

Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms. Founded in 1984 and focused primarily on high net
worth private clients, we are dedicated to meeting the needs of our clients by delivering strong, risk-adjusted returns together with the highest
level of personalized client service. For more information or to subscribe to Gluskin Sheff economic reports, visit www.gluskinsheff.com
December 1, 2009 – BREAKFAST WITH DAVE

Meanwhile, the markets seem oblivious to the growing crisis in U.S. commercial
real estate, where the default rate just doubled in Q3, to 3.4% (and up 52bps from The markets seem oblivious
Q2) with vacancies on the rise and rents on the decline. This shoe is already to the growing crisis in U.S.
dropping for the banking system. commercial real estate

As for residential real estate, the White House is now moving more aggressively to
force lenders to modify mortgage loans, which can only mean that principal
reductions are coming hard and fast and this in turn means … more write-downs
are on there way. Caveat emptor when it comes to the U.S. financials, a sector
that already looks very toppy — see page B3 of the NYT — Treasury Presses
Mortgage Lenders for Payment Relief.

Overseas, the next worry spots range from sovereign credit risks in Greece, to
fiscal stress in the U.K. and Ireland, to signs of a property bubble in China, to a
severe debt refinancing calendar in Russia and many the Baltic states. In the U.S.,
try the burgeoning losses at Fannie and Freddie, not to mention the FHA’s razor-
thin reserve cushion and the inevitable need for a taxpayer bailout. Dubai was
very likely NOT the last in the series of post-credit-bubble aftershocks.

HOW CAN THE RECESSION BE OVER?

There are four items that go into the NBER recession call:
1. Employment
3 of the 4 economic
2. Real personal income excluding government transfers indicators that the NBER
3. Industrial production uses to access business
cycles are still in decline
4. Real sales

Three of these four indicators are still in decline — only industrial production looks
to have even remotely put in a discernible bottom. Employment was down 0.1%
MoM in October after dropping 0.2% in September; real organic income dipped
0.03% to a new cycle low in October after a more visible 0.2% decline in
September; and we just now got the real manufacturing/retail/wholesale trade
sales data for September and they showed a 0.2% drop in September after a
similar falloff in August.

So, it begs the question as to how a recovery has started with just one limb
So how can a recovery start
hanging on the body. Just because the equity market is up more than 60% from
with just one limb hanging
the lows by no means suggests that this is some official arbiter of how the real on the body?
economy is shaping up. Remember, it was the same equity market hitting new
highs through the first ten months of 2007, seemingly oblivious to the fact that the
worst economic downturn in seven decades was merely a few weeks away.

HOW CAN THIS NOT BE A DEPRESSION?

One in every eight Americans …
• With a mortgage are either in arrears or in the foreclosure process
• Are unemployed or underemployed
• Are on a food stamp program

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December 1, 2009 – BREAKFAST WITH DAVE

Wall Street and Main Street are on opposite sides of the planet right now. Have a
read of the op-ed article today on page A15 of the WSJ (Working Two Jobs and Still
Underemployed).

CHICAGO!
The Chicago PMI did improve to 56.1 from 54.2 in October (as did New York,
Dallas, Kansas City, Cincinnati and Milwaukee!). But this diffusion index is spotty
at best in terms of predicting ISM, and ISM itself is currently not reliable given that
it is biased towards large companies and it is small business that is cutting back
on spending activity and is having trouble accessing capital.

CHART 1: SMALL BUSINESSES HAVING TROUBLE ACCESSING CAPITAL

United States: National Federation of Independent Business Survey:
Percent Reporting That Credit Was Harder to Get
(percent)
16

12

-4
98 99 00 01 02 03 04 05 06 07 08 09
Source: Haver Analytics, Gluskin Sheff

Going back to 1974 (the history for the National Federation of Independent
Business (NFIB) optimism index), on average, when the NFIB is around the current
level of 89.1 (as of October) ISM is usually at 44.0 (currently at 55.7 in October).
So in essence, the NFIB index is currently trading as if ISM is 44.0, not 56.0.

Not only that, but during expansions, the NFIB index averages 100.2; during
recessions, the NFIB, on average, is at 92.2. The NFIB is currently at 89.1, so this
notion that we are out of recession seems to be at odds with a lot of other
information out there outside of a 65% rally in the equity market.

SOME MAJOR NON-CONFIRMATIONS

• Railway carloadings and electricity output down 5.0-7.0% YoY
• Mortgage applications for home purchases down 15% YoY
• Tax revenues down more than 10% YoY
• Bank lending down 6% YoY
• Financials peaking out nearly two months ago and rolling over
• Divergences in both the small-cap stocks and emerging markets

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December 1, 2009 – BREAKFAST WITH DAVE

• Major topping formation in the transports despite Warren Buffett’s foray and
lower energy prices (triple-top in the transports-to-utilities ratio?)
The U.S. consumer still looks
to be on pretty shaky terrain
• Bond yields below their 200-day moving average.
• Real rates (10-year TIPS yield) all the way down to 1.10% (from 1.5% barely
over a month ago).
• Baa spreads widening 15bps from nearby lows and by 25bps in the high-yield
market.
RETAIL SALES UPDATE
U.S. chain-store sales in November did not look that great but we will find out more
on Thursday. As for auto sales for the month, Edmunds.com is calling for 10.34
million at an annual rate, which would translate into a 10% decline from October’s
tally. The U.S. consumer still looks to be on pretty shaky terrain. The official U.S.
retail sales data will be released on December 11.

Note that one giant wild card in this Friday’s U.S. nonfarm payroll report (which
everyone has upgraded post last week’s claims data) is retail employment. This is
the sector’s largest hiring month of the year and if there is anything we know with
certainty, it is that merchants went into this season deliberately mean and lean.
This may end up being a large swing factor that could cause the data to line up on
the soft side, irrespective of the seasonal adjustment factor.

Note that while this is still early days in the holiday season, Cyber Monday was
very mixed — more eyeballs than a year ago (+16%), but less $$$ per buyer (
-12% per sales ticket). This was much like Black Friday at the malls — total
traffic was up but the average purchase was down 8% to below 2007 levels
(average of $340 per shopper). Also note that the giving spirit is being
negatively affected by the ongoing frugality too — only 21% of business owners
are planning to give year-end bonuses this year versus 44% last year, as one
example (see Rethinking Holiday Perks on page B7 of the WSJ).

GOLDBERG, NOT ROSENBERG

Gold just capped off its best month in a year — up 14% in November and 34% so
far in 2009. Not even the S&P 500 can compete with that. Helping drive the Gold just capped off its best
month in a year — +14% in
latest gains was the news out of the China Gold Association that the country’s gold
November and 34% year-to-
demand is on pace this year to exceed 450 metric tonnes, a 14% increase over
date
the 395.6 tonnes in 2008. (In contrast to India, jewelry sales are up double-digits
in China so far this year.) By way of comparison, China, which recently surpassed
South Africa as the world’s largest producer, is on its way to 310 tons of newly
mined output this year, or more than 30% below its level of demand.

It’s not just the middle-class in China that is starting to buy gold, but the central
bank, which has very deep pockets, is going to do likewise. We just came across a
Bloomberg News article quoting an official from the state-owned Assets
Supervision and Administration Commission (Ji Xiaonan, the Chief) as saying “we
recommend China increase its gold reserves to 6,000 metric tons within three-to-
five years and possibly to 10,000 tons in eight to 10 years.” China’s reserves,
after a 76% buildup since 2003, currently stand at 1,054 tons, so we are talking
here about the prospect of some pretty heaving buying in coming years.

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December 1, 2009 – BREAKFAST WITH DAVE

If China were to lift their gold reserves to 5,000 tonnes, which is equivalent to
about two years of global production, that shift in demand would boost the gold Make no mistake, we are
price by $800/oz to around $2,000 ($1,978) based on our models. If China gold bulls; central banks
moves towards 10,000 tonnes, well, that would end up taking the gold price to have deep pockets and
$2,623/ounce if our calculations are in the ball-park. production of gold is
stagnant so the demand-
Make no mistake, we are gold bulls. Central banks have deep pockets and supply backdrop for bullion
production of gold is stagnant so the demand-supply backdrop for bullion is bullish. is bullish
At the same time, we have to pay respect for market positioning over the near-
term. The market for precious metals is overextended right now after the
parabolic move of the past two months. The net speculative long position has
swelled to a record 273,552 contracts (100 ounces each) on the COMEX. Open
interest has never been higher, at 693,661 contracts. So this is one crowded
trade — as is the short-trade on the USD against all the major currencies,
especially the commodity-based units.

So, we could get a meaningful gold correction at any time, and we are talking
about a correction in what is still a secular bull market — the 200-day moving
average is $970/oz, which means we could get as much as a 20% pullback and
no fundamental trendline would be violated. We remain long-term gold bulls,
and our commentary remains fundamentally bullish, but anything that could
spark a countertrend rally in the U.S. dollar, which is our principal near-term
concern, would put gold at a much better price point for investors than the peak
we are at today.

CHART 2: GOLD UP ALMOST 70% FROM THE NEARBY LOW

London Gold Bullion, PM Fix
(US$ per Troy oz)

1200

1100

1000

900

800

700
NOV DEC JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV
09
Source: Haver Analytics, Gluskin Sheff

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December 1, 2009 – BREAKFAST WITH DAVE

CHART 3: RECORD NET SPECULATIVE LONG POSITION IN GOLD

Gold: Reportable Noncommercial Long minus Short Position
(number of contracts)
300,000

250,000

200,000

150,000

100,000

50,000

-50,000

-100,000
95 98 01 04 07

Source: Haver Analytics, Gluskin Sheff

NOT A BAD TIME TO BE THINKING INCOME

Steady as she goes — whether it be in the bond market or bond proxies in the
equity market (ie, large-cap dividend payers). Treasuries have delivered near 8%
returns since the summer (annualized). From the worst levels late last year,
corporate bonds have delivered 35% returns. Within the equity universe, total
returns in utilities from the March low are close to 40% and in the telecom
services sphere, closer to 50%. In both cases, dividend yields are at least
double the rest of the market.

Over the past six months, U.S. investors have put a net $26 billion into equity
funds while plowing $254 billion into bond/hybrid funds, in what appears to be a
secular change in behavior — allocating more cash into the fixed-income market.
This divergence could persist for some time because at last count, less than 7%
of household assets were in bonds and 25% were in equities (and 30% still in
real estate!).

Institutional demand for bonds has been solid too. The Treasury managed to
sell $44 billion of 2-year Treasury notes last week at a record low yield of 80bps.
The average bid-to-cover ratio at the Treasury auctions so far this year has been
2.59 versus 2.19 in 2008 despite a record $1.4 trillion budget deficit. Through
the first nine months of 2009, foreign investors, public and private, have added
more than $400 billion to their holdings of Treasury securities — matching all of
the activity posted in 2008. So much for an international buyers’ strike as far as
U.S. government bonds are concerned.

STRONG DEMAND IN CANADA

The Canadian economy eked out a 0.4% annualized advance in Q3 but that
masked a huge improvement in final demand, which accelerated at a 4.7% annual
rate — the best spending performance since the fourth quarter of 2007. As with
the U.S.A., the “post-downturn” rebound in real GDP was extremely tepid by the
standards of post-WWII cycles (then again, this was hardly a normal recession).

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December 1, 2009 – BREAKFAST WITH DAVE

To put +0.4% in Q3 into perspective, a typical quarter that follows a recession

posts a 4.3% annualized growth rate. Dare we say that the last time we had such
a soft post-recession quarter was in 1980, a double-dip was only a year away?

In any case, the only reason why the GDP headline was not an absolute blow-out
was because imports surged at a 36% annual rate. But outside of commercial
construction, which sagged at a 13.8% annual rate (fourth quarter in a row of
contraction) the Canadian economy is humming along:
• Consumer spending +3.1% at an annual rate in Q3
• Capex +25.6%
• Exports +15.3%
• Residential construction +8.1%
• Renovation activity +11.5%
• Government +7.9%

So while much of Canadian demand was filled with foreign production with
imports soaring, the strength in spending is consistent with improved confidence
levels in Canada across the household and business sectors. The improvement
in the auto sector from depressed levels no doubt helped underpin exports but
this will likely be temporary and import substitution given the strong Canadian
dollar is probably going to be an enduring theme — and is already triggering
some deflation pressure as the final domestic demand price deflator actually
dipped at a 0.4% annual rate after being flat in the second quarter. That was
the first decline in two years and is constructive for the Canadian bond market
as it gives the BoC that much more leeway to stay on the sidelines for longer.

CHART 4: DOMESTIC DEMAND DEFLATOR IS HEADING DOWN

Canada: Final Domestic Demand Implicit Price Deflator
(year-over-year percent change)

15.0

12.5

10.0

7.5

5.0

2.5

0.0
65 70 75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

Page 7 of 11
December 1, 2009 – BREAKFAST WITH DAVE

PRODUCER DEFLATION IN CANADA CONTINUES

Industrial prices in Canada, as measured by the industrial product price index
The trend in producer prices
(IPPI), which is similar to the U.S.'s PPI index, unexpected fell again in October,
in Canada is down
deflating 0.3% versus consensus expectations of a +0.2% MoM gain and on
top of September's -0.4% reading. It seems that the strong Canadian dollar
played a major role in pulling IPPI lower this month as it appreciated 2.6%
versus the U.S. dollar in October. Without the effects of the strong Loonie, IPPI
would have been +0.4% instead of -0.3% MoM. But this has no bearing on the
Bank of Canada's thinking as it already stated that the “persistent strength in
the Canadian dollar” is going to “subdue inflation pressures”.

Nonetheless, the trend in producer prices in Canada is down. On a year-over-

year basis, IPPI is deflating at a 6.3% rate, which is not that far off from the
record -7.1% rate seen three months ago. And, excluding energy (petroleum
and coal products), which rose 1.6% in October, partially reversing the 2.6%
decline in September, IPPI fell 0.5% MoM in October and is now flat or
deflating seven months in a row. On a year-over-year basis, IPPI excluding
energy is deflating at a record 4.5% rate in October. Of the 21 major groups,
over 70% are either down or flat on the month.

As for the raw materials price index (RMPI), it rose 2.5% MoM in October
reversing the 1.0% decline in September. The increase in this index was
mainly due to mineral fuels, in particular crude oil. The year-over-year rate for
RMPI is becoming less negative, at -7.6% in October compared to -21.4% in
September and -34.5% just three-ago; however, there seems to be no flow-
through to the later stages of production: the price index for intermediate
goods is 0% and finished goods is deflating at a 0.7% rate.

Overall, all this attests to our deflationary theme for finished goods and hence
the income-heavy tilt to our investment strategy; and the inflation that is
centered in primary production due to Asia’s secular growth dynamics also
leaves us with an overall constructive stance on the resource sector.

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December 1, 2009 – BREAKFAST WITH DAVE

PRICES OF CAPITAL EQUIPMENT IN CANADA DEFLATING — GREAT NEWS ON

A PRODUCTIVITY STANDPOINT
Within the IPPI report produced by Statistics Canada, we saw that prices for
capital equipment continues to fall, down 1.0% in October, which makes it the
seven months of consecutive declines — a streak we last saw in mid-2004.
This bodes well for companies to investment in capital equipment, which in
turn could potentially increase productivity.

CHART 5: PRICES OF CAPITAL EQUIPMENT DEFLATING —

GOOD NEWS FROM A PRODUCTIVITY STANDPOINT
Canada
(quarter-over-quarter percent change at an annual rate)

40

Industrial Price Index for

30 Capital Equipment

20

10

-10

-20

-30
Business Investment in
Machinery & Equipment
-40

-50
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Haver Analytics, Gluskin Sheff

Page 9 of 11
December 1, 2009 – BREAKFAST WITH DAVE

Gluskin Sheff at a Glance

Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms.
Founded in 1984 and focused primarily on high net worth private clients, we are dedicated to the
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investment returns together with the highest level of personalized client service.

OVERVIEW INVESTMENT STRATEGY & TEAM

As of September 30, 2009, the Firm
managed assets of $5.0 billion.
Gluskin Sheff became a publicly traded
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We offer a diverse platform of investment equities that we sell short. For corporate
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1 September 30, 2009
Income).
The minimum investment required to
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PERFORMANCE
$1 million invested in our Canadian Value
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2 followed and under-appreciated small
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$1 million usd invested in our U.S.
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usd on September 30, 2009 versus $8.7
2
We have strong and stable portfolio
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Portfolio Managers have been with the interests are directly
Firm for a minimum of ten years and we
aligned with those of
have attracted “best in class” talent at all
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levels. Our performance results are those
Sheff’s management and
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employees are
We have a strong history of insightful collectively the largest
bottom-up security selection based on client of the Firm’s
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investment portfolios.
look for companies with a history of long-
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fundamental analysis and our top-down

million usd for the S&P 500 Total
macroeconomic view, with the noted
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