Basic Points June 2009 Bmo Cm

Basic Points Summer Issue Who Will Really Lead the Global Rescue?

June 8, 2009

Published by Coxe Advisors LLC Distributed by BMO Capital Markets

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Don Coxe THE COXE STRATEGY JOURNAL

Summer Issue Who Will Really Lead the Global Rescue?

June 8, 2009 published by

Coxe Advisors LLC Chicago, IL

THE COXE STRATEGY JOURNAL Summer Issue Who Will Really Lead the Global Rescue? June 8, 2009

Author:

Don Coxe 312-461-5365 [email protected]

Editor:

Angela Trudeau 604-929-8791 [email protected]

Coxe Advisors LLC. 190 South LaSalle Street, 4th Floor Chicago, Illinois USA 60603

www.CoxeAdvisors.com

Who Will Really Lead the Global Rescue? OVERVIEW Judging by the stock market performance since March, the green shoots should be as high as an elephant’s eye by the time this text reaches you. The longest-sustained rally in decades caught bears unaware. We hear from clients that the rally is driven by professional investors’ fear that the Pelosi-Obama stimulus might work almost instantly and they’d miss out on the move that would put their clients back on side after the 50% meltdown. Paradoxically, as fund managers fly from fear into stocks, insiders fly from fear to cash. The insider trading reports suggest that corporate bigwigs’ stockholdings are being managed by acolytes of Nouriel Roubini, Nassim Taleb, and David Rosenberg—who were so right for so long about the extent of the housing disaster. Bulls who saw green shoots at a time insiders were green around the gills said, “We have nothing to fear but fear itself.” Problem for bulls: which fear should they fear more: fund managers’ fear of missing The Recession-Ending Mega-Rally or the insiders’ fear that their companies’ miseries are far from ended? The fear that is winning proclaims, “Happy Days Are Here Again!” The opposed fear growls, “That song came out in 1929.” And whatever happened to Greed? Has it been repealed? This has been one of the few times in most institutional clients’ lives when their business is the first order of business for media and governments and social conversations—day-after-day, week-after-week, month-after-month. Everybody wants to know what professional investors think. And nearly everybody wants to hear that the Obama optimism which spread across the land and across the sea is fully justified. As hard as it may be for clients to tear their attention away from screens and screaming front-page stories, we believe this is a time to step back and reflect. This lengthy summer issue is meant to be used along with suntan lotion and gin-and-tonics. Our theme this month is that this one of those rare moments when history is being made without most of its leading participants recognizing that they are collectively reading from the wrong script. With the industrial world in its first serious deflationary downturn since the Depression, the acknowledged leader of the rescue brigade is Barack Obama. That title goes with the lease to the White House. Had John McCain managed to hold his pre-Lehman lead in the polls, then he would now be the Hope of the World.

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But Mr. Obama’s personal claim to leadership is one that would not have been accorded to McCain. He is the most popular American President abroad since Roosevelt. On his European tour, he showed he could draw crowds that were both larger and more enthusiastic than local leaders could pull. (Indeed, even the Germans—the Germans!—have been gripped by Obamamania: the new hot toy there is a stuffed animal that looks like the White House dog.) His domestic poll ratings remain high—and are as high at this stage as G.W. Bush’s, which, thanks to the crisis that followed 9/11, stayed so lofty that Congress backed not only the invasion of Afghanistan but of Iraq. Obama’s the man, and the image he projected of cool centrist as crisis manager was exactly right. But what if America’s economic problems are so serious—and the PelosiObaman remedies are so seriously wrong—that he will not be able to pull his nation—let alone the rest of the industrial world—out of the bog and back into sustained non-inflationary growth? Our fear is that the President’s past enthusiasm for reshaping America from the top down by summoning statist changes from the ground up will push him—and America—into a new adventurism that will ultimately lead to the shift of global economic leadership abroad. We are continuing to reduce the share of US assets in our Recommended Asset Mix. The next stage of the dollar bear market has begun. Have a rewarding summer. Our next issue comes out in 3 months.

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Who Will Really Lead the Global Rescue? Since 1943, the US has been the dominant military and economic power in the world. Although the barefoot Krushchev told the UN he would “bury” the capitalist world, his successors were unable to keep pace with the dynamism of America and resurgent Europe, and Reagan and Thatcher were able to bury Communism alive. In each postwar recession, it was the US that pulled the rest of the industrial world out of its downturns. Not only was the US economy so much larger than any others, including what would become the Eurozone—it remained the centre of innovation, risk-taking and productivity gains. Meanwhile, powerful trade unions were able to retain their stranglehold on most Continental economies even after Thatcher had broken their power in Britain. Trade union veto power on US economic progress waned during the 1970s and shrank dramatically thereafter, as capitalist vitamin content flourished in America’s bloodstream. The technology boom of the 1990s was, in retrospect, the high-water mark for American capitalism. As new billionaires were being anointed each month, and outsized productivity gains became accepted as inevitable, US equities’ value soared to more than 60% of total global equities.

At the peak, financial companies were reporting 41% of US corporate earnings. Except that their overstatement of earnings turned out to be on a scale that made the Nasdaq cheaters look like pusillanimous Puritans.

But what was glittering wasn’t, as Greenspan believed, a new Golden Age. As Nasdaq soared through 5,000 and Baby Boomers were planning luxurious retirements for their forties or fifties, investors who had feared that the Millennium would bring Y2K shock, found that it brought something much scarier: reality. They learned that Tech company earnings were vastly inflated, due to failure to account for stock options (which were the main form of compensation for top execs), and that Asian-based companies were rapidly gaining global market share in terms of employees, profits, and patents. What would become the stars of this decade—Google, Apple and RIM—were either not public during the boom, or had proprietary products based on brand-based profit margins that were no longer available to the established manufacturers of the defining commodities of the 1990s—chips and bandwidth. America retained its stock market leadership until 2007 because of the new centre of high-margin innovation—Wall Street. At the peak, financial companies were reporting 41% of US corporate earnings. Except that their overstatement of earnings turned out to be on a scale that made the Nasdaq cheaters look like pusillanimous Puritans. Those new techspawned financial products that created trillions in reported profits after paying hundreds of billions in unearned bonuses turned out to be frauds designed to fool investors, US ratings agencies and financial institutions at home and abroad. June

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Who Will Really Lead the Global Rescue? Those who do not learn from history… The sudden implosions of Long-Term Capital and Enron came from market volatility that the Myron Scholes model said was of a rarity that could occur only once since mammals replaced dinosaurs as the masters of the universe. How did Wall Street’s biggest, boldest and brightest respond to those late 1990s debacles? By imitating LTCM and Enron!

How did Wall Street’s biggest, boldest and brightest respond to those late 1990s debacles? By imitating LTCM and Enron! They levered up LTCM style, using hidden off-balance-sheet entities Enron-style, with risk probabilities calculated on models used by both LTCM and Enron. Should anyone have been surprised that Wall Street got the same results? The bosses expected sustainably black earnings statements from following those models. Instead, they created Black Swans on a scale that devoured the available supplies of junk financial food—with predictable results for the consumers’ financial health. There is talk of criminal prosecutions against the big names that got the big payouts and spawned the big disasters. However, apart from insider selling prosecutions such as have finally been launched against Countrywide’s Angelo Mozilo, we predict few prosecutions and even fewer convictions. Wall Street’s accused could win acquittal on the grounds of insanity. A well-known proof of insanity is trying the same experiment over and over, expecting to eventually achieve a different result. What they did in creating trillions in AAA-rated illiquid products out of financial sewage should be enough to trigger insanity diagnoses from Park Avenue psychiatrists with sterling records in testifying on behalf of the tarnished rich. The accused would surely be let off on pledges to continue their treatment programs with their psychiatrists, and at their golf and bridge clubs. Last month, we asked, “Where Will America Go to Grow?” Were America, once again, relied on to pull the global economy out of recession, what would be its Comparative Advantages—in terms of trade in goods and services? A new book by Robert C. Allen (The British Industrial Revolution in a Global Perspective) seeks to explain why Britain was the first home of the Industrial Revolution. It argues that cheap, abundant energy was the key factor. Britain had a huge comparative advantage in terms of carbon-based energy. Its coal reserves were Europe’s largest, and its early emphasis on converting coal and iron into steel gave it a lead that was crucial in the formation of the British Empire, which was based on the Navy’s power to sustain free trade in commodities, food, and industrial goods. Britain prospered by importing commodities from its colonies and selling them its manufactured goods.

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The first century of American industrial prowess was also energy-based. After Spindletop launched the US oil industry, America powered ahead to global leadership based on oil for transportation and coal for electricity and steel—and by benefiting from global free trade enforced by the British Navy. America replaced Britain as world leader, in part because the British had dwindling supplies of cheap coal, negligible supplies of oil and gas, and world leadership in entrenching the power of industrial and transportation unions that could bring the economy to its knees, thereby reducing its international competitiveness in each new cycle. Chris Patten observed that, for the first eighteen centuries of the Christian (or Common) Era, the two largest economies were China and India. They didn’t experience the Industrial Revolution and therefore ceded leadership to America and Europe. In the first half of this century, he predicted, the world would revert to normalcy.

[Obama] shouted, (like the Marxist Labourites who kept the party out of power until Tony Blair cowed them), “I stand with the workers!”

Although few forecasters publicly dispute this long-term prediction, even fewer suggest that this global recession would put the world into fast-forward into the future. Consider a few developments—at home and abroad—since Obama and his party swept to dominance: 1. The recessions in the US and Europe have been far more severe than consensus forecasts predicted. 2. After two decades in which economic growth was positively correlated to nations’ reliance on capitalist principles, the industrial world has suddenly accorded to governments and central banks the entire responsibility for saving the global economy. Capitalism is widely blamed for the Crash, and government is now the savior. (A recent New Yorker cartoon sums up the new consensus: it shows a king with his head on the chopping block, with the headsman holding high the axe; a man is rushing in, shouting, “Stop! Wait! Government’s no longer the problem—it’s the solution!” 3. As Chrysler’s bailout was proceeding, President Obama appeared on TV to denounce “the speculators” who were insisting that their ownership of secured bonds gave them priority in the bankruptcy. This was not the calm, cool, compromise seeker who had reassured the business community that he would respect its claims to full participation in the economic rescue program. He shouted, (like the Marxist Labourites who kept the party out of power until Tony Blair cowed them), “I stand with the workers!” In the outcome, the UAW, whose benefit programs were unsecured creditors, was awarded a 55% ownership share in the company, and the

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Who Will Really Lead the Global Rescue?

The Fed has been transformed into a Fast-Feeding operation.

secured bondholders were given only pennies on their holdings—and threats of the kind of personal retaliation suffered by AIG officers. Only later did we learn (on Page 16) that “the speculators” included public pension funds in Indiana. The state funds had, (despite the investment rules in ERISA), invested heavily in the secured debt of Chrysler, which was, directly and indirectly, a major economic power in Northern Indiana. In GM’s bankruptcy, a large percentage of the secured debt was held by yield-seeking individual investors, and leading law firms announced their willingness to protect their rights from White House assaults. Result: this bankruptcy is now, thankfully, proceeding according to the law, and GM executives need not fear being harassed in their homes by ACORN radicals paid, (at least in part), by Washington. 4. The Pelosi-Obama budget that swept through Congress with Indy speed will, according to the non-partisan Congressional Budget Office, double the national debt within five years and treble it in ten—even assuming that the President is right that US economic growth in the coming decade will be far above its average level of recent—capitalist-driven—decades. The growth will come from millions of jobs in clean energy, new techniques in health care management, and public (read “unionized”) education. Offshore drilling bans will ensure that none of the nation’s vast untapped oil and gas reserves will compete with switch grass bio-fuel and other expensive new forms of energy. (Mr. Allen would presumably be astonished.) 5. The Fed has been transformed into a Fast-Feeding operation. Its balance sheet has doubled, and it keeps finding new classes of assets to buy. Apart from its newfound willingness to lend against some of Wall Street’s pet products, it is buying longer-dated Treasurys to try to ensure that interest rates—particularly mortgage rates—stay low. Like other aspects of the stimulus programs, results of this unprecedented initiative are somewhat disappointing: yields on the Ten-Year Note (the basis for first mortgage rates) have climbed 85% since year-end. Among those holders of Treasurys who have expressed public alarm at quantitative easing and other novel programs are the Chinese—the biggest gluttons in what Bernanke once called “The global saving glut.” (When Tim Geithner spoke to a Beijing audience last week, student laughter greeted his claim that the dollar would remain strong and the Administration’s policies would protect the value of Treasurys. Those students are already learning how to act like tough, arrogant creditors to yesterday’s #1 economy.) 6. Indian voters went to the polls at a time of a global economic crisis, and civil wars in two of its neighboring states—Pakistan and Sri Lanka. Defying predictions that the next Parliament would be even more hamstrung

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by excessive leverage from Communist and other intransigent minority parties, voters gave Manmohan Singh’s Congress resounding support. Nor were these gladsome results due to an unexpectedly high percentage of stay-at-homes: 58.5% of eligible voters cast their ballots. So much for the theory that only the Chinese can make modified capitalist principles work. Then, India rather suddenly became a beneficiary of the defeat of the terrorist Tamil Tigers, and Sri Lanka was no longer one of the two neighboring threats to regional stability. 7. China chose not to emulate the strategy of Obama’s rescue package: SinoStimulus was aimed at immediate results, not in entrenching vast new government programs designed to lock in a far bigger share for the state in the economy of the future. Yes, China’s growth has slowed—to 7%—at a time the US and European economies have been declining by almost equal percentages.

Sino-Stimulus was aimed at immediate results, not in entrenching vast new government programs designed to lock in a far bigger share for the state in the economy of the future.

8. Commodity prices, which suffered their greatest two-month decline since records began, have been rebounding. No thanks to the US and Europe: large-scale Chinese purchases of oil, soybeans and metals have been major contributors to the rebound. RJ-CRB Futures Index June 1, 2008 to June 4, 2009 500 450 400 350 300 250

259.79

200 150 Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

Baltic Dry Index June 1, 2008 to June 4, 2009 12,000 10,000 8,000 6,000 4,093

4,000 2,000 0 Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

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Who Will Really Lead the Global Rescue? Crude Oil June 1, 2008 to June 4, 2009 150 130 110 90 70

69.50

50 30 Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

Soybeans June 1, 2008 to June 4, 2009 17.00 15.00 13.00

12.30

11.00 9.00 7.00 Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

Copper June 1, 2008 to June 4, 2009 4.50 4.00 3.50 3.00 2.50

2.33

2.00 1.50 1.00 Jun-08

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Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

9. Commodity stock prices have responded: MS Commodity Related Equity Index (CRX) relative to S&P 500 June 1, 2008 to June 4, 2009 110 100

98.36

90

Commodity stock prices have responded.

80 70 60 Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

Gold Stocks (TTGD) relative to S&P 500 June 1, 2008 to June 4, 2009 160 142.90

140 120 100 80 60 Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

Coxe Commodity Strategy Fund (COX.UN) relative to S&P 500 June 1, 2008 to June 4, 2009 130 120 110

106.33

100 90 80 70 60 Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

(Readers please note: we cite as the example of commodity stock performance the fund in which we are Advisors, because it includes all four main commodity sectors, with weightings approximating those that have been

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Who Will Really Lead the Global Rescue?

...as is so often the case, investors with inadequate knowledge of history are nonetheless among the most dogmatic in citing it to justify their conclusions.

recommended from time-to-time in this publication. We are not aware of any other exchange-traded company that has investment policies that reflect those discussed each month in Basic Points. If any readers are aware of comparable products, we’d be pleased to be informed—and will include them in a future issue. Citing the Fund herein does not constitute a recommendation to buy its units or warrants.)

The US Claim to the Title ‘The Global Economic Rescuer’ It is widely taken for granted that the US has been the driver of the world economy since World War I—which so devastated the economies of Britain, France and Germany that the US succeeded “The Old World” as industrial and military leaders—and has stayed in that role ever since. We suggest that, as is so often the case, investors with inadequate knowledge of history are nonetheless among the most dogmatic in citing it to justify their conclusions. It is an oft-cited “fact” that the US has pulled “The Old World” out of each recession since 1921; that record, we are told, means it is the world’s only hope for exit from this deep recession. Since World War I, there have been three great recessions, two of which were deflationary and one inflationary. The Great Depression and this one have been the deflationary downturns; the first of the 1970s recessions was the sole inflationary recession. (No less an analyst than Niall Ferguson says (New York Times Magazine, May 17th) the 1973–75 recession was “every bit as severe and protracted as the one we’re in now.”) Yes, the US pulled the world out of all the recessions since World War II, but it was the Old World that pulled the US out of the Great Depression—by engaging in World War II. Yes, yes, we know that it’s an American article of faith that Roosevelt and the Democratic Congress saved America and the world from the Depression caused by Herbert Hoover and the Republicans. Roosevelt did a splendid job of restoring American faith in itself, and he was a great leader during World War II. Perhaps, without Roosevelt, there would still be Prohibition, Hollywood wouldn’t have experienced its Golden Age, Fred Astaire would have continued to avoid movies in favor of Broadway and vaudeville, and Victor Fleming wouldn’t have had the unique opportunity to direct Gone With the Wind while he was completing The Wizard of Oz.

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Give Roosevelt credit for any or all of the above, but be cautious about crediting him with ending the Depression. In actuality, Hitler, Hirohito and Stalin did more than Roosevelt to slash US unemployment rates by 80%. Despite the Rooseveltian alphabet soup of government programs, including NRA, WPA, and Social Security, and the brief mid-decade recovery, US unemployment was still 17% by 1938. Then, as Continental European leaders at last realized that Hitler was a greater threat to peace than Winston Churchill—and launched large-scale rearmament. As many scholars have noted, the net benefit to the economy of Roosevelt’s job-creation programs such as WPA sidewalk painting was largely offset by the unforeseen effects of the Wagner Act and other Rooseveltian programs to magnify trade union power. As Charlie Chaplin’s Modern Times (1936) showed, staging strikes as soon as the workers finally had jobs after years of large-scale unemployment may have been good for union power, but what workers needed most was jobs. The powers granted to union leaders under these programs ensured that the minority of private sector workers with unionized jobs ultimately made major gains in real income, but they actually prevented overall employment growth for Americans because the products they made were too expensive for much of the population. Worse, major industries became even less competitive with factories abroad, forcing intensification of Smoot-Hawley protectionism that had the inevitable effect of overseas backlash that shut America out of major overseas market. That process was exacerbated by the strength of the dollar as the world’s gold flowed into Fort Knox and currency devaluations became routine across the world.

In actuality, Hitler, Hirohito and Stalin did more than Roosevelt to slash US unemployment rates by 80%.

Ironically, the federal nature of the US would turn out to be its ace in the hole in post war era, compared with European economies in which employment rules were mostly set at the national level. “Flexible employment arrangements” became (apart from seemingly endless supplies of low-cost coal, oil and gas) America’s greatest competitive offset to the new industrial challenges from Europe and Japan. Right to Work laws, which banned compulsory union membership, undergirded the South’s strong recovery and powerful job growth since 1960, as the former, seemingly-all-powerful big businesses in the North succumbed to competition from abroad and the South, and the industrial states became Rust Belt states. Roosevelt’s panoply of programs and preferences might actually have worked to end the American—but not the global—recession, had he and the Fed understood monetarism and the futility of beggar-thy-neighbor trade policies. (Of course, there wouldn’t have been anything worse than a recession had Hoover and the Fed understood monetarism—and the futility of beggar-thyneighbor trade policies.)

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in 1971...the dollar was still so overvalued relative to European currencies that the best-selling book for American tourists was Frommer’s Europe on $5 a Day.

By the time FDR took office, US M2 was down one-third from its 1929 peak. Needed: rapid growth of Fed credit. However, existing laws limited monetary expansion that was not backed by growth in gold holdings. Roosevelt did in fact address this challenge by (1) raising the price the Fed would pay for gold from $20.67 an ounce to $35, and (2) making private holdings of gold bullion and coins illegal. However, monetary policies during the rest of the decade were hopelessly inadequate to the challenge—and no amount of increase in the supply of WPA sidewalk painters would be able to offset the Fed’s failure. The reality is that the Old World, (with help from Japan) in its final collective act of madness, pulled the US out of the Depression by 1941. Marx had said that capitalism needed war to survive. A large body of leftist economic thinking drew that lesson from Roosevelt’s failed efforts to end the Depression, and how waging war set US factories humming—and put millions of unemployed Americans into military uniforms. The economists concluded that Big Government would be needed in the postwar era to ensure sustained growth in jobs once Rosie the Riveter and her colleagues switched from producing weaponry to producing babies. The rebuilding of shattered economies and expectations in Europe and Japan took decades, and the US trade balance gradually turned from permanent surplus into permanent deficit, as European and Japanese manufacturers began to take advantage of the demise of Smoot-Hawley and the complacency of US manufacturers, in an era of large-scale featherbedding, and annual growth in union wages and benefits regardless of productivity. The European and Japanese factories built after the bombing ended used the best-available technologies, and, (apart from Britain, where 19th Century labor attitudes on the shop floor and among Labour politicians in Parliament prevented a sustained postwar industrial renaissance), the fast-reviving economies relied on welfare state programs, and Value-Added Tax regimes to redistribute actual production costs away from factories to taxpayers at large. The post-Depression US consumer, who hadn’t experienced the horrors of bombings, came to believe that prosperity was his/her birthright. Because US factories had to price not only outsized wages, but health care and pension costs into their output, their competitive position against European and Japanese competitors weakened by the year, and Americans began finding more and more bargains that weren’t Made in the USA. Until the dollar bear market that began in 1971 with Nixon’s closure of the gold window, the dollar was still so overvalued relative to European currencies that the bestselling book for American tourists was Frommer’s Europe on $5 a Day.

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Result: the US consumer of goods, services and holidays became the industrial world’s buyer of first and last resort—and the sine qua non rescue force for minimizing and ending postwar recessions across the industrial world. Until American mortgage and credit card lenders finally realized that they had run out of credit-worthy first-time home buyers and qualified borrowers a few trillion dollars back on the road—and until a meaningful percentage of the credit-worthy borrowers finally discovered there was a peril heading their way that was much more immediate than global warming. That shock was a long time coming. Although some US economic analysts began to predict a peak in American households’ willingness to increase their acquisition of goods and services decades ago, for nearly all the time we have been managing money, the word to the wise was “Wall Street is littered with the bones of analysts who said the US consumer was tapped out.”

Until American mortgage and credit card lenders finally realized that they had run out of credit-worthy first-time home buyers and qualified borrowers a few trillion dollars back on the road...

Which means that America and the rest of the world are finally going to have to find a new set of buyers for their output. Were Roosevelt to return to the USA from his eternal home, he’d recognize—and presumably applaud—one-third of the Washington response to this recession, but would be amazed by—and presumably applaud—the other two-thirds. By now, if he’s been in Heaven, he’ll have learned from Milton Friedman of the importance of stimulating money supply growth—and will be mentally fitting out Ben Bernanke for angel wings. When he considers the Pelosi-Obama programs, he’ll recognize that they’ve been reading from his script. Their priorities are (1) expanding union power, because an economy based on strong unions should be a prosperous economy, and (2) making government(s) the consumer of first and last resort until the household sector has rebuilt its finances and saved something for its retirement costs. Under Goal (1), the Democrats are pledged to legislate “Card Check,” the AFL-CIO’s top legislative priority. This law would take away workers’ rights to secret ballots when a union is trying to organize an employer. The decision to join a union would hereafter be made at the employee’s kitchen table, with eager assistance, one assumes, from hearty, husky union organizers, and from those in the employee’s work unit who have already joined the union.

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Who Will Really Lead the Global Rescue?

...since programs like carbon tax and banning offshore oil drilling will kill vast numbers of private sector jobs, why not hire people in the Department of Labor to say what American workers should be paid and how many hours they should work?

Included in this bill is a brand-new provision that, once a company is organized on the basis of signed cards, if the employer is unwilling to meet the union’s demands, it can’t just shut down and go where it believes it can produce competitively. Those big, brotherly people in Washington will send in an arbitrator, who will declare what future wages, work rules and benefits must be. The great advantage of this new system is its simplicity: instead of competing arguments about the economic value of an employee’s work, it will be decided by one of the well-trained people in a great new make-work program for well-trained people who may not otherwise have great jobs with great paychecks. The President has promised to create millions of new jobs, and, since programs like carbon tax and banning offshore oil drilling will kill vast numbers of private sector jobs, why not hire people in the Department of Labor to say what American workers should be paid and how many hours they should work? So, a returned Roosevelt would be delighted. Yes, a returned Ford, Rockefeller, Edison, Kroc, or Carnegie would be appalled, but they believed in creating jobs and wealth in the private sector by competitively producing products people at home and abroad wanted and bought. That is so passé these days. As the scope of Washington bailouts proceeds, our sympathy for the pressures on the President grows. Somehow, he will have to take out time from deciding which models of cars Chrysler and GM must produce, to dealing with Ahmadinejad, Kim Jong Il, the Taliban and other tiresome people. Don’t they understand that all that’s needed is for us to talk together? Don’t they know that Bush—the biggest global threat to peace—is gone? Even if the Pelosi-Obama stimulus program succeeds in generating modestly positive US economic growth, it won’t do much for the rest of the world. The Buy-America provisions that bespangle the stimulus bill have already kicked off mini-trade wars with Canada and Mexico, and Europe is mulling over potential retaliation. No, they wouldn’t strike a returned Roosevelt as a worthy substitute for Smoot-Hawley, but at least they have what might be called by sophisticates a soupçon of Smoot-Hawleyism. That said, American politicians might try to justify these Smoot-Smart evasions of WTO rules by pointing out that America’s allies have mostly confined their involvement in the global strategic crisis to criticizing the US. Apart from Canada, Britain and Australia, America’s allies have not only done almost nothing to help crush the jihadists in Iraq and Afghanistan, but they’ve done squat in Swat and virtually everywhere to its South and West. Nor, after Obama wowed crowds in their homelands by announcing closure of Guantanamo, are they stepping up to take those “victims” into their own

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prisons. (How many prisoners were subjected to “aggressive interrogation”—the euphemism Bushies used for water-boarding? According to a Page 16 story we read recently, three Gitmo inmates were water-boarded—Sheik Khalid, who organized the 9/11 massacres, the self-confessed beheader of Wall Street Journal reporter Daniel Pearl, and one other.) As Obama is learning, a global policeman’s lot is not a happy one. Obama spent weeks abroad apologizing for America’s past sins dating back to the A-Bomb. Until he attended the D-Day anniversary, he never once mentioned the hundreds of thousands of US military corpses in European cemeteries or the sacrifices America made to prevent a Soviet takeover of Germany and France. Mr. Obama must be wondering, with allies like these, who needs enemies?

As Obama is learning, a global policeman’s lot is not a happy one.

Among the few prominent academic economists to challenge Obama’s longterm stimulus programs is Stanford’s John Taylor, the renowned thinker who devised Taylor’s Law for setting economically-successful fed funds rates. Writing in the Financial Times last week, he observed: “The federal debt was equivalent to 41 per cent of GDP at the end of 2008; the Congressional Budget Office projects it will increase to 82 per cent of GDP in ten years; with no change in policy it could hit 100 per cent of GDP in another five years.” He cites Obama’s defense: We have an unprecedented financial crisis and we must run unprecedented deficits, and he replies, “While there is debate about whether a large deficit today provides economic stimulus, there is no economic theory or evidence that deficits in five or 10 years will help to get us out of this recession. Such thinking is irresponsible. If you believe deficits are good in bad times, then the responsible policy is to try to balance the budget in good times.” He rejects Obama’s pledge to cut the deficit in half, citing the CBO’s projection that the deficit in 2019 is the same percentage of GDP as the Administration’s estimate for the deficit in 2010—“a zero per cent cut.” Finally, he dismisses Obama’s justification, We inherited this mess. “The deficit was 41 per cent of GDP at the end of 1988, President Reagan’s last year in office, the same as in 2008, President Bush’s last year in office. If one thinks policies from Reagan to Bush were mistakes does it make sense to doubledown on those mistakes?” We have quoted so extensively from Mr. Taylor, because he is both eminent and wise—and we believe that, if his view of the future is even close to being accurate, America will not be #1 for long. June

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Who Will Really Lead the Global Rescue?

Capital that survives and prospers is a coward, not a lover.

So, unless Mr. Obama reverts to being the cool, charismatic leader whose public policies synthesize the dynamic aspects of American economic process with the expansion of government’s new roles, the global rescuer’s torch will be passed at some point soon. As clients are aware, we were enthusiasts for him when he was elected and in the early months of his work thereafter. We are not yet willing to assume that he cannot yet be the great unifier and sensible visionary who swept the nation at the polls. But we do believe investors should have a new caution that the recent Obama will strive to carry out his statist programs in ways that will be deleterious both to the economy and to investment returns. Watchful caution—not Panglossian enthusiasm—is in order. There is a world of opportunity outside the USA. Capital that survives and prospers is a coward, not a lover. When will the new global leadership emerge? Maybe as soon as the early years of the next decade, if the US economy has become so solipsistically engaged in snaring itself in Laocöonesque coils that it has neither the resources nor the prestige to sustain its position of global economic leadership. If not us, who?

The New Best Hopes for the World Shanghai Stock Exchange January 1, 2008 to June 4, 2009 6,000 5,500 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 Jan-08 Mar-08 May-08

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2,764.83

Jul-08

Sep-08 Nov-08

Jan-09 Mar-09 May-09

Bombay Sensex January 1, 2008 to June 4, 2009 21,500 19,500 17,500 15,500

15,116.27

13,500 11,500 9,500 7,500 Jan-08 Mar-08 May-08

Jul-08

Sep-08 Nov-08 Jan-09 Mar-09 May-09

Brazil Bovespa January 1, 2008 to June 4, 2009 75,000 70,000 65,000 60,000 55,000 50,000 45,000 40,000 35,000 30,000 25,000

53,764.98

Jan-08 Mar-08 May-08

Jul-08

Sep-08 Nov-08 Jan-09 Mar-09 May-09

Morgan-Stanley Emerging Markets January 1, 2008 to June 4, 2009 1,300 1,200 1,100 1,000 900 800 700 600 500 400 Jan-08

781.76

Mar-08 May-08

Jul-08

Sep-08 Nov-08

Jan-09 Mar-09 May-09

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Who Will Really Lead the Global Rescue? Positions Open: Rescuers for The Global Economy Applications requested to fill slots for two or more large economies which each meet all—or most of—the following criteria, and show likelihood of being able to continue to meet these tests over the next five years. Canada and Australia meet most of the tests, but their populations are too small to give them the global clout as Rescuers.

Qualifications 1. Capitalist-oriented economies that are continuing to be driven primarily by risk-taking in the private sector and are not reliant on sustained new forms of large-sale government intervention. 2. Respect for the rule of law in commercial transactions, particularly bankruptcy, where the commercial rules in the Anglo-Saxon economies have evolved slowly over three centuries. 3. High household savings rates. 4. Demonstrated competitiveness in international trade. 5. A record of fair trade cooperation with neighbors where regional trade agreements are in force. 6. A banking system that has passed the open market stress test of survival and growth in recent months, (not a backdoor analysis) and has not been subject to bailouts amounting to more than 1% of GDP. 7. A public educational system in which students at Grade Eight level and higher grades rank in the top 25 in the world in mathematics, science and literacy. 8. If not a net creditor globally, then not a net debtor to foreign investors of more than 2% of GDP. 9. 9.Average per capita real GDP growth rates in the previous five years of at least 3%. 10. Positive demography, such that each new generation of first-time homebuyers is larger than its predecessor. Likely claimants: China, India and Brazil. (Canada and Australia meet most of the tests, but their populations are too small to give them the global clout as Rescuers. Their economies and stock markets are the most obvious winners among the industrialized nations from the sustained growth in commodities demand that will occur if those three heavyweight emerging economies continue to grow strongly.)

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There are obvious caveats: 1. China is only non-democratic nation in the select circle, and proclaims itself as being ruled by the inheritors of Mao’s branch of Communist theories. It remains to be seen how long it can achieve its astonishing rate of progress to the status of advanced industrial nation if it continues as the oxymoronic Communist free economy. 2. India’s southeast is more secure now that the Tamil rebellion in Sri Lanka has been quashed. However, its problems from Pakistan’s vulnerability to the Taliban and other Islamic extremists remain. There has been some good news in recent days, with the government’s new commitment to challenging the Taliban with the full power of its well-regarded army. Jihadist terrorism cannot be eradicated in open military combat, but the citizenry will justly conclude that democracy is doomed and defect to the cutthroats if they are able to defy the national army successfully. This is one military campaign that absolutely must be won. Even those who ritualistically oppose all American military involvement abroad might have second thoughts if the Taliban and Al Qaeda gain control of Pakistan’s nuclear arsenal.

Even those who ritualistically oppose all American military involvement abroad might have second thoughts if the Taliban and Al Qaeda gain control of Pakistan’s nuclear arsenal.

3. Brazil’s wise, benign ruler, Lula, is nearing retirement, and the nation has a record of more than a century of disappointments—being the mostoften cited candidate for title of Tomorrow’s Great Global Success Story. As Margaret Thatcher observed, when asked whether “Thatcherism” would survive, “It will continue if the next Labour government is elected on, and continues, the elements of what you call “Thatcherism.” Tony Blair—and even Gordon Brown—demonstrated that Labour had learned from the Iron Lady, and the party wasn’t going to revert to the sterile socialist policies that had been the Tory party’s greatest electoral assets. 4. Now that Kim Jong Il has proved that one of the poorest nations on earth can develop workable atomic weapons and inter-continental ballistic missiles, Asia faces frightening new challenges to its plans to continue its drive to prosperity. North Korea cooperates openly with Iran, and the mullochracy is probably only months away from having both nuclear bombs and long-range missiles. Dick Morris, former Clinton advisor, says that an unchecked Iran will attempt to carry out its threat to “wipe Israel off the map.” It will not be done with missiles, but by giving suitcase bombs to terrorists. Although Hezbollah failed to win at the ballot box in Lebanon last weekend, it still has a large brigade of jihadists on its staff, eager for action. But since Ayatollah Khomeini took power (while Jimmy Carter stood aside and waxed eloquent about democratic progress

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Who Will Really Lead the Global Rescue?

...this is one of those Hinges of History that dictate changes to investment policies.

as America’s ally—the Shah—went down), Iran has never failed to make clear that it regards America as “The Great Satan,” which, in its interpretation of Shia prophecies, means America must be dislodged from its global throne. So any American city could, in theory at least, be the first victim of a suitcase bomber—and destruction of any major city would, if only because of insurance and rebuilding costs, wipe out the American economy. We only mention these geopolitical challenges because Planet Earth is probably the riskiest it has been since the day before the meteor landed in the Yucatan and wiped out most life. No investment thesis can protect private wealth from a cataclysm of those proportions. We can only hope that Obama and his military advisors are seriously pondering the implications of the suddenly-changed situation. Unfortunately, were the CIA to learn that a catastrophe looms, it could lack the credibility to convince the Administration that desperate measures must be planned, because Ms. Pelosi, major architect of the stimulus program, has repeatedly charged the agency with misleading Congress and serial lying.

So What Should Investors Do Now? After having made passing reference to the (thankfully) still-remote possibility of The End of the World As We Know It, we resume consideration of what a peaceful transformation of global economic leadership means to investment policymakers. If, in fact, over the next year or so, global investors gradually come to conclude that the Third World, as led by China and India, is the key to global economic recovery, then this is one of those Hinges of History that dictate changes to investment policies. We sum it up as “The Old, Old World Has Come To Redress the Balance of the New.” Among the basic investment axioms that have underlain concepts of portfolio construction in our lifetimes are: 1. US Equities will always be the global standard, and the US stock market will always have the greatest liquidity and highest capitalization. 2. The US bond market will always be the global standard, and will always have the greatest liquidity and highest capitalization. 3. The dollar will remain the global store of value—perhaps not for always, but certainly for the foreseeable future.

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4. Global equity markets will continue to follow the lead from Wall Street and the US economy. 5. Commodities’ share of global wealth and GDP will, across most economic cycles, continue their two centuries of decline, because industrialized societies’ commodity content declines as the values of manufactured goods and services increase. Commodity stocks’ investment outperformance will occur during periods of rapid inflation (such as the stagflationary 1970s), but otherwise will be seen as mere aberrations and will be short-lived.

...yelling “Stop!” is not, for most of us, an option...

If, however, the Obama rescue programs do not produce the gaudy results he has predicted—and which voters have come to believe—then the probability exists that investors will reduce their exposures to US equity and debt products relative to those from the economies that are demonstrating global leadership. If a parade is proceeding along a street, one can choose to watch it or join it: standing in front of it yelling “Stop!” is not, for most of us, an option. As the Chinese, Indian and Brazilian economies were booming, and stock markets in those countries were solidly outperforming the S&P, and as the dollar was underperforming most major currencies, and as commodities and commodity stocks outperformed, many respected investment commentators said, knowingly, “Don’t join this parade. It’s about to come to an end.” After “The Midnight Massacre of July 13th,” those experts were—at last— vindicated. Emerging Markets’ equities were savaged more severely than the non-financial sectors of the US stock markets, Emerging Markets bonds were savaged as severely as US junk bonds, and commodities had their quickest and most brutal collapse since 1930. The parade ended quickly and ingloriously and the spectators dispersed. But then, the pattern began to shift back toward what had been normal for most of this decade: US Dollar Index (DXY) July 1, 2008 to June 4, 2009 95 90 85 80

79.41

75 70 Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

June

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Who Will Really Lead the Global Rescue? Morgan Stanley Emerging Markets Index July 1, 2008 to June 4, 2009 1,100 1,000 900 800

781.76

700 600 500 400 Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

Shanghai Stock Exchange July 1, 2008 to June 4, 2009 3,100 2,900 2,764.83

2,700 2,500 2,300 2,100 1,900 1,700 1,500 Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

Bombay Sensex July 1, 2008 to June 4, 2009 16,000 15,116.27

15,000 14,000 13,000 12,000 11,000 10,000 9,000 8,000 Jul-08

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Nov-08

Jan-09

Mar-09

May-09

RJ-CRB Futures Index July 1, 2008 to June 4, 2009 500 450 400 350 300 259.79

250 200 150 Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

We believe that relationship is about to return, and will be the leitmotif of the music of the markets over the next five years.

We see this shift as more than a blip. We think it heralds an emerging reappraisal among globally-oriented investors to “go back to the future.” From 2002 until “The Midnight Massacre,” the S&P significantly underperformed most of the stock markets of two kinds of economies: those (such as Australia or Brazil) in which commodity exports are large or major components of GDP, and those (such as China) in which commodity imports are large components of GDP. In the first category can be some industrial or newly industrializing economies; in the second are newly industrializing countries. It was these nations’ stock markets’ sustained outperformance from 2002 through June 2008 that, in retrospect defined the real growth of the global economy. The S&P’s performance from March 2002 to July 2007 was, we now know, heavily based on heavily-overstated earnings of the financial stocks, which reported 41% of total S&P profits. If one adjusts the US stock market’s performance for all the financial frauds and folly, the outperformance of economies linked by growth in commodity trade becomes even clearer. We believe that relationship is about to return, and will be the leitmotif of the music of the markets over the next five years. We also believe that it will have especial impact on the prospects of the important commodity-oriented companies… Which prospered so mightily as soaring commodity prices made these producers the “scarcity stories” on stock exchanges this decade… And which could soon be acquiring a rather different kind of scarcity value.

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Who Will Really Lead the Global Rescue? Are Private Sector Commodity Companies Capitalism’s Next Endangered Species?

...trillions of dollars in bailout funds for companies whose leaders had previously been as rich and haughty as Tiberius (although not, as far as we know, as personally appalling as Caligula).

Since last summer, we have been reporting (with growing concern) on the tragic fall of free market capitalism from prestige and leadership in the global intellectual and economic pantheons. Rome’s fall was due, in great measure, to the failure of Augustus’s successors to live up to his ethical standards. Roman soldiers and citizens lost faith in the system. (We know just how decadent many of them were because of Suetonius’s classic Lives of the Twelve Caesars, which, with its enthusiastic reporting on the emperors’ sexual proclivities, has been delighting prurient history students for nearly two millennia.) Similarly, many of our modern Masters of the US Financial Empire have betrayed their capitalist heritage, collectively undermining not just their own companies and the global financial system, but—most tragically of all—the strategic and moral justification for letting large capitalist companies function in privileged positions at the core of the financial system. Taxpayers across major Western countries are being hit for trillions of dollars in bailout funds for companies whose leaders had previously been as rich and haughty as Tiberius (although not, as far as we know, as personally appalling as Caligula). Each week, one reads new commentaries arguing that the neo-capitalist models most countries adopted after the collapse of Bolshevik Communism are being rejected in favor of statism in various modes. What text can capitalists use to defend themselves? Oddly enough, the Chinese government is publicly suggesting that the OECD nations should go back to Adam Smith. Chinese premier, Wen Jiabao, spoke at Davos of Smith’s book Theory of Moral Sentiments, saying it was a guidebook for the rulers in Beijing. Who would have thought 20 years ago that China would be the third biggest economy in the world by 2010? And who would have thought that a red-hot favorite book in of Asia’s communist leaders would be written by the father of the Western capitalism. We live in wondrous times.

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The best-known modern American book praising the glories of unrestricted capitalism and denouncing socialism is probably a novel published fifty years ago—Ayn Rand’s Atlas Shrugged. It describes an American dystopia of the future run by politicians, pundits, union bosses, and leftist foundations. Ms. Rand was a better pamphleteer than novelist, and the book was panned by critics for its Castro-length speeches by capitalists, and the simplicity of its characterizations of public and private figures who were either glorious heroes or despicable villains. Belletristic merit, and subtlety it lacks, but it was an enormous hit and has never gone out of print. We haven’t re-read it in decades, but we thought of it as we watched President Obama declare war on Chrysler’s secured bondholders. Mr. Obama, whose only paid job other than being a “community organizer” (whatever that may be) was as a law professor, overturned bankruptcy preference rules which have been on the books here since the Constitution, part of English Common Law for a century before that, and a strictlyenforced part of European laws—from the Hanseatic League to Renaissance Switzerland and Italy—for centuries before that. But such an uncontested legacy of business practice could not be allowed to get in the way of satisfying the demands of the UAW.

In his Chrysler speech, Obama seemed to have stepped right out of the pages of Atlas Shrugged— an America ruled by leftist demagogues (called “looters”)...

In the same week, he announced that he would withhold California’s $14 billion in federal emergency funds unless the tarnished Golden State restored the full wages, benefits and work rules of state employee locals of the Service Employees International Union. The Governator had imposed some work hour cutbacks and unpaid holidays on many state employee groups as part of crisis measures to deal with a $20 billion deficit. In his Chrysler speech, Obama seemed to have stepped right out of the pages of Atlas Shrugged—an America ruled by leftist demagogues (called “looters”) who were strongly influenced by “enlightened” socialists and strongmen abroad. Her tale begins with a story of the looting of a commodity-producing company by a Latin American Marxist dictator. The scion of a family (loosely modeled on the story of the Patinos) arranges to have the family’s great copper-producing operation blown up rather than handing it over to a Latinstalinist. What dates Atlas Shrugged most is its view of the major strengths of the American economy of her era, which was dominated by heavily unionized basic industries—commodity-producing companies, auto companies, and railways. The economic progress that has defined America since the Reagan Revolution made capitalism respectable has been led by newer, non-unionized industries.

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Who Will Really Lead the Global Rescue?

Despite such Randian robberies as the looting of Freeport-McMoRan’s nickel mines in Cuba, the mining industry still remains largely in private hands...

(We exempt the construction industry from this comparison, because that industry has long been led by companies which have pension and benefit funds jointly managed with the construction trades unions. From long personal experience working with clients in those funds—in Canada and the US—and from speaking at the jointly-managed conventions of the International Foundation for Employee Benefits, we can attest that this is a model that works for the industry, its employees and the economy. The old-style adversarial labor relations of the auto companies and airlines operate in an outdated, Randian mode.) Were Rand alive today, she would be shocked at what had happened to the oil industry, which was then the biggest and most profitable of the goodsproducing industries. Back then, “The Seven Sisters’—the transnational Supermajors—dominated the global oil industry, and, from the fruits of their worldwide exploration, owned most of the world’s proven oil reserves. Although reviled by fashionable politicians, pundits and moviemakers, they kept finding new oil and gas—and the postwar economic boom was based on cheap, reliable energy. Today, analysts estimate that the surviving supermajors—Exxon-Mobil, Shell, Chevron, ConocoPhillips, BP and Total—own only 3% of total known conventional reserves. State-owned or controlled enterprises are collectively the owners of most of the known oil and gas deposits. What about the other commodity industries? Despite such Randian robberies as the looting of Freeport-McMoRan’s nickel mines in Cuba, the mining industry still remains largely in private hands, subject to royalties and other income-sharing contracts with nations and states. Notable exceptions: (1) Codelco, the Chilean government company, is the world’s foremost copper producer and a respected industry leader; (2) after Yeltsin-era privatization and a decade of stockholder control, Norilsk, the Stalin Gulag nickel giant, has reverted to Kremlin control—but remains a public company. However, the mining industry’s era of private ownership is now threatened by the emergence of a new trend in the commodity world: the desire of commodity-short new industrializing economies to gain control—and ownership—of important commodity production facilities. The miners’ first experience with this brave new world in which the biggest commodity buyers would try to use their financial muscle to control their access to resources came with Chinalco’s (China Aluminum Co.) dramatic intervention into the takeover battle of Rio Tinto by BHP Billiton.

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With the notably insipid Alcoa as front man and junior partner, and with the approval of the Chinese government, Chinalco bought 12% of Rio Tinto in a matter of hours. That effectively blocked BHP’s bid. Chinalco thereafter entered into negotiation to acquire outright some of RTP’s major mineral properties in Australia. As we were preparing for publication, RTP stunned the financial markets with the announcement that its deal with Chinalco was off, and that it was entering into a partnership with its former foe—BHP Billiton—to develop major iron ore properties in Western Australia. Chinalco’s consolation prize is a $195 million breakup fee. Heavily-indebted RTP will rebuild its finances with a $15.2 billion rights offering, and a $5.8 billion payment from BHP for its share of the joint venture.

...the American response to the CNOOC’s bid to buy Unocal showed the Chinese that domestic politics could bedevil the best-laid plans of mice and Maoist men.

This multi-billion-dollar deal has two strategic elements that suggest that other attempts to buy major commodity producers are inevitable: (1) to buy enough of a commodity-producing company to have real influence—or even a veto—on its major decisions and investments, and (2) to buy particularly desirable properties owned by the company, develop and manage them, and ship their production to the investing country. Had this deal succeeded China would have become a large-scale producer of metals and minerals abroad, and acquired major influence on global pricing of those metals and minerals. (China has, in fact, been trying to open mines in some of the parts of the globe with the most noxious rulers, and, to its disappointment, has enjoyed only modest success. The rebels in the Congo, for example, didn’t show any more respect for the Chinese than they had for capitalist investors. That may be another reason why it decided to switch its strategy to investing in proven superstars with global reach.) Why didn’t China just buy Rio outright? We believe that the American response to the CNOOC’s bid to buy Unocal showed the Chinese that domestic politics could bedevil the best-laid plans of mice and Maoist men. Chevron was able to win the bidding war without having to pay an excessive price because of threats by some Congresspersons against a Chinese takeover of “a national treasure.” (Unocal was hardly a national treasure, and its biggest appeal for CNOOC was its hydrocarbon reserves in the South China Sea, which should hardly have concerned politicians whose energy policies have been mostly directed toward banning offshore drilling. But the “Chinese Peril” publicity worked. This wasn’t as disgraceful a Congressional intervention as its cover-up and connivance in the corruption at Fannie Mae, and it wasn’t even low comedy: it was just low.)

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Who Will Really Lead the Global Rescue? What was supposed to distinguish the Rio Tinto-Chinalco deal from CNOOC’s setback was that it was merely a business venture between two mining companies. Beijing spokesmen denied that the government was behind the bid. China Inc. is now zerofor-two in takeovers of Western mineral giants.

However, the outraged response from RTP shareholders and Australian politicians showed that the market believed Beijing was deeply involved. Chinalco’s chances of having its offer judged solely on financial merits evaporated quickly when its Chairman and CEO, Xiao Yaqing, was named to the State Council, China’s cabinet, shortly after the deal was announced. The Chinese doubtless also learned of the political perils in outright takeovers from what happened to Inco when it negotiated a merger with Falconbridge. Because the two companies together had such a sizable share of world nickel production, anti-trust bureaucracies in Washington and the EU had to sign off. Swiss-controlled XStrata also wanted to buy Falconbridge. Washington granted approval fairly quickly, but the Brussels snouts kept rooting around trying to find a threat to the competitiveness of European steel manufacturers. A tie-up period of stock control expired as Inco frantically tried to complete the deal. XStrata leapt in, bought Falconbridge, and, hey presto! No problems with Eurocrats! Control shifted from Sudbury to Zug—then the home of that fine, principled capitalist, Marc Rich. (We cannot help but suspect that some Eurocrats may have had personal reasons for gloating about the victory of a Continental company (even if it isn’t in the EU). Brussels is, after all, an expensive city to live in. What can we do next? Hey, those guys at Intel have been displaying the kind of arrogance you expect from Yanks. Let’s see whether there’s something we can nail them with.) China Inc. is now zero-for-two in takeovers of Western mineral giants. Does that mean that commodity companies should breathe easier? We strongly believe that the Chinese will lick their wounds, learn from what went wrong—and will be even more forceful the next time. Beijing will not be content to continue its policy of reducing its acquisition of Treasurys through purchase of commodities. It has powerful reasons to become an owner of major resource properties. It showed it could move with lightning speed in blocking BHP’s takeover and becoming the largest holder of RTP shares. Next time, it will doubtless be more selective in its choice of partners, and will be more willing to pay up. Better to own a significant share in production of what you need to buy to grow, rather than holding an extra quarter-trillion-or-so of bonds denominated in the currency issued by the most profligate big nation on earth.

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If the world’s economic power has shifted, then managements of none of the major diversified companies except Teck can feel secure about their futures. (Teck’s multi-vote share structure precludes a takeover unless the controlling stockholders approve.) These companies are worth more to the Chinese (and, for that matter, the Indians) than they are to open market investors. Why? Because ownership of strong minority interests allows China to intervene in pricing decisions on products subject to long-term contracts, such as iron ore and metallurgical coal. As the world’s biggest buyer of both those bulk products, China has powerful reasons for wanting to break open the producers’ group that sets global prices. If effective control of major mining companies is going to be acquired by government-controlled companies for purposes other than profit maximization, then we could well be seeing a dramatic shrinkage in supply of commodity equities as the next cycle unfolds.

As the world’s biggest buyer of [iron ore and metallurgical coal] China has powerful reasons for wanting to break open the producers’ group that sets global prices.

Apart from coal and iron ore, what other mined mineral of great concern to China and India is subject to such contractual pricing formulas? Non-nitrogen fertilizer—particularly potash—might be the most obvious. Rumors that BHP would make a bid for Potash Corp. have been titillating underemployed investment bankers for years. They resurfaced after BHP floated a large bond issue for “general corporate purposes.” At its annual analyst day, CEO Bill Doyle was asked outright about the possibilities of a takeover, and he was suitably dismissive. [Full disclosure: We were there to give the luncheon speech, not as analysts or as stockholders.] Now we know that BHP had enough cash on hand to be able to leap back into bidding for RTP properties—to the tune of $5.8 billion—on what seemed to be a few days’ notice. Potash management and its shareholders can relax—for now. Remarkably, there is one major agricultural stock subject to 90% control that just might become controlled by open-market investors—thereby going against the trend we think will come in the next cycle. That is CNH Global, the world’s second-largest manufacturer and distributor of farm equipment. FIAT owns 90% of the stock and there had been rumors it might make a divestiture to concentrate management’s full energy on the manufacture of cars if its grandiose plans to merge its operations with Chrysler and GM’s Opel divisions were approved. Canada’s Frank Stronach (of Magna fame), seems to have won the Opel auction, so at the moment it looks as if CNH will continue in its role as the most reliable cash flow producer in the FIAT organization.

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Who Will Really Lead the Global Rescue?

What got their attention was the threat that food might not be available at almost any price because of export controls abroad.

However, the trend is already rapidly becoming global in agricultural land. As we often noted, one factor which made this global food crisis different from past occasions of soaring grain prices was the appearance of widespread state intervention among grain-producing countries to control grain exports. For decades, governments of grain-producing countries across the world had competed with each other to promote grain exports. What had changed? First, almost unnoticed by consumers, politicians and policymakers alike, the grain surpluses which had been at the core of farm policies quietly shrank… until observable supplies of corn, wheat and rice were down to levels that would mean that almost any crop failure anywhere could raise prices above government support levels. Second came the first serious outbreak of global food inflation since the stagflationary 1970s, and prices of all grains skyrocketed. Result: governments began to tax—control—or even ban exports of grains and oilseeds. Two motivations appeared: (1) the rebirth of autarky among nations , which hadn’t been seen since World War II; it reappeared in a few countries where food scarcity among urban residents suddenly became a hot political issue; (2) keeping food at home to suppress domestic inflation, even if it meant that local farmers were forced to sell their output at prices far below world levels. The major food-importing nations that had the money to buy food weren’t initially frightened as grain prices climbed. What got their attention was the threat that food might not be available at almost any price because of export controls abroad. Their response has been astonishing. Saudi Arabia, South Korea, China, Egypt, Kuwait, Qatar and Bahrain have been making deals to buy or lease farmland to grow grains that must be sent to the investing nation. According to The Economist, at least 5.4 million hectares have already been acquired by foreign government agencies in such countries as Sudan, Cambodia, Ethiopia, Mozambique and Turkey—and the process is still proceeding rapidly. The International Food Policy Research Institute told The Economist that between 15 and 20 million hectares “have been subject to transactions or talks involving foreigners since 2006—That is the size of France’s agricultural land.”

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Some of these deals (such as Saudi Arabia’s with Ethiopia) involve production of grain for delivery to the foreign investors from poor countries that are receiving emergency food aid from the UN. (When Joseph agreed to supply Egyptian grain for delivery to Jacob’s family in modern-day Israel, he wasn’t taking it out of the mouths of poor residents of Egypt: they were already well-looked after, thanks to excellent long-range crop forecasting, and major expansions of grain storage facilities.) If deep-pocketed food-importing nations are going to pour billions into irrigating and farming in grain-producing nations abroad, how will this affect the share prices of the great input stocks, such as Monsanto, Deere, Syngenta, Potash and Mosaic? We suspect that investors who spend time pondering this question will conclude that, over the long run, it should help to prevent sudden grain price spikes such as corn’s runup from $2.50 to $7. We believe it will significantly increase sales of fertilizers, seeds and high-end farm equipment, because the new owners (or lessors) are spending heavily to produce gobs of grain. To the extent that this massive inflow of capital does make vast stretches of under-utilized land rich and productive, this could do more to prevent a truly disastrous global food crisis than all the food aid one could imagine. So we are, in principle, in favor of this trend.

...will the whooping crane-sized population of high-quality publicly-traded non-oil-producing commodity companies become an endangered species?

We conclude this discussion by raising the following overall question about growing government ownership in commodities. In the last cycle, once commodity prices began to climb, the producers’ stocks soared, and were the pre-eminent sector of many global stock markets until “The Midnight Massacre.” Will they be even more valued this time because sovereign wealth funds and other emanations of governments will, from time to time, choose a more appetizing investment alternative than Treasurys? And will the whooping crane-sized population of high-quality publiclytraded non-oil-producing commodity companies become an endangered species? To us, the likely answers to these questions suggest strongly that the great commodity companies should be at or near the top of most investors’ short list of “Buy And Hold” stocks.

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Who Will Really Lead the Global Rescue? INVESTMENT ENVIRONMENT Back in the Sixties, there was a saying in some intellectual circles. “Learn a foreign language! If you’re an optimist, learn Russian! If you’re a pessimist, learn Chinese!” ...the multi-trillion-dollar smorgasbord of policies on offer seems to be a mixture of Depression-Era Roosevelt and Modern-Era France and Belgium.

That reflected the fashionable feeling that capitalism’s best days were behind it. And a very good thing, too, because most of the history of capitalism was of robber barons, exploited workers, raped environments, and wars. Even a few months before the Wall fell, liberal elitists thought that the USSR was an economically successful society, albeit undemocratic, and with a regrettable tendency toward building dreary housing developments in dreary cities. We cite those perceptions from the past as evidence one must be wary about assuming that the economic system that has, for two centuries, been the source of most of the world’s progress, is about to cede leadership to the self-proclaimed heirs to a Communist fanatic responsible for more deaths among his own people than either Hitler or Stalin. We are, of course, delighted that the current Beijing politburo reads Adam Smith. That gives China an automatic advantage, because we doubt that Smith is standard bedtime reading in the White House—or in leading economics departments other than the University of Chicago’s. The remarkable paradox of our time is that China since Deng Xiaoping has achieved its longest continuous politico-economic program in at least two centuries—with dazzling success—while the new US leadership is in the process of dismantling the model developed by Reagan, and continued— mostly—by his successors. During that time US GDP climbed far faster than Continental Europe’s, which managed its economic torpor brilliantly: it offset that underperformance by convincing most of the most powerful American liberals that its model was better than America’s. Now that it is President Obama’s job to get the economy performing the way it did between Reagan’s First Term and the Recession of 1999, the multitrillion-dollar smorgasbord of policies on offer seems to be a mixture of Depression-Era Roosevelt and Modern-Era France and Belgium. With one conspicuous exception: the only Rooseveltian initiative that not only created jobs and economic gains almost from Day One was the Tennessee Valley Authority (TVA). This became, over the years, one of the world’s most successful energy development programs and was a big factor in fulfilling the classic defiant cheer from Dixie: “The South will rise again!”

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But, apart from a few windmills and a lot of research into converting hay into electricity, there is nothing in the Obama program that creates jobs now—and continuously into the future—and finances them TVA-style—in public debt markets based on cash flow generated from electric power plants and other contributions to economic renaissance. TVA became a big producer of nuclear power, which somewhat tainted it in the eyes of the True Left. What about the hundreds of thousands of real jobs fixing the worn-out highways and bridges across America that would be at the core of the Obama recovery program?

We lost the roads and bridges somewhere along the way.

We lost the roads and bridges somewhere along the way. The number—and dollar value—of new US highway and bridge contracts has actually plunged since the stimulus was announced. So much for all those shovel-ready projects that were going to create jobs and improve transportation. Obama’s vision of creating economic progress through millions of jobs in governments, universities and NGOs is doubtless a hit in Brussels. Following those policies has meant that the unemployment rate in Continental European countries in this decade has for many years been roughly at the levels America is experiencing now—and twice the rate it experienced under the horrors of the Bush Administration. We think the likeliest outcome of our current discontent is a recovery that will disappoint both bulls and bears—by making neither much richer. Obama could have stimulated large-scale immediate job creation in the private sector in California and other coastal states by authorizing and promoting offshore drilling. Instead, he banned it, while reveling in visions of millions of jobs in clean energy. The sudden selloff in the long Treasury bond market last week sent yields on the Ten-Year Note to levels that are forcing significant increases in home mortgage rates. The re-fi boom that swelled bank profits and shone the first rays of sunshine into the housing gloom is over. Ben Bernanke is engaged in the Sisyphine project of driving down long Treasury yields by printing money. Since he started, rates are up by roughly two-thirds, and the dollar is down 5%.

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Who Will Really Lead the Global Rescue? Nevertheless, money supplies are growing at unRooseveltian rates, unemployment statistics have improved dramatically, consumer confidence is rising, and the effects of $65 oil won’t show at the gas pumps for a few weeks. Obama...is richly fulfilling our expectations for him as Cheerleader-in-Chief

The Baltic Dry Index is on a tear, which means that real economic transactions are taking place at a faster pace in nations separated by seas. We believe the low for the Bear was reached in March, and although we think the S&P faces choppy waters for the next six months or so, we also believe that Emerging Markets equities and bonds will continue their process of being re-rated upward. The geopolitical risks remain just that—risks. Since Obama was inaugurated, almost all the foreign news has been bad. Except for one reassuring fact: the man retains his magic when he speaks to crowds or on TV. Roosevelt redux. Yes, he’s ’way better than Hoover. In fact, on the platform, he’s as good as they come. As disappointed as we are about his economic and fiscal programs, he is richly fulfilling our expectations for him as Cheerleader-in Chief—and that is a highly useful function of those in high places in an age of mass communications. We do not share the gloom of those who believe the economy is about to plummet into Depression. Friday’s Non-Farm Payroll may have marked the turning point for the US economy from deep downward slide to stability and recovery. Historically, once the numbers show for the first time that the economic consensus had become far too bearish, and that some previouslyannounced job losses were overstated, then the economy has bottomed. In fact, like Angela Merkel, who fears that the Fed and other central banks have overdone the reliquification, we believe it’s time to stop fibrillating over Depression fears: the likeliest outcome is that talk of a stagflationary recovery will banish the apocalyptic pronouncements.

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Who Will Really Lead the Global Rescue? RECOMMENDED ASSET ALLOCATION Recommended Asset Allocation (for U.S. Pension Funds) Allocations 18

Change unch

Foreign Equities European Equities Japanese and Korean Equities Canadian and Australian Equities Emerging Markets

6 2 11 14

unch unch +2 +3

Bonds US Bonds Canadian Bonds International Bonds Long-Term Inflation Hedged Bonds

8 5 11 10

unch unch unch unch

Cash

15

-5

Years 3.50 3.75 3.50

Change -0.50 -0.50 -0.25

US Equities

Bond Durations US Canada International

Global Exposure to Commodity Stocks

Precious Metals Agriculture Energy Base Metals & Steel

33% 33% 22% 12%

Change -2% unch unch +2%

We recommend these sector weightings to all clients for commodity exposure—whether in pure commodity stock portfolios or as the commodity component of equity and balanced funds.

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Who Will Really Lead the Global Rescue? INVESTMENT RECOMMENDATIONS 1. The current US equity rally shows signs of needing a summer rest. But it will not fall back into the Slough of Despond. This is a cyclical bull market within a structural bear market—until proven otherwise. What it most needs now is a lift from the bank stocks—and from sharply rising volume on days the market rises sharply, and from falling volume when it falls. It has been getting none of the above. 2. Remain overweighted in the commodity stocks, and remain diversified among the four commodity groups. Leadership will rotate from week-toweek, but all four groups are showing good strength relative to market indices. 3. We hope we are right that gold-related investments will be rewarding, but will likely underperform other commodity-related investments in the next few months. That means the global economic recovery was proceeding without setting off inflationary sparks. Thereafter, concerns about the dollar and the effects of the all-out reflation programs will once again boost demand for gold. 4. The dollar has attracted fundamental criticism from one of its largest holders—the Chinese. They have also transformed their Treasury holdings by buying bills and selling notes and are well on their way to becoming a demand depositor at the Fed. By forgoing nearly all the interest they could earn, they are telling investors that we should be concerned about the dollar. Believe those who back their bets against the buck so big. 5. The Canadian dollar remains undervalued relative to the greenback. Canadian companies should emulate Teck: borrow, where possible in US dollars. Canadian equity investors should shop at home first, then look for US bargains. 6. Keep bond durations low. We have entered a bond bear market at a time of a declining dollar. That has historically been a lethal combination. 7. Do not join the all-out bears on America. The American economy is more resilient than the gloomsters believe. It can even survive the wounds inflicted on it by the Wall Street-Fannie-Freddie-Frank follies—and the Pelosi-Obama programs. Nevertheless, there are now some better investment alternatives elsewhere—across the Pacific and above the 49th Parallel.

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