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Paris 1, 2 & 3 December 2009

Global Strategy The investment opportunity of a generation or the start of another lost decade? Albert Edwards & Dylan Grice

December 2009 IMPORTANT: PLEASE READ DISCLOSURES AND DISCLAIMERS AT END OF DOCUMENT

Source : John Trever, Albuquerque Journal. Used by permission

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December 2009

Inflation is always and everywhere a fiscal phenomenon … Official Net Debt, % GDP*

Total net liabilities (funded and unfunded), % GDP**

750%

500%

250%

0% Germany

Spain

France

Italy

UK

EU

US

* 2010 OECD projections ** 2005 estimates of total Fiscal Imbalance

Source: Gokhale (2009)

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The last time China was about to take over … Columbus’ ship next to Zheng He’s

Photograph by Lars Plougmann

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December 2009

Pocket of value? Grain hasn’t participated in the rally … 110

GSCI Grains Spot GSCI Grains Excess Return

100

S&P500

90 80 70 60 50 40 30/06/08 30/08/08 30/10/08 30/12/08 28/02/09 30/04/09 30/06/09 30/08/09 Source: Datastream

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Anatomy of a bubble: the Kindleberger-Minsky model Displacement

Revulsion

Boom

Crisis

Euphoria

Source: Kindleberger, SG Cross Asset Research

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December 2009

Gold is cheap against USD: US monetary base divided by gold held 1.60 1.40

Gold is expensive - USD overbacked by gold

1.20 1.00

0.80

Gold is inexpensive - USD underbacked by gold

0.60 0.40

0.20 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Source: SG Cross Asset Research

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Equities way behind government bonds 280

280

260

260

240

240

220

220

200

200

Bonds

180

180

160

160 140

140

Cash

120

120 100

100

Equities 80

97

98

99

00

01

02

03

04

05

06

07

08

09

Source: Thomson Datastream

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80

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December 2009

S&P 10 year compound returns 1936-2008

Source: S&P

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Phases of inflation & phases of investment: relationship between US bond & equity market yields

16

16

Culting of the equity 14

Equity yields are an average of Dividend & Earnings Yield

12

Interest rates are a weighted average of bond yields (2/3) & short term interest rates (1/3)

The dismal years

The long bull market 14

Interest rates

12

10

10

8

8

6

6

4

4

0

2

Equity yield

2

0 1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

Source: Thomson Datastream 11

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December 2009

Ice Age derating of equities v bonds 8

8

The Ice Age Bond yield Bond yield

7

7

6

6

5

5

4

4

3

3

Equityyield yield Equity (avof ofearnings earnings&÷nd) dividend) (av 2

2 93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

Source : Thomson Datastream

Source: Thomson Datastream 12

Japanese bond/cash flow yield ratio derating has led the US (strangely similar hey?) 1.20

1.20

1.00

1.00

US

Ice Age derating…relatively “cheap” US equities getting

0.80

0.80

cheaper and cheaper

0.60

0.60

0.40

0.40

0.20

0.20

Japan (led 10 years) 0

0 83

85

87

89

91

93

95

97

99

01

03

05

07

09

11

13

15

17

Source: Thomson Datastream 13

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December 2009

Source: Datastream

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The Great Moderation lie – back to volatility

Source: St Louis Fed 15

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December 2009

Total US debt as % of GDP

Source: Lacy Hunt, Hoisington Investment Management

16

Leverage Ratios %

Source: San Fran Fed

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December 2009

US domestic borrowing by sector ($bn) 6000

6000

5000

5000

4000

4000

3000

3000

2000

2000

1000

1000

0

0

-1000

-2000

federal + state & local government financial sector non-financial domestic private sector total domestic

-1000

-2000

-3000

-3000 2005

2006

2007

2008

2009

Source: Thomson Datastream 18

Lessons from Japan: Equity markets became highly cyclical with frequent +/-25% moves 100 90

Ice Age volatility

80 70 60 50 40 30 20 10 0 -10 -20 -30 -40

Jan-64 Jan-65 Jan-66 Jan-67 Jan-68 Jan-69 Jan-70 Jan-71 Jan-72 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

-50

YoY change in the Nikkei 225

25% fall

25% rise

Source: SG Cross Asset Research

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December 2009

Japanese Ice Age PE de-rating followed the cycle Cyclical lead indicator

80

90

(rhscale)

70

80

70 60 60 50 50 40 40 30 30 20

20

Forward PE 10

10 91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

Source: Thomson Datastream 20

Bubble, upon bubble, upon bubble!

"It

will not be too bad this year. Both China and America are addressing bubbles by creating more bubbles and we're just taking advantage of that. So we can't lose," he said.

Lou Jiwei, Chairman of China’s sovereign wealth fund, China Investment Corp. Wealth Fund Muscles Up as Markets Recover: Reuters, August 28, 2009

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December 2009

Is the Fed at it again?

Source: Zerohedge

22

US bank lending (ex securities yoy%) 20

20

15

15

10

10

5

5

0

0

-5

74

76

78

80

82

84

86

88

90

92

94

96

98

00

02

04

06

08

-5

Source: Thomson Datastream 23

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December 2009

Deleveraging lasts well past end of the recession 20

14

loans to gov (treasuries)

12

15 10

10

8

6 5

total

4

0

2

0 -5 -2

recession bank loans (private)

-4

-10 1989

1990

1991

1992

1993

1994

1995

Source: Thomson Datastream 24

Early 1990s stop/start recovery drove US bond yields lower and lower 10.00

110

9.50 100 9.00

8.50 90 8.00

7.50

80

7.00 70 6.50

6.00

5.50

expectations (rhscale)

60

10y yields

5.00

50 1989

1990

1991

1992

1993

1994

Source: Thomson Datastream 25

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December 2009

Source: CSFB 26

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December 2009

The unwind goes on and on and on

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The Fed’s printers are already working flat out

Source: SG Cross Asset Research (A. Edwards)

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December 2009

Have you forgotten how horrible things were when inflation last exceeded 20%?

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Source: SG Cross Asset Research (A. Edwards)

US 10y still in clear bull market 10

10

9

9

8

8

7

7

6

6

5

5

4

4

3

3

2

2 86

87 88

89

90

91 92

93

94 95

96

97

98

99

00

01

02

03

04 05

06

07

08

Source : Thomson Datastream

Source : Thomson Datastream 31

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December 2009

US expectations ripe for correction 140

140

120

120

100

100

80

80

60

60

expectations 40

40

20

20

present situation 0

0 2002

2003

2004

2005

2006

2007

2008

2009

Source : Thomson Datastream 32

Watch the nominals (US GDP and wage bill) 12

12

10

10

8

8

nominal GDP

6

6

4

4

2

2

0

0

-2

-2

-4

-4

wage income -6

-6 90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

Source : Thomson Datastream 33

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December 2009

US core CPI crashes in the recovery phase 35

6.00

headline ISM (inverted, 6mth mav)

5.50

40

5.00 4.50

45

4.00 50

3.50 3.00

55

2.50 2.00

60

1.50

core CPI (rhscale) 65

1.00 88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06 07

08

Source : Thomson Datastream 34

Spanish core CPI inflation heading to 0% 6

6

5

5

4

4

3

3

2

2

1

1

core

0

0

-1 -2

-1

headline 95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

-2

Source : Thomson Datastream 35

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December 2009

Australian annualised GDP growth – 2Q 14

14

nominal

12

12

10

10

8

8

6

6

4

4

2

2

0

0

real

-2

-2

-4

-4

-6

-6 95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

Source : Thomson Datastream 36

Hawley-Smoot here we come?

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December 2009

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December 2009