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Complimentary Report from john@13d.
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WHAT I LEARNED THIS WEEK
August 27, 2009
I am always doing that which I can not do, in order that I may learn how to do it.
Pablo Picasso
Gandhi equated God with truth, and for Lord Acton the essence of a society’s devotion to freedom was its belief in truth.
J. Rufus Fears, A History of Freedom
Things don’t change, but by and by our wishes change.

Marcel Proust
When you reach the top, keep climbing.

Zen aphorism
In Greece, there was always the concept that every right also had an obligation or a duty.
Revolution is impossible until it becomes inevitable.

Leon Trotsky
Never mistake motion for action.

Ernest Hemingway
You have not converted a man because you have silenced him.
Viscount John Morley
A jest’s prosperity lies in the ear of him that hears it, never in the tongue of him that makes it.
William Shakespeare
We have taken a different course in our society. We decided that we can separate private and public morality, and thus we have,
again, rejected the lessons of history and of the past. We have also, as a society, decided that truth is not an
absolute value. Again, for the Greeks, truth and liberty were one and the same, and that there were enduring truths like
justice and honor ordained by the gods, and whatever the laws or the attitudes of the majority might be, as Antigone tells us,
“These laws of truth endure forever.”
13D Research, Inc. (208) 726-1565 www.13d.com What I Learned This Week 08/27/09
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Complimentary Report from john@13d.com
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You should know that we hate all Americans . . . from the bottom of our souls, we hate you.
Ansar Abbasi, a Pakistani journalist to Judith A. McHale, the Obama Administration’s new Under Secretary
of State for Public Diplomacy and Public Affairs, on August 17, 2009.
There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in
the introduction of a new order to things.
Niccolò Machiavelli
The best leaders of all are the ones people do not know exist. They turn to each other and say we did it ourselves.
Zen aphorism
Four things come not back: the spoken word, the spent arrow, the past, the neglected opportunity.
Omar Ibn Al-Halif
Silence is the true friend that never betrays.

Confucius
The artist is nothing without the gift, but the gift is nothing without work.
Émile Zola
Always do sober what you said you’d do drunk. That will teach you to keep your mouth shut.
Ernest Hemingway
Advice is like snow; the softer it falls the longer it dwells upon, and the deeper it sinks into the mind.
Samuel Taylor Coleridge
Death is not extinguishing the light; it is putting out the lamp because dawn has come.
Rabindranath Tagore
Always be a little kinder than necessary.

Sir James Matthew Barrie
The fool wonders, the wise man asks.

Benjamin Disraeli
I do not believe today everything I believed yesterday; I wonder will I believe tomorrow everything I believed today.
Matthew Arnold
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God is in the details.

Ludwig Mies van der Rohe
Knowledge can be conveyed, but not wisdom. It can be found, it can be lived, it is possible to be
carried by it, miracles can be performed with it, but it cannot be expressed in words and taught.
Herman Hesse
1. Deleveraging is a myth (continued). Who is buying all the U.S. Treasury

securities? We asked this question again last week, in an attempt to get to the bottom of
the mystery surrounding the actual purchasers of the Treasury’s recent debt auctions.
With record deficits and borrowing required by the U.S. in future years, discerning the
direction of the dollar will be critical for investment success.
Last week, we advised our readers to heed Buffett, after he reiterated his warning of
inflation in The New York Times. This week, President Obama took time out from his
vacation to announce the re-appointment of Bernanke as Fed chairman, as the dollar index
was teetering on the precipice of another break to the downside. This is an interesting
confluence of events that may not be purely coincidential.
The financial blog Seeking Alpha (seekingalpha.com/article/158330) recently carried an

interesting analysis by Chris Martenson (www.chrismartenson.com), who argued that the
Fed has been monetizing more debt than advertized by “cleverly enabling foreign
central banks to swap their Agency debt for Treasury debt.”
(It goes without saying that Agency debt is not formally guaranteed by the U.S.
government. When we were in China in October 2008, we met with an important
member of the economics staff of the U.S. Embassy in Beijing. This person told us that
the subject of whether the U.S. government would stand behind its Agency debt came up
in conversation with Chinese officials literally every day.)
Martenson likens the process to a shell game in which foreign central banks (FCBs) sell agency debt
out of the custody account, with those bonds then being purchased by the Fed with newly created money,
which then allows the FCBs to buy U.S. Treasury securities at auction. Martenson astutely points
out the following: “The Federal Reserve does not want to be seen directly buying US
government debt at auctions (and in fact is not permitted to, but many rules have been
'bent'…during this crisis), because that could upset the whole illusion that there is
unlimited demand for US government paper, but it also desperately wants to avoid a
failed auction.”

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While we cannot ascertain with certainty whether or not the Fed is actually disguising its
monetization of the debt through FCB swaps out of Agencies, there is little question that
the institution is a master at obfuscation—a point that was driven home by the recent
U.S. District Court ruling that compels the Federal Reserve to identify the companies
participating in its emergency lending programs. The ruling came in response to a Freedom
of Information Act lawsuit filed by Bloomberg LP. The Federal Reserve is trying to delay
enforcement of the ruling, claiming that the recipients of the emergency funding could
then “suffer irreparable harm.”
However, in our view, this argument has become substantially weaker since the first
quarter of this year, a time when talk of bank nationalization essentially put our nation’s
biggest and strongest financial institutions on life support. Does anyone now think that any new
disclosures of emergency funding, after all the rumors that were spreading earlier this year, will make any
difference?
Allen Grayson, a Democrat serving on the House Financial Services Committee, was
quoted by Bloomberg as follows: “The Federal Reserve has to be accountable for the
decisions that it makes. It’s one thing to say that the Federal Reserve is an independent
institution. It’s another thing to say that it can keep us all in the dark.” The House
of Representatives may vote in the near future on a bill that might require the Fed to be
audited by the Government Accountability Office (GAO).
Bianco Research recently commented on Martenson’s analysis as follows: “This story puts
a very interesting twist on what we have previously labeled nothing more than a flight to
safety among foreigners. Because the Federal Reserve does not currently offer much
information in terms of its internal operations…there is no way to know for sure if the
shell game described above is actually a reality. Let’s suppose for a minute that foreigners
are selling their agencies to the Federal Reserve and using those proceeds to buy
Treasuries. How long could this game last?” Bianco then noted that since last
summer, FCB holdings of Treasuries jumped from a little over $1.3 trillion to more
than $2 trillion, while FCB holdings of Agencies dropped from $984 billion to $784
billion.
We also know that foreign holders of Treasury securities are increasingly moving to
shorter-dated securities, having increased their holdings of short-term Treasury bills by
$113.8 billion, while increasing their holdings of Notes and Bonds by only $43 billion since
the end of last year. From this, one can draw the reasonable conclusion that, based on the
most available data, FCBs are increasingly opting for shorter-term securities as a likely
measure of protection from inflation and potential dollar weakness.

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Peter Warburton of Halkin Services Limited (see related themes) recently wrote
that loose monetary policy is likely to continue for some time. We quote as follows:
In the week that Fed Chairman Ben Bernanke has been nominated to serve another term, it is curious
that so much attention is given to the removal of monetary stimulus and its timing. The endorsement of
Bernanke’s experimental and unconventional approaches to monetary policy gives a strong signal that
loose policy is likely to prevail for quite some time. There is an interesting debate as to the future
balance between very low interest rates versus quantitative expansion of the money supply. Increasingly,
commentators are coming to understand that interest rates can be raised before
asset purchase plans are wound down. Indeed, the Bank of Israel raised interest rates this
week.
2. Has Gold Production Peaked? Since closing at a 20-year low of $252.90 following the
sale of 25 metric tons by the Bank of England in 1999, the price of gold has increased
374%. Yet producers have not responded to the market’s pull—primary production has
since fallen 9%. With central bank gold sales falling to a fifteen-year low, investment
demand surging, and Chinese demand mounting (see WILTW 8/6/09), we can’t help but
wonder how readily global gold producers could ramp up production.
The bullish answer for gold prices is that a surge in demand could not be readily
met by increased primary production—global gold output may have already
reached its practical peak.
Egyptians began mining gold over 4,000 years ago, but visions of Tutankhamen’s tomb,
Conquistadors plundering the New World, and the 1849 gold rush notwithstanding, the
rate of gold extraction has been far greater in modern times. The United States Geological
Survey (USGS) reports that more than two-thirds of all the gold extracted in the history of the world
has been mined in the last 50 years.
Annual World Gold Production & Price
3,000 $1,000
$900
2,500 $800
Average Price
MetricTons
$700
2,000
$600
1,500 $500
$400
1,000
$300
500 $200
$100
0 $0
1900
1907
1914
1921
1928
1935
1942
1949
1956
1963
1970
1977
1984
1991
1998
2005
Source: Derived from USGS Historical Statistics

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As this chart shows, primary production topped out early this decade. Considering
gold’s 20-year bear market during the 1980s and 1990s, it is not surprising that exploration
fell and production dipped.
As gold is extracted, active resources are depleted. In order to increase production over
time, producers must collectively discover and develop new resources at a faster rate than
they extract the precious metal from existing sources. If self-preservation weren’t enough
to motivate exploration for new resources, soaring prices should certainly encourage
development. Despite exploration spending increasing 6-fold since its low of 2002,
resource increases from significant new discoveries have plummeted.
The average cost of producing and replacing gold doubled over the last decade, but with
average total cash costs estimated by GFMS at $467 per ounce, plenty of profit remains to
encourage expansion. It can take a decade or more to bring a new gold discovery into
production, so decreased mine production could reflect reduced exploration stemming
from weak pricing in the 1990s—and would miss the significance of expanding
exploration more recently. For this reason, it is wise to look more directly at new
discoveries and at changes in economic reserves and total reserve base.
The overall impact of depletion could easily be missed by those following only
large gold producers. According to a recent study by Metals Economics Group (MEG),
companies with 2008 production over 450,000 troy ounces replaced depletion nearly two-
for-one over the last decade through a combination of exploration, acquisitions, and
resource upgrades. Since these large miners are responsible for 55% of global gold
production, it would be easy to conclude that new discoveries are outpacing depletion—
but in fact total global depletion has doubled new discoveries.
Source: Metals Economics Group

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Despite the surge in exploration spending, over 90% of exploration-derived

reserveincreases for major producers are the result of resource upgrades at existing
projects. While the nearly four-fold increase in gold prices has allowed previously sub-
economic resources to be reclassified as reserves, the number and size of new discoveries
has been shockingly low. For instance, as of mid-June, no significant discoveries could be attributed
to 2008 global exploration activities.
Number of Major New Discoveries

16
14
12
10
0
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Source: Metals Economics Group
Given the massive increase in gold prices and upgrading of resources by major producers, one
would expect a substantial shift in global resources from a sub-economic reserve base to
profitably exploitable reserves. In fact, the share of the known reserve base classified as
economic reserves has fallen substantially, and gross economic reserves are also
trending lower. While the identified gold resource has grown, most could not be
recovered economically at last year’s average price of about $872.

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Global Gold Reserves and Total Reserve Base
100,000 100%
Reserve Percent of Total

90,000 90%
Metric Tons 80,000 80%
70,000 70%
60,000 60%
50,000 50%
40,000 40%
30,000 30%
20,000 20%
10,000 10%
0 0%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Reserves Sub-economic % Reserves Trend (% Reserves)
Source: Derived from USGS Data
Reinvigorated efforts to discover new gold deposits have failed to halt production declines.
While new resources have been found, most remain uneconomic. Discoveries in
recent years have included fewer large high-grade reserves and relatively more small low-
grade resources. Barrick Gold, the world’s largest gold producer, noted the challenge in its
2008 Annual Report:
“Mine supply, which represents over 60% of total gold supply, is expected to decline over the next
several years as production is challenged by maturing mines, the lack of large discoveries, financing
constraints and longer development timelines. Taken together, all of these factors are extremely
supportive of higher gold prices in the future.”
Since the easiest and most economic resources are more readily found and exploited than
those in more remote and risky environments, it naturally becomes more difficult and
expensive to find replacement reserves over time. MEG estimates that only 19% of all
advanced-stage non-producing gold projects are in lower-risk jurisdictions—while
57% face medium-risk and 24% are in high-risk areas.
Peak production theory holds that after about half of a total resource is extracted, riskier,
more remote, and reduced-grade resources cause production to plateau or decline.
According to a synthesis of USGS data published over the last several years, an estimated
160,000 metric tons of gold have been mined throughout the history of the world. With the remaining
global reserve base reported to be only 100,000 metric tons, USGS estimates imply that
over 60% of the world’s known recoverable gold has already been extracted.
In a 2007 article titled “Peak Gold”, Anatal Fekete of Gold Standard University, pointed
out that gold was historically mined conservatively with profitable, but marginal ore

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targeted first—leaving a store of value of higher grade ore to sustain mine life. According
to Fekete, the old gold tenet “worst grade first, best grade last” has been abandoned
over the last 25 years for quick payouts of high-grade ore.
Were gold still mined as in years of old, it would be comparatively easy to ramp up
production by simply mining richer ores—at least temporarily. But with high-grade ores
having been cannibalized for sustenance during the 20-year bear market of the 1980s and
1990s and for quick profits this decade, many of the world’s large mines face
deteriorating ore grades. With lower ore grades, the same input of mining effort
produces less output of gold. South Africa’s quest for gold has taken some mines more than 2 miles
deep, leading to ever-rising production costs and many fatalities.
Dynamics associated with peak production are often observed in individual mines where
production begins to decline, depleted shafts are shut down, and the mine is eventually
closed. But what has been the experience of total gold production over large
productive areas? (The world’s largest gold producing countries include China, South
Africa, the United States, Australia, Peru, Russia, Canada, and Indonesia.)
After peaking in 1970, South Africa’s gold production has steadily fallen by nearly 75%—
last year’s output was the lowest since a national strike in 1922. U.S. production has fallen
37% since peaking in 1998. Despite robust mining industries, Australia’s gold production
peaked in 1997 and Canadian production peaked in 1991. Australia’s gold output has
since fallen 30%, and Canada’s has fallen 43%. Peru’s production has fallen 16% since
hitting a high in 2005, while Indonesia’s sporadic production has been trending down this
decade. These countries collectively account for over 45% of global gold mine output.
Russian gold production climbed early this decade, but has stayed fairly steady since then.
Of the major gold producing regions, only China has consistently increased output
over the last decade. According to GFMS, the gold price rally has driven China’s
increased production: “In response to the rising price, an extensive number of small, low-
grade and high-cost mines have been brought into production…[fueled by] incentives and
support offered by various Chinese government departments.” China’s current rate of
production will exhaust its USGS-estimated reserves in just four years.
The picture that emerges is one in which gold production appears to have already
peaked in most major producing regions throughout the world despite
skyrocketing prices. China, the only country that has been able to increase production
substantially in recent years, seems likely to hoard any excess output it is able to produce.
Although miners can dig deeper and explorers can negotiate more treacherous territory, a

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mounting body of evidence points to the difficulty of increasing global gold production.
The huge run-up in gold prices over the last decade occurred despite what GFMS
calculates to be an 8% drop in total demand. During that time, official sector sales
averaged 12.2% of total global supply. GFMS now forecasts that official sector sales
will fall 71% this year from the long-term average, effectively cutting supply by
8.6%.
How long can increased recycling make up the shortfall? How long before jewelry
demand bounces back? How long until surging demand for gold in China and for
investment around the world force prices higher? It may not be long—and meeting
increased demand by mining may prove most challenging.
3. The incredible shrinking private sector. Even as millions of private-sector jobs have
disappeared in the past year, government hiring has continued—this despite massive
budget deficits and the burgeoning pension time bomb. According to a recent report by
the Nelson A. Rockefeller Institute of Government, private sector employment as a whole
shed 6.9 million jobs between the December 2007 start of the recession and July 2009.
Over the same period, state and local government employment rose by 110,000 jobs or
0.6%, with increases in both state and local governments. According to the report,
politically-powerful unions have helped preserve public jobs, as has the more than $36
billion of fiscal relief the states received under the American Recovery and Reinvestment
Act.
Although magnified by the economic downturn, this is not a new trend. As figures
from the Bureau of Labor Statistics show, private sector job growth has
been practically non-existent over the past decade.
Source: Bureau of Labor Statistics

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As BusinessWeek’s chief economist, Michael Mandel observes: “Between May 1999 and
May 2009, employment in the private sector rose by only 1.1%—by far the lowest 10-year
increase in the post-depression period. . .It is impossible to overstate how bad this is.
Basically speaking, the private sector job machine has almost completely stalled over the
past ten years.”
According to BLS statistics, over the last 10 years, the private sector has generated
roughly 1.1 million additional jobs, while the public sector has created about 2.4
million jobs. But, as Mandel, points out, the private-sector figures include health care,
social assistance and education—all of which receive a lot of government support. Strip
these jobs out and “the labor market would have been flat on its back.”
Industry Change, May 1999-2009
(thousands of jobs)*
Private healthcare 2898
Food and drinking places 1567
Gov education 1390
Professional and business services 885
Gov except health and education 843
Social assistance 796
Private education 772
Arts, entertainment, and recreation 188
Gov health 148
Mining 133
Financial activities 130
Utilities -40
Transportation and warehousing -43
Retail -91
Accommodations -119
Wholesale -166
Construction -238
Information -525
Manufacturing -5372
*Government health and government education based on April 2009 estimates
Data: BLS
The U.S. is already one-third public (if you include education and healthcare)
workers. Just as with its entitlement programs, America continues to offer salaries,
benefits and pensions to a growing number of public employees it cannot afford.

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To appreciate how massive city, state and local public-sector costs have become, consider
the following data points compiled by John Avalon, a senior fellow at the Manhattan
Institute:
There are 22.5 million public-sector employees in the United States. The average state and
local government employee now makes 46 percent more in combined salary
and benefits than his private-sector counterpart does, according to the Employee
Benefit Research Institute—including 128 percent more on health-care and 162 percent more on
retirement benefits. Four out of five public-sector workers have lifetime pensions. . .New York City
spends an average of $107,000 for each of its 218,000 current employees—a whopping 63 percent
increase since 2000. At the same time, its direct pension expenses each year have increased from
$615 million to $5.6 billion. Forty states estimate that their combined liabilities
for public-sector health-care and other benefits exceed $400 billion—more than
their entire public debt, according to Standard and Poor’s.
Even amid state budget crises, pension costs continue to soar. Consider Los Angeles.
Collecting nearly $318,000 a year, the former head of Los Angeles’ Department of Water
and Power tops a list of 841 pension recipients paid six-figures benefits. And like many
retirees he will be paid more beginning this summer—$327,000—because of annual cost-
of-living increases.
As The Los Angeles Times recently observed: “In our public workforce, we have created
an ivory tower parallel class who exist in a different world than that of the private
worker. Many are no longer affected by the free market—even as we watch city after city
and state after state suffer with massive shortfalls.”
Going forward, private workers will continue to shoulder an increasingly heavy burden thanks to the
multitude of new hires in the public arena. As one blogger recently mused: “Your world is not so
nice—but as generous folk you are doing a heck of a job supporting the other one-third.
The new paradigm economy—transferring money from private to public to subsidize the
smaller (but faster growing) portion of the workforce.”
4. Yemen’s growing instability and the consequences for the world. As the Obama
administration shifts its attention from Iraq to Afghanistan, it may be overlooking what
could potentially be the hottest spot in the Middle East—Yemen, the ancestral birthplace
of Osama bin Laden.
In the past few weeks, Yemen’s ongoing conflict with Shi’ite rebels in the north has
flared into fierce fighting. Scores of people have been killed and over 100,000 have
been displaced. (The northern rebels, the Houthis, like most tribesmen in Yemen’s

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northern highlands, belong to the Zayid sect of Shi’ite Islam, whose Hashemite line ruled
the country for 1,000 years before the revolution in 1962.) Earlier this month, the Houthis
tried to block the road connecting the capital Sana’a with the province of Saada where they
are based, as well as the highway between Saudi Arabia and Yemen in the Al-Malahaid
area. The rebels rejected a cease-fire offer from the Sunni Muslim-dominated government
at the beginning of the holy month of Ramadan, last Friday. The region has since echoed
with the fire of artillery, tanks and aircrafts as Yemeni forces move to crush the uprising.
The conflict in Yemen is also connected to a wide political conflict in the region—
namely animosities between Iran’s Shiite-led government and its Sunni Arab neighbors.
As The Los Angeles Times recently reported: “Yemen has intimated that Iran is funneling
weapons and money to the rebels. Iran’s new media have alleged that Saudi forces have
joined Yemeni troops in putting down the rebellion. The Saudis, who worry that unrest
may seep across their border, have only publicly acknowledged that the kingdom is
consulting with Yemen about the violence.”
Despite Tehran’s denials, Najeeb Ghallab, a political analyst at Sana’a University, believes
the Iranian government could be behind the Houthis rebels. “Iran has strategic goals in
this regard, and the Iranians believe an army will come from Yemen to support the long-
awaited 12th imam, the Mahdi. . .Any threat to the Yemeni state will also threaten
Saudi Arabia, the only force that can confront Iran. Iran therefore has an interest in
promoting threats to Yemen.”
As armed conflict rages in the north, the country is also battling a secessionist movement
in the south. Southerners in Yemen have long complained that northerners abuse the
1990 unity agreement by stealing their resources and discriminating against them.
Meanwhile, growing numbers of Al-Qaeda fighters are using the country as a base
to launch attacks across the Middle East. Clearly, a seriously unstable Yemen on the
scale of pre-2001 Afghanistan or the present-day Somalia poses a serious threat for
Riyadh, U.S.’s interests in the region, and much of the world’s oil supply which
travels through the Bab al Mandeb (the narrow straits separating Arabia from Africa) and
around the Gulf of Aden.
Few have studied Yemen and its tinderbox status as closely as Robert Kaplan. In a recent
essay in Foreign Policy, “The Revenge of Geography” (see WILTW 05/21/09), Kaplan
underscored Yemen’s threat to the Saudi Arabia:
Where Saudi Arabia is truly vulnerable, and where the shatter zone of Arabia is most acute,
is in highly populous Yemen to the south. Although it has only a quarter of Saudi Arabia’s

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land area, Yemen’s population is almost as large, so the all-important demographic core of the
Arabian Peninsula is crammed into its mountainous southwest corner, where sweeping basalt
plateaus, rearing up into sand-castle formations and volcanic plugs, embrace a network of oases
densely inhabited since antiquity. Because the Turks and the British never really controlled
Yemen, they did not leave behind the strong bureaucratic institutions that other former colonies
inherited.
When I traveled the Saudi-Yemen border some years back, it was crowded with pickup trucks
filled with armed young men, loyal to this sheikh or that, while the presence of the Yemeni
government was negligible. Mud-brick battlements hid the encampments of these rebellious
sheikhs, some with their own artillery. Estimates of the number of firearms in Yemen vary, but
any Yemeni who wants a weapon can get one easily. [It is one of the most highly
armed populations in the world, according to World Bank statistics, with
about four AK-47s or grenades for every Yemeni: 80 million arms for a
population of 19 million.] Meanwhile, groundwater supplies will last no more than a
generation or two.
I’ll never forget what a U.S. military expert told me in the capital, Sana’a: “Terrorism is an
entrepreneurial activity, and in Yemen you’ve got over 20 million aggressive, commercial-
minded, and well-armed people, all extremely hard-working compared with the Saudis next
door. It’s the future, and it terrifies the hell out of the government in
Riyadh.”
Yemen is not only well-armed, it is poor, lawless and over-populated. The country’s
population growth rate is higher than 3%—one of the highest in the Middle East. Half of
the country’s population consists of children under 15—few of whom are educated.
In a 2003 essay for The Atlantic Monthly, Kaplan recounts an exchange with a Yemeni
solider after he had asked a particularly hostile knot of young men if they attended school:
“Once you have a gun, why bother to learn to read and write?”
Yemen is also vast. As Kaplan explains in Imperial Grunts: “You have the desert badlands
in the north, but also a sophisticated, cosmopolitan culture in the northeast, the
Hadhramaut, with Indian, Indonesian, and Thai influences, cut off from everyplace else.
Its age-old spice trading links to southeast Asia, make perfect links not only for
legitimate business and financial networks but also for terrorist networks.”
In the past few years, oil revenues have helped President Ali Abdullah Saleh curtail the
wave of kidnappings of Westerners that plagued Yemen in the late 1990s. Saleh increased
the military presence along the main roads and made financial deals with tribal leaders to

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halt the abductions. Earlier this year, nine foreigners, including two German women and a
South Korean woman, who turned up dead two days later, were kidnapped. The central
government blamed the Houthi rebels who have strenuously denied any involvement.
(The group has no history of killing foreign nationals). This issue was one of the key
sparks that ignited the current conflict.
Kidnappings are likely to grow increasingly common as Yemen continues to experience

falling oil output. Hopes that the country’s new LNG exports—expected to set sail for
the liquefaction plant in Balhaf in mid-September—will offset these losses, appear
overblown. As Robert Powell, Middle East analyst at the Economic Intelligence Unit,
recently noted: “Yemen is facing the complete exhaustion of its oil reserves by the
next decade, and will become a net oil importer around 2011. So the Yemeni LNG
project is enormously important. . .They desperately need more income. The gas project is
going to give them a breathing space, but it will not get much further than that.” Oil
production accounts for up to 75% of Yemen’s government revenues.
As if the situation were not bad enough, the country is also wrestling with an
addiction to khat, a plant that provides a mildly energizing narcotic effect when chewed.
As much as 90% of men and 1 in 4 women in Yemen are estimated to chew the leaves. As
Time recently reported in “Is Yemen Chewing Itself to Death?”: “At around $5 for a bag
(the amount typically consumed by a single regular user in a day) it’s an expensive habit in
a country where about 45% of the population lives below the poverty line. (Most families
spend more money on khat than on food, according to government figures.) A khat-
addled public is more inclined to complacency about the failings of government, khat
ceremonies reinforce the exclusion of women from power and, as is obvious to anyone
finding a government office nearly empty on a weekday morning, khat is keeping the
country awake well past its bedtime.”
As devastating as the plant is to the country’s morale, it is even more so to its already-
restricted water supplies. Nearly all of Yemen’s arable land is devoted to khat. The
plant is extremely water-intensive. As Time writes: “Khat fields are typically flooded
twice a month, consuming about 30% of the country’s water—most of which is pumped
from underground aquifers filled thousands of years ago, and replenished only very slowly
by the occasional rainfall that seeps through the layers of soil and rock. A recent explosion
of khat cultivation has drawn water levels down to the point where they are no longer
being replenished. The option of pumping desalinated water over long pipelines from
coastal plants is too expensive for such a poor country. Yemen is in real danger of becoming the
world's first country to run out of water.”

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5. Hemingway’s first great tragic loss.

When he eventually wired her to come down to Lausanne, Hadley thought that Ernest would like to
show [Lincoln] Steffens more of his work. So she rounded up all Ernest’s manuscripts and packed
them into her little overnight bag, in which she also put all the necessaries for her train trip. No one
saw her off, as no one knew she was leaving. She reached the Gare de Lyon well in time for the train.
A porter took her luggage to the compartment, placed her big bag up out of the way and left the
overnight case, with all the manuscripts, where she could easily get to it. There was still lots of time and
so she went out and walked up and down on the platform where she met several newspaper
correspondents she knew who were going to the same conference. When she got back to her
compartment she thought at first she was in the wrong one as the overnight case was nowhere to be seen.
But it wasn’t in any of the other compartments either and then she realized that it had been stolen.
Alice Sokoloff,
Hadley: The First Mrs. Hemingway
There were always other ways of disposing of what the man a woman is married to writes including
the loss of everything the husband had written and not yet published (original
manuscript, typewritten copy and carbons; each in its separate folder) through
having a suitcase stolen in the Gare de Lyon in 1922. A man’s wife was bringing the manuscript and
carbons for him to work on during a Christmas Vacation from working for The Toronto Star, INS
and Universal Service at the Lausanne conference. The suitcase was stolen while she went out to buy
herself a bottle of Vittel water.
But you do not marry a woman for her ability to care for manuscripts and I truly felt sorrier for how
awfully she felt than I did for the loss of everything I had written. She was a lovely and loyal woman
with bad luck with manuscripts.
Hemingway, “Preface,”
A Hemingway Check List, Lee Samuels
6. The impact of growing water shortages on agriculture. Droughts around the world
continue to intensify with a likely impact on global grain production.
In Canada, history may be repeating itself with prairies of Alberta and Saskatchewan
suffering the driest winter and spring in 50 years (70 years in some areas) and
rainfall less than 40% of its normal level. Many fields may have already been lost, even
if heavy rains come. Roughly 900 farmers in one area have ploughed their crops under

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and filed for insurance coverage. The president of Canada’s National Farmers Union estimates
losses of up to 30% in wheat, barley, rapeseed and hay if the drought persists.
Droughts have impacted farmers for the last decade in the central and eastern prairies of
Canada. In the fall of 2008, water levels on the St. Lawrence River were so low that water
had to be pumped in from Lake Ontario. Poor infrastructure adds to the problem. In
Montreal, 40% of the water carried by pipes leaks out.
Evidence from tree rings and ancient algae indicates that the Canadian prairies
have long been drought-prone, with the 20th century an unusually wet period. As
global warming melts mountain glaciers, the summer flow of rivers has shrunk by up to
60% of their historical average, while an increasing amount of water is being drawn by
cities, irrigation and the processing of oil from tar sands. David Schindler, an ecologist at the
University of Alberta, fears that the prairies could become semi-desert unless the trends are reversed.
In Mexico, the nation’s water commission warned that the country is at risk of a “critical”
water shortage beginning in early 2010, due to El Nino, climate change and low rainfall.
The National Farmers Confederation in Mexico recently estimated that the current drought could cause
losses of up to 15 billion pesos ($1.2 BB).
In Texas, agriculture losses from its worst drought in half a century are $3.6 billion
and could exceed $4.1 billion by yearend, when under normal circumstances,
farmers and ranchers bring in about $20 billion per year, according to the Texas
AgriLife Extension Service. Ranchers with small cow-and-calf operations are being hurt
the most, because their forage and water supplies have dwindled, while cattle must still be
fed. Although the federal government has yet to declare a state of emergency, which
would enable ranchers to be eligible for low-interest loans, Governor Rick Perry has issued
a disaster proclamation for most of the state.
In other parts of the Midwest, rainfall has been less than 50% of normal over the
last 30 days, according to the High Plains Regional Climate Center in Nebraska. Presently
corn plants are growing at about half the five-year average, and the rate of pod-filling by soybeans is 17
percentage points below normal, says the USDA.
NASA’s Gravity Recovery and Climate Experiment (GRACE) satellites, which measure
subtle changes in the Earth’s gravitational field, often the result of shifting water, either on
the surface or deep beneath, has detected significant depletion in the Ogallala Aquifer

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under the western plains and the groundwater of California’s Central Valley. California’s
San Luis reservoir in the Central Valley is less than 20% full.
“Groundwater resources are being rapidly depleted in many regions of the world,” says
James Famiglietti, a U.C. Irvine hydrologist. “These signals of groundwater loss, in
particular in the Central Valley, are very strong.” Most of California is in a drought emergency,
while the Colorado Plateau is in its eighth year of drought. The five states comprising the plateau are
withdrawing water from the basin faster than it is replaced, and some scientists have estimated Lake Mead
and Lake Powell, the nation’s largest reservoirs, could be empty in 20 years.
In India, GRACE data indicates that its heartland lost 109 cubic kilometers of water from
the Indus River plain aquifer between August 2002 and October 2008. The loss is
equivalent to more than twice the capacity of Lake Mead. “By our estimates, the water
table is declining at a rate of one foot per year averaged over the Indian states of
Rajasthan, Punjab and Haryana, including the national capital territory of Delhi,” says
NASA hydrologist Matthew Rodell.
Nearly 63 cubic kilometers of water are drawn from the aquifer annually, while only about
45 cubic kilometers of water recharge the aquifer annually, according to Indian
government estimates. “The problem is that groundwater consumption was not
capped at a sustainable level and now it will be difficult to curb demand,” says
Rodell. About 20% of water used globally is sourced from underground, with withdrawals expected to
rise 50% by 2025.
Surface water supplies in India are also dropping. Seventy-five percent of the nation’s
rivers, lakes and dams are contaminated by human and agricultural waste, and industrial
effluent, says the Ministry of Urban Development.
The poor monsoon is compounding India’s water and agriculture woes. Summer
rains from June to mid-August were 29% below average, and were down by over
60% in Uttar Pradesh. Although rainfall has risen in some areas in recent days, it is too
late for many crops that require an even sprinkling throughout the hot summer. At this
point, heavy showers could damage the already reduced sugar cane crops.
Agriculture accounts for 18% of India’s GDP, employing 60% of the population. As a
result of the likely poor harvests, these consumers are likely to curb spending this year. In
2002, GDP growth slowed from 5.8% to 3.8% when Monsoon rains dropped by 19%. A

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poor monsoon can also lower power production since hydropower accounts for 25% of
the nation’s electricity.
Although the government has stated it will raise food subsidies in rural areas, and permit
farmers to delay paying bank loans, cattle sales are rising steeply, despite low prices. A
growing number of farmers are also committing suicide because the dry summer means
financial ruin and disgrace.
In Pakistan, water availability has sunk from 5,000 cubic meters per capita in the
early 1950s to under 1,500 per capita today. The country’s water availability per capita
is ranked last in a list of 26 Asian countries and the U.S., according to the FAO. Pakistan’s
per capita water availability could fall below 1,000 cubic meters by 2020, or even possibly
earlier.
In China, drought in the northern part of the country has left 4.6 million people and
4.1 million head of livestock short of drinking water, while damaging crops, and dry
weather in the south could intensify shortages. China’s imports of oilseed surged 28% to
26.5 million tons during the first 7 months of 2009, with speculation demand could continue.
Earlier this year, the Chinese government said the South-North Water Diversion Project’s
central canal, stretching 800 miles from a tributary of the Yangtze River to Beijing, will be
delayed five years to 2014. As a result, the delay will further complicate the water shortage
in northern China, putting the region under increased water stress, while Hebei will have
to supply water to the capital instead of being a beneficiary of the project. Presently, a
300-kilometer long canal section from the Hebei city of Shijiazhuang to Beijing is being
used to supply emergency water to Beijing from three reservoirs in the drought stricken
region.
We continue to believe the stage has been set for a recovery in grain prices to prior
highs from the combination of tighter credit, reduced plantings, climate change,
and persistent, long droughts. As a result, we think a cross section of agriculture-
related companies will benefit, because any technology that can increase crop yields will
see higher demand (see related reports).
Last week, Jain Irrigation systems Ltd. (JI IN, 699.15 INR, www.jains.com), the world’s
second-largest producer of drip irrigation systems after private Netafim (A.C.S.) Ltd.
(see WILTW 5/29/08), estimated its annual profit will double this year, as India’s

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worst drought in years prompts the government to increase spending on projects to lift
farm output. Indian farmers that purchase irrigation systems get a 50% subsidy from the government.
Jain sees a 30% to 50% jump in sales of sprinklers and drip water systems, and is investing
2 billion rupees to increase production capacity. India is encouraging farmers to sow
winter-crops earlier, including wheat, to help offset the loss of 10 million tons of summer-
sown rice due to drought. “We are seeing demand for micro irrigation coming because of concern
about food security, and the need to ensure incomes for small-farm holders,” said Anil Jain, managing
director.
Management estimates that micro irrigation systems could account for 75% of total sales
in the next two-to-three years, up from 50%, with group sales reaching 38 to 40 billion
rupees, up from an estimated 29.5 billion this year. Presently, only 3.5 million hectares
of India’s 60 million hectares of irrigated farmland uses drip irrigation and
sprinkler equipment, even though the systems can raise farm output by 40%. “With
penetration of just 6 percent, we see an opportunity for the next two to three decades,”
said Jain. Jain Irrigation Ltd. is presently valued at 10.3 times 2010 consensus EV/EBITDA and a
price-to-earnings-growth-rate (PEG) ration of 0.69, based on its expected growth rate of 29%.
7. A buy signal for India (continued)? The world’s biggest infrastructure boom
(continued). Patel Engineering (PEC IN, INR 422.25) is a high-quality niche engineering
company that is very well positioned to benefit from India’s planned $500 billion
investment in infrastructure over the next five years. It has earned a reputation as a leader
in hydroelectric power plants, with an estimated 22% share and over 60 years of
experience, as well as strong positions in irrigation projects, urban infrastructure and
transportation.
Power generation is a major focal point of the government’s infrastructure spending, with
the latest Five-Year Plan envisioning some $150 billion to be spent over the next five years
to add nearly 80 gigawatts (GW) of new electric capacity—an increase of almost 60% from
the current estimated installed base of 135 GW.
Roughly one-quarter of India’s power supply comes from hydroelectric projects, and given
constraints on the availability of imported oil and natural gas, hydroelectric power is likely
to continue this role for the foreseeable future. According to Patel, hydropower has the
potential to generate five times its current generating capacity.
The importance of India's hydroelectric power infrastructure was highlighted in our

discussion last week of China's proposed diversion of the Tsangpo River, which feeds into

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India's Brahmaputra River, located in Arunachal Pradesh in the far northeastern tip of the
country. Aside from the Brahmaputra, India has six other major river systems, with
numerous tributaries, containing huge hydroelectric power generation potential.
Patel has demonstrated a significant amount of expertise in the construction of Roller

Compacted Concrete (RCC) Dams and it built the country’s first three dams utilizing this
method. According to Patel, RCC dams can be constructed 30% cheaper and 40%
faster than conventional dams, because concrete is laid and rolled horizontally across
the body of the dam, instead of being installed in vertical blocks. The company has
completed more than 40 RCC dams around the world.
The company also is a leader (with an estimated 95% market share) in “micro tunneling,”
which involves the excavation of small diameter tunnels to facilitate water supply, drainage
and sewerage. These small diameter tunnels then can be used to install service pipelines
without digging trenches, which would disrupt road or rail traffic. This is a huge advantage
when placing underground pipelines in heavily-populated urban areas.
Part of the growth in this segment will be driven by the government’s Jawaharlal Nehru
National Urban Renewal Mission, which entails a budget of nearly $25 billion to be spent
over seven years, covering water supply and sanitation infrastructure to 63 cities, each with
a population exceeding one million.
In the irrigation business, last December, Patel won the Pranahita Chevella Lift Irrigation
contract, a major project valued at more than $330 million. Even before the relative
disappointment of this year’s monsoon season, irrigation was taking on greater importance
in the government’s view, with annual investment spending slated to rise from $5.6 billion
in FY2007-08 fiscal year to $13.7 billion in FY2011-12. According to the company, only
43% of India’s net planted area is irrigated, providing ample opportunity for
growth.
Despite a growing population, accelerating economic growth and greater urbanization, the per capita
availability of water has declined an estimated 60% since the late 1940s.
While Patel’s six decades of experience has given it a tremendous advantage in its areas of
expertise—primarily irrigation/water supply and hydropower (each accounting for 44% of the
order backlog of June 2009)—it is small enough so that each project has a meaningful impact
on the bottom line. The company’s order book grew at more than 30% compounded

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annually in the last five fiscal years—19% in the last fiscal year alone—and now stands
in excess of $1.5 billion.
In addition, the company has been taking advantage of international opportunities,

handling projects in the U.S., Arabian Gulf and elsewhere in Asia. The company’s
international revenues grew from 13.8% of the total in FY08 to 21.9% in FY09. The
company cited estimates forecasting $2.8 trillion of planned infrastructure spending over the next five
years in China, India, the Middle East and Southeast Asia combined.
The company’s financial metrics have shown steady improvement, with the June 2009
quarter indicating a 15.2% rise in operating income and a 236 basis point improvement in
EBITDA margin to 16.4%. For the full fiscal year ended in March 2009, the company
generated a 72 basis point improvement in return on capital employed to nearly 13%,
while generating just over $500 million in revenue.
The stock, which has a market capitalization of more than $500 million, trades at a
reasonable 15.8 times FY2010 and 12.8 times FY2011 estimated EPS. Although the stock
has quadrupled from its bear market lows, it nevertheless trades at an approximate 60% discount
from its early 2008 high, even though its underlying fundamentals have become stronger, not
weaker, in the interim.
8. The true test of a free society. We continue our reading of the many lectures by Dr.
Rufus Fears, Professor of Classics at the University of Oklahoma, where he holds the G.T.
and Libby Blankenship Chair in the History of Liberty. Fears received a Ph.D. from
Harvard University, and has been a Danforth Fellow, a Woodrow Wilson Fellow, a
Harvard Prize Fellow, a Fellow of the American Academy in Rome, a Guggenheim Fellow,
and twice a Fellow of the Alexander von Humboldt Foundation in Germany.
We quote below from A History of Freedom (Part I of III):
Americans entered the 21st century convinced that we are the only superpower and that the innovations
of science, technology, and industry have opened a new era of individual liberty, prosperity, and peace.
It should be remembered that Europeans entered the 20th century under similar
delusions. This course of lectures ends on a cautionary note, one that was already voiced in the
Athenian democracy of the 5th century B.C. Excessive individualism is not liberty but rather license.
There can ultimately be no separation between public and private morality. A
democratic society can survive only if its citizens have a shared set of moral and political values.
Excessive prosperity can lead to that public apathy about politics which is the death knell of liberty. In
the end, the true test of a free society is its ability to produce leaders of ability, vision, and moral
character.

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9. China’s economic transformation (continued). The rise of the Chinese consumer.

Stephen Roach, chairman of Morgan Stanley Asia and a frequent critic of Beijing’s
stimulus package, recently expressed a rare sense of optimism regarding the Chinese
consumer in an interview with McKinsey Quarterly this month:
I’ve learned, in my last 12 to 15 years of following China, don’t underestimate the
commitment and the determination of the Chinese authorities to address a
problem when they finally realize they’ve got a serious one. I think a realistic
goal…would be to aim for a 50 percent consumption share of GDP within five years…That’s [an
increase of] 14 percentage points of GDP, 15 percentage points of GDP in five years. I think it’s
achievable if they do move aggressively on social security, pensions, and nationwide medical care.
In another McKinsey interview with several influential Chinese economists, we came across
some interesting comments by Bai Chong’en, Dean of the Department of Economics,
Tsinghua University. Responding to a question regarding ways to increase the income
share of households and reduce the payroll tax, Professor Bai responded as follows:
You ask a very good question: where does the money come from? One source is the profit of state-
owned enterprises, especially those with monopoly power. When we talk about savings,
actually the largest share of savings increase is in the corporate sector. [By the
way, this is also a key point we learned from a high-level official at China’s central
bank during our last trip to Beijing. According to McKinsey, over the past two
decades, the corporate share of China’s national income has risen from 14% to 22%;
meanwhile, the household share has fallen from to 72% to 56%.] And these savings were
not controlled. They were invested in low-efficiency projects. So if the government forces these firms to
pay higher dividends, it’s actually one stone that kills two birds. One, you use the money to finance
the social-security system. Therefore, you have room to reduce payroll tax. Second, you strip the
money away from the state-owned enterprises so that their ability to invest is mitigated.
Echoing these suggestions, earlier this week, Zhang Ping, head of the National
Development and Reform Commission (NDRC), said in his report to the standing
committee of the National People’s Congress that China “should deepen the reforms on
income distributions and increase the share of household incomes [relative to total
incomes].”
The State Council announced this Wednesday that it was considering a plan to curb
overcapacity in some industries like steel and cement. This is a clear signal that Beijing
wants to shift the focus of its stimulus from investment to domestic consumption, hoping
the recovery in the West will buy it some time on the export sector.

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In the past two decades, the export—and investment—driven model has been extremely
successful in absorbing excess labor and providing social stability. However, the value-
added production [and therefore profits] created by export companies has been meager,
with most export companies operating near breakeven and many of them
generating the bulk of their profits from export tax rebates.
A shift away from the export—and investment—driven development model to one mainly
driven by domestic consumption would imply seismic changes for the Chinese economy
and China’s corporations. Running a manufacturing company focusing on filling export
orders requires a different skill set—both managerial and technical—than running a
marketing-oriented company that extends its value chain all the way through aftermarket
service. Most Chinese companies have a long way to go to fulfill the latter role.
However, the opportunity to capitalize on the underserved consumer segment will

likely prove highly profitable for those that are able to exploit it. Just like the
American consumer has nurtured some of its iconic companies and brands like Ford, Nike,
Wal-Mart, Walt Disney, and Apple Computer, among others, and Japan’s rise helped bring
Toyota, Sony, and Nintendo around the globe, meeting and understanding the needs of the
Chinese consumer will help create a new breed of enterprise that is more competitive,
responsive and profitable.
To the best of our knowledge, there are no ETFs tracking Chinese consumer stocks.
Therefore, in this and future issues, we will try to identify consumer-oriented
Chinese companies that have already established a complete value chain, either in
services or in production, at least within China. The recent correction in the Shanghai
market has presented a buying opportunity in some “A” shares for qualified foreign
investors:
Suning Appliance (002024 CH, CNY 15.28) is a leading home appliance and electronics
chain-store in China, similar to Best Buy in the U.S. By the end of 2008, Suning had 812
chain-stores in 178 cities across mainland China.
Suning increased its percentage of chain-stores in second—and third—tier cities from

46.6% in 2007 to 49.9% in 2008, making it better prepared to benefit from Beijing’s rural
home appliance subsidy program. Suning also seeks to leverage its prestigious brand and
nationwide sales network to win favorable deals from its suppliers. Since last year, Suning
has signed direct purchase deals with Lenovo, Dell and Hewlett-Packard and also signed
an agreement to become the only strategic partner of Whirlpool in China, with

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exclusive sales rights for the Whirlpool brand name in China. These agreements should
help Suning better control its purchasing costs and enhance profit margins.
In the first half of this year, Suning’s revenue rose 5.5% year-over-year while net profits
attributable to shareholders increased 14.7%, indicating improving gross margins. This
June, Suning made its first overseas takeover by acquiring a majority ownership in LAOX, a
major electronics chain-store in Japan.
Suning trades at 24.9 times 2009 estimated earnings and 20.6 times 2010 estimated
earnings, according to Bloomberg.
Fuyao Glass Industry Group (600660 CH, CNY 11.35) is China’s largest, and the world’s
fourth-largest, automotive glass producer. The company claims more than a 50% share
of the overall domestic market and sells its products under the brand name “FY.”
Fuyao is set to benefit from both China’s car sales boom and the post-crisis global auto
market recovery, as some automobile glass production capacity in western countries has
been permanently closed.
During the first half of 2009, automobile glass accounted for 85% of revenue and 88% of
gross profit, with over 28% of revenue being derived outside of China. Earlier this year,
the company sold a money-losing construction glass production line in order to focus on
its core competency in auto glass. Excluding an asset impairment charge of 215 million
yuan ($31.3 million) in the first half, Fuyao’s net profits would have been flat with those of
the prior year, despite difficult market conditions earlier in 2009.
Fuyao trades at 29.5 times 2009 estimated earnings and 21.0 times 2010 estimated earnings,
according to Bloomberg.
10. Will Iraq’s oil industry survive the next civil war (continued)? We first asked this
question in WILTW 7/30/09, when we highlighted the growing tensions between Kurds
and Arabs, who have long fought over disputed, oil-rich territories.
While most observers have applauded the dramatic recovery of Iraq’s oil production over
the last two years—largely as a result of the improvement in security—it has gone totally
unnoticed that Iraq’s spare capacity has been whittled down to practically nothing.
According to the latest IEA estimates, Iraq’s output has remained essentially flat from
May through July this year—within a band of 2.49 to 2.52 million bpd—despite the
dramatic improvement in global oil prices in the interim and no quota restraints.

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About one-third of Iraq’s production comes from fields in the north-central part of the country—the region
most exposed to Arab-Kurd conflict. Any escalation of regional violence—which appears to be
happening now—could place a good portion of this output at risk. Note that violence in
Nigeria has taken about 1.6 million bpd of output off line, according to government
sources, so a catastrophic decline in Iraq’s production cannot be ruled out.
According to Reuters, a series of deadly truck bombings and suicide attacks have taken
place near the city of Mosul in northern Iraq—near lands which are claimed by both the
Arab majority and the Kurdish minority—with each side blaming the other for the
violence.
While the Kurdistan Regional Government (KRG) blames Iraq’s Arabs for inciting
violence in an effort to ethnically cleanse the region of Kurds, the Sunnis have in turn
blamed Kurdish Peshmerga soldiers for breaching security. Reuters describes the situation
as follows: “The boundary between Kurdistan and the rest of Iraq is blurred due to
seemingly intractable disputes over territory and oil between Iraq's Arabs, now led by a
Shi'ite Muslim government, and Kurds. Kurds see parts of northern Iraq as their ancestral
homeland, and want them folded into Kurdistan. Arabs and Turkmen in those areas fear
Kurdish hegemony. The tensions have triggered standoffs between the Peshmerga
and Iraqi security forces that have come close to war.”
Turkey—which has been involved in a low-scale conflict with the Kurdistan Workers
Party for some time—is just as concerned about Kurdish nationalism as the government in
Baghdad, which complicates matters further. What would happen to Iraq’s northern oilfields if
Turkey were compelled to invade northern Iraq?
Most disconcerting, the conflict has given Al-Qaeda an opportunity to thrive in the
mountainous region. Iraqi Minister of State for National Security, Shirwan al-Waeli, told
Reuters the following: "Political differences have left security breaches. There are disputed
areas in which Iraqi security forces do not enter, so they are exploited by Al-Qaeda and
other terrorists." The Kurd-Arab feud is now regarded by U.S. officials as the greatest
threat to Iraq's stability.
Last week’s bombing in Baghdad, which killed about 100 people and injured over 1,000,
was also widely viewed as the work of Al-Qaeda. The withdrawal of American forces
from the area has created another opening for opponents of al-Maliki’s government to do
harm, and al-Maliki’s prior orders (recently suspended) to have protective blast walls
removed from locations around the city also contributed to the latest round of violence.

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This bombing also presents a reality check for U.S. officials, whose thinking has been
guided by a desire for Iraq to defend itself without American help: The blast was
reportedly caused by two open-topped trucks carrying nearly eight tons of explosives
that came within close range of the Foreign and Finance Ministries. The New York
Times added the following: “It could have been even worse. Two other bombings seem to
have been planned for Wednesday. A truck carrying 2,200 pounds of ammonium nitrate
fertilizer was found abandoned just blocks from the Foreign Ministry. In addition, a car
packed with explosives was stopped by the police, who said they arrested two extremists.”
The latest bombing also helped generate further mistrust of al-Maliki’s Shiite-dominated
government ahead of next year’s elections. Even some of Iraq's other Shiite parties are
abandoning al-Maliki's party, as The Wall Street Journal pointed out earlier this week. This
mistrust is manifested among all the rival factions dominating Iraq’s oil
development discussions. As we noted last month, the first round of oilfield licensing
was a huge disappointment, and there is considerable skepticism that the second round of
licensing will show any meaningful improvement. Without the requisite protection of oilfield
installations and workers and respect for contract terms, Iraq could likely be viewed as too risky for foreign
multinationals for quite some time.
Then, there is the question of Iran, which is sympathetic to the interests of Iraq’s Shia
majority. The U.S. options increasingly look like a choice between lesser evils: As George
Friedman at STRATFOR recently pointed out, if the U.S. maintains a residual force in Iraq
over the long haul to protect Sunni and Kurdish interests, it risks offending Iran and
attracting more destabilization. If the U.S. pulls out completely, Iraq would attract
competition for influence from Turkey, Iran, Saudi Arabia, Syria and even Russia, which
will make Iraq even more unpredictable than before.
11. A new class of antiviral drugs could revolutionize healthcare. The coming plagues
(continued). We have long warned that the growing resistance of pathogens and bacteria to antiviral
drugs has significant implications not only for the health care industry, but also for the future of mankind.
Traditionally, antiviral drugs are developed for a specific bug so that the drug blocks viral
replication by binding to part of a viral protein. The problem is that a minor mutation,
which slightly changes the shape of a protein, can make a drug ineffective, as is increasingly
occurring with Tamiflu. While a few existing antiviral drugs, such as interferon, can fight a range of
viruses, these drugs have been less effective than hoped for originally.
Several new approaches are being pioneered by a few biotech companies that
exploit a key weakness of all viruses: their dependence on their cell hosts.

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Functional Genetics (functional-genetics.com), a private firm, is focusing on identifying

key parts of proteins that are essential for viral replication, but not for the survival of the
host. To date, the company has identified over 100 different human proteins that flu
viruses require to replicate, but which cells can survive without, according to New Scientist
magazine.
For instance, Functional Genetics has developed a small molecule drug that can block the
interaction between viruses and TSG-101, a protein involved in the transport of materials
within cells, which is often used by viruses in replication. The drug, called FGI-101, can
selectively identify or eliminate cells that have been infected with a wide range of viruses,
such as hepatitis C, influenza, Respiratory Syncytial Virus (RSV), Herpes (HSV-1 and
HSV-2), Parainfluenza virus, HIV and Ebola. The company plans to submit an IND
application to the FDA in 1Q10. FGI-101 that can also bind to TSG-101 and trigger cell
destruction the moment the virus tries to break out of the cells. The company’s FGI-103
drug under development also works on a number of viruses, including Marburg and
Parainfluenza, without any significant side effects. Importantly, the compounds are not specific to
one virus, with researchers identifying over 30 viruses relying on TSG-101 for replication.
The company has also designed an antibody called FGI-101 that can bind to TSG-101 and
trigger cell destruction the moment the virus tries to break out of the cells. The company’s
FGI-103 drug under development also works on a number of viruses, including Marburg
and Parainfluenza, without any significant side effects. Importantly, the compounds are not specific
to one virus, with researchers identifying over 30 viruses relying on TSG-101 for replication.
Prosetta Bioconformatics (www.prosetta.com) of San Francisco is taking a different

approach, targeting parts of proteins required for viral assembly. Each family of viruses
appears to rely on between 20 and 40 hijacked proteins for coat assembly. “But the virus
comes in and says, ‘You – stop doing whatever you’re doing for the host, and work for me
now’”, says Vishwanath Lingappa.
While Prosetta’s drug candidates focus on a smaller number of viruses than Functional
Genetics’ drugs, they still cover far more than conventional antiviral drugs. For instance,
one compound Prosetta is working on has demonstrated effectiveness against 6
flaviviruses, including dengue fever, yellow fever, West Nile fever, and hepatitis C.
Prosetta is developing drugs targeting 14 of the 21 virus families associated with
causing human disease. The company aims to also develop combinations of drugs that

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can slightly inhibit several proteins simultaneously, rather than disabling a single protein,
which could reduce side effects even more.
Peregrine Pharmaceuticals (PPHM, $0.75, peregrineinc.com) of Tustin California has

developed an antibody called bavituximab, which binds to exposed phosphatidylserine, a
fatty substance in certain molecules on the inner surface of a cell’s membrane. Once
bavituximab binds to the targeted cell, the immune system can destroy it, and prevent viral
replication. In theory, bavituximab should be able to bind to cells in which common
viruses have wrapped themselves in the cell membrane of the host cells, which can act as
an invisibility cloak to the immune system.
In early testing on guinea pigs infected with Pichinde virus, half of the animals survived,
while all those infected with a control antibody perished. “We were doing something that was
quite extraordinary,” says Philip Thorpe, a pharmacologist at the University of Texas Southwestern
Medical Center. “We had let the animals progress in their disease until they were heavily symptomatic,
and then started treatment. It was a major accomplishment to knock that disease back.”
Peregrine has begun human trials of bavituximab against HIV and hepatitis C,
with early results looking promising, as the drug appears to reduce the viral numbers
without major side effects. The company is also in advanced testing of bavituximab as an
anticancer agent, because phosphatidylserine appears on the surface of tumor cells.
Additionally, Peregrine is testing bavituximab against influenza, measles, and strains of
smallpox and rabies. Bavituximab is in clinical trials for the treatment of hepatitis C virus,
and preclinical development for the treatment of viral hemorrhagic fevers, as part of a
contract with the U.S. Defense Threat Reduction Agency.
The advantages that host-targeted antiviral therapy offers are significant, although it
remains in early stage development. First, the approach could provide a means to fight new
viruses for which other treatments have not yet been developed. Second, host-targeted
therapy is expected to be resistance to viral mutation, because when the host is targeted, it
is difficult for the pathogen to avoid attack. Over the next several years, host targeted antiviral
therapy could revolutionize healthcare treatment.

Founded 1983
12. The man who developed Winston Churchill’s greatest gift. We recently began to re-
read the two-volume biography of Winston Churchill’s mother, Lady Randolph Churchill.
The book is entitled, Jennie: The Life of Lady Randolph Churchill. Lady Randolph was one of
the most beautiful women of her time. She was very influential in social and political
circles, and had many lovers, including King Edward VII.
We quote as follows from Volume II:
It was Jennie who was the most influential factor in the development of her son Winston. Besides the
courage, spirit, and drive she instilled in him, besides shaping his mind through their constant
discussions and correspondence, besides introducing him to the people who helped determine his future,
besides her own maneuvering for him in every area in which she could protect his interests and further
his ambition—besides all of those things, at a crucial stage in his life Jennie provided
Winston with the only real father figure he ever had, the one man who was most
vital in helping him develop the greatest of all his gifts.
Several generations later, Democratic Presidential candidate Adlai E. Stevenson, himself a speaker of
sparkling wit and elegance, asked Winston Churchill whose example had helped fashion the famous
Churchill oratorical style. “It was an American statesman who inspired me . . . and taught me how to
use every note of the human voice like an organ,” Churchill answered. And then, to Stevenson’s
amazement, Churchill quoted long excerpts from speeches made by Bourke Cockran some sixty years
before. “He was my model,” Churchill said. . .
For Winston, Bourke loomed not only as a father figure, but also as a man of enormous wisdom and
experience, a great orator, a man of taste and style, much the model of the man he himself wanted to be.
More than that, Bourke was much the model of the man Jennie wanted Winston to be. . .
They talked until very late almost every night. Bourke not only unwrapped the breadth of his
experience and the depth of his mind, but he taught Winston how to use language. “What people
really want to hear is the truth—it is the exciting thing—speak the simple
truth.”
Avoid can’t, he said, avoid mannerisms, invective, egotism. The two men analyzed their mutual
admiration for the great English orator of a previous century, Edmund Burke. “Burke mastered the
English language as a man masters the horse,” Cockran said. “He was simple, direct,
eloquent, yet there is a splendor in his phrases that even in cold type reveals
how forcibly he must have enthralled his visitors. . . How I should have loved to have
heard him.”

Founded 1983
Winston wanted to hear Cockran speak, and he persuaded him to read some of his speeches. What
was so memorable to Winston was Cockran’s titanic vigor, his poetic vision, the fire without frenzy. . .
Bourke explained to Winston how he prepared for his speeches: studying the subject
in detail, storing in his memory material from a wide range of reading, trying to simplify the most
abstruse questions with familiar, easily understandable illustrations, and then trusting to the
inspiration of the moment for the phrasing of sentences. Until then, everything Winston knew about
oratory derived from his own analysis of what he himself had heard. Now for the first time he was
learning basic techniques from an expert.
But it was more than technique, more than fine phrases that Winston absorbed. It was the spirit
of oratory, something he already had within him but that was now suddenly made more exciting.
Kiril Sokoloff
kiril@13d.com

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