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Don Coxe

STRATEGY ADVISOR,
BMO CAPITAL MARKETS

CONFERENCE CALL TRANSCRIPT


March 4, 2011
The Call: Don Coxe’s Weekly Conference Call
conducted exclusively for clients
and employees of BMO Capital
Markets and BMO Nesbitt Burns

“What’s Good for Black Gold Could Be Even Better for


Yellow Gold”
DON COXE CONFERENCE CALL
What's Good for Black Gold Could Be Even Better for Yellow Gold
Thank you all forMarch
Friday, tuning inamto(EST)
4 – 10:00 “The Call”, which comes to you from Chicago.
Telephone ‘live’ call: 416-695-6624 / 888-742-2490; Passcode: 4092058
The charts that
Click on icon
to listen to the
we sent out were very recent charts of Crude Oil and Gold,
Replay: http://bellwebcasting.ca/audience/index.asp?eventid=70081727
replay
and the tagline is, “What’s Good for Black Gold Could Be Even Better for
Yellow Gold.”

Crude Oil (WTI) Gold


February 1, 2011 to March 2, 2011 February 1, 2011 to March 2, 2011
105 1,460

101.92 1,440 1,436.20


100
1,420

95 1,400

1,380

90
1,360

1,340
85
1,320

80 1,300
1-Feb 5-Feb 9-Feb 13-Feb 17-Feb 21-Feb 25-Feb 1-Mar 1-Feb 5-Feb 9-Feb 13-Feb 17-Feb 21-Feb 25-Feb 1-Mar

Source: Reuters Source: Reuters

Shifting sands…
Having just returned from the ebullient optimism of the Nesbitt Burns
Global Mining Conference, we come back to looking at a world that’s a little
more complicated.

We thought that by combining these two charts — it’s the basis for what I
want to take you through, which is that the commodity story has managed
to put on a dazzling display over the last 5 years, (and that includes the
Crash) before we start seeing any evidence in the Industrial World of
inflation of the kind that scares people.
Don Coxe
Chairman
COXE ADVISORS LLP.
Chicago, IL
(312) 461-5365
email: DC@CoxeAdvisors.com
Don Coxe Conference Call Transcript: March 4, 2011

The stagflation syndrome…


I want to discuss this as the notion that I think the next phase that we’re
going to see is going to much more resemble the stagflation of the 1970s.

We have not seen that — you might have said that back in 2008 and 2009
we had stagflation, because we had a deep recession and yet we still had
some positive inflation in the Industrial World, (not much) so if that was
the worst, then we’re going to be okay and we are going to have normal
growth once we come out of it, with all the stimulus help we got from the
governments.

Built-in buffers…
I want to advance the argument of why it is that we didn’t get (immediately)
from the inflationary moves from the raw materials, that we didn’t get that
cost pass-through into the CPI (which the central bankers use) or even the
CPI, the normal consumer price index, because the system was first of all,
much more efficient than it was back then — there have been tremendous
capex, and we had the benefit of all that technology that was built into
the system, so that the Industrial World was much better able to handle
inflation when it came.

But I think frankly that we’ve used up most of those benefits, and the next
phase is going to be a phase in which it becomes much more difficult to
avoid passing on the costs from raw materials.

Just to give you an idea, I’m using a 5-year number here to give you a sense
of how big the moves have been in that period of time — oil is up by 2/3,
gold up 150%, silver 265%, copper a double, corn up 220%, and wheat
up 188% — these are monster price increases, and remember that in that
period of time we had no performance from the stock market.

When the idea takes hold…


What we lack is an inflation psychology, except of course in the poorest
countries of the world where they are experiencing serious food inflation,
and that’s the one that they notice. Even the energy inflation that’s there
isn’t for most of the people in those countries the big deal to have to cope
with day-to-day, and there’s no question whatever, that we’ve seen the
effect of food inflation in politics.

Back in the 70s the food and fuel inflation brought down governments in the
Western World because they said, “Our leaders seem unable to cope with
these situations”, so governments were replaced all over the place.

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Don Coxe Conference Call Transcript: March 4, 2011

That’s not the case this time.

The displacement is occurring in the poorer countries and even the


dictatorships, so what’s happening in the Arab World is sort of an eerie
replay, because this all started in Tunisia where one street vendor
immolated himself because he couldn’t afford to buy bread — now that
sounds like something from millennia earlier, where we needed bread.

The tipping point…


I am not suggesting that all those overturns of governments there were
driven entirely by food inflation, what happened was that was the catalyst
that set off the flames, which were deeply rooted in their resentment of
their dictatorships, thereby repealing the bigotry of low expectations that
the elites have had towards the Arab World, which is they are quite content
with their dictatorships — they can’t handle democracies.

You may remember that when George W. Bush said that he was going to
bring democracy to Iraq, that the elites who were against him for all sorts
of reasons said, “There’s no way they’re going to have democracy in Iraq,
that’s not what they do over there.” “The divisions between Sunnis and
Shias are too great; they have no experience with it and they’re not going to
be able to handle democracy.”

And although one would hardly say that the government of Iraq (it took
them so long to put a cabinet together) is a stable democracy, you can also
say that even in the Advanced Industrial World, in the state of Wisconsin,
they can’t convene the senate meeting because the Democratic senators
have gone on strike, so we have our own problems.

Influential fear factor…


The fact that we have these revolutions going across the part of the world
that has the dominant position in oil production, naturally has had its
impacts on everything else, but the amazing behavior this week of oil
and gold after we sent out the chart, where we had the pullback — a very
modest pullback in oil because of the announcement that Hugo Chavez was
going to find a peaceful settlement in Libya.

Hugo Chavez as peacemaker is about as bizarre a role as you can imagine


for this guy, but it was enough given traders’ positions, that they were
reversing them, so they knocked gold down $25, because they said the fear
factor was being taken out.

We haven’t made that back up, but gold is up $10 today as people reassess
the probabilities of this happening.

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Don Coxe Conference Call Transcript: March 4, 2011

The Colonel’s staying power…


The best way to look at Gadafhi is to realize what a successful dictator he
has been.

It’s fair to say that no other living human being has had as many standing
ovations at the UN General Assembly, as Gadafhi.

For years he was chairman of the UN Human Rights Committee and when
they revised that (because it was a bit embarrassing) Libya was still on the
committee and they this week for the first time, have discussed whether
Libya really should be on the committee.

Of course the UN Human Rights Committee has always been made up of a


collection of dubious dictatorships and quite awful governments, and the
reason Gadafhi could get these ovations was because he stood for what the
majority of the UN general assembly really felt, which was that the leading
villain in the world is Israel, and number two is the United States and after
that, it’s the ex-Imperialist powers, so that he could give a long, rambling
speech attacking those three bêtes noires for the Afro-Arab block, and get
these tremendous ovations.

He was taken very seriously and as a matter of fact, he was winning


designations from otherwise sensible governments, even in recent weeks,
before this thing came up.

It’s significant that Robert Samuelson, a very distinguished commentator


on the outlook in the world, in an issue of Newsweek on February the 14th
in which he talked about Americans were in denial about coming high gas
prices from these revolutions, he talked of 5 governments which he thought
were at risk in this — he didn’t include Libya in this.

Why? Because Gadafhi has been there since 1969 — why should he fall
now?

Masterful staying power…


Gadafhi is really best understood as being an Arab Tito because Libya was
one of those countries that’s on the map, which has rectilinear borders, and
you should always be suspicious of countries where the borders are exactly
straight lines at right angles, because it means that they are theoretical.

They do not reflect anything about where people live, and in fact there are
about 7 different tribal zones in Libya. King Idris had been able to get them
together in an uncertain alliance, but Gadafhi and his army people deposed
him and set up a dictatorship, and what he showed himself really good at,
was being an absolutely ruthless dictator and playing the tribes off against
each other.

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Don Coxe Conference Call Transcript: March 4, 2011

Uncertainty prevails…
Even now, the battle that’s going on is because the tribe that he was closest
to (that he represents) is the one that’s hanging on in Tripoli, but these
other tribes who have various resentments against him, are the ones that
dominate the rebels in what is a full-scale civil war.

So the idea that Hugo Chavez would be able to restore peace to this region
— look at what we had to do in the former Yugoslavia after Tito was gone,
who had been the first person who’d been able to unite that region, because
he was smart, adroit and tough, and certainly it’s not easy to see how all of
this is going to happen in Libya.

The black gold highway…


And Libya is the source of Libyan-light crude, which gives you more than
twice as much diesel gasoline as Saudi heavy crude, so the fact that the
Saudis are pumping more of their gunk doesn’t offset this for a refinery
industry that’s already in trouble.

Then we now have troubles in Oman, which also produces an extremely


attractive light crude, and Oman is also the entrance to the Persian or
Arabian Gulf (depending on who draws the map) and next to Oman is
Yemen, which is in a minor sort of civil war and that’s the southern border
to Saudi Arabia.

The other entrance to Saudi Arabia comes at the causeway of Bahrain and
that enters right into the center of Saudi Arabian oil production, which is
also the heavy concentration of Shias.

This is not a stable situation.

It’s different this time…


The best assumption then is that the oil shock this time will not be a sudden
shock that gets terminated suddenly, which is what happened after the
Yom Kippur War, where the Arabs united to attack Israel and looked like
they were going to defeat them, but the Israelis rallied brilliantly with
tremendous help from Richard Nixon, and they defeated the Arabs.

The Western World was punished then by the Arabs cutting off oil
production for a while — that’s what led to the deep recession of the mid-
70s and it set the stage for runaway inflation because it brought down
governments.

And that was a time when the workforce in the Western World was heavily
unionized, with COLA contracts so that inflation got passed right through
the system — it was not a problem for unionized workers.

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Don Coxe Conference Call Transcript: March 4, 2011

In the US now it’s only about 7% of the private workforce that’s unionized,
and the heavy unionization is in the public sector, and they are going to
have trouble getting wage increases or even keeping their jobs in a lot of the
states.

This is not going to be 70s-style inflation.

Pass-through punch line…


The economists who’ve ridiculed commodity inflation as being just a small
part of actual GDP, I don’t think are going to win out this time, although they
have to-date because there has been no cost transmission, or very little, but
that will end pretty soon because we had record prices this week for both
beef and pork, (in the form of the lean hogs contract and the feeder cattle)
so the BBQ season (when it comes) is going to be a season in which it is no
longer possible to say there’s no food inflation.

But for the world taken together, where the poorer you get, the more
dependent you are on grain prices, this is as the FAO has said day after day,
this is serious food inflation — the worst since the 70s.

In other words, we have a situation where the neat formula which was
that the western industrialized countries, as a result of all the central bank
monetary explosions and the big deficits that were run up and stimulus
packages, that it would gradually come back to normal growth, and we’d be
back to something like the world was before the Crash.

Lingering instability…
What will prevent that happening is (I believe) the breakdowns across so
much of the Arab World, which are going to be ongoing.

There’s not going to be a nice, neat election, where a bunch of nice Twitter-
type Liberals dominate and they have a stable populace supporting them.

I believe these revolutions are a basically good thing, but very few
revolutions end sweetly and suddenly. In most cases it takes a long time
to work them out and in a regrettably large percentage of the cases, it’s a
small, ruthless minority that take over, and they don’t have democracy in
their name, although they always name their country “The Democratic
Republic of….”

I think we’re going to have a negative backdrop for the concept of a global
economy, where as a result of the G-20 and the WTO, (and all these other
very enlightened mechanisms that we’ve got) that we can have stable
growth in world trade as a backdrop to improving situations among the
aging Industrial Economies.

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Don Coxe Conference Call Transcript: March 4, 2011

Rear view…
This is not the backdrop of strong bull markets in the Industrial World, and
although we got a really good employment number today in the US, (with
unemployment down below the magic 9% level for the first time) I am
afraid that that reflects conditions as they were, and business confidence as
it was, and as we know, consumer confidence last week was reported at the
highest level since the Crash.

We also know that a huge percentage of all consumer spending has


been financed out of government deficits and out of various government
programs, which automatically kick-in with unemployment.

Time-lapse transformation…
We’re not going to be gaining a lot of private sector jobs, we are going to be
losing public sector jobs, and all this at a time when people are going to be
paying more for fuelling up their vehicles and paying more for food, but
because this

pass-through has not yet occurred — partly because of the bitter


competition in the refining sector, and the Walmart-driven competition in
the food sector, this will be something that will unfold more gradually.

It will be the drip, drip, drip, of a different kind of world.

Endangered species?
There are very few money managers around who were actually managing
money back then.

Warren Buffett got rich because after the Yom Kippur War we had the big
stock market crash (the worst since ’29) and briefly the Dow got down to a
5.9 multiple, and when you could buy Coca Cola at an 8 or 9 time earnings,
Warren Buffett was prepared to be the biggest owner of Coca Cola stock.

But most of the portfolio managers — the demography has shifted.

I noticed that this week, at the wonderful conference in Fort Lauderdale,


and I was mentally contrasting it with the years where I was the keynote
speaker, and the demography of the audiences then.

When it all started back in 2002, it was a small crowd, and most of the
crowd were contemporaries of mine.

Well we are now a small demographic minority in the group and there are
all sorts of newly scrubbed CFAs, and that’s great.

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Don Coxe Conference Call Transcript: March 4, 2011

What we have now therefore is a lot of people who are making a living
managing commodity stocks — good stuff — but in terms of how they’ve
been trained and what their expectations are — they’ve lived in a world
where the stagflation of the 70s was ancient history and of course they
stopped teaching history in schools long ago, but they’ve learned about that
from the CFA program, (about what it was like) but that’s only a few pages
of text in it.

Arab influence…
So I think there’s going to be a challenge to portfolio managers to respond
to a very different kind of world, and the irony is that this kind of world is
once again coming because of collective decisions in the Arab World, only
last time it was a few Arab leaders who decided they were going to get rid of
Israel once and for all, whereas this time it’s millions and millions of Arabs
who are saying, “We want to have legitimate governments.”

So this is a much better thing — this is a triumph of the human spirit, but
when you have simultaneous triumphs of the human spirit with different
kind of agendas, it is a very complex world and there’s going to be lots of
bad developments along the way.

Uphill battle…
In our case (the greedy case shall we say) in the Western World, of our
dependency on fossil fuels, this will mean at the very least, discontinuities
in production.

The oil companies who had participated heavily in development of crude


oil in those countries they could get in to, are going to find that they don’t
know whom to negotiate with. The rights that were given to them in Libya
by Gadafhi are likely to be revised by whoever replaces him, or as quite
likely the case, Libya breaks up into different regions.

Because of Mercator’s projection and its location so close to the Equator


— some people don’t realize how big Libya is — it’s a big country, but it’s
a desert country and not a really good agricultural country, and its wealth
comes primarily from oil.

This is going to take a long time to unfold.

Beyond the blue sky…


I believe therefore that those who are managing general equity portfolios,
should not be guided by the fact that we’ve got a great ISM number and
all these good statistics now, but they should be looking at what will be

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Don Coxe Conference Call Transcript: March 4, 2011

the series of shocks and surprises, (most of which will be of the negative
variety) which will gradually have a drip, drip effect on investor sentiment.

What this means is that precious metals are bound to be a refuge for those
who up until now could argue (quite legitimately) saying, “There’s not
enough inflation out there to justify it.”

Flip side…
I’ve talked to people who say, “Look, commodity prices have gone up so
much more than the rate of inflation, so they are way ahead of inflation
now” as if when inflation starts to catch up, that means that commodity
prices will stall, allowing inflation to close the gap.

I think it will be the other way around.

Mentality of the masses…


In effect what the commodities boom today has done, is reflected real
supply and demand without an inflation psychosis.

Back in the 70s it was inflation psychosis that took over because there
wasn’t that much growth in demand, because the billions of people who are
now bidding up commodity prices didn’t have the money to bid them up
back then.

So drawing those distinctions, I think that you loyal members of “The Call”
club can feel, “If I look at any sector of my portfolio it seems to be doing well
because stocks are up, and the prices of the commodities they produce are
up.”

Splitting up?
But this is what Trotsky would have called an unprincipled alliance — in
the longer run, copper and gold won’t go up together.

Back in the 70s, briefly copper and gold went up together, but then copper
was stalled-out because there wasn’t enough demand, and although copper
went from 35 cents a pound up over $1, gold went from $38 to $800.

I am not predicting (at this stage) anything like that in percentage terms
because we’ve already got $1400 gold, but I am saying that from here on
in, copper, which as we know is the one that’s got the Ph.D in economics,
because it reflects actual industrial activity and because we’ve had this
robust expansion of domestic activity in countries which did not contribute
to industrial activity back in the 70s, but it’s going to be much tougher for
copper, nickel, lead, zinc and even iron ore going forward, in the kind of
discontinuities which are likeliest in the world now.

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Don Coxe Conference Call Transcript: March 4, 2011

Bond bust?
As for the bond markets in this, remember it was the worst of all possible
worlds for bond markets in the 70s.

At the moment the bond markets are benefiting for the fact that we
had central banks buying the bonds at a breathtaking rate, (which is
unsustainable) and also from asset allocators who are using moves from
either commodities into bonds (depending on the outlook) or from the S&P
into bonds, and those asset allocators (if they are nimble enough) have been
able to do very well.

But when you have an environment where we are starting out with interest
rates at just about the lowest levels in history, it’s almost banal to say
interest rates have nowhere to go but up, but the question is, do they go up
to levels which produce great losses for portfolios and produce intolerable
pressures on western economies?

The price of freedom…


At this stage, nobody can predict because we are going through such a
chaotic period, but the comfortable forecasts of saying, “GDP growth will
be in a range of 2-3-4%”, and using long-term averages like this, then this
gets us back to the old joke about the economist who drowned in a river of
average depth of 3 feet.

Something like this may be coming.

For those of you who are concentrating on the commodity sector, remember
I told you to scale back on precious metals in January in Basic Points
because of the fact that all the news seemed to be good.

The aspirations of hundreds of millions of Arabs have changed the financial


and economic outlook, even though they’ve improved the economic outlook
for individual people.

For the second part of that we can do nothing but give thanks — for the first
part of that we can dig deeply into our pockets to pay for the costs.

That’s it — any questions?

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Don Coxe Conference Call Transcript: March 4, 2011

QUESTION # 1 Intelligence agencies and social media?

Hi Don. I was wondering if you had any comments


on the effect of things like Facebook and Twitter in
terms of what’s been going on in the Middle East and
whatever the historical form of intelligence agencies,
intelligence gathering we have has to change their
methods a great deal.

RESPONSE: Small scale…

Thank you.

Yes, the Facebook and Twitter crowd are a gigantic liberalizing force in the
world, but we are talking of a tiny minority in these countries.

Sixty percent of Egyptians are illiterate and forty percent live on $2 a day,
and although the statistics vary from other countries and some of the
countries that have experienced this have a very large educated population,
but a very large percentage of that population can’t find jobs.

The endgame not as envisioned…

The analogy I would use is to think about the French Revolution, where it
began with the liberals — the Condorcets and the Girondistes, who were
liberals in the Locke tradition and influenced by the classic liberalism of
the Scots and the British, and then the critics such as Voltaire, but once
Rousseau and the Jacobins took over, the guillotines came out and the only
way they settled that was an army officer who said, “We’ll dismiss this mob
with a whiff of grapeshot”, and what they got was an Emperor to replace the
King, and what we had was massive wars.

It was a very small percentage of the French population, when they got
together with the Estates General to decide how the government was going
to be after the monarchy was deposed — the liberals lost out.

I think that’s too often the case in revolutions — it certainly was in Russia
— and in this case, given the demographics of these countries where the
median population age is extremely young, and where the unemployment
rate is so high, and no prospects (locally) of jobs to reflect what their
education level is, this is a very risky situation.

You didn’t have that many highly-educated people in France at the time
of the revolution, and a large percentage of those had been educated in
the Catholic tradition, which gave them a sense of another world that they
could adjust to, and a whole moral structure to the society.

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Don Coxe Conference Call Transcript: March 4, 2011

The liberals were deists who basically said, “There’s a God out there but
it’s a God who is a clockmaker and not one that’s going to be affected by
religious rites.”

There’s nothing like that kind of thing in the traditions (I think) in the Arab
World, so therefore it’s very difficult to draw from history a very optimistic
conclusion about the next few years, as we go through this.

Tender shoots in the grass roots uprising…

But it’s wonderfully inspiring to see those images on TV of these young


people who realize that a generation ago, this could not have happened.

That’s the good news — the bad news is that there are only a small number
of them relative to the population.

Thank you.

QUESTION # 2 Will supply rise to meet demand?

Good morning Don. I’ve got two points I want to raise


with you. One is that surely the food inflation, the
answer to that — high prices will generate much more
production of food, and I notice that Putin is releasing
an amount of land in Russia to farmers, the size of
Great Britain.

RESPONSE: Barren land — a bare necessity…

Thank you.

That’s true, but as soon as you move into the regions of Russia (on the
steppes) where they are going to be releasing farmland, you can’t assume
that that instantly translates into 140 bushels of corn per acre, and you’ve
got to have a lot of technology applied.

Stalin murdered 8 million of the Kulaks who knew how to grow grain and
although they’ve been replaced in subsequent generations, the agricultural
population has to expand to use that and yes, there are big aggregators
going into Russia to do this.

Gun-shy…

But what we’ve learned from the Putin experience, is that as soon as they
are successful they are probably going to find out that there is some Russian
corporation which they’ll be told they’ve got to hand it over to them — that’s
been the experience of the oil companies.

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Don Coxe Conference Call Transcript: March 4, 2011

I think there will be a caution about bringing in capital and technology on


a grand scale, to add to the Russian food production, in the light of Putin’s
past policies.

If not, you have to wonder about the wisdom of those people who’ve got
more money than brains.

Thank you.

REDIRECT: Commodity consumption in Iraq?

My second point to ask you is do we have any measure


of use of commodities in Iraq now, compared to what it
was say 5 years ago?

The economy seems to be really picking up — there’s


tourism being promoted — I would imagine copper
and steel usage has gone up quite noticeably there, and
won’t the same thing apply to the Egypt’s of this world
now they are getting in to a bit more freedom?

RESPONSE: Bought and paid for…

Yes, undoubtedly there will be some improvement, but remember that was
billions and billions and billions of American money, that went in to do this.

It’s not clear that Egypt can attract that kind of money to create an industrial
base and a tourism base, given the fact that — unless of course there is no
recrudescence of Islamic extremism in Egypt, because tourism has been
the backbone of the Egyptian economy, and that’s been the one that the al-
Qaeda forces have aimed at most, killing off and attacking tourists.

Bad for business…

So before we get a tourist boom there, I think we’ve got to be satisfied that
al-Qaeda has somehow or other vanished into the sands.

I have a feeling we’re going to be hearing more from al-Qaeda, but I hope
your optimism is justified.

Thank you.

Thank you all for tuning in — we’ll talk to you next week.

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Don Coxe Conference Call Transcript: March 4, 2011

THE CALL
The Call: Don Coxe’s weekly conference call conducted exclusively for employees and clients of BMO Capital Markets and
BMO Nesbitt Burns.
Published by: COXE ADVISORS LLP.
4th Floor
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Web: www.CoxeAdvisors.com
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email: AT @CoxeAdvisors.com

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after publication, and are required to hold any such positions for a minimum of one month.
Coxe may enter into distribution agreements with various unaffiliated third parties to redistribute its publications. To the extent that
any publication is reproduced, redistributed, or retransmitted, Coxe is not privy to, and makes no representations regarding, such unaf-
filiated third parties’ positions in any Investments discussed therein. Any distributor authorized by agreement with Coxe to redistribute
this publication is not affiliated with Coxe. Third parties having permission to reproduce, redistribute, or retransmit Coxe publications
may offer to effect transactions in some or all discussed Investments. Coxe makes no recommendation with respect to the use of any
particular brokers or agents, and no such recommendation should be inferred by virtue of any distribution agreements that Coxe may
enter into with third parties.

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