Issue no.

101
Monday 18th April, 2011

Introduction

Colombo Street, Christchurch

“Adversity is like a strong wind. It tears away from us all but

the things that cannot be torn, so that we
see ourselves as we really are”

Arthur Golden

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The earthquake in Christchurch has been our focus for the last two months and we apologise for missing
an issue of Global. However, economics and business are of lesser importance than the loss of friends
and work colleagues……..and we have been affected more than most in this regard.

It is important now to drift back to normality.

Or, as Joe Bennett put it so brilliantly (Ch.Ch. Press 13/4/11):

“As the Condor of Cataclysm swoops across the globe and throws livestock into
panic with the swoosh of its slow-beating wings, and causes Middle Eastern
tyrants to biff missiles at the subjects they profess to love, and visits financial ruin
upon one exhausted European country after another, and sets brother against
brother in the hellholes of West Africa, and threatens nuclear cataclysm in Japan,
and brings earthquake, flood and fire that send the people gibbering through the
streets until the air is thick with the wailing of teeth and the gnashing of infants,
and the end of the world is visible if you just walk to the end of the road and peer
round the side of the dairy, lo, fluttering down through this apocalyptic maelstrom
comes a press release that Woman’s Day has got a new editor. Her name is Sido
Kitchin.

Ms Kitchin finds the prospect of editing Woman’s Day “incredibly exciting”.

“We have a royal wedding on the horizon,” she says, “so what a wonderful time to
be starting Woman’s Day”

Wonderful indeed – the ordinary world.

The New Zealand and Japanese

earthquakes were devastating in
their destruction and also typically
created an over-reaction in the
markets.

This set up opportunities – the

plunging NZD, the 17% fall in the
Nikkei (in 2 days), the temporary
hike in the Yen (before
government intervention), and the
collapse of uranium company
shares.

In a study of similar catastrophes such as the Kobe earthquake in 1995; the Taiwan earthquake of
1999; the US terrorist attacks in 2001; and the 2010 Chilean earthquake – in all cases their share
markets regained pre-catastrophe levels within 78 days.

It has been estimated that the Christchurch earthquake will cost nearly $16 billion, which would amount to
about 45% of the $36 billion insured losses in the world from catastrophes in 2010.

It is seriously affecting business (particularly tourism) in Christchurch could mean that NZ goes close to
recession, and should affect the economy by around 1.4% of GDP (reducing growth to about 0.9% for
2011). The RBNZ has cut the Official Cash Rate by 50 basis points.

Of concern is the ongoing picture of academics, politicians and councillors sitting around waxing
lyrical about their “vision” for the city, when most of the properties and businesses are in fact
owned by private enterprise (largely ignored). It is all very well having a highly verbalised image for
Christchurch, but the vital element is to get the “motor” going. Good external appearances are
important, but very much secondary to having the heart beating. Business must be resurrected
……..which will lead to the employment of people and the circulation of the life blood (known as
commerce).

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The massive 8.0 magnitude earthquake, resulting tsunami and nuclear meltdown in Fukushima will
probably cost Japan around US$200 billion, about double that of the great Kobe earthquake in 1995. The
main area impacted is the Tohoku region of north-east Japan, accounting for 6% of Japanese GDP.
However, the nearby Kanto and Chubu regions account for 56% of the GDP. On a global basis, Japan is
the 3rd biggest economy, representing about 10% of the world’s GDP. An estimated reduction in Japanese
GDP this year of 1.5% would knock 0.15% off global growth.

The question then arises whether, on a net basis, the reconstruction will be good for either economy. One
argument (first explored by Frederic Bastiat in 1850) was that if a child broke a window, he creates work
for the glazier, who then has money to buy from the baker, who has more money to buy shoes from the
cobbler….and so the initial money circulates, which is good for the economy. It’s similar to Keynesian
theory.

The fallacy is that if the owner of the window didn’t have to pay the glazier, then he would have the
cash himself to generate the money flow. Furthermore, the reconstruction of an asset does not add
to anyone’s wealth.

However, in NZ’s case, there may be a net benefit for the private sector. If a building is demolished, and a
construction company rebuilds it, employees get paid, materials are bought….and the money-go-round
starts from there. The hit is then taken by the large re-insurer, who is inevitably offshore. That can create a
net benefit – later ameliorated by higher premiums. There may be less benefit in Japan, which probably
carries more end-product insurance in their own country.

Against that, there will be a net loss to the public sector (estimated at $8.5 billion) for uninsured local
government infrastructure (roads, sewerage etc); insurance excesses on schools and hospitals; temporary
housing; ACC; business support packages and land remediation.

When looking at the opportunities that could arise, an obvious one in NZ is Fletcher Building, which is
running the Earthquake Commission’s (EQC) Canterbury repair project.

A greater number of opportunities arise in Japan, because of its size in “Japanese folk wisdom
the world markets. A major area relates to its dominant position in the holds that earthquakes are
world technology industries. The country manufactures around 20% of caused by the thrashings
the global combined technological products - including 40% of all of a giant catfish that lives
electronic components; 44% of audio-visual equipment; 19% of semi- in the mud below the earth.
conductors; 30% of flash memory (used in smartphones); 15% of D- Normally the fish is kept
Ram memory (used in computers); and 78% of electrode materials for under control by the god
lithium ion batteries. Kashima, who has placed a
These supply chains will be materially affected, with many large stone on top of it.
factories facing temporary or partial closure. Every so often though
Kashima snoozes on the
Competing products will benefit from this, particularly in nations such job and the catfish breaks
as South Korea and Taiwan. These countries can easily be invested in free”
through the South Korea iShares (EWY) or Taiwan iShares (EWT), on
the New York Stock Exchange. Or, specifically, Samsung and Texas Financial times
11/03/11
Instruments (US:TXN) should benefit.

Other opportunities exist with Japanese heavy equipment manufacturer Kohmatsu and waste
management company Clean Harbours (US:CLH – which has an excellent chart).

Japan imports 59% of its food intake and radiation into the sea should, in due course, boost the sales of
excellent products such as NZ King Salmon. However, transport infrastructure will have to be repaired first.

On the nuclear energy side, 4 of the 6 reactors at the Fukushima Daiichi power plant are finished……..and
the other two might as well be. Each plant has 7 pools filled with spent fuel rods that have been collected
over 40 years…..sitting on the top of the 6 reactor buildings. Each reactor building houses 3,450 fuel rod

3
assemblies and each assembly holds about 63 rods. There is also a common pool holding between 6,000
and 7,000 fuel rod assemblies.

As a result there are apparently over 600,000 spent fuel rods in the facility.

Which is why the plant has been elevated to a category 7 rating, alongside Chenobyl.

The shut-down of the nuclear reactors should represent about 1.5 million
pounds of uranium no longer being imported, which is only about 1% of the “Anyone who thinks
world market. However, it will have an effect on nuclear plant development, critically about the
with Germany reversing a prior plan to extend the life of 17 reactors, and future of energy
China has suspended approval of 25 reactors under construction (possibly supply will inevitably
not for long). draw the conclusion
that nuclear energy
The situation has affected the share prices of uranium producers such as will be a significant
Paladin Energy (Australia) and the industry giant, Cameco (Canada). No part of our future
doubt the market will calm down in due course, but we would stand aside energy portfolio.”
until the dust settles.
The Australian
22/3/11
Better opportunities probably exist in the energy generating replacements
that Japan will have to buy to get their electricity production back up to speed
– particularly natural gas and thermal coal.

It gives us no joy to be writing about opportunities that arise from catastrophic events….and hope
(obviously jinxed - after experiencing two Christchurch earthquakes and the Queensland floods) to
personally avoid them in future.

Global Risk
“Last week, Portugal became the latest country to succumb to the European debt
crisis and to apply for a bail-out. But Portugal is a relative tiddler and its
application for a bail-out was actually welcomed by the EU authorities. A Spanish
bail-out, if it were to ever happen, would be much bigger”

Financial Times
11/4/11

“Portugal's request for a bailout from its European “The ECB went ahead
partners may have been the most visible symptom of Thursday and added
the crisis in the eurozone, but the decision taken in the expected 25 basis
Frankfurt to press ahead with an interest rate rise points to the main
could have a far more corrosive impact on the Euro's refinancing rate. This
long-term future. may only be a small
move in absolute
Analysis shows that because the interest rates on the terms, but as a signal
bailouts provided to Greece and Ireland track the it’s a much bigger
European Central Bank's lending rate, a series of deal.”
increases could push these countries – and Portugal
– into default” Wall Street Journal
The Guardian 8/4/11
10/4/11

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As expected, Portugal has become the third Eurozone country to request financial assistance from the
European Central Bank (ECB). It has financing needs of at least €20 billion a year until 2013…and requires
a total amount of €75 billion. This compares to €110 billion for Greece and €68 billion for Ireland.

The real question, particularly in light of the ECB now moving

“Portugal now joins Greece and
to tighten monetary policy, is whether or not the debts, rising
Ireland in the Eurozone’s intensive-
interest rates, and new austerity measures are sustainable.
care ward. Its public debts are
nowhere near as monumental as
The German led pre-condition for the troubled nations is that Greece’s; its banks not as reckless
they must adopt new binding fiscal rules, and an overhaul of as Ireland’s. It has succumbed
state pension schemes and labour markets. because of a humdrum failure to rein
in wage increases and to modernise
However, Portugal has an economy that grew on average by a bureaucracy schooled in tallying
just 1.1% a year between 2001 and 2007….and has the quiet remains of the first global
performed worse since then. Financial retrenchment could empire, as well as an inability to
create unbearable misery in the economic and social sense, coax upstanding family companies,
and it is debatable whether the people and the unions will which for centuries have crafted
stand for it. textiles, ceramics and shoes, into
competing with the Chinese. As a
The real problem is a lack of competitiveness. Between 1999 result, harsh as it may seem, a
and 2007 unit labour costs, relative to Germany’s, rose by country whose collective memory is
31% in Ireland, 27% in Greece (and Spain), and 24% in still scarred by the austerity
Portugal. Because these countries cannot adjust their demanded by the IMF in the early
currencies, they have to effectively lower their wage 1980s must once again subject itself
structures to compete in the Zone. to tough reforms demanded by
foreigners”
The new rules will require a massive change of culture. In
Greece, for instance, corruption is endemic. A recent inquiry The Economist
into a public hospital found that they had 45 gardeners on the 7/4/11
staff….….but no garden.

Germany is in an interesting position. Because it is an economic powerhouse, the country can issue bonds
for 12 months at an interest rate of around 1.3%. The periphery nations are paying about 6%. Furthermore,
Germany’s large export industry is benefitting from the Euro being considerably lower than the currency
would have been if they were independent.

However, Germany is not off the hook, because around one-third of the estimated €250 billion owed by
combined public sectors and banks, of these three countries is to German banks (which are reasonably
fragile in themselves). German voters do not want to extend handouts, and German banks cannot afford for
these nations to default.

The structure seems incapable of being resolved without at some stage spooking the global debt markets.
However, currently Spain appears to be ring-fenced – which is relaxing the markets, but just delaying the
inevitable fact that some of these nations will surely default.

*****
“In its latest oil market report, released on Tuesday, the International Energy
Agency described the response by OPEC, the oil-producers’ cartel, to the loss of
Libyan supply as “limited”. The turmoil in Libya has taken more than 1m barrels a
day off the market, leading to an overall fall in production among OPEC’s 12
members of 890,000 barrels a day between February and March”

Financial Times
12/4/11

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The problem with the loss of Libyan oil, in spite of it making up just 2% of global supply, is that it produces
a premium “light sweet” crude that is difficult to replace…… apart from in countries such as Nigeria and
Algeria (which have their own geo-political problems).

The big “swing” nation, with regard to extra oil production, is Saudi Arabia. However, it takes three times as
much “heavy” Saudi oil to make diesel as Libyan oil.

The Middle East is in a political turmoil which could change the strategic and economic shape of the
region. The implications for oil and the developed nations that depend on it are serious. Tunisia, Egypt and
now Libya have suffered revolt. Still in the firing line are Yemen, Syria, Bahrain, Jordan, Oman, Morocco,
and Saudi Arabia.
“There has long been bad
The crux of the matter relates to the Saudis and the Iranians, blood between the Saudis and
the two major oil producing powers. They are on opposite Iran. Saudi Arabia is a Sunni
sides of the tension, with the Shiites (who dominate Iran) Muslim kingdom of ethnic
comprising large parts of the population in Sunni controlled Arabs, Iran a Shiite Islamic
countries. Saudis are mainly Sunni. republic populated by ethnic
Persians. Shiites first broke
The key place to watch is Bahrain. It is a very strategically placed with Sunnis over the line of
country, as the US 5th fleet is based there (which is why the US succession after the death of
was happy for Saudi Arabia to have a military presence). The the Prophet Mohammed in the
ruling family are Sunnis, while 80% of the population are Shiites, year 632; Sunnis have regarded
who are natural allies of Iran. them as a heretical sect ever
since. Arabs and Persians,
There is now serious potential for a significant hike in oil prices to along with many others, have
disrupt the global economy. Each of the last 5 major downturns in vied for the land and resources
global economic activity has been immediately preceded by a of the Middle East for almost as
major spike in oil prices. Sometimes they were supply shocks, long”
while at other times they were demand surges (as in 2008).
Inevitably, an increase in oil prices over 12 months, in excess of Wall Street Journal
100%, leads to a downturn. 16/4/11

The direction that the global powers are taking with regard to the unrest and revolution is dangerous, but
potentially exciting. As the Financial Times (18/3/11) said:

“If Europe and America, hitherto wedded to a network of strongmen in the interests of
stability, cheap oil and the security of Israel, now stay realigned with Arabs intent on
reclaiming their destiny, that will open the widest, most sunlit avenues towards
democratic change in the region for more than half a century”

*****
“The stock indexes barely budge, trading traffic slows to a crawl, and everyone is
holding his breath for the big event. No, not that wedding that has sold out every
balconied room overlooking Buckingham Palace, and not even the first-quarter
earnings that companies will begin reporting this week, but the end of the Federal
Reserve's "quantitative easing" regime”

Barron’s
9/4/11

“After two years of rallies and only one major correction, the global bull market
may soon face its biggest test.

The impending end of the Federal Reserve’s latest easy money program
(“quantitative easing” or QE2), along with seasonal weakness in stock markets and
other events, could cause investors to doubt this bull once again”

6
 MarketWatch
16/4/11

Investors will appreciate that we closely follow the US, because (in spite of China) it remains the most
influential economy in the world.

To date, this economy has been stimulated in a Keynesian type of approach, by two massive Federal
Reserve programmes of quantitative easing. This means that the Fed adopted an unconventional
monetary policy to stimulate the economy by buying government bonds and other financial assets, in order
to increase money supply and create greater reserves in the banking system. The total for both
programmes was $2.3 trillion.

It was designed to encourage lending, but to a greater extent has lifted the price of risky assets such as
shares and commodities, as well as dropping the USD. It has been of assistance to the US economy.

At the end of June, it will cease. The key question relates to what effect
this will have on the US economy, currencies, inflation, shares, “The big question is
commodities and the bond market. i.e. it has implications for risk oriented what happens when the
assets globally. Stopping this process could unnerve markets and Fed stops handing out
potentially lead to a rise in risk aversion – benefitting safe havens, the happy pills. Many
including the US dollar and Treasuries. It could see risky assets tank smart analysts think that
(including equities and commodities). the only way the Fed is
affecting stock prices is
To a large extent, the effect of QE2 has been psychological rather than by providing investors
actual – as witnessed by the fact that when the Fed started flooding the with a measure of
market with money interest yields went up rather than down (i.e. it had the confidence. These
opposite effect to what was intended). Effectively the markets took analysts say that the Fed
assurance from the exercise and plunged into risky assets. has been more of a
placebo effect than
The most dangerous thing about the change from QE2 to a anything else”
traditionally normal environment is the fear of the transition itself.
Investors should be very wary of equity, bond, currency and Strategic Advantage
commodity markets from May onwards. 5/4/11

We believe that there is scope for a significant correction to markets as the end of June nears, but the Fed
will remain accommodating, with interest rates close to zero, through until 2012…… which will still be good
for equities.

When the dust settles (watch the 50 day moving average) it could be a time to buy.

The Global Economy

“The global economy is on firmer ground because the US economy, which is still
globally dominant, is getting stronger; and the Chinese economy, which is the key
contributor to global growth, is becoming more balanced”

Bank Credit Analyst

8/4/11

Economies in the developed world are not yet back to normal, with the rate of unemployment in the US still
about 4% above the 6-year average, before the pre-financial crisis; while Europe is around 1.5% higher.
While acknowledging the “terrible human toll” caused by Japan’s disaster, the IMF has said that its
economic impact would be limited.

7
Of concern though are the underlying current account imbalances –
“There is an urgent need for
caused by the public sectors in countries such as the US, UK and
the US to tackle the deficit
many Eurozone nations, stimulating their economies after the
in the government's
financial crisis. The IMF believes that not enough effort is being put in
finances, according to the
to rectifying these.
International Monetary
Fund (IMF). The
At the same time countries such as Japan and China are running
organisation has warned
large external surpluses……and the balance is badly skewed.
that the size of the deficit
risks creating instability in
It was fine during the chaotic days of 2008 and 2009, for the badly hit
the financial markets.
nations to spend heavily on getting their economies kick started, but
However, the global
it is now time to correct the deficits. The developed countries need to
economic recovery is
cut back on government spending, while the Asian nations should
gaining strength”
attempt to lift their consumer demand.
BBC News Online
The world economy needs rebalancing.
12/4/11
However, the IMF said that “global activity seems set to accelerate again” and has forecast world
economic expansion at 4% for 2011, and 4.5% in 2012. The bulk of this is still being generated by the
emerging nations.

United States

The US economy roared back to life in the

fourth quarter of 2010, recording annualised
GDP growth of 3.1%. A large part of this was
due to the consumer sector, which has been
buoyed by the rapid improvement in the
unemployment rate - down from 9.8% in
November, to 8.8% in March (see adjoining
chart).

The private sector has added over 200,000 jobs

in each of the last two months, for the first time
since before the recession. The Fed’s “beige
book”, which informally surveys economic
growth at the coal face, also reported last week
that the economy continued to improve across
all regions.

However, high fuel prices are starting to take their toll on consumers and businesses alike, and are likely to
provide a drag on economic growth in future months.

Retail sales rose 0.4% in March, from February - but excluding petrol, purchases were only up by
0.1%....... as consumers spent more at the pump, and stagnant wage growth meant that they had little left
for other items. Wage growth is below headline consumer inflation, meaning that in real terms it is
negative.

The Conference Board overall index of consumer attitudes fell from a 3-year high of 72.0 in February, to a
still high 63.4 in March.

Businesses remain cautious of the economic recovery, and are delaying their spending and hiring
decisions. The Index of Small Business Optimism dropped 2.6 points to 91.9 in March, and the Services
Sector Purchasing Managers Index fell to 57.3 from 59.7, where readings over 50 signal expansion.

On the brighter side, the outlook for the main driver of the recovery to date, manufacturers,
remains very positive. This sector’s Purchasing Managers Index slipped only slightly to 61.2 in
March, from 61.4 a month earlier.

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The IMF expects that the slow pace of job gains, and higher oil prices, will take their toll on US economic
growth this year, and has lowered its 2011 full year GDP forecast to 2.8%........ rising to 2.9% in 2012.

China

China’s economy grew at a staggering annual average pace of 11.3% over the last five years…….. but the
government has now signaled that price stability, rather than immense growth, will be its top priority going
forwards.

Consumer prices increased by 5.4% year-on-year, in March,

compared to 4.9% in February – which was the biggest jump since “The World Bank chief
July 2008. This indicates that the focus on inflation is not yet economist says China has
working……...and is a warning for commodity markets. The People’s accounted for about a
Bank of China has raised official interest rates four times in the last quarter of global economic
six months in an attempt to control food inflation (which has growth between 2000 and
traditionally been a cause of social unrest). 2009, edging out the U.S. for
the top spot. Most
These tightening measures concern some economists who predict economists predict another
that Chinese growth is set to stall. So far, this has not been the case. banner year for Beijing and
forecast further growth—
Manufacturing activity continued to expand in March, and the official especially with a boost from
Purchasing Managers Index rose to 53.4, compared to 52.2 in the U.S. economy's gradual
February. Exports rose by 35.8%, compared to a year earlier last recovery—although slightly
month, and were up 2.4% on February. Imports also increased 27.3% less than last year's 10.3%”
(year on year). These figures meant that, in March, China registered
Wall Street Journal
its first quarterly trade deficit in seven years – which indicates the
11/4/11
economy might be rebalancing along the lines that Western
economists are recommending.

China’s economy is approaching half the size of the US……..but per capita GDP is still well behind.
The country has a long way to go in its industrialisation and urbanisation path.

The International Monetary Fund forecasts economic growth of 9.6% in 2011, and 9.5% in 2012.

India

Despite consistently high inflation, India’s economy shows no signs of slowing.

March’s Manufacturing Purchasing Managers’ Index stood at 57.9, which was well above the 50-point
expansion mark. Exports surged by 49.8% in February compared to a year earlier, while imports were up
by 21.2%. Industrial output also grew by 3.6%.

The Reserve Bank of India has raised its official borrowing rate by 2.25%, and the lending rate by 1.75%,
since March 2010, as it grapples with intolerably high inflation. Currently inflation is running at around 9%.

To match China, India is overdue for a number of reforms. The public-education system is a
shambles; no significant publicly owned businesses have been privatised for years; the promised
modernisation of the financial system has happened only in fits and starts; land reform is needed
to stimulate industrialisation……… and malnutrition remains widespread.

The IMF has forecast economic growth of 8.2% in 2011 (down from 10.4% last year), and 7.8% in 2012.

Japan

The massive earthquake and tsunami that devastated Japan’s northeast coast in early March will slow
economic growth to a crawl over the next quarter. While the full impact of the disaster is uncertain, it is
unlikely that the country will fall back into recession. Reconstruction efforts will almost certainly accelerate
growth towards the end of the year.

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Consumer prices were down 0.3% from a year earlier in February,
marking the 24th straight month of deflation. Unemployment fell to 4.6%,
but this is sure to rise in the coming months.

Industrial output posted a surprise gain of 0.4% (month on month) in

February, but this should stall - according to the latest manufacturing
data. The Purchasing Managers Index dropped to 46.4 in March, from
52.9 in February (which represents contraction).

Ironically, natural disasters often turn out to be a catalyst in an

economy…..and in due course, this tragedy could be an economic
positive for a nation that has been plagued by debilitating deflation.

The International Monetary Fund is forecasting the economy to achieve

growth of 2.5% this year, and 1.5% in 2012.

Eurozone

With the Eurozone credit crisis recently claiming its third peripheral
victim in the form of Portugal, the chasm between the two tiers of the “The volume of retail sales
economy continues to widen. Portugal will join Greece and Ireland in in Germany was 1.1%
imposing draconian austerity measures, while other vulnerable states, higher in February than in
including Spain and Italy, draw up their own deficit-reduction measures. the corresponding last year
and 3.9% stronger in
The ongoing crisis is having an effect on Eurozone-wide confidence, France. But, in Spain,
reflected in the Economic Sentiment Indicator being down in March. where unemployment is
The consumer sector is flat with a 0.1% slide in retail sales in February more than twice the euro-
(from January), representing annual growth of just 0.1%. zone average, sales were
5.6% weaker on the year,
However, Germany is going from strength to strength. Industrial while in Portugal they fell
production is rocketing along at an almost Chinese pace, with a 4.5% and in Ireland they
1.6% monthly gain in February, and an annual increase of 14.8%. were 3.0% weaker”

Germany is also generating a significant proportion of the Eurozone’s Financial Times

inflation, ironically leading the hawkish central bank to tighten monetary 5/3/11
policy for the first time since 2008 (causing more problems for the
down-on-their luck periphery nations).

Who’s recommending joint currencies (such as between Australia and NZ) these days?

Nevertheless, the outlook overall for businesses in the Zone remains positive. The Purchasing Managers’
Index (PMI) for the services sector hit a nearly 4 year high in March at 57.2, while the manufacturing sector
index eased slightly from 59 to 57.5……..still signaling expansion. The improving outlook has helped boost
hiring, with the unemployment rate dipping under 10% (to 9.9%) for the first time since late 2009.

However, compare this with Spain’s jobless rate of 20.5% overall…..and a record 43.5% of youth (who are
available for work) unemployed.

The IMF forecasts Eurozone GDP growth of 1.6% in 2011, and 1.8% in 2012.

United Kingdom

On the face of it, things don’t look promising for the British economy. GDP contracted (by 0.5%) in the
fourth quarter of 2010, and the prospects of ongoing government austerity are likely to continue taking
their toll on economic growth.

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We enjoyed this statement from the Financial Times (22/3/11) on the “There’s no getting
restricted nature of the country’s economy: away from it:
household spending,
“Guiding the UK economy is rather like playing Gridlock, the the engine of the UK
addictive computer game in which a small yellow car is economy for the best
surrounded by large vans and trucks. No move is possible part of two decades,
without first shifting about six other vehicles. On the eve of his is going in reverse”
annual Budget the chancellor must feel similarly hemmed in”
Wall Street Journal
Consumers, the lifeblood of the UK economy, have all but given up hope 13/4/11
(despite inflation remaining high) and retail sales dropped by almost 2% for
the year to March…….. the biggest fall in 16 years.

Manufacturers, who have been enjoying a robust recovery on the back of a weakened currency, are also
starting to face worsening conditions. The sector’s Purchasing Managers’ Index slid for the second month
in a row - after reaching a record high of 61.2 in January, the index hit a 5-month low of 57.1 in March.

There is some light at the end of the tunnel – services, which is the biggest sector (contributing to
75% of output) in the UK economy, surged in March, with the Purchasing Managers’ Index soaring
to 57.1, from 52.6 in February.

The IMF has joined the chorus expecting lower growth in the UK, dropping its 2011 forecast to 1.7%,
although it expects a pickup to 2.3% in 2012.

Australia

After a stellar performance in 2009, and early 2010, the Australian economy is now underperforming some
of its developed peers. Devastating floods and a cyclone in key mining and agriculture regions earlier this
year, have temporarily hampered economic growth.

The Consumer Sentiment Index fell 2.4% (month on month) in

March, hitting a nine month low, and retail volumes remain soft.
Sales have risen by a meagre 2.1% over the last year, largely
due to the very hefty rise in consumer savings (as shown in the
adjacent chart).

Australian households squirreled away $74 billion in

savings last year, equivalent to $3,300 for every man,
woman and child. Total borrowings by individuals and
corporations are down by 11% over the last year……… the
biggest decline on record. For the foreseeable future it
appears that economic growth will coming from spending
on business investment, rather than consumption.

According to the Australian (2/4/11):

“The soaring Australian dollar is threatening to exacerbate the “two-speed”

divergence across the sectors in the domestic economy”

The difference between the performance of the mining sector and other parts of the economy is also
becoming more of a problem, as the Australian dollar passed parity with the Greenback last month – and
this is hampering the Manufacturing sector (which is basically in recession). The Purchasing Managers
Index was down to 47.9 in March – the 6th time in seven months that activity has contracted.

The labour market is, however, riding on the back of the resources sector, with almost 48,000 jobs created
in February. Overall unemployment remained steady at 4.9%.

Following the January floods, the IMF has downgraded its assessment of Australia’s economy, now
predicting that it will grow by 3% this year, and 3.5% in 2012.

11
New Zealand

NZ’s economy has narrowly avoided falling into a “double dip” recession. After falling 0.2% in the June to
September period, GDP edged up by 0.2% in the December quarter.

The figures were underwhelming and the latest earthquake, “The February 22 earthquake in
which shattered the country’s second largest city, has thrown a Christchurch dealt another cruel
spanner in the works…… which will mean further tough times blow to the city and the country
ahead. Building consents for new dwellings are down to the as a whole. On top of the human
lowest level in two years and consumer confidence (according to suffering it inflicted, it has also
the Westpac McDermott Miller survey) has now fallen to a level set back economic recovery by 3
where pessimists outnumber optimists. to 6 months. Some businesses
will never reopen, shrinking the
Growth in manufacturing activity (expectedly) slowed in March, economy’s productive base. The
with the Purchasing Managers Index down to 50.1, which is just government will bear significant
above the 50-point expansion mark. costs of infrastructure rebuilding,
as well as pouring financial aid
The terms of trade are, however, at an all time high, due to the into the city. In addition, it will
strength of the agricultural commodities sector. receive a much lower tax take
than the Treasury forecast just
Rebuilding in Christchurch and the Rugby World Cup will provide late last year”
positive momentum for the economy towards the second half of
the year….and onwards. Reconstruction in Christchurch should ASB
last for 5 years….…and much longer at the current rate of 14/4/11
activity.

Growth forecasts have been slashed by the International Monetary Fund. They now predict economic
expansion of just 0.9% this year, and 4.1% in 2012 (note the drop in one year and large boost in the next).

Inflation & Interest Rates

“On Thursday, the European Central Bank (ECB) raised interest rates for the first
time in three years – initially by only a quarter of a percentage point to 1.25%.
Jean-Claude Trichet, the President, cited inflationary risks stemming in part from
“strong economic growth in emerging markets”, as well as “ample liquidity at the
global level, [which] may further fuel commodity price rises”.

It is not just the ECB that looks at China and sees a more inflationary future. This
week the People’s Bank of China, the central bank, raised rates for the fourth time
since October, as well as taking other action against price rises. Others are
expected to follow suit by the end of the year”

Financial Times
8/4/11

There is an old saying that “low interest rates flatter all asset classes” – and (overall) inflation and interest
rates remain low, in traditional terms, in the global economy. This is positive for equities and commodities.

The situation may not remain, as inflation is beginning to track higher, fueled by further improvement in the
global economy and rising prices in commodities and in the emerging markets.

China has been a major catalyst for falling inflation and interest rates over the last 30 years. When
this massive country started integrating with capitalism in the 1980s, it added more than 20% to the
global workforce, effectively becoming the world’s factory. It delivered a massive labour supply
shock that had a negative effect on inflation rates.

12
Because of competition problems, industrial workers in
“Data released on Friday showed a
developed nations had difficulties when bargaining for wage
surge in Chinese and Indian
increases. It created a shift in emphasis in those countries
inflation, highlighting the threat to
from blue-collar industries to service sectors.
the global economic recovery as
China’s share of world merchandise exports rose from 1.1% emerging markets overheat and
in 1982 to over 10% at the end of last year. In spite of rapidly commodity prices rise
increasing productivity and the migration of factories to the Consumer prices in China
lower cost central areas, wage costs in China are rising. The increased 5.4% year-on-year in
government, as always concerned about social unrest, raised March – their biggest jump since
the minimum wage by 20% earlier this year. July 2008.
Headline inflation in India,
Inflation is also becoming of greater concern across the rest meanwhile, rose to almost 9% in
of Asia, fueled by high energy and food prices…… and central March, compared with 8.3% in
bank interventions into currency markets to maintain their February.
export competitiveness is preventing rising currencies from Emerging market countries are
doing their work in assisting to tame inflation. Many of these tightening fiscal policy to combat
countries over-reacted to the 2008/09 financial crisis by over inflation, potentially reducing an
stimulating their economies and now have high capacity important source of global demand
utilisation rates that are causing inflationary concerns. for advanced economies already
Unemployment is below 4% in Malaysia, Thailand, Singapore, struggling with high unemployment
Hong Kong and South Korea. and fiscal cutbacks”

Australia, due to huge benefits in supplying commodities to Financial Times

the region, can also be included, with unemployment at a low 15/4/11
4.9%.

There is not much slack left in Asia.

The situation is different in the US, which is suffering from what has
been described as a “wageless recovery”. The Fed follows “core” “Inflation is not a problem
inflation (excluding energy and food), which currently sits at for the G7 economies
0.8%......the lowest that it has been since records began in 1959. (France, Germany, Italy,
Furthermore, annualised growth in hourly wages (the most important Japan, United Kingdom,
element for inflation indices) is just 1.7%, which is the lowest figure in United States and Canada),
25 years. In real (CPI inflation adjusted) terms, wage growth is although it is causing
negative. substantial policy responses
from emerging markets. The
The Fed has a mandate to target unemployment (which is currently global bond market is not
at 8.8%) as well as inflation. Capacity utilisation is still below the too concerned about
long-term average and house prices are extremely weak. inflation. However, the
medium-term inflation
Of interest to investors is speculation over the effect on interest rates outlook is uncertain”
from the completion of the QE2 stimulation programme, at the end of
June. There are a number of pundits who believe that when the Fed Bank Credit Analyst
stops buying bonds (which should increase rates) the resulting 8/4/11
slowdown in the economy could in fact drop interest yields – as it did
at the end of QE1.

The Eurozone & UK are mid-stream with regard to inflation. The central banks of both regions follow
headline inflation (including energy & food) – which is being affected by high food and oil prices. Recently,
the European Central Bank raised interest rates for the first time since 2008, due to inflation jumping to
2.7% in March.

This however, has led to criticism over the effect that it will have on the besieged peripheral nations. CPI
inflation in the UK is running at 4.4%, which is more than twice the Bank of England’s target, also putting
pressure on the bank to raise interest rates.`

13
Confidence is weakening and the economy slowing in NZ, due to the fragile nature of the recovery and the
effect of the Christchurch earthquake. Consumer demand is weak and the Reserve Bank (RBNZ) dropped
the Official Cash Rate by 50 basis points in March. The last RBNZ bulletin (31/3/11) said:

“We think that price inflation remains comfortably under control…….consequently,

it now seems prudent to keep the OCR low until the recovery becomes more
robust and underlying inflation pressures show more obvious signs of increasing”

Let’s look at NZ & US interest rate trends that we have recorded in previous issues, compared to Friday:

Instrument Current Issue No Issue No 99 Issue No 98 Issue No 97 Issue No 96 Issue No 95

Rate (%) 100 (31/1) (20/12) (22/11) (25/10) (30/8) (26/7)
Rate(%) Rate(%) Rate(%) Rate(%) Rate (%) Rate (%)

New Zealand

Call (OCR) 2.50 3.00 3.00 3.00 3.00 3.00 2.75

90 Day Bank Bills 2.67 3.24 3.19 3.17 3.19 3.23 3.27
1 yr Govt Bonds 2.61 3.30 3.39 3.59 3.48 3.49 3.64
5 yr Govt Bonds 4.59 4.55 4.83 4.86 4.38 4.41 4.71
10 yr Govt Bonds 5.77 5.50 5.89 5.66 5.09 5.12 5.40

United States

Fed Funds Rate 0 to 0.25 0 to 0.25 0 to 0.25 0 to 0.25 0 to 0.25 0 to 0.25 0 to 0.25
90 day T-Bill 0.06 0.14 0.10 0.13 0.12 0.14 0.15
10 yr Govt Bonds 3.41 3.32 3.33 2.87 2.52 2.64 2.99
30 Yr Govt Bonds 4.47 4.53 4.44 4.24 3.91 3.69 4.01

NZ rates are lower at the short end of the curve, because of a 50 basis point cut in the Official Cash Rate.
They are higher further out, due to rising rates in the US.

Currencies
“Two years of total inactivity on the rate front by the west’s biggest central banks
came to an end this week as the European Central Bank (ECB) raised its policy
rate.

This was not a surprise when it happened, but it is still a big deal. It is the first time
in the ECB’s relatively brief history that it has taken the lead in starting to tighten
monetary policy, rather than waiting for the Fed.”

There is room for debate between inflation’s hawks and doves, but plainly the ECB
is a better bet than the Fed to raise rates and to combat inflation; and on both
counts, that points to a stronger Euro and weaker Dollar.

Financial Times
8/4/2011

14
The adjoining chart shows that the US dollar
was in a sustained downturn from its peak in
2001, until the financial crisis in 2008……. a
period which coincided with strong running
equity and commodity markets.

The chart also explains the long bull run in

gold – which has a close negative
correlation with the USD.

The USD tends to fall during times when

risk is being sought (and shares are being
bought) – as large US investors place their
money overseas.

The Greenback has been a counter-

cyclical currency for over a decade.

It then bounced and showed its paces as a safe haven currency (with US investors repatriating funds)
…….throughout the global recession (until early 2009).

Fluctuations since then have been largely driven by the sovereign debt
crises in Europe, and the quantitative easing programmes carried out by the “There’s no
US Federal Reserve. support for the
dollar, so
The USD and EUR are the two biggest currencies in the world and tend to be traders are
negatively correlated (currencies do not move in a vacuum). The commodity going anywhere
currencies (including NZD) also tend to move in an opposite direction to the USD. but”

The ongoing debate has recently been whether the USD would rise (due to a Wall Street
stronger recovering economy) and EUR fall; or the EUR would instead rise (and Journal
USD fall) due to a greater propensity for the European Central Bank (ECB) to lift 3/4/11
interest rates. We believe that with low core inflation the US has the ability to push
its currency lower, thus boosting their exports……. and commerce in general.

In our last newsletter (31/1/11) we said:

“The crux of the matter is that the US should win its battle to lower its currency to boost
the economy. America has an infinite amount of ammunition, as there is theoretically no
limit to the amount of dollars that the Fed can create – particularly with lower inflation
than most of the rest of the world. The Fed will keep easing until the US economy is
satisfactorily reflated. This is negative for the Greenback”

The ECB concentrates on headline inflation (including food and energy), while the Fed watches core
inflation (excluding the volatile food and energy figures). The ECB is therefore more concerned about their
current inflation figures and have recently started their interest-hiking regime.

This is positive for the Euro and negative for the USD – which (in the above chart) is already
showing a technical weakness, with a large double top formation pointing downwards. The AUD
and NZD are rising against the USD……..and we expect NZD/USD to go through $0.80.

The above negative USD stance is conditional on the Eurozone being able to ring-fence problems with
Greece, Ireland and Portugal and how the markets react to the completion of US quantitative easing (QE2)
at the end of June. We anticipate volatility ahead.

With respect to other currencies…… the Bank of England is faced with increasing inflationary pressures,
which will force them to start normalising monetary policy in the coming months. This will widen the interest
rate differential with the US.

15
The adjacent chart of the GBP/USD shows
a steady appreciation of the Pound against
the Greenback…….which should continue.
The NZD remains positive against the
Pound.

The Bank of Japan should be the last

central bank to begin tightening monetary
policy following the devastating earthquake,
tsunami and nuclear catastrophe suffered in
March.

The Japanese Government (alongside the

G7 nations) has been intervening to keep a
ceiling above the Yen – which is unlikely to
strengthen against the USD (or NZD) while
the potential for further intervention remains.

The re-emergence of Yen-funded “carry trades” into high yielding commodity currencies should also assist
the Yen to weaken. The Australian dollar, the highest-yielding developed-world currency, has been a major
“carry trade” target.

The NZD is likely to remain weak against the AUD – until later in the year, when Christchurch insurance
proceeds are being remitted, and NZ Reserve Bank tightening appears likely to resume.

Share Markets
“If the professional economists can’t predict economies and professional
forecasters can’t predict markets, then what chance does the amateur investor
have? You know the answer already, which brings me to my own "cocktail party"
theory of market forecasting, developed over years of standing in the middle of
living rooms, near punch bowls, listening to what the nearest 10 people said about
stocks.

In the first stage of an upward market - one “Peter Lynch secured his
that has been down awhile and that nobody reputation as probably the
expects to rise again - people aren’t talking most successful fund
about stocks. In fact, if they lumber up to ask manager in the history of the
me what I do for a living, and I answer, "I equity markets while in
manage an equity mutual fund," they nod charge of the Fidelity
politely and wander away. If they don’t wander Magellan Fund between 1977
away, then they quickly change the subject to and 1990. During this period
the Celtics game, the upcoming elections, or he grew the fund from $20
the weather. million in assets to $14
billion. A $10,000 investment
Soon they are talking to a nearby dentist about in 1977 would have grown to
plaque. When 10 people would rather talk to a $288,000 by 1990. His
dentist about plaque than to the manager of an average annualised returns
equity mutual fund about stocks, it’s likely that over the 13 year period were
the market is about to turn up. 29% …….and he
In stage two, after I’ve confessed as to what I outperformed the market on
do for a living, the new acquaintances linger average by more than 13% a
with me a bit longer - perhaps just long year. He had a
enough to tell me how risky the stock market fundamentalist approach”

16
 actually is - before they move over to talk to the dentist. The cocktail party talk is
still more about plaque than about stocks.

The market is up around 15% from stage one, but few investors are paying much
attention.

In stage three, with the market up 30% from stage one, a crowd of interested
parties ignores the dentist and circles around me all evening. A succession of
enthusiastic individuals takes me aside to ask what stocks they should buy. Even
the dentist is asking me what stocks he should buy. Everybody at the party has put
money into one issue or another, and they’re all discussing what’s happened.

In stage four, once again they’re crowded around me -- but this time it’s to tell me
what stocks I should buy. Even the dentist has three or four tips, and in the next
few days I look up his recommendations in the newspaper and they’ve all gone up.
When the neighbours tell me what to buy, and then I wish that I had taken their
advice, it’s a sure sign that the market has reached a top and is due for a tumble”

Peter Lynch
One Up on Wall Street

Equities are currently entering the 3rd stage. After a two-year bull market, we are moving into the later part
of the cycle where the hoards of investors, who so-far have missed out on large scale gains, give up their
resistance and join in…….. providing the market with more energy. These periods, often characterised by
rising inflation, but still relatively low interest rates, make the later stages more volatile……. but they can be
extremely profitable.

According to the Financial Times

(10/4/11):

“The amount of money

wending its way into US
equities suggests that the
market is a sanctuary for
investors.

As the earthquake and

tsunami ravaged Japan and
the populist revolts waged
on in North Africa, last
month, US equity funds saw
net inflows of as much as
$538 million, according to
the latest estimates of the
global fund tracker EPFR”

The current phase is shown in the above chart of the share market cycle. It is approaching the time when
excited newcomers rely on faith and momentum, rather than knowledge and skill.

It reminds us of the excellent “classic” book the Extraordinary Popular Delusions and the Madness of
Crowds, when the Victorian writer Charles Mackay describes a company formed during the South Sea
Bubble, in 1720, which declared in its prospectus that it was “for carrying on an undertaking of great
advantage, but nobody is to know what it is”.

After investors hurried to buy shares, the founder “set off the same evening for the Continent” and
was never heard of again.

17
A well-worn expression is that share
markets love to “climb a wall of worry”.

That is exactly what the Dow Jones World

Index has done, as shown in the adjacent
chart. There have been pullbacks relating
to the end of the first US quantitative
easing (QE1) programme, and recently
with regard to the earthquake and tsunami
disasters in Japan – but the world market
has more than doubled since the financial
crisis.

The trick in projecting an ongoing upwards

trend in equity markets is to ask
(particularly with regard to the leading US
market):

1. Is there still upside to the global

economy? The answer is yes.

2. Are inflation and interest rates

under control? The answer is
yes, but less so than before -
particularly with regard to food,
energy prices, and the
emerging nations.

3. Are equities of reasonable

value? The answer to this is
also yes, with price earnings
ratios similar to the long-term
traditional average. See the
adjacent chart with regard to
the NZ forward P/E multiple.

4. Are corporate earnings continuing to grow? The answer to this is that they are, but not at the
same hectic pace that immediately followed the financial crisis.

This then establishes the fundamentals – which are still positive for equities. Because of low interest rates,
alternative investments such as cash and bonds are less attractive for investors. In NZ a median market
gross dividend yield of 6.6%, combined with ongoing growth potential, makes equities a compelling story.
In a well balanced portfolio, dividends typically make up 50 to 60% of total returns.

The next element to watch for are the headwinds, or “black swan” events that
can derail the markets. We have already discussed the major issues under “Investors are
our Global Risk section – with regard to the European sovereign debt issue; reluctantly
conflict in the Middle East, and its effect on oil prices; and the looming end to overweight
quantitative easing in the US. If shares were expensive (eg. in NZ, a price equities. The
earnings multiple of 16 to 17) then each of these problems would have the combination of zero
potential to cause a major correction. rates and rising
inflation makes
However, because the fundamentals are reasonable, the markets have been them fearful of
able to climb this “wall of worry”. Indeed, these issues provide a good restraint bonds and cash”
– because if equity markets go straight up, then they don’t last for long.
Financial Times
However, the major issues have to be watched to see that they do not 12/4/11
become overbearing to the extent that investors start to seriously bail out – as

18
they did with regard to the 2007/08/09 subprime and financial credit issues (which struck when the market
was over-valued). We follow sentiment indicators closely to gauge what effect these problems are having
on investors.

As mentioned, our immediate concern is the completion of QE2, in the US, at the end of June.

What of the emerging nation equity markets?

In our last issue (31/1/11), we said:

“Emerging markets are currently losing favour as they are being impacted more than the
developed world by the escalating prices of energy and food and their central banks are
in tightening mode. We have therefore (mostly) stepped aside from this sector……with
the thought of re-entering at lower prices down the track”

After a period of underperformance, they

have come back, as the adjacent chart of
the iShares Emerging Markets ETF shows.

While inflation remains elevated, major

emerging nation central banks are late in
their tightening cycle, and are now allowing
their currencies to gradually appreciate,
alleviating the need for excessively high
interest rates, and providing greater
certainty to their share markets.

The IMF is predicting that “emerging and

developing economies” will grow by 6.5%
during this year and next; while the
developed economies will expand by 2.4%
this year, and 2.6% in 2012.

There are still opportunities with regard to these high performing emerging countries – particularly when
food and oil prices start to level off – which we are anticipating. We have re-entered this sector, buying
South Korean iShares (US: EWY) – a play on technology disruptions in Japan; and Russian (US:RSX)
Market Vectors ETF – relating to upside to their economy from oil.

This bull market is not yet done. It could be interrupted this week from inflation fears in China, and also in
the next month or so from the end of QE2 (or perhaps an escalation in one of the other major issues). But
in the medium term ongoing economic growth, lowish interest rates and reasonable values should prevail.

International News
In Washington today, US President Obama named ex.
President George W Bush as his leading adviser on the
American excursions into Libya.
The President said that "we are assigning U.S. forces
to a dangerous mission in a Muslim nation that poses
no real threat to America, but whose instability could
mire us in an expensive, pointless conflict for years to
come. To that end I thought that no-one knows more
about this than President Bush."

19
A delighted Mr. Bush immediately leapt into action – and can be seen in the above photo working out
precisely where Libya is. He admitted that he was antagonistic when he first got the call “because when
Laura said Obama was on the phone again……. I got him mixed up with Osama".
He said that he was more than happy to heed the current President's call, because he has already offered
some advice on the situation in Libya.

“I told the President to start wearing a flight suit whenever it is possible……… a nice green one with the
belts and straps and all that”.

President Obama commented that he had also considered ex. President Clinton but said that “the last time
he accompanied the Secretary of State to Libya he wound up disappearing for hours with Mr. Gaddafi's
Ukrainian nurse."
*****
In the bloody clash in the Ivory Coast between strongman Laurent
Gbago (who was holed up in the Presidential Palace) and the
supporters of the elected new President, Alassane Ouattara, more than
one million people fled their homes and thousands were killed. To add
to the chaos Liberian mercenaries were apparently fighting on both
sides.

Representatives of the elected President reported today that they had

approached France, Great Britain, the US and the United Nations to
intervene in the crisis, in the same manner as occurred in Libya…….. in
order to establish democracy and justice, and to stop the ex. President
from killing his own people.

The immediate response was “how much oil do you have?”

“We have cocoa. Lots and lots of cocoa. It is delicious. Chocolate

is made from cocoa" they said, dispersing large amounts of M &
Ms, Toblerone, and pineapple chunks, “it’s an important
ingredient in cake”.

This generated loud cackles of mirth from members of the UN Security Council.

“The Ivory Coast is also a leading exporter of coffee” they cried, but no-one appeared to give a damn.

They also tried to get them interested in traditional and intricate African ceremonial masks, but this only
elicited a ripple of laughter ……….with the US representative saying “too bad that it is not Halloween”.

Finally, after four months, President Sarkozy of France agreed to bomb the Palace in the hope of getting
down on some ivory……… not realising that the country does not possess significant amounts, but was
merely a continental off-loading point during early colonial times.

*****
After viewing the protests in Christchurch relating to the
speed, or lack of it, with regard to the rebuilding of the
city…..and their own thoroughly “munted” churches, the
Christchurch Bishops of both the Anglican and Catholic
churches have decided to temporarily remove patience
from the official list of virtues.

“We used to think that it was virtuous to just sit around

and wait for stuff to happen,” said a spokesman from
both churches, “but we know a lot more about virtue
today than ever before, and it’s clear that patience
doesn’t fit that profile.”

20
He added that “there is underlying evidence supporting our new stance” and referred to an
American Psychiatric Association study indicating that people who exhibit an abundance of
patience are very often bipolar.

“We therefore do not ask for charitable forbearance, but instead insist that activities get cracking in what
previously would be considered as an unseemly manner”.

In an unrelated message, Christchurch police have today asked people to desist from the new habit of
walking in the middle of the street, particularly on the city’s busy ring roads - as it “presents a danger to
traffic who have to weave past these pedestrians”. They added that “we have put down thousands of
cones to make driving more adventurous and certainly do not want members of the public to assist us in
this regard”.
*****
You read it here first, we cover the night beat for the Daily!

Commodities, Resources & Precious Metals

Commodities plunged amid a rising chorus of
analysts warning that high prices were eating into “An increasing number of
demand. commodity prices and
related assets are getting
Commodities such as corn, copper, and cotton have ‘high in the tree’. This is true
hit record highs in the past 2 months, and crude oil, for many of our long-
which is closely watched due to its widespread standing favourites,
influence on the broader economy, hit 2½-year highs including corn, copper,
last week. aluminium, petroleum crack
spreads, energy services
Prices have been rising on tight supplies as well as stocks, as well as the
on many central banks loose monetary policies, Canadian and Aussie
which increased the flow of investment into what is dollars. Still it is not yet time
traditionally perceived as a risky asset class. to cut exposure”

But the magnitude and speed of the latest run up, Bank Credit Analyst
which started in the second half of last year, is 5/4/11
reaching a tipping point, especially given the fragile
underpinnings of developed nations economies”

Wall Street Journal

12/4/11

“The medium-term outlook for commodities remains fairly benign. Above-trend

global growth, abundant liquidity, and a tight supply backdrop should sustain the
commodity bull market for the next two to three years.

Beyond then, however, the outlook for commodities appears quite worrisome.
Higher interest rates and increased supply will weigh on commodity prices and
China’s incremental demand for base metals is apt to decline”

Bank Credit Analyst

8/4/11
In our last newsletter (31/1/11) we said:

21
 “There is room for a commodities correction as Barclays have estimated that US$60
billion was injected by speculative trading into commodities during 2010. Hedge funds, in
particular, have been very bullish”

And:

“We remain positive on commodities this year, but expect more modest gains and
volatility than in 2010. A 10%+ “overbought” correction is on the cards”

Respected investment bank, Goldman Sachs, issuing a warning last week that sent shivers through the
previously optimistic commodity markets, and the benchmark Reuters-Jefferies Commodity Index fell by
over 3% …….after hitting a 15-month high earlier in the month.

High inflation, increasing interest rates, and tightening credit

conditions have had investors concerned about an economic
correction in China. In March, annual inflation rose by 5.4%
year-on-year, compared to 4.9% in February – which was the
biggest jump since July 2008. The commodity markets are
not going to take this lying down – although we believe that
the biggest contributor, food, will level off; after a year that
has been severely interrupted by bad weather.

China is relevant. In 2010, the country consumed 24% more

copper, 59% more zinc, and 31% more aluminium than the
mighty US. The inevitable long-term problem is that when the
expansion in this great developing nation starts to tail off, and
they concentrate more on consumer demand than export growth
– then the extra annual expansion in commodities demand will
start to wane. This happened in the emerging nations of old……
such as Japan, South Korea and Taiwan.

For instance, if China’s consumption per capita converges to that of Japan, then Chinese copper
demand growth would only average 3% per year, over the next 20 years, representing a 60% drop
in incremental demand.
“The ANZ Commodity Price
An economy cannot continue expanding at double-digit growth
Index lifted 4.7% in March, a
forever (particularly a rapidly ageing one like China), and so it is
new record and the 7th
only natural that economic growth will slow in the years ahead.
consecutive monthly rise in
the index. This latest month
Currently a “soft landing” for China remains the most probable
also recorded stronger
outcome, and manufacturing and trade data were positive last
increases in commodity prices
month….. indicating that demand for raw materials remains intact.
than any of the preceding 6
Waiting in the wings, with an expected longer-term impact, is
months. For the first time in 17
India.
years there wasn't a single
decrease in the price of any
We believe that we are now entering the later stage of the
individual commodity in the
commodities cycle – which can be both profitable and dangerous.
basket of 17 commodities “
Over the next two years, supply constraints are likely to put
upwards pressure on prices, but there are huge warning signs
Sharechat
after that. An increase in volatility from now on is almost
4/4/11
guaranteed.

Oil
“Last week at the Public Policy Forum hosted by the U.S. Energy Association, Dr.
Robert Simon provided a congressional view of volatile oil prices. Simon is the
staff director of the Senate Energy and Natural Resources Committee. He shared
the Senate's conclusion that events in the Middle East and North Africa comprise
the major force driving oil prices - which had been set out last month when

22
 Senator Jeff Bingaman reported the four factors that the Committee believes are
contributing to increased oil prices:

• When the world's key oil producing and exporting region, which is the
Middle East and North Africa, is unstable, world oil markets are also
unstable.

• When political unrest threatens major chokepoints

in the world oil transit routes, world oil prices “Nobody is
react, as they have. predicting a
decline in demand
• When a Member of the Organisation of Petroleum this year. But high
Exporting Countries stops exporting oil, which has prices are forcing
virtually occurred in the case of Libya, world oil a rethink on the
markets react. pace of
consumption.”
• When there are fears that a nearby neighbour and
close ally of Saudi Arabia, home to the world's Financial Times
largest spare oil production capacity, might begin 15/4/11
a series of political upheavals in the Persian Gulf
region, world oil markets react as well.

Into this uncertain environment, we now have a new source of even greater
uncertainty, that is, the earthquake and the ensuing tsunami and nuclear disaster
that have struck the island nation of Japan"

RealMoney
12/4/11

After trading sideways for most of last year, the oil market came to life in 2011.

Prices have risen more than 40% since October last year when conflict first broke out in the Middle East.
Protests and fighting in Egypt, Tunisia, Gabon, Nigeria, Bahrain, and Libya have elevated concerns that
much-needed supplies will be shut off from the markets.

By far and away the greatest worry has been the ongoing situation in Libya…..which is a major producer
of oil, and supply has dropped by 85% - from 1.6 million barrels a day to just 250,000.

A major issue is that Libya produces the much sought after light, low sulphur crude, which is not produced
in Saudi Arabia. Nigeria (which supplies more than 10% of US oil) is the next best country for this product,
and they have their own political upheavals, associated with upcoming elections.

Saudi Arabia and the United Arab Emirates

have boosted production in the last couple
of months to take up some of the slack, but
spare capacity is rapidly reducing, and if
the situation in the Arab region deteriorates
even further then supplies could be
seriously tested. However, inventories in
the developed nations are high.

The adjacent graph of the Light Crude

Continuous Contract illustrates the surge in
oil prices this year.

The focus in oil markets has also shifted

recently to worries that high prices could
affect global oil demand.

23
The Organisation of Petroleum Exporting Countries (OPEC) has cut (by 50,000 barrels a day) its world oil
demand growth forecast for 2011. They believe that demand will now grow by 1.39 million barrels per day
(or 1.61%) to 87.94 million barrels per day.

The International Energy Agency has kept its oil demand prediction unchanged at 89.4 million barrels per
day, but also warned that there are risks emerging that the current economic climate cannot handle $100 a
barrel-plus prices.

From the investment perspective, if oil prices remain at an average of $100 a barrel or more,
Russian oil revenues will increase by between US$100 billion and $350 billion, which would equate
to up to 21% of their GDP. To this end, we have purchased shares in the Russian (RSX) Market
Vectors Exchange Traded Fund, which tracks the oil dominated Russian stock exchange index.
Russia is currently producing more oil than Saudi Arabia, and the IMF expects oil to average $107 a
barrel this year, and $108 in 2012.

We anticipate volatility in oil prices over the coming months as the market’s focus fluctuates around
competing forces. There is downside in the short-term as speculators take profits, but we are positive in
the medium to longer term.

Gold
“As long as the environment remains risky, as long as the peripheral European
sovereign risk remains an issue, as long as the Middle East remains in turmoil,
there is always going to be demand for an asset like gold”

Mineweb
6/4/11

“Gold is useless. At its simplest analysis, gold has very little to recommend it. It
has no metrics, no real valuation, and no commercial use. Its supposed proxy for
world currencies is all based upon the "greater fool theory": Its value as a currency
is derived only from what the next guy believes is its value as a currency. To me,
that is a very scary rationale to investment. Gold is the world's most respected
Ponzi scheme”
RealMoney
28/3/11

The above conflicting statements represent the different attitudes with regard to what is known as the
“barbarous relic”. We have never been a great lover of the metal, mainly because it generates no income
(such as interest or dividends) as an investment, and gold mining companies have earnings problems due
to ever increasing costs and ever depleting mines. New gold fields are hard to find and the larger
companies tend to grow mainly from acquisitions.

Having said that, gold does have a

tendency to act like a quasi-currency
……not that it is now, but it once was. To
this end it tends to be negatively correlated
to the world’s largest currency, the USD,
which we maintain still has downwards
potential.

This negative correlation is shown in the

adjoining 10-year chart.

An additional positive element is China

– which is the world’s largest gold
producer. It has allowed its residents in
recent times to buy gold, and as a result
the country imported over 200 tonnes in
2010 – which was a 5-fold increase on 2009.

24
China is approaching India as the world’s largest consumer.

Our stance this year is that we are positive on gold – until the market anticipates the US Federal Reserve
starting its monetary tightening process, in which case the price should correct. We note that Goldman
Sachs has stated, in a note to clients, that gold is a “compelling trade” in the short-term, rather than a “long
term investment”.

We like gold for 2011.

Base Metals

“The bottom line is that destocking will eventually lead to restocking in China,
which will push copper prices to new highs. Chinese industrialisation has a few
years to run; power generating equipment, autos, low-housing construction,
infrastructure, and alternative energy all require massive amounts of copper.

However, the path will not be in a straight line. Prices remain vulnerable to a
technical correction”
Bank Credit Analyst
5/4/11

Sentiment towards the base metals sector has flattened in recent months as doubts creep in over the
sustainability of current prices, and whether a notable correction is on the way. However, we believe that
although China has been tightening its monetary policy, this is coming to an end, and the economy is in for
a soft landing only.

Additionally, Japan is now going to ramp up demand for base metals. Everything from the power grid to
housing construction, vehicle replacement, and consumer appliances are required. Japan bought 1.1
million metric tonnes of copper last year and (when the dust settles) this will soar.

However, the performance of different metals is diverging. Within the base metals complex we favour
copper and aluminium, over nickel and zinc.

Copper was one of the standout

performers in 2010, and into early 2011,
with prices rising to record highs. However,
since peaking in early February, prices fell
more than 5%...... and are now tracking
sideways.

This contradicts the reports that we have

been receiving that the metal will be in
supply deficit for the foreseeable future –
although there is a limit as to how high a
commodity can rise, before consumers
substitute other products…… and scrap
metal dealers come more into play.

Poor trade data from China in February also made investors fret as to whether the world’s most
voracious consumer is using less copper..……and investors reacted negatively to this. There have
also been wild rumours over rogue deals in China – including a theory that copper is used as a
“financial asset”. Non-users get access to credit to import the metal, sell it……..and then continue
to use the proceeds for property deals. It helps bypass credit restrictions on real estate.

Additionally, there are eyewitness accounts that there are about 600,000 tonnes lying idle in bonded
Chinese warehouses – which are taxed once they are released to domestic buyers. This was not a
problem while prices were rising, but a substantial release of the metal could lead to lower prices.

25
To counter this, March import data (released last week) showed copper imports jumping 29% for the
month, which went some way to easing investors’ fears and proving that China still remains a strong buyer
of the metal. February’s weak figures also likely reflected a running down in inventories – which they do
from time to time, to confuse the pricing structure. The Chinese New Year period would have also reduced
demand.

Bear in mind that Rio Tinto has estimated that the copper supply deficit could be around 500,000
tonnes for 2011…..…and continue for at least a couple of years. New exploration projects are also
not bearing much fruit.

Overall (in our mind) the long term fundamentals for copper (and base metals in general) remains positive,
although there could be a continuation of the short-term correction due to destocking…… followed by a
price recovery from China’s massive urbanisation plans, and Japan’s reconstruction efforts.

Aluminium has lagged the general commodity bull-run over the past two “Aluminium
years, but the outlook is improving. Inventories are steadily trending demand is
downwards, and demand for the lightweight metal, used in consumer and expected to be
industrial products, is increasing. driven by the big
emerging markets,
Japan is Asia’s biggest importer of the metal, meaning that demand will slip in including a 12%
the near term….but gain momentum further down the track. Deutsche Bank increase from
estimates that demand for the metal will grow by 5% this year, which is greater China”
than the predicted increase in supply. Recent policy changes in China could
also drive prices upwards. Financial Times
1/4/11
The Chinese government’s push to reduce power consumption and carbon
emissions culminated in power being cut off to numerous aluminium smelters late last year. The sharp fall
in estimated annual production, from about 17.5 million tonnes last year, to 14.5 million tonnes this year,
could mean that they are forced to turn to the international market for supplies – potentially creating a
supply squeeze.

The metal is widely produced in the Middle East, and could also suffer from supply disruptions over there.

Aluminium is a product that has widespread application and is a ready substitute for other metals, and
consumption remains strong – particularly with regard to motor vehicles (where global growth is around 5
to 10% per annum). Its price is off its 2008 peak, but we remain positive.

The price of nickel has probably peaked this year, and fundamentals are expected to turn
increasingly sour over the remainder of 2011 – as the market moves into surplus.

The International Nickel Study Group expects supplies from the world nickel market to exceed demand,
which is negative for prices. This compares with a previous deficit position, due to strong stainless steel
production (which makes up 60% of nickel’s end usage).

Overall base metals remain in a late stage of the cyclical bull market – meaning that there is upside ahead,
accompanied by increased volatility. In the shorter term inflation in China will be a negative.

Coal
“Thermal coal is the largest source of energy for the generation of electricity
worldwide and demand could rise still further if nuclear programmes suffer a
setback following the crisis at the Fukushima reactors in Japan”

Financial Times
1/4/11

“Anglo American’s chief executive says that there will be extremely strong medium
and long-term demand for coal as an energy source from the developing world,
despite moves to clamp down on carbon emissions around the globe”

26
 The Australian
8/4/11

Thermal coal prices have been rising over the last year, as increasing demand and supply distruptions
continue to tighten the market…..and the recent Japanese disaster is likely to intensify price gains. The
devastating tsunami and following nuclear crisis caused more than one-quarter of Japans nuclear energy
capacity to be lost or damaged and at this stage it is unknown when that capacity will return.

Thermal coal, which currently accounts for around 30% of Japan’s energy
“Demand for coal is
needs, is the main substitute to fill the gap. Japan is the world’s 3rd largest
increasing in
importer of thermal coal.
booming Asian
economies. Huge
Global inventories were already low following the widespread flooding in
demand for energy
Australia at the beginning of the year. The country is a major player in the
resources in China
market, and their coal production was reduced by around 30 million tonnes.
and India has pushed
Heavy rain in the last 6 months has also hampered output in Indonesia,
the price of thermal
South Africa, and Colombia.
coal to an all time
high”
And if this wasn’t enough, China and India’s demand appears to be
accelerating. Last year the two countries imported 197 million tonnes of coal
Financial Times
– about 9 times the level of 2003. Forecasts for 2011 figures are for further
1/4/11
increases.

The latest quarterly contract price settled at a record high of $130 a tonne, which was well above the 2010
April settlement of $98 a tonne.

It illustrates the tightness in the market. The industry is in a sweet spot.

The Japanese earthquake will also create extra demand for coking (or metallurgical) coal. Coking coal,
used in the production of steel, will benefit from the enormous rebuilding and reconstruction that Japan will
undertake over the next few years. Large amounts of steel will be needed for infrastructure and building
construction. Japan is the biggest single importer of coking coal – taking around 60 million tonnes a year.

The ANZ has lifted its 2013 coking coal forecast by 15% to $241 a tonne.

We are bullish on coal prices for the year ahead.

Iron Ore and Steel

“Many global steelmakers increased production in the second half of 2010 as

world economies strengthened. But price increases followed because of stronger
demand - and higher costs for raw ingredients, such as iron ore, coal and scrap -
across a broad spectrum of products, such as premium automotive-grade steel,
pipe and tube for energy markets and plate steel for ships. The price of plate steel
rose 22% in major steel-producing countries and the price for pipe and tubing rose
14% in the second half.

Now, prices are falling as demand softens, in part because of unrest in the
Mideast, the effects of Japan's earthquake and tsunami and relatively high supply.
Steel prices in China meanwhile have fallen around 8%-10%. The fundamental
problem the Chinese mills have faced in recent times has been strong competition
among the 30-plus entities selling their products to the same customers"

Wall Street Journal

10/4/11

27
Spot iron ore prices have eased over the last couple of months, down to around $178 a tonne - compared
to its record high of $195 a tonne reached earlier in the year. However, analysts are saying that we should
not expect a collapse in prices.

Supply disruptions from India, the world’s third largest supplier, had “Iron ore prices will
previously been one of the factors pushing iron ore to record prices. The struggle to move much
Karnataka region had banned exports from 10 ports around 8 months higher after India’s
ago, in an attempt to crack down on illegal mining and help local steel Supreme Court this week
makers source the local raw material. The ban was overturned by the lifted an eight-month ban
Indian Supreme Court earlier this month, in a move which will potentially on iron ore shipments
free up 25 million tonnes for export. from its key Karnataka
state.
Iron ore has been a stand out commodity for miners over the past year. Iron ore supply is rising
but no market collapse is
Despite the recent increase in supply, two factors should underpin prices imminent”
in the year ahead:
Australian Financial Review
1. Steel inventories have been falling worldwide, which suggests 7/4/11
that demand conditions are strong. Japan is a major producer of
global steel, and the devastating earthquake and tsunami have
temporarily hampered steel production……..but the rebuilding
process will boost the country’s demand. Japan is the second biggest buyer of iron ore in the
world.

2. The continued urbanisation of developing nations. The world’s largest iron ore miner, BHP Billiton,
has forecast that China and India combined will represent 60% of global steel growth over the next
15 years. India is seen as being in its early stages of development, while China is still committed to
massive urbanisation and industrialisation plans. These two alone will keep iron ore demand
robust.

Forecasters expect second quarter iron ore prices to fall to $160 a tonne, before rising to $175 in the third
quarter …..and $180 in the fourth quarter of 2011.

Down the track – long-term forecasts remain unchanged at around $100 a tonne, as the expected “wall of
supply” comes to the market in 2014, and beyond.

We remain cautiously positive on iron ore and steel prices.

Agriculture

“There is a synchronised boom right across the soft commodities spectrum. It has
got many wondering out loud if the long-promised boom in soft commodities is
finally materialising”
Australian Financial Review
2/4/11
“As agricultural commodity prices continue to rise – with corn matching the record
set during the 2008 food crisis – central bankers face an uncomfortable choice: to
tighten monetary policy in response to food and energy inflation or to bank on the
surge being just a temporary problem and focus on much lower core inflation”
Financial Times
5/4/11

A range of factors led to record high prices, and low inventories, of soft commodities such as food in
2010/early 2011 – as shown in the chart below of the Goldman Sachs Agricultural Futures Index.

It is a cost and inflation problem for poor countries, where people spend much of their disposable income
on food.

28
The reasons for the price rises included drought in Russia, Australia and Argentina; floods in Canada,
Australia and Pakistan; export bans by countries wanting to hold down prices and supply their own
populace; speculation by importers seeking to store supplies; and advance buying by unstable Middle
Eastern countries looking to dampen down riots by supplying subsidised food to their residents.

Many of these factors are weather related and (hopefully) just temporary.

Other elements are more structural and

should lead to a long-term lift in demand for
agricultural products. In particular around
75 million people (around the population of
Germany) in Asia each year gravitate into
the middle classes, where their propensity
to eat protein increases significantly. It is
much more energy intensive to grow a field
of cows than a field of wheat or barley.

It takes approximately 10 kilos of plant

protein to produce just one kilo of animal
protein. It also takes around 1,150 to 2,000
litres of water to produce 1 kg of wheat, but
about 16,000 litres for 1 kg of beef. Water,
and access to it, is a growing problem
around the world.

The increased use of farm produce, such as corn, as a substitute fuel for
oil also affects supply. Ethanol currently accounts for just 8% of America’s “As America exports
fuel for vehicles, but it consumes almost 40% of the extremely large corn half the world’s corn, a
crop. If the diverted corn instead went into food, then the global edible corn third of the world’s
supply would increase by 14%. soyabeans and up to a
fifth of the world’s
However, the energy market is more valuable than the food market. wheat, changes in US
Rising oil prices and geopolitical factors (it is not generated from the supply, demand and
Middle East) make ethanol more attractive. inventories have a
significant impact on
The exercise that we face is working out what the level of prices (and global agricultural
therefore opportunities to invest in food related stocks and commodities) markets”
will be in the year ahead. We are conscious of the economic maxim that a Financial Times
wild swing in one direction typically generates a significant movement in 31/3/11
the other.

Planting acreage will undoubtedly increase…….. although a mitigating factor is that the price of
cotton rose 160% last year, and in March 2011 was at its highest level in 140 years of trading in
New York. US farmers are planting this more valuable crop at the expense of corn, wheat and
soyabeans. Cotton prices are expected to plummet…...but it is still more profitable at half the
current price level, and takes less water to grow. It should however, affect the price of wool.
“The NZ Reserve
The United States is the largest food exporter in the world. A 2011 US
Bank has delivered a
Department of Agriculture report recently released indicates that farmers plan
bullish assessment
to plant 8.6 million additional acres this year. Cotton acreage is expected to
of farm-gate prices,
increase by 15%, while corn and wheat will gain 5% and 8% respectively.
predicting the
Soyabean acreage is predicted to drop 1%. Additional plantings will relieve
commodity prices
the pressure on prices.
which have sent the
st NZ dollar soaring in
However, the Department also reported that corn inventory levels on 1
recent weeks are
March 2011, compared to a year earlier, were down by 15%; soyabeans
here to stay”
down by 2%; but wheat was up by 5%. They were bullish on corn and
soyabean prices, but believe that wheat prices will drop.
Christchurch Press
13/4/11

29
China, as usual, also comes into the mix. It used to be the world’s largest soyabean producer, but now is
the world’s largest soyabean importer. It is also the world’s second largest corn producer…… but is
expected to import more corn in 2011 than it has in 15 years (about 2.5 million tonnes). With its middle
classes shifting to meat consumption they need extra corn to feed livestock.

The outlook is still very much dependent on harvests in Russia, the Ukraine, Australia (which is predicted
to be high), the US and China this year – and good yields would lower prices considerably. This will also
affect prices for protein products such as beef…… which are fed on corn and soyabeans.

We expect prices this year to soften, but still remain at a high level.

Real Estate
“The "ABC of Global Macroeconomics" is a set of guidelines that I use, among
many others, to organise the world and view current events from a perspective
where I can consider them and place them with continuity. It consists of three
principles:
• As goes housing, so goes the U.S. economy
• As goes the U.S. economy, so goes the world economy
• What's good for the U.S. is good for the world”

RealMoney
30/3/11

“The US housing market recession is not yet over, and none of the statistics are
indicating any form of a sustained recovery.”

Financial Times
29/3/11

“The stock of unsold homes on the NZ market will take more than a year to clear at
present lacklustre sales volumes, one of the highest levels of inventory ever
recorded, according to industry figures”

Dominion Post
2/4/11

The troubled global real estate market is weakening. Prices are falling, sales remain subdued, inventories
are high and confidence low. There are generally few signs of improvement (although NZ shows a glimmer
of hope) and the demand for rental properties is increasing.

This is of particular concern, as inflation and interest rates are starting to rise across the globe – which
should impact negatively on the market.

United States

The love affair that Americans have with housing

is over – as reflected in the lacklustre market and
the declining rate of ownership (see adjacent
chart).

Home prices continue to fall, and have now

slumped further since their peak in 2006 than they
did at any time during the Great Depression of the
1930s. The Case-Shiller home price index was

30
down for the 7th straight month in January, with prices 3.1% lower than for the same month a year ago.

New home sales have been abysmal, falling by nearly 30% year on year in February - which reflects the
huge gap between existing home prices and the cost of construction. Builders currently have a combined
inventory of 186,000 houses, which is the lowest level in 40 years.

A large overhang of foreclosed homes, high unemployment, tighter lending standards, and a general
negative attitude towards housing are all hampering the market. Almost 40% of houses sold today are due
to someone not being able to pay their mortgage. It is taking 37 weeks on average to sell a property.

Housing starts fell by an annualised 22.5% in February……. to a seasonally adjusted (annual) rate of
479,000. Along with weak sales volume, this is further evidence that the housing sector is slowing, even
though the general economy is improving.

The market is unlikely to lift much in coming months.

China

Real estate is extremely important to China’s economy, with investment in property accounting for 12% of
GDP in 2010. A property crash could seriously damage the economy. The breakneck construction pace of
2009 and 2010 caused a severe overhang of inventory, including extensive ghost blocks of empty
apartments. However, unlike developed countries, China has a huge migration of workers (about 15 million
a year) from the poor rural areas to the industrialised cities in the coastal regions. This structural change to
demographics has the ability to solve the problems of overhanging stock.

The government has also continued to clamp down on speculators, by raising bank lending rates and
minimum mortgage deposits, as well as restricting the purchase of 2nd and 3rd homes in some cities. The
authorities are attacking supply by building 10 million subsidised housing units this year.

Prices in February remained unchanged from a month earlier and house price inflation appears to be
improving.

United Kingdom

UK house prices rose unexpectedly in March. However, this is considered “A revival in the UK
more a sign of volatility rather than representing an ongoing upturn in housing market is
prices. unlikely while the job
market remains weak,
The Nationwide House Price Index increased by 0.5% in March (month on real wage growth is
month) and is now marginally above levels from 12 months ago. The negative and
measure for the last 3 months (seen as a less volatile gauge than monthly) consumer confidence
showed a small decline of 0.4%. subdued.”

Transactions remain at historically low levels and mortgage demand was Wall Street Journal
down markedly in the first quarter……… suggesting that the outlook 31/3/11
remains cloudy.

The fundamentals are also deteriorating. The Bank of England is likely to increase interest rates to
dampen inflation; stamp duty is being raised on higher valued housing; and the government has planned
extensive cuts to public spending. The austerity drive is having an impact on consumer sentiment.

It all points to ongoing weakness for the remainder of the year.

Australia

The current Australian housing market figures are a stark contrast to this time a year ago when home price
growth was running at an annual rate of 12.5%. There has been a significant slowdown since then and
home prices have increased by only 0.8% over the last 12 months.

31
A big part of the problem is affordability – which is deteriorating due to
rising interest rates. Inventory levels are up by 50%, over a 12-month
period, and sales turnover is low – having dropped 19% over the last year.
Sales figures are around the levels experienced in 2008….in spite of the
economic recovery. The construction of new homes has slumped, and is
way below the government stimulus driven levels of last year.

According to The Economist property price indicator, Australian houses

are the most overvalued (by 56%) in the developed world.

The market should remain weak.

New Zealand

The national housing market showed signs of the start of a recovery in March, with unconditional sales up
30%, and the national median price increasing by $15,000 (4.28%) to $365,000, compared to February. It
was up $4,500 (1.25%) on a year ago.

Underscoring the volume growth, the national median “days to sell” (measuring the number of days from
listing date to unconditional date) fell from 58 days in February 2011, to 41 days in March…… compared
with 35 days in March 2010.

A 50 point cut in the official cash rate has lowered mortgage costs, resulting in affordability being
at its best level in 7 years. Leading the market is Auckland.

Building consents have, however, taken a hit

…..although this will improve inventory levels. In the
three months to February, consents issued were down
by 25% from a year ago, and down by 12.6% from the
three months to November.

The Economist believes that the NZ market is still over-

valued by at least 20%. The average ratio of house
prices to household income has traditionally been
around 3.3, but rose to 5.7 from 2002 to 2007….and is
now down to about 4.5.

NZ housing activity is expected to remain reasonably flat in the foreseeable future…..but should strengthen
later in the year, due to an improving economy and a shortage of inventory.

Investments
“The current bull market, though still young in age, will enter a new phase that will
be characterised by slower price gains and possibly higher volatility. Why? It is
highly unlikely that stock prices and corporate earnings will double again in the
next two years. There will be no new policy support for the economy and equity
markets after QE2 ends in June.

A further escalation in oil prices and materials costs could cut corporate profits,
further slowing earnings growth. For the economy as a whole, higher energy costs
are a negative and therefore for growth and corporate profitability as well.”

Bank Credit Analyst

8/4/2011

32
As we move into the later phases of the equity cycle, it is important to focus on areas that will improve
along the way.

The current bull market started in March 2009, and recently celebrated its second birthday. As we move
towards the later stages of the cycle, and given the surge in commodity prices, we are starting to direct our
focus on areas that are less vulnerable to supply and demand shocks…..particularly inelastic areas such as
defence and healthcare.

As it turns out, these sectors happen to have underperformed relative to the overall market over the last
two years, mainly because they have low beta (risk). However, remember that the aim of the game is to
buy low and sell high!

Defence

Defence has underperformed the global share market (given

potential threats to funding as governments around the world
adopt fiscal austerity) to the tune of about 60% since March
2009.

However, the recent unrest in the Middle East and North Africa
has served to reinforce its importance, particularly in the US
where political gridlock (with the Republicans winning the
majority in the House in November’s elections) will soften the
feared cutbacks to the Pentagon’s funding.

Many defence companies have spent the last few years

anticipating the worst, improving their productivity and service
offerings, and diversifying into other fields. The companies that
have done this are now set to benefit.

ManTech International (US:MANT) is one of the US government’s leading providers of innovative

technologies and solutions for national security programs, with expertise covering systems engineering,
software development, information technology, communications and intelligence operations support.

ManTech is one of the fastest growing defence contractors in the US, well positioned in the major growth
segments of the defence market, particularly in regards to C4ISR (Command, Control, Communications,
Computers, Intelligence, Surveillance and Reconnaissance) and cyber warfare (computer network attack,
exploitation and defence) where growth has averaged 20 to 40% per annum since the division was
introduced in 2001.
Fiscal Quarter Revenue Net Income Earnings per
In addition, with operations in 40 Ended $million $million share (cents)
countries, the company enjoys Dec-09 542 29 82
geographical diversification. Mar-10 588 27 76
Jun-10 662 32 88
The financials are impressive. Sep-10 657 31 86
Dec-10 698 34 93
The quarterly figures are positive,
showing steadily rising income and Fiscal Year Revenue Net Income Earnings per
earnings. Ended Dec $million $million share (cents)
2006 1,137 51 149
The annual figures display solid gains 2007 1,448 67 195
in both revenue and earnings, with no 2008 1,871 90 255
ill-effects from the global recession, 2009 2,020 112 311
recording annual growth of 22% in both 2010 2,604 125 343
sales and earnings over the last five
years.

These are good figures.

33
The company is priced at a discount to the
market, with a trailing P/E ratio of 13.06. The
PEG ratio of 1.04 and price/book ratio of 1.7
imply ManTech offers good value for its
growth prospects. ManTech has little debt,
reflected in its debt/equity ratio of 0.21.

Analysts estimate that average earnings

growth will be 11.7% per year for the next 5
years.

The adjacent chart shows that ManTech’s

share price is firmly in a rising channel, with
solid support at its 50-day moving average.

ManTech is listed on the New York Stock Exchange, its current price is $44.22……and we own a few.

Health Care

Health related stocks have been “under the weather” during much of the bull market to date, reflecting the
uncertainty of the so-called ‘Obamacare’ package touted by the US President.

US Government involvement in the health

care sector is currently uncertain, as it faces
bringing its spiralling deficits under control,
for expensive health programmes such as
Medicare and Medicaid.

However, with the ongoing ageing of the

world’s population, global healthcare
companies like AstraZeneca (US:AZN) are
well positioned to take advantage of the
trend in medicine.

The adjacent chart shows that, after a

period of consolidation, the share is poised
to continue rallying…….. after strongly
crossing through its 50-day moving
average.

AstraZeneca (formed as the result of a merger between Swedish and UK companies Astra and Zeneca,
respectively) is a global integrated prescription-based biopharmaceutical company, with a wide range of
branded products across a variety of fields, including asthma drug Symbicort.

Focused on developing and acquiring Fiscal Quarter Revenue Net Income Earnings per
innovative new products using the best Ended $million $million share (cents)
science and technology, the company Dec-09 8,945 1,553 107
has an extensive research and Mar-10 8,576 2,777 190
development budget, and a strong Jun-10 8,178 2,107 145
pipeline with products scheduled for Sep-10 7,898 1,548 107
launch over the next 5 years. Dec-10 8,617 1,621 114
AstraZeneca places high importance
Fiscal Year Revenue Net Income Earnings per
on protecting its intellectual property,
Ended Dec $million $million share (cents)
rigorously enforcing patents.
2006 26,475 6,043 385
As shown in the adjoining tables, the 2007 29,559 5,595 373
company enjoys good financials. 2008 31,601 6,101 420
2009 32,804 7,521 519
2010 33,269 8,053 556
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While US revenues have been affected by patent expiry (whereby generic pharmaceutical manufacturers
can copy these products), AstraZeneca continues to experience strong growth in emerging markets, and
from new products coming into force.

AstraZeneca has enjoyed solid rising revenues on an annual basis, while stable margins have seen
earnings consistently grow at an average rate of 12.95% over the last 5 years.

While earnings are expected to grow at an annual rate of just 6.2% over the next 5 years, AstraZeneca
pays a hefty 7.67% dividend, and is priced at a significant discount to the market with a trailing P/E ratio of
8.68, and a forward P/E of 7.02. For what it is, in the sector that it is in - AstraZeneca represents good
value.

AstraZeneca is listed on the New York Stock Exchange, the current price is $49.34…...and we have a few.

Coal

“Thermal coal producers are poised to benefit from uncertainty surrounding

Japan’s widening nuclear crisis, with experts predicting strong demand for the
commodity in the wake of the national disaster”

Australian Financial Review

15/3/11

“Given the heightened coal demand in the Pacific markets throughout 2010,
coupled with late-2010 weather related demand increases in the Northern
Hemisphere and supply constraints in key exporting nations such as Australia,
Indonesia, South Africa, South America and Canada, prices for seaborne
metallurgical and thermal coal have been escalating”

Zacks
31/3/11

Coal is an important commodity for the global economy. Both thermal and “Thermal coal is
coking coal prices have been steadily increasing over the last two years, driven the largest source
by powerful demand from emerging nations. of energy for the
generation of
The recent disaster in Japan should also be positive for coal prices. In addition electricity
to the problems caused by the Fukushima crisis, power companies have also worldwide and
shut down 15 other nuclear reactors with a combined capacity of 10 gigawatts – demand could rise
or 20% of Japan’s total nuclear power. That shortfall has to be made up still further.”
somehow, and thermal coal (Japan’s second biggest source of electricity) is the
Financial Times
realistic alternative.
1/4/11
Japan is currently the third largest importer in the world for thermal coal, but coal substitution for uranium
could potentially lead to a rise in imports of 30 million tonnes this year – which would place great pressure
on supplies.

Emerging economies, like China and India, are reshaping the global
economy and these countries rely heavily on coal to fuel their
impressive growth. The adjacent graph illustrates the increase in
thermal coal imports to the two countries over the last 15 years.

Additionally, almost half of all America’s electricity is generated by

thermal coal, and this is expected to remain the case for a number of
years. The US has not built a nuclear power plant since the Three
Mile Island meltdown in 1979.

The coal sector has negative reputation with regard to global

warming……. and reducing carbon emissions has been a high

35
political priority. What is not commonly known is that the sector has been working diligently to reduce
carbon emissions and since 1970 pollutants from coal power plants have reduced by approximately 84%.

Coal will be an integral part of the world’s energy future – and the stage is set for even higher prices.

We have looked at Australian and American coal mining companies for investment purposes and found
that the US ones had better fundamentals and the (export) advantage of a weak currency.

Market Sectors Coal ETF (US:KOL)

One easy way of investing in coal is to buy

shares in an exchange-traded fund that
globally covers the main players across the
industry. The Market Sectors Coal ETF
seeks to replicate as closely as possible the
price and yield return performance of the
Stowe Coal Index.

This index provides exposure to publicly

traded companies, worldwide, that derive
greater than 50% of their revenues from the
coal industry, have a market cap exceeding
US$200 million, and a 3-month average
daily turnover greater than $1 million.

The index comprises a globally diversified group of coal companies, including those engaged in coal
transport, equipment manufacturing, and the production of clean coal.

The chart appears to be now breaking out after consolidation in the early part of this year. The fund trades
through the New York Stock Exchange and the current price is $49.50.

Alliance Resource Partners (US: ARLP)

Coal companies in the US have been benefitting from higher prices, due to export growth to coal-guzzling
Asian countries over the last 5 years.

Alliance Resources Partners is a major

producer and marketer of thermal coal in
the US. The share price has shown
excellent technical characteristics over the
last two years, barely pausing on its strong
uptrend.

The company produces a diverse range of

quality energy coal for a large customer
base of utility, industrial and energy
companies. It operates nine coalmines in
the Illinois, Kentucky, Indiana and West
Virginia coal producing regions, with a
tenth mine currently in construction.

Alliance has 697 million tonnes of proven coal reserves, and production will ramp up to an annual 32
million tonnes this year.

The CEO had this to say about the US coal industry in the 2010 annual report:

“Our long term view of the supply/demand dynamics in the domestic market remains
positive. After two difficult years, the United States economy is showing signs of growth,

36
 raising expectations for higher electricity consumption in the future and pointing to
increased coal demand”

The financials are robust.

The quarterly figures show a strong uplift, with Fiscal

the December 2010 quarterly earnings being Revenue NPAT EPS
Quarter
over 100% more than the figures for the same ($ million) ($ million) (c)
Ended
quarter in 2009. Dec 09 298 42 15
Mar 10 380 75 156
Annual earnings have been steadily growing Jun 10 400 85 182
over the last 5 years and the 2010 annual
Sep 10 410 73 148
figures show revenue up by 31% compared to
Dec 10 418 87 182
2009, and income increasing by a powerful 67%
for the year. Fiscal Year Revenue NPAT EPS
Ended Dec ($ million) ($ million) (c)
Alliance has a very reasonable P/E, and forward 2006 967 172 303
P/E ratio, of 11.59 and 10.4 respectively; as well 2007 1,033 170 305
as an excellent net profit margin for the sector of
2008 1,156 134 241
19.9%; a 5-year expected earnings growth of
2009 1,231 192 300
10%; and a return on equity of 79.4%.
2010 1,610 321 668
These figures are excellent and we believe that there is further upside ahead.

Alliance Resources is listed on the NASDAQ, and its current price is $75.23.

*****
The Last Free Lunch: Global is free. If new readers wish to join the list, then they should log onto
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posted to the site.

Disclosure: We have shares in Fletcher Building (FBU); South Korea iShares (US: EWY); Russian Market
Vectors ETF (US:RSX); ManTech International (US:MANT) and AstraZeneca (US:AZN).

Acknowledgement: is given to Humorfeed Daily News Satire……for the contribution to International

News

Disclosure Statement: A disclosure statement is available on the website front page.

Research & Editing: John Ryder M.Com (Hons), CA, CMA; Tim Gordon B.Com, B.Sc (Hons); Katherine
Powell B.Com (Hons).

Investors can look at the charts of all shares mentioned in this report by logging on to www.bigcharts.com.
However, the stock symbols should be preceded with NZ: , UK: , AU: , CA: , HK: etc for the country where the
stock is listed. There is no need for this with regard to the US. Moving averages can be imposed by referring to
SMA. Another alternative for US stocks can be found at www.stockcharts.com . NZ & Australian share charts can be
viewed at www.findata.co.nz.

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Global is a private, non-commercial academic publication. No fees are charged for the publication and no
remuneration of any kind is received in relation to the newsletter, or the securities mentioned. Neither Global nor its
principals are investment advisers and they do not give investment advice as part of their job or business. The
approach of the newsletter is to consider economic parameters in the major economies of USA, Great Britain, the
Eurozone, Asia, Australia & New Zealand with respect to broad financial movements and investment trends.
Economic fundamentals are investigated and technical elements (such as chart patterns) are studied for timing
purposes. The comments are personal opinions only, which may be of interest to readers. They should be used for
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which may or may not be positive. Holdings in shares mentioned in Global may change at any time. John Ryder
M.Com(Hons);CA;CMA. Level 1,1 Radcliffe Rd, Belfast, Christchurch, New Zealand. Ph: 03-3759025.
E mail: jwdryder@xtra.co.nz. Website: www.globalnews.co.nz. Copyright reserved.

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