MONTHLY INVESTMENT NEWSLETTER

Global Macro Strategy: March 2011

Current edition contains:

REVISITING EUR/SEK
1
Short calls @ EUR/SEK 9.30.

JAPANESE EARTHQUAKE AFTERMATH

2
Defensive consumer staples were unjustly sold off.

NUCLEAR ENERGY IS NOT DEAD

3
Watch for political decisions made in the developed world over short term.

PARTICULARLY UNCORRELATED INDIA

4
India flashing buy signal as inflation is tackled by tight monetary policy.

© ATWEL International, s.r.o. www.atwel.com Page 1

1) REVISITING EUR/SEK

It has been some time since we entered into the EUR/SEK. Thinking about it, it was probably a position that we held
for the longest time in portfolio (today, we believe USD/SGD will be another great performer, with low volatility and
steady trend due to copying normalization in USD/CNY). Anyways, it is only natural that once a correction in the pair
had to occur and we would be forced to respect internal rules and realize gains.

After reaching local lows of 8.70, EUR/SEK corrected all the way to 9.03. And we are facing the decision point
whether to re-enter and where to set our target. As you know, currency forecasting is a craft of its own. Every
currency is driven by fundamentals over the long term, but unfortunately, one gets a lot of white noise and greed
and fear in between.

Still, let us present couple of facts why Swedish Krona remains our favorite currency:

1) On purchasing-power-parity basis, where we take 1994-97 as a basis period due to balanced Swedish
current account, EUR/SEK is as much as 10% overvalued on a CPI basis and 5% overvalued on PPI basis. (see
Chart 1)
2) The current account is in surplus as much as 6% of GDP, driven mainly by surpluses in trade. And let us
stress here that we talk about high-tech and high value added goods such as machinery, transport vehicles
and chemical products; not commodities as in case of Australia. We really like the current account indicator
as it is pointing to a clear undervaluation. If 6% deficit in current account is a point where most macro
textbooks agree that the country is on the verge of balance of payments crisis, then 6% surplus must be a
screaming buy, right? However, on a net basis, Sweden is running a trade deficit with Eurozone, which
stems purely from trade with Germany. Trade deficit with Germany is as large as 2% of GDP.
3) On the base of unit labor costs, Sweden has been moving in tandem with Germany since 2001. The reason
why Germany is running surpluses therefore lies in quality, pricing power and strength of German brands.
Globally and EU wise, Sweden is still more competitive than almost any other OECD country.
4) Fiscal spending is well behaved and budgets are posting surpluses. That means the general government
debt-to-GDP ratio will keep falling over time.
5) Sweden has stabilized its pension system long time ago and finds itself well ahead of most European
countries.
6) Swedish spot real rates today and rates one year out are both delivering positive carry. Swedish RIskbank
First Deputy Governor Oeberg declared that Sweden should tighten at each meeting over next two years.
That is a bit hawkish but shows that Sweden is not stuck in negative real rates kind of thinking.

These are all clear positives for the currency. But how much is it baked into the market? After all, Sweden is not
some kind of emerging market, where you have long-term productivity gains serving you as a tailwind. One cannot
assume that Sweden will grow much faster than rest of Europe. All we have to play with is spot under/over-
valuation.

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 Chart 1 Chart 2

12
EURSEK
11,5
Model
11

10,5

10

9,5

8,5

1.10.2002

1.12.2003

1.11.2006

1.10.2009

1.12.2010
1.1.2001
1.8.2001
1.3.2002

1.5.2003

1.7.2004
1.2.2005
1.9.2005
1.4.2006

1.6.2007
1.1.2008
1.8.2008
1.3.2009

1.5.2010
We have tested EUR/SEK on several indicators that could explain moves in the currency pair. We found 4 statistically
2
significant variables with total R = 63%. T-statistics of debt-to-GDP is surprisingly too weak and thus we did not
include it into the model. After all, it is a lagged mirror image of current account deficits. The regression equation of
EUR/SEK model is following:

Coefficients
Intercept 7,853432089
EU Unit labor costs / Sweden Unit labor costs -0,551727708
Sweden Current account (%GDP) - EU Current account (%GDP) +0,091050052
Sweden Real rates – EU Real rates -0,211234029
ln( VIX ) 0,528041797

We still have some work to do on the model as the R squared is not as strong as would desire. We have also tried to
plot in trade balance between Sweden and original EU-12 instead of current account balance. Unfortunately, this
inclusion did not improve our model either. Still, we believe that watching trade balance between Sweden and
Germany and ULC development into future will be of importance.

Graf 3 Graf 4
Swedish balance in goods with EU-12 as a % of GDP Unit Labor Costs, Sweden / Germany
% ratio
0 1,15

-0,2 1,1
-0,4
1,05
-0,6
1
-0,8
0,95
-1

-1,2 0,9

-1,4 0,85

-1,6 0,8
-1,8

-2
01 02 03 04 05 06 07 08 09 10 Total Economy Industry (C_E) Business Sector (C_K)

As of now, current model points to slight overvaluation of EUR/SEK and return to 9.30. We are convinced this is quite
safe price due to increasing differentials between real rates in Eurozone and Sweden. Therefore, we would advise
selling out of money call options on EUR/SEK with 3 months maturity and strike price 9.30. Such strategy will give
you roughly 2,5% p.a. and offer a very attractive entry point on EUR/SEK position.

© ATWEL International, s.r.o. www.atwel.com Page 3

2) JAPANESE EARTHQUAKE AFTERMATH

A lot has been written about Japan and new estimates of recovery costs are being updated by the day. What we
know by now is that total damage incurred is estimated at JPY25trn, about double of Kobe in 1995. The known
unknown is yet the impact on global supply chains. Automakers and tech were especially hit, as every car has at least
one part which is made in Japan. And that is true for any automaker in the world. No matter how simple or cheap
that part may be, if you concentrate one part of entire supply chain in Japan, you are more vulnerable. Try google
out for instance how barbie-dolls are made and you will be surprised about the complexity of production process
and globalization of sourcing.

Based on anecdotal stories from Japan, we remain confident that the road to recovery in Japan will be a short one.
Just take a look at the picture underneath where a completely destroyed road was rebuilt in six days only! Our hedge
fund is based in Czech Republic and this story caught us surprised with awe. Here, it would have taken two months
with straight face.

We are sure that reconstruction of Japan will be quick. Following Kobe, manufacturing recovered just in three
months, with production up +4.4% following January 1995.
As you know from our prior articles, we are no bulls on Japan due to terrible demographics and deflationary forces
that make the debt unsustainable. So if we were to touch any Japanese companies, it would be defensive industries
with great global reach.

If you want to get really defensive, go for Japanese consumer staples. This kind of asset will offer you nice valuation
protection, low correlation and defensive touch. Let us mention two companies which we deem highly attractive for
going long:

FamilyMart Co. Ltd. (8028 JP)

FamilyMart has more international store locations than any of its Japanese competitors (about 7.000 of total
14.000), and given that those stores are housed in some of the fastest growing markets in the world, it is hard not to
be bullish. The company is paying a 2.4% dividend and on the P/B it trades at 1.5 multiple. Based on normalized
earnings, it trades at roughly 16 times earnings, which we consider cheap given the company estimates growth in

© ATWEL International, s.r.o. www.atwel.com Page 4

earnings to be about 10% going forward and low risk. As the third largest convenience store operator in Japan,
behind Seven-Eleven Japan and Lawson, FamilyMart is strongly ingrained in the growing local convenience store
market. Over the next five years the company plans to further expand the number of stores in fast growing countries
like China, Thailand and Vietnam, where much of the groundwork has already been laid. With consistent revenue
from local markets and a growing international footprint in increasingly consumer driven economies, we think
FamilyMart should perform well in a variety of market conditions. In terms of the earthquake impact, FamilyMart
announced that just 1% of stores remains closed, which we deem immaterial to long term prospects of company.

Lawson Inc. (2651 JP)

Lawson is the second largest convenience store chain in Japan with about 10.000 points of sales. Unlike FamilyMart,
its overseas operations are focused only in Shaghai where it operates over 300 stores. That means it is in a very early
stage of international expansion compared to FamilyMart. The latest international initiative dated from April starts
new operations in Chongqing. The main factor why we like Lawson is its new plan to increase ROE from roughly 10%
to 15-20% by 2020 through following measures:

a) Growth in overseas sales and expanding product lines to include fresh food, healthy meals, and pharmacy
products that are likely to be purchased by aging customers.

b) Beyond a differentiated strategy, the company is also focusing on productivity gains. Over the last two years
Lawson has implemented a state of the art inventory tracking and ordering system PRiSM that has helped reduce
lost sales and waste while increasing operating margin.

c) Through increased dividend payouts and new stock buybacks, the company will leverage up the equity stake.

We believe all these three initiatives pointed to generating value should be beneficial to share price.

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3) NUCLEAR ENERGY IS NOT DEAD

With the blasts in Fukishima plant, everyone seems to be scared to death and questioning the future of nuclear
energy. Every company that has anything to do with nucleus has been down since the event. Uranium miners,
engineering companies, nuclear plant builders, etc.

Some major thoughts are coming to our mind concerning this issue:
1) Political stance in developed markets is essential over short term: Nuclear plants in developed world
account for roughly three quarters of world’s market share. If we forget about different efficiencies of
nuclear plants in the world, we could well liken nuclear power plant generation capacity to uranium
consumption. No matter how fast BRICs are going to ramp up nuclear capacity, if there were major
shutdowns in developed world, developing nations could not make up for this shortfall. (Chart 1)
2) We see, however, little evidence of any major shutdowns now. Germany may be the biggest threat as is
revisiting its plans to postpone closures. As a matter of fact, Germany wanted to decommission their plants
in 2022. Later they decided this action could be postponed by another 12 years till 2036. After Fukushima,
plans of decommissioning are back on table, yet they are conditioned by revisiting safety of these plants
first. Spain plans no changes in their nuclear power plants, nor does France. Back in 1986, France had a sort
of nuclear power plant issue itself and they still did not deviate from their initiatives to keep building. India,
has reaffirmed its ambitious nuclear program, too.
3) China is a country that matters the most in the market over long term. China is the global nuclear
industry’s hope for future growth as it accounts for nearly half of all new reactors under construction
worldwide. And market got bit scared as even China suspended approvals for new plants until authorities
complete a comprehensive safety review. We believe the Japanese crisis is unlikely to deter China from
continuing with its own ambitious nuclear energy program. The proposed target for 2020 installation of 70-
86 GW will probably reach the lower end as some planned plants in tectonically more active areas will be
dismissed. Chongqing, Shaanxi and Gansu development plans are the ones most likely to be scrapped. The
major implication from China may point towards adopting newer generation designs that are provided
especially by international companies such as Areva, Hitachi, Westinghouse, etc. Westinghouse and Areva’s
3rd generation designs are far safer than the 2nd generation CPR 1000 plants, which form the majority of
the plants currently under construction in China.
4) In case mines are not built fast enough and China builds plants like no tomorrow, we could see a low single
digit deficit in uranium by 2015. In case politicians went mad and shut down old plants without opening new
ones, we could be looking at 15% surplus. This surplus could bring prices further down as the cash
production costs of major player lie around USD 20-25. So despite the spot price of uranium fell from 62 to
50, there is some potential for correction further down.
5) We believe developed world cannot afford to go off nuclear. Germany is pretty much the only country that
can afford to support clean energy. In terms of solar, Italy was the last bastion where producers of solar
panels could sell their products big way. Now that the government subsidizes are gone, solar producers will
have a hard time finding final demand for their products.
6) Our understanding of the nuclear related assets is that they should rebound in price over time. Yet due to
political rhetoric over near term, there may be some ups and downs. In a world, where governments have
to save like never before and do their best to secure cheap energy, going off nuclear would be a stupid
mistake.
© ATWEL International, s.r.o. www.atwel.com Page 6
 Chart 1 Chart 2
World, Share of nuclear energy consumption World, Share of nuclear energy consumption
% %
100%
10,34%
90% 23,25% Others
32,27%
80% 37,07%

70%

60% Developed
world
50% 76,02%
60,44%
40% 51,76%
47,32%

30% BRICs

20%

10% 16,32% 15,97% 15,61%

13,64%
0%
0,00% 2,00% 4,00% 6,00% 8,00% 10,00% 12,00%
2008 2030 low 2030 mid 2030 high
BRICs Developed World Others Mid target Low target High target

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4) PARTICULARLY UNCORRELATED INDIA

Living in the correlated world, we were particularly struck when we saw a correlation chart between India and MSCI
World turning deeply negative for the first time since 1996. While S&P is up 4% since the start of the year, Sensex
has dived into deep red -8% territory.

To be honest, market timing is a painful exercise which we get rarely right. But we believe there is a growing
probability of Sensex to stop underperforming and we would definitely start tipping our toes into long Indian
equities, should it be Sensex itself or small caps.

Without doubt, the main reason for India to underperform was high inflation in the first place. The transmission
channels how high inflation feeds into equities underperformance are numerous. First, high inflation propels wage
hikes and makes exporters uncompetitive. Second, high inflation irritates central bankers who in turn have to tighten
monetary policy. Higher interest rates and less money in the economy will cause revenues slow down. Third,
companies may not have enough pricing power to carry higher input costs into prices of finished products. There are
other channels such as less money (read less oil in the economy gear seat) will expose all the frauds and badly
managed companies relying on cheap interest. We had such an example in Indian microfinance companies or
Reliance conglomerate.

Today, Indian inflation measured as CPI dropped from 16% y/y to about 9% y/y. We all know that due to Balassa-
Samuelson effect, low income nations tend to experience higher inflation. But is 9% high or low? And where is the
inflation heading?

Chart 1 Chart 2
World, GDP per capita and inflation
%
16

14

12

10
y = -0,987ln(x) + 13,115
8
R² = 0,2154
6

-2
0 5000 10000 15000 20000 25000 30000 35000 40000

From the Chart 2, we can see that Indian inflation is a notch or two too high and equilibrium inflation would stand
around 5-6%. As we wrote in earlier publications, the main reason for high Indian inflation is the quantity and quality
of infrastructure. But the central bank cannot let inflation run loose otherwise it would lose credibility. And we think
the recent tightening in India and across Asia will be sufficient to bring inflation down in the second half of year. As
you can see, slope of Indian yield curve is close to reverting, real 1Y rates are getting slowly to positive territory and
M1 growth is decelerating. All this points to lower inflation across rest of 2011 (see Chart 3).

© ATWEL International, s.r.o. www.atwel.com Page 8

As the inflation may get exhausted and there will be little need for 10Y bonds to rise, Indian stock market are starting
to flash green buy signal on us. See the Sensex Fed model which is based on difference between earnings yield and
10Y bond yields. You can easily speculate on India via ETF:PIN or SCIF.

Chart 3 Chart 4
India, SENSEX 30, Fed Model
left axis = 10Y bond yield - earnings yield; right axis = index level

6% 22000
5%
20000
4%
3% 18000

2%
16000
1%
14000
0%
-1% 12000
-2%
10000
-3%
-4% 8000
01/2006 10/2006 07/2007 04/2008 01/2009 10/2009 07/2010 04/2011

Difference Stock Exchange Level

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Disclaimer

This document is being issued by ATWEL International s.r.o. (Company), which is a financial intermediary registered with Czech National Bank.
Company provides this document for educational purposes only and does not advise or suggest to its clients or other subjects to buy or sell any
security traded at financial markets, despite the fact such security may be mentioned in this material. Company is not liable for any actions of a
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Educational methods of the Company do not take into consideration financial situation, investment intentions or needs of other persons and
therefore do not guarantee specific results. Company and its employees may purchase, sell or keep positions in shares or other financial
instruments mentioned in this material and use strategies that may not correspond to strategies mentioned in this material.

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