Agcapita UpdateMay 2010

1

Contents

4 TheInflationLag4 DieLeerverkäuferSindKaputt4 DevelopedWorldHastheDebt

Problem,CanYouBelieveLessSoFortheEmergingMarkets

5 ‘SomehorrendousKeynesian/monetaristnightmare’

5 AGlimpseIntotheFinancialHellofStagflation

6 QEUpdate–WhenistheSterlisationGoingtoHappen?

7 TheMarketGoes“NoBid”7 WhoisinworseShape–USin

2009orArgentinain2001?7 Acomparisonofpublicdebtto

revenueratiosduringpastcriseswithsomeofthosetoday.

7 IntheCategoryofYouKnowYouHaveProblemWhen…

8 IntheCategoryofYouKnowYouHaveanEvenWorseProblemWhen…

PerCePtion and reality

Ithasbeensaidthatgoodinvestmentrequirestheskilltocapturethearbitrageavailablebetweenperceptionandrealityandthereforeitiscriticaltoknowboth.

Considertheperceptionandrealityreflectedinthefollowingquotes:

“In some ways it’s a battle of the politicians against the markets. That’s how I do see it. But I’m determined to win this battle.” AngelaMerkel,GermanChancellor

“How did you go bankrupt? Two ways. Gradually, then suddenly.” ErnestHemingway

Ithinkthatthereissomethingemblematicofourcurrentfinancialpredicamentinthesetwosnippetsoftext.Withconstantfiscaldeficitsthegovernmentsofthedevelopedworldhavesofarbeengraduallybankruptingthemselves.NowbysteppingintotransferprivatesectordebtproblemsontoalreadyprecariouspublicsectorbalancesheetsIbelievetheymaybemovingontothesuddenstageofbankruptcy–ifnotde jurethende facto.WhatChancellorMerkelisreallysayingisthatsheisunhappythatthemarketisstartingtoseethroughthefalseassumptionofsovereignsolvencyandisactingaccordingly.

Hereareafewmoreobservationsinthecategoryofreality/perceptionarbitrage:

– Perception: Bailouts stabilize the system and reduce volatility Reality:Bailoutsincreaselong-termvolatility/riskbycreating

moralhazardandsubsidizingfailure–whateveractivitiesyousubsidizeandde-riskyouwillultimatelygetincreasedproductionof,notless.

Summary

2

– Perception: Government intervention will help maintain growth Reality:Increasingthesizeofgovernmentisreducingnot

improvingourabilitytocreaterealgrowth.Theideathatwemustkeepcreditavailabletothestateatanycostbecauseonlystatespendingcanmaintaingrowthwhiletheprivatesectorrecoversbordersonlunacy.Governmentspendingispurelyatransfermechanismandtypicallydestroyscapital.Thereforeincreasinggovernmentspendingatthistimedestroyscapitalexactlywhenitisneededthemosttorebuildbalancesheetstherebyensuringlowerrealgrowthratesinthefuture.

– Perception: Private sector debt reduction/defaults make deflation our biggest risk – CPI shows that there is no inflation

Reality:Theabsenceofgeneralpriceinflationbeingusedasproofofthelackofinflationmissesthemuchmoresubtlenatureofinflation-inflationdoesnothappenintheaggregateandnewlycreatedmoneyandcreditflowsintocertainassets/goodsfirstthenonlyovertimeisspreadthroughouttheeconomy.Monetaryinflationhasformanyyearsbeenfocusedonriskassetsratherthanconsumptionitems(itisconsumptionsitemsthatoverwhelminglydrivethetypicalinflationmeasuresuchasCPI).

Youcanhaveaneconomythatisexperiencingstronglyincreasinganddecreasingnominalpricesatthesametimeasnewlycreatedmoneyandcreditrotatesfromsectortosectorinsearchofreturns.

Ofcourse,theheavilygearedassetclassesthatwerethebeneficiariesofthemonetaryexpansionofthelastdecade–thefinancialsector,sovereigns,residentialandcommercialrealestatecomeimmediatelytomind-shouldcontinuetosufferongoingsolvencyissuesandpronouncednominalpricedeclinesascreditisre-allocatedwithinthesystembutthisisnotthesameasgeneralizeddeflationthrough-outtheeconomy.

Summary (continued)

9 GreeceversusUS9 ChinaMaySurpassUSGDPby

202710 MoreonSovereignDefaults…11 BondholdersBeware?11 UnsustainablePublicSector

FiscalPath12 CheerleadersGetPaidBetter

ThanYouThought12 FiscalAnalysis–Reductions

RequiredinVirtuallyEveryCountry

13 USFarmlandReturns13 IEA2010EnergyDemand

Report14 WorldEnergyMarketsbyFuel

Type15 EnergyFactoids

Contents Continued

3

Giventhis,itwouldseemagoodassumptionthatmuchoftherecentlycreatedmoney/creditwillultimatelyflowintoanewpartoftheeconomy–likelythosesectorswhosefundamentalsremainthemostunimpairedandwheregearinglevelsarelower.

– Perception: Governments are not monetizing their debt Reality:Moneyisfungiblesobybuyingbankassetsandencouragingtheriskfreetradeofinvesting

insovereigndebtwithexcessbankreserves,centralbankshaveusedthecaptiveand/ornationalizedbankingsystemasavehicletomonetizegovernmentdebt:– TheBankofEnglandprinted£200bn=2009UKgovernmentdeficit.– TheUSFederalReserveprinted$1.25trillion=2009USgovernmentdeficit– ECBprintingEuro750billionforGreekbailout=2009EU27governmentdeficit

Inanyevent,Ibelievetherewillcomeapointwhencentralbankswillmonetizegovernmentdeficitsmuchmoreopenly.Logicallythevastamountsofgovernmentdebtrollingoverthenextyearscombinedwithalreadylargeandgrowingfiscaldeficitswillbethecatalyst.Injustoneexample,howcantheUSborrowanadditional$10trillionandrolloveranother$13trillionindebtovernextdecadewhenthecurrentmoneysupplyisonlyaround$15trillion?Evenassumingthatbudgetestimatesareaccurate–andmanyobserversexpectthetotaltobemorelike$20trillionthan$10trillion–thenisafailedUSdebtauctionapossibilityinthefuture?

Intheneartermvolatilitywillremaintheorderofthedayastheeconomiesofthewestexperiencetheclashofstronginflationaryforcesagainsttheliquidationofdecadesofmal-investmentsplayingoutacrossmanyassetclasses.

Therefore,Icontinuetobelievethatcapitalpreservationshouldbegiventhehighestprioritywithanallocationtoinvestmentswithreturnslinkedtomarketswithgenerallyfavorabledemographics,lownationaldebtlevels,highsavings,andtradesurplusesthatcanbeexpectedtocontinuegoingforward(e.g.emergingeconomiesandAsiainparticular).

Regards

StephenJohnston-Partner

Summary (continued)

4

Agcapita Update (continued)

the inflation lag

Inhisbook,“The Dying of Money”JensParssonsdiscussedtheconceptofthe“inflation lag”.Theideaissimple;themoneysupplyoftencanincreasesignificantlyoveranextendedperiodoftimebeforeinflationbecomesapparent.Wehaveexperiencedalmost30yearsofbenigngeneralpriceinflationcoupledwithmassivemonetarybaseexpansionsuchthatalargeinflationgaphasaccumulated.Wheninflationbeginstoaccelerateitmaybecommensuratelymassiveandlengthyasthegapisclosed–seechart1.

die leerverkäufer sind kaPutt

TheGermanbreedofshort-seller(“Leerverkäufer”)issettobecomeextinct.Inthespiritofthe“battle of the politicians against the markets”Germanyhasbannednakedshort-selling.Themessageisclear,nakedderivativestradeswheretheunderlyingistheEurowillnotbetolerated-adesperateattempt

toshoreuptheEuroandshifttheblameforitsweaknesstothefinancialmarketsratherthantheprofligatebailoutofGreece.

develoPed World has the debt Problem, Can you believe less so for the emerging markets

Chart2showsanIMFforecastforgovernmentdebtlevelsofdevelopedanddevelopingcountries.Theemergingsovereigns’debtlevelsaremuchlowerandstablewhiletheirmore“developed”brethrens’levelsaremuchhigherandaccelerating–yearsofunrestrainedgovernmentspendingcominghometoroost?AsPaulKedroskyrecentlyquippedarethedevelopedeconomiescalledthat“because they have developed a fully metastasized case of societally terminal debt?”.

Chart 1: mZm stoCk, PPi, CPi

191019201930194019501960197019801990200020102020

3,600

3,200

2,800

2,400

2,000

1,600

1,200

800

400

0

Source:StLouisFederalReserve

IndexMZMN5,1960-04=100PPIACO,1960-04=100CPIAUCNS,1960-04=100

Chart 2: general government gross debt ratios

(% gdP, 2009 PPP-gdP Weighted average)

2000200120022003200420052006200720082009201020112012201320142015

120

100

80

60

40

20

0

Source:DBGlobalMarketsResearch,IMF

LowIncome

AllAdvanced

G-20Advanced

G-20Emerging

Emerging(broadsample)

“Inflation Lag”

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Agcapita Update (continued)

‘Some horrendouS KeyneSian/monetariSt nightmare’

RoyalBankofScotlandstrategistBobJanjuah’srecentresearchnotehasasomewhatdarkmoodtosaytheleast:“I had assumed, after doing what it took in late 08 and early 09 to avoid global depression and systemic financial system collapse, that policymakers & their buddies would see the light and realise that the only path to long term success for the problem economies (US, UK, most of Europe, Japan, etc) would be a period of Austerity, Balance Sheet repair, Deflation, Real Structural Economic reform and Serious Financial System/Accounting regulation/reform. This path is NOT the easy path near term, but it is the ONLY path for ensuring the long term health and success of the problem economies, as well as ultimately the ONLY path which will both successfully iron out the grotesque global imbalances and help ensure the long term success of the global economy. SADLY, during my period of reflection, I have come round to the view that we have missed this golden opportunity. What instead I am seeing is a desperate attempt to re-write history (‘there was no bubble’, ‘rates too low for too long had nothing to do with it’, ‘it’s all just the fault of a bunch of greedy traders’, etc etc) AND at the same time it is clear global policymakers and their buddies, whilst jaw-boning us about ‘exit’ and ‘austerity/fiscal repair’, simply do NOT mean what they are saying – in other worlds, they are talking ‘responsibly’ but are acting IMHO in a reckless and irresponsible manner. And in my book actions ALWAYS speaker far more clearly and far louder than (cheap) talk. The Greece bail-out, the goings on at the IMF involving the huge build-up of ‘new bail-out’ reserves, and all the talk in the UK about fiscal repair based on

fantasyland ‘efficiency gains’ are the latest evidence that policymakers EVERYWHERE have no appetite to be brave, to be strong and to do the right thing. It seems that it is clearly too painful to do anything else. Instead, policymakers EVERYWHERE seem to have decided that the only way out of the hole is MORE DEBT, MORE DEBASEMENT, MORE BAILOUTS, ugly INFLATION and/or even uglier STAGFLATION, FAKE AUSTERITY, ZERO STRUCTURAL ECONOMIC REFORM, & MINIMAL REGULATORY REFORM.We are trapped in some horrendous Keynesian/monetarist nightmare, where policymakers, aided/abetted/advised by their buddies in the media, in the lobbyist cabal and in financial system, have YET AGAIN decided to go down the route which merely delays the problem/pushes it down the road, but which virtually guarantees that when the NEXT bubble collapses (I assume it will be the Global Government Debt/Bond Bubble and/or the Global Fiat Money/Paper Money/FX Bubble), there is NO pleasant way back.”

a glimPse into the finanCial hell of stagflation

RoyalBankofScotlandstrategistAlanRuskinrecentlyconductedathoughtexperimentonaUSsovereigndebtcrisis.AccordingtoRushkin,onlyfoodcommoditieswouldbeworthowning.“Now a US Treasury crisis should also never have to extend to default, as long as the Fed is willing to buy US Treasury debt, and deliver the haircuts to investors through inflation rather than direct restructuring – which may be preferable for reputational interests. Unfortunately the inflation route is still desperately

6

Agcapita Update (continued)

painful, not least because it drives up nominal yields and delivers the pain incrementally through bond and currency losses, rather than all upfront as a restructuring. Such bond losses are indicative of how a fiscal funding crisis quickly ends up as a monetary policy crisis, and a collapse in central bank control across the curve. Although this all feels like jumping deep into the land of the hypothetical, the above scenario is not too far removed from the late 1970s period of stagflation. I have gone back a good deal further, to the start of the 20th century to see how assets coped with stagflation (a relatively rare phenomenon) which would be the likely backdrop to (or outcrop of) a US sovereign crisis. The conclusions are not pretty. As feared there have been very few places to hide outside commodities when US growth is very soft and inflation is above a 5% threshold. Sell, equities, be a big seller of BAA then AAA bonds and yes buy FOOD commodities. Food commodities have been up as much as 30% y/y in years since 1900 when US per capita income was negative and inflation is above 5%, perhaps because these conditions are also accompanied by energy shocks or war, that are among the other darkest channels to financial blight.’

Qe uPdate – When is the sterlisation going to haPPen?

AccordingtheSocGenanlalystDylanGrice“In 2009, the BoE printed £200bn, thus completely financing the UK government deficit. It can’t have felt good about doing it but since the alternative scenario was so scary– financial meltdown and possibly IMF support– it held its nose and did it anyway. It said it was going to sterilise the intervention, but

on discovering that such was the financial system distress it was unable to, it just carried on regardless. In the US, the Fed printed $1.25 trillion to monetise the problematic mortgage market. It also said it was going to sterilise the intervention, but like the BoE it soon found it couldn’t, and like the BoE continued anyway because the alternative financial meltdown scenario was too scary to contemplate. Today, the ECB is buying insolvent Eurozone government debt which it is promising to sterilise. Yet they face the same stark calculus faced by their Anglo-Saxon cousins in 2008. You can only worry about the economy’s ‘price stability’ if the economy hasn’t already melted down! So here’s my prediction: they won’t sterilise, and the program will expand. Most economists seem to think that QE puts us in uncharted waters. It doesn’t. Printing money to finance government expenditure is a very well trodden path which is as old as money itself: persistent monetisation causes inflation. Of course the current monetisation need not be persistent. Central banks can theoretically just stop it at any time.

But with government balance sheets in such a mess across the developed world (even with yields at historically unprecedentedly low levels), government funding crises are likely to be a recurring theme in the future. Since banks hold so much “risk free” government debt, those funding crises point towards more banking crises which point towards more money printing. When do they stop? When can they stop? But what does it all mean? The question to my mind isn’t whether or not inflation will accelerate from here. If government balance sheets are in as big a mess as I think they are, inflation is inevitable.”

7

Agcapita Update (continued)

the market goes “no bid”

Varioushighfrequencytradingsystemsorfatfingerexplanationsnotwithstandingherearetwoexperiencedmarketcommentatorswithmuchsimplerideasabouthowmarketscanfallunexpectedlyandrapidly–simplyputanabsenceofbuyers.

JohnKennethGalbraithdescribedthecrashof1929asfollows:“Of all the mysteries of the stock exchange there is none so impenetrable as why there should be a buyer for everyone who seeks to sell. October 24, 1929 showed that what is mysterious is not inevitable. Often there were no buyers, and only after wide vertical declines could anyone be induced to bid ... Repeatedly and in many issues there was a plethora of selling orders and no buyers at all. The stock of White Sewing Machine Company, which had reached a high of 48 in the months preceding, had closed at 11 on the night before. During the day someone had the happy idea of entering a bid for a block of stock at a dollar a share. In the absence of any other bid he got it.” John Kenneth Galbraith, 1955, The Great Crash

RichardRusselldescribedthe1973-74crashasfollows:“I started accumulating stocks in December of ‘74 and January of ‘75. One stock that I wanted to buy was General Cinema, which was selling at a low of 10. On a whim I told my broker to put in an order for 500 GCN at 5. My broker said, ‘Look, Dick, the price is 10, you’re putting in a crazy bid.’ I said ‘Try it.’ Evidently, some frightened investor put in an order to ‘sell GCN at the market’ and my bid was the only bid. I got the stock at 5.” RichardRussell,1999,Dow Theory Letters

Who is in Worse shaPe – us in 2009 or argentina in 2001?

Acomparisonofpublicdebttorevenueratiosduringpastcriseswithsomeofthosetoday.

in the Category of you knoW you have Problem When…

EventheUSmilitarythinkstheUSbudgetdeficitistoobig.ToquotearecentresearchpaperbytheArmy “Although these fiscal imbalances have been severely aggravated by the recent financial crisis and attendant global economic downturn, the financial picture has long term components which indicate that even a return to relatively high levels of economic growth will not be enough to right the financial

Source:SGCrossAssetResearch,ReinhartandRogoff2009

181614121086420

Historicalpublicdebt/revenueratiosduringselecteddefaults Selectedratiostoday

Mexico,1827

Spain,1

877

Argentina,1890

Germany,1932

China,1

939

Turkey,1

978

Mexico,1962

Brazil,1963

Philippines,1983

SouthAfrica,1

985

Russia,1998

Pakistan,1998

Argentina,2001

Greece,2009

Spain,2

009

Japan,2009

US,2

009

Chart 3

8

Agcapita Update (continued)

picture. The near collapse of financial markets and slow or negative economic activity has seen U.S. Government outlays grow in order to support troubled banks and financial institutions, and to cushion the wider population from the worst effects of the slowdown. These unfunded liabilities are a reflection of an aging U.S. Baby-Boom population increasing the number of those receiving social program benefits, primarily Social Security, Medicare, and Medicaid, versus the underlying working population that pays to support these programs.

Rising debt and deficit financing of government operations will require ever-larger portions of government outlays for interest payments to service the debt. Indeed, if current trends continue, the U.S. will be transferring approximately seven percent of its total economic output abroad simply to service its foreign debt. Interest payments are projected to grow dramatically, further exacerbated by recent efforts to stabilize and stimulate the economy, far outstripping the current tax base shown by the black line. Interest payments, when combined with the growth of Social Security and health care, will crowd out spending for everything else the government does, including National Defense. The foregoing issues of trade imbalance and government debt have historic precedents that bode ill for future force planners. Habsburg Spain defaulted on its debt some 14 times in 150 years and was staggered by high inflation until its overseas empire collapsed. Bourbon France became so beset by debt due to its many wars and extravagances that by 1788 the contributing social stresses resulted in its overthrow by revolution.

Interest ate up 44% of the British Government budget during the interwar years 1919-1939, inhibiting its ability to rearm against a resurgent Germany. Unless current trends are reversed, the U.S. will face similar challenges, anticipating an ever-growing percentage of the U.S. government budget going to pay interest on the money borrowed to finance our deficit spending.”

in the Category of you knoW you have an even Worse Problem When…

AccordingtotheUSArmy “A severe energy crunch is inevitable”.InarecentreportArmyanalystswrote“To meet even the conservative growth rates global energy production would need to rise by 1.3% per year going forward. By the 2030s, demand is estimated to be nearly 50% greater than today and even assuming more effective conservation measures, the world would need to add roughly the equivalent of Saudi Arabia’s current energy production every seven years (1.4 MBD per year). The discovery rate for new petroleum and gas fields over the past two decades (with the possible exception of Brazil) provides little reason for optimism that future efforts will find major new fields.

At present, investment in oil production is only beginning to pick up, with the result that production could reach a prolonged plateau. By 2030, the world will require production of 118 MBD, but energy producers may only be producing 100 MBD unless there are major changes in current investment and drilling capacity.

9

Agcapita Update (continued)

By 2012, surplus oil production capacity could entirely disappear, and as early as 2015, the shortfall in output could reach nearly 10 MBD.

A severe energy crunch is inevitable without a massive expansion of production and refining capacity. While it is difficult to predict precisely what economic, political, and strategic effects such a shortfall might produce, it surely would reduce the prospects for growth in both the developing and developed worlds. Such an economic slowdown would exacerbate other unresolved tensions, push fragile and failing states further down the path toward collapse, and perhaps have serious economic impact on both China and India. At best, it would lead to periods of harsh economic adjustment.” Emphasismine

greeCe versus us

Inthelast42yearstheUSFederalGovernmenthasrunadeficit88%ofthetimeanddeficitsof9%,7%and6%areexpectedoverthenext3years.Greece,thecurrentposterboyforprofligategovernmentspending,hashadaveragedeficitsof7%ofGDPoverthelast5years.

China may surPass us gdP by 2027

GoldmanSachsispredictingthattheGDPofChinawillsurpasstheUSin17years,13yearsearlierthantheirpreviousprediction.

Chart 4: us defiCit/surPlus as PerCent gdP

4%

2%

0%

-2%

-4%

-6%

-8%

-10%

-12%

Source:Bloomberg

1975198519952005

70,000

60,000

50,000

40,000

30,000

20,000

10,000

200620112016202120262031203620412046

Chart 5: gdP ProjeCtions briCs v West ($billions)

Source:GoldmanSachs

“IlSorpasso”:2027(previously2040)

BrazilChinaIndia

RussiaGermanyJapan

UnitedKingdomUnitedStates

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Agcapita Update (continued)

more on sovereign defaults…

Thelessonsoffinancialhistory,inflationandoutrightsovereigndefaultsasdistilledbyNiallFergusonauthorof“The Ascent of Money”:

Whatdogovernmentsnotdowithworldwarsizedebtburdens?– Slashexpenditureonentitlements– Reducemarginaltaxratesonincomeand

corporateprofitstostimulategrowth– Raisetaxesonconsumptiontoreducedeficits– Growtheirwayoutwithoutdefaultingor

depreciatingtheircurrencies

Whatdogovernmentsusuallydowithworldwarsizedebtburdens?– Obligecentralbankandcommercialbanksto

holdgovernmentdebt– Restrictoverseasinvestmentbyfirmsandcitizens– Defaultoncommitmentstopoliticallyweak

groupsandforeigncreditors– Condemnbondinvestorstonegativerealinterest

rates

Whatarethegeopoliticalconsequencesofcrisesofpublicfinance?– Infiscalstabilizations,discretionarymilitary

spendingisusuallythefirstcasualty– Incasesofdefaultonexternaldebt,conflictswith

creditorscanarise– Incasesofcurrencydepreciation,reserve

currencystatuscanbelosttoarisingrival

Chart 6: Periods of banking Crises, default and inflation by Country

Source:ReinhartandRogoff(2009)

Sinceindependenceor1800 Since1800*

Shareofyearsinabankingcrisis

Shareofyearsindefaultorreschedul-

ing

Totalnumberofdefaultsand

reschedul-ings

Shareofyearsinwhichinflationexceeded20%

Shareofyearsinwhichinflationexceeded40%

Numberofhyperinfla-tionyears

Austria 2 17 7 21 12 2

Belgium 7 10 7

Denmark 7 2 1

Finland 9 6 3

Germany 6 13 8 10 4 2

Greece 4 51 5 13 5 4

Hungary 7 31 7 16 4 2

Italy 9 3 1 11 6

Netherlands 2 6 1 1

Norway 16 5 2

Poland 6 33 3 28 17 2

Portugal 2 11 6 10 4

Spain 8 24 13 4 1

Sweden 5 2

UnitedKingdom

9 2

Source:ReinhartandRogoff(2009)

11

Agcapita Update (continued)

bondholders beWare?

Chart7representstherealannualreturnsonUKandUSbonds,1900-1995.Areweheadingintoanotherperiodofnegativerealreturnstobonds?

unsustainable PubliC seCtor fisCal Path

“Our projections of public debt ratios lead us to conclude that the path pursued by fiscal authorities in a number of industrial countries is unsustainable. Drastic measures are necessary...”ThatisadirectquotefromarecentstudybytheBankofInternationalSettlements(“BIS”).Thestudylooksatpublicsectorfiscalpolicyandpublicdebtinanumberofdevelopedcountries(seechart8)andconcludes:“Our projections of public debt ratios lead us to conclude that the path pursued by fiscal authorities in a number of industrial countries is unsustainable. Drastic measures are necessary to check the rapid growth of current and future liabilities of governments

and reduce their adverse consequences for long-term growth and monetary stability... It follows that the fiscal problems currently faced by industrial countries need to be tackled relatively soon and

Chart 7

Source:GFD

12

10

8

6

4

2

0

-2

-4

-6

-8

-10UK US

1900-19091910-19191920-19291930-19391940-19491950-19591960-19691970-19791980-19891990-1999

Chart 8: debt/gdP ProjeCtions

Source:BIS

300

250

200

150

100

50

080900010203040

Portugal

80900010203040

Ireland

80900010203040

Greece400

300

200

100

080900010203040

Spain

600

500

400

300

200

100

080900010203040

UnitedKingdom500

400

300

200

100

080900010203040

UnitedStates

500

400

300

200

100

0

400

300

200

100

0

Baselinescenario

Smallgradualadjustment

Smallgradualadjustmentwithagerelatedspendingheldconstant

12

Agcapita Update (continued)

resolutely. Failure to do so will raise the chance of an unexpected and abrupt rise in government bond yields at medium and long maturities, which would put the nascent economic recovery at risk. It will also complicate the task of central banks in controlling inflation in the immediate future and might ultimately threaten the credibility of present monetary policy arrangements.”

Cheerleaders get Paid better than you thought

AccordingtoastudybyMcKinsey,WallStreetequityanalystshaveonaverage,overestimatedS&P500earningsbytwotimesforalmost30yearsand

Chart 9: reality versus Wall street “analysis”

Source:HBR/McKinsey

181614121086420-2

Forecast1Actual2

1985-901987-921989-941991-961993-981995-001997-021999-042001-062003-082004-09

Long-termaverage%

1Analyst’s5-yearforecastforlong-termconsensusearnings-per-share(EPS)growthrate.Ourconclusionsaresameforgrowthbasedonyear-over-yearearningsestimatesfor3years.2Actualcompoundannualgrowthrate(CAGR)ofEPS;2009dataarenotyetavailable,figuresrepresentconsensusestimateasofNov2009.

demonstrateamarkedinability(unwillingness?)toforecastdownturns.Notanunsurprisinginstitutionalbiasinasectorthatisdependentonsellingsecuritiestotheunsuspectingpublicregardlessofthequalityoreconomicconditions.

fisCal analysis – reduCtions reQuired in virtually every Country

AssuminggovernmentswantmerelytostabilizedebtlevelsasapercentageofGDPthenumbersinchart10representthecontractioninfiscalspendingnecessarybetween2010and2030asapercentageofGDP.Notapromisingpicturegiventhevirtualinabilityofgovernmentstoundertakesustainedreductionsinoutlaysinthefaceofpoliticalpressurefromthevotersandthecurrentlowinterestrateenvironment.

Source:IMF

14

12

10

8

6

4

2

0

-2

-4

-6

Chart 10

Korea

Switzerland

Norway

Iceland

New

Zealand

Sweden

Israel

HongKongSAR

CzechRepublic

GermanySlovenia

Italy

SlovakRepublic

Denmark

Canada

Finland

Austria

Belgium

Singapo

reAustria

Netherlands

Portugal

France

UnitedKingd

omGreece

Spain

Ireland

UnitedStates

Japan

13

Agcapita Update (continued)

us farmland returns

InstitutionsthathaveinvestedinUSfarmlandhaveearnedareturnof11.2%since1992,withnodownyears.

iea 2010 energy demand rePort

“The global economic recession that began in 2007 and continued into 2009 has had a profound impact on world energy demand in the near term. Total world marketed energy consumption contracted by 1.2 percent in 2008 and by an estimated 2.2 percent in 2009, as manufacturing and consumer demand for goods and services declined. Although the recession appears to have ended, the pace of recovery has been uneven so far, with China and India leading and Japan and the European Union member countries lagging. In the Reference case, as the economic situation improves, most nations return to the

economic growth paths that were anticipated before the recession began.

The most rapid growth in energy demand from 2007 to 2035 occurs in nations outside the Organization for Economic Cooperation and Development (non-OECD nations). Total non-OECD energy consumption increases by 84 percent in the Reference case, compared with a 14-percent increase in energy use among the OECD countries. Strong long-term growth in gross domestic product (GDP) in the emerging economies of non-OECD countries drives the fast-paced growth in energy demand. In all the non-OECD regions combined, economic activity—as measured by GDP in purchasing power parity terms—increases by 4.4 percent per year on average, compared with an average of 2.0 percent per year for OECD countries.

The IEO2010 Reference case projects increased world consumption of marketed energy from all fuel sources over the 2007-2035 projection period (Chart 12) Fossil fuels (liquid fuels and other petroleum, natural gas, and coal) are expected to continue supplying much of the energy used worldwide. Although liquid fuels remain the largest source of energy, the liquids share of world marketed energy consumption falls from 35 percent in 2007 to 30 percent in 2035, as projected high world oil prices lead many energy users to switch away from liquid fuels when feasible. In the Reference case, the use of liquids grows modestly or declines in all end-use sectors except transportation, where in the absence of significant technological advances liquids continue to provide much of the energy consumed.

Chart 11

35%

30%

25%

20%

15%

10%

5%

0%199219931994199519961997199819992000200120022003200420052006200720082009

1992-2009annualizedreturns

YearlyReturns,NCREIFFarmlandIndex

6.3%

6.3%6.3% 6.3% 6.3%

6.3%

6.3% 6.3% 6.3%

6.3%

6.3%

6.3%

6.3%

6.3%

6.3%

6.3% 6.3%

6.3%

6.3%6.3%

6.3%

Farmland

LehmanAggregate

Russell3,000

14

Agcapita Update (continued)

Average oil prices increased strongly from 2003 to mid-July 2008, when prices collapsed as a result of concerns about the deepening recession. In 2009, oil prices trended upward throughout the year, from about $42 per barrel in January to $74 per barrel in December. Oil prices have been especially sensitive to demand expectations, with producers, consumers, and traders continually looking for an indication of possible recovery in world economic growth and a likely corresponding increase in oil demand. On the supply side, OPEC’s above-average compliance to agreed-upon production targets increased the group’s spare capacity to roughly 5 million barrels per day in 2009. Further, many of the non-OPEC projects that were delayed during the price slump in the second half of 2008 have not yet been revived.

After 2 years of declining demand, world liquids consumption is expected to increase in 2010 and

strengthen thereafter as the world economies recover fully from the effects of the recession. In the IEO2010 Reference case, the price of light sweet crude oil in the United States (in real 2008 dollars) rises from $79 per barrel in 2010 to $108 per barrel in 2020 and $133 per barrel in 2035.

World energy markets by fuel tyPe

Liquids remain the world’s largest energy source throughout the IEO2010 Reference case projection, given their importance in the transportation and industrial end-use sectors. World use of liquids and other petroleum grows from 86.1 million barrels per day in 2007 to 92.1 million barrels per day in 2020, 103.9 million barrels per day in 2030, and 110.6 million barrels per day in 2035. On a global basis, liquids consumption remains flat in the buildings sector, increases modestly in the industrial sector, but declines in the electric power sector as electricity generators react to rising world oil prices by switching to alternative fuels whenever possible. In the transportation sector, despite rising prices, use of liquid fuels increases by an average of 1.3 percent per year, or 45 percent overall from 2007 to 2035.

To meet the increase in world demand in the Reference case, liquids production (including both conventional and unconventional liquid supplies) increases by a total of 25.8 million barrels per day from 2007 to 2035. The Reference case assumes that OPEC countries will invest in incremental production capacity in order to maintain a share of approximately 40 percent of total world liquids production through 2035, consistent with their share over the past 15 years. Increasing volumes of conventional liquids (crude oil and lease condensate,

Chart 12

199020002007201520252035

Source:IEA2010

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History Projections

Liquids

CoalNaturalGas

Renewables

Nuclear

15

Agcapita Update (continued)

natural gas plant liquids, and refinery gain) from OPEC producers contribute 11.5 million barrels per day to the total increase in world liquids production, and conventional supplies from non-OPEC countries add another 4.8 million barrels per day (Chart 13).

Unconventional resources (including oil sands, extra-heavy oil, biofuels, coal-to-liquids, gas-to-liquids, and shale oil) from both OPEC and non-OPEC sources grow on average by 4.9 percent per year over the projection period. Sustained high oil prices allow unconventional resources to become economically competitive, particularly when geopolitical or other “above ground” constraints limit access to prospective conventional resources. World production of unconventional liquid fuels, which totaled only 3.4 million barrels per day in 2007, increases to 12.9 million barrels per day and accounts for 12 percent of total world liquids supply in 2035. Oil

sands from Canada and biofuels, largely from Brazil and the United States, are the largest components of future unconventional production in the IEO2010 Reference case, providing a combined 70 percent of the increment in total unconventional supply over the projection period.”

energy faCtoids

AccordingtotheIEA:– Chinaisexpectedtoconsume11%ofglobal

oilproductionin2010– Chinaaccountedfor45%ofthegrowthin

globaloildemandoverthepastdecade

Chart 13

199020002007201520252035

Source:IEA2010

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History Projections

Non-OPECconventional

OPECconventionalUnconventional

Total

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