Don Coxe

STRATEGY ADVISOR,
BMO CAPITAL MARKETS

CONFERENCE CALL TRANSCRIPT

August 27, 2010
The Call: Don Coxe’s Weekly Conference Call
conducted exclusively for clients
and employees of BMO Capital
Markets and BMO Nesbitt Burns

Banking on a Weaker Recovery

Thank you all DONforCOXEtuning
CONFERENCE in to “The Call”, which comes to you from Sutton
CALL

Quebec — for Banking

thoseon a Weaker
of you who areRecovery
not sure where that is, I am looking out
my window here with the border of the Green Mountains of Vermont, which
Friday, August 27 – 10:00 am (EDT)
Telephone ‘live’ call: 416-695-6624 / 888-742-2490; Passcode: 4068170
are onlyto the5 miles away. This is gorgeous countryside — would everything
Click on icon
to listen
replay Replay: http://events.startcast.com/events6/122/C0018/Default.aspx
else that we were looking at or talking about was anything near as beautiful.

KBW US Regional Bank Index ETF (KRE) relative to S&P 500

August 24, 2009 to August 24, 2010
120

115

110

105

100
96.86
95

90

85

80
Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10
Source: Reuters

The recovery sizzle fizzles…

The chart that we sent out was certainly not a thing of beauty; the chart is
the KRE Index, which is the Keefe Bruyette and Woods ETF for regional
Don Coxe banks, and it’s 50 regional banks so it’s the best picture of Main Street USA.
Chairman
COXE ADVISORS LLP. Those of you who have been following our work for years know that
Chicago, IL
(312) 461-5365
we consider this one of the most reliable indicators and it’s not a very
email: DC@CoxeAdvisors.com encouraging chart, and relative to the S&P is the way we value it.
 Don Coxe Conference Call Transcript: August 27, 2010

Looking back year over year, it outperformed from November 8th until April
23rd at which point it was up 16% relative to the S&P, and that was a time
when we could feel pretty optimistic that the economic recovery was intact.

However since then it’s been going down — it’s now minus 4%; (relative to
the S&P on a year over year basis) not devastatingly bad, but this tends to
confirm all those other indicators out there.

The pulse weakens…

The GDP number that we got this morning is the kind of thing to send
people like Paul Krugman into paroxysms of rage.

It was only up 1.6% — they had previously estimated it at 2.4%, and that’s
despite booming business investment up 17.6% in the quarter.

Equipment and software expenditures up 24.9% — previously they had

estimated it at 21.9% — in other words notwithstanding that all the stuff
that you read about businesses just sitting on their cash and doing nothing,
that was a roaring pattern of business investment in the quarter — but what
went wrong?

Well, exports only up 9.1% and imports up 32.4% — the previous high
which was way back in the 80s was 28.8% — in other words, this was just
an astounding growth in imports, and that isn’t because every American
consumer suddenly turned bullish.

I think what that reflects is that so much of the business equipment and
software, which may be designed in Silicon Valley or Austin Texas (or
places like that) is actually manufactured abroad and so that was coming in
along with machinery made in Germany, that sort of thing.

I think that the capital goods — I am not an economist but I suspect that
that particular surge in growth was driven by capex, but it was capex that is
going to make America more efficient — that’s the good news.

The bad news in the near-term is that the economy is softer.

Finding an effective antidote…

Then you add in to the fact that the monetary base is now flat (dating back
to last October) and the debate that will go on now with Jackson Hole
opening up today is between the schools of the economists.

In the New York Times today, Paul Krugman got into one of his splenetic
rages but he is a terrific and articulate exemplar of the post-Keynesian
(that claims to be Keynesian) school, which basically doesn’t believe that

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 Don Coxe Conference Call Transcript: August 27, 2010

government deficits are bad, (they are good) and paying for things in the
next generation or the generations after it is okay where it to get us out of
what we are in now, so as far as he’s concerned, stimulus has to be done by
increasing government deficits.
http://www.nytimes.com/2010/08/27/opinion/27krugman.html?ref=todayspaper

He’s critical of Obama not doing enough, but he blames that on the
Republicans who are just saying ‘no’ to everything.

The monetarists would say, “If the central bank isn’t expanding its balance
sheet, don’t expect the economy to grow”, and you’ve got to have it growing
faster than GDP in order to have the economy grow and the only component
of their book that’s been growing is cash.

Hunkering down…
What we’ve got here is the phenomenon that people are holding cash,
(which does nothing for the economy) and in addition we’ve had those
statistics from the World Gold Council, (this is worldwide admittedly, but
I suspect Americans are a big part of this) which is the amount of gold
that they are buying in various forms, lots of it in actual specie and that’s
evidenced by the amount of advertising one sees on television in the United
States for buying gold coins and buying small pieces of gold, plus of course
the gold ETFs where the flows are just gigantic.

So we have a buildup in cash (in print money that is) and we have a buildup
in gold, and beyond that there’s not much going on.

That’s why the S&P is up about 1% year over year and it’s hardly of the kind
of environment that’s going to get those investors who left the stock market
after the Flash Crash, saying “We don’t believe the market is any realistic
place for ordinary individuals anymore”— this is not going to get them
running back in to buy stocks.

What has done well in this period of time?

The great grain gain…

Crude oil is flat year over year, and its correspondence to the S&P is so close
as to be almost mystical and there are various explanations for that.

I am not sure I know exactly how to explain it but in any case crude oil is
flat year over year, copper is up a bit, the Dollar is up 5%, the euro is down
10%, the Loonie’s up 4%, but corn and the grains are up – they are the
strongest area with corn up 15% and wheat up over 12%.

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 Don Coxe Conference Call Transcript: August 27, 2010

We have an interesting situation where something that you cannot

program in advance (which is some changes in weather patterns in major
grain growing regions) produces tremendous growth in the prices of one
asset class, but it’s not one that’s tied (except tangentially) to the overall
economy.

It’s the only really good thing about the Illinois economy at the moment
because the farmers in Illinois are going to have a great, great year.

Rising dough and the downside…

The got a great price for what they are producing and they are going to be
producing probably a record amount of it, but apart from that what you
can’t say is that having pressure on the upside for basic foods is going to be
good for the world; certainly it’s not good for the people that they are trying
to rescue in Pakistan and in the poorer parts of the world — in other words,
it’s sort of perverse.

What we don’t have now is the basis for optimism that we had last fall, that
the economy was growing and that it seemed to be working.

Knowing where you’re going…

It was good news on two counts, one that the economy was growing and
two that the stimulus (which was something confected in Washington) was
actually working, so therefore it reinforced people’s sense of confidence
that we weren’t just adrift hopelessly on a sea where we couldn’t see where
land was, and that the future was bleak.

What this suggested was yes, we’d been through the worst downturn since
the Great Depression but we were coming out of it and the people in charge
knew what they were doing.

Lacking leadership…
You could criticize them (as we did) about the fact that the money that they
were spending wasn’t productive for the economy in the longer run because
it was just paying off various constituencies, but it did seem to be producing
economic growth.

Well as Lady Macbeth’s words; “Nought’s had, all’s spent” because now
there’s no stomach in Washington for further programs like this, and we are
coming up to midterm election where all the polls show it’s going to be a big
swing to the Republicans.

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The Republicans don’t have any answer to this situation either; they’ve
gotten by, by just saying ‘no’ to whatever it was that Obama proposed,
and if you see some of the people who managed to win in the Republican
primaries, you can’t have much confidence that the new Congress is going
to be any more responsible than the old, it’s just going to be irresponsible in
another direction.

This isn’t a pretty picture.

Corporate confidence?
We can also see that with the takeovers that are going on that big
corporations are saying that (somehow or other) the world is not going to all
go down into a double dip, if that’s the fate of the US and that still remains
to be seen.

We’ve got lots of takeovers going on in the software side of the economy and
then of course the big, big story which is the Potash takeover, and this is a
fascinating one; we talked about it last week at length.

Solid staying power…

What is really fascinating about it is that these are the longest duration
assets that are up for sale (if you can put it that way) because you are
looking at 3 to 4 centuries (based on current consumption) of reserves in the
ground.

As you know our mantra has always been you buy commodity stocks on
the basis of unhedged reserves in the ground in politically secure areas of
the world, and Marius Kloppers is doing just that with his bid, because the
duration of the other assets that BHP has are in the order of a few decades.

They’ve got the Olympic Dam mine; they’ve got some wondrous properties
out there, Escondida, these kinds of things — that’s what makes them such
a formidable corporation, but nothing like the duration that lasts century
after century.

What’s in it for BHP?

I’ve been reading very complicated critiques by financial analysts based on
cash flow ratios and things like this, but I believe that for BHP that this is
their one chance to dramatically increase the overall average duration of
the assets of the company, and they know (which so many analysts don’t
know) that a company (if it’s going to survive) has to be at least holding the
duration of its assets, if not increasing them.

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This is their chance to offset the declines in duration that they have in lots
of their other assets such as their oil production, where they don’t have
anything like multi-decades of reserves, so it’s a big chance and therefore I
am still skeptical about the valuations that are being used by these analysts
who are saying, (particularly the British analysts) “BHP, if they pay more
than $152 they should fire Marius Kloppers.”

First of all, BHP’s earnings are so spectacular and their balance sheet is
bulletproof — this is their chance because remember he was only in the
job 6 weeks and tried to buy Rio Tinto and failed on that because they got
Chincalco in and scotched his bid.

Fast money folly…again?

This is a make or break story for Mr. Kloppers and although I am not
predicting that it’s going to go up to a much higher price, because I don’t
know.

They are saying that already about 40% of the stock may be in the hands of
hedge funds and arbitrageurs — it was over 50% for Inco and Falconbridge
at the time of that frenetic series of takeovers.

Saskatchewan speaks…
What the province of Saskatchewan has indicated is they are going to take
a strong look at this, and their argument is that they want to make sure that
when he was talking about breaking up Canpotex and using BHP’s idea,
which is producing flat-out, relying on the quality of their production to
drive out marginal producers, that’s just not going to be applicable to what’s
going on in Saskatchewan.

They want to develop and let other smaller companies prosper and the
other two members of Canpotex, Agrium and Mosaic, have been in effect
sheltering under the wings of Potash and now Kloppers is doing a bit
of a backspin on this and saying he’s got no near-term plans to breakup
Canpotex, but I believe that will be a condition of getting the Saskatchewan
government’s sign off on this, and that’s not related to the price of the stock.

Headquarter hassle…
What does seem to be influencing this is the fact that the executive
management of Potash although the company is headquartered in
Saskatoon that they are located in a suburb of Chicago and therefore it
doesn’t have quite the same ‘Canadian flag’ character to it.

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I don’t put much stock in that because Bill Doyle spends so much of his
time in Saskatchewan and they are the biggest feature in the tremendous
economic growth Saskatchewan has experienced in recent years, but when
you are talking about emotions and soft qualities like this, it’s difficult to
generalize.

Foregoing the future?

I can’t give you any advice as to what you do near-term on the stock,
although what I am saying is that the British critics, and you can read
through — the FT has a series of articles this week on this and they are very
detailed as to their suggestion of what the upside limit should be.
http://www.ft.com/indepth/bhp-potashcorp
http://www.ft.com/cms/s/0/13f300cc-b13a-11df-b899-00144feabdc0.
html?ftcamp=rss

The pot of gold is not always visible…

I reject the method that’s being used to value that, because of our concept
which is building up unhedged reserves in the ground in secure areas of the
world, and the Potash assets (on that basis) are the best assets in the world,
period.

They deserve some kind of premium — if they don’t get it, it’s because most
people disagree with us.

Most analysts use fairly short-term earnings projections and they do good
work but in effect, they treat commodity companies too much the way they
would treat other companies.

I certainly agree with you’ve got to use 1 and 3 and 5-year earnings forecasts
if you are taking over a supermarket or if you are taking over a software
company, but if you are taking over a mining or oil company, I think the first
thing you should be looking at is what this does to the total reserve picture
of the company that’s acquiring them.

Does it improve the average life of their production?

If it does, (in this case you’ve got a gigantic adrenaline shot into reserve
calculations) then to that acquirer this is worth more money than any of
those CFAs are going to ascribe to it, and if the deal goes through at a higher
price, they can ridicule Kloppers as much as they want, he will have done
something for the stockholders of the company.

What should investors be doing in this kind of environment, where the US

economy is clearly struggling and where nobody has an answer?

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Ben is up to bat…
I think frankly that this is a case in which it becomes really important for
Ben Bernanke and his colleagues to find some way to expand the monetary
base, and the argument against it is they are just pushing on a string — I
doubt that, but clearly they can’t sit back and just let the monetary base be
as flat as the surface of Lake Michigan.

There has got to be growth in the monetary base or otherwise the US

economy is not going to perform anywhere near up to expectations, and
that’s not just going to be bad news for Mr. Obama and Ms. Pelosi — it’s bad
news for the whole world.

I think that’s going to have to be the answer.

Strike one, strike two…

It cannot anymore be Congress or the administration, and it’s absolutely
futile to send one’s time blaming Obama for all this — he was doing what
his economic advisors told him to do.

At that time, Bernanke had expanded his balance sheet in the most dramatic
fashion ever seen by a major central bank, so the Fed had done its work first,
and Congress responded with an increase in the deficit of money that was to
be spent soon, but they pitched it to us as “shovel-ready” projects, and of the
money that’s been spent so far on this, about 4% went into highways and
bridges under the federal projects, that’s all.

Detrimental discretionary spending…

The rest of it was dissipated in various other areas, which I am not saying
was all wasted, but they had a close correlation to where various favored
unions were involved as protecting their jobs, and in getting pay increases
for their members.

And by the way, the Congress went through by giving a pay increase to all
federal employees, and since government employees already had a huge
margin (when you took in their benefits, pension plans and health care)
relative to private sector employees, that was really sticking it into the
eye of the private sector, but again you can argue that that created some
stimulus at the time.

Assuming that we cannot rely on political saviors here, it’s got to be on

central banks and on the private sector, and the private sector has got to see
it’s got a reason for assuming risk.

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Healthcare headaches…
Unfortunately this is one case where the classic expression that they used
which is, “It’s a shame to waste a good crisis” and bringing in the health
care bill, there is no doubt that the implications for businesses who have
more than 25 employees are really negative for this.

So what you are going to have is companies that are very careful not to
expand past that magic number — at that point they have to pay a cash
penalty if they don’t provide health insurance to them.

In past recoveries, it was these kinds of companies that were actually

providing the dynamism by hiring, even though they weren’t necessarily
that gigantic in GDP, but they were creating jobs.

Something has got to give…

What you’ve got now is (as Bernanke has put it, not referring to this)
“unusual uncertainty” — unusual uncertainty is not the backdrop for equity
investors to be taking big new risks.

So despite the zero or near-zero interest rates, we have a situation

approaching stasis.

Stasis in inherently unsustainable, it’s going to move one direction or the

other.

Managing the magic of money…

In the meantime I suggest to you that gold is a pretty good resting place,
because if in fact we do get a dramatic expansion once again of the
monetary base, (I don’t know exactly how they do it) that will probably be
negative for the Dollar.

It’s interesting that the Dollar did in fact strengthen when the monetary
base stopped growing, which is one of the things that the quantitative
analysts about gold and money numbers should have appreciated.

A stronger dollar doesn’t help at all in US exports, so therefore by finding

some way to print money that somehow or other works its way out and
develops a multiplier — that’s the challenge facing them in Jackson Hole
and when they go back to Washington.

We’ll see how they do it, but Bernanke has exhibited first of all a knowledge
of encyclopedic character of what led to the Depression and what sustained
the Depression, and he’s also shown that he’s extremely creative and
original and gutsy about what he can do, so the ball is in his court, and I
suspect we are going to get some kinds of announcements fairly shortly.

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 Don Coxe Conference Call Transcript: August 27, 2010

Holding their own…

I think this is a time to be watching closely because we are on the knife-
edge of something one way or the other, and an optimist would say they’ll
find something to do, in which case the United States will not drag down the
whole global economy.

It’s clear the United States is not going to be the ‘rescuer of the economy’
in this economic cycle (as it has been in so many) but as long as they don’t
drag it down then commodity prices will hold up, so our favorite asset class
will continue to outperform as it has been doing, and that is I guess the best
consolation that’s out there — I wish I could be more ebullient.

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

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 Don Coxe Conference Call Transcript: August 27, 2010

THE CALL
The Call: Don Coxe’s weekly conference call conducted exclusively for employees and clients of BMO Capital Markets and
BMO Nesbitt Burns.
Published by: COXE ADVISORS LLP.
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