2007 Basic Points APRIL

Basic Points
BYE-BYE, BOND BULL
April 13, 2007
Produced by BMO Financial Group

Distributed by BMO Capital Markets
Basic Points
An Investment Journal
Donald G. M. Coxe
Global Portfolio Strategist, BMO Financial Group
(312) 461-5365
e-mail: don.coxe@bmo.com
Research/Editing Angela Trudeau

e-mail: angela.trudeau@shaw.ca
Production/ Anna Goduco (print orders and mailing lists)
Distribution e-mail: basicpoints@bmo.com
BYE-BYE, BOND BULL

Overview
The Best of All Possible Bond Worlds was born in September 1981. It grew
and prospered, because of the mutually reinforcing effects from money
management by born-again monetarist central bankers, the growth of free
trade, the Triple Waterfall Collapse of commodities, productivity gains from
technology, and the end of the Cold War. For a quarter-century, inflation and
interest rates were in secular decline from their stagflationary peaks.
Apart from a few bumps in the road, long zero-coupon bonds have been—by
far—the top-performing sector in the investment-grade fixed income market.
As interest rates declined to levels that would have seemed Heaven-sent in
the Hellish Seventies, junk bonds became irresistible to the yield-starved.
We have been bond bulls for 26 years, except in 1993-94. We became even
more bullish in 1998, when we began arguing that deflation, not inflation,
had become the primary challenge to the global price system.
We now believe that inflation is returning, and the great bond bull will soon
be history. Supply Side Economics was a big part of the bond bull story in the
1980s. It is the core of today’s bear story.
This month, we look at the four great supply side challenges to the global
economy—energy, metals, grains, and workers—especially skilled workers.
The bond bull gamboled happily when all four were in sustained surplus
conditions. Three have already morphed from deflationary oversupply to
inflationary shortage; as for the fourth, unemployment statistics continue to
set new lows, and worker shortages have begun to show up in many other
places than Fort McMurray, Alberta. The two-decade-long display of the
power of management at the expense of workers will soon be fading away.
Together, these supply side failures give an inflation bias to the OECD
economies that will intensify in coming years. Only a recession will bring a
return of bond-friendly surpluses, and those will disappear once economic
growth returns.
Sustained global disinflation was the benign background that allowed—

indeed encouraged—the financial market rescue operations familiarly
known as the Greenspan Put. The Bernanke Fed’s freedom of action will be
constrained by a new economic environmental challenge—Global Economic
Climate Change.
We are adjusting our Recommended Asset Allocation, deleting our exposure

to long-duration bonds.
April 1
Recommended Asset Allocation
American Portfolios
U.S. Pension Fund
Allocations Change
Domestic Equities 27 unch
Foreign Equities 29 unch
Domestic Bonds 12 unch
Long-Duration Bonds 0 -10
Foreign Bonds 15 unch
Cash 17 +10
Foreign Equity Allocations
Allocations Change
European Equities 6 unch
Japanese and Asian Equities 6 unch
Canadian & Australian Equities 6 unch
Emerging Markets 11 unch
Bond Durations
Years Change
Global 4.25 unch
US 4.50 unch
Canada 4.75 unch
2 April
Basic Points
BYE-BYE, BOND BULL
The Four Scarcity Stories of Our Time
1. Energy
To the stunned statisticians at the International Energy Agency and most

analysts on Wall Street, the Asian Century’s first creation of global scarcity—
energy—came out of nowhere. The IEA’s high-priced roster of tax-exempt ...the soaring
Parisian boulevardiers was shocked…shocked. Wasn’t China an oil exporter middle class in
when we last checked? How could a poor country like that be driving up oil China, India and
demand and prices for the whole world? elsewhere in
the Third World
2. Metals expands its diets
The next to be shocked were managements of major mining companies (and midsections)
who were happily shorting copper at 90 cents a pound, only to learn that
China had created its second global scarcity. Phelps Dodge, the industry’s
most adamant bear, was absorbed at a mere six times earnings by Freeport
McMoRan, the industry’s most adamant bull. Phelps management had
hedged itself into oblivion.
3. Grains and Oilseeds
The third Asian-spawned scarcity—feed grains and oilseeds—has just arrived.

To read the profusion of stories on Page One, this first-ever cereal scarcity
without a major crop failure would seem to be purely an ethanol story
(which is itself another response to the oil scarcity story). However, that only
helps to explain the bull market in corn. The coming rises in prices for meat,
eggs, and dairy products will reflect the overall supply/demand imbalance of
coarse grains and soybeans while the soaring middle class in China, India
and elsewhere in the Third World expands its diets (and midsections) with
non-vegetable proteins.
4. Workers
The fourth shortage story—which will be the most powerful contributor to

Asia’s rise to global economic dominance—is homebred in the OECD: the
multi-decade collapse in reproduction. Before the industrial world began
outsourcing jobs to China, it had begun a process that would ultimately ensure
that outsourcing and soaring trade deficits would not lead to widespread
unemployment. The worker never born is the worker never unemployed.
April 3
GDP is simply output per worker multiplied by the number of workers.
Nations which don’t replace their workforce can maintain neither their
historic economic growth rate, nor their standing in global economic
rankings.
...the Street
Scarcities create winners and losers.
proclaimed
“The End of the The first two shortages showered wealth on the top management of
Commodity Bull commodity-producing companies and on investors in those companies—
Market.” particularly those obstinate souls who held on to their investments through
the numerous occasions during which the Street proclaimed “The End of the
Commodity Bull Market.”
The third scarcity has been benefiting farmers, and the managements and
investors in the relative handful of companies involved in the grain sector.
The fourth scarcity has only begun to appear within the last year: The shortage
of workers, the most important scarcity of all, will inexorably benefit workers
across the OECD, at the expense of managements and investors. As the
Boomers age and retire, they will not be fully replaced by new labor force
entrants. The billions of people that the neo-Malthusians warned would
produce global starvation and sustained unemployment were never born.
They will not be around to produce the wealth that ageing OECD economies
will need to finance social security and health insurance programs—nor to
care for the ageing Boomers and Gen-Xers.
Asia’s Thirst for Industrial Commodities

Today’s shortages of oil and metals were conceived and nurtured in the Triple
Waterfall collapse of those industries.
Crude Oil
July 1985 to April 2007
80
70
60
50
40
30
20
10
0
Jul-85 Jul-88 Jul-91 Jul-94 Jul-97 Jul-00 Jul-03 Jul-06
4 April
Basic Points
The Yom Kippur War and the Carter-assisted takeover of Iran by the mullahs
were the supply-side shocks that by 1980 had driven oil prices to seven times
their Sixties levels. Thereafter, oil was in global surplus because of all the oil
Big Oil had found and developed that the OPEC producers later grabbed.
Fresh from its success in looting, the cartel was able to relax in what seemed Fresh from its
to be perpetual control of petroleum supply and pricing. Houston’s boom success in looting,
and bust from 1973 through 1988 was only the biggest and most-publicized the cartel was able
chapter in a grim story of economic contraction across the non-OPEC oil to relax ...
world. Bankruptcies decimated the ranks of the drilling and oilwell service
companies, a melancholy pattern that reinforced the oil industry’s conviction
that OPEC’s hegemony would endure forever.
Within that cartel, a new kind of competition emerged—for shares in OPEC’s

quotas. As the “swing producer,” Saudi Arabia adjusted its production to
leave room for oil from the smaller member autocracies. That benign regime
soon found itself challenged by widespread cheating among its membership.
Given the ethical makeup of the club, that should have been no surprise.
Quotas were set in relation to each member’s statement of its proven reserves.
This honor system meant there was an incentive to overstate reserves. (That
would become Nigeria’s motivation to force Shell to overstate its Niger Delta
reserves.)
The other temptation toward what a critic might call “OPECcancy” was to
produce above quota and make private arrangements to sell the excess to
anyone (such as Marc Rich) who promised anonymity, could lease tankers
and find customers eager to buy discounted oil.
By 1986, the Saudis, experiencing severe budget problems from their

exploding population and imploding economy, decided that swinging could
no longer be their thing. Sheik Yahmani, Saudi oil minister and grand vizier
of OPEC, opened the Saudi spigots wide—driving oil prices below $10 a
barrel.
The Saudis’ dramatic assertion of power battered an already depressed global

oil industry into submission. Its agonies were briefly eased when the First
Gulf War sent oil prices briefly higher. Thereafter, the strong global economy
of the 1990s created a record international stock market boom at which Big
Oil was a mere bystander. Worldwide, drilling remained at depressed levels,
and few observers noticed the slow upward creep in global consumption—or
China’s switch from being an oil exporter to being an oil importer.
April 5
By the time experts such as Daniel Yergin had finally begun to notice how
Chinese demand was driving global oil prices skyward, the supply side
was already showing signs of serious ageing. Decades of OPEC’s practice
of draining oil revenues to finance corrupt governments and dysfunctional
...their own version economies had led to the inevitable problems of maintaining production.
of The Goose that These regimes were practicing their own version of The Goose that Laid the
Laid the Golden Egg: Golden Egg: they didn’t behead the goose—they just starved it, giving most
they didn’t behead of its food to family pets. The supermajor oilfields, such as Saudi Arabia’s
the goose—they Ghawar and Mexico’s Cantarell, began to experience increasing difficulties
just starved it. in maintaining their output. There were no lusty new giants to pick up the
slack.
Those geologic-based problems for the government-owned oil giants were

unfolding while the private companies were struggling to maintain their
own output. Big Oil decided during the 1990s that its future lay with the
development of major fields in Russia, Venezuela, Nigeria and Angola.
Exxon spun off more than half its interest in Alberta’s Syncrude project to
the Canadian Oil Sands Trust, because Lee Raymond didn’t believe oil prices
would trade above $35 except during brief geopolitical crises, which meant
Syncrude would always be, at best, a marginal profit generator. He needed to
maintain his company’s Reserve Life Index, and for that he required access
to the kind of huge prospects that were on attractive offer from three eager
promoters—Putin in Russia, Chavez in Venezuela, and Obasanjo in Nigeria.
He was even willing to bet heavily on deals with the long-time Communist
thug of Angola, Eduardo Dos Santos. Dos Santos came out on top in the
settlement with Jonas Savimbi that followed a four-decade-long civil war.
Savimbi, who had been backed by the US during the Reagan era, was
assassinated in 2002 by government troops, reportedly backed up by South
African mercenaries.
Mr. Raymond turned out to be absolutely right about the quality of oil reserves
available from those countries, and absolutely wrong about the political risk
to his stockholders from relying on his deals with them. His company has
already been seriously stiffed by Putin and Chavez, and Angola has joined
OPEC, and has recently announced it is dissatisfied with the terms of deals
made when the central government was distracted by its problems with “the
rebel Savimbi.” By the time Mr. Raymond retired, the world’s largest private
sector oil company was risking Paper Tiger status because of increasingly
questionable assumptions about its Reserve Life Index.
6 April
Basic Points
XOM should be greatly discounting the value of its giant reserves in Russia
and Venezuela, and should be assigning some risk factor to its reserves in
Nigeria and Angola. The other highly questionable aspect of Big Oil’s reserve
accounting that is very important to XOM is boe—converting natural gas
reserves to oil on its energy-equivalent basis. Exxon’s acquisition of Mobil ...Big Oil’s global
had given it ownership of that company’s giant LNG operations in Indonesia. challenges...
According to SEC rules, six units of LNG in a producing field connected to competition for
pipelines counted as a barrel of oil in a company’s RLI. That historic ratio ownership of oil
reflected the relative energy content of six mcf of natural gas compared to and gas properties
a barrel of oil, and the relative prices of those two fuels during the 1990s from a new crop
tended to validate the accounting assumptions. However, LNG is the result of of state-owned oil
a costly cryogenic process of cooling and compressing the gas and shipping companies...
it in specially-built tankers. Gas to be converted into LNG is hardly worth as
much as gas delivered to a pipeline. Only if oil prices soared far faster than
gas prices would Exxon-Mobil have real problems, but that seemed like pure
fantasy as long as OPEC controlled global oil prices.
XOM’s problems were broadly representative of Big Oil’s global challenges.

The industry had historically functioned in a bipolar world—OPEC and
the privately-owned oil producers. As the new decade dawned, the majors
and supermajors began to face competition for ownership of oil and gas
properties from a new crop of state-owned oil companies, including China’s
CNOOC and Sinopec, India’s national oil company, and the state-owned
companies in oil-rich states of the former Soviet Union.
The Miners Get a Major Shock

Copper
December 1988 to April 2007
400
350
300
250
200
150
100
50
Dec-88 Dec-91 Dec-94 Dec-97 Dec-00 Dec-03 Dec-06
April 7
The mining industry went through similar misery—and a similar un-
anticipated shock of prosperity.
Base metal producers had some moments of elation during their Triple
Waterfall Crash—notably the speculative copper squeeze of 1988—but the
Regrettably, Inco
industry was, apart from the global Left and the armaments makers, the
and Falconbridge
biggest loser from the Fall of the Wall on 11/9/89. That meant the Cold War
are no longer held
would soon end, thereby slashing global demand for military hardware. In
publicly; had they
an eerie numerological coincidence, that outbreak of painful peace would
not been acquired
end on 9/11/01.
at bargain prices...
Canadian base This decade has seen what consumers considered shocking increases in the
metal stocks’ prices of minerals, and what Wall Street strategists considered even more
performance would shocking increases in the prices of the shares of the mining companies.
be beyond Shock— (Regrettably, Inco and Falconbridge are no longer held publicly; had they
and be within the not been acquired at bargain prices by acquisitors whose wisdom so vastly
realm of Awe. exceeded the Street’s, Canadian base metal stocks’ performance would be
beyond Shock—and be within the realm of Awe.)
Gold’s performance was a useful benchmark of the global trend from

runaway inflation to disinflation and even deflation: apart from brief rallies,
its two-decade-long collapse finally bottomed in 2001—when deflation was
the clear and present danger to many major economies. Its strong rally since
then was not a sign of the return of 1970s-style inflation psychosis, but a
reflection of soaring Indian and Chinese demand. Like the devastated oil and
base metal industries, gold’s long bear market had created conditions that
would prevent a characteristic response to soaring product prices.
A summary of what we have been saying since 2002, about the commodity
industries:
1. The hundreds of millions of new Asian residents of homes with indoor

plumbing, electricity and basic appliances, and the tens of millions of
new owners of cars have been the progenitors of the huge price increases
for energy and metals.
2. Unlike all the earlier commodity cycles, this soaring demand has produced
merely a series of baby-step supply side responses. For the first time,
the historic pattern of major production increases that came on stream
when—or after—commodity prices peaked did not repeat itself.
3. In part this is due to the long-term pain to producers from the Triple
Waterfall: The greatest investment opportunities come from an asset class
where those who know it best, love it least, because they have been disappointed
most.
8 April
Basic Points
4. Big Oil has been the commodity world’s biggest loser from the widespread
operation of our Law of Political Risk for Third World Commodity
Producing Countries: The political risk for foreign investors increases as the
square of the price increase of the commodity. Russia, Venezuela, Ecuador
and Bolivia are the trend-setters. If the Reserve Life Index of Big Oil were The political risk for
adjusted for the noxious political developments in those countries, it foreign investors
would go down sharply—and few of those companies would qualify as increases as the
true Blue Chip investments on a longer-term basis. square of the price
increase of the
The Bull Market in Grains: The Meat of the Story commodity.
The sudden bull market in feed grains and oilseeds, (which will inevitably
trigger food price inflation) has, to date, produced more skeptics than
believers.
Corn
April 2004 to April 2007
450
400
350
300
250
200
150
Apr-04 Aug-04 Dec-04 Apr-05 Aug-05 Dec-05 Apr-06 Aug-06 Dec-06 Apr-07
Soybeans
April 2004 to April 2007
1100
1000
900
800
700
600
500
400
Apr-04 Aug-04 Dec-04 Apr-05 Aug-05 Dec-05 Apr-06 Aug-06 Dec-06 Apr-07
April 9
To the skeptics, who have dominated the media commentary, these outsized
gains come from “the ethanol craze.” They sarcastically argue that ethanol is
taken seriously primarily because the Iowa primary (the caucuses) must be
taken seriously by all presidential candidates.
...the impact of
Apart from this cynical (and possibly accurate) view of the motives of the
China and India on
most prominent ethanol proponents, critics of corn-based ethanol as a
coarse grain prices
gasoline substitute note that it is protected by a 51-cent tariff against sugar-
is a déjà vu story.
based ethanol (from Brazil and the Caribbean). As for ethanol being a great
“green” fuel, the critics point out that the amount of gasoline needed by the
farmers to produce and deliver the corn, and to transport the ethanol to gas
stations, plus the amount of natural gas needed to make ammonia-based
fertilizer and operate the ethanol plants, makes the net energy from truly
renewable sources minimal.
Supporters point out that ethanol burns cleaner than regular gasoline or
MTBE, and that the risks to the US from dependence on the Gulf States and
Venezuela justify the extra costs. Chavez and Ahmadinejad are ethanol’s
biggest advertisements, and they manage to inject their spleen into global
headlines with sufficient frequency to make ethanol look like a Heaven-sent
ingredient in national security strategy.
There is a precedent for building uneconomic energy facilities. Virtually

no American nuclear power plants would have been built if they had been
based on competitive economics—because in the Fifties and Sixties oil was
routinely trading at $3 to $4 a barrel. Eisenhower said the nation’s long-
range national security dictated a large-scale commitment to nuclear power,
and at that time the Sierra Club was no national force—so the nukes were
built.
In the past week, there have been signs of media rethinking of the grains story
as being much more than ethanol. Both The New York Times and The Wall
Street Journal published articles showing that Chinese meat consumption is a
crucial component in the pricing of corn and soybeans.
As we have been arguing rather strenuously this year, (including in interviews

with reporters of The Times and Journal) the impact of China and India on
coarse grain prices is a déjà vu story: we saw what they did to the prices
of oil, coal, steel and base metals. In its well-researched story on soybeans,
10 April
Basic Points
The Times printed a chart showing China’s soybean imports soaring from 10
million to 33 million tons over the past six years. Not one of those beans is
being converted to biofuel.
Potash Corporation’s annual report notes, “China’s GDP grew more than 10%,
There are no
while India’s was up 8%...With higher incomes, the first priority for many
super-giant
people is more nutritious, protein-rich food. China’s meat consumption,
grain fields...
for example, has more than tripled in less than two decades. Producing
more animals takes a greater use of grain and feed supplements….A rising
global population with more money leads to spreading urbanization.
The agricultural land base per capita is less than half the 1950 level and is
expected to fall a further 13% by 2020 making higher crop yields a necessity.
Added to this, uncertainty over the world’s oil supply and desire for cleaner
fuels have resulted in a surge of demand for alternative energy sources such
as biofuels.”
The new boom in global grain prices is, in large measure, based on the rapid
growth of the Asian middle class. The people who went from bicycles to
motorcycles to cars, and from hovels to homes with indoor plumbing and
electricity, are graduating from a diet of rice, lentils and bread to the inclusion
of dairy products and meat. The growing prosperity of the US’s midsection is
coming from the growing midsections of the growing middle class in Asia.
This change in the diets of the new Asian middle class would have ultimately
had important implications for global food price inflation. But when the
already short supplies of corn and soybeans were bid up by biofuel producers,
the two decades of benign food prices came to an end.
To date, North American prices for meat and dairy products have not
reflected the huge price increases for corn and soybeans. Producers’ hedges
have cushioned the impact to date, but those are wearing off.
The third kind of commodity boom—feed grains and oilseeds—is different

from the others in one major respect: there are no super-giant grain fields,
and the only political challenges come from EU and environmental paranoia
about genetically-modified seeds, and from other forms of protectionism.
Otherwise, this boom is like the others: there has been remarkably modest
supply side response to the surge in demand for feed grains and oilseeds.
April 11
Global acreage allocated to coarse grains, as the following data published by
the USDA Economic Research Service shows, has been virtually unchanged
in this decade.
World Supply & Utilization of Major Crops, Livestock, & Products

[from USDA Economic Research Service: “Agricultural Outlook: Statistical Indicators”]
1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 F 2006/07 F
Million units
Wheat
Area (hectares) 228.4 225.1 215.4 217.6 214.7 214.6 209.9 218.8 218.4 212.8
Production (metric tons) 610.0 590.0 585.8 581.5 581.1 567.6 554.6 628.6 620.6 593.1
Exports (metric tons) 104.5 102.0 112.7 104.1 110.8 110.1 104.5 113.1 113.6 110.7
Consumption (metric tons) 577.3 579.0 585.0 583.9 585.0 603.8 588.5 610.0 624.4 619.3
Ending stocks (metric tons) 197.1 208.1 208.9 206.5 202.7 166.6 132.7 151.2 147.5 121.2
Coarse grains
Area (hectares) 311.2 308.5 299.7 296.7 301.4 293.0 306.9 300.4 301.1 302.7
Production (metric tons) 881.2 890.9 877.6 862.3 893.7 875.1 915.9 1,014.0 977.5 966.7
Consumption (metric tons) 867.2 869.2 882.4 884.4 906.6 902.3 945.9 975.9 989.1 1,014.5
Oilseeds
Crush (metric tons) 264.3 278.4 247.3 254.4 264.9 268.9 278.5 302.1 317.9 324.6
1998 1999 2000 2001 2002 2003 2004 2005 2006 P 2007F
Beef and Pork

Broilers and Turkeys
Dairy
Milk production (metric tons) 373.7 376.7 381.6 384.8 395.0 399.0 406.1 414.0 423.3 432.2
Source: USDA Economic Research Service, Agricultural Outlook: Statistical Indicators, March 2007: http://www.ers.usda.gov/Publications/
AgOutlook/AOTables/
Result: this crop year carryover will be the lowest (in relation to consumption)
on record. Huge price increases for grains have not produced meaningful
expansions in acreage. In the US, the conservation set-asides have remained
roughly intact, as farmers content themselves with Washington’s rental
payments for marginal lands that protect wildlife.
12 April
Basic Points
Abroad, Brazil has the potential to open up large tracts of well-watered land
for soybeans, but the fields are more than 600 miles from the sea, and the
only transportation is by truck over a narrow, potholed road. Most other
major grain producers are already using all the watered land available. Coarse
grains and oilseeds need far more water than wheat production requires, so How many of these
the potential for expanding output now that corn and beans are so expensive new investors in
is modest. Each week, as the cities of China and India expand, more farmland agriculture, one
disappears. wonders, can tell a
heifer from a steer
The USDA announcement, on March 30, of farmers’ planting intentions
was the most eagerly-awaited in history. Corn had become a Page One story,
as hedge funds crowded into corn futures and tales of Wall Street denizens
buying farmland were relayed on trading desks. (How many of these new
investors in agriculture, one wonders, can tell a heifer from a steer, or know
that the word “gilt” is a proper noun for a female pig, whereas “gilt” as
used on the Street is the slang contraction of “gilt-edged”—the term for UK
government bonds?)
Naturally, these late enthusiasts for the agricultural story drove spot corn
prices up too fast, and were in a panic to exit their positions when it was
announced that the acreage for corn would be the biggest since 1944. (Back
then, photographs of much of what is now Chicago, Greenwich, Boston and
Atlanta could have been used to depict the “amber waves of grain.”)
With corn down-limit after the report, some of Wall Street’s most prominent
soothsayers could barely contain their glee. They tut-tutted the “dangerous”
level of commodity speculation. (When the Street becomes pompously
puritanic about “speculation,” while a bull market is still rampant, it usually
means that those who have been making money by taking risks have been
earning outsized returns in products or sectors the Best Minds had not been
recommending.)
Stories exulting spot corn’s plunge from $4.25 to $3.75 led readers to believe
this noisy market effusion had only been a belch, not the proof of a sustained
change in the behavior of the system.
April 13
True, there was no doubt that the ethanol story was generating speculation,
and that many of those players had been forced to leave the field. However,
the value of the corn crop to be harvested in 2008 attracted rather less attention
from the speculators, and considerably less rage/shock/disappointment/
...the value of profit-taking/panic after the USDA report was published.
the corn crop to
be harvested in Corn
2008 attracted... Sept 2006 to April 2007
less rage/shock/ 450
disappointment/
400
profit-taking/
panic... 350
300
250
200
Sep-06 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07
Corn Futures December 2008

Sept 2006 to April 2007
410
390
370
350
330
310
290
Sep-06 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07
In all past periods when corn and bean prices surged, the cause was a crop
failure that did not recur. Futures market prices for the following year’s crops
did not share in the short-term bullishness. Big backwardation was the
pattern in the charts.
Not this time.
14 April
Basic Points
What is happening in the grains is more like what happened to oil prices:
coarse grain prices have gone up—and stayed there through another crop
year—without any actual or expected interruption of production and without
stimulating huge new global plantings.
This time, it could
The sharp rise in corn plantings that the USDA reported for this year comes
be the shortage
mostly at the expense of soybean planting, but also from cotton. In terms of
of bees.
feeding the newly carnivorous tummies in China and India, the switch in
planting from soybeans to corn still means higher feeding costs for livestock
production, because soybean meal (48% protein) is the most efficient way
to produce animal protein.
The Midwest, the pre-eminent global corn producer, has had 15 straight years
without a significant crop failure—the longest on record.
What if the prairie skies are not cloudy all day this July?
What if food price inflation becomes the highest in decades at a time when
oil prices continue to trade near $60?
Food Price Inflation – Can Bondholders Stomach It?

Food price inflation has already begun. As with some past inflation shocks, it
could be kick-started into high gear by a spectacular piece of bad economic
luck. The painful food-price inflation of the 1970s was kicked off by the
collapse of the anchovy harvest after the major El Niño of 1973. (Back then,
anchovies were the protein feed supplement of choice. Thereafter, soybean
meal replaced them as the staple.)
This time, it could be the shortage of bees.
Bees are nature’s gift to producers of a wide range of crops, particularly fruits.
For reasons experts have not yet been able to establish, the populations in
bee colonies across much of the US and Canada have been decimated since
last autumn. Apiarists call this a crisis. Already a Congressional committee
has met to consider the evidence and suggest some remedies. Even now,
nobody knows with any certainty what has caused the die-back and nobody
knows what to do. It has already spread to nine countries in Europe.
April 15
Honey Bee Colony Collapse Disorder
Map of Affected States, February 2007
Investors should
take note of the
“frankenfood”
smears.
Source: USDA Economic Research Service, Agricultural Outlook: Statistical Indicators, March 2007;
and Mid-Atlantic Apiculture Research and Extension Consortium (MAAREC), February 2007,
[http://maarec.cas.psu.edu/pressReleases/CCDMap07FebRev1-.jpg].
How can a previously-unknown pathogen suddenly appear and proceed to

slaughter bees on an unprecedented scale across much of North America and
Europe simultaneously?
Some environmentalists are using this phenomenon to rally new support

against “frankenfoods,”—genetically modified seeds. The only evidence they
have is that no one has been able to identify the culprit. Ergo, something
they’ve always feared and despised must be to blame. Anyone who looks
at the map from the Congressional report showing the incidence of CCD
would see that the cornbelt—where GM seeds have taken over—still remains
nearly free of reported die-backs.
Nevertheless, investors should take note of the “frankenfood” smears,

because Monsanto, DuPont and Syngenta may well be judged guilty until
they prove their innocence. ’Twas ever thus. When syphilis suddenly spread
across Europe in the late 1490s, the English immediately called it “The French
Disease,” and the French called it “The English Disease.” In reality, Spain was
to blame. It had been brought back from the New World by Columbus’s men
and by the troops accompanying the conquistadores—partial punishment for
the Europeans’ introduction of smallpox to the Americas.
16 April
Basic Points
A prominent American beekeeper, who was the first to go public with a report
of die-back, suggests that widespread adoption of a new kind of pesticide—
neonicotinoids—could be the explanation.
Crops that collectively contribute approximately one-third of the American

...if there ain’t
diet, and almost $15 billion to the US economy, are at risk. A Research
hay in Wisconsin
Report to Congress on this previously-unknown conditions, tentatively titled
this summer, the
“Colony Collapse Disorder” notes: “Across the US 35% of all the bees are
milk and cheese
gone. In some states 90%”.
consumer’s cost
In particular, alfalfa, which is the key component of hay, relies entirely on ain’t hay.
insect pollinators. The dairy industry, already reeling from soaring corn and
soybean prices, could be truly at bay.
And if there ain’t hay in Wisconsin this summer, the milk and cheese
consumer’s cost ain’t hay.
If the bees don’t return with the flowers of spring, food price inflation this
year, which is already climbing quite strongly, will be at front-page scare
story levels before the full impact of $3.80 corn has reset the prices of meat,
cereals, eggs, and dairy products.
Inflation Pressures: Bad-Luck Ben follow Auspicious Alan?
US Year-Over-Year CPI
January 1998 to April 2007
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07
Fed Governor William Poole, who hails from the St. Louis Fed, the keeper
of the purity of the monetarist flame, recently gave a speech in which he
restated the Fed’s responsibility as fighting inflation—not trying to manage
the economy. Located not far from fields where corn and soybeans would
soon be planted, he was certainly aware that inflationary pressures were
returning. He expressed himself as very worried about inflation.
April 17
Alan Greenspan luxuriated in baths of sweet-scented admiration. He was
even knighted. (Her Majesty, as we know from seeing The Queen, has her
off days.) He was certainly lucky. His predecessor, the saintly Paul Volcker,
was finally called in by Carter as the US was sinking into a stagflationary
Long-Term Capital swamp. He had to drive interest rates to seemingly intolerable levels to undo
Markets, which the damage. Greenspan inherited a strong economy experiencing falling
imploded due inflation and falling interest rates, which was on the cusp of the strongest
to a heretofore productivity gains in a generation.
unknown
These blessings gave him the flexibility to dabble in another role—the
condition—
Manager of the US Economy—the Maestro, as he would be called in a best-
a critical mass of
selling hagiography. He could respond to collapsing stock markets or a
Nobel economists.
weakening economy by slashing interest rates and printing money, without
worrying about the impact on inflation.
Having helped to inflate a commercial real estate bubble that then burst,
leading to a recession he didn’t recognize even when it was half-way
completed, he would move on to bigger game—presiding over the biggest
stock market bubble of all time. His sole act of restraint was to produce
a one-day stock market selloff when he publicly mused about “irrational
exuberance.” His final injection of gas into the bubble came when he was
once again delivering the “Greenspan Put” to a tottering financial market
after the collapse of Long-Term Capital Markets, which imploded due to a
heretofore unknown condition—a critical mass of Nobel economists.
Nasdaq
September 1, 1998 to March 10, 2000
5500
5000
4500
4000
3500
3000
2500
2000
1500
1000
Sep-98 Nov-98 Jan-99 Mar-99 May-99 Jul-99 Sep-99 Nov-99 Jan-00 Mar-00
The recession which followed the Nasdaq collapse occurred at a time when
Greenspan had carte blanche to restimulate the economy, because, for the first
time since the Depression, the pricing challenge to the US economy came
from deflation.
18 April
Basic Points
Ben Bernanke has no such luck.
Greenspan’s Chairmanship was mostly characterized by surpluses and soft

prices for commodities, and by labor surpluses and weak wage pressures
from workers; moreover, he could, with a flourish that made him seem to his
Mr. Bernanke,
acolytes like a monetary Batman, rush to the rescue of a frightened Gotham
known for his beard,
with the Greenspan Put without worrying over-much about a dollar collapse,
not his Batmobile
because of the reliable support from Beijing and Tokyo—the deep-pocketed
partners in “The Great Symbiosis”.
Mr. Bernanke, known for his beard, not his Batmobile, faces a far more
hostile economic and financial environment. The global economic climate
is changing from strong to weak growth, and from weak to strong inflation.
US Dollar Index
February 2006 to April 2007
92
90
88
86
84
82
80
Feb-06 Apr-06 Jun-06 Aug-06 Oct-06 Dec-06 Feb-07 Apr-07
Gold
750
700
650
600
550
500
April 19
Copper
400
The BOJ...unleashed
350
panic among the
conspicuously rich 300
in Greenwich and in
London’s West End. 250
200
iShares Emerging Markets (EEM)

125
120
115
110
105
100
95
90
85
80
Just prior to taking over as Chairman, he had cleverly arranged to have the
Bank of Japan intervene in soaring metal markets by commissioning, editing
and publishing, in his Journal of International Central Banking, a memo
prepared by BOJ economists showing how the BOJ’s zero interest rate policy
had unleashed a huge expansion of the euroyen market that let hedge funds
and investment banks borrow at less than 0.5% to play in a variety of risk
assets—notably gold, metals and Emerging Markets. When the BOJ at its
March meeting reversed that policy, draining 30 trillion yen (roughly $175
billion) from its Monetary Base in a mere 11 weeks, it unleashed panic among
the conspicuously rich in Greenwich and in London’s West End.
20 April
Basic Points
With gold and copper back up near their 2006 highs, is it time for another
BOJ bash on speculation?
The BOJ is not ready for an encore, given the ponderous, Kabuki-paced level
of activity in the Japanese economy. The Bank announced this week that it
Most nightmares do
was holding its rate at 0.5%. In his commentary on the meeting, Governor
not prefigure actual
Fukui said that the yen’s weakness was not due to a major resumption of
disasters, except in
the carry trade. He was suitably opaque: “Currencies fluctuate every day for
plays and novels.
various reasons, but at the moment the movement is stable.”
Some do.
A year ago, he was able to cite a strengthening Japanese economy when he
bailed out Bernanke. That return of robustness turned out to be yet another
false dawn over what was once called the Land of the Rising Sun.
In a very real sense, the inflation signals from commodities are much
stronger now than then. Back then, grains were still, as they had always been,
objects of government solicitude—both in the US and EU—as unzippered-
wallet recipients of farm income supports. Now, the grains are threatening
to unleash the strongest food price inflation in years. If gold goes through
$700 to stay this time, and if the dollar breaks 80 on the Dollar Index, then
discussions at the Fed will not focus on parsing the meaning of the most
recent Retail Sales and Non-Farm Payroll reports—or even about the plunge
in housing starts at the outer reaches of the nation’s cities on lands that could
be more wisely used for corn or soybeans.
The Bernanke nightmare scenario: subprime problems hobble the financial

system, and the housing and auto sectors go into deep recession together,
dragging the economy down at a time CPI increases become the highest in
many years and the long end of the bond market finally responds the way
Greenspan predicted it would when he started tightening three years earlier.
The dollar breaks down, foreign central banks find themselves unable to help
much, and the stock market plunges.
Most nightmares do not prefigure actual disasters, except in plays and

novels.
Some do.
April 21
The Fourth Scarcity: People
Japan’s approach to reproduction (DON’T!) has become the role model for
most of the OECD. At current European and Canadian fertility rates, each
ensuing generation’s workforce will be roughly half the size of its predecessor.
Japan is
Japan is maintaining its lead in the tortoise-paced race to long-term extinction,
maintaining
but it now has plenty of competition. Among the ways today’s Japan ensures
its lead in the
that the birth rate continues its asymptotic decline is by the decrease in the
tortoise-paced
supply of obstetricians to the zero level in smaller towns and cities.
race to long-term
extinction. In America, the Fourth Scarcity is the product of a notably successful campaign
in the Sixties and Seventies to change American reproductive habits based on
wildly inaccurate forecasting. Paul Ehrlich, author of the Sixties bestseller
The Population Bomb, predicted global disaster from overpopulation, and
his acolytes had enormous impact. The US fertility rate fell from 3.42 per
woman in the early 1960s to 1.8 by 1975.
That deficit has, in the United States, been offset somewhat by the flood of
illegal immigrants and their offspring, and, (to a lesser degree) in Europe
by Muslim immigrants and their offspring However, the success of the neo-
Malthusians’ campaigns among the established US population is reflected in
today’s overall shortage of US workers, with the unemployment rate holding
at 4.4% despite slowing economic growth.
Within the OECD, only in America are babies being produced at the
replacement rate—2.1 per female. According to the diehard environmentalists,
for whom babies are consumers of resources and emitters of CO2, this is just
another example of Americans’ scandalous disregard for the planet Earth.
(Latino mothers who are collectively responsible for America’s atypically
high rate of reproduction do not, it would appear, belong to Friends of the
Earth.)
But maintaining the fertility rate at the Zero Population Growth level doesn’t
provide enough new entrants into the labor force to offset the ageing of
the Baby Boomers, or to keep GDP growth rates above 3%. Last Friday, it
was reported that the US had added more jobs than economists expected,
driving the unemployment rate down to just 4.4%. It was also reported that
22 April
Basic Points
US employers have already used up the quota of highly-trained professional
immigrants on H-1B visas for this year (a pitifully low 165,000), and that they
would hire hundreds of thousands more if the government would let them
in. (Congressional policy, in a display of bipartisanship on the immigration
question, cannot agree on doing anything effective about keeping out millions What if they
of mostly untrained immigrants who cross into this country illegally, but had a recession
will continue to ensure that the American executives, engineers, scientists, and nobody
nurses and doctors are protected against competition from potential turned up at the
immigrant executives, engineers, scientists, nurses and doctors. As Microsoft, Unemployment
IBM and other major companies have told Congressional committees, one Office?
of the biggest stimuli to outsourcing is the shortage of qualified workers in
America.)
Meanwhile, in Canada, which has very few Latino immigrants, the

unemployment rate is at a thirty-year low—along with the fertility rate; in
the EU, the unemployment rate is at a 14-year low, driven by above-trend
economic growth surging to an unsustainable 2%.
What if they had a recession and nobody turned up at the Unemployment

Office?
No, we aren’t predicting the end of the economic cycle. We are predicting
that if a US house price collapse does indeed trigger a recession in North
America, unemployment, like politics, will be mostly local.
The drastic change in reproductive habits across the industrial world since
1970 has meant that today’s populations in those countries are roughly one-
third smaller than Sixties demographers predicted (adjusting for improved
mortality experience during that period).
One way of looking at this is to compare it to the Black Death, which wiped
out more than one-third of Europe’s population in four years. The hardest-
hit nation was Britain, where, experts now believe, an anthrax epidemic
among cattle and sheep increased human mortality above the rate seen on
the Continent. Medical practitioners of the time were obviously not skilled
enough to be able to isolate anthrax deaths from bubonic plague deaths.
April 23
What happened in England after the plague subsided is well-recorded.
Feudalism, which was already decaying because of the growth of towns,
barely recovered. Many barons and other landlords were no longer able to
rely on their serfs to look after their estates, and had to recruit laborers in the
That was Sudden open market. It no longer became possible in most shires to enforce the laws
Death: this is that tied serfs to their lords’ demesnes. Nor was the Church able to insist that
Slow Dearth. its lowliest parishioners had to abide by their oaths of loyalty to their lords.
One reason was that the mortality rate from the plague was frequently highest
among the clergy; priests and nuns who, obedient to their vows, continued to
attend the dying and deceased, were obviously at high risk of contracting the
disease; since so many clergy lived together in monasteries, the disease could
spread rapidly: many a monastery and nunnery was completely wiped out.
Why, asked the newly skeptical, did those who devoted their lives to serving
God die at a higher rate than the rest of the populace in Christendom?
There is no spiritual component to this latest massive population loss.

That was Sudden Death: this is Slow Dearth. Because the economic impact
has developed slowly over the past two decades, during a time when the
impacts from technology and competition from low-wage nations were
leading to highly-publicized layoffs and plant closures at long-established
corporations, the declining rate of new entrants to the labor force attracted
little attention.
Ben Bernanke has mentioned wage inflation pressures twice in the past
month. That Average Hourly Earnings are now growing at the same rate as
when the Fed last tightened may be a coincidence. But back then, GDP and
overall employment were growing more briskly than now. The difference, we
believe, is that the pool of potential new workers ages 18-25 keeps getting
smaller. The Street’s assumption that a weak payroll number means the
economy is growing too slowly has been valid for most of the past fifty years.
But when the supply of labor is no longer in surplus, a lack of jobs growth
could be due more to employers’ inability to find the workers they want at
the rates they are willing to pay them, than because the economy’s gears are
stuck in neutral.
There may be one last big rally in bonds if a recession arrives.
After that, it will be time for a Requiem for the Greatest of Them All.
24 April
Basic Points
Preparing a Goodbye to the Greatest of All Bond Bulls

This bond bull is a record-setter—in terms of its duration and the scale of the
drop in interest rates.
US 10-Year Treasury Note Yield One by one, the
May 1987 to April 2007 non-monetary-
11 policy factors
10 promoting
9 disinflation have
8 been crumbling.
7
6
5
4
3
May-87 May-90 May-93 May-96 May-99 May-02 May-05
Government of Canada 10-Year Bond Yield

June 1989 to April 2007
12.5
11.5
10.5
9.5
8.5
7.5
6.5
5.5
4.5
3.5
Jun-89 Jun-91 Jun-93 Jun-95 Jun-97 Jun-99 Jun-01 Jun-03 Jun-05
The remarkable global economic progress of the past 25 years has come largely
because Paul Volcker, Karl-Otto Pohl, Ronald Reagan and Margaret Thatcher
challenged and conquered the inflation that had been gaining strength even
as industrial economies weakened over the previous three decades.
One by one, the non-monetary-policy factors promoting disinflation have

been crumbling. First and second to go were cheap energy and cheap metals.
Until recently, five powerful factors that had helped hold down inflation
were still at work—food prices, labor surpluses, a reasonably firm dollar,
disinflation driven by imports and outsourcing, and productivity gains.
April 25
The last two factors are still disinflation-friendly: the US continues to import
disinflation. As for productivity, it no longer promotes cost controls as
powerfully as it did from 1994 through 2002, a process Alan Greenspan
correctly identified.
The Year
A strong dollar is a powerful disinflationary force. The dollar is no longer
of the Death
strong, but it hasn’t completely broken down.
of the Bond: 007.
US Dollar Index
92
90
88
86
84
82
80
As for labor costs, average hourly earnings in the US have been climbing at
more than 4%—their fastest clip since the peak of the last cycle. Anecdotally,
we hear new stories each week of employers’ difficulties in finding qualified
help. The Challenger layoffs report last week not only did not project more
bad news for employees, but reduced the number of previously-announced
layoffs that would actually be implemented.
A recession might stop this rise in wage costs in its tracks, but the ensuing
recovery will, we believe, see an historic shift in the power balance between
employers and workers. The big, unseen Presence at all future bargaining
tables will be the Unborn. They will be casting their votes for the workers—
and against management.
The Year of the Death of the Bond: 007.
26 April
Basic Points
INVESTMENT ENVIRONMENT
On CNBC last week, I followed two commentators who were agreeing that a
weak Non-Farm Payroll number could make the Fed cut rates. I argued that
with a weak dollar, gold heading back to $700, food inflation, commodity New Century
inflation and now wage inflation, “those who keep looking for a Fed rate cut Financial, the most
are out to lunch….and lunch will cost a lot more.” conspicuous creator
and packager of
Everyone seems to agree that the main challenge to the US economy comes
toxic waste, is the
from the end of the boom in house prices. Like so many American real estate
biggest bankrupt
booms, its latter phases included excess supplies of credit and weakening
to date, but more
credit standards. Alan Greenspan kept the fed funds rate at a risible 1% for
will join it in the
too long, and a motley host of new-age mortgage originators and investors
mortuary.
found neat new ways to debauch longstanding credit guidelines and
constraints. It was as if those slick Silicon Valley denizens who pioneered
and proliferated the back-dated stock option programs were called in by the
new breed of mortgage originators. The tech sharks would do their best to
ensure that probity in mortgage appraisals would become as rare as probity
in tech companies’ financial reports.
As discussed in last month’s issue (DON’T ASK; DON’T TELL: IT’S SUBPRIME
TIME!), the subprime mortgages with teaser rates, followed by resets to
market rates, have conspicuously high mortality rates.
Adjustable rate mortgages are priced off Libor, whereas conventional fixed-
rate mortgages are priced off the Ten-Year Note. Floating rate subprime
mortgages and so-called “Alt-As” and “Alt-Bs” are Libor-priced.
We get the feeling that much of the urgency out there for a Fed rate cut is that
it would cut Libor and that would help the mortgagors most at risk—those
facing resets.
Why shouldn’t the Fed ease their pain—and the pain being experienced by
financial institutions who lent not wisely, but to the financially unwell? The
pain is already over for 20 of the upstart mortgage lenders; they have gone
bankrupt or otherwise out of business. New Century Financial, the most
conspicuous creator and packager of toxic waste, is the biggest bankrupt
to date, but more will join it in the mortuary. It now appears that nearly
40% of all mortgages issued last year in the US were subprime or the next
category up—Alt-As. Since the borrowers either had no proof of their ability
April 27
to service the debt (subprime) or inadequate proof (alt-As), the already-high
default rate on home mortgages would become grim were the US to fall
into recession. This week a major mortgage REIT revealed that it was taking
writedowns on some loan packages ranked as high as AA. It would appear
...the fed funds that confining the term “problem loans” to the categories that may appear, on
rate was 1%— closer examination, to be designed primarily for the hapless homeless does
the equivalent not address the full problem. It is as if there were a large cesspool upwind of
of pricing a real an upscale neighborhood: the odor would not be confined to the low-rent
diamond as if it district. Senator Dodd, Chairman of the Senate Banking Committee, pledges
were a rhinestone... aid (undescribed) to borrowers who are victims of “predatory” lenders. (The
Senator’s use of the term “Predatory” in this context is confusing. Does being
a predator involve shoveling out 100% or more of the purchase price of a
house to people whom any experienced, disciplined lender would rate as
likely deadbeats? Or does the predator prey on investors in the Collateralized
Debt Obligations who he thinks will soon be stuck with a portfolio full of
garbage?)
The Greenspan Put was a great gift for bad banks and hubristic hedge funds.
It was never designed for consumers who were in over their heads. To the
extent that Greenspan concerned himself with homebuyers, it was to give
advice that turned out disastrously. It was he—lest we forget—who, when
the fed funds rate was 1%—the equivalent of pricing a real diamond as if
it were a rhinestone—advised homebuyers and homeowners not to burden
themselves with fixed-rate mortgages at the high interest rates that the
then-upward-sloping yield curve decreed. “Get the low-interest, adjustable-
rate mortgages and rely on us to keep out inflation so those rates won’t go
up,” quoth the newly-knighted seer. Given his media reputation, perhaps
we should not be surprised that the number of subprime loans using resets
exploded after Greenspan gave his recommendation. Perhaps his parting gift
to his successor was a few million mortgage defaults based on his ability to
time the market.
Perhaps we are seeing something even bigger unfold: The Great Bond bull
was born, bred and fed during the era when leftist parties were being wiped
out at the polls. Keynesianism and its American equivalents had reached
global dominance during the 1970s. (When Nixon unveiled wage and price
controls, he proclaimed, “We are all Keynesians now.”) Reagan and Thatcher
demolished the die-hard survivors of the discredited breed. Bill Clinton, was
able to get elected and re-elected at a time of disinflation and skepticism
about big government by espousing centrism and free trade. He might not
be able to even get the Democratic nomination with those policies today.
28 April
Basic Points
The conservatives have had their decades in power, and perhaps voters think
it is time to try protectionism, handouts, increased union power and weaker
defense policies again. History may judge President Bush as the man who
made voters believe they’d be better off doing what had kept inflation and
the Cold War going. It is hard to
construct a bullish
As Marx observed, “History repeats itself: first as tragedy, then as farce.”
scenario for US
stocks against a
Conclusion
bearish scenario
The outlook for bonds had already become bleak before we heard about the for Financials.
vanishing bees.
The possibility that the Bee Die-Back will be the once-in-a-century food
catastrophe that will be the final ingredient in a Perfect Storm for the bond
market may still be remote, but we shall be hearing a great deal in the next
six weeks or so about Apis mellifera, the indispensable member of Order
Hymenoptera.
What is bad for bonds is also bad for Financial stocks.
BKX
135
115
95
75
55
35
15
May-92 May-94 May-96 May-98 May-00 May-02 May-04 May-06
Financial stocks soared skyward along with techs, lending legitimacy to

the Street’s collective replay of The Rake’s Progress on a bigger canvas. The
Greenspan Put and the roaring bond bull market saved them from serious
punishment during the stock shakeout attending the early years of Nasdaq’s
Triple Waterfall crash.
It is hard to construct a bullish scenario for US stocks against a bearish

scenario for Financials.
April 29
However, it is possible—indeed eminently reasonable—to remain bullish
about commodity stocks while going short bonds and the BKX.
The three commodity scarcity stories are long-term in nature, which means
commodity stock investors who can look through a downward correction of
...CEO’s
the dollar and the overvalued bond market can expect continuation of strong
compensation
returns.
packages, which—
in some Black The labor shortage story is also long-term in nature. That it implies that
Mass perversion workers’ shares of the income pie should outpace gains for top managements
of marriage should not be construed as bad news. Plutocracy is not an attractive alternative
vows—pay these to democracy.
princes gigantically
The new SEC rules are forcing companies to tell us about CEO’s compensation
whether the
packages, which—in some Black-Mass-style perversion of marriage vows—pay
stockholders be
these princes gigantically whether the stockholders be richer or poorer, and
richer or poorer...
the payments must continue—or even escalate—after the CEO has departed
the organization until death do them part and he goes to that Great Executive
Suite in the Sky. As the reports of billions in payments made without regard
to performance pour out, we realize anew that one of Milton Friedman’s
greatest insights was, “The principal problem with capitalism is capitalists; the
principal problem with socialism is socialism.”
The scale of CEO compensation packages, even after eliminating those highly-
publicized excesses for which the term “obscene” is inadequate, seems to
be based on a Lake Wobegon-style belief system of boards’ compensation
committees: all CEOs are better than average and ours is among the best of
that superbly-performing lot.
It looks as if the global winners in the next few years will be farmers
and workers. And maybe not CEOs, although they have those external
compensation advisors, who are paid handsomely to tell the Board
compensation committees how to “keep the company competitive.”
If the workers are finally going to receive greater percentage increases in

compensation than the average CEO whose company underperforms, that
might be a consummation devoutly to be wished.
Even though it would mean that the world has changed and the CPI will be
going up.
Painfully.
30 April
Basic Points
INVESTMENT RECOMMENDATIONS
1. Reduce bond durations to below benchmarks, and in particular, reduce
exposure to long duration bonds.
2. In balanced accounts, maintain exposure to long zero-coupon bonds as

hedges against commodity stock positions for as long as US recession risk
remains higher than normal.
3. Maintain market weight in Energy stocks, with emphasis on producing

companies in the Alberta Oil Sands. They will continue to have special
appeal for as long as Big Oil has big problems with its Reserve Life Indices.
Within the oil service sector, emphasize the Offshore Drillers.
4. Overweight exposure to gold, using mining stocks and/or the ETF. If the
US Dollar Index breaks 80, add to your gold positions promptly.
5. Remain overweight the producing base metal stocks with long-life secure
reserves. They remain the pre-eminent asset class for the next five years.
6. Underweight Financial stocks. Within the group, emphasize the “dull”

banks who stick to their knitting, don’t take big derivative bets, and grow
their dividends faster than inflation. Given the huge growth in personal
incomes of the Midwest farming community in this and coming years,
banks headquartered in farming communities will be prime takeover
candidates by big banks headquartered in the coastal regions where the
news will tend to be mostly bad.
7. Continue to build major overweight positions in the agricultural stocks.

This is, like the other commodity groups we have been recommending, a
long-cycle investment theme.
8. The Canadian dollar remains severely undervalued compared to the

greenback. American accounts should overweight Canadian assets (other
than exporting companies). In particular, American investors should
consider the wide range of Maple Bonds now available in what once was
the severely constricted Canadian bond market. Canadian accounts should
underweight US assets. There is no discernible reason for Canadian fixed
income accounts to hold unhedged US dollar-denominated bonds.
April 31
9. Remain overweight Emerging Markets, concentrating on economies with
positive demography. Russia has the greatest diversity of mineral resources
of any major economy, but the worst demography of any major economy.
Caveat emptor.
10. Continue to underweight technology stocks. Within the biotech sector,

consider the GM seed companies as attractive alternatives to the
pharmaceutical companies.
11. Real-return government bonds, are about to become collectors’ items for
the wise. The total supply outstanding is modest, and will prove grossly
inadequate for the coming growth in demand—particularly from pension
funds.
32 April
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the date hereof and are subject to change without notice. Some of the information, opinions, estimates,
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2007 Basic Points APRIL

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Basic Points

BYE-BYE, BOND BULL

April 13, 2007

Produced by BMO Financial Group

Research/Editing Angela Trudeau

BYE-BYE, BOND BULL

Sustained global disinflation was the benign background that allowed—

We are adjusting our Recommended Asset Allocation, deleting our exposure

U.S. Pension Fund

Foreign Equity Allocations

To the stunned statisticians at the International Energy Agency and most

3. Grains and Oilseeds

The third Asian-spawned scarcity—feed grains and oilseeds—has just arrived.

The fourth shortage story—which will be the most powerful contributor to

Asia’s Thirst for Industrial Commodities

Within that cartel, a new kind of competition emerged—for shares in OPEC’s

By 1986, the Saudis, experiencing severe budget problems from their

The Saudis’ dramatic assertion of power battered an already depressed global

Those geologic-based problems for the government-owned oil giants were

XOM’s problems were broadly representative of Big Oil’s global challenges.

The Miners Get a Major Shock

Gold’s performance was a useful benchmark of the global trend from

1. The hundreds of millions of new Asian residents of homes with indoor

There is a precedent for building uneconomic energy facilities. Virtually

As we have been arguing rather strenuously this year, (including in interviews

The third kind of commodity boom—feed grains and oilseeds—is different

World Supply & Utilization of Major Crops, Livestock, & Products

Beef and Pork

Corn Futures December 2008

Not this time.

Food Price Inflation – Can Bondholders Stomach It?

This time, it could be the shortage of bees.

How can a previously-unknown pathogen suddenly appear and proceed to

Some environmentalists are using this phenomenon to rally new support

Nevertheless, investors should take note of the “frankenfood” smears,

Crops that collectively contribute approximately one-third of the American

Inflation Pressures: Bad-Luck Ben follow Auspicious Alan?

Greenspan’s Chairmanship was mostly characterized by surpluses and soft

iShares Emerging Markets (EEM)

The Bernanke nightmare scenario: subprime problems hobble the financial

Most nightmares do not prefigure actual disasters, except in plays and

Meanwhile, in Canada, which has very few Latino immigrants, the

What if they had a recession and nobody turned up at the Unemployment

There is no spiritual component to this latest massive population loss.

There may be one last big rally in bonds if a recession arrives.

Preparing a Goodbye to the Greatest of All Bond Bulls

Government of Canada 10-Year Bond Yield

One by one, the non-monetary-policy factors promoting disinflation have

The Year of the Death of the Bond: 007.

What is bad for bonds is also bad for Financial stocks.

Financial stocks soared skyward along with techs, lending legitimacy to

It is hard to construct a bullish scenario for US stocks against a bearish

If the workers are finally going to receive greater percentage increases in

2. In balanced accounts, maintain exposure to long zero-coupon bonds as

3. Maintain market weight in Energy stocks, with emphasis on producing

6. Underweight Financial stocks. Within the group, emphasize the “dull”

7. Continue to build major overweight positions in the agricultural stocks.

8. The Canadian dollar remains severely undervalued compared to the

10. Continue to underweight technology stocks. Within the biotech sector,

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