January 2013

FEAR, GREED & LIQUIDITY

Value matters. It seems simple but the market is far from convinced of the concept right now. The market is enthralled by stocks that are beating estimates and has no patience for companies facing any type of turbulence. The market is being pushed, pulled, and generally bullied by the forces of fear, greed and liquidity. 3 FORCES OF ASSET PRICING 1999: 2006: 2008: Greed + Liquidity = Tech Bubble Greed + Liquidity = Housing Bubble Fear Liquidity = Market Meltdown

Current Day: Fear + Greed + Liquidity = Market Bifurcation

The current combination of greed, fear and liquidity, however, has meant certain assets such as government bonds, high quality corporate bonds and quality stocks are hitting multi-year highs, while other assets are hitting multi-year lows. This bifurcation of asset values is evidenced by certain areas of the market defying gravity (Treasuries) and being priced for perfection (U.S. Mega Caps) whereas other market segments are declining precipitously (natural resource related companies) and are priced to never recover (U.S. coal companies). Market participants exacerbate this volatility by focusing on day-to-day news, such as macro headlines, political news and quarterly earnings announcements, rather than longterm fundamentals. In these uncertain times Tradewinds knows the importance for investors to keep calm and carry on! Investors must remain objective, 1) recognize the massive amount of liquidity being pumped into the system, 2) avoid overvalued areas of the market where there is either an abundance of greed or a lack of fear and 3) take advantage of opportunities where others are fearful due to temporary challenges. These currently unpopular investments could protect wealth by providing exposure to scarce assets and sustainable franchises that will retain value.

LIQUIDITY

Chappatte in "International Herald Tribune" - www.globecartoon.com. Opinion Piece. Please see Important Disclosures in the Endnotes.

One should not expect an increase in demand growth to increase real growth on a sustained basis, but if at all, only in the short run. -William Dewald, Research Director, Federal Reserve Bank of St. Louis (1998)

In an age where austerity is faux pas, many governments assume unsustainable leverage and currency printing is the only remedy for an economic slowdown. Large central banks are attempting to drive asset prices up in an attempt to stimulate economic activity. Everybody wishes monetary easing the best of luck, in hopes that leverage will eventually drive real economic improvement. Nobody wishes for reality to surface, governments are livin on a prayer today and hoping that tomorrow will be better. Were half way there Livin on a prayer Take my currency and well make it I swear Livin on a prayer - Not quite the lyrics of Livin on a Prayer, Bon Jovi. In Bon Jovis praises of blind faith in 1986, he was talking about tough times. The hero of the song, Tommy, was laid off from the docks after a union strike. Things were indeed tough in 1986. Unemployment was 7.2%, mortgage rates were 10.7%, GDP growth was 3.4%, inflation was 1.9%, nominal GDP growth was 5.23%, and money growth was 9.26%. In retrospect, things werent all bad for Tommy! First, he had a girlfriend, named Gina who was gainfully employed at a diner and was able to provide support for the couple. Second, unbeknownst to Tommy, Alan Greenspan would come to power as Chairman of the Federal Reserve Bank in 1987. Greenspan would soon become Gina for the entire country. This co-dependent relationship is highlighted by the term Greenspan Put which refers to Greenspans monetary policy. The Greenspan Put offered investors a sense of protection when markets tumbled. Mr. Greenspan popularized the notion that tomorrow will be a better day, with opportunistic deficit spending and expansionary monetary policy today. Economic tailwinds at the early stages of Greenspans reign delayed his expansionary monetary measures for a few years. In 1987, interest rates that had been at historical highs were coming down. To sweeten things up, our export situation was improving from lower oil prices and greater American competitiveness. For the U.S., the early 90s were good. After a series of positive events, nominal GDP grew faster than money supply (M2). In other words, we experienced real economic growth. The following chart below helps to tell the story, showing M2 money supply vs. nominal GDP.

Opinion Piece. Please see Important Disclosures in the Endnotes.

TRADEWINDS GLOBAL INVESTORS . 2

U.S. Money Supply (M2) vs. U.S. Nominal GDP

$10,000 B M2 Money Supply ($U.S. Billions) M2 $8,000 $6,000 $4,000 $2,000 $GDP $16,000 B $14,000 GDP ($U.S. Billions) $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 1959-01-01 1960-12-01 1962-11-01 1964-10-01 1966-09-01 1968-08-01 1970-07-01 1972-06-01 1974-05-01 1976-04-01 1978-03-01 1980-02-01 1982-01-01 1983-12-01 1985-11-01 1987-10-01 1989-09-01 1991-08-01 1993-07-01 1995-06-01 1997-05-01 1999-04-01 2001-03-01 2003-02-01 2005-01-01 2006-12-01 2008-11-01 2010-10-01 Unemployment Rate Mortgage Rate (30Y) GDP Growth (Real) Inflation GDP Growth (Nominal) Money Growth 1986 7.2% 10.7% 3.4% 1.9% 5.2% 9.3% 2006 4.4% 6.2% 2.7% 2.5% 6.0% 5.8% 2012 7.8% 3.5% 1.8% 2.0% 4.0% 6.8%
Source: Bloomberg Finance L.P., Federal Reserve Bank of St. Louis, as of 7/31/12.

$-

When the tailwinds calmed in the mid-90s, Mr. Greenspan sprang into monetary action to keep the good times rolling, cementing his rock star reputation. Money supply began growing at 1.5x the growth rate of nominal GDP, to continually spur economic growth. The new money had to find a home; the result was a tech bubble in the late 90s and a real estate bubble in the mid 2000s. The growth of money supply can be categorized by two stages. During stage one (19952007), Americans levered up. Financial leverage burgeoned, especially at the household level. As long as asset prices kept pace with money supply, we could party like rock stars.

120 100 Percent of GDP 80 60 40 20 0

U.S. Debt Outstanding (seasonally adjusted)

Household Nonfinancial Business Federal Government State and Local Government

120 100 Percent of GDP 80 60 40 20 0

1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011

Source: Federal Reserve Board of Governors, as of 12/31/11.

Opinion Piece. Please see Important Disclosures in the Endnotes.

TRADEWINDS GLOBAL INVESTORS . 3

During stage two (20082012), the government printed money. By 2008, the leverage of American consumers had become shockingly high. As we all remember, asset prices stalled and ended the party. It suddenly became apparent that many Americans were insolvent. Consumers snapped into a deleveraging mode, while the Federal Reserve engaged in efforts to keep money supply growing. QE1 initiated the effort in November 2008, and the Federal Reserve has since continued to grow its asset. The following chart shows the growth in Federal Reserve assets versus relevant gold backing. Even with a sharp increase in the gold prices, only 15% of the U.S. currency is backed by gold compared to over 25% as recently as 2008.

U.S. Gold Reserves vs. Federal Reserve Assets

$3,500 B 3,000 2,500 2,000 15% 1,500 1,000 500
-

30% U.S. Federal Reserve Assets U.S. Gold Reserves as a % of Fed Balance Sheet

25% 20%

10% 5% 0%

Source: Bloomberg Finance L.P., as of 9/30/12.

The U.S. was not the only country pushing on the liquidity accelerator. The chart below shows aggregate money supply growth for the Eurozone, China, the United States, Japan, the United Kingdom, South Korea, Australia, Canada, Taiwan, Brazil, Switzerland, Mexico, Russia, Thailand, and Turkey. The growth rate for this entire group over the period was 10.32%. China has been growing their money supply (M2) by an average of 20.6% over the past 10 years in order to suppress their currency and finance incredible growth. The only country to grow their money supply at a faster pace was Russia at (28.2%), from a much smaller base.

Opinion Piece. Please see Important Disclosures in the Endnotes.

December-94 April-95 August-95 December-95 April-96 August-96 December-96 April-97 August-97 December-97 April-98 August-98 December-98 April-99 August-99 December-99 April-00 August-00 December-00 April-01 August-01 December-01 March-02 July-02 November-02 March-03 July-03 November-03 March-04 July-04 November-04 March-05 July-05 November-05 March-06 July-06 November-06 March-07 July-07 November-07 March-08 July-08 November-08 March-09 July-09 November-09 March-10 July-10 November-10 March-11 July-11 November-11 March-12 July-12

TRADEWINDS GLOBAL INVESTORS . 4

Top 15 M2 vs. Global Gold Reserves

$60,000 B 55,000 50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 $0 December-01 May-02
Top 15 M2 (U.S.$B) Global Gold Reserves (U.S.$B)

December-11

May-12

October-02

September-05

February-06

December-06

October-07

September-10

February-11

January-04

November-04

January-09

November-09

Source: Bloomberg Finance L.P., as of 9/30/12.

GREED
The wall of liquidity discussed in the previous section has impacted various assets in divergent but powerful ways. This flood of liquidity has created mini asset bubbles where greed is flourishing. How do we spot areas of greed? Sometimes greed is easy to identify, for example the rampant house flipping in the mid-2000s. Yet greed sometimes arrives at a party in a much more subtle fashion. Greed isnt always a byproduct of people trying to get rich; instead, greed sometimes stems from a lack of fear. To detect areas driven by greed, we look to see where investors are not fearful and do not demand reasonable returns for the risk they are taking. Lack of Fear In our equity markets today, there are many narrow segments of the market that have alarmingly high valuation metrics. Investors are betting on an environment where a small subset of companies will not only outperform their competition, but will outperform at an increasing rate. This blind faith regardless of price is reminiscent of the 90s tech bubble. 1999 and Now: Extended Valuations?
MSCI U.S. Tech Index Price to Earnings Ratio S&P 500 Internet Retailing Index Price to Earnings Ratio
Source: Bloomberg Finance L.P.

12/31/1998 41.3x 12/31/2011 42.4x

12/31/1999 60.7x 12/18/2012 72.7x

Our team has spoken at great lengths in prior notes about the bond market not showing signs of fear. Owning U.S. Treasuries seems to offer a serene sense of safety. In the following chart, fear is abundant in the early 1980s when investors wanted to be compensated for inflation risk, and has since dissipated.

Opinion Piece. Please see Important Disclosures in the Endnotes.

TRADEWINDS GLOBAL INVESTORS . 5

October-12

March-03

July-06

May-07

March-08

August-03

June-04

April-05

August-08

June-09

April-10

July-11

Treasuries: Where is the Fear?

16 14 12 10 8 6 4 2 Mid Price 1.7251 High on 09/30/81 15.842 Average 6.638 Low on 07/31/12 1.4687

Generic Government 10-Year Yield

1962-1964 1965-1969 1970-1974 1975-1979 1980-1984 1985-1989 1990-1994 1995-1999 2000-2004

Source: Bloomberg Finance L.P., as of 10/31/12.

2005-2009 2010-2014

Hindsight reminds us that there was a pronounced lack of fear in some areas of the market in the late 90s, resulting in bifurcated valuations. Like 1999, the 50 largest contributors to the MSCI ACWI index return during 2012 were companies that were expensive compared to the index on a price-to-earnings basis. Those who invested in the popular and highly valued segment of the market were whipsawed. As 1999 reminds us, value and price paid always matters in the long run. While valuation is not a timing device, it is a fundamental tenet to rational investing.

WHERE ARE WE TODAY?

2009 Dave Blazek . looseparts@comcast.net . Distributed by Tribune Media Services, Inc. Opinion Piece. Please see Important Disclosures in the Endnotes.

TRADEWINDS GLOBAL INVESTORS . 6

Market valuations are relatively middle-of-the-road. The current price-to-book ratio for the MSCI All Country World index is 1.7x, 1.6x forecasted for 2013. Given that some areas have run up dramatically, that leaves a lot of areas where the market has left an abundance of value on the table. Current Overall Market Valuation: Middle of the Road

MSCI ACWI P/B Ratio

3.5 3.0 P/B Ratio 2.5 2.0 1.5 Dec 29 1995 Dec 31 1997 Dec 31 1999 Dec 31 2001 Dec 31 2003 Dec 30 2005 Dec 31 2007 Dec 31 2009 Dec 30 Dec 31 2011 2013
P/B 1.3927

Source: Bloomberg Finance L.P., as of 9/30/12.

The price-to-book ratio of the ACWI is low on a historical basis but up off the bottom. The current price-to-book ratio of the ACWI is 1.75x but expected to drop to 1.39x over the next 2 years. The ratio for the U.S. is 2.2x, Europe is 1.5x, Japan is 0.9x, and the emerging markets is 1.6x.

FEAR

2008 by Randy Glasbergen - www.glasbergen.com.

Given the abundance of liquidity and greed in the markets, how are index valuations at average levels? The simple answer is areas of fear.
TRADEWINDS GLOBAL INVESTORS . 7

Opinion Piece. Please see Important Disclosures in the Endnotes.

Due to uncertainty regarding the medium and long-term, there is an undue amount of emphasis placed on short-term earnings for equity performance. This uncertainty creates an environment where short-term and moderately impactful events can arouse significant fear causing asset prices to fall well below their intrinsic value. Tradewinds believes that the best opportunities arise when the markets lose sight of the medium to long-term. U.S. Natural Gas In our view, fear in the natural gas market is based on transitory, curiously low spot prices that do not imply the attractive intermediate to long-term supply and demand balance. Natural gas prices have plummeted from excess production with shale technology and our second warmest winter in the past 117 years. As we all know from our college economics courses or conventional wisdom, supply and demand imbalances correct themselves. On the supply side, the number of rigs drilling for natural gas in the U.S. has dropped dramatically.

U.S. Natural Gas Prices (Henry Hub) vs. Natural Gas Rig Count (Baker Hughes)
1,800 1,600 1,400 Baker Hughes Rig Count 1,200 1,000 800 600 400 200
Sep-02 Dec-02 Sep-03 Dec-03 Sep-04 Dec-04 Sep-05 Dec-05 Sep-06 Dec-06 Sep-07 Dec-07 Sep-08 Dec-08 Sep-09 Dec-09 Sep-10 Dec-10 Sep-11 Dec-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Dec-11 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Mar-12 Jun-12

U.S. Natural Gas Rotary Rig Count Henry Hub

16 14 12 10 8 6 4 2 Henry Hub (US$ mmbtu)

Source: Bloomberg Finance L.P., as of 6/30/12.

On the demand side, more than $15 billion of chemical plants have been announced in Texas alone. The use of natural gas for transportation is expected to grow 14% per year through 2020. Pike Research projects that demand for natural gas for cars and trucks could total 14 bcf/day by 2030, 21% of todays total natural gas production, compared to consumption of around 90 mcf/day this year, only 0.14% of production. Transportation fleets (buses, taxis and garbage trucks) have begun opportunistically cutting their fuel costs. (NG costs $2.20/gallon equivalent of gasoline). With a sudden decline in rig count and a steep increase in prospective long-term demand, we are confident that fear in natural gas related equities is transitory. Coal The rest of the world is looking to buy our cheap coal if we dont use it here. Exports of American coal were 50 million tons in 2006 and are expected to surpass 120 million tons in 2012. This is sizable, considering current U.S. coal production is only slightly above one billion tons annually. The market believes the U.S. is permanently oversupplied with abundant cheap energy, and has discounted the

Opinion Piece. Please see Important Disclosures in the Endnotes.

TRADEWINDS GLOBAL INVESTORS . 8

relevant equities for the sector accordingly. Significant prospects for the U.S. economy are empowered by cost advantaged energy and we are elated by the opportunities this presents. Insurance Insurance companies have gone through a difficult period, with yields on their fixed income portfolios hitting multi-decade lows. These yields have historically generated the vast majority of their income. To make matters worse, insurance companies have suffered a weak policy pricing environment for the past 8 years. The price-to-book ratio for this industry remains below 1.0x, reflecting pessimistic expectations. Conditions are improving, however, as companies have responded by re-pricing their policies. Tradewinds looks for quality insurance companies who own fixed income portfolios with conservative net durations so that when rates begin to rise they will greatly benefit. The long-term outlook for the strong companies who can survive is encouraging.

160 150 140 Percentage 130 120 110 100 90 80 1970

U.S. Insurance Premiums & Commercial Bank Assets Divided By Nominal Gross Domestic Product
U.S. Insurance Premiums / Nominal GDP (1970 = 100) U.S. Commercial Bank Assets / Nominal GDP (1970 = 100)

2010

1968

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Source: Insurance premiums: AMBest Aggregate. Bank assets: U.S. Federal Reserve. U.S. Nominal GDP: Bloomberg. Compiled & scaled by Tradewinds, as of 12/31/11.

Gold Miners Gold mining equities are quite possibly the most feared sector of the market, hitting multi-year lows on price-to-earnings, price-to-book, and price-to-net asset value ratios. From January 2011 to November 2012, the gold price has risen 20% while gold miners are down 22%. The market is focused on cost inflation of the sector and a history of poor capital allocation, fearing that it can only worsen without a corresponding increase in the gold price. The market is ignoring all efforts deployed in response to cost inflation, namely recent management team changes. New management teams have installed stringent return on capital requirements for prospective mining operations; this has resulted in the cancellation of several uneconomic large scale projects. Management teams have also taken initiative in engaging workers to understand budgetary constraints and to track project economics real time. The market is fearfully projecting negative short-term trends in perpetuity and thus creating tremendous opportunities. In response, we are opportunistically analyzing each companys flexibility to adjust capital allocation and costs to generate returns for their shareholders.
Opinion Piece. Please see Important Disclosures in the Endnotes.

TRADEWINDS GLOBAL INVESTORS . 9

2008

2012

LIQUIDITY, GREED, AND FEAR

The market is being pushed, pulled, and generally bullied by the forces of fear, greed and liquidity. This is causing a bifurcation of asset values; some defy gravity and some decline precipitously; some are priced to perfection and some are priced to never recover. In these uncertain times Tradewinds knows the importance for investors to keep calm and carry on! Investors must remain objective, 1) recognize the massive amount of liquidity being pumped into the system, 2) avoid overvalued areas of the market where there is either an abundance of greed or a lack of fear and 3) take advantage of opportunities where others are fearful due to temporary challenges. These currently unpopular investments could protect wealth by providing exposure to scarce assets that will retain value. We are and always will be highly disciplined investors, evaluating any opportunity to invest in mispriced equity of companies with robust asset bases and sustainable franchises. When the market refuses to credit quality companies for their merits and long-term potential, we will seize the day and confidently take ownership. Thank you for your patience and your partnership.

Drew Thelen, CFA Co-Chief Investment Officer Tradewinds Global Investors

IMPORTANT DISCLOSURES The statements contained herein reflect the opinions of Tradewinds Global Investors, LLC (Tradewinds) as of the date written. Certain statements are forward-looking and/or based on current expectations, projections, and information currently available to Tradewinds. Such statements may or may not be accurate over the long-term. While we believe we have a reasonable basis for our comments and we have confidence in our opinions, actual results may differ from those we anticipate. We cannot assure future results and disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. Statistical data was taken from sources which we deem to be reliable, but their accuracy cannot be guaranteed. It is important to remember that there are risks inherent in any investment and there is no assurance that any investment or asset class will provide positive performance over time. Value style investing presents the risk that the holdings or securities may never reach their full market value because the market fails to recognize what the portfolio management team considers the true business value or because the portfolio management team has misjudged those values. In addition, value style investing may fall out of favor and underperform growth or other style investing during given periods. Foreign investing presents additional risks such as the potential for adverse political, currency, economic, social or regulatory developments in a country including lack of liquidity, excessive taxation, and differing legal and accounting standards. These risks are magnified in emerging markets. This commentary should not be construed as investment advice with respect to any particular security, asset class, or strategy. Past performance does not guarantee future results.

TRADEWINDS GLOBAL INVESTORS . 10