83063321 stifel market strategy 2012-02-28 boomerang

Barry B. Bannister, CFA [email protected] (443) 224-1317

Stifel Nicolaus Equity Trading Desk US: (800) 424-8870 Canada: (866) 752-4446

Market Commentary/Strategy

Boomerang: How the EU, China and dollar impact the Paper vs. Hard Asset trade

As our attached exhibits describe, we attribute 2001-present leadership of Hard Asset equities to: (a)post-9/11 dollar weakness, (b) Chinese capex/construction underwritten by currency devaluation, and (c)extractive capacity reduction 1980-2000 which led to cost-push inflation for new capacity thereafter. Comingfull circle, we now see: (a) extractive industry capex as hurdle rates have fallen (but the equities respond tofalling commodity prices which seek to close the marginal cost/price gap, and not commodity EPS), (b) Chinarebalancing away from fixed investment due to peaking national savings in tandem with a break-out in incomeper capita, and (c) a sharp reduction in downward pressure on the dollar as the eurozone and China areseveral years behind the U.S. in a painful rebalancing process, with potential dollar shortages as a result.Thus, we believe Hard Asset leadership ends after the current seasonal October-2011 to April-2012(E) rally.

To recap, our 2012 macro view, largely unchanged YTD is: We see the S&P 500 ending 2012 at 1,400 and 1,600 by

2013/14, with commodity equities and small cap having a final seasonal beta rally Oct-11 to Apr-12. By mid-2012, we

expect QE3 as fuel costs pinch GDP and weaken stocks. Beyond 1H12, we see large cap growth leading to ~2013/14,

with Financials also participating. We believe the S&P 500 benefits from the U.S. head start rebalancing, deflation

being averted, Fed laxity offsetting fiscal tightening, and foreign U.S. inflows as the EM & EU painfully rebalance.

We believe the locus of the financial crisis was Chinese and German surpluses that created excess savings which

served to cheapen money via the inducement of debt in the U.S. and EU periphery, respectively. That rates remained

low despite rising demand for credit is evidence this was an excess savings "supply-side" issue. S&P 500 weakness

(the S&P 500 is flat with the late 1990s) simply discounted ephemeral GDP derived from excess credit. As the 2000s

drew to a close, and to escape debt deflation as housing failed, the U.S. inflated the eurozone and China via

Quantitative Easing (Q.E., or Fed asset purchases with electronic money), driving food and energy prices up and

forcing the surplus states to re-balance toward a greater domestic consumption profile.

We see no U.S. dollar weakness due to currency rivals, and thus we see no currency-related upward lift for what

remain largely dollar-traded global commodities. Our opinion is the U.S. is three years ahead of the eurozone

rebalancing and four years ahead of China, with a fairly well-defined playbook. Layering a competitive North/South

eurozone unit labor cost disparity (labor cost per unit of output), we believe eurozone deficits can only be remedied by

mild German inflation and peripheral wage stagnation, hardly a prescription for euro strength. Dollar stability followed

by strength usually benefits Technology, Financial and Healthcare equities, just as dollar weakness benefits Materials,

Energy, Industrials and Utility stocks. Hard asset industry stock valuation multiples usually compress at pricing turns

despite strong investment spending on new extractive capacity.

We think China faces peaking gross national savings (corporate retained earnings + personal savings + government

surplus = national savings) and thus peaking investment (in a largely closed system, savings = investment) before

rising income per capita and consumption can take up the slack. In a sense, the future may be better for labor in China

than for investors in China. Similarly, for what we term the "CRABS" (Canada-Russia-Australia-Brazil-S. Africa,

traditional commodity exporters), heretofore hand maidens to China's fixed investment boom, we see those currencies

depreciating as China rebalances and they are exposed as one-trick ponies.

February 28, 2012

Market Strategy*******

Stifel Nicolaus does and seeks to do business with companies covered in its research reports. As a result,investors should be aware that the firm may have a conflict of interest that could affect the objectivity of thisreport. Investors should consider this report as only a single factor in making their investment decision.

All relevant disclosures and certifications appear on pages 38 - 39 of this report.

$4.00/gallon = S&P 500 ceiling

in our view.

Market StrategyFebruary 28, 2012

Source: Factset prices, U.S. BEA, U.S. BLS, Stifel Nicolaus format.

Exhibit (1) - Oil will cap the S&P 500 in 2012, in our view. U.S. gasoline prices are returning to

recession-inducing levels (left chart). Until the S&P 500 and crude oil correlation breaks down, we

see ~$4.00/gallon firmly capping S&P 500 rallies (right chart).

$0

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ati

on

-ad

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ted

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I, $

pe

r b

bl.

Infl

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on

ad

j. U

.S. A

ll G

rad

es

Re

tail G

as

olin

e P

ric

es

($

/ga

llo

n)

Inflation-adjusted U.S. Retail Gasoline vs. Refiner's Acquisition

Price for Crude OiI, $ per bbl.Spikes above $100/bbl. & $3.25/gallon exacerbate major recessions.

Inflation-adjusted U.S All Grades Retail Gasoline Prices ($ per gallon)

Inflation adjusted WTI $ per bbl.

1Q 1980 4Q 2007

1Q 2011

$700

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S&

P 5

00

Ind

ex

Infl

ati

on

ad

j. U

.S. A

ll G

rad

es

Re

tail G

as

olin

e P

ric

es

($

/ga

llo

n)

U.S. All Grades Retail Gasoline, including taxes (Left Axis)

vs. S&P 500 Index (Right Axis)

U.S All Grades Retail Gasoline Prices, including taxes S&P 500


We believe dollar debasement

created correlation, so U.S. GDP

traction ends correlation.


Dec-2001 to Dec-2011

All Domestic Equity, Various Indices,

(Price + Dividends)

Exhibit (2) - Minerals led 2001-2011 (table),

but we think fade as valuation contracts

due to demand growth(1) slowing and the

U.S. dollar bottoming, in our view.

Source: Factset total return indices, Standard & Poor‟s (Cowles Composite joined to S&P 500), U.S. PPI All Commodities joined to CRB futures (rebased).

(1) The mineral producer stocks and those of companies that serve the industry often experience valuation multiple contraction as the second derivative, or rate of

change in rate of change, for commodity prices or demand growth peaks.

-5%

-3%

-1%

1%

3%

5%

7%

9%

11%

13%

15%

17%

19%

21%

-5%

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19

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19

98

20

03

20

08

20

13

E

When commodities lead, the S&P 500 lags (the

growth stocks mostly)10-yr. Growth Rates

U.S. Commodity Price Growth (%), Left Axis

U.S. Large Cap Stock Market Total Return (Price + Dividend), Right Axis

Exhibit (3) - We see commodity price growth of

~5%/yr. and the S&P 500 total return ~9%/yr. 2011-

21. We see China fixed investment slowing, the

U.S. dollar flat/up, and expanding U.S. P/E ratios.

AnnualTotal

Return

Non-Energy Minerals………………………………………………….15.5%

Energy Minerals……………………..………………………………………………….12.9%

Consumer Non-Durables………………………………………………………………….11.1%

Industrial Services (Oil svc./equip., E&C, pipelines)…… 10.0%

Consumer Services (Media, resaurants, lodging)………………………………………………………………….10.0%

Process Industries (Chemical, ag, paper)…………………………………………9.8%

Health Services………………………..………………………………………………….9.1%

Utilities………………..………………………………………………….8.1%

Transportation…………………………………………………………………………….7.7%

Distribution Services……………………………………………………………………..6.9%

Retail Trade……………………………………………………………………..6.2%

Technology Services (Software, internet)……………………………………………………………………..5.0%

Communications…..………………………………………………….4.5%

Producer Manufacturing……………………………………………………………………..4.0%

Consumer Durables…………………………………………..3.4%

Electronics (Semis, aero/def., computing, telco eq.)……………………………………………………………………..3.3%

Banks & Financial Services………………………………………………….………………………………………………….3.1%

Health Technology………………………………………………….………………………………………………….2.5%

Commercial Svcs (Fin'l. pub., personnel, advertising)……………………………………………………………………..-0.6%


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1999

2000

2001

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2007

2008

2009

2010

2011

2012

PHLX OSX Oil Service Stock Index (Right)

vs. Brent Crude Oil (Left)

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CAT + Deere Stock price (Right)

vs. Brent Crude Oil (Left)

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2005

2006

2007

2008

2009

2010

2011

2012

Freeport-McMoRan Copper & Gold

Stock Price (Right) vs. Brent Crude Oil (Left)

Source: Factset price history.

Exhibit (4) - “Got Oil?” Commodity producing or serving equities follow commodity prices, and

appear to us value traps. We compare Freeport-FCX (left), Caterpillar-CAT + Deere & Co.-DE

(middle) and Oil Service-OSX (right) to Brent crude oil. Since Oct-11 click here we have been

participating in an Oct-Apr seasonal commodity rally, but we believe long term leadership is over.


https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=bbc6775e-5938-4222-b632-dbedac69d26d&mime=pdf&co=Stifel&[email protected]&source=libraryView






70

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94$0

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$150 Jan

-06

Ap

r-06

Ju

l-06

Oct-0

6

Jan

-07

Ap

r-07

Ju

l-07

Oct-0

7

Jan

-08

Ap

r-08

Ju

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Jan

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Ap

r-09

Ju

l-09

Oct-0

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Jan

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Ap

r-10

Ju

l-10

Oct-1

0

Jan

-11

Ap

r-11

Ju

l-11

Oct-1

1

Jan

-12

Ap

r-12

DX

Y U

.S. D

olla

r Ind

ex

Bre

nt C

rud

e O

il, $

per b

bl., i

nvert

ed

axis

DXY U.S. Dollar Index (right) versus Brent Crude Oil, $ per bbl. (left), Jan-06 to Feb-12

Brent Crude Oil, $ per bbl. DXY U.S. Dollar Index

Correlation Coefficient = .77

Exhibit (5) - Oil and the U.S. dollar – inverse trend. As the DXY dollar index (and China yuan/USD,

not part of the DXY) stabilize within the post-2008 crisis range, combined with weaker growth

overseas, we expect Brent oil may begin weakening to the $85/bbl., which we expect by 2013/15.

Source: Factset prices


Exhibit (6) - Seasonality in commodity producing and commodity-serving stocks supported an Oct-

11 to Apr-12(E) rally. As shown below, major Engineering & Construction stocks(1) with ties to

commodity producers tend to under-perform from April to October (left), but even more striking the

energy E&C stocks tend to out-perform from October to April (right), depicted below for 50 years.

Source: FactSet Prices.

(1) Stocks charted are listed in the bottom of each chart panel, each covered by Stifel Nicolaus E&C analyst Robert Connors, CFA, CPA. We found similar seasonality

among Oil Service, Machinery and related commodity sensitive equities.

-60.0%

-50.0%

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

110.0%

120.0%

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

E&C average

October to Aprilreturns

CBI since 1979, FLR since 1966, FWLT since 1963, JEC since 1972 and MDR since 1963.-60.0%

-50.0%

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

110.0%

120.0%

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

E&C average

April to Octoberreturns

CBI since 1979, FLR since 1966, FWLT since 1963, JEC since 1972 & MDR since 1963.


10

100

1,000

10,000

100,000

1896

1901

1906

1911

1916

1921

1926

1931

1936

1941

1946

1951

1956

1961

1966

1971

1976

1981

1986

1991

1996

2001

2006

2011

Dow Jones Industrial Average, 1896 to 2011

Secular bear market = 14 to 20 range-bound, flat years

1907-2114 years

1929-4920 years

1966-8216 years

2000-

Source: Dow Jones, U.S. Census, 1896 to 1913 is the WPI for Commodities from the BLS and other agencies. 1914-56 is the PPI All Commodities, and 1957-present is

the CRB Continuous Commodity Index, now an equal-weighted, front-month index of 17 commodities including most high-use energy & agricultural commodities.

(1) Equity bull market blow-offs can occur in the late stages of private credit creation, when added dollar supply via credit may debase the currency at the same time.

Exhibit (7) - Paper vs. Hard Assets trade-off. Secular bull markets for commodities (left) align

with secular bear markets for large cap U.S. equity (right), and vice versa. Though not exact, the

inverse relationship is clear. U.S. equity strength corresponds to flat commodities and a dollar

with value, and generally not strong commodities or a debased(1) dollar.

1.00

10.00

100.00

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96

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06

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19

96

20

01

20

06

20

11

1907-2114 years

Commodity Price Index, Log ScaleData 1896 to 2011

1929-4920 years

1966-8214 years

2000-11 years


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550

600

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Aug

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-12

Commodity Prices (CRB Futures Continuous Commodity Index)

Daily prices 08/14/1998 to present

DIM

INIS

HIN

G R

ET

UR

NS

BO

TT

OM

TO

TO

P

“SECULAR” BULL

MARKET STAGES

Source: Stifel Nicolaus.

(1) Apologies if you like cats.

(2) We believe secular bear markets cause investors to be “long term” when they

should be short-term and opportunistic. Conversely, secular bull markets cause

investors to be short term, selling too soon, such as commodities 2000-11 above (or

Tech stocks 1991-2000), when they should be long term and practice buy-and-hold

until the trend fails to over-take the previous high, signaling secular bull market‟s end.

Jul-16, 1999 S&P

500 peaks vs. CRB

1Q12 dead cat

bounce?

Exhibit (8) - Commodities relative to the S&P 500 have followed a classic “bubble pattern” (left

chart), and we think may be in a seasonal 1H12 “dead cat bounce(1)” that fails to retake the old

high (right chart). Whether a “bust” or just a slowing for commodities occurs depends on China,

but in either case a long-term sluggish period may be termed a “secular bear market.” The long

term is irrelevant in secular bear markets(2), however, so our eyes are on potentially aggressive

1Q12 China easing that slows – but does not stop – needed rebalancing.

Dead

cat

bounce

Source: Stifel Nicolaus, CRB Futures from Factset.


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-12

Commodity Prices (CRB CCI) vs. S&P 500 Daily prices 10/14/1998 to present

Source: Historical daily price series, Compustat, Factset. Regression is: y = 0.5928x - 152.54 R² = 0.8364 daily 9/1/08 to present for SPX vs. CRB.

Exhibit (9) - We see less S&P 500 vs. commodity correlation, with the S&P 500 ahead. That is because

correlation was driven from 2002 to 2007 by private debt, which was quickly followed in 2008-11 by

the liquidity response to crisis which debased the dollar. So, it follows that U.S. GDP traction relative

to the world and the long unwind of private leverage restrains money growth and reduces correlation.

Dollar debt fed

correlation…

…Crisis

liquidity

drove

correlation

to a peak.

-1.00

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-11

LTM correlation S&P 500 and CRB CCI, Jan, 1990 - Current

Mostly positive correlation 2001-2011

Mostly negative correlation 1990-1999


We observe commodity price

momentum drives commodity

stocks, not the EPS derived

from production and investment.


Source: Company annual reports, FactSet, BEA

(1) “Major U.S. Commodity Industrials” are ExxonMobil (XOM) as Exxon (Standard NJ) + Mobil (Standard NY) pro forma, Chevron (CVX) as SOCAL + Gulf + Texaco +

Unocal pro forma, Phelps Dodge + Freeport post-97 (PD/FCX) pro forma, Caterpillar (CAT), Deere & Co. (DE), and Cleveland Cliffs/Cliffs Resources (CLF).

(2) The assumed 60/40 WACC (60%-Equity, 40%-Debt) is the trailing 10-year compound U.S. large cap equity total return (price + dividend) for the cost of equity and

the trailing 10-year average Moody‟s Baa bond yield after taxes based on U.S. corporate taxes paid (Historical Statistics of the U.S., U.S. NIPA accounts).

Exhibit (10) - Commodity equities are responsive to commodity prices, not the capex cycle.

Commodity capital spending cycles are facilitated by inexpensive capital (left chart), and one

should continue for several years, in our view, but it is the growth of commodity prices that

drives the related commodity equities (right chart), and that appears to have peaked to us.

0%

1%

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1991

1996

2001

2006

2011

Major U.S. Commodity Industrials(1):

Remaining Life of Fixed Assets vs. Hypothetical 60/40 WACC(2), 5-Yr. Averages, 1931 - Present

Net PP&E/DD&A Exp. WACC %

High = Young fixed assets with many years of depreciation remaining (left axis) & expensive cost of capital (right axis),

so further capex is constrained.

Low = Old fixed assets with few years of depreciation remaining (left axis) & cheap cost of

capital (right axis), so capex is increased.

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0%

2%

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6%

8%

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1936

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1966

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1986

1991

1996

2001

2006

2011

Major U.S. Commodity Industrials(1):

Remaining Life of Fixed Assets vs. US Commodity Price Indicies, 5-Yr. Averages, 1931- Present

Net PP&E/DD&A Exp. Commodity

Y/Y %


Source: S&P, company annual reports, Factset. 1920-56 is the PPI All Commodities, and 1957-2001 is the CRB Continuous Commodity Index, now an equal-weighted, front-month index

of 17 commodities including most high-use energy & agricultural commodities. 2001-2011 is the average of daily values. 2012 prices are intraday Feb-23, 2012.

0%

1%

2%

3%

4%

5%

6%

7%

-9%

-6%

-3%

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9%

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18%

1920

1926

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2004

2010

Deere

sto

ck d

ivid

ed

by t

he S

&P

500

Co

mm

od

ity P

rices, y/y

%,

5-y

r. m

ov. avg

.

U.S. Commodity Price Index(1), y/y% change, 1920 to 2012 latest, 5-yr. M.A. versus Deere relative to the S&P 500 1927 to Present

Commodity Price Index, y/y % change, 5-yr. moving average, left axis

Deere stock relative to the S&P 500 (S&P Composite in earliest periods), right axis

* Producer Price Index for Commodities to 1956, CRB Futures 1957-present0%

1%

2%

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5%

6%

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8%

9%

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-6%

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18%

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1951

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1960

1963

1966

1969

1972

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1981

1984

1987

1990

1993

1996

1999

2002

2005

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2011

2014E

Cate

rpilla

r sto

ck d

ivid

ed

by t

he S

&P

500

Co

mm

od

ity P

rices, y/y

%,

5-y

r. M

.A.

U.S. Commodity Price Index(1), y/y%, 5-yr. M.A. versusCaterpillar relative to the S&P 500

Commodity Index, y/y%, 5-yr. moving average, left axis

CAT relative to the S&P 500 (S&P Composite in earliest periods), right axis

* Producer Price Index for Commodities to 1956, CRB Futures 1957-present

Exhibit (11) - Commodity price momentum drives commodity serving equities. We compare

Caterpillar (CAT) to commodities since 1945 (left) showing the increasingly close relationship, and

Deere & Co. (DE) since 1926 below for which the relationship has always been tight.


1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

13%

-9%

-6%

-3%

0%

3%

6%

9%

12%

15%

18%

1920

1925

1930

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015E

U.S. Commodity Price Index (1), y/y%, 5-yr. M.A. versusU.S. Commodity Producers relative to the S&P 500(1)


Commodity Producers relative to the S&P 500, right axis

Source: S&P, company annual reports, Factset. PD data linked to FCX post-2006 merger. 1920-56 is the PPI All Commodities, and 1957-2001 is the CRB Continuous

Commodity Index, now an equal-weighted, front-month index of 17 commodities including most high-use energy & agricultural commodities, and 2001-2011 is the average of

daily values. 2012 prices are intraday Feb-23, 2012. The group “U.S. Commodity Producers” includes DE & PD/FCX 1931 to present and CAT post-WWII.

Break to

Include

CAT

0%

3%

6%

9%

12%

15%

18%

21%

-9%

-6%

-3%

0%

3%

6%

9%

12%

15%

18%

19

30

19

36

19

42

19

48

19

54

19

60

19

66

19

72

19

78

19

84

19

90

19

96

20

02

20

08

20

14

E

U.S. Commodity Price Index(1), y/y% change, 5-yr. M.A. versus PD/FCX relative to the S&P 500


PD/FCX stock relative to the S&P 500, right axis

* Producer Price Index for Commodities to 1956, CRB Futures 1957-present

Exhibit (12) - Commodity price momentum drives commodity producing equities. We compare

Phelps Dodge and successor Freeport to commodities since 1931 (left), and in the right chart we

show a composite of Caterpillar (CAT), Deere & Co. (DE), and Phelps Dodge/Freeport (PD/FCX).


We think Eurozone and Chinese

rebalancing and currency issues

undermine hard asset pricing.


Source: Dow Jones prices, Bloomberg.

(1) The comparable market in terms of speculation to the 1920s-30s Dow (left) is the NASDAQ (right) today. Just as 1932-37 was supported by federal debt, 2002-07

benefited from housing debt. In both cases, 1938 and 2008, removal of support was detrimental, leading to unilateral actions by struggling states in 1939-40.

Exhibit (13) - To escape deflation the U.S. inflated surplus countries (Germany, China) post-2009,

forcing them to tighten (and re-balance). Just as the 1930s-40s equity(1) pattern was: (a) cheap

money boom, (b) speculative asset and investment bubble bursts, (c) credit inflation remedy

applied, (d) credit removed some years later, and (e) debt deflation leading to conflict (left), we

believe 2000-2011 has followed that pattern (right chart), up to QE 1 & 2 and China’s currency peg.

(e) Debt

deflation (e) Debt

deflation


-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

1…

1…

1…

1…

1…

1…

1…

1…

1…

1…

1…

1…

1…

1…

2…

2…

2…

2…

2…

2…

Re

al F

ed

era

l F

un

ds

Ra

te

Real Fed Funds Rate

70

75

80

85

90

95

100

105

110

115

120

125

130

135

19

73

19

75

19

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19

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05

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07

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09

20

11

Re

al T

rad

e-W

eig

hte

d D

olla

r In

de

x

Real Trade-Weighted Dollar

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

30

40

50

60

70

80

90

100

110

120

1936

1941

1946

1951

1956

1961

1966

1971

1976

1981

1986

1991

1996

2001

2006

2011

E

U.S

. GD

P s

hare

of

glo

bal G

DP

No

min

al t

rad

e-w

eig

hte

d U

.S. $

Nominal Trade-Weighted U.S.$ Major Currency Index, 1936 to 2011 (Left) versus U.S. GDP as a share of global

GDP in Current U.S. $, 1950 to 2011E (Right)

U.S. share of

world GDP and

U.S. dollar

leveling or

bouncing in

2012+, in our

view.

Exhibit (14) - We expect U.S. GDP traction relative to a decelerating EU and China, as well as

slowing commodity demand, to support the U.S. dollar. The dollar is affected by the U.S. share of

global GDP (left chart) and U.S. real short term interest rates (right chart). Those factors, in turn,

affect investor equity preferences(1). Nominal (and real) U.S. dollar depreciation has not been

linear the past four decades, spiking occasionally, making extrapolation a high risk endeavor.

Source: World Bank, IMF, U.S. Federal Reserve, Stifel Nicolaus estimates pre-1971 based on U.S. trade balances and applicable cross-currency rates.

(1) Thus we expect interest to shift from short duration equity (such as commodity stocks) to long duration equities (traditional “growth” stocks) in 2012-15E.


Source: Commodities 1913 to 1956 is the PPI for All Commodities, and 1957 to present is the CRB Continuous Commodity Index, currently an equal-weighted index of 17 commodities including energy

and agricultural. Annual values are the average of CRB CCI values for each month, except for the latest decade, which considers all individual trading days of the year. For M3 1897-1958 we use M1 +

vault cash + monetary gold stock + bank time deposits + mutual savings bank deposits + S&L deposits . From 1959-2005 the Fed reported M3 (SA). For 2006-Current we use: M2 + large time deposits

+ institutional money market + Fed Funds & Reverse repos with non-banks + interbank loans + eurodollars (regression-derived). We also add excess reserves at the Fed to M3, which takes into account

funds in surplus over those mandated by reserve requirements. We add them to M3 to better reflect high powered money, but realize the Fed could remove those reserves by selling its liquid assets.

Exhibit (15) - We think commodities roll over if Pax Americana (secular, capitalist democracy) takes

hold. The fiat dollar in the 20th Century funded a beneficent secular, capitalist democracy in W.W.1 &

2, the Cold War, and by democratizing China via enrichment using reserve-enabled growth.

1.00

10.00

100.00

18

05

18

15

18

25

18

35

18

45

18

55

18

65

18

75

18

85

18

95

19

05

19

15

19

25

19

35

19

45

19

55

19

65

19

75

19

85

19

95

20

05

20

15

E

20

25

E

U.S. Commodity Prices, Annual Averages, Linked Indices

War of 1812 &

Napoleonic Wars (1814

peak)

U.S.Civil War (1864 peak)

World War 1

(1920 peak)

Cold War

(1980 peak)

Commodity Price Index, Log Scale

Data 1805 to 2011

World War 2,

Korean Conflict

1897 (low)

China storesexcess savings as U.S.

dollars, pegs currency - artificially boosts gross fixed capital formation

(commodity intensive)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

19

13

19

20

19

27

19

34

19

41

19

48

19

55

19

62

19

69

19

76

19

83

19

90

19

97

20

04

20

11

U.S. Commodity Price Index, 10-Yr. Average Annual Growth Rate

U.S. M3 Money + Excess Reserves 10-Yr. Average Annual Growth Rate

W.W. 1Colonial Powers

Cold War (1980 peak)

Communism

Westernize the EM via

reserve

growth, post-9/11 conflicts,

anti-Secular states

Commodity Prices (Left Axis) vs. U.S. M3 Money Supply +

Excess Reserves at the Fed(1) (Right Axis)Did funding the proliferation of Secular, Capitalist Democracy, a "Pax Americana," create

the illusion of commodities as an asset class?1913 Fed creation to 2011 shown below

World War 2,Fascism


Source: U.S. Census Bureau International Database.

(1) Fixed investment (construction and capital spending) is both highly cyclical relative to consumption and easier for government to “direct” in a command economy.

5.00

5.50

6.00

6.50

7.00

7.50

8.00

8.50

9.0065%

66%

67%

68%

69%

70%

71%

72%

73%

74%

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011E

2013E

2015E

2017E

2019E

2021E

2023E

2025E

China's working age population (15-64), % of total (LS)

vs. China Yuan per USD (RS)

Working Age Population (15-64) % of total

China Yuan per USD

Exhibit (17) - A China hard landing risk we see

is plunging fixed investment(1) overwhelming

less cyclical consumption during rebalancing.

Piling on even more state-directed bank loans

is not a long-term solution, in our view.

0%

1%

2%

3%

4%

5%

6%

7%

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

Gross Fixed Capital Formationas % World Nominal GDP

China US Euro Area

Exhibit (16) - China’s worker wave has crested.

China devalued 1993-2011 initially in response

to inflation but later to accommodate a surge in

working age people, but that issue crested in

2011, and rebalancing is our expectation.

Chinese

fixed

investment

now larger

than entire

EU or U.S.


1-Jan-90

1-Apr-90

1-Jul-90

1-O

ct-90

1-Jan-91

1-Apr-91

1-Jul-91

1-O

ct-91

1-Jan-92

1-Apr-92

1-Jul-92

1-O

ct-92

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1-Apr-93

1-Jul-93

1-O

ct-93

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1-Apr-94

1-Jul-94

1-O

ct-94

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1-Apr-95

1-Jul-95

1-O

ct-95

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1-Apr-96

1-Jul-96

1-O

ct-96

1-Jan-97

1-Apr-97

1-Jul-97

1-O

ct-97

1-Jan-98

1-Apr-98

1-Jul-98

1-O

ct-98

1-Jan-99

1-Apr-99

1-Jul-99

1-O

ct-99

1-Jan-00

1-Apr-00

1-Jul-00

1-O

ct-00

1-Jan-01

1-Apr-01

1-Jul-01

1-O

ct-01

1-Jan-02

1-Apr-02

1-Jul-02

1-O

ct-02

1-Jan-03

1-Apr-03

1-Jul-03

1-O

ct-03

1-Jan-04

1-Apr-04

1-Jul-04

1-O

ct-04

1-Jan-05

1-Apr-05

1-Jul-05

1-O

ct-05

1-Jan-06

1-Apr-06

1-Jul-06

1-O

ct-06

1-Jan-07

1-Apr-07

1-Jul-07

1-O

ct-07

1-Jan-08

1-Apr-08

1-Jul-08

1-O

ct-08

1-Jan-09

1-Apr-09

1-Jul-09

1-O

ct-09

1-Jan-10

1-Apr-10

1-Jul-10

1-O

ct-10

1-Jan-11

1-Apr-11

1-Jul-11

1-O

ct-11

1-Jan-12

1-Apr-12

$60

$65

$70

$75

$80

$85

$90

$95

$100

$105

$110

$115

$120

$0

$200

$400

$600

$800

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$1,200

$1,400

$1,600

$1,800

$2,000

$2,200

$2,400

$2,600

$2,800

$3,000

$3,200

$3,400

19

90

19

91

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92

19

93

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97

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98

19

99

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00

20

01

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02

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20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

US

Do

llar: M

ajo

r Cu

rren

cie

s In

de

x, N

om

ina

l

Ch

ine

se

Fo

reig

n E

xc

han

ge

Re

serv

es

(B

illio

ns

US

D)

Historical US Dollar Major Currencies Index

vs. Chinese FOREX Reserves

Jan-1990 to Dec-2011

Chinese FX Reserves (Left Axis)

US Dollar: Major Currencies Index, Nominal (Right Axis)

10 t.

60 t.

110 t.

160 t.

210 t.

260 t.

310 t.

360 t.

19

00

19

10

19

20

19

30

19

40

19

50

19

60

19

70

19

80

19

90

20

00

20

10

Iro

n o

re p

rod

uced

, to

ns p

er

tho

usan

d p

eo

ple

World Annual Iron Ore Production Tons per thousand people,

Years 1904-2010 (solid line)post-2001 U.S. currency devaluation in box

Is this a demand-side bubble?

2001

Source: US Geological Survey, U.S. Census, U.S. Department of Commerce, Cambridge, FactSet, People‟s Bank of China.

Exhibit (18) - We expect China’s steel-intensive fixed investment (manufacturing capacity &

construction), as evidenced by iron ore imports, to result in Chinese over-capacity, trade tensions,

and negative “operating leverage” for China’s corporate GDP, a sizable source of domestic savings

that in circular fashion funds fixed investment, thus placing a limit on Chinese GDP growth. China

catapulted world iron ore usage to an extreme by 2011 (left chart). Not coincidentally, China pegged

to a plunging dollar, but the dollar may be bottoming and Chinese reserves cresting (right chart).

2002

What took the West 30

years 1945 to 1975 to

do China did in 10

years employing

unlimited reserves and

currency policy.


Source: Worldbank, IMF WEO/IFS, OECD.

Note: Gross National Savings is

the sum of the government

surplus/(deficit) plus personal

savings and corporate savings

(retained earnings). Gross

Fixed Capital Formation

(GFCF) measures the

acquisition of new or existing

fixed assets by the private and

public sectors, unadjusted for

deprecation, less disposals.

Exhibit (19) - We think it will be better to be a Chinese citizen than a commodity supplier to China

or an investor in China the next decade. We see Chinese GDP per person doubling by 2012 (7%

CAGR) while commodity intensive construction/capex slow due to peaking savings(1) (and thus

investment), as occurred in Japan, Korea and Taiwan circa 1974, 1990 and 1988, respectively (left

chart, “T+0”). We see Chinese GDP decelerating from ~9%/year to ~5%/year by 2021 (right chart).

$0

$5

$10

$15

$20

$25

$30

20%

25%

30%

35%

40%

45%

50%

55%

T-1

0

T-8

T-6

T-4

T-2

T+

0

T+

2

T+

4

T+

6

T+

8

T+

10

T+

12

T+

14

T+

16

T+

18

T+

20

Gross National Savings as % of GDP (Blue, LS) vs. GDP per capita in U.S. $ (Red, RS)

Chinese savings (and thus fixed investment) is peaking, while income per capita takes off, much as

Japan, Korea & Taiwan did at the same stage.

3-Country Avg:Japan 1964-1994

S. Korea 1980-2010Taiwan 1978-2008

Gross National Savings (LS)

US $Thous.

% ofGDP

China: Gross

National

Savings peaking


S. Korea 1980-2010Taiwan 1978-2008

Real GDP per capita (RS)

China: GDP/Capita

tracking normal

(1) Gross National Savings is the sum of the government surplus/(deficit) plus personal savings and corporate savings (retained earnings). Gross Fixed Capital Formation (GFCF) measures the

acquisition of new or existing fixed assets by the private and public sectors, unadjusted for deprecation, less disposals.

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

T-1

0

T-8

T-6

T-4

T-2

T+

0

T+

2

T+

4

T+

6

T+

8

T+

10

T+

12

T+

14

T+

16

T+

18

T+

20

3-Country Average Real GDP Growth* per Annum (Solid Line) vs. Present-Day Chinese (Dotted Line)

GDP deceleration is normal as fixed investment peaks

China:Y/Y Real GDP

Growth (%) 2001-2011


S. Korea 1980-2010

Taiwan 1978-2008Real GDP y/y %

X


Exhibit (20) - Bad Romance: German Bundesbank (Buba) central bank credit(1) extended to

peripheral Europe is too large to believe that Germany has much bargaining power, so we expect

a “deal” soon. The periphery lost access to external credit in 2008 (left chart), so Buba (Northern

Europe et al.) filled the void (middle chart). Because Buba credit simply replaced private credit,

that created the illusion of current account(2) prosperity for Germany (right chart). Ultimately, we

expect minimal cost for both debtors and Germany as peripheral spreads to bunds collapse via

easily engineered ECB rate suppression (penalizing savers and the euro) and peripheral reforms.

Source: Charts Stifel Nicolaus, data from respective national central banks & OECD.

(1) Under TARGET2 (Trans-European Automated Real-time Gross Settlement Express Transfer System) the German Bundesbank has lent over €460 billion to PIIGS central banks since about

2007 when the global financial crisis cut off much of the peripheral „s access to external credit.

(2) The current account is the sum of the trade balance (exports less imports) plus net income/(expenditure) from overseas investments, receipts, debts and disbursements.

-€100

€0

€100

€200

€300

€400

€500

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Eu

ro, B

illi

on

s

The Bundesbank has extended creditto mirror the PIGS*' lost access

to external credit since the 2008 crisis

German Bundesbank: Net Foreign Claims on

other NCBs (via ECB)

PIGS Cumulative Current Account Deficit,

Starting 2008 (Inverted)

PIGS Sum of Current Accounts (Inverted)

* Portugal, Ireland, Greece & Spain.

-139

-137

-106

-104

-62

66

98

143

495

-€200

-€100

€0

€100

€200

€300

€400

€500

€600

Euro, Billions

Net Claims on other National Central Banks (NCB) via ECB/TARGET2, Dec-2011

Germany is in too deep to trigger

insolvencies in the PIGS

Germany

Netherlands

Luxembourg

Finland

Portugal

Italy

Greece

Spain

Ireland

€50

€100

€150

€200

€250

€300

€350

€400

€450

€500

€550

65.0

70.0

75.0

80.0

85.0

90.0

95.0

100.0

105.0

110.0

115.0

Se

p-0

8

Ma

r-09

Se

p-0

9

Ma

r-10

Se

p-1

0

Ma

r-11

Se

p-1

1

Ma

r-12

The illusion of export-led prosperity: Credit extension to maintain German exports to the

PIGS is only offsetting capital flight from

the PIGS to Germany

German Current Account (Indexed): Receipts/Expenditures

German bank loans to Foreign Non-Sovs % German deposits (Indexed)

Bundesbank Claims on Euro-national central banks via TARGET2

EuroBillionIndex


90

100

110

120

130

140

150

20

00

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01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

Unit Labor Costs in Europe: A gap we see closing by inflating the best

(leaving the U.S. well positioned) and deflating the rest

1Q2000 = 100, Seasonally Adj.

Greece

Portugal

Ireland

France

Italy

Spain

U.S.

Germany

Source: Jagadeesh Gokhal, “Measuring the Unfunded Obligations of European Countries,” 2009; OECD, respective state statistical bureaus.

(1) Productivity is output per hour. Unit labor costs are hourly labor costs divided by productivity, or the labor cost per unit of production.

(2) U.S. private de-leveraging may take 4 more years, as described previously. This fits our view that the U.S. rebalancing in 2012 is 3 years ahead of the EU (7-4 = 3 years).

0%

200%

400%

600%

800%

1000%

1200%

1400%

Fra

nce

Germ

an

y

Gre

ece

Irela

nd

Italy

Po

rtug

al

Sp

ain

U.K

.

U.S

.

% o

f G

DP

Guess which debts won't be paid?

Households Non-financial Corp.

Official Govt. Unfunded Govt.

U.S. and Germany

are in-line, but

periphery + France

are un-competitive.

Exhibit (21) - A more pressing issue we see is that the euro periphery will always run a trade deficit

so long as unit labor costs(1) of the German “savings machine” are ~20% lower (left chart). What is

needed is ~3% German inflation (via ECB laxity) while peripherals + France wages are flat for ~7

years(2) (or some combination, i.e. the peripheral recession accelerates this process) to close the

unit labor cost gap (i.e., ~7x3% = ~20%). Peripheral wages may rise >0%, but only sustainably if

accompanied by structural change (regulatory, labor, privatization) and productivity, in our view.

It is only in the long term that we see

eurozone (and U.S.) debts as a problem due

to what we view as impossibly high un-

funded government promises (red bars).


-8.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

22.00%

24.00%

T-1

0

T-8

T-6

T-4

T-2

T+

0

T+

2

T+

4

T+

6

T+

8

T+

10

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12

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14

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16

T+

18

T+

20

An

nu

ali

zed

Gro

wth

: O

il C

on

su

mp

tio

n p

er

Cap

ita

3 Country's Average Barrels of Oil Equivalent (Oil + Natural Gas) Consumption per Capita, Y/Y Growth

Rate* vs. China 2001-Present

China (2002-2011)

Japan (1964-1994)

Taiwan (1978-2008)

Korea (1980-2010)

*Shown smoothed

-20.00%

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

T-1

0

T-8

T-6

T-4

T-2

T+

0

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2

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4

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6

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8

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12

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14

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20

An

nu

ali

zed

Gro

wth

: C

op

per

Co

nsu

mp

tio

n p

er

Cap

ita

2 Country's Average Annual Copper Consumption (Kg per Capita) Y/Y Growth Rate* vs. China 2001-

Present

China (2002-2011)

Japan (1964-1994)

Korea (1980-2010)

*Shown smoothed

Source: BP Annual Review, IEA, UN, Japanese Ministry of Internal Affairs and Communications, OECD, IMF.

(1) Although Japanese demand for both oil and copper was dramatically reduced by the 1973-74 Oil Shock, Korea after 1990 and Taiwan after 1988 both slowed, yet they

were not affected by a similar resource price shock. We attribute slowing demand to reduced fixed investment as a percent of GDP and rising consumer economies.

Exhibit (22) - For commodities, the 2nd derivative (rate of change in growth) matters. We think China is

following the path up to and after Japan in 1974(1), Korea in 1990 and Taiwan in 1988 in terms of a

peaking fixed investment contribution to GDP growth (as the pool of savings also peaks,) and much

slower but sustainable GDP growth thereafter, with greatly reduced fixed investment. Both petroleum

(left chart) and copper (right chart) demand growth should shrink, especially copper, in our view.


In a macro sense, we think oil

remains the greatest risk, but

slowing demand followed by

new supply should prevail.


-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

Jan-7

3

Jan-7

5

Jan-7

7

Jan-7

9

Jan-8

1

Jan-8

3

Jan-8

5

Jan-8

7

Jan-8

9

Jan-9

1

Jan-9

3

Jan-9

5

Jan-9

7

Jan-9

9

Jan-0

1

Jan-0

3

Jan-0

5

Jan-0

7

Jan-0

9

Jan-1

1

Inflation-Adjusted U.S. Gasoline Retail Price ($/gallon, left axis, solid area)vs. y/y U.S. Real GDP converted to monthly (line, right axis)

Fuel shocks (not level, but rather spikes) as catalysts for negative y/y GDP

Inflation- adjusted Retail Gasoline $/Gallon (Left Axis) U.S. Real GDP Monthly y/y % chng. (Right axis)

Exhibit (23) - We suppose there are those who still believe fuel price spikes do not affect U.S.

GDP. But 40 years of data support the notion that U.S. consumers recoil at gasoline price

spikes, and one may be in the offing in mid-2012, in our view, unless overseas demand slows.

Source: Bloomberg, EIA, Stifel Nicolaus format.


Source: Bloomberg, EIA, Stifel Nicolaus format.

* We use heating oil (HO1) as a proxy for diesel fuel.

0.00

0.10

0.20

0.30

0.40

0.50

0.60

Jan-0

0

Jan-0

1

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

Jan-1

0

Jan-1

1

Jan-1

2

Jan-1

3

Gross US Distillate Fuel Oil (DFO, mostly diesel)

exports by destination,mil. bbl/d

Central & S. America Europe Other

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

0.00

0.20

0.40

0.60

0.80

1.00

1.20

Jan-0

0

Jan-0

1

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

Jan-1

0

Jan-1

1

Jan-1

2

Jan-1

3

Gross US Distillate Fuel Oil (DFO, mostly diesel)

exports, (mil. bbl/d, LS)vs. HO1-WTI* crack spread ($ per bbl, RS)

and HO1-Brent* crack spread ($ per bbl, RS)

DFO Total Exports HO1 crack spread $ per bbl Brent-HO1 Crack Spread

Exhibit (24) - U.S. exports of distillate fuel oil (DFO) have soared, lifting refinery pricing

power and forcing U.S. drivers to compete aggressively with the rest of the world. The

increase in U.S. DFO exports has lifted crack spreads (a measure of refinery profitability)

sharply since the Great Recession began (left chart). The export destinations (right chart)

are the EU, where oil is so heavily taxed that demand is less price elastic, and South

America, where refineries are not configured for demand and South American buying power

(currencies) are elevated due to the China currency peg and fixed investment bubble.


Exhibit (25) - We think non-G7 oil demand is ripe for pull-back as world GDP slows and non-G7

oil/fuel subsidy distortions(1) are perhaps rolled back due to budget woes we expect in that area.

G7 country(2) oil demand, which is 38% of the world total, is likely to remain weak (left chart),

having experienced in 2007-09 an oil shock similar to 1979-81. In contrast, non-G7 country oil

demand has grown at ~3%/yr., is 62% of world oil demand, and is precariously above trend.

Source: EIA, BP Statistical Review, United Nations, IEA, Stifel Nicolaus.

(1) We estimate ~25% subsidies on numerous refined products in parts of the EM, equating to a consumer price for oil in parts of the EM that we believe is only $75/bbl.

(2) G7 is the U.S., U.K., Germany, Japan, France, Italy and Canada. Non-G7 is the remainder of the world.

To flatten

2011-14E,

in our view


Source: EIA, Bloomberg, BP Statistical Review of World Energy, Stifel Nicolaus format.

Exhibit (26) - Higher oil prices reduced western demand, so lower oil prices should pressure

developing country oil demand by making government oil subsidies un-affordable, in our

view. As shown below, OPEC demand growth was extraordinary the past decade (table left),

rising more in low population Saudi Arabia in terms of total barrels than in India, for

example, the result of generous subsidies that insulate domestic OPEC consumers (right

chart). We see subsidies under pressure as oil prices fall.

Oil: Consumption Change Change

2010 vs.2000 2010 vs.

2000 2010 2000, 2000, % of

Thousand barrels daily (000) b/d (000) b/d (000) b/d World Total

BRICS*

China 4766 9057 4291 40%

India 2261 3319 1058 10%

Brazil 2018 2604 585 5%

Russian Federation 2698 3199 502 5%

Singapore 645 1185 540 5%

* Added Singapore, deleted S. Afr. 6975 65%

Group of Seven (G7)

United Kingdom 1704 1590 (114) -1%

France 1994 1744 (250) -2%

Germany 2746 2441 (305) -3%

Italy 1930 1532 (398) -4%

US 19701 19148 (553) -5%

Japan 5530 4451 (1080) -10%

Canada 1922 2276 354 3%

(2346) -22%

OPEC

Saudi Arabia 1578 2812 1234 11%

Other Middle East 1155 1653 498 5%

Iran 1304 1799 495 5%

Other Africa 1238 1676 438 4%

United Arab Emirates 396 682 286 3%

Venezuela 559 765 206 2%

Kuwait 249 413 165 2%

Qatar 60 220 160 1%

Algeria 191 327 136 1%

Ecuador 128 226 98 1%

3716 34%

Rest of World

All other countries 2432 23%

Total World 76605 87382 10777 100%

Inland demand + international aviation, marine bunkers, refinery fuel & loss.

Consumption of fuel ethanol and biodiesel is also included.

Differences accounted for by stock changes, consumption of non-pet. Additives,

substitute fuels, and unavoidable disparities in the definition.

OPEC demand for its own

oil accounted for 34% of

the world increase, yet

that demand depends on

high oil prices that fund

subsidies to be

sustained.

To make room for the

BRICS' oil demand (65%

of the 10-year global

growth in oil consumed

was the BRICS) ….

…the industrial G7

countries gave up living

standards (G7 oil demand

fell 2.3md/b over 10

years)...

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

U.S. vs. OPEC retail gasoline & diesel prices,

$ per gallon

U.S. retail avg. diesel price

U.S. retail avg. gasoline price

OPEC retail avg gasoline price

OPEC retail avg. diesel price


Exhibit (27) - Tight oil (shale oil) may be the greatest U.S. macro positive in decades. We believe

that if the U.S. displaces(1) 3 million barrels per day (mb/d) of oil imports via tight oil by 2022, it

could provide savings sufficient to service all ($6.2 trillion) of the debt needed to back-fill the

U.S. output gap (the gap between potential GDP(2) and projected GDP) from 2011 to 2022.

10

11

12

13

14

15

16

17

18

19

2000Q

1

2001Q

1

2002Q

1

2003Q

1

2004Q

1

2005Q

1

2006Q

1

2007Q

1

2008Q

1

2009Q

1

2010Q

1

2011Q

1

2012Q

1

2013Q

1

2014Q

1

2015Q

1

2016Q

1

2017Q

1

2018Q

1

2019Q

1

2020Q

1

2021Q

1

GD

P (

$2005 tr

illi

on

)

Potential vs. Actual Real GDP, 1Q2000 to 1Q2021, with Stifel Nicolaus Projections after

3Q2011 based on 3% real GDP growth 2011 to 2022

Potential GDP Real GDP

The gap separating forecast GDP (3% growth) versus

potential GDP from 2011 to 2022E is

$6.2 trillion, cumulatively.

(1) When we refer to “displacement” we are not referring to the myth of oil self sufficiency, but rather outward U.S. funds flows shifting from funding oil imports via

the current account (trade deficit) to instead servicing debt under the U.S. capital account (capital outflows).

(2) The highest level of long-term real gross domestic product attainable under natural and institutional constraints. Limited resource utilization is assumed to be

absent of any cyclical contribution, as with labor, working hours, capital equipment, raw goods, technology and managerial skills.

Under various interest rate and WTI oil price assumptions

below, if U.S. tight oil (shale oil) production (plus GOM

deepwater) by 2022 reaches a net 3 million barrels/day addition

from the Bakken, Eagle Ford & Niobrara formations, which we

believe to be a realistic figure, then 1.1 billion barrels per year

(365 days x 3 mb/d) of added domestic output (assuming

offsets to declining production in Alaska, etc.) could service all

or much of the cumulative U.S. fiscal deficit incurred to close

the output gap (chart right), or actual vs. potential GDP to the

year 2022. That would shield the public from the worst effects

of the ongoing mini-depression, in our view.

Source: For the chart, Congressional Budget Office (CBO), Bureau of

Economic Analysis (BEA), & Stifel Nicolaus Projections.

$85/bbl. $95/bbl. $105/bbl. $115/bbl. $125/bbl. $135/bbl.

1.00% $9.31 tril. $10.40 tril. $11.50 tril. $12.59 tril. $13.69 tril. $14.78 tril.









Assumed WTI Oil Price in 2022

Es

t. 5

-ye

ar

Tre

as

ury

ra

te i

n 2

02

2


$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

$9,000

$10,000

$11,000

$12,000

$13,000

$14,000

$15,000

$16,000

Ja

n-8

1J

an

-82

Ja

n-8

3J

an

-84

Ja

n-8

5J

an

-86

Ja

n-8

7J

an

-88

Ja

n-8

9J

an

-90

Ja

n-9

1J

an

-92

Ja

n-9

3J

an

-94

Ja

n-9

5J

an

-96

Ja

n-9

7J

an

-98

Ja

n-9

9J

an

-00

Ja

n-0

1J

an

-02

Ja

n-0

3J

an

-04

Ja

n-0

5J

an

-06

Ja

n-0

7J

an

-08

Ja

n-0

9J

an

-10

Ja

n-1

1

M3 money + Excess Reserves at the Fed ($ bil.)

Excess Reserves

Institutional Money Funds

Eurodollars

Repos

Large-Time Deposits

Retail Money Funds

Small Denom. Time Deposits

Savings Deposits

Demand & Other Check Deposits

Currency & Travelers Checks

M2 = Below

Sum = M3

M1 = Below

Deng currency reforms in China,

Mexican Peso & Asian debt crises.

100

150

200

250

300

350

400

450

500

550

600

650

700

Jan-9

5

Jan-9

6

Jan-9

7

Jan-9

8

Jan-9

9

Jan-0

0

Jan-0

1

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

Jan-1

0

Jan-1

1

Jan-1

2

Commodity Prices (CRB Futures Continuous Commodity Index)

Daily prices 01/01/1995 to present

Exhibit (28) - If you triple the unit of account, you triple commodities denominated in that unit. Asian

savings facilitated U.S. credit(1), tripling U.S. money supply (left chart) post-1995. Since dollars are

the unit of account, commodities tripled (right chart). Fed “QE” + Chinese fixed investment boosted

commodities 1Q09-2Q11, but we expect commodities to only track M3 money in the future.

Source: Source: U.S. Federal Reserve. For M3 1981 to 2005 the Fed reported M3 (SA). For 2006 forward we use: M2 + large time deposits + institutional money market balances + Fed Funds &

Reverse repos with non-banks + interbank loans + eurodollars (regress historical levels versus levels of M3 excluding Eurodollars). Excess reserves at the Fed are funds in surplus over those mandated

by reserve requirements. CRB Continuous Commodity Futures, Stifel Nicolaus format. ). We also add excess reserves at the Fed to M3, which takes into account funds in surplus over those mandated

by reserve requirements. We add them to M3 to better reflect high powered money, but realize the Fed could remove those reserves by selling its liquid assets.

(1) Foreign purchases of U.S. Treasuries & Agencies kept U.S. rates low and recycled the trade deficit. As for money creation, when a bank makes a loan and the recipient re-

deposits the loan, the bank holds back a ~10% reserve at the Fed and makes another loan. In that way $1 of reserves creates $10 of money supply.

~+300%

2008

~+300%


-10.0%-9.0%-8.0%-7.0%-6.0%-5.0%-4.0%-3.0%-2.0%-1.0%0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%

10.0%11.0%12.0%13.0%14.0%15.0%16.0%17.0%18.0%19.0%20.0%

18

05

18

15

18

25

18

35

18

45

18

55

18

65

18

75

18

85

18

95

19

05

19

15

19

25

19

35

19

45

19

55

19

65

19

75

19

85

19

95

20

05

20

15

E

20

25

E

20

35

E

Commodity price inflation follows a Kondratiev CycleK-Waves peak (and bottom) every ~55 years, with failed peaks in between. On that basis,

2011 is a failed peak, and commodity prices should slow the next 12-15 years to a ~3% growth rate (10-yr. m.a.) before resuming the sharp uptrend 2025-2035E, in our view.

1814 peakWar of 1812/

Napoleonic Wars

1864 peakU.S. Civil

War

50 years

2035peak?

1920 peakJust after

W.W.I

1980 peakCold War

56 years

60 years

55 years

54 years52 years

61 years

56 years

Source: Commodities 1795 to 1890 are the Warren & Pearson U.S. commodity index constructed with farm products, foods, hides & leather, textiles, fuel & lighting, metals & metal products,

building materials, chemicals & drugs, household furnishing goods, spirits and other commodities. 1891 to 1913 is the Wholesale Commodities Price Index from the BLS and other agencies. 1914

to 1956 is the PPI for All Commodities, and 1957 to present is the CRB Continuous Commodity Index, currently an equal-weighted, front-month index of 17 commodities including most high-use

energy and agricultural commodities. Prior to 2002, annual data are the average of monthly values. For the trailing decade, all daily closing values for the CRB CCI index are considered.

Exhibit (29) - In the long term, commodity prices follow Kondratiev Cycles, implying low commodity

inflation 2011-25 and potentially very high inflation 2025-35. The ~55 year peaks between Kondratiev

peaks (and bottoms) shown below signals a ~13 year respite in commodity prices, possibly due to

added supply, China re-balancing, and western deflationary de-leveraging, followed by a high

inflation 2025-35, possibly to discharge debt from the (then dying) Baby Boomer entitlement costs.

Est.

path

2012-

2035

2047

bottom?


Exhibit (30) - Supply writes the obituary for oil price inflation. The four secular bear markets for oil

since the 20th Century began were ~17 years (see chart, 1899-1915, 1926-45, 1957-72 & 1980-98), with

an average 35% decline, impacted by new oil supply. If ~$100/bbl. in 2011 was the peak, a 35% 17-

year (to 2028E) decline would take oil prices to an estimated $65/bbl., all else being equal (See table).

Source: BP data, BLS, EIA, Stifel Nicolaus projections.

Note: Although inflation led to a higher second peak in the 1970s, accumulated debt since 1980, which is deflationary, would prevent that reoccurrence, in our view.

Inflation-adjusted Crude Oil Prices, $ per bbl. - Double Peak, Then 17-Year Slide

$1

$10

$100

1892

1897

1902

1907

1912

1917

1922

1927

1932

1937

1942

1947

1952

1957

1962

1967

1972

1977

1982

1987

1992

1997

2002

2007

2012

2017

2022

2027

1899-1915

California

alone reached

22% of global

oil production.

Large oil

discoveries in

Spindletop,

TX, Glenn

Pool, OK and

Louisiana. In

addition,

Anglo-Persian

struck oil in

Persia.

1926-1945

Venezuela's

output hits #2

globally.

Dormant since

1920, Post-

Bolshevik

Revolution

Russian

production ramps

to repair the

economy. The

Black Giant is

discovered in

East Texas.

Romanian oil

production ramps.

1957-1972

Middle East

production

rises to 30%

of world

total.

African

output rises

(mainly

Libya).

Between

1955-1960,

Russian

production

doubles

under the

"Soviet

Economic

Offensive."

1980-1998

By 1981, non-

OPEC

surpasses

OPEC due to

Mexico, Alaska

& North Sea.

From 1980-

1985, Saudi

output falls 2/3

as they defend

oil prices amid

rising OPEC

member non-

compliance

and Russian

production.

But, in Nov-

1985, Saudi &

OPEC flood the

market to

maintain Saudi

share.

End of

the gold

standard 2011-2028E

WTI Oil falls

to $65/bbl. on

increased

U.S. output,

strong ramp

in Iraqi oil

production

(out-of-quota),

a breakdown

in OPEC

cohesion as

regimes seek

to maximize

cash flow to

support

welfare states

and forestall

rebellion,

weaker EM

demand as

China works

through credit

problems,

U.S. dollar

strengthens

moderately as

a result of

euro solvency

and EU

integration

challenges.

OilDecline

Year 1899 $1.29 /bbl. Est.16 Years -50% Decline

Year 1915 $0.64 /bbl. Est.


Year 1945 $1.05 /bbl. Est.

Year 1957 $3.04 /bbl. Est.15 Years 17% Increase

Year 1972 $3.56 /bbl. Est.


Year 1998 $14.39 /bbl. Est.


Year 2028E $65.23 /bbl. Est.

Period Percentage Price Change

Period

Nominal Oil $/bbl. (Chart, left is real price)


We believe gold performance is

stoked by deflation fear, but

Goldilocks undermines the bull

case for bullion.


$0/oz.

$200/oz.

$400/oz.

$600/oz.

$800/oz.

$1,000/oz.

$1,200/oz.

$1,400/oz.

$1,600/oz.

$1,800/oz.

$0

B (M

3)

$1

,00

0B

(M3

)

$2

,00

0B

(M3

)

$3

,00

0B

(M3

)

$4

,00

0B

(M3

)

$5

,00

0B

(M3

)

$6

,00

0B

(M3

)

$7

,00

0B

(M3

)

$8

,00

0B

(M3

)

$9

,00

0B

(M3

)

$1

0,0

00B

(M3

)

$11

,00

0B

(M3

)

$1

2,0

00B

(M3

)

$1

3,0

00B

(M3

)

$1

4,0

00B

(M3

)

$1

5,0

00B

(M3

)

Gold Price (U.S.$/oz.) vs. M3 Money,

1970-2011 (i.e., During Gold Exchange Standard)

1980

2011

2001

1970

$15/oz.

$20/oz.

$25/oz.

$30/oz.

$35/oz.

$40/oz.

$45/oz.

$0

B (M

3)

$1

00

B (M

3)

$2

00

B (M

3)

$3

00

B (M

3)

$4

00

B (M

3)

$5

00

B (M

3)

$6

00

B (M

3)

$7

00

B (M

3)

$8

00

B (M

3)

$9

00

B (M

3)

Gold Price (U.S.$/oz.) vs. M3 Money,

1919-1971 (i.e., During Gold Exchange Standard)

1934

1970

1930

Source: Stifel Nicolaus analysis, U.S. Federal Reserve, Bloomberg.

(1) Bretton Woods was the 1945-71 agreement in which the U.S. dollar fixed to gold price at $35/oz. (for foreigner s) and foreign currencies loosely fixed to the U.S . dollar.

Exhibit (31) - As money (credit) grows more slowly, and fears of “tipping over” into either deflation

or inflation subside, we see gold prices coming under increased pressure. Whether we examine

the period before the end of the gold standard (left), or the period after the gold standard ended

(right), changes in money supply (horizontal axes below) drive great swings in the price of gold

(vertical axes). If money (credit) growth slows as we expect, we would expect the gold price to fall.

Great

Depression

begins

FDR reflates

out of Great

Depression

One year

before Bretton

Woods(1)

ends.

Peak of U.S.

CPI inflation

April 1980

9/11, Tech

Bubble burst

Euro crisis,

China slows


-10%

-5%

0%

5%

10%

15%

20%

25%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015P

NE

M M

ine

Pro

du

ctio

n G

row

th

NE

M R

ea

l(1)

WA

CC

NEM Real(1) WACC (Blue, Left) vs. NEM Mine Unit Production Growth for Copper & Gold (Red, Right),

7-Yr. moving avg. 1950 to 2011P

Cu Pre-1965 and Au Post-1965

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

13%

14% 1913

1918

1923

1928

1933

1938

1943

1948

1953

1958

1963

1968

1973

1978

1983

1988

1993

1998

2003

2008

2013P

Glo

ba

l Go

ld M

ine

Pro

du

ctio

n G

row

th M

on

ey (

M3

) G

row

th (

INV

ER

TE

D)

Aggregate Money Supply (M3 Left, INVERTED) vs. Growth in Global Gold Mine Production (Right),

7-Yr. Annualized Average Growth Rates, 1950 - 2010 Actual, 2011 Projected

Source: Company reports, U.S. Geological Survey, Morningstar/Ibbotson large capitalization U.S. equity total return, Stifel Nicolaus format.

(1) Economic profit is ROIC minus WACC (Weighted Average Cost of Capital) which is [D/(D+E)] KD (1-T) + [E/(D+E)] KE. The real WACC is thus WACC minus mineral appreciation. If the WACC

is 10% and gold rises 20%, the real WACC is negative 10% to carry reserves and not produce them. Conversely, if the gold price falls 10% and the WACC is 10%, that is a +20% (10% minus a

minus10%) carrying cost for reserves, and an incentive to produce. For cost of equity we use CAPM, with 1 year t-bills as RF, 5-yr. avg. beta and S&P trailing 10-year total return as market return.

Exhibit (32) - If money (i.e., credit) remains sluggish as we expect, we would expect less pressure on

miner’s costs and more gold supply to result. This may be better for gold miners than bullion prices.

When money supply growth is rapid (credit drives money

supply; left axis is inverted), we think the cost of gold mining

per ounce (fuel, machinery, people) rises, so gold output

falls. But when money slows, costs fall and output increases.

Miner’s gold production also follows economic profit(1)

reasoning. Rapid money growth causes the gold price to rise

versus money. This gives the miner a low cost of carry for

reserves, so it more rewarding to leave the gold in the ground.

Low carrying cost for

reserves, less

production results.

High carrying cost

for reserves, more

production results.


Important Disclosures and Certifications

I, Barry B. Bannister, certify that the views expressed in this research report accurately reflect my personal viewsabout the subject securities or issuers; and I, Barry B. Bannister, certify that no part of my compensation was, is, orwill be directly or indirectly related to the specific recommendation or views contained in this research report. Forour European Conflicts Management Policy go to the research page at www.stifel.com.

Stifel, Nicolaus & Company, Inc.'s research analysts receive compensation that is based upon (among other factors) StifelNicolaus' overall investment banking revenues.

Our investment rating system is three tiered, defined as follows:

BUY -For U.S. securities we expect the stock to outperform the S&P 500 by more than 10% over the next 12 months. ForCanadian securities we expect the stock to outperform the S&P/TSX Composite Index by more than 10% over the next 12months. For other non-U.S. securities we expect the stock to outperform the MSCI World Index by more than 10% over thenext 12 months. For yield-sensitive securities, we expect a total return in excess of 12% over the next 12 months for U.S.securities as compared to the S&P 500, for Canadian securities as compared to the S&P/TSX Composite Index, and for othernon-U.S. securities as compared to the MSCI World Index.

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SELL -For U.S. securities we expect the stock to underperform the S&P 500 by more than 10% over the next 12 months andbelieve the stock could decline in value. For Canadian securities we expect the stock to underperform the S&P/TSXComposite Index by more than 10% over the next 12 months and believe the stock could decline in value. For other non-U.S.securities we expect the stock to underperform the MSCI World Index by more than 10% over the next 12 months andbelieve the stock could decline in value.

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