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MATTER OVER MIND

After a significant recovery from the March '09 bottom during which our equity compositesoutperformed, the markets suffered a setback in the last quarter, during which our portfoliosunderperformed from the unusual decline in Canadian small capsthe TSX Venture Exchangedown 17% in the quarter and down 22% from its early March high. Investor psychology in thequarter became excessively negative even though stocks generally, and the companies in ourportfolios, became even more compelling with discernible progress ahead. In our view thecurrent investor mindset does not correspond with what should really matter to an investor.

Mind Games

As the markets declined in the quarter, stocks became significantly oversold from the negativepsychology resulting from the negative headlines. And there were and are many of them: thefinancial rescue of Greece, and the implications for Europe and its other precarious economiessuch as Ireland and Portugal and, now, Spain and Italy too; the potential slowing of the Chineseeconomy; supply chain disruptions from Japans earthquake; poor U.S. jobless numbers; ahigher than expected U.S. trade deficit; continued falling U.S. house prices; a potentialdeadlock in the U.S. budget talks and the debt ceiling debate; the Fed cutting its forecasts foreconomic growth; potential headwinds from government austerity programs; fear of a slowing

economy; fear of deflation; fear of inflation; rising commodity prices and declining stockprices. A mindset of fear and fear. CNBC recently reported that investors were moreconcerned about the economy than at any other time during the past five years; a CBS pollfound that 39% of Americans believe the economy is in a state of permanent decline. We allknow the mind can play tricks. Risk aversion. That wall of worry. But when perceived risk isso great it is typically reflected more than warranted in depressed share prices. Its in themarket. The news doesnt have to be good, just not as bad as everyone believes.

What Matters

What matters is that, while global growth has slowed somewhat, all of the global liquidity

should induce increased growth later this year, particularly as Chinas tightening ends andJapan resumes its production and growth, as will U.S. factories. Chinas economy still

managed to grow 9.5% in Q2 from a year earlier and India continues strong too. U.S.manufacturing activity picked up in May. U.S. purchasing manufacturers index improved inJune. Industrial commodity prices remain strong. The Dow Jones Transports recently hit anall-time high. U.S. housing sales will improve from prices stopping their decline, fromshrinking loan delinquencies, from low new housing starts, from diminished inventories, frominflationary pressures, from easier credit and, best of all, from affordability. Canadian housingstarts strengthened in June. A record high level of Canadian firms expect to increaseemployment over the next year as sales and investment in machinery continue to rise.

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U.S. interest rates are at historical lows and the yield curve remains steepincentives for newlending. Fed stimulus remains in the system even if the Fed were to stop its asset purchases.And if more monetary stimulus is needed the Fed will supply it, no matter how it equivocates.Meanwhile, personal incomes are rising and U.S. consumers are getting strongera savingsrate of 5% in May, and the May PCE price index up 0.3%an inducement not to defer

spending. The ratio of consumer debt payments to incomes is the lowest since '94. TheS&P 500 Retailing Index just hit a record high. U.S. exports should strengthen from the weakdollar and stronger overseas growth. While U.S. unemployment remains high as state and localgovernments shed jobs, private sector job growth is slowly improvingall as it should be.Employment will improve as manufacturing and housing pick up. State finances areimprovingCalifornia, New York and Texas, for example. The U.S. debt ceiling will beraised and a favourable deficit-cutting bipartisan deal reached. Natural tsunamis cant beavoidedman-made ones can. Global growth should accelerate. Left-wing governmentseverywhere are moving to the centre right and compelled to get their fiscal houses in order,ultimately good for growth and good for business. Short-term austerity for long-termprosperity. Or, as value investors prefer, short-term pain for long-term gain.

What Really Matters

But, for we narrow-minded stock investors, what really matters is that valuations are unusuallycompelling, that monetary conditions are very favourable, and, finally, that the psychology hasbecome sufficiently negative to induce the recent rally. To continue climbing the wall ofworry. The big caps first, with the smaller, in typical fashion, immediately following.

What really matters to us, as stock investors, are corporate earnings and their future growth,and what we have to pay currently for those businesses. Oh, and what we think others arelikely to pay in the future for the then earnings, in order for us to realize our estimated potentialgain.

What really matters to us is that currently our stocks are unusual bargains, many trading at thesame depressed valuations as their March '09 lows. What really matters is that S&P 500forward earnings have risen to a new record high and that the forward multiple dipped below12x in mid-June before the recent rally, when fair value is over 15x. What really matters is thathealthy profits will encourage businesses to invest, hire and grow. And rebuild inventories,currently low relative to sales. And that earnings this year are expected to be up 18% andrevenues 8.5%, year over year.

Hays Advisory notes that whenever its dependable Monetary Composite is as bullish as it isnow, over the next 18 months the stock market could be up by over 30%. And its ValuationComposite suggests the odds are high that the stock market will be much higher over the next4-5 years. It believes that bad news is good since it causes stocks to be cheap and monetaryliquidity to be plentiful.

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What really matters is that corporations are flush with cash which should allow more capitalspending and employment. And increased share buy-backs, dividends and merger andacquisition activity. And what really matters is that, in terms of protecting purchasing power,stocks are safer than bonds.

With earnings right back to their long-term trend line and at all-time highs, the S&P 500 isselling at a 15% discount to our Fair Market Value. Yet, bonds, with paltry yields, remainfavoured by U.S. households and pension funds over equities, so equity allocations are atmulti-year lows. The stock market will be propelled higher by the mountain of cash on thesidelines as the overwhelming fear ultimately abates.

We think now is an extraordinarily good time to invest. The large-cap indexes areundervalued. Stocks today are, by far, the preferred asset class compared to bonds and cash.Our TRAC and TRIM work are positivea number of markets and sectors appear to haveinflected up from key support levels. And, most important, risk-reward parameters for ourindividual holdings are so highly favourable.

These Stocks Matter

Our current portfolio holdings are below-average riskthat is, the likelihood of permanentimpairment in those securities is minimal, if at all. Even in our downside analysis we forecastgains.

We always look for stocks that are mispriced from being misunderstood or unknown. But inthis correction smaller-cap holdings such as ours appear to be unwanted mostly becausenervous investors prefer the perceived safety of cash. To boot, our four largest holdings hadannouncements in the quarter which led to short-term concerns about the companies. In ourview, these were all temporary issues in those companies which all have below-average riskand significant upside potential. And, inasmuch as our targets have not changed, their currentupside is even higher than at the start of the quarter.

Corridor Resources declined after Apache, its joint venture partner for its shale gasdevelopment, elected not to proceed with a second stage following poor results from twohorizontal exploratory wells. Corridor believes the wells were drilled incorrectly and the partners withdrawal did not alter our appraisal of the company. Corridor now intends to

proceed with a pilot project of its own with drilling commencing late this year.

We expect Corridor, with or without a new partner, to commercialize the Frederick Brook shaleproject. The size of the prize is enormous and should attract lots of interested parties. And,given the markets reaction, it seems to be overlooking the fact that Corridors first targetedshale well, its G-41 well, which Corridor itself drilled vertically, had excellent results. If theinitial flow rates from subsequent Frederick Brook wells are less than half of G-41, and even ifgas prices remain depressed, the projects economics are still adequate. Also, both wells drilledby Apache encountered strong gas shows while drilling. Meanwhile, the companys reservevalue is in line with the current share price, so were getting this project , and the othersignificant potential of Corridor, free.

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Our target remains $16 over the next 3 years, more than 5 times the current share price. Ourappraisal adds the current reserve value plus only a fraction (3% net of an anticipated partner)of the potential value of the 59 Tcf Frederick Brook shale resource with zero value ascribed to:higher natural gas prices; Old Harry in the Gulf of St. Lawrence (potentially 2 billion bbls ofrecoverable oil in place where we anticipate a partner shortly, with drilling to begin in '12/'13);

and Anticosti Island (a potential shale oil project where Corridor just announced results of anindependent engineering report with a best estimate showing Corridors interest of 19.8 billionbarrels of oil equivalent resources). We expect a partner to be announced for Anticosti as wellthis year.

St Andrew Goldfields had slower than anticipated production in the first part of the year, butwhich is expected to ramp up in the second half and over the next several years, and withexploration news coming on a regular basis from its expanded drill program. St Andrew holdsthe largest land position in the Timmins mine campthe third most prolific mine campgloballywith 120 km along the Porcupine Destor Fault. Interestingly, all gold stocks, butparticularly the juniors, suffered in the quarter, notwithstanding high bullion prices. Gold

stocks in general appear to be historically cheap versus bullion and St Andrew trades at amaterial discount to its Net Asset Value (a 25% discount even using a $1200 gold price). Goldstocks should overtake bullion. Unlike bullion, stocks get a rate of return and grow. So shouldSt Andrew. Even assuming no material addition from exploration growth, we have an upsidetarget of $2.40 in 3 years (assuming only $1350 gold and 7x cash flow), nearly 3 times thecurrent share price.

Orca Exploration declined after the announcement that the company needed to do remedialwork on the liner of some wells which temporarily slowed production and utilized cash.However, the company just released that Songas agreed to increase the capacity of the SongoSongo gas plant by 22%, a very material announcement. Including only the reserves of SongoSongo East produces a valuation over 70% higher than the current share price. With Tanzaniaand surrounding regions power starved, production should continue to increase. Value shouldalso grow from exploration properties in Italy and Songo Songo West. Our 3-year target is$16 or 3 times the current share price.

Xcite Energy, which ran up 10 fold from its 2010 low aided by drilling success at the Bentleyfield in the North Sea, fell precipitously after publication of a reserve report misunderstood bythe market. Most importantly, the company has proven the commerciality of the Bentley field.Because the company was intending to begin a phased field development plan, the engineersassigned the company 28 million barrels of reserves, leaving another 87 million barrels ascontingent. In our opinion it is merely a technical discrepancy which separates thesecategories. Assuming, as we anticipate, the company has a staged process, then all 115 millionbarrels could be included as proven and probable reserves. Even assuming anticipated sharedilution, the value of the company today is nearly twice the share pricea value we expect tobe driven higher over the course of 2012 with drilling outside the core area and from additionalprospects from enhanced oil recovery techniques. The lower-risk development project shouldbegin in the fall and our 3-year target is more than 4 times the current share price.

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Manitok Energy, though well off its high, has had nothing but good news. Its initial Stolbergwell (1,350 bpd once on line) was a success and when added to current production (350 bpd),plus the land value and its cash, we arrive at a value nearly 2 times the current share price.Manitok is focused on development wells in the Alberta foothills where they reenter existingwell bores or twin nearby wells. Land prices had fallen back to '98 levels and the company was

recently successful in posting highly prospective land adjacent to its existing land holdings.Chance of success is high due to the development nature of its drilling, and the commensuraterates of return on capital spending are high too. The company has a competitive advantage inits region, very high expected internal rates of return from conventional drilling and a provenmanagement team that has drilled over 50 wells per year in the area for several years. Weexpect a ramp in production to 8,000 bpd over the next 18 months which could increase thevalue of the company to more than 4 times the current share price.

Dell, though somewhat misunderstood, has held up well in the recent correction. Its PCbusiness is now a negligible portion of profits. Like other IT giants, Dells business hasmorphed toward the enterprise market and IT services. Dell remains one of the leading global

brands yet the shares are valued at merely 5x free cash flow, excluding its net cash. Even in ano-growth scenario which we dont foresee, but which allows us to stress-test Dells valuation,the companys actual trailing 12-month free cash flow supports a value in excess of the currentshare price. The companys growth strategy is paying off. We anticipate a potential lift back to

12x free cash flow and about 10% annualized growth which should combine to lift the sharesby over 40% per year, to twice the current share price, over the next 2 years.

Hewlett-Packard, like Dell, has reinvented itselfits PC business now representing less than10% of overall profits. Even assuming no growth in actual trailing 12-month free cash flow,H-P is worth about 40% more than its current share price. Whereas, in fact, H-P has shown,and should continue to show, strong growth and its higher margin repeatable IT service andsoftware related segments, along with the printer and associated cartridge business, continue todominate. The company now has the ability to provide a wide range of convergedinfrastructure hardware solutions, integrating servers, storage, software, networking andconsulting. Trading at less than 7x free cash flow, more than a 40% discount to our appraisedvalue, this top 10 global brand is undeniably undervalued. Also, like Dell, we anticipate morethan a 40% per year return from H-P, or a double, over the next 2 years.

We did sell an initial H-P position in late May after it declined from quarterly results giving usa TRAC sell signal. We sold Cisco for the same reason. But after H-P recently declinedeven lower, to a floor, we bought it back.

When Microsoftfell recently to a TRAC floor, we added it too. The company has steadilygrown its FMV, with a greater increase over the last couple of years on the back of Windows 7.Windows 8 looks even better and the Office suite of software continues to drive earnings.Xbox is now contributing too. The share price has languished for years as it remainedsubstantially overvalued for some time. But now, at 8x earnings, ex the cash on hand, it too hashigh potential and we expect a rise of about 37% per year, nearly a double, over the next2 years.

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Specialty Foods continues to produce healthy profits. Cash on hand at year end should equalthe current price we carry it atenough to repay our debentures. However, the debentures wehold are convertible into equity and there are opportunities for Specialty Foods to grow itsbusiness which would benefit equity holders. We would like to see the company enter into anew contract with its hotdog licensor, Nathans Famous. Even if the existing contract ends up

expiring in March of 2014, the convertible debentures should have an equity value that is atleast double our carrying price.

Porto Energy has just begun to exploit its 1.8 billion bbls resource. They have 7 majoridentified exploration trends and more than 45 mature, mostly oil, drilling targets. Thecompany already discovered natural gas which only requires reserve certification and a tie-in toa pipeline to move it to proven producing status. Assuming they book reserves of only15 million bbls, a small fraction of the overall resource, we arrive at a value over 30% higherthan the current price. The company should be able to demonstrate at least $3 per share ofvalue shortly from its lower-risk development opportunities aloneover 3 times todays shareprice.

We own a position in Pivot Acquisition via a convertible debenture with a 12% coupon. Pivotis a private company which intends to go public in the next few months. Revenues are alreadyahead of our projections and pre-tax earnings from their value-added IT reselling businessesshould exceed $50 million this year. Valuation is highly compelling and the conversion price isfavourable (about half the ultimate IPO price), and if the company fails to list within its first12 months, we receive a 10% bonus. We anticipate at least a double in the next year.

Also, in small-cap land, we added further to our Fortress Paper position. Fortress trades atonly about 4x next years earningsmuch too low. And, there are near term catalysts thatshould lift the shares up toward reality, not the least of which is the startup of its newlyconverted dissolving pulp mill in Quebec.

Though we continue to pursue larger-cap companies, until our more undervalued smaller-capholdings recover, we will proceed patiently because, even though they are more volatile, thesmall-cap holdings clearly still offer much better value on a risk-reward basis. Their stockprices are also so depressed that each could be an attractive target to an acquirer.

We pointed out in our last quarterly letter that valuation risk was low for our holdings. Its

even lower now after their recent declines. At the same time, our companies also have lowerthan average financial risk since they operate with clean or cash laden balance sheets. And,operational risks appear below average as they operate in safe jurisdictions and/or are low costoperators and/or operate with stable profit margins that have potential upside. Meanwhile,potential tailwinds are also in place from our macro views that could push overall sectorsuplike a recovery in tech spending, or rising energy prices. And, the key driver, our holdingstrade well below our conservatively appraised values giving rise to our expectations foroutsized potential gains.

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Top of Mind

The next few months should bring major developments to our key holdings: Corridor shouldprocure joint venture partners for all three of its major projects and complete a small financing(likely flow through shares at a premium) to fund a pilot test of the Frederick Brook;

St Andrews production should lift materially into year end and we expect continuedexploration news which should be market moving as they hone in on key areas; Orca willexpand production significantly and commence drilling exploration wells in Italy and SongoSongo West; Xcite will receive government approval to proceed with its development project,finalize its debt and equity financings and begin drilling and cash flowing; Manitok and Porto just started their drilling programs and a continuous flow of results is expected; Pivot andSpecialty Foods debenture holdings will likely be converted to equity to realize on thesignificant underlying value.

Minding Your Income

In our income accounts we continue to hold: Specialty Foods convertible debentures and, asabove-noted, the company has nearly as much cash as debt; Advantex debentures which arefully secured by the companys receivables; Student Transportation shares, an extraordinarilysteady school busing business; High Riverdebentures, the only non-project debt of thecompany with material asset and earnings coverage; CompuCreditnotes, the company havingmore cash than next years put price of our debentures; Dynacordebentures, the only debt ofthe company which is secured and well covered by assets and earnings; Ticketmaster bondswhich should be priced higher given the companys oligopolistic position; Pivot Acquisitionconvertible debenturesa fast growing company led by a world-class management team withsubstantial interest coverage; and Southern Pacific Resources convertible debentures where thecompanys low-risk oil sands assets generously cover the overall debt.

We recently boughtLender Processing Services 8.125% July 2016 senior notes. LPS is far andaway the market share leader in its mortgage servicing field; its interest obligations areextremely well covered by profits and the company should generate enough free cash to retirethe bonds even if sales remain flat. We also purchased Armtec Holdings 8.875% September2017 senior notes. Armtec is a Canadian construction/infrastructure company whose bonds arevery well covered by the companys valuable assets. A selloff in the common shares and

concerns about a refinancing knocked the bond price down to about 16% below par, where weentered. Theres very little debt senior to our bonds, sufficient cash flow available to service

the bonds and an asset value about double the total bond issue.

We sold all of our Pizza Pizza position when it breached our appraised FMV level, ArcticGlacier bonds as we were concerned about its restructuring and Chukchansi and Connacherbonds as both lifted to the point where we saw better value elsewhere.

Most of our bond/debenture holdings have well above market yields and, in some instances,offer potential conversion privileges which could lead to substantial capital gains.

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Matter of Fact

A client recently commented that he thought we were always bullish. Interestingly, HaysAdvisory got the same comment from its clients. As value investors, we obviously believe wehold cheap stocks with little downside risk and substantial upside potential, so we must usually

be bullish on our holdings. In the years prior to '08 we could not find value in big-cap namesso we shunned them, and emphasized cheap smaller-cap names. That cheapness didnt matterin the Panic of '08 and early '09 when the bids disappeared. We remained invested because theoverall markets were not overvalued and the values of our holdings were inordinatelycompelling. Clearly, though, were not always bullish. In 2000 and 2001, when most otherswere bullish, we believed the market was inordinately overvalued, and were 40% short,including Nortel, then constituting a third of the TSX, and now in bankruptcy.

Despite, or perhaps because of, the poor last quarter, we are very bullish today. The volatilityof the last quarter should not imply that the portfolio is risky. It should rebound smartly.Indeed we think our current portfolios may comprise the best values weve ever had, both

big-cap and small. We continue to grow the big-cap component because, while having lessupside potential than our smaller-cap names, we are prepared to trade off some value forliquidity. And although we are investors, not traders, our TRAC and TRIM work should

allow us to trade some of our bigger-cap names ifthey go on sell or on buy at ceilings andfloors in our work. We can also use options, in accounts that allow it, for some risk protection,as we recently did as a hedge with S&P put options on two occasions when the votingoutcomes in the Greek Parliament were in question, threatening global markets.

We are positive for the short term, and, for the longer term, encouraged by the improvingconditions for corporate earnings growth. We also continue to be bullish on commodities andmaintain our significant overweightings in energy stocks. We believe depressed natural gasprices are set to move considerably higher. Important for Corridor. U.S. storage levels are below last years level and the 5-year average. Consumption is rising and production isdeclining with fewer gas drilling rigs at work. Oil prices relative to natural gas prices are at awhopping 22:1 ratio, and gas is cheap compared to coal too, an incentive for power utilities toswitch to gas.

Minding Our Business

Not only do we believe our portfolios are the best theyve been, we believe our team of analystswho uncover and cover the ideas are the best too. Jeff Sayer, Anthony Visano and R.J.Steinhoff, each with a distinct skill set and interests. And our experienced team of portfoliomanagers and dedicated marketing people who believe in our capabilities to outperform forinvestor clients.

We pride ourselves in having a philosophy of continuous improvement. We continuallyenhance our TRAC workto better optimize our entry and exit from stocks. We have addedTRIMan indicator of momentum to help perceive the next panicour back test to WWIIcaught all major (>20%) market declines with the exception of the '87 crash, a massive one daydecline. And, we have added the potential use of options to hedge our accounts if our TRIMwork or other signals point to a serious market decline. We have also raised our target rates of

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return. Big caps need to offer a potential 2-year 25% per year return. And, a small-cap stockmust now provide us a potential 40% annualized return over the next 3 years or were notinterested. Its not that we are trying to shoot the lights out, we simply want to make sure thediscrepancy between price and value is widera larger margin of safety. And, were trying tobe less complacent. In '08 we held a handful of companies that took on debt and then became

vulnerable in the credit crunch/panic period. We plan on being more proactive should thatthreaten again.

Frame of Mind

There will be market corrections along the way, such as the last quarter, and we are striving toget better at anticipating them and minimizing their impact. But these are normal fluctuationsin an improving market and world economy, and corrections should be seen as opportunities toadd.

Value investing requires patience. We recognize that, as professionals, our analysis gives us a

greater tolerance for market fluctuations, for short-term pain, than our clients. But, short-termpain for long-term gain, trite as the expression may be, surely applies to value investing.Waiting is an essential part of the value investing process. After all, we buy whats unpopular

and need to wait for it to become popular. For the milestones. For better markets to appreciatethose bargains. For what we believe are the inevitable positive outcomes with minimaldownsides. For what we believe will be ultimate gratification. Peace of mind.

Herbert Abramson andRandall Abramson, CFAJuly 14, 2011

The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is notguaranteed. This report is not to be construed as an offer, solicitation or recommendation to buy or sell any of the securities herein named. Wemay or may not continue to hold any of the securities mentioned. Trapeze Asset Management Inc., its affiliates and/or their respective officers,directors, employees or shareholders may from time to time acquire, hold or sell securities named in this report. It should not be assumed thatany of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment decisions we make in thefuture will be profitable or will equal the investment performance of the securities discussed herein. E.&O.E.