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2/10TRADEWINDS GLOBAL INVESTORS .

One should not expect an increase in demand growth to increase real growth on a sustained basis,

but if at all, only in the short run.

-William Dewald, Research Director, Federal Reserve Bank of St. Louis (1998)

In an age where austerity is faux pas, many governments assume unsustainable leverage and

currency printing is the only remedy for an economic slowdown. Large central banks are attempting todrive asset prices up in an attempt to stimulate economic activity. Everybody wishes monetary easing

the best of luck, in hopes that leverage will eventually drive real economic improvement. Nobody

wishes for reality to surface, governments are livin on a prayer today and hoping that tomorrow will

be better.

Were half way there

Livin on a prayer

Take my currencyand well make it I swear

Livin on a prayer

- Not quite the lyrics of Livin on a Prayer, Bon Jovi.

In Bon Jovis praises of blind faith in 1986, he was talking about tough times. The hero of the

song, Tommy, was laid off from the docks after a union strike. Things were indeed tough in 1986.

Unemployment was 7.2%, mortgage rates were 10.7%, GDP growth was 3.4%, inflation was 1.9%,

nominal GDP growth was 5.23%, and money growth was 9.26%.

In retrospect, things werent all bad for Tommy! First, he had a girlfriend, named Gina who was

gainfully employed at a diner and was able to provide support for the couple. Second, unbeknownst

to Tommy, Alan Greenspan would come to power as Chairman of the Federal Reserve Bank in 1987.

Greenspan would soon become Gina for the entire country. This co-dependent relationship is highlighted

by the term Greenspan Put which refers to Greenspans monetary policy. The Greenspan Put offeredinvestors a sense of protection when markets tumbled. Mr. Greenspan popularized the notion that

tomorrow will be a better day, with opportunistic deficit spending and expansionary monetary policy

today.

Economic tailwinds at the early stages of Greenspans reign delayed his expansionary monetary

measures for a few years. In 1987, interest rates that had been at historical highs were coming down.

To sweeten things up, our export situation was improving from lower oil prices and greater American

competitiveness. For the U.S., the early 90s were good. After a series of positive events, nominal

GDP grew faster than money supply (M2). In other words, we experienced real economic growth. The

following chart below helps to tell the story, showing M2 money supply vs. nominal GDP.

Opinion Piece. Please see Important Disclosures in the Endnotes.

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1986 2006 2012

Unemployment Rate 7.2% 4.4% 7.8%

Mortgage Rate (30Y) 10.7% 6.2% 3.5%

GDP Growth (Real) 3.4% 2.7% 1.8%

Inflation 1.9% 2.5% 2.0%

GDP Growth (Nominal) 5.2% 6.0% 4.0%

Money Growth 9.3% 5.8% 6.8%

Source: Bloomberg Finance L.P., Federal Reserve Bank of St. Louis, as of 7/31/12.

When the tailwinds calmed in the mid-90s, Mr. Greenspan sprang into monetary action to keep the

good times rolling, cementing his rock star reputation. Money supply began growing at 1.5x the growth

rate of nominal GDP, to continually spur economic growth. The new money had to find a home; the resultwas a tech bubble in the late 90s and a real estate bubble in the mid 2000s.

The growth of money supply can be categorized by two stages.

During stage one (19952007), Americans levered up. Financial leverage burgeoned, especially at

the household level. As long as asset prices kept pace with money supply, we could party like rock stars.


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M2 GDP

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

M2MoneySupply($U.S.

Billions)

GDP($U.S.Billions)

U.S. Debt Outstanding(seasonally adjusted)

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PercentofGDP

PercentofGDP

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20

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1951 1976 1981 1986 1991 1996 2001 2006 20111956 1961 1966 1971

Household

Nonfinancial Business

Federal Government

State and Local Government

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

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During stage two (20082012), the government printed money. By 2008, the leverage of American

consumers had become shockingly high. As we all remember, asset prices stalled and ended the party. It

suddenly became apparent that many Americans were insolvent. Consumers snapped into a deleveraging

mode, while the Federal Reserve engaged in efforts to keep money supply growing. QE1 initiated the effort

in November 2008, and the Federal Reserve has since continued to grow its asset. The following chart

shows the growth in Federal Reserve assets versus relevant gold backing. Even with a sharp increasein the gold prices, only 15% of the U.S. currency is backed by gold compared to over 25% as recently

as 2008.

The U.S. was not the only country pushing on the liquidity accelerator. The chart below shows

aggregate money supply growth for the Eurozone, China, the United States, Japan, the United Kingdom,

South Korea, Australia, Canada, Taiwan, Brazil, Switzerland, Mexico, Russia, Thailand, and Turkey. The

growth rate for this entire group over the period was 10.32%. China has been growing their money

supply (M2) by an average of 20.6% over the past 10 years in order to suppress their currency and finance

incredible growth. The only country to grow their money supply at a faster pace was Russia at (28.2%),

from a much smaller base.


U.S. Gold Reserves vs. Federal Reserve Assets

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U.S. Gold Reserves as a % of Fed Balance Sheet

U.S. Federal Reserve Assets

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

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GREED

The wall of liquidity discussed in the previous section has impacted various assets in divergent but

powerful ways. This flood of liquidity has created mini asset bubbles where greed is flourishing. How do

we spot areas of greed?

Sometimes greed is easy to identify, for example the rampant house flipping in the mid-2000s. Yet

greed sometimes arrives at a party in a much more subtle fashion. Greed isnt always a byproduct of

people trying to get rich; instead, greed sometimes stems from a lack of fear. To detect areas driven by

greed, we look to see where investors are not fearful and do not demand reasonable returns for the risk

they are taking.

Lack of Fear

In our equity markets today, there are many narrow segments of the market that have alarmingly high

valuation metrics. Investors are betting on an environment where a small subset of companies will not

only outperform their competition, but will outperform at an increasing rate. This blind faith regardless

of price is reminiscent of the 90s tech bubble.

1999 and Now: Extended Valuations?

12/31/1998 12/31/1999

MSCI U.S. Tech Index Price to Earnings Ratio 41.3x 60.7x

12/31/2011 12/18/2012

S&P 500 Internet Retailing Index Price to Earnings Ratio 42.4x 72.7x

Source: Bloomberg Finance L.P.

Our team has spoken at great lengths in prior notes about the bond market not showing signs of fear.

Owning U.S. Treasuries seems to offer a serene sense of safety. In the following chart, fear is abundant

in the early 1980s when investors wanted to be compensated for inflation risk, and has since dissipated.


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Top 15 M2 vs. Global Gold Reserves

Global Gold Reserves (U.S.$B)

Top 15 M2 (U.S.$B)


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Treasuries: Where is the Fear?

Hindsight reminds us that there was a pronounced lack of fear in some areas of the market in the late90s, resulting in bifurcated valuations. Like 1999, the 50 largest contributors to the MSCI ACWI index

return during 2012 were companies that were expensive compared to the index on a price-to-earningsbasis. Those who invested in the popular and highly valued segment of the market were whipsawed.

As 1999 reminds us, value and price paid always matters in the long run. While valuation is not a timingdevice, it is a fundamental tenet to rationalinvesting.

WHERE ARE WE TODAY?


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1962-1964 1965-1969 1975-1979 1980-1984 1985-1989 1990-1994 1995-1999 2000-2004 2005-2009 2010-20141970-1974

Mid Price 1.7251

High on 09/30/81 15.842

Average 6.638

Low on 07/31/12 1.4687

GenericGovernment10-

YearYield


2009 Dave Blazek . [email protected] . Distributed by Tribune Media Services, Inc.

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Market valuations are relatively middle-of-the-road. The current price-to-book ratio for the MSCI All

Country World index is 1.7x, 1.6x forecasted for 2013. Given that some areas have run up dramatically,that leaves a lot of areas where the market has left an abundance of value on the table.

Current Overall Market Valuation: Middle of the Road

The price-to-book ratio of the ACWI is low on a historical basis but up off the bottom. The current

price-to-book ratio of the ACWI is 1.75x but expected to drop to 1.39x over the next 2 years. The ratio

for the U.S. is 2.2x, Europe is 1.5x, Japan is 0.9x, and the emerging markets is 1.6x.

FEAR

Given the abundance of liquidity and greed in the markets, how are index valuations at average

levels? The simple answer is areas of fear.


Dec 311999

Dec 311997

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2.5

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P/B 1.3927

P/B

Ratio

MSCI ACWI P/B Ratio


2008 by Randy Glasbergen - www.glasbergen.com.

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Due to uncertainty regarding the medium and long-term, there is an undue amount of emphasis

placed on short-term earnings for equity performance. This uncertainty creates an environment where

short-term and moderately impactful events can arouse significant fear causing asset prices to fall well

below their intrinsic value. Tradewinds believes that the best opportunities arise when the markets lose

sight of the medium to long-term.

U.S. Natural Gas

In our view, fear in the natural gas market is based on transitory, curiously low spot prices that do

not imply the attractive intermediate to long-term supply and demand balance. Natural gas prices have

plummeted from excess production with shale technology and our second warmest winter in the past

117 years.

As we all know from our college economics courses or conventional wisdom, supply and demand

imbalances correct themselves. On the supply side, the number of rigs drilling for natural gas in the U.S.

has dropped dramatically.

On the demand side, more than $15 billion of chemical plants have been announced in Texas alone.

The use of natural gas for transportation is expected to grow 14% per year through 2020. Pike Research

projects that demand for natural gas for cars and trucks could total 14 bcf/day by 2030, 21% of todays

total natural gas production, compared to consumption of around 90 mcf/day this year, only 0.14% of

production. Transportation fleets (buses, taxis and garbage trucks) have begun opportunistically cutting

their fuel costs. (NG costs $2.20/gallon equivalent of gasoline).

With a sudden decline in rig count and a steep increase in prospective long-term demand, we are

confident that fear in natural gas related equities is transitory.

Coal

The rest of the world is looking to buy our cheap coal if we dont use it here. Exports of American

coal were 50 million tons in 2006 and are expected to surpass 120 million tons in 2012. This is sizable,

considering current U.S. coal production is only slightly above one billion tons annually. The market

believes the U.S. is permanently oversupplied with abundant cheap energy, and has discounted the


U.S. Natural Gas Prices (Henry Hub) vs. Natural Gas Rig Count (Baker Hughes)

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U.S. Natural Gas Rotary Rig Count

BakerHughesRigCount

HenryHub(US$mmbtu)


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relevant equities for the sector accordingly. Significant prospects for the U.S. economy are empowered

by cost advantaged energy and we are elated by the opportunities this presents.

Insurance

Insurance companies have gone through a difficult period, with yields on their fixed income

portfolios hitting multi-decade lows. These yields have historically generated the vast majority of theirincome. To make matters worse, insurance companies have suffered a weak policy pricing environment

for the past 8 years. The price-to-book ratio for this industry remains below 1.0x, reflecting pessimistic

expectations. Conditions are improving, however, as companies have responded by re-pricing their

policies. Tradewinds looks for quality insurance companies who own fixed income portfolios with

conservative net durations so that when rates begin to rise they will greatly benefit. The long-term

outlook for the strong companies who can survive is encouraging.

Gold Miners

Gold mining equities are quite possibly the most feared sector of the market, hitting multi-year lows

on price-to-earnings, price-to-book, and price-to-net asset value ratios. From January 2011 to November

2012, the gold price has risen 20% while gold miners are down 22%. The market is focused on cost

inflation of the sector and a history of poor capital allocation, fearing that it can only worsen without a

corresponding increase in the gold price.

The market is ignoring all efforts deployed in response to cost inflation, namely recent management

team changes. New management teams have installed stringent return on capital requirements for

prospective mining operations; this has resulted in the cancellation of several uneconomic large scale

projects. Management teams have also taken initiative in engaging workers to understand budgetary

constraints and to track project economics real time.

The market is fearfully projecting negative short-term trends in perpetuity and thus creating

tremendous opportunities. In response, we are opportunistically analyzing each companys flexibility to

adjust capital allocation and costs to generate returns for their shareholders.


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Percentage

U.S. Insurance Premiums / Nominal GDP (1970 = 100)U.S. Commercial Bank Assets / Nominal GDP (1970 = 100)

U.S. Insurance Premiums & Commercial Bank Assets

Divided By Nominal Gross Domestic Product

Source: Insurance premiums: AMBest Aggregate. Bank assets: U.S. Federal Reserve. U.S. Nominal GDP:

Bloomberg. Compiled & scaled by Tradewinds, as of 12/31/11.

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10/10TRADEWINDS GLOBAL INVESTORS

LIQUIDITY, GREED, AND FEAR

The market is being pushed, pulled, and generally bullied by the forces of fear, greed and liquidity.

This is causing a bifurcation of asset values; some defy gravity and some decline precipitously; some are

priced to perfection and some are priced to never recover.

In these uncertain times Tradewinds knows the importance for investors to keep calm and carry on!Investors must remain objective, 1) recognize the massive amount of liquidity being pumped into the

system, 2) avoid overvalued areas of the market where there is either an abundance of greed or a lack of

fear and 3) take advantage of opportunities where others are fearful due to temporary challenges. These

currently unpopular investments could protect wealth by providing exposure to scarce assets that will

retain value.

We are and always will be highly disciplined investors, evaluating any opportunity to invest in

mispriced equity of companies with robust asset bases and sustainable franchises. When the market

refuses to credit quality companies for their merits and long-term potential, we will seize the day and

confidently take ownership.

Thank you for your patience and your partnership.

Drew Thelen, CFACo-Chief Investment OfficerTradewinds Global Investors

IMPORTANT DISCLOSURES

The statements contained herein reflect the opinions of Tradewinds Global Investors, LLC (Tradewinds) as of the date written. Certainstatements are forward-looking and/or based on current expectations, projections, and information currently available to Tradewinds. Suchstatements may or may not be accurate over the long-term. While we believe we have a reasonable basis for our comments and we haveconfidence in our opinions, actual results may differ from those we anticipate. We cannot assure future results and disclaim any obligationto update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. Statistical data wastaken from sources which we deem to be reliable, but their accuracy cannot be guaranteed.

It is important to remember that there are risks inherent in any investment and there is no assurance that any investment or asset class willprovide positive performance over time. Value style investing presents the risk that the holdings or securities may never reach their fullmarket value because the market fails to recognize what the portfolio management team considers the true business value or because theportfolio management team has misjudged those values. In addition, value style investing may fall out of favor and underperform growth orother style investing during given periods. Foreign investing presents additional risks such as the potential for adverse political, currency,economic, social or regulatory developments in a country including lack of liquidity, excessive taxation, and differing legal and accountingstandards. These risks are magnified in emerging markets. This commentary should not be construed as investment advice with respect toany particular security, asset class, or strategy. Past performance does not guarantee future results.

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