BMO Capital Markets Client Conference Call for October 31, 2008

Don Coxe
New York

“When The Markets Took Fright, The Fed Took Flight”

Thank you all for tuning in to the call, which comes to you from New York. The chart that we faxed out this week was the chart from the balance sheet of the Fed. And the tag line was “When The Markets Took Fright, The Fed Took Flight”. And I never thought that I would have a chart like this for a conference call.

And so I want to talk about the meaning of this, why it is that we are making the signs of a bottom for this terrible bear market. This is the last day of October and this is a month that people would rather forget. But they’re going to be writing about this month for centuries to come. So we’re all living through history, but that doesn’t ease the wounds for those of us who’ve been suffering through it.

The reason of course for this chart being so dramatic is that the Fed in five weeks, in effect doubled the adjusted reserves on its balance sheet. And as you can see from the chart, nothing much happened for a long, long time to this, because the Fed was in restraint mode even though it was cutting interest rates. When the Fed doesn’t grow its balance sheet, you’ve got a fundamental deflationary force.

And the leap that was taken, which was an unprecedented leap, is something that would bring smiles to the face of people such as Milton Friedman, because what’s been done here in this absolutely dramatic and unprecedented move is the beginning of the cure for the financial crisis. And that means also for the ills besetting the stock market.

So, this is so dramatic that we’ve got to discuss first of all what it was that could have triggered this and I believe it was the unprecedented – again, I hope I don’t use this adjective too often in this call – leap in the TED spread after the bankruptcy of Lehman. In retrospect, I’m sure if they had a chance to do it over again they would have saved Lehman. They underestimated the effect of Lehman abroad. They were looking at it as a US investment bank and they were sick and tired of bailing out US investment banks.

But, the TED spread monitors and it’s been discussed a lot, but as somebody who’s been following it since 1973, because I have managed to survive all those crises dating back to then in my career. The TED spread measures the difference in the value of the front month T-bill contract as against the front month Eurodollar contract. These are both three-month contracts. For years I’ve been telling people that if you want to be watching an exciting scene when there’s a stock market or a financial crisis, you should be at the Eurodollar pit in Chicago. Because that’s the epicenter of the crisis.

Now why is that? Because Eurodollars are uninsured bank deposits outside the US, what they do is measure the health of the Dollar financial system worldwide and the banking system. And so, you can take it that when the TED spread leaps – and I know this from meetings I’ve had with Fed officials over the years – is that this tells them that there is a crisis in the banking system and that means they got to move out the rescues. Although they don’t know initially which banks are most at risk. All that they know is that a disease is running through the system. And all other banks follow this too.

And when the TED spread leap, interbank lending dries up. Because banks lending to each other are lending that’s uninsured and all that they know is that somebody’s going down unless there’s a rescue everywhere. So the easiest thing to do is not to lend out money overnight or certainly not for a longer period of time. That is therefore the key to all the other things that you’ve read about: the freezing up in the commercial paper market, and the failure of banks to make even routine loans, which is a key to understanding what’s happened to the collapse of the Baltic Dry Index. I mean this just spreads across the system where anybody has got to get payment somewhere in the future and they can’t get the bank credit against those.

So, the TED spread at this all-time record level was a sign that as the Deputy Governor at the Bank of England said “This may be the worst financial crisis of all time.” And the reason he could make that statement was because we had never had a TED spread at these levels. And that meant that so many banks were at risk and the basic liquidity, the bloodstream of the financial system, had clots in it. You can think of the TED spread as the electrocardiogram of the global banking system. And that what you’ve got here is a major cardiac event. And until that’s been dealt with, until the patient is brought out of the emergency ward, then we can’t get back to normal business.

So the kind of statistic we got this morning with the Chicago Purchasing Manager’s Index collapsing, this is just some of the fallout from the leap in the TED spread. We moved from an adjustment from central banks who were fighting inflation to fighting all out deflation and collapse.

And that explains why it was possible to get this response from central banks all around the world to flood the system with liquidity, is that they knew that without having to do a daily audit of every one of their banks, that there were just going to be banks tumbling. And therefore liquidity had to come in to deal with, also what was implied, bank insolvency.

The good news is that the TED spread which reached nearly five hundred, is now down to 208 and a half. And the financial crisis will be over once we break 150 on the down side and we’ve come down so far, I believe that’s going to happen. And the latest maneuver of the Fed, which was announced yesterday, again shows how they know it’s a global force, not just something they deal with a national bank basis.

Most of the other central banks are just dealing with their own local banks, the Fed understands that it’s the central bank to the global economy still, notwithstanding the diminished role of the US economy in the global economy. And explains their unprecedented – again, there’s that adjective – announcement yesterday that they were arranging Dollar swaps with the central banks of Korea, Singapore, Mexico and Brazil.

Because the spread on emerging market debt over Treasury yields had once again got up to the kind of level it’s had in past global crises, particularly the Third World debt crisis of 1997.

Now I’ve been telling you for years that we weren’t going to have that kind of crisis again, because back in 1997 and 1998 that problem was due to the fact that emerging markets had overvalued currencies and very small foreign exchange reserves. And that situation had been unwound over the years to a situation where these currencies were actually being held down as central banks piled up foreign exchange reserves, concentrated of course, in Dollars, in order to make their economies more competitive.

And it explains, for example, why the Russian Ruble was virtually valueless at the previous crises, that the Ruble had been one of the stronger currencies and how Russia could suddenly be in a situation that notwithstanding their gigantic foreign exchange reserves, that those are just melting away. A big constraint, of course, on new adventurism from Vladimir Putin.

Now, along with that, the other sign that we have switched from a situation of worrying about inflation to deflation, was the unprecedented collapse in the CRB futures index. The worst collapse for which we have records, of the commodity index. I attended that Bank of Canada meeting organized at the end of June in Alberta, on commodities and the global economy. And there were five central banks represented. And although I cannot quote from any of the statements there because of the oath that we took to participate in this closed-door meeting at which I presented a paper on the global food crisis, most of the other papers were on oil, but I can tell you that the entire discussion was about inflation risk. So the central banks of the world had to switch from worrying about inflation to worrying about deflation.

Now there’s three kinds of so-called inflation hedge assets. And these are variable assets, which are stock prices, real estate prices and commodity prices. And although we had the stock markets of the world in a bear market, and there were housing collapses spreading from the US to Britain to Ireland to Spain and other countries, that what we had not had was any kind of reassuring signal on the commodities side and of course the reason why commodities reached their peak even though these other so-called inflation hedge assets were in major bear markets, was, of course, the China/India story in this cycle. And until they rolled over, the central bankers who had learned from the experience of the ‘70s, that if you had a runaway commodity market at a time of economic problems and falling value of other kinds of assets, that you would still have inflation. The nightmare being a recession accompanied by inflation.

And that was the kind of stagflationary situation which made the ‘70s such a miserable decade. And as I’ve commented many times before, things were so bad for equities in that decade, as an asset class, that as of Thursday the 12^th of August 1982, after Paul Volcker had driven US rates to 22% to fight inflation the constant Dollar Dow Jones Industrials - which was the index we used to follow quite a bit back then, and haven’t seen for years being quoted – the contant Dollar Dow Jones index was back to where it was after the first week of the crash of 1929, which meant that the characteristic pension fund asset, as the asset that would outperform inflation over the long-term, for funding and pension plans, had totally failed. That’s how bad things were then. So when people say that this is the worst of all time…no, no, no this is nothing compared to that long period of agony. And this time they’re not going to let it be a long period of agony. Because they learned from Milton Friedman that deflation is much easier to solve than inflation. Inflation you fight it by inverted yield curves, by continued tightening, and you squeeze inflation out of the economy.

Well, they don’t have that luxury now. In fact, what they’re doing now in a neck-snapping twist is they are in an all-out fight against deflation. And the Fed is leading the way with this astounding doubling of it’s reserves in a period of a mere five weeks. I don’t know whether any central bank of an industrial country has had anything like this happen since the Weimar Republic. We’re not going to repeat the Weimar hyperinflation, but it shows you that the Fed was willing to assume this kind of risk, because it saw that the deflationary forces were such as to drive the whole economy down by destruction of the banking system.

So that’s the background to what happened this week where we had these amazing moves in the stock market with one of the biggest days in the history of the Dow where we had the Dow jump 889 points. And we finally got some support from commodities and commodity stocks.

Now, for me, part of the surprise in this was that the commodity stocks underperformed during the sell off. But I realize that it’s because of the fact that people had stopped believing in any kind of inflation risk and were getting out of the last standing inflation hedge asset, which was commodities. And that’s what took gold down from 950, down to briefly below 700, which it reached on October 24^th. We’re at 738 on gold now, so it’s had something of a bounce. And that is also a sign that the healing process has begun.

I’ve told you many times that in a bear market for equities which is lead by the bank stocks relative to the S&P, that the bear market cannot end until we’ve had six weeks, at least, of outperformance, by the bank stocks to the S&P. Well the bank stocks double-bottomed at the level that they were at on July the 11^th, before the Midnight Massacre, and they since then, because of the double bottom they were already outperforming, and they’ve actually risen. The bank stock index has been the best-perfoming index. And so it shows you that this reliquification process is working.

And so, that’s the first of the tools that you need to say that we are forming a bottom for the bear market in stocks. The other things that we need to have happen, of course, is to get the TED spread down so that this is not a rally driven purely by the injection of adrenaline right into the heart of the patient. It’s got to be something that returns to normal.

And what’s happened is we’ve had this powerful rally in the Dollar and the Yen. The Dollar is the currency of the debt that the hedge funds have and as they’ve been forced to unwind their positions, they’re paying off debt denominated in Dollars, that drives up the Dollar. The other reason for the rise in the Dollar was the European banks in particular, who had loaded up on the toxic waste excreted by Wall Street. As they put those on their balance sheet, because they didn’t want to have more exposure to the Dollar which was in such a long-term bear market. They hedged their exposure by shorting the Dollar, so as they’ve written down those assets, what they’ve been doing is pulling in their hedges.

So the rise in the Dollar is an expression of the principle first annunciated in George Orwell’s Animal Farm, “Weakness is Strength”. Because it’s precisely the weakness of the US financial system, and the unwinding of it, drives that Dollar rally. It’s not because the US economy is in better shape than all the other economies of the world.

The other currency of course that’s dramatically outperformed has been the Yen. And the Yen is once again, the debt currency. Not an equity currency. Japan is back to its Triple Waterfall low, that means that this is now the longest outstanding Triple Waterfall crash, it’s now lasted twenty-six years.

I had thought that Japan might have been emerging from its Triple Waterfall crash when Koizumi came in and there was reform in Japan. Regrettably, he couldn’t run for re-election and Japan has lapsed back into its deflationary demographically deflationary decline.

So the fact that the Yen is the top-performing currency in the world is another bearish sign and we will not be over this bear market until both the Yen and the Dollar have retreated back to levels that reflect economic reality in these economies. I don’t know how long that’s going to take, but we had a big sell off in the Dollar a couple of days this week. And the Yen did pull back, but it’s still at levels that reflect the unwinding of debt. So the deleveraging process is still proceeding, but it’s not proceeding with the kind of fury and desperation we had a couple of weeks ago as liquidity flows in to the global financial system from the massive re-liquification.

Therefore, we’ve got most of the pieces in place that we can now see how it is that we’re going to bottom out in this bear market. And what that also means, because of the emergency measures that have been used, that it won’t be years to come before we start fearing inflation again.

Certainly the Fed is going to do what it can, once it can have an option in this, to try to withdraw liquidity from the system, which means that it’s not so much a matter of interest rates, interest rates are just one measure of a central bank’s response. It’s a matter of the Fed’s own balance sheet. And unless they do something, the Dollar will go into a major bear market. And we’re going to have inflation problems again.

So what that also means, a signal we will get will come from a rally in gold. Gold, by the way, reached a new high denominated in Euros and in most other currencies, after the Lehman bankruptcy. So gold was still performing its function of being, in effect, a shadow currency, at a time of a financial crisis where you moved in to something with real value.

I hope this isn’t bewildering for you all, but the reason I need to talk about all these factors is that it’s realistic to say that we are forming a base. And that doesn’t mean we aren’t going to re-test lows, but this is not going to be the kind of ongoing deflationary misery that we’ve had…those people who compare this to the ‘30s…that’s not going to happen.

We still have, notwithstanding that the next President of the United States, Barack Obama, during the election campaign, said that his first official act was going to be to call up the Presidents of Mexico and of Canada to tell them he was going to tear up the NAFTA agreement. And he regretted that remark, because of course, it was pointed out to him that Canada doesn’t have a President.

And I think that was just talk, because of the intensity of the Ohio Democratic primary. He now has an advisor, Paul Volcker, than whom there is no better advisor, he is still, in my view, America’s most distinguished private sector public servant. So the fact that he is an open supporter and advisor to Barack Obama is the most cheerful thought you can have about the upcoming election in this country.

How long will it take to get a new bull market? I don’t know the answer to that. But I can tell you which groups are going to lead the next bull market when it comes. The financial stocks will, because every bear market, since 1972, has been lead by the financials on the down side. So they will lead coming off the bottom, they will be one of the leading groups, because the economy will still be in recession.

And the other group will be the commodities, because once the re-liquification occurs, we’ll go back to a situation as described by Chris Patton, former Governor of Hong Kong when he was named Chancellor of Oxford, in his commencement address pointed out that for the first eighteen centuries of what we call the Christian or Common Era, the two biggest economies in the world were China and India. He said, in the first half of this century we will revert to normalcy. And what’s happened in this crisis is that the date for the shift of power abroad has been moved on to fast forward. Because, although China and India economic growth rates obviously are negatively effected by this global crisis, they are still stronger economies than in the OECD.

And the big thing you see in China that people don’t emphasize enough is that they have a 40% savings rate over there, whereas the US has a zero savings rate. And so, we cannot rely on the US consumer as we have in all other economic cycles of the post-war era to drive the global economy in this decade, as Ned Davis has pointed out, for every $100 of debt accumulated public and private in the US, we’ve had a 19 point improvement in GDP, in the US. In other words, just a little less than five times as much debt for each one point improvement in GDP.

So, the credit cards, the in-house ATM against the mortgages, these kind of excesses, they’re going to take a long time to unwind and that means a rise in US personal savings rate. And that means the US economy is going to be struggling for some time. When you’ve had a long drinking binge like this, the drying out process for the alcoholic takes time and it is accompanied by pain in the form of DT’s.

Therefore, what you want to have, and the market will sense this, is you want to have a tie in to what is the necessary ingredient in a global recovery, which is strengthening the global financial system. And you want to be tied in to the assets which are directly levered to the strongest economies and of course that’s commodities.

So, the other factor is that in this commodity cycle, we had this fabulous performance of commodities relative to other asset classes, but it was not because people bought them purely as inflation hedges, which is what they did in the ‘70s, when commodities outperformed at a time when nothing else was doing well. I believe that will happen in the next few years, so in my view, commodity prices in the early years of the next decade will be higher than I had predicted before. And therefore, the reason though for people buying them will to some extent change, because they won’t just be buying them as calls on economic growth, they’ll be investing in them as a basis that they get a hedge against inflation.

And they’re not going to be buying houses again as a hedge against inflation because of demographic decline. That game is over. With each new generation in the OECD being 60% the size of its predecessor, the idea that house prices would keep spiraling skyward was a form of madness and mania.

That’s the background to why it is that I believe that the worst is over. The best is yet to come but it’s going to come…out there. But we’re already getting some signals as to how it is that you will be able to play this as investors. For those of you who say, well we’ve got a bit of a rally here, I’d better sell into it, unless you absolutely need the cash, I don’t recommend that you do that, because I think, particularly if you own the commodity stocks, it won’t be long before you regret that decision.

This week the International Energy Agency came out with its revised view of the outlook for oil. And one of the points that they made was the collapse in oil prices and in the price of oil company stocks was going to mean higher oil prices in the future because the expensive projects needed to bring on new oil deposits, those will be pushed into the future or stretched out. We see that Shell has announced that it’s scaling back on its expansion of its oil sands in Canada. There will not be new oil sands projects announced for some time to come. And we need to replace roughly four and a half million barrels a day per year just to make up for the declines from existing oil fields which are long since past their peak.

So higher oil prices will come but in the meantime one of the big reasons that can have some confidence about the global economy is that it's not going to be choked off by energy prices at sky high levels.

So the drop in the oil prices is a boon both to China and India who are major importers and the sell off that we got in the grains is also a near term boon to these economies because these are the economies that are increasing the demand on global grains because of having their people going from a low protein diet to a high protein diet and therefore we've got to a time that we need some help for consumers particularly in those countries, the help has come from the commodities collapse. That is a temporary development and in particular in the case of the grains as you know we remain concerned about the outlook of the crops next year because of the fact the sun spots have not returned. This is now being discussed somewhat more widely as a potential negative because if they don't come back it's going to cause a very significant problem for grains.

The US had the second best corn crop on record because, and I found this out at a dinner in 1978 in Toronto, the USDA was worried about the prospects of global cooling because of sun spot sensitivities back in the '70s with crop failures and they started discussions with Monsanto about creating genetically modified seeds that could be fast growing in a year of a late spring and although that was not a necessary feature they were built right into the GM seeds which are used across the Midwest. This was the year we needed them because we were six weeks late getting the corn and soy beans into the ground. So we have the second best crop of corn on record.

In the rest of the world the corn crop was not a strong crop because in so much of the rest of the world they do not use GM seeds. More of those adjustments will be needed. There's a cover story in this new issue of Wired magazine about the future of food and they make points like this about what we need to do with GM seeds to adapt to new kinds of demands.

So wrapping it up before the question period. We're certainly not out of the woods but the forest does not stretch for hundreds of miles. This is not the '30s over again. This is not the '70s over again and the big reason for that is because the central banks of the world understand from those past disasters what it is they need to do to make sure the economies do not implode. I believe that what they are doing is the right thing. I believe they are going to prove to be winners which means we all will be winners.

32:00

That's it. Any questions?

Question 1 (Steven Bartholomew): Can you talk a little bit about which subsectors of commodities that you favor the most coming out of this and specifically what do you think of the ag components given what's going on with the Brazilian farmers and the capital spending reductions that are going on down there in terms of equipment and how that's going to affect companies like Deere and the fertilizer companies. So if you could give me a broad subsector brush and then a specific focus on ag with the Brazil and Russia troubles and the cutbacks going on in those markets.

DC: Thank you. Well I remain of the view that the absolutely decisively important group for the next cycle is agriculture. I'm going back to India next month and when I talk to you after that return on these calls I will update you on my views and you'll recall that it was my previous trip to India in 2006 that convinced me that agriculture was going to be the big surprise commodity story. We're looking at the fertilizer companies that are trading now at three and four and five times earnings.

SB: Doesn't that reflect yesterday's business with those low multiples?

DC: Well the answer is that this is still an absolutely necessary ingredient and so I believe that whether it gets stretched out a bit or not that we have only a few companies in the world that are significant enough to be able to produce what is needed to get the crops that are needed. We still have extremely low carryovers of all the crops. So that story has not changed.

There's squeezes of course. Naturally when you pull back the prices particularly of soy beans which are key to Brazil because soy beans prices at these levels when you've got soy beans trading at 9.32 down from as high as $16 that is a blow. But remember that the biggest soy bean exporter is Argentina and what they are doing to their farmers there is going to be very negative for production and exports worldwide and again it's because there's only a handful of companies that are absolutely necessary if we are going to feed the world over the next ten years. So they still have intrinsic investment merit which I think makes them the top of the list.

The next group of course I believe that you've got to own the golds because although you've got to be very selective about those gold mines that are producing in politically secure areas of the world and they've underperformed the metal itself because of fears about their rising costs and political risk.

One of the big rising costs for the gold mines was of course sky high energy prices and particularly for them also soaring steel prices. Well steel prices are down. Energy prices are down. So that I believe that you're going to find that although the cost per ounce of gold, people were talking about it that the cost per ounce was rising to $750 which is applied breakeven. It's the same sort of thing that you get with the oil sands companies in Canada where the depreciation of the Canadian Dollar plus oddly enough the drop in energy prices reduces some of their input costs.

So I still believe that gold and those energy companies that have the unhedged reserves in the ground because we have a big contango in oil and that contango in oil reflects I believe the view as expressed by the IEA that we're just not going to be bringing on enough new production. So that although spot oil has been blasted down and a small bounce to 64.95 but oil for delivery in 2015 is at 88.29 that is one of the sharpest contangos on record.

I believe that reflects the views of oil companies as to their view of what oil will be in the future and particularly of the consumers of oil that they're prepared to buy up the curve to reduce their volatility. If you're a Dow Chemical or another user of oil or hydrocarbons, what you're saying is that it's impossible for you to calculate your earnings going forward if you have these wild price swings. Oil going from $52 to 147.

So the oil futures curve is the combined judgment of producers and consumers about where oil prices should be and if you use then unhedged reserves in the ground valued at these levels in Dollars, what you can see is that these stocks which have been trashed are terrific value.

It leaves us still with the risks for the mining companies but we're getting one announcement after the other of cut backs or stretch outs or cancellations of new projects and again what they're doing is being priced right now on what the price is for copper, nickel, lead, zinc and aluminum and those prices just cannot last.

So all of the groups on a three year hold basis have terrific merit but in order of where you buy them I still think that you look at ag first and I just hope that we still have all these ag companies as publicly traded companies two years from now.

Remember that if the fertilizer companies were reclassified as mining companies, the big mining companies of the world who still have loads of cash and they still have cash flows and their cost of producing in most cases of their ore bodies that they've had for a long time are still going to generate positive cash flow even with copper at a buck seventy-eight (1.78).

So frankly I think that to price everything on the basis of spot prices for commodities is short termism gone mad but I'm not surprised because of the sheer devastation here. But I think we're going to get a new set of buyers coming in as we come out of this who are going to look back to what happened when inflation came back in the world.

Right now although to talk about inflation sounds crazy with deflation as being the only threat. The amount of reflation going on here. This is the grandfather and grandmother of all reflations and we have not yet disproved Milton Friedman's dictum that inflation is always and everywhere a monetary phenomenon. So at some point we're going to get back to worrying about inflation again and then you're going to try to find inflation hedge assets and real estate no longer cuts it as an alternative.

Thank you. Next question.

Question 2 (Steve Osmak): Don, I'm just wondering if you could comment on two things. Number one credit default swaps. I guess about a month ago that was one of the biggest worries I think and I haven't heard anything I haven't seen any progress or ideas on how that problem can get solved and the other one would be the Baltic Dry Index. I believe it peaked at 11,500 in June and now it's below 1,000 which I heard indicates there's basically no raw materials being moved across the world. So I don't know how accurate that is or if you have any insight on that.

DC: Thank you. I'll deal with that one first. That is the ultimate in short term index. Because Vale has stopped shipping iron ore out that takes one major buyer of dry cargo right out of the market and right now the iron ore companies are renegotiating with China in particular what the prices will be and once they've got a new pricing structure although China's steel prices are down, China is continuing with its infrastructure development. The Chinese economy is not collapsing and they still have got to carry forward their 30 year plan of having 200 cities of more than a million population to permit the migration which will be the greatest migration in history of people from small farming units of one and two hectares into the city because one and two hectare farms do not produce the extra food that's needed to support urban populations.

So the Chinese will not abandon that strategy. They've reduced their interest rates and reserve requirements three times in a short space of time. This is the fastest response from China on record. Therefore at some point what you're going to be able to do is see cargos flowing again. The other thing is that because of the banking crisis you couldn't get bankers willing to put up the money for the trade credits needed that you could ship it and you'd know you'd get paid in a bank draft at the other end. The banking system had just basically shut its doors.

So the reliquification of the global banking system which will be virtually complete once we've got the Ted spread down through 150. My prediction is that once the Ted spread is down there you're going to see a sharp leap in the Baltic Dry Index. The prospect that you were going to load up a ship and send it out and you weren't going to be paid at the other end was enough that you weren't going to bother chartering a ship to do anything.

So this is what happened on that index and it's very much an index driven by a very few cargos - the dry cargos. So it reflects the collapse in the metals sector in particular. Thank you.

Your other question was?

SO: It was just regarding the credit default swaps.

DC: Yes. Well by coincidence I spoke to a dinner in New York this week of people in the financial sector and the fellow next to me at dinner is with one of the three major companies in the world that do the trading of credit default swaps and they don't do it on a principled basis, they do it on an agency basis and you may have noticed that there was a leap in the price of one of the other players in this field and so what I learned was that the unwinding of the Lehman swaps and the expected unwinding of the Wamu credit default swaps both of which he was very optimistic about, the ultimate fall out that again what you're going to see is that this is in effect a trailing indicator. Now the credit default swaps are a murky world to me and I'm not an expert on them but the Lehman unwinding turned out to be a nonevent which means that the optimists who said that most of these things just cancel each other out because of the fact that of the way counter parties spread it out back and forth. He explained that to me over dinner.

Now you may say, "Well he is a biased observer because this is one of his main product lines. It's not his only one," but his view was that this market was improving and that we may be able to stop worrying about those in a few months also and again frankly there is no way that credit default swaps would be a reliable investment. They had to be frozen up as long as you had the Ted at those levels because you did not have any interbank lending going.

So once you get interbank lending at a reasonable level that would tend to reinforce all of these derivative type markets as long as they aren't derivatives tied directly or indirectly to house prices.

Thank you. Next question.

Question 3 (Tyson Amies): Just looking at some of your comments and if we're looking at the US suffering from this debt hangover and we're also looking at food and energy inflation inputs. How does that - with the US Dollar weakening how does that effect China's ability to export and grow on a go forward basis. Is that going to put a cap on their GDP?

DC: Thank you. I'm still of the view that China remember the US is no longer as decisive in the Chinese economy as the export arrangements that they have within Asia itself. Now of course obviously their biggest trading partner now is Japan and Japan is in a recession again but the big part of their activity there is supply chain work and arrangements with other Asian economies and with the sky-rocketing price for external debt of these other smaller Asian economies. This was actually more of a threat I think to China on a longer term basis than the US housing crisis and recession because China is basically building itself up as the leader of Asia and so therefore what you've got is a situation where the healing process for all of Asia is going to be beneficial to China as Asia becomes the dominant region in the global economy.

So remember the lowest growth rate China's had in any year since Deng Xiao Ping took over was 6% and that helped to trigger the Tiananmen Square riots. So I think that if China's growth rate falls to 8% that still means they're going to be using lots of commodities and the US isn't going to be in a three year recession. It's going to be slower growth and there are going to be massive adjustments about world trade patterns but I don't see this as anything like the bad news of either the '30s or the '70s and so you still bet on what is the strongest fundamental economy and remember that 40% savings rate means that they're generating the internal cash to do their infrastructure work and to look after their poor. So you can do a lot of marvellous things when you've got those kinds of domestic savings.

Thank you. Next question.

Question 4 (Robert Zito): Actually, Don, you've covered my questions in the responses to the last questions. Thanks so much.

DC: Thank you. Next question.

Question 5 (Roberto Umanis): Thank you. This is Robert H with Trade Winds. Just trying to figure out if you're looking at the gold Comex futures. I think there are about 30 million ounces trading hands on paper but only 8 million ounces to cover it. So I wonder what the real risk is in your view of default. That is if people start taking delivery because they don't believe the price that they're seeing on the screens and they want to get the physical. Is that a real threat in your view?

DC: Well I'm hearing various stories from bankers actually about the lack of physical gold and that this is a source of concern to them and there's no doubt that the derivatives volumes that are out there are large in relation to physical gold and of course if we're not adding a lot of physical gold to production as you know so there is a possibility of a squeeze on gold. I don't know enough about the actual data except to tell you that those kinds of numbers do indicate that the idea that the gold futures would be a nice self-sustaining upward contango arrangement which they've been most of the time since gold became legal to trade in futures markets that it could be subject to a squeeze. I don't think you need that as a reason for investing but I've had people telling me directly that they have been unable to get physical delivery of gold and of silver actually. They've been told, "Oh no. It's going to take a couple more weeks to do it."

So it may be that we've got too big a supply of the future derivatives in relation to the physical and in particular of the ability of the mines to produce enough to meet all of this. But if such a squeeze developed I think you would get probably get help from the IMF which is trying to find ways of selling it because it's got such a gigantic percentage of its balance sheet in gold that they would get the freedom to move physical gold in to meet those kinds of needs to prevent a crisis because the signal that would be given to the global banking system if we suddenly had $1200 gold would be enough that the central banks and countries that control the IMF would say, "No it's time to meet this need and to free up some of your gold."

So that's what I believe is the ultimate backstop on this but it will take quite a few other developments and quite a few other dominoes falling I think to produce a crisis in that market.

Thank you. Any other questions?

Question 6 (Noel Lohmer): My question is about global oil demand and I saw one story indicating that despite demand destruction in North America and Europe global demand is still increasing by about 200,000 barrels a day. Can you verify that?

DC: Well again frankly I get statistics from so many sources on this. We know that within the OECD demand is falling sharply but remember oil prices are subsidized by so many economies and the oddity has been that the fastest growth in consumption occurs in oil producing countries. We're told that within about three years Iran will no longer be producing enough to meet their needs and of course they have to import gasoline. They don't have enough refining capacity.

So that one of the things that has sustained total demand has been the willingness of countries to subsidize their consumers and again I have to believe that some sort of adjustment would be made and given the fact that oil prices are at these levels maybe a lot of these subsidies will be taken off which would produce oddly enough rising oil prices in these economies. So that it would have to be phased in. But I think you have to assume that a commodity that gets burned up in relation to GDP growth that it's unlikely that we're getting real growth in total demand worldwide at a time that we have recessions across the OECD and slowdowns in the emerging economies. I just don't know where you could get out of that problem and we do know that there was enough new oil production brought on to offset the declines of the North Sea, Cantarell, Ghawar and the major fields that I assume that we still have something of a surplus in oil. But you're right. There are murky statistics.

Thank you. Any other questions?

Question 7 (John Donahue): With a new administration coming into the US if it is going to be Obama do you have any comments concerning how the administration might tackle the issue of currency between the two countries related to the Chinese Renminbi and the US Dollar and also a general policy stance on China or India. Obama has had quite a few opinions about outsourcing and the impact on American jobs.

DC: Thank you. Well it so hard to make a call on this because Obama is a master politician and it's been remarked by many people that he's a blank slate. We really know very little about him and his background. He's never run anything. He was a part of the Daley machine and he was a foot soldier in that and so he's had all sorts of connections which the Republicans have tried to publicize. But the collection of people that he's assembled to be on his side as advisors during the late phase of his campaign, none of them would be advising him to be doing anything dramatic on that front or being protectist or trying to get dramatic revaluations of currencies or anything. These are very wise men.

So I think that he's had to deal with the fact that this was a hate symbol in so much and particularly in key Democratic constituencies who blamed the problems of US industries to subsidize China's competition and since China has been such a responsible participant now in the reflation of the global economy, I think that you'll see that a lot of that rhetoric will not be the basis of policy making from the White House.

I've got much more concern about the fact that an Obama landslide is going to mean that the Democrats are going to have a veto proof Congress in both houses and that a lot of the people there are people who are given to making totally irresponsible statements and that they don't have the kind of wisdom around them that surrounds Obama. So I wouldn't be at all surprised if he turned out to be our best defense against a runaway Congress. It would be a paradox but gosh knows we've seen lots of those in the last two years.

Thank you. I've got time for a couple more questions.

Operator: There are no futher questions.

DC: Okay. Well thank you all for tuning in and we'll talk to you next week.

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Don Coxe profile from the BMO websites:

Donald G.M. Coxe is Chairman and Chief Strategist of Harris Investment Management, and Chairman of Jones Heward Investments. Mr. Coxe has 27 years experience in institutional investing, including a decade as CEO of a Canadian investment counseling firm and six years on Wall Street as a 'sell-side' portfolio strategist advising institutional investors. In addition, Mr. Coxe has experience with pension fund planning, including liability analysis, and tactical asset allocation. His educational background includes an undergraduate degree from the University of Toronto and a law degree from Osgoode Hall Law School. Don joined Harris in September, 1993.

http://www.donaldcoxe.com/reviews.html