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March 22, 2004

March 22, 2004

This letter discusses among other things, U.S. interest rates, currencies and metals and how they are closely interrelated. It starts however, discussing derivatives and offering some advice for your investment portfolio.

On March 10, 2004, a front-page article in the Financial Times of London pointed out that over the last four years Fannie Mae had $25 billion in losses on derivative transactions. Fannie Mae responded saying this was not correct and guided the public to wait until they filed their annual 10K report about ten days later. When the 10K became public, it showed that as of December 31, 2003, Fannie Mae had retained earnings of approximately $22 billion after accounting for realized and unrealized derivative losses of about $14 billion in the last two years.

Is it any wonder that in the last three weeks, the Chairman of the President’s Council of Economic Advisors, Gregory Mankiew, the Chairman of the Federal Reserve, Alan Greenspan and the Treasury Secretary, John Snow all independently commented in speeches that Congress should reign in the quasi-governmental organizations Fannie Mae and Freddie Mac, that they should not be allowed to expand their balance sheets by buying or issuing any more derivative instruments, and that these entities are not guaranteed by the US government?

When speaking of Fannie Mae, Treasury Secretary Snow even went so far as to say said that there is no “too big to fail” doctrine. Obviously, they are implying that if Fannie Mae and Freddie Mac do have balance sheet problems, neither the Federal Government, nor the U.S. taxpayers have an obligation to bail them out or insure their debt or equity. In addition, the government will not be obligated to protect the other financial institutions on the opposite side of these derivative instruments.

It appears that the over-the-counter derivative mess, which I have mentioned in past memos, is coming home to roost. Fear of this has set the world equity markets on their ear. Developed stock markets in general have been declining for the past few weeks. Emerging markets have also recently begun to stall. It is not difficult to see the havoc that a meltdown or partial meltdown in derivatives would do to the world financial system.

I issue this recommendation to all friends and clients: I suggest that you own part of your net worth in gold and possibly silver coins. The mechanics are simple. Buying gold coins from a coin dealer is common. For those who have sufficient liquidity, ten percent of your portfolio might be a good goal for you. Perhaps purchasing them over time in order to get an average price makes some sense. Owning gold bullion coins held in a depository, safe deposit box or other safe place where you can get at them is a good idea right now.

Remember, when you sell your coins, you will be required to pay capital gains taxes if you have profits. Of course, if you have losses you can use them to offset gains in the rest of your investment portfolio.

Our next instruction is to hope and pray that the coins decline in value and that your other assets such as stocks, bonds and real estate perform well, and that there is no economic crisis or a melt down in the value of the U.S. Dollar. Buying these coins is an insurance policy of sorts.

STOCKS

U.S. stocks have been receding for the last several weeks and they may continue to correct for a bit longer. Fear has begun to dominate and psychological reaction to the suffering of lower stock prices has begun to infuse the market. Meanwhile, economic and company fundamentals remain strong. Therefore, we are using our cash reserves to buy out-of-favor, beaten down stocks in the metals, energy and technology areas.

In addition, we are taking some positions in foreign stocks. We presently favor India, Japan and Russia.

JAPAN

A stronger Dollar in recent weeks has led to a rally in the Japanese stock market. Today, Japan has become the most popular market with U.S. institutional investors. However, we are skeptical about Tokyo’s ability to keep the Yen down. Their complex intervention (buying US government bonds to sterilize their intervention) has been a boon to the U.S. as it has helped keep U.S. interest rates low.

We have made a small commitment to Japanese OTC stocks. We see the large Japanese corporations as being too slow growing and vulnerable to a strong Yen, and therefore plan to focus on faster growing small to middle-sized companies.

INDIA

We continue to believe that Indian stocks in the technology and basic materials and consumer areas have some attraction. India is gradually opening its markets to foreign products and is reforming its large public sector by selling off majority pieces of government owned companies. As this process is completed, the Indian public is becoming more aware of the opportunities in stock investing and new Indian and foreign capital is flowing into the Indian equity markets. The Indians will go to the polls to pick a new parliament in the next few weeks. If the pro-business parties currently in office retain control, we expect a stock market rally after the election.

RUSSIA

President Putin has been reelected by a landslide and political stability is at a high point in Russia. The GDP is growing at a fairly fast rate and the Russians are spending their increased income on consumer goods. We have owned the cell phone companies and are looking into cosmetic companies that are benefiting from a new consumerism in Russia.

Russian women spend approximately twice as much of their income on cosmetics and toiletries as American and Western European women do. As incomes rise, perhaps this percentage falls, but the total dollars spent on cosmetics in Russia should continue to grow at a substantial rate. Because we believe Russia is in a period of increasing economic growth combined with political stability, we are looking for other consumer areas in which to invest.

CHINA

China is another situation. Chinese financial stability is being hampered by the desire of the Central government to slow the rapid growth of politically motivated credit by local and regional banks to politically connected borrowers. Much of this debt is never repaid. This tug of war between the Central government and the local politicians is creating uncertainty about the future of the Chinese banking infrastructure and has frightened foreign investors and Chinese nationals. The tug of war has led the central government to threaten to slow the economy, just to reign in the local bankers and their wild lending. This is not good news for investors. The Chinese stock market is declining and will continue to do so until the investing public can be assured that the banking system is orderly and viable.

GOLD

As you know, when gold prices were falling, we were buying. Now that gold is rising we may take some profits when our gold stocks reach our price objectives.

We believe that gold prices will rise for a few months. As the economy strengthens and employment rises later in 2004 we believe that gold will start to decline temporarily. So as gold shares rise in the next few weeks, we may take some profits in our gold shares. As you know, we are not gold share traders. Rather, we are investors who will take partial profits on price rises and add to our positions on pullbacks in price.

CURRENCIES

The Dollar has most likely seen the high point of its rally that began several weeks ago. At the present time the British Pound, Canadian Dollar and Swiss Franc are the most attractive currencies to hold in our opinion.

This is another reason that we believe that U.S. and Asian stocks will rise further. The weak U.S. Dollar is good for the corporate profits of most U.S. based exporters and for exporters in many Asian countries who have pegged their currencies to the Dollar. When the Dollar declines, exporters of goods to Europe for example, receive a larger dollar price for the same quantity of goods while the exporters costs (if set in dollars) remains constant.

If the company produces a commodity like oil or copper, then as the dollar falls, the world price of the commodity will often rise by approximately the same amount as the dollar falls. For example, in Euros, the price of oil has not risen in the last 2 years while it has skyrocketed in U.S. dollars.

BASE METALS AND ENERGY

The decline in the dollar is not over, so in our opinion the rise in commodity prices is not over. We believe that the earliest commodity prices are likely to peak is mid 2005. Historically, the price of commodity stocks has discounted the end of the commodity price rise about one year in advance.

The trick is to figure out when commodity prices will peak. This is an exceedingly difficult job and we spend a lot of time reading the economic tea leaves worldwide to come to a conclusion in this area.

SUMMARY

Stocks in the U.S. and Asia have been correcting. Japan has been an exception to this trend, and has been rising. We believe that because U.S. economic and company fundamentals remain strong, stocks may be within a few weeks of the turning point and we are using our cash to buy new stocks in the metals, energy and technology areas.

Currencies are beginning to rise versus the U.S. Dollar again. The Dollar’s rally, which was fairly lengthy but quite shallow, appears to be ending. As currencies rise, U.S. exporters enjoy rising profits. In addition, low interest rates and accommodative monetary policy are still stimulating the U.S. and world economies. We are using the markets’ declines to buy positions in good companies with visible growth that are selling at reasonable valuations.