Average Book Current Market Annual Est. Annual

Quantity Investment's Description Symbol Cost: Value: Price: Value: Yield(%): Income:

Common Shares:

Financial Sector: 6.858%

42 Bank of Montreal BMO $63.19 $2,653.98 $59.30 $2,490.60 4.43% $117.6091 Power Financial Corp. PWF $29.30 $2,666.30 $29.34 $2,669.94 4.78% $127.40105 Great-West Lifeco Inc. GWO $25.45 $2,672.25 $24.54 $2,576.70 4.83% $129.15

$7,992.53 $7,737.24

Communications Sector: 5.535%

85 BCE Inc. BCE $31.36 $2,665.60 $39.94 $3,394.90 6.92% $184.45135 Shaw Communications Inc. SJR.B $19.67 $2,655.45 $21.11 $2,849.85 4.93% $130.95

$5,321.05 $6,244.75

Pipeline Sector: 6.404%

71 Transcanada Corp. TRP $37.93 $2,693.03 $42.83 $3,040.93 4.64% $124.96108 Enbridge Inc. ENB $24.93 $2,692.44 $38.74 $4,183.92 4.53% $122.04

$5,385.47 $7,224.85

Utilities Sector: 2.055%

124 TransAlta Corp TA $21.54 $2,670.96 $18.70 $2,318.80 5.39% $143.84

Consumer Staples Sector: 1.965%

35 George Weston Ltd. WN $75.59 $2,645.65 $63.33 $2,216.55 1.91% $50.40

Common Share Totals: $24,015.66 $25,742.19

Inverse (ETFs):

380 Horizons BetaPro Inverse ETF HIF $9.19 $3,490.83 $7.88 $2,994.40 0.00% $0.00S&P/TSX Capped Financials Index

600 Horizons BetaPro Inverse ETF HIX $11.06 $6,633.00 $10.86 $6,516.00 0.00% $0.00S&P/TSX 60 Index

ETF Totals: $10,123.83 $9,510.40

Stock Market Investments: $34,139.49 $35,252.59 $1,130.79

Investment Portfolio Totals: $107,652.53 $112,824.62 3.86% $4,150.94

 

Thoughts and Concerns:

1) Inflation Fears: There continues to be a lot of chatter about the threat of inflation, mainly due to the massive expansion of liquidity by governments. This seems to be the only argument used to support the argument for inflation. The growing economic weakness in Europe and China do not support this fear. In fact, if it were not for the recent 36% jump in the price of oil, the official inflation numbers would certainly be much lower and in some instances possible indicating a deflationary direction. Elevated levels of long-term unemployment (Nearly half of the unemployed in the U.S. have been out of work for six months or longer. In the past, corresponding unemployment duration was only 10 weeks.), low Manufacturing Capacity Utilization Rates, the chronically low velocity of money within world economies and the continuing uncertainty in Europe (as evidenced by the weekly government announcements of bail-outs, bank stress-tests, financial firewalls, etc.) are all helping to keep inflation at bay.

2) Bond bubble? Accompanying the increased chatter about inflation is the renewed fear of a potential bubble in bond prices. Much of this discussion cites

• The amount of money flowing into bonds, • The record low levels of interest rates and • The rapid increase in liquidity injected into the financial system by

governments,

…as reasons for a bond bubble and its eventual bursting.

A couple of things to consider when you see these arguments presented. • With respect to money flows into the bond market, you should keep

in mind the majority of the money flows have been into corporate bonds, as a pseudo, safer stock market trade, not government treasuries. So the pricing risks of a bond bubble are probably more in the corporate bond market, not the government bond market, and their future price performance is probably more tied to stock market performance.

• As a reference for judging the current record low interest rates, we often use rates from prior periods. Why do we think past rates impose some kind of invisible downside limit on current and future rates? For over 25 years, I have been hearing how interest rates are about to go higher because they just can’t get any lower and guess what, they keep getting lower each year. No one knows where interest rates will be next week, next month or next year. For an example of where interest rates could head, just look at Japan.

• Concerns over the current level of liquidity in the financial system usually support two distinct arguments for higher interest rates. The first is with so much money injected into the system, inflation is just around the corner and, thus, interest rates must rise. The second argument is once the Central Banks begin to remove the liquidity from the financial system, interest rates will rise to a more normal level.

 

o The first argument assumes the liquidity moves from the Central Banks to domestic banks and, finally, into the hands of consumers who will spend it and eventually drive the economy into growth, resulting in rising inflation and higher interest rates. Unfortunately, the money is not getting to the consumer. The money is staying on the balance sheets of domestic banks, bolstering their balance sheets.

o As for the second argument, it assumes the liquidity is only temporary and it is going to be withdrawn by the Central Banks at sometime in the future. But what if they do not withdraw the liquidity? We are beginning to believe that the injected liquidity is permanent and will never be withdrawn. The current liquidity and Central Bank balance sheets have simply established new, permanent levels of liquidity for the financial system. So if the liquidity is not withdrawn, then the downward pressure on interest rates will remain in the system.

In addition, we believe the bonds of Canadian issuers should remain attractive for investors when compared to available bond options. For this reason, we feel their prices should prove to be less volatile than bonds of issuers outside Canada.

3) The other face of inflation - Financial Repression! There are two faces to inflation. The most recognizable is where our income and wealth cannot keep pace with rising prices for a prolonged period, as we experienced in the 1970’s. The lesser-known face of inflation occurs when our income and wealth declines faster than the prices we pay, which we are experiencing today. Governments around the world are forcing incomes to lower levels at a faster pace than prices can fall. How is this achieved? By adopting policies that promote austerity in the absence of corresponding reductions in taxation.

• Keep interest rates artificially low. This reduces the amount of interest income earned on the savings of individuals, corporations, pensions, institutions, etc.

• Reduce pension income by extending pension eligibility dates, reduce future pension plan benefits, and increase employee contributions and reduce employer contributions. These measures translate into lower income and higher expense burdens for individuals.

• Reduce social transfers to individuals through reduced health care, education, welfare and social funding. This also increases the expense burdens for individuals, as their current income must now bear greater expenses.

• Shifting tax structures away from income/assets and toward consumption. Shift away from corporate taxation and toward taxation at the individual’s level.

• Suppress income gains through negotiated employee contracts. Obtaining a 0% pay increase has become the norm in most

 

economies. (This may also be a function of the weakness in the overall economies, but it has also become a government policy, not just in North America, but also in Europe.)

Financial repression can feel just as bad as when prices rise ahead of our income (traditional inflation). With income and wealth declining, prices (inflation) do not necessarily need to increase for us to feel the stress. A quick note: In the most recent U.S. reports, real income declined month-over-month, which is very much at odds with the job creation figures unless that job creation reflects extraordinarily low-paying jobs. Real disposable income growth has now dropped to just 0.3% year-over-year, which is lower than the rate that is typically observed even in past recessions. 4) The natural flow of money! As discussed in the previous quarter’s Thoughts and Concerns, money flows are becoming a larger concern. We believe this is evidenced by the European Central Bank’s (ECB) recent intervention with direct buying of sovereign bonds (est. 300 billion Euros) and their 1.2 Trillion-Euro 1.0% loan program to banks (est. approximately 300 billion of this has gone to purchase sovereign bonds). These measures, in the short-term, have averted a bank liquidity crunch and helped countries like Italy and Spain to rollover maturing bonds. Unfortunately, the ECB’s intervention has caused a developing confidence crisis for private investors. As the charts below demonstrate, private capital flows are declining as they are pushed out by the ECB’s emergency liquidity injections. One of the main reasons for the retrenchment in private capital is that ECB loans jump to the front of the line for claims against the borrower’s assets. This pushes private capital from a secure position into an unknown position, which causes confidence in lending to deteriorate. As private money leaves, the burden on the ECB, IMF and newly created bailout programs increases. Unfortunately, in the long-term, government funding cannot replace private funding – something has to give.

                                   

 

 

 

 

 

   

 

 5) Oil self-sufficiency for the United States. Wow, what a couple of years and a few new technologies can do for a carved in stone belief – that is the Peak Oil Theory. In the U.S., for decades, consumption of oil rose, production fell and imports increased, and now every one of those trends is reversing. In 2011, the United States imported just 45 percent of the liquid fuels it used, down from a record high of 60 percent in 2005. That is a massive shift within only six years. Declining demand, the development of fuel-efficient vehicles, new imaging and seismic technology, horizontal drilling and much improved fracking processes have all contributed significantly to this developing new world order for energy markets. For the first time in over 80 years, the United States is fast approaching self-sufficiency when it comes to the consumption of energy. So dramatic is the shift that analysts now project U.S. oil and gas production will surpass that of Saudi Arabia and Russia by the end of 2020. (Canadian and Mexican production is soaring too, which is why analysts now call North America the new Middle East.) According to the Institute for Energy Research, North America’s vast energy resources include;

• Oil: o Total Recoverable Resources: 1.79 trillion barrels. o Enough oil to fuel every passenger car in the United States for 430

years. o Almost twice as much as the combined proved reserves of all

OPEC nations.

 

o More than six times the proved reserves of Saudi Arabia.

• Natural gas: o Total Recoverable Resources: 4.244 quadrillion cubic feet. o Enough natural gas to provide the United States with electricity for

575 years at current natural gas generation levels. o Enough natural gas to fuel homes heated by natural gas in the

United States for 857 years. o More natural gas than all of the next five largest national proved

reserves (more than Russia, Iran, Qatar, Saudi Arabia, and Turkmenistan)

According to some analysts, the United States has gone from energy basket case to energy self-sufficient and in the next few years it will become a net exporter of energy. For investors, the slowing economic activity in China and Europe, accompanied with the declining demand for energy in the United States, should be a negative for energy prices. The explosive growth in North American energy supplies should also have a long-term negative impact upon energy prices. In the face of these very strong, long-term trends, investors should ensure their investment portfolios are balanced in their exposure to the oil and gas energy industries. In addition, if the energy supply/demand trends begin to move energy prices lower (namely the price of oil),

• This will significantly change the official inflation statistics causing the numbers to decline and possibly move into the negative – deflation.

• The TSX index would come under strong downward pressure as approximately 25.92% of the index is focused upon energy companies.

Note: So if oil supplies are rising rapidly and demand is declining why are oil prices so high? Well, most will say the current high prices are due to increasing demand from the developing countries, but this does not explain the entire rise in oil prices. Another significant contributor to oil’s strong pricing is due to speculators, which market participants can and probably will debate for eternity. 6) Reversing Taxation Trends? For the past few decades, governments have embarked upon a process of transferring taxation away from income and wealth and toward consumption. Is this about to change? Income tax reductions, for both individuals and corporations, were missing from the recently announced Ontario and Federal government budgets. It makes one wonder if reductions in income tax have reached their lower limits and will future budgets include income tax rate increases? If the trends do reverse, we wonder what the impact would be for investments and investing in general. With interest rates so low and the wave of capital invested in dividend investments, would the dividend tax credit be at risk? Maybe, we are premature in our curiosity.

 

Investment Actions: No changes were made to the sample portfolio during the quarter. For the remainder of 2012, we anticipate investors and markets will struggle with the following issues

• Declining growth rates for corporate earnings • Slowing economies in Europe, Asia and North America • Continued financial repression as interest rates remain low and expense

burdens for individuals continue to increase as incomes and wealth shrinks.

• Accelerating reductions in government spending, as austerity becomes the new catch phrase. Governments around the world are focused on reducing their current operating deficits through eliminating jobs, reduced spending of social programs and services and raising fee/tax revenue. All potential negatives for economies.

Given the above, we are comfortable with the portfolio’s current investments and asset allocation.