Will inflation result in lower overall bind returns for 2012. Or has it already happened?

1. Gnostam
LLC
March
13th,
2011
PO
Box
960
Inverness,
CA
94937
Newsletter
Independent Investment Advisor
DANGERS FROM THE US BOND 1941 when the US started its massive
MARKET: WWII spending.
Bill Gross the largest Bond Fund Manager In nominal terms the average interest rate
in the world announced this week that for US government bonds for the period
Pimco, manager of the Bond total return from 1790 to date is around 6%. Today
fund had sold his entire holding of US we have rate around 3.40% for the 10 year
Government Bonds. and Fed Funds at 0.25%. This is clearly
an unsustainably low rate of interest and
This is big news. clearly this is Bill Gross’ motivation for the
sale of his massive position in US
As can be seen from Figure 1 below, the government debt.
rate of increase pf US Debt as a % of
GDP is on the sharpest increase since [Continued on Page 3] Although the US
Figure
1.
US
Government
Debt
as
%
GDP
1792
to
2010.
Source:
US
office
of
management
and
budget.
1

2. Gnostam
LLC
March
13th,
2011
PO
Box
960
Inverness,
CA
94937
Newsletter
Gnostam LLC performance Graphs
Chart
1
Gnostam
Performance
Gnostam
was
established
in
February
2004.
Since
inception
the
annualized
rate
for
return
for
a
client
portfolio
managed
by
Gnostam
LLC
has
returned
a
total
9.56%.
For
the
period
from
January
2007
to
date,
the
managed
portfolio
has
returned
an
average
of
1.53%
vs.
-­‐2.55%
of
the
S&P
500.
Please
see
table
below.
2

3. Gnostam
LLC
March
13th,
2011
PO
Box
960
Inverness,
CA
94937
Newsletter
Government inflation statistics show that every item that has gone up in price, such as
inflation is tame, the exclude almost energy, all foods, such as wheat and corn
Chart
2.
US
Interest
rates
cycles
Fig
3.
US
Inflation
rate
Jan
1990-­‐Jan
2011
3

4. Gnostam
LLC
March
13th,
2011
PO
Box
960
Inverness,
CA
94937
Newsletter
Portfolio
Changes
and
Recommendations
for
February
15th
2011
2011 will be a difficult year for investors. Too The following is a table of our best
much money has come into the market, buys:
especially money that chases returns, such as
mutual find money. There is almost no chance • Photronics [PLAB] 12.2 x
in my mind that the market will go much higher multiple;
than it is at the moment. I would sell most • Kulike & Soffa [KLIC] 11.9
stocks that are financial and related to housing, multiple;
and retail. Instead, buy rare metal miners, gas • Cambrex [CBM] 8.9 multiple;
pipelines and gas producers. Once the value of
solar stocks has come down, they may be a In Oil and Gas exploration, valuations
place to look. of the deep-sea drillers [<4,000 feet]
are attractive. With the new Petrobras
Gas pipeline strong buys are as follows: find, there has been a re-deployment
from the GoM to the deep offshore
Kinder Morgan, [KMI] drilling areas off the coast of Brazil,
El Paso, [EP] and rates are expected to climb by
Williams Partners, [WPZ] 11% in 2011. Best choices are:
Plains All America, [PAA]
• Helix Energy, [HLX] 12.7 x
Most of these will be subject to consolidation in multiple;
my view. I would add the following utility, UGI, • Diamond Offshore [DO] 11.33 x
which is a liquefied natural gas play. multiple;
In genomic equipment and services, Life Solar Plays that may be of interest:
technologies, [LIFE] while expensive has an
almost unique exposure to the high quality LDK SOLAR, [LDK] $14.45
earnings from genomic research and genomic MEMC [WFR] is a buy
tools. If I were a Pfizer, this is the type of
company I would want to acquire. FSLR is a short.
Semiconductor Equipment has great potential
for producing superior returns in the first quarter
of 2011.
4

5. Gnostam
LLC
March
13th,
2011
PO
Box
960
Inverness,
CA
94937
Newsletter
have been rising consistently and are one been grumbling for years about the failure
of the reasons for the revolts in the Arab of the US Government to provide for a
world. stable currency. Most bond investors who
have bought US Treasuries from abroad
The real shock to bond investors will come have been loosing their shirts in a total
when they realize that there are fewer and return basis, if their base currency is the
fewer buyers of US Government bonds. Euro or say the Ozzie $. In fact the only
The Japanese will probably have to sell real buyer of Treasuries in size is the US
some positions following the terrible Government and the Fed.
Tsunami/Earthquake. The Chinese have
5

6. Gnostam
LLC
March
13th,
2011
PO
Box
960
Inverness,
CA
94937
Newsletter
WHY A RISING BOND YIELD MATTERS. priced.
Consider this scenario. The US Treasury This game cannot continue for ever.
and the Fed buy entire portfolio’s of junk Something has to give, Either:
or underwater assets of banks in 2008-
2009. This is because the banks are 1. Short term rates will rise
unable to finance these portfolio’s in short regardless of the Fed, or bond
term money market’s as the money investors will no longer accept a
market does not believe banks are 3.4% return for holding long term,
solvent. Not to mention the impact on the debt, given that the US $ has
cost to service US Government debt at devalued 3% in one year relative
higher rates. to the Euro;
2. Or inflation will accelerate and
For over 2 years large US banks [Bof A, destroy the value of US
Citibank et al] have been recapitalized by government debt.
a massive subsidy from the US taxpayer.
The banks can borrow at 0.25% and re- It seems that Bill Gross is not waiting
invest in Treasuries at 3.5%. As there are around for option 2.
only 2 ways to make money in bonds,
[interest rate risk or credit risk] the US What happens if 5-30 year rates as it
government is subsidizing the banks seems will rise to a “normal” 4.5%-7%
“interest rate risk”. There is no interest range?
rate risk for the banks as long as Ben
Bernanke artificially guarantees access to 1. The banks will be in terrible
0.25% Fed Funds rates, a 3.25% shape. The value of their “long”
unleveraged spread, which once dated financial assets will
leveraged the customary 10-20 times is a implode by 20-25%. The cost of
>32.5%. No wonder banks are making funding these positions will rise,
money. And they are paying senior bank making it necessary to sell bonds
employees great bonuses, while banks into a down market;
shareholders have lost 1.5% on aggregate 2. The banks will be too big to fail
over 5 years. In essence the banks have yet again, and the Fed will have
survived with the value destroying to bail them out again;
capabilities intact. 3. Our Asian investors will finally
throw in the towel on US
All this time banks have not lent. They Government debt;
have loaded up their balance sheet with 4. All debt will loose value;
US Government debt and earned from the 5. Bond funds will begin to unwind;
spread between short term an long term 6. Pressure will be put on money
Government debt rates. The banks in market funds again as funds flow
essence have privatized their losses, [we into these as only safe haven,
the taxpayers own those] at the very time only to flow out just as fast once
when we should be spending our way out the opportunity cost of holding
of the recession. That and absurdly high 0% balances is taken account of.
entitlement spending make holding US
Government debt unattractive. So I would urge you to do what Bill
Remember US Government debt is the Gross has already done.
benchmark upon which all other debt is
6

7. Gnostam
LLC
March
13th,
2011
PO
Box
960
Inverness,
CA
94937
Newsletter
Sell your bonds. It may be your last chance nonfinancial assets—all the
to do so without losing your shirt. commodities that are in big demand
to keep these economies humming.
Resist the urge to buy Muni Bond funds. China, in particular, has been buying
They will underperform, and you will lose up hard assets worldwide, often
money on them as they face redemptions instead of dollar-denominated
and are forced to sell into the worst Muni investments.
market in 50 years.
What to do if you are
a Euro Investor?
The $ has taken a
real beating. And the
Treasury never
speaks of the need
for a strong currency
any longer.
The supply of
dollars is
conspicuously on
the rise. With
interest rates at
close to zero in
the U.S. since the
financial crisis of
2008, and the
Federal Reserve
Board no longer able to lift the economy As long as monetary policies remain
by lowering interest rates, the government linked to the U.S., inflation pressures
has turned to "printing money," boosting will only intensify in emerging
the money supply through quantitative markets. Emerging countries will be
easings. The most recent, involving left with no choice but to adopt
purchases of up to $600 billion of independent monetary policies and
Treasury bonds, is expected to run revalue their currencies, or risk social
through June. chaos. Such a move is politically
sensitive; although it will increase the
Given the concern that Treasury rates purchasing power of their
now have almost nowhere to go but up, constituents, it will cut into business
which would reduce the value of bonds, exports. Likewise, if a decoupling of
money has been flowing to those exchange rates comes to pass, U.S.
economies with higher growth rates than consumers can expect to see the
the U.S., such as China and Brazil, but value of their money depreciate, and
whose interest rates are comparatively U.S. companies can expect exports
low because they are linked to those of to rise.
the U.S. That's led to a boom in borrowing
and spending, and investing in
7

8. Gnostam
LLC
March
13th,
2011
PO
Box
960
Inverness,
CA
94937
Newsletter
A similar scenario is being played out in currency will end in the next 10 years.
Europe, where Germany's economy has The greenback, he says, is likely to share
been vibrant and inflation is a threat, while the throne with the renminbi and the
Spain, in particular, as well as Ireland and euro. He sees the dollar eventually
Portugal and Greece are mired in debt and dropping 20% in order to make U.S.
depressed economies—yet all are tied to goods more appealing for export.
the same currency and interest-rate
policies. Barron's Randall W. Forsyth began
predicting the end of the dollar's
SWISS FRANC AS A SAFE HAVEN: hegemony in December.
This has clearly been the winning currency Reflecting the growing pessimism, short
in terms of safe haven. As can be seen positions in the dollar, or bets against it,
from the chart below, this is the place to on the International Monetary Market
hold your cash if you want it to hold its currency-futures exchange reached the
value. highest level ever during the first week of
March, reaching some $41.5 billion and
$ TO LOOSE RESERVE STATUS? exceeding the previous record of $38
billion in November 2007, according to
Barry Eichengreen, a professor of Nomura Securities. The short position is
economics and political science at broad-based, but it appears to be biggest
University of California at Berkeley, against the Canadian dollar, the
penned an opinion piece in The Wall Australian dollar, the Swiss franc and the
Street Journal predicting that the Japanese yen.
dollar's reign as the dominant world
8

9. Gnostam
LLC
March
13th,
2011
PO
Box
960
Inverness,
CA
94937
Newsletter
It's getting easier for individuals to take Van Eck Global's MarketVectors have all
their own dollar positions. It can be as entered the fray, with nearly 40 funds
simple as buying stock in big multinational now available to investors to pursue
companies found in the Standard & Poor's strategies as simple as hedging a
500; they derive ever-increasing portions portfolio or as sophisticated as predicting
of their profits from overseas sources, a currency's direction, based on technical
which gives them a natural hedge. Coca- analysis.
Cola (ticker: KO), IBM (IBM) and
ExxonMobil (XOM) are prime examples. Pimco's Gross recommends ETFs tied to
currencies of faster-growing emerging
Alternatively, any number of online markets, such as China and other Asian
brokerage firms, including TD Ameritrade's countries, plus Brazil and even Canada
thinkorswim platform, make sophisticated and Mexico.
software tools and automated trading
available. Foreign-exchange specialists WisdomTree Dreyfus Emerging
FXCM (FXCM) and Gain Capital (GCAP) Currency Fund (CEW), at nearly $400
each came public within the past few million in assets, is a popular, actively
months, taking advantage of the managed offering that invests in eight to
heightened interest in currency trading. 12 emerging-markets currencies in equal
Another, Utah-based Interbank FX, says it proportions, using derivatives such as
is watching its competitors' experiences swaps. The fund is invested currently in
closely and considering its own initial Mexico, Brazil, Chile, Poland, Israel,
public offering. Turkey, South Africa, China, India, South
Korea, Taiwan and Malaysia. It had a 6%
Certificates of deposit in euros and other total return for the past 12 months.
nondollar-denominated world currencies
are also available. EverBank, a BY FAR, THE BIGGEST OF THE
Jacksonville, Fla., consumer bank, offers currency ETFs is the PowerShares DB
such a service through its Brentwood, Mo.- U.S. Dollar Index Bullish (UUP), with
based world-markets division. $873 million in assets. There's also a
bearish version of that fund, but this isn't
One of the most effective approaches is to necessarily the way to hedge against a
pick a good exchange-traded fund, the falling dollar. An advantage of ETFs is
same strategy many investors are that they can be shorted, and research
following for gold. ETFs based on conducted by Ned Davis Research
currencies and currency strategies have suggests that long-term investors could
flooded the market, especially in the past do as well, if not better, by shorting the
few years, as demand has heated up. The bullish fund than by investing in the
assets of the these funds now total $6.3 bearish fund, owing to complications
billion, approaching the level of the red-hot related to daily rebalancing and
energy ETFs. compounding.
Rydex SGI launched the first currency There are also less popular exchange-
exchange-traded fund in 2005, the traded notes linked to currencies. ETNs
CurrencyShares Euro Trust, which is are more like bonds, in that they pay no
essentially a euro-denominated money- interest but carry a guarantee that the
market fund. Since then, Barclays iPath, issuer will make a cash payment at
Invesco Powershares, WisdomTree and maturity equal to the return of an
9

10. Gnostam
LLC
March
13th,
2011
PO
Box
960
Inverness,
CA
94937
Newsletter
underlying index. However, exchange- No one's recommending that the
traded notes carry credit risk; they are average investor start actively trading in
treated as unsecured debt of the firm that foreign exchange, but to maintain a
issues them. competitive rate of return on
investments, and to assure a standard
of living that is competitive
with the rest of the world,
U.S. investors must become
better acquainted with the
relative values of global
currencies as a matter of
course—and not just when
planning vacations abroad. A
truly diversified portfolio will
now also need to hold some
currencies.
Some of America's more
savvy corporate titans have
gotten a jump on the coming
shifts in the structure of the
currency market. In the past
six months, and for the first
time, Caterpillar (CAT) and
McDonald's (MCD) have
received approval from the
Chinese government to issue
bonds in Hong Kong based
on the Chinese renminbi—
so-called "dim sum" bonds—
to finance their business
projects in China. The moves
save the companies the
expense of converting bonds
issued in dollars into
renminbi.
CHINA, NOW THE
WORLD'S second-largest
economy behind the U.S.,
went even further in mid-
January when its 70%-
government-controlled Bank
of China began allowing
individual and corporate
accounts to buy and sell
renminbi at its New York and
Los Angeles branches.
10

11. Gnostam
LLC
March
13th,
2011
PO
Box
960
Inverness,
CA
94937
Newsletter
Individuals are limited to trading the volume is already eight times as large as that of
equivalent of $4,000 renminbi a day the world's stock markets. All those folks who
and $20,000 a year, but it's another spent much of the past decade buying
step toward putting the renminbi in a emerging-market stocks might now do well to
league with the dollar, yen and euro. consider those countries' currencies.
The foreign-exchange market is far too big
for investors to ignore, and it's only getting
bigger. By some estimates, its trading
Disclaimer:
The information and any statistical data contained herein have been obtained from sources which we
believe to be reliable, but we do not represent that they are accurate or complete, and they should not be
relied upon as such. All opinions expressed and data provided herein are subject to change without notice.
Gnostam LLC and/or its shareholders, directors, officers and/or employees, may have long or short
positions or deal as principal in the securities discussed herein, related securities or in options, futures or
other derivative instruments based thereon. The securities mentioned in this report may not be suitable for
all types of investors. ALL investments involve different degrees of risk. You should be aware of your risk
tolerance level and financial situations at all times. Furthermore, you should read all transaction
confirmations, monthly, and year-end statements. Read any and all prospectuses carefully before making
any investment decisions. You are free at all times to accept or reject all investment recommendations
made by the Gnostam LLC. As you know, a recommendation, which you are free to accept or reject, is not
a guarantee for the successful performance of an investment and we are expressly prohibited from
guaranteeing accounts against losses arising from market conditions.
Past performance is no guarantee of future results, and current performance may be lower or higher than
the performance data quoted.
Investment Disclaimer All investments involve different degrees of risk. You should be aware of your
risk tolerance level and financial situations at all times. Furthermore, you should read all transaction
confirmations, monthly, and year-end statements. Read any and all prospectuses carefully before making
any investment decisions. You are free at all times to accept or reject all investment recommendations
made. All products sold are subject to market risk and may result in the entire loss to the client's
investment. (For example: excessive withdrawals may result in the depletion of your account). Please
understand that any losses are attributed to market forces beyond the control or prediction of Gnostam
LLC. As you know, a recommendation, which you are free to accept or reject, is not a guarantee for the
successful performance of an investment and we are expressly prohibited from guaranteeing accounts
Gnostam
LLC
5731
Kirkwood
Place
N
Seattle,
WA
98103
USA
E-­‐mail:
pcorsano@gnostam.com
www.gnostam.com
11