TestingYourMetal DoYouHaveSystemicInsurance?

GrantsConference
NewYork April11,2012

INTRODUCTORYREMARKS
Good afternoon! The last two times I presented at the Grants conference, in early 2007 and in 2008, I spoke about CDOs, subprime mortgagebacked securitiesandabouthow securitizationwasenablingunsustainablelevels ofleverage. I also spoke about distressed opportunities that would come from the inevitable unwinding. Everyone knows what happened to many securitizations and we were fortunatetopartakeintheresultingopportunities. I am back here today to talk again about unsustainable conditions because despite the crisis of 2008, broader imbalances remain unaddressedand, if anything, may have worsened. Rather than taking the necessary pain, governments have been taking on massive additional debts, which does nothing but delay the next inevitable unwinding. Today I will talk about what this should mean to investors.Forthosewhowonderwhetherthereisanythingtheycandotoprotectthemselves,theansweris:Yes,youcan! Butfirst,IalsowantthankJimGrantforachancetoaddressa groupwheresomanysharemyrecentlydiagnosedproblem.Ireferto thesocalled1%problem. Thisisastepupforme.IwasbornintheSovietUnionwhere,beingJewish,Ihadalessexclusive2%problem.ThatsbecauseJewish peopleaccountedfor2%ofthepopulationand,despitebeinggenerallysuccessful,wereviewedasaproblem.Forexample,topschools had2%quotasforJewishstudentsandthesamewastrueforthetopemployers.Allintheinterestoffairness,ofcourse.Then,asmy family emigrated in 1978, fairness required that we leave our assets behind to pay back for everything the state had done for us. Many immigrants come to America with $100 because thats all the money they have. I came with a $100 because thats all I was allowedtobring.Whenyougetsingledoutforspecialtreatment youdontneedtolookfortrouble;itwillfindyou.Usually,when youcanleastaffordit. So,asyoucansee,Ihavealeveloffamiliaritywiththeissuesofrepression,fairsharing,andfinancialweaponsofglobaldestruction, allofwhichbringsmetomytopicofSystemicInsuranceandthe roleofgoldasasafehavenasset. Before launching into the presentation, I would like to clarify the difference between investing and insurance. Investing is about positioningcapitaltoprofitfromthe outcomes oneexpects.Insuranceisaboutincurringarelatively small cost to protect against the outcomesthatonedoesnotexpectbutthatmayprovecatastrophicifthey,infact,occur.

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UnderstandingSystemicRisks

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ISITREALLYABOUTARMAGEDDON?

Before

During

After

Governmentshavealwaysusedapocalypticthreatstovalidateendjustifiesthemeans policies.

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SYSTEMICDISRUPTIONSARENOTARMAGEDDON
1961-1990 1991-1997 1998-Present

Before

During

After

Systemicdisruptionseffectmultipleinstitutionsandmajorityofthepopulation,i.e.risksarehighly correlated.

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EXAMPLESOFSYSTEMICDISRUPTIONSAREPLENTIFUL

TypicalSystemicRisks:
Widespreaddefaults,sovereigndebtcrises,devaluations,capitalcontrols,bankholidays,etc.

Howitusuallyhappens:
Nowarning; Emergencyannouncementoveraweekend; Drasticmeasurestoprotectthepublic against[insertsuitableculprits]; Outcome someonesvaluegetsexpropriated.

Yes,itcanhappenhere ithasinthepast.

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SYSTEMICRISKATWORK GOLDNATIONALIZATIONOF1933

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SYSTEMICRISKATWORK SUNDAY,AUGUST15,1971

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SYSTEMICRISKATWORK THEAFTERMATH

Say,whateverhappenedtothatbugaboo ofdevaluation?

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THISTIME ISNEVERTHATDIFFERENT DRIVINGCORRELATION HIGHER

Crisisof20072009wasaHighCorrelation disruption: Multipleinstitutionsandmajorityofthepopulationwereaffected. Reducingsystemicriskcalledforloweringcorrelation,i.e.firebreaks,decoupling,etc. Instead,governments actionssince2008havebeenincreasingcorrelation: FiscalPolicies sovereigndebtsarehigherthaneverandstillgrowingfast; MonetaryPolicies brokenpricemechanism=systemwidemisallocationsandmispricings; TooBigToFail biggerthanbeforethecrisis; EuroZoneCrisis solutions keepincreasinginterconnectedness amutualsuicide pact; FinancialRegulation wassupposedtoreducetheriskbutstalledthroughstiffopposition: AsingleJPMorgantraderisreportedtorun$100bln CDSbook?!?!?!?!?! LackofTransparency moreopacitysincethecrisis;marktomarketremainssuspended. Everyoneknowsthisbutonlyfewarewillingtoaccepttheimplications;fewerstillarewillingtoact.

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SYSTEMICCRISESFOLLOWWELLESTABLISHEDPATTERNS

Therearealwayslosersandwinners manymorelosersthanwinners.

Majorityhasnormalcybias tendencytounderestimateriskofdisaster.

Onlyafewheedtherisksandmakepropercontingencyarrangements.

Historically,financialdisasterpreparednesshasenabledacceleratedwealthcreation.

SystemicInsuranceistheonlywaytoprotectwealthfromHighCorrelation events.

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InsuranceandHighlyCorrelatedRisks

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THECORRELATIONDILEMMAOFINSURANCE

CorrelatedlossesaretheAchilles Heel ofconventionalinsurance: Insuranceworkswhenmanypaysmallpremiumstocoverlargelossesofthefew. Iflargelossesaresufferedbymany,insurancecounterpartiescannotcoverallthelosses. Highlycorrelatedrisks(war,riot,flood)aretypicallyuninsurableintheprivatesector.

Whatistheimplication? Insurancecontractsagainsthighlycorrelatedrisks,evenifoffered,canneverpayoff.

Highlycorrelatedrisksrequireunconventionalinsurancesolutions.

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DOYOUNEEDSYSTEMICINSURANCE?

Fromthebuyers perspective,insuranceisadvisableANDfeasiblewhen:
Specificriskscanbedefined; Riskprobabilityisnontrivial; Lossseveritycouldbecatastrophic; Thecostisreasonablerelativetopotentiallossseverity; Counterpartyriskcanbeaddressed.

Insuranceisthecostofprotectingagainstunexpected butpotentiallycatastrophicoutcomes.

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DefiningCurrentSystemicRisks

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FINANCIALREPRESSION ITSABOUTYOUR MONEY!

Thealreadyunfoldingcrises: TheEurozone,Argentina. Redistributionofwealth: ZIRP Takingfromnetsaversforthebenefitofnetdebtors. Inflationtargeting Debasingdebtsattheexpenseofsaversandbondholders. Pendingtaxhikesfortopearners. FinancialMarshalllaw: FBARandFATCAraisepenaltiesandtightenreportingonallfinancialassetsheldoffshore. Argentina Currencycontrols;Dollarsniffing dogsattheairportsandbordercrossings. Governmentscooptbankstopolicetheassetswithinthesystem: FATCA allforeignfinancialinstitutionstoreportonallUScustomersorface30%withholding. SwissbankshavebeenfiringUSclients;dealonreportingisin theworks. SwissbankshaveagreedtoreportontheirGermanandUKcustomers accounts.

FINANCIALREPRESSIONISANARRAYOFPOLICYTOOLSTHATPRECLUDECAPITALFLIGHT ANDENABLEWEALTHTRANSFERFROMTHESAVERSTOTHEDEBTORS.

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AretheProbabilitiesHigherThanTrivial?

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ASSESSINGPROBABILITIES RISKBAROMETER ISAPRODUCTOF EXPERIENCE

WesterneconomieshaveenjoyedVshapedrecoveriesanddomesticpeaceforover65years.

Mainstreaminvestorshaveneverexperiencedareset orrepression,financialorpolitical.

DisdainforhistoryandpostWWIIWesternexceptionalism underpincollectivehubris:
There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refugeofthethosewhodonothaveinsighttoappreciatetheincrediblewondersofthepresent. JohnK.Galbraith

Complacencyismisplaced despiteapparentnormality,therisksarehighandgrowing.

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CouldtheCostofSystemicDisruptionProveCatastrophic?

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CORRELATEDLOSSESMEANHIGHSEVERITY

AnalyzeThis:

CrisisofSeptember2008Without TheBailouts= $$,$$$,$$$,$$$,$$$

Duetomassivenewdebtsandpoliticsgovernments capacityforfuturebailoutsislimited.

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IstheCostReasonableRelativetoPotentialLoss?

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INSURANCECOSTISAFUNCTIONOFLOSSEXPECTATIONS

PriceofSystemicInsurance=ProbabilityofDisruptionXPotentialLossSeverity

InsuranceischeapwheneverconsensusunderestimatestheProbabilityofDisruption.

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WouldtheCounterpartiesPerformWithouttheBailouts?

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COUNTERPARTYRISK+HIGHCORRELATION=NONPERFORMANCE

Counterparties Before

During

Counterparties After

HighlyCorrelatedCounterparties

HighlyCorrelatedLosses

CounterpartyNonPerformance

Systemicinsuranceboughtwithinthesystemcannotaddresstheriskofcounterpartynonperformance.

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COUNTERPARTYRISK BOTHABILITYANDWILLINGNESSARE QUESTIONABLE

FinancialinstitutionsroutinelysellCDSagainsthighlycorrelatedevents: LehmanbackedCDSagainstacreditcrisispaidcentsonthedollar;Lehmanfailed. AIGbackedCDSonsubprimeCDOs werepaidbythegovernment;AIGcouldnotperform. Butforthebailouts,subprimeshortsandotherCDSwouldhavefailedtopayout. Evencustodialcounterpartieshaveprovenunsafe: Conventionalcustodyischeapbecausecustodiansmakemoneyonrehypothecation. Theclientsendupwiththecounterpartyrisk LehmanUKin2008;MFGlobalin2011. ISDAanditsmembers Sofarabletopaybutalreadynotreallywilling. UnambiguousGreekdefault agreementtopaytooktimeandextensivedeliberations. Withwillingnessalreadylow,whathappensif/whenaLARGEdebtordefaults?

Effectivesystemicinsuranceisastrategy,notacounterpartydependentcontract.

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StrategyforProtectingand,Potentially,EnhancingWealth

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SAFEHAVENASSETS SYSTEMICINSURANCESTRATEGY

SystemicInsuranceStrategy Adynamiccontingencyplanwithtwoobjectives: Protectameaningfulportionofwealthagainstdisruption: Accidentscannotbetimed notbeingtooearly =toolate; Evolvingrisksrequireactivemanagement; Absoluteperformanceisirrelevant whenmanylosealot,alittlegoesalongway.

Usepreservedwealthtocapitalizeontheopportunitiesbrought onbythecrisis: Everycrisistriggersliquidations especiallywhenprecrisisleverageishigh; Convertpreservedvalueintotheoverlydevaluedalternatives.

Manyoftheworldsgreatestfortuneswereborneoutoftheworldsgreatestdisruptions.

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SystemicProtectionThrough Unlevered,SecurelyOwnedSafeHavenAssets

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SAFEHAVENTRADE CANNOTOFFERANEFFECTIVESAFEHAVEN

SafeHavenTrade UsingfinancialinstrumentstospeculateinSafeHavenassets. OpportunitytoprofitfromexpectationsbutNO protectionifsystemiceventoccurs. Completerelianceonfunctioningcapitalmarketsandoncounterparties performing; Highsovereignrisks; Lowcosts,highliquiditybutonlywhenfinancialmarketsfunction.

SafeHavenAssets Physicalownershipoutsidethesystemandwithgeographicdiversification. OpportunitytoprofitfromexpectationsAND protectionifsystemiceventoccurs. Norelianceonfunctioningcapitalmarketsoroncounterparties performing; Lowsovereignrisks; Highercosts;liquidityislowerbutavailableirrespectiveofthefinancialmarkets.

HighercostsofowningSafeHavenAssetsareapartofthecostofSystemicInsurance.

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SAFEHAVENASSETS KEYREQUIREMENTS

IdealAttributes Valuable,uniform,divisible,portable,storable.

NoOnesLiability Physicalform,unlevered,nonfinancialcustody;norelianceoncapitalmarkets.

MultipleExitStrategies Diversityofbuyers;abilitytoexitviadifferentcurrencies.

GeographicDiversification Theonlyfeasiblewaytomanagesovereignrisks.

Flexibility Ownershiparrangementsmustbeactivelymanagedtoaddressevolvingconditions.

ExposuretoSafeHavenassetsviafinancialinstrumentsISNOT SystemicInsurance.

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SAFEHAVENASSETS DEFENSIVE,LONGTERMSTRATEGY

ProvenSafeHavensforpreservingvaluethroughthetrough ofacrisis:

RealEstate Real butimmovable;notuniform,usuallyownedwithleverage;easily taxable. Diamonds Valuable,portableandstorablebutneitheruniformnordivisible. Art,Antiques,Collectables Issueswithsubjectivevaluations,authenticityandprovenance.

Inacrisis,uniqueassetsarepronetothePhiladelphia problem.

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THEPHILADELPHIA PROBLEM

ART,ANTIQUESANDCOLLECTABLESHAVEBEENPROVENHIGHLYEFFECTIVE INPRESERVINGVALUEOVER TIME. HOWEVER,ABILITYTOOBTAINFAIRVALUEINTIMESOFDISTRESSISOFTENLIMITED.

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SAFEHAVENASSETSFORALLSEASONS PRECIOUSMETALS

PreciousMetalscanpreservevaluethroughacrisisANDprovideliquidityduringacrisis:

Silver PoorMansGold butimpracticalforlargesums. Platinum Thebullionisnotasreadilyavailableasgold. Palladium Somewhatesoteric.

GOLD Alwaysliquid,widelyavailable,universallyaccepted,deepestmarkets,globalpricing.

Gold 2,500yearunbrokentrackrecordofliquidityandSafeHaven performance.

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ANOBSERVATION

AsaSafeHaven,goldhasneverfailedtoperformforover2,500 years andyet:

Inanindustrywheretrackrecordisking,

goldhasthelongest,andthemostdisregarded,provenrecord.

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TestingtheMetal SecurelyStoredGoldBullion theUltimateSafeHaven

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AVOTEOFCONFIDENCEFROMANUNEXPECTEDGOLDFAN

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GOLD THESAFEHAVENTHATHASSTOODTHETESTOFTIME

Withoutfunctioningcapitalmarkets,conventionalhedgingstrategiesaremoot; Goldenjoysthecriticalmass ofglobalacceptanceandaprovenrecordofbeingidealCrisisCurrency.

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THENYFEDSIMPLAUSIBLEPAEANTOGOLD ITIS ASTOREOF VALUE

Whypeopleowngold:
Forcenturies,goldhadaprofoundimpactonhistory,asa symbolandastorehouseofwealthaccepteduniversallyaround theworld. Whenpeopleareworriedaboutpoliticalinstability,waror inflation,theyoftenputtheirsavingsintogold. Goldfunctionsasamediumofexchange,particularlyinareas wherecurrenciesaredistrusted.

WhytheUSgovernmentnationalizedgold:
The1933prohibitionagainstgoldownershippreventedhoarders fromprofitingafterCongressdevaluedthedollar(intermsof gold) by41%.

Thisbrochurewasupdatedin2008.

ACCORDINGTOTHENYFED GOLDISAPHENOMENALASSET ANDANIMPORTANTSTOREOFVALUE GOLDNATIONALIZATIONOF1933PRECLUDEDTHESAVERSFROMPROTECTINGTHEVALUEOFTHEIRASSETS.

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GENERALBACKGROUND

THECHAIRMANAGREES GOLDISUSEDASAPROTECTIONAGAINSTBADOUTCOMES.

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THEFED WESTOREFOROTHERS;OUROWNISOUTSIDETHE BANKS!

As of early 2008, the Feds vault contained roughly 216 million troy ounces of gold about 22 percent of the worlds official monetarygoldreserves.

The United States owns approximately 27 percent of the monetarygold 262milliontroyouncesasof2007.

A majority of [the U.S.] reserves is held <> at Fort Knox, Kentucky,andWestPoint,NewYork.Mostoftheremainderisat the Denver and Philadelphia Mints and the San Francisco Assay Office.

Thisbrochurewasupdatedin2008.

WATCHWHATTHEYDO;NOTWHATTHEYSAY: THEU.S.GOVERNMENTSTORESITSGOLDWITHTHEMILITARY,NOTTHEBANKS. APPROXIMATELY49%OFALLMONETARYGOLDISPHYSICALLYLOCATEDONTHEU.S.SOIL.

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DoYouHaveSystemicInsurance?

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BASEDONGOLDDEMAND,WESTERNINVESTORSAREUNDER INSURED
AggregateGoldDemand:20002010
DevelopedMarkets: 25% 7,200tonsofGoldbarsandjewelry ETFs: <7.5% 2,200tons CentralBanks: NetSellersof3,300tons EMERGINGMARKETS: 79% 23,200tons(9,000tonsIndia+China)
GMOLLC

WESTERNINVESTORSHAVEBEENPURSUINGTHESAFEHAVENTRADE,NOTSYSTEMICINSURANCE.

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SUPPLYISLIMITED MINEPRODUCTIONHASAVERAGED2,600 TONSP.A.

Goldhasaprovenrecordandenjoystheglobalcriticalmass ofsupport; Billionsaroundtheworldacceptgoldasastorevalue,especiallyintimesofcrisis.

Losingwealthcanbeanemotionaldisasterasmuchasfinancialhardship: Tisbettertohavelovedandlostthannevertohavelovedatall doesnotapplytomoney!

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INSURANCECHEAPNESS ASINSURANCE,GOLDISSTILLVERY CHEAP

PriceofSystemicInsurance=ProbabilityofDisruptionXPotentialLossSeverity
ConsensusProbabilityofDisruptionisstilllow. NewSupplyofgoldbullionisconstrained=SUPPLYOFINSURANCEISLIMITED.

ConsensusisunderestimatingtheProbabilityofDisruption=Insuranceischeapfornow.

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DONTBECAUGHTUNPREPARED PROTECTAGAINSTTHE UNEXPECTED!

Tisbettertohavelovedandlostthannevertohavelovedatall doesnotapplytomoney!

Dontletthishappentoyou:

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EidesisCapitalLLC 500FifthAvenue,56thFloor NewYork,NY10110 Telephone:(212)7922170 Facsimile:(212)7922171 SimonA.Mikhailovich Simon.Mikhailovich@eidesiscapital.com Telephone:(212)7922172

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