MARKET REVIEW
Second Quarter 2012

lmost all major commodities and commodity-related equities declined during the quarter. Agricultural commodities were the exception, rising largely due to the heat wave across most of North America’s farmland. The market rebounded in June, though much of the positive return came on the last day, after the policy announcement to ease the European credit crisis. It will be months before we will know whether this was the beginning of a true solution to the problem. The combination of European issues with slower economic growth in China and disappointing statistics on the US economy resulted in the quarter’s decline.

All of this macroeconomic uncertainly has investors fleeing into US Treasuries, and therefore to the US dollar. The DXY Dollar Index gained 3.3%. A rising dollar has a negative impact on commodity prices, especially gold, which fell 4.2%. While that was a better return than most commodities, it is hardly the safe haven that some investors were anticipating. Gold companies declined 9.7%. We added to gold stocks on recent weakness. We do not buy gold stocks to capture the movement in gold prices. Instead, we seek to take advantage of the difference between the price of gold and the implied gold value of the underlying companies. When the Portfolio has a significant allocation to gold, we tend to hold many companies in order to diversify company-specific risk. Gold and silver companies now comprise 14.6% of the Portfolio.

Oil prices fell dramatically; West Texas Crude declined 17.9% and Brent Crude lost 21.9%. The slowing global economy and rising dollar hurt oil prices, as well as the rest of the commodity complex. However, oil had some unique headwinds such as reduced tensions with Iran (for now) and an improving outlook for US oil production. Oil related equities, both producers and drilling companies, outperformed crude itself.

Natural gas was the only major commodity to increase in price this quarter, up 38.4%. While this is a large return, it comes after years of declining prices. Since we believe that the US will become more of a natural gas-powered economy over time, the Portfolio holds some gas production and gas-focused servicing companies. But the shift to increased natural gas use, in contrast to merely more natural gas production, will take years, if not decades. While it may inform portfolio decisions in the background, it is not likely to be a significant theme for some time.

Base industrial commodities (principally iron ore, copper and metallurgical coal) also declined, as is typical during periods when the economic outlook weakens. Companies in these industries underperformed their underlying commodities. The Portfolio continues to have relatively modest exposure (under 20%) to these companies given the asset class.