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MARKET UPDATE

MAY 2012

THE MARKET MIRAGE

Always test of your conviction for a certain outcome by maintaining constant objectivity.
"A Thing Long Expected Takes the Form of the Unexpected When at Last it Comes" - Marc Faber

real optical phenomenon, which can be captured on camera since light rays actually are refracted to form the false image at the observer's location. The interpretive faculties of the human mind, however, determine what the image appears to represent. For example, inferior images on land are very easily mistaken for the reflections from a small body of water. (Wikipedia) The human mind is a very complex thing with the ability to fool even the most intelligent people. We understand this here

A mirage is a naturally occurring optical phenomenon in which light rays are bent to produce a displaced image of distant objects or the sky. The word comes to English via the French mirage, from the Latin mirare, meaning "to look at, to wonder at". This is the same root as for "mirror" and "to admire". In contrast to a hallucination, a mirage is a

; Market Update May 2012

at KSIR, and so we try our best to sit back, ponder our investment thesis, and ask ourselves what brought us here? What is keeping us here? Has anything changed? One of the keys of maintaining an objective outlook is to be comfortable knowing that you dont know everything. This state of mind will allow one to continue to play out an investment thesis with the facts. We launched the KSIR gold and silver mining fund in January of this year to exploit a pricing arbitrage that formed in the near term producers and early stage production companies. We often invest in sectors derided by the majority, and currently the few fund managers that have invested in this sector have been forced into throwing up the shares because of the intense negativity led by the main stream press, Mr. Buffet and Mr. Munger, and talking heads alike. As we take a hard look at the facts, we currently feel there is a mirage that has formed in the markets. Most of this is due to the central banks optical backstops that have been so successful in paving a few extra miles of road for the Fiat paper regimes to kick the can down. To focus in on the true value of the sector we look at the blue chip mining companies for the macro trends. Instead of pricing them in US dollars we look at the value relative to the metal they produce. As you can see relative to the metal most of the major gold and silver mining companies are cheaper today than at the lows in gold at $300 and silver at $4.50 an ounce! We ask: how can this be? Are input costs rising faster than the metal price and forcing margin pressure on the companies?

; Market Update May 2012

The margins, as a group, are today 10 times what they were back in 2000 and 2001, and yet the stocks producing the metal are relatively priced the same or lower. Maybe it is because the introduction of the physical metal ETFs differing close to 100 billion away from the equities.
Name SPDR Gold Trust (ETF) iShares Silver Trust (ETF) Central Fund of Canada ETFS Silver Trust ETFS Gold Trust Central Gold-Trust iShares Gold Trust(ETF) Sprott Physical Gold Trust Sprott Physical Silver Trust ETV Total Value in Millions Mtk cap 67,179 9,274 5,265 565 1,788 1,188 8,999 2,053 1,067 97,379 3

; Market Update May 2012

Or could it be that worldwide governments austerity measures are going to turn everything around. The chart below from the Federal Reserve shows that the trend for more debt financing is still intact; in fact it is accelerating at an almost vertical rate since 2008.

So where is the money going? In an effort to keep interest rates low, fixed income investments have gone parabolic as the reach for yield goes to levels previously unseen. The chart above shows the Bank of America Merrill Lynch High yield total return index value. The US still has to fund over $600 billion of debt for the year and the top 3 foreign buyers are basically net flat over the last 7 months. The Fed will be forced to pick up the slack. We forecast that the Fed comes out with some type of programwhatever it may be calledby the end of June. Sentiment among small businesses, which is what traditionally drives the recovery cycle, is at a multi decade low!

The Federal Reserve is adding unprecedented amounts of liquidity to the system.

The government spent $454 billion for the fiscal year 2011 on interest. (http://www.treasurydirect.gov/govt/charts /charts_expense.htm) The average on balance sheet cost of borrowing was around 2.9%. For the fiscal year of 2012 the interest rate is averaging 2.7% so far with projected expenses north of last years $454 billion. 4

; Market Update May 2012

from the Fed, in the event that the real estate market goes south once again from higher interest rates and the banks are forced into another wave of foreclosures and short sales.

Since most of the debt has been rolled over to shorter maturity dates to push the overall cost of borrowing down an uptick in rates could be disastrous. 2012 interest rate expense should be closer to the $500 billion number with average rates around 2.65%. If we had a modest bump to 5% it would eat up about half of all tax receipts received for the US Government. The main point to take away is that we are going to see continued debt monetization for the foreseeable future. With no foreign buyers large enough to take on the deficits of the US the Federal Reserve will have to pick up the difference and continue to buy these bonds in order to keep interest rates low. Look what is going on in the mortgage market below: With rates well below what

So now we have established the fundamentals of Gold and Silver, the output products of our mining stocks. Both are still in strong uptrends. The negativity in the shares and metals themselves has reached a pinnacle level never before experienced. How can this be when gold is only 15% off its all-time high? The correction in gold in 2008 was about 40% and silver was 60% yet a lot of the underlying equities are priced today at the same levels. These types of consolidations have been some of the most powerful as gold went from 1000-1900 in less than 24 months.

you could get at the top of the real estate market and home prices continue to decline! The banks are now holding excess reserves, mostly

Both metals are still in a short term neutral trading position, in very strong uptrends. What we need to ponder as fiduciaries is as follows: is the bull market in the metals over? Or will this play out as one of the more difficult consolidations that shake out the weak and even some of the strong hands! If this is the case you better believe we are in for an even more violent up move in the near future as most of the sellers have already sold. As far as the mining sector goes KSIR does not own any of the featured large cap miners. We specialize in early stage producers that are, believe it or not, trading at cheaper levels than the majors! As the capitulation continues we will be very happy to take those shares off your hands. If you would like to invest you can reach us at: brett@ksircapital.com tucker@ksircapital.com

The information provided on or within this document available herein is for assistance only and is not intended to be and must not be taken alone as the basis for an investment decision. Each recipient of this information should make such investigations as it deems necessary to arrive at an independent evaluation of an investment in the securities offered hereby, and should consult its own legal counsel and financial, accounting, regulatory and tax advisors to determine the consequences of such an investment. The securities offered hereby have not been and will not be registered under the Securities Act of 1933, as amended, or the securities laws of any state or any other jurisdiction, and are being offered and sold in reliance upon exemptions from the registration requirements of the Securities Act and such laws. In addition, the Partnership will not be registered as an investment company under the Investment Company Act of 1940, as amended. The securities offered have not been approved or disapproved by the securities authority of any state or any other jurisdiction, or the Securities and Exchange Commission of the United States, nor has any other authority or commission passed upon or endorsed the merits of this offering or the accuracy or adequacy of any supporting documents. Any representation to the contrary is unlawful. The securities being offered are suitable only for sophisticated Investors for whom an investment in the securities does not constitute a complete investment program and who fully understand, are willing to assume, and who have the financial resources necessary to withstand, the risks involved in an investment in the Partnership. Each purchaser of the securities offered hereby must be an Accredited Investor within the meaning of Regulation D promulgated by the SEC under the Securities Act and will be required to make certain representations and provide documentation to assure compliance by the Partnership with applicable anti-money laundering laws. The securities offered are subject to prior sale and subject to the right of the Partnership, in its discretion, to reject any subscription in whole or in part. The Partnership and its affiliates reserve the right to modify any of the terms of the offering and the interests in the securities described herein or to withdraw the offer at any time.