Quarterly Commentary:
April 2005

The Quarter in Review

The first quarter brought an end to the euphoria of late 2004 as rising interest rates and commodity prices finally permeated the psychology of the capital markets. Ironically, it was a terrible quarter for the diversified investor, as virtually every asset class declined.

• Goldman Sachs Natural Resource Index	15.0%
• REITs	-7.2
• Foreign Equities (EFA)	-0.2
• S&P 500	-2.6
• Nasdaq 100 (QQQQ)	-8.1
• Gold	-0.5
• Lehman Aggregate Bond Index (AGG)	-1.4

First Quarter Tactics

We started the New Year almost entirely in cash or short-term fixed rate instruments. As in most things in life, our choices of avoidance contributed as much to our results as our deliberate selections. Asset allocation for the quarter was almost entirely limited to adjustable rate bond funds, natural gas, and copper.

Equities

Our bearish stance prohibited any temptation to reinvest in U.S. market indices. The equity markets were soft for most of the quarter, and declined precipitously by the end of March.

Fixed Income

We started the year in some accounts with sizeable long-term fixed income positions. By late February, we sold substantially all such assets, just before an approximate 14% decline. Frankly, we were lucky.

Our dominant fixed-income positions continue to be adjustable-rate bank loan funds, an intermediate-term fund, and a global income fund (as hedge against falling dollar).

Commodities

A change of heart encouraged a foray into commodities. We bought about 5% of assets (for some accounts) of San Juan Basin Royalty Trust (SJT), the largest natural gas field in the United States. SJT pays a dividend of 8-11% (depending on purchase price) and has appreciated about 30% for the quarter. We also bought (5% of assets) Southern Peru Copper (PCU), yielding 5-8%, which also appreciated about 22%.

Strategy for Second Quarter

The cycle of cheap money that fueled the stock, bond, and real estate markets for the last twenty-five years has come to an end, and consequently has initiated the fundamental market shift we have anticipated for the past year. Rising commodity prices have eliminated any illusion that inflation is tame. Markets fear an acceleration in the rate of interest rate increases that begin 12 months ago.

Equities

• We believe any Domestic recovery will be snuffed out by rising interest rates and commodity prices. As such, we believe the next big move will be DOWN. We’re not sure if the market decline will be sudden or long and gradual. But the second quarter may prove to be quite unpleasant.
• European markets have performed favorably, primarily due to the falling dollar versus the euro. This trend may have ended, at least temporarily. We are neutral.
• The next sustainable bull markets lie in Asia. The buy-and-hold investor is well served by investing in China, India, and surrounding countries. We wait for a buying opportunity, but have conviction to build positions in these economies.

Initially, we assumed the rise in Commodity prices was merely part of the liquidity bubble affecting all asset classes. Upon further research, we now believe the commodity bull market to be genuine and sustainable.

We expect commodities in general, and oil in particular, to outperform throughout 2005, for two reasons: 1) much of the demand is perceived to come from China and booming Asian countries; and 2) as other asset classes continue to decline, more attention (and dollars) will focus on oil and commodities for investment return.

Commodities are infamous for volatility. The predominant threat will be the perceived hard landing of the Chinese economy, not unlikely if interest rates continue to rise. As such, our preference will be commodity stocks that pay substantial dividends, which effectively provide price support and cash-flow during market downdrafts.

Fixed-income: We will stay short. We are comfortable with our adjustable rate funds, but we will not add to them. We will take a position in a foreign bond fund, to provide a hedge against a falling dollar.

Long-term fixed income is expected to decline throughout the second quarter as rates rise. However, should rising rates (together with rising oil) overwhelm our over-leveraged economy, such predictions may prove uncertain. We will watch.

Asset allocation: We do not expect to allocate more than 25-30% to commodities. We hope to allocate about 40% to foreign equities. We may re-evaluate the S&P 500 index if the market collapses and a buying opportunity emerges. The balance will remain in our fixed-income portfolio.

Tactics for Second Quarter

Our Equity target positions:

• San Juan Basin Royalty Trust (SJT)	10% (total portfolio)
• Southern Peru Copper (PCU)	10%
• iShares International (EFA)	10%
• iShares Europe (EZU)	10%
• iShares Pacific ex-Japan (EPP)	10%
• iShares Goldman Sachs Nat’l Resources (IGE)	5%

Our Fixed-income target positions:

Short-term, price stability (30%)

• iShares Lehman 1-3 year Treasury bond fund (SHY). Current yield about 2.0%. A logical holding during rising interest rates, but this fund offers such poor yield, we may reallocate throughout the quarter.
• Nuveen, Pimco, ING Floating Rate Funds (NSL, JFR, PFL, PPR). Exchange-traded funds, invests in corporate senior lien loans, leveraged by about 30% to enhance yield. Loan rates adjust, so price fluctuation in a rising interest rate market should be minimal. Currently yields from 5.5 – 6.7%. These funds have been more volatile than logic would dictate. A portfolio of funds may smooth volatility.

Foreign bond funds (10%)

• Templeton Global Income. This fund is a fixed-income hedge against a falling dollar. The dollar rallied late in the quarter, and the price of this fund declined by about 11%. We believe the dollar rally is temporary, and the fund will rebound.

Interest rate hedge, mutual fund (5%)

• Rydex Juno fund (RYJUX) is one of the only mutual funds that provide a hedge against long-term interest rates. We have allocated about 5% of total assets for our larger accounts. However, even as interest rates rise, this fund has proven to be a poor hedge. As such, we will sell in market rallies.