Hi to All Investor Brethren and Happy New Year 2004.

The 2004 plan is my 3rd annual investment plan. I would again like to share my plan with you, if I can be
so presumptuous, and give you additional ideas to help with your own investment plan.

To recap last year’s plan (emailed on Dec. 31, 2002) and how it fared:

My overview of the market to you at the end of 2002:

“2003 will be good for stocks, especially small cap, and not so good for long-term bonds. But the rally
may fade at around 10,000 on the Dow and we could retest the October 2002 low of 7200 during the new
year. I believe we are in a multi-year trading range between those extremes. If this is true, then
dividends will come back into style (especially if legislation in the Congress eliminates double taxation on
dividends) and stock picking will be more important to achieve short-term gains.”

My 2003 projections were pretty close to the mark. It turned out that stock picking didn’t really matter, as
the entire market did well (and much better than I thought it would). The Dow rally didn’t fade at 10,000,
but kept right on going to 10,454. Small caps did best, and much better than I had hoped. Dividend
taxes were not eliminated by the government, but were significantly cut (to 15%). The dividend tax
reduction, combined with personal and business income tax reduction, a middle income tax rebate,
artificially low interest rates, and improving geo-political landscape, all conspired to make this a much
better than expected year for investing.

As predicted, the Dow did come close to retest its October 2002 lows, by hitting 7524 on March 11 during
the first week of the Iraq war. But it did not make a technically negative “lower low”. So from mid-March,
it was off to the races.

My estimate for year-end 2003 was 9500 on the Dow and 1800 on NASDAQ. Not too far off on either.

My investment recommendations for 2003 were:

+ Stay conservative

+ Protect against the possibility of inflation (this time it more likely will happen) by going to short term
bonds and TIPS (Note: this really paid off in June ‘03 when rates reversed direction)

+ Use REITs to provide downside protection and some upside plus current income up +5.2% in 2002, as
compared with S&P500 down –16.55%) (Note: REITs had their best year in many, up 33.3%, and have
probably topped out this cycle)

+ Stocks: buy small cap index; two examples: Neuberger Genesis (growth) –0.9% in 2002 and the Fidelity
Low Price (value) –2.4%. (Note: Small Caps, especially growth and tech, had a terrific year. Relatively
conservative and diverse NBGEX is up 30.76% and FLPSX is up 39.24%; Tech oriented small cap funds
did much better)

+ Stick your neck out just a little and begin SLOWLY accumulating High Volatility Techs and Biotechs
(see following for a good method) (Note: the referenced got better much faster than expected. If you had
bought both high beta techs (internet) and biotechs at the beginning of 2003, you would have had gains in
each over 100%. My slow but steady “dollar cost averaging” approach yielded 50%+ for each)

Here are my recommendations and my Outlook for 2004 and my thoughts on investing in the New
Year:

+ Stay conservative (Still True and will be until equities are again cheap…below 10x current earnings)
+ Protect against the possibility of inflation… inflation is very likely in 2004, more so than many years
past. The economy has been “kick-started” by deficit spending. This will have an impact on interest rates
and inflation, probably this year.

+ Sell REITs when the industry average dividend return falls below the inflation rate; industry return today
is 5%;

+ Stocks: the large cap Value sector is the last stop during a business cycle. LCV has lagged during the
past year. High dividend, high ROE, large cap, and slow growth stocks will do well in 2004; Medical,
insurance, energy, consumer staples (household) products, Defense, are the place to be at the cycle
peak and going into a business downturn (in 2005); expect a 10-20% return in 2004 on this sector;

+ Stay away from high growth, low profit, small caps like Internet and retail in 2004; they will correct
significantly (-20% to -40%);

OVERVIEW of 2004:

The market is still expensive by historical standards. The long term P/E of the Dow Industrial is 14.5. We
continue to hover around 20, higher for lower cap indexes. The very low interest rates have a lot to do
with the high market P/Es. At some point, likely in late 2004 or early 2005, interest rates will rise
considerably, to offset the weak dollar and to accommodate inflation in commodity prices. Inflation may
also occur due to the Administration’s success in ramping the economy. Capital investment has been nil
the past three years. Production capacity is tightening and inventories are low, putting pressure on
supply. The interest rate increase will increase the required earnings yield (reciprocal of P/E ratio) to
maintain parity with bond rates, requiring stock prices to decrease (ex.: P/E of 20 equals 1/20 or 5%
earnings yield; if zero risk 10 year Treasuries exceed 5% in 2004, P/E must decline to maintain parity;
6% Treasury implies maximum of 1/6 or 16.67 P/E, implies 17% decline in stock averages).

Also in 2005, the FASB will issue new guidelines on expensing stock options and accounting for pension
expenses. These actions will serve to lower corporate aggregate earnings, hurting the “E” in P/E,
requiring a reduction of “P” to maintain the ratio. I have been using Cash Flow as a superior metric for
value. The Cash Flow ratio is about 10% less than Earnings (on average), depending on the industry and
its requirement for capital investment (and the resultant depreciation/amortization expenses, which are
kept out of Cash Flow). “Free Cash Flow”, which also deducts R&D expense, is yet lower on average, and
is a much better indicator of value. The Cash Flow metric makes value comparisons between industries,
with dissimilar capital and R&D requirements, much more meaningful.

Conclusion: To regain historical valuation, the market must tread water for several years until rescued by
earnings (cash flow) or inflation, or a combination of both.

What happened to the USA stock market in 2003 and why will it do well for part of 2004?

Stocks followed last year’s script by doing great in the 3rd year of a presidential cycle. This tendency was
discussed in last year’s newsletter. It was predictable that the Fed, which wants to retain its Federal
appointments, would help the Administration fire up the economy. It was especially true this time since
President Bush, Jr. has the insight gained from watching his father lose the 1992 election because of the
‘90-91 recession. As commentators in the past have said, when it comes to elections “it’s the economy,
stupid”.

So where do we stand in December 2003 in respect to other historical periods? The second year after a
large decline, such as occurred from 2000-02, is often a transition from the bear market rally “bounce” to
another smaller downturn. This 10-15% “correction” can be seen in both the 1933-34 period, DOW 105 in
August ‘33 to DOW 85 in July ‘34 (almost five years after the 1929 crash), and in 1976 (in “real dollars”
during a period of higher inflation, from the ‘73-74 bottom). See the graph that follows:
 10000

1000
Dow Ind 1925-1940

Dow / NASDAQ 1967-1982

NASDAQ COMP 1995-

2010
100

10
Jul-24

Jul-29

Jul-34

This chart shows the three most significant market declines of the past 100 years and overlays them.
The months are shifted slightly so that the peaks and valleys overlap. The October ’29 peak corresponds
to the March ’00 peak for example (green line). Also note, the ’65-80 period is a composite of the Dow
Industrial 30(prior to ’71) and the NASDAQ Composite (an index started in that year). It is my belief that
the NASDAQ is now the most dramatic measure of the market and is roughly equal to the Dow Industrial
in previous periods (the Dow Industrial was a measure of the latest “High Tech” companies in 1925, with
GE, RCA and Whirlpool some of the examples. In past times, the Dow Transports/Utilities were the low
growth, high dividend companies now represented by the Dow 30). What is very revealing in the graph is
the similarity between the past and present. This is no surprise. The human psychology that controls
market action has not changed in 100 years (and may not in 1000). The market is driven by basic
emotions of fear and greed. In the short run, emotion drives a market (as opposed to Earnings and
Interest Rates in the longer run). So, in 12-24 month periods, the emotional record of the past is very
instructive regarding the future.

The market and economy over the past ten year looks very similar to the market of the late 60s and early
70s. Look at the graph and see the comparison in the market averages. The major difference is that the
peak in the ‘72-‘73 period has a flat top, looking something like Mt. St. Helens from my native Northwest.
Why the flat top? How does that relate to the typical frothy “blow-off” of a topping market? Remember
that happened politically during this period? President Nixon implemented a “Price Freeze”. When prices
are frozen, so are earnings. With earnings growth capped, so was the market. But this cap did not
change the shape of the market curve over the longer term. Interesting. It leads me to the conclusion
that long-term market forces are repeatable through history. We are in a period like the 70s.

The primary negative in 2004 will be the story of the Weak Dollar. The USA dollar has weakened against
world currencies for two reasons: the Fed and Treasury want it that way. Why? to help American
exporters and thereby increase employment, leading to re-election for the incumbents. However, the
USA deficit is causing concern among major foreign investors, causing those investors to invest relatively
more in foreign denominated equities / bonds, than in American denominated investments. This net
outflow of dollar denominated funds will continue to weaken the dollar in 2004.

The greatest investment danger in 2004 (other than extraneous political / military events beyond
anticipation) will be a complete collapse of the dollar. The Administration is walking a tight rope with its
budget deficits and weak dollar to pay for economic stimulus. If foreign investors throw in the towel, as
our low interest rates and the declining dollar create negative returns, they will sell dollar denominated
securities en masse and in the process the dollar could collapse.

A “run on the dollar”, just like bank failures in the past, would have serious negative side effects for the
economy and markets. The Treasury would have to dramatically increase interest rates to attract foreign
investment and reverse the direction of the dollar (moving rates up by 3% or more). This would cause a
significant downward adjustment to the stock market price to earnings (P/E) ratio, dropping stocks by the
same percent amount. A significant increase in interest rates would also stop economic growth and throw
the USA back into recession.

To a significant, but lesser effect, declining dollar value vs. foreign currencies also result in inflating prices
for imported goods. This inflation is passed along to consumers and businesses alike. Net effect is either
domestic price increases, or profits are squeezed, halting the economic recovery.

The Treasury and Fed understand the risk and are playing a little game of “chicken” with investors. In
any case, the interest rate and deficit issues must be dealt with in the near future. Once the election is in
hand, the new (Bush) administration will address the problem, will likely raise taxes and interest rates,
and thereby damage equity and bond markets in 2005. This forecast is consistent with historical
presidential cycles in the USA.

The question to ask is: when will investors take notice and begin pricing the anticipated government
actions into the markets? My guess is by July 2004.

My approach for 2004

Based on the above analysis here is my game plan for 2004: A range of 8200 to 11,800 for the DOW,
900 to 1250 for the S&P500, 1340 to 2200 for the NASDAQ. Any gains in averages will be prior to
September 2004. After that, anticipation of changes post-election, to shore up the dollar and stem dollar
outflows, will result in declining markets through year-end. We may still see a year over year increase in
the more defensive / high dividend DJI 30 average by next December, but a small decline in the S&P500
and large decline in NASDAQ average is likely. (I will guess at a close of 11,300 (+9.4%) for DJI 30,
1500 (-25%) for NASDAQ Composite, and 1040 (-5%) for S&P500.

As mentioned the last two years in this report, I believe the USA stock markets will be in a trading range
for several years (until at least 2010) as the markets consolidate all the damage of the stock bubble in
2000-2002, and the current mortgage / currency bubble, providing time for USA national debt to be repaid
(or devalued by inflation) to less than annual GNP and allow earnings (cash) to grow so that the market
P/E gets back into line with historic averages. My opinion is not original and has been expressed by
Warren Buffet and others, in the past. Even if you accept the above scenario, it is hard to know where in
that range the year will end.

Asset Allocation:

I always try to keep a balance in my portfolio so that I won’t be hurt too much if my personal predictions
don’t work out. Asset Allocation is the number one determinant of investing success according to several
academic studies. The same research shows stock picking is not very important to long term
performance, although it can be a lot of fun. You can use tools like Quicken to analyze your portfolio and
provide long term returns based on a particular mix of investment types. The idea is to get the maximum
return within the limits of your personal risk tolerance (which likely decreases with age).

It may not surprise you that I am not very risk tolerant. Any of my friends who have gone to the casino
with me will tell you that. I hate losing money and only take chances with a small part of my portfolio. (I
don’t even like gambling, much).

Here is my relatively conservative asset mix: 60% stock, 20% bonds, 10% real estate (excluding our
home), 10% cash. I have held this mix pretty constant the past five years. It kept me underexposed
during the 1999-2000 years of stock outperformance (and I was kicking myself at the time). In 2001 and
2002 the same approach has protected me. In 2003, I was able to match the stock market return
(25.82%) with much less risk/volatility. The bottom line is that this allocation has kept me even or ahead
of other allocation models suitable for my age, like the Fidelity Freedom 2020 (+5.07% annual for the past
five years), which is my personal portfolio benchmark. Fidelity offers these portfolio models with risk
designed for retirement in the stated year, in my case 2020. It makes a good portfolio benchmark. By
comparison, my 5-year total portfolio performance is 7.70%.

Stock:

Stocks rotate by cap size along with the economic cycle. Historically, the rotation begins with Small Caps
at economic recovery (more nimble) and moves to Large Caps (better global exposure and able to
acquire small caps as the business cycle generates cash flow). There is also a rotation in terms of risk,
from Growth at the beginning of an expansion, to Value at the beginning of a contraction. Stocks can be
lumped by industry or sector into these groups of value vs. growth and small vs. large cap, to assist with
the selection process.

At the beginning of 2004, we are midway through an economic recovery. The recovery is cyclical, not
secular. We are in a long term period of economic entrenchment, for reasons already stated. This is not
a cheap market or a slack economy. Consumption has continued near all time peak levels. The
consumption has been financed by debt, mostly from refinancing out of the real estate sector.
Government is also at all time highs. Long term “secular” economic recoveries start from a base of low
demand and deconstructed supply, as in the 30s or 70s. We are in a time of economic stagnation, with
little room to grow the economy and no large increase in demand. For this reason, we may want to stay a
little defensive in our stock picks, which would bring us to value stocks (both large and small). Opposite
last year, in 2004 large cap, blue chips are the place to be.

A long-standing relationship between large and small cap stocks as compared by the P/E ration is that
small caps command a small premium to large (due to the faster growth rate possible with smaller cap
size). Right now, small caps are at a 20-30% premium as compared with large caps. Buy large cap
value stocks and funds.

Large cap value (Defensive Stock) is called for at this point in the cycle. Individual stocks can be
purchased here, if you like picking stocks, or an index can be used. Some of the value names in
individual stocks to consider for 2004 are Microsoft (really!), Unilever, Exxon, ConAgra, J&J, Merck (see
attached list for large caps that passed a value screen). Stock picking is less important for large caps and
indexes will probably do as good or better than individual pickers. Vanguard Value, Dodge and Cox (my
favorite), Clipper, American Funds’ Washington Mutual, and Oakmark are good picks.
Since small caps are hard to pick, unless you know something about a company based on personal
experience, it is good to use mutual funds for small caps. As mentioned, two good ones (according to
Morningstar) that I own are Neuberger Genesis (SCG) and Fidelity Low Price (SCV). There are several
others that can be researched by using Morningstar. Look for low volatility (beta) and high relative return.

Another way to participate in stocks is to guess at the sectors that will outperform in the future. Over the
mid term (3-5 years) the best performing sectors are likely to come from the worst performing the past
three years. This is where contrarianism really can pay off. Where are the worst sectors of the past three
years? A review of the Big Charts site: (http://bigcharts.marketwatch.com/industry/bigcharts-
com/default.asp?bcind_compidx=&bcind_period=3yr) shows Gas Utilities, Pipelines, Wireless
Communications, and Airlines are the worst over three years. I would avoid Airlines, but consider the
other three. Unless a sector becomes obsolete like “buggy whips”, it will be back, but maybe with
different names in the leadership. Some sectors, like airlines, have never been able to show a long term
profit, and probably never will. In the case of airlines, the problems are high capital expense, non-
differentiated product, and inventory with no shelf life (airline seats).

Because it is hard to know who will survive in a damaged industry sector, the best way to buy into the
future performance of the sector is with sector funds. The only funds with which to do this once were only
at Fidelity. But now, a new low-cost way to participate in sectors is available by buying “Exchange
Traded Funds” (ETFs). These are baskets of stocks that trade daily on a stock exchange, mostly the
AMEX. You can buy any sector and any foreign country index this way. The maintenance costs are also
very low compared with mutual funds (0.20% vs. 1.2% for example), so you keep more of the returns. All
the above sectors can be purchased through either the HOLDRs series or the Ishare series.

Emerging Markets: This is a stock (and bond) theme that should play a large role in any portfolio (5-10%
of total). Emerging markets are the source of future long term growth in the world economy. They
provide a good hedge against dollar weakness, and will increasingly provide a hedge against the
domestic economy (as Asia, for example, becomes a net consumer of products). The best way to play
the Emerging Markets is with managed funds. The best managers live in the market in which they invest.
Mark Mobius of Templeton Funds, is at the top of the heap. He lives in Hong Kong and runs several
mutual and closed end funds for Franklin funds. Templeton Dragon (TDF), invested in China/Hong Kong,
is a fund I have owned since 1996. It had an increase of 69.8% in 2003, and has a 25.78% five-year
average. Emerging Markets Fund (EMF) has a broader EM scope and provides exposure to East Europe
and Russia. “TEI” is a bond version of the Emerging Market funds. All are way up in 2003 and are due
for a short-term correction. I am “dollar cost averaging” to gain exposure without too much risk.

“High Beta” / high return stocks: Another stock category for the long term is Biotech. If you look at
investing themes that will do well over time, the first thing to consider is the sectors that are driven by
basic human needs. People probably perceive health care as number three among necessities. One
and two are food and shelter. But these are both commodities and could be great investments over the
near term, in an inflationary environment. Both categories tend to be good defensive sectors going into a
period of inflation or a recession as was demonstrated by these sectors the past the 70s and 2000-02.

As dynamic as they are at the end of a recession, Biotechs and small tech stocks can be hazardous to
the investor’s health at the end of a cycle. They are extremely volatile and subject to investor emotion.
Maybe only one of ten biotech companies will actually produce a viable medicine. No one, not even the
founders of the biotech, knows what the successful compounds will be. I am not recommending it for
2004, but on the next rebound, a good biotech ETF, that owns many companies and is capitalization
weighted (and includes profitable Amgen, Genentech and Biogen) is the way to go. Try Ishares’ ‘IBB’ or
HOLDRS ‘BBH’. ‘IGN’ is a good Tech ETF fund.

The best way to buy into damaged or volatile sectors? I have found that an account with
Sharebuilder.com is a good option. Sharebuilder.com allows you to deposit on account through wire
transfer from a savings account and make periodic investments of a given amount in a wide range of
stocks. This includes the aforementioned ETFs. In this way, you can invest gradually and “dollar cost
average” into a sectors with the ETF. You can choose the flat rate plan and buy as many stocks as you
want, in any increment, for $12 per month (up to six purchases). Not a bad deal. You can open both
IRAs and taxable accounts here.

The “Hedge”: A few months ago I picked up a small position in a notorius, but successful “Bear Market
Fund” called “Prudent Bear” fund. David Tice, who along with Robert Prechter, is a long time and famous
stock Bear, manages this fund. BEARX did very well in 2000-2002. This demonstrates of being long a
short fund, so to speak, during a market decline. BEARX had a 16.16% annualized performance from
Jan. 2001 – Dec. 2003, when the S&P500 was declining, topped by a 88.24% performance from 1/5/02 to
10/9/02 (the depth of the Bear market). I would not advocate the use of this fund as a “naked”
investment, since the long term average of the market is always up. But, as a way to counter potential
downfalls in the market, it provides inexpensive insurance (see “Options” below for a more sophisticated
and expensive way to protect a portfolio). “BEARX” also provides some positive exposure to Gold. This
has kept BEARX at even money the past 8 months, even though the market has advanced.

Another great fund run by Dave Tice is the “Global Income Fund” which is invested in more secure, non-
USA dollar denominated bonds and fixed income securities. This fund avoids dangerous Emerging
Markets. David Tice and friends are concerned about paper currency based economies in general, and
the USA dollar specifically, due to paper’s use as a subsidy for consumption oriented economies that are
deep in debt (USA). If you are worried about the thesis of over-printed USA dollars, and the subsequent
undermining of the USA fixed income markets (and all other economies pegged to the USA dollar), this
fund “PSAFX” is a good choice. It returned 16% in 2003 and has returned 10% on average since 2000.
It is invested in very secure sovereign currencies (Sweden, Switzerland, Euros) and Gold.

Bonds:

Short term and inflation-protected bonds (Treasury Inflation Protected Securities called TIPS) are called
for with rates headed up in 2004. Vanguard is the best source of bond funds, based on its very low
expenses. VIPSX is Vanguard’s low cost TIPS product. PIMCO and its all-world manager, Bill Gross, is
another very good choice for all type of bond funds. Besides short term treasury and TIPS options there
are other interesting bond possibilities. Based on expanding world economies one is an Emerging
Markets (read “third world”) bond fund. This type of fund does better in a recovery and worse in a decline
than the USA equivalent fund. It also will take advantage of the weak USA dollar and provide currency
plus market returns. It may even be somewhat de-linked from the USA bond market (moving up while the
USA moves down). A bond (or stock) fund’s correlation to the USA is shown by its “Alpha” which can be
found on the Morningstar.com site under “Risk Measures”. A negative alpha shows negative correlation
to the USA benchmark, T-bills.

Another alternative fund is a high yield corporate bond fund. Vanguard has a good offering here, too
(VWEHX). The spread between high yield (junk) bond funds is less than last year at this time, reducing
the attractiveness of this option. High Yield funds will move down in value if the market moves back
toward recession by the end of 2004 or into 2005.

Another way to buy into bond and debt assets at very low cost is ETFs. There are new versions by both
Ishares and HOLDRs that track all types of debt instruments. You can use Sharebuilder for this as well,
to gradually build your bond portfolio.

Real Estate:

I believe real estate is good ballast in a portfolio. It has low correlation to the stock market (as measured
by Beta. Available by company on Moneycentral.msn.com/company report, the lower the better). Real
estate moves with the economy and with inflation. As a hard asset is one of the best inflation hedges
available (along with commodities and precious metals). It moves, for the most part, independent of the
stock market. Improperly financed real estate could be hurt by the increase in interest rates.

I would like to offer that a good REIT will return almost exactly the same as a direct real estate investment
when all is considered. In a REIT you are a limited partner. The general partner gets paid for actively
managing the properties. In direct investment time (yours) and materials will offset any gains achieved by
not paying for a General Manager. Most who own property directly hire a property manager in any case.

As for the capital appreciation, if REITs were leveraged to the degree of the average direct real estate
investment, they would return as much. Most REITs are a very conservative 50-50 or 60-40 debt to
equity mix today. I would guess most personal real estate investments are 70-30 or 80-20. But with
leverage (return) comes risk. If one really wanted to leverage up a REIT to get the better capital
appreciation, one could buy on margin, and probably pay for the margin interest with the dividends of the
REIT.

Real estate continues to be an important part of a diversified investment portfolio, but is not the great
value that it was last year at this time. With a 33.3% return in 2003 (FRESX), REITs have returned 3
years worth of performance in one. The long term REIT average total return is 12%.

If you can find a way to purchase offshore real estate funds in a depressed market such as Japan, now is
the right time. USA funds are now overvalued. The return on USA real estate will likely be sub-par for
the next couple years.

Hard Assets / Commodities:

This category was not mentioned in previous reports, but is an area of great interest. The base materials
(natural resources) markets have outperformed many equities and all bonds in 2003. Gold, like oil and
other natural resources, has reversed a 25 year downtrend. This is very significant. It was only two years
ago that many central banks decided to liquidate gold reserves, pressuring prices with the anticipation of
increased supplies. Now, gold has gone from 250, to well over 400 in 18 months. What does this mean?
Is it a portent of things to come? Gold has been the “Anti-dollar” since 1971, when the USA (and by
extension, any central bank with currency linked to the dollar) went off the gold standard and onto a paper
based standard (the USD). Gold prices went from $35 in 1971 and eventually to $850 in 1980, during
the height of inflation. Then as now, gold strengthens when the dollar (and other paper currency)
weakens, as gold is the alternate form of world financial exchange.

Gold and other commodity prices are considered by many economists to be predictors of future inflation.
Inflation is created by excess debt leading to declining currency valuation. If government and consumer
debt and money supply is again in excess, than inflation and declining purchase power of the USD is on
the way. The deficit spending of the past 3 years rivals the late 60s, during Johnson’s “Guns and Butter”
program, as a percent of GNP. But the story is really worse this time. Unlike the 60s, when the USA was
still the world’s creditor nation coming out of World War 2, with positive balance of trade, now, the USA
has severely negative balance of trade. Continued build up of national and personal debt is doubly
troublesome. Unlike the 1970s, now have nothing to offset our debt, except more paper.
Potential “Doomsday” scenarios come out of this ominous situation. At best, (as hoped for by me), the
large national debt will result in a price inflation, a stagnant economy, flat stock market, and declining
bond prices (in concert with increasing interest rates). See the 1970s for an example. I believe this is
what the Fed is now trying to engineer: dollar devaluation and price inflation. The dollar devaluation
makes exports more attractive and imports less attractive, helping our trade balance. Price inflation
reduces the impact of long-term debt for both government and consumer (at the expense of the creditors:
mortgage holders in the case of consumer debt and foreigners in the case of government Treasury
bonds).

In the worst case scenario, the dollar’s value will disintegrate taking the USA and many other dollar-
denominated economies with, leading to a global financial crisis and depression that could last for 10 or
more years. From this depression will emerge a new global financial power, China, which would de-link
its currency from the USD, and make the China Yuan as the new global currency standard. As the new
creditor power (replacing the USA role from the 50s and 60s), China will dictate world policy.

The end result of these concerns is the need to own either commodities (in the form of mining, energy or
other natural resource companies), and rare metals (gold, silver, platinum, etc) in certificate or in fact.

Energy stocks are another commodity that would do well in an international financial crisis. Asia (China)
continues to increase consumption of energy products, like oil and coal. Supply is limited and requires
years of effort to expand. Commodities will also do well during a period of global inflation, or deflation, as
during the 30s. Raw material values may not increase in absolute terms during periods of deflation, but
they do not decrease much, either. So, if currencies increase in value, as they do during a period of
deflation, then commodities appreciate in relative terms.

Another way to protect gain protection from possible financial disaster is to purchase a put option or
futures contract on a stock index. Like “BEARX” this strategy provides a “hedge” against unforeseen
negative events, but is much more leveraged, and therefore, can provide more protection with less
investment.

Options and Futures:

A good “hedge” or insurance policy for your portfolio will be “Put Options” in the USA stock market. If you
get a December ‘04 option on S&P500 of ‘700’, for example, the cost is $3.80 (on Dec. 27, 2003). That
$3.80 purchases $1000 of coverage. So, if one has a portfolio of $100,000 to protect, then one must
purchase 100 contracts at $3.80 each, or $380 total cost. This provides one year of coverage against the
worst happening. The $380 should also be deductible on income taxes as an investment expense.
Every dollar less than the “strike price” of ‘700’ for the SP500 index, would result in an additional dollar of
return. Protection begins at 700 and continues thereafter, if held to expiration. Everything above 700 is
said to be “out of the money”, and a potential tax deduction (my research at the IRS.ORG site indicates
that option expenses can be deducted against capital gains, after expiring or selling at a loss). It is
possible to receive a premium on a Put Option if sold at a higher than “strike” price, but if the market
declines prior to expiration. The closer to expiration the contract is sold, the less the contract is worth.

Cash:

Cash continues to be problematic in terms of return, in this interest rate environment. Cash is needed in
every portfolio, to provide investment opportunity, without liquidating current investments, but has been a
poor performer the past two years. The best place to keep cash is in a “Stable Value” fund. This is the
money market-like investment vehicle that is part of most IRA or 401K retirement accounts. This type of
fund investments in a range of short term instruments, including corporates. The diversity of investment
allows a much better return than the standard “money market fund”.

Good and successful investing in 2004.

Brian