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WERE ANY VIGILANT OBSERVERS SURPRISED? WE HAVE BEEN PREDICTING THAT DERIVATIVES WERE A POTENTIAL MESS FOR MANY YEARS.

Surprise, the hedges that some failed speculators in the bond market have put on, failed to act in the way that they were mathematically supposed to act. This is according to Sowood, the failed Boston based, bond speculating hedge fund.

For years, we have been telling people in public and in private that those who write the derivatives, including bond hedges use mathematical models which do not understand the psychology and periods of illiquidity that exist in the investment markets.

The mathematicians make assumptions which experienced market professionals know are not always correct in times of crisis. Currently, the models have failed to identify that there may be long periods where no one will bid for your assets at a reasonable/rational price. Yet your creditors may withdraw your line of credit and demand immediate payment of your debts. How do you pay them if even your conservative assets can not be sold at a reasonable price? Many of the mathematical models have been poor at factoring in fear and greed.

We hear over and over in past days that there is a buyer’s strike for mortgage bonds, and that the only buyers are offering ridiculously low bids. All we can say is, welcome to the world of panicky markets where the only buyers are opportunists who know that they have you over a barrel and who plan to buy only if they can get a very, very good deal.

Mathematical models generally don't understand the consequences of being unable to hold onto positions until rationality reestablishes itself. In essence, up to this point, mathematical models have demonstrated severe limitations in real world situations. The problem is that many mathematicians are not familiar with the real world of trading, and traders are generally not sophisticated mathematicians. However, anyone who has worked with derivatives and who simultaneously understands how markets work knows that it is true.

HOW WE ARE PROTECTING OUR CLIENTS

The majority of our client assets are currently held in cash. The cash is held in government instruments: U.S., British, Canadian, and Australian short term government bonds. Our clients’ investments are in oil related, base metals and precious metals and a few foreign stocks in countries with very fast growth.

We have our own money invested along with yours. We have decades of experience, we have been through many crises like this one over the past 40 years, and we have a long track record of avoiding or minimizing major world market declines in our client portfolios.

Currently, we are enjoying good returns this year, and are working hard to protect the profits that the portfolios have earned.

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