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First Quarter 2006

The first quarter of 2006 was characterized by robust growth, healthy consumer spending, and steady inflation. Americans are showing the highest levels of consumer confidence in four years, whereas the U.S. jobless rate remains at four year lows. Concurrently, manufacturing indices are accelerating. The Federal Reserve Board raised rates for the fifteenth consecutive time on March 28th to 4.75%, and new Chairman Ben Bernanke indicated that “further policy firming may be needed.” Despite this, we believe that the Fed is coming to the end of its interest rate hike cycle. In a speech before the Economic Club of New York, Mr. Bernanke argued that long term interest rates have taken a structural step downward, saying that because of “trends in global savings and investment, required policy rates will be lower” going forward.

Global risks remain very real, however, and are increasing. Oil appears to be heading back toward $70 dollars a barrel, as gasoline approaches $3 at the pump. Iran, the number two OPEC producer, is causing deep geopolitical tension with its nuclear ambitions and stated policy of the destruction of Israel. Worldwide oil demand continues unabated while the capability of the oil industry to meet demand is either peaking or in decline. Slightly more than 100 oil fields make up half the world’s oil supply. Among them, 14 fields account for 20% of the world’s oil supply, and many are more than 50 years old. In Saudi Arabia, five oilfields account for nearly 90% of that country’s oil production, which have all peaked back in the 1980’s and are now operating at only 50-60% of their peak production levels. If the Al Qaeda February 22 attack on Saudi Arabia's largest oil complex at Abqaiq had been successful, oil prices could have thrown the world’s economies and stock markets into a spin. U.S. protectionism is growing as globalization is now perceived by the public as more of a threat than an opportunity. Congress thwarted a Chinese acquisition of Unocal last year, while Dubai’s DP World was judged untrustworthy to run any U.S. ports. But protectionism has consequences, and many Arab Central banks are already selling their dollar reserves.

In the final weeks of March, the Chinese Central Bank’s dollar reserves exceeded $1 trillion. Senator Charles Schumer of N.Y. proposed imposing a 27.5% tariff on Chinese imports if Beijing doesn't allow its currency to appreciate in order to reduce the gargantuan U.S trade deficit. Domestically, the $8.3 trillion national debt, rising health care costs, underfunded pensions, no end to the war in Iraq, and the housing market and credit bubbles do not lend to investor confidence. The net result, in our view, is a negative outlook for the dollar, as economic power shifts more toward Asia. This explains why gold has been ascendant of late, along with almost all other metals.

For the first quarter of 2006, the Dow was up 4.0%, the S&P 500 rose 4.16%, and the Nasdaq gained 6.1%.

Grant Rogers Elizabeth Allen

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