If this scenario continues…

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Over the past quarter, the TSE 300 total return index was up 8.06%. TSE leading sectors were Oil and Gas, Real Estate and Consumers Products. The lagging sectors were Utilities, Mines and Minerals, and Paper and Forest Products. The Standard and Poor’s 500 index was down 3.48%. The EAFE (Europe, Australia and Far East) total return was down 3.9% in US dollars.

Interest rates across the developed countries remain unchanged, fluctuating by approximately 0.10%. Again, Mr. Greenspan has spoken several times about the strength of the US economy, the threat of inflation re-igniting, and the possibility of higher rates if this scenario continues. Therefore, real interest rates stay at an abnormally high level. As far as we are concerned, we would rather not “fight the Fed” and choose a neutral stance for the time being.

The Canadian Dollar slipped some more to stand at US$ 0.6756 at the end of the second quarter. The Euro also ended slightly lower, at US$ 0.9502. Basically, the capital markets believe that the US is the place to be, thanks to a strong economy supporting a strong currency.

Oil prices, having reached US$ 31.00 during the quarter, have settled down around US$ 28.00. Saudi Arabia has decided to increase its production in order to maintain oil prices around US$ 25.00. We have come across an interesting observation by “The Gartman Letter” that we would like to share with you:

 

“ Last year, the Saudi budget was in deficit of nearly US$ 7.47 billion. This year, with oil revenues ramped up rather materially, the Saudi government is likely to enjoy a budget surplus of perhaps as much as US$ 4.0 billion, a net change of US$ 11.47 billion.

 

If government spending is held steady, the Saudis will enjoy another budget surplus next year which it shall have to invest somewhere. The question is whether it shall be invested in US or European debt markets (the easy bet is the US; the more interesting one is Europe).”

Please refer to the portfolio valuation in the next section of this report for a complete list of securities you own. You will find a transaction report that includes comments and descriptions of selected securities that have been purchased and sold.

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Now that reality has set in upon the Internet landscape, we thought this might be an opportunity to review the lasting effects brought to the world of business by the Web.

The Internet is essentially a communication tool that has changed the way companies are doing business over the last 2 years. It has allowed them to harvest the benefits of technology like never before:

Simplistically, an operating company has to deal with 3 sides of its business: the buy side, where it interacts with its suppliers; the sell side, where it interacts with its customers and the make side, where it interacts within its own operations. Through the Internet, companies discover huge opportunities in productivity improvement and cost reduction which ultimately flow either to the bottom line, or to the consumers in the form of better products and a higher standard of living.

Companies such as Ford have embraced the Internet with strategies directed toward all three sides of its business. Specifically on the buy side, under its electronic data interchange, it already communicates well with its Tier 1 suppliers. It now is in the process of integrating its Tier 2 suppliers (the companies that provide parts to the Tier 1 group) into the information loop. With an Internet-based supply chain, all suppliers in the loop will see the changes in Ford’s orders on a real time basis and can prepare their inventory and manufacturing lines accordingly.

Ford’s orders will also be accessible to anyone, anywhere in the world, who thinks he can handle the order. That in itself offers the possibility of substantial cost savings.

But the savings are also about transaction costs. Currently, Ford makes in excess of one million purchases (transactions) per year. Management believes that through the Internet-based supply chain, a real time order would cost an estimated $15.00 instead of the current $150.00, a 90% saving per purchase.

General Electric has developed its own three-pronged Internet strategy: on the buy side, it now uses reverse auctions through the Web where pre-qualified suppliers bid for GE business.

It buys many of its $15 billion worth of maintenance, repair and operations supplies online. With 4 million transactions per year, costs would drop from $50 to $100 each to as low as $5 per transaction if they all went through the Web, according to management.

GE is also in the process of automating much of the selling. It estimates that each customer phone call to a service center costs about $5 versus only 20 cents if the same information was to be disseminated over the Web. The appliance division alone takes in 20 million calls a year between orders and customer service.

Over the last 2 years, we have witnessed a mania for high tech Nasdaq stocks, reminiscent of other manias in the 60’s (the conglomerates mania) and the 80’s (the leverage buyout mania). As was the case with prior ones, this unbridled enthusiasm will also come to pass. However, the Internet is here to stay and it is forcing major changes in prevailing business models. As we have mentioned above, the winners from Business to Business (B2B) on the Internet will not necessarily be the New Economy companies. They are more likely to be the well-established companies that learn how to play the network. We will bet that the Wal-Mart, Home Depot, book publishers, or auto dealers will use the “Net” to expand upon and sell more of their already established product lines. After all, the Internet is just another communication and distribution tool that will enable the smartest companies to become better and stronger, which is the essence of capitalism. Technology, utilized to sell prosaic products, seems more useful than technology for technology’s sake.

A sharp correction in the prices of some egregiously overvalued Nasdaq stocks – were it to occur – would not necessarily indicate the end of the current bull market. The fundamentals for equity investing remain solid – federal budget surplus, low inflation, reduced capital gains tax, consistent profit growth and demographic shift into equity investing. After all, such correction would not end the information revolution.

The proliferation of the Internet has also accelerated the research and development in the telecommunications industry. The latter has brought us fiber optics, high speed Internet access, digital subscriber line and cable modem etc. It has in turn brought the cost of long distance phone calls to close to zero (it will reach zero in the foreseeable future). Pretty soon, we would be able to efficiently surf the net through our cellular phone. As the cost of accessing the Net comes down, software developers will come up with ingenious applications to fill needs that we do not yet know we have, just like when the cellular phone was invented.

For the time being, we know that the underpinnings of our economies may change fantastically in the next eight or nine years. Grady Means and David Schneider, in their new book entitled Metacapitalism, claim: “We are on the verge of unleashing undreamed of possibilities and solutions to problems that have plagued the human race ever since we came down from the trees…. The period 2000-2002 will represent the single greatest change in worldwide economic and business conditions ever, and much of the impact will occur in the next couple of years”.

As for us, our job is to identify the companies which, at the end of the day, manage to harvest the benefits of the Internet and the information revolution that ensues and to increase the wealth of their shareholders. And we are working hard at uncovering these types of enterprises.