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David Rosenberg - 02/10/10

VIEWS: 511 PAGES: 13

									David A. Rosenberg                                              February 10, 2010
Chief Economist & Strategist                                    Economic Commentary
+ 1 416 681 8919


Lunch with Dave
                                                                                                                    IN THIS ISSUE
The intense risk aversion of the past week is fading somewhat with global
equities rallying. Asian equity markets are up for the second day in a row                                          • While you were sleeping —
(+0.3%) and European bourses love the bailout chatter.                                                                the intense risk aversion
                                                                                                                      of the past week is fading;
                                                                                                                      we are 2½ years into the
Bonds are on an even keel despite today’s $25 billion 10-year Treasury note                                           global credit crunch and
offering but this comes after yesterday’s sharp backup in Treasury yields (even                                       investors are still
with a decent 3-year note auction). The German bund market is selling off                                             salivating over bailout
discernibly right now even if U.S. and Japanese yields are tad lower. The U.S.                                        prospects
dollar’s sharp climb seems to have been curbed and as such the commodity                                            • Market commentary — in
complex has a small bid to it at the current time (see more below).                                                   our view, the stresses in
                                                                                                                      the private sector in the
Here we are, 2½ years into the global credit crunch and investors are still                                           U.S., especially the
salivating over bailout prospects — the chatter is that the troubled European                                         mortgage market, are still
                                                                                                                      in place; the good news is
countries, Greece in particular, is on the precipice of receiving such a package,
                                                                                                                      at least the balance sheet
primarily, it seems, in the form of German loan guarantees. So, what we see                                           of large-cap businesses
today is Greek bond yields plunging and German bund yields on the rise. Great                                         are in reasonably good
deal for the German taxpayer, don’t you think? Maybe it should be the                                                 shape
Deutschland that plans an exit strategy (Martin Wolf’s column in today’s FT, and                                    • The call for bonds — the
its dire conclusion, is worth reading — “a currency union whose core country not                                      share of the debt pie 10
only exports deflation but also stands aside as members collapse is in deep                                           years or longer in the U.S.
trouble”). Investors seem to be believe that such a lifeline is being made                                            is at a 30-year low …
available because the cost of insuring Greek bonds against default (CDS                                             • … yet, sentiment on bonds
spreads) have collapsed 36bps, to 343bps (and down 15bps for Portugal, to                                             quite negative — JPM
189bps since one bailout will most certainly beget another — this is a classic                                        survey of fixed-income
example of PIGS (Portugal, Ireland, Greece, and Spain) lining up at the trough).                                      investors showed that
                                                                                                                      27% of the respondents
                                                                                                                      are bearish on bonds
Even so, the draconian budget cuts looming in many European countries is
certainly going to pose a drag on growth forecasts in the continent and globally as                                 • U.S. small business
well; all the more so with China and India swinging from policy stimulus to restraint                                 sentiment still at low
and the Fed planning its own exit plan. Watch Bernanke today — and look at Chart
1 below — the Fed is concerned about being politicized and yet at the same time it                                  • No hiring — the NFIB
is holding $1 trillion of ‘motherhood’ home loans in its balance sheet!                                               survey noted that job
                                                                                                                      openings remain near all-
                                                                                                                      time lows; the JOLTS
Maybe the economists are also going to have to take a knife to the global GDP
                                                                                                                      survey also shows that
forecast in the aftermath of some pretty sad industrial output numbers out of                                         there continues to be no
France (-0.1% MoM in December) and Italy (-0.7% MoM). Moreover, the Bank of                                           hiring in the general
England sliced its projection for U.K. growth (even though its manufacturing data                                     economy
came in above expected) and also stated that the risk is that inflation will                                        • Revisions to the U.S. Q4
UNDERSHOOT its targets (a hint that aggressive monetary policy stimulus                                               real GDP already to the
measures will remain intact for some time). On the trivia front, China officially                                     downside
surpassed Germany as the number one exporter in the world in 2009 — $1.2                                            • New truck index in reverse
trillion to $1.1 trillion.

Please see important disclosures at the end of this document.

Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms. Founded in 1984 and focused primarily on high net
worth private clients, we are dedicated to meeting the needs of our clients by delivering strong, risk-adjusted returns together with the highest
level of personalized client service. For more information or to subscribe to Gluskin Sheff economic reports, visit
February 10, 2010 – LUNCH WITH DAVE

United States: Reserve Bank Credit: Mortgage-Backed Security
(US$ millions)






          JAN     FEB MAR        APR MAY   JUN JUL   AUG   SEP   OCT NOV   DEC   JAN FEB

Source: Haver Analytics, Gluskin Sheff

It now seems obvious given yesterday’s trade that the U.S. dollar had become
extremely overbought, the Euro and equities oversold, and in fact we have seen
data reconstructed showing that developed country sovereign default risks were
                                                                                           While the focus has been
                                                                                           on Greece, and the PIGS in
being priced at premiums not seen in at least 20 years. For long-term
                                                                                           general, let’s not forget
commodity bulls, the fact that so far during this general pullback in risk appetite
                                                                                           that fiscal strains are
the 200-day moving averages in gold, oil and copper have managed to hold is                evident everywhere from
quite a constructive signpost — all the more so since the DXY index did break              the U.K., to Japan, to the
above its 200-day moving average (though it was off 50 ticks yesterday).                   U.S.A.
While the focus has been on Greece in particular, and the PIGS in general, let’s
not forget that fiscal strains are evident everywhere from the U.K., to Japan, to
the U.S.A. (and several states). The U.S. has a record $2½ trillion of new borrowing
requirements this year (nearly 20% of GDP that has to be financed or rolled over).
Fully 75% of U.S. federal debt ($4.7 trillion) comes due in the next five years and that
number is still rising — the average term to maturity is nearly four years.

The stresses in the private sector, especially the U.S. mortgage market, are still
in place. Another wave of foreclosed units will be hitting the market unleashing
a fresh wave of deflation in residential real estate. In fact, what is particularly
ominous is that 1 in 15 of folks out there who are delinquent on their mortgages
are actually current on their credit cards! Remember all those option-adjustable
rate mortgages issued between 2004 and 2007 ($230 billion worth)? Well, they
come due starting now and through 2012 and it will be interesting to see who
bails these folks out as their interest rate gets reset into the stratosphere.

                                                                                                           Page 2 of 13
February 10, 2010 – LUNCH WITH DAVE

The sustained erosion in household credit quality is surely one reason why bank
lending continues to implode — down $28 billion last week and $100 billion in         There remains a glaring
just the past month (in excess of a 12% annualized decline). It’s a good thing        supply-demand imbalance
Uncle Sam has his wallet out because without, the economy would still be              in the U.S. housing market,
contracting according to our models!                                                  which can only mean more
                                                                                      home price deflation
With regard to the U.S. housing market, there remains a glaring supply-demand         ahead
imbalance that can only mean more deflation ahead. There are 231,000 vacant
newly-built housing units for sale. On top of that, we have 3.29 million existing
owner-occupied housing units listed for sale. Then we have 3.5 million empty
housing units for sale that have been taken off the market for unspecified reasons
(this is the fabled shadow inventory via the foreclosure process). Right there we
have over seven million of supply overhanging the residential real estate market,
and there are 112 million homeownership units, so this classifies as a 6.3% total
vacancy rate. At the same time, we have a competing rental vacancy rate of nearly
11% and the homeownership sector is also battling it out against an apartment
market where median asking rents have come down an average of 3.5% over the
past year and the decline is accelerating. Inflation indeed.

On a brighter note, at least balance sheets among large-cap businesses are in
reasonably good shape. Debt-equity ratios in the broad corporate sector have
been coming down and short-term debt has been termed out, so corporate
financing needs will be minimal in both the U.S.A. and Canada in the coming
year, reducing the risk of a blowout in credit spreads. (The U.S. corporate sector
reduced its bank loan and commercial paper exposure by 20% in the past year
while raising 10% more money in the bond market).

The net result is that the ratio of long-term to total credit market debt has risen
around four percentage points in the past year to a record of 72%. Not only that,
but corporations, in the aggregate, have a tremendous amount of cash on hand
and as such their liquid asset/short-term liability ratio has surged over 10
percentage points in the past year to a record of 46%. These balance sheet
fundamentals should help establish a firm ceiling on credit spreads even in the
event of an outright collapse in the economy.

                                                                                                      Page 3 of 13
February 10, 2010 – LUNCH WITH DAVE

United States:
Nonfinancial Corporate Business: Long-Term Debt/Credit Market Debt







            55        60      65         70   75   80   85   90    95   00        05

Source: Haver Analytics, Gluskin Sheff

United States: Nonfinancial Corporate Business:
Liquid Assets as a share of Short-Term Liabilities






                 80              85           90        95        00         05

Source: Haver Analytics, Gluskin Sheff

While Canadian data is harder to come by, as best we can tell, the liquid asset
ratio north of the border has also risen to all-time highs. Canadian nonfinancial
corporations have allowed their short-term debt to run off by more than 3% in
the past year while they tapped the bond market for 9% more funding. Again,
what this does is it helps reduce any problems occurring when it comes time to
refinance … at a minimum it helps buy time (everyone’s most precious
resource). In the past year, Canadian companies have paid down $13 billion of
total short-term debt, raised a net $18 billion in the bond market and an
additional $32 billion in the equity market.

                                                                                       Page 4 of 13
February 10, 2010 – LUNCH WITH DAVE

As an aside, and this supports our cautious strategy, Zillow just updated its          When it comes to long-
database for Q4 and 21.4% of U.S. homeowners with a mortgage are now “upside           duration Treasury
down” (negative net equity — a critical driver of the default rates). More than        securities, they are
1,000 homes were repossessed by lenders in December, a record high. Home               actually less abundant
prices, my friends, have not bottomed, I am afraid to say. And the equity market       than is generally
has peaked, or so it seems. So even after last year’s bout of asset reflation, aided   perceived. This is why the
and abetted by dramatic government and central bank intervention, the reality is       consensus forecast for a
that the U.S. household sector is still beset with a level of net worth that is $12    rise in 10-year yields, to a
trillion lower today than it was two years ago — or the equivalent of $100,000 per     4-5% range, may be so far
worker. The future implications of this on the savings rate, discretionary spending    off base
and credit demands are intensely deflationary and call into question the
consensus view of the sustainable growth needed to bring the U.S. economy back
on the road towards full employment. Unfortunately, there are no more policy
rabbits to be pulled out of the hat.

While we highlighted the future debt rollover burden in the USA, keep in mind
that less than 10% of the outstanding U.S. Treasury debt is in maturities of 10
years and longer — $555 billion of the total outstanding debt held by the public
of $6.2 trillion. The share of the debt pie 10 years and longer is actually at a 30-
year low! So while it is going to be critical that the demand for Treasuries is
strong as the refinancing calendar picks up steam (we think it is important to
note that much of the supply is existing debt to roll over, as well as to cover the
upcoming huge budget deficit) the general public has the capacity to meet the
government’s obligations. After all, the household sector did buy a net $400
billion of Treasury securities in 2009 and that was in a year that saw a huge rally
in equities. Imagine what the demand will be this year if risk aversion comes
back into vogue. Banks, insurance companies and pensions buy Treasury
securities as well.

What Chart 4 below shows is that while the U.S. government has been ramping
up record deficits to cushion the blow from the deleveraging in the private
sector, when it comes to long-duration Treasury securities, they are actually less
abundant than is generally perceived. This is why the consensus forecast for a
rise in 10-year yields, to a 4-5% range, may be so far off base. There is actually
a lack of appreciation for how little there is in terms of outstanding supply
relative to potential demand for what must be characterized as the benchmark
risk-free asset for funding actuarial liabilities.

                                                                                                        Page 5 of 13
February 10, 2010 – LUNCH WITH DAVE

United States: Share of Federal Debt That is 10 Years or Longer







                 80               85     90    95          00         05

Source: Haver Analytics, Gluskin Sheff

Lacking any call risk or credit risk, long term Treasury bonds (and particularly
zeros) are unique in their ability to deliver a specific cash flow exceeding the
current rate of inflation for a Baby Boomer’s pension benefit in 2040. Inevitably,
future rates of inflation will prove to be the key determinant of future levels of
long-term bond rates. It is reasonable to expect that the inflation rate will be
down for at least the next year or two, and given the demographic profile and the
magnitude of unfunded pension liabilities in the U.S. (and internationally) it is
very easy to underestimate the potential demand. So, focusing solely on supply
is akin to trying to call the winner of the Super Bowl based solely on a strong
conviction that the Colts will score 17 points.

It’s rather amazing that the asset class that delivered the greatest returns in the
past decade is the one that is most detested. We just saw the JP Morgan survey
of fixed-income investors. As of February 8th, a mere 10% were bullish — down
from 16% a month ago — and 27% are bearish (63% are neutral). A month ago,
22% were bearish on bonds. But here we are, past the peak rate of growth for
the cycle, the ISM already near the 60 level and policy reflation behind us, and
there are nearly three times as many bond bears as there are bulls. The primary
trend is not to return to the 2002-07 parabolic asset and credit cycle, nor is it
the brief interruption from last year’s unprecedented policy reflation — the
primary trend is one of deflation, in wages, credit, rents and cyclically-sensitive
goods and services.

                                                                                      Page 6 of 13
February 10, 2010 – LUNCH WITH DAVE

The National Federation of Independent Business (NFIB) small business
                                                                                      In spite of the
optimism index rose 1.3 points to 89.3 in January — highest since September
                                                                                      improvements in the
2008; however, a real disappointment considering that we should have seen a
                                                                                      economy in the second
much more vigorous response in the aftermath of the Scott Brown victory since
                                                                                      half of 2009, small
at least health care cost concerns should have been alleviated. Moreover, to          business optimism in the
put this level in perspective, this reading is still below the average level we see   U.S. remain low
during recession when we typically see a reading of 92.0. We are even further
away from the levels we see typically during an expansion — on average the NFIB
index is at 100.2 during economic expansions. So, we shall just have to call this
apparent end to the recession as somewhat as an imposter. Indeed, this 89.3
reading is only 8.3 points away from the low we saw back in March 2009. Take
a read the NFIB’s press release and one will see how cautious small businesses
still are. To wit: “Optimism has clearly stalled in spite of the improvements in
the economy in the second half of 2009. Small business owners entered 2010
the same way they left 2009 – depressed.”

United States: NFIB: Small Business Optimism Index
(1986 = 100)







                  90                     95         00        05

Shaded region represent periods of U.S. recession
Source: Haver Analytics, Gluskin Sheff

There continues to be no improvement in the labour picture for small firms. On
net, -1% of small business owners are planning to increase employment, which
is an improvement from the -2% reading in December and the -10% reading
back in March 2009, but this still indicates that firms are planning to cut jobs,
not hire. The percentage of firms with one or more job openings was unchanged
at 10%, still near the all-time low of 8%.

                                                                                                     Page 7 of 13
February 10, 2010 – LUNCH WITH DAVE

United States: NFIB: Percent of Firms with One or More Jobs Open






                90                      95                      00                      05

Shaded region represent periods of U.S. recession
Source: Haver Analytics, Gluskin Sheff

The number of firms planning capital expenditures in the next 3 to 6 months
rose to 20 from 18 in December. However, overall, small firms are hesitant in
undergoing any new capital spending until they see a dramatic improvement in
the business outlook (“now is a good time to expand the business” metric fell to
5% from 7% in December and is now down 3 out of the last 4 months) and
“some support from reluctant customers.”

Inflation continues to be non-existent in the small business sphere. According to
the press release, 27% of the respondents reported average price reductions
and only 11% reported raising average selling prices. And while the net
percentage of firms planning to raise average selling prices rose to +8% in
January from +3% in December, this reading remains low by historical standard
— the average is 23 (data back to 1973).

United States: NFIB: Single Most Important Problem: Inflation





                90                      95                      00                     05

Shaded region represent periods of U.S. recession. Source: Haver Analytics, Gluskin Sheff

                                                                                             Page 8 of 13
February 10, 2010 – LUNCH WITH DAVE

There is also no wage pressure in small businesses. Indeed, when asked about               Looking at the JOLTS
the cost of labour, only 4% of the respondent said that it was a problem. The net          report, there are half as
percentage of firms raising workers comp fell to 1% from 3% in December and                many job openings today
those planning to raise wages remained stuck at 1%.                                        as there were at the end of
                                                                                           the last business cycle in
Despite the policies that President Obama has implemented for small                        late 2007, yet the number
businesses, credit was still relatively hard to come by for these firms. The net           of unemployed in the U.S.
percentage reporting that credit was hard remains at a near-cycle high of 14%.             has doubled to 15 million
Moreover, the majority of small firms are still not convinced that credit                  from 7 million
conditions will ease: this metric did rise 2 points to -13 in January, but this is still
very close to the cycle low of -16.

As for the single most important problem facing small businesses, poor sales
remain the number one concern, followed by government requirements and

We saw another sentiment reading come out yesterday — this one was for
February — in the form of the IBD/TIPP economic optimism index. This index
tends to track the University of Michigan consumer sentiment index reasonably
well. In February, the IBD/TIPP index reversed course, to 46.8 from 48.8 in
January, and is now well off the nearby post-green shoot high of 52.5 posted in
September. It’s all the way back to where it was in July. And, the ABC
News/Washington Post consumer comfort index remained in depression terrain
in the February 8th week, at -48 (-49 on January 31st) and the ‘state of the
economy’ subindex slipped to -84 from -82.

The NFIB survey was notable for the continued recession level of +10 on the job
opening index — one-third the level we saw at the peak of the last bull market.
The Job Openings and Labor Turnover Survey (JOLTS) was released and it
revealed a 52k decline in new hires in January, the second decline in the past
three months. And, there are half as many job openings today as there were at
the end of the last business cycle in late 2007 and yet the ranks of the
unemployed have doubled (up 7 million) to 15 million. We wonder how you can
possibly build an inflation view out of that unless you reside in the old paradigm
of a secular credit expansion.

                                                                                                           Page 9 of 13
February 10, 2010 – LUNCH WITH DAVE

United States: JOLTS: Total Private: Job Openings







            02           03              04   05   06   07       08        09

Source: Haver Analytics, Gluskin Sheff

The U.S. wholesale trade report was soft with inventories posting a 0.8%
December drop, which followed a 1.6% increase in November. Together with the
0.1% drop in December factory inventories, we could well see that 5.7% initial
GDP headline print trimmed to 5.5% — but there is much more information still
to come. As we have said, that 5.7% estimate for Q4 is ripe for revision just as
the 3.5% initial take in Q3 was taken down 2.2%.

A new economic barometer called the Ceridian-UCLA Pulse of Commerce index
(now how’s that for a tongue-twister?) which closely tracks U.S. trucking activity
(by analyzing real-time diesel consumption of trucks) is now showing that the
economy hit stall-speed in January despite the spurious strength seen in the ISM
index. (The three-month average of this index throttled back to a 3.3% annual
rate after a brief spurt to double-digit terrain in November and December.)
Edward Leamer, Chief Economist for the PCI and Director of the Anderson
Business Forecast stated that “Inter-state freeways that crisscross the country
are the arteries of the U.S. economy and goods that are transported on them
are the lifeblood.”

Not only do we have a new economic indicator to chew on but we have a new
market barometer to gauge as well. The ever-reliable ‘The Short View’ column in
the FT (page 15) runs with a new metric to look at — the copper/gold ratio. The
copper price reflects global economic activity and gold reflects financial stability.
Indeed, we checked it out and the ratio does have a 95% correlation with
movements in the stock market.

                                                                                        Page 10 of 13
February 10, 2010 – LUNCH WITH DAVE

United States

 1600                                                                                                      0.60
                                                                              correlation: r = 0.95
                                                S&P 500 Index
 1500                                                                                                      0.55
                                                (left hand side scale)

 1400                                                                                                      0.50

 1300                                                                                                      0.45

 1200                                                                                                      0.40

 1100                                                                                                      0.35
                               Copper Price relative to Gold Price
 1000                            (ratio: right hand side scale)                                            0.30

  900                                                                                                      0.25

  800                                                                                                      0.20

  700                                                                                                      0.15

  600                                                                                                      0.10
        07                                 08                            09                           10

Source: Haver Analytics, Gluskin Sheff

                                                                                                                  Page 11 of 13
February 10, 2010 – LUNCH WITH DAVE

Gluskin Sheff at a Glance
Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms.
Founded in 1984 and focused primarily on high net worth private clients, we are dedicated to the
prudent stewardship of our clients’ wealth through the delivery of strong, risk-adjusted
investment returns together with the highest level of personalized client service.

OVERVIEW                                                         INVESTMENT STRATEGY & TEAM
As of December 31, 2009, the Firm           We have strong and stable portfolio
managed assets of $5.3 billion.             management, research and client service
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Gluskin Sheff became a publicly traded
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corporation on the Toronto Stock
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remains 65% owned by its senior                                                                                                                 our clients, as Gluskin
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management and employees. We have                                                                                                               Sheff’s management and
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client of the Firm’s investment portfolios. shareholder-minded management and a
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                                            share price below our estimate of intrinsic
We offer a diverse platform of investment                                                                                                       in 1991 (its inception
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strategies (Canadian and U.S. equities,                                                                                                         date) would have grown to
                                            equities that we sell short.
Alternative and Fixed Income) and                                                                                                               $10.7 million2 on
investment styles (Value, Growth and        For corporate bonds, we look for issuers
          1                                                                                                                                     December 31, 2009
Income).                                    with a margin of safety for the payment
                                                                                                                                                versus $5.5 million for the
                                            of interest and principal, and yields which
The minimum investment required to                                                                                                              S&P/TSX Total Return
                                            are attractive relative to the assessed
establish a client relationship with the                                                                                                        Index over the same
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Firm is $3 million for Canadian investors                                                                                                       period.
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investors.                                  our top ten holdings typically represent
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PERFORMANCE                                 way, clients benefit from the ideas in
$1 million invested in our Canadian Value which we have the highest conviction.
Portfolio in 1991 (its inception date)
                                            Our success has often been linked to our
would have grown to $10.7 million on

                                            long history of investing in under-
December 31, 2009 versus $5.5 million for
                                            followed and under-appreciated small
the S&P/TSX Total Return Index over
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the same period.
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particular needs of any specific person. Investors should seek financial          particular circumstances from an independent tax professional.
advice regarding the appropriateness of investing in financial instruments
and implementing investment strategies discussed or recommended in this           The information herein (other than disclosure information relating to Gluskin
report and should understand that statements regarding future prospects           Sheff and its affiliates) was obtained from various sources and Gluskin
may not be realized. Any decision to purchase or subscribe for securities in      Sheff does not guarantee its accuracy. This report may contain links to
any offering must be based solely on existing public information on such          third-party websites. Gluskin Sheff is not responsible for the content of any
security or the information in the prospectus or other offering document          third-party website or any linked content contained in a third-party website.
issued in connection with such offering, and not on this report.                  Content contained on such third-party websites is not part of this report and
                                                                                  is not incorporated by reference into this report. The inclusion of a link in
Securities and other financial instruments discussed in this report, or           this report does not imply any endorsement by or any affiliation with Gluskin
recommended by Gluskin Sheff, are not insured by the Federal Deposit              Sheff.
Insurance Corporation and are not deposits or other obligations of any
insured depository institution. Investments in general and, derivatives, in       All opinions, projections and estimates constitute the judgment of the
particular, involve numerous risks, including, among others, market risk,         author as of the date of the report and are subject to change without notice.
counterparty default risk and liquidity risk. No security, financial instrument   Prices also are subject to change without notice. Gluskin Sheff is under no
or derivative is suitable for all investors. In some cases, securities and        obligation to update this report and readers should therefore assume that
other financial instruments may be difficult to value or sell and reliable        Gluskin Sheff will not update any fact, circumstance or opinion contained in
information about the value or risks related to the security or financial         this report.
instrument may be difficult to obtain. Investors should note that income
                                                                                  Neither Gluskin Sheff nor any director, officer or employee of Gluskin Sheff
from such securities and other financial instruments, if any, may fluctuate
                                                                                  accepts any liability whatsoever for any direct, indirect or consequential
and that price or value of such securities and instruments may rise or fall
                                                                                  damages or losses arising from any use of this report or its contents.

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