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The 2010 Euro Outlook January, 2010 Kathleen Stephansen Chief Economist

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1


Euro/USD: where to? Euro Reference Exchange Rate: US Dollar EOP, USD/EUR

1.6

1.6

1.5

1.5

1.4

1.4

1.3

1.3

1.2

1.2

1.1

1.1 06 07 Source: European Central Bank /Haver Analytics

08

09

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The Euro Outlook • The crisis underscored the non-sustainability of global imbalances. • Any adjustment should lead to an intensification of capital flows directed to emerging economies and to reserve diversification. • We believe the dollar is on a longer-term downward trend and the euro should benefit partially from this adjustment. • Near-term, the tension between positive and negative factors will keep the Euro-USD in a relatively tight range. We project it to end the year close to 1.50. • Historical perspective: The Euro has been a success. The challenge ahead is to restore growth without the benefit of the demand impulse from the peripheral countries.

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Much hinges on the CNY/USD. The end of the 2005 peg has benefited the euro and is the manifestation of a currency redistribution away from the dollar. Foreign Exchange Rate: European Monetary Union US$/Euro

Foreign Exchange Rate: People's Republic of China Yuan/US$

1.6

8.4

EUR-USD (LHS) USD-CNY (RHS)

1.5 8.0 1.4 7.6 1.3 7.2 1.2

1.1

6.8 04 05 06 07 Sources: Federal Reserve Board /Haver Analytics

08

09

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China’s contribution to global growth has risen steadily this past decade Chinese and US contribution to global growth in ppt (PPP weights) US Contribution

China Contribution

2

1.5

1

0.5

20 10 e

20 08 20 09 e

20 07

20 06

20 05

20 03 20 04

20 02

20 01

20 00

19 99

19 98

19 97

19 96

0

-0.5

-1

Sources: IMF/Haver Analytics

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‌ Reflecting the strength in exports but also in infrastructure build Sector contribution to real GDP growth Consumption

Fixed Investment

Net exports

14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 -2.0

Sources: China National Bureau of Statistics/Haver Analytics

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Structural changes Structural changes bring tensions in currencies that reflects shifts in financing and capital flows. The near-term adjustments to credit restraint, de-leveraging and restructuring of debt, private demand in the G-2 (US & UK) could be a restraining factor to the positive multiplier effects of recovering trade flows, a negative for the euro. The longer-run de-emphasis of the US consumer implies a narrowing of the US current account deficit, a factor that should slow the pace of USD decline. The burden shifts to China to redirect its drivers of growth away from exports to domestic demand. This process has started already but will gain traction in years to come. This reduces the demand for dollars and benefits the EM space and currency diversification away from the dollar, a positive for currencies such as the euro.

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US: Consumer-led growth is set to change Sector contribution to real GDP growth

Consumption

Fixed Investment

Net Exports

6.00 5.00 4.00 3.00 2.00 1.00 0.00 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 -1.00 -2.00

Sources: BEA/Haver Analytics

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Marked decline in the share of industrial countries’ consumption to global consumption Shares of Regional Consumption to World Consumption NJA

LATAM

Industrials (rhs)

12%

84%

11% 82% 10% 80% 9% 8%

78%

7% 76% 6% 74% 5%

Sources: 4% Bureau of Economic Analysis/Haver Analytics 93

94

95

96

97

98

99

00

01

72% 02

03

04

05

06

07

08

Sources: DataStream International; IMF; OECD

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China’s current account surplus should decline, implying less aggressive purchases of US Treasuries, and a slowdown in demand for dollars China: BOP: Current Account Balance as a Percentage of GDP %

12

12

10

10

8

8

6

6

4

4

2

2

0

99 00 01 02 03 04 05 06 Source: State Administration of Foreign Exchange/Haver Analytics

07

08

0

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The expansion of Chinese domestic demand benefits NJA-ex China. NJA export share to China tripled over the period 19982009, jumping to 15.4% in 2009 from 4.8% in 1998 NJA Exports to ROW ($mln, LHS)

NJA Exports to China ($Mln, LHS)

Share of Exports to China (%, RHS)

15.0

1,415,000 1,215,000

13.0

1,015,000

11.0

815,000

9.0

615,000 7.0

415,000

5.0

215,000 15,000

3.0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Note: 2009 statistics cover the first 10 months of the year Sources: Datastream

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A shift in trade flows should lead to FX reserve diversification. To date, upward pressures on Asian currencies against the USD implies intervention, thereby limiting the decline of the USD.

1500 1400

52

India Rupee-USD (RHS) Thai Baht-USD (RHS) Korea Won-USD (LHS)

48

1300

44

1200

40

1100

36

1000

32

900

06 07 Sources: BOK, BoT, RBI /Haver

08

09

28

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Near-term positive Euro factors

• Global FX diversification away from the USD; • Global liquidity; • Return to risk appetite; • The timing of the ECB monetary policy exit.

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EM countries, whose currencies are under upward pressure, incur FX reserves accumulation that is set to continue Intl Liquidity: EM Foreign Exchange (NSA, EOP, Tril.US$) 4.000 3.500 3.000 2.500 2.000 1.500 1.000 0.500

Ja n00 Ju l-0 Ja 0 n0 Ju 1 l-0 Ja 1 n02 Ju l-0 Ja 2 n03 Ju l-0 Ja 3 n04 Ju l-0 Ja 4 n05 Ju l-0 Ja 5 n0 Ju 6 l-0 Ja 6 n07 Ju l-0 Ja 7 n08 Ju l-0 Ja 8 n09 Ju l-0 9

0.000

Sources: Bloomberg Financial Markets/Haver Analytics/

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‌ which is linked to the rise in global liquidity and risk appetite Quantitative Liquidity Measures (percent of G3 GDP) Base Money Plus Reserves

Reserves

Base Money

12 10 8 6 4 2 0 2000Q1 2001Q1 2002Q1 2003Q1 2004Q1 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1 -2

Sources: IMF/ Eurostat/Haver Analytics

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Synchronized growth brings a return to risk appetite VIX and PMIs Global PMI (LHS)

VIX (Inv. Scale- RHS)

60.00

10.00 9.00

55.00 8.00 50.00

7.00 6.00

45.00 5.00 40.00

4.00 3.00

35.00 2.00 30.00 Jan-06 May-06Sep-06 Jan-07 May-07Sep-07 Jan-08 May-08Sep-08 Jan-09 May-09Sep-09

1.00

Source: WSJ; Markit/Haver Analytics

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‌ A positive for the Euro US$/EUR

VIX (Inv. Scale RHS)

1.5800

10.00 9.00

1.5300 8.00 1.4800 1.4300 1.3800 1.3300

7.00 6.00 5.00 4.00 3.00

1.2300

2.00

1.1800

1.00

Ja n: 20 06 M ay :2 00 6 S ep :2 00 6 Ja n: 20 07 M ay :2 00 7 S ep :2 00 7 Ja n: 20 08 M ay :2 00 8 S ep :2 00 8 Ja n: 20 09 M ay :2 00 9 S ep :2 00 9

1.2800

Source: WSJ; Markit/Haver Analytics

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Foreign appetite for US assets has slowed movv12m<LT001GN> Net foreign purchases of US assets, 12-month moving average, $ Mil. movv12m<LT001KN> movv12m<LT001MN> movv12m<LT001PN> 100000 80000

100000

Net Foreign Purchase of US Fedral Agencies Net foreign Purchase of US Stocks Net Foreign Purchase of US Treasurys Total

80000

60000

60000

40000

40000

20000

20000

0

0

-20000

-20000 99 00 01 02 03 04 05 06 Sources: TREASURY, TREASURY, TREASURY, TREAS /Haver

07

08

09

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European appetite for US assets has slowed the most Net European (including the UK) purchases of US assets, 12-month moving average, $ Mil.

Europe: Net Fgn Transactions of Long-Term Securities 12-month MovingAverage

Mil.$

45000

45000

37500

37500

30000

30000

22500

22500

15000

15000

7500

7500 00 01 02 03 04 05 Source: Department of Treasury /Haver Analytics

06

07

08

09

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Will the ECB exit QE ahead of the Fed? We believe so, and it should lead to a gradual widening pressure on Europe-US yield spreads UK Japan US Euro

BOE

6

6

5

5

4

4

3

3

2

2

1

1

0

0 07 08 Sources: BoE, BoJ, FRB, ECB /Haver

09

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Near-term negative Euro Factors

• Euro area growth differentials with the US; • Euro area needs rebalancing of growth; • Perceived Sovereign Risk fears.

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Growth differentials between the US and the Euro area favor the USD, replacing the risk aversion/USD relationship US Real Gross Domestic Product (SAAR, Bil.Chn.2005$) % Change Annual Rate

Euro area Real Gross Domestic Product (Mil.Chn.00.Euros) % Change Y/Y

7.00%

4

6.00% 5.00%

3

4.00%

2

3.00%

1

2.00%

0 1.00%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 -1

0.00% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 -1.00%

-2

-2.00%

-3

-3.00%

-4

Note: Aladdin projections in Red Sources: Bureau of Economic Analysis/Statistical Office of the European Communities/Haver Analytics

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Collapse in growth in smaller countries GDP year-on-year % change

6

Euro Area Portugal Spain

4

6

12

Euro Area Greece Ireland

4 8

2

2

0

0

-2

-2

-4 -6

01

12

8

4

4

0

0

-4

-4

-4

-6 02 03 04 05 06 07 08 09 10 11 Sources: Statistical Office of the European Communities /Haver Analytics

-8

01

-8 02 03 04 05 06 07 08 09 10 11 Sources: Statistical Office of the European Communities /Haver Analytics

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Loss of competitivenessâ&#x20AC;Ś Business Sector: Unit Labor Cost

% Change - Year to Year

SA, 1992=100

EA 16: Unit Labor Costs

% Change - Year to Year 6

SA, 2000=100 6

US Euro Area

4

4

2

2

0

0

-2

-2

-4

99 00 01 02 Sources: BLS, ECB /Haver

03

04

05

06

07

08

09

-4

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…And deterioration in the Euro area fiscal outlook… Euro area General Government Balance-to-GDP 2008

2009 (est.)

2010 (f)

5

0 BE

DE

IE

GR

ES

FR

IT

CY

LU

MT

NL

AT

PT

SI

SK

FI

-5

-10

-15

Sources: OECD/Haver Analytics

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â&#x20AC;Ś Have led to sovereign fears, a negative for the Euro Greece: 10-Year Government Bond Yield %

Germany: 10-Year Government Bond Yield %

6.00

6.00

Greece Germany

5.25

5.25

4.50

4.50

3.75

3.75

3.00

3.00

2.25

2.25 02 03 04 05 Sources: Financial Times /Haver Analytics

06

07

08

09

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The fiscal situation has deteriorated in the US as well, dampening the negative effect on the Euro/USD Budget deficits (-)/surpluses (+) by fiscal year (as a percentage of gross domestic product)

2.0

20 10 (f)

20 08

20 06

20 04

20 02

20 00

19 98

19 96

19 94

-2.0

19 92

19 90

0.0

-4.0 -6.0 -8.0 -10.0 -12.0 Source: Congressional Budget Office

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â&#x20AC;Ś With the accumulation of debt at both the Federal Federal Government: Liabilities: Credit Market Instruments SA, Bil$

8000

8000

7000

7000

6000

6000

5000

5000

4000

4000

3000

03 04 05 06 Source: Federal Reserve Board /Haver Analytics

07

08

09

3000

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â&#x20AC;Ś And State and Local Government Levels State & Local Govt: Liabilities: Credit Market Instruments SA, Bil$

2400

2400

2200

2200

2000

2000

1800

1800

1600

1600

1400

03 04 05 06 Source: Federal Reserve Board /Haver Analytics

07

08

09

1400

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Historical Perspective

â&#x20AC;˘ The success story

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Euro declines rapidly against the USD, then rebounds strongly USD/EUR 1.6 From 1999-2002 the Euro was trading in electronic markets and the FX market

1.5 1.4 1.3 1.2

Jan-09

Jan-08

Jan-07

Jan-06

Jan-05

Jan-03

Jan-02

Jan-01

Jan-00

Jan-99

After 2002 the Euro was fully deployed and national currencies were withdrawn from circulation

Jan-98

Jan-97

Jan-96

Jan-95

Jan-94

0.8

Jan-91

0.9

Jan-93

1

Jan-92

The European Currency Unit (ECU), a theoretical "basket" currency, is used as a proxy for the Euro when calculating the USD/EUR exchange rate, pre-1999

Jan-04

1.1

Sources: Bloomberg/Cumberland Advisors

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The Euroâ&#x20AC;&#x2122;s success measured by its rapid expansion: After ten years, 11 became 16

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International debt issued in Euros and USD is roughly equal Amounts outstanding of international bonds and notes, by type, sector and currency (in billions of US dollars) 14000 Euro

12000

US dollar

USD billions

10000 8000 6000 4000 2000 0 1993

1995

1997

1999

2001

2003

2005

2007

Sources: BIS Quarterly Review: 'June 2009

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Global cash outstanding in Euros Is Greater than in USD 1090 990 Euro Circulation in USD 890

USD Circulation

US Dollar

790 690 590 490 390 290 190 Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Note: Euro area (changing composition) - Net Circulation - number of banknotes/coins in circulation (for banknotes it has to be calculated, and equals created notes less destroyed notes less stocks of the NCB) - Banknotes - All denominations - 1st design - Stock - denominated in Euro. Sources: Federal Reserve Bank of St. Louis, European Central Bank, and Cumberland Advisors

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Aladdin Capital Management (ACM) is dedicated to providing all the information you need to make a truly informed decision about engaging us for our services. This presentation book is for sophisticated, accredited investors only - and you have it because we believe you meet those criteria. While it is our goal to help you achieve your investment objectives, it is important that you understand that, unless otherwise indicated, the Funds and products discussed in this book are only for investors with the ability to absorb substantial risk of loss of all of the money invested. Although the firm will manage accounts for clients whose primary objective is the preservation of principal, unless otherwise indicated herein you should consider the Funds and the products and/or services discussed in this book to be speculative investments, involving a higher degree of risk than many other investments. The performance of the Funds or portfolios discussed herein can be volatile, and the use of leverage magnifies the intrinsic volatility of the trading strategies they employ. A Fund’s or portfolio’s manager may have total trading authority over that Fund or portfolio. Use of a single investment adviser applying generally similar trading programs results in a lack of diversification and potentially higher risk. We want to be clear that, unless otherwise indicated, there is no secondary market for shares or units of the Funds we discuss in this book, and none is expected to develop. Therefore, an investment in the Funds should be considered illiquid. The Funds’ performance-based fees are significantly higher than, for example, mutual funds registered under the Investment Company Act of 1940. The Funds are not registered under that Act. These fees (and expenses) will reduce the total return earned for the investor. The Funds or portfolios are compared herein with indexes published in financial journals and dailies, or otherwise generally accessible or widely reported via other means of publication. In some instances the referenced index may be based upon securities that are dissimilar in type and volatility to the securities in which the Funds or portfolios discussed herein invest. In such case, the performance comparison is for illustrative purposes and is being used solely to contrast the Fund or portfolio with other investment options which are or comprise dissimilar classes of securities. For credit funds and portfolios, such as those discussed herein, the most relevant indices are credit indices the reference securities of which are most similar to those selected by ACM for the Funds or portfolios it manages. Any gross actual performance of any Fund or portfolio disclosed herein will be accompanied by net actual performance (net of management fees and expenses) for a complete representation of performance during the relevant period(s). If the net actual performance of any Fund or portfolio has, for some reason, been omitted you should obtain this information by calling ACM at the number indicated herein and the information will be sent to you promptly. Targeted returns/performance as may be discussed herein represent the considered expectation of ACM after review of various quantitative models which assume certain market conditions and which are believed to be reasonable. Any projected returns represent annualized returns after consideration of net actual returns for the period. In both aforementioned cases, nothing herein should be construed to mean that such returns will be achieved, and the present or past performance of any Fund or portfolio does not guarantee future results. Assets under management herein are the aggregated leveraged and un-leveraged assets under management of ACM. Offering of the Funds’ shares or units is made by Aladdin Capital LLC (member FINRA/SIPC), unless otherwise indicated, pursuant to written private placement memoranda published by the Funds, and investment in any Fund must be made by subscription, properly executed, and delivered to the Fund at the appropriate address and in the manner indicated in the private placement memoranda or subscription agreements. Nothing herein should be construed as an offer to sell shares or units of any of the Funds. ACM is registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Part II of ACM’s federal Form ADV, which contains information about the firm and its professionals, is either contained in this book or is available upon request. ACM’s federal registration number under the Investment Advisers Act of 1940 is 801-61518. Further information about ACM is available at http://www.adviserinfo.sec.gov.

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Kathleen Stephansenppt Jan 1010  

ALADDIN CAPITAL LLC January, 2010 Kathleen Stephansen Chief Economist 6 Landmark Square, Stamford, CT 06901 / Phone: (203) 487-6700 / Fax: (...

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