| Dear Investors, The Tarpon Folio declined 4.7% since my last letter to you, or more specifically, over the three month period from March 31 through the end of June. The benchmark S&P 500 declined by 2.8% over the same period. Since the beginning of its fourth year, Tarpon has increased by 27.6% compared to an increase of 13.6% in the benchmark over the same timeframe. Had you been watching everything I did in the portfolio on a daily basis this quarter, I suspect the process would have resembled watching sausage get made. For the first time since launching Tarpon, I became concerned enough about macro events to get defensive. For reasons discussed below, developments in Europe - specifically in Spain - were unsettling enough to warrant some real caution. So at various times this quarter, we were hedged in Tarpon by being significantly short the market via ETF and/or holding a relatively high amount of cash - until my concerns about Europe were alleviated, and we got fully long again as usual. So while our second quarter performance was far from inspiring, we were able to avoid the worst of the recent market correction through what some call 'tactical positioning' - shorting, keeping each holding on a very tight leash in terms of price declines and/or holding significant amounts of cash. That sort of thing is not something I enjoy doing, nor do I foresee doing it again for all but the most serious of circumstances - but I felt it was necessary nonetheless. And in the end, I believe we once again came out of another market correction better positioned than we went in. And I was already pretty happy with what we owned going in. Despite all the activity this quarter, Tarpon is always going to be a value portfolio managed for the long-term. As a reminder, we don't pay any commissions on the trading we do on FOLIO, and that trading is done in as tax-efficient as manner as possible through the use of tax lots. But in retrospect I suppose this quarter's activity was driven by the desire to survive the short-term in order to see the long-term value in our portfolio realized. I think that focus on the short-term probably says much more about the state of the market these days - in particular the dominance of high frequency trading and the algorithm wars - than it does about value investing, but in any case, this quarter was a rather busy one. A little context about Europe is important to understand my concerns in early April. I am of the opinion that Germany has been very deft in using the markets to help drive home a political message of fiscal prudence in the other Eurozone countries - the correct thing to do, in my opinion. The Germans are playing a game with a much longer time horizon than other EZ members, however. And if Germany were to begin to be seen as using the markets to aggressively punish deviations from the outcome that it alone saw as the best possible solution, then that would compromise the ability of all of Europe to come together and engineer a true fix. The pain in other countries would get too intense, in other words, to shape the policies that would end the crisis for good, and the “market discipline” approach of Germany would backfire spectacularly. And early this quarter, for a number of reasons, there were signs of an alarmingly high increase in the probability of that backfire happening in Spain. Greece, despite all of the attention it has gotten, is really a sideshow in terms of its global economic importance. But Spain leaving the euro, either voluntarily or due to a hard default, would be, to put a fine point on it, very bad for the markets. So I got temporarily defensive in both Tarpon and Gecko. Fortunately - and you are forgiven for not noticing this while those Heat games were on - there was a minor miracle of sorts in Europe at the end of June. Helped by a narrow win by the pro-bailout parties in Greece, Germany indicated it might actually do whatever it took to save the euro. More specifically, Germany assented to allowing European leaders to use European bailout funds to directly recapitalize their troubled banks - much like our own TARP program of four years ago. That's the short version, anyway. The slightly-longer-but-still-acronym-free version goes something like this: By simultaneously backstopping Europe's banks, which are overflowing with bad loans, and offering real support for the governments themselves, the Eurozone can finally break the maddening link between troubled assets and insolvent governments. In the big picture, this sort of resource pooling and aggregated authority is a huge step towards the political and fiscal union that is needed to end the crisis and make the euro really viable in the future. That June summit also eased some austerity measures and allowed for direct government bond purchases by the European Central Bank, which will reduce the borrowing costs of Spain…one of those key indicators that had set off alarms for me back in April. It also seems to me that the fiscal and political union of Europe is likely to happen faster than most pundits seem to believe. And by 'faster,' I mean within a year or two. To be sure, it's far from a done deal yet, and things could still go wrong, but my point is that the worst in Europe certainly seems to be over. Whew. So where are we now? The potential upside in Tarpon is very large, but macro risks are still high. China's economy is slowing down. Ours isn't looking too noteworthy, either. There's the fiscal cliff. Taxes are going up for many folks. We've had some abysmal labor reports of late. We're going to see legislative gridlock in everything possible until after the November elections. And it's not that pessimism is so high as much as it is that there is a widespread fear and lack of confidence surrounding almost every major institution you can think of these days. On the other hand, the recovery in housing is finally here. This is a big deal. Gas prices have also dropped, and for every $0.10 drop in the price of a gallon of gas right now, consumers save about $15 billion, which might be viewed as a nice little tax cut of sorts. And corporations have a record $1.2 trillion in cash on hand. So the odds of another recession are still quite low. Most important, though, is that our companies are, to a one, ridiculously cheap. After the volatility in the second quarter, we now own a number of natural gas companies, including WPX Energy, which we bought during its recent trifecta of cheapness - it's a neglected spin-off bought with natural gas prices at a ten-year low and as its shares, too, were being thrown out with the Euro-drama bathwater. AIG is another new holding for us, and that investment case can most be easily summarized by this: huge share buybacks so far below book value are going to be massively accretive for us. So much so that you'll forget all about how crazy AIG made you in the bailout days of 2008. And if you can't get excited about Dell trading at under four times cash flow, well, then you, my friend, need another margarita. I cannot predict exactly when it will be that valuations will matter again in the stock market, but we're closer to that point now than we were when the quarter started. It will be worth the wait. In the meantime, there's plenty to keep us from getting complacent. And in keeping with a new quarterly schedule for these letters, my next one will come out after the end of the third quarter in September. As usual, call or email anytime with questions. Thank you. - Cale | 
Cale's Notes: 