They were valuable because they helped frame where we are in the mortgage crisis, which has been the main shark in the water over the past couple of years. You should know where that shark is and whether or not it is hungry. The chart below shows you the ferocious fish may still have an appetite.

It shows you that we are past the viscous subprime crisis, when that shark chewed through the balance sheets of a number of banks and financial institutions, in some cases devouring them whole. However, it is not yet safe to get back in the water:

There are these other slices of mortgages that are not quite as risky as subprime that reset in the next couple of years. Years 2010 and 2011 face big resets in so-called Alt-A and Option ARM loans. What this means is more write-downs and more losses for banks and others who hold these mortgages.

Making all this worse is the fact that the housing has not yet recovered. The T2 duo made the case that the current "stabilization" of the housing market is a head fake. Mostly, it's due to huge government support of the housing market. But there is still a large inventory of homes out there. And with these resets coming due, we've still got a large amount of foreclosures on the horizon.

All the while, the unemployment numbers are still poor. The T2 duo calls the unemployment situation the "most severe since the Great Depression." The US economy has shed over 8 million jobs in this recession and unemployment - officially - is nearly 10%.

Plus, it's not like the average US consumer is in a good position to sail through this crisis. Household liabilities are still high, as this next chart shows:

US consumers need to save and rebuild their financial strength. This is why the savings rate is on the rise. This is why, for the first time since the 1950s, household credit debt declined.

As investors, it seems clear that any idea that depends on discretionary consumer spending - say, buying trendy new sweaters or watches or expensive shoes - faces some big head winds. Better to the stick with the necessities, I say.

Also, it looks like the bounce in the stock prices of overleveraged banks and financial institutions is premature. Most bank stocks should be sold, not bought. The bounce in home building stocks looks ridiculous in light of what they have to look forward to. The T2 duo actually recommended shorting the home building stocks through the iShares Dow Jones US Home Construction ETF (ITB). By shorting it, you make money when the stock prices of the home builders go down.

They made a compelling case, of which I will highlight a few things. Exhibit A would be the fact that the average new home has been on the market for 12.9 months. Exhibit B is that we have about 2-3 years of existing home sales just to absorb the vacancies that exist. According to T2, about 6% of all homes built this decade are vacant.

Exhibit C is that the home builders themselves have too much debt and too much inventory relative to their thin equity cushions. The home builders are in the position of trying to hold up a bowling ball with a sheet of paper...in the rain.

Lastly, the home builder stocks are almost universally expensive on a price-to-book basis, as this chart shows:

Stocks with lots of debt, too much inventory and an awful market don't deserve premiums over book value. Discounts are more like it.

So there you go. I like the idea of shorting the home builders. At the very least, I wouldn't buy one. I'd also stay away from banks and financial institutions that hold mortgage assets. American real estate is not worth zero, as Dobson said, but it can be worth a lot less than today's price.

I recommend staying with the sorts of companies that own essential assets and/or sell essential items. As I like to say, stick with what keeps civilization a going concern. And avoid any stock that is dependent on regular access to the credit markets. As we saw in 2008, a mortgage crisis can shut down the credit markets. We don't want to be held hostage by lenders in that situation, so stick with excellent financial conditions.

Regards,

Chris Mayer
for The Daily Reckoning Australia

• All Ordinaries Reach 52 Week Low
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Last summer, Cameron Intl. announced it would acquire Natco Group for $780 million, or about 9 times trailing EBITDA. (EBITDA stands for earnings before interest, taxes, depreciation and amortization. It's a good rough measure of earnings power to use when comparing firms across a sector.)

It's been a while since we've seen some headline-grabbing acquisitions in this space. It's about time. Last summer, Precision Drilling bought Grey Wolf, a clunky land driller with old rigs, for 5.1 times EBITDA. And before that, we had a spate of deals north of 10 times EBITDA, including Hydril's purchase of Tenaris.

In the same view, we can buy Tesco - a quality oil field services company known for its cutting-edge technology - for under 3 times EBITDA. If Natco went for 9 times EBITDA, this one ought to go for no less. And that would mean a gain of 226% from here. Even without the acquisition, though, there is lot to like. Let's talk technology for a minute to understand just what Tesco does so well.

Tesco designs, makes, sells, rents and services top drives. A top drive is a motor that sits on top of rig and spins the drill. I don't want to get too geeked up in the technical aspects of this - if you're interested, there is plenty of detailed information on the company's Web site. The key thing to know is that top drives power the directional and horizontal drilling rigs that access unconventional natural gas reserves - all those shale plays. As more and more supply comes from shale plays, unconventional wells will grow much faster than conventional ones. Hence, a nice backdrop of demand for Tesco's top drives.

This is a big market with an installed base of over 3,000 top drives around the world. As time goes by, more and more rigs will have top drives, which provide some growth opportunities even if the total number of rigs stays flat. In particular, there is more opportunity in the land rigs than offshore.

Most of these existing top drives are from National Oilwell Varco. Tesco is No. 2. And Canrig, a division of Nabors, is No. 3. Tesco also rents top drives. In this business, it is top dog, with a rental fleet of about 126 top drives.

As for casing services, Tesco has a proprietary service that allows a driller to drill and case a well simultaneously. Casing a well means putting steel pipe down the well bore so the thing doesn't collapse on itself. The ability to drill and case at the same time cuts in half the number of days needed to complete a well. It's a big timesaver, and many expect the industry to adopt Tesco's technology, which would be a big boon to Tesco.

This casing technology really makes Tesco stand out from the pack. There is no other company with Tesco's technology. Tesco thinks that the market for this technology is in the billions. Currently, it's only about $50 million and growing. We've got a long runway here, though I think someone will buyout Tesco before too long.

I want to emphasize that these products are highly engineered and complex. Tesco owns a portfolio of over 80 patents and is developing another 120 patents to protect its proprietary applications. This is why I think of Tesco practically as a tech stock. And it's why Tesco deserves a premium valuation and remains a great acquisition for somebody. A much larger company, like a National Oilwell Varco, could take this know-how and apply it more widely over a larger customer base and push these products through its bigger distribution network.

About half of Tesco's business is from outside the US, which is holding up better than the US market in this mess. This recession also plays well to Tesco's strengths, because its tools cut the time needed to drill and complete a well, and help its customers make more money.

Also, Tesco's customers are mostly large firms - BP, EnCana, Petrobras, Occidental and the like. They are not the little guys who are going belly up. Tesco's customers are likely to remain active even in a relatively low-price environment.

As far as the financials go, there is not a lot to worry about here. The company has a strong balance sheet. Cash was $20.4 million at the end of the second quarter and debt was only $44 million. Tesco produces good cash flow and has low capital spending requirements - and most of that is discretionary. Management intends to finish the year with zero debt. So we have a company able to build cash even in this tough environment.

There are 38 million shares outstanding, and the stock trades for $8.50 as I write. That's a market cap of $319 million. Add in the net debt of $24.6 million and you can have the whole company for $345 million today (enterprise value, or EV). This year, the company will generate EBITDA of about $75-100 million. (Last year, EBITDA was $109 million). On a trailing EBITDA basis, Tesco trades for about 3.2 times EBITDA. Comparable companies would include Weatherford, Cameron, National Oilwell Varco and Natco, among others. As I pointed out earlier, Cameron bought Natco for 9 times trailing EBITDA. That kind of multiple gets you a $25 stock price for Tesco.

But you don't need the acquisition to make money when you buy at 4 times EBITDA or better. Cameron, for example, trades for 6 times EBITDA today. Even just getting back to a more normal historical multiple would put Tesco's stock closer to $15. It's just very cheap, especially when you consider the bright future ahead of it. It wasn't that long ago when people were talking about Tesco as a $40 stock.

This is not the retail sector, in which we have to figure out whether or not Tesco's next hot bluejeans are going to sell or whether customers will like the new store formats. We're talking about stuff you need to produce the oil and gas that keeps civilization a going concern. We're talking about highly engineered products that save customers a lot of dough. We're talking about a company that benefits from one of the great stories of our time: going ever deeper to reach untapped reservoirs of hydrocarbons once thought inaccessible. It's a heroic effort and the companies that can do it are going to make a lot of money - and so are their shareholders.

An added bonus: The executives and directors own 18% of the stock. So they have every incentive to maximize the value here. I'm betting they will.

Regards,

Chris Mayer
for The Daily Reckoning Australia

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In markets, one of the most watched and ongoing match races is the one
between Emerging (or developing) Markets and Developed Markets. The
former include China, India, Brazil and others. The latter include the
US, the EU and Japan. Which one do we bet on and when?

It's a particularly good question now, as we pick through the
smoldering ashes of the 2008 bust. Emerging markets have had a hot 10-
year run, even if you include the crackup in 2008. In fact, even if you
had invested in the MSCI Emerging Markets ETF (NYSE:EEM) on Jan. 1,
2008, you would be sitting on a profit today. By contrast, the S&P 500
Index has delivered a double-digit loss over the same timeframe.

The emerging markets have snapped back surprisingly quickly. As
Jonathan Anderson, a UBS strategist put it, "Not even the worst
economic crisis in the postwar era has been able to derail [them]." In
financial markets, ideas, like thoroughbreds, run hot and cold. Past
performance doesn't necessarily decide the issue any more than it does
in horse racing. But it turns out there is a pretty reliable way to
handicap the race between Emerging and Developed Markets.

The "handicapper" in this case is the aforementioned Mr. Anderson, who
wrote about his findings in the Far Eastern Economic Review. His title,
"Emerging Markets Poised to Perform," hints at his conclusion.

It all comes down to those old financial constructs called balance
sheets. In essence, a balance sheet shows you what you own versus what
you owe. These are snapshots in time, a measure of financial health,
like an EKG of one's heart rate. You can often spot trouble here before
it becomes fatal.

In my investment services, I always seek out companies with strong
balance sheets - the sorts of companies that own much, but owe little.
Enterprises like theses have the ability to withstand adversity better
than those with weak balance sheets. A strong balance sheet also means
that a company can fund its growth independently and more securely,
without having to rely on fickle lenders.

As investing star, Martin Whitman, wrote in his most recent shareholder
letter: "Don't invest in the common stocks of companies which need
relatively continual access to capital markets, especially credit
markets... Even the strongest, best-quality issuers can be brought
down, or almost brought down, if they continually have to refinance."
Unfortunately, many investors learned this lesson the hard way during
last year's severe credit crisis.

As it turns out, balance sheet strength is also very important for
entire nations. But that's hardly a surprise. Countries that owe a lot
of money tend not to grow as much or as reliably as those with healthy
balance sheets. Anderson created a "stress index" to measure the
financial health of entire nations. A country with high debt levels and
deficits earns a high stress index score. He then plotted this index
(inverted) against a rolling average of GDP growth, a rough measure of
economic growth.

Guess what? There's a close connection between the two.

So one way to explain the growth of emerging markets is to consider the
strength of their balance sheets. When they have healthy balance
sheets, they grow faster than when they have weak balance sheets.

You can see that the last time the emerging markets had a long stretch
in the sun was in the 1960s and 1970s. Emerging markets grew 5% or
better. As Anderson notes, not a single emerging market - not Africa,
not even the Soviet Bloc - failed to post 5% annual growth during this
time. And you'll also note that the balance sheets were healthy.

As a result, emerging markets sailed through the first global oil shock
in 1973-75 without much trouble. The developed world, by contrast,
suffered the pain of a deep recession. Investors who stuck with their
emerging market stocks throughout this period reaped big rewards.

According to Anderson, "Between 1965-1980 the dollar-adjusted return on
nascent equity markets in Mexico, Hong Kong, Taiwan, Brazil, South
Africa and other lower-income nations ran into the hundreds of percent
- while indexes in the US and Europe were essentially flat over the
same 15-year period."

Of course, as I say, these things run hot and cold. The emerging
markets "imploded" after the 1980-82 recession. A dozen different
countries reported inflation rates north of 100%. As Anderson points
out, 20 currencies lost 50% of their value each year. From 1980-99,
emerging markets struggled mightily and barely grew. And as you see
from the chart, their balance sheets went south as well.

Emerging Market returns during this period were poor overall. A dollar
invested in emerging markets in 1990 was still worth only about a
dollar 10 years later. In 2000, though, the game changed again.
Emerging markets opened up. They cleaned up their debts. And the
emerging markets went on a tear that continues today.

In general, emerging markets still have healthy balance sheets today.
In fact, they are as strong as they've been in 50 years. At some point,
that will swing the other way, as these things always do. At some
point, there will be too much debt and too much leverage. But for now,
that condition seems a ways off.

As Anderson concludes, "All the preconditions are in place for a
protracted period of strong economic growth." He guesses 5-6%, which
would crush the Developed World's growth rates. In fact, the superior
(and diverging) growth rates of the Emerging economies are already very
visible.

First up, take a look this graph, from The Economist, which shows the
industrial production of emerging Asia compared to the United States.

Looks like Asia is recovering pretty well. The chart above clearly
illustrates the "decoupling" that became such a hot topic of discussion
last year. The idea was that the Emerging markets would not necessarily
follow lockstep with the Western countries.

The Developed World suffers through what Richard Koo, the chief
economist at Nomura Research in Tokyo, calls a "balance sheet
recession." The Western world suffers from too much debt. That fact
shifts the focus from making profits to repaying debt, according to
Koo. Debt repayment will continue until the West repairs its balance
sheets, a process that takes years to correct, as Japan's long
recession shows.

So the same dynamics that make emerging markets look good, work in
reverse for the Developed World. According to Anderson's model, the
stressed balance sheets of the Developed World predict slow growth.

As investors, then, we'll have to continue to look to the emerging
markets for growth. The market never ladles out its rewards evenly,
though. To drill down further, the big winner is really Asia and its
big markets of China, India and Indonesia.

Anderson estimates that these regions could grow 7% or more annually,
well above the tepid rates of developed markets and better than most
emerging markets. "This is a very hefty gap," he writes, "and one that
is very likely to continue to reward investors who take advantage of
the opportunity."

Chris Mayer

for The Daily Reckoning Australia

• The Century of the Emerging Markets
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• Dr. Woody Bock’s Essay: The Future Evolution of the Debt-to-GDP Ratio

The dollar has been the "Coca-Cola of monetary brands," says James Grant, editor of Grant's Interest Rate Observer. But even the best of brands can be lousy investments. Grant uses the analogy of The New York Times. It was the greatest name in newspapers. In 2002, the stock sold for $53 per share - an all-time high, as it turned out. Today, the "Gray Lady" fetches only $8 per share.

"What happened?" Grant asked. The World Wide Web happened, he says. "The Times has hundreds of reporters, but this is a story they seem to have missed." As if the lowly stock price was not evidence enough of its decline, the NY Times got another reminder when it borrowed $225 million against it headquarters building. The cost of such borrowing, Grant reports, was 14%. The august Times today borrows at rates no better than a working-class stiff at a pawnshop. The US Treasury should take note. The government seems as intent on creating dollars as prolifically as bunnies create other bunnies.

Here we get to John Paulson, a presenter at the Grant's Fall Investment Conference and undoubtedly the richest man in the room. Portfolio magazine dubbed him "The Man Who Made Too Much" after he made $3.7 billion by betting against mortgage-backed securities (MBS). He is one of the greatest hedge fund managers ever.

Gold is his favorite today. As to why, Paulson presented a simple, but compelling case. First, the monetary base has exploded in a way we've never seen before. The monetary base is essentially the Federal Reserve Bank's currency and reserves. The Fed, by buying up securities in this crisis, has pumped a lot of money into the economy.

You've probably seen this chart, or some variation of it. Still, there haven't been noticeable signs of inflation as a result of that big spike - not yet.

As Paulson explained, that's because this base money has not yet been lent out and multiplied throughout the economy. Yet the monetary base and money supply are highly correlated, "almost 1-to-1 between the two," Paulson said.

That means that as the monetary base expands, the money supply surely follows, though there is a lag. (Money supply is a broader measure of money than just the monetary base, as it includes personal deposits and more. The monetary base is like a kind of monetary yeast. It makes money supply rise.)

If money supply grows faster than the economy, that will create inflation, says Paulson. As it is impossible for the economy to grow anywhere near that vertical spike in the monetary base, Paulson contends inflation is coming.

The US is not alone in its money-printing exercise. The supply of most currencies is expanding rapidly - even the normally tame Swiss franc. In the race of paper currencies, they are all dogs. Hence Paulson's interest in gold, which no government can make on a whim.

Therefore, in the content of the exploding monetary base, gold seems relatively cheap. In other words, as the money supply rises, so does the price of gold, eventually. As a result, says Paulson, "gold has been a perfect hedge against inflation."

There is some slippage over time. The gold price can change faster or slower than the money supply. But when the market gets worried about inflation, the gold price usually changes much faster - as happened in the 1970s. In 1973 - to pick a typical year - inflation was 9% and gold rose 67%. That was a pattern common in the 1970s.

The potential for inflation this time around is greater than it was in the 1970s, given that the growth in the monetary base is so much greater than it was in the 1970s. Gold could do much better this time around, reaching "$3,000 or $4,000 or $5,000 per ounce" as Paulson said.

I keep thinking how future historians will look back at the present day and see clearly how this unfolded. They will see the litany of news items that pointed to the dollar losing its top perch: China and Brazil settling up trade in their own currencies. The Russians and others openly calling for a new monetary standard. Even mainstream outlets are discussing alternatives to a dollar-based standard, a province once solely occupied by cranks and gold bugs. Not a week goes by without these kinds of stories.

As for a replacement waiting in the wings, Grant offers up gold. Indeed, a kind of "de facto gold standard" seems to be taking shape. The SPDR Gold Trust, the largest gold-backed security in the world, is now the sixth largest holder of the metal in the world. Anybody with a brokerage account can easily buy gold today through the trust, which trades on the NYSE under the ticker GLD.

It's still early. Most people still own no or very little gold. As it becomes clearer what's happening, they will buy more gold, especially as it is now easy to do so.

The gold supply, too, is limited against the vast pool of dollars. As Paulson points out, global money supply is 72 times the value of gold. I'm betting that gap will narrow. It only has to narrow a smidgen and the gold price flies.

As Grant eloquently put it: "Gold is a speculation. But it is a speculation on a certainty: the debasement of the currency." Gold stocks, too, are a speculation. But they are a speculation on an inevitably higher gold price.

Regards,

Chris Mayer,
for The Daily Reckoning Australia

• A Gold Standard, Without Gold
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• US Dollar Declining as China’s Currency Rises

Qatar's greatest asset is its natural gas reserves. In fact, the largest gas field in the world is here. Its discoverers were disappointed when they found it in 1971. They were looking for oil.

The boom Qatar now enjoys is the result of some daring investments in liquefied natural gas (LNG) back when people thought doing such a thing was a little batty. Faisal Al Suwaidi, the head of Qatargas, deserves the props for his wager, which have paid off handsomely. Today, Qatar produces about one-quarter of the world's natural gas.

Qatar supplies such faraway customers as Japan, India and China. Qatargas also operates the largest LNG terminal in Europe at South Hook on the Welsh coast. This facility provides Britain with a fifth of its gas needs.

Qatar's dominant position has filled its coffers and changed the country forever. On a per capital basis, it is one of the wealthiest countries in the world. And given the world's growing energy demands and the appeal of clean-burning (and cheaper) natural gas when compared with oil, Qatar seems in a good position.

In Dubai, the story is quite different, as Dubai does not have Qatar's gas reserves, nor does it have much oil. Dubai's story is one of trade and finance.

As I write, the sun is just peeking over the horizon. It is dawn in Dubai. Out my hotel window, I can see two buildings with cranes over them and in the distance another building in scaffolding. For a city that was once booming and turned bust - as with most places - there is still a lot of construction going on.

As recently as September 2008, realtors could claim that no one had lost money in the Dubai property market. That's no longer true. In fact, now the market has too much of just about every property type. One headline story noted how 32,000 homes are about to come on the market next year, which is a big number to choke down in any city. Dubai had a huge property boom and now must suffer the flip side.

The hotels, too, are pretty empty. We are staying at the new Address Hotel downtown, which has been open for only 25 days, we are told. I'm the first person to stay in my room. It still has that new carpet smell.

I wandered down for breakfast and was alone in a cavernous dining room. The hotel is brand-spanking new and everything looks wonderful. It's just mostly empty. I think there are more hotel workers than there are guests.

In Dubai, revenue per room is down 35% from a year ago. Yet there is still an expansion going on. Next year, estimates call for a 15% increase in the number of rooms. This would mean a 40% increase in two years.

Over breakfast, I perused my complimentary copy of The National. One of the things I like to do in a foreign city is to read the local newspapers. I'm kind of a newspaper junkie anyway - I get three dailies delivered to my doorstep at home. In any event, I always find interesting nuggets from a perspective you might not get if all you read is The Wall Street Journal or Financial Times.

Today's business page carried an array of tales... There was the arrival in Doha of a new LNG tanker, fresh from Seoul's shipbuilding docks. There was a story about how UAE consumer confidence is up. Also, notes on bond issues in the Gulf, the latest figures on money supply in Kuwait (it's rising at a frighteningly quick pace of 18.7%), the price of villas in Dubai and more. All sorts of little odds and ends that help paint the picture.

There was also a lot of chatter about infrastructure, which I found particularly interesting. Abu Dhabi, the capital of the UAE, which I will visit on this trip, is looking to raise $100 billion for infrastructure projects. From The National: "The emirate needs to fund new transport, electricity and telecommunications schemes..."

Dubai itself also has ambitious infrastructure spending plans. Last night, as we made our way to our hotel, we could see the new Dubai Metro stops along the way, which, lit up as they were in soft blue and white twinkling lights, looked like something out of the future.

Incredibly, the Dubai government last year spent about 45% of its budget on infrastructure projects - mostly on the roads and ports. But there is a lot more on tap, as The National reports:

"Dubai could invest as much as $20 billion in desalination projects in the next decade alone as it increases its water output by 2.72 billion liters a day... [There are also] plans to add 14,405 megawatts by 2017... Construction costs for those new plants amount to $11.6 billion, while infrastructure costs, including substations and transmission lines, will be about $11.6 billion."

This massive build-out is not unique to Dubai, or even the UAE. There are also big infrastructure projects of all kinds in India and China and other emerging markets.

Regards,

Chris Mayer
for The Daily Reckoning Australia

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• DMCC and their Precious Metals Vault
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But with all the artificial stimulus money floating around, you can never be sure of what you see. Is this a real recovery or is it an artificially ripened tomato, and hence an imposter? When the stimulus money stops flowing will the recession get worse?

It's hard to say, but let me give you a couple examples of distortions.

CNN's bailout tracker reports that US government stimulus has totaled $2.8 trillion so far this year, with another $8.2 trillion in commitments. Most of this money has gone to the financial sector. Some of it has gone to infrastructure projects and to consumers (cash for clunkers, for example).

That is a lot of money. It is hard to say how all of this spending has artificially boosted economic activity in some sectors of the economy. It is obvious that such spending cannot continue indefinitely.

This has also been a worldwide phenomenon. There isn't an economy of size that does not have some stimulus-spending program in place. Governments are spending money they don't have. The result is widening budget deficits and higher debt levels.

First up, take a look this graph, from The Economist, which shows the industrial production of emerging Asia compared to the United States.

Looks like Asia is recovering pretty well. That chart shows the "decoupling" that became such a hot topic of discussion last year. The idea was that the emerging markets would not necessarily follow lockstep with the Western countries.

But this graph only tells a part of the story. China is one of the countries in "Emerging Asia." China supposedly grew in the first quarter at an annualized rate of 15%. Yet, the government also spent a lot of stimulus money. As Eric Sprott writes in his latest letter to shareholders:

"The Chinese have injected a stimulus equivalent to 64% of their first half 2008 GDP in the first half of 2009...The Chinese government has effectively spent and lent enough in six months to buy 122 Ford Class aircraft carriers at US$8.1 billion a piece. It is akin to the US government injecting (and US banks lending) almost $4.5 trillion USD to its citizens and businesses before July 2009...an ungodly sum that would impact every asset class under the sun. Is it any wonder then that the Shanghai stock exchange has more than doubled from trough to peak since its November lows?"

Let me remind you that GDP is a clumsy way to get at an economy's size. It is a figure that includes government spending. So, put another way, stimulus money this year is about 64% of the recorded economic activity in the first half of last year for China.

In some ways, the Chinese government spent well - investing in the commodities it craves. It's locked down oil and gas assets, iron ore contracts, interests in rare earths and more. It's put up power plants and laid down roads and pipelines. It's made long-term investments in Africa and Brazil. Some of that will pay dividends down the road, if not already.

For instance, in the first six months of this year China became Brazil's single largest export market. That's the first time that's ever happened. The Chinese and Brazilians are doing deals. For instance, China will lend $10 billion to Petrobras in return for 200,000 barrels of oil per day. China, in fact, has been active throughout South America, investing billions in mines, refineries, ports, and railroads.

These shifting patterns of trade always fascinate me. And we are living in an era of great change on that front, as new patterns emerge on a scale we have never seen.

It's clear that China will have enormous needs for commodities over time. In the short-term, we are surely seeing distortions from the stimulus money. But the long-term demand is there nonetheless and the Chinese have a lot of money to spend.

In fact, infrastructure needs - especially in the areas of water and energy - are becoming more of a headline issue than ever. Not a week goes by where I don't pick up a handful of stories of infrastructure falling apart somewhere. This, too, is a global story.

A couple weeks ago, for instance, there was a terrible accident in a Russian hydropower plant. Eleven people were killed and 65 were missing after water burst into a turbine room. It also destroyed the turbine. Besides the irremediable loss of life, it will take hundreds of millions of dollars and years to repair the demand.

As the FT reported, the accident "was a powerful reminder of Russia's dire need for hundreds of billions of roubles in investment in its crumbling Soviet-era infrastructure."

Putin's government put aside $200 billion for infrastructure in two oil windfall funds, but that money is already being tapped for social spending programs and to help make up budget deficits. As in many places, including in the US, money set aside for infrastructure has been essentially hijacked by the political process and diverted to other uses.

Another story comes from Britain. Britain faces huge deficits in energy and the risk of widespread blackouts. Its energy complex is old and strained. The Economist reports: "The nuclear stations are simply too old to carry on: most are over a quarter of a century old. Around half have already been shutdown and are being decommissioned."

About half of its electricity comes from natural gas, a legacy of its North Sea riches. But the North Sea peaked in 1999 and has been in steep decline ever since. Britain's coal plants struggle under new pollution control rules and the effects of age. It's an ugly situation that will cost a lot of money to fix.

Regards,

Chris Mayer
for The Daily Reckoning Australia

• China Reduces Holdings of Treasury Securities
• Japan “Wasted Trillions” on Stimulus Programs
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• Roubini Says United States Will Climb Out of Recession Towards End of Year
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To set the table, water rates in China have been so far below the global average it's ridiculous. Especially when you consider the severe water problems in China. The graphic below is from The Wall Street Journal ("China Cities Raise Water Price in Bid to Conserve" by Andrew Batson):

The Chinese are water-poor. They are sucking their aquifers dry. It is particularly bad in the north of China. The groundwater under the North China Plains is draining away quickly. By some estimates, China will exhaust this water supply in the next ten years.

You probably know that the city of Venice is sinking a fraction of an inch per year. But that's nothing compared to what is going on in Beijing. Parts of Beijing are sinking 8 inches a year! According to Andrew Lees (The Right Game), it is the world's largest cone of depression (an underground hole created by a depleted water table) at over 15,000 square miles. The second largest cone of depression is around Shanghai.

So finally, many cities are raising the price of water. The WSJ points out several places where water prices could rise 25-48%. Shanghai, for instance, raised water rates 25% in June and plans another 22% increase next year.

The second event that caught my eye was the collaboration between China and India to monitor the health of Himalayan glaciers. This area is very important to both countries. They fought a war over it in 1962. So, the fact that they are getting together on the Himalayan glaciers is meaningful.

Here is why it is so important: Seven of the world's largest rivers, including the Ganges and the Yangtze, are fed by the glaciers of the Himalayas. They supply water to about 40 per cent of the world's population.

Well, those glaciers are shrinking. The Indian Space Research Organization, using satellite images, has studied the changes in 466 glaciers. It found they had lost more than 20% of their size between 1962 and 2001.

This melting increases the water flow at first, but eventually slows dramatically as the glaciers either melt completely or reform. These observations have given rise to a kind of "Peak Himalaya" where people wonder if we have not seen the maximum water flow from the mountains.

We know the current run rate on demand is already well above what is sustainable given annual rainfall and river flows. That's why you have those depressions. That explains the depleted aquifers and the rivers that don't reach the sea. Now throw into that ugly brew a decline in water supply from the Himalayas. The situation is worse than it seems, if that is possible, because much of the existing fresh water in both countries is so polluted it is unfit for human consumption.

As if all of that weren't bad enough, the demand for water is still rising rapidly in China and India. The water use per capita in China and India are still well below global averages. As these countries industrialize, they'll consume exponentially more water. It takes water to make just about everything. For example, to make a 1 tonne passenger car takes more than 100,000 gallons of water. Just to make a cotton shirt takes over 1,000 gallons of water. And most of our water goes into making our food.

So, population growth by itself guarantees increased water demand. (Globally, water consumption increases at more than twice the rate of population growth.) These two countries already have big populations and both will get bigger. When you look at demographic trends, China and India alone will add close 600 million people over the next 30 years. That's two present-day United States.

Fresh water, like oil, is getting a lot harder to find for 40% of the world's population. It will get worse before it gets better. The days when we think of water as a cheap resource are coming to a close. That's especially true for China and India.

Bottom line: We need to create more fresh water. You do that by finding new sources either through new supplies (drilling deeper, desalination, etc.) or by using existing supplies more efficiently (irrigation and other efficiency gains).

All of that takes time and energy. Desalination is energy intensive. Drilling deeper for water or going to more distant source requires energy to pump and move the water. Replacing older, less efficient plants and equipment takes time and energy again. (Detect a theme here?)

Countries, companies and people will find ways to make this transition. The companies that can solve these problems will do well.

Regards,

Chris Mayer
for The Daily Reckoning Australia

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First off, the stated objective of cutting carbon emissions by 83% by 2050 will go down in history as outrageous - akin to when Who drummer Keith Moon drove his Lincoln Continental into the pool at the Holiday Inn. I think members of Congress must be smoking the same thing Moon was.

To show you how patently ridiculous such a goal is, I turn to Questar's CEO - a man with the unfortunate name of Keith Rattie. Questar is an oil and gas company. Rattie is an engineer. He has been in the business since the 1970s. He walks us through the basic math in a speech he made at Utah Valley University on April 2 called "Energy Myths and Realities." Rattie uses Utah as an example:

"Utah's carbon footprint today is about 66 million tons per year. Our population is 2.6 million. You divide those two numbers and the average Utahan today has a carbon footprint of about 25 tons per year. An 80% reduction in Utah's carbon footprint by 2050 implies 66 million tons today to about 13 million tons per year by 2050. If Utah's population continues to grow at 2% per year, by 2050, there will be about 6 million people living in our state. So 13 million tons divided by 6 million people equals 2.2 tons per person per year.

"Question: When was the last time Utah's carbon footprint was as low as 2.2 tons per person? Answer: Not since Brigham Young and the Mormon pioneers first entered the Wasatch Valley and declared, 'This is the place.'"

You can extend this math over the whole country - a growing mass of 300 million people. To meet the Waxman-Markey bill's goals would mean we have to go back to a carbon footprint about as big as the Pilgrims' at Plymouth Rock circa 1620.

So I think the bill is absurd. I think it is also a great blow to what is left of American industry. But who cares what I think? As the great Jeffers wrote, "Be angry at the sun for setting/ If these things anger you." This is the way the world works. Politicians do dumb things. We have to play the ball where it is. And that means we have to figure out who wins and who loses.

Here are some thoughts along those lines...

Agriculture. Agriculture, for whatever reasons, is exempt from the new rules. So farmers don't have to worry about those manure pools out back or the flatulent cows emitting methane all over God's green meadows. Those big tractors? Burn up that diesel!

Agriculture is a winner by virtue of not losing, like a hockey team that skates to a tie.

Steel. Big loser. U.S Steel, AK Steel and even foreign steel companies with US operations all get a big kick in the family jewels on this one. Steelmaking emits all kinds of carbon dioxide. The worst-case scenario here is that the US simply won't be making steel at some point in the future. The plants will all go to Brazil. China is already the biggest steel producer in the world. Now we just handed the country a bunch of new business.

Avoid big steel in the US.

Utilities. Mostly losers. Under the bill, utilities will have to get 12% of their electricity from renewable sources. That means they are going to spend money buying windmills and solar panels. For some of the coal utilities, this is bad news - even though they caught a break when the government made a change to let coal have carbon permits for free to start off with. Gas utilities are better off, as they emit less carbon, but since coal gets some free carbon allowances upfront, their advantage will not be as big as I made out in my letter to you a month ago. (See, the problem with writing about potential legislation is the rules change every week.)

Still, I'd avoid coal producers or coal utilities. They wear big targets on their backs and can't do much about it, except spend a lot of money. Bad for shareholders. There may be some very good ideas on the picks-and-shovel angle for coal, though. For example, a number of companies will sell equipment to clean up coal. And of course, the solar and wind guys are big winners.

Oil refiners. Losers. This is an industry in which it is hard to make money most of the time as it is. Now, under the new bill, refineries are really screwed. Basically, they are on the hook for about 44% of US carbon emissions. They would be among the biggest buyers of carbon emission allowances. I think with one stroke of the pen, the US government just made the US refining industry that much smaller. Lots of these older refineries will just have to close. US imports for gasoline will rise.

I think the refinery industry already sees the writing on the wall. This is one reason why Valero, the biggest US refinery, has been quick to get into the politically favored ethanol business. It's also expanding overseas.

Avoid the refineries.

Trading desks. Winners. It figures. As if the government doesn't help financial firms enough, it is going to hand them a nice tomato in trading carbon credits. The head of Morgan Stanley's US emission trading desk said: "Carbon, while relatively small, is a critical piece of our commodities offering." So some financial firms with trading desks in carbon get a nice little payday.

To sum up, this is only the beginning. At the end of the day, this obsession with carbon footprints means that Americans are going to have to pay a lot more for products that use fossil fuels. It means we are going to pay a lot more for energy. Obama and his crew can draw up whatever fantasies they want, but they can't repeal the laws of economics, which, like forces of nature, win out every time.

Regards,

Chris Mayer
for The Daily Reckoning Australia

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"The value of gold, as the only true 'hard currency,' is coming to the fore, as evidenced by the investment choices of some of the world's most seasoned investors."

- AngloGold Ashanti Ltd. Chief Executive Officer Mark Cutifani

For the first time in a couple of decades, some of America's most successful, big-name investors are buying gold. David Einhorn, the hedge fund manager who predicted the downfall of Lehman Bros., recently bought gold for the first time. And then there is John Paulson, the guy who made billions of dollars by correctly anticipating the housing bust and credit crisis.

Paulson just plunked down $1.3 billion for an 11% stake in AngloGold. He's also got a big position in Kinross Gold.

Peter Munk, the 82-year-old chairman and founder of Barrick Gold, also offers up his own anecdote about gold's broadening appeal. "I have had more phone calls in the past six months than ever before - from people who have $120,000 inherited from grandmother, and from hedge fund managers with millions," he says. "I am not saying George Soros, but people of that caliber have told me they are buying gold."

You no longer have to be a gold bug to think gold will rise in price. In fact, this buying by some of the world's greatest investors may be the leading indicator for a quick 116% climb - to $2,000 per ounce or higher. Give gold the cold stare of a professional handicapper and the odds look very good, indeed.

Why? The biggest reason is that the value of the dollar looks about as brittle as a 90-year-old's hip socket. And if you worry about the value of the dollar - or any paper currency - then gold is a good alternative.

In fact, gold has held up well while most everything else has taken a beating over the last year. On a recent conference call with investors, First Eagle fund manager Abhay Deshpande points out that gold is at a new high in just about every currency apart from the U.S. dollar and Japanese yen. "It has performed its job for everyone in these countries," he says. "It has held its value."

Take a look at the nearby chart and you can see the falloff of the dollar in recent years and the rise of gold.

"But there have always been worries about the value of the dollar," you say. "That's not new." True. What is new is a global financial crisis unlike anything we've seen in the post-World War II era. And that crisis has brought with it serious doubts - the most serious in decades - about the dollar's ability to keep its top perch in the aviary of world currencies. As that doubt increases, gold gathers new fans.

As I write, the headlines are abuzz with China's proposal to replace the dollar as the world's reserve currency. (The U.S. Treasury secretary, in a weak moment, said: "We are quite open to that." He took back those words, but the hammer had already hit the nail.) China and other countries hold a lot of dollars. And they are not too happy to see the U.S. government handing out bills like after dinner mints. America's $2 trillion (and ballooning) annual deficit and ballooning national debt causes them to wonder about the value of all the paper they hold.

They are not the only ones worried, as I noted up top. Many top investors are already buying gold.

It is easy to buy gold today with gold exchange-traded funds (ETFs). They are like mutual funds that hold gold. As investors pile into these ETFs, the ETFs' gold holdings also go up. It's one way to see the dramatic increase in demand for gold in just the last few quarters. (See chart below.)

So we have to ask: At $900 per ounce, are all the fears baked in or are we on some new history-making path?

I have a good friend who advises institutional clients on investing. As he reminds me, the really big money hasn't started buying yet. There are no big pension funds or endowments with significant gold holdings. That could change. If so, the gold price will go wild.

"Gold is a small market," Munk notes. Munk's career spans 60 years and he knows the gold market as well as anyone. Says he:

"Let's say a small percentage of the world's central banks - or simply the United Arab Emirates itself - do not believe President Obama's pledge that he will halve the U.S. deficit by the end of his first term. They shift some of their dollar reserves to gold. It would not take many decisions of this kind to push the price above $2,000 per ounce."

That's how gold gets to $2,000 per ounce - just a bit of doubt turning into action. The mind boggles at what would happen if China decided to hold more gold! Gold could well hit $5,000! As long as President Obama, Fed Chief Bernanke and pals treat the dollar like confetti, gold should continue to gather new fans. And gold stocks should do even better.

Gold stocks are supposed to do especially well as gold rises. But that has not been the case over the last year and a half. Mostly, this was because mining costs were rising as fast as, or faster than, the price of gold - thanks in part to record-high energy prices. But as Deshpande points out: "These things have reversed in recent months as gold stocks became quite cheap relative to the underlying value of the gold in the ground."

The case for gold and gold shares is a nice and clean setup, like one of those toy houses in the window at Macy's on Madison Avenue. The world order will not always hinge around the dollar. Global finance will not always find its center on Wall Street. As Munk pointed out: "Look around Davos this year. So Goldman Sachs cancels its dinner party. In its place, a Kazakh company has a dinner party."

As the dollar goes bust, who knows what will replace it? With gold, you don't have to worry too much about the answer.

Regards,

Chris Mayer
for The Daily Reckoning Australia

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- Jan Morris, Among the Cities

It was pouring rain in Manhattan when I tried to begin my long journey back to my hometown in Maryland. There was a long line for cabs, and I had to get to Penn Station to catch a train. So I took a bicycle rickshaw whose driver was eager for business. "The only way to travel in Manhattan," he said. He was a stout fellow with a shaved head and bad teeth that looked like blackened pylons on an old waterfront.

I hopped in and we zipped through traffic. At one point, he crossed over the double-yellow line daring oncoming traffic. "You don't see any taxicab get away with that!" he hollered back at me after blowing through a red light. Just like being in Asia again!

It was a different way to look at Manhattan and its towering skyscrapers as far as the eye can see down any block you choose to look. Somehow, it all seemed a lot bigger in a rickshaw. Hard to believe that within six years, New York will no longer be among the world's five largest cities.

The new top five? Tokyo is No. 1, with a population (35 million) greater than all of Canada. Then follows Mumbai, Sao Paulo, Delhi... and Dhaka. Dhaka? Yes, Dhaka. It's the capital of Bangladesh.

There are some big changes afoot in the world's cities. These changes will create enormous opportunities for investors that a previous generation could barely imagine.

Consider some of these notes from National Geographic Traveler:

In the past 20 years, the world added about 3 million people a week to its urban populations

More than half of the world's populations live in cities and more two- thirds will by 2030

The fastest growing cities are all overseas: India has 40 cities with more than a million people; some Chinese cities are growing at more than 10% per year; and Africa's population should double by 2050.

"All cities are cities of the moment," says Richard Wurman, the celebrated American architect says. He is right. No city stays on top for long. In the year 1000, the most populous city in the world was Cordova, Spain. Beijing was tops in 1500 and 1800. London was the biggest in 1900, New York the biggest in 1950. Today, Tokyo.

The pace of urbanization is particularly swift in China and India. More than 25 million people move to cities each year.

Some of the numbers are hard to fathom. As U.S. Global Investors points out in a recent presentation, China will add more people in 15 years than the entire population of the United States. "There will be up to 50,000 new skyscrapers," the company notes, "the equivalent of building 10 New Yorks. There could be up to 170 new mass transit systems. There are only about 70 in Europe today."

This massive population shift has enormous effects on infrastructure spending. Trillions of dollars will have to go toward building power systems, roads, water and wastewater systems, ports and more.

It's like what the U.S. went through in the early 20th century - only on a much more massive scale. Historian Scott Nelson likens the current period to the Long Depression of 1873-96 vintage. Then, a banking crisis toppled Wall Street, too. Unemployment in New York hit 25%. But the Long Depression also paved the way for rising industries such as railroads, oil and steel and spawned a period of innovation and industrial growth.

As Richard Florida comments in The Atlantic:

"In 1870... America's population overwhelmingly lived in the countryside. By 1900, the economic geography had been transformed from a patchwork of farm plots and small mercantile towns to a landscape increasingly dominated by giant factory cities like Chicago, Cleveland, Pittsburgh, Detroit and Buffalo."

Depressions destroy some things and make others anew. Before the Great Depression, few Americans owned a home. But government policies created the long-term mortgage that led to the rise of the suburbs and homeownership of nearly 70% by 2004. The malaise of the 1970s created the Rust Belt, but also saw explosive growth in the Sun Belt.

Now imagine a transformation very much like America's from 1870-1900, as people moved off farms and into cities. Especially imagine it on a global scale in China and India. Future historians will wonder how we couldn't see this great boom unfolding before our eyes - the boom in the building of cities.

Regards,

Chris Mayer
for The Daily Reckoning Australia

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