Marius Kloppers had his numbers wrong. He said there were 74 resource projects in Australia at an advanced stage worth $80 billion. Yesterday, the Australian Bureau of Agricultural and Resource Economics (ABARE) said it was 74 projects for $112 billion. That's a 67% increase from this time last year. Is it inflation? Or just Gorgon?

These were projects already in the pipeline before the commodity price correction of 2008. The Gorgon gas project off the Northwest Shelf alone is a $43 billion project (nearly 40% of the total). Energy projects make up 38 of the 74 projects and 72% of total capital spending - which is why in both Australian Small Cap Investigator and Diggers and Drillers, Kris and Alex are recommending both conventional and unconventional energy shares.

But usually the companies doling out billions in new cap ex are larger companies with deeper pockets. That doesn't mean they aren't shares you want to own, or that their share prices aren't correlated with rising commodity prices. But we reckon you're going to find bigger cap ex related gains from the companies getting some of the contracts related to projects like Gorgon. These are the "pick and shovel" companies of the cap ex spending boom.

Or you can look at the other end of Resource City, to the explorers and developers. ABARE reports that last year set another record in resource exploration spending in Australia. Some of it was brownfield exploration (old sites or mines being redeveloped) and some was greenfield (brand new sites or mines). All up, there was $6 billion in exploration spending in Australia last year.

More than half of that was a frenzy of small companies drilling for new oil. $3.8 billion was spent on petroleum exploration. That tells you what the industry thinks about oil prices: they are going higher. Coal exploration spending was up 27%, with iron ore exploration up 30%.

The big shocker was that uranium exploration and gold exploration spending were both down by double digits in the last year. The uranium exploration spend was down 20% and gold down 26%. Yet the price forecasts for both commodities look, at least according to Alex's research, pretty damn bullish. So why aren't the explorers out kicking rocks and taking names?

It turns out they are, just not in Australia. The ABARE numbers measure exploration spending within Australia. But many Australian-listed firms are looking for gold and uranium in other places, especially in Africa. They're doing so because production costs are lower there, even if political risk is higher (although in some places, it's more than acceptable for the projects on offer).

They're also doing so because if you find a country with an acceptable level of political risk, you can also find greenfields mines to develop and build. Granted, that takes a lot of capital. But some of the developers never plan on running the mine anyway. What they're looking for is an economic deposit (high ore grades that can be produced easily) leveraged to higher commodity prices. They can then sell that off to a producer without ever turning a shovel in anger.

Just this morning, Aussie-listed Impact Resources said it believes it's found a large new uranium province Botswana. In a possible case of "nearology," Impact said the new province has similar characteristics to A-Cap Resources 98 million pound inferred resource in the same neighbourhood.

We have no idea what the facts are for either company. What we do know is that Alex told us two things (in his November letter) that you should look for with Aussie uranium companies: they need to have a resource big enough to produce a given amount of uranium each year and they need to be in production by 2012-2013. Impact's resource, according to Alex's research, was not big enough to qualify on the first measure.

As to the second measure, that's when Alex believes a shortage could hit the uranium market, thanks to interrupted mine supply at BHP's Olympic Dam and Cigar Lake in Canada. That, plus the removal of Russian-supplied recycled nuclear warheads. And that's just on the supply side. On the demand side, well, you've probably heard that story so we won't go into it.

Of course all this fuss about oil, gas, gold, and uranium presumes there will be a functioning world economy needing and/or wanting these things next year. Maybe not so, says a report from Societe Generale!

The French bank published a note to clients warning them to be ready for a possible "global economic collapse." In its report, "Worst case debt scenario," the bank said what we've been saying for the last month: the transfer of private sector debts to government balance sheets threatens a sovereign debt crisis (which is really a kind of debt-induced fatal heart attack for the fiscal welfare state).

The bank shows that overall debt-to-GDP ratio in the U.S. (when you include government, business, and households) is 350%. Bank analyst Daniel Fermon says in his report that even without more fiscal stimulus, government debt-to-GDP ratios will, within two years, be at 105% of GDP in the UK, 125% in the U.S. and Eurozone, and 270% in Japan.

This massive global debt burden is more than the underlying assets can bear. That is, the assets (collateral and the tax base) will not generate sufficient income to service the debt. It's global Ponzi Finance. What's in store, then, is another great forced deleveraging where debts are liquidated and asset values are forcibly written down.

That's not anyone's idea of a good time. "Under the French bank's 'Bear Case' scenario," writes Ambrose Evans-Pritchard in the Telegraph, "the dollar would slide further and global equities would retest March lows. Property prices would tumble again. Oil would fall back to $50 in 2010."

Hmm. Doomer porn? Or prudent preparation? You decide!

Rock-star bank analyst Meredith Whitney has already made up her mind. She told CNBC in an interview, "I haven't been this bearish in a year...There's nowhere to hide at this point...The Fed and the Treasury have to get the banks to pay back TARP. That means the banks are going to raise capital again."

She was asked if the banks are adequately capitalised? "No way," she answered evasively. "All this said...I don't know what's going on in the market right now 'cause it makes no sense to me. There's no root in fundamentals."

That's the trouble with a market trading on liquidity alone. Valuations don't make sense. But that's doesn't keep people from making them, or having an opinion anyway. Take gold (or pay $1,143.20/oz. for it).

Another report from Societe Generale - this one from analyst Dylan Grice - says that if the U.S. dollar were fully backed by gold, as it was in during the peak of the 1970s gold bull - it would trade for $6,300 per ounce. That makes gold, er, cheap at these prices.

Is this a case of gold entering its mania phase? Are analysts now starting to outdo each other with gold predictions? Maybe.

But Grice makes a sensible case. He writes that, "The U.S. owns nearly 263 million troy ounces of gold (the world's biggest holder) while the Fed's monetary base is $1.7 trillion. So the price of gold at which the U.S. dollar would be fully gold-backed is currently around $6,300. Gold is very cheap - at current prices, the USD is only 15 percent gold-backed."

If gold goes to $6,300, a lot of things will have gone wrong. Uber-bear Nouriel Roubini fears things are about to go from worse to much worse. He writes in an op-ed that the American unemployment picture is harbinger of bad times ahead.

"This is very bad news but we must face facts," Roubini writes. "Many of the lost jobs are gone forever, including construction jobs, finance jobs and manufacturing jobs. Recent studies suggest that a quarter of U.S. jobs are fully out-sourceable over time to other countries."

"As a result of these terribly weak labour markets, we can expect weak recovery of consumption and economic growth; larger budget deficits; greater delinquencies in residential and commercial real estate and greater fall in home and commercial real estate prices; greater losses for banks and financial institutions on residential and commercial real estate mortgages, and in credit cards, auto loans and student loans and thus a greater rate of failures of banks; and greater protectionist pressures."

It's pretty gloomy. But at least now, at the end of the week, the status quo seems to have clarified itself. We think we know what the opposing forces are in the market and just what's at stake.

In the red corner is the spectre of another massive forced deleveraging (debt deflation). Banks are undercapitalised. Assets are overvalued (shares, property, commodities, and most definitely most government bonds). This fighter will pummel stock markets and asset prices much lower as the world comes to grips with too much debt that produced too few productive assets and real income.

And in the blue corner is Helicopter Ben Bernanke. His mission, should he choose to accept it, is to devalue the U.S. dollar (and all those currencies currently pegged to it) and create more new money faster than deleveraging can wipe out debt. In theory, Bernanke is just the man for the job. Why?

He's an avowed deflation fighter. And, again in theory, there is no limit to how much money the Fed can create. Through monetary policy and other methods, the Fed can continue to shovel liquidity into the banking sector to keep it fictitiously capitalised and nominally solvent. In this fight, the Fed expands its balance sheet two to three times its current size (at least).

Of course if the Fed does begin growing its balance sheet at that rate one thing will happen and another thing might happen. First, gold will get closer to $6,300 as global dollar holders realise the Fed's intentions toward the dollar (not honourable). But there is another possibility.

The other possibility is that the U.S. Congress, not understanding anything, but seeing the fiscal deficit explode and the dollar plunge, begins to call for Bernanke's head on a pike. Or, to be more precise, bill's stripping the Fed of its independence and calling for a formal audit might began garnering support in the Congress.

There might even be some elected representatives of the American people who try and prevent a further currency calamity for Americans (who are rapidly realising that a weaker dollar means a lower standard of living and rising prices for imports). Don't hold your breath, though.

Congress get tough with the Fed? Granted, it's a stretch. My colleague Dan Amoss back in the States suggests Bernanke's political strategy could be to let a little deflation creep back into asset markets. A drop of 10-15% on the Dow would get Congress good and worried again, and mid-term elections are not far off are they? With another spell of deleveraging, Congress might just back off and let Chairman Bernanke continue his long-slow, back-door re-capitalisation of the zombie American banking sector.

You have to wonder, though, if the markets will be so compliant with the Fed's plans (assuming the Fed's plans are anything like we've described). You have to wonder if normal people are beginning to lose confidence that the so-called authorities have our best interests at heart, of even know what they're doing.

Above all, you have to keep really tight trailing stops to lock in your equity gains, increase your allocation to cash, and keep an eye on element number 79 in the periodic table. It's telling you exactly what to expect.

A final possibility is that the United States is ripe for a populist demagogue who either rails against the unfairness of China's currency policy and/or tells Americans it's time to close the borders, repudiate the debt, and get the fiscal house in order...with a big broom...and some pitchforks.

Dan Denning
for The Daily Reckoning Australia

• Uranium: A Carbon-friendly Substitute for Coal
• Energy Debate in Australia Needs to Get Serious
• Uranium Shares To Show Gains in Face of $120 Oil
• Red Bear Rising: Russia’s Resource Based Geopolitical Strategy
• BHP Billiton: The Oil Company That is Not an Oil Company

Of course there is. George Soros is picking up more shares of gold and potash producers. Mineweb reports that, "Billionaire investor George Soros' Soros Fund Management substantially raised its shares in PotashCorp as well as invested in gold ETFs during the third quarter. In Form 13F documents filed with the SEC, Soros Fund raised its PotashCorp from 1.98 million shares to 2.95 million shares with a fair market value of $266.4 million."

And while China and America bicker over currencies, Chinese firms are scrambling to buy real assets. And while Aussie banks source foreign borrowing to lend in local real estate, Aussie mining firms go begging for bits of capital that would bring world-class ore bodies (and key strategic resources) into production...by local producers and owners.

Take Moly Mines. It's aiming to operate a 10 million tonnes per annum copper and molybdenum mine at Spinifex Ridge in Western Australia. Prior to the credit crisis last year, things were going swimmingly. Molybdenum is a hardening agent used in steel-making. There aren't a lot of economic ore bodies in the world. Moly, according to the research we published in April of 2008 in Diggers and Drillers, had one of the most economic deposits.

But it all went off the rails with the credit crisis. The company couldn't secure the funding it needed to bring the project into production. And the share price fell. That made management amenable to any offer that would secure financing and rescue what was still, by all accounts, an immensely valuable and lucrative resource.

Yesterday, the Foreign Investment Review Board (FIRB) approved a $200 million investment in Moly by China's Sichuan Hanlong Group. It gives the Chinese group majority control in Moly and could see the development of the project at Spinifex Ridge begin in the middle of next year.

Good on the Chinese for finding a great project to invest in at a bargain price. The truth is, Australia has more good mineral and energy projects than the local capital markets can realistically fund (given the preference by the banks for investing in/spruikin property). BHP CEO Marius Kloppers made this point yesterday in a lecture to the Lowy Institute in Sydney.

Kloppers said there are 74 separate resource projects worth $80 billion the advanced stages of planning. Those projects need capital. "'Although clearly not simple," Kloppers said, "a part of the solution lies in continued foreign investment, meaning that both Australia and Australian companies need to be open to this kind of investment, despite its immediate and strategic implications."

What are those "immediate and strategic implications?" Well, up to now, existing Australian shareholders are being clobbered. Those who owned equity in these projects before the credit crunch have been diluted as the firms in question raised money with rights issues or institutional placements.

That's fair enough. Owning shares implies an assumption of risk. The stock market is not a savings account. But the other immediate implication is the transfer of majority ownership of these key projects to overseas owners (including the transfer of a big chunk of income from the assets).

This is what it is. And in most cases, it is not an issue of national security. The truth is, many of these projects won't get off the ground without foreign capital. They will create Australian jobs, export earnings, and share price gains for Australian investors. They will also secure key resources for foreign manufacturers.

There's no sense getting all lathered up about it. The status quo is a result of Australia's status as a net capital importer and the investment decisions made with the money Aussie banks have borrowed. The banks could have chosen to invest in Australian mines. But mining is a risky business.

Is it as risky as property? We don't think so. But the way the Australian property market is currently structured - with the government supporting prices directly through grants and indirectly through miserly land releases, and the banks channeling new lending into the market - it's a rigged game for the banks. Why wouldn't they invest in property? It's certainly in their interest.

Whether there is a national interest at stake in the mining industry is another question. You'd certainly think so, given how much government revenue is derived from royalties and exports. But most state governments and the Federal government seem happy with the current arrangement.

The large producers have an unassailable competitive position. And the smaller explorers and developers are left to their own devices to find capital for their projects. Hey...that's why they call it capitalism!

For investors with the patience to investigate the smaller fry, it's a great market. Our new editor of Diggers and Drillers, Alex Cowie, looks like an insomniac in a coffee shop when he comes to the office each morning. There are literally more good stories than he can possibly research.

The important point is that what might be a national problem - selling of mining projects to foreign investors - is an individual investor's opportunity. You always want to invest where you have an advantage. And as an Aussie resource investor looking at the mid and small caps, you DO have an advantage.

Sure, you may be investing alongside the Chinese, who may be getting a better deal. But there are dozens of smaller projects across the resource spectrum that - as long as the world does not plunge into a second great manufacturing depression - make compelling investment stories.

Murray got back to us with his U.S. dollar index chart. You may recall that the other day we published a chart of the dollar index showing that the short-term and long-term moving averages were in danger of crossing. Murray, a full time technical analyst, basically said our chart looked nice but didn't communicate any useful information to traders about when to enter or exit positions affected by the dollar's decline (or rise).

Murray sent over his chart with a note that begins, "The US dollar index is still in strong downtrend. My last update (to Slipstream readers) said that we needed to keep an eye on the 10 week/35 week Moving Average as the confirmation for any change of trend. Also we needed to see a close above around 81 to confirm a re-entry into the distribution between 78 and 89 formed over the last year."

"None of these indicators are close to being confirmed. So, from a long term perspective, you have to remain bearish the dollar although entry into any short positions is highly risky at this point. Have a look at the chart and you can see that the lowest dotted blue line comes in around a price level of 73 which is close to where we are now."

Click to enlarge

"The meaning of the lower dotted blue line is just that it is an area where a false break can occur. So even though the current price action doesn't look like it is related to the distribution between 78 and 89, it still could be so beware. You can see from the other ranges that I have shown in the chart that a break through the low of the range saw a move to around that lower blue dotted line and then saw a squeeze from there. The first one saw a move all the way back to the top of the range and the second one tried to re-enter its range but ultimately failed.

"The point being, if you had sold down at the lower dotted blue line on either occasion you would have ended up in a difficult position. The market usually looks terrible at those points, but all too often you will see a reversal there which will at least move back to the bottom of the range.

"In this case that would see a move back to 79ish. And from there a re-entry into the range could see a quick move to the point of control at 84 and on to the highs at 90. I think we will see the Dollar create a low somewhere between 67 and 74 and then we will see a big short squeeze to take out traders in what has become a very overcrowded trade.

"Don't get me wrong," he concludes. "I still think the US Dollar is toilet paper, but it doesn't mean it won't buck around like a wild bronco on its way to fiat currency heaven."

Yee haw!

Dan Denning
for The Daily Reckoning Australia

• Australian Recession in the Works? Ask the Sharemarket
• The Dark Underbelly of Australia’s Resource Boom: Chinese Resource Demand
• Australian Iron Ore Shares on China’s Menu
• The Aussie Dollar as a Measure of Global Risk Appetite
• Foreign Investment in Australia, How Much is Too Much?

In today's analog-inspired edition of the Daily Reckoning, we take a big step back and question some of our key arguments over the last three months. Is Australia's banking sector at risk from foreign borrowing? Will Japanese sovereign debt be the first to run into higher rates, triggering a rise in the cost of global capital? And are we wrong about China's fixed asset investment boom? Is it a bubble...or is it paving the way to decades of prosperity?

It's a lot of heavy lifting today. And we did have a quick glance at the markets at home before heading into the office. It doesn't look like anything important happened. So we're going to get tucked into some of these weightier issues and see how they taste.

First, for the last few weeks we've been making the point that Australia's banking sector is vulnerable because it's a large importer of capital. All the booms in the local market - in shares, housing, or commercial real estate - are, to some extent, financed by foreign lenders. Like most foreigners, overseas bankers like what they see from Australia.

Capital flows are good now. The sun is shining and the country is lucky. But if we're right and the strong Aussie dollar is mostly a function of the U.S. dollar carry trade, capital flows can reverse just as quickly. Currency traders probably love this because of the volatility. But the question is: how risky is it for Australia's economy to source so much of its borrowing needs overseas?

Well, until today we've neglected one aspect of that question. When you borrow, you can theoretically borrow in your own currency - a loan denominated in Aussie dollars - or in another currency, say, American dollars. There are risks and advantages to both. America has been able to issue debt in its own currency for years, always paying it back in the same currency. It's been a huge economic advantage (that's probably going away slowly).

The big risk to borrowing in a foreign currency is that you must pay the loan back in the foreign currency too. That's all well and good when exchange rates are stable. Let's say you're an Australian business and you borrow $100,000 in US dollars while the exchange rate is at .94 cents. If the rate stays there, you'll pay back US$100,000 plus interest, but neither nor more nor less in principal.

In fact, if the Aussie dollar appreciates even more against the U.S. dollar (say it goes to parity, or one Aussie dollar buys you one U.S. dollar) then the loan gets cheaper for you pay off. The nominal amount (US$100k) is the same. But because of the exchange rate move, you can buy more U.S. dollars with your stronger Aussie. A move to parity from here, for example, could make your $100k loan about six percent cheaper than you first planned.

But if you borrow in a foreign currency and your own currency weakens against the currency in which you have borrowed, look out! This is what happened in many Eastern European countries over the last five years. The local banks borrowed from larger bank lenders in Western Europe (Austria especially) in order to finance local housing booms (yes, this DOES sound familiar).

When the local currency depreciates against the one in which you've borrowed, paying back the borrowed money gets a lot more expensive. You must somehow raise money in the borrowed currency to pay it back. You can sell things, give up equity, or default altogether in which case the collateral posted for the loan is transferred to the lender. And there's always the possibility that you just throw your hands up in the air, shrug, and say, "Sorry. We're all out of money! Go screw yourself."

That's why having a large percentage of your borrowing denominated in foreign currencies is dangerous. But the larger your demands for capital are (and Australia's are large) and the less you can source new lending from existing deposits (for regulatory and other reasons), then the further abroad you must look to borrow, even if it IS in someone else's currency.

A recent study by the Australian Bureau of Statistics concluded that Australia's total foreign currency debts grew by 130% between 2005 and now. The ABS says the banks have $548 billion in foreign currency debts while "other financial institutions" have $117 billion.

If these borrowings weren't properly hedged, a fall in the Australian dollar would make repaying them more expensive. But, according to the ABS, 95% of the foreign currency borrowings ARE hedged. According to Geoff Winestock in today's Australian Financial Review, "The share of unhedged foreign currency debt is roughly the same as four years ago, even though the total volume of debt has increased."

Whew!

"In many cases," Winestock reports, "the debts are naturally hedged because they have been used to buy income producing assets of shore. Taking this into account, Australia had a large net-positive foreign currency exposure."

How about that? Not only is the rise in foreign currency debt not a problem, it's a good thing! Aussie borrowers have taken that money, the ABS reports, and bought foreign assets that produce income. It's a win-win! What could possibly go wrong?

Well, one interesting fact from the ABS report is that while the debts appear to be properly hedged, the assets are not. For example, Australia has $456.7 billion in foreign equity assets, half of which are denominated in U.S. dollars. The ABS concludes that, "Overall, the reported net exposure of $388.1b appears largely due to equity assets and net foreign currency receipts that are largely unhedged."

Hmm. The only thing we can think of that might go wrong is that assets can fall in value while debts generally do not. Take, for example, collateralised debt obligations and other securitised assets. They are bundles of debt whose value is based on the regular income and principal payments of borrowers. And they never fall in value at all, do they?

Oh wait. Yes. Sometimes assets DO fall in value. Like U.S. houses...and all the securities that derived their value from those houses.

So it comes down to the quality of the assets you get with your borrowed money and how regular the income is. And frankly, we haven't given the assets that much scrutiny yet. It could be that a U.S. dollar rally raises the value of Australia's dollar-denominated stocks, even as it makes paying debts more expensive. That would be the hedging.

But you can colour us a tad skeptical. We've heard plenty of people claim debt was not a problem. We've heard very few claim it was "net positive." And we're not hearing many people show that assets denominated in U.S. dollars and that are unhedged are risky assets.

But maybe we're just being old-fashioned. Is debt really that big a deal? Isn't a bit hysterical to claim, for example, that a sovereign debt crisis is unfolding in the Western Welfare states?

Well, maybe not. Yields on 10-year Japanese government bonds are up 12% since the start of the year. According to Brendon Lau in today's AFR, "The fall in prices and the subsequent rise in yields may reflect worries about the country's deteriorating fiscal position, as government spending is tipped to surpass tax revenue this financial year for the first time since World War II."

Japan's public sector debt-to-GDP ratio is approaching 200%. But the Japanese are no longer saving at the same rate they used to. Granted, the pool of national savings remains high. And the government is hoping the ageing Japanese population will transfer its pension assets to government bonds and continue financing large deficits.

But Lau reports that the Japanese saving rate has fallen from 15% in 1991 to just 2% today. That rainy day everyone was saving up for - or that retirement - is finally here. Japan's own people may not be able to finance the government's large Keynesian deficit. So the country will have to find the money from somewhere else.

Hmm. Britain and America are already shaking down the world's saving nations for more money. Japan may find lenders. But you can be sure that it will cost more money to borrow. Rates will keep rising. Already the five-year credit default swap spread on Japanese bonds has risen 0.75 percentage points.

In other words, the cost of insuring Japanese sovereign debt against default is rising. Japan's CDS spreads now put in the same neighbourhood as Chile and the Czech Republic. By all accounts, Chile and the Czech Republic are nice places to visit and live. Chile sounds like a great place to visit and the Czechs have great beer.

But Japan is the second-largest economy in the world. Its cost of capital is going up. This could be the first sign that the cost of capital is going up all over the world. Higher interest rates are on the way.

That would be a major change. As we showed earlier this week, the cost of capital (like the cost of energy) has been in a long-term downtrend. Cheap money and cheap energy have both fuelled a global boom - a boom in which 2 billion people have been lifted out of poverty and brought into the industrial economy. Nowhere has this been truer than China.

Which brings us to reconsider what we wrote about China yesterday. We wrote that its rates of fixed asset investment were largely driven by political and not economic considerations. China's central planners value stability, and full employment brings stability. Even if factories are cranking out goods Americans can no longer afford (or want) to buy, it keeps people working.

Idle hands do the revolutionary's work.

But Glenn Mumford tells us not to worry. He quotes from a report by Mingchun Sun, the China economist for Nomura International. Sun says that China's current investment boom will prove, "a major milestone in China's economic development." The main claim, though, is China is paving the way for decades of new growth, greater consumption, and more developed domestic economy with rising per capita incomes.

In fact, China might actually be UNDER-investing in fixed assets. "Sun warns that investment demand for capital goods, raw materials and energy could be so strong that some upstream sectors now facing overcapacity may soon experience shortages...[Sun] is forecasting fixed-asset investment in the first-half of 2010 to rise 40%, year-on-year. This would be great news for Australian exporters."

Anything is possible. It certainly IS possible that the China boom is sustainable and getting larger. But it's also possible that the Super Cycle in fiat money is reaching a thunderous climax. And after the boom?

Dan Denning
for The Daily Reckoning Australia

• Aussie Banks Addicted to Foreign Borrowing
• Rally in Stocks and Rise in Aussie Dollar is a Result of the Carry Trade
• Citizens Easily Coerced into Using Government Currency
• An International Currency Not Just on Paper
• IMF Report Concludes Aussie Banks are “Very Sound”…

And counter to our prediction of an imminent, counter-trend U.S. dollar rally, the dollar is most definitely not surging. Take a look at the chart below. We've been writing about the decline of the dollar for nigh on ten years. So we looked at a ten year chart to tally up the damage. It is considerable.

Click to enlarge

What's at stake with the interpretation of this chart? If the dollar rallies on short covering from the dollar carry trade (a BIG if), then other "risk" assets like gold, stocks, and emerging markets would probably sell off. And yes Australian stocks, that includes you. As well as the Aussie dollar.

The chart shows that the index's 50-week moving average is set to cross below its 200-week moving average. That is mixed news. The first time it happened on this chart was back in early 2003. That was the early days of a long decline in the index. The second time, though the move failed to confirm the "flight to safety" rally of 2008 had staying power in 2009.

Once the fear that gripped markets in 2008 went away, the investment world sold the dollar and started borrowing en masse to buy other, higher-yielding currencies and assets (like the Aussie dollar and resource stocks). That's where we are now.

But based on the chart, is the next move down in the dollar index a new low, which the crossing of the long-term MA by the short-term MA would suggest? Or is it a false move? Will the dollar quickly and violently rally for some reason (geopolitical perhaps) that currently remains unknown to the human beings of this world?

"It's an interesting chart," said our technical analyst Murray Dawes. "But it is not useful for timing your moves out of or into trades related to the dollar's movement."

"So you're saying our chart doesn't have any useful information from a trader's perspective?"

"Not really."

Murray promised to show us HIS dollar index chart tomorrow. We'll bring it to you, live and in colour. But in the meantime, we think the one piece of important information communicated by our chart is that the dollar's trend is down. But there IS a catch.

The catch is that when this many people are this uniformly bearish, everyone is probably wrong. Consider this a warning then, that a dollar rally is just the sort of thing that will lead to a correction in the gold price and the stock market. We won't speculate on the sort of things that could lead to a dollar rally. But surely they're out there and sooner or later they'll come.

The other possibility is that the dollar is in its death throes and that this is the big one, in currency terms. That is such a momentous and disastrous event that people consider it both kooky and unlikely, not to mention undesirable to a predictable and comfortable world. But it IS possible.

And do you get the feeling that this kind of manic melt up rally is the sort of irrational frenzy that comes just before everything goes haywire? Haywire is not a precise financial term. So what do we mean?

We meant that the world enjoyed a 20-year economic relationship based on a fundamentally unbalanced global economy. Manufacturing capacity migrated to Asia where wages were lower. For awhile, this was mostly good news in Western countries. Goods got cheaper but jobs didn't vanish.

Now the situation is not so pleasant. The world is awash in manufacturing over-capacity, especially in China. Wage deflation (in the Western world) looks like a long-term trend, leading to a lower standard of living. This wage deflation is occurring at exactly the same time that Western governments are encountering demographic crises of ageing populations.

We all knew the ageing of the Boomers would put pressure on public finances right around now. But no one reckoned on a global financial crisis further saddling the public balance sheet with debt. And no one reckoned that Western wages and incomes would be falling at just the time people needed them most. And no one reckoned that savers would lose the most from low interest rates on fixed income - even though those low rates are keeping the American housing sector on life support.

It's a bit of global impasse. America's needed structural adjustment has come. Households and businesses are reducing debt, trying to live within their means. But the net adjustment to the American balance sheet is not happening because public sector debt is growing so fast.

Meanwhile, the other obvious adjustment is that the Chinese currency ought to be allowed to strengthen. For political and social reasons though, China will not allow this. It means China is actually adding to its industrial over capacity. It is conjuring up the world's largest ever bubble in fixed asset investment, including commercial real estate.

It is easy to see why China is reluctant to allow a stronger Yuan. Exports account for 39% of Chinese GDP. The Chinese economy, and probably the Communist Party itself, cannot survive on unleashed Chinese domestic demand. They need American markets. But American consumers - in addition to reducing debt - are now realising that the focus on finance over manufacturing from American policy makers has worked out for Washington and Wall Street, but not terribly well for the average American worker.

Where do we go from here? How about the blame game. U.S. Treasury Secretary Tim Geithner once blamed the Chinese for being currency manipulators. He back-tracked later. And yesterday, Liu Mingkang, the chairman of the China Banking Regulatory Commission, had a go at America.

"The continuous depreciation in the dollar, and the US government's indication that, in order to resume growth and maintain public confidence, it basically won't raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation." He is blaming the U.S. for fuelling a destabilising global bubble.

Of course that bubble is felt most acutely because China pegs its currency to the dollar. China is right to blame the U.S. for manipulating its currency to try and improve its competitive position. And China is right to worry about the value of its dollar-denominated assets in a world of exploding U.S. debt supply.

But China has put itself in this position. And here we are at the end of 2009 with a world still fundamentally un-adjusted to a new, workable currency arrangement. The world remains burdened by trillions in assets purchased with debt. Those assets linger on bank balance sheets, on government life support but fundamentally lifeless at fictitious book value prices.

And meanwhile, the China-US currency arrangement has fuelled a global bubble. Australia is part of this bubble, too. The question is how it will end. In the U.S., the housing market looms as the Achilles heel of the economy. It could strike households, banks, and the government again in the next 12 months are more mortgages reset at higher rates (with lower home values).

If the event that pops this bubble comes from America, look for the supply of credit to the emerging world to dry up again. And though Australia is not a developing economy, we saw last time what happened when U.S. credit markets imploded. Australian banks had to get a government guarantee to borrow money in the wholesale market.

We'd suggest that lending for residential housing and commercial real estate would take a real dip in Australia on another U.S. housing crisis (even if Aussie banks aren't exposed to actual U.S. housing-backed RMBS and CDOs. You don't have to own toxic debt to be impacted by it.

If the bubble pricking comes from China, what then? Well, China does everything big. So a Chinese bust would be world-class. It's a subject that requires its own Daily Reckoning. More tomorrow.

Dan Denning
for The Daily Reckoning Australia

• CRB Index Correction Likely to Go Further
• U.S. Markets Could Rally on Oil Price Decline
• Price of Gold Communicates U.S. Monetary and Fiscal Policy is Lousy
• The Aussie Dollar as a Measure of Global Risk Appetite
• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike

That's fantastic! Just 18 more months before we can put all of this behind us. Why didn't they aim to overcome the crisis a year ago? Oh well. Better late than never.

Of course, it is possible the leaders of the APEC nations have no idea what to do, and certainly don't agree on how to manage their currencies. The Journal reports that everyone is badgering the Americans and the Chinese to quit their cozy currency arrangement. America has effectively devalued the dollar with low interest rates, and the Chinese have matched the devaluation because of the semi-formal currency peg.

The results is a global race to the bottom, otherwise known as competitive currency devaluation. Exporting nations must mimic the Fed and keep rates low (or sell their own currencies and buy dollars) to stay competitive. It suits China and America for different reasons.

America's weak dollar hasn't exactly helped exports like everyone expected. In fact, the trade deficit widened last month on a weaker dollar, mostly due to huge oil imports. But as long as U.S. interest rates are kept low, the housing market will not implode. The weak dollar suits the Fed.

And a weak Yuan suits the Chinese for now. They remain the world's low cost producers. And their goods get even cheaper when the Yuan declines with the dollar. More market share is good for Chinese producers. But it doesn't make any other exporters trying to compete in manufactured or consumer goods very happy. About the only people, or metal, made happy by the current state of affairs is gold.

The weekend edition of the Australian Financial Review has gold on the cover, incidentally. You can see a picture of it a few paragraphs down. Underneath the giant golden letters it reads, "Why you shouldn't laugh about gold hitting $US2000 an oz." But if anyone's laughing, it's a nervous laughter.

Why? Well, the fact that the gold made the cover of the AFR confirmed our view that it was an excellent month to research uranium stocks. That's just what Diggers and Drillers editor Alex Cowie did. He published his first report as the full-time editor of Diggers and Drillers on Friday. It was on uranium, including one specific recommendation.

We talked with Alex about whether to write about gold this month or uranium. Trouble is, he'd already written about gold in October. We've been getting a lot of questions here at the DR about gold. The gold price is making new highs in U.S. dollars ($1,123.40 in the futures market last week), but hasn't carried over into Aussie dollar.

The strong Aussie dollar has capped the Aussie gold price for now. You can read what Alex has to say about it here. The short version, though, is that Aussie investors looking for leverage to higher gold prices ought to look at producers who incur cash production costs in U.S. dollars. This keeps costs under control, but ought to benefit share prices (all things being equal) if gold continues to make new highs.

November 2009	Winter 2006
Source: The Australian Financial Review	Source: Diggers and Drillers

By the way, a report predicting $2,000 gold was the very first letter we mailed when we began our financial publishing business in 2006. The prediction seemed a bit crazy back then. And truth be told, the report bombed. That is, very few readers took us up on the offer to subscribe to Diggers and Drillers and see what else we had to say about gold stocks and the resource industry.

And to be fair, the prediction hasn't come true...yet. Most Aussie gold stocks have lagged the move in bullion prices. And some people still think that gold itself as a genuine asset class is a crazy idea.

The author of the AFR's piece, Robert Guy, is grudging in his recognition of gold's recent performance: "Often dismissed as cranks and conspiracy theorists, true believers may have found vindication in gold's record-breaking run, which has underscored the migration of the mainstream to the long-held world view of these fringe dwellers."

And then he can't help himself. "Gold bugs' dystopian vision of debased currencies, enfeebled banks, debt-burdened governments resorting to the printing press, coupled with the menacing spectre of inflation, presents a worrying analogue to reality," he adds.

An 'analogue to reality'? Last we checked, all those things Guy mentions weren't just prophetic visions. They ARE reality. The real vision - in the sense of a something that appears in fevered recesses of the mind but has no existence in the physical world - is that government-led efforts to revive the economy by taking on more debt have actually worked and that everything is getting better and better.

But then, the idea that investors who buy gold are crazed believers is a convenient way of dismissing monetary history. Close your eyes and pretend everything is all right!

To understand the investment benefits of gold, you don't have to "believe" in gold in the way that, say, you have to believe in the Virgin birth or the resurrection to call yourself a Christian. You just have to understand how gold has always been part of a sound money system and how it promotes responsible government and personal liberty. It is not an act of faith. It's a rational conclusion.

Further, gold's physical attributes - durability, divisibility, transportability, relatively scarcity, and its sameness in all places - make it such a useful medium of exchange. To the extent that those qualities make for really useful money, gold does have an inherent value. Gold is very good money, which is why it's being remonetised after years in the Keynesian wilderness.

But we've written so much about gold in the past you are probably sick to death of it. So we'll conclude with two points. A sovereign debt crisis is brewing because Western Welfare states refuse to live within their means and are increasing public sector debt. This makes their currencies dangerous to own and their bonds subject to default. At the very least, most paper currencies face major devaluations.

The second point is that gold bullion is not a panacea for the problem of fiat currencies. It's a good start. But if you think the monetary world will somehow muddle through, then gold stocks give you leverage to a higher gold price. As eye-catching as gold's recent gains have been, we reckon most investors haven't begun to stock up and gold.

While the easy money in gold has been made, the big money has yet to be made.

All that said, we think Alex's timing on uranium is good. Turning to your attention to those asset classes that no one wants to touch is hard to do. For one, you have to be conscious that what everyone is talking about is either fully priced or over-priced. Secondly, it takes some courage to step into a market that everyone hates, or finds so uninteresting that it's not worth the time.

Granted, uranium does not exactly constitute a hated asset. But it hasn't been in the limelight lately, has it? There was a small story in this weekend's Australian, though. Energy Resources Australia's CEO Rob Atkinson says the pieces are in place for a uranium shortage down the track.

He cited three factors. First, the GFC cut off the capital for new mine development. This happened with oil and gold, too, both of which were facing production peaks anyway. But in the uranium industry, you've had major interruptions of mine supply from two sources that were expected to be a lot more productive, BHP's Olympic Dam and Cameco's Cigar Lake mine.

On the demand side is the resurgence in the world's fleet of nuclear reactors, which use uranium as fuel. Of course nuclear power remains controversial in some places (like Australia) even as it figures prominently as part of the energy portfolio in other places (like China and India).

No matter how you "feel" about it, it's pretty likely that nuclear will emerge as the clear winner as an alternative to hydrocarbons. Who knows what kind of madness the world's leaders will agree to. The idea that the world can give up burning coal and still maintain a comfortable standard of living is belly-laughable.

But even if next month's climate change summit in Copenhagen fails to produce a breakthrough (and it already looks like that may be the case), uranium should come out of the summit...er...glowing. And don't get us started on that summit. We've heard the interviews and read the articles. It does indeed look like a massive power grab. But that is a subject for another day.

As an investment issue, uranium stocks present better value right now than some other commodity stocks. One reason is that prices in the spot uranium market have trended between US$40 and US$50 all year. They soared to US$140 along with oil in 2007, but have since fallen, stabilised, and consolidated.

In other words, uranium is one of the assets to resist the rising tide of global liquidity. That doesn't mean it's coiled like a spring and will inevitably rise. But there are some good reasons to take a closer look at it now. And Alex pointed out an important fact in his November article: future uranium producers will have to produce above a certain number of pounds per year for at least ten years in order to enter into agreements with the utility companies that buy uranium for fuel.

That means that not just any explorer or developer is going to win the uranium sweepstakes if prices begin to rise in the spot market. And, of course, if global GDP and industrial production again collapse because of a second credit crisis, demand for electricity - including future projections - will go down. Maybe the world will build fewer nuclear reactors than planned, needing less uranium than expected.

Dan Denning
for The Daily Reckoning Australia

• AUD Price of Gold a Measure of Gold’s Strength Against Other Currencies
• Good Month for Aussie Stocks, While U.S. Stocks Fell to Close the Quarter
• Uranium: A Carbon-friendly Substitute for Coal
• Thorium as a Nuclear Fuel
• Uranium and Gold Exploration Spending Both Down in Last Year

Then on Tuesday the market snapped up $25 billion in ten-year notes and yields fell. Sovereign debt? Big whoop! Whether it's the end of the year and investors feel safer in Treasuries, or some other reason, Tuesday's auction showed no signs of an impending "bond fire of the vanities." The bond bubble keeps getting bigger.

Today, though, the market gagged. In an effort to lock-in low rates for longer terms, the Treasury served up $16 billion in 30-year bonds. The market turned sour. Reuter's reports that demand for the 30-year was the weakest since May and that yields moved up as the weak auction triggered selling.

And then everyone seemed to lose their nerve. Stocks fell across the board. Gold set a new high at $1,123.40 in New York trading, before retreating. The weak 30-year auction has people thinking...what happens when Treasury supply overwhelms demand?

What will happen to bond prices then? To inflation? What should I do?

The rest of today's Daily Reckoning will be devoted to some constructive apocalysm. We may have left the impression yesterday that there was nothing but pain and heartache ahead for investors. But that doesn't have to be the case. But you have to start with the big picture. And that begins with the end of the bull market in bonds.

Check out the chart below from Ron Greiss at the www.thechartstore.com. Ron's chart shows long-term U.S. bond yields since 1941. Mostly this reflects the yield on 30-year bonds, although there were periods where 30-year issuance was discontinued. Either way, it shows a great cycle...which appears to be bottoming out.

What story does this chart tell? We reckon it shows you why the U.S. government (and so many banks and borrowers) are eager to sell as much debt now as possible. Rates are near historic lows. If and when they go up, it's going to make borrowing and servicing new debt even more expensive. Bond prices will fall and yields will rise again.

Now you could say that, according to the chart, there is room for another decade of low yields. The Fed, for example, could move to set rates further out on the yield-curve. It only sets rates right now for short-term debt. But the quantitative easing program has moved the Fed out to ten-year yields. It's done this to try and keep mortgage rates low, as mortgage-rates are keyed to U.S. ten-year yields.

But we reckon not even the Fed can keep yields low forever by supporting prices. It will have to wind down its programs eventually. For example, the U.S. government ran its largest October deficit ever last month, at $176 billion. Between demographics and existing debt, the Fed may not have the resources to support bond prices too.

Besides, you'd think markets would begin to tire of U.S. debt, given the lousy fiscal position of the American government. At least that's what we'd think. And if we were trading it, we'd look for put options on ETFs that track bond prices, or call options on ETFs that track bond yields. That would be the cheap trade.

The investment decision is to find assets that out run inflation as bond yields move up. Granted, this assumes there is going to be inflation, which is a whole other argument. But if you'll grant us the assumption, we'll continue with the strategy...of finding assets that beat inflation.

You don't have to look far. Gold...oil...iron ore...tangible assets are what you're after. Does this conflict a bit with our analysis yesterday that China's resource demand is more fragile than reported? Yes, it does. But it still pays to focus on those resources that will be in demand no matter how bad the global economy gets again. What do nation states really want to own? What can they not do without?

You know they can't do without oil. And you know more and more of them prefer to own at least some gold rather than rapidly devaluing foreign currencies. That leaves us where we began, buying oil and gold and selling U.S. sovereign debt. Production of the first two is hard to increase. Supply of the last one is growing.

"There is a strong case to be made that we are already at 'peak gold'," Barrick's Aaron Regent told London's The Daily Telegraph today. Regent was speaking at RBC's annual gold conference in London. "Production peaked around 2000 and it has been in decline ever since, and we forecast that decline to continue. It is increasingly difficult to find ore."

Gold exploration budgets are up. But with the exception of China, gold production from traditional stalwarts like South Africa and Australia has trended down. Alex Cowie at Diggers and Drillers recently wrote a report suggesting that the best Aussie gold stories are listed here in Australia but digging for gold in Africa, where they incur production costs in U.S. dollars and where there are more greenfield projects than recycled brownfield projects.

Frankly, we have no idea if gold production has peaked. Mine supply could grow this year for all we know. But finding and mining gold is not easy and it's not cheap. And even if the gold supply does grow, we'd take it to the bank that the global gold supply will not grow faster than global money supply.

And oil? Any scenario in which an economic collapse leads to falling GDP ought to mean lower demand for oil and lower oil prices. But the case for oil is not really about the demand side. You reckon that's bound to grow over time anyway, unless someone comes up with table top cold fusion. The real oil bull story is on the supply side.

Earlier this week the U.K.'s Guardian reported that, "The world is much closer to running out of oil than official estimates admit, according to a whistleblower at the International Energy Agency who claims it has been deliberately underplaying a looming shortage for fear of triggering panic buying."

" 'The IEA in 2005 was predicting oil supplies could rise as high as 120m barrels a day by 2030 although it was forced to reduce this gradually to 116m and then 105m last year,' said the IEA source, who was unwilling to be identified for fear of reprisals inside the industry. 'The 120m figure always was nonsense but even today's number is much higher than can be justified and the IEA knows this.'"

We remember writing about the IEA figure a few years ago. And we remember pointing out that producing 120 million barrels of oil per day would be a 44% increase on producing 83 million barrels per day. And you'd have to find that oil first. You'd have to explore, drill, and produce it. And you'd have to maintain existing production levels at the world's big elephant fields like Cantarell and Ghawar.

In point of fact, production at Cantarell has fallen by 25% since 2004. Energy expert Matthew Simmons says Mexico's days as an oil exporter will end in 18 to 36 months. This makes Mexico's government-which derives 40% of its revenues from oil sales-the most likely candidate for "next failed state."

By the way, if you think illegal immigration is problem in America now (and it is), imagine what would happen if the finances of the Mexican state imploded with a production catastrophe at Cantarell. The Obama administration would face another crisis, but this one right on its massive southern border.

Not everyone believes in Peak Oil. But it's not really a matter of faith. Either oil production is declining or it is not. It does not mean there isn't any oil left. In fact, technology has lengthened the life of productive fields. And technology has also made it possible to find and produce oil in increasingly hostile environments (deep water drilling, the Arctic, etc.)

Even rank and file petroleum geologists are mostly in agreement (and sometimes in disagreement with their corporate overlords) that Peak Oil is real and it's here now. But we make this point not to say that all is lost. It isn't. It's just the great changes in the world are afoot.

You have a secular bond bull that's long in the tooth. The post-war monetary system that supported the expansion of the fiscal welfare state through perpetual debt is failing. Energy, which has been getting cheaper and cheaper for years as we found more and more of it, may start becoming more expensive and harder to find.

That's going to make the world a slightly less friendly place. But for investors, there are heaps of opportunities. For example, right now Alex is looking at what the fallout from next month's Copenhagen summit is. It has opened the door to a great entry point for energy investments, but not necessarily oil. Fear not! Or fear a little. But prepare.

Dan Denning
for The Daily Reckoning Australia

• Attack of the Bond Yields
• Central Bankers Encourage Debt Booms That Become Debt Bombs
• U.S. Bond Prices Rose and Yields Fell
• Higher Oil Prices, the New Normal
• Choking on Debt in the Unfolding Anglo-Saxon Bond Crisis

Why this three part thought experiment? Well, just because our analysts are in agreement that the cautious way forward is to surf the liquidity in the markets higher, your editor is, at heart, a massive worry wart. Plus, all these disaster movies about the end of the world must be affecting our state of mind, or amplifying its natural tendencies.

We're always worried about the worst-case scenario, always thinking of the things that could go wrong. This just seems like a prudent way to prepare. It will be better if these things don't happen. But let's just assume they will and work backward from there. And then let's figure out what you can do - if anything - to avoid getting wiped out again, and maybe even making a buck or two on it.

First cab off the rank is the total implosion of the Chinese economy. This might be bearish for Aussie resource stocks. But how likely is it to happen?

Well, not very likely if all you were looking at is the raft of official data released this week. Retail sales in China were up 16.2%. Industrial output was up 16.1%. And exports, even though they were down 13.8% in October, decreased at the lowest rate in ten months. Fixed asset investment for the year is up 33.1% over last year's pace.

You could take all of these as signs that China is leading the world to recovery and managing itself quite well. It should achieve 8% GDP growth. That's the growth rate that China's economic planners reckon the country must achieve to maintain high unemployment. And high employment rates promote political stability - valued above all else by a regime that makes free market gestures but still is run by old school communists.

What's more, if you take up the question we asked a few weeks ago - when is it in China's interests to allow its currency to strengthen - the answer is starting to emerge: when a stronger currency keeps inflation in check. China's currency managers are making noise about letting the Yuan strengthen against the dollar.

But it's not to please Barack Obama, who visits Beijing this month. A stronger Yuan, among other things, gives Chinese consumers more purchasing power. That might slowly reduce the contribution exports make to Chinese GDP (and to forex reserves which are then recycled into U.S. Treasuries.

Or it could all fall apart more quickly than anyone expected. Why?

China has massive over capacity in steel and cement. Granted, these two materials are quite literally the building blocks of industrial society. But according to Bill Powell in Fortune Magazine, China has enough spare production capacity in the cement industry to meet annual cement demand from India, Japan, and the U.S....combined!

This fact would be consistent with a country that's massively over-investing in fixed assets to achieve high rates of employment. And then there's steel. China's own National Development and Reform Commission says the country will have 250 million tonnes of excess steel production capacity by the end of next year.

Chinese steel production is approaching 600 million tonnes per year. But its current demand is around 350 million tonnes. That means it's either planning to put the rest of the world's steel makers out of business by dumping cheap steel on to global markets...or there is massive overcapacity and inefficiency in the steel sector.

Either way, it's probably a good idea to consider the possibility that China's investment binge is more fragile than it looks. In short, the bear case on China is that, "the Chinese have dangerously overheated their economy, building malls, luxury stores and infrastructure for which there is almost no demand, and that the entire system is teetering toward collapse."

Naturally this would be bad for Australia, whose economy is lately coupled with China's prosperity. It would argue for reducing your allocation to common stocks, raising your cash position, and not taking the China growth story at face value.

Next cab off the rank is global rush to refinance debt while interest rates low. Moody's reports that there is $10 trillion of bank debt maturing between now and the end of 2015. What's more, the average maturity of bank debt fell from 7.2 years to 4.7 years over the last five years.

This means bank debt (like sovereign debt, especially in the U.S.) is getting more interest rate sensitive. Not only do banks have to roll over a lot of debt in the coming years, they may have to do so at higher rates (assuming they can find takers for it.) Moody's is not confident.

In a research note published to clients, and also on the FT's Alphaville blog, Moody's analysts wrote that, "credit costs should continue to put banks' earnings and profitability under considerable pressure, which might cause investors to seek additional risk premia, as governments gradually exit from the direct support they have so far provided. In other words, we see weaknesses on both sides of the balance sheet, and we are concerned that the risks associated with both assets and liabilities may fuel each other, cause losses and undermine investor confidence."

Even if you concede that Moody's might be overly-dire now to make up for its non-existent warnings about the risk of sub-prime related debt, you have to take the warning seriously. In fact, in a report released last weekend, the IMF said banks were not out of the woods yet at all and remained at risk.

Its analysts wrote that, "Banking systems remain undercapitalized, suffering from impaired legacy assets and, increasingly, non-performing loans. Deleveraging pressures will likely remain a constraint on bank credit for some time. Activity in securitization markets remains dependent on public sector support. Moreover, large public interventions have transferred risk to sovereign balance sheets, raising market concerns that have abated somewhat recently."

We'll get to the sovereign balance sheets in a second. But in your financial disaster preparations, spare a thought for the banks. Serious problems remain. And if you're looking for where risk resides in the financial system today - the next AIG, or Mrs. O'Leary's cow if you prefer - you might not have to look any further than the banks.

But as the IMF noted, a great deal of private sector risk has been transferred to the public sector via bailouts, loan guarantees, and other schemes. This exposes sovereign borrowers like the U.S. and the UK to interest rate shocks (increased borrowing and debt service costs). But more importantly, these countries already faced fiscal dilemmas with ageing populations.

There is not much detail to add to this point. We've covered it before. But it's the best reason to own gold and tangible assets (your house, vodka, cigarettes). All the world's paper currencies are drowning under a sea of public sector debt that's becoming increasingly unsustainable. And this has happened at just the point where the Western welfare states will begin spending more money on caring for ageing populations.

Where will the money come from? Between a China meltdown, a bank implosion, and the rising risk of sovereign debt default, there are at least three known unknowns that worry us right now. And don't even get us started on the unknown unknowns.

Dan Denning
for The Daily Reckoning Australia

• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike
• Chinese Economy Seems to be Growing
• Australian Iron Ore Shares on China’s Menu
• Chinese Surge in Construction Explains Pickup in Base Metals Stocks
• China Performs a Kind of Financial Alchemy

But here is where the world of super collides with the world of the credit crunch. Aussie corporate bond issuance has increased as access to foreign bank loans tightened up in the last two years. Domestic savings (in the banks) may be inadequate to fund the country's credit requirements. But if borrowers could siphon off a bit of the super money...that would be the ticket.

It's this whole issue of Australia still being a net importer of capital. It's a major economic vulnerability. And there are some bankers who are already looking for a way around it. In today's Age we read that, "Commonwealth Bank of Australia Ltd (CBA) group treasurer Lyn Cobley said there was a place for the government to mandate more superannuation savings to stay in Australia to fund some of the lending that was now funded from offshore."

Let us deconstruct. Super is compulsory. Now CBA (or one of its officers) has broached the idea that compulsory super money be compelled to invest in corporate bonds." Not much choice there for you, is there? Your money being taken away and being made to invest in assets not of your choosing.

All of that as a solution to the worst two years of super performance in memory? In today's essay, Kris Sayce shows why now is not the time to be complacent about super. Even if this year's rally has erased some of the sting from the last two years, there are a lot of good reasons to fundamentally reconsider your relationship to super.

Or you could take up Texas Hold 'Em poker. Joe Cada, a 21-year old college dropout from Detroit won the World Series of Poker (and $8.5 million) yesterday...with a pair of nines! A pair of nines?!

Cada's story is a great American vignette. News reports say he is the son of an out of work auto-parts design engineer. His mother deals black jack at the Motor City Casino in Detroit. Cada is the youngest winner in the history of the tournament, and beat a logger from Maryland and a Frenchman in a fourteen and a half hour final session. He went all in on the last hand.

It's great for Cada. It sounds like he's a pretty good poker player. But it may not be so great for America that the only way a young man from Detroit can make it big in the United States is to win a poker tournament in Las Vegas.

Dan Denning
for The Daily Reckoning Australia

• Your Average Australian Super Fund
• Is Kevin Rudd Planning to Steal Your Superannuation and Bankrupt Your Retirement?
• A Look at Debt and Super
• Actively Managed Superannuation Funds Have Not Had a Stellar Few Years
• Attention Dr. Ken Henry: Government Could Make Employee Voluntary Contributions Compulsory

But the proper question - if you're sitting on the fence about this move - is how broad the rally is. Are all stocks rallying? The other day, 29 of the 30 Dow components were up. Kraft was not. By the way, Kraft has gone hostile in its bid for Cadbury. This partly explains why its shares were down.

When a company makes a takeover bid, what usually happens is that the bid places a premium on the shares of the company being sought. Those shares rise.

The shares of the seeker (in this case Kraft) often fall. There's a whole school of trading (and even some hedge funds we've heard about) who arbitrage like this on takeovers. They buy the shares of the company being acquired and sell the shares of the acquirer.

That seems like a lot of work, even though it might turn a profit. You could hardly call it a long-term wealth building strategy. Anyway it's certainly not the same as looking for capital efficiency or firms with high net tangible assets selling at a discount. It's a trading strategy.

But then, that brings us back to the question. Is this a trader's market or an investor's market? One way of knowing what's really going on is looking at measures of breadth and volume. A big day in a small number of stocks can move a whole index higher. But that doesn't tell you how most stocks are travelling. So how are they travelling?

Have a look the chart below, and especially the lower part. The top part is the S&P ASX/200 over the last year. You see the market within kissing distance of a new 52-week high. But how broad is the participation? That's what the advance/decline line below shows you.

Bigcharts.com says, "The Breadth Advance/Decline Indicator is the number of advancing issues divided by the total number of both advancing and declining issues. Readings above 0.5 are considered 'bullish' while readings below 0.5 are considered 'bearish.'"

By that definition, the market action would look pretty bullish. But it also looks like the a/d ratio is just as about as high as it has been at any time in the last twelve months. And each time it is neared .75, a big correction has followed. Hmmn.

We asked our technical wizard Murray Dawes to tell us how broad the participation is in the Aussie market rally. Is it just the banks and the miners, or is everyone getting in on the action? Stay tuned for his report. And incidentally, yes, the charter offer on Slipstream Trader has now expired. But that doesn't mean membership is closed. For details, go here.

Dan Denning
for The Daily Reckoning Australia

• Discussing the Dreaded Fibonacci Retracement
• Trading Airline Stocks in an Energy Bull Market
• Your Second Chance to Escape the Bear Market
• Big Difference Between Stark News in Job Market and Behaviour of Stock Market
• Most Commodities Are in a Bull Market Today

"So what you're saying is that if the Fed leaves rates low, the market basically has permission to rally to new highs, even if they have no basis in projected earnings and stretch valuations even further?"

This was the question we put to our editorial roundtable yesterday. Kris Sayce, Murray Dawes, Alex Cowie, and Shae Smith were all there. The office was hot and sweaty. The air conditioners broke under Melbourne's mild heat wave. But everyone at the table seemed to be in agreement: the Fed has put a rocket under the market.

The conclusion is important to your investment strategy for the rest of this year and probably through half of 2010. The Fed is giving traders as much fuel as they'd like - via low rates - to borrow low and invest high (high yielding assets). The conclusion of the traders, the small cap guys, and the resource guys and gals in our office is that the whole market is going to float higher on a sea of liquidity.

That's just what happened yesterday in New York. The Dow rose over 2% to reach a new 2009 high. The S&P 500 was up 2.2%. And tangible assets like gold and oil surfed higher too. Only the sorry old excuse for a currency, the U.S. dollar, was lower.

Tactically, the editors here at the moon factory reckon that the way forward is up. But it's a dangerous journey. Valuations in a credit boom go out the door. If you participate in this kind of move, you have to be aware that it's liquidity driven (the Fed's liquidity) and not anything else. All the editors agreed to ride it with their open positions, but to initiate trailing stops in all the positions.

Why? The reversals - and they always come - can be brutal. A trailing stop locks in at least some of your gains. So here's a free piece of advice today: set some mental trailing stops on your open positions. No sense in not profiting from a good rally if you are in the market.

If you're not in the market, is now the time to jump in? Will you miss an even bigger upside by staying cautious? Probably. But we reckon that in the longer-term you're better off using moves like this to reduce your allocations to stocks. Sell into strength and get out while the getting is good.

Of course that's a pretty bearish view, not held (or spoken very loudly these days) by too many people. The conventional wisdom is that the stock market really is telling us that the economy is on the verge of a big breakout next year. And besides, stock rallies are always driven by liquidity.

The unconventional wisdom is that the Fed has learned nothing from the last bubble - or is so scared of deflation it's willing to gamble on another bubble in asset prices. The trouble , the eventual bust in asset prices has to be reckoned up. And the Fed, along with all central banks who key off the Fed's policy, are just kicking the can down the road, hoping asset values improve.

But stocks are not engaged in this debate. They are moving up nicely. One sign of a toppy market is an acquisition where the big fish try and eat each other (as opposed to dining on the little, more manageable fish). Yesterday AMP made a $12 billion bid for AXA. That's about all we have to say about that, almost.

Late yesterday afternoon, Kris Sayce sent out a note to Australian Wealth Gameplan readers advising to take a 37% gross profit and sell AXA (ASX:AXA) shares. He recommended the stock as an income play back in June - when we launched the super, income, and safety-focussed letter (as a companion and counterpart to the small cap letter).

Why sell a stock that's giving you capital gains as well as income?

"It's like getting nine months of income in one day," Kris reckoned. And that sounded about right. There will be other higher-yielding stocks on the market (and probably with less risk). Kris isn't changing the income strategy for AWG. But it is a good example of how you can use rallies like this to take profits on existing positions and gradually re-allocate your assets to a longer-term plan.

And speaking of super, the pressure seems to be mounting on the funds management industry to change its compensation model. That will tend to happen when you have two consecutive years of losses and charge people for the privilege. This exposes in plain sight the fact that most funds simply mimic the market (because most funds own the same big cap stocks). When the market drops, the funds go down.

Boom goes the dynamite!

"The reality of a rising market is that many managers generate large fees from general market growth rather than actually delivering out-performance for clients," wrote Frontier Investment Consulting's CEO Fiona Trafford-Walker, quoted in today's Australian Financial Review, under the category of "Gee, you don't say?"

But what's bad for the funds management industry - and end to management fees based on compulsory super contributions - is probably a good thing for investors. We say probably because most investors are lazy and don't want to actively manage their money. It involves thinking, and that competes with watching television, going to the beach, and pruning the hibiscus plants.

For those that do see this as the chance of a lifetime to take more control of super AND get better performance, it means fund managers will have work a bit harder, not just for their money. But for you. And obviously this is good news for the good funds managers. They'll get more business.

And what would a good funds manager recommend right now? Well, we're not running anyone's super. In fact, as an American we don't even have a super fund here in Australia. But we are doing exactly what we recommend to readers anyway: building a position in gold when prices look cheap and being very selective about how many and which stocks to own for this market.

By "this market," we mean one where it looks like another monster low-rate-rally....exactly the sort that preceded the all-time highs in 2007 - right before the reckoning. Once more into the breach...

By the way, we're trying out a new name for our newish offices, "the moon factory." It turns out the building we are now in is an example of Edwardian Freestyle architecture. What's more, historical records show the building has a name. It's called Thalassa.

Wikipedia tells us that Thalassa may be a primordial Greek goddess of the sea, and also a moon of the planet Neptune. The moon options just felt more appropriate than...writing as a primordial Greek goddess of the Sea. That might be interesting too, but what happens in St. Kilda should probably stay in St. Kilda.

Finally, you know you've had a good night when your dinner companion says "Waiter, could we have the cheque and another bottle of wine please?" Former Rude Awakening editor and current US DR editor Joel Bowman was in Melbourne last night with his lovely partner Anya. We joined them for dinner at Fed Square looking over the Yarra, although they had to catch a late flight back to Taiwan, hence the unusual request.

Joel is an Aussie living abroad, while your editor is an American living in Australia. We compare expatriate notes from time to time and talk about the market. We both agreed that the world is an exciting place with lots of opportunity, but probably with more risk than every day Australian and Americans are used to, or, in most cases, financially prepared for.

That's changing. For Australia, it seems to be a positive change. There are lots of income and capital gains opportunities in the Aussie stock market, although being coupled to the Chinese economy certainly has its own set of risks for the next few decades. And there is always the risk that Australia's current prosperity is largely a function of reflated asset bubbles, and thus just as vulnerable as last time (2007).

For Americans, the change is not so positive. The U.S. dollar is a secular decline, yet the American political establishment refuses to accept the fact that nation's finances are in massive disarray. They are either in denial, or just exceptionally stupid, even for politicians. Not surprisingly, their sense of entitlement knows no bounds.

They believe they will be able to keep borrowing from foreign creditors to enjoy a high standard of living. This is the same as saying that the social promises fulfilled with other people's money really are non-negotiable. This isn't high-minded. It's childish.

From our time abroad, we'd say that day of reckoning - where the world's up and coming populations subsidise American consumerism - is upon of us. Has been since 2000 really, when gold became the trade of the decade. The decade isn't quite over yet, and neither is gold's run. But we have a feeling the political, economic, and even military aftershocks from the dollar's decline are just beginning.

Dan Denning
for The Daily Reckoning Australia

• Your Average Australian Super Fund
• Your Actively Managed Superannuation Fund Cannot Beat the Market
• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?
• Superannuation Raiding Party Being Formed II
• Is Kevin Rudd Planning to Steal Your Superannuation and Bankrupt Your Retirement?