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?

About twenty minutes later we found ourselves tucked away in Café Paradis reading about the latest deep-water oil find off the coast of West Africa. The positive drilling results in the Venus well off the coast of Sierra Leone are not far from the Jubilee field Ghana, which is Africa's largest deep-water oil field. It could be, so the experts say, the next big off-shore oil bonanza.

Jubilee...Venus...there's an air of love and triumph in the oil exploration business now, isn't there? At least off the coast of Africa, which, if you don't mind political risk, is one of the great prospective areas for oil in the world. The oil is probably there. But you'll just have to accept the risk that comes from operating in that part of the world.

As an aside, we wonder if there's really any more political risk to operating an oil business in Africa than, say, buying U.S. Treasury bonds from a bankrupt government that's increasing its deficit spending as we speak. Risk is risk, even if it's dressed up in a nice fancy greenback with a respectable looking dead president on it.

Later when we got back to our hotel we managed to see that Woodside Petroleum is involved in the Venus well. Woodside's Sydney-listed share was up just over 1.5% in Thursday trading. The company isn't yet at a 52-week high. But it's moving.

If he were here, we'd ask Lord Swarm where the Slipstream would take us if we tucked in behind WPL at just this moment.

The other Aussie story that we spilled coffee on while scanning our bleary eyes over the pink pages was that BHP says China's recovery is going to make steel demand, "soar." "BHP Billiton yesterday predicted global steel demand would double over the next 15 years as the world's biggest mining group said the 'upswing' already evident in China would be followed by a rebound in growth from developed nations in 2010."

Airplanes ARE kind of time machines. But after reading this story your editor wondered if he had been transported back to 2003. That's when we last lived in Paris and first felt our first flush of desire at learning of BHP's exposure to the China story. It certainly was a torrid three next years.

But is the story as good now-or even better-nearly six years on? We'll have to sleep on it and get back to you on Monday, once the jet lag subsides. Until then, we'll expect stocks, oil, and gold to keep marching up. That seems like what they want to do right now.

Paris on Thursday was colder than Melbourne when we left on Wednesday. How disappointing. And even the old neighbourhood had fallen on harder times. The bakery where we used to buy our breakfast pastry on Rue St. Martin has been replaced by a Subway Sandwich Shop. A Starbucks is nearby.

But the real surprise is that the scaffolding has finally come off the Tour St. Jacques off the Rue de Rivoli. For all we know this could have happened years ago. It's been several since we were in Paris. But for all the time we were here, the old tower was shrouded in scaffolding as it was being restored. Today, in the grey gloom, it looked just like we thought it would: a big stone tower with lots of carvings on it.

We'll have a closer look tomorrow. And get back to you on what Australia looks like from France. Until then...

Dan Denning
for The Daily Reckoning Australia

• The Offshore Drilling Boom Creates Demand for Infrastructure
• Water Usage by Big Companies
• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike
• Riding the Bear & Deep Drilling in Australia
• Peak Oil – The Rewards

Well just a day after highlighting the size and scope of the Gorgon LNG project in Western Australia, we have news that it really is a big deal. It is so big, in fact, that Martin Ferguson, the Federal Minister for Energy and Resources, said Australia is emerging as an "energy superpower."

Shazzam!

Ferguson was in Beijing last night to sign a deal sending $50 billion worth of Gorgon gas to China over the next twenty years. Exxon Mobil will sell the gas to PetroChina and the Australian government will siphon off as much as $40 billion in tax and royalty revenues over the life of the project.

China gets energy. Exxon gets profit. Australia gets jobs and revenue. Investors get a whole new industry to play with.

Mind you, this comes after the Gorgon consortium agreed to sell $25 billion worth of gas to India over the next 20 years as well. The deals are truly flowing. And there could be more. "As well as Gorgon and Woodside, there is the Sunrise project in the Timor Sea," Ferguson says. He's right. In fact, there are four major LNG zones in Australia.

Back in April we wrote this in a weekly update to Diggers and Drillers subscribers, "The other three major areas of LNG development are the Browse Basin (off the Kimberley Coast), Darwin (for LNG from the Timor Sea), and Gladstone in Queensland (the proposed terminal for export of coal-seam-methane projects in the Bowen and Surat basins). Under the Howard Government, Australia had as ambition the production of 60 million tonnes of LNG per year for export (mtpa). The current capacity of the four regions, according to industry analyst David Wood is more like 90mtpa. That would be more than half of current global production of 175mtpa."

Some of those regions are considered "conventional" LNG zones. Others, like the coal-seam-methane district in Queensland, are "unconventional." There are a few small firms operating there that Kris Sayce has been all over at the Australian Small Cap Investigator. Ferguson is excited about these too. "We also have an emerging industry on the east coast -- coal-seam methane. So we now have the opportunity, in my opinion, over the next 12 to 18 months, of getting investments of up to $100bn in the LNG sector."

With all that investment pouring into LNG production, and all those contracts pouring money into corporate and government coffers, you have to wonder what all the fuss about iron ore is over. In dollar terms anyway, it seems like less of a big deal. Aren't Australia and China getting along swimmingly?

For example, yesterday we learned that Andrew Forrest's Fortescue Metals Group will cut iron ore prices by 35% from last year's price in exchange for $7.2 billion in loans to fund expansion of its operations in the Pilbara. We should note that the price cut was negotiated with the China Iron and Steel Association (CISA) and that the loans will come from Chinese banks.

What gives? It's not likely that Fortescue's agreed price cut of 35% from last year's benchmark price (which is just two percent larger than what BHP and Rio have already agreed to with Japanese and Korean customers) is going to influence the negotiations between Rio Tinto and the CISA. But that seems to be the message behind the deal: you play nice with us and we'll loan money to you.

Fortescue has agreed to sell 20 million tonnes of ore over the next six months at the discounted price. Keep in mind that annual seaborne iron ore trade is closer to 400 million tonnes a year. It is a big deal. But not a huge deal, certainly not the sort of deal that would bring down the spot price of iron ore, which at over $110/tonne, is higher than the target benchmark price being sought by Chinese firms.

In any event, it looks to us like pricing power in the iron ore business is moving toward a new equilibrium. The annual price negotiations in which the ore producers are represented by one party (that can be squeezed by Chinese political machinations) and the steel makers are represented by another party (in this case, the CSIA, which seems to have made a meal of it) will be replaced.

But with what? BHP wants a benchmark index. China, seeking price certainty and the control a large customer expects to have, resists.

Whatever happens, we're beginning to think that energy exports will matter a lot more to Australian bottom lines than iron ore exports. Of course BHP and Rio are large diversified miners and employers. Troubled relations with China for to the two largest miners by market cap on the ASX are not good for investors.

But what is good for investors is the LNG boom. The big risk, as with any commodity, is that increased demand leads to over-supply. But that is not something we're worried about just yet. These projects take years to develop and secure permitting. Just in time LNG doesn't exist.

That means the firms with the biggest head start and the best prospective areas are going to be worth punting on. At least that's the idea anyway.

But while we're at it, let's report that at least one major investment bank is predicting a second commodity boom driven by a shortage of capital spending and resurgent demand. You always wonder if Goldman Sachs is just talking its own book because it's already made its bets in the sector. But for what it's worth, Goldman is predicting another commodity boom.

"We expect a commodity supply shortage in 2010," a company report proclaimed recently. "We have long emphasized that the commodity problem is, at heart, a supply shortage due to decades of suboptimal investment, which has been exacerbated over the past year by the sharp drop in prices and tight credit conditions. As the commodity markets rebound with the broader global economy we expect a redux of 2008 when severe supply constraints forced the rationing of demand through sharply higher prices to keep the markets balanced."

Goldman argues that the, " imbalances have actually worsened owing to the sharp drops in prices and tight credit conditions that have further impeded investment. In this context, it is important to emphasize that the commodity crisis is, at heart, a supply shortage. Although emerging market demand growth has been strong, the structural rise in prices that has been a key feature of commodity markets for the past several years would not have occurred if supply were sufficient. In reality, trend demand growth for many commodities has been slowing due to supply constraints that are restricting overall demand growth despite robust emerging market demand growth."

Goldman's note goes on to recommend a handful of blue-chip firms that will benefit from higher demand growth. Firms like Cairn India, Cameron (US), CNOOC (China), Hess (USA), Peterobras (Brazil), Suncor Energy (Candada), and more. For Aussie investors, there are a smaller number of energy blue chips and a larger number of excellent speculations.

Dan Denning
for The Daily Reckoning Australia

• The Iron Ore Pricing War Between China & Australia
• Buying Oil on Sale as U.S. Dollar Gets Weaker
• Rio Scraps Deal to Sell to Aluminium Corporation of China
• Giant Costco Opens in Melbourne!
• Bailout Deal Will Expand China’s Influence in U.S. Economy

Are Australian banks going to be able to sustain their dividends? Over the last ten years, bank fee income has become a big driver of bank profitability (and the source of the dividends paid by banks). The credit crunch has crunched the amount of money banks make lending money. The net interest margin - the difference between what Aussie banks pay to borrow from overseas and what they make lending domestically - has been shrinking.

Here's a question then...if the bank's cut their fees, are they cutting off their own heads? For example, NAB is axing its penalty fees for overdrawn accounts. A Reserve Bank study published in May showed that so-called "exception fees" resulted in $1.2 billion in fee charges to Aussie households - or 10.34% of total bank fee income for the year.

Total domestic bank fee income for Aussie banks was up 8% last year to $11.6 billion. You can see from the chart below that fee income has been growing by about 11% the last few years. But keep in mind that aggregate profits of the Big Four banks last year were $15.9 billion. That means fees accounted for nearly 73% of total bank profits, according to our back-of-the-envelope math.

This actually shows you how bad a business banking typically should be. You can only make money lending money by taking more risk (both as a borrower on international capital markets and a lender on the domestic residential real estate market). If you take less risk, you have to make up for the fall in income by raising fees, which infuriates customers and law makers. Banking isn't a low margin business. But maybe it's headed that way.

Speaking of cash, should BHP sending more cash to share holders? That's the question some investors are beginning to ask, according to Bloomberg. Our co-Melbourne based commodity giant told investors that its record of seven consecutive profit results has ended. Underlying full-year profit for 2009 was down 30% to $12.8 billion on the back of lower commodity prices and demand in the fiscal year.

But the company left its dividend in line with the second half of last year at US 41 cents per share. It did not increase the dividend. However that dividend is 17.1% larger than the year before. So why not give back more cash to investors?

Mining is a capital-intensive business. BHP has been around the commodity block a few times. It knows that to expand production when commodity demand picks up requires cash. You have to keep that cash around for a rainy day for when the cycle turns.

Or, conversely, if the cycle turns down again - as it might if the global recession takes a second, depressionary dip - the cash is a bulwark against weak demand. It's also nice to have a war-chest to buy out asset-rich, cash-poor firms that cannot ride out a sustained drought in earnings when production is shuttered. BHP remains in a better capital position than nearly all its global rivals.

But if you don't want to put your capital risk in common stock, why not have a look at the new inflation-indexed bonds being issued by the Federal government for the first time in six years? Yesterday's Age reports that the Australian Office of Financial Management plans to introduce the bonds back to the market in September or October of next year.

Finding assets that deliver a return greater than the rate of inflation is going to be the big challenge in the years ahead. Inflation-indexed bonds are one strategy. Small cap growth stocks are another (especially precious metals and energy stocks leveraged to higher gold and oil prices). Emerging markets are a third. We'll ask the Australian Wealth Gameplan editor what he thinks of these bonds and get back to you tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Australian Banks Must Increase Fees or Expand Loans to Remain Profitable
• Commonwealth Bank (ASX: CBA) Nearly Doubles Bad Debts Over Last Year
• Note to Australia: Buy Resources, Not Banks
• Aussie Banks Addicted to Foreign Borrowing
• One in Four US banks Announce Unprofitable Quarter

By the way, what has happened to Stern Hu? He's disappeared from the front pages of Aussie papers. As far as we know, he's still being held in jail without charge. Do you reckon the writ of habeas corpus exists in the Chinese legal system?

Speaking of jails and steel, BHP says Chinese iron ore imports are recovering and spot iron ore prices are up 38% year-to-date because of the resurgence in Chinese demand. China's Ministry of Transport says iron ore imports to major Chinese ports were up 35% in July from a year earlier. That's a lot of steel.

But is it too much?

Is it possible China's steel industry - which is hovering up so much Aussie iron ore - has excess productive capacity? Would demand for iron ore be lower if the Chinese steel industry were more efficient? And what effect would that have on the Aussie ore industry?

We'll answer some of those questions in a moment. But first this from the 21st Century Business Herald, "Mr Xu Lejiang Baosteel chairman also confessed the existing of both structural and periodical overcapacity in China's steel sector. The former refers to the heavy polluting and energy-intensive capacity like construction steel, and must be weeded out. He said that while the latter points to those redundantly advanced capacities that cannot find sufficient demand like ship plate."

"China's steel output has taken up 48% of the world's total in the H1 of this year, further exacerbates the oversupply picture and hurts the healthy industrial development. And Mr Roland Verstappen vice president of ArcelorMittal also said steel overcapacity is quite clear in China and which will press down steel prices, sweep smaller mills out of the market and causes unemployment."

Full employment is a political objective in China, and probably dictates a fair bit of economic policy making. But if Roland Verstappen and Xu Lejiang are correct and China has too much steel capacity, we reckon it's something Aussie ore juniors (and their investors) should keep in mind. Of course for there to be a contraction in Chinese steel production, there'd have to be a policy shift...or the entire Chinese economy would have to contract/implode for a period after the popping of its own credit bubble.

But let us leave aside the bubble fall out in China for another day. Let's get back to Australia. BHP and Rio are larger suppliers to major steel makers. They'd be fine even if Chinese demand fell for a while. But the smaller ore outfits who have made supply deals with smaller mills...they might have a rougher time of it.

By the way, we don't have time to get into it in detail today, but yesterday we said to keep your eye out for tangible assets at good valuations. By that, we were referring to companies with net current assets at or in excess of their market capitalisation. It's more complicated than that. But we'll have to expand on it next week.

Some reader mail?

--Hi,

Peter H.

Good questions. Answers can be sent to dr@dailyreckoning.com.au

--Dear Dan,

Noah (Brisbane)

This morning it was the orange pill. And it was called Ibuprofen. The best way to deal with the garbage in the newspapers is not to read them. But the best defence against misinformation is your own education and knowledge. Keep building your ark.

--Dan,

Rose

The honourable men of Rome were more than vilified after they killed Julius Caeser. They were killed. More from Shakespeare next week!

Dan Denning
for The Daily Reckoning Australia

• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike
• Australian Iron Ore Shares on China’s Menu
• RBA Leaves Rates Unchanged, Rio Wraps Up Negotiations
• Red Bear Rising: Russia’s Resource Based Geopolitical Strategy
• The Iron Ore Pricing War Between China & Australia

It's not exactly a ringing endorsement of central bank policies. But it does indicate that in at least some credit markets, there might be money to borrow if you can talk a bank into lending it to you. However, as Dr. Marc Faber told the Agora Wealth Symposium yesterday, "You cannot create prosperity through money printing and debt growth."

It's a fair point, isn't it? You don't get rich by spending money. Wealth cannot be achieved through a systematic attempt to impoverish the middle class through higher debt levels, lower asset values, higher taxes, and lower real wages.

That all sounds like common sense. So why are so few policy makers using their head? The people who hope the global economy can be revived through a resumption of credit growth seem to forget that it was massive credit growth that created the problem (massive global imbalances, huge debt levels, and mal-investments) in the first place. That problem now resides on bank balance sheets in the form of bad collateral and on household balance sheets in the form of credit card debt and a mortgage.

This sets up an interesting problem. How can you have inflation if impaired bank assets prevent the resumption of bank lending? Our old friend Dan Ferris says this about the issue, "Mass destruction of bank collateral certainly reduces lending capacity. Since our banking system is where the bulk of our money is created, deflation seems a rational expectation...Except," Dan adds, "that the redwood seeds in the money-creation forest - excess bank reserves - have grown approximately 4,500% lately, to around $900 billion."

"Multiply those reserves by 30 or so, as the banking system would over time, and you get more than double the entire GDP of the United States. But as long as the banking/lending apparatus is broken, it's hard for the system to multiply new money into existence via loans and deposits."

Dan makes some great points. Most money creation in the economy does come from the banks. Through the wonders of fractional reserve banking, the banks can turn each new dollar of deposits into ten dollars of new lending...and then lend on each of those ten dollars when they make their way back to the banks. This is why banks are the traditional engine of money supply growth in an economy, and thus the proximate cause of inflation (an increase in the money supply).

But if banks are still nervous about asset quality, they are much less likely to rev up the money creation engine with new lending. In fact they're likely to do the opposite and stockpile cash. That's what Dan has pointed out, showing that excess reserves held by banks at the Fed are rather large.

And if banks don't have cash to stockpile against further losses, they'll just go out and raise some. That's exactly what NAB has done. "National Australia Bank Ltd., the nation's biggest lender by assets, said it will raise A$2.75 billion selling shares to help weather rising bad loans and finance potential acquisitions," reports Malcolm Scott at Bloomberg yesterday.

This is part of "Operation balance sheet repair through the equity markets." NAB is not alone in using secondary offerings on the stock market to raise capital this year. Secondary offerings in the Australian stock market raised nearly $90 billion in fiscal year 2009. That was up 74% from the year before. Meanwhile, initial offerings (IPOs) raised just under $2 billion for FY 2009, an 83% decline from the year before (which itself was horrid).

That tells you there was hardly any new capital available for new businesses. Only 45 companies went public last year, compared to 236 the year before. That shows you how tight capital really has been. Of course, even listed companies have had trouble raising money in the secondary market.

So what does it all mean? It means Aussie investors (institutions and households) have provided Aussie companies with a capital cushion during the worst of the credit crisis. Will it be enough? What will the return on the capital be? Is it throwing good money after bad?

Those are all questions you have to look at on a stock by stock basis. Some companies are more efficient with capital than others. And a company that delivers a high return on net tangible assets without having large, recurrent capital expenditures is probably a company worth owning, or at least looking at-especially in this era where capital (and real capitalists, people who know how to put it to work) are so rare.

This, by the way, is why we're still so bearish on financials. The capital infusions on to bank balance sheets are there merely to offset the decline in the value of bank collateral (mostly residential and commercial real estate, as Dan says, but also all sorts of other securitised loans). But when a company like Santos raises $1.2 billion in new capital, you can be pretty sure it's not to offset losses from high-risk mortgage lending.

By the way, speaking of Santos and LNG, did you see that China's biggest offshore oil and gas producer, the China National Offshore Oil Co. (or CNOOC) is going to drill three wells in the Northern Bonaparte Basin and look for natural gas? Yesterday's West Australian Business News reported that, "The guaranteed first stage program, worth $80.8 million, will include up to five wells and 400 square kilometres in 3-D seismic work...The commencement of drilling will be a major milestone for CNOOC, which has been leading China's global push to secure long-term energy supplies."

Back to traditional capital for a moment. Does the fact that Aussie firms have raised so much equity capital mean the nation is not nearly as dependent on imported capital as we have feared in the past? The jury is still out on that one.

"Foreign banks are refining their lending activities in Australia rather than returning to their home bases," reports yesterday's Australian Financial Review. This means foreign lenders haven't abandoned Australia entirely. "But the funding pressures on Australian companies remain intense. Data show an 80% fall in the amount of syndicated loans in Australia in the first six months of the year."

Syndicated loans are loans where one or two banks organise an overall loan package in which multiple foreign banks are lenders. This reduces the risk (theoretically) of any one lender losing a lot on a loan. According to the AFR, "Global syndicated lending totalled $947 billion in the six months to June 30, a 49.2% fall from the year-earlier period. Australian loan volume fell an even steeper 80% to US$9.7 billion."

We realise that this is a lot of scrutiny to pay the capital structure of a company. But that matters now as much as it ever has to individual investors, and probably more. A company (like a bank or non-traditional mortgage lender) whose assets are mostly made up of iffy loans can quickly see its equity wiped out on high loan losses. This wipes out common shareholders.

Also, as we've seen, companies with huge refinancing needs can hit the wall quickly if capital markets are not keen to reinvest in the business (and they might not be if the business is an inefficient user of capital). That raises the question of how the banking industry itself is allocating capital in the real economy, and where a nation's accumulated savings are being productively invested (or unproductively squandered).

But let's not go into national capital allocation strategies today. Let's focus on two potential opportunities in this idea for Aussie investors. The first is that Aussie banks fill the lending gap and are able to do so at very favourable rates to themselves (and shareholders, via a rebound in dividends that were cut earlier this year). Their share of the syndicated loan market could increase if there is less foreign competition (although Chinese banks seem eager to loan some of their accumulated capital to Aussie businesses and consumers).

The second opportunity is something Kris Sayce has been looking at in his new publication, Australian Wealth Gameplan. We're talking about the growing universe of fixed income and hybrid securities listed on the ASX-or really anything that produces more income for you as an investor. Of course the world of high-yield fixed interest investments is not exactly a risk-free place these days (property, managed investment schemes etc).

But the retail bond market-where you can buy a corporate or government bond as easy as you can buy a share of BHP or Rio Tinto-is developing quickly in Australia. Both AMP and Tabcorp issued bonds in April targeted to the retail investors. And if there is liquidity to be found among Australian investors looking for risk-free income, you can bet Australian companies will find a way to tap that liquidity, even if it means doing something new like selling bonds instead of new shares (which dilute existing shareholders).

Of course there is no such thing as "risk-free income." Government bonds have that reputation (increasingly undeservedly). That's why the ASX is working with the Australian Office of Financial Management to list government bonds on the local exchange. The government would love to tap retail funds in order to finance its deficits (which are large and growing).

But you could probably do better-at least in terms of yield AND capital gains-looking at corporate bonds. The nice thing about being a bond holder is that you rank the highest in a company's capital structure. That means if the company does go bankrupt, you get paid first because you are a secured lender (unless you are GM or Chrysler bond-holder and you get strong-armed and ripped off by a socialist American president).

You could do even better buying distressed bonds. You look for companies that everyone thinks may go bankrupt. Then you just have to do a little balance sheet analysis. If the assets exceed the liabilities, you can almost guarantee that you'll make money. At the very worst, as a secured creditor, you get your money back in a liquidation of the firm's assets.

Or, if Christian Noyer is right and global credit conditions improve, you'd get a capital gain (if you bought the distressed bond at a discount to par) AND whatever yield the bond has (typically high the higher perception of risk). And that would be a mighty fine trade if that's your game.

We'll keep you posted on what Kris finds in the fixed income world. His solution is a lot simpler than the strategy we outlined above. Australian blue-chips, for whatever reason, have tended to pay higher average yields than their American counterparts. In fact the dividend yield on the S&P/ASX 200 tends to exceed the yield on the S&P 500.

That may reflect Australia's traditional status as an importer of capital, and the need to offer higher yields for what are perceived as riskier assets. But Kris has already found one blue-chip with a great yield and a great return on net tangible assets (capital efficiency).

The good news is that we think the market should favour investors who can look at the capital structure of Aussie firms and capture yield from the ones that are not burdened by non- or under-performing loans. The better news is that Kris is doing the looking so you don't have to!

Mind you we're not implying that Noyer is right and everything is fine. Hardly! We think banks will continue to play it safe (and quake in their boots). Aussie banks continue to hold around $2 billion on reserve at the RBA. This is down from the double-digit overnight figures in the panic days of last year. But it still shows some reluctance to unleash a new credit boom via bank lending (or a lack of new, worth projects to lend to).

But we should probably be very thankful that Aussie banks haven't gone whole hog back into the lending market. Though the RBA says inflation is tame, the amount of monetary reserves in the global financial system are just the sort of thing that could lead to a wildfire of inflation, including here in Australia. It's just what the Fed wants to assure us it will NOT let happen. But the Fed may not be able to control the actions of the most profligate spenders of all: national governments.

We believe that in the absence of new bank lending to promote economic growth, governments are going to ramp up deficit spending even more this year and next. As Dr. Faber said in Vancouver, "I believe next year's economy will face even larger deficits. Their deficit is attempting to stimulate credit growth. Unless real credit growth returns, they will have to put more and more money into the system to maintain the status quo. All polices target consumption. That is a mistake."

So what's this mean for the market? This is just one of the questions we're taking up at next week's debt summit in Melbourne. As for the U.S. Faber says, "The S&P 500 will not recover to 2007 highs. At the peak, 44% of the S&P was the financial sector. That is gone... not coming back."

Does that mean the recovery in Aussie financial stocks is a fake out move too? More on that tomorrow. But just keep this in mind the meantime...this debt crisis doesn't mean the world will end. It just means there's going to be a big change in who owns global asset. That ownership is being transferred from debtors to creditors. That's what worries us here in Australia...

Dan Denning
for The Daily Reckoning Australia

• Biggest Factor Affecting Consumer Price Inflation is Growth in Bank Credit
• Australian Banks Must Increase Fees or Expand Loans to Remain Profitable
• U.S. Fed Now Accepts Credit Card Debt as Collateral
• RBA Rate Cut Does Little to Unlock Credit Market
• Banks or BHP?

It's probably not fair to leave common stocks out of the question. After all, the ASX is on a 5-day winning streak and some analysts are now confident enough to say the bear is dead. No one is exactly predicting a return to the boom-time years of 2003 and 2008. But with oil up, gold up, shares up, property up, commodities up, and bonds up, it does feel a bit like 2003, when everything inflated thanks to low interest rates across the globe.

The Australian share market news is dominated by production figures this week. Back-from-the dead Oz Minerals reported that productionfrom its gold and copper mine at Prominent Hill will meet guidance. Last week Rio Tinto reported an 8% increase in iron ore production, but weaker production for aluminium, alumina, and bauxite.

We'll get to the sector that really interests - energy - in just a moment. But to amplify a point made yesterday - keep in mind that the rally in Aussie resource stocks may be fuelled by a lending bubble in China that's going to pop. That means resource demand and underlying commodity prices may be a lot more volatile in the years ahead, as Chinese regulators struggle with the conflicting goals of full employment and containing inflationary bubbles.

"(We) must control the risk of real estate loans," said Liu Mingkang, the head of the China Banking Regulatory Commission, according to CNBC. He says Chinese banks must take better measures to evaluate the creditworthiness of borrowers. Liu said, "In the first half of the year, our country's banking loans expanded rapidly and helped play an important role in stabilizing the economy, but the loans growth has led to accumulated risks also increasing."

A real estate bubble in China would undoubtedly lead to inflated demand for construction materials in the commercial and residential real estate sector. But let's assume the China lending bubble doesn't pop this week. And let's assume the value of Aussie shares is driven by underlying demand from China that IS sustainable and super cyclical. On that basis, what' worth a look right now in the share market? How about energy.

For starters, there's today's news that Energy Resources Australia has reported unaudited profits that are triple what it expected. The $120 million half-year profit comes from much higher than expected uranium oxide productions and a 27% increase in uranium prices since the March low of around US$40.

The uranium spot price is coming off a low after a big correction. But as we've covered in Diggers and Drillers, the demand for nuclear fuel from global utilities is on the rise. Australia - with over 30% of the world's proven uranium reserves - is in the pole position (side by side with Kazakhstan, arguably) to provide the world with what it needs.

That will only happen if the uranium mining industry really takes off. And maybe that's starting to happen. Last week Federal Environment minister Peter Garrett approved what will become Australia's fourth major uranium mine at Four Mile in South Australia. Four Mile is located about 550km north of Adelaide. It's owned 75% by U.S.-based Heathgate and 25% by locally listed Alliance Resources (which zoomed up on, and even slightly before, the approval was announced).

"Production is set to begin early next year at what will be the world's 10th-largest uranium mine," according to Barry Fitzgerald in the Sydney Morning Herald. "Its predicted annual haul of 1400 tonnes would be worth about $260 million at current contract prices and will increase annual production of the radioactive material in Australia by 14 per cent to 11,400 tonnes."

And there could be more on the way. "Queensland mining 'inevitable'," leads a story by Paul Robinson over at the ABC today." "Just as there's going to be uranium mining on an increasing basis in Western Australia, South Australia and the Northern Territory, we'll see uranium mining in Queensland in due course," says Federal Resources Minister Martin Ferguson.

"Mr Ferguson has told a Resources Conference in central Queensland, uranium mining is no different to developing coal or liquefied natural gas. 'It's about supplying the energy needs of other countries...We are energy rich, we do not need nuclear power, our responsibility is to mine uranium with safe hands and to guarantee that our uranium is used by countries that are only prepared to guarantee that it is used with safe hands."

We're not sure why Australia couldn't benefit from nuclear power too. But the Minister is right that between coal, LNG, and uranium, Australia presents investors with a great portfolio of energy choices. And that's not including traditional oil and gas explorers and producers.

Two more points about energy. First, the trading in shares is going to be volatile. That makes buying and holding a nerve-wracking strategy. The global economy is in transition. And with China and America wrestling over the bigger contribution to global growth - and overall resource demand - there's going to be a lot of unpredictability to both resource prices and demand. The shares will see saw.

That means investors may have to look at more actively managing their positions in resource shares. This is not to suggest that we should all be market timers now. But you'll want to have a strategy for dealing with volatility that allows you to lock in gains on rising share prices, but also buffers you from these big periodic falls that we expect to get as markets - and indeed the whole global economy - make the transition to a new normal.

The second issue on energy is that it may replace bulk commodities like coal and iron ore as Australia's largest export industry. Here we're talking about conventional off-shore LNG production AND unconventional coal-seam-gas LNG production. The unconventional LNG industry is admittedly a much newer (and we'd argue, riskier) industry that iron ore production. But that's what makes it such an alluring investment opportunity.

If you want to know what the oil majors think of the industry, keep an eye on Santos this week. In yesterday's Australian Financial Review, Paul Garvey reports that Santos could be a few days away from offloading a bunch of undeveloped gas fields in the Bonaparte Basin. Those fields could fetch the company nearly $500 million, according to Garvey.

But if you're interested in the kind of transactions that might move the company's share price, it's Santos' 60% stake in the coal-seam-gas fed Gladstone project that may start to attract cashed-up takeover suitors. Garvey reports that, "A series of standstill agreements preventing third parties from launching hostile takeover bids for Santos will expire in August and September."

Santos has a 17.7% interest in Exxon-Mobil and Oil Search's Papua New Guinea LNG project. Garvey says that project, "would be attractive to many energy companies, given its status as the most advanced LNG project now on the relatively cluttered drawing board in the region."

It IS a cluttered drawing aboard. That means there are going to be a lot of losers and a few big winners. Between the more traditional LNG, oil, and gas firms we're looking at in Diggers and Drillers, and the unconventional players in the Queensland CSG market that Kris Sayce is active with at the Australian Small Cap Investigator, there are a lot of intriguing firms to choose from.

Hopefully we've got it right that energy shares are the best way to invest in energy as an asset class. Of course shares are still shares. But one of the reasons we like Australian energy shares so much is that energy itself has become a kind of global capital - gradually replacing the worthless fiat trash pumped out in increasing volumes by governments. More on government debt as an asset class tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Uranium: A Carbon-friendly Substitute for Coal
• Energy Debate in Australia Needs to Get Serious
• Big-picture Case for Energy Stocks is Pretty Bullish
• Australian Iron Ore Shares on China’s Menu
• LNG – The Energy Play for 2009

There was quite a bit of snarky e-mail yesterday criticizing our comparison of gold to the S&P 500 over the last ten years. "Your time periods are arbitrary!" "You only picked dates that would support your argument!" "Housing has done better. So has oil. The Aussie gold price is up less than the All Ords! Why not just buy BHP and hold?"

So many critics! But a few of them may have missed the point, we'd humbly suggest. Of course you can cherry pick dates to support your argument for the performance of one investment over another. But that wasn't our point, or our intention.

Our point was that at certain moments in the life of markets, you witness long-term trend changes. One secular bull market ends while another one might begin in a different asset class. Gold began a secular bull market in 2000 just as stocks ended an 18-year bull market. That's why the trade of the decade was to buy gold and sell stocks.

Those are the kinds of sea changes you have to be aware of if you're going to make money as an investor. This doesn't exclude making money in other ways or other asset classes. But it's useful to know what the primary trends are moving the market-especially since a huge portion of your total return in any investment comes from being in the right asset class (and not stock selection).

So yes, there is more than one way to skin a bull. By all means, buy BHP if you want to invest in the long-term commodities bull. We recommended BHP shares to readers of Strategic Investment back in 2003, for example. Even then, we were a bit late to the trend. But the important thing was investing along with the big trend.

Just to be clear though, the big trends now are soaring inflation and falling financial asset prices, along with increased energy scarcity. This produces a variety of pair trades, which include: short government bonds, long energy, short residential housing, long gold, and probably short commercial real estate and corporate bonds as well, while going long farmland and agriculture. But how corporate bonds fare in the coming months depends a bit on the aforementioned government bond yields. So let's get stuck into them, shall we?

Over in America, ten-year yields advanced to their highest level since last October. It happened just as Uncle Sam was throwing an additional $19 billion of ten-years over the line and into the battle against deflation. The sale of the bonds took place at an average yield of 3.99%.

Tomorrow is the auction for $11 billion in 30-year bonds. Thirty-year yields are already as high as they've been since October of 2007. And by extension, borrowing costs linked to government bond yields will rise too. Mostly this affects the U.S. mortgage market. It means that refinancing a mortgage-providing you can find a willing lender-will get more expensive.

But we think rising U.S. bond yields indicate that the Credit Depression is entering a new phase. The cost of capital is rising, after slumping to historic lows during the credit boom. Investors-including other sovereign nations-will demand higher yields to loan to deficit-challenged governments. Or they may just dive into asset classes with better growth prospects.

For example, Russia's central bank says it may switch out of U.S. bonds and into IMF bonds. Russia's Finance Minister Alexei Kudrin says Russia will buy $10 billion in IMF bonds. China floated a trial balloon earlier in the week about buying $50 billion in IMF bonds. Brazil said it will buy $10 billion worth of IMF bonds.

This is just the beginning of the beginning. Or maybe it's the middle of the beginning. Or it could even be the end of the beginning. But it's pretty clear that the balance of power in the global financial system is shifting. It favours real resource producers and creditors. It does not favour governments with big deficits and bad demographics (more recipients of governments in retirement years and fewer workers to support those retirees).

You can see that Australia fits in both categories. It's a resource producer with high levels of personal and corporate debt. We reckon that over the coming years, government debt will grow too.

But Australia will be a target for international investment, given its resource wealth and comparatively high interest rates. That means the country shouldn't have a huge amount of difficulty financing Kevin Rudd's deficits. That doesn't make said deficits are a good thing. And it doesn't mean Aussie interest rates won't rise too, making borrowing more expensive for Aussie businesses and households. But an auction for American bonds is more likely to fail than an auction for Aussie bonds.

Aussie deficits are still wrong-headed and unnecessary, mind you. This recession (and it IS a recession, despite the statistical flim-flammery) was not caused by insufficient consumer and business demand, as Wayne Swan and others stupidly repeat. That's what all the Keynesians say. Thus, their policy prescription is for the government to run a deficit and support spending until consumers and businesses get back on their feet.

But when you diagnose the problem incorrectly, your cure will be faulty too. This is a balance sheet recession. The cause of it was the accumulation of too much leverage at the household and business level. The only cure for this kind of a recession is the write down in non-productive investment made with credit (residential housing, for example) and deleveraging (paying down of debt).

A recession that was caused by too much credit and massive bad investment is not cured by more government spending. It's like trying to cure a cold by kicking a dog. What's more, when you have over-capacity in global industrial production, lowering interest rates to try and stimulate the demand you think is missing is a waste of time. Business won't borrow at lower rates when they don't need to. Why expand production when there is already too much to begin with and demand is stagnant in most places and falling in the rest?

Besides, what does a government really accomplish when it manages to increase consumption through transfer payments? In most of the Western world, increased consumer spending primarily benefits the producers of consumer goods. Those producers are in China and the developing world, not America and Australia. It's true that local retailers may profit. But the bulk of the profits go back overseas anyway.

At the heart of this bad policy is a simple mistake (or simple economic illiteracy). This mistake is thinking that prosperity comes from consumption. Spending money doesn't create wealth. Prosperity begins with capital formation and production. You have to make something you can sell in order to earn an income you can trade for other goods. If you don't make anything, you can't consume.

For some reason, most modern policy makers have it all backward. They think wealth begins with consumption and spending. And in the meantime, they have-along with an assist from the financial industry-engineered a structural change in Western economies that favours the financial industry (which doesn't produce anything) over manufacturing or real goods production.

That's turning out to be a world historical mistake of the first order. But at least for Australia's sake, the consequences of that economic strategy will be somewhat beneficial. As America produces less and borrows more, the buyers of its bonds and dollars will defect to better investments in other places.

Australia is one of those places. So is gold. So is oil. Housing? Not so much. Government bonds? Definitely not. And common stocks? More on those tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Finding Assets that Out Run Inflation as Bond Yields Move Up
• U.S. Bond Prices Rose and Yields Fell
• Lower Bond Yields by Any Means Necessary
• Choking on Debt in the Unfolding Anglo-Saxon Bond Crisis
• Look out! It’s The Bond Vigilantes!

BHP is seeking permission from the West Australian government to mine the Yeelirie deposit in WA. BHP reckons it's a $17 billion ore body at current uranium prices, capable of producing 5,000 tonnes of uranium a year for 30 years. It says the project would increase Australia's uranium exports by 50%.

You don't have to worry about a uranium supply glut quite yet, though. It's a subject we've been covering over at Diggers and Drillers. There are other, smaller ore bodies that could enter into production if the uranium industry ever gets off the ground in Queensland. And many Australian explorers are active in Africa.

But the big story of the week-the one that's got us really excited-has been under-reported. Norway's largest oil company, StatoilHydro, and Chesapeake Energy Corp. from the States are kicking around Asia and Europe for unconventional natural gas projects to develop. Asia includes Australia, according to the story in Bloomberg.

Statol's Olivind Reinertsen, who runs the company's U.S. and Mexican operations told an interviewer that, "At this point in time, we are looking at 14 different plays all over the world together with them to try to narrow it down." The plays will be similar to the Marcellus and Barnett shale formations in the States that helped increase un-conventional U.S. gas production in the last two years.

Australia has some shale formations that are suitable for this kind of production. It's capital intensive. And the formations have to be injected with something to drive the gas out, mostly because the sandstone formations are not porous enough to allow for conventional production. They don't call it unconventional for nothing.

But one thing you'll notice about natural gas produced from shale formations is that it's not coal. It's not uranium either. As the Federal government tightens the noose around the coal industry via the delayed but not-dead-yet emissions trading scheme, we wouldn't be surprised to see unconventional gas production enjoy its own mini boom in Australia.

Uranium, of course, would be a carbon-friendly substitute for coal in terms of generating abundant and cheap electric power for Australia's economy. But there is an irrational fear of developing a domestic nuclear industry. So even though uranium is going to be a valuable export commodity, the fact that only WA, the NT, and SA permit new mines to open means you're not exactly spoiled for choice when it comes to uranium explorers who have ore bodies that can realistically be developed in the next five years.

What does that leave us with? Well , you have conventional off-shore LNG and unconventional on-shore coal-seam-gas. Seeing as how we've got both those stories covered in Diggers and Drillers and the Australian Small Cap Investigator, we're going to bid you adieu for the day and get on the shale story for the May issue of D&D. See you next week!

Dan Denning
for The Daily Reckoning Australia

• Buying Oil on Sale as U.S. Dollar Gets Weaker
• Latest Energy Bull Market Won’t Be Confined to Crude Oil
• Australia Presents Investors With Great Portfolio of Energy Choices
• Thorium as a Nuclear Fuel
• Australia’s Next Big Export Industry

U.S. stocks ignored the backward-looking GDP and concentrated on the present-looking bond market data. Yesterday we mentioned that ten-year yields in the U.S. were up as the U.S. government sold a boatload of debt. Well, ten-year yields fell today by about five basis points to 2.74%.

Maybe investors were relieved that the auction of US$24 billion in seven-year notes went off without a hitch. It's always good to know your creditors haven't cut you off yet-especially when you need to borrow another $2 trillion. It's no wonder the Dow rallied 174 points and the NASDAQ climbed into positive territory for the year.

Here in Australia there is a bevy of interesting news to digest. At the top of the list is the fact that BHP raised $4.36 billion in the European bond market this week after raising $4.64 billion in the U.S. bond market last week. Credit crunch? What credit crunch?

Now that it doesn't have to borrow heavily to finance the cancelled takeover bid for Rio Tinto, BHP can turn its eyes on other prey. It appears to be doing just that. Why else would it build its cash position by tapping the bond market? And who is it after?

Hmm. Maybe the Foreign Investment Review Board knows something we don't. That is, maybe the China Minmetals bid for OZ Minerals is not as urgent as it appears if there are other, more local bidders for OZ.

But who knows about specifics? All we know is that BHP had relatively little difficulty growing its balance sheet in the last two weeks. We also know that the big fish buy the little fish in the consolidation phase of the resource cycle. BHP is a big fish.

So this action is telling us that at some level (even though commodity demand hasn't recovered and prices for bulk commodities are falling) we may have reached a turning point in the resource market. Even if the recovery is slow, you'd expect BHP, China Inc., and other cashed up players to be on the hunt for good projects they can buy at rock bottom prices.

And then there's oil. It was up nearly three percent yesterday in New York to close at $54.34. As recently as February 18th, you could get a barrel of West Texas Intermediate crude for $34.67. It's gone up 56% since then (79% if go back to Christmas Eve-eve, when oil bottomed at $30.28).

Oil Futures Curve Shows Traders Are Betting on Higher Prices

Click to enlarge

Source: Bloomberg.com

For the last month we've been watching the futures market and the contango there. Contango is where the futures price exceeds the spot price. It looks to us like traders are betting oil prices are going to go much higher later this year.

Maybe OPEC production cuts will kick in at just the moment demand begins to recover. Or maybe, as we've speculated, the oil price crash virtually guarantees a supply deficit in 2010, and traders are going long now as the price bottoms. That's a lot of maybes.

What we know for a fact is that at one point, the December 2011 futures contract was trading much, much higher than the spot price. It was a "super contango." The contango has since narrowed since with the rally in the spot price. But if the oil trade is back on, oil stocks are certainly worth a look. In fact, the bigger energy stocks in Australia have already rallied more than 20% from their lows.

The Australian Office of Financial Management is getting into the spirit of things. Its director Neil Hyden says Australia's federal debt outstanding could quadruple in the coming years to over $200 billion. Before you complain, just remember you can't bribe voters with handouts unless you have some money. And if you don't have a surplus to waste, then you'd better start hitting up foreign lenders.

Borrow and spend! Borrow and spend! It's the wave of the future!

But who to borrow from? Here's an idea. Why not China!

The Courier-Mail reports that the biggest investor in all the debt Australia is floating to pay for the stimulus is none other than the People's Republic of China. "Market insiders believe China is buying 15 to 20 per cent of the $2 billion in Treasury securities being issued every week. This would make China the single biggest lender to Australia, although details of who owns the bonds are cloaked in secrecy. The program, authorised by Treasurer Wayne Swan, will leave Australia with a debt bill approaching $200 billion."

"Trust me. I'm a banker. Housing is fine."

It's not all bad news. The Reserve Bank released its latest Financial Stability Review yesterday. The organisation is content that Australia's housing market isn't in for big trouble, especially if interest rates remain low. As it controls short-term rates, the Reserve Bank has some say in this matter.

It was painful, but we reviewed what the bank said...and found it wanting. There were a few charts that showed a rising trend for non-performing loans and higher mortgage stress. We'll get to those in a minute. But have a look at what the bank said about the Aussie housing market. We'll quote and comment in between quotes.

"Overall, the Australian housing market has held up better than those in many other countries over the past year. Nationwide indices show a decline in house prices in Australia of around 4 per cent since their peak in March 2008, compared with declines from their peaks of around 10 to 25 per cent in the United States (depending on the measure used) and almost 20 per cent in the United Kingdom. In Australia, the recent weakness has been most evident at the top end of the market, with prices in less expensive suburbs broadly unchanged over the latter part of 2008, after having declined over the previous year."

No comment. So far so good.

"While further softness in the Australian housing market is possible, the market does not appear to have the same vulnerabilities that have been evident in some other countries. Importantly, the adjustment in the housing market - after a number of years of very large price gains - started at the end of 2003 and thus was well advanced before the onset of the current financial crisis."

Prices have fallen gently so far. But prices are set at the margin. An increase in the number of sellers (boomers cashing out to finance retirement) can accelerate the decline.

"Reflecting this, the ratio of house prices to household income has declined noticeably from its peak in late 2003. While this ratio remains higher than was the case in previous decades, this is at least partly explained by a number of structural factors, including the transition to an environment of lower inflation and thus lower nominal interest rates. In addition, Australia did not see the very marked decline in mortgage lending standards that occurred in other countries, particularly the United States, and the related negative impact on house prices resulting from a surge in loan foreclosures and a large amount of housing stock coming onto the market."

Warning! Now entering Absurdistan! As the chart below shows the noticeable decline in the ratio of house prices to household income is still noticeably high (and higher than most other markets in the world). Claiming that this is explained by a structural factor like "an environment of lower nominal interest rates" seems to suggest that interest rates stay low forever. They'll rise again. It is true, probably, that you never saw a descent to U.S. lending standards. But that hasn't prevented an increase in the number of people falling behind on their mortgage, as you'll see in a moment.

House Prices Still Five Times Income

"Also differentiating the housing market in Australia from that of the United States is that the demand for new housing in Australia has outstripped net new additions to the housing stock over much of the past decade, suggesting there is substantial underlying excess demand for housing. Finally, housing affordability has increased considerably over recent months as interest rates have fallen, with the cost of borrowing now similar to rental payments in some situations, after many years when renting was much cheaper than buying."

See reader comment below on the secret stash of investor housing that may come on the market to meet "excess demand." And really...housing affordability has increased because access to credit and grants has increased? Isn't that what happens in credit bubbles? Prices as credit floods the market. Is this really housing become more affordable or is it just credit giving the illusion of home ownership?

There's been a rise in non-performing loans. It is still, however, small percentage of bank loan books. Arrears are up, especially for loans made by non-traditional lenders. And there's this as well from the RBA, "Across all housing loans in Australia, it is estimated that around 20,000 borrowers were 90 or more days behind on their mortgage repayments in December 2008, compared with an estimate of 13 000 the previous December."

Hmm. A 53% increase in the number of borrowers who are 90 days or more behind on their mortgage payment? Maybe this is why some are predicting that 30,000 homes will be repossessed by December. That seems a bit exaggerated, even by our standards. But if unemployment rises even more...

Shall we call it a week then? Let's! We'll leave you with a few more reader e-mails.

Hi Dan

It seems that the price of housing is a very sensitive subject I guess that's because over the last few years a lot of people have been acquiring investment properties with a belief that houses will always go up. I can't understand what the frenzy is, houses fell in price from the peak in the 80s through to the low in the 90s I know first-hand. I had to sell for a loss 7 years later in Brisbane. So I can't understand why people refuse to accept the business cycle. Over the last few years I know many people who have purchased investment properties. But I don't know any first home buyers, to me it seems because property became a bubble it was easier for investors to raise the capital than it was for first home buyers.

So investors could snap up properties faster than first home buyers could save for a deposit, which means the pool of available houses is getting smaller that first home buyers have to choose from so prices are forced up. If investors decided to sell their multiple houses that they have purchased in the last five years there would be plenty of houses available for first home buyers.

The housing bubble is only the result of investors being able to get access to credit easier than 1st home buyers. Houses will fall again like they did in the 90s especially as unemployment increases. I can't understand why people find this cycle hard to accept or maybe it's a case of people being too heavily mortgaged so they come up with any reason to justify that they made the right decision. I tell you hope will not stop prices from falling.

Glenn D

And more.

Read your page with interest this morning and I have a suggestion.......... Australia has a history going back nearly two centuries of selling primary products overseas and then buying back the finished goods at high prices......... Could we not suggest a deal where we have the Chinese pay a part of the amount in developing Manufacturing facilities in Oz in joint ventures; with these reverting to Oz ownership after a certain time........ For thirty years now we've seen the decline of Australian manufacturing and I just thought that this, or a variation on this theme could be a way to stimulate growth in Australia instead of using OZ as a big quarry until it's exhausted and we become a third world country. The Chinese need our minerals etc. There couldn't be a better time to help turn our economy around and start making dependable products instead of throwaway stuff that just makes the local tip a huge industry.

Cheers,

George

And finally this.

The present Chinese government is a vicious military dictatorship. It is utterly corrupt and without morals or scruples. It treats its own people as medieval serfs. China has a prison population of around 60 million people, which is used as slave labour. No country in the world can compete with their manufactures, and hence workers in Australia and all developed countries lose their jobs. Do we really want to get into bed with such a monster? Our own little Mandarin monster, The Krudd [ed. note, Australian Prime Minister Kevin Rudd], a notorious Sinophile, thinks so. I wonder what's in it for him. Has Therese been given permission to set up employment agencies in China?

Phillip D.

Dan Denning
for The Daily Reckoning Australia

• Aussie Housing Market Actually Leads the U.S. by Three Years
• Negative Equity Becoming the Norm in U.S.A.
• Most People Think a Rising Housing Market Makes Them Richer
• How U.S. Mortgage Rates Affect Aussie Stocks
• American House Prices Continue to Fall While the Same Can’t Be Said About Australian House Prices