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?

Last week, stocks went up. Stocks went down. Not much was proved one way or another. The week ended in a draw, as near as we can tell.

But we think we are making progress in understanding what is going on. The private sector is de-leveraging. Now, it's the public sector doing the heavy lifting. It is leveraging everything it can.

Leverage in the private sector led to the banking crisis/bear market of 2007-2009. Debt always leads to trouble. Next up: a crisis in the public sector.

But wait...hold on...not so fast...we haven't reached the end of the private sector crisis yet! Bank lending is still falling. House prices are still falling. Unemployment is still falling. Soon, stock prices will be falling again too...

First, let's see what's in the headlines. Last week there was a lot of press about the pay czar and his efforts to limit compensation in the companies that the feds bailed out. The public and the news media love this sort of thing. It's a battle between the greedy rich and the public interest, or so they believe. The public hates bankers. But they don't want to see just pay capping; they want to see knee-capping. We'd like to see it too. Or maybe public flogging. Or at least a lapidation or two.

But our true sympathies are with the greedy CEOs. After all, they stole the money fair and square. They should be allowed to keep it. The feds wanted to leverage up the financial sector by giving money to the banks. What'd they expect? The bankers took it.

Yes, the financiers are paid outrageous amounts of money - far beyond anything they are worth. In fact, if you studied it carefully, you'd probably discover that their net contribution to the betterment of mankind is now negative.

The bankers are betting that the money they were given by the feds will be worth less next year than it is this year. So they exchange it for everything and anything, confident that when it comes time to pay it back it will be even easier to come by than it is now.

So far the bet has gone their way. Copper has doubled. Gold is up 20%. Stocks markets all over the world are up 60%. Foreign currencies, too, have beaten the dollar.

Will the wager against the dollar continue to pay off? Well, that's the big question. If so, you should stay in stocks, gold and commodities. If not, you should move to cash.

But it hardly matters to the gamblers. They're playing with someone else's money! If the bets go well, they pay themselves huge bonuses. If they go badly...well...hey...gimme a bailout!

In the long run, bets against the dollar are almost sure to turn out okay. All paper currencies go to zero, eventually. But in the short run, who knows? The whole world is betting against the greenback. With such a massive short position against the buck, it would be just like Mr. Market - aka Mr. Mischief- maker -- to send the dollar up.

But you can't blame the bankers. They're performing a very valuable service. They are helping to separate fools from their money. Too bad we taxpayers are the fools....

Among all the whiners and kvetchers about bankers' huge bonuses hardly a single one draws the obvious conclusion:

That them that deserve to go bust should be allowed to do so.

"I remain of the view," writes Martin Wolf, a bit pompously, in The Financial Times, "that the only thing worse than rescuing the system would have been not rescuing it."

He's welcome to his opinions. And if he used his own money to bail out the bankers we would have no objection. In that case, it would just be a futile and foolish act. Instead, he insists upon using our money...which raises the charge from stupidity to larceny.

Another message that came through last week was that the real economy is not improving. Good news came in from several quarters. But the news that really counts - housing prices and jobs - was bad.

"It's all bad. That's all we know," said John Stepek, editor of MoneyWeek. "People ask if we're going to have inflation or deflation. The bulls think we're going to have inflation. The bears bet on deflation. But I'm not sure it matters. We're probably going to have both.

"The point is, whichever we have, it's going to be the bad sort. Neither inflation nor deflation is necessarily bad. Prices have to adjust. That's how the market conveys its signals. When prices rise, it tells producers to get busy and increase output. When prices fall, it tells them to lay off. In the natural order of things prices usually fall. Or, they should fall. This is 'good' deflation. It just means that producers are becoming more efficient, as they should. There's good inflation too - when prices rise due to increased real demand. When people earn more money, they can buy more things; prices rise.

"But what we're going to see is bad. Bad inflation. And bad deflation. It is the result of monetary problems and mismanagement. And it is going to send all the wrong signals and inevitably make things worse. First, the deflation is bad because it is result of a massive de- leveraging accompanied by a write-down of debt and assets. It's a depression. Or a major recession. Or a 'great contraction.' Call it what you will. It's a deflation in which prices fall...and it's not going to be any fun.

"Then, there's most likely going to be bad inflation too - caused by the central banks printing too much money. This is bad inflation because it is just an increase in the quantity of paper money, not an increase in real demand.

"We don't know exactly what is coming. But whatever it is, it will be bad."

Another big item in last week's financial press was the "Cash for Houses" scheme. The feds give new house buyers an $8,000 tax credit. But since not all new buyers buy because of the credit, the actual cost to the government per additional new house purchased is much higher than 8 grand. For each additional house purchased because the credit taxpayers are paying as much as a quarter of the entire cost of the house.

And now there is a proposal to extend and broaden the credit. Soon it may be "Cash for Everything."

This sounds crazy, but there are a lot of economists who think more stimulus is necessary. Nobel prize winner Paul Krugman, for example. And Richard Koo, mentioned here last week. They've seen what happened in Japan. And they see that the real economy is not recovering as they hoped it would. Now, they warn that America might have a "Lost Decade" if it doesn't continue to stimulate the economy.

How long must it continue bailing out and stimulating? Until consumers have finished de-leveraging, they say. How long will that take? Maybe another 5 years, by our calculation...maybe much longer.

But wait...the whole problem is too much debt, right?

Yep.

But the only way the government can stimulate is by going further into debt, right?

Yep.

And isn't the budget deficit already at $1.6 trillion...or 11% of GDP...the most it has been since WWII?

Yep.

Well, then where's the benefit? Won't the public sector have to de- leverage too?

Bingo!

How does the public sector deleverage?

Two possible ways - honestly...and dishonestly. It can pay down its debts to a level at which they can be carried even if interest rates go up sharply. They did it after the War Between the States...after WWII...and even during the Clinton years. Believe it or not, when the Congressional Budget Office looked ahead in 2001, it saw a budget SURPLUS for 2008 of more than $600 billion. Surpluses had been coming in for years during the Clinton administration. They thought it would keep going like that. Instead, 2008 saw a DEFICIT of nearly $500 billion.

The higher the debt and deficits go the harder it is to pay them down honestly. Eventually, the feds reach the point of no return...like a guy who's so deep in debt he can't possibly work his way out. Then, you get another crisis...either in the form of default...or (hyper) inflation...or both.

Tomorrow, we're off on the road to the Andean highlands...

No phone. No internet. No fax. No Blackberry. No iPhone.

We've got cows to round-up, wrestle, and vaccinate.

In the meantime, we'll leave our "Crash Alert" flag flying...and send a message as soon as we can...

Until then,

Bill Bonner
for The Daily Reckoning Australia

• Bankers Take Money From the Government and Use it to Speculate
• The More Money in a Financial System the Less Each Unit is Worth
• Warren Buffett: People Do Not Make Money by Betting Against the US Economy
• The Feds Are Trying to Avoid Deflation
• The Battle Between the Forces of Inflation and Deflation Wages On

Two important things happened yesterday, both of which cast a crimson light on things.

First, the Dow dropped again; it has only gone up one of the last 7 days. It went down 203 points. Could be nothing. Could be something big...the beginning of the long awaited 'next leg down' for the bear market...the opening day of a bloody Red October.

Charts of oil, commodities, copper, the dollar, and Treasury bonds tell us the same story. The greed investments are topping out. The fear investments are headed up.

What's a 'greed investment?' It's anything that benefits from an improving outlook for the economy and inflation - oil, commodities, and stocks, mainly.

What's a 'fear investment?' It's something that goes up when people begin to suspect the boom is a phony - namely the dollar and US Treasury bonds.

The dollar is rising. So are Treasuries. Yesterday, 30-year US Treasury bond yields fell below 4% for the first time since April.

And what about gold?

Well, that's the other important thing that happened yesterday. Gold held above $1,000.

So what?

So what?? Well, dear reader, you are in a prickly mood this morning, aren't you?

This is important because gold could go either way. Gold is a refuge in times of fear - especially when people fear inflation or a falling dollar. Gold is also a target of greedy speculators sometimes, even when the going is good. According to a study done by the World Gold Council, you never know what gold will do. That study was a great comfort to us here at The Daily Reckoning; we thought we might have missed something. But no. We may not know what gold will do, but neither does anyone else.

Looking around, we see no sign of consumer price inflation. So gold's recent rise must have been driven by optimistic speculation - along with oil and stocks. Now, when oil and stocks go down... we have to wonder whether gold will go down too. The answer, given yesterday, was what we expected - yes, but not as much.

There's substantial risk in gold as well as stocks. The ultimate low for the Dow should be below 5,000. That is, let's say, about a 50% haircut from current levels. And let's assume that gold does what it did yesterday...let's suppose that it goes down only 40% as much as stocks. That would still be a drop of 50% of 40%, or 20% - to the $800- an-ounce level.

If you would be gravely upset by a drop of that magnitude...you probably shouldn't buy gold at this level. And, of course, you should have sold your stocks already. Stick to cash - and gold, if you're long-term oriented - until this next phase is over.

The economic news was mixed, as usual...with nothing to make us think that our basic outlook is wrong.

On the optimistic, bullish side...consumer spending rose in August. Pending homes sales went up too.

But on the pessimistic, bearish side... "September auto sales plunge," says a Reuters headline. Yes, auto sales drove off a cliff last month - just like we said they would. GM reported a 47% drop.

What happened? The clunkers program was an economic fraud. Like all attempts to boost consumption, it merely shifted sales from the future to the present (now the past). Which is a big reason why August consumer spending looked good too.

But wait a few weeks for the September consumer spending numbers. Especially if the stock market continues to fall... Then we'll find out how sustainable those retail sales numbers really are.

As you know, here at The Daily Reckoning headquarters...in the building with the gold balls on the south side of the Thames...we are often accused of 'pessimism.' We deny it. We're optimistic about the fate of mankind. But we are pessimistic about many of his current pretensions - such as health food, enlightened central banking, contemporary art, mass education, global climate control and progressive democratic government.

But maybe we are wrong to be optimists. Pessimists always have the last laugh - when the optimists die. "I told you so," they say, under their last breath.

Bill Bonner
for The Daily Reckoning Australia

• Is Gold Going Up Because People Fear Inflation?
• Biggest Factor Affecting Consumer Price Inflation is Growth in Bank Credit
• Abandoned Shopping Malls to Follow Abandoned Houses
• China Stepping Up Purchases of U.S. Treasury Debt
• September is the Best Month for Gold

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

Meanwhile, the U.S. dollar index is showing all sorts of weakness. The chart below tells you a couple of things. First, you can see that when the short-term moving averages cross the longer-term moving averages, it usually signals a move. We're not making this up, by the way. We asked technician Gabriel Andre why the crossing of the 50-day MA over the 200-day MA was significant. His answer below.

"Is it sort of like Ghostbusters, where you're not supposed to cross the stream," we asked?

"No."

"Okay, please explain."

"Yes. The shorter-term price action has more weight. When the 50-day crosses the 200-day on the upside, it's bullish, as your chart shows. Conversely, when it crosses the 200-day in a negative direction, as your chart also shows."

"What happens when the longer-term moving average moves down too?"

"When it rolls over?"

"Is that what it's doing?"

"Perhaps. You would have to look at a longer-term chart. But this one indicates dollar weakness, which is showing up in Aussie dollar strength and a rise across the commodity sector. The prices are all relative to the weaker dollar."

Ah yes, the world of relative pricing. We admit we approach the technical explanations of market movements with a great deal of trepidation. The belief among the chartists and the technicians is that all the relevant information about an asset - it's past, present, and future - show up in the chart. You just have to learn how to read the chart, which is admittedly more of an art than a science (in our opinion).

Nonetheless, the chart of the dollar index is consistent with our own fundamental diagnosis of the dollar's weakness. Big fiscal deficits, massive unfunded social liabilities, low interest rate, a labour market facing lower structural wages and more service sector jobs, an increasingly reliance on government transfer payments, and higher taxes in the offing to pay for government-sponsored health insurance ...these are all bad signs for America's economy and its currency.

And by contrast, Australia looks downright bullish. So bullish, in fact, it appears to have cheered up Dr. Doom himself. Nouriel Roubini was in Kalgoorlie yesterday at the Diggers and Dealers conference signing Australia's resource praises. "As the global economy goes toward growth as opposed to recession, you are going to see further increases in commodity prices especially next year," he said.

Those commodity price increases - and the earnings that Aussie firms will generate from them - are what investors are queuing up for right now. It's what's sending stocks higher. But is it real growth or phantom growth?

We know that China is the world's biggest metals consumer. And we know that China's GDP grew in the second quarter at 7.9% and we know that China is spending hundreds of billions of dollars to keep its economy ticking over, employment full, and metals fully stock piled.

But what we don't know is if the world's economy has really reached the bottom of this debt-deflation cycle, where the bad investments and underperforming assets of the credit boom are written down, or off altogether. Is the balance sheet recession - the reduction of debt and the write down in assets bought with debt - really over?

That's the question. We'd suggest the answer is no. But then, it doesn't pay to argue with markets does it? The wretched performance of the U.S. dollar and dollar-denominated bonds leaves investors with a simple choice: speculate on other, riskier assets, or watch the value of your dollar-based savings erode.

So we have the era of forced speculation. It's a kind of dollar exodus. And anything that is not the dollar is a potential promised land. The upside - if you own oil, base metal, and commodity shares - is that there's a strong tailwind behind your investments.

The downside is that the speculation may not be based on real sustainable growth. It's just another lending bubble in China piled on the rubble of the real estate lending bubble in America. Bubbles built on rubble aren't stable. That means you may be better of trading the shares, rather than buying and holding and getting whipsawed by volatility. It's worth thinking about.

Not that we're complaining that shares are rising. But it's important to distinguish between a genuine bottom in the cycle and an epi-cycle, a mini asset boom in the middle of a broader bust (which is what we think this phase is). If it's one and not the other, your investment strategy and trading tactics would change.

The only real reason to whinge about it, from a value investor's perspective, is that it makes it harder to find under-bought bargains. Dirt cheap valuations and laggards are harder to find when a liquidity boom drives up all stocks. With so much cash coming in from the sidelines, it sure looks like a liquidity driven rally.

One asset that's especially confusing is oil. It's benefitting from its "not-the-dollar" status. But there are also, we believe, some fundamental reasons to like oil and energy stocks.

According to a recent article in Britain's Independent, "The world is heading for a catastrophic energy crunch that could cripple a global economic recovery because most of the major oil fields in the world have passed their peak production."

The report quotes Dr. Faith Birol, the chief economist at the International Energy Agency (IEA). Dr. Birol told the Independent that, "global production is likely to peak in about 10 years-at least a decade earlier than most governments had expected."

The IEA provided a detailed assessment of 800 major world oil fields. Those fields account for more than 75% of the world's proven oil reserves. The IEA concludes that that production at most of the biggest fields has already peaked and that, "the rate of decline in oil production is not running at nearly twice the pace as calculated just two years ago."

"On top of this," the Independent reports, "there is the problem of chronic underinvestment by oil producing countries, a feature that is set to result in an 'oil crunch' within the next five years."

Back in March we reckoned this underinvestment was going to lead to a spike in oil prices. There was the little matter of the super-contango in the oil futures market, where the futures price for oil was, briefly, nearly four times the spot price. This indicated that speculators and traders were betting on much higher oil prices later this year.

Since then, the futures price has declined a bit as the global economy proved more resistant to fiscal stimulus than first expected. But the spot price has soared. The contango has narrowed. But the net result is that oil is much higher. So what now?

The trouble with forced speculation is that it makes all asset prices more volatile. They are less driven by supply and demand and more driven by relative movements in other asset prices (currencies and bonds). But with oil, we prefer to keep our eye on the long-term supply picture. Why?

Barring a total collapse in industrial civilisation, it's safe to assume demand growth for oil will resume. You may not know when. But you know it will happen eventually.

Supply growth is a whole different mammal. Not only does the IEA report show that production at the world's major fields is declining faster than expected, it shows that traditional oil exporters are exporting less and consuming more of their own exports. When you combine those two factors with a resumption in demand growth - it leaves countries like Australia on the outside looking in.

Exporters are producing less and exporting less (at least that's the trend). And Australia must compete with large consumers like the U.S., India, China and Japan. Not a pretty position to be in. But for investors, it's not a nightmare either. The junior oil patch is heating up.

What about the rest of the market? Chart Partners Group Ltd. tells Bloomberg that the S&P/ASX 200 could plunge by as much as 19% in the next three months. It reckons the index will peak at 4,300 (about 1% up from here) and then hit 3,500 by October.

Keep in mind the whole thing is up 35% from a five-year low in March. A correction would be in order. But as reading the chart is not our game, we're going to get Swarm Trader Gabriel Andre on the case and report back to you tomorrow on what he says. Until then...

Dan Denning
for The Daily Reckoning Australia

• Higher Oil Prices, the New Normal
• Oil Price Chart Shows Slight “Correction” in Near Future
• Dollar’s Demise Has Started a Chain Reaction in Currency and Commodity Markets
• CRB Index Correction Likely to Go Further
• U.S. Dollar Strength or Oil Weakness?

"China also bought 590,000 tonnes of aluminium, 159,000 tonnes of zinc, 30 tonnes of indium and 5,000 tonnes of titanium, said Yu, who works in the National Development and Reform Commission's industry department." Now that metals prices have rebounded, though, will the stockpiling continue, even at high prices? Or was it a case of bargain shopping at everyday low prices?

There are several components of demand. There's real economic demand (you need the stuff to make other stuff). There is investment demand (you're buying it in order to make a profit from what you think the price trend is. There is also pure speculation, and it's possible that some middle-men were flat-out speculating by buying alongside China's State Reserve Bureau (sort of like the banks and brokers in the U.S. buying Treasuries ahead of the Fed late last year to improve Q4 earnings).

But if you're trying to figure out the ultimate direction of certain base metals prices (or commodity prices in general) you have to also consider the currency in which they're priced. Or, as my colleague Dan Amoss writes, "You also want to consider what Ben Bernanke and Tim Geithner will do to debase the dollar in the coming years. If you're a foreign creditor facing with this constant portfolio decision, which has higher marginal utility? Is it 1.) US$2.32 or, 2.) one pound of copper?"

Dan is referring to a pretty handy economic concept. Marginal utility is the economist's attempt to quantify how much satisfaction or benefit you get out of each additional good or service you buy. You have probably heard the term "diminishing marginal utility" more often.

An easy way to understand this is that while one cheeseburger may satisfy your appetite (and your craving for animal fat), four cheeseburgers gobbled down in a row are neither useful nor terribly good for you. They might even be bad (although as an American, we are reluctant to concede this point).

In Dan's scenario, U.S. dollar holders will ask themselves if each additional dollar owned is more useful. Given the fact that the U.S. monetary authorities are making so many dollars, it's pretty clear that each additional dollar added to supply makes each existing dollar less useful. It is not very satisfying to see a methodical reduction in the purchasing power of your savings.

If Dan is right, then stockpiling real assets (even during a relatively weak economy) makes more sense that stockpiling U.S. liabilities. Or, as Dan says, "The Chinese will probably go with #2, especially because copper (and oil, and iron ore) can be stored and used in infrastructure projects to keep the population somewhat placated with infrastructure jobs," says Dan.

He adds that you should look for the Chinese to stockpile resources on the dips in commodity prices, while selling/divesting of U.S. Treasuries into the rallies that come with 'safe-haven' buying. That sounds right to us. But the only catch to the plan is if Treasuries fail to rally on safe haven buying.

On that score, the Treasury market seemed to survive last week's big auction without a huge spike in yields. If the economic news remains neither bullish nor exceptionally bearish, then we reckon Treasuries could rally (prices up, yields down), providing a discrete exit opportunity for certain large investors.

Incidentally, we still haven't seen much in the Australian press about the long-term consequences of government deficits. That's probably because most people are accepting the government's case that Australia's borrowing (and its deficits) will be temporary. We're not as sure. And besides, there are some serious questions about how structural deficits affect a country's currency, its credit markets, and its interest rates.

Those are just some of the questions we hope to take up at our upcoming debt symposium/summit, which will precede the first Australian screening of I.O.U.S.A. We've even picked a date, booked a venue, and secured a cracking panel of experts to train their eye on Australia's very own addiction to debt. Stay tuned for your official invitation!

Meanwhile, did you see that China has astonishingly and rather conveniently discovered some 3 billion metric tonnes of hematite and magnetite iron ore? It's apparently true, and probably comes in pretty handy during the current stagnated annual price contract discussions with Aussie iron ore producers BHP Billiton and Rio Tinto.

As you know, China is the world's largest steel maker and thus the largest importer of iron ore. Chinese geologists claim they have found Asia's largest iron ore deposit ever in Benxi city, which is in the northwest province of Liaoning. The good news is that the deposit is said to be about 2.5 miles long and 1.8 miles wide and could, officials say, have a mine life of 50 years-if a mine is built.

The bad news is that the resource (not a reserve because it's not know if it can be produced economically) is buried around a mile underground. That's a long way down, or a long way to lift iron up, if you prefer, and if you're strong (which China is).

Contrast that with the Pilbara, where the stuff seems to lying around waiting to be found in the hundreds of millions of tonnes by any Tom, Dick, or Kerry. That's right. Iron Ore Holdings, owned by Kerry Stokes, told the ASX yesterday it was increasing by 50% its estimate of its mineral resource at Iron Valley in Western Australia.

This deposit is only 97 metres below ground. It's surrounded by big projects by BHP, Rio, and Fortescue. And the company says it reckons its sitting on a 132 million tonne resource-which is up from the 88 million tonnes it believed it had just three months ago.

Proving up a resource into a reserve-and seeing your share price benefit because of it-is the name of the game for the iron ore juniors. Despite the big Chinese find, we reckon the Iron Valley story is where the Big Picture meets the Little Juniors (or where the rubber meets the road, if you prefer).

At the right prices, stockpiling commodities makes sense to people who will need them later anyway and already have too many U.S. dollars. And if prices aren't right...if..in fact...commodity prices decline (either because of slow economic growth or a halt in stockpiling) then commodity stocks probably fall a bit too...which makes those very stocks-especially the smaller ones that need capital and JV partners-the next logical candidates for acquisition or accumulation.

Dan Denning
for The Daily Reckoning Australia

• Australian Iron Ore Shares on China’s Menu
• India Beats China to Walk Away With 200 Tonnes of IMF Gold
• Have the Chinese Stopped Industrial Stockpiling of Raw Materials?
• China Performs a Kind of Financial Alchemy
• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike

But first, the market action. Crude oil kept on keeping on and closed up 3.4% in New York at $68.58 a barrel. Oil is up 54% this year.

Overall, the Reuters/Jeffries commodities index was up 3.07%. Oil, copper, gold, stocks, the euro-pretty much anything that is NOT the U.S. dollar or U.S. Treasury notes and bonds-is going up. At 81 cents versus the greenback, the Aussie dollar is at an eight-month high.

So it's happening again. Can't you see? Everyone is moving out of U.S. Treasuries and into commodities and stocks because the recession is over! Demand for government debt is falling. Demand for risk is rising! Dollar weakness equals economic strength!

Well. Maybe not. But that's the story that's being spun today. China's Purchasing Manager's Index expanded for the third month in a row. The dragon is breathing fire and building roads. "By the end of April, China had built 20,000 kilometres (12,430 miles) of rural roads, 214,000 low-rent homes, 445 kilometres of highway, and 100,000 square meters (1.08 million square feet) of airport buildings under the stimulus plan," reported China's National Development and Reform Commission on May 21.

Talk about shovel ready.

The Chinese surge in building and construction activity goes a long way to explaining the pickup in base metals prices and base metal stocks. But that just makes yesterday's news even more curious. Matthew Murphy over at the Age reports that the China Iron and Steel Association (CISA) has rejected the benchmark iron ore price negotiated last week between Rio Tinto and Japanese and Korean Steel mills.

That agreement cut the annual contract price for fine ores by 33% and for lump ores by 44%. According to Chamber's report, the CISA is rejecting the agreement because, "those cuts did not reflect the real supply and demand situation in the international market." "These prices do not reflect a mutually beneficial, win-win relationship for steel makers and iron ore suppliers," said a CISA statement. "CISA therefore cannot accept these prices and will not follow them."

We'll see about that. Maybe the Chinese are pushing for an even bigger cut. This is the peculiarity of the iron ore pricing system. Prices are negotiated between producers and consumers (Asian steel makers) on an annual basis. Last year, that worked out great for BHP and Rio Tinto. The 2008 contract price average was nearly double the 2007 price.

This year, even with a 45% cut from the 2008 price, the eventual price will still be higher than the 2007 price. That's not bad at all for Aussie ore producers, considering how awful business has been for everyone everywhere else. It shows a lot more resiliency in pricing-and a lot stronger Chinese demand-than you might expect.

What does it mean for shares? Well, if the price cuts in the contract price are smaller than expected, traders are going to revalue the ore producers at the new contract price. And of course, we're assuming that Chinese steel production is going to remain stable.

There is always the possibility that there is already way too much capacity in the Chinese steel industry and that ore demand, as resilient as it is, does not reflect a sustainable economic situation. But we'll just have to see about that won't we?

Whatever the fate of Chinese steel production, it's pretty clear China is beginning to swing its economic weight around. U.S. Treasury Secretary Tim Geithner was in Beijing promising that the U.S. would be a good borrower and reduce its deficits and not to worry about them so much and just make nice please and stop worrying and smile for the cameras would you please?

Meanwhile, former Chinese central bank adviser Yu Yongding was more direct. "I wish to tell the U.S. government: 'Don't be complacent and think there isn't any alternative for China to buy your bills and bonds','' Yu said in an interview yesterday. "The euro is an alternative. And there are lots of raw materials we can still buy.''

Yes, there are. And by the way, why not a gold exploration boom? Gold mining requires lower capital overheads than bulk materials extraction. And with a rising gold price, it's worth a punt. If the gold mania really takes off (it's starting), look for a boom in the junior explorers.

But back to Yu. Yu has encouraged the U.S. to think about China's interests, "So that your own interest can be protected...You should not try to inflate away your debt burden." He hinted that if the U.S. does that, China has options like the euro. "Yes, some people say the euro is very weak...Okay, weak is good, we'll buy very cheap.''

The man is both a psychic and a good trader. He is also a moralist with an old fashioned sense of fiscal responsibility. "The borrower should keep their promises...The U.S. should be a responsible country."

Note to Yu. U.S. central bankers and government policy makers gave up being responsible a long time ago. 1913, 1971, 1980...take your pick. The policy of perpetual debt and gradual inflation has been around for nearly a century now. The only trouble is that the liability side of the Federal balance sheet has exploded. Hence the need for greater inflation via quantitative easing...and the situation we all find ourselves in today.

It's just the sort of thing that could trigger another dollar crisis. And THAT is what's really behind the market moves, we think. It's not a cyclical rotation out of bonds into higher risk assets because everything's peachy. It's a stealth retreat from U.S. bonds under the covering story of economic recovery.

But what's really going on is that investors are heading for the door on U.S. debt. Ten-year yields spiked again today and bond prices fell. Goldman Sachs reckons the U.S. will have to borrow over $3 trillion this year to finance new deficits and roll over old ones. And if it can't borrow it, the Fed will have to buy it.

For some reason, the Fed is confused about why bond yields are rising. A Reuters headline reads, "Federal Reserve puzzled by yield curve steepening." Are investors ditching the dollar and U.S. bonds because the U.S. credit rating is in jeopardy? Is the huge new supply of debt causing the Bond Vigilantes to protest inflation and punish President Obama buy selling bonds? Or are investors just so confident in the economy now that they feel no need to hide out in the government bond market until they get the all clear signal?

Hmm. What's so confusing again?

A few years ago, we called it "The Money Migration." That still seems like the right description today. You've got a debtor nation whose largest corporate institutions are failing (perhaps a preview of State failure). It's shipped its industrial infrastructure off-shore and replaced it with a financial industry that thrived on credit and derivatives. And now you wonder why investors are pushing interest rates on your debt up?

It's not hard to see who's in the global driver's seat now. It's creditors and producers. And for Australia's sake, that's good news. Because the world's largest creditor and producer is keenly interested in Australian assets, both as a hedge against the fading greenback and as a key input to its long-term expansion, which seems to be coming along just fine for now.

Dan Denning
for The Daily Reckoning Australia

• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike
• Red Bear Rising: Russia’s Resource Based Geopolitical Strategy
• Gorgon LNG Deal with China a Really Big Deal
• RBA Leaves Rates Unchanged, Rio Wraps Up Negotiations
• Dry Bulk Market in Riot Mode

A smattering of articles in recent weeks has highlighted the stockpiling of metals by the China State Reserves Bureau. The Bureau scarfed up 329,000 tonnes of copper in February and 375,000 tonnes in March. This buying has partly fuelled copper's 47% rise year-to-date (it's tied with lead for the biggest gain so far) and its 70% rise from a low of around $2,800 in December of 2008.

Couple this with additional stockpiling of metals like aluminium, nickel, zinc, and tin, and you could make a case that China is trying to back its currency with metal. After all, that would be consistent with the call in March by People's Bank of China Governor Zhou Xiaochuan for a global reserve currency that was not the U.S. dollar. Also, a currency backed by a basket of commodities would certainly have more tangible value than a currency backed by a basket case of basket case currencies (yen, dollar, euro, Yuan).

But the story is probably simpler that a great global currency end game. Copper prices fell by 70% from their July 2008 high to their December lows. Trading depreciating U.S. dollars for copper at rock-bottom prices is a great trade. It's especially great for a nation that plans to electrify itself (which takes a lot of copper) and be a world-leading producer in hybrid cars (which also takes a lot of copper...and a lot of rare earth metals, by the way).

So is China laying the foundation for a commodity currency backed by stockpiled metals and minerals? Probably not. It's just stockpiling minerals and metals while prices are low. And to the extent that the move has anything to do with a currency, it's not China's currency. It's the U.S. dollar.

The Chinese economic planners realise they have made themselves strategically vulnerable to dollar devaluation by owning so much long-term U.S. Treasury debt. The U.S. government is loading up on debt. It intends to pay it back with printed money. This classic devaluation punishes long-term bond holders whose principal is thrashed by inflation.

Besides, since Chinese companies (State-owned and otherwise) keep getting rebuffed trying to take equity stakes in foreign resource producers, it's better to take the Jim Rogers approach and just by the stuff directly and not bother with Wayne Swan and FIRB.

Does any of this benefit Aussie resource producers? Well, yes. Chinese stockpiling of metals has lead to a seven percent rise in aluminium prices in the last month and a nearly twenty percent gain in much maligned zinc prices. As we showed in a Diggers and Drillers e-mail update two weeks ago, Aussie base metals producers have surfed the Chinese liquidity surge into commodities to double digit share-price gains.

Liquidity surfers beware!

The trade only makes sense for would-be stockpilers if prices on the Comex and the London Metals Exchange remain attractive (rock bottom). If speculators try to climb on board the stockpiling bandwagon, it's going to make for a really volatile trading market. Copper for three-month delivery lost 3.6% in London trading on the LME. And on the Shanghai futures exchange it fell even further, down 5% in yesterday's session.

My my my. Let's think about this, shall we?

This situation isn't exactly the same as the across-the-board rally in all asset classes that began in 2003 after Alan Greenspan cut U.S. short-term rates to 1% and left them there for awhile. But it is absolutely the same in one particular aspect: U.S. monetary and fiscal policy is fuelling inflation in certain asset classes, and probably not the asset classed policy makers intended.

In this case, the Fed's quantitative easing policy is designed to drive-down borrowing costs and free up credit. What's happening, though, is that U.S. creditors are abandoning the long-end of the yield curve of the bond market and flooding the short-end (when they aren't bidding up commodities). Fewer creditors want to lend the U.S. government money for 30-years. More are willing to do it for 90 days, even if yields are low, just for the sake of having a liquid, near-cash investment in a still dodgy financial landscape.

You can see this vividly by looking at two-year charts showing the yields on 90-day T-Bills and 30-year Treasury bonds. Check them out below. Bloomberg reports that according to data from the U.S. Treasury Department, China bought $5.6 billion in bills in February and sold $964 million in longer-term notes. Its preferences are clearly changing. You'd expect the 90-day T-bill to again approach zero, and 30-year yields to rise. And in fact, that's exactly what the chart shows.

90-Day T-Bill Rates Again Approach Zero

30-Year Rates Bounce as U.S. Creditors Factor in Inflation

These two charts are bad news for Uncle Sam and probably good news for Uncle Kevin. For the U.S., the shift in borrowing to shorter-term notes and bills makes future borrowing needs extremely interest rate sensitive. Every try rolling over a $1 trillion in debt when interest rates have doubled? And remember, future borrowing needs are massive, with the Congressional Budget Office predicting a deficit of $1.4 trillion next year and nearly $10 trillion by 2019.

If creditors aren't willing to fund U.S. deficits, then the Fed will. And that means printing money. This has two effects. One, it drives up interest rates on longer-term bonds even more (making long-term financing expensive) and it accelerates the flight out of U.S. debt into tangible assets.

Either way, funding U.S. deficits with borrowing-whether its long- or short-term-is the prelude to dollar devaluation. The only way that money gets paid back is through money printing. There is a remote possibility that new taxes could cover the interest expense on U.S. debt. And in case you missed it last Friday, the U.S. Environmental Protection Agency officially classified carbon-dioxide and several other so-called greenhouse gasses as threats to public health.

This reclassification gives the EPA authority to regulate threats to public health under the U.S. Clean Air Act. More likely is the passage of a bill in the U.S. Congress to institute a "cap-and-trade" system on carbon dioxide in which carbon dioxide "polluters" could bid for permits that allow them to emit a certain amount of CO2.

The folks in the Obama administration reckon a "cap-and-trade" regime on CO2 could generate anywhere from $500 billion to $1 trillion in new government "revenues." And the best thing of all is that it won't look like a tax increase. It's a new regulation that imposes upon business the real cost of producing CO2 emissions.

If you think for a minute that those costs won't be passed on to consumers, though, you are obviously brain dead and not reading this at the moment (RIP). Consumers will bear the brunt of a cap-and-trade system with higher energy costs. And that's if the higher costs don't put energy producers out of business altogether. After all, it's not hard to imagine the government imposing a "cap-and-trade" system that raises production costs, but simultaneously capping retail electricity rates (howling voters freezing in their sub-prime prisons).

Do these people really hate coal that much?

You can see that all across the world, the effort to prop up asset values with more inflation is having a widening circle of negative unintended consequences. To keep all that borrowing from being immediately inflationary, governments are grubbing like addicts for new sources of "revenue" that don't arouse the ire of the population. And they don't seem to care if they wreck the economy in the process.

Which brings us to Uncle Kev. Australia's future borrowing needs look small compared to Team America's. Right now, the Aussie government reckons that the deficits as a percentage of GDP will be around 2% in the upcoming budget year and 3% in the year following. That doesn't sound so bad, does it?

In the U.S., the CBO projects the 2009 Obama budget will produce a deficit 13.1% of U.S. GDP. Even under an optimistic scenario, the ratio only declines to 9.6% by 2010. The trouble with deficits is that they become part of the public debt. And the public debt as a percentage of GDP is already at 74% in the U.S. and climbing.

Granted, it's been much higher in other countries (like Japan) and not led to a collapse deficit financing. But each country's case is particular. And what we'd say here is that the long road to national debtor status begins with running annual deficits out of "necessity." The real trouble with short-term deficits is that they add up, year after year, into long term debts.

Speaking just before Reserve Bank Governor Glenn Stevens confessed that Australia was in a recession, Kevin Rudd-in that tortured parlance that he has mastered-said, "The truth is this - the global economic recession makes it inevitable that we'll have a recession in Australia which means that, as we frame the budget, we're going to have to make even stronger our economic stimulus strategy because unemployment will rise even further."

What on earth does that mean?

We think it means that Rudd is already laying the ground work for further transfer payments to Australians which he is going to call "stimulus" and which he is going to claim will help the country avoid recession. But that was the goal the first time around in December, and it didn't seem to work then. So why try again?

Undoubtedly, the people in Canberra who are eager to borrow on your behalf and funnel the money to favoured constituencies will say that the "stimulus" made things less worse (as if a $900 cash payout makes up for the risk of losing your job). They will keep on stimulating until the Prime Minister's poll numbers fall, at which point China will probably be blamed for something to distract the public's attention. Or perhaps the issue will be immigration. Who knows?

Mind you, we're not saying the Liberals look any better on this issue. Across the world, moron politicians on the Right and the Left are trying to spend their way out of a recession that was caused by too much spending. Only an idiot could embrace and defend that strategy. But then, we are talking about politicians here.

The danger here for Aussie investors is that increased government borrowing to finance transfer payments and backstop the commercial property sector will force up interest rates. Higher interest rates are bad for household borrowing, corporate borrowing, and anyone who has a lot of debt to service (which includes a lot of Aussie households).

The secret to any good lie, we remember reading somewhere, is that the number of people who find out the truth is smaller than the number of people who heard the lie once and believed it. Most people are lazy. We hear a good lie once and even if we don't believe it, it sticks in our head. Say it enough and it begins to pass for truth, even if it's absurd.

Australians keep getting told that government stimulus is the way to soften the effects of recession until the recovery takes hold (an event which keeps getting further and further away on the horizon). But this is a lie. The stimulus doesn't solve any of the problems that face the economy. It just keeps people busy and distracted for awhile, while annual deficits and a rising debt (which must be financed by foreigners) become a fact of life in Australia.

The only upside to continued world-wide government ham-fistedness is that the monetary and fiscal insanity heighten the appeal of real assets. This represents tangible wealth for which there is a world-wide market. That's why in the April edition of Diggers and Drillers we resume our look for smashed-down base metals stocks that have exposure to commodity price gains by way of proven reserves of various base and precious metals. It's the best trade of the year so far. Just ask the Chinese.

Dan Denning
for The Daily Reckoning Australia

• China Has Stopped Stockpiling Metals
• Geithner Reassures China that America Takes Financial Obligations Seriously
• Australia’s Currency and its Economy Will Benefit from China’s Stimulus Package
• Chinese Foreign Mining Acquisition Equal to All of 2007
• Everyone is Busily Debasing Their Currency

Less than one month later, the price has cleared the long-term support line on the downside (that goes through points A and B on the chart). As a result, the bearish sentiment strengthens and will probably drive the price even lower in the coming weeks. The price closed at $6,860 a tonne 2 days ago on the London Metal Exchange (LME).

Click to Enlarge

What is going on?

Copper has fallen 22 percent from the peak of $8,775 posted on June 30, as increasing stockpiles signalled weaker demand. Imports of copper and copper products by China fell 4% in August compared with July.

Another element that has an impact globally on commodities markets is the recovery of the US Dollar. Remember that despite the exchange being based in London, copper is priced in US Dollars. A rebound of the Greenback therefore reduces the dollar-priced investments.

The price had moved within a long-term indecision triangle pattern. The basis line of this triangle was the long-term support line that backs the bullish trend started in late 2003. It had been tested and validated in February and December 2007 (points A and B on the chart) where the price bounced back strongly.

The upside of the indecision triangle pattern was the resistance line that goes through the highs posted in May 2006, and in March and April this year. This resistance zone was set around $US 8,900.

The last retracement level (61.8%) of the sharp bullish trend occurred between last December and last March (between points B and D). This had been the opportunity for a small rebound (point H) but it failed to cross above the 38.2% level (point K).

Since the beginning of this month, both the 61.8% level and the long-term support have been broken on the downside. This means the negative trend still goes on.

The MACD has just triggered a new bearish signal, and the Momentum indicator and the RSI are also negatively oriented. In this bearish scenario the next important target is the level of the previous long-term low which is the low posted in December last year (point B), around $6,300.

Gabriel Andre
for The Daily Reckoning Australia

• S&P/ASX 200 Clears Resistance Line
• Macmahon Holdings Limited (ASX:MAH) Near a 52 Week High
• The Aussie Dollar as a Measure of Global Risk Appetite
• Corn Prices on the Rebound
• How to Trade Gold Shares

"The Year of the Rat is supposed to be good for business...good for money...that's what I heard."

We were walking down the street in Paris' Chinatown. It was Friday, the second day of the Year of the Rat. Out in the street, a young girl in a gaudy costume hammered on a wooden drum. Beside her, two Chinese dragons undulated...stood up on their hind feet (the boy in front jumped up onto the bent legs of the boy behind him). Suddenly, firecrackers went off...a series of them...that lasted for about two or three minutes.

"This is the section of the town known as Belleville. Elle magazine calls it a 'babel town' because there are so many different nationalities speaking so many different tongues. We heard Chinese, of course...but also Arabic, along with dozens of other languages from Asia, Africa and India that we couldn't recognize.

"This is the area that Edith Piaf came from," a colleague explained. "It was a working-class French area. Then the Arabs came...and then the Africans...and now the Chinese."

A minute or two later, the two dragons came into the restaurant where we were having lunch.

"What are they doing?" we asked the Chinese waiter.

"They're probably hungry," he replied.

Against the good omen from the Rats is a bad one from the Giants. The Giants won the Superbowl...something they had not since the early '90s. The last time they did so, the U.S. economy went into recession soon after.

Then, there is the January Effect. As January goes, so goes the year, say the old timers.

If so, 2008, is going to be bad. In technical market terms: this January was a stinker.

On the other hand, copper is going up! Copper is often said to be "the metal with a Ph.D. in economics," because it tends to be a good advance indicator. Industries planning to build more refrigerators, more houses, or more airplanes buy copper. The price of copper rises...reflecting more economic activity underway. Copper is up 13% so far this year, after a steep tumble in October and November of last year. Is copper telling us that the worst is over?

Commodities, generally, are going up. The CRB index hit a new record high at 518 last week. Gold is near its all time high too. But there is still time to get in on our Trade of the Decade - especially since we think the price still has quite a ways to go.

And then, there's the bond market. What story are bonds telling? They went up in the fall, signaling a coming business slowdown. But lately, they've been going down - a sign of inflation and/or growth.

No, dear reader, we don't know which way it is going to go. There is a fierce battle raging - between inflation and deflation...between Mr. Market and the market manipulators...between greed and fear...between growth and recession.

In short, Boom...or Bust? Rats or Giants?

"Yes" is our answer. We're likely to see them all. Most likely the market manipulators won't be able to save the boom, because it has always been fraudulent and hollow. But they are god's own gift to the gold market. The more inflation they pump into the system to try to revive the boom, the more gold rises.

Our guess: At best, stock prices...house prices...buyouts...and Wall Street bonuses will stagnate. At worst, they will all go down. U.S. stock prices are down about 9% so far this year. House prices are said to be down about 10% from their top. And the financial industry is still reeling from the subprime debt crisis...which has leaked into all forms of debt - home equity, credit card, corporate, buyout, SIV...you name it. Last week, the Financial Times estimated losses from subprime alone at $400 billion. Banks and grand investment houses are quaking. Two of America's biggest had to be bailed out by foreigners. And the news this morning is that one German bank had to be bailed out with $7 billion.

Meanwhile, commodities and gold continue to hit new highs.

Expect corrections, reverses and surprises along the way...but the basic pattern is likely to hold for many months: inflation in commodities and gold....deflation in housing and stocks.

Still, the most important thing is to stay out of the crossfire. In any given month, the battle could go either way. Any day now, we could have a buoyant rally in stocks...and a breathtaking correction in gold. Or, stocks could crash...and gold could shoot over the $1,000 mark. Watch out. Hold gold and cash. Be happy.

Bill Bonner
The Daily Reckoning Australia

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