And what is this "breakeven point" for oil? The last I heard, a couple of years ago, is that oil needed to be higher than $70 a barrel to make their relevant governments' budgets balance, taxes and duties being what they were.

However, that was back when the inflationary idiocy of "quantitative easing" was still considered an absolute stupidity by every known theory of economics since Adam Smith in 1776, but which now has become "conventional operational mode" thanks to a system of cowardly, corrupt and embarrassingly ignorant-to-the-point-of-stupidity governments (especially the federal one), a laughably incompetent public school system that has turned out generations of ignoramuses, the irresponsible greed and ignorance of the populace, and an ignorant and often complicit media, a pox upon all their houses.

With higher energy prices begins the bleating of us beleaguered bumpkins who must pay these higher and higher energy prices, and the higher prices of all of the things made with petroleum products, without an offsetting increase in our incomes because my stupid boss says that I am overpaid as it is and she would cut my salary and fire me if she wasn't so afraid of me.

And we whine, "Why doesn't the government think about me and my precious, precious children, and do something about higher prices, like give me money like they are giving everyone else?"

And it is not just oil, but all commodities that are shooting up, as Ian Mathias here at The Daily Reckoning reports that commodities are on a tear (up 12.3%), and that "May was the best month for the CRB Index since 1974," which was more than a third of a century ago.

And things are going to get worse, as we import most everything nowadays, and Mr. Mathias notes that "After falling through its 200-day moving average earlier this month, the dollar index has been in steady decay. The index crashed through another important level this morning - the 80 score, a long-standing point of support."

Sure enough, he includes a chart that shows the dollar index falling from 89 to less than 80 in a month! This is a shocking collapse in relative buying power, sort of like my IQ during that "lost" phase of my life that I don't talk about mostly because it's all kind of a blur, but I somehow ended up married and working a full-time job, which I assume is the karmic price I must pay for whatever I did, which I figure must have been really bad.

And when talking of foolishness, it is no mystery to me why the dollar has been falling, and is thus no mystery to me why Randall W. Forsyth, in his Current Yield column in Barron's, notes that "This has been the worst Treasury bond market ever, at least by some measures," which is sort of like saying "your performance has been the worst in company history, at least by some measures," which is almost exactly what my boss told me in my last Employee Annual Evaluation, although she could not cite relevant, inflation-adjusted statistics to prove the allegation of "worst in company history" to my complete satisfaction, and so the meeting degenerated into a shouting match of me calling her a lying shrew who is out to get me because she lusts for my Hot Mogambo Body (HMB), and she is yelling at me how she is disgusted and revolted at the thought of my HMB and she's yelling into the phone, "Get security personnel in here! Now! All of them!"

Just as that episode in the Tragic History Of The Mogambo (THOTM) turned out badly, I expect the same for the economy, as Mr. Forsyth notes that "Amid concern about the Treasury's trillion-dollar borrowing needs, the reluctance of creditor nations to accommodate them and the Federal Reserve's money printing, the benchmark 10-year Treasury yield climbed to a high of 3.70% Wednesday, from just over 2% at the turn of the year. And the 30-year long bond vaulted more than two percentage points from its December lows to 4.63%"

These are virtual doublings! Gaaahhh! Higher interest rates are NEVER a good thing!

This comes at the same time as the Federal Reserve is "quantitatively easing" So Damned Much Money (SDMM), and then using the money to buy up scads and scads of other people's bad debt and Treasury debt, exploding the balance sheet at the Federal Reserve, so this is exactly what you would expect; inflation rises so interest rates must rise, too.

And that means that our old friends gold, silver and oil, will rise, too, in the general inflation! Whee! This investing stuff is easy!

Until next time,

The Mogambo Guru
for The Daily Reckoning Australia

• Federal Reserve Has Destroyed the Economy
• No Silver at the U.S. Mint
• Oil Prices Has The Mogambo Guru Sticking His Thumb in His Eye
• SOS: Suffocating On Spending
• Gold Flourishes but Silver is the Real Precious Metal Story of Late

With a crook laptop and an hour to go before we fly to Baltimore via San Francisco, your editor has plugged a few coins into an Internet kiosk at the airport to see what in the world is going on. A lot.

A Category Five hurricane (Gustav is hurtling toward the coast of Louisiana and Texas, just three years after Hurricane Katrina devastated New Orel ans. Bloomberg reports that oil and gas pipelines in the region are already being shut.

Hurricane season always reveals the two Achilles heel's of Gulf oil industry (Achilles had two feet after all, even though only one of them was not protected by the gods). The first is that off-shore productionsome 1.3 million barrels per day from the Gulfhas to be idled when the storms roll in and can remain off line for repairs for weeks.

The other issue is that Gulf based crude oil refineriesyou know, the ones that produce petrol for American carshave to shut too.
Better hope those tanks are topped up for the Labour Day weekend!

Meanwhile, wouldn't you like to know what was said during the one-hour phone call this weekend between British Prime Minister Gordon Brown and Russian President Dmitri Medvedev? Brown got off the phone, wiped the sweat from his brow, and told all of Britain, "No nation can be allowed to exert an energy stranglehold over Europe."

He promises a "root and branch" review of Britain's relationship with Russia. Sounds about right.

The trouble is, nations with abundant oil and gas reserves DO exert a stranglehold over those without them. Oil and gas are no good if you can't sell them. That's true. But the Russians can sell going East and West.

The Indians and the Chinese will be happy to lock up long-term energy supplies from Russia. After all, that's where all the growth is. Where does that leave Europe? Well, it's September, so it's not cold yet. But in a few months, Russian gas, even if it comes with all sorts of geopolitical provisos, will look mighty nice compared to huddling in the dark and eating tinned food.

So energy joins the credit story on the front pages. And don't even ask us about Sarah Palin! We know nothing about the governor of Alaska who's been named as John McCain's running mate on the Republican ticket. But as we'll be in the States for two weeks, we're sure to hear plenty more and will pass on anything worth knowing. Till then, we’ll hand you over to Diggers and Drillers editor Al Robinson…

From Al Robinson, at The Old Hat Factory:

What’s the best way to tell you have a real shortage on your hands? The government starts blaming producers for it.

And how do you find the answer to any problem? Scout out where the government is looking. Then look somewhere else.

Two cases in point popped up on our screen in the news today. The government’s looking for the solution to high prices. Where’s it looking? Company sales, revenue reports, shifty executives. The solution isn’t in a board room though. It’s out in the blistering hot oilfields of Saudi Arabia. Or Australia’s parched wheat belt.

Case one. We’re all having to pay more for food. Personally, we’ve switched to kangaroo sausages. They’re only $5 a kilo. But what’s the real reason prices are so high? Farmers are still suffering from drought and high energy prices. They have limited land to feed a growing global population. It’s a matter of constrained supply.

The government can’t make more rain, more oil or new fields. Don’t expect Kevin Rudd to launch into an energetic rain-dance at his next press conference, complete with tribal head-dress and grass skirt. We need the rain. But that won’t help, though it may disgust or amuse.

So seeing as Canberra can’t fix this, it needs someone to blame. Who else but food retailers? After all, they set the prices, don’t they? It must be greedy corporations hijacking consumers’ wallets. Fiends.

The ACCC is running a gloved finger over Coles and Woolworths to check if the industry needs more competition. We’re not sure what the watchdog will do if it finds evidence of under-competition. Maybe set up fruit and veg stalls outside the Melbourne and Sydney ACCC offices.

It’s busy poking its nose into the gas sector too. Australian gas prices, which have been well under the global standard for years, have risen. Especially in Western Australia. In WA, gas has more than tripled in price in recent years, from $2.50 per gigajoule to $8.

Could this be simply be the forces of supply and demand? Yes, to be blunt. Natural gas prices in the US have risen from US$1.70 in 2001 to over US$10 this year.

Also, West Australian gas has one customer that dwarfs the rest. Mining. Has any sector of any industry in the world grown faster this decade? According to the Minerals Council of Australia WA will need another 50,000 workers by 2020. With that population, they could earn spare cash as a rent-a-crowd for test matches at the MCG.

But politicians don’t solve things. They win elections.

“It is very important we know more about the competitive impacts of this situation,” Resources Minister Martin Ferguson said in The Australian today. "What the Opposition needs to explain to West Australian gas customers is why the Howard government did nothing, as gas prices continued to rise, to pressure companies to pass on the $460million they reaped following that Government's excise cut of 2001.”

We certainly aren’t saying either of these inquiries are a waste of time. Who knows? Maybe Woodside is squeezing blood out the companies digging up stones in WA. Perhaps they’ve added their own premium on top of the energy crisis.

What we are saying is that there’s a real shortage. The government is making a big show like it’s fixing things. It probably isn’t.

But it’s acting. And that means there’s truly something wrong. If this is severe enough to make politicians act, it’s severe enough to threaten their next election. That means it’s severe enough to be affecting voters.

That’s the point. At the core, this is a supply and demand issue that’s taking place in the real world. Labour can blame whoever it likes. These misguided efforts only punctuate the fact that an energy shortage is, at this stage, a real and unassailable trend. Energy prices are going higher.

And really, that’s what makes the whole thing an investment. Still.

Al Robinson
for The Daily Reckoning Australia

• Water Usage by Big Companies
• Americans are Paying Record Prices for Energy and Food
• Increased Energy Prices Slowing Global Economy
• Top Resource Prices in 2008: Food, Water, Energy & Metal
• Trading Airline Stocks in an Energy Bull Market

Take bananas a few years ago. One day you could walk into a store and buy them cheap. A few cyclones in Queensland later, and banana prices were through the roof. For most share investors, this wasn't an opportunity. It just made bananas and banana bread more expensive.

But in other markets - especially resource and energy markets - a sudden change in the availability of basic resources can change everything. A commodity can go from abundant to scarce relatively quickly. Its price can go from cheap to expensive quickly as well. Naturally, the share prices of companies that produce volatile commodities can change quickly too. We're counting on that this month.

The Leading Edge of the Energy Storm

The high cost of energy - especially coal and oil - is directly impacting resource production in two countries: South Africa and China. As energy prices grind higher - or even hold where they are - this will force the production of certain base metals to lower-cost countries. It will also change the supply-demand dynamic for these base metals, creating new investment opportunities in the process. A good example is South Africa.

You have no doubt read about the power crisis in South Africa. South Africa has a booming resource economy like Australia's. It's driven by gold, palladium, platinum, coal, diamonds and other resources.

Dan Denning
The Daily Reckoning Australia

The trouble is, South Africa's economy is growing faster than its electrical industry. Contrary to all the gloomy reports, we found the place pretty positive when we visited in late February (mostly Johannesburg). Like any fast growing country starting from widespread poverty, you're going to have a lot of chaos, crime and uncertainty.

But one of the few things you want to be able to count on is the power. You flick a light switch, the lights go on. That's so basic that you and I take it for granted. Not so in South Africa. The folks who run South Africa's only large power company told the government years ago that it would have to invest more in power to keep up with the economy's growth. The government didn't listen.

The result is what you have today: rolling blackouts and "load shedding" by the power provider. Demand for power has grown much faster than the available supply. This is not make-believe land. When demand exceeds supply something has to give, and in South Africa, that means power must be cut to someone.

Energy-Intensive Industrial Users on the Chopping Block

The government's first response to the power crisis was to cut supply to the places that used the most of it, namely the suburban business parks where most of Johannesburg's business community has relocated in the last yen years. That makes sense. You can only cut power to people who are using it. But cutting power during the middle of the business day unexpectedly is not exactly good for business, or for people's state of mind.

The government decided to look at industrial users of power. And once it did that, it wasn't going to be long before South Africa realised - like China is now realising - that there is one particular industrial process that uses much more energy than any other: aluminium.

You make aluminium in several steps. First, you have to refine bauxite ore into alumina. Then, you turn alumina into aluminium by adding generous amounts of electricity in an established process. I won't go into the details. But the basic ingredients are what we want to focus on: bauxite and energy.

Bauxite is plentiful. You can find it all over the world. Australia happens to have plenty of the stuff. But it is not alone.

Australia is the Saudi Arabia of Bauxite

World Bauxite Mine Production, Reserves, and Reserve Base

Because of its large bauxite reserves, Australia is also one of the world's largest aluminium producers, as you can see from the chart. But because bauxite has been cheap for so long, other countries that use a lot of aluminium decided to increase production in the last few years. After all, it's cheaper to make aluminium if you have the raw materials than import it. So that's what China and South Africa began doing.

China is Aluminium's Largest Producer

China, as you know, has been using a lot of everything. China's economy grew at double digit rates in the last quarter. Aluminium is a key commodity for commercial and residential real estate activity. It's a lot like copper in that respect. When an economy expands, demand for aluminium increases.

To meet that demand, China has increased its production of aluminium, importing bauxite from Indonesia as well as mining its own. In the first three months of 2007, China increased its aluminium production by a whopping 40%. China's ability to produce aluminium is expected to grow by 15% this year, according to the Australian Bureau of Agricultural and Resource Economics (ABARE).

We're not so sure. Why?

Bauxite is cheap and plentiful. Energy is not. China and South Africa have strained power grids. But more importantly, electric power generation in both countries comes from expensive coal.

Asia Depends on Coal

Hydro-electric power is much more common in North America, Europe, and Latin America than it is in Asia and Africa. Africa does have some large hydro-electric dams, but they are on large rivers, and South Africa's power mostly comes from coal.

Coal prices in Newcastle, New South Wales have been rising in the last month as world demand grows and supply bottlenecks tighten. The rising cost of coal, not to mention the awful environmental side effects are beginning to add up for countries like China and South Africa. What it means - in practical terms - is that it's getting too expensive to make aluminium in countries that don't have cheap energy.

In a recent report, ABARE says that, "the electricity intensive nature of aluminium production, and the fact that most electricity in China is generated from coal fired power stations, means that expansions to aluminium smelting capacity can, indirectly, have adverse environmental impacts."

"To address this issue, the Chinese Government has indicated its desire to limit the production and export of aluminium. In late 2006, the Chinese Government imposed regulations on the size, capital investment requirements and environmental standards of new smelters, and also increased the tax on exports of aluminium metal to 15 per cent (from 5 per cent)".

It's not a difficult conclusion to reach: increased power costs (and shortages) in China and South Africa will lead to lower aluminium production. There is still probably going to be a surplus this year. But the futures market is already pricing in increases later this year and early next year.

That would be a change from aluminium's recent performance. Of all the base metals it's been the big laggard. There was good reason for this, too. Bauxite is easy to mine and easy to find. Energy was cheap. Turning bauxite into alumina and alumina into aluminium was not a high- margin business.

Emerging Sources of Electrical Power in 2008

But now that the energy part of the equation has changed, a shift is taking place in the global aluminium market. Aluminium production will move away from China and towards places where energy is cheaper. In fact, it's already happening.

Aluminium has lagged base metals until now

Source: Bloomberg

Many countries in the oil-rich Persian Gulf are building aluminium smelters. Did you see last year that Dubai planned to build the world's largest aluminium smelter ever?

It's a US$5 billion project with the aim of producing a smelter that can generate 700,000 tonnes per year. It is not alone.

Saudi Arabia has plans for a US$3.8 billion smelter. Oman has plans for a US$2.2 billion smelter. Qatar has plans too.

Saudi Arabia has also said it has plans for a US$7 billion "mine-to- metal" project that includes bauxite mining, refining and aluminium smelting. It calls this the "third pillar" of its oil and petrochemical strategy.

It's an attempt at economic diversification that does not include loaning billions of dollars to struggling American financial institutions. You can argue about whether or not it makes sense for the Gulf States to become aluminium producers. But you can't argue that they have the energy to do it. China and South Africa can't say the same.

What do the Gulf States lack? To make aluminium you need bauxite, electricity and the capital to build a smelter.

Capital? Check (the Aussie firm Worley Parsons (ASX:WOR) got a AU$300 million contract to do work on the Saudi smelter). Electricity? Check (plenty of oil and gas, for now.) Bauxite? Hmmn.

Well there's plenty of that in Guinea and Australia, isn't there?

Rio Tinto (ASX:RIO) is supremely placed to profit from all this, especially because of the Alcan acquisition. BHP Billiton (ASX:BHP)... not so much.

But if we are right and the rising cost of energy forces a shift in global aluminium production away from China and toward the Middle East...what is the best way to profit from this?

But if we are right and the rising cost of energy forces a shift in global aluminium production away from China and toward the Middle East...what is the best way to profit from this?

Bauxite? Alcoa (NYSE:AA)? Or infrastructure firms building smelters in the ME? Or all three?

The answer to that question can be found in what happened with Australia's iron ore business. For many years it was dominated by just a handful of companies, mostly BHP and Rio Tinto.

Then, a few visionary entrepreneurs saw the changes coming (that China would be a big customer for years). You know the rest of the story. Chinese, Japanese and Korean steel companies are inking deals with anyone who can produce iron ore, from Rio Tinto and BHP all the way down to much, much smaller producers.

One of the best performing stocks on the ASX last year was Murchison Metals (ASX:MMX), a small producer in the Mid-West (not the Pilbara). And Fortescue Metals (ASX:FMG), which hasn't actually produced any iron ore at all, did even better:

"Major players such as Fortescue Metals Group (up 460 per cent in 2007), Murchison Metals (up 182 per cent) and Mount Gibson Mining (ASX:MGX) (up 215 per cent) are expected to benefit from higher contract iron ore prices to be negotiated later this year," according to the Herald Sun.

These are exactly the kinds of gains we're after as small cap investors. We think that aluminium prices are going to rise in the next two years and take bauxite with them. Short of buying Rio or the large US company Alcoa, you could do worse than find a small Aussie company poised to rise from a sudden increase in aluminium prices. We believe we've found just the share to do the job.

Following the Pilbara Pattern

The path to Australia's first big bauxite fortune will look a lot like the path Andrew Forrest trod in iron ore. Forrest - who according to Forbes magazine is Australia's richest man - realised he didn't need to compete with BHP and Rio Tinto. Just becoming Australia's third biggest producer of iron ore would be enough to make him a very rich man.

He was right. Incredibly, Forrest's company Fortescue Metals (ASX:FMG) has yet to ship any actual ore to China. But the inherent sense of the business proposition - and rising iron ore prices - have propelled the stock to amazing heights anyway.

Incidentally, while Warren Buffett took the crown as the World's richest man this year (net worth of US$72 billion), India had four men in the top ten. Russia had 87 billionaires on the Forbes list. Russia's richest man, Oleg Deripaska, is the world's ninthrichest. He made his money in Russian aluminium, not in Russian oil.

The company we're tipping this month went public in 2006...

[Editor's Note: In fairness to subscribers to Australian Small Cap Investigator we can't publish the tip to the general public. But if you take us up on our 3 month trial offer, we'll send you this tip as well as the latest issue due to be released in the next few days with yet another tip.]

Dan Denning

The Daily Reckoning Australia

Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). A specialist in small-cap stocks, Dan draws on his network of global contacts from his base in Melbourne, Australia and pens the small cap newsletter, The Australian Small Cap Investigator. He is also a contributing editor to the Australian resource investing publication Diggers & Drillers.

View all articles by Dan Denning.

• Base Metals Prices Spiking After China Earthquake
• Chinese Foreign Mining Acquisition Equal to All of 2007
• BHP Billiton (ASX: BHP) to Report Second Half Results Today
• The Market Price for the Resources China Wants is Rising
• Australia Presents Investors With Great Portfolio of Energy Choices