Phew! Thank goodness that whole thing about toxic assets is over. Now we can get back to passively investing in stocks that only ever go up.

There is a serious case of denial coming from institutional investors and the financial media about what's ahead. Sure, it's tempting to think that because things have been so bad they won't get any worse. But what exactly emerged yesterday that changed the situation banks and investors face?

Not much, that we can tell. But that's because this is not a subjective crisis. Whether the situation has really improved does not depend on how you perceive a bank's balance sheet or a company's earnings. It depends on whether that balance sheet is actually healthy and the company can actually grow earnings.

But let's not quibble. The job of the Bear is to lure investors back in so he can smack them back down later. Frankly, the bear was gorging himself a bit anyway and getting a bit lazy.

Stocks were down on average about twenty percent in major Western markets. Consumer confidence levels were low and getting lower. The Bear needs fresh meat. And he can only get that if he can attract more investors back to the market. In you go!

The major economic news released yesterday is at odds with the way the market behaved. We're talking about the news from China that exports dropped 25.7% in February. Imports were down 24.1%.

If China makes and the world takes, China is making less because the world is taking less. And of course, China takes from Australia to make for the rest of the world. If China is making less, it will take fewer Australian resources.

There is a raft of data that need sorting, though. First, fixed asset investment in China actually grew by 25%. Fixed asset investment could be roads, bridges, and buildings-the sort of investment that needs copper, nickel, zinc, coal and iron ore. Or it could be commercial real estate-the kind of shovel-ready government busy work that doesn't lead to any bottoming in commodity prices ore sustained resource demand from China.

Also comes the news from Japan on thermal coal negotiations between Chinese utilities and major coal sellers Rio Tinto and Xstrata. It now looks like thermal coal prices for 2009-2001 are going to come in around US$70-72 per tonne, according to Matthew Stevens in today's Australian.

That's a 44% decline from last year's price of around $125 per tonne. But it's still higher than the spot price of US$60. And it's still 25% higher than the price for 2007-2008. So, as big as the percentage decline is, it's coming off a large base.

That doesn't make coal stocks an instant buy. But here is a clear difference between the extractive resource industries and the financial industries. Prices are responding to changes in demand. Resource producers are not being bailed out or directly subsidised by the government. There is a lot more transparency about what's going on the industry.

What's missing, to use a word analysts love, is visibility. No one can see that far ahead for the economy. This makes reliable price forecasts for commodities difficult to make, which makes earnings estimates hard to make, which makes valuations difficult to make.

Our suggestion? Keep it simple. Focus on companies with cash, little debt, and world class ore bodies (poly metallic for metals miners).

It's a bit nauseating to be told over and over the problem is confidence. We suspect this is a political tactic. Blame the credit bubble and resultant insolvency of the financial system on confidence! Then, give the people a dose of free money, which may numb the pain of the approaching second freight train to hit them.

That freight train is the credit market not responding to increased central bank liquidity in the desired fashion. "Libor's creep shows credit markets at risk of seizure," reports Bloomberg. "The cost of borrowing in dollars is rising as the global recession deepens and central bank efforts to prop up the financial system fail to prevent a growing number of banks from requiring government bailouts."

It is still a bear market in trust within the financial system. Central Banks are more than willing to lend to banks. But banks are hoarding reserves. The only upside of this is that banks haven't relent expanded reserves into the real economy. That would be the engine of inflation.

The downside is that increased bank reserves don't do much to improve the value of the assets on bank balance sheets. To address that, expect G20 finance ministers meeting in London to make a lot of noise about mark-to-market accounting. They want to change the rules so that firms don't have to constantly revalue assets to their current market value.

In any event, the action in the credit markets-Vikram Pandit's ray of sunshine not withstanding-suggest that the financial system is just as vulnerable to trillions more in losses and failures now as it was six months ago. Not a single thing has changed in the last few days to alter that fact.

Nonetheless, the market may rally anyway. The G20's political leaders meet in London in early March. This could be a world-historic event, but not for any positive reasons. We are pretty sure the leaders of the G20 nations are not going to gather together to ratify and sign an agreement that solves all the problems.

On the other hand, all their quarrels and divergent national interests will be on full display for investors and savers the world over. Investors are going to realise this problem is bigger than even big government's ability to contain it. What happens after that should be interesting...

Dan Denning
for The Daily Reckoning Australia

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This will never happen, of course. Automatic withholding taxes are a key source of government revenue at a time, the world over, where liabilities are rising fast. But it would be a lot more efficient than having Canberra, Washington, or London sprinkle out the money on projects that may or may not enrich politicians and their donors.

That is part of the big picture. In the littler picture, news came out yesterday that Chinese GDP growth may not reach the eight percent target set by the old men in Beijing. It will, perhaps, be just six percent growth this year.

Six percent GDP growth-if the number can be taken at face value-is no small feat during a worldwide recession. But China's policy makers have said in the past that in order to meet employment objectives (you need factory work for the millions moving off the farms) the economy has to grow at eight percent.

How will rising unemployment and closing factories affect China's political stability? Hmm. We have no idea. But we do know that according to yesterday's data, China's exports fell for the second consecutive month. They were down 2.2% in November and another 2.8% in December. It's the worst export performance since 1999.

More ominously for Aussie investors who would like to find the bottom in mining shares, China's imports fell 21.3%. As China imports a great deal of raw materials, this is not good news for the Aussie share market. In fact, the market was down nearly two percent intra-day, before finding the courage to close just in the red for the day.

Today, though, some of the world's biggest miners announced cost cutting measures. Rio Tinto is suspending underground work at its copper and gold project at Northparkes in New South Wales. It's also shelving plans for auto-mated trains at its iron ore operations in the Pilbara.

Mining shares are down at the open today. But behind the scenes, it looks like Chinese companies are using the commodity price crash as a chance to secure long-term off-take deals with Aussie companies. "Emerging West Australian iron ore producers are facing renewed Chinese interest in long-term off take agreements before an expected drop in contract prices," reports Sarah-Jane Tasker in the Australian this week. "Hartleys resource analyst Andrew Muir said Chinese steel mills were still looking for long-term off take agreements, but he warned that companies would now be more selective."

This is what Diggers and Drillers editor Al Robinson calls the "Pebbles" phenomenon. While BHP and Rio were engaged in a soap-opera like love/hate fest over conquering the resource world, Chinese banks and steel mills have been diligently sifting through the wreckage of the resource market for projects they want to finance, own, or invest in.

For example, Dow Jones Newswires reports that Gindalbie Metals has received conditional approval of a $1.8 billion loan for its iron ore project at Karara. Gindalbie is also funding the project by selling equity to Chinese outfit AnSteel.

So you see, business is still getting done. Let's not forget this. Someday, this crisis is gonna end. All the things we've discussed here in the Daily Reckoning will have come to pass (perhaps not exactly as we've forecast) and the world will get on the business of life, replacing one financial growth model with something less leveraged and more oriented to the growing places of the world. But just when that it is and whether or not it will be good for investors in Aussie resource juniors this year is unclear.

What is clear? Ben Bernanke is terrified. "Fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system," Bernanke told fellow terrified people yesterday at the London School of Economics. "More capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets."

Here we are, 525 basis points lower on short term U.S. interest rates, a doubling of the Fed balance sheet to US$2 trillion and growing, and US$750 billion into a TARP that can't cover the rotting corpse of the financial system, and Bernanke told the world yesterday that the basic problem-bank balance sheets impaired by assets they can neither value nor sell-is no closer to being solved.

That seems like bad news.

Bernanke went on to explain the various policy tool kits at the Fed's disposal. You can break it down into three big hammers: lending directly to financial institutions, providing liquidity to key credit markets, and the direct purchase of assets. The Fed has already begun purchasing assets like mortgage-backed securities. But in theory, there is no limit to what kind of assets it may choose to buy and add to the balance sheet. It could even buy gold mines if it wanted.

"You don't really think it's the government's plan to make people poorer do you," one of our sceptical friends asked last night over a cold beer on a scorching Fitzroy Street in St. Kilda. "If they did that, you'd have social chaos. Revolution even. This isn't Batman. Bernanke isn't the Joker. He doesn't want to watch the world burn. He's just trying to start a little inflationary camp fire to fight deflation in financial assets."

"Should I get marshmallows?"

"Be serious. You write to people every day and predict things that...well if they were true, would truly be disastrous. The only reason it's not so monotonous reading the same thing every day is that it's often scary in some new way you've managed to think up. Don't you feel bad for all your fear mongering?"

"No. Do you realise how few people the Daily Reckoning reaches? And on any given day, I have no idea who's choosing to tune in. So we have smash our way through the garbage in the paper to let people know that things are happening in the world that have real consequences. There's a lot at stake. I don't feel bad for trying to highlight that. Plus, daloob."

"What?"

"Look, the answer is no. Bernanke is not trying to burn the world down. Maybe there are some people in government who are happy with that outcome, though. More than you'd like to think. It leaves them stronger and more powerful and the rest of us weaker. I don't know. Disorder is one way of keeping people busy and weak. But no, I don't think Ben Bernanke goes to bed at night plotting ways to turn the world's savers into serfs. But I do think that the destruction of paper wealth is going to be the end result in America and other places. This is how fiat money ends. And fiat money is what we have."

"You say that all the time. But you're going to pay for my beer with fiat money."

"Well, I always pay for your beer. And you never listen. Money is not wealth. Money is a commodity, a simple means of exchange. Paper money that is not backed by something real is not real wealth. It's not capital. It's just paper. And once people lose confidence in it, it's gone baby gone."

"What happens next?"

"Argentina. Weimar Germany. Zimbabwe. Take your pick. Us Americans and Briton and you Aussies as well, like to think it can't happen to us because...well because we have a high opinion of ourselves and the world's most powerful military. But the bills just keep piling up. It's a lousy way to live and a lousy thing to do to your kids. And it just doesn't last forever."

"Unlike your daily reckoning."

At that point, your editor left and returned to his home office to find this plan of action from a fellow reader. We liked it so much-and it's roughly what we have been steering toward for the last few months, that we reproduce it for your benefit. We're tentatively calling it the Emergency Private Pension Plan.

Hi Bill

"I just want to boil things down a bit - the DR can be a bit long winded (But it's free so who cares!) What we really want to know though is how we can retire in luxury within 2-3 years or less - perhaps you could develop the following for us a bit:

1. Now: We are basically in a recession with a tendency for deflation

2. Now: Governments are reflating / printing money to reverse the recession and deflation

3. Now: Governments are reducing interest rates to unprecedented lows - to reflate

4. Within 6 month: When inflation starts to rocket, so do interest rates

5. Within 12 months: When/if the recession "ends" we then get even more amplified inflation there being heaps of cash about

6. Within 18 months: To pay off the massive debts, taxes rocket but production also remains stunted so economies tend into a long slow recession with continuing high inflation again

So from this we conclude what we should do:

1. Now to four months: Expect a choppy Bear Market rally: great for leveraged traders and high dividend quality blue chips: double your money.

2. Four to six months: Swap into gold, puts/shorting and fixed interest securities: double your money in 6 months

3. Up to Twelve months: Swap into rebounding property but keep the gold: double your money again

4. Before 18 months: Cash in again and go into recession/ inflation resistant assets such as staples, telecoms etc, but probably retain 25% of the gold: double your money again over 2 years.

So after multiplying your initial cash by a factor of 16: cash-in, open a gold current account and go and live in luxury in Thailand (Where there's no capital gains tax!)

What do you reckon?

Cheers, SJC

--We'll drink to that.

Dan Denning
for The Daily Reckoning Australia

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The sun, for sorrow, will not show his head:

Go hence, to have more talk of these sad things;

Some shall be pardon'd, and some punished:

For never was a story of more woe

Than this of Juliet and her Romeo.

Romeo and Juliet, Act V, Scene III

At last. The liberation of the American Main Street has begun. If, by liberation, you mean further bonds of perpetual debt.

But first, the tale of woe between BHP and Rio Tinto. After 18 months, BHP got tired of waiting for its cold-footed would-be bride and left the altar for a drink. Rio is left in wings of the church, wondering if there are any single, cashed-up guests. It would be a shame for all those flowers to go to waste.

Rio seeks a new partner, and quickly, as Alan Kohler put it in today's Business Spectator. "Single mining company, 103 years young, seeks genuine life partner for romantic strategic off-sites, walks on the beach and candle-lit board meetings (to reduce carbon footprint). Ideal partner is someone who will love me for who I am, although if you want to change me - well, that's okay too. But you will have to accept my neurotic family of bankers, including the weekly Sunday roast."

"I have an unfortunate condition known as DLC Bipolar Syndrome and as well as chronic indigestion from swallowing too much aluminium last year. However, a small amount of nursing aside, I will be a desperately loyal spouse. Happy to learn Mandarin."

By the way, yesterday we sent out a note mistakenly saying it was the Eureka Report's first birthday. The Eureka Report has been around, like the DR, for over three years now. It's Business Spectator that's celebrating its first birthday this month. Congratulations to the whole lot there. You can learn more about the Eureka Report here.

For Rio, tomorrow is another day, starting today. The company still gas all that rich red Pilbara soil, the same way Scarlett O'Hara had the rich red Georgia soil of Tara. But the stock? That was in the red too, falling nearly 40% in European trading. What's ahead for the company? We asked Diggers and Drillers editor Al Robinson for his take.

"Rio could easily fall $20 today after BHP canned its takeover bid. But that's not what investors should take from this. It's a sign of the times. The mining industry has come to the point where everyone is putting the blinders on. Diggers are focusing on making their own businesses as good as they can. Even the biggest players of all - BHP and Rio."

"To be honest," the Bard of Bendigo continued, "a few miners won't have as much business as they did in the last four years. But some still have great businesses. And right now, that's fantastic - because so much of the sector is priced like the resource business won't even exist next year. It's just a matter of picking good businesses priced like bad businesses."

"If you're a punter, the junior market will be one sure-fire place to find underpriced businesses in 2009. But right now, I'm scrounging through the energy sector. And there are some major, blue-chip bargains out there."

Meanwhile, over in America, Henry Paulson rummaged through his suit pockets last night and found an extra $800 billion for American households. Sort of.

The Fed and the Treasury will use $600 billion to buy troubled mortgage-backed securities from government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. They hope this will "unlock" the market for mortgage finance.

"As the economy is turning down, it is very important that lending be available to consumers," Paulson told reporters. "This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally," the Fed proclaimed in a statement.

"Oh please housing bubble. Please reflate. We beg you."

Paulson also announced a new program called the Term Asset-Backed Securities Loan Facility or TALF for short. It's designed to, "increase credit availability and support economic activity by facilitating renewed issuance of consumer and small-business ABS at more normal interest-rate spreads."

In other words, the Feds are trying to revive the ABS market so consumers can take on more debt. "That's right, just put these shackles on and give me the key." As serious as the subject is, all we could think of when we read about this latest monstrous acronym of a program is this:

"Are you kidding? I love securitised student loans almost as much as I love cats!"

There is a lot more going on in the U.S. credit markets. But let's take a break today for some reader mail.

Dear DR,

What I still can't get my head around is what the heck an individual is meant to do in the current market except, obviously, reduce discretionary spending and reduce consumer debt. Times are bad = buy gold? Recession coming = Cash is king? Fed printing money = inflation/hyperinflation on its way = Cash becomes worthless overnight? Hyperinflation = Hold assets?

Every day I read numerous reports and articles about the economy and I understand more of the mechanics of the market and how we got where we are now. I understand more of the thinking behind the actions of the world governments and central banks BUT I still have absolutely no idea what to do as an individual!

HELP!!!!

Paul A.

You're asking all the right questions. The media and financial authorities have suddenly fallen in love with the "D" word (deflation). We believe this is so they can prepare the public for massive deficit spending. It helps justify more government borrowing.

Eventually, we believe massive deficit spending will lead to much higher global inflation. But it hasn't so far, mainly because banks have become black holes for cash. What's needed by the Central Bankers and elected officials is a way to get cash into the hot little hands of consumers, whom they hope will spend it. Hint, government-issued debit cards.

In the meantime, now that the FDIC in the States is explicitly guaranteeing the issuance of bank debt, we'd expect banks to demonstrate a preference for high-yield corporate debt over cash reserves at the Fed or U.S. Treasuries. This should, in theory, drive yields up on U.S. government bonds, and drive investors toward equities for an end-of-year rally. Easy as cake and Bob's your Uncle.

But anything can happen. What should you do? You should be having a conversation with your financial advisor about your asset allocation. How much money do you want in shares? And if you're in the position to select your own shares for your Super fund, you'll want companies that don't have leveraged balance sheets (banks) and can generate cash flow from tangible assets (they can make money without spending a lot more money or borrowing).

Hi guys

I enjoy your commentary regarding the current financial climate. I'm asking a simple question regarding the Federal Reserve and printing money and the possible US Dollar collapse. Does the Federal Reserve actually 'print' money or is this just figuratively speaking when discussing lowering of interest rates so people spend money and the "oil' is back in the machine so to speak.

From all the commentary I can find, the Fed actually prints money. Isn't this irresponsible? Would this then mean the US dollar debasing itself, eventually becoming not even worth the paper the note is printed on? Won't the US crediting nations, (Japan, China and the OECD nations) start to offload US dollars and probably take on Euro's? Would the US then start to lose its US dollar leveraging power as the key trading currency?

What options does the US have? Increase interest rates and taxes to unprecedented levels to remove the $53t debt? This will be popular choice for the new President-elect Obama and a test of his leadership prowess. Relinquish the status of the primary trading currency, would this see the dollar collapse? I can see pain in the US with both options.

How does the US pay back the $8.7t loans, when they are a consuming nation? Is it better for the world that the US is cut? Like a bad debt and the rest of the world continues? Feels like the US is pulling everyone else down.

Could the rest of the world continue without the US being the major player and use the BRIC economies? Interesting time in history. I know I asked too many questions here and your time would be limited, so if I could have an answer on the Fed printing money, will suffice.

Kind Regards,

Michael R.

Jim Rogers thinks the dollar is headed for the scrap heap of history, and favours commodities as a refuge. Marc Faber says the global economy is imploding. He likes gold. The Fed says it isn't actually printing money yet. The graph of the adjusted monetary base, courtesy of the St. Louis Fed, suggests otherwise.

For the record, we doubt the U.S. has any intention of ever repaying its debts. The whole genius of a funded national debt (designed by the English under Walpole) is that the interest on sovereign bonds can be paid by levying taxes, while the principal is continually rolled over. All that's required is a regular buyer for new bonds to replace those that mature. Out with the old, in with the new, and long live the King!

So far, mostly because of the Japanese and Chinese, there have been regular buyers for new U.S. bonds (debt). The dirty little secret of American borrowing, however, is the maturity schedule of marketable U.S. debt held by the public. That sounds like a mouthful. But it just means debt held by banks, individuals, corporations, or even foreign central banks.

When you look at that schedule, it shows you that 66% of America's $5.2 trillion in marketable debt held by the public matures within the next four years. Obama! Once those bonds mature, the U.S. government will try to "roll them over," or sell new bonds to the previous owners, preferably at the same low interest rate.

Source: United States Government Accountability Office, FINANCIAL AUDIT, Bureau of the Public Debt's Fiscal Years 2008 and 2007 Schedules of Federal Debt, November 2008

When a nation relies on over-seas saving to fund its perpetual debt, it's playing a dangerous game. Britain found this out the hard way in the eighteenth century. It becomes beholden to its creditors and ultra-sensitive to rising interest rates.

The Dutch were Britain's big creditors at the time (having racked up huge surplus savings through trade and commerce.) When the Dutch began selling British government bonds because they feared rising British debt, it drove up interest rates in Britain, making it more expensive for the government to borrow for its war with the rebel colonists in America.

The world can't just decouple from America they way you might stop answering the phone calls of an old flame. Too many people own too many dollars. But the expansion of government borrowing in America will, we believe, eventually drive up interest rates and drive down the value of the U.S. dollar at the same time.

The trouble is, there aren't too many other currencies that have better fiscal back-stories either. The Yen and the Swiss Franc are probably the exception. And there is always gold. But how the dollar drama plays out will be one of the most pressing questions for 2009. We'll have more on it this week. Until then...

Dan Denning
for The Daily Reckoning Australia

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• Fall in Commodity Prices Will Reduce Inflationary Forces

It doesn't get much more direct than that. The truth is, governments are trying to do the impossible. They are trying to make bad loans turn good by propping them up with extra money, money that comes from out the blue. And instead of encouraging household saving that would form the base for future productive investment, governments are encouraging more consumption and nursing along trillions in mal-investment (housing-related securities).

Debt-based consumption and the securitisation of those debts are what brought us to the point of systemic crisis in the first place. Had markets been allowed to work, the over-leveraged financial firms would have failed, a deep recession would have ensued, and consumers-cut-off from credit-would be forced to save rather than consume.

So far, though, efforts to save the system by propping up bad debts are only weakening confidence in the system itself. It's happened with surprising speed. My friend John Robb writes that it's a cascading collapse of ever larger bubbles. It starts small and grows to encompass the entire global financial system.

• Small. A belief in the US consumer. US subprime mortgages collapse. US prime mortgages and US commercial real-estate and consumer credit follow.
• Big. A belief in the Shadow Banking system. The investment banking system implodes. Hedge funds liquidate. Money markets/commercial paper seize up. Financial insurance evaporates.
• Bigger. A belief in the global banking and market system. Systemic bank failures. Global markets crunch.
• Huge. A belief in the US as a global economic power. US treasuries and the dollar crash. Numerous national bankruptcies

A critical point to realise for investor is that creating more debt and credit is not going to solve the problem. The bad debts need to be liquidated and the people who made them need to be replaced by better capitalists who can put available savings to a productive use. Yet propping up the people who got us into this mess with more money is precisely the response we are headed for. In an interview with CNBC last week, Jim Rogers predicted an 'Inflation Holocaust.'

In an effort to save their own skins and prevent consumers around the world from a very healthy and natural return to living within their means, global politicians are again making a bogus promise that everything will be fine if we just borrow more money. By doing so, they've upped the ante in the crisis and put the entire financial system-in its current form-at risk.

Will the 2003 lows on the ASX and Dow be taken out?

Before we get to the larger question of what will happen to the global financial system, let's return to the more immediate question of what stock markets are going to do when they open Monday (assuming they do, in fact, open for business as usual). Without a clear plan emerging (as of yet) from the G20 meeting in Washington (it followed the G7 meeting), the futures in Asia are down, although the ASX/200 futures are up 27 points as of this writing.

Where stocks go from here depends on what they are pricing in. Remember, stock markets are forward looking. The market tries to determine the current value of future earnings. There are two factors that cloud that picture right now: the credit crunch and a global recession.

The crisis in the financial sector was not successfully quarantined. Banks are not only unwilling to lend to one another, but to anyone at all. Hence the freeze in the short-term commercial paper market. Companies that relied on the money market and commercial paper market to fund payrolls and inventory now have to go straight to the local central bank. Wire service reports from the U.S. suggest General Motors may soon borrow directly from the Fed.

The earnings picture is nearly impossible to paint if the credit markets remain locked up like this. We simply don't know who can get credit from the Central Banks and who can't. Who will fail and who will survive? Who will have to cut prices or slash payrolls?

The other factor weighing on shares is the emerging fact that we are facing a synchronised global recession. If consumers are also denied access to credit, consumption must decline as savings rates rise. Unless retailers slash prices (and profit margins) we don't see how they will sustain revenues for the last quarter of 2008 and the first quarter of 2009, much less increase them.

That means stocks would have to begin factoring in a dramatic decline in consumer spending and 2009 earnings. The analysts would prefer to do this in piecemeal fashion. The market will likely do it in a few lump sums.

3,500 or Taking out the 2003 Low?

Last week we published analysis by our chartist and Swarm Trader Gabriel Andre. Gabriel said the first line of resistance for the ASX/200 would be at 4,300. That support was taken out on Friday. If the index is unable to regain it, Gabriel highlighted the next line of resistance at 3,500. That decline would be just 460 points from current levels-or 11.6% in percentage terms (one very bad day of trading or two awful days, at this rate).

Click to Enlarge

An 11.6% decline from the current levels would put Aussie stocks back at 2004 levels. You'd have to think that the big blue chip miners would start to look extremely attractive at those prices-once (and if) the banking crisis is quarantined (via nationalisation and equity stakes). Cashed-up private investors might be willing to come in from the sidelines at that point, lured by the valuations.

But we have drawn a third line on the index where the 2003 lows are. We should consider the possibility that the current crisis is going to wipe out all of the equity gains that began with the low-interest rate cycle in 2003. The March, 2003 low on the ASX was 2,715. A fall to that level form 3,960 would represent a decline of 31%.

Obviously a decline of that magnitude on top of the 40% drop from the October 2007 high is astonishing. Remember, the closing high for the ASX/200 was 6,853 on November f1st of 2008. A decline to 2,715 or below would represent a 60% fall on the index (which curiously coincides with one of Gabriel's key Fibonacci retracement levels.)

2003-2007: A Bear Market Rally

Could the market really give up 60% from its all time highs? The argument to support this retracement starts with the claim that this bear market began in 2000, not in 2007. Stocks declined for three years as the market purged the easy money created in the tech boom.

Then a host of a factors-cheap exports from China and Asia to keep down consumer price inflation in the West, low interest rates to fuel simultaneous booms in housing, shares, bonds and commodities-conspired to prevent the bear market from doing its work. Globalisation and interest rates banded together to give us a mighty, but unsustainable boom.

In essence, this view suggests that the entire rally from 2003 to 2007 was simply a rate-fuelled rally in the midst of a secular bear market. It you accept that view, then it becomes quite easy to see how the 2003 lows could be challenged. And if the view is correct, they won't just be challenged, they'll be taken out and a new low established.

For this scenario to unfold, you'd have nothing less than a global financial system reboot. It would represent the complete collapse of the global system in which American consumption, fuelled by credit, is the engine of global growth. It would also mark an emphatic end to the system whereby global exporters keep their currencies artificially cheap against the U.S. dollar in order to remain attractive to the U.S. market.

You could also expect to see a sudden and violent end to the habit of recycling trade surpluses in the U.S. stock and bond market (a form of vendor financing that no longer makes sense when your customers are broke and can't get credit.) The Treasury market would see much higher interest rates and the U.S. dollar would crash (especially against gold, oil, and commodities, giving us the 'Inflationary Holocaust' predicted by Jim Rogers).

Global Rebalancing

This series of system shocks would eventually bring about the long-anticipated "global rebalancing," where Americans save more out of necessity and the developing world eventually consumes more of its own production. On the American side, it means lower levels of consumption, more saving, paying down debt, and investment in real wealth production (infrastructure and energy rather than residential housing and shopping malls).

For the developing world, it means more investment in domestic infrastructure and the domestic economy. Savings will have to be unleased locally to finance this investment, rather than loaned to rich Western countries to finance deficit spending. And with rising per capita incomes and the beginning (yikes) of consumer credit, you'd expect to see higher rates of consumption on consumer and durable goods, all of which is resource intensive and in the long-run, very good for Australia.

But all of that is an enormous shift, a huge wealth transfer from the consumption and debt based economies of the industrialised world to commodity producers and high-savings nations in Asia. It is the Money Migration at light-speed. It creates real wealth for investors while destroying bogus balance sheet value for bankers.

In the meantime, you can expect global policy makers to try and engineer some replacement for the broken system of global finance. Italian Prime Minister Silvio Berlusconi called for a new "Bretton Woods." It will involve ever greater monetary cooperation and centralisation.

It is worth noting that the G7 nations think they will be the architects of the new financial system. It has not occurred to them that perhaps the global balance of economic power is now tilting away from Europe and America toward something else entirely. More on where this leads in tomorrow's regularly scheduled Daily Reckoning.

The Best Value in the Resource Share Market

For now, suffice it to say that there IS real economic growth in Asia. And once the global economy emerges from the recession induced by the collapse of the leveraged credit bubble, demand for the resources to build the developing world will resume. Valuations in the resource sector will not be driven by speculative money hitching a ride on soaring commodities prices (the first phase of the commodity boom).

Instead, valuations will be driven by solid balance sheets, excellent projects, and good management (the second phase of the commodity boom). For Aussie resource share investors, it means it will be your best chance since 1987 to buy best-of-breed resource companies leveraged to the urbanisation, industrialisation, and infrastructure trends that are making Asia the new engine of global growth.

But how do you know where to begin your search? In light of the crisis and the appetite for helpful analysis, we've elected to publish a small section of the latest issue of Diggers and Drillers, normally available only to paid subscribers. In it, you'll find what editor Al Robinson is doing now to turn this crisis into an opportunity.

Al has selected his four favourite cash-rich Aussie companies to emerge from the crisis stronger. To protect the investment made by paid-up subscribers, you won't read about those four in this free sample. But we have given you a table of ten firms Al researched and what he found.

How to Find the Safest, Cheapest Resource Stocks During the Crisis
By Al Robinson, Diggers and Drillers

How do you know which undervalued stocks will survive the mauling in finance? You search for the ones with quality assets and cash. Cheap mining and energy companies can use cash to shield their currently-oversold mining, oil, and gold assets.The businesses survive. The cheap assets live on and rise to their real value.

That means steady, satisfying, long-term investment gains for you if you play your cards right in the next few months. I've scanned the entire resource market and laid out the ten of the most cash-greedy stocks. They have some of the most profitable assets; oil wells, coal mines, gold reserves and iron deposits. All are going on a massive sale this month.

But these ten companies are sitting on a $2.1 billion mountain of cash. That's your ticket to safety.

Ten Oversold Resource Firms, Each with a Shield of Cash

This selection includes both producers and juniors. It includes energy and mining stocks. It includes small-caps and mid-caps. It's a table with variety. But they all have big cash accounts in common. Of the resource shares in the top 300 listed Australian companies, these companies have the most liquid backing. They ooze safety compared to the rest of the market. They're getting cheaper just as fast though.

They have minimal short-term debt maturing in the next year. That's just as crucial as the cash balance itself. These companies have liquid assets unsoiled by heavy borrowing. They aren't leveraged to the credit crunch through debt exposure. They are leveraged to the resource boom through asset exposure.

All up, these 10 stocks have over $2.1 billion in cash on hand right now. Their market cap is $6.2 billion. Over 35% of the equity here is un-invested and un-spent.

Credit stretches and contracts like a length of elastic. That gives credit-based companies a wild ride up and a wild ride down. But cash doesn't stretch. It's solid. It sits there. It does nothing until you need it. That time has come.

Overall the companies above have less than $1 million in short term debt. It's insignificant. And above all, every single firm owns a quality project that the market is chronically devaluing this month.

Six are energy stocks. That's not surprising, considering the massive boom in energy company cash-flows over the last year and a bit. Oil, gas and coal assets have leapt in price. Liquidity has flowed to the companies that own them. These ones held onto it.

But the juniors have cash too - if you're brave enough. Some aren't producing yet. They've filled their wallets with clever financing methods instead. And the juniors on that list are still getting a lot of attention from important investors.

Al Robinson
The Daily Reckoning Australia

• The Australian Resource Boom Isn’t Dead Yet
• Lehman CDS Auction Hammers Australian Resource Stocks
• The Future of the Australian Resource Market, Two Ways the Boom Could End
• Big Australian Resource Stocks Up 24% in 2008
• The Dark Underbelly of Australia’s Resource Boom: Chinese Resource Demand

The uranium price from last year reminds us a bit of when Jack tossed those magic beans out the kitchen window. Zip. Pretty soon a massive growth had burst out of nowhere.

But the seeds of Uranium Boom 2007 were sown years ago, back in the ‘90's.

For the entire decade of the 1990s, fossil energy was cheap and accessible and abusable. Crude oil crouched below US$30 until the turn of the millenium. The service station down the road was charging you 67 cents a litre for a tank of petrol. The gas that lights your stove and heats your home was a quarter the price it is now.

With everything was so cheap, who could care less about nuclear power?

Certainly not elected officials. They had little choice. What government would incur the wrath of environmentally conscious citizens while heating oil and gas prices are so low? No-one wanted to swap their nice fat oil cow for a handful of silly magic beans. Especially not magic beans that cause radiation poisoning.

So the beans were discarded on the back lawn. Nuclear infrastructure development stagnated. Europe dropped many of its planned projects. US policymakers wouldn't touch the issue. Gas flared, stovetops bubbled, coalfires raged.

Eventually, those beans sprouted, though. Oil has become five times as expensive since the year 2000. Policy-makers and planners have begun to realise that gas is finite. Coal, the other source of base-load electricity, is now copping flak for carbon emissions. In China these days, 60% of big cities have air quality below acceptable limits. Two billion people are going through rapid industrial development in Asia. How can cities keep the lights on without gas or coal?

Countries have changed their tune in recent years, especially developing nations with massive future energy loads to bear. China plans to take its nuclear energy load from 2% of total power to 8% in the next 15 years. To do that it'll have to build two nuclear reactors per year. India wants to double its own nuclear capacity over the same period.

All this nuclear power is going to need uranium fuel. Last year, investors realised this. So the nuclear beanstalk grew. Uranium prices boomed at exponential rates. It spiked at a price of US$140 per pound. Then it crashed.

Despite the crash, you know that sooner or later, uranium demand is going to fire up again. That's what makes the following uranium shares look especially oversold.

First up, Paladin Energy (ASX:PDN) has fallen a long, long way from its high of last year. From a long-term perspective, this chart is really interesting. This uranium company's share price recently rebounded from a low of AU$4.28 on April 14th. This corresponds exactly with a 61.8% Fibonacci retracement. It also matches up with long-term support established back in 2006.

The stock looks as though it may have taken a beating. But technically speaking, that beating may be overdone. Uranium has only fallen a little over 50% in the same period. With this new support, many investors will see this as an opportunity to buy back into uranium shares. It could grant Paladin a new bullish momentum.

Energy Resources of Australia (ASX:ERA) is another uranium miner we like the look of at the moment. Technically, it's also strong, but for different reasons than Paladin.

Since August 17th 2007, the share price has gained 38%. You can see this bullish trend clearly in the brown line on the bottom half of the graph above. The stock is currently trading just above the support line, with a positive outlook on the near-term. Traders have rarely been brave enough to venture below that brown trend line.

We don't think they will now. But also, the MACD indicator on the top half of the graph shows an "upward cross". The full brown line has crossed the dotted black line. This is a bullish signal for momentum traders. It's confirmed by action in moving averages; the 10-day moving average is about to cross above the 20-day moving average.

That adds to the argument for ERA's shares. The stock is simultaneously finding support, and getting two green lights for a turnaround. Now could be the time that these two uranium shares find their bottoms before a long-term bull market.

Gabriel Andre
The Daily Reckoning Australia

• Thorium as a Nuclear Fuel
• Uranium: A Carbon-friendly Substitute for Coal
• Good Month for Aussie Stocks, While U.S. Stocks Fell to Close the Quarter
• How to Trade Gold Shares
• Rising Coal Prices to Increase Electric Bills in Australia

Higher U.S. interest rates would justify long-term dollar strength. But with house prices falling by an average of 12.7% in the last twelve months (according to the Case-Shiller survey of 20 U.S. cities), and with foreclosures up 112% year-over-year, do you really think the Fed will be raising rates any time soon?

The Fed is trying to soften the blow of falling asset prices by making it possible for homeowners to refinance into longer-term loans at lower rates, and then ride out the bear market in housing and credit. In other words, the Fed has kicked the dollar to the curb. It's on its own now.

That doesn't mean the dollar won't really from time to time. As a proxy for economic growth, there will be times in the coming years, let's call them false dawns, where the U.S. economy appears to be emerging from the slump, or is at least growing faster than Europe's sluggish economy. But the long-term trend for the dollar index is lower highs and lower lows. For gold and oil, it's just the opposite, higher highs and higher lows.

Speaking of highs and lows, our friend Dr. Joanne Nova at GoldNerds.com read our note yesterday about the challenges of deep-water drilling. But drilling deep is a challenge anywhere, even on land.

"Here's another perspective on the difficulty of drilling Brazil's new oil field a full 10km below the surface," Joanne writes. "Did you know the deepest hole ever dug reached down to 12km, but it took 19 years to get there? The Soviets started planning the Kola Superdeep Borehole in 1962 and began drilling in 1970 reaching the record depth in 1989.

"They initially aimed to reach 15km, but were forced to give up a few years after they set the record. Things were too hot, too strange, and too expensive. And this was not a hole designed to produce anything except interesting scientific papers. Twelve kilometers down, the rocks were under so much heat and pressure they behaved more like plastic than rock. The hole apparently kept flowing closed whenever they had to replace a drill bit. Makes production hard if the hole keeps disappearing."

Yes it does.

Incidentally, Australia's deepest on-shore drilling effort doesn't have anything to do with oil, gas, or mining. It is energy related though. Geothermal hopeful Geodynamics (ASX:GDY) finished drilling its Habanero 3 well in early February to a depth of 4,221 metres.

Even if you don't get all the way through the Earth's crust at that depth, it's still pretty hot down there, which is the whole point. Geodynamics hopes to be operating Australia's first commercial geothermal electric generating plant by the end of this year, with a capacity of 50 megawatts per year.

We know a bit about the project and the share because we tipped it in the Australian Small Cap Investigator. The credit crunch has not been kind to small-cap stocks in general or alternative energy stocks in particular. But if you look at these stocks in terms of their ability to generate future earnings, there is a lot to like. The assets should produce growing cash flows, and who doesn't like that?

We showed a chart a few weeks ago demonstrating that GDP growth and electricity are pretty well correlated. A growing economy needs its energy doesn't it? Australia's economy is growing and so are its energy needs.

Perhaps that's why Citigroup reckons Origin Energy (ASX:ORG) will grow its earnings by 16% a year for the next five years, according to Rebecca Keenan at Bloomberg. And perhaps that's why Britain's BG Group Plc. offered to buy Origin for $12.9 billion. That represented a 40% premium on yesterday's closing share price of $10.47. Proving that markets can sometimes be pretty darn efficient, Origin is up 37% in early trading.

As a trade, we might even consider shorting or buying puts. After all, Origin hasn't accepted the bid yet. But our interest isn't in trading these events, it's in anticipating them. BG's bid is based on asset quality and earnings growth. It's a stock picking story, not a China narrative, although the two are related. Take iron ore.

"Right now, I think this is the best stock picker's market in resources that we've seen for quite some time," says fund manager James Bruce in today's Financial Review. He could not be more right.

He was referring to today's breaking news that China's first-ever hostile takeover of an Australian company-Sinosteel's $1.37 billion bid for Midwest (ASX:MIS)-looks like it will go through. Midwest is in a trading halt this morning, suggesting an announcement could be forthcoming.

Sinosteel raised its bid for Midwest from $5.60 a share to $6.38 a share. This seemed to please the board of Midwest, which had been holding out for $7 a share. It probably doesn't hurt that, as Michael Vaughan reports in today's Financial Review, Sinosteel agreed to support the issue of 15 million options to two Midwest directors.

The exercise price on the options is $1.46. With the bid at $6.38, that means those 15 million options are worth about $73.8 million. That's a nice pay day, if you can get it. We've always said that owning your own business is the only real way to get wealthy.

"China was busy last night," writes Diggers and Drillers editor Al Robinson. "It closed the net around one little iron miner, and took stakes in a couple of others. It looks like Chinese steel mills are focusing on the leaders in the second tier of iron companies. By that, we mean the companies outside of BHP, Rio Tinto and Fortescue who have the best-developed assets.

The "other" company which Sinosteel appears to have set its sights on is Murchison Metals (ASX:MMX). Al has more details over at Money Morning. The entire mid West region of Western Australia is ripe for this sort of Sino-Japanese financing and takeover. The ore in the region is a little lower quality than the famous hematite of the Pilbara. The infrastructure doesn't exist yet, either, to move that ore from mine to port and on to points North.

On that score, keep your eyes on May 9th. That's the deadline for proposals to be submitted to the WA government for building out the iron ore infrastructure in the mid West. There are two major proposals, one backed by China and one essentially backed by Japan.

In the meantime, if you want to catch up on who the junior producers are in the mid West, you may want to introduce yourself to the Geraldton Iron Ore Alliance. Don't be shy. She's friendly.

There are seven firms in the alliance. Mount Gibson (ASX:MGX), MidWest (ASX:MIS), Gindalbie (ASX:GBG), Murchison (ASX:MMX), GoldenWest Resources (ASX:GWR), Royal Resources (ASX:ROY), Asia Iron Holdings (not listed), and Atlas Iron Limited (ASX:AGO).

Who will win? This is where we reach the limits of the free security analysis we provide in the DR. The heavy lifting and deeper digging goes on at Diggers and Drillers. We will tell you that valuing the companies comes down to looking at the quality of their assets and their ability to finance projects without a lot of debt.

Better hurry, though. "The Chinese invasion of corporate Australia is continuing apace with Chinese Iron and Steel Group announcing plans to lift its stake in outback prospector Apollo Minerals to 19.9pc, just short of the 20pc level that would require it to mount a full takeover under Australian law," according to David Litterick in Britain's Telegraph.

Dan Denning
The Daily Reckoning Australia

• The Fourth Biggest Iron Player in Australia
• Australian Iron Ore Shares on China’s Menu
• Red Bear Rising: Russia’s Resource Based Geopolitical Strategy
• Saudi Arabia Pours Oil Investment into Australia
• Wayne Swan Approves Chinalco Investment in Rio Tinto (ASX: RIO)

What does that mean? Investors are going to have to begin considering the embedded energy costs in tangible goods. Everything in life takes energy, from making your scrambled eggs in the morning to smelting aluminium. Some resources are more energy intensive than others.

Take the Mexican stand off between BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO). BHP feels its exposure to coking coal, oil, and gas gives it an earnings advantage over Rio. Not so!, says Rio. Rio says its exposure to iron ore, copper, and aluminium means it will grow is earnings more and sooner than BHP.

Energy earnings versus metals earnings. It kind of reminds you of the Priority Dispute between Newton and Leibniz over who invented the calculus, doesn't it? Chicken, egg. Egg, chicken. Cluck.

Aluminium is an energy-intensive metal, and therefore more price sensitive in an energy-scarce world. This is to Rio's advantage, the company reckons. "The price for aluminium now has a new base," Rio's chief economist Vivek Tulpule told investors in Melbourne last week.

"Margins for existing aluminium producers who have cheap energy, their own bauxite, and who aren't exposed to the Chinese currency, go up. This is a phenomenon that people have only started to clue on to very recently."

Tulpule also said that, "Though Chinese aluminium supply had traditionally risen in tandem with demand, keeping a lid on prices, soaring energy costs in China and rising bauxite costs had made Chinese producers the most expensive in the world."

In gold, the mantle of lowest-cost producer has always been coveted. In resource, the mantle of lowest-energy-intensity may be the key to figuring out which resources will go up the fastest. Energy-sensitive resources will see producers get hit hard by rising costs. This will cause some to close up shop, reducing production and supply. Prices will rise.

"An energy shortage in Chile may do for copper what cuts in electricity supplies did for platinum in South Africa spark a record-setting rally in prices," according to Heather Walsh at Bloomberg. "Chile may be forced to limit power use for the first time since 1999 because a drought has reduced water levels at hydroelectric reservoirs."

Proximity and possession of energy may even better than access to cheap capital in coming years. Energy is a kind of capital, isn't it? If that's the case, Australia has a huge capital base, with its reserves of coal, natural gas, and uranium.

Thermal coal prices are set to double from US$55 to US$125. That's based on the agreement between Japan's Chubu electric power and Xstrata which should be come the benchmark for 2000-09 contract prices. Spot prices for thermal coal have tripled in the last year. Spot coking coal (steel marking) prices have quadrupled in the last 12 months, and in the last two months they've doubled. Notice a pattern?

"The value of announced cross-border acquisitions by China so far this calendar year is now US$24.5 billion from 56 deals according to Thomson Financial-already almost equaling the record of $US29.8 billion for all of 2007," according to Colleen Ryan in the Financial Review. As usual in the financial world, the easiest way to find where asset prices are headed is to follow the money.

"China's acquisitions of foreign targets reached US$15 billion in the mining sector-the most active sector, largely comprising companies engaged in metals, mining, and chemicals-rising from just US$243 million in the same period last year," Ryan writes. Are you listening BHP?

Dan Denning
The Daily Reckoning Australia

• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike
• Why an Energy Crunch Could Lead to Booming Profits in “Solid Electricity”
• BHP Billiton (ASX: BHP) to Report Second Half Results Today
• Base Metals Prices Spiking After China Earthquake
• Australia & China: Already Partners in the Commodity Boom

Resources on the whole are a typical case; most announcements related to company value are scattered with unique terms and mining lingo. And shareholders regularly re-value the worth of any mining or energy company on the ASX at a moment's notice, given the release of profit results or a change in commodity prices. With this in mind one of the most important items that crops up regularly is a drilling result. Learn to interpret this piece of information and you'll have a head-start on the hoards of novice investors diving into the market upon hearing of the 28% gains the mining sector has made so far in 2007.

To that end, here are some of the primary drilling methods miners employ when defining the characteristics of a solid ore body...

Rotary air blast drilling is one of the fastest, cheapest, easiest ways for miners to obtain a sample from their resource. In an RAB operation, a spinning tungsten drill bit forces its way down through the ore, blowing fragments back up to the surface for examination. It is one of the least accurate methods, as these sample fragments are often compromised by other particles on their way up the drill hole. Consequently, companies tend to look at this technique as their first port of call for estimating the specifications of a given deposit; at this stage accuracy is not critical. RAB drilling is generally used for relatively shallow depths of up to 25m, or to remove soft rock on top of the deposit.

Miners use another type of drilling method, air percussive drilling, when the layers of rock are quite hard. Instead of a rotating drill bit, in air percussion a hammer bit strikes the rock, forcing its way through to cut samples from the ore which are then blown back up the drill hole in the same way as in an air rotary operation. Accuracy of air percussion samples suffers for the same reasons as air rotary samples, so companies commonly apply it early on too.

Mud rotary is similar to the rotary air drilling method in many respects. The only major difference is that water, not air, is the medium by which fragments travel back to the surface. Mixing water with the cuttings yields a "slurry", upon which geologists perform analysis after removal. This yields low-accuracy results at a lower price, but miners use it at deeper depths than an air rotary operation, mostly on soft rock material.

The final method of drilling is diamond core drilling. For the purposes of an investor, the results from a diamond core drill are the ones to take notice of. The technique stands out from the rest of the field in terms of accuracy, but is also the most expensive, and hence is used towards the end of a definition study. A hollow, cylindrical diamond encrusted drill bit rotates at high speed, cutting through the ore and extracting a solid sample that travels up through the drill pipe. This gives an unbiased estimate of the deposit, because no other particles have a chance to contaminate the ore on its journey up the drill hole.

The most important thing to remember is that while the different drilling methods outlined are appropriate for different scenarios, they also imply difference levels of confidence in the sample. For example, in Victor Rudenno's 2004 manual The Mining Valuation Handbook, he notes that the integrity of air rotary drilling alone does not substantiate definition of a reserve, without correlation between rotary results and an appropriate nearby diamond core sample. Though there is always uncertainty in results, the diamond drilling method gives analysts the best chance to identify what lies beneath.

You should apply a liberal dose of skepticism to any drilling release. Some companies tend to report only the most positive results when offering shareholders a picture of mine progress, so it is best to always assume the worst.

We partially derive the value of a mining business from what it owns underground, but we can usually only estimate what it owns underground. By the time analysts identify the economic potential of a geological structure beyond doubt, the market has usually factored it into the share price, so knowing how to interpret drilling results will give you a rough idea of where market value is likely to head. This is one way to get a head start on the rest of the pack.

By Al Robinson
The Daily Reckoning Australia

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