Not that any of this week's news will change what we think is going on in the real economy. And what is that? Asset values bid up to record heights during the credit boom are deflating. This most seriously affects the value of bank collateral (commercial and residential real estate). But listed property trusts, infrastructure funds, and unlisted assets held by superannuation funds and state and local governments are also affected.

For example, today's Australian reports that the property sector alone has seen $51 billion in the value of its assets "wiped out" in the last twelve months. "After 10 years of 16 per cent annual growth, fuelled by offshore buying sprees and debt binges, the property industry's gross assets dropped from $420bn last year to $396bn this year, according to industry analyst Property Investment Research."

The "wipeout" in the sector was especially bad news for Babcock & Brown, Rubicon Asset Management, and Record Funds Management. These heavily leveraged firms didn't survive the steep rise in global borrowing costs. It didn't help that asset values began tumbling when the leveraged dried up.

There are still some big players in the listed property trust sector. These firms stand to lose even more if there is a second wave of deleveraging in the financial system. This list includes Westfield Group, with $56.4 billion in assets, Centro Properties ($28.4 billion in assets), Macquarie Group ($16 billion), and Stocklands ($14.7 billion).

Of course we're not suggesting that assets are worth nothing. But to the extent these assets are dependent on the growth and strength of consumer spending in the economy...well yeah, we'd be a bit worried. Wage deflation in the Western world is a given. This means that in real terms, the average consumer is going to have less and less discretionary income to spend each year. Unless he can make up the difference with credit, we'd suggest it's bad news for many of the retailers that lease space from the listed property titans.

But don't forget the unlisted sector! AMP Capital Investors is the biggest asset manager in the group and also the largest property securities funds manager. You see, Australians don't just bet on higher house prices in the residential mortgage market. They've been betting on higher property prices all throughout the system with many unlisted property-linked securities. It means that more destruction of bank collateral could have a much larger affect on a lot of listed and unlisted investments than most people imagine.

To counter this wave of debt deflation, at least in America, is the huge growth in bank reserves and low interest rates. But here in Australia, it looks like interest rates may be headed up, not down. That won't be good news for anyone who is trying to refinance loans to support falling property values.

So what will do well in the next six months? Keep in mind that results this week from Rio Tinto and Centennial Coal are likely to show the volatility of earnings for commodities that are not continuous prices (thermal coal, coking coal, and iron ore). Those are still pretty bullish markets - if you're banking on a Chinese century. But what about energy?

You could make the argument that U.S.-dollar sensitive energy prices are the most likely to beat inflation. It's not a sure bet, of course. If the global economy is sluggish, energy prices won't soar. And U.S. dollar weakness is generally bullish for all commodities.

But for the record, we think energy shares are the best inflation beaters. Britain's Sunday Telegraph reports that Shell is chasing Arrow Energy's coal-seam-gas assets. Shell already owns 30% of Arrow's Australian assets. But coal-seam-gas has emerged as complimentary/competitive fuel source to Liquid Natural Gas. Shell wants more.

And beyond liquid fuel, you have energy stored in chemicals. Namely we're talking about lithium ion and nickel metal hydride batteries. Both, along with some zinc technologies, are bidding to be the chief battery type for the electric and plug-in-hybrid car industries. There a handful of intriguing plays listed in the Aussie share market in this space. It's a story we're covering over at Diggers and Drillers.

Finally for Monday, today's Sydney Morning Herald is reporting that, "Six OF the country's nine banks have tightened the amount of money they are prepared to lend to first-home buyers in a response to claims that the Federal Government's cash handouts to the housing market are causing a bubble in prices."

Tough spot for the banks. Do you lend to marginal buyers to prop up demand and take the risk of increased non-performing loans? Or do you tighten up lending standards and reduce average loan sizes, at the risk of leading to wider losses in collateral values? Sounds like a no-win situation, doesn't it?

Dan Denning
for The Daily Reckoning Australia

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And we've found just the thing.

Everyone has heard the oil story. Everyone knows about iron ore. But who has seen the LNG story? Almost no-one. In fact, the reason so few people know about LNG is that nobody has bothered telling the story. Or if they have not many people have listened.

After doing a lot of research for the recent edition of ASI we have come to the conclusion there will be an increase in demand and an increase in supply for at least one commodity - LNG.

LNG is produced by liquefying natural gas and then sending it on a ship in liquid form to a regasification plant in Japan or the United States where it is converted back into a gas and then distributed to homes and businesses. The reason it is converted into a liquid is due to space. LNG it uses just 1/600th of the space of natural gas.

The reason we are getting onboard with LNG in 2009 is due to the abundance of it in Australia. Yet currently, Australia is producing natural gas and LNG at a fraction of the full potential. You only have to look at the developments taking place off the coast of Western Australia and in Queensland to get an idea at the potential size of this industry.

Also consider two of the major stories in the resources industry during the last few months. BG Group's $6 billion takeover bid for Queensland Gas, and Origin Energy's joint venture with US energy giant ConocoPhillips.

In 2009 the LNG story looks set to be the next market ready to boom.

Kris Sayce
for The Daily Reckoning Australia

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