Inflation Begets Inflation - Fred Sheehan

by Fred Sheehan

Reaping the Whirlwind

The aspects of inflation are as varied as those of a diamond rotated in the sunlight. Each is illuminating, once one has the ability to distinguish between gemstones. To the untutored, higher oil prices cause inflation. This is similar to rotating a rhinestone, instead of a diamond. The connoisseur understands that too much money-cum-credit causes inflation.

The cost of energy is rising in dollars. Dollar production does not require exploration. The additional increment of energy is hard to find, difficult to evaluate, and susceptible to daily reevaluation upon further investigation (shale oil versus ethanol). Federal Reserve Chairman Ben Bernanke made the market call of the decade in 2002, when oil cost $25 a barrel: “Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation…the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper money system, a determined government can always generate higher spending, and, hence, positive inflation.”

Now to rotate the diamond. Bernanke did not address the printing presses in China, Russia, and Brazil. Americans spend more dollars buying goods shipped into the United States than foreigners pay for American goods that are sold abroad. The result is a mountain of dollars piling up in foreign countries. These extra dollars flow into those local economies. This causes an acceleration of production and consumption -- inflation. An example might be posed as a question: If Americans had spent a trillion dollars less on goods from China et al. over the past decade, would China now be a net importer of coal or India a net importer of grains? China would probably not be increasing its consumption of beef by 20% a year. The base off of which that growth rate is compounding would certainly be at a much lower level.

This elevated base and rate of consumption has accelerated at a much faster pace than the ability to ship and produce the structural material. For instance, one half of urban homes in China now own air conditioners; the power grid cannot compete with such indulgences.

The situation is a bit like the wedding feast at Cana. The caterer badly underestimated the amount of wine required to lubricate the happy glands and bonhomie of the gathered guests. The guests’ teeth were grinding to a halt. It was at this moment that Jesus arrived and produced wine for the multitudes.

We might pray for a miracle, but among other considerations, there is little money to be made from an instant solution. The early stages of discovery are chock-full of moneymaking (and capital-destroying) opportunities. Energy, dollar, and physical construction are inseparable from global hyperactivity.

An integrated specimen is the worldwide housing boom, any component of which involves energy. This pushes energy prices north. A facet of the integration: Russian housing starts have risen 70% over the past year. Russian central bank holdings of U.S. dollars have increased 50% over the past year. The two growth rates are very much related: The Russian central bank converts U.S. dollars received for Russian oil that was exported to the United States. In converting, the central bank prints rubles in exchange for the dollars. These rubles -- that had not and would not exist if not for American energy demands -- then make their way into the Russian economy. Real estate developers are mighty pleased.

We can turn the diamond slightly and see how higher energy costs have increased prices for milk and tortillas. The U.S. government’s solution to limited oil resources includes a vast commitment to ethanol. According to the game plan, the energy used to run cars will, in effect, replace gasoline with corn. The effort may be flawed, but government subsidies, once in motion, rarely come to a screeching halt.

The U.S. produces 11 billion bushels of corn a year. In 2005, 1.5 billion bushels were sequestered for ethanol production. This leapt to 2.3 billion bushels in 2006 and an estimated 3.3 billion bushels in 2007. The price of corn has risen. The Mexican diet is heavily tortilla-ized, especially at the lower income stratum. Riots scarred the early months of President Felipe Calderon’s term of office. He slapped price controls on tortillas. Borrowing from the book of Castro, Calderon warned, “We won’t tolerate monopolists and speculators.” His Cuban counterpart made more sense when he declaimed the “sinister idea of converting food into fuel.”

The little man is also exposed in the United States. Farmland and grazing land are being rotated to the highest-priced crop. Cows are no longer fashionable. Thus, domestic milk prices have risen 63% over the past year. According to Andy Lees at UBS in London, world milk prices have risen 60% over the past six months (measured by the price of skim milk powder, commonly used as the benchmark). The U.S. has no surplus milk powder. It had 2.7 billion pounds in storage in 1983; the last 27 million pounds were sold last year. European warehouses are empty. Other food prices are rising by double digits. (Most everyone knows the government trumpets a consumer price index that does not include food and energy. Less well known is the absence of commodities such as milk, eggs, butter, and cheese from the seasonally adjusted CPI number that does -- purportedly -- include food and energy.)

The pace of energy production required to catch up with energy demands leads to possibly regrettable decisions. Again, from Andy Lees: “Growing plants for fuel will accelerate the already unacceptable levels of topsoil erosion. By using crops for biofuels, we would effectively be ‘mining’ the topsoil, and there is only about six inches of this around the world, on average. Even the best places in North America have seen the topsoil erode from 18 to 10 inches over the past 50 years, but it would have been dramatically more had it not been for replacing it with fertilizer (fossil fuel based)…Fertilizers provide 28% of the energy crops need…” Topsoil erosion due to topsoil mining reduces yield levels. Thus, more fertilizer is needed at the cost of ever more energy just to remain static.

The production of fertilizers consumes energy. Since the cost of energy is rising, the cost of fertilizer production follows. PotashCorp of Canada thinks the cost of producing potash fertilizer in Brazil will rise by nearly 70% this year, due to increased demand for food and fuel. The ethanol binge thus consumes more energy in an effort to produce more energy. The cost of farming is rising, as is the cost of buying a farm: Over the past year, farm prices have risen 10% in Australia and 15% in the U.S.

Unintended consequences surround us. Cambridge Energy Research Associates estimates the worldwide cost to produce oil and natural gas (labor and equipment) has risen 53% since 2004. In some cases, the rising costs have led producers to scrap exploration. Exxon estimated the cost of building a gas-to-liquids plant in Qatar at $3 billion in 2004. Current estimates have risen to $18 billion. The joint project of Exxon and Qatar has been dropped. This foregone production is an aspect of higher energy costs that is invisible, so not widely appreciated. The increased energy, labor, and materials costs of mining have postponed or eliminated many projects. Copper production is no higher than a year ago, despite rising prices. Those staring into the rhinestone declare, “Higher prices increase production, which will reduce the price.” Yes, but at what price is it worth exploring?

It is not only the investment, but also diminished profits that cause exploration to lag. Profits of South African gold miners have suffered because the cost of the miners’ diet -- heavily weighted toward beef -- has risen. Beef prices have risen (around the world) as grazing land is turned into ethanol incubators (corn, sugar, palm oil, and so on).

Ethanol cannot be transported through pipelines (the water and chemicals prevent it); trucking is expensive, so the most economic solution is railroad transportation. Rails are constructed from steel. Steel prices are rising as demand increases. The metals used to construct steel are not mined fast enough. Skyscrapers are constructed from steel. Economist David Hale calculates that between 1900-1970, when America’s urban population increased from 30 million to 154 million, per capita steel consumption rose 600%. The current Chinese migration to the cities has received wide publicity, but the trek to the cities -- and apartment buildings -- is global.

Nickel is an essential ingredient of stainless steel. Stainless steel is essential to marine construction (which is at a record book order). Nickel has risen from $7 a pound in early 2006 to over $20 a pound. Besides nickel, the other key ingredient, ferrochrome, has been rising in price since the beginning of the year. Posco, the Korean steel manufacturer, is “emphasizing” nickel-free, ferritic stainless steel. Sean Corrigan of Diapason Commodities Management describes one of the inevitable consequences of inflation: “One can’t help feeling that sometime in the next decade an awful lot of bottoms are going to fall out of ships that were…built in Guangzhou and Shanghai…”

Steel craves iron ore. A much-traveled route is from Australian iron ore mines to Chinese steel plants. Ships now wait 30 days at Australian coal and iron ore terminals. Iron ore producers must pay for the ships to sit. The queue is caused by Australian rail deficiencies. In Andy Lees’ estimation, “This bottleneck is likely to last for several years.” Thus, iron ore needs to be mined at a faster pace to build the tracks to more economically export the iron ore. New railroad track is delayed by another bottleneck in most every locale associated with frantic digging and drilling: The Australian jobless rate is the lowest in 31 years.

All producers and consumers pay more, since idle ships reduce those available at any one time. Hence, Baltic freight rates for bulk carriers have more than doubled in 2007. Brazil is the most efficient soybean producer in the world, but shipping costs (to Asia) are pricing the Brazilian crop out of the market. (The fact that China is importing soybeans from South America also shrinks the number of available ships available for world cargo trade. China has recently become a net importer of coal for the first time. This adds pressure to shipping, steel, and iron ore prices.)

All of this activity means energy discovery and production works harder just to stay in place. Consider: The China trade into Los Angeles and Long Beach exceeds capacity -- ships are rerouted to Mexico and Canada, while trucks carry freight 60 miles east to San Bernardino, where a warehouse the size of eight Manhattan blocks is being built. In a three-day period, port expansions were announced in Dalian (China’s largest crude oil terminal), DP World’s port in Dubai (a 67% expansion), and Qinhuangdao (China’s largest coal port). China plans to build 25,000 miles of rail track by 2010 “in an effort to ease bottlenecks in the transport of everything from coal to soybeans to people”; 86 subway systems are under construction in Chinese cities; 85 biodiesel plants are under construction in the U.S. Gas rigs in the U.S. rose from 17,000 in 2000 to 28,000 wells in 2005, yet produced 5% less gas. The Ghawar oil field in Saudi Arabia employs 8,700 wells -- from 800 in 1978. The May 25 issue of Compass Maritime Services’ Weekly Market Report could barely control its excitement: “Newbuilding prices [for ships] are also firming as 2010 berths are disappearing and it was reported that 70 [bulk carriers] were ordered this week!...Shipbuilding capital markets remain hot, hot, hot, as close to $2 billion in capital was raised in the past month.”

We’ll finish by dropping the diamond on the floor to see the world through Bernanke’s myopic view -- that is, from the United States, which is all he is permitted to consider. The amount of steel for apartment construction in Shanghai and Istanbul or the growing appetite for power and power plants around the world escapes his blinders. (Iran’s power plants cannot keep pace with demand; a good part of the increment is produced by consumer electronics imported from China.)

Forget about SUVs. The Toll Brothers (both of them), who manufacture the highest-cost houses in the U.S. (average price for new sale is $675,000 -- and falling), note that buyers opted for ceilings of eight feet in the 1980s. Then it was nine feet and now it is 10 feet. The basic house includes optional equipment. Toll house buyers are drawn to visual trinkets on the facade (e.g., Ionic columns in front of the doghouse), rather than additional insulation. The best-selling box is now “the Hampton,” a 4,800 square-foot pile. The best-seller five years ago was 4,000 square feet. These figures do not reflect the additional two feet of air to be heated and air-conditioned. Nationally -- with or without the Toll Brothers -- the fastest-growing house configuration between 1990-2005 was the five- (or more) bedroom model.

Energy output needs to work hard to keep up with such production, but even the Hampton falls short of rising consumption. Houses are bursting at the seams: The amount of self-storage used by Americans has grown 50% since 1995. There are now 1.89 billion square feet of self-storage space -- six square feet for every man, woman, and child. Much of it is climate controlled.

Many of the fastest-growing real estate markets are full of hot air (California, Las Vegas, Arizona, Florida) or cold air (New England to Washington). The Phoenix-Scottsdale, Ariz., population has risen from 2 million in 1990 to 4 million. Landowners and developers have staked out a rough plan for 8 million sun seekers in 2016. (The betting here is they will be sorely disappointed.) On hot days now, Phoenix uses more energy than New York City. SUVs can be traded for a Cooper; house consumption is here to stay (or rot). Looking abroad, the United Arab Emirates, now rolling in $850 billion of foreign currency reserves, will not be quick to delay construction of new aluminum plants, fertilizer plants, or refineries, not to mention Dubai’s 25-story, air-conditioned ski slope inside a glass bubble.

Naysayers will identify the ski slope as the ultimate bubble. They will also note the weak straw is of centrifugal dollar claims turning centripetal. Fair enough. However, there is probably less than $1 invested in commodities (inventory, common stocks, derivatives) for every $100 of claims on fancy derivatives. Some unfortunate investors are finding the world is not interested in buying CDOs supported by shrinking asset values, but the world needs another 10 million tons of fertilizer -- now.

Regards,

Fred Sheehan

Fred Sheehan is columnist and economist with Marc Faber's Gloom, Doom and Boom Report.

The Global Strategy of the Russian-Iran Cabal - David Jonsson

David J. Jonsson
June 29, 2007

If you believe: “Your Life Can Be Wonderful if we get out of Iraq now!” the events going on around the world become a haze as you watch the latest golf scores or read the propaganda for the latest appeasement journal or cable news cast.

All you hear are the speeches of the latest ‘Tokyo Rose” complaining about the U.S. and its war mongering, blood for oil or unfair treatment of terrorists.

There is a group that wants to destroy our way of life in our life time.

The Tough Questions that Must be Answered

The question remains as to if the allies joined for freedom and liberty will support a battle against the forces of evil.

In a time of war, the critical elements for success are to know:

Who is the enemy?

What are their goals?

What is the definition of success, and finally

What will the world be like if we lose?

Up to the time of the Munich Agreement in 1938, these questions were not answered. The West faces the same situation following the cease-fire in Lebanon in 2006. The West must decide on the answers to the questions or be prepared to live under Shariah Law in a totalitarian Islamic state. The question that has to be answered is: Would you choose appeasement and wind up as a lampshade in a palace or fight for Western democracy, freedom and liberty?

On our comprehensively terrorised globe, almost everybody, from covert, stateless bands of Jihadists—Hezbollah, Hamas and al-Qaeda to name a few to accredited members of the United Nations, believes himself in need of either ready-made atomic bombs or the technology and expertise with which to manufacture them. And nuclear weapons have become the weapons of the poor. Terrorism as a means of warfare is not confined to so-called non-state actors like Mohamed Atta and his colleagues, but is habitually employed by nation states.

International Affairs Is A Zero Sum Game.

When power is withdrawn by one state, another state or group will fill that power vacuum. History has proven this in the past. When British hegemony declined, American power filled that gap in the western world. Communism similarly filled power vacuums left after America’s withdrawal from Vietnam. President Jimmy Carter’s defense spending cuts diminished American influence in Africa, South America, and Asia. I might add Carter continues to support anti-Semitic rhetoric, Iran and Hamas.

The same rules of international affairs hold true today. Should America withdraw from Iraq, Afghanistan and elsewhere, that power vacuum will be filled by some state or group.

In the Middle East, it is clear that Iran is filling power vacuums that the Iraqi government has not filled when authority was handed to it by the US military, and similarly in Lebanon, Gaza, and Afghanistan where there is weak political leadership.

Iran has further expanded its power through its allies and affiliated organizations in Syria, Lebanon, Gaza, and Afghanistan. Iran along with its allies and sponsors will continue to do so until they are countered with force or by a competing political influence.

The Appeasement of the West

Decades from now, historians will discover that the United States, the West and the international community were being targeted by global ideologi­cal movements which emerged in the 1920s, survived World War II and the Cold War, and carefully chose this timing for its onslaught against democracy.

Whether it realizes this or not, America is facing a kind of liberal-Islamic alliance: a sympathetic relationship that leading leftists in America have with Islamic radicals around the world. I’m not suggesting the two groups actually like each other. Actually, they despise each other. Leftists like Pelosi, Barney Frank and Michael Moore despise bin Laden and his fellow radicals because they are religious fundamentalists who want to impose Islamic [Shariah] holy law. That means goodbye to freedom of religion, women’s rights and gay rights and, in all candor, goodbye to people like Pelosi, Frank and Moore. By the same token, Islamic radicals like bin Laden detest the American left because, as they see it, the left is the party of atheism, family breakdown and cultural depravity. The left is in the vanguard of imposing secularism and libertine social values in America and the EU.

The West’s Fatal bugs in the Software

If one looks at the military strength of the West compared to Iran, victory would seem to be inevitable, even if Iran acquires nuclear weapons. Iran does not have the military machine that the Axis powers had in World War II, nor the Soviet Union during the cold war. The Leftist/Marxist – Islamist Alliance may be more effective than the earlier totalitarian movements operating individually. They could even win. That’s because, however strong the Western hardware, its software contains some potentially fatal bugs. Three of them – pacifism, self-hatred, and complacency combined with the Oil Weapon could provide the needed weapons to succeed.

Many on the American Left loathe America—while they love the Constitution and their vision of what America could be but they have contempt for the average American. That is why most of the Left speaks of America as bringing immeasurable misery and sadness to the world and as essentially deserving attacks on it.

Ditching the “War on Terror”

Politicians in the US and Europe are ditching the “War on Terror”, however this is probably not the big news. The “War on Terror” will probably not survive the next Republican Administration, let alone the next Democratic one.

The real news is that little or no attention is paid to the Russia, China and India. While attention is directed to the Middle East, there is little attention to the rising great powers.

Among the Democrats, their foreign policy proposes that the major rising powers are no threat at all. It's no surprise that Edwards and Obama want to boost foreign aid. They believe the poor world threatens the U.S. more than the rich. Mitt Romney and John Edwards have proposed a new type Marshall Plan. The real danger, they argue, is from states that are too dysfunctional to educate their people, provide public health or control their territory—thus export a swarm of pathologies, from jihadist terrorism to lose nukes to even bird flu. Their answer is a foreign policy hence directed to social programs, and even a new “Marshall Plan” and flinch at the hard nosed calculations of survival of the West.

Social programs in dysfunctional states will not remove the threats to our democracy, liberty and freedom, How the US handles the treats from these totalitarian major powers and the their surrogate pawns of Iran, Syria, Venezuela, etc. will determine how dangerous the world becomes in the coming years and whether the US remains its lone superpower.

“The Gulf states have passed China!” “Six Persian Gulf States now have almost $1.6 trillion in foreign assets, dwarfing even China’s mammoth $1.1 trillion of foreign reserves, according to a new report from the Institute of International Finance” according to the Financial Times.

These Gulf States are all members of the so-called Gulf Cooperation Council (GCC). They are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.

There are massive piles of wealth growing in the GCC.” “Along with China and other countries, the GCC is increasingly setting aside more and more of these funds to invest abroad -- in stocks, real estate and private businesses. What they buy could have a huge impact on market prices -- and your investments.” See also my article: Nationalization: A Plan for World Domination?

It appears strange that politicians would suggest that the US fund a Marshall Plan to support the Islamic countries when the Islamic Countries of the Gulf are accumulating hordes of US dollars. It is in the Islamic countries that we are seeing the growth of terrorism.

We will discuss how these elements are directly interrelated and suggest potential solutions for consideration.

The Apocalyptic Teaching of Islam

Islam has many apocalyptic prophecies; this aspect of Islam contributes to the driving force and power of Islam. See also my article: Iraq, Iran, Global Warming and The Apocalypse.

Iran joined by Syria wants to end the democratic experiment in Iraq. Iranian money, weapons and expertise are used by terrorists to kill Americans in Iraq. Iran’s support of Hamas disrupts Palestinian peace efforts. Hezbollah, a group also backed by Iran and Syria, seeks to destabilize Lebanese democracy and restart a border war with Israel. Iran which denies that a European Holocaust ever took place is now planning to create a second Holocaust in Europe and in the U.S. with the development of nuclear weapons and the missiles to deliver the weapons.

Only the sustained American policy of ostracizing Iran and Syria and their alliance partners and sponsors, galvanizing the international community to enforce financial and trading sanctions, supporting Iranian and Syrian reformers, and keeping all options for war on the table including a high-profile presence in the area offers any hope containing a potential holocaust.

Exclusively increasing military strength, diplomacy or withdrawing from Iraq will not defer or result in a lasting peace. Whatever way the Iran and Iraq crisis is resolved, it will lead to a major shift in the geopolitical landscape. The goal is to have a soft landing.

This will require sacrifice, compromise but not appeasement, and most importantly prioritizing the most important elements of our culture – faith, freedom, liberty, and democracy, as we know it in America.

Decision time is fast approaching. Unfortunately both Iran and the U.S. may be underestimating the power of the other side and overestimating their own. Iran thinks it has a lot of deterrents, in Iraq and elsewhere, and in the armed forces - and it sees the US bogged down in Iraq, Washington is divided and public opinion in the Western world—led by the propaganda of Leftist/Marxist – Islamist Alliance is opposed to war.

Similarity to Events Preceding World War II

One cannot help but recognize the similarity between the events leading up to World War ll and the current events.

“With every passing year following the events of 9/11 the rise of Leftist/Marxist-Islamist Alliance has increased global instability. By the beginning of 2006, nearly all the combustible ingredients–far bigger in scale than those leading to World Wars 1 and 11 and the Gulf Wars of 1991 or 2003–were in place.”

Remember Iranian President Mahmoud Ahmadinejad has a plan just like the Nazi’s “Four Year Plan“, he is a scholar of history, and he also is a follower of the Qur’an.

“Iran is no different than Nazi Germany”, the Israeli Ministry of Foreign Affairs (MFA) source said. “They too built up an army, resources and created the V-2.” The V-2 was the first man-made object launched into space, during test flights that reached an altitude of 189 km (117 miles) in 1944. “While Germany was putting the finishing touches to the V-2 which was eventually used against Britain, the world stood by wanting to talk. Now we have Iran repeating history, declaring to “wipe Israel off the map” while planting bombs in Iraq and Afghanistan”

“Iran which denies that a European Holocaust ever took place, is now planning to create a second Holocaust in Europe and in the US,” said the Israel MFA source. “Europe will be first to feel this nuclear suicide bomb, as London, Moscow, Madrid, Rome and Paris are now in range of Iranian missiles. We no longer have the luxury of time to implement sanctions. This is not a movie. This is not the “24” TV series about nuclear terrorism. This is real. Sanctions worked against North Korea, they can and will work against Iran.”

Likud leader Benjamin Netanyahu on November 13, 2006 drew a direct analogy between Iran and Nazi Germany.

“It’s 1938 and Iran is Germany. And Iran is racing to arm itself with atomic bombs,” Netanyahu told delegates to the annual United Jewish Communities General Assembly, repeating the line several times, like a chorus, during his address. “Believe him and stop him,” the opposition leader said of Iranian President Mahmoud Ahmadinejad. “This is what we must do. Everything else pales before this.”

While Iran is developing WMD and forming alliances throughout the world including Cuba just 90 miles off the coast of America, Russia and China are providing arms for the alliance and equally important Russia is finalizing the energy noose around Europe. The Islamists along with their Leftist/Marxist alliance partners meanwhile are quietly assuming key positions in the governments, the media and even financial institutions.

Failure to Understand Muslim Culture

There is a failure to understand the Muslim Culture. After September 11, Bush explained that the attacks showed that the friend of your enemy is also your enemy. As he put it last September, “America makes no distinction between those who commit acts of terror, and those that harbor and support them, because they’re equally guilty of murder.”

Bush failed to note the converse of that reality: the enemy of your enemy is not necessarily your friend and allay. Here the distinction generally relates to Sunnis and Shiites. We fail to grasp that just because Shiites and Sunnis are rivals don’t mean that they will join forces with the U.S. to fight one another, or won’t join forces with one another to fight the U.S. to accomplish their goal of establishing the Islamic kingdom of God and the return of the caliphate. This and the failure to recognize the goals of Russia and China have and will continue to cause the Americans no end of difficulty. We also fail to recognize that these forces have also joined with the Leftists abroad and with in us.

There is an Arab saying to the effect that “the enemy of my enemy is my friend.” While this may be the standard for many countries in the Middle East, it is not the standard by which a democratic nation like the United States can afford to operate.

Equally important is to recognize that Russia and China are also linked with mutual interests – world domination and that Russia is neither the friend of the EU or the U.S.

Unfortunately, these forces have combined into the alliance of the Leftist/Marxist and Islamists – with the common goal of world domination.

Why do Islamists Hate America? That is Wrong Question

Many propagandists of the Leftist/Marxist – Islamist Alliance are using all efforts to attempt to question why the Islamist hates America. While it is true that the hedonistic life style of the Leftists runs counter to the Shariah law, many Leftists are drawn into the support of the Islamist movement. It should also be noted that Bible believing Christians and Jews do not support the hedonistic life style of the Leftists.

Counter to the question of “Why do they hate us?” one has to ask the question:

“What is the goal of Islam?”

Islam, from its very beginning, and the teaching of Muhammad was and is to create the Islamic kingdom of God on Earth. Their desire for this kingdom is to be a kingdom ruled by a caliph under Shariah law where all non-believers—infidels—are subservient to Muslims. It has been said by many apologists for Islam, that Christians and Jews lived together peacefully under Islamic rule for 500 years. This was true, but only as dhimmis living in servitude to Islamic rule. The Islamists and their Leftist propagandists wish to have us believe this is the way to peace.

The Jihadists drive to instill Shariah Law—Islamic law into Muslim society, and ultimately recreate that society under their interpretation of the law, which often translates into an endorsement for violent jihad as practiced by bin Laden, and espoused by the Muslim Brotherhood and others.

Ideology is often overlooked and is considered separate from the strategic and operational aspects of Islamist militancy. The ideology of this movement is similar to, or even worse than, the Nazi ideology, and it should be dealt accordingly.

Therefore, I still believe that one of the primary missions of the international community today is to repeat its experience with Nazism and to deal with this dangerous barbarian culture exactly as it dealt with the Nazi culture. If this does not happen, the near future is liable to bring many events, the consequences of which will be far more severe for all of humanity than the consequences of World War II.

The Disturbing Recent Events

The Fall of the Gaza Strip - “Hamastan”and “Fatahland”

The Hamas victory in Gaza is a warning that the West is currently losing that war.

The real force behind the Gaza mayhem seems to be, a combined al Qaeda and Iran strategy, strange bedfellows perhaps, but for the time being, closely-linked partners in a common strategic goal to establish "Hamastan" as a forward base for Global terrorism. Al Qaeda's ultimate objective is to destabilize and destroy the moderate Arab nations, first in line post- Mubaraq's Egypt, then the Hashemite Kingdom of Jordan and finally, the Sunni cradle of Saudi Arabia. A similar aim is Tehran's Shiite Crescent strategy - thus both partners are united, even if their spiritual heritance differs widely and even conflicts sharply, in their religious deism. See also my article: Caliphatism - Establishing the "Islamic Kingdom of God on Earth".

It should be noted that The Fatah-Hamas differences concern personnel, approaches, and tactics. They share allies and goals. Tehran arms both Hamas and Fatah.

The “moderate” terrorists of Fatah and the bad terrorists of Hamas equally indoctrinate children with a barbaric creed of “martyrdom.” Both agree on eliminating the Jewish state. Neither shows a map with Israel present, or even Tel Aviv.

The Gaza Strip is now firmly in the control of Hamas, a radical terrorist group funded by Iran and Syria. Some have called Gaza “Hamastan”, expecting that the area will become an Islamic quasi-state akin to Iran where Shariah law is strictly enforced. The fear is that Gaza will become a Lebanon-like Hamastan, a wasps’ nest that in the future will attract al-Qaeda men and extensions of Iran. All of these things are coming to life before our very eyes.

The Financial Times in the article of June 19: Missed opportunities, Gaza and the spread of jihadism—“Splinter groups linked to al-Qaeda are already emerging in Gaza. Some Israelis are fretting that they have a new Somalia or Afghanistan on their border.

Hamas in Gaza is also allied with the Muslim Brotherhood in Egypt.” See also: Islamic Economics and the Final Jihad: The Muslim Brotherhood to the Leftist/Marxist - Islamist Alliance.

While on the Palestinian-Israeli conflict, Washington is putting on a brave face over the Palestinian rift, with talk among the diplomatic community of “silver linings” and “windows of opportunity”.

An international response to these woeful events is now coming into view. But the path signaled by the US and Europe looks dangerously close to an attempt to micromanage and to pick sides in an internal Palestinian dispute. More importantly the US and the EU fail to understand that the reality in the Arab world is: the enemy of your enemy is not necessarily your friend and allay.

Behind the new international consensus is the goal of making the West Bank an exemplar of the benefits of co-operating with the west and renouncing terrorism. There is also a desire to limit contacts with Gaza to providing humanitarian aid and ensuring that essential staff are not left destitute. The champions of this approach are the US and Israel, but, as the biggest donor to the Palestinians, the EU also matters.

Alarmingly, countries such as the UK and France now seem to be scaling back their earlier insistence that Mr. Abbas’s new government be as inclusive as possible. But reconciliation is crucial. The EU and the west must send the strongest possible message that Fatah should not take advantage of the new situation to settle old scores with Hamas on the West Bank.

US and Israeli Positions on Palestine Grounded in Fantasy

Both the US and Israel may have a strategic vision for the future of Abbas’s Palestine, but it is grounded in fantasy. US President George W. Bush and Prime Minister Ehud Olmert will gush about their support for Palestinian statehood. Bush and Olmert announced their full support for Fatah chief and Palestinian Authority chairman Mahmoud Abbas’s new government. Israel will give Fatah $700 million. The Europeans and the rest of the international community will give the “moderate, secular” terror group still more money and guns and love. The US will likely also demand that Olmert order the IDF to give Fatah terrorists free reign in Judea and Samaria. See: Yadlin Warns What Happened In Gaza Will Happen in Judea, Samaria.

They fail to realize that Israel now borders Iran in Lebanon and Gaza. And Fatah is also supported by Iran. This is truly a dangerous game played out in the name of appeasement.

The Muslim Brotherhood in America

It should be noted here that The Chicago Tribune, Sept. 19, 2004 in A rare look at secretive Brotherhood in America by Noreen S. Ahmed-Ullah, Sam Roe, and Laurie Cohen reported that “Brotherhood members helped form The Islamic Society of North America, the umbrella group for the Muslim Youth of North America and the Muslim Students Association, but that their overall influence has been limited.”

“The Groups that the Brotherhood helped form printed Islamic books, many of which were distributed at mosques and on college campuses. They included Sayyid Qutb's "In the Shade of the Koran" and "Milestones," which urges jihad, martyrdom and the creation of Islamic states. Scholars came to view his writings as manifestos for Islamic militants.”

“In recent years, the U.S. Brotherhood operated under the name Muslim American Society (MAS), according to documents and interviews. One of the nation's major Islamic groups, it was incorporated in Illinois in 1993 after a contentious debate among Brotherhood members.”

On August 12, 2006 protest marches were organized by the A.N.S.W.E.R. Coalition in numerous cities across America. The marches were announced at: August 12 National March to Stop the U.S.-Israeli War. Hundreds of organizations from around the country have endorsed and pledged to mobilize for the August 12 demonstration which was initiated by the ANSWER Coalition (Act Now to Stop War & End Racism), the National Council of Arab Americans (NCA) and the Muslim American Society Freedom Foundation.

Photos taken at the "Stop the US Israeli War rally San Francisco" <> rally in San Francisco on August 12, 2006 show masked protesters with a Hamas flag and a Palestinian flag and the Hamas flag in front of San Francisco's City Hall. It was one of several similar rallies held around the country on the same day.

Jihadist Movements Growing Worldwide

The north of Lebanon has seen fighting provoked by the rise of Fatah al-Islam, which is inspired by al-Qaeda. Jihadist movements are also growing in strength in the Kurdish areas of Iraq and Turkey, in Jordan, Yemen, and Egypt and across North Africa. Even south-east Asian countries - despite rapid economic growth - now have serious problems. Thailand, Indonesia and the Philippines all have active and violent Islamist movements.

Above all, Iraq is serving as an inspiration and training ground for a new generation of jihadists - just as the Afghan war against the Soviet Union once did. Terrorist techniques perfected in Iraq are cropping up elsewhere. Suicide bombing was unknown in Afghanistan until a couple of years ago. Now it is a deadly, almost daily occurrence.

A familiar refrain - particularly in Europe - is that the key to soothing Islamist militancy lies in “solving” the Palestinian problem. There are obvious holes that can be picked in this argument.

Hamas is not interested in negotiating with Israel to create a Palestinian State. Hamas wants Israel to be eliminated. And further Hamas wants to create the new caliphate, a new world order ruled by Islamists.

Osama bin Laden has never shown much interest in a two-state solution. The attacks of September 11, 2001 were planned when the Middle East peace process was in relatively good shape. Al-Qaeda’s demands are so unrealistic - and its narrative of grievance so selective - that it will not be swayed by any changes in western policy.

With Hamas now in the control of Gaza and both Hamas and Fatah armed by Tehran, combined with Iranian-backed Hezbollah’s influence in Lebanon, it furthers the move of Iran for control of the Mediterranean. Add to this the building of Russia building military ports in Syria and providing arms to Syria further demonstrates the power of the alliance.

As reported by David Eshel for Defense Update on December 23, 2006: “In fact, as had been revealed recently, Russia, Iran and Syria have already entered a defense pact aiming at Moscow's ambitions to the process of altering the balance of power in the entire Middle East. Russia’s own part in this pact has been kept relatively secret for a long time.”

“The appearance of Russian ships in Tartus [Syria] will signal a dramatic reinforcement of Russia’s naval potential in the NATO dominated Mediterranean Sea, even when compared to the cold war period.”

The Democrat Controlled Congress Seeks to Break up Iraq

Both Rep. Ellen Tauscher of Walnut Creek and her California colleague and fellow Democrat, Sen. Barbara Boxer want the United States to admit that the idea of a strong national government in Iraq won’t work and instead aim to set up a federal system in which Sunnis, Shiites and Kurds can separate, cool the sectarian killings and manage their own affairs. Her proposal, which she calls the Change the Course in Iraq Act, is going places in Congress because it has acquired a most-powerful patron, House Speaker Nancy Pelosi, D-San Francisco. The speaker has written Tauscher a letter expressing support and pledging a vote on the legislation at some point in the next few months.

If they are successful in breaking up Iraq, as would be expected, the Southern part of Iraq is controlled fully by Iran; this gives a full and complete access for Iran to the Mediterranean and the creation of the Shiite Crescent.

Turkey’s Move to Join the Middle East and away from the EU

In considering relations with Turkey, the West must remember that the enemy of your enemy is not necessarily your friend and allay. In a departure from its traditional foreign policy which has gone largely unnoticed, Turkey is now becoming an important player in the Middle East. See: Turkey Rediscovers the Middle East, Foreign Affairs July/August 2007 and The city where Turkey’s republic lost its way, Financial Times June 26, 2007

Turkey’s growing concern over Kurdish nationalism has brought Ankara closer to the governments of Iran and Syria, which also contend with restive Kurds at home.

The shift is also accompanied by the gradual Islamization of the country led by the ruling Islamist Justice and Development Party (known as the AKP), headed by Prime Minister Recep Tayyip Erdogan, who has managed to tap into rising popular nationalism by fusing it with Islam.

Some 60 percent of all U.S. military equipment destined for Iraq goes through the territory or airspace of Turkey, a Muslim ally and member of NATO.

If this route to Iraq were restricted or closed entirely, the ability of the United States to effectively combat the insurgency and violent militias in Iraq would be impaired. The Erdogan government could also come under domestic pressure to restrict U.S. use of the air base at Incirlik in southern Turkey to re-supply American troops in Afghanistan. Should it be necessary to take military action against Iran or even Russia, the availability of bases in Turkey is critical.

In addition Turkey controls access to the Bosporus Strait an oil choke point for oil supply to Europe. Energy is a major driver behind the warming of Iranian-Turkish relations. Iran is the second-largest supplier of natural gas to Turkey (after Russia).

Iran’s nuclear ambitions, however, are a source of serious concern in Ankara. A nuclear-armed Iran could have a destabilizing impact on the Persian Gulf region and force Turkey to take countermeasures for its own security.

If Iran refuses to comply with the demands of the International Atomic Energy Agency, Ankara will have essentially three options: expand its cooperation on missile defense with the United States and Israel; beef up its conventional military capabilities, especially medium-range missiles; or develop its own nuclear weapons capability.

The Required Missile Defense against Iran in Central Europe

Iran’s push for nuclear weapons is accompanied by its development of ICBMs. The threat of a nuclear armed Iran is no longer just a problem for Israel and their Arab neighbors. Iran’s development of ICBMs that could reach Washington DC brings the threat home with added urgency. The nuclear Iran is not just a local issue for Israel.

An Iranian ICBM with a range of nearly 2,500 miles could reach as far west as Central Europe and well into Russia, China and India. The U.S. Defense Intelligence Agency has told Congress that Iran in fact may be capable of developing a 3,000-mi.-range ICBMs by 2015.

It’s unlikely the neighbors would complain if a family installed an alarm system, especially if the family offered to install alarms in every home on the block. Such a generous offer would protect everyone from crime. Friendly, law-abiding neighbors would realize they have everything to gain and nothing to fear.

Russia Objects to Nuclear Defense against Iran

But one neighboring leader objected: Russian President Vladimir Putin. The proposed missile-defense screen would lead to an “inevitable arms race,” he warned, adding, “If the American nuclear potential grows in European territory, we have to give ourselves new targets in Europe.”

Nuclear potential? Targets? That’s an odd way to describe a defensive program that would actually protect nations from weapons. And in fact, Putin seemed to later see the error of his stance, going so far late last week as to volunteer to take part in the defense screen—or did he?

Well, not really. On June 18, The Iranian Foreign Ministry says it has received assurances that Moscow will not let the United States share a Russian radar facility in Azerbaijan as part of a missile shield against Iran -- despite an offer by President Vladimir Putin to U.S. President George W. Bush to do exactly that. The ministry says Russia has no intention of allowing the Americans to use the radar base. Was Putin bluffing when he made the offer to the United States?

Russia is not confirming the Iranian version of events. But it raises the possibility that the Russian offer was bogus and that Putin was merely maneuvering to occupy the high ground in the dispute over the antimissile system.

Anticipating a U.S. rejection of his offer, Putin could say that Russia had gone out of its way to offer a solution but that Washington had not been willing to accept it.

Uranium and Nuclear Power in Kazakhstan

Kazakhstan and Iran share access to the Caspian Sea. Kazakhstan could provide the nuclear materials for an Iranian nuclear weapon. Over the past two years, US relations with former Soviet Central Asia nations have collapsed. Indeed, China has become a major player in this region. Russia is also stepping up its military presence in this region. Moreover, barely acknowledged by the Western media, both China and Russia have conducted war games in Central Asia, in collaboration with their own coalition partners. Of special interest are these activities in Central Asia, under which military exercises involving the participation of Russia, Kazakhstan, Kyrgyzstan and Tajikistan are conducted under the Collective Security Treaty Organization, (CSTO). Iran is developing a mutual military defense strategy with Kazakhstan. See also my article: Global Threats Leading to the Leftist/Marxist -- Islamist Takeover.

If the US can not defend our border, and “Other Than Mexicans” (OTMs) enter at will, can we count on the dysfunctional Kazakhstan government controlling their border. Some of these OTMs could be bringing in nuclear material for Hezbollah, Hamas or al-Qaeda terror cells in the US.

Because of large deposits of uranium, Kazakhstan has developed facilities for the entire nuclear cycle including enrichment of uranium.

Kazakhstan and Russia boast the world’s second and third largest uranium reserves, which are respectively 1 million and 0.8 million tons.

In addition to their nuclear activity, they do have research facilities for designing and manufacturing chemical and biological weapons.

Kazakhstan is rich in oil, one of the 10 largest oil fields in the world in located there. By 2015, it is expected to be the fifth largest producer of oil in the world.

Utembayev Ambassador of Kazakhstan said his country supports Iran’s right to acquire peaceful nuclear technology. “Kazakhstan supports peaceful nuclear research and is opposed to proliferation of nuclear weapons,” Utembayev told IRNA.

Asked about ways to put an end to the nuclear standoff between Iran and the West, he said the issue must be resolved through negotiations and within the International Atomic Energy Agency.

Iran and UAE Review Expansion of Economic Ties

Developing expansion of economic cooperation between Iran and the UAE will lead to forging unity among regional countries. A large Iranian Expiate population is in the UAE.

On June 18, “Iran’s Minister of Commerce Masoud Mir-Kazemi conferred in Dubai with the UAE’s Minister of Economy and Industries Sheikh Hamdan bin Rashid on expansion of mutual and regional cooperation, IRNA reported.”

“Iran possesses new technological know-how with highly profile scientific and technical knowledge in various fields which could be take into consideration, he said.”

The US and the EU and NATO rely on military bases in the UAE and Bahrain to support military operations in the Gulf. The US has also provided advanced military aircraft to the UAE.

The Gulf Cooperation Council will not be used in Attack on Iran

Gulf Arab countries will not be used as a launch pad for any military attack on Iran; Saudi Interior Minister Prince Nayef Bin Abdul Aziz was quoted as saying on June 18.

He said Iran had no interest in striking its oil-producing Arab neighbors if it comes under attack from the United States. “I think the brothers in Iran are totally aware that ... Iran will not be a source of harm for their neighbors and brothers ... These countries (Arab neighbors) will not be a source of harm for Iran,” he said to state news agency SPA.

The Dragon Fleet (China’s Role)

US defense planners are likely to continue to find it hard to take China’s good intentions on trust while the country remains an authoritarian and avowedly communist one-party state. Beijing meanwhile still shows little willingness to embrace the level of transparency that might allay their suspicions.

It is extremely difficult to judge both the current capabilities of China’s maritime fleet and also the strategic goals to which Beijing is likely to put it. But there is no doubting that the navy, long the neglected arm of the People’s Liberation Army, is now at the heart of China’s drive to build a military to match its growing economic and diplomatic clout.

The Need for Addressing the Global Risk

Diplomacy and military strength may deter the expansion of the threat of a global confrontation but the West must address its lack of energy security and dependence on ‘energy interdependence’ instead of ‘energy independence’.

The foreign policy of the United States and Europe must address the energy, the environment, foreign trade, financial, immigration, homeland security and defense tracks in a unified manner. Similarly, addressing the crisis in the Middle East, including the Israel-Palestine solution also involves solving relations with Russia, China and Eurasia.

This will require commitment and pain now to our way of life. It will require sacrifice. The alternative will be even worse.

Until the U.S. and its allies understand who the enemy is and their goals, and put forward a plan for survival, the world will be heading toward a major war of untold destruction. As mentioned above, we are revisiting 1938 and commercial interests and not security are driving our actions, as then.

Europe followed by America stand at the precipice, will they succumb to a hedonist Leftist future scenario and then becoming Islamicized either through the actions of Leftist/Marxist – Alliance or nuclear Holocaust or will they reestablish their Judeo-Christian heritage. The loss of Europe and America may occur by virtue of a collapsed population, faith and identity. Which will it be? It is not possible to determine the outcome, but, YOU the people living in Europe and America can influence the outcome. Decision time is fast approaching.

My advice is to let your position be known.

And “Prepare for War—Pray for a Miracle”.

David J. Jonsson is the author of Clash of Ideologies —The Making of the Christian and Islamic Worlds, Xulon Press 2005. His new book: Islamic Economics and the Final Jihad: The Muslim Brotherhood to the Leftist/Marxist - Islamist Alliance (Salem Communications (May 30, 2006). He received his undergraduate and graduate degrees in physics. He worked for major corporations in the United States and Japan and with multilateral agencies that brought him to more that fifteen countries with significant or majority populations who are Muslim. These exposures provided insight into the basic tenants of Islam as a political, economic and religious system. He became proficient in Islamic law (Shariah) through contract negotiation and personal encounter. David can be reached at: djonsson2000@yahoo.co.uk

“Pretty High Land” - Byron King

by Byron King

I told you last week that I have come up to Alaska to participate in a geological field trip, looking at the rocks, minerals, and energy resources of the 49th state from the Kenai Peninsula in the south to Prudhoe Bay and the Arctic Ocean in the north. I have just completed the majority of the trip, and was able to fly down to relatively balmy Fairbanks from very chilly Deadhorse. So now, dear readers, I can take some time to reflect and write to you.

Thrilling and Humbling

On a personal level, I am both thrilled and humbled by my trek across Alaska. In many respects, I am awestruck. And I am privileged, if not blessed, to have been part of the endeavor. I was in the company of a group of astonishingly smart and gifted geologists, supplemented by a number of subscribers to Whiskey & Gunpowder who answered the call of a note that I put out in March. The Whiskey readers were outstanding participants and overall super troopers, as one would expect of such a hardy breed. And the geologists on the transect included the famous Gil Mull, one of the original Richfield Oil (later, ARCO) team that discovered the 15-billion-barrel Prudhoe Bay oil field in 1967. As you can imagine, the discussions of geology and, in particular, the oil and gas potential of Alaska were… well, they were pretty deep. (OK, sorry for the pun.) We “went there,” if you know what I mean. And once you go there, perhaps, I think that you can never really come all the way back. There is just so much to say, dear readers. Where to begin?

Mountains and Pipelines

Let me begin at the beginning and go back to Aug. 21, 1778, when the redoubtable British sea Capt. James Cook was sailing north through what would later be named the Chukchi Sea. Cook had, in fact, sailed farther north than even the most daring Russian navigators of that era or previous times. He went into a region inhabited by the relatively nomadic, but also relatively friendly and industrious Native Alaskan people who eked a living from the sparse fruits of a cold sea. Cook gazed at one distant body of land and wrote in the ship’s log about a place that “appeared to be pretty high land, even down to the sea.” Cook also noted, of interest, that it was “destitute of wood.” Cook called the place Cape Lisburne, after a British earl of that same name. Cape Lisburne is the westernmost extremity of what is now called the Brooks Range.

And what a range of mountains is that Brooks Range! It is a rugged, jagged, foaming ocean of snowcapped mountains, 150 miles wide and 750 miles long, extending from the northwest coastline of Alaska far to the east and deep into the Canadian Yukon. The Brooks Range is larger in many respects than the Appalachians, yet in my experience, few have even heard of this massive geological feature. The Brooks Range, so named in the 1920s after a brilliant and bold geologist who pioneered the exploration of the mountain system, boasts peaks of 10,000 feet in elevation, and lies entirely above the Arctic Circle. Much of it lies within the protective jurisdiction of the Gates of the Arctic National Park and the Arctic National Wildlife Refuge (ANWR). The Brooks Range is the northernmost range of mountains in the world, geographically isolating a very flat coastal plain the size of California that is called the North Slope of Alaska.

Earlier in the 20th century, many geologists thought that the Brooks Range was an extension of the U.S. Rocky Mountains and their northerly companion, the Canadian Rockies. But now, in an era when plate tectonics is the operative geological paradigm, it appears that the Brooks Range is its own Arctic mountain system, sui generis, and filled with thrust-faulted masses of sedimentary rocks that are, in turn, closely related in time, space, and tectonic force to the opening of the Arctic Ocean Basin due to sea-floor spreading. And because of this interesting scientific tidbit, the Brooks Range and North Slope offers an entirely different sort of petroleum and natural gas system than one might initially expect when using “lower 48” forms of geological thinking. Hold that thought, dear readers.

I will discuss more geology in this and, of course, future articles. But I also want to get you thinking about the fact that the Trans-Alaska Pipeline System (TAPS) -- in particular, the famous Alaska Pipeline -- has to cross the mighty Brooks Range as part of the first leg of its route south from Prudhoe Bay, about 500 miles east of Cape Lisburne. Thus, in the first push for the petroleum of the North Slope, immense pumps the size of several railroad locomotives connected together in a series drive the oil from sea level to up and over the aforementioned Brooks Range, along a “utility corridor” established by federal law for just that purpose. Currently, the oil pushed through and making the ride amounts to about 800,000 barrels per day, although in earlier years the North Slope was producing, and the Alaska Pipeline was transporting in excess of 2.2 million barrels per day. (The decline is due to reservoir depletion.) Think of just the energy required in overcoming the force of gravity, in order to lift that much oil high enough to cross a broad, high mountain range. Hold that thought, too.

TAPS crosses the Brooks Range at Atigun Pass, a narrow crack in one particular mountain composed of mostly solid quartzite conglomerate. Atigun Pass is about 170 miles south of Prudhoe Bay and sea level, offering one of the only clear shots to the south, albeit over a glacially carved valley and at an elevation more than 4,800 feet above sea level. Atigun Pass is, they say, utterly treacherous in wintertime, which is most of the time up here. And the Brooks Range is just one of three immense mountain ranges, and nearly 1,000 rivers and streams, that the Alaska Pipeline crosses in its long 800-mile path to Valdez on the southern coastline of Alaska. Hold that thought as well.

Putting Thoughts Together

OK, dear readers, I asked you to hold some thoughts and now it is time to put some of these thoughts together from the perspective of Outstanding Investments. [Greg’s Note: Outstanding Investments is the best performing stock research newsletter in the world over the past five years. Go here to subscribe.]

Hydrocarbon-Bearing Formations

One of the oil-bearing and -producing formations at Prudhoe Bay is called the “Lisburne limestone.” Does that name sound familiar? It should, because it is related in time and origins to the rocks that form Capt. Cook’s so-named Cape Lisburne, many hundreds of miles to the east. And there are many other hydrocarbon-bearing rock formations that the good Capt. Cook never saw or suspected, currently productive or otherwise prospective, north of the Brooks Range. These rock formations are deeply buried under the North Slope, and extend from under the Chukchi Sea, along the northern coastline of Alaska and offshore, following the line of the Arctic Ocean all the way over into northern Canada. Also of exploration interest, somewhere in northern Canada, according to some geologists, lies the “other half” of the Arctic Basin rift system, where there may be rock units similar to what we find beneath the North Slope. So there is immense hydrocarbon potential along the North Slope, and perhaps elsewhere in the northern region of North America.

Isolated, Vast, Cold

Yet despite the rich prospective hydrocarbon potential of this vast Arctic area, it is immensely difficult to accomplish even the most basic of tasks. The place is almost entirely uninhabited and there are simply no roads or other infrastructure. Ingress and egress is by dog sled in winter, airlift most other times (except when the winds are blowing 150 miles per hour), or barge during the few ice-free months of summer. Most everything else currently arrives in Deadhorse, Alaska, after a 420-mile trip up the 20-foot-wide gravel “Haul Road” (now named the Dalton Highway) that parallels the Alaska Pipeline from Fairbanks to Prudhoe Bay. My group of touring geologists rode up that rough road in a set of tough vans, viewing (and feeling) every hard mile of Haul Road, and observing the Pipeline in all its industrial glory, which is significant.

Climate is, as one would expect so far north of the Arctic Circle, constantly extreme and from an environmental standpoint extremely fragile. As Capt. Cook noted, the area is “destitute of wood.” Yes, indeed, and it is destitute of almost everything else under God’s sun. In fact, for many months of the year, it is destitute of even the sun. And it is cold, too. It is very cold, my friends. When I stood at the edge of the Arctic Sea the other day, a sunny day in June, with my boots just touching the ice-clogged waters, the temperature was nominally in the low 30s Fahrenheit. But I think that somebody was lying. It had to be colder than that, or perhaps it was the 40-knot gusts of wind that cut through and penetrated a U.S. Navy-issue Gore-Tex Arctic outer liner, plus numerous other layers of protective clothing. There is something about the Arctic wind that just wants to kill you, and for a deeper understanding of that, I recommend any of a number of poems by the great Robert Service. But the point is: Wow, was it ever cold!

When you find something in that frozen north (and if you look hard, dear readers, you probably will), what do you do with it? How much is there? What are the numbers on any given prospect? What are the economics? What is the environmental impact? How do you plan for large-scale industrial development in such a remote and harsh environment? What are the logistic challenges, the hurdles, the utter barriers (such as crossing Gates of the Arctic National Park lands or ANWR) to accomplishing what you want to do? How do you arrange for long-term extraction operations, and transport your treasure to the eager markets of the world? These are just the first of many hard and exceedingly expensive questions you have to ask.

One of the World’s Great Oil Finds

I mentioned earlier that geologist Gil Mull, who was part of the original exploration team that found the Prudhoe Bay field in 1967, was on the trip to the north. Gil described the early days of exploring around Prudhoe Bay in the mid-1960s, when the oil workers would take off in a transport aircraft from Fairbanks and fly north to an utterly isolated drill site on the edge of the frozen Arctic Ocean. This was, of course, before the Haul Road, the Pipeline or anything else even remotely resembling the current state of development after 40 years. There was no global positioning system (GPS) in those days, and not even any of the radio navigation aids that were then around and available farther south but not working so far north. All they had to steer by was dead reckoning, aiming the nose of the airplane eventually at the glowing light on top of the drilling rig. Little rig, big Arctic. And once they saw the light, they would land the airplane, in the dark, on an ice runway carved out of frozen tundra. Any volunteers?

To give away the happy ending of the story of the first well in the Prudhoe Bay area, the “discovery well” of one of the world’s great oil finds, they drilled into a 300-foot gas cap at the top of a deeply buried structure, underlain by dozens of feet of oil-soaked sandstones and conglomerate. Many months later, when they drilled the confirmation well about seven miles away on the flank of the structure, they found over 400 feet of oil column in the rocks. Gil discussed how, during one coring operation, they started to pull the core out of the drilling tube and “it simply flowed out, just sand and rock and oil, 180 degrees or so hot, flowing and steaming all over the drilling deck.” At one point, the geologists conducted what is called a “drill stem test,” in which they allowed the fluids from the well simply to flow into the drill pipe. “We rapidly had a supercritical pressure buildup,” said Gil. “And then we closed off the drill stem mechanism and it took over 12 hours simply to blow down the pressure. We were flaring natural gas for 12 hours just to get the high pressure down.”

Yes, Gil was fortunate enough to have been part of a group that found the largest oil field ever discovered in the U.S. or Canada, 10 billion barrels, or so they thought at the time (now we know that it is much larger, near 15 billion barrels). But the Prudhoe Bay field got developed only because it was so large. Anything much smaller might not have paid off, because there was no other infrastructure. The next step was to build the Haul Road and adjacent Alaska Pipeline, which ultimately took an act of Congress and a total of $11 billion in 1970s-era dollars.

Could we do something similar today? And we have to ask, would it be worth it to do so? Because, dear readers, whatever happens is going to cost, and cost really big, and I mean that in many respects. This is spectacular territory, but it is spectacularly fragile and treacherous as well. As Barry Lopez wrote in his book Arctic Dreams, “No summer is long enough to take away the winter. The winter always comes.” To my observation, winter never really leaves.

Think of this in terms of current and future exploration to the far west of Prudhoe Bay, in what is quaintly labeled on the pretty maps as the “National Petroleum Reserve-Alaska.” Yeah, right. “Petroleum Reserve.” Piece of cake, huh? Who is going to develop that “petroleum reserve”? Who will pay to drill it up, and to build the next part of the Arctic energy complex? Who will take the risks, and make a series of large hydrocarbon discoveries, and then build an accompanying “Northern Pipeline” across 500 miles of North Slope and Arctic Ocean coastline? Will anyone venture to build something else down to the south (and if so, to where?) across that all-but-impenetrable Brooks Range of mountains? Think about it. Who is going to do that? Will someone find another Prudhoe Bay and mark out another Atigun Pass, maybe? There is nothing easy about this, nothing at all, not even breathing that cold Arctic air.

Things Are Going to Happen

I will close by saying that I believe strongly that many great and vast and difficult things are going to happen in northern Alaska, and I am going to watch it all like a hawk. But I know, and I am absolutely certain, that whatever happens will have to occur in a harsh and utterly unforgiving Arctic world that is very much different from the world in which our civilization developed its resources in the past. People are, in all likelihood, going to do what has to be done, and spend the funds to accomplish the tasks. But what challenges! And what expenses! And what risks! Fools dare not rush in, and we want to screen those fools out of our Outstanding Investments portfolio. That is why I am discussing so much in this update to you.

Looking at things more broadly, I do not think that, at any time over its entire history, mankind has ever done anything remotely similar in scope to what is going to occur up in the frozen north over the next few generations. As I stated near the beginning of this article, I am simply humbled at the measure of the task. I am awestruck.

Please keep reading this newsletter, dear readers. There is much more to say. But for now, I bid you all adieu.

Until we meet again…
Byron W. King

For Whiskey and Gunpowder

Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments.

The Solitary Bear - Puru Saxena

by Puru Saxena

BIG PICTURE - Cash is trash! Today, currencies continue to perform their function as a medium of exchange, but they certainly aren't a genuine store of value; or a guardian of purchasing power. Thanks to the ongoing unprecedented money-supply and credit growth (inflation) on a global scale, currencies have stopped fulfilling this crucial function; thereby robbing the masses of their hard-earned savings. In this highly inflationary world where more or less everything is in a bull-market (at least when measured against various currencies), the only "asset" that is in the bear's lair is central-bank produced paper "money". Figure 1 clearly highlights the fact that the major world currencies have lost between 25% and 75% of their purchasing power through inflation since 1980! For this system to work however, this solitary bear-market in "money" must remain concealed from the public for the fear that the masses may stop accepting these currencies as a medium of exchange. In order to proliferate this fraud, the officials keep up with the "inflation-fighting" propaganda through their totally bogus and meaningless "inflation" figures which are constantly spewed out by the media.

Figure 1: Safe haven of cash?

Source: Hans Eisenkolb

Taking into account the course of action chosen by the various central-banks, I am convinced that the various currencies will continue to depreciate in value against assets. In other words, I expect that the stealth confiscation of savings will continue through inflation. For sure, they may be temporary set-backs or corrections in asset-prices but the major trend is up. Before you disagree with my assessment, take into account the fact that despite an average economic backdrop (sky-high deficits and debt-levels in the developed nations), over the past 4 years, all assets appreciated at the same time! Despite rising interest-rates and geo-political tensions, even property and bond prices managed to stay strong together with equities, commodities and collectibles.

At the beginning of this decade, if I had told you that 7 years later crude oil would be trading above $60 per barrel, gold would be close to $700 per ounce, food prices would be at multi-year highs and the Dow Jones would be trading around 13,500, you would have pronounced me crazy! However, this is exactly what has happened and there is nothing in the works to suggest that this major trend is about to change in the near future. In other words, I anticipate that barring short or medium-term corrections, asset-prices will continue to trend higher in nominal terms UNLESS the central-banks change their expansionary monetary policies and decide to rapidly raise interest-rates. In all likelihood, this scenario may not unfold for a few more years and until such time, investors should be able to protect their savings through the returns generated from the capital markets.

In the world of investing, it all comes down to supply and demand. Items which are in high demand tend to rise in value against items whose supply is increasing rapidly. So, turning to today's situation, the money-supply is rising by roughly 10% per annum in several countries and the supply of assets is not keeping pace. Hence the bull-market in asset-prices when measured in terms of currencies. Now, I am not saying that the explosive growth in the supply of currencies cannot and will not be reversed in the future, thereby causing sharp contractions in asset-prices. For sure, it could easily reverse. But for that to happen, we would have to see genuine monetary-tightening through significantly higher interest-rates and a sharp increase in the banks' minimum reserve requirements. The central banks know fully well that given the high debt levels, such drastic measures would probably cause a global depression, widespread unemployment and social unrest. So, they will try and avoid or delay this outcome as much as possible, thereby further assisting the bull-market in asset-prices and the death spiral for your cash savings.

Recently, several well-regarded economists and analysts have issued compelling reports explaining why the end is nigh. I tend to agree with their assessment that some assets are over-stretched and ripe for a correction (Chinese A-shares come to mind). However, I do not buy into the thesis that just because the bull-market in equities and commodities is 5 years old, it must stop immediately. History has shown that since the abandonment of gold in the early 1970's, bull-markets have lasted for very long periods of time. Moreover, the current bull-market in equities (especially my preferred emerging-markets) and natural resources is well-supported by the very real forces of Asian industrialization, urbanization together with supply and demand imbalances. So, taking into account the strong money-supply growth and the rapid transformation of Asia and Latin America, I am inclined to think that the global boom in stocks and commodities will continue for several more years.

There can be no disputing the fact that the global expansion is now 5 years old and well-advertised, accordingly the "low-hanging fruit may not come by so easily. Furthermore, I envisage that in the future, investors will have to become more selective when making decisions and deploying their capital. For maximum success and safety, I would urge you to invest your capital during pullbacks whilst avoiding overstretched markets. Despite all the talk of "doom & gloom", this strategy should continue to deliver reasonable returns in the period ahead.

The above is an excerpt from Money Matters, a monthly economic publication, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly reports, subscribers also benefit from timely and concise "Email Updates", which are sent out when an important development in the capital markets warrants immediate attention. Subscribe Today!

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Puru Saxena is the founder of Puru Saxena Limited. Vastly experienced and respected in his field, he is a registered investment adviser with the SFC. He conducts in-depth economic research and formulates our firm's investment strategy.

Puru Saxena has a decade’s experience in the finance industry, specifically relating to investment advice and asset management.

An investment adviser based in Hong Kong, he is a regular guest on CNBC, BBC, Bloomberg, NDTV Profit and writes for several newspapers and financial journals.

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Big Growth Opportunities in Wellhead Equipment - Dan Amoss

by Dan Amoss

Oil and gas resources once thought completely out of reach have now arrived in the fuel tanks and furnaces of consumers around the world.

Opinions differ about the future capabilities of oil field technology. Some argue that technology will allow us to unlock trillions of barrels worth of oil out of unconventional and not-yet-discovered resources. Others argue that every technology in use today was developed 20 or 30 years ago; not only that, but growing service industry bottlenecks could halt several desperately needed development projects in their tracks.

While both sides of this debate have valid points, I think it's important to remain focused on the progress under way at major projects and depletion of large existing fields, and not argue about potential resources 30 years into the future. We want to profit from the decline of Peak Oil and its subsequent political instability now.

Since the advent of the oil business, scientists and engineers have developed a series of very remarkable technologies. Oil field technology tends to compound at a steady rate, extending the boundary of what was long considered the absolute limit of exploration and production.

Resource owners usually want to produce a hydrocarbon reservoir as fast as safety and engineering limits allow, so it makes sense that most oil field technology was developed to accelerate the process. The concept of "time value of money" doesn't end on Wall Street; it extends to the oil patch. Producers are under pressure to satisfy the demands of employees, bankers, tax collectors, and shareholders, so the sooner oil and gas arrive, the better.

This picture of working to beat the clock not only applies for newer discoveries, but it also applies for projects that strive to extend the lives of older fields. Oil field equipment and services have become very expensive and are likely to become even more expensive in the coming years. The free market is the driving force behind oil field technologies.

If there's thought to be a few million more barrels of oil left in an old well, an operator will go ahead with an enhanced oil field recovery project if the return on investment is high enough. But if oil and gas prices fall and service prices remain high over the course of this project, this operator can lose a lot of money. So timing is of the essence.

Oil service stocks that can grow regardless of operator budgets are difficult to find. But I recently discovered one for Strategic Investment readers that’s fairly unique. It’s fairly insulated from the booms and busts of the oil field investment cycle, yet has incredible growth potential. Its technology has proven to be very valuable for operators extending the lives of older wells, but it also plays a key role in unlocking the value of low-quality oil and gas. Its equipment and expertise will remain in very high demand by oil field operators around the globe for years to come.

How Sour Crude Can Lead to Sweet Profits

Low-viscosity, or "sticky," heavy crude and sour crude with high levels of impurities like sulfur require extra steps in both wellhead processing and refining. The initial step in crude oil refining really occurs at the wellhead, the site where it's first pulled from the ground.

The trend toward heavier, sourer crude oil will directly benefit manufacturers of specialized wellhead equipment. These lower grades of crude make up a steadily rising share of global oil production because, just as you'd expect, the sweetest, lowest-hanging fruit in the oil patch tends to be picked and consumed first.

More barrels of crude will require upgrading, particularly the abundant, yet barely accessible heavy crude from sources like the Orinoco Belt in Venezuela. Technology is what the Venezuelans, the Russians and the Saudis need, and they will pay up for it.

Some of the biggest wealth-creating companies of the next generation will be those that can unlock the value of these politically unstable resources - without committing billions in capital to projects that can be seized overnight.

I’ve already told my Strategic Investment readers all about a company that specializes in manufacturing oil and gas production equipment. It sells this equipment into most major oil and gas basins around the world, and it’s a great way to play on the growing natural gas market.

With that said, the odds are the next few years will look like the last few - a period of growing resource nationalization not unlike hoarding. Leaders of countries sitting on vast reserves are taking actions in the best interest of their people (or their personal Swiss bank account) and telling major oil companies to get out.

Vladimir Putin and Hugo Chavez wouldn't have kicked the big oil companies out if they hadn't planned on granting major development projects to big service companies like Schlumberger, Baker Hughes and Halliburton, just because of the fact that most of their countries’ remaining reserves are difficult to produce.

"Megaprojects" Hampered by Bottlenecks

Yet despite having access to the best oil field technology in the world, most big projects still suffer from bottlenecks, delays, and cost overruns. This phenomenon is widespread enough that it supports the core ideas behind the Peak Oil theory - most notably that the "easy oil" has already been consumed.

Chris Skrebowski, editor of Petroleum Review, became a leading Peak Oil theory proponent after initially setting out to prove that it was nothing more than worrywarts seeking to make headlines. With decades of international oil field consulting and research experience, he ran the numbers and concluded that data on both historical production and future projects were not precise enough to assume ample oil supply as far as the eye can see.

So Skrebowski started a "megaprojects" database to track the projects widely expected to satisfy growing demand. He's noticed an undeniable trend of delayed startups and shortages of everything from drilling rigs to qualified personnel. Assuming that the current backlog of projects proceeds without a hitch, he expects that "24.8 [million barrels per day] of new capacity [is] due to come onstream between January 2007 and December 2012."

An extra 24.8 million barrels per day of new capacity may sound like plenty for the world's 2012 production needs. After all, it represents a little over 4% annual growth over the next six years. But this ignores depletion of the existing base, the elephant in the room that most Peak Oil critics either overlook or avoid.

Skrebowski warns that the data behind the existing base, especially from national oil companies like Saudi Aramco, are not transparent enough for us to make happy assumptions about long-term supply. If average global depletion is running a little over 4% per year - a fair estimate - the world is likely to have the same oil production capacity in 2012 as it has today. With relentless demand growth, flattening worldwide production would send oil prices well into the triple digits for good.

Skrebowski draws two conclusions from his latest megaprojects analysis. "First, data on production, project performance, and depletion rates are wholly unsatisfactory, particularly for the OPEC producers. Second, the large volumes of new capacity being added between 2007-2012 may not translate into the sort of increased production flows the world economy needs to underpin economic growth."

Companies that play critical supporting roles in extending oil and gas production will be great investments over this 2007-2012 timeframe.

Good investing,
Dan Amoss, CFA

for Whiskey and Gunpowder

Dan Amoss CFA is managing editor of Strategic Investment, the highly respected US newsletter. Previously Dan worked at Investment Counselors of Maryland - investment advisors tor one of America's top small-cap value mutual funds over the past 15 years.

Dangerous Divergences in the Global Bond and Stock Markets - Gary Dorsch

Once upon a time, many years ago, the US stock market lived in fear of a violent band of traders known as the "bond market vigilantes". Whenever the Federal Reserve's money supply measures grew too rapidly, or the US economy grew too strongly threatening to stoke higher inflation, the "bond vigilantes" would take matters into their own hands, by jacking-up 30-year Treasury bond yields as much as 25 basis points or short-term T-bill rates by 50 basis points in a single day.

Former US Treasury secretary Robert Rubin convinced his boss, President Bill Clinton that taming the "bond vigilantes" by reducing the budget deficit was the surest way to reach long-term economic prosperity. As Clinton's political guru James Carville famously put it, "I used to think if there was reincarnation, I wanted to come back as the president or the Pope or a .400 baseball hitter, but now I want to come back as the bond market. You can intimidate everybody," he once quipped.

But during the first Bush administration, when the Treasury's budget was spinning out of control with a $445 billion deficit in fiscal 2004, the infamous "bond vigilantes" slipped into hibernation. Instead, a new band of traders with much deeper pockets, the Bank of Japan, the People's Bank of China, and the Arab Oil kingdoms were cornering the US Treasury market, and keeping yields pinned near historic lows.

Tokyo and Beijing acquired a combined $2.1 trillion of foreign exchange reserves, mostly held in US dollar bonds, thru massive intervention to keep the yen and yuan weak, and plowed their newly acquired dollars into US bonds. Today, Japan owns $612 billion of US Treasuries, after purchasing $334 billion US dollars in 2003-04. Beijing owns $420 billion of US Treasuries, and more than $500 billion of US agency and corporate bonds, with little regard for the outlook for inflation.

As crude oil prices more than doubled to over $65 per barrel, OPEC's oil revenue reached $968 billion in 2006 from around $300 billion in 2002, Arab Oil kingdoms invested about $314 billion into the US Treasury market thru their London brokers, representing one-fourth of the $1.3 trillion of petrodollars invested globally over the 3-years. Last week, the US Treasury said holdings of US securities by foreign central banks and governments rose to $2.3 trillion by the end of June 2006.

Perhaps, the most important single factor allowing the global economy to grow at 5% or more for each of the past four years has been historically low bond yields, courtesy of Asian central banks and Arabian petrodollars. Indirectly, abnormally low bond yields spawned $1.5 trillion of US mergers and takeovers in 2006, and $1 trillion so far this year, up 70% from the same period a year earlier. Globally, M&A mushroomed to $3.6 trillion in 2006 and $1.9 trillion so far this year.

Also behind the boom in global stock markets, hedge-fund assets tripled in the past decade to $1.57 trillion, and private- equity companies are bidding $447 billion for companies so far this year, versus $228 billion in the year-ago period. Corporate treasurers are exploiting the gap between the low yield on bonds and the earnings yield on stocks through record share buybacks, driving equity prices sharply higher.

The Bernanke Fed is also operating behind the curtain, inflating the broad M3 money supply at an annualized 12.2% rate, its fastest clip in 5-years. Each morning, before the opening of the NYSE, the Bernanke Fed buys Treasuries to accommodate strong loan demand from private equity groups and leveraged takeover artists, and prevent short-term borrowing rates from rising.

The global stock buying frenzy might not have been possible, if the "bond vigilantes" weren't sedated by Arab Oil kingdoms, China, Japan, and other central bankers.

But interestingly enough, when the Dow Jones Industrials climbed above the psychological 13,000 barrier for the first time, the "bond vigilantes" began to crawl out of their cave. On June 1st, the Treasury's 10-year yield rose to 4.98%, its highest level in nine-months. Treasury yields were rising despite news that the US economy slowed to a scant 0.6% growth rate in Q'1, its weakest in 4-½ years, largely due to a sharp downturn in the housing sector.

Fed officials believe the correction in the housing market is likely to "weigh heavily" on economic growth for the remainder of the year, but "the risk that inflation would fail to moderate as desired remained the committee's predominant concern," the Fed said on May 30th. So as hopes fade for Fed rate cuts this year, traders are dumping long-term T-Notes in favor of high flying US and foreign stocks.

The "bond vigilantes" might have greater room to maneuver in the months ahead, as Beijing observes its massive US bond portfolio, estimated at over $900 billion, slide into a free-fall, when depreciating US dollars are converted back into Chinese yuan. China's massive $233 billion trade surplus with the US last year is going up in smoke, even before the "bond vigilantes" have a good crack at the bat.

China controls $1.2 trillion in foreign exchange reserves and steady purchases of longer-dated Treasuries could evaporate, after the PBoC widened the trading band for the yuan on May 18th, allowing for a swifter devaluation of the US dollar. Beijing could decide to recycle its massive trade surplus into riskier assets.

But Fed chief Ben Bernanke is not worried about Beijing dumping US bonds in the future. "I think the cost to them of doing this would be greater than the cost to us. A substantial move on their part would be disruptive in the market in the short term, but in the longer term, the dollar and Treasury yields would largely recover," he told the Senate Banking Committee on Feb 14th.

"I do not believe China's substantial accumulation of reserves (recycled into US bonds) in itself represents a problem for the United States or for US monetary policy," Bernanke wrote on March 26th. "Because foreign holdings of US Treasury securities represent only a small part of total US credit market debt outstanding, US credit markets should be able to absorb without great difficulty any shift of foreign allocations," he said in a letter to Sen. Richard Shelby, an Alabama Republican.

"And even if such a shift were to put undesired upward pressure on US interest rates, the Federal Reserve has the capacity to operate in domestic money markets to maintain interest rates at a level consistent with our economic goals," Bernanke added. Would Bernanke speed up the printing presses to buy bonds from Beijing?

Bond Vigilantes Unleashed in Europe

While American bond vigilantes are just stepping into the batter's box, the German bund vigilantes are already on first base, jacking up European benchmark yields to multi-year highs. Germany's 10-year bund yield rose to 4.50% this week, its highest since Dec' 2003, while the 2-year yield climbed to 4.42%, a five-year high.

"Euro zone inflation risks are rising and the European Central Bank is keeping its options open on how much further to raise interest rates," said Greek central banker Nicholas Garganas on May 30th. "All the options for a further increase in interest rates and the pace and size of further adjustment are open. Inflation risks are on the upside and increasing," he warned.

"A number of factors are pointing to an inflation rate which is higher than expected so far this year," Garangas said, pointing to strong money and credit growth, higher oil prices, and lower unemployment. "The ECB needs to exercise strong vigilance to keep price pressures in check," warned Bundesbank chief Axel Weber on May 16th.

Since March 13th, Euro zone traders have been dumping German bunds and switching into high-flying European blue chips stocks. The ECB has spoken a million words about the risks of higher inflation, but has only lifted its repo rate a quarter-point this year. The ECB has tolerated explosive growth of the Euro M3 money supply, which hit a 24-year high of 10.9% in March, far above the central bank's target of 4.5%, which it believes is consistent with low inflation.

"It would be unwise to discard monetary analysis, especially now that asset prices are at a high and liquidity at an unprecedented scale worldwide," warned the BBK's Weber on June 3rd. "Interest rates are low in the Euro area," said Dutch central bank chief Nout Wellink on June 4th. "These low interest rates show up in asset prices, not only in the stock market, but also the housing market and other financial markets."

The ECB's slow-motion tightening strategy hasn't restrained the growth of the European money supply. In fact, Euro M3 money supply is growing at a much faster rate today, than when the ECB began raising its repo rate in December 2005. While the mainstream media points to ECB rate hikes as proof of a tighter monetary policy, double-digit Euro M3 growth points to a super-easy ECB money policy.

The ECB pursues a clandestine policy of pumping up European real estate and stock markets, to boost consumer confidence and spending at home by inflating M3. The ECB's sleight of hand is part of its game of "Smoke and Mirrors" designed to lull German "bund vigilantes" to sleep, while it quietly pumps up asset markets.

But the Norwegian government recognized the shell game on April 13th, and said it planned to raise the equity component of its $314 billion oil fund to as much as 60% of total assets from 40%, while reducing the portion held in bonds. According to the Norwegian Pension Fund's 2006 report, it owned 154 billion crowns ($25.7 billion) of German Bunds, and 44 billion crowns in European Investment Bank bonds.

To restore its badly tarnished image of an inflation fighter, the ECB has telegraphed a quarter-point rate hike to 4.00% in June, and to 4.25% by September. The ECB was forced into the tightening mode, since gold is flirting with the psychological 500 euros /ounce. In Frankfurt, Euro Libor traders are pricing in the possibility of a third ECB rate hike to 4.50% by year's end.

So it was surprising that on June 1st, the ECB decided to suspend its remaining share of gold sales thru Sept 26th. That gave a small shot of adrenalin to the gold market, jumping back to 500 euros per ounce, and lifted the yield on the Euro Libor rate for December by 7 basis points to 4.57 percent. Stubbornly high gold prices in Europe provide more fodder for the German "bund vigilantes" in Frankfurt, whose set the benchmark yields for the rest of the Euro zone.

The Bank of England faces a Backlash

For the past three years, the ECB has operated under the same modus operandi as the Bank of England, inflating the money supply to buoy home and equity markets. But last week, the British gilt vigilantes, who have been locked in a tight box for the past eight years, came very close to breaking out. Two-year British gilt yields climbed to 5.78% on June 1st, a level not seen since in seven years. Ten-year gilt yields climbed to 5.32%, the highest since mid-2002.

For the past eight years, the UK's 10-year Gilt yield has been locked in a tight range between 4.00% and 5.35%, benefiting from foreign capital inflows seeking to profit from an appreciating British pound. But how much longer can the long-term Gilt market ignore the monetary abuse of the BoE? On April 24th, a group of leading UK economists including former BoE member Charles Goodhart criticized the BoE for ignoring double-digit growth of the money supply since 2005.

A week later, BoE chief King admitted that, "the growth of money and credit may signal in advance of other indicators that the Bank rate is set at a level inconsistent with bringing inflation back to the target in the medium term," he said. On May 10th, the BoE lifted its base lending rate by a quarter-point to a 6-year high of 5.50%, with consumer inflation raging at 3.1% it's highest in more than a decade.

But UK house prices jumped 0.9% in April and 0.5% in May, even after three BoE rate hikes, and stand 10.3% higher from a year ago. The price of a typical UK house is 181,584 pounds, or about 17,000 pounds higher than at the same time last year. Not surprising, with the UK's M4 money supply 13.3% higher from a year ago.

Asian Bond Vigilantes Ring the Alarm Bells

The Korean Kospi Index has been on a record-breaking rally over the past two months, and is up 20.6% so far this year, surpassing the 1,700-point mark for the first time, after extending gains for a 13th straight week. A quarter of listed Kospi stocks rose 50% or more this year, and 8% of Kospi stocks are up more than 100%.

South Korea's economy, Asia's third-largest after Japan and China, has expanded for 16-quarters in a row, marking the longest winning streak since the 1990's. Behind the scenes, the Bank of Korea (BoK) is inflating its M3 money supply, buoying stock prices but rattling the bond market. (A 5-year graph of the Korean M3 money supply and Koribor rates is presented in the June 8th edition of Global Money Trends).

The Korean central bank lifted its overnight loan rate by 125 basis points to 4.50% last year, and raised bank reserve ratios by 2% to 7%, but in defiance of its baby-step tightening maneuvers, Korea's M3 money supply exploded from a 7% growth rate to an annualized 12.3% in April 2007, its fastest rate in 4 ½-years.

Korean housing prices are growing four times as fast as consumer prices. Housing prices across South Korea were 9.7% higher in May than a year before, compared with a 2.3% annual rise in consumer prices. Despite the explosive growth of the money supply, coupled with a strong economy, the BoK is holding its overnight loan rate steady at 4.50% for a tenth consecutive month.

Korean "bond vigilantes" are alarmed by the BoK's super-easy money policy, and have jacked up the government's borrowing costs by 50 basis points over the past three months. Seoul plans to sell 3.74 trillion won ($4 billion) of Treasury bonds in June, compared with 4.45 trillion won worth offered in May, adding to bearish sentiment. But the half-percent increase in 5-year yields hasn't been sufficient to knock the Kospi Index off its upward trajectory.

"Abundant global liquidity is one of the risky factors that all countries need to monitor," South Korea's finance minister Kwon O-kyu told reporters on May 17th. "We have to monitor how much the US economy slows down and how much growth in China and India can compensate. Global liquidity may be maintained for some period but the China effect cannot continue for ever," he warned.

The Bank of Korea is disturbed by the double-digit growth of the M3 money supply. So what's preventing the BoK from raising its interest rates, and what other powerful force in the global marketplace helps the Korean Kospi Index defy the law of gravity? The answers are inter-related and were provided in the June 1st edition of Global Money Trends).

Aussie Bond Vigilantes dig deeper "Down Under"

Australian bonds have lost considerable ground in recent weeks as Aussie traders dumped safe-haven government debt, in favor of riskier stocks. Australian bond futures fell to their lowest in three years on June 5th, with Aussie "bond vigilantes" taking their cue from bears in Asia, Europe, and North America. The Aussie 10-year bond yield broke thru the psychological 6% barrier last week, and a break-out above 6.20% would send yields to their highest since 2002.

The latest slide in Aussie bonds has caught many traders off guard, since the Reserve Bank of Australia (RBA) is expected to leave its cash lending rate unchanged at 6.25% for the remainder of the year. On April 23rd, the Australian statistics bureau said the local consumer price index climbed 0.1% in the first quarter, lowering the annual rate of inflation to 2.4% from 3.3% in the previous quarter.

That left the CPI in the middle of the RBA's 2% to 3% inflation target. But not all Aussie bond traders are duped by inflation statistics conjured up by government apparatchniks. Instead, Australia's jobless rate fell to 4.4% in April, to a 32-year trough and stoking concerns that a super-tight labor market would eventually threaten higher inflation and interest rates.

While the mainstream media points to doctored-up government statistics on inflation as gospel, Aussie "bond vigilantes" are following the money. The Australian bank's cash rate of 6.25% might sound high compared to other countries, but in reality, the RBA is pursuing a super-easy money policy, allowing its M3 money supply to expand at an explosive 13.7% annualized rate. (A fascinating graph of the Aussie M3 money supply and Libor rates is included in the June 8th edition of Global Money Trends).

What's most interesting about the Australian bond market is that the government barely issues enough new paper to cover maturities. Flush with cash after a string of budget surpluses, Aussie bonds outstanding are around A$60 billion, down from around A$94 billion when Prime Minister John Howard came to power in 1996. That is in sharp contrast to the United States where total public debt has ballooned by 50% since the turn of the century to reach $8.8 trillion.

Foreigners have become big buyers of Australian government bonds and hold around 75% of all marketable debt, up from just 30% in the early 1990's. So the task of the Aussie "bond vigilantes" in jacking-up Treasury bond yields is daunting, given the small supply of T-bonds outstanding, and the insatiable appetite of Asian central bankers. But a super tight jobs market, a booming economy, explosive growth of the M3 money supply, and a new round of $A67 billion in income tax cuts, gives the Aussie "bond vigilantes, plenty of ammunition to work with.

Canadian Bond Vigilantes Flex some Muscle

Canadian "bond vigilantes" have chipped away at government bond prices for the past three months, following a slew of economic data that paints a picture of a red-hot economy and higher inflation. The Canadian economy grew 3.7% in the first quarter of 2007, compared with 1.5% in the previous quarter, setting the stage for a new round of Bank of Canada rate hikes.

Canada's commodity exports are booming and the core rate of inflation is above target at 2.5% in April. "On balance, the bank judges that there is an increased risk that future inflation will persist above the 2% inflation target. And some increase in the target for the overnight rate may be required in the near term to bring inflation back to target," the Bank of Canada warned on May 29th.

Canadian bond vigilantes are grinding government paper lower, even as Ottawa pays off some of its national debt. After paying down C$13.2 billion on Canada's national debt in September 2006, the budget for 2007 further reduces the debt by C$9.2 billion, which would bring the balance down to C$472.3 billion, or 35% of GDP, a 25-year low. Canada's federal debt has fallen by C$81.4bn over the past decade.

The inflation alarm bells went off in the Canadian bond market, because the central bank miscalculated the underlying strength of the economy and permitted its M3 money supply to expand at double-digit rates in April. Canada's M3 money supply surged from 6.3% in June 2006 to a 10% growth rate in April, after the central bank made a pre-mature decision to pause its rate hike campaign at 4.25%.

(A cool graph of the Canadian M3 money supply and the Bank of Canada's overnight loan rate is presented in the June 8th edition of Global Money Trends). In order to rein-in the M3 growth rate, the BoC must narrow the interest rate gap with the US fed funds rate of 5.25%. That's lifted the Canadian dollar to 30-year highs against the US dollar, which can help shield Canada from higher import prices.

Prime Minister Stephen Harper gave a thumbs-up to a stronger Canuck buck on May 31st. "The rising Canadian dollar is a reflection of the underlying strength of the Canadian economy. Interfering with the currency's appreciation to save manufacturing jobs would be a huge mistake," Harper said. The energy and mineral based economy in western Canada, has been the driver of economic growth.

Natural resources have outperformed the weakening manufacturing sector in Ontario and Quebec, which has been hard hit by a high Canadian dollar and troubles in the lumber and paper industry. Overall, Canada's unemployment rate has not budged from 6.1%, a 33-year low, for three straight months, so with the BoC set to rekindle its tightening campaign in the weeks ahead, the Canadian "bond vigilantes" have plenty of ammunition to work with in the months ahead.

Dangerous Divergences and the Chinese "Bond Vigilantes"

It's easy to say that what goes up, must come down. But stock markets don't necessarily follow the laws of Newtonian Physics. The Russian Trading System Index stays perched in the stratosphere, with the Russian central bank inflating its money supply at a 57% annualized rate.Central banks have to make a determined effort to deflate stock market bubbles, even at the cost of a slower economy.

Explosive money supply growth, stock buybacks, and mergers and takeovers, are all linked to the super easy money policies, within the context of a larger game of competitive currency devaluations. However, the most powerful force moving global stock markets today, wasn't even mentioned in this article, but is highlighted in each weekly edition of the Global Money Trends newsletter. So far, this powerful force moving stock markets shows no signs of abating, but what are the early warning signals of a possible reversal of the market's good fortune?

In Shanghai, the Chinese "bond vigilantes" have jacked-up yields on the benchmark 5-year Treasury bond by 105 basis points over the past two months, to 3.82% today, the highest in 3-years, and including a 50 basis point surge over the past 2-days. While the mainstream media points to Beijing's tiny 0.2% tax increase on stock transactions to explain the wicked 21% correction in Shanghai red-chips, quietly, little is spoken of the Chinese "bond vigilantes," emerging from hibernation.

On May 23rd, Guru Al Greenspan said the recent boom in Chinese stocks could not last. "It is clearly unsustainable. There's going to be a dramatic contraction at some point," he correctly predicted, but did not say why. On May 31st, PBoC deputy Wu Xiaoling told a seminar on global imbalances, "In my view, every market develops in twists and turns. The Chinese stock market is growing too rapidly. We hope it can grow in a steady manner," Wu said.

At its peak, the combined market value of the two bourses in Shanghai and Shenzhen hit a record $2.5 trillion, exceeding the country's savings deposits for the first time in history. The value of shares in China surged more than six-fold in the past two years, to become the world's fifth-biggest equity market.

Policy makers were not sympathetic to the plight of over zealous red-chip bulls on June 4th. "The speed that stock prices have soared by is extremely unusual, which underscores the structural bubbles in the stock market. China's increase in stamp duty is a proper forward-looking adjustment to avoid greater systemic risks in the market and to ensure its healthy development," the state-owned China Securities Journal wrote. "The huge price fluctuations within each trading day reflect the fact that this trading is unsustainable," the Xinhua News Agency- said.

The Shanghai Stock Index tumbled 7.25% in the morning of June 5th, to as low as 3,402, after PBoC chief Zhou Xiaochuan left open the possibility of further monetary tightening. "There are many reasons for price changes, including money supply, international market movements, domestic supply and demand and so forth. The central bank will use monetary policy to cope with it," he warned.

Yet Shanghai red-chips finished the day with a furious 10% rally off the intra-day low to close 2.6% higher at 3,767-points. Bargain hunters swooped into the marketplace, after Shanghai red-chips had tumbled as much as 21% in four trading days, wiping out $450 billion of market value. Buyers spread rumors that Beijing would not introduce a capital gains tax for 3-years to stabilize the market.

There is an unshakeable belief that Beijing can move the red-chip market to its desires by remote control, thru jawboning and adjustments in the money supply. The rise in China's 5-year bond yield to 3.82% is not as threatening as it appears, when one considers that China's official inflation rate is expected to accelerate to 3.5% to 4% in the months ahead, reflecting sharply higher food prices.

However, there is a much bigger storm looming on the horizon that could overwhelm Beijing, and wreak further havoc on Chinese red-chips, its economy, and the Asian region. This gathering storm was under the spotlight in the May 25th and June 1st editions of Global Money Trends, with further updates for the June 8th edition.

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Mr Dorsch worked on the trading floor of the Chicago Mercantile Exchange for nine years as the chief Financial Futures Analyst for three clearing firms, Oppenheimer Rouse Futures Inc, GH Miller and Company, and a commodity fund at the LNS Financial Group.

As a transactional broker for Charles Schwab's Global Investment Services department, Mr Dorsch handled thousands of customer trades in 45 stock exchanges around the world, including Australia, Canada, Japan, Hong Kong, the Euro zone, London, Toronto, South Africa, Mexico, and New Zealand, and Canadian oil trusts, ADR's and Exchange Traded Funds.

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Another Inconvenient Truth - Puru Saxena

THE BIG PICTURE - Let's face it, our planet is facing an energy crisis. If nothing is done to reduce our dependence on crude oil and if the human race is unable to find a viable alternative source of energy, the 1970's oil-shocks will look like a picnic! Most people remain oblivious to the fact that the supply of oil is struggling to keep up with rising global demand. And when you factor in the reality that over 60% of the world's top oil-producing nations are already past their peak output, the picture starts to cause some alarm. Now, I am not saying that our world is going to run out of oil tomorrow. Far from it! However, the rate at which we pump this stuff out from the ground is likely to enter an irreversible decline.

When painting a rosy outlook for the world's energy situation, the governments always like to talk about the huge amounts of oil reserves supposedly present in the Middle-East. Whether these "reserves" are there at all or if they have been over-stated, is highly debatable. However, what the officials forget is that reserves are not worth much if they cannot deliver oil fast enough. For example, I may claim that I have discovered a trillion barrels of oil under my backyard, but how helpful is this reserve in solving the world's energy problem if it only produces say a hundred thousand barrels of oil per day? In a world where the global demand for oil is running at 84.5 million barrels per day and supply is extremely tight (Figure 1), rather than taking comfort from the Middle-Eastern oil-reserves, we must focus on the amount of oil that we can actually bring to the market.

Figure 1: Can supply continue to expand?

Source: Dr. Ed Yardeni

Moreover, in order to grasp the world's oil supply dynamics, it is crucial to understand that every oil-field or oil-province on the planet is governed by the laws of geology. In other words, once you have extracted more than 50% of the oil present in any given field, the rate of production peaks and thereafter enters a decline. This is what geologists refer to as "Peak Oil". Now, some would argue that this is a conspiracy, but a quick look at some historical data proves that "peak oil" is a reality; an inconvenient truth!

There can be no disputing the fact that the United States' oil production peaked in the early 1970's and today its output is roughly 50% below its record-high. In other words, despite all the amazing technology at its disposal, the world's most "developed" nation, has failed to ramp up its oil-production and now imports roughly 65% of its oil. So, if "Peak Oil" is indeed a myth or a conspiracy and if new forms of technology will surely help us find and produce an unlimited quantity of oil, why then, has the most technologically advanced nation failed in this "easy and simple" task? Simply, it does not exist.

Next, let us turn to Saudi Arabia. It is interesting to note that despite their highly- advertised reserves of 270 billion barrels, Saudi oil production has in fact fallen since 2004 and is still below the record-output achieved in 1981 (Figure 2). It is not as if the Saudis do not have an incentive to produce oil when it is trading above $60 per barrel. So, you have to wonder why the Saudi's have failed to maintain let alone increase their oil production.

Figure 2: Saudi Arabia's production in decline!

Source: Dr. Ed Yardeni

It is no secret that all of the "super-giant" oil-fields in Saudi Arabia were discovered several decades ago and are very mature. Some geologists claim that these oil-fields are now in a permanent state of decline and the national oil company (Saudi Aramco) is taking desperate measures (injecting massive quantities of water) in order to maintain the pressure in their oil-fields. If this assessment proves to be correct, we are in trouble.

Over in Mexico, the news is also ominous. It was recently announced that its largest oil-field (Cantarell) peaked in 2004 at 2.15 million barrels per day and since then 600,000 barrels of oil per day has been lost due to the inevitable "peak". Today, Cantarell (the world's second largest oil field) produces only 1.5 million barrels of oil per day; a sharp fall in a short period of time! Over the coming year or two, Mexico expects to lose another 500,000 barrels per day of oil production as Cantarell's decline accelerates.

In Asia, the picture also looks gloomy. DaQing, China's largest oil-field is also past its peak output, which means that the world's most populated nation will have to import even more oil in the future.

Declining production from existing oil-fields in different parts of the world would not have been worrisome if we were still discovering gigantic oil-fields in new frontiers. However, it is my observation that over the past 35 years, only a single gigantic oil-field has been discovered anywhere in the world (Kashagan Oil-field discovery in 2000). Furthermore, it is worth noting that due to rising costs and technological difficulties, its production will only commence in 2009 and peak output may reach 1.5 million barrels per day - a drop in the ocean.

So, the point I am making is that even if we were to discover a world-class oil-field today, the supply from that will probably not reach the market for another decade and we will need to find many oil-fields to feed the rapidly rising global demand. To complicate matters further, over the coming years, it is expected that more and more existing oil-fields will enter a decline. So, rather than adding to the global supply in any meaningful manner, additional supplies from new fields may only just about compensate for the decline in the older fields. This is a sobering thought often overlooked by many oil-analysts and economists.

In any market, it is pointless to only look at supply without examining demand, so let us review some of the trends in this area. Despite elevated prices, the global demand for oil is at a record-high. So far, "high" prices have not had any impact on curbing demand. Although demand from the industrialised nations has declined somewhat, the emerging-world, led by China and India, has continued to consume ever-larger quantities of oil. Going forwards, it is expected that roughly 500 million Asians will migrate areas to urban centres over the coming decade and this will continue to increase the demand for crude oil.

Today, the average American uses roughly 25 barrels of oil per annum, whereas the average Chinese uses a miniscule 2 barrels per annum and the average Indian burns less than a barrel per year! Some of the more developed Asian nations such as Hong Kong, South Korea and Japan consume roughly 17 barrels of oil on a per-capita basis. It is worth noting that despite extremely low per-capita consumption levels, today China and India combined, consume 11% of the world's crude oil versus 6% at the start of the decade! If current growth rates continue over the next decade, we would require an additional Saudi Arabia to fulfill this demand.

Now, my research has convinced me that there is no other Saudi Arabia waiting in the ranks to meet the rising Chinese and Indian demand. Moreover, if my assessment is correct and the global supply of oil is unable to appreciate by much from the current levels (84.5 million barrels per day), we will see a significantly higher price of crude oil. Ultimately, if nothing is done to solve this problem, we may see shortages and rationing of the world's most important natural resource.

The above is an excerpt from Money Matters, a monthly economic publication, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly reports, subscribers also benefit from timely and concise "Email Updates", which are sent out when an important development in the capital markets warrants immediate attention. Subscribe Today!

Puru Saxena
www.purusaxena.com

Puru Saxena is the editor and publisher of Money Matters, an economic and financial publication NOW available at www.purusaxena.com.

An investment adviser based in Hong Kong, he is a regular guest on CNBC, BBC, Bloomberg, NDTV Profit and writes for several newspapers and financial journals.

Copyright © 2005-2007 Puru Saxena Limited. All rights reserved