James Owers, Professor of Finance at Georgia State University, said: “The market expects that regulations will be tightened more quickly and aggressively by Obama than by McCain, which is generally bad for company profits. But then it was lax regulation that got us into this mess and Obama has some very astute economic advisers. It is a question of who can get the best balance between regulation and economic stimulation.” Hugh Johnson, founder and head of Johnson Illington, a US fund manager, thinks that a McCain victory would be better for the stock markets in the short term, but that US shares would fare better under Obama long term. He said: “Although both candidates wanted to keep taxes low, Obama wanted to increase capital gains and dividend tax and to roll back the Bush tax cuts for the highest two income brackets. So McCain’s proposals will provide a greater stimulus to the economy than Obama’s, putting upward pressure on US shares. But in the longer term, the US deficit will go up and the economy will suffer.”

Analysts say that an Obama victory had been priced into the markets in recent weeks. However, the recent share rally is down to the likelihood of a further economic stimulus package rather than the prospect of an Obama presidency, they say.

Pete Najarian, an options trader in New York, said: “Whoever has been named president-elect, the fact that the decision has finally been made will bring a huge degree of relief. The market has been in such a volatile state in the past few months and we just wanted an answer on who the new president would be. In the past week and two days, share price volatility has dropped by about half and it should fall further now.” Jeremy Siegel, of the Wharton Business School in Pennsylvania, said that shares usually perform better on the day after a Republican president is elected, as investors, who are generally conservative, celebrate but in the long run, Democrats have had better returns. Professor Siegel studied stock returns in the days surrounding US presidential elections between 1888 and 2004.

From Monday morning to Wednesday night, US stocks rose by an average of 0.7 per cent in the event of a Republican victory. They dropped by 0.5 per cent, on average, over the equivalent periods of Democrat victories.

In 1967, Yale Hirsch released data based on the previous 134 years, which determined that, on average, shares performed better in the final two years of a presidential term, a trend he attributed to manoeuvring by the party in power to increase its chances of reelection.

“As presidents and their parties get anxious about holding on to power, they begin to prime the pump in the third year, fostering bull markets, prosperity and peace,” according to a recent edition of the Stock Trader’s Almanac, the monthly newsletter set up by Mr Hirsch, which covers the financial markets.

However, with stock markets down by 30 per cent this year, it would be unwise to put too much store in the long-held theories on the stock market’s relationship with the president.

Source: http://business.timesonline.co.uk/tol/business/economics/article5084111.ece

It took a while before it became clear (or at least, accepted) that the problem was system-wide. Initially, it was smaller, local banks that got into difficulty.

The first Japanese bank failed in August 1995 (the first since the war). This was dismissed as a local difficulty because it was Hyogo Bank, a regional bank affected by the Kobe City earthquake in that year.

The blanket deposit guarantee was introduced in June 1996, but it did not prevent runs on the banks for two reasons. One was credibility. Saying the money was safe was one thing; proving it was another. Second was practicality. Imagine your bank does go bust. Even if there is no question about whether you will get your cash back, you are faced with complete uncertainty. Far better to get it out straightaway.

The specifics of every banking crisis vary by country and by cycle, but the general forces are the same. When expanding gearing gives way to contracting debt, the stage is set for a liquidity crisis.

For Japan, this occurred in 1997-98. Two large brokers and one big money-centre bank failed, followed a few months later by the nationalisation of two long-term credit banks. A similar liquidity crisis has struck the West.

It is not obvious that the process in the US and the UK has been shorter. If you define the stock-market peak as 1999-2000 and the rally since early 2003 as no more than a relief rally (analogous to Japan’s recovery from 1992 to early 1996), then the timetable is actually similar.

A liquidity crisis has a sharp impact on lending to other parts of the economy. As a result, the economy slows and the debt built up by households and businesses becomes harder to support. This gives rise to the third and final phase: a solvency crisis. Japan’s big banks reached that point about five years after the liquidity crisis.

Three kinds of adjustment are needed before stability can return. First, asset values must discount the credit- constrained world. That is already happening with a vengeance, but take care not to assume too quickly that the process is complete.

A sucker rally (or three) should be expected, to make sure that hope is extinguished before share and house prices can return to any sustainable rising trend.

The Nikkei plunged about 40% in 1990-92, rallied by about one third, then traded between 15,000 and 20,000 from 1992 to early 2000. This range included three rallies of more than 30%.

Second, the banking sector needs to write off bad debts, consolidate (a polite way of saying shrink), and rebuild its capital base. In banking terms, completing the MUFG merger in October 2005 marked the end of the crisis.

Third, the real economy must also adjust to the new credit constraints. In Japan’s case, car sales, land prices, bank lending and the household spending index have, like share prices, returned to the levels of the early 1980s.

Corporate gearing ratios are at levels not seen for 40 years. Its economy has been through a wrenching adjustment over a long time.

Could it take this long in the West? Experience has taught that we should not rule out such a possibility. You could argue that the imbalances in the West are greater and have been allowed to build for longer than in Japan. It is that build-up of imbalances which will determine the scale and duration of this adjustment period rather than the actions of politicians and regulators (who have a tendency first to deny, then to fight the last battle rather than this one).

The author heads the Société Générale Asset Management Japan Core Alpha team

Source : http://www.timesonline.co.uk/tol/money/investment/article5061770.ece

Second, liquidity conditions now may actually be worse than when the entire credit-crisis mess began to unravel this time last year. For example, the benchmark London Interbank Offered Rate (LIBOR) remains higher than so-called “policy rates” and U.S. Treasuries of comparable maturities.

This suggests that banks still don’t trust each other and therefore are keeping so-called “Interbank” borrowing rates high in order to reflect what they perceive to be the added risk of doing business. We’ve been warning investors to watch out for this since as far back as April, and have generally been preaching caution since the credit crisis began last year.

In other words, the fact that Libor-Treasury spreads are wider today than they were a year ago suggests that the banks really don’t know who continues to hold the toxic debt instruments the entire world has come to fear – despite a recent earnings parade of CEOs making claims to the contrary.

The upshot: Many institutions are hoarding cash - something you’d hardly expect to see if the credit crisis were really on the mend.

Third, judging from recent reports, it’s beginning to dawn on financial regulators that this crisis was never about a lack of liquidity in the first place, which is something I suggested in an open letter to U.S. Federal Reserve Chairman Ben S. Bernanke some time ago.

Instead, this crisis is about three things:
• Too much liquidity.
• Fundamental structural problems in the credit industry, including the almost-total lack of regulation.
• And the lack of transparency of complex financial instruments for which there is no public market, making them tough to value and nearly impossible to trade.

It is becoming clearer by the day that – partly because of these three factors – a good deal of money has been made fraudulently, if not illegally.

Granted recent changes surrounding the “mark-to-market” accounting of so-called “Level 3” assets are a step in the right direction. But what few people realize is that, in the short-term, these new requirements could involve the immediate recognition of even larger losses than we’ve seen to date.

The reason is that many of the firms involved – think Merrill Lynch & Co. Inc. (MER), Lehman Brothers Holdings Inc. (LEH) and Citigroup Inc. (C), for example – will no longer be able to hide their losses in Level 3 assets, as they have in the past.

As you might expect, there’s a counterargument to this, and it’s a highly popular one on Wall Street - especially inside the CEO set, whose members desperately want to stop the financial hemorrhaging their firms are enduring. They claim they’re “selling” risky assets and “de-leveraging” their balance sheets.

But here’s what they are not telling you.

Even though these folks are technically “selling” assets – particularly the distressed “Level 3” assets I mentioned a bit earlier – what they are really doing is assigning the upside to hedge funds, private equity firms, and sovereign wealth funds in exchange for cash.

And here’s the kicker: The banks actually are holding onto the downside liability in the event the underlying securities go bad. That brings us back to the start of this commentary, when I said that I expect more securities to go bad.

No matter how you look at it, these financial institutions are playing a vicious shell game, hoping all the while that they’re not the loser who is taken to the cleaners when he picks up the wrong shell.

Where this goes from bad to worse is that at the same time they’re playing more fancy accounting tricks, these firms continue to pony up to the Fed’s private backdoor lending window for sweetheart financing. After all, they can’t get the financing anywhere else.

That means that every taxpayer in this country is involuntarily being put in the bailout business. As for whether or not we’re near the end of the credit crisis as a whole, it depends on whom you ask.

When this crisis started a year ago, I was asked a similar question and answered it by saying that we would not even begin to approach the end of the line until the total losses exceeded $1 trillion.

My audience chuckled politely.

Fast-forward 12 months, and nobody’s laughing anymore – especially when I say that I’m now raising my industry loss estimate to nearly $2 trillion.
Increasingly, other analysts are embracing a similar viewpoint. UBS AG (UBS) raised it’s estimate of the total cost of the credit crisis to $600 billion, while noted hedge fund manager John Paulson suggested $1.3 trillion is not unthinkable.

Meanwhile, in a report issued last May, the International
Monetary Fund (IMF) projected the bailout costs at $1 trillion.
All of this leads us to a single conclusion: At least for now, this is a “recovery” in name only.

[Editor’s Note: The “Super Crash” isn’t coming… it’s already here. Combined, the swirling forces of inflation, the credit crunch, exploding trade deficit, stagnate economy will cost the average American $85,000 dollars over the next 6 to 18 months. But over 50,000 investors are already using Peter Schiff’s unique strategy for profiting from the “Super Crash.” And now – for
the first time – you’ll be able to join them for free.]

Copyright 2008–present,Monument Street Publishing, LLC 105W.Monument St., Baltimore,MD 21201
All rights reserved. No part of this report may be reproduced or placed on any electronic medium without written permission from the
publisher. Information contained herein is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed.

"The pace of economic activity has slowed markedly in recent months," the
Fed said "Moreover, the intensification of financial market turmoil is likely to
exert additional restraint on spending, partly by further reducing the ability
of households and businesses to obtain credit."

Although inflation has been high, the Fed believes that the recent drop in
energy prices and the weaker prospects for economic activity have reduced this
threat to the economy.

In Europe, which also has been hard hit by the financial crisis, the Bank of
England cut its rate by half a point to 4.5 percent, while the European Central
Bank sliced its rate to 3.75 percent.

In addition, the Fed reduced its emergency lending rate to banks by half a
percentage point to 1.75 percent. Given the intense credit crisis, banks have
been ramping up their borrowing from the Fed's emergency "discount" window.

In response, the prime lending rate for millions of borrowers will drop by a
corresponding amount. The prime rate applies to certain credit cards, home
equity lines of credit and other loans.

The hope was to spur nervous consumers and businesses to spend more freely
again. They clamped down as housing, credit and financial problems intensified
last month, throwing Wall Street into chaos. Many believe the country is on the
brink of, or already in, its first recession since 2001.

The Fed's last rate cut was in late April, capping one of the most
aggressive rate-cutting campaigns in decades as it scrambled to shore up the
faltering economy. After that, the Fed moved to the sidelines, holding rates
steady as zooming food and energy prices during that period threatened to ignite
inflation. In the past few months, energy prices have retreated from record
highs reached in mid-July, giving the Fed more leeway to drop rates again.

At its last meeting in September, the Fed struck a more dire tone about the
economy, hinting that a rate reduction once again could be in the offing.

Even with the unprecedented $700 billion financial bailout quickly signed
into law by President Bush on Friday, the failing economy and the jobs market
probably will get worse. Many believe the economy will jolt into reverse later
this year -- if it hasn't already-- and will stay sickly well into next year.

One of the most crucial pillars of the economy -- the jobs market -- has
cracked, and wage growth is slowing. This means that consumers will be even more
hard-pressed to spend in the fashion that helps grow the economy.

Increasingly skittish employers slashed payrolls by 159,000 in September,
the most in more than five years. A staggering 760,000 jobs have disappeared so
far this year. The unemployment rate is 6.1 percent, up sharply from 4.7 percent
a year ago.

The unemployment rate could hit 7 or 7.5 percent by late 2009. If that
happens, it would mark the highest rate of joblessness since the months
immediately following the 1990-91 recession. Some economists say the jobless
rate could rise even more before the situation starts to get better.

Mounting job losses, shrinking paychecks, shriveling nest eggs and rising
foreclosures all have weighed heavily on American voters. The economy is their
No. 1 concern, polls have shown.

Spooked consumers and businesses have pulled back so much that some analysts
fear the economy stalled -- or even worse, shrank -- in the July-to-September
quarter. Many predict the economy will contract in both the final quarter of
this year and the first quarter of next year, meeting the classic definition of
a recession.

The financial crisis that intensified in September is forcing a seismic
shake-up on Wall Street.

Lehman Brothers, the country's fourth-largest investment bank, filed for
bankruptcy protection. A weakened Merrill Lynch, deciding it couldn't go it
alone anymore, found help in the arms of Bank of America. American International
International Group was thrown a financial lifeline. And, the last two
investment houses -- Goldman Sachs and Morgan Stanley -- decided to convert
themselves into commercial banks to better weather the financial storm. The
number of banks that have failed this year are up sharply from last year. On
Friday, Wachovia Corp. said it will be acquired by Wells Fargo & Co. wiping out
Wachovia's previous plan to sell its banking operations to rival suitor
Citigroup Inc.

The dollar fell against 14 of the world's most-traded currencies on Sept. 19, including the euro, as Paulson unveiled the plan, while the Standard & Poor's 500 Index rose 4 percent. The plan may end the rally that began in June and drove the U.S. currency up 10 percent versus the euro, 2 percent against the yen and almost 13 percent compared with Brazil's real, strategists said.

Paulson's plan, sent to Congress Sept. 20, would mark an unprecedented government intrusion into markets and increase the nation's debt ceiling by 6.6 percent to $11.315 trillion. Officials may also start a $400 billion Federal Deposit Insurance Corp. pool to insure investors in money-market funds.

Dollar `Downdraft'

``The downdraft on the dollar from the hit to the balance sheet of the U.S. government will dwarf the short-term gains from solving the banking crisis,'' said David Woo, London-based global head of foreign-exchange strategy at Barclays, the third- biggest currency trader, according to a 2008 survey by Euromoney Institutional Investor Plc.

Paulson and Federal Reserve Chairman Ben S. Bernanke began plotting the rescue last week after New York-based Lehman Brothers Holdings Inc. filed for bankruptcy, the government seized control of American International Group Inc. and Merrill Lynch & Co. was forced into the arms of Charlotte, North Carolina-based Bank of America Corp.

Morgan Stanley dropped as much as 44 percent Sept. 17, the biggest one-day decline in its history, and Goldman Sachs Group Inc., where Paulson was chief executive officer from 1998 to 2006, lost 26 percent. Both are based in New York.

Dollar Hegemony

The dollar fell 2.5 percent to $1.4831 per euro as of 4:05 p.m. in New York, after dropping 1.7 percent in the week to Sept. 19. It slid 2.1 percent to 105.24 yen, extending last week's 0.5 percent decline.

In the four days following Lehman's bankruptcy, the ICE future exchange's Dollar Index, which measures the currency's performance against the U.S.'s six biggest trading partners, dropped 1.2 percent. It fell 2 percent today, leaving it little changed this year.

``After years of doubting the hegemonic status of the dollar, this proves it's still there,'' said Stephen Jen, London-based head of research at Morgan Stanley. ``But of course this situation is definitely not stable. The capital leaving the emerging markets is only going into the dollar and that's a powerful force. It's a very uncomfortable balance.''

By the end of the year, the euro will weaken to $1.43 and the yen will trade at 108 to the dollar, according to analyst surveys by Bloomberg. The dollar will depreciate to 1.65 against the real, compared with 1.83 on Sept. 19.

Growth, Deficits

Although the dollar may suffer short-term, at least one analyst says the U.S. government's planned rescue will strengthen the currency before long. Paulson's proposals will return foreign-exchange markets to the trend of the past months, according to Adam Boyton, senior currency strategist at Frankfurt-based Deutsche Bank AG, the world's biggest currency- trading bank. Since the end of June, the Dollar Index has gained 5 percent.

``It's a positive plan that's ultimately good for the dollar,'' said New York-based Boyton. ``It reduces risk and volatility and gets the focus back on macroeconomic fundamentals, which suggest weakness throughout the rest of the globe next year, with returning strength in the U.S.''

The U.S. economy may expand 1.5 percent next year, according to the median estimate of 80 analysts surveyed by Bloomberg. That compares with 1.1 percent for the euro-region and 1.15 percent for Japan, the world's second-largest economy.

`Huge New Supply'

The rescue comes as the U.S. budget deficit and the current-account balance, the broadest measure of trade, grow. The Congressional Budget Office projects the spending shortfall will increase to $438 billion next year from $407 billion. The current account deficit is up from $167.24 billion in December.

``Investors may start to worry about the amount of debt the U.S. is taking on and its impact on the dollar,'' said Geoffrey Yu, a currency strategist in London at UBS AG, the second- largest foreign-exchange trader. ``The fact that they mentioned taxpayer money implies that they're going to issue debt. If there's going to be a huge new supply of Treasuries, this will be dollar negative. It's too much for the dollar to take.''

Traders are also concerned the bank bailout will spread to other U.S. industries suffering from the credit crunch that's holding back an economy growing at its slowest pace since 2001. Detroit-based General Motors Corp., the world's biggest automaker, said last week it will tap the remaining $3.5 billion of a $4.5 billion credit line to pay for restructuring costs.

`Damaged' Currencies

Lower interest rates may also weigh on the dollar. Futures on the Chicago Board of Trade show there's a 45 percent chance policy makers will lower their target rate for overnight lending between banks to at least 1.75 percent by January from 2 percent currently. A month ago, they showed a 50 percent chance of an increase to 2.25 percent.

Rates in the U.S. are already the lowest of any Group of 10 industrialized nations except Japan, where they are 0.5 percent. The European Central Bank's benchmark is 4.25 percent.

Another drawback for the dollar is that the Fed's key rate is 3.4 percentage points less than the rate of inflation, the most since 1980, so investors lose money by investing in short- term U.S. fixed-income assets.

``People thought that the Fed was done cutting,'' said Andrew Balls, an executive vice president and member of the investment committee of Newport, California-based Pacific Investment Management Co., which oversees almost $830 billion. ``In the longer term the diversification away from the dollar will remain intact. The U.S. hasn't done itself any favors in making its assets attractive to foreign investors.''

Brazil, Australia

The biggest beneficiaries may be Brazil's real and Australia's dollar, as demand for higher-yielding assets rebounds, according to Goldman Sachs. The two currencies, the biggest losers versus the dollar since July, may rebound 7.7 percent and 4.6 percent, respectively, in the next two weeks, Goldman Sachs forecasts.

``The currencies that have been damaged the most have the best growth,'' said Jens Nordvig, a strategist with Goldman Sachs in New York. ``You're going to see a lot of flows back into these currencies now.''

To contact the reporters on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net; Anchalee Worrachate in London at aworrachate@bloomberg.net
Last Updated: September 22, 2008 16:09 EDT

What Happened In The Last Month?



The chart below shows it may be a mistake to assume the move in the dollar will not last very long. Like all the charts we present, the purpose is not to predict or forecast, but to understand possible realistic scenarios which could play out.



Secular and Cyclical Trends

The long-term story for a weak dollar remains intact. The long-term story for strength in commodities remains intact. These stories (or fundamentals) apply to a period that could last almost twenty years and are referred to as secular stories or trends. Based on history, it is important to understand that counter-trends or cyclical retracements of secular trends can be of significant magnitude and duration. More importantly, they can destroy principal even when you have correctly identified the long-term fundamentals. The chart below of gold prices from 1973 through 1981 illustrates the point. Even if you have the story right, are you willing and emotionally able to suffer a 48% loss in a core position?



The chart of the NASDAQ (below) illustrates our task, which is to balance the desire to stay with a secular trend with the need to protect against large and hard to recover from losses.



What Could Be The Motivation To Want A Stronger Dollar?

While complex financial markets never have singular and simple cause and effect relationships, we can identify a few of the major contributors to the significant shifts which have occurred in the last month. When examining the related movements between the dollar and commodities, the classic chicken and egg question always comes into play. Of the many possible reasons to set an orchestrated dollar move in motion are:

* A weak dollar has contributed to global inflation which cannot easily be addressed by central banks raising interest rates in the face of slowing economies and a credit crisis.
* European exports have been seriously negatively impacted by the weak dollar/strong euro.
* Additional evidence of European economic weakness has surfaced in recent weeks.
* The same issues, exports and economic weakness, also apply to the emerging market economies.





The major drawback for the U.S. is the weak dollar has helped fuel a significant increase in exports. The surge in exports has propped up America’s GDP in recent quarters. From the Saturday, August 16, 2008 edition of The Wall Street Journal:

"A stronger dollar, if sustained over a longer term, could put the U.S. economy on shakier ground by raising the cost of exports. Without the improving U.S. trade position, the U.S. economy would have contracted in the second quarter. Exports grew at a robust 9% annual rate during the quarter, helped along by the cumulative effects of the dollar's weakening in recent years."

When Fundamentals and Technicals Fail to Align

My read-between-the-lines of the current economic environment includes:

* The Fed’s attempt to prop up the economy by lowering interest rates has not and is not working, which is no secret to anyone.
* The availability of credit is contracting which is exactly what the Fed was trying to avoid by lowering rates.
* Stock markets around the globe are not anticipating a significant recovery anytime soon.
* Banks still have serious problems with continued deterioration of their balance sheets caused primarily by falling home prices, which have no rationale hope for finding a permanent bottom anytime soon.
* The recent slide in commodity prices underscores the contraction of credit, housing outlook, and anticipated future economic weakness. This is not good for stocks.
* At least for the time being, financial markets are placing economic weakness and the possibility of deflation ahead of any concerns about possible future inflation.
* All asset prices, including commodities, are on the ropes.
* Based on the evidence we have today, a rapid reversal in the U.S. stock market is possible between current levels and 1,365 on the S&P 500 (now at 1,298).
* A possible, but much less probable, outcome is for stocks to respond positively, in a rapid upside move, to falling commodity prices and break through 1,365. The basis for this scenario is that capital is flowing out of commodities and could rush into stocks if managers feel they are being left behind. The move could take the form of an upside "blow off" where the panic buying is quickly replaced with panic selling.

The concepts above appear to be supported by recent disconnects between some fundamental and technical elements in both commodities and stock markets.







Stocks Remain in Downtrend



At Some Point Nothing Else Matters Except Protecting Principal

When asked their secrets of success, money managers who consistently have been top performers almost without exception state the importance of "cutting losses and letting winners run." Similarly, when the best professional managers are asked to name common mistakes made by individual investors, they typically put the failure to cut losses at the top of the list. The cruel reality of the markets is when you lose 30% you need to make more than 30% to get back to break even. As the chart below shows, if you lose 30%, you need to make 43% to get back to break even. The two boxed rows show the danger of “staying the course” while bear markets destroy your hard earned principal. If you "rode out" the 2000-2002 bear market in the S&P 500 Index, your losses from peak to trough would have been roughly 45%. To get back to break even, you would have needed to earn an 82% return from the bottom which was made in October of 2002. When losses begin to pile up, at some point you have to put both the fundamentals and charts on the back burner and focus on preserving principal in order to have the opportunity to fight another day.



The previous statements and charts are not meant to be forecasts, but simply an assessment of current risk/reward profiles and probabilities as we see them. If the odds shift to more favorable or alternate outcomes, we are keeping an open mind and will gladly adjust our thinking as new evidence unfolds.

Chris Ciovacco
Ciovacco Capital Management

Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com

Despite the high prevailing prices, demand in 2008 is expected to total 86.9 million barrels compared to 85.96 mb/d in 2007. For 2009, global oil demand is expected to reach 87.7 mb/d.



Anemic economic growth in the US, particularly in energy intensive areas such as construction and auto manufacturing, along with consumer resistance to high gasoline prices, is expected to cut into demand on an absolute basis with US disappearance expected to total 20.2 mb/d. The decline is likely to persist into 2009, with forecasted demand expected to total 19.8 mb. European demand given the significantly lower base along with the high retail prices will likely stagnate at 15.1 mb/d.

Due to the forecast for an absolute decline from the US and Europe, growth in demand will be reliant upon emerging market economies. In China, the domestic economy is beginning to show strains from high inflation which is encouraging an increasingly proactive role on the part of the government to moderate capital investment and likewise demand in order to control inflationary pressures. In India, fears have been apparent over the high cost of subsidizing domestic consumption of oil products. Subsequently, demand if anything might fall short of expectations as governments restrain growth through more rational pricing policies that do not strain national budgets. Subsequently, forecasts suggesting growth in Chinese demand in 2009 to 8.42 mb/d from 7.96 in 2008 might be overly optimistic. For non-OECD areas, demand is expected to reach 39.71 mb/d, an increase of 1.4 mb/d over forecasts for 2008. However, any shortfall in Chinese demand might hold out the potential for non-OECD demand falling short of forecast.

Supply Increases Enough?




Just as demand has responded to the higher prices, global crude oil supply availability has also started to expand. Although concerns remain over the depletion of existing fields in the US, North Sea and Mexico, high prices have encouraged an expansion in supplies from areas in Brazil, Saudi Arabia, Iraq and Nigeria. In addition, aggressive biofuel and LNG programs are beginning to have an impact. Only with higher prices could the gains in substitute programs and deep sea drilling have been achieved. The belief that the high price environment is finally becoming ingrained in assessing the potential profitability of projects is helping encourage investment, particularly in Brazil and the Gulf of Mexico. The high prices have also raised the pain threshold by which the costs, including environmental impact associated with drilling on the Continental shelf, are being reassessed.

Despite the favorable price environment, the gains on the production side are still not spectacular; yet appear to be enough for now to provide the basis for a balance tending toward surplus supply/demand situation. Led by steady gains in emerging markets and stabilization in developed areas, demand will eventually resume an upward growth path. The ability of supplies to keep up with these gains will be a key variable to the future price environment surrounding crude oil and the structure of its forward curve.

For 2009, global oil supplies including biofuels, natural gas liquids and condensate are expected on a preliminary basis to total 87.8 mb/d compared to 87.3 mb/d forecast for 2008. OECD supplies are expected to fall to 19.3 mb/d compared to 19.5 mb/d in 2007. European supplies are projected to fall the sharpest, reaching only 4.2 mb/d in 2009 compared to 4.5 mb/d in 2008. North American supplies will actually show an increase as production from the Canadian tar sands and higher US output attributed to further increases of ethanol supplies and expansion in production in the Gulf of Mexico more than offset declines in Mexico due to lower production from the Cantarell field.

In non-OECD areas, supplies are projected to increase by .5 mb/d to 28.5 mb/d. Major concerns are linked to the Russians, where abrupt policy changes and a punitive tax regime is discouraging investment. With uncertainty associated with the government support of joint ventures, foreign investment in new projects is likely to lag. A bright spot remains Brazil, but even there deepwater development will demand patience and substantial capital. In Asia, supplies are showing increases as the demand for energy remains buoyant and absorbs what increases might be attained in Vietnam, China and Thailand.

OPEC production levels led by Iraq and Saudi Arabia have continued to expand. Recently, OPEC production reached 32.4 mb/d. This is as much as 1.8 mb/d above year ago levels. Concerns had recently been expressed that due to dwindling spare capacity, OPEC had lost their pricing power. However, given recent declines it looks like the Saudis once again hold sway over the market. Currently they appear to have a desire for a stable price environment which will not threaten demand. What the breaking point might be on both the downside and upside remains to be seen but Saudi statements have tended to foreshadow any change in policy and will have to be watched closely. For 2009, it looks like sustainable capacity will likely expand by upwards of 1 mb/d. However, OPEC remains wary of committing further capital into new and expensive production until the depth of the recent economic slowdown and impact of renewables can be more accurately gauged. A move back below the 100.00 area could encourage calls by more radical OPEC members such as Venezuela and Iran to reign in production.



Conclusion




A surplus supply situation is likely as we move into 2009 based upon current supply/demand trends. Demand prospects will not only be influenced by apparent off take linked to economic activity but also by speculative involvement which will continue to be driven by the dollar and inflationary trends. Efforts to thwart institutional involvement will continue to be a potential weight on the market. On the supply side, Saudi Arabia will likely come under increasing pressure to cut production if prices break back near the 95.00 area particularly if the statistical balance has moved into surplus. Inventory levels, which have been slow to reflect a build in OECD countries, will need to be monitored closely. An increase in inventory levels would not only put pressure on prices but also provide validation to OPEC that supply availability has overtaken demand. The rebuilding in inventories could provide the basis for values falling back toward the 94.00 level, similar to what occurred in July of 2006 when values reached a high of 78.40 before falling back to a low of 50.00 basis the active contract. A key reflection point looks to be near the 110 level basis the nearby contract. Eventually OPEC looks like it will need to intervene and cut production to move supply/demand back into better balance.

Longer term, we see the potential for values to move higher as emerging markets try to satisfy a growing need for energy and production lags. Nevertheless, it will take time to shake off the economic malaise in the developed countries and rebuild demand growth in emerging markets.

Questions or comments about this article, please contact Steve Platt at 1.877.377.7931

The information and comments contained herein are provided as general commentary of market conditions and are not and should not be interpreted as trading advice or recommendation. The information and comments contained herein are not and should not be interpreted to be predictive of any future market event or condition. The information and comments contained herein is provided by ADM Investor Services, Inc. and not Archer Daniels Midland Company. Copyright © ADM Investor Services, Inc.

All Charts Courtesy of DTN.


About the Author


After graduating from Georgetown University in Washington, D.C., Steve Platt joined an economic consulting firm focused on agricultural policy and research. In 1979, he relocated to Chicago and worked for two major brokerage houses as Senior Analyst and Research Director, servicing the needs of both institutional and retail clients. In 1998, Steve set up and was given operational control of a trading desk at Morgan Stanley, DW Inc. specializing in precious metals, foreign exchange, and futures. The desk also serviced specialized spec and hedge futures accounts trading in U.S. and International markets. Over the years, Steve has been quoted in major financial publications and seen on a variety of financial news programs discussing market fundamentals. Steve can be reached at (877) 377-7931.

Source: FutureSource.com

Prestowitz is not a doomsayer, neither is he alone in his views. As president of the Economic Strategy Institute, a Washington think tank, he is in regular contact with the most influential US business leaders, several of whom -- Warren Buffet and George Soros included -- have taken steps to hedge their currency positions against the possibility of a cataclysmic plunge in the greenback.

"Right now," he says, "we have a situation in which the US is running huge trade deficits -- about $US650 billion ($766 billion) in 2004 -- which are financed by borrowings from the central banks of Asia -- mainly the Chinese and the Japanese. All the world's central banks are chock-full of US dollars -- they're holding many more dollars than they really want. They're holding those dollars because at the moment there's no great alternative and also because the global economy depends on US consumption. If they dump the dollar and the dollar collapses, then the whole global economy is in trouble.

"However, some countries have a bigger stake than others in maintaining the status quo. China and Japan have a big stake in maintaining the flow of their exports to the US and keeping the US economy humming. Russia, on the other hand, does not export much to the US. India doesn't export much to the US. Yet Russia and India are also big dollar-holders. They hold many more dollars than they really want or need.

"It doesn't take any great stretch of the imagination to see what could happen if one of these central bank managers decides to dump dollars. We had a situation recently when a mid-level official at the Central Bank of Korea used the word 'diversification'. It was a throwaway remark at some obscure lunch, but there was instantaneous overreaction. The US stock market fell by 100 points in 15 minutes because the implication was that South Korea might be shifting out of US dollars.

"So picture this: you have a quiet day in the market and maybe some smart MBA at the Central Bank of Chile or someplace looks at his portfolio and says, 'I got too many dollars here. I'm gonna dump $10 billion'. So he dumps his dollars and suddenly the market thinks, 'My god, this is it!' Of course, the first guy out is OK, but you sure as hell can't afford to be the last guy out.

"You would then see an immediate cascade effect -- a world financial panic on a scale that would dwarf the Great Depression of the 1930s."

Prestowitz says the panic could be started by something as simple as a hedge-fund miscalculation.

"We had exactly that scenario in the US recently," he points out, "when a big hedge fund called Long Term Capital Management went belly-up. These guys were pros. They had two Nobel prize-winning economists writing their trading algorithms, and their traders were the creme de la creme among New York bond traders.

"They made a big bet -- a trillion dollars leveraged 20 to one, and they blew it. They went belly-up. That threatened to bring down the whole system so US Federal Reserve chairman Alan Greenspan had to organise a bail-out through the Federal Reserve Bank of New York.

"Now consider this: there are currently 8000 hedge funds in the US alone. Every day $6 trillion of derivative instruments trade on international markets. If there are four people in the world who understand those trades, I'd be surprised. So the potential for another disaster is not insignificant. This is why Warren Buffet, chairman of investment giant Berkshire Hathaway, is betting $US21 billion against the dollar. This is why currency speculator and hedge fund manager George Soros has also made a big bet against the dollar.

"Soros is one of the greatest currency speculators of all time. He was the guy who broke the British pound in the early 1990s by betting $US10 billion it would fall. He made a quick billion when it did. In 2002, he warned that the greenback was in danger of losing a third of its value. Of course, it could be argued that Soros is a professional hedge fund manager whose job is to play the ups and downs of currencies and his remarks could be seen more as manipulation than prophecy. And yet, in conversations with me, Soros has expressed concern about the market fundamentalist view that prevails in Washington and parts of Wall Street.

"This is the belief that markets are self-correcting and best left alone. Soros calls this a dangerous siren song. Far from being self-correcting, he emphasises, markets tend to excess. They over-shoot. Anyone with any experience of markets knows this.

"When markets are going down, all the weaknesses get concentrated, and you need intervention at the right time to stop things from getting out of control. If the dollar started to melt down, the results could be really nasty. A 1930s-style global depression is not out of the question."

To underscore the point that he is not alone in this, Prestowitz cites Paul Volcker, head of the Federal Reserve before Greenspan, who has said publicly there is a 75 per cent chance of a dollar crash in the next five years.

"No wonder people look at this and say, 'Holy cow!'," he says. "No one knows for sure what will happen, but clearly the global markets could implode very quickly. The lack of an alternative to the dollar is the only reason it hasn't taken a big fall already."

Prestowitz, formerly a trade adviser and negotiator for former US president Ronald Reagan, believes the US will continue to be the world's most powerful economy for the foreseeable future. But he foreshadows an inexorable decline, a trend that is likely to continue "depending on the way we play our cards".

"Right now, we're playing them just about as badly as it's possible to play them, and that has geo-political implications." he says. "We've outsourced trying to deal with North Korea to China, we really can't deal with Iran, so we've outsourced that to the EU, which is struggling, and Iran is cozying up to China. Other bad actors like Zimbabwe's Robert Mugabe and Sudan are cozying up to China.

"America's global hegemony is already under challenge, and that challenge is going to become more and more evident as the extent of the relative US economic decline becomes evident. Right now, the US dollar is probably 40 per cent overvalued versus the Japanese yen or the Chinese renminbi. How's the US going to look as a global power when the dollar is at 50 per cent of its current value?"

Source: http://www.theaustralian.news.com.au/story/0,20867,16416680-28737,00.html

Given the strong price correlations between the two commodities, many economic commentators wrote of the gold/oil relationship in terms of a 15/1 ounce/barrel ratio. As the late Warren Brookes wrote in his 1982 book, The Economy In Mind, “In 1970 an ounce of gold ($35) would buy 15 barrels OPEC oil ($2.30/bbl). In May 1981 an ounce of gold ($480) still bought 15 barrels of Saudi oil ($32/bbl).

More modernly, in March of 1999 The Economist predicted $5/bbl oil in the future because “the world is awash with the stuff, and it is likely to remain so.” Instead, with the gold/oil ratio of roughly 25/1 historically out of whack, crude proceeded to rally beyond the 15/1 ratio; reaching $24/bbl by September of 2001.

Since 2001, gold has rallied powerfully owing to the dollar’s debasement over the same period. Unsurprisingly, oil has skyrocketed too. With many commentators on both sides of the political spectrum unfamiliar with the relationship between the dollar, gold and oil, apocalyptic notions of shortages and “limits to growth” have revealed themselves much as they did in the ‘70s.

More realistically, the oil “shocks” of this decade were rooted in dollar shocks that were bound to make oil dear in dollar terms. As of last month, oil since 2001 had risen over 380 percent in dollars versus 160 percent in euros. Though the numbers were different in the late ‘70s, this was not unlike oil’s 43 percent rise in dollars from 1975 to 1979; a “shock” that did not register in deutschemarks, yen and Swiss francs where oil rose 1 and 7 percent in deutschemarks and yen, versus a 7 percent fall in francs.

Last month, gold rose at one point to nearly $1,000/ounce, and oil hit an all-time high of $147/barrel. Since then, oil has fallen roughly 23 percent against a 17 percent drop in gold. So as is always the case, a large reason for oil’s current weakness has to do with a dollar that presently buys 1/827th of an ounce of gold, as opposed to nearly 1/1000th a month ago.

Still, oil has fallen further, and while rumblings of greater supply reaching the market due to presumption of liberalized drilling rules might explain some of the disparity, another realistic explanation lies in the aforementioned gold/oil ratio. As of last month, the ratio was roughly 6.8/1, so if history is any kind of indicator, oil was and is due for an even greater fall versus gold given the longstanding relationship between crude and the yellow metal. Looking ahead, no matter the direction of gold, oil has room for further weakness given a ratio that as of this writing is roughly 7.3/1.

What explains the dollar strength that has revealed itself in lower commodity prices? To some degree we can tie it to the coupled world economy that had never “decoupled” in the way so many pundits suggested. Simply put, dollar debasement regularly leads to world currency debasement, and with economies around the world struggling under the inflation that bats 1.000 when it comes to economic uncertainty, the severely weakened dollar has perhaps paradoxically been seen by investors as a safe haven in these treacherous times.

More interestingly, polls and market-based measures of political outcomes such as Tradesports.com point to a Barack Obama victory in November. Whatever his many policy faults, Obama recently met with strong-dollar advisors Paul Volcker and Robert Rubin, and not long after told a gathering of potential voters in Ohio that a strong dollar would help reduce the cost of fuel.

Obama’s new position dovetails nicely with a recent Forbes.com interview of McCain advisor, Douglas Holtz-Eakin. Holtz-Eakin talked up the value of a strong dollar, and this is very important for putting the dollar in play as a campaign issue. Looking past November, the markets are perhaps pricing in better dollar policy ahead, regardless of the winner of the presidential contest.

It’s also notable that Treasury Secretary Henry Paulson a few weeks back termed a strong dollar “very important.” The latter is a not insignificant improvement over his “the strong dollar is in our nation’s interest” comments that the markets understandably did not take seriously. Investors of course ignored Paulson’s boilerplate statements given the Bush administration’s anti-dollar stance that has revealed itself through a true policy of "benign" dollar neglect, tariffs on steel, lumber and shrimp, not to mention frequent jawboning of China over the value of the yuan.

If the long neglected dollar’s collapse is permanently reversed, look for lower commodity prices across the board. And while many commentators will say this is evidence of a weakening world economy, don’t be fooled.

Since 1971, all commodity “shocks” have been dollar shocks; the dollar’s debasement real inflation that has revealed itself through more expensive commodities and a weaker economic/investment outlook. Conversely, commodity weakness has regularly resulted from dollar strength that enhances the value of the money we earn, all the while leading to greater investment for inflation not destroying the returns gained from that same investment.

Put simply, the nascent bear market for commodities is a bullish economic turn for it signaling a resumption of dollar strength. If commodities continue to fall, this will be more evidence of better dollar policy that will occur alongside rising equity prices and a more economically confident electorate.

John Tamny is editor of RealClearMarkets, a senior economist with H.C. Wainwright Economics, and a senior economic advisor to Toreador Research and Trading. He can be reached at jtamny@realclearmarkets.com.

Currency traders consulted by Forbes.com said the slide in the dollar on Monday morning was a short-term correction to its recent rally, sparked by a rise in oil prices. Nomura analyst Peter Scullion said there was still a strong chance of the greenback continuing to build strength against the euro between now and the beginning of next year. "Some of the biggest macro funds will now be looking to establish long-dollar positions," he said. "We're going to see small periods like this where commodities and the oil price is a determinant factor on short-term moves on the dollar."

Crude oil rose for the first time in three days as a storm near Cuba prompted evacuations from rigs and platforms in the Gulf of Mexico, which account for about a fifth of U.S. production. Crude futures were up 68 cents, at $114.46, on Monday morning on the New York Mercantile Exchange, from $115.14 late Friday in New York. Copper for three-month delivery also jumped $80, to $7,440, on the London Metal Exchange on Monday morning.

Underpinning the dollar's recent rally have been growing concerns about the global economy. Last week, a spate of gross domestic product data showed that the economies of Germany and France had contracted in the second quarter. And on Sunday, the British Chamber of Commerce said there was a "distinct possibility" of the United Kingdom facing recession in the next six to nine months. (See "Recession Knocks On Europe's Door.") "With the latest indicators out of the United States, people are looking at signs of bottoming, whereas in Europe, it's just beginning its fall," said Scullion.

The iPath EUR/USD Exchange Rate (nyse: ERO - news - people ) exchange-traded fund, which provides exposure to the euro/U.S. dollar exchange rate, closed down 1.0%, or 56 cents, at $56.37, on the NYSE on Friday. It has fallen 7.2%, or $4.40, in the past month.

Source : www.Forbes.com

The plunge mirrors a similarly steep drop in August last year. Unlike last year, however, this fall has not been driven by Japanese investors dumping the currency, the chief currency strategist at Westpac, Robert Rennie, said.

Small Japanese investors have developed a lucrative line speculating on foreign exchange. A favourite trade is to borrow in Japan, where interest rates are low, and invest in Australia and New Zealand, where rates - and returns - are relatively high.

Mr Rennie said he was "very concerned" a speculative bubble was emerging, with Japanese retail investors rapidly increasing their total stake in the two currencies to $US30 billion.

"This is not long-term investment. This is short-term speculation, and the numbers that we are talking about are very significant," he said.

If Japanese investors do start to dump the Australian dollar it could head even lower. But Mr Rennie said the dollar would find plenty of support if it dropped too low.

The head of foreign exchange strategy at the Tokyo branch of the Royal Bank of Scotland, Masafumi Yamamoto, agreed the Australian dollar was unlikely to fall too far. But it would come under pressure if commodity prices continued to fall.

In recent weeks, global crude oil prices have fallen 20 per cent since record highs above $US147 a barrel. Base metal prices are also at six-month lows, driven by fears Asian demand is cooling.

A senior currency strategist at the ANZ Bank, Tony Morriss, said a key trade on currency and commodity markets in the past year was to bet on rising commodity prices and a falling US dollar.

"Both of those positions would have paid handsomely, but that's clearly being unwound," he said.

Mr Morriss said the severity of the recent changes suggested a fundamental shift in market views, rather than a brief correction. "The speed of the move that we've seen in recent weeks … would suggest that we are at a turning point.

"All the things that were very supportive previously [for the Australian dollar] have turned out to be eroded."

Stagflation

Remember "That '70s Show"? We could be in for a rerun. Oil and other commodity prices rise relentlessly, spurring runaway inflation not seen since the 1970s. All the while, growth stays weak, a double dose of misery that crushes corporate profits and stock-market returns. There's a word for this: stagflation.

Fortunately, the odds of this history repeating itself are slim. Inflation readings are nowhere near as high as they were in the 1970s and early 1980s, when the year-over-year percent change in the consumer price index soared as high as 14.8% at one point; it was up 5% in June.

And a key driver of that era's hyperinflation is missing: In those days, strong labor unions were able to wrest wage increases at every tremor of the inflation rate. Companies passed their higher labor and energy costs to consumers in the form of higher prices, which encouraged still more wage increases, in a grim dance economists call a "wage-price spiral."

Today workers have much less bargaining power, and wages haven't kept up with inflation. That hurts consumers and the economy, but it will at least keep inflation in check.

One wild card: If the U.S. dollar continues to weaken, then that could keep inflation going despite the lack of a wage-price spiral. "This would be checkmate for the U.S. economy, turning a relatively mild recession into a severe one," Paul Kasriel, chief economist at Northern Trust, told clients recently.

Odds: 20 to 1 against.

'Lost Decade'

One word -- Japan. If stagflation is the world ending in fire, then this scenario is Apocalypse by ice. Some observers worry the U.S. is following a path Japan blazed in the 1980s and 1990s. Like the U.S., Japan had stock and real-estate bubbles fueled by easy credit.

The aftermath for Japan was a "lost decade" for its economy and stock market, an especially terrifying time for policy makers because there seemed to be little they could do to fix it. Low interest rates were useless because nobody wanted to borrow.

The likelihood of this scenario is not high, either. Unlike Japanese officials, who waited for years to try to stimulate Japan's economy, the Federal Reserve, the Treasury Department and Congress have responded quickly with rate cuts and stimulus packages and won't hesitate to break out more, if necessary.

What's more, Japan tried to keep its troubled banks alive, creating "zombie" institutions that only extended the pain of the financial crisis. U.S. officials are well aware of this history and will likely avoid it -- though some analysts warn they've merely kicked problems down the road by preventing the collapses of Bear Stearns, Fannie Mae and Freddie Mac.

Odds: 15 to 1 against.

Next Year, the Turnaround

Like Chicago Cubs fans always looking to the next season, there are analysts who have been calling for a turnaround for months despite evidence to the contrary, yelling their hearts out for what so far has been a losing cause.

According to their theory, this has all been a fever dream, a midcycle slowdown like the one the economy suffered in 1998, when stocks briefly swooned, but the technology bubble quickly went right back to inflating. This is the same crowd who dismissed the collapse of the housing market because it's just a small part of gross domestic product and who said the subprime mortgage meltdown would be no big deal.

And now, $400 billion in losses and one bear market later, they're still calling for the rosy outcome, and there's a chance they might be right, given the fiscal and monetary stimulus flowing through the system. Perhaps banks, emboldened by a wide government safety net, will start lending again to consumers and businesses eager to borrow and get back to the high life. This, along with the still-booming export sector, could cause the economy and stocks to rocket higher once again.

Unfortunately, this also seems unlikely. "This financial crisis is the worst since the Great Depression," points out New York University economist Nouriel Roubini. "The recession is unavoidable at this point."

One wild card here is the U.S. consumer, the lifeblood of the economy. Though their debts are growing and their inflation-adjusted wages are not, analysts have unsuccessfully predicted a slowdown in their spending for years. A dramatic plunge in oil prices could give them extra incentive to spend.

Odds: 10 to 1 against.

Just Getting By

If you've enjoyed the economy for the past year, then you'll love this, because it involves more of the same. The trouble is that most people haven't enjoyed it, but it's the most likely outcome, according to many economists.

In this scenario, weaker global growth cools inflation, but not by much, as China, India and other emerging economies stay hungry for oil and other commodities.

The U.S. economy improves little and perhaps slides into a mild recession, as the repercussions of the credit crunch, housing-market collapse and high oil prices work their way slowly through the system.

Banks, stung by hundreds of billions of dollars in losses and under pressure to rebuild their coffers, keep a tight lid on borrowing. Businesses, squeezed by higher costs and lower sales, lay off more workers, raising the unemployment rate.

"We can keep muddling along, but we may have to accept more inflation and more weakness and adapt to that," says Bruce McCain, chief investment strategist at Key Private Bank in Cleveland.

Odds: 2 to 1 for.

Write to Mark Gongloff at mark.gongloff@wsj.com

By keeping interest rates low, the Fed is raising the supply of dollars and other forms of liquidity in the financial system, thus weakening the value of the U.S. currency. But the lack of scrutiny of the central bank in the current oil debate is curious.

"We suspect that at least some of the liquidity being pumped into the system by the Fed is going into the oil market," says RGE Monitor analyst Rachel Ziemba. "There are global supply-and-demand forces driving oil prices on a long-term basis, but in the short-term, the Fed's actions must be lending momentum to the market."

A spokeswoman for the Fed declined to comment.

It's difficult to figure out exactly how the Fed's manipulation of the money supply is affecting the energy markets. The Fed reports that its broadest measure of the money supply, M2, increased by 6.3%, or $457 billion, over the last 12 months.

While the Fed is expanding the monetary base in an attempt to stimulate the sluggish economy and cushion the financial system against the ravages of the credit crunch, some observers say it's driving speculation in the red-hot energy markets.

Some lawmakers have pointed fingers at unnamed speculators for high prices, and big oil companies like Exxon Mobil(XOM - Cramer's Take - Stockpickr) and Chevron(CVX - Cramer's Take - Stockpickr) have pushed to loosen current restrictions on domestic oil drilling.

The central bank is designed to be independent from the federal government in its decision-making, but Congress created the central bank and it does have oversight responsibilities for it. The Fed's decisions on interest rate policy are particularly sensitive during an election year. This time around, rate hikes would be viewed as a boost for Democrats, while further rate cuts would favor the incumbent Republicans in the fight for the White House.

The Fed has slashed interest rates by 325 basis points since the credit storm made landfall on Wall Street last summer.

On Wednesday, the Fed elected to keep rates steady, with only Dallas Fed President Richard Fisher dissenting from the decision in favor of a rate hike.

While the Fed took no action, meeting expectations on Wall Street, it did talk tough about inflation in its policy statement.

"Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased," the central bank said.

The Fed also reiterated its longstanding -- but so-far woeful -- forecast that inflation pressures will soon abate as oil prices moderate.

"However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high," said the Fed.

Despite those statements, futures markets show that expectations for rate hikes from the Fed later this year are waning. Crude oil prices set a new record above $142 a barrel in trading on Friday, while the dollar weakened against other major currencies. The Dow Jones Industrial Average, meanwhile, made new lows for 2008, with shares of General MotorsGM hovering near a 53-year low.

Bank shares have also been crushed of late, with Merrill LynchMER dipping Friday after a Lehman Brothers analyst said it expected $5.4 billion in fresh writedowns in the second quarter, due to downgrades to bond insurers MBIAMBI and AmbacABK.

Anthony Crescenzi, chief bond market strategist with Miller Tabak and a contributor to RealMoney.com, said in a note Thursday that the dollar was declining in response to lowered expectations for rate hikes from the Fed.

"Weakness in equities is spurring a flight into investment strategies that are working, such as buying commodities," said Crescenzi.

Source : www.thestreet.com

The bottom line: "Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased." Which is what recent Fed-speak had implied anyway.

But that doesn't mean any rate hikes anytime soon. Indeed, odds in the fed-funds futures market were little changed in the wake of the FOMC decision. The futures put a 38% chance of a 2.25% target rate at the Aug. 5 meeting and a 68% probability of a 2.50% funds rate (with at least 2.25% a sure thing) by the Oct. 28-29 meeting.

"The case for an early tightening is still weak, in our view," argues BCA. "The underlying inflation picture is better than the headline data suggest, many market interest rates are still higher than before the Fed started to ease, and the credit system is not yet functioning properly. Market expectations of a 50 basis point rise in rates over the next six months are too aggressive."

Lena Komileva, head of G7 Market Economics for Tullett Prebon in London, sees the uncertainty about future rate hikes -- which has pushed up term (that is, longer than overnight) money-market rates -- working in the Fed's favor. "The Fed is now making a better use of the yield curve to meet its conflicting growth and inflation objectives. Low overnight rates and liquidity-supporting measures in short-term financial markets will help counter downside risks to growth. At the same time, higher term funding rates will provide a hedge against rising inflation risks."

But there are risks to this tack. "A steeper money market curve on expectations of Fed rate hikes has the effect of reducing visibility into the liquidity outlook, which will ultimately slow down the banking sector's remedial balance sheet efforts causing further damage to private-sector credit conditions," she adds.

Since the April 30 FOMC meeting, when the panel signaled it was finished cutting rates, and indeed since the mid-March rescue of Bear Stearns, monetary conditions arguably have tightened. As High Frequency Economics' Shepherdson points out, the M2 measure of the money supply is shrinking. And since that time, the dollar has stopped making new lows and gold is more than $100 off its high of over $1,000 an ounce.

"The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability," the FOMC concluded. The risk is that those economic and financial developments will be negative, which will likely preclude any rate hikes in 2008 and well into next year.

Source: www.barrons.com

Peak Oil Implications
Demand

Demand for oil has consistently risen globally. Should demand continue to rise when total output has reached its peak, basic economics tells us that oil prices will steadily rise with demand. And when production falls - which will occur when oil becomes harder and harder to find - oil prices will rise at a much greater rate. Oil exploration will become much more aggressive, and alternative oil sources - such as Canada's oil sands - will be increasingly exploited to squeeze out every last drop of oil.

Alternative Energy

Alternative energy sources will become much more popular as countries are forced to move to a sustainable energy supply, and as fossil fuels simply become too expensive. The way we live our lives would dramatically change if oil-based energy becomes economically out of reach. For example, people will probably live closer to where they work, leaving municipalities strained in their attempts to provide adequate transit as well maintain social services and infrastructure at a much higher cost.

When and if peak oil does arrive, it needn't be all doom and gloom. It can be a major investment opportunity as there are areas in the market that will benefit. Some of these investment opportunities include:

* Oilfield Services
As the amount of reserves oil companies hold starts to diminish, oil companies will need to increase oil exploration and drilling to replenish reserves - after all, they are in the business of selling oil. As oil producers increase spending on exploration, it is the oilfield services sector that will win by receiving more orders and seeing higher revenue. Oilfield services companies provide the tools and equipment required in the exploration of oil including drilling rigs, offshore rigs and transport equipment. Therefore, with a dramatic increase in drilling, oil field service companies are likely to be in demand, making them a hot investment.

* The Oil Giants
Investing in the top guns of the oil industry is a good bet, peak oil or not. If peak oil is reality, the steady decline in supply will drive the price of oil up causing each company's oil inventory to steadily increase in value. This will result in higher valued stocks for these companies. Basically, the higher oil prices are, the more oil and derivative products will be sold, which should increase profits.

* Alternative Sources of Oil
As conventional oil is depleted and becomes harder to find, oil companies will increasingly look to unconventional sources to boost production. Additionally, higher oil prices brought on by higher demand and lower production make these alternative oil sources financially feasible. The oil sands in Canada and Venezuela are examples of such an unconventional source, where bitumen - a heavy crude oil - is mixed together with sand and clay. This substance is extracted and refined to produce oil.

Oil shale is another alternative. Extracting oil from oil shale - rock containing kerogyn that can be converted to synthetic crude oil - is an even more intensive process than that of the oil sands. Oil shale production is only a viable alternative when oil prices are over $70 per barrel.

Some processes exist that convert coal to synthetic oil. However such methods will likely only be interim alternatives because coal is also a finite resource.

* Alternative Energy
The most obvious option in the peak oil dilemma is to move to something other than oil for our energy needs. This option isn't yet as feasible. Alternative energy only accounts for a small percentage of energy sources, but the onset of peak oil will force society to look elsewhere to meet its energy needs. If the optimists are right and peak oil is decades away, we have time to develop new technologies to harness alternative energies. But with the hype generated by high oil prices and peak oil speculation, this industry is getting a boost.

Because such a very small percentage of our energy sources include alternatives to oil, it could be said that the market for these products has nowhere to go but up. Energy sources such as geothermal, solar and wind energy will be sought after as solutions. Additionally, because many of the technologies that harness these energies are built using oil dependent machinery, there will be an additional push to develop technology for this purpose as well.

Hybrid and electric cars have become increasingly popular in recent years due to high gasoline prices. Expect a greater degree of growth in this area with the arrival of peak oil and higher prices at the pump.

All of the technology required to produce alternative forms of energy will need further research and development to ensure greater efficiency and economic viability. Investments in the companies leading these R&D initiatives will likely bear much fruit. As oil production falls and oil prices rise, research will become more intensive as industry puts both feet forward to develop the next generation of energy technology.

Investments to Avoid

In general, the investments to avoid in a peak oil situation include companies that rely on oil and other petroleum products as a major input cost. For example, transportation companies and airlines are susceptible to price fluctuations in oil and would be hurt by the extremely high prices that would be the result of a peak oil situation.

Conclusion

Peak oil brings with it several opportunities for investors. Whether it's oil, oil field services, or alternative energy, investors can cash in on this phenomenon. But be careful. If we reach peak oil, it will mean dramatic changes to society in the way we live and do business. Watch your investments closely and be sure to adjust to a changing marketplace.

John Hanley has a Bachelor of Arts degree in political science from the University of Alberta. He is a freelance writer and has lived in Edmonton, Alberta with his wife Mikaela for the past eight years. John grew up in Saskatchewan and previously worked as a radio broadcaster.


Source: http://www.investopedia.com/articles/07/peak-oil.asp?viewall=1