Today’s special Comment is not so much a special comment. Rather, I realized that everything so far in today’s letter was ‘bond this’ and ‘bond that,’ so I sat down for a conversation with Executive Editor Justin Ford and Investment Director Eric Roseman. The idea was to hammer out some of the basics behind bonds and look at where they’re headed in the next calendar year…

Q: Eric, let’s set some background here. What happened to the fixed-income markets in 2008?

A: In September, investment-grade bonds were hammered following the collapse of Lehman Brothers Holdings, and they posted their single worst month of performance since February 1981. Many bonds plunged more than 15% alone in September.

And more than half of the investment grade bond sector is comprised of financial services debt or bonds issued by some of the largest banks in the United States and Europe. With the Fed’s implicit guarantee on the largest issuers of such debt, investors can now tap into bank issued bonds trading at a 5.16% premium to expensive Treasury bonds.

Q: Now speaking of the government, there were a few occasions this year - Fannie and Freddie being the most prominent - where a company’s bondholders were bailed out while the shareholders were hung out to dry. Why does this happen Justin?

A: It’s important to remember that bonds always take precedent over equity in the capital structure of a company. For example, let’s say I own a pizzeria. I start doing well for myself, and you come along and say that you’d like to become a partner in the company. I agree, you make an investment and we share in the ownership of the company. We share costs, profits, etc.

Now suppose we hit hard times and we need a loan. We take out a US$50,000 loan from Eric, but then the company ends up in default. Now, as you’d expect, Eric’s loan will take precedent over our ownership interest. And rightfully so…he was just loaning us the money.

We were the owners, and we were poised to reap the profits if we did well. Conversely, we’d be expected to take the heat if the company fails. In this situation, Eric’s the bondholder and you and I are shareholders.

Q: So in chaotic times like these, it’s more than just the cold comfort of fixed returns that draws investors to the fixed-income arena?

A: That’s right, they’re just more practical when uncertainty abounds. After all, a company is far more likely to slash dividends than default on a batch of bonds and risk their credit rating. And that’s why you’re seeing experts like Thomas Fischer from JGAM recommending low allocations in equities and growing positions in investment-grade and even distressed debt. I mean, the yields right now are very attractive.

Distressed Debt ETFs from such major names as BlackRock and PIMCO are currently yielding upwards of 20-30%. You’re simply not going to find dividend yields like that in equity markets…period.

Q: The yields on some distressed debts are definitely quite attractive at this point…but what’s all this I’ve been hearing about Capital Gains?

A: Well, there’s the face value of the bond, called ‘par’. And distressed debt trades at discount to par. So if you buy distressed debt for say, 80 cents on the dollar, not only are you making the coupon rate, but you’re also going to make that extra 20% in profit when the bond comes to term. Depending on the situation in the secondary, you can even trade the bond before it comes to term and capture some of this premium. In the meantime, you’re still collecting the coupon.

Q: But isn’t the discount simply offsetting the increased risk of default?

A: Well, that’s what it’s intended to do. Remember that fear has overtaken greed as the driving emotion in the marketplace right now. So investors and banks are all-too-willing to slap a steep discount on any debt that has the slightest risk of defaulting. But even in some of the roughest times, you’ll find that bond default rates rarely reach above 20% across the board. And with some distressed debt already trading with that kind of discount or greater, you can stand to make some serious capital gains when panic dries up in the marketplace…that is, as long as you know what you’re looking for.

Q: Thanks for your time, gentlemen, and a happy New Year to you all.

Forget about the Bailout Bonanza. The Credit Crunch will deliver your paycheck. Let me explain…

You heard a lot about LIBOR and bond spreads this year…but what does it all really mean? Well, it means that the banks screwed up…royally. They made huge amounts of unfeasible loans and grossly understated their risk of default. As a result, most American banks are technically insolvent, keeping them from lending to even the most qualified of borrowers.

In short; the banks stopped doing their jobs. And the real, global cost of their mistakes is gigantic.

World Credit markets ground to a halt as central banks fought to get their Frankenstein version of Capitalism back on its feet. And as a direct result, the cost of credit shot through the roof. And that’s the key here.

The cost of credit shot through the roof not just for homebuilders and real estate companies, but for serious money-makers… “pillars-of-society” types like IBM or Proctor & Gamble, and made credit all but unattainable for less-qualified recipients. The bankers essentially thrashed the whole system of credit with their greed and short-sightedness. And all the babies were thrown out with the bathwater.

As the world begins to sober up in 2009 and we all begin to remember the difference between really making money and financial “engineering” (witchcraft) you can expect the credit markets to begin returning from La-La land…and those few investors who were brave and savvy enough to step up and manage default risk where the banks were clearly incapable or unwilling…well, they’ll be the ones we’re talking about in this series next year.

Instead, there was an accident. The car she was in careened into a light pole at 45 miles-per-hour. Believing that the car was in danger of exploding, her friend Lisa Torti pulled Alexandra’s injured body from the smoking wreckage. At the hospital, Alexandra found out that she sustained injuries that would leave her a paraplegic for life.

So what’d she do? She sued her friend Lisa…of course.

“You’re going to have to go over that whole story for me again,” I told our Privacy & Rights expert, Mark Nestmann. He explained that – despite California’s existing Good Samaritan law – Lisa could still be at fault here. Thanks to the ‘legalese’ in which the Good Samaritan law was written…

“The decision comes despite the plain wording of the state’s Good Samaritan law,” Mark explained to me, “which reads:

“No person who in good faith, and not for compensation, renders emergency care at the scene of an emergency shall be liable for any civil damages resulting from any act or omission.”

“However,” he went on, “the court magically inserted the word “medical” after the word “renders” to interpret the law as providing protection only to those providing emergency medical treatment. If you’re merely pulling someone from a smoking vehicle that’s about to explode, and that person alleges injury as a result of your actions, you’re not covered.”
So what’s a Good Samaritan to do?

“Even if you live in a state with a ‘strong’ Good Samaritan law, you can still be sued if you botch a rescue attempt. You’ll need to hire an attorney to defend yourself, take time to prepare a defense, and hope that you prevail. Liability insurance can pay some or all of these expenses, although insurance companies can and do contest some Good Samaritan claims”

“In some states, you have a legal obligation called a “duty to rescue” to assist someone in distress. This is particularly true if you’re a medical professional or work in emergency services. But, absent this duty, intervening in an emergency situation is an invitation to a lawsuit.”

Well, there’s no guarantee that a rally will happen, but I’m going to jump on the band wagon with a low risk, bullish options trade on Woolworths (WOW).

This company has held up well during the market turmoil and is currently trading in an Elliott Wave sideways pattern after coming off its recent lows. See Chart 1:

click to enlarge

I have chosen to trade WOW with an Out of the Money Calendar spread using Call options. I am buying the March 09, $28 contract because I believe that WOW has the potential to trade back up to this price over the next 2 months and I want to use longer dated options to give myself time to be right.

The problem is that options are still expensive due to the current implied volatility levels. So, to offset a lot of the cost of this trade I’m going to sell the February 09, $28 Call contract and create a Calendar spread.

The actual order that I give to the broker will be this.

Buy to open 1 March 09, $28 Call contract and at the same time sell to open 1 February, $28 Call contract for a debit of 35 cents. This means that I’m not concerned with what price the individual contracts are, as long as I only pay 35 cents for the spread. The trade will actually cost me $350, as one contract contains 1000 shares.

Now, how do I work out easily what the profit is likely to be if I’m right and WOW is trading around the $28 level when my short February options expire? The process is fairly simple, at that time; my long options will still have 30 days to expiration and are basically at the money.

To get a reasonable idea of my profit then, I just need to look at what the current January 09 $25.50 options are worth now, to see what 30 day, at the money options are worth. In this case that’s about $1.25.

This means that I can expect to make around 90 cents ($1.25 minus the 35 cents I paid originally) or $900 per contract profit. This is supported by the risk graph in Chart 2:

click to enlarge

The initial trade plan is simple. The best outcome would be to have the February contract expire worthless and then sell the March contract for a profit.

However, should WOW rise above the $28 level, I would have to make a different adjustment. This would probably involve buying back my short position and then deciding whether or not I would sell my long position at that time. How I decided to adjust the trade would be determined by my analysis of where I thought WOW was likely to go next.

That’s the beauty of options trading, the risk is normally low and there is more than one type of adjustment that can be made. I will explore some of these alternatives in a future article should WOW rise above $28.

click to enlarge

If you are an exporter you may like the direction of the Aussie – down, down, down. If you are an importer or are wanting to buy a consumer durable then you won’t like it. Consumer durable? Give us plain speak Tom. Ok. Durables are things that last. Well that was how it was when the term was first used. Things like cars, TVs, fridges etc. But we know they don’t last like they used to – like ‘in the good old days’. There is a sort of ‘planned obsolescence’ and therein lies a problem. Planned obsolescence was working until the recession hit – yes it is here – and we stopped buying. And if we haven’t stopped yet we will soon – especially ‘durables’ because they are going to be heaps more expensive.

We stop buying ‘durables’ and ‘consumables’ and China and others slow down imports of raw material, demand for the Aussie dollar falls – which could again become the ‘lil Aussie battler’ – and demand for our currency will fall. London to a brick.

But you may ask is the savage fall of the Aussie – just that – or is it the rise and rise of the American dollar? There is no definitive answer to that. It is a bit of both but which is the more dominant cause I could not put hand on heart and state categorically. I am sure there is some Rhodes economic scholar that has the answer. But not Tom.

For many holders of USA debt a fall in the US dollar would be very nasty indeed. I am not suggesting that they are holding the US dollar up but pain will set in if it falls.

So that is why I say it is all a tangled complex web.

And I am going to add one more ponderable. The above daily chart showed a continuing downward path for the Aussie but if we look at a weekly chart we can see a slightly varying scenario:

click to enlarge

And that is the prospect of a relief rally before the final fall from grace.

If I was to show a chart for say copper – of which we export heaps – it would be almost the exact same for the above. That is we may see an easing in the US dollar, a rise in US denominated priced copper and other base metal prices and a rise in the Aussie for a while.

Sometimes it is really clear and other times it is ‘clear as mud’

Here’s how it worked. When a loan was made, the debt was carved in a standard fashion on the surface of a small (preferably hazel-wood) stick, and then the stick was split in half through the center of the carving. The longer end of the IOU was given to the purchaser, and its handle was called the ‘stock’…the root of the word’s use in today’s markets.

Even a mostly illiterate public could read the amount scratched into the wood, and the stick would only fit perfectly with its original other half. That way, when the debtor returned with the money (or goods) owed, the sticks would be matched and the debt would be ‘tallied.’

In that fundamental use, they worked perfectly. But of course - as is governments’ way - the King was tempted to stretch those bounds.

Take the two lead stories on the News Ltd business web page: “BHP to slash resources output” and “Oil ‘could slump to US$25.‘”

It’s an interesting proposition. And it further highlights why Western economies will not suffer from deflation. Sure, prices for some things may be falling - such as oil and petrol. But will that filter through to other areas of the economy?

We’ve spent the last four years ridiculing central bankers for discounting fuel and food costs from their inflation models, so we aren’t about to discount fuel when it is falling.

With the new policies of ’super-easy’ credit from the RBA, the Fed, ECB and Bank of England, the main concern remains inflation.

When the bankers and economists talk just of prices when they consider inflation they are only looking at half of the picture. Their argument goes that because the economy is slowing, business and consumers will spend less money. Thus prices will fall, and that could lead to deflation.

Their solution is to set interest rates as low as possible. They are backing that up by issuing as many bonds as possible to soak up excess capital. This is excess capital that the banks don’t want to lend to anyone apart from the government.

Governments are then going out and, erm, lending the cash to the sort of companies - other banks, auto manufacturers, etc. - that the banks wouldn’t dream of lending money to.

Once that source of cash dries up - and it must soon in the US based on bond prices and yields - the only other option left open is to print more money and spend it. Some of it may be for worthwhile projects. But the key is that as worthy as the projects may be, it is simply increasing the supply of money in the economy, which as anyone can tell you, is inflationary.

Yet, this is being overlooked in favour of spreading the false fear of deflation. Why? Simple, a government that spends money is seen to be doing something. Telling the public and business that the best course of action is to let events work things out for itself would never be palatable - people may start asking why the politicians are there in the first place.

It’s the Oil Supply Not the Demand That Matters

But back to the oil and resources story. Oil is a strange beast. The price of crude oil climbed over USD$100 a barrel between 2003 and 2008, until it reached a peak of nearly USD$150.

During that time production and demand increased, setting off fears of global shortages. Of course, the price was also influenced by other issues such as terrorists and hurricanes. And most of all by China.

Today, recession is in the air and now all the talk is of slowing demand and OPEC production cuts.

Analysts from Merrill Lynch now believe the price of crude could dip “all the way to USD$25 a barrel.” But remember, most of the analysts on Wall Street and elsewhere were not convinced that oil prices would rise in the first place. They were constantly playing ‘catch-up’ with their analysis.

As the price ratcheted up ever higher they would call the top and then suggest prices would stabilize. Now the price is falling and they show their true thoughts.

Trying to pick the future price of any asset is hard. Even harder for something as volatile as oil. Despite the likelihood of a global slowdown, it is arguable whether it will necessarily be reflected with a big drop in demand for crude.

You only have to take a look at the traffic on the roads in the last few weeks. There is little doubt that more and more people have ditched public transport and fired up the cars again.

The main influence is not so much the demand - which most of the mainstream seems to be concentrating on - but the supply. OPEC is terrible at trying to control production levels from member states.

As we mentioned recently, there is the constant struggle between supporting a higher price and producing as much as possible to take advantage of the price.

The structure of the national oil companies within OPEC is also of importance. Even if the price of crude falls to near or below breakeven, they will not stop extracting the oil. One reason is that it would lead to civil unrest in already unstable countries as thousands of jobs are lost.

And secondly, even though viable alternative energy may seem to be decades away, a decision such as OPEC closing down unprofitable wells would be the catalyst to speed this process up. It’s amazing what can be done in the face of real adversity!

Lead by oil and metals, especially copper, the downward march of commodity prices continues apace.

Oil fell under $US44 a barrel yesterday; it’s more than $US103 down from the July peak of $US147.47 a barrel. Oil is at a three and a half year low.

Non-traded spot prices for coal and iron ore are weak. 

Vale, (CVRD), the big Brazilian iron ore and nickel miner, yesterday chopped its global workforce by 2.1%, or 1300 people. More than 6,000 others will be sent on unpaid leave or be retrained.

Copper fell again, off another cent and pushing the US front futures price under $US1.50 a pound: yesterday’s finish was around the lowest since early, 2005. 

Copper is down more than 70% from its May peak of  $US4.2605 a pound. Copper fell 9.75% on Thursday alone.

The same is happening across the board: even gold remains hesitant, the fear of recession and sluggish demand is undermining confidence.

The Reuters-Jefferies CRB index, a major global benchmark for commodities prices, dropped to its lowest level since 2002 yesterday when it fell to around 218: the index has plunged 60% from July’s record of 473.97.

The drop came after oil prices fell to fresh three-and-a-half year lows on successive days.

Oil is the main driver, especially with OPEC’s odd decision last week to sit still and not cut production. Prices hit a four year low overnight Thursday of around $US43.60 a barrel, down almost 7% in one day.

UK analysts wonder if there’s a split in the group between countries which need extra output (Nigeria and Venezuela) and those who see the dangers from sparking another oil price surge, or the futility of trying to in the midst of a global recession

OPEC said at a weekend meeting in Cairo that it would delay production cuts until mid-December, when it will convene again in Oran, Algeria. 

Futures prices see the global price falling to $US40 a barrel in the next couple of months: it could come earlier than that, by year’s end given the flood of depressing news about the global economy, despite rate cuts and other pump priming measures.

Merrill Lynch said in a report on Thursday that prices may dip below $US25 a barrel next year if the recession spreads to China. Without a recession in China, the firm saw prices around $US50 a barrel.

Much will depend on the Oran meeting of OPEC, when the group is expected to cut output by 1m-1.5m barrels a day. 

But even that confidence has been undermined by news that the financially-strained Kuwait and the United Arab Emirates reportedly told some of their larger customers in Asia that they would supply them with more oil in January than in December.

The group has so far cut about 1m to 1.2m barrels a day of a promised 1.5m b/d cut.

Copper and other metals have eased despite suggestions that China is buying metals for a national strategic reserve.

China is certainly attacking the iron ore and coking and thermal coal supply contracts held by Australian, Indonesia, Canadian and other suppliers to drive down prices next year. Volumes will also fall.

Copper prices fell to the lowest since July 2005 on growing worries that the price is heading for the important $US1 a pound market thanks to the growing global slump.

That’s being reflected in the surge in London Metal Exchange stocks of unsold metal. (The LME is a terminal market, so when its stocks rise and fall, you know that demand is strong or weak. At present it’s weak to getting weaker). Copper stocks are running around 293,000 tonnes, the lowest since mid 2004.

The slump has produced a flood of decisions this week from major producers and processors.

Freeport-McMoRan Copper & Gold Inc., the world’s largest listed copper producer, suspended its dividend and will reduce output over the next two years. 

Freeport said it will now produce 4.1 billion pounds (1.86 million tonnes) in 2009, down from the October decision to lift output to 4.3 billion pounds. That’s around 90,000 tonnes less.

Its 2010 output will fall 11% and the company yesterday said more cuts would happen if the price weakened.

Freeport is really hunkering down: besides cutting out and suspending the dividend it is more than halving its capital expenditure in 2009 to $US1.1 billion from October’s estimate of $US2.3 billion.

In Japan, Nippon Mining Holdings Inc, Japan’s leading copper producer, is considering cutting production by 10% to 20%. It expects to make a decision by month’s end.

An output cut by Nippon Mining, which has an annual copper production capacity of about 610,000 tonnes, would follow curbs at its Chinese competitors.

Tongling Nonferrous Metals, China’s second largest copper producer, has reduced copper output due to low prices.

If The Nippon Mining cuts output, it will buy less copper concentrate in 2009.

According to the London based Bloomsbury Mineral Economics, global copper production will outpace demand by 244,000 tonnes in 2009, a 109,000 tonne surplus.

Last week RBS Capital analysts reckoned next year’s surplus would be 250,000 tonnes and possibly double that in 2010.

In September, the Japan Copper and Brass Association cut its estimate for Japanese copper demand to 977,000 tonnes for the year to March, a decline of 2.1 percent from the previous year.

Lead dropped to a two-year low in London after Ivernia Inc., the former supplier of 3% of world output, was given the greenlight to resume an 8,000 tonne shipment from Western Australia. Aluminum prices hit four year lows. 

That missing metal has seen lead stocks fall this year by just over 5%. But the Ivernia news came as stocks jumped 2.7% in a day.

Three month lead fell 11% on Wednesday on the news to $US975 a tonne after touching $US970 a tonne, the lowest since June 2006. lead prices recovered slightly Thursday 

The Financial Times reported that China was looking to buy commodities:

“China, the world’s largest metals consumer, is considering a plan to build up state reserves of base metals to help fight the impact of the global economic slowdown, according to an industry association.

“Wen Xianjun, vice-chairman of the China Nonferrous Metals Industry Association, told a conference that central government was considering buying all types of base metals to boost domestic demand.

“It was the second time this week that Chinese officials had suggested that the country might buy base metals.

“On Monday, in a statement greeted with widespread scepticism by the market, the government of Yunnan province, a base for significant Chinese metal production, said it would buy 1m tonnes of base metals.

“But Zhang Liqun, director of the financial research institute at the State Council, the country’s cabinet, said on Wednesday that the government’s goal was still to force a restructuring of inefficient mining companies.”

How could the dollar possibly rally during the worst financial crisis in a generation? (That was a year ago before we knew how far and wide the credit crunch would reach.)

But the fact is, that’s exactly what’s happening now.

I’ll admit that the dollar didn’t rally right away. It took months. In fact, the dollar index didn’t bottom until the day after the Fed bailed out Bear Stearns.

But then, the dollar slowly started to creep higher. And since mid-year, the dollar has been on a tear against the world’s major currencies. In fact, the dollar has jumped 16% just since September.

Crisis Profiteering: Your Dollar Profits from Credit Crunch

And it looks like this dollar rally will continue.

In fact, the dollar is one of the few currencies we are long-term bullish on for 2009. We see the dollar rallying through at least the first half of 2009. As I said on Tuesday, the dollar will continue to fly high on a combination of…

• Its Safe Haven Status: Scared traders are running back to the world’s reserve currency as the credit crunch continues to sweep the markets.
• The Mad Dash for Cash: Stock investors are still dumping whatever is left of their portfolios and running back into cash (in this case, the U.S. dollar).
• Whoever Can Fix the Crisis Gets the $: For now at least, it seems Forex traders believe the U.S. is better equipped to deal with the credit crunch, so they’re pouring money into dollars.
• Crisis Feeds Low-Yielding Currencies: During recessions, Forex traders run for safety, so they trade in their high-yielding currencies for the safety of lower-yielding currencies. So the dollar, now yielding 1%, actually has an advantage right now.

• Yes, You Can Invest in a Dollar Rally With Foreign Currencies

  Now it may seem strange to play a dollar rally by investing in foreign currencies, but actually there are a couple key ways to profit off this massive dollar rally next year in the currency market.

  You could call your stockbroker, and simply ask to short any number of currency ETFs, or even go long the few dollar ETFs they have available.

  That’s an excellent way to play the dollar rally - particularly if you’re a longer-term investor. However, ETFs only offer conservative returns (15% to 20% - definitely not bad, assuming stocks continue to plummet).

  But in my opinion, there is a bit more interesting way to play this dollar rally either in the options or exotics market. For one reason: Leverage. Leverage allows you to invest a smaller amount, but still shoot for the big gains - often double or triple-digit gains in just a matter of weeks.

Move Over Buffett, B&B Strike Deal of the Millennium
Hooray! Phoenix from the flames. Back from the dead. The resurrection. Off life support.

You’ve guessed it, our friends at Babcock & Brown [ASX:BNB] are back trading again this morning after a two week trading suspension.

And what do you know, they have roared back with a vengeance. As we write, the company’s shares are trading at the giddy height of 51 cents. That, readers, is a 100% increase from the price it last traded at before the suspension.

You can see why investors have got themselves so excited when you read the release to the Australian Securities Exchange (ASX). You’ve got to hand it to these investment banking lot, they are nothing if not geniuses.

Not content with cobbling together any old business under a massive debt arrangement and then flogging it off to unsuspecting retail investors, they have now done the same thing to ‘one of their own.’ Or rather, 25 of their own.

The business in this instance is itself - namely Babcock & Brown. It is lumbering under billions of dollars worth of debt which if it wasn’t for a $150 million cash injection by the 25 bank syndicate would render it insolvent and out of business.

But the creme de la creme of this arrangement is something even the B&B executives must be surprised they have got away with. You see, the terms of the debt repayment are that funding will be provided until 31st December 2009. The interest rate will be a whopping great 6% above the 30 day BBSY (that’s right, BBSY, not BBSW incase you were thinking of writing in) rate.

That’s pretty expensive debt. But B&B needn’t worry, because under the terms of the deal the repayments of interest will be made on a - and this is true - “Pay If You Can” basis!

Yet the futures markets were telling us otherwise. The SFE Target Rate Tracker had a 1% cut fully priced in and was even pricing in a small chance of a 1.25% cut. But that was never really going to happen.

The RBA cash rate is now down to 4.25%. That’s the lowest point that rates got to while John Howard and Peter Costello were trying to run things. Only time will tell if Rudd and Swan decide to make any capital out of the low interest rates.

But that isn’t enough. Now the market wants another 1% cut as evidenced by the futures markets. As of yesterday, the futures prices have already built in a 98% chance of a cut to 3.25%. But they’ve got a long time to wait as the next RBA meeting isn’t until February.

We won’t go into detail on the rate cuts. Quite frankly there isn’t much more to add. Apart from the amusement of seeing politicians and the mainstream media urging consumers to spend, spend, spend. Obviously they have quickly forgotten the reason for the recent credit nightmare.

Either that, or in typical fashion they are only interested in the short term benefits of a spending spree against the longer term benefits of moderation.

Oil - $30 or $150?

So, instead of that, this. What is going to happen to the price of oil?

As of this morning, the price of crude oil has dropped below USD$50 a barrel. Not that long ago it was trading at nearly USD$150 a barrel.

OPEC is trying its best to cut production so that the price remains elevated. It’s been talking about that for a few months now. Even so, it hasn’t stopped oil from nearly halving in that time.

With global economies moving into recession, forecasts are for oil demand to wane. For the time being. Don’t forget that the margin between supply and demand is still very tight at only a few hundred thousand barrels per day. That’s out of a global demand of about 85 million barrels per day.

John Kilduff at MF Global told Agence France Presse (AFP), “if they [OPEC] expect to have any chance of halting the current price slide and reaching their goal of maintaining anywhere near a 75-dollar price level, a clear demonstration of unity is necessary. They must take more oil off world markets. Stockpiles are clearly at very high levels.”

That’s a tough task. The reaction from OPEC nations to the falling oil price is just like the stampede to exit the stock market when prices are falling. They know that pumping out more oil at these prices is going to drive the price down, but they also know that if they don’t then other nations will and the price will fall anyway.

Now the price has broken through the USD$50 a barrel mark, and with negative economic headlines for the world economy, there is a very real chance that crude could head towards USD$30. That would be a price level not seen since 2003.

We aren’t game to predict that, because we just don’t know. To be honest, the fall from USD$150 down to the current level has happened a lot quicker than we expected.

But. As we know, markets tend to over-react to the upside and the downside. The fundamentals of oil supply have barely changed. Apart from the hopeless activities of OPEC.

The issue of Peak Oil has not gone away, and alternative energy sources still need to be considered. The question is whether there will still be the same urgency with oil at USD$40.

Some would argue that there was only marginal urgency when it was three times that price, and that nothing will change.

Stay tuned for another upturn in oil prices once global economies start to recover.

Many of us will be sitting on the sideline with our heads in our palms. Shaking our heads, crying to ourselves and worrying about the future. The poor-house will be much more crowded than it was before…and it won’t be easy for anybody. Some will have to adjust their retirement plans, take less vacations, not buy that beach-house to retire in. Some will even have to come out of retirement…and into one of the worst job markets in a lifetime.

All because they didn’t move their feet fast enough.

So I’m going to be painfully clear, because I don’t want anyone who’s wise enough to keep up with my weekly commentary (and that’s you) to be a part of that crowd. What’s happening out there in the world should be seen as nothing less than a mass extinction…a changing of the guard.

Don’t believe me?

And I don’t need to tell you that the picture is outdated. Now you can add Citigroup, several European institutions, the whole country of Iceland, pension funds, mutual funds, possibly every sub-par auto manufacturer in Detroit, and several American cities who’ve gone from metropolis to lowly beggar in a matter of months.

This is not a bad thing. Not at all. To the contrary, it’s a wonderful confirmation.

You never believed that the guy wearing the tie in the corner office and making millions a year was any smarter than you. Well guess what? You were right! It turns out that - if anything - he wasn’t nearly as smart as you are.

But it can be disconcerting too…no longer can you take your life savings and hand it to some guy in a posh office with “Lehman Brothers” tattooed on the wall in gold. No longer can you simply assume that he knows best and he can make all the decisions. No longer can you see steady returns trickle in from dividends and stock price appreciation.

It’s just not that easy anymore.

But wasn’t it all an illusion anyway? Adjusted for inflation - and at today’s levels - the S&P 500 has gained less than 25% in the last 40 years! That works out to annualized returns of about .5%…pitiful if you ask me.

Where have all the Profits Gone?

Meanwhile…the individual thinkers…the diamonds in the rough, the truly Sovereign Individuals were busy elsewhere. Busy with real opportunities. Not with brokers who memorized all of Gordon Gekko’s lines from Wall Street.

Their strategies have never depended on being part of an “old boys’ club,” and their propensity for telling the truth has made them unpopular in some circles…but their intelligence has stood the test of recession, and proven itself not to be a part of Wall Street’s “Grand Illusion.” I want to show you one more picture…

Have a look at those dates if you will. Most of these trades have been closed out in the interim, and this particular portfolio stands at a 1,800% gain with zero losers.

Make no mistake, these guys are the real deal, and they’re not messing around. The follies and failures of the rest of the world’s “investment experts” have opened huge windows of opportunity and these stand-alone traders are making a fortune.

It is an easy proposition for any retail trader to model this style of investment and trading strategy. By using technical and fundamental analysis it is possible to profit from the higher probability opportunities top down analysis reveals. A sprinkling of additional economic and seasonal analysis of markets can help massively in order to produce solid trading results. If we review an example, it is easier to put the current context into perspective.

Through the latter parts of 2007 it was evident that the Sub Prime issues in the US were spreading to global markets and that the financial sector in Australia was starting to suffer. Comparing a sector to the overall market is easy using the Relative Strength Comparison (RSC) tool in your software and can demonstrate which sector is displaying strength or weakness, regardless of the overall market direction.

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Although the top 200 shares in the ASX were falling, the rising red line in the lower chart clearly displays that this particular index was massively outperforming the XFJ (the financial sector). Over this period and in this circumstance it becomes a simple case of running scans for short trading opportunities over individual companies that lie within that sector. Hence it is possible to identify those that are most likely to drop from a technical perspective.

If we move to the same charts over the current period there is a different story playing out. Of course, you can also do this to assess the strength of any sector (e.g. the materials or energy sector the XMJ or XEJ respectively).

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Evidently, the most recent price changes would suggest evidence that the XFJ is beginning to outperform the ASX top 200 shares. This signifies a reversal of the predominant share market action of 2008.

Now would be a perfect time to look for short term reversal trades (such as those supported by Elliott Wave 5 set ups) on shares of companies that are involved in this sector or are perceived to benefit from a rise in this part of the economy. Profits from any potential run up into Christmas period in line with the potential Santa Claus rally seem to be on offer over the next few weeks.

That is quite some feat. We write of course, on the subject of the BHP Billiton/Rio Tinto story.

Aside from all the benefits that a takeover would have brought to BHP, the big point to take from it is that even mega companies are reluctant to add debt to their books at the moment. And it also gives an indication that if it is troublesome for the likes of BHP and Rio to raise money in this market, think about the smaller companies and how they must be faring.

An example of this is one of the companies in our Australian Small Cap Investigator (ASI) portfolio. Last week it released details of a new joint venture deal it had entered into. Three days later the window closed for shareholders to pick up more stock in a capital raising.

The result was that the company raised less than 40% of the capital is was hoping for. If it was twelve months ago we are sure they would have raised the full amount. Fortunately, the company in question does have a Plan B. But many small companies out there don’t. If they can’t borrow from banks and can’t raise additional capital from shareholders, it makes it very hard for smaller companies to invest in growing their business.

On the other hand, that is one of the reasons why rather than stepping back from looking at new investments for ASI, we are actually ramping up the coverage in the New Year.

The credit markets will eventually recover, but it may be slow. However, even before this becomes obvious to the market many small cap companies will have already taken advantage and should surge ahead in price.

In our view, we believe the next six months will be the best time in years to pick up undervalued small cap companies.

We live in a world made up entirely of fiat currencies. “Fiat” means “an arbitrary order or decree.” In other words, our money doesn’t derive its value from a particular good or basket of goods, but from the government decree that brings it into law.

So the value of these currencies isn’t fixed. Instead, it tends to fluctuate and vary, depending on everything from interest rates and policy decisions to exports and civil unrest. So if you want to know what a currency is worth at any given time, you just have to ask yourself, “What could it buy?”
 
A soda, a half-gallon of gas, a big mac etc. And we do the same thing in the Forex world when comparing currencies. A particular currency can only buy so many yen, so many Swiss francs, etc. 

So it stands to reason that if a currency’s exchange rate is falling, then another’s is rising. That’s the law of relativity when it comes to currencies. If the dollar’s exchange rate against the yen is declining, then you can buy less and less yen with your dollar. But at the same time, you’re able to buy more and more dollars with your yen.

This is where the idea of an eternal bull market comes from.