I’ll admit it’s hard to come to grips with our current financial crisis.

You see I’ve become blended. In the process of all my research and discovery, I’ve lost a little bit of my individuality. I’m guessing you might be in the same boat. You’re concentrating so much on your own work, family and financial needs, that it can be difficult to remember that not everyone lives your life and faces completely different problems.

I know that’s where I am. And as I wade through this Rescue Bill, I keep flashing back to the reasons they tell us it’s “necessary.”

“…if we don’t pass this the economy will grind to a halt. More average, hard working citizens will be crushed and it’ll take years to pull ourselves up again.”

I took a walk around my neighborhood last night. It’s a large middleclass community here in south Florida. Lots of kids…great place to live. Yet it looks no different than it did two years ago.

Flashback to two years ago… The Florida real estate market was booming. The value of everyone’s homes was going up 25% a year. People were happy, new cars were in the driveways. Certain kids went to private schools.

And then last night, many people were out walking, running, biking…smiling and saying hello. The kids were out playing in their manicured yards next to the new cars shining in the driveways…nothing looked any different. Yet.

You see, for now, I’ve been fortunate. I don’t know anyone who’s lost his or her job in all this mess. No friends or even friends of friends who’ve lost their home to foreclosure. I don’t even know anyone who had to move because they couldn’t pay their mortgage.

So if this is what I’m seeing then (remember everything just seems to blend together these days) it’s easy to assume that everything is okay.

It’s easy to think this is JUST a Wall Street problem. Sure, it’s spilled over to cars and housing but these industries have always been – and will always be – in boom-bust cycles. Hot economy…lots of new cars and houses…secure jobs. It’s almost too easy to believe that nothing new is happening here…no national crisis.

But the fact is: This time IS different. The “mess” will be coming to my world. I know it. I can feel it. I have no proof…Everything still looks the same but…

This could all easily change. Neighbors won’t always be able to pay those mortgages. Friends can lose jobs. New car purchases will be put on hold. Cooling economy…layoffs…maybe even foreclosures.

The world is changing – and it’s about to reach your neighborhood and mine, whether we’re ready for it or not. And it will look a lot like the world you’ve been reading about.

Don’t expect to get any mortgage relief tomorrow. That’s the message from the Government. The banks are being coy. They can afford to be as everyone else is arguing on their behalf.

We’ve written before that we aren’t in the habit of telling people how to run a business. So we won’t break that habit. The individual banks should be in the best position to know what is and isn’t affordable for them to do.

But, it does seem as though they have been given a free kick. The expectation is that the banks won’t lower interest rates tomorrow if/when the Reserve Bank of Australia (RBA) cuts the Cash Rate by either 0.25% or 0.50%. Chances are that the banks will pass something on. It probably won’t be the whole lot.

The interest rate markets have priced in a 95% certainty of a 0.50% rate cut.

But considering all the talk of them potentially passing on nothing, a cut of 0.12% will be dressed up as extreme generosity by the banks.

Don’t get us wrong. We have questioned for some time how wise it is for the RBA to be cutting rates while inflation remains so high. Does the RBA really need to cut rates or is it just pandering to the share market?

An Interest Rate Cut That Won’t Make a Difference
We are a little bit confused about the rationale for cutting rates. Is it to reduce the funding costs for banks? Or is it to prevent the economy from falling into a recession?

Either way we can’t see that it is going to do anything to address the problems. Supposedly the problem in the credit markets is twofold. First is that banks are reluctant to lend to each other and to clients. Second is that they cannot get an accurate price for various credit securities held on their books.

An interest rate cut by the RBA wouldn’t seem to be the solution to either of these issues. Sure, it has the potential to give them access to funding at a marginally lower rate, but unless the banks are prepared to take on more risk by writing new loans then all it does is add to the banks’ bottom line.

Are banks prepared to take on additional risk? Anecdotally the answer seems to be no.

Considering we have been told by the banks, regulators and government that Australian banks are superbly capitalized then cutting rates would hardly likely to have much impact.

Now we’ll see how this bailout actually works. Or if it works. It didn’t do much to spark the market on Friday. The Dow fell 157 points. The ASX 200 futures pointed towards a one-percent fall at the opening today. Below, you’ll find our two-month forecast for the market (please include a pinch of salt).

–With Congressional action out of the way, expect to see Central Banks step forward and fire en masse at the forces of chaos. The RBA meets Tuesday. Judging by the action the currency markets (the Aussie dollar at a 14-month low), the market is pricing it at least a 50 basis point cut from the current cash rate of 7%.

–Will it make any difference? “A difference to whom?”, is probably the better question. It’s not very likely Aussie banks are going to pass on the rate cut to you. But if it makes the banks more likely to lend to one another, well then yes, it will make a difference.

–By the way, it’s a bit of a surprise the Fed didn’t cut rates on Sunday in the States. We expected a more coordinated international volley of rate cuts prior to Monday’s opening in Asia. But so far, nothing. Bernanke must be keeping his powder dry for an intra-day rate cut. You know, one of those days when the Dow is down a few hundred points before noon because another bank or insurance company fails.

–While we’re on the subject of banks, the IMF’s report on Australia released a few weeks ago provided three notable conclusions: Australian banks are dependent on international markets for about 40% of their funding, mortgages make up a large part of Aussie bank loan portfolios, and Aussie house prices are not terribly overvalued.

–The first conclusion has the most relevance for the market today. The IMF says the increase in the cost of funding highlights the vulnerability of Aussie banks to lock-ups in the short-term debt markets. The IMF reckons Australian banks have about $220 billion in short-term loans from foreign lender with maturities of 90 days or less. The big four account for $160 billion of that short-term lending.

–The means the entire Aussie banking system has to roll over about 20% of GDP every three months from foreign lenders. Do you think it’s easy to raise that kind of money easy in the current conditions? The IMF is pretty understated about it, but puts it this way, “This highlights the dependence of Australian banks on a stable international funding environment, which in current circumstances cannot be taken as a given.”

–And what’s the second vulnerability of the Aussie banking system? It’s the massive growth in mortgage lending. You can see it on the chart below. It shows that over 50% of the banking system’s loans are mortgages. But what does it mean?

–Well, it means the boom in house prices was fuelled by a mortgage lending boom. It’s a positive feedback loop. More lending leads to higher prices which leads to more lending which leads to higher prices. The IMF says much of it is driven by investors.

–”Investor activity in the residential property market has been a key driver of the recent property boom), with many investors pursuing the negative gearing strategy that is allowed by Australian tax rules. As a result, about one-third of all mortgage loans are for investor housing.”

–A deep contraction in bank lending would, presumably, end the feedback loop. It’s possible, of course, that investors give up on shares and move back into property as an asset allocation decision. But if banks cut off funding for investors in property, where does that leave house prices? Without new money being lent to support investors and first time buyers, shouldn’t Aussie house prices fall?

–The IMF, surprisingly we reckon, says house prices are only over- valued by between two to fifteen percent, depending on which model you use. Why the big difference? Different house price models use different variables (interest rates, affordability, immigration etc). But in general, the IMF doesn’t see a huge bubble in property prices. Hmm.

–What’s the risk? Well so far the default rates on Aussie mortgages are low compared to their American cousins. That means the banks probably don’t face big losses on their huge mortgage loan portfolios. We say ‘probably’ because confidence is a delicate quality. It can vanish quickly, both from a borrower’s and a lenders perspective.

–If the Aussie banks have trouble funding operations because global credit markets remain tight, we doubt even a full percentage point interest rate cut by the RBA will spur the banks into increasing local mortgage lending. Without that lending, it’s hard to see how property prices can climb. And if they’re not climbing, they’re either going nowhere in inflation adjusted terms…or falling.

–Here’s a quick forecast for you. Investors are going to crowd into government bonds waiting for the stock market to bottom. They will push yields on short-term U.S. Treasuries back toward zero. A huge reservoir of cash will build up as people wait to see how the bailout goes. The major indices are in for a few more 3-4% down days.

–Before the end of the year, perhaps after the election in the U.S. is resolved, you’ll see a big short-term rally in stocks and commodities. Those cash reservoirs will be deployed back into shares. Over sold blue-chips that generate a lot of free cash flow will be worth a look, as will be the mining juniors (who’ve suffered massive amounts of punishment.)

–But don’t forget about the big down days. The New York Times reported that AIG has already used US$61 billion of the $85 billion lent to it by the Federal Reserve a few weeks ago. AIG was supposed to use the Fed life line to engineer an orderly sell-off in its assets. But that doesn’t seem to have happened.

–Instead, the company has spent $53 billion “shoring up” its structured finance and securities lending business. What does that even mean? Uh oh.

–Moody’s heard the news and downgraded AIG’s unsecured debt on Friday. If other ratings agencies follow that move, and if other types of AIG debt are downgraded, the company is going to have trouble borrowing again and may have to hit up the Fed for more money.

–And remember, AIG sold credit-default swap insurance to investment banks and other parties. That insurance allowed those parties to load- up on mortgage-backed investments that otherwise (without the default insurance) would have been too risky. Without that insurance, those parties have to sell their mortgage-backed assets.

–It was the near collapse of AIG that brought the financial markets to the very brink of systemic crisis. Don’t be surprised if AIG is in first in line for some of Treasury Secretary Paulson’s $700 billion slush fund. And don’t be surprised if the markets begin to lose confidence that the Plan is going to work.

The last time we talked about the iron junior market was in the first half of the year. Since then, most of the best quality reserves have been bought out. China’s playing for keeps now. Midwest (ASX:MIS) went for a 53% premium. Portman (ASX:PMM) got a 19% better offer three weeks ago.

But there are still good reserves out there.

In fact, most of the iron plays out side of Fortescue (ASX:FMG), Rio Tinto (ASX:RIO) and BHP (ASX:BHP) are now back to pre-boom levels.

Guess what? You get to start from the ground floor again. So here’s a quick money-map of the iron sector. There are three to look at this month, for three different reasons.

For sheer volume overall Gindalbie (ASX:GBG) wins. It simply has more iron. The company is sitting on a bunch of scattered tenements. The best is the Karara reserve, with over 500 million tones of economically mine-able iron.

A little more organized is Mount Gibson (ASX:MGX). It’s the latest fending off takeover rumours. The company’s producing - but it’s finding more iron than its digging up. According its last reserve statement from last month it added another 2 million tonnes of iron to its reserves.

Atlas Iron (ASX:AGO) just upgraded its indicated resource by 756 million tonnes yesterday. That’s not necessarily all money in the bank. It’s just a huge upgrade in a market that doesn’t care at the moment.

Kris Sayce has an over-sold, under-loved favourite iron play too. He just told his premium small-cap readers about it.

By the way, here are two to avoid: Strike Resources (ASX:SRK) and Territory Resources (ASX:TTY). They’ve both had recent troubles with loans or financing. In this credit (and equity) market, that’s not worth the risk for retail investors. Juniors need financing.

Buy $3 in Cash for $1

And on that note, there’s one more to look at. Cape Lambert Iron (ASX:CFE).

We’ve only looked at this briefly, so we could be wrong. You’re welcome to inform us if you know better at moneymorning@moneymorning.com.au.

But after selling its major iron project to China Metallurgical, the company reckons it is sitting on $400 million in cash. It can invest that in new iron projects, or it can develop anything other current prospects.

It’s trading at a market cap of $116 million today. According to the last annual report, it has $5 million in debt.

That means $395 million in cash is selling for $116 million. At face value, you can buy $3 for $1.

Cape Lambert jumped 30% yesterday. A big shareholder is trying to replace the board. So the company is shaking things up. It’s organising a $100 million payout to shareholders too. Even those don’t seem to warrant such a massive discount to this kind of liquidity though.

What we like about it most? Basically, the stock has its finger on the investment trigger. Right now, when mining projects are selling cheaper than they have in 4 years, it has a mountain of cash to buy them with.

Australia’s Earnings Outperform

Meanwhile, Australia’s earnings outperformed expectations at the latest annual report. Punters expected the trade balance to be $200 million in August. It came in at almost $1.4 billion.

It’s still a coal and iron story. It will be until exporting contracts are renegotiated. Cheaper oil imports helped too.

The Aussie dollar, meanwhile is trading at a 14-month low. We’ll say it again. Australia is the most undervalued stock in the global market.

The cheapest energy usually wins. That’s what history tells us anyway. Coal, oil and gas have always been cheaper than the rest. We had big North Sea reserves churning out black goop all through the 90s. The cheap oil kept other energies from getting started.

Now we have $94 oil in a global recession. That’s how scarce things are. But governments and central banks worldwide are flooding the global economy with money. French leader Nicholas Sarkozy is proposing a 300 billion Euro bailout now. Central banks worldwide have been flooding the economy with new money all week.

The problem? They’re like a smallish 6-year old trying to negotiate a full-size fire-hose. They can’t quite control where the liquidity goes.

It’ll go where it’s treated best. Some will head to gold or safety.

But some of it (combined with high levels of saved Asian cash) will probably return to the energy sector through speculators at some point. Peak oil will still be around when the banking crisis is over.

That’s a while away yet. But it’s time to start looking through ideas now. And the alternative energy sector has developed a lot since the last round of cheap money.

Ausra’s an interesting company. It isn’t listed, unfortunately. But we like the idea at face value. Its solar panels are cheaper than the expensive, mainstream photovoltaic technology.

Giralia Resources NL (ASX:GIR) is an exploration company with projects in Australia, Indonesia and USA. The company is mainly focused on exploration for precious and base metals.

Like many of the resources and metals-related stocks of the materials sector of the ASX, GIR has been hammered in the past quarter. It lost two-thirds of its value between early July and end of September.

The reason is that the financial crisis that may lead to a global economic crisis threatens investors. They expect a slower demand from emerging countries and this weighs strongly on base metals prices, and therefore on base metals explorers and producers.

Of course a further decline is possible in the coming months. Especially if more bad news convinces investors that the economic slowdown is worse than expected.

However there are currently opportunities for a technical rebound in obviously oversold stocks. This is the case here with GIR.

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It hit a long-term support line two days ago, on September 30 (point D on the chart). This support has been valid for more than one year now. It is built by the higher lows posted since August 2007 (points A, B and C). It’s a strong basis for the upcoming price development, as the negative momentum has lost most of its power. A consequence of this bearish trend completion is that the technical oscillators left their “oversold” area.

The Relative Strength Index (RSI) and the Money Flow Index (MFI) have indeed bottomed and have already started to curve upward. By crossing above their respective signal line, they have just triggered bullish alerts yesterday.

A retracement of the 66% decline occurred between June and September (points E and D) is therefore expected. The first intermediary resistance line might be the 23.6% Fibonacci ratio, but the main target for a rebound after such a fall is likely to be directly the 38.2% ratio, around $1.65. Yesterday the price closed at $0.99.

Fortescue Bounces for the Second Time this Year

Three things happened in the iron sector this week you should know about.

One: Fortescue (ASX:dipped below $5 for the second time this year. It bounced for the second time this year too. We haven’t taken a serious look at the company today. So that’s no prediction or recommendation. Just a fact you might be interested in.FMG)

Two. BHP (ASX:BHP) got approval from the ACCC on the Rio (ASX:RIO) bid. More on how that fits in below.

And three: Chinese companies decided to boycott Vale’s (NYSE:RIO) demands for higher iron prices.

Let’s deal with number three first. Vale must have been feeling sheepish it didn’t ask for more money when it was negotiating iron contracts mid-year. It got around 20% less than Rio or BHP.

So now it’s reneging. Last month it raised iron prices without asking. By no less than 20%. It’s like a restaurant charging you $20 for a $17 plate of spaghetti after you’ve ordered it. “Sorry. You know how inflation is these days.”

It’s really not surprising that China finally got fed up. Marketwatch reports that Chinese steel firms are boycotting Vale, the world’s biggest iron miner. They’re looking for alternatives.

Alternatives, eh? What do you get when you take Vale out of the iron sector? It’s a pretty simple equation.

Iron ore production - Vale = Australia.

BHP and Rio Move Closer to Merger

There’s an obvious problem with that, though. Top line players in Australia don’t actually have any advantage. Vale’s asking for more. But Rio and BHP have already asked for more and gotten it.

The three big guns hunt in packs. Contract negotiations fall into place pretty quickly once one big gun gets a price. We read somewhere about the possibility of an ‘iron OPEC’ earlier in the year. To be honest, the world already has one. It’s just not official yet.

When is the current meltdown over?

Today is another difficult day for the S&P/ASX 200, and little by little there are many stocks that become oversold. Investors are actually waiting for signals that could convince them to come back on the market and to take advantage of a rebound.

Obviously the timing for a rebound has not come yet. The bad news coming out from the US is not over. And equity markets can remain oversold for a while. This argues for a further decrease on the S&P/ASX 200. After 4 years and a half of continuous rise between March 2003 and November 2007, the investable benchmark for the Australian equity market has now retraced 50% of this bullish trend. Take a look at the chart below to see what I mean.

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The coming weeks should be particularly sensitive as the global equity markets are on the edge (lows of the year, 50% retracement of the 2003/2007 bullish trend). The news from Wall Street about potential new collapses will keep investors nervous and anxious therefore markets will remain volatile. Large swings and strong rebounds and pull backs may be expected on the near-term.

The weekly chart shows the 50% retracement of the bullish trend occurred between March 2003 and November 2007 (between points A and B on the chart). This support level has already been hit in early August (point D), generating a small rebound.

Today the price closed below this 50% retracement level. It’s an additional bearish sign and may confirm (the lowest closing price this year has been posted at 4,552.30 on September 18) that the support is cleared. Another false break signal is improbable therefore the price action will move further down. With the price support broken here, where is the next low? More on that in a moment.

Rebounds are difficult to assess right now. The price action rebounded in early September but was unable to gain positive momentum. New longs entered the market, but it was not enough to convince the rest of the market to fly back into the ASX 200 stocks. As a result, the technical indicators which were moving up since mid-July again triggered bearish signals.

This is the case with the MACD which crossed below both its signal line and the 0 line. It is also the case with the Momentum indicator which peaked and turned downward to cross below the 100 level. Consequently it is more than likely that the Index will fall lower on the near-term.
What could be the next target for this price action?

Where is the new low?

The new target will be the 61.8% Fibonacci retracement which is set around the level of 4,300 points. There will be a probable rebound as it is the last significant support level. Indeed, the 61.8% ratio also corresponds to a previous high which had been posted in March 2005 (point E). Previous highs become new lows therefore some buying interest should appear at this level.

Ultimately, there is another support at 3,500 points, which was a previous high level posted in June 2001, February and March 2002 (points F and G). On the upside, the current resistance line goes through the highs posted in early November 2007 (point B) and in May this year (point C).

The index is setting up for a mighty rebound. That means individual stocks will rebound as well. It will be impressive. But between now and then, we’d expect further declines in confidence from the U.S. banking crisis to lead to lower lows here on Australian stocks. We’ll be biding our time and building a list of rebound stocks to trade when the new lows are put in, or some other external event triggers an unlooked for reversal.

New items in the Senate Bailout Bill, SEC relaxes market-to-market rules

By the time the Australian market opens for trading on Thursday, the U.S. Senate will have voted on its version of the Paulson bailout bill. However, the Senate version of the bill has some new bells and whistles not included in the version that failed to pass the House. Two of the main measures added seem aimed more at shoring up political support for the bill, rather than improving the chances that the plan will actually work. But let’s take a look at them anyway.

First, the Senate wants to temporarily increase Federal insurance on deposits in U.S. commercial banks from US$100,000 to US$250,000. You might wonder what an increase in Federal deposit insurance does to improve the quality of assets on bank balance sheets. The answer is, “it doesn’t.”

But the increase in what the FDIC can offer is designed to make the Paulson plan more difficult to oppose in the House. Who is against providing ordinary savers more insurance for their life savings? Anyone? There is also the question of confidence.

By increasing FDIC insurance to $250k, you reassure (hopefully) people that there’s no need to remove their money from the bank. Here the Feds aim to prevent a run on banks by depositors that leads the bank to fail. This is what happened first at Indy Mac in July and at Washington Mutual earlier this week.

Depositors took out a whopping $16.5 billion from WaMu between September 15th and the end of the month. That kind of run is a serious drain on a bank’s capital. It’s a scenario the Congress wants to avoid by increasing FDIC insurance. It does nothing to improve bank balance sheets, unless, by restoring confidence, it prevents a huge drawdown in a bank’s assets (its deposits).

SEC relaxes market-to-market rules

Meanwhile, to address the value of those damaged assets that Henry Paulson can’t wait to get his hands on, the SEC clarified its stance on Tuesday with regard to mark-to-market accounting rules. This move is designed to give banks some wiggle room when it comes to valuing their damaged assets. The higher the banks can value the assets at, the less likely they are to have to take losses on those assets or sell them to meet capital requirements. They can stay in the game.

Here are some excerpts from the SEC’s clarification. Emphasis added is our own:

Can management’s internal assumptions (e.g., expected cash flows) be used to measure fair value when relevant market evidence does not exist?

Yes. When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable….This can, in appropriate circumstances, include expected cash flows from an asset. Further, in some cases using unobservable inputs (level 3) might be more appropriate than using observable inputs (level 2); for example, when significant adjustments are required to available observable inputs it may be appropriate to utilize an estimate based primarily on unobservable inputs. The determination of fair value often requires significant judgment.

How should the use of “market” quotes (e.g., broker quotes or information from a pricing service) be considered when assessing the mix of information available to measure fair value?

Broker quotes may be an input when measuring fair value, but are not necessarily determinative if an active market does not exist for the security. In a liquid market, a broker quote should reflect market information from actual transactions. However, when markets are less active, brokers may rely more on models with inputs based on the information available only to the broker.

Are transactions that are determined to be disorderly representative of fair value? When is a distressed (disorderly) sale indicative of fair value?

The results of disorderly transactions are not determinative when measuring fair value. The concept of a fair value measurement assumes an orderly transaction between market participants. An orderly transaction is one that involves market participants that are willing to transact and allows for adequate exposure to the market. Distressed or forced liquidation sales are not orderly transactions, and thus the fact that a transaction is distressed or forced should be considered when weighing the available evidence. Determining whether a particular transaction is forced or disorderly requires judgment.

And so on.

How does one make an estimate of an assets value based on “unobservable inputs?” How is one to reasonably estimate future cash-flows on a mortgage-backed security when house prices continue to fall? When a “market does not exist for a security” doesn’t that mean no one is willing to buy it at the current price? Why is that disorderly?

It is not overly-transparent account rules that have brought the banking system to its knees. It’s the fact that so many global banks own securities tied to the value of U.S. houses.

No bailout plan in the world is going to force banks to lend, even if they can get rid of their bad assets. More importantly, no bailout plan in the world is going to reverse the fall in American house prices (or even arrest in). Until someone comes along with a plan that severs the connection between residential American real estate and the banking system, the system itself remains on the edge of crisis. More on why the plan must fail below. But first…

When will the current meltdown end? The short answer is, not yet. There’s probably another few hundred points to go.

Yesterday was another difficult day for the S&P/ASX 200. Little by little, stocks are becoming oversold. Investors are actually waiting for signals that could convince them to come back on the market and to take advantage of a rebound.

Obviously the timing for a rebound has not come yet. The set of bad news that come out from the US is not over. And equity markets can remain oversold for some time before recovering. This argues for a further decrease on the S&P/ASX 200.

After a 4 and a half year rise between March 2003 and November 2007, the benchmark for the Australian equity market has now retraced by more than 50%.

The weekly chart tells that story (between points A and B on the chart). This support level had already been hit in early August (point D), generating a small rebound. Yesterday the price closed below this level. It’s an additional bearish sign and may confirm (the lowest closing price this year was 4,552.30 on September 18) that the support is cleared.

That means lower share prices for a little longer.

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The price action rebounded slightly in early September, but was unable to gain positive momentum. A few profit taking trades or new long positions built up but it was not enough to convince the rest of the market to move back into the ASX 200 stocks. As a result, the technical indicators have triggered bearish signals since mid-September.

The MACD has crossed once again below its signal line. So too the 40-day Momentum indicator. It has peaked and turned downward to cross below the 100 level. On the very-short term, the 5-day Stochastic Momentum Index has also turned bearish.

It’s more than likely that the Index will fall lower before any significant bounce back.

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So what’s the next target?

As mentioned in our last update (September 17), the new target will be the 61.8% Fibonacci retracement which is set around the level of 4,300 points. Expect some sort of rebound there. It’s the last significant support level.

Indeed, the 61.8% ratio also corresponds to a previous high from March 2005 (point E). Previous highs become new lows therefore some buying interest should appear at this level. We’ll re-assess at that stage. Until then it’s probably a good idea to be a spectator, not a speculator.

If Australia is a share on the global stock exchange, it’s oversold. Definitely oversold relative to other global markets. Possibly oversold in regards to its real value. That’s our contention.

Why? Well, here’s the market’s lesson for the day. Investors have separated global assets into two buckets. The first bucket is marked ‘risky’. The second is marked ‘not risky’.

Into the first bucket goes pretty much any asset you can buy that isn’t a sure thing. Shares, funds, commodities (oil in particular), high-yield currencies and anything else that isn’t pinned down go in there. Into the second bucket goes triple-A grade government-backed securities, low-yielding currencies and gold.

When investors want safety they go for the second bucket. But they’re still greedy enough to head back to bucket A from time to time.

Dow Gains 5% on Rescue Hopes

Take this week. Monday saw the Dow Jones drop 7%, oil drop 10% and the Aussie dollar fell below US80 cents.

Last night all those things gained. Oil is up US$4 this morning. The Dow Jones added 5%.

Why? Because rumours abound that the US Fed is about to take some risk out of the risky bucket. How? By orchestrating a global interest rate cut to relieve gasping credit markets.

It might happen. It might not. We’re not sure it’s even relevant. The Fed injected billions into the market after the bailout plan self-destructed. But we do know this. Investors will swing between the two buckets depending on whether a risk-reducing rescue mission looks likely or not.

Australia is definitely located in the risky bucket at the moment. The world sees mining shares as risky. Australia has mining shares. Ergo, Australia is risky.

Recently so much talk has been made about whether the global economy is coupled, decoupled…re-coupling, decoupling, or who knows what. Do individual countries economies move alone or are they all intertwined in one big global economic cesspool?

For example, if I showed you a chart of two indexes, but didn’t tell you what they were… you could tell me if they track each other just by looking at them.

Here we’ve got two indexes that over the last year seem to be following the same pattern. While they’re not exact… they track each other pretty well. The two lines on the chart represent the S&P 500 index and the iShares MSCI EAFE index (a broad measure of 21 individual country indexes).

Are these coupled, do they move together? Well in simple investing terms, the answer is yes. The S&P 500 index over the last year is down 22% and the MSCI EAFE index is down about 26%. So are global markets coupled?

Well the answer isn’t always as clear as the example seems…some are and some aren’t.

Just because the broad U.S. markets have been heading south all year and the larger more familiar international countries’ markets have also been on a year-long losing streak…don’t think that every market is following lock-step.
There are opportunities out there in the global markets. Not everyone is facing the same crises as the United States. Some South American countries, the Middle East, parts of Africa and others offer intriguing opportunities.

NEW YORK - Wall Street snapped back on Tuesday after its biggest selloff in years amid growing expectations that lawmakers will salvage a $US700 billion rescue plan for the financial sector.
Following Monday’s shellacking, the key Dow Industrials index picked up 485.21 points, or 4.68 per cent, to 10,850.66, while the broader S&P500 ran 58.35 points, or 5.27 per cent, to 1,164.74.
The NASDAQ, which carries tech and more recently listed heavyweights, climbed 98.6 points, or 4.97 per cent, to 2,082.33.

LONDON - Bargain hunting helped lift the London, Paris and Frankfurt stock markets on Tuesday after investors worldwide had dumped shares following the unexpected rejection of a US financial bailout package.
In London, the benchmark FTSE 100 index rose 83.7 points, or 1.74 per cent, to 4,902.5.

FRANKFURT - In Germany, the benchmark DAX 30 index lifted 23.94 points, or 0.41 per cent, to 5,831.02.

PARIS - In France, the benchmark CAC 40 index climbed 78.62 points, or 1.99 per cent, to 4,032.1.

TOKYO - Japan-based shares plunged more than four per cent on Tuesday, breaching a three-year low after US lawmakers unexpectedly rejected the Wall Street bailout.
The Tokyo Stock Exchange’s benchmark Nikkei 225 index lost 483.75 points, or 4.12 per cent, to end at 11,259.86, its lowest point since June 9, 2005.

HONG KONG - Hong Kong-based shares closed close to one per cent higher on Tuesday after a rollercoaster day saw the bourse fall more than six per cent at one point.
The benchmark Hang Seng index finished up 135.53 points, or 0.76 per cent, to 18,016.21.

WELLINGTON - New Zealand-based shares dived more than three per cent in the wake of the plunge on Wall Street. Shares fell as much as 4.65 per cent in early trading, but regained ground later in the day on fairly light volume.
The benchmark NZX 50 index fell 98.32 points, or 3.08 per cent, to close at 3,090.22.
In early trading today, at 0815 AEST, the NZ market had risen 64.56 points, or 2.09 per cent, to 3,154.79.

SYDNEY - Australian stocks are expected to show a stronger performance today, following a stronger performance on Wall Street overnight.
At 0800 AEST, the December Share Price Index futures contract on the Sydney Futures Exchange was 127 points higher at 4,812.
In economic news today, the Australian Industry Group and PricewaterhouseCoopers release their Australian Performance of Manufacturing Index (Australian PMI) for September, and the Reserve Bank of Australia releases its index of commodity prices.
The Hudson employment expectations survey for the 4th quarter also is due.
In company news, Orica Ltd chief executive Graeme Liebelt addresses the Committee for the Economic Development of Australia in Melbourne.
Court action against James Hardie Industries continues in Sydney.
In Brisbane, its the third and final day of the Coal Tech 2008 conference, and in Perth, it’s day two of the two-day Paydirt Asia Pacific Down Under conference.
Yesterday, the benchmark S&P/ASX200 index fell 206.9 points, or 4.3 per cent, to 4,600.5, while the broader All Ordinaries dropped 207.9 points, or 4.2 per cent to 4,631.3.

NYMEX

Oil prices swung back above $US100 a barrel Tuesday following a plunge a day earlier, with a growing consensus among investors that Congress will resurrect a failed US financial bailout plan.
Light sweet crude for November delivery rose $US4.27 to settle at $US100.64 a barrel on the New York Mercantile Exchange, after earlier rising as high as $US101.40.
In London, November Brent crude rose $US4.19 to settle at $US98.17 a barrel on the ICE Futures exchange.
Crude’s rise came despite a stronger US dollar. Investors often buy crude futures as a hedge against a weakening dollar and inflation, and sell when the dollar strengthens.
On Tuesday, the euro bought $US1.4069 compared with $US1.4472 late Monday in New York.
In other NYMEX trading, heating oil futures rose 10.62 cents to settle at $US2.8947 a gallon, while gasoline prices rose 8.77 cents to settle at $US2.49 a gallon. Natural gas futures rose 21.7 cents to settle at $US7.438 per 1,000 cubic feet.

COMEX

The December contract for COMEX gold fell $US13.60 overnight to $US880.80, after spiking above $US900 on Monday in the face of the Wall Street equities meltdown.
Silver and copper also falling overnight. December silver on COMEX lost 75 cents to settle at $US12.275 an ounce, while December copper fell 2.75 cents to settle at $US2.879 a pound.

The bailout was back - for about 24 hours or so. But last night the US House of Representatives voted against socialising its financial crisis. The score was 205 for, 228 against. Despite Hank Paulson’s confidence, all those foot-notes added to the bailout over the weekend came to nothing.

And now we have a serious panic. You can expect two things to happen.

Firstly, it’ll be a bad, bad day on the Aussie market. You’d be forgiven for going back to bed, reader. The Dow Jones had its worst day in history, falling 7%. Commodities are down too. Last we checked, oil was down around US$10.52. Metals and other commodities are following it down. Resources and the Dow Jones are the two biggest drivers of the Aussie market on any given day.

Secondly, credit markets are about to come grinding to a spectacular halt. Forget buying ‘good’ banks that seem undervalued. They’re about to become even more undervalued. Money market rates will soar as lending comes to a standstill.

It leaves the Federal Reserve and Treasury largely helpless. Unless a new plan goes through the American political system quickly, US banks are stranded. The only other weapon the Fed has against a crisis of liquidity and solvency is interest rates. It can lower them further.

It’s disastrous for the US economy. It’s inflationary too.

What’s ACTUALLY Happening in the Free Market

Unfortunately, self-proclaimed free enterprisers - President George W. Bush is one among many - are either ignoring or are unable to accept the fact that some people must suffer as the purging process runs its course.

Often their vision is blurred by their quest for a tighter grip on the private sector. They call it “compassion,” but I call it “zeal for power.” Worse yet, they use other people’s money — namely, yours!

In its infinite wisdom and undying compassion for the public, our government does all it can to hamper the market’s cleansing tools — recessions and deflation.

Instead of one swift painful smack in the head by the invisible hand, their very visible hand “helps” to ensure the economy will grow much less efficiently AND remain much more vulnerable to future shocks to the system.

That’s not compassion…it’s nonsense!

Really, on a historical basis, many parts of the U.S. economy are in awfully good shape. We’re told to believe otherwise because doom and gloom dominates what the mainstream media consistently reports.

One of the biggest fear indicators they use: Employment numbers. After all, Americans don’t want to lose their jobs.

But look at the current employment situation on a historical basis: While U.S. job losses are on the upswing, they are fairly modest … and should be expected in a self-cleansing market.

As my chart shows, taking into account only the last 40 years, today’s unemployment rate sits relatively low compared to 1975, 1983, and 1993.

If we play our cards right we could see the current rise in unemployment top out around the same levels as it did roughly five years ago. That would be nothing to panic over.

We May Just Be the “Least Ugly” Right Now By Comparison

Let’s look at inflation — another economic boogeyman…

Current CPI in the U.S. sits just north of 5%. That’s easily less than the roughly 6% to 7% back in 1991. And in 1980, for example, inflation reached almost 15%.

Countries, particularly emerging markets, would kill to have inflation as LOW as 5%!

More to the point, Americans can afford necessary food items as easily as ever. Here’s a snippet from an article put together by the Federal Reserve Bank of Dallas last month:

Based on the average U.S. pay rate, it takes less than two hours of work to pay for 12 basic food items — tomatoes, eggs, sugar, bacon, milk, ground beef, oranges, coffee, lettuce, beans, bread, and onions.

That figure is nearly as low as it’s ever been.

Consumption may finally be taking a breather, as it should, but discretionary items like computers, DVD players, cell phones, digital cameras and color TVs have become far more affordable. And that even includes those families considered “poor.”

Moreover, despite my view that the U.S. government is dipping its hand way too deeply into the markets, making them increasingly less free, it’s all a relative game.

Many other countries around the world are either officially in, or about to slip into, recession.

And on a relative basis, because their governments are much more entrenched in the market than Uncle Sam is in ours, their ability to recover is hampered even more.

Why is this an important part of the dollar equation? Because it means that, despite all our warts, it’s quite possible the U.S. might still win the global economic beauty contest by getting judged the least ugly.