Dear Subscriber,

Oil has pulled back from its highs, and now analysts are lining up to say the top is in. I've been saying all along that volatility is the name of the game in oil this year. Let me tell you now that I think oil could go lower in the short term — maybe to $110 a barrel, $100 if we're really lucky. Then, hold on to your socks, because we're probably seeing the set-up for oil's next HUGE rally.

Why do I think crude oil may have some more work to do on the downside? Nothing goes up in a straight line, and crude's run has been phenomenal — it was trading at just $78 a barrel a year ago. A short-term pullback is a normal and necessary part of any bull market, and crude is no different.

Short-term drivers that could push crude oil to $120 or even $110 a barrel include ...

• Easing tensions with Iran.
  
  
• U.S. consumers driving less — 3.7% less than this time last year, according to the Department of Energy. That doesn't sound like a lot, but it's a savings of 9.6 billion miles and hundreds of millions of gallons of gasoline.
  
  
• Expectations that Chinese demand will slack off now that preparations for the Olympics are finished.
  
  
• Fears that the financial crisis will translate into more pain for the U.S. economy and consumers.

Still, these are all short-term forces. For example, people are driving less because prices at the pump went up so far, so fast, that it came as a shock. Let prices go down a bit, let people get used to new "higher lows," and we'll probably see demand pick up again.

Now, let me tell you about some of the LONG-TERM forces in play that should drive oil to $150, $200 a barrel and beyond ...

Thirsty Tigers: The U.S. may be the world's leader in energy thirst (over 20 million barrels of oil a day) but China is coming on strong. According to the Energy Information Administration (EIA), China consumed 7.6 million barrels of petroleum each day of 2007. That's up 860,000 barrels/day in just two years.

What's more, Rigzone.com reports that China's oil imports in the first half of 2008 imply an increase of 480,000 barrels a day over the same period a year earlier.

Drive Me Crazy: What is China doing with all that oil? Fueling cars. In China, car sales rose by 20% in the first quarter of this year to 1.85 million vehicles. And while SUV sales are tanking in the U.S., the number of SUVs sold in China rose 43% in May compared with the previous year. Indeed, China's demand for gas is much of the reason for the run-up in global oil prices.

China alone accounts for about 40% of the world's recent increase in demand for oil. Fifteen years ago, there were almost no private cars in the country. China now has 15.2 million private cars. Still, less than 4% of the country's 1.3 billion people have already bought a car. That's the same percentage of car ownership the U.S. had in 1915!

China, India, and other emerging markets will continue snapping up cars — and oil — like crazy.

Emerging Markets in the Driver's Seat: China isn't alone. Demand is also soaring in India (up about 7% year over year), where the locals are lining up to buy the world's cheapest car, the $2,500 Tata Nano. India's government will spend $42.5 billion this year on oil subsidies — twice what it spent last year. And that's AFTER subsidies were scaled back in June.

And oil demand is also booming in Russia, across Asia, and the Middle East. In 2008 China, India, Russia and the Middle East for the first time will consume more crude oil than the U.S., burning 20.67 million barrels a day, an increase of 4.4% over year earlier levels, according to the IEA. U.S. demand will contract 2% to 20.38 million barrels daily.

Won't Less Demand from Developed Countries
Offset This Emerging Market Thirst?

No. Even though the U.S. Europe and Japan saw their combined demand drop by 760,000 barrels a day, according to the EIA, that's not enough.

China Syndrome: Oil demand is rip-roaring, and will overtake the U.S.

If China's present growth rate of oil demand continues at its current pace (6% to 7% per year) China will use 20 million barrels a day by 2020. That's about as much as the U.S. uses today.

And by 2030, China would be up to 40 million barrels a day — TWICE what America is using now.

Meanwhile, Supplies Are Strictly Limited!

EIA data shows the amount of petroleum products shipped by the world's top oil exporters — 15 countries which account for 45% of all production — fell 2.5% in 2007, despite a 57% increase in prices. This trend is continuing this year, as petroleum exporters use more and more of their own oil.

For example, last year, the region's six largest petroleum exporters — Saudi Arabia, United Arab Emirates, Iran, Kuwait, Iraq and Qatar — curbed their shipments by 544,000 barrels a day. At the same time, their domestic demand increased by 318,000 barrels a day, leading to a loss in net exports of 862,000 barrels a day.

Well, we'll just get oil from outside of OPEC, right? Sorry, but the International Energy Agency says that production in non-OPEC countries is set to peak within the next two years. Fatih Birol, chief economist of the IEA, pointed a finger especially at the North Sea, where production is falling at 7.5% per year, and at Mexico, which is experiencing double-digit percentage declines in oil production.

All this is squeezing global spare capacity mercilessly. The global supply cushion is officially listed as 2 million barrels a day; in reality it's probably less. It wouldn't take much of an emergency to take away all that spare capacity and then some.

Indeed, we saw crude firm on Monday on news of more attacks on pipelines in Nigeria and the news that the United Arab Emirates will cut its production by at least 100,000 barrels per day for up to 40 days starting in October. You have to wonder what's going to happen next.

Then there's ...

Mexico: Been Down So Long,
Don't Know Which Way Is Up

Petroleos Mexicanos, the state-owned energy company, said Mexico's oil output fell 11% in June from a year earlier. The decline at its flagship Cantarell field is even worse — down 35% year over year!

Mexico is pumping new fields to compensate for the drop at Cantarell, but can't bring on enough oil quickly enough.

Remember, Mexico is the third-largest supplier of crude to the U.S. It exported 1.415 million barrels in June, down 19% from the previous year, and the lowest level in a dozen years. This is already affecting a name you're probably familiar with — refiner Valero Energy. Mexico told Valero it would cut supplies to one of the company's Gulf Coast refineries by up to 15%.

What About the Good 'Ol U.S. of A?

Four decades ago, the U.S. was the biggest oil producer in the world. But America's crude oil output peaked in 1970, at 9.6 million barrels a day, which was enough to cover most of the country's needs back then.

Now, U.S. crude production stands at 5.1 million barrels a day. On the demand side, America consumes one of every four gallons of oil in the world but has barely 3% of the world's proven reserves of conventional oil.

End result: The United States now imports nearly 60% of its crude, twice the ratio of imports before the 1973—74 Arab oil embargo, as we thirst for the fuel to drive 220 million cars.

Our demand is going down for now. But the real drivers of global demand are in the emerging markets. So even if we cut back on our oil usage, oil prices will probably continue to zig-zag inexorably higher.

In the short term, the only answer is conservation. "Drill, Drill, Drill" isn't realistic because all the oil rigs are rented out for the next three to five years. Heck, we may have even less — the contracts for sea-based rigs are being snapped up by national oil companies from Brazil to Saudi Arabia, and Chinese oil companies make shopping trips for land-based rigs in North America. They break 'em down and ship 'em back home for their own urgent energy exploration program.

Longer-term, as I told you last week, I think we'll use a regular "energy buffet" of wind, solar, nuclear and more.

But Peak Oil is coming — or already here — and as the world's remaining giant oil fields follow Mexico's Cantarell into decline, you will be amazed by just how high oil prices can go.

So Take Steps to Protect Yourself and Profit!

There are two great energy funds that have gotten cheaper as oil has pulled back. I don't think they will be down for long.

The United States Oil Fund ETF (USO) tracks the price of oil pretty closely by holding crude futures contracts. I consider it a good place to be to ride the next leg up in oil.

I also like the iShares Dow Jones US Oil & Gas Exploration & Production Index Fund (IEO), which is stuffed with good stocks including Occidental Petroleum, Devon Energy, Apache Corp, EOG Resources and more. Those are the kind of stocks that will make the most of the big oil bull market. After all, these stocks make money hand over fist when oil is at $100 a barrel — they'll make an absolute killing when oil goes to $150 ... $175 and higher.

Yours for trading profits,

Sean

Dear Subscriber,

Many Americans are disgusted by the fact that, faced with an energy crisis, the government seems to produce nothing but hot air. I think the government is paralyzed because there's no one clear solution.

Instead, there are a multitude of options — more drilling, nuclear power, hydrogen cars, solar power ... you name it. Every alternative has a lobby in Washington to press its case, but there's no one to tell our elected officials which is the best route to take.

I field these questions all the time, from friends and co-workers who ask me if this or that particular energy solution is the next big thing. So let me give you my appraisal of three alternative energy solutions that work and three that DON'T — along with some choice investments you can make to power your own bottom line.

Let's start with ...

Energy Solutions That Don't Work

You probably already know that corn-based ethanol isn't the right solution, for the simple reason that nearly as much energy is used making corn-based ethanol as you get out of it. So I won't waste a lot of time except to point out that the U.S. Department of Agriculture STILL anticipates corn ethanol production of 9.3 billion gallons for the crop marketing year 2007/2008. That will use more than one-fourth of our corn crop (and drive your food prices through the roof). Now, here are three more solutions you may think will work ... that probably won't.

Bad Idea #1 — Oil from Algae

Not all algae are created equal. Some are just pond scum, and some algae, properly cultivated, can produce biodiesel — that is, diesel you can grow right in your own back yard (or converted swimming pool).

Biodiesel from algae is still a ways off from large-scale viability.

So what's the problem? Scale.

While it is true that algae can produce more biodiesel per acre per year than many land crops, it takes either lots of ponds or land covered in clear plastic algae-growing tubes, which have to be made from the oil you're trying to grow.

So algae-based biodiesel will become a viable solution when the technology improves or we convert Lake Michigan to a biodiesel refinery.

Bad Idea #2 — Hydrogen Cars

What many people don't understand is that hydrogen isn't a fuel, it's a storage medium. So, whatever energy you store in a hydrogen-powered car has to be generated some other way (coal, natural gas, nuclear, etc.).

And then there's the danger factor. A tank of compressed hydrogen can explode with an earth-shattering "KA-BOOM" if hit hard enough. So you end up with highly pressurized, reinforced storage vessels which are three to four times the size of conventional fuel tanks.

Then there's the cost — the price of a hydrogen car easily runs over $150,000. Sure, costs will come down, but not that much.

Why does this idea have so much traction? Because both Washington and Wall Street love expensive boondoggles, making hydrogen fuel cells into black holes for your tax dollars.

Bad Idea #3 — Shale Oil

There is a big difference between oil shale and shale natural gas, and it is confusing the heck out of people. Let me make it simple: Shale natural gas works. Shale oil doesn't — not yet anyway.

Oil shale is a rock that contains an organic compound called kerogen. Left on its own, kerogen might turn into oil in 100 million years. Oil shale is different from shale natural gas in a lot of ways. For one thing, shale gas is economically feasible, but shale oil hasn't proved profitable (yet).

To harvest the kerogen, the rock is dug up and heated to 700 degrees Fahrenheit. On average, you have to process about two tons of rock to get one barrel of synthetic oil. The rock expands during the heating process, so you can't put it back in the hole you took it out of (or at least, not all of it). And the kerogen-harvesting process makes the rock carcinogenic, so you have to be careful how you store it.

Newer technology removes the kerogen without digging up all the rock, but that process still has bugs that are being ironed out.

Finally, three barrels of water are needed to make one barrel of synthetic crude from oil shale.

The Bureau of Land Management estimates the shale formation in western Colorado, where a lot of activity is focused, could yield as much as 1.8 trillion barrels of oil. However, that part of Colorado is dry country. It will also probably take a lot of energy to crack the oil out of the rock, though nuclear power could provide that energy.

Royal Dutch Shell is trying to prove naysayers wrong — it is investing a lot of money in oil shale. Petrobras, one of the world's best-run and most forward thinking oil companies, is also experimenting with oil shale. So maybe it will work eventually. But right now, the technology isn't there yet.

In fact, the problem with many solutions that sound good on paper is that the technology just doesn't work yet. But ...

Here Are Three Energy
Solutions That Work Right Now

These three sources of energy can work — today — to power our homes and rev up our cars.

Solution #1: Wind Power

Critics will point out that the wind seems to stop blowing when you want electricity most — on hot summer days. And that is a problem. However, a study last year by Stanford University shows that wind power from interconnected farms can be used as reliable base load electric power.

Wind power, especially when used on a large scale, is a great alternative source of energy.

As one might expect, not all locations make sense for wind farms.

But legendary oilman T. Boone Pickens says the United States should take advantage of the so-called "wind corridor," stretching from the Canadian border to West Texas. Energy from wind turbines built there could supply 20% or more of the nation's power by 2030, according to a new report from the Department of Energy.

U.S. electrical demand is expected to grow another 39% through 2030, so wind would help fill the gap.

And although wind is expensive, costs per unit should come down with a larger scale operation. Besides, with the cost of coal and natural gas rising, wind is already becoming more competitive.

Solution #2: Solar Power

Unlike wind, we tend to get the most solar power when most electricity is needed — during hot summer months. And the technology is working now.

There are two general forms of solar power. The first is PV or photovoltaic, which converts energy from photons directly into electricity. The second is thermal, which uses the sun's heat, concentrated to heat liquids to transfer that heat, boil water and turn a turbine.

A rooftop photovoltaic system is fairly expensive — about $35,000 to $40,000, though the cost can be reduced through tax incentives and rebates. In sunny Florida, where I live, the system would probably pay for itself in 15 years or less — a lot less if electricity rates go through the roof, as Florida Power & Light is now threatening.

Solar thermal is also expensive, though cheaper than PV-based solar power. The Mojave Desert in the southwest is home to the largest solar thermal system in the United States. This Solar Energy Generation System (SEGS) has a total capacity of 354 megawatts.

New technology allows for better, cheaper storage of solar energy even when the sun isn't shining. Of course, wind and solar aren't widely used to power cars ... but that can change.

Solution #3: More and Better Electric Cars

There is technology available today to plug an electric car into your home power grid. In short, it turns a fleet of electric cars into a network of mobile generators that can draw energy from the power grid and send electricity back to the grid during periods of peak demand. It's called a vehicle-to-grid system, or V2G.

Only 20% of cars are in use at any time, so the rest could work as plug-in batteries and load buffers for the electric grid. By combining new electric cars with wind and solar power we'd have a 1-2-3 integrated solution to the energy crisis.

America's existing electric grid could support 180 million electric cars, and a concerted effort to upgrade the grid could let it support 200 million.

There are other advantages, too. With the same amount of electricity, you can drive an electric car three times farther than a hydrogen car. On 100 kilowatts of electricity you can drive an electric car 75 miles while a hydrogen fuel cell car of similar size can do only about 16 miles.

Are there obstacles? Yes! First of all, many electric cars can't keep up with the speeds on America's highways.

The easy solution to that is to lower the speed limits for all cars (55 or 60 mph) and allow electric cars to go at even lower speeds (45 mph or so) on major highways.

As Ronald Reagan said, when confronted by government-mandated 55-mph speed limits, "Speaking just personally, I think it's not a bad thing if we all slow down just a bit and enjoy the scenery a little more."

The second problem is that manufacturers simply can't make electric cars fast enough. U.S. consumers buy between 15 million and 17 million new cars per year. Meanwhile, Toyota only makes 20,000 of its Prius hybrid models a month, and GM is planning on building just 60,000 of its new Volt electric cars in 2010.

The new battery-powered Think City, which will enter the U.S. market at the end of 2009, will be able to travel up to 110 miles on a single charge, with a top speed of about 65 mph, and be priced below $25,000. Yet the manufacturer plans to sell only 10,000 units at most in the U.S. during its debut year.

But that's where the government can help, too. World War II saw U.S. auto makers go from making cars to tanks in a matter of months. With can-do spirit, government money and a big ol' pair of scissors cutting through red tape, Detroit could become the electric car capital of the world.

Look, there is no "silver bullet" solution. It's a bunch of bullets strung together for just one possible solution. And I haven't covered other workable alternative energy solutions including nuclear power, electrified rail or cars powered by compressed natural gas.

Moreover, the best thing we can do is use less energy — conservation. The cheapest oil is oil you don't use.

Still, I want you to know that there are workable solutions right now. And not only can they help our country, but they can reward investors, too ...

How You Can Profit in Alternative Energy

There are a bunch of great funds in the alternative energy space. Here are two that focus on two of the solutions I talked about today — wind and solar.

The Claymore/Mac Global Solar Energy Index ETF (TAN) holds a basket of 25 stocks in the solar space, and it is a fund with a global portfolio, as its name implies.

The PowerShares Global Wind Energy ETF (PWND) is a basket of 32 companies, also worldwide, that are focusing on wind energy.

Yours for trading profits,

Sean

Dear Subscriber,

When is enough, enough? How much is too much?

Those are the questions I've been pondering lately as I survey the housing and mortgage market landscape.

It seems like every week we get another borrower bailout initiative.

Or another multi-billion dollar package of legislation.

Or another whiz-bang Federal Reserve program that keeps U.S. banks and brokers on the dole for a few more months.

Or more recently, a blatantly transparent attempt by the Securities and Exchange Commission to squeeze short-sellers and drive stock prices higher ... but only for a select group of 19 financial companies.

Are we a free market society? Is this a capitalist economy? I thought so.

But with each extra step to prevent the failure of a lender who made too many stupid decisions ... with every effort to keep borrowers who overextended themselves on home mortgages ... and with every move to prevent what NEEDS to happen to restore health in the housing market — namely, falling home prices — I wonder that much more.

And I'm afraid the long-term consequences of all these bailouts will be severe. So today, I want to examine how we got here — and talk about where we're going ...

The Fed Shifts into Hyperdrive ...

The credit crisis started striking in earnest last summer. The Fed's initial response was to cut interest rates, hesitantly at first, then much more aggressively. The idea was two-fold:

#1. Drive funding costs lower in order to bail out lenders by fattening their net interest margins (the difference between what they pay to borrow money and what they make on loans) ...

AND

#2. Bail out borrowers with adjustable rate mortgages or home equity lines of credit by lowering the cost of paying their loans back.

The Federal Reserve has cut interest rates, and thrown billions and billions at the markets ...

But the Fed didn't just deliver 325 basis points of interest rate cuts. It has also rolled out liquidity program after liquidity program for commercial banks and (later) investment banks.

The Fed's efforts on that front began in December 2007 with the Term Auction Facility, or TAF. The TAF allows depository institutions to swap securities for Fed loans.

Originally, the TAF auctions were going to offer $20 billion a pop, with 28-day maturities on the loans. But the Fed soon raised the auction sizes to $30 billion ... then $50 billion ... then $75 billion. The Fed also said TAF auctions would last "at least" six months.

Then this week, things changed again. The Fed said it will now offer 84-day loans on top of 28-day ones. And it released an auction schedule that implies TAF auctions through November at least. In other words, the "temporary" bailout program is now going to last for who knows how long.

And even the TAF wasn't enough for bailout-hungry lenders!

The Fed was forced to roll out the TSLF — or Term Securities Lending Facility — in March. The TSLF lets primary dealers bring all kinds of less-than-pristine securities to the Fed and swap them for top-notch Treasuries.

Fannie and Freddie debt? Residential mortgage backed securities? Commercial mortgage backed securities? Bundles of car loans, student loans, and credit card balances?

"No problem. We'll take it all," said the Fed. The total amount of U.S. debt up for grabs: $200 billion.

Did that do it? Nope. The brokers started facing more funding problems. So the Fed put them on the dole as well, introducing the Primary Dealer Credit Facility, or PDCF. This allowed other dealers, as opposed to just depository institutions, to borrow at the Fed's discount window. Like the TAF, it was originally slated to be in place for six months.

But surprise, surprise: Our financial institutions apparently aren't in good enough shape to actually operate without tens of billions of dollars of Fed assistance month in and month out.

So rather than cut them off and let them stand on their own two feet and merits, like American businesses USED to have to do, the Fed just announced that it will extend the PDCF and TSLF programs through January 30, 2009.

Anyone want to lay odds that "deadline" will stick? Didn't think so.

Treasury, Congress Get into the Game, Too ...

At the same time, the Treasury Department and Bush administration started rolling out various programs to help borrowers.

The FHASecure program was designed to make it easier for borrowers who had fallen behind on their ARMs to refinance into FHA-insured mortgages.

Meanwhile, Congress and the Treasury Department have introduced a slew of aid programs!

Then there was the HOPE NOW coalition, a government-industry joint effort to encourage more loan modifications. That's when lenders extend loan maturities, reduce interest rates for a period of time, or otherwise try to stave off foreclosure by changing the terms of borrower's mortgages.

Meanwhile, tax laws were modified so that forgiven debt was no longer considered income. Let me explain ...

Say you bought a $200,000 house with no money down, and its value fell. You might negotiate a short sale with the lender that would allow you to sell the house for $180,000. You would use the proceeds to pay off that part of the mortgage balance, while the lender forgives the remaining $20,000.

Previously, that $20,000 would have been considered income, and you would have paid taxes on it. That ended when Bush signed the Mortgage Forgiveness Debt Relief Act of 2007 into law in December.

And now the President just signed the massive Housing and Economic Recovery Act of 2008 into law this week. This bill has a little bit of everything:

• It authorizes the FHA to insure up to $300 billion in new mortgages. Lenders are required to write down the principal of outstanding loans to 90% of the current value of the underlying properties. Then borrowers can refinance out of their private loans and into new FHA-backed mortgages.
  
  
• The bill also permanently raises the size of home mortgages that Fannie Mae, Freddie Mac, and the FHA can back or buy — to as much as $625,000 in higher cost areas.
  
  
• Localities will get $3.9 billion to buy, renovate, and resell foreclosed properties. State housing authorities will be granted permission to sell another $11 billion in tax-free bonds to fund mortgage refinance programs.
  
  
• And first-time home buyers who purchase between April 9, 2008 and July 1, 2009 will get a $7,500 tax credit (though in reality, the benefit is essentially an interest free loan that you have to pay back over 15 years).

But the most important — and potentially, the costliest — provisions pertain to Fannie Mae and Freddie Mac. The two so-called "Government Sponsored Enterprises" now have access to an unlimited line of credit from the Treasury (Previously, it was $2.25 billion each). The government has also pledged to buy equity from the two GSEs, should they need help raising money.

Officially, these moves don't bring Fannie Mae's and Freddie Mac's $5.2 TRILLION in direct and contingent mortgage liabilities onto Uncle Sam's balance sheet. But by making the implicit backing of the companies explicit, the government might as well have taken that step.

And of course, the mortgage and housing industries were ALREADY receiving billions of dollars worth of subsidies and tax favoritism.

Since 1997, married couples have been able to exclude as much as $500,000 in capital gains from the sale of their primary residences from the tax man. Stocks and other assets get no such treatment.

Borrowers can also deduct the interest on up to $1 million in first mortgages and up to $100,000 on home equity loans. That means you can borrow $5,000 against your house to cruise the Mediterranean and then catch a tax break for it!

Here's the real question that needs to be asked ...

What's the Price of All These Bailouts?

My fingers are almost blistering from recounting the various direct and indirect ways the Fed, Congress, and the Bush administration have tried to bail out lenders, borrowers, builders, and everyone else who helped inflate and/or profited handsomely from the housing bubble.

There's just one problem. Bailing out anyone and everyone isn't free! The cost of the Fannie Mae and Freddie Mac support program alone could total as much as $100 billion, according to the Congressional Budget Office. All the other provisions in the latest housing bill will likely end up costing billions more.

Meanwhile, the Fed's actions are increasingly weakening its OWN balance sheet. Total Federal Reserve credit is about $883 billion, up from $850 billion a year ago. The vast majority (about 92%) of the Fed's money was in rock-solid U.S. Treasuries a year ago. Now only 54% is. That's a consequence of lending tens of billions of dollars to institutions via the TAF ... of assuming $29 billion in lousy paper as part of the Bear Stearns bailout ... and more.

And the cost of all the old tax breaks on housing and mortgages (things like the mortgage interest deduction)? Well, that will come to about $148 billion in 2008, according to a Washington Post piece from Robert Samuelson. He writes:

"The real lessons of the housing crisis have gotten lost. It's routinely portrayed as the financial system run amok; the housing market became a casino. The remedy, we're told, is to enact rules that prevent a repetition. All this is partly true. But it ignores a larger truth: Our infatuation with homeownership, embedded in dozens of government policies, has turned housing — once a justifiable symbol of the American dream — into something of a national nightmare.

"As a society, we're overinvesting in real estate. We build too many McMansions. They use too much energy, and their carrying costs, including mortgage payments, absorb too much of Americans' incomes. We think everyone should become a homeowner, when many families can't or shouldn't. The result is to encourage lending to weak borrowers who are likely to default. The avid pursuit of a few more percentage points on the homeownership rate (it rose from 64 percent of households in 1994 to 69 percent in 2005) has condoned enormously damaging policies."

It's not like we have all this money lying around to pay for all of these programs, either. New projections show the budget deficit should come in at about $389 billion in 2008. And next year, it's poised to explode — to a record $482 billion. The previous estimate was for a 2009 deficit of just $409 billion.

What does that mean? We'll have to sell Treasuries by the truckload to fund all the red ink! You, I, and our kids and grandkids are going to have to pay that bill.

None of this even TOUCHES upon the moral hazard question — whether all these bailouts will just reinforce the idea that lenders and borrowers are free to recklessly speculate, knowing that if they get in trouble as a result, Uncle Sam will bail them out (using our money).

Finally, has anyone stopped to think about whether mobilizing the full faith and credit of the U.S. to prevent or slow the decline of home prices is a laudable goal?

From where I sit, falling home prices aren't the problem. They are the SOLUTION!

As prices fall, homes will become more affordable for NEW buyers.

They'll be able to purchase houses with traditional 30-year fixed loans — not all the newfangled crap the industry foisted on people between 2003 and 2006.

They won't have to take out loans with payments that swallow 40% or 50% of their monthly income.

They'll be able to enter SUSTAINABLE homeownership, not just get into a house for the sake of getting into a house — and then lose it a year or two later.

Even investors will be enticed back into the market if lenders are allowed to foreclose and fire sale more property. Heck, that's already happening in some select markets here in Florida, in California, and a few other of the places where prices have fallen the hardest and fastest.

The combination of owner and investor buying, in turn, will reduce inventory levels and get supply back in line with demand ... IF we let prices go where they need to go.

It's certainly food for thought as the bailout brigade keeps riding out from the stables of Washington, D.C.

Until next time,

Mike

Dear Subscriber,

You can never actually know for sure what's going to happen on any given day, in any given market. And it's thinking you do know that can get you into real trouble.

Instead, you should think about the markets in terms of probabilities. I believe that is the real key to successful trading.

Here's how legendary trader Richard Wyckoff put it ...

"Listen to What the Market Is Saying About
Others Instead of What Others Are Saying About the Market"

In other words, you need to be open to information the market is sending you.

In short, we have forecasts, time-frames, and reasons, but if the market tells us those things are wrong — we should act. Let me give you a great example from this past Thursday:

• U.S. second-quarter GDP growth undershot expectations ...
  
  
• Weekly jobless claims overshot expectations ...
  
  
• And capital started stampeding out of the dollar.

In a game of expectations, it seemed as though traders were ready to erase the dollar's latest rally and send it dramatically back to test all-time lows.

Turns out, it only took a few hours for the all-out dollar stampede to make a sharp U-turn.

In fact, the U.S. dollar index actually finished the session relatively flat from where it stood when the fireworks started.

In my opinion, this demonstrates two important points about the U.S. dollar right now:

Critical to Thursday's whipsaw action was the anticipation of Friday's U.S. jobs report. We know now that jobs declined less than forecast even while unemployment jumped more than forecast in July.

The immediate reaction following the better-than-expected news was mostly positive for the greenback.

What about the dollar's longer-term prospects? I think we should look past the day-to-day action for that answer ...

This Year, the Dollar Is Down —
So Is It a "Smile" or a "Frown?"

At the beginning of the year, I told you about a concept called the Dollar Smile. That idea offered up three potential scenarios for the greenback. Briefly:

1) The U.S. dollar appreciates on risk. In other words, the buck could ignore its weak fundamentals and rally on a flight to quality. This assumes foreign currencies and investments lose their appeal in the event of a global financial crisis. So far we have not seen this scenario play out.

2) The U.S. dollar appreciates on surprise growth. Clearly, this hasn't happened. Any positive surprises regarding the U.S. economy were few and far between. I ruled out this scenario in January, and I think it's safe to rule it out again. At least for the rest of this year.

3) The U.S. dollar falls as the U.S. economy muddles along. For the most part, this is exactly what has happened since January when I published the Dollar Smile concept here in Money and Markets. Each new month the economy revealed greater disappointment. And the U.S. dollar index has fallen as much as 7.8% since then.

Considering the way the dollar has been behaving over the last several weeks, I thought it would be good to go back and think about where we are with the dollar smile. In doing so I decided the environment is far different from the environment back in January.

With that in mind, I developed something a tad bit different from the dollar smile; something I think does a better job of offering up potential scenarios for the buck. Let's call it "the dollar frown."

Have a look at the following graphic. On top you'll find the Dollar Smile. It's a visual representation of how the dollar behaves based on the three scenarios I just described. On the bottom is the Dollar Frown. It's a representation of the three scenarios I'm about to lay out for you.

Scenario #1 — The U.S. dollar falls on risk. Again, if we look back to analyze the dollar's performance since January, we'll actually find that the buck has done poorly during major bouts of risk aversion. It's no secret the U.S. stock market is having a stinky year. And it's no secret the dollar is following that lead.

Just recently we experienced what I call the triple whammy — a flight out of U.S. stocks, U.S. bonds and the U.S. dollar. This points to the possibility that investors are growing increasingly concerned about a potential collapse of the U.S. financial system. This type of risk bodes ill for the buck because capital would flee ALL U.S. assets.

Scenario #2 — The U.S. dollar rises as the U.S. economy becomes relatively less bad. For much of the last couple years, the U.S. has been the laughingstock among major global economies. And for longer than that the buck has been sinking lower and lower and lower versus the major currencies.

But now analysts, economists and investors are beginning to notice a weakening trend seeping into many developed nations. The secret is already out on the United Kingdom. They're following the path of the U.S.

The commodity dollar countries — Canada, Australia, New Zealand — have all had their scares, too.

And European countries are now on the economic watch list for fear they're at risk of major collapse. And it doesn't look like they'll be getting off that list any time soon.

Bottom line: If the U.S. muddles along while Europe et al start to crater, the dollar can rally as its disadvantage narrows.

Scenario #3 — The U.S. dollar falls on doom and gloom. Of course, it doesn't matter so much what's happening in Europe or anywhere else if it pales in comparison to what's happening in the U.S. This scenario is similar to scenario #1, but to me it implies a LENGTHIER dollar decline.

Which scenario is most likely right now? I'm leaning toward scenario #2, especially in light of what I saw happen this past Thursday.

Best wishes,

Jack

Dear Subscriber,

With America's economy sinking rapidly into recession, with much of America's financial system teetering on the brink, and with a presidential election just three months from today, our leaders in Washington are under siege.

What are they saying behind closed doors? What worst-case scenarios are they contemplating? What contingency measures are they debating?

I have no pretense of being privy to the answers. Nor can anyone forecast what they will do in the press of events. But we do have abundant research and data to serve as a basis for guessing. Add a healthy dose of imagination, and I can begin to draft a script, below.

Just bear in mind that what follows is fiction — a scenario that I trust will give you greater insight into the dire reality of our times, along with a better understanding of what's likely to come.

The Last Government Rescue
(Draft Script for a Fictional Scene)

A regularly scheduled meeting between Treasury Secretary Paulson and Fed Chairman Bernanke is hastily expanded to include the CEOs of Fannie Mae and General Motors, plus former Fed Chairmen Alan Greenspan and Paul Volcker.

The Treasury Secretary seeks unanimous vows of confidentiality and opens the discussion with an air of confidence. His immediate agenda: To get everyone on the same page to make consistent public pronouncements in support of the government's rescue efforts for the economy.

Treasury Secretary Henry Paulson: Gentlemen, I know we have problems, and that's why we're here today. But let's begin by counting our blessings: The stimulus plan has supported the economy during this difficult period, and it couldn't have been timelier. American families spent, American companies invested, and the country as a whole benefited from strong export growth.

Yes, I know the 1.9% growth in GDP in the second quarter disappointed some people. But a lot of that was due to a decline in inventories, which is healthy. The economy is not contracting; it's growing. Employment is still historically very high. Inflation is still historically low.

Moreover, this is the message I would hope to see everyone put out. In normal times, I wouldn't presume to tell you what to say or how to say it. But in this unsettling climate — in this atmosphere of frazzled nerves on Wall Street — the last thing we need is dissenting voices from the administration, from former government officials or even from industry. To restore confidence — to prevent panic — we must present a united front, a single voice that resonates with the public, that's credible, that can inspire, that can motivate investors to invest and banks to lend.

Fed Chairman Ben Bernanke: I agree. We have to tell the truth. But there should be no rush to tell the whole truth. Always count your blessings, and do so publicly.

Former Fed Chairman Alan Greenspan: Blessings? This is a disaster and it's getting worse. The United States is living through a once-in-a-century crisis tied to the plunge in home prices, and those prices are nowhere near a bottom.

Paulson: I know housing continues to be at the heart of our economic challenges and remains our most significant downside risk. I know home prices are likely to decline further on a national basis. I know foreclosures are going to be increasing. And I didn't say we should deny these realities in public. I myself have recently admitted to all of them — in speeches, in front of dozens of TV cameras.

Bernanke: My sense is that if we don't acknowledge at least some of the most obvious issues, we look foolish.

Paulson: Agreed. But you and I also agree that we don't have to be so blunt as to cause panic in the markets. Look. I'm not asking anyone here today to ignore the issues. What I'm asking is that we do everything we can to stress the positive. Focus on the big steps we've taken — like the stimulus package and the housing legislation. Talk about the brevity of the current correction and the longevity of the coming recovery.

Give people hope, damn it! Don't run around talking about the housing market as a bottomless pit ... or about the huge risks the Fed is taking by inserting itself into broker balance sheets ... or about Fannie Mae being insolvent.

Greenspan: The last of those three statements was not mine. But it's true. Fannie Mae is insolvent. And what you're advocating — that we sugarcoat the realities even more than we normally do — is a huge mistake in its own right. The sooner people face the music, the sooner they'll deal with it and the quicker we'll get this thing behind us. The longer we cover it up and pussyfoot around, the worse it's going to be in the long run.

I said it once, and I'll say it again: Gentlemen, face it. This is a disaster and it's getting worse. Home prices, which we said would stabilize, are doing nothing of the kind. Detroit, which we said would be turning the corner, is falling off a cliff. The credit crunch, which we said was ending, looks like it's just beginning a new, broader phase. Inflation, which we said was moderate, is doubling. The federal deficit monkey, which we said was tamed, is going wild again.

That's what folks out there are talking about. That's what's in their face every day on the nightly news. Heck, the only "good" thing I hear anyone talking about nowadays is the fact that a barrel of oil costs "only" $125, which, I need not remind you, is double what it was last year.

Paulson: So that's what you want to tell the American people? That "this is a disaster and it's getting worse"?

Greenspan: No, but how can we address the dangers we face if our primary agenda is to disguise the true gravity of those dangers? First, we risk losing all credibility — looking like horse's asses. Second, we risk a situation in which we ourselves start believing our own B.S. But most fundamentally, we risk losing the opportunity to cure the cancer before it spreads to critical organs of our economic body.

Fannie Mae CEO: I can no longer dispute the comment that we're insolvent.

Paulson: Please give us a heads up on that.

Fannie Mae: This week, we are going to announce still another round of downgrades in our forecasts for credit losses.

We've already warned investors that credit-related losses, such as payouts on loans we guarantee, were going to rise for the rest of the year. But this market is crumbling far faster than anyone dreamed possible. Even the Jeremiahs and Cassandras at Fannie Mae — and believe me, there are more of them coming out of the closet every day — even they underestimated how fast the home market could come unglued. Even they underestimated the degree to which that pattern would persist through the present and into the future.

Look at the numbers that just came out. You've got home prices falling far faster than expected. You've got more people defaulting on their mortgages at a faster pace than expected. And you've got foreclosures spreading faster than anything we've ever seen in the history of this country. It's a revolution. It's sweeping the country like wildfire. And it's being led by people willing to abandon their homes without the least remorse.

Paulson: Bottom line?

Fannie Mae: Bottom line, the forecast we made back in May — and Freddie Mac's forecasts as well — are way off target.

Paulson: Is that why Standard & Poor's just raised its loss estimates on your risky loans? Is that why Wall Street is saying you may not have enough capital to offset those losses?

Fannie Mae: Yes. We did ratchet up our expectation for 2008 credit loss ratio to at least double our historical range. But now we know it's going to be a lot worse.

Paulson: OK. I understand. But whatever you do, don't admit to the idea that you're insolvent. Stick to our story! Your primary regulator, OFHEO, says you have adequate capital. I've testified before Congress that you have adequate capital. You've said you have adequate capital. We can't let the market bust our bubble.

Fannie Mae: Bust our bubble? The bubble has already burst, and look who's getting stuck with most of the foreclosed properties: Fannie Mae.

Let me give you a concrete example: We have 5,000 real estate brokers all over the country handling our foreclosure sales. And in Flint, Michigan, we have one broker trying to sell one particular home for a price that will shock you.

Paulson: About thirty or forty thousand dollars?

Fannie Mae: No. He first tried to sell it for $6,900. But he had no takers. So then he cut the price to $5,000. Still no buyers! And this is a three-bedroom home in a residential neighborhood we're talking about. Not a two-door Chevy on a used car lot!

Bernanke: How widespread is this?

Fannie Mae: Just in the first quarter, we got saddled with twice the number of homes through foreclosure than we could sell. We're trying to get rid of them quickly. But we keep falling further and further behind.

Bernanke: How much do you and Freddie Mac have in foreclosed homes on your books?

Fannie Mae: As of March 31, $6.9 billion worth. Right now, much more.

Bernanke: That's a lot, but in proportion to the $5 trillion-plus in mortgages that you and Freddie own or guarantee, it doesn't sound like that much to me.

Fannie Mae: Maybe not. But try this arithmetic exercise: Throw together all the foreclosed homes owned by every single one of the nation's 8,500 commercial banks and thrifts. How much do you think that adds up to? I'll tell you. It adds up to a figure of $8.56 billion.

See that? 8,500 banks and thrifts have $8.56 billion in foreclosed homes. But between Fannie and Freddie — just two companies — we're stuck with almost as much $6.9 billion. In fact, if you look at all money tied up in foreclosed homes in the U.S., about $4 of every $10 is our burden.

Bernanke: What are you doing about it?

Fannie Mae: Until now, our stated goal has been to always try to get the highest possible price, even if that meant hanging on to the properties longer. But that's about to change. Now, we're going to have to start pricing our properties a lot more aggressively. And consider this: Once we send the directive to our 5,000 brokers across the country — to start dumping — there's no way we can keep that directive under wraps. The Street will know. Everyone will see what's really going on.

Paulson: Could it be that you are overstating the price declines and the losses that they could cause? Take that house in Michigan, for example. It must have been a dump to begin with. Do you know how much it sold for originally?

Fannie Mae: It's a dump all right. It needs a new roof. It needs new carpeting. The plumbing has been ripped out. But just three years ago, in 2005, it was not a dump. Three years ago, it sold for $110,000. So even assuming we can find a buyer for the $5,000, its price has fallen by over 95%.

Naturally, most of our foreclosed homes for sale haven't fallen that far, that fast. But this gives you an anecdotal illustration of what we're up against. And it gives you a sneak preview of the much deeper home price declines that are possible in the future.

Paulson: But how widespread is this, really?

Fannie Mae: What definition are we using for "widespread"? If I told you that among the supposedly "AAA" rated subprime mortgage securities issued in 2006, the default rate is now about 85%, would that qualify as "widespread"?

Paulson: Eighty-five percent?

Fannie Mae: Yes, 85%! And I'm not referring to a small, little subset of our portfolio. We've got about $70 billion in subprime and Alt-A securities in our portfolio. Freddie Mac is even more at risk, with nearly $150 billion. And that's not even our primary concern. Our primary concern is the surging foreclosure rate in "prime,"supposedly "high-quality," "safe" mortgages, which represent the bulk of the paper we hold or guarantee.

Paulson: What is your official posture on that aspect?

Fannie Mae: We used to say all this was "contained." Now we're trying to put out the message that it's "temporary." But we can't keep up that fiction much longer.

Paulson: Why not?

Fannie Mae: One reason is that, until recently, at least the rating agencies were playing along with us on this, postponing downgrades, keeping the fantasy alive. But now they're downgrading this paper step by step. They're forcing Fannie Mae — and all of us here around this table — to face reality. They're telling us that, until we face reality, this is going to be an endless soap opera.

Paulson: I know all about that. But what makes you say you're insolvent?

Fannie Mae: I was afraid you'd come back to that. Because, I must say, that's the big, immediate downside of facing reality. When we face reality, we're going to have to increase our reserves by such a huge amount, it will finally be abundantly obvious, even to our dearest friends at OFHEO, that we are not adequately capitalized after all — that we are, indeed, insolvent, bankrupt.

Now I ask you: How much longer can we hide this from the public? From ourselves? A few weeks? Days?

Paulson: I don't get it. I just don't get it. I'm not talking just about Fannie Mae. I mean the entire economy. The Fed cut interest rates all the way down to 2%. But that didn't do the trick. We rushed through the stimulus package, and that helped a bit, but barely enough to keep things going for another quarter. Now what do we do? Now what do we say to the American people?

General Motors CEO: I'll tell you what you do. You do whatever it takes to keep Fannie Mae and Freddie Mac capitalized, even if that means making them wards of the United States government. You do whatever it takes to keep banks like Washington Mutual, Wachovia — and certainly mega-giants like Citigroup and HSBC — capitalized.

And while you're before Congress, or the president, or the McCain or Obama people — and while you're making the case that the GSEs and the big banks are vital to America's financial security — you must also make the case that our nation's great auto manufacturers are equally vital to America's security.

You talk about home prices plunging. But have you seen the collapse in used SUV prices? At the end of a two-year lease, one of our most popular SUVs was supposed to be worth $22,000. But as it turns out, the best price we can get for it in the used car market is less than $11,000.

You talk of a housing collapse. But please don't ignore the auto industry collapse. You talk about a mortgage collapse. But God help us all if you ignore the collapse in auto credit! And don't forget the collapse in auto leasing that's coming with the collapse in used car prices.

Most people are clueless about what's really going on, even analysts on Wall Street. For example, we've just reported a $15.5 billion loss for the second quarter ... and that doesn't even begin to reflect the big write-offs from the auto leasing debacle.

The $15.5 billion loss equates to a loss of $27.33 per share. But you want to know the loss most people on Wall Street were expecting? Less than $3 per share!

So, yeah, sure, we did a good job of "putting out a positive message." And, yeah, we fooled them all right. But what good did it do us? All it did was give us an excuse to delay much-needed action.

Paulson: What kind of additional action were you contemplating?

General Motors: For starters, telling it like it is — telling you, telling Congress and telling the American people that unless you give us the same access to capital and funding as you're giving Fannie Mae and Freddie Mac ...

Paulson: ... But the reports I saw last month said you had plenty of cash — enough to last at least a year, maybe two.

General Motors: That was our messaging, yes. And we tried to convince folks that "we knew what was coming in the latest horrendous sales results," that "we knew what we needed to do to respond and react." But now it looks like we really did not know. Now it looks like we'll run out of cash a lot sooner. So like I was starting to say, unless we get federal help, General Motors is history. Ford is history. Chrysler is history.

Paulson: And you still believe that where GM goes, so goes the United States?

General Motors: Yes, I do.

Former Fed Chairman Paul Volcker: I've been listening to all this with increasing unease. Gentlemen, do you not see where this discussion is headed? It's headed toward nationalization of the GSEs, nationalization of Detroit's Big Three, nationalization of major banks.

Earlier, it was said that this thing is spreading like a cancer. What was really meant by that phrase? Well, I can't answer for the person who first spoke it, but I can give you my own interpretation of its meaning:

The truly dangerous cancer that's spreading is the cancer of mistrust. First, mistrust in subprime mortgages. Then, mistrust in higher quality mortgages. Now, mistrust in Fannie Mae and Freddie Mac.

If it were mistrust based on unfounded rumor, we could ignore it. But if it's mistrust based on hard data that's been distorted, quarantined or simply lied about ... then that's another matter entirely.

Let me fast-forward to the final, fatal stage of this cancer, the stage we must avoid at all costs. Let me take you to the day, however unlikely that day is, when it could spread to the U.S. government itself, when investors all over the world can no longer trust the debt of the United States Treasury Department.

Gentlemen, I know what I'm talking about. I looked the precursor of that mistrust in the eyes nearly three decades ago, in my first year as Fed chairman. And in those days, we did not have collapsing mortgage markets or collapsing auto markets or insolvent GSEs. All we had was plain-vanilla, double-digit inflation, without all these extra alarm bells and whistles. In that sense, the mistrust back then was less complex — and more manageable — than it is today.

But it was powerful nonetheless — so powerful, in fact, that it nearly shut down the entire market for U.S. government bonds.

Greenspan: I meet a lot of people who don't remember that time, or don't quite grasp its significance. Please help make sure everyone in this meeting does.

Volcker: It was 1980. We were meeting at Camp David. Present were President Carter, myself, the Treasury Secretary, plus CEOs from Merrill Lynch, Salomon Brothers and other primary government security dealers.

In some ways, this meeting today reminds me of that meeting then — the same sense of siege, the same philosophical disagreements. But there was one aspect we all agreed upon: The spreading investor mistrust in U.S. government bonds.

That mistrust was so intense and so widespread, we could not sell U.S. government bonds. Treasury bills were still fine. But not bonds. No one wanted long-term bonds and the entire market for them was as close to a total shutdown as it's ever been in the history of our country.

Greenspan: Go into the crux of the crisis.

Volcker: The crux of the crisis was that the fear of inflation was so intense, and government bond prices were going down so swiftly, there were virtually no more buyers of government bonds. Worse, primary government security dealers had lost so much money from falling bond prices that they were afraid to buy them at auction, hold them in inventory and resell them.

Yet that's precisely what we needed from them. It's through those dealers that the U.S. government sells nearly all of its bonds. It's through them that we raise nearly all of the money we need to refund maturing bonds and fund the government's day-to-day operations.

Our network of government security dealers is much like GM's network of auto dealers. The dealers buy the merchandise at auction, mark it up, put it on their lots and then hope to resell it.

Now, imagine what would happen if GM's dealer network were to shut down! How would GM be able to sell its cars? That's the same kind of situation the U.S. government was facing for its bonds in those dark days of early 1980. Except for a couple of the biggest dealers, like Salomon Brothers and Merrill Lynch, nearly all the government security dealers were shutting down their government bond operations.

Salomon would call Merrill to sell what's considered a small lot of, say, $100 million in 20-year Treasury bonds. At the same time, someone else at Merrill would call Salomon to place a similar trade. It was like two kids trying to trade the same marbles. There were no buyers. Virtually all the other dealers had packed up and gone home.

The point is, in that environment, we could not sell U.S. bonds.

Three-month Treasury bills? No problem. People trusted us for three months. But 20- or 30-year Treasury bonds? No! The market for Treasury bonds had dried up. And without it, the U.S. government simply could not continue to fund its own operations, couldn't meet payroll. Hard to believe, but true: We faced a shutdown of the U.S. government.

Our only answer was to kill the monster that had fomented all the mistrust — inflation. But to do that, we had to jack up interest rates. We had to cut off credit to millions of Americans. And in the process, we knew we were going to squash the economy.

Carter was up for re-election. So you can imagine his initial resistance to the Draconian steps we were proposing. But he had no choice. To bring the point home, he was asked: "Which do you prefer: The chance of losing the election in November? Or the certainty of the presidential paycheck bouncing right now in February?"

Paulson: Can we bring this back to the present?

Volcker: Absolutely. Let's bring this back to the present by asking this question: Is this the direction you want to take the country? If anyone in this room is willing to take that risk, say so now or forever hold your peace.

Because that's the inevitable fork in the road ahead — the end of the fast lane you're now on. I'm referring to the fast lane of open-ended government bailouts. The fast lane of "consistent messaging" to cover up the true cause — and the true consequences — of these bailouts.

Henry, never forget: Millions of investors, mostly overseas, have put their faith in U.S. government securities. They've loaned you their money because they trusted you, the U.S. Treasury Department. If you turn around now and pour their money down the bottomless pits we talked about today — Fannie and Freddie, GM and Ford, major banks — what do you think their reaction will be?

What makes you believe that they'll respond any differently than they did in 1980, when they disappeared from the U.S. government security market or, worse, dumped their bonds in fear?

What makes you believe you can stop the cancer of mistrust from spreading to 1500 Pennsylvania Avenue — to the U.S. Treasury Department itself?

When and if that day arrives, I know we will make the right choices. I am absolutely sure we will never let U.S. Treasury bonds become the next victims of the subprime crisis.

But if we know this now — if we CAN look ahead now and see that's the ultimate choice we will confront someday ... why not make the right choice now, while our economy is still standing, while our country still has the resources to make the needed sacrifices?

Face it, gentlemen: The last government rescue must not be to save the government itself. We must first save ourselves.

Good luck and God bless!

Martin

Dear Subscriber,

As a teenager, I couldn't wait to get off the family vegetable farm. While the rest of my friends were joyriding around town, swimming, and otherwise having tons of fun, I was always working.

But attitudes sure do change over time. Now I live in Montana to recapture that rural lifestyle that I hated so much as a teenager.

That's why I laced up my hiking boots and headed to Glacier National Park for one more hike before I jet off to Beijing in six days. I just can't get enough of the outdoors.

I guess you can take the boy off the farm but you can't take the farm out of the boy.

My love of the outdoors and my farming roots have helped me in the investment world, too. And they'll be especially useful for this upcoming China trip. I say that because I am going to visit several of the key agricultural companies in China ...

These Companies Happen to Be Making a Fortune
From the Booming Business of Food!

Why am I so interested in agricultural companies? First of all, food is an essential commodity for life. And since the world's population is forecast to be three times bigger by 2010 than it was in 1950, the demand for food is exploding.

Just as important, a greater proportion of that growing population is becoming affluent enough to eat well.

Thanks to growing incomes, the demand for better diets and more protein is just beginning. I believe that you've only seen the early stages of an agricultural boom, and that it will be one of the most profitable sectors you can invest in.

At the same time, the growing consumption of corn, sugar, and wheat to produce ethanol is essentially taking food out of hungry mouths. President Bush, in his last State of the Union address, proposed increasing the production of alternative fuels fivefold to 35 billion gallons by 2017.

And as is often the case for many of today's new hot investment trends, you need look no further than China to find some of the best investment opportunities.

Four Reasons to Jump on
The Chinese Food Bandwagon ...

While China is known for rice farming, there are plenty of other attractive agriculture investment areas ...

#1. China has changed from being a net exporter to being a net importer of major agricultural crops. With 1.3 billion hungry mouths to feed, China can't produce enough food to meet its own demand, let alone other country's needs.

#2. Chinese agricultural companies are protected by the government and foreign competition is heavily regulated. There are two Great Walls in China; the physical Great Wall and the governmental "great wall" that protects Chinese companies against foreign competitors. Chinese agricultural companies enjoy a state-sanctioned monopoly.

#3. Recent droughts and extreme water pollution have negatively impacted China's food supply. Rapid industrialization has severely polluted China's water supply and made the current drought even more painful.

#4. As more Chinese move from the rural interior to more affluent coastal cities, consumption of all food commodities have exploded. And this will only continue as more Chinese move into urban settings!

If you're interested in the Chinese agricultural companies, there is no shortage of investment options, many of which are traded on U.S. exchanges. Here is a partial list of companies that have piqued my interest:

American Dairy is the largest dairy company in China.

AgFeed Corp sells premixed food for livestock, particularly hogs.

Agria Corp produces corn seed and sheep breeding products.

Chaoda Modern Agriculture is China's largest vegetable and fruit grower.

China Green Agriculture makes humic acid, a liquid fertilizer.

China Mengniu Dairy is another Chinese dairy producer.

China Organic Agriculture is one of the largest producers of organic rice in the world.

Global Bio-Chem Technology deals in corn starch, corn sweeteners, and corn feed.

Origin Agritech makes bioengineered rice, corn, canola, and cotton seeds.

New Oriental Energy & Chemical manufactures urea, a chemical used for fertilizer.

Sinofert is a major Chinese fertilizer distributor.

There are also dozens of American companies that are doing a substantial — and growing — amount of business in China. Some of the familiar names are Mosiac, Potash, Archer-Daniels-Midland, Bunge, and Monsanto.

Now, don't rush out and buy any of these stocks. I haven't even had the chance to conduct my customary in-person due diligence and research on these companies yet.

Sure, I've done the nerdy financial homework on these companies, and I've found some spectacular bargains on paper. But I need to visit these companies in person before I will make any recommendations to my Asia Stock Alert subscribers.

I've learned the hard way that just because a company looks good on paper doesn't make it a winning investment. Kicking the tires in person has been my key to finding home run stocks.

Best of all, I'll get to dig around in some dirt, and get back to my farming roots this trip. My dad will be very proud of me!

Best wishes,

Tony