We’ll be honest. This falling stock market has us licking our lips.

The S&P/ASX 200 has dropped 6.2% in two weeks.

And yesterday the index had its first 100-point fall since 3 October last year.

The ASX Emerging Companies index has done even worse. It has dropped 17.1% in seven weeks.

Good or Bad News for Small-Cap Investors?

That’s bad news if you hold small-cap shares, but great news if you want to buy beaten-down stocks on the cheap. It’s also why we suggest you only invest a small part of your portfolio in these high-risk punts.

You can make or lose a big chunk of your investment in a very short period of time.

In that case, you may wonder why you should invest in small-cap stocks at all, if the global economy is as bad as we say it is.

The answer is simple.

First, while we believe the global economy is going through a necessary bout of deleveraging that will ultimately lead to deflation. Central banks and governments will fight tooth and nail to prevent that.

They want inflation. And that likely means periods of rising asset prices…followed by periods of falling asset prices as the inflationary policies fail, and deflation takes hold again.

Second, despite market moves and the threat of recession (or depression) most firms carry on doing business. And most entrepreneurs carry on thinking of new ideas.

New ideas are what small-cap investing is all about.

It’s about entrepreneurs (and investors) seeing the chance to make a lot of money, regardless of what happens to the broader economy.

That’s why we say, if you’re after a punt, buy small-cap stocks now. You can take out a no-obligation trial to our small-cap newsletter, Australian Small-Cap Investigator now. Click here for details…

Buy Small-Cap Stocks at 2009 Bargain-Basement Prices

For some time we’ve told you to ditch your blue-chip growth stocks. Today the Aussie blue-chip index is at the same level as it was in July 2009. That’s almost three years with no growth.

And for long-term investors, we don’t see that changing.

But small-cap growth stocks are a different kettle of fish. Most of them don’t have any revenues and don’t earn a profit. These are the riskiest stocks on the market.

It means when trouble hits the economy, small-caps fall the most. But here’s the thing…if an oil stock finds oil, or a gas stock finds gas, or a technology stock develops a game-changing product, then these small-cap stocks can soar higher regardless of what happens in the market.

Bottom line, it could be that the world economy is entering the deflationary cycle that should have happened in 2009. Government stimulus programs and central bank money-printing only delayed the inevitable.

But don’t let that stop you investing in stocks, because you still need to grow your wealth. And when stocks are hit this hard and everyone is rushing to sell, this is often the best time to invest.

Just make sure you hold cash (plenty of it), reduce debt where you can, hold gold and silver for security, and stick with a few reliable dividend paying stocks for income.

What’s left over, use to snap up small-cap stocks panicking investors are selling at bargain-basement prices.

Cheers,
Kris.

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Why Europe Will Ditch Green Energy

In today’s Money Morning, we’ll show a chart that could give you a sneak peek into the future.

When we showed it to our old pal, Sound Money. Sound Investments editor, Greg Canavan, he said, ‘That’s what outright deflation looks like. Savers’ purchasing power grows in terms of financial assets.’

In other words, the value of money rises as asset prices fall.

That’s deflation: The friend of prudent savers. The foe of over-leveraged borrowers…and banks.

In short, when deflation hits, make sure you’re a saver, not an over-leveraged borrower.

Deflation – A Sign of the Future

This chart is of the Athens Stock Exchange General Index. Based on yesterday’s close, the index is down 89.7% from the October 2007 peak.

It’s a clear warning sign of what can happen when investors lose faith in an economy. And when investors lose faith, they stop investing. When they stop investing, asset prices can take a big hit.

But what does this have to do with Australia and Aussie investors?

Well, perhaps investors have already stopped investing. Certainly Aussie mining giant, BHP Billiton [ASX: BHP] has had second thoughts. This from Bloomberg News:

‘BHP Billiton Ltd. (BHP), the world’s biggest mining company, will fall short of its $80 billion spending target for building mines and expanding assets over the next five years as it sees commodity prices declining.’

BHP – A Sign of Asset Price Deflation for Aussie Stocks?

Over the past year, BHP shares have fallen 25%, mainly due to investor concern about Chinese demand.

If BHP does ditch plans to spend $80 billion on new projects, it indicates investors were right to sell BHP.

So much for the resources boom that’s supposed to last another 50 years!

(By the way, although he’s too modest to say it, Slipstream Trader, Murray Dawes picked this market crash like a peach. For a flashback to see and hear why Murray saw this crash coming, check out the free weekly video update that was first broadcast last week. You can view the stock market update here…)

So if companies are cutting back on investments in their business, why should individual investors bother investing? Why wouldn’t they just keep most of their money in the bank?

That’s the problem. And so the deflationary cycle begins.

As we’ve said before, deflation isn’t a bad thing. It’s good for savers, and it’s good for wage earners. It’s just that in an over-leveraged economy that has gotten used to debt spurring growth, deflation can cause a whole bunch of problems…especially for banks.

But it’s not the Aussie banking sector that draws foreign investors. Australia is a very lopsided economy. Foreign investors come to Australia to invest in one thing…Aussie resources firms.

But they’ll only do that if they believe there’s a strong growth in demand for resources. So when the world’s biggest mining company says it won’t invest a planned $80 billion, investors take note and they withhold their dollars.

And without mining sector growth, that spells a lot of trouble for the entire Aussie economy. Especially those firms (and governments) that have banked on big spending from the miners and increased tax receipts.

Cheers,
Kris.

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Why Europe Will Ditch Green Energy

Sometime in the next few weeks we’re going to find out if Greece can afford to stay in the euro. We’re also going to find out if Spain and Italy can afford to leave the euro. Access to credit markets is the key issue. The stigma of default will lock a country out of capital markets. If you don’t have a plan to replace your currency and then devalue it, you’re doomed.

But first, the crisis in Greece didn’t come to a head over night but it can’t be far away. Rival political parties have been unable to form a government. New elections are scheduled for the second week in June. The financial has definitely become political. The people have run out of patience with unsound money and the world built on it.

All that said, the Greeks managed to make a €430 million payment to hold-out creditors last night. Nearly 97% of Greek creditors agreed to the restructuring of the country’s debt in March. That wiped off over €100 billion in Greek debt and resulted in 70% losses for some of the bondholders who accepted the deal. Not all of them did.

Yesterday, the bondholders who didn’t accept the deal got paid in full. There is still about €6 billion worth of debt owed to creditors who refused to participate in the restructuring. You can imagine that the Greek decision to pay the holdouts would anger the creditors who agreed to the deal. They look like schmucks now. Schmucks.

The Real Issue of a Greek Default

But in the current scheme of things, €430 million is chump change. The real issue is whether the Greeks are going to default on €150 billion worth of government debt. If those bonds are owned by foreign creditors – let’s call them other European banks – then the Greek crisis becomes a European crisis. We’ll come back to this issue of ‘containment’ shortly.

For the Greek people, the most alarming aspect of what’s going on is that their life savings are at serious risk of a massive, overnight, non-voluntary devaluation. There are a lot of words for the magical process of turning one thing into something else: alchemy, transmutation, and transubstantiation come to mind. But to the Greeks it’s going to look a lot like highway robbery.

You’ll go to bed one night with your life savings denominated in euros. You’ll wake up the next day with them denominated in drachma. And your euro savings will be automatically converted to drachma at an exchange rate not of your choosing. For example, your 1,000 euros will become 100 drachma…or even 10,000 drachma. The nominal amount won’t matter. What matters is that the devaluation strips you of 70% or 80% of your purchasing power.

Most people would avoid that kind of value destruction if they could. Maybe that explains why €700 million was withdrawn from Greek banks on Monday, according to remarks made by Greek President Karolos Papoulias and reported in the Wall Street Journal. The Journal reports that between €2 and €3 billion in deposits have been withdrawn from the Greek banking system each month for the past two years. January was a high point, with €5 billion.

A bank run by any other name would look as desperate. And who wouldn’t be desperate now?

Leaving the euro, devaluing the drachma, and defaulting on debt owed to foreign creditors are Greece’s best long-term economic survival strategy. But the unavoidable side-effect is to destroy the savings of the people, not to mention usher in a period of lower standards of living.

That won’t win you many votes. It may start a revolution.

And how do you prevent the Greek precedent from being imitated by the Spanish and the Italians? To be candid, we don’t think it matters much now. Greece can’t afford to stay in the euro. The Spanish and the Italians can’t afford to leave it.

The Future of Europe

The economies and banking systems of Spain and Italy are indispensable to Europe. If they leave the euro, there is no euro. The Greeks can leave, devalue, default and use a weaker currency to claw their way back to economic competitiveness. If the Spanish and Italians leave, they lose access to private capital, they lose access to the ECB and they take down Europe’s banking system. They can’t leave. More importantly, they can’t be allowed to leave.

This makes the task of the European Central Bank (ECB) much easier. It simply has to guarantee Greek debt owed to all non-Greek creditors. Or, it could simply buy that debt. This would solve the problem of anyone outside Greece taking losses on Greek debt.

This is what corporatism looks like, when the Big State and Big Finance become the Big Power in the economy. Losses cannot be tolerated. Any loss results in lower equity capital at a financial firm would require selling assets. Since everyone owns a piece of everyone else, and owes to everyone else, any major loss in one place results in losses everywhere.

Of course it’s absurd that Europe is moving toward this kind of ‘extreme socialism’. The people most responsible for the crisis are not accountable and the people who have saved get punished. The elite are enriched and everyone else is enslaved.

This is why the financial crisis could so quickly become a political and social crisis. When people don’t think they can get justice from the courts or the cops, and when they think that cheating is the only way to get ahead in a system, the political and financial order is on borrowed time. The clock is ticking.

Dan Denning
Editor, The Daily Reckoning Australia

Publisher’s Note: This article originally appeared in The Daily Reckoning Australia

Ed Note: Dan Denning is the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing. He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. If you like what you’ve read from Dan today, why not sign up to his free daily newsletter, The Daily Reckoning.

You’ll get an independent and critical perspective on the Australian and global markets. But it’s not the kind of stiff-necked analysis you read from most financial commentators, instead, the Daily Reckoning delivers you straight-forward, humorous and useful investment insights from Dan and a wide range of other Aussie and global analysts. To take out a free subscription to The Daily Reckoning, click here…

From the Archives…

What Newton Knew About House Prices …That the IMF Should
2012-05-11 – Kris Sayce

Why a Greek Exit From the Eurozone Could Be Great News For Markets
2012-05-10 – John Stepek

Why Europe Will Ditch Green Energy
2012-05-09 – Kris Sayce

Why It’s Time to Buy Gold
2012-05-08 – Dr. Alex Cowie

Why You Should Be Watching Japan’s Economy
2012-04-07 – Dan Denning

Gold a bubble? No chance, says respected Swiss investor Marc Faber.

The reason that people think gold is a bubble, says Faber, is that its current price seems a lot higher than its 1999 price of $252. But despite the significant gains, gold is still not as widely owned as other assets were during past examples of bubbles.

“In 1989, everybody owned Japanese stocks. And in 2000, everybody owned tech stocks. That is the bubble, when the majority of market participants own an asset. I think there are more people that own Apple stock than gold.”

The increase in gold’s price is down to the huge increases in debt levels, not tech-boom-style irrational exuberance.

“We had an explosion of debt, not just government debt, but private sector debt, and an explosion of unfunded liabilities.”

This creates “a situation where maybe the price of gold should be much higher because the economic and financial conditions are worse than they were 12 years ago.” The hard times encourage indebted governments to print even more money, driving up the value of gold.

Gold Reserves?

Faber, who writes the Gloom, Boom and Doom newsletter, also thinks that the growing reserves of emerging market governments will also help the gold price in the long run. “International reserves accumulate principally at the hands of Asian central banks and central banks in emerging economies,” notes Faber. Right now those reserves are in dollars and euros but Faber thinks that will change.

“Even a central banker, with his just-below-average intelligence, will one day notice that maybe it’s not that desirable to be in the US dollar or Treasury bills that have essentially no yield. In other words, you have a negative real interest rate on these dollars.

“So they move money into gold. They should have done it a long time ago. But don’t expect too much from a central banker.”

James McKeigue
Contributing Editor, MoneyWeek (UK)

Publisher’s Note: This is an edited version of an article that first appeared in MoneyWeek

From the Archives…

What Newton Knew About House Prices …That the IMF Should
2012-05-11 – Kris Sayce

Why a Greek Exit From the Eurozone Could Be Great News For Markets
2012-05-10 – John Stepek

Why Europe Will Ditch Green Energy
2012-05-09 – Kris Sayce

Why It’s Time to Buy Gold
2012-05-08 – Dr. Alex Cowie

Why You Should Be Watching Japan’s Economy
2012-04-07 – Dan Denning

One of the buzzwords at this week’s Australian Petroleum Producer and Explorer Association (APPEA) conference is ‘Shale’.

And specifically, shale gas.

If you’re not familiar with it, shale gas is gas that’s trapped within deep shale rock formations. Until recently, it was almost impossible to recover this gas.

But technological advances mean natural gas companies can now access this gas. To the extent that it’s now revolutionizing the energy world right before your eyes.

The US Shale Gas Story

Nowhere has it had a bigger impact than in the United States. Less than 10 years ago, the US faced an energy crisis. Today they have more natural gas than they know what to do with.

Based on what I’ve heard this week at the ‘oil and gas show’, Australia has a chance to follow the same path. And that could be great news for you, if you get in early…

Shale gas already makes up 30% of the US gas supply. By the end of the decade, it could reach 50%.

The rapid success of shale gas exploration and production means cheap natural gas for the US. Really cheap!

Just four years ago, gas was USD$14 per million British thermal units (mmBtu). Last month, it fell below USD$2 mmBtu. This cheap energy can make life tough for the producers, but is a gift for the US economy.

The benefits go beyond affordable heating, transport, and more competitive manufacturing. It also creates jobs.

According to J. Michael Jaeger, the CEO of BHP Billiton Petroleum, ‘the unconventional energy sector has been responsible for 600,000 new jobs in recent years, and this is set to increase to 850,000.’

And by his estimates, the sector adds USD$100 billion to the US economy each year.

But this American energy revolution didn’t come easy.

In North America between 2008 and 2011, explorers drilled 15,000 shale gas wells. That takes a lot of investment, a lot of time and a lot of risk.

Abundant Shale Gas Basins

But, as you can see on the map below, you’ll find shale basins all over the world. Canada, Brazil, Argentina, South Africa, Europe, China, and of course…Australia.

But in the time the North Americans drilled 15,000 wells and ensured cheap gas for decades to come, how much progress has the rest of the world made?

Less than 100 wells drilled.

So Australia has a lot of catching up to do. But it’s making tracks.

The Australian Shale Gas Story – Still in Early Stages

The market has embraced the shale story. Aussie shale stocks like Buru Energy (ASX: BRU) have gone up eight–fold in the last two years.

It’s an exciting start, but there’s still a long way to go for the Aussie shale industry.

And the best time to get in is before the industry becomes mainstream…before local explorers have drilled 15,000 wells.

My old pal, Australian Wealth Gameplan editor, Dan Denning knows this. Dan first wrote about shale gas in 2005.

This is what he wrote at the time:

‘If the U.S. government is eventually going to pump billions of dollars into the development of the shale industry, with the goal of national energy independence, I want to figure out who’s going to benefit the most…

‘…I’d rather be ahead than behind on the shale curve.’

He was ahead of the curve. Back then, the US produced less than two billion cubic feet (bcf) of shale gas per day.

This year the US is set to produce nearly 25 bcf of shale gas per day.

And last year he tipped a handful of Aussie stocks that he thought would benefit from the Aussie shale gas story.

But the real billion–dollar–question is, can we recreate North America’s success with shale gas, here in Australia?

We have the potential, but there are some big differences between Australia and the US.

Shale Gas With an Oil Kicker?

Research and Consulting Service, Wood Mackenzie, asked this question at the conference this week. The good news is they reckon it can be done.

The bad news is a number of stars need to align first.

First, explorers need to do much more drilling to see if the geology is right, and whether it’s possible to produce natural gas commercially.

Then there’s the issue of support services. It’s still a new game here, and, unlike in other resources sectors, we don’t have all the players, expertise and equipment to get the job done.

Remote locations, and the wet season, add an extra challenge.

We also need to ask the question — does Australia even need shale gas?

We have plenty of conventional natural gas already. Then we have the Coal Seam Gas industry, which is still growing, and now meets 40% of East Coast Australia’s natural gas needs. And, as I mentioned yesterday, the LNG industry is already set to triple production in the next six years.

So where does shale gas fit in to the Australian energy mix?

As with everything, it depends on the production cost. If it’s cheap enough, Australia can enjoy even more affordable natural gas, and could turn it into another export revenue stream.

But shale gas isn’t the only opportunity. The real money–spinner could be in ‘shale oil‘.

Shale Oil – ‘Liquid Rich’

They call shale ‘liquids rich’ when it contains oil. Oil is more profitable, and easier to export. Finding it in Aussie shale plays could help kick–start the development of a profitable Aussie shale industry.

The biggest opportunities for shale oil are in the Canning, Cooper and Georgina basins. They each have ‘liquids’ potential, but so far no–one has struck shale oil yet, only shale gas.

There’s a lot of Australian shale exploration planned this year. Joint ventures between small Aussie companies and giant overseas firms are drilling the better–known ‘Canning basin’ in WA and ‘Cooper Basin’ in South East QLD.

Drilling and hydraulic fracturing (fracking) is also taking place in the Georgina Basin in the Northern Territory, Gippsland in Victoria, and Galilee Basin in Queensland.

Back when the US shale boom was at this early stage, land was cheap.

Today, US shale acreage valuations are through the roof. Early investors in the right projects scored big.

This is probably why you see big players like Mitsubishi (TYO: 8058), BG Group (LON: BG), ConocoPhillips (NYSE: COP) and Hess Corp. (NYSE: HES) moving in early on the Aussie shale gas story.

And ConocoPhillips for one says it wants more.

With big companies getting in at the ground floor — and with so much focus on the sector at Australia’s largest oil and gas conference — it already looks like the shale sector is set to be Australia’s next resources boom.

Dr. Alex Cowie
Editor, Diggers and Drillers

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Imagine you are one of two people playing Monopoly. While you follow the rules religiously, the other player, who also happens to be the banker, does not.

He routinely appropriates properties. If he doesn’t like the score on the dice, he simply changes them. He continually takes as much money from the bank as he likes. Whenever the rules don’t suit he arbitrarily alters them in his favour.

Oh, and he hates to lose. Rather than concede defeat, he is perfectly willing to set fire to the table.

Imagine no longer. This is the state of the financial markets. You are playing against the world’s central banks.

For some time now, the Financial Times has been running articles (under the inauspicious label of ‘Collateral Damage’) discussing the merits or demerits of central banking. Only one contributor, Ron Paul, has challenged the status quo:

"[W]hile socialism and centralised economic planning have largely been rejected by free–market economists, the myth persists that central banks are a necessary component of market economies."

Every other contributor thus far has sought to defend central banking as a necessary part of the system… a view that seems categorically embraced by most people. In browsing through the comments of Dr. Paul’s FT article, for example, one reader posted:

"The problem with blindly accepting Dr Paul’s diagnosis is that he lacks the necessary qualifications to make a diagnosis. Would you trust a medical diagnosis made by Ben Bernanke, Mario Draghi or Mervyn King?"

No, I wouldn’t. But I wouldn’t trust an economic diagnosis from any of those individuals either. Given their track records, why would anyone?

No Central Banks

Getting rid of central banks (over time, let us be realistic) would have several effects.

First, it would require insolvent commercial or investment banks to fail properly, as opposed to feeding off the blood of taxpayers indefinitely.

As an example, lest anyone regard the $2 billion loss recently announced by JP Morgan as comparatively trivial, it should perhaps be seen in the context of the same bank’s overall derivatives exposure, which is shown graphically below.

JP Morgan’s total derivatives exposure stands at $70.1 trillion, or roughly the same size as the entire world economy. Each of the $1 trillion towers in the image is double–stacked to a height of 930 feet (283 meters).

Second, eliminating central banks would require governments to balance their books, no longer able to monetize the debt through its relations with the central banker.

Third, asset prices would revert to being determined by the market, and not by unelected economists serving the interests of bankers and politicians.

As this is clearly not going to happen anytime soon, most investment managers seem content to embrace the system and continue playing the cards they’ve been dealt.

To give you an example, the FT reported that, last year, US pension funds for the very first time put more of their assets into bonds as opposed to equities.

Like many investors, these fund managers fail to understand the risks they’re running and seem to have accepted the convention that nothing could possibly go wrong while central bankers are in charge.

Yet with Treasury yields as low as they are, this is unlikely to end well. The chart below shows the impact on investors who purchased British Gilts during the stagflation suffered in the UK during the 1970s.

Investors who bought conventional Gilts in 1973 had to wait for 12 years to earn a positive real return on their investment. And this is exactly the sort of financial repression we have to look forward to under the current system controlled by the political and central banking elite.

Tim Price
Contributing Editor, Money Morning

Publisher’s Note: This article originally appeared in Sovereign Man: Notes From the Field

From the Archives…

What Newton Knew About House Prices …That the IMF Should
2012–05–11 – Kris Sayce

Why a Greek Exit From the Eurozone Could Be Great News For Markets
2012–05–10 – John Stepek

Why Europe Will Ditch Green Energy
2012–05–09 – Kris Sayce

Why It’s Time to Buy Gold
2012–05–08 – Dr. Alex Cowie

Why You Should Be Watching Japan’s Economy
2012–04–07 – Dan Denning

For editorial enquiries and feedback, email letters@moneymorning.com.au

Over the last six months, energy stocks have been some of the best performers in the stock market.

With good reason – global energy demand is set to keep soaring.

As I mentioned in yesterday’s Money Morning, the International energy Agency (IEA) estimates global energy demand will increase by ONE THIRD in the next 25 years.

So to get the ‘good oil’ on the oil and gas sector, I’m in Adelaide to join 3000 other delegates for the Australian Petroleum Production and Exploration Association (APPEA) annual conference.

It’s a pretty heavyweight conference…

We heard from the International Energy Agency (IEA).

Federal and State politicians have weighed in.

Plus, we’ve seen the top executives from global oil companies like Total, and big Aussie firms like Woodside and BHP Billiton Petroleum. But yesterday’s highlights were just as much about what wasn’t said as about what was said, as I’ll explain now…

The Bureau of Resources and Energy Economics talked bullishly about China’s demand for natural gas. Unconventional gas has had a lot of focus, with very interesting talks from Clough Ltd [ASX: CLO], Wood Mackenzie and more from Total S.A. [NYSE: TOT].

All this info means there is a great deal to take in and think about.

After a long day of furious note taking, my brain seized up and it was time for a few medicinal cold ones to help process it all.

So, how would I sum up the first day?

In reflection, the speech from the Saudi Arabian oil minister, Ali Ai-Naimi, should have been a highlight of the first day.

As the most senior executive person in the world’s largest oil exporter, he’s the world’s most important ‘oil-man’. The auditorium was packed, and I was looking forward to his talk. This should have been the meatiest speech of all.

But it was as meaty as a veggie burger.

Saudi Arabia ‘Optimistic’ About New Oil Finds

The big-man was funnier than I expected, but he didn’t give much away at all.

He warmed up with a few gags about how he felt right at home in Australia because of the sand dunes, scuba diving and camels.

Great – but let’s get to business. So when he got talking about the importance of geopolitics of the energy revolution, I thought things were about to get interesting. Would he reveal his views on Iran…maybe Syria…what about China and India?

No luck.

All we got were clichés on the benefits of developing good trade ties with Australia. Nothing on US sanctions squeezing Iranian production. Not a bean on India buying Iran’s oil with gold. And silence on the threat of a potential blockade of the Persian Gulf.

Ali Ai-Naimi also spent a surprising amount of time talking up renewable energy. I thought this was an oil and gas conference? I guess he has to earn the requisite number of politically correct points in public, seeing as his nation is indirectly responsible for a large chunk of the world’s CO2 emissions.

But what about how Saudi Arabia planned to raise its production levels?

The Saudis forever talk about increasing production. They claim they have spare capacity of a few million barrels a day. When the world uses around 90 million barrels a day, that much spare capacity would really take the heat out of the oil price.

But, for all the talk, it’s never happened. How can we believe they have this spare capacity? And how do they plan to increase production from ageing oil fields in the future?

This was the good part of the speech. We heard how Saudi Arabia is investing in technological improvements. They have increased their brain trust by employing three times as many scientists, and have increased collaboration with Australian Universities. They have new seismic data and other geophysical information. That could bear fruit in the long-term.

But what about now?

Here’s what al Naimi said:

‘We are targeting the discovery of significant additional oil resources within the Kingdom… We have also initiated a program to explore frontier areas within Saudi Arabia, including the Red Sea. And while are in the early stages of exploration and evaluation, we are optimistic about the potential for significant discoveries’

Optimistic? That’s nice.

Optimism doesn’t guarantee results. For some time, I’ve been ‘optimistic’ that Port Phillip Publishing will give Keira Knightley a job as a secretary…but it’s yet to happen.

Anyway, one part of the plan to increase output could work. Using recent improvements in production technology, the Saudis aim to increase production by ‘…Increasing aggregate recovery in our major producing fields from the current 50% average to 70%’.

The technological improvements in recent years are astonishing, and could breathe new life into old fields.

The catch is that the methods are usually significantly more expensive. This may be why Saudi Arabia increased the oil price ‘target’ to $100 a barrel back in January. Or that could have just been due to the increased fiscal cost of pacifying Saudi citizens during the Arab Spring.

All up, I had expected much more from Ai-Naimi, the ‘Central banker of Oil’. But clearly he was here as a diplomat, creating relationships – and not controversy.

So, what about the rest of the day?

30 Years of Energy Growth

Fortunately, it was as meaty as it gets, and I got what I came here for. The meat and potatoes were the expert’s views on the exciting future of unconventional energy, and Australia’s place in what could be the biggest money-spinner and job-creator in the resources sector for the next 30 years or more.

To begin the day there were a few mandatory pot shots fired between the politicians and everyone else.

The politicians talked up how incredibly well Australia could do from the energy boom, while everyone else was saying that this boom depends squarely on the politicians creating a stable regime.

In the words of APPEA’s Chairman, David Knox:

‘…I’m talking about the need for a stable fiscal and regulatory environment. Governments need to mindful of not just their capacity to facilitate investment growth, but also their capacity to impede it…[they] need to be conscious that projects are competing for investment dollars globally… My message to the Australian Government is: Do not create uncertainty.‘

It takes me back to those heady early days of the mining tax debate. Politicians’ eyes lighting up with dollar signs, while those living in the real world reminded them it’s only fair that investors ask for fiscal stability when they’re stumping up a few hundred billion dollars.

We’ve seen all this before. But what I didn’t see coming was Minister for Resources and Energy, Martin Ferguson, agreeing. He conceded tax changes and uncertainty are no good for the energy sector, and warned the cabinet against fiscal instability. Who would have thought?

The Managing Director and CEO of Woodside, Peter Coleman, also made the same point about having a stable and competitive fiscal regime.

A good example of how governments can impede growth is that Australia is the second most expensive producer of LNG.

This is partly because of higher labour costs due to a skill shortage, which could be fixed with changes to immigration policy. Production costs are also higher as Aussie States have different safety standards, so companies in two states have to jump through twice as many legal hoops, causing unnecessary extra costs without making anything safer.

Aussie LNG Imports to Rise 460%

Woodside celebrated its first LNG shipment from its Pluto project this year. Coleman pointed out the timing was auspicious – it is 70 years exactly since its namesake, the ‘Pluto’ pipeline, was built across the English Channel in total secrecy. This carried oil to Allied troops in Europe. In the words of General Patton: ‘My men can eat their belts…but my tanks gotta have gas.’

Today it’s Asia that’s ‘gotta have gas’. 17 LNG receiving terminals are being built across Asia, and 18 more are planned for construction before 2020. Asia is the greatest source of LNG demand, though globally demand is expected to increase around 5% a year for the rest of this decade. Where’s it all going to come from?

There are a few LNG producers globally, with Qatar the biggest, but Australia has a chance of becoming the largest. Pluto has just come on line, but there are another eight huge projects in the wings, including Gorgon, Browse, Ichthys, Gladstone and others.

Cristophe de Margerie, the Chairman and CEO of Total pointed out that Australia currently produces 25 million tonnes a year. By 2018, this could increase to 80 million tonnes a year. Going out to 2024 it could be more like 140 million tonnes.

That’s if everything goes to plan of course – but when does that ever happen?

Finally, the biggest buzzword at the conference is ‘Shale’.

There have been some excellent presentations on ‘shale gas‘ and ‘shale oil’. Technological advances have opened up energy resources that simply weren’t there 7 years ago.

Shale is completely rewriting the energy landscape in terms of new suppliers, new markets and commodity prices. But I’ll save that for tomorrow.

This morning’s presentations are about to kick off and are titled ‘making the unconventional conventional’, so it’s time to knock back a few more coffees and get the notepad out.

I’ll be back tomorrow.

Dr. Alex Cowie
Editor, Diggers and Drillers

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As the Eurozone continues to show weakness, events in Greece may accelerate the situation. The downward movement in oil prices in both London and on the NYMEX testifies to the rising concern.

The aftermath of the Greek elections propelled the new radical left party SYRIZA into the limelight as the second strongest party in the country. Given the adamant refusal by SYRIZA leadership to accept bailout reforms, the party’s new brokering position means the crisis will continue.

Bitter austerity measures await the formation of a coalition government, since no party received a majority of the seats in parliament from the vote. The coalition is supported by both the New Democracy and socialist PASOK parties, which have taken turns ruling Greece for nearly four decades.

But the surprise showing of SYRIZA has thrown the possibility of an accord into disarray.

At best, this means a further delay and likely a new election.

On the other hand, Greece has little time left. Any further delay in forming a government, with no guarantee that a very angry population will vote any differently the next time around, puts the next tranche of the European Union bailout package in jeopardy.

It is now more likely that Greece will leave (or be pushed out of) the Eurozone, casting a greater uncertainty on both the currency and the southern tier of countries still in the zone.

What Then?

Spain is the current focus of concern, but Italy is also exhibiting renewed weakness.

Unlike Greece, Spain and Italy have debt problems that dwarf the ability of any Brussels-led support package. These economies are simply too large to be “rescued” from the outside.

The concerns over contagion, therefore, may actually expedite a Greek departure earlier than most thought possible.

Including me.

It is true that any members leaving the Eurozone will have a negative effect upon currency strength and economic prospects. It is also unclear how the Greek departure will aid in shoring up either Spain or Italy. The problems in each of these economies are endemic; they are not primarily a result of “spillovers” from the situation in Greece.

All of which means, to borrow a phrase from former U.S. Secretary of Defense Donald Rumsfeld, there are a series of “known unknowns” now facing the E.U. The credit and banking problems are essentially the “known” part of this equation. The extent of the fallout on the euro as a whole is the massive “unknown” flowing through the calculations.

This is accentuated by recent developments in the two major economies using the euro -Germany and France. No rescue package for any E.U. member is possible without the leadership of these two dominant European economies. To date, Paris has emphasized protecting its suspect banking sector, while Berlin has a strong political undercurrent demanding additional protection of German production and trade.

However, the recent French elections, in which a socialist has been elected president, and indications surfacing that the German economy may be facing a slowdown, will put continued support of a “bailout for austerity” approach to Greece in question.

Thus far, both major nations have led the E.U.-Greek approach, strongly arguing that the preservation of the euro demands it. The dramatic political events unfolding in Athens are rapidly undermining that support.

And this has impacted on the price of oil.

The Oil Market: Like 2008?

The only way oil prices are coming down is by the advance of pressures outside (exogenous to, as the analysts say) the oil market itself.

This is what happened in 2008. The rise in crude and the corresponding spike in the cost of oil products like gasoline, diesel, and heating oil retreated only when the full weight of the subprime mortgage-induced credit freeze hit.

Overall demand dried up as the ensuing recession hit.

We are seeing a similar short-term pullback in prices as concerns over falling demand levels parallel the European confusion.

Yet this time there are three important differences.

First, the American economy is largely insulating itself from what happens on the continent (assuming the JP Morgans of the world can oversee their traders).

Second, oil demand continues in those parts of the world that actually determine the pricing level. As I have said a number of times before, these are not North America, Western Europe or the developed (OECD) countries. This is based on developing and accelerating new economies elsewhere.

There is also a third factor of some importance.

The 2008 collapse and resulting worldwide recession centred on dollar-denominated assets, the assets basic to the global network of trade, cross-border capital flows, and wealth.

Not so this time around.

The current situation tends to benefit the value of the dollar against the euro. With virtually all international oil trades in dollars, that does mean prices may stabilize for a time. But it also means the concentrated asset wealth in those oil transactions will increase.

And despite the events in Europe, the ultimate value of oil contracts will increase as well – especially in a market where the essential rise in demand is occurring in those regions of the world not directly impacted by the euro zone problems.

So, farewell Greece, good luck, Spain.

Once the dust settles, oil holdings will continue to exhibit significant value gains moving forward.

Dr. Kent Moors
Contributing Editor, Money Morning

Publisher’s Note: This article originally appeared in Energy & Oil Investor

From the Archives…

What Newton Knew About House Prices …That the IMF Should
2012-05-11 – Kris Sayce

Why a Greek Exit From the Eurozone Could Be Great News For Markets
2012-05-10 – John Stepek

Why Europe Will Ditch Green Energy
2012-05-09 – Kris Sayce

Why It’s Time to Buy Gold
2012-05-08 – Dr. Alex Cowie

Why You Should Be Watching Japan’s Economy
2012-04-07 – Dan Denning

Gold prices had gold bugs giddy in the fall of 2011. In September, the luminous yellow metal touched an intraday high of $1,920 a troy ounce, putting the precious metal up roughly 35% for the year.

At the time it seemed like investors, traders and even the guy at the corner store were all buying, hoarding, and lusting for gold.

But the stellar gains were short lived, and by the end of the year gold prices had fallen by nearly 20%.

Part of the striking decline in gold was due to the fact that the “smart” money that had once been amongst gold’s biggest cheerleaders, sold it.

Some booked profits, some sold it to reflect gains in portfolios, others were forced to sell to meet margin requirements, and others wanted to start the New Year with a clean slate.

Gold Prices in 2012

Enter 2012, and gold prices enjoyed a lustrous January, rising some 10%, helped in particular by Chinese New Year celebrations.

Gold has since languished as investors became more willing to take on added risk, delving more into equities. While gold prices foundered, the Dow rose 8% in the first quarter, the S&P 500 gained 12%, and the Nasdaq enjoyed a nearly 19% gain.

And more recently, not even gold’s best friend, Federal Reserve Chairman Ben Bernanke, offered up much help.

Following the commencement of the two-day FOMC meeting, gold experienced a volatile day, but managed to end virtually flat from the previous trading session. The Fed left interest rates steady and extinguished hopes for immediate further monetary loosening measures.

Without a promise of more quantitative easing, long gold holders headed for the exits.

Nonetheless, many sophisticated gold traders are poised to pounce on gold with every dip.

Among them is the storied and accomplished commodities investor Jim Rogers.

Best known for calling the commodities rally in 1999, Rogers recently said, “If there is a shock to the system, such as a eurozone country like Spain going bankrupt, then everything will go down, and I hope I am smart or alert enough to buy more gold at that point.”

The renowned investor also added that if India, the world’s largest bullion buyer, implemented another tax increase on gold imports, it would pave the way for a smart entry point for investors, since it would limit the country’s input to the gold market. The Indian government hiked the tax level for gold bars, coins and platinum to 4% in March, up from 2% in January.

Meanwhile, Rogers is mildly bullish about economic conditions in the United States for 2012, noting that because we are in an election year, the government is pulling out all the stops to boost the U.S. economy for at least two years.

So, Rogers is positioning his portfolio by stocking up on commodities, including gold. He explains that if economies do recuperate and prosper, they are going to need more commodities.

Conversely, Rogers says that if growth wanes and a recession looms, he wants to have a stash of commodities because of the flood of money-printing that is bound to follow.

Either way, Rogers likes gold.

That is not to say that gold is bulletproof. In fact, Rogers says a gold price correction could happen sooner rather than later, and the downside is $1,200-$1,300 a troy ounce.

Investors may be wise to watch for and seize upon any sell-offs in gold.

The Power of Gold

Of course, there are myriad reasons to be enamored by the precious metal.

As the World Gold Council notes:

• Gold is one of the few financial assets that does not rely on an issuer’s promise to pay.
• It offers investors insurance against extreme movements in the value of other asset classes.
• It provides a portfolio with diversification, adding protection against fluctuations in the value of one single asset or group of assets.
• It acts as a hedge against inflation because it retains its purchasing power.
• It is held as a hedge against currency fluctuations.
• The demand for gold has shown sustained growth in recent years and the supply/demand ratio has positioned the yellow metal for its most positive outlook in over a quarter century.

And as more and more people become disenchanted with paper currency as a store of value, gold prices promise to rise.

Diane Alter
Contributing Writer, Money Morning (USA)

Publisher’s Note: This article originally appeared in Money Morning (USA)

From the Archives…

What Newton Knew About House Prices …That the IMF Should
2012-05-11 – Kris Sayce

Why a Greek Exit From the Eurozone Could Be Great News For Markets
2012-05-10 – John Stepek

Why Europe Will Ditch Green Energy
2012-05-09 – Kris Sayce

Why It’s Time to Buy Gold
2012-05-08 – Dr. Alex Cowie

Why You Should Be Watching Japan’s Economy
2012-04-07 – Dan Denning

The oil and gas world meets in Australia this week.

Today and for the next two days I’m at the 50^th annual get-together for APPEA – that’s the ‘Australian Petroleum Producer and Explorer Association’.

I packed my bags and kissed the family goodbye last night to fly up here for this year’s conference. It’s a busy day ahead and I’ll tell you more about it tomorrow.

But this morning I just wanted to give you a heads up on the key issues driving the global energy market…what they mean for Australia…and most importantly what they mean for you…

With over 3000 delegates meeting at Adelaide’s Convention Centre it’s by far Australia’s biggest oil and gas conference.

No wonder it was so hard to find a hotel room!

The important thing to note is that this is not the kind of resources conference that’s full of big and small companies spruiking their story. APPEA is a real industry event where the biggest players in the game get together to talk technical.

In fact, the keynote speaker is none other than Saudi Arabia’s oil minister, ‘His excellency’ Ali Al-Naimi.

Saudi Oil and Gas

As guardian of the world’s largest oil and gas exports, he may be the most powerful person in the world of energy. They call him ‘The Central Banker of Oil’.

As I write, he hasn’t spoken yet. But his talk this morning will be on ‘The future of oil and gas – a Saudi Arabian perspective’.

But the real question everyone wanted to ask is just how Saudi Arabia hopes to increase its oil output to the levels it keeps telling the world it can.

Every time the oil price creeps up, the Saudi’s talk the price down. They say they’ll increase production to suppress the price. Why do they want a lower oil price? Excessively high prices make people look for alternatives, which is no good for a country that makes all its money from oil.

It’s a clever trick, because Saudi Arabian oil exports have never even come close to the levels they claim possible.

Oil fields have a natural lifespan, and Saudi’s fields are no spring chickens.

This chart shows Saudi Arabian oil exports since 1970. It’s never been above 10 million barrels a day, let alone the 12.5 million barrels a day – the red line – Saudi Arabia claim they can produce.

Saudi Arabian oil exports – never come close to claimed potential

Click here to enlarge

I’d like to ask ‘His Excellency’ about the mismatch between actual production levels and claimed production potential, but unfortunately there isn’t a Q&A after Ali Al-Naimi’s speech. So I’ll have to bail him up later instead, and maybe soften our friendly teetotaler up over a few hot chocolates.

I could also ask him if he reckons his country can keep the US as an ally. Especially when the shale gas revolution will see the US become far less dependent on Saudi oil in the coming decades.

Saudi Arabia is in an interesting position right now, so I’m keen to hear what he has to say.

In a resources market that has taken some serious body blows in the last 6 months, oil and gas stocks are still doing well. One reason is this doubt that Saudi Arabia has any spare supply. The bigger reason energy stocks are doing well is simple: the world’s energy needs are increasing.

The International energy Agency (IEA) estimates global energy demand will increase by ONE THIRD in the next 25 years. That’s a huge jump.

Most importantly, the IEA reckon China and India will account for HALF of this growth.

Australia’s Big Bet on Oil and Gas

China is already Australia’s biggest customer, taking a quarter of our exports. But don’t overlook India. In recent years it has gone from 1%, to now taking 7% of our commodity exports. And India is a story to keep watching in coming years. Both these numbers are rising fast. This gives Australia’s fast expanding energy sector a great opportunity.

This is why Aussie firms are making a colossal bet on things panning out like this.

The total investment in Australia’s oil and gas sector in the period to 2020 is estimated to be $330 billion.

To put that in context, it would be like spending a THIRD of Australia’s super-fund pool on oil and gas projects in the next 8 years.

The $330 billion to be spent on oil and gas projects is also an incredible 60% of the $550 billion planned investment for all resource industry investments in that time.

Like I said, we’re betting big on oil.

The CEO of Total S.A. [NYSE: TOT], one the world’s biggest oil companies, is also talking about turning Australia into a ‘global energy hub on par with the Middle East, Canada and Russia’.

I’ve tipped oil and gas stocks for Diggers and Drillers readers this year, and plan on tipping more. This is maybe the most important theme in the resources market today.

And after this weekend’s terrible economic numbers from China – showing imports have all but stopped growing – oil and gas will be one of the few areas of the resource sector that stand to keep performing for the foreseeable future.

Dr. Alex Cowie
Editor, Diggers and Drillers

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