Investors too often focus on specific stock selection and watch their investments get swept away when powerful undercurrents spawn market-moving capital waves.

But finding that needle-in-the-haystack stock isn't as important as picking the right haystack.

At this critical market juncture, the easy money has already been made. Whether investors are able to hang onto recent gains and take advantage of future opportunities will be determined by where - and how quickly - giant capital pools react to financial, economic and political forces.

The new religion in investing doesn't rely on faith. If you know the sea is being parted, you don't have to walk on water.

You instead must understand how to read the ripples and invest in the waves...

Ride These Five Capital Waves

The first step to successful capital-wave investing is to understand the big picture. You can pick a stock with great promise, but if its overall industry group drifts down or is tanked by an exodus of investment capital, you're sunk.

Likewise, if you pick the right industry - and even the right stock - but the overall stock market drops, that's also bad luck.

To maximize your potential for finding winning positions, start by picking the right asset class. But also make sure that you're on the correct side of the underlying trend. If you catch the big wave, you have significantly enhanced your prospect of making money when the wave pushes all boats in front of it towards profitability.

The major asset classes where huge capital waves drive quick-and-robust profits consist of:

1. Developed-world equities.
2. Emerging-market stocks.
3. Fixed-income assets.
4. Currencies.
5. Commodities.

Profits on Our Home Shores

To really see the big picture, investors increasingly must understand political events and how they impact investment decisions and huge capital flows. Political decisions around the world affect local markets and global markets when policies impact trade relations, interest rates, currency values, taxes and regulatory matters. There are other factors, but these are the big themes to watch.

Here's what is happening around the world. And here's how to correctly position yourself in the major asset classes.

The United States is still the world's No. 1 economy and what happens here moves markets. President Barack Obama and Congress are grappling with several major political decisions. Healthcare, regulatory reform, economic stimulus and, eventually, taxation, are the major forces that will create capital waves.

The Obama administration, Congress and the U.S. Federal Reserve cannot allow interest rates to rise. They will do whatever they can to keep rates low: Otherwise, the recovery will be choked off.

Inflation is not an immediate problem. In fact, a little inflation would be an excellent tonic, and should help with asset appreciation. Also, don't get hung up on the potential ramifications of the growing U.S. deficit and escalating national debt.

The huge budgetary shortfall will hurt some investments, even as it creates huge opportunities elsewhere. But the true effects of the deficit will take more time to work their way through the U.S. economic system, meaning there are other factors that are right now more critical to consider.

With headline unemployment at almost 10% and consumers retrenching in the face of declining housing values and tight bank-lending standards, the perception of rising inflation will be offset by the need to get America going again.

Bet on low interest rates: As long as interest rates remain low, the stock market can maintain its current upward trend.

Pay careful attention to marketplace undercurrents, particularly those that are politically based. Closely follow anything that points to an end to the stimulus programs, to the market's reaction to the passage or failure of healthcare legislation, and to any real regulatory reforms that are enacted. And given the projected deficits and expected growth in U.S. debt, watch to see if any tax-law changes take place.

The trend is your friend, and right now the market trend is up. But it's a good time to be nimble, and to take profits and cut losses to give yourself the opportunity to better gauge the future direction of U.S. stocks as these major political currents play themselves out.

If you opt to remain invested in winning positions, make sure to employ protective stop-loss orders.

Ride the Tides to Global Investing Profits

The rest of the developed world is a mixed bag. Bet on Australia: As overseas economies go, it was hurt the least by the credit crisis and housing bust and has been the first to emerge. In fact, Australia is so strong that it was the first country to raise interest rates, which it never would have done if its recovery were threatened.

Canada is another strong bet. Get exposure there.

Europe is a mixed bag. The big European companies who are leaders in their respective businesses around the world are going to continue to expand and grow revenue. The governments of their home countries support and coddle the giant corporations that employ thousands and generate billions tax revenue. At this juncture, invest in the multinational leaders that are headquartered in Europe. But don't try to play any particular country.

Europe's growth prospects are inexorably tied to the euro. From a political standpoint, the European Union (EU) wants to see the euro to fall relative to the dollar and other world currencies. Why? Because, like everyone else, EU-member countries want to export their way out of recession. And a cheaper euro makes their goods and services less expensive to the rest of the world.

There's a danger, however: Europe could get too much of what it seeks.

In the face of mounting economic woes - not to mention debt that's soaring in relation to gross domestic product (GDP) - watch out for a big spike in fears that the EU could become unglued. That could cause the euro to drop too far.

This is how capital waves lead to investment opportunities. Watch the momentum of the euro: If it breaks recent support levels, it will make a great short. Put that in your currency asset-class file as a potential home-run trade.

Emerging equity markets are humming along. You should be invested internationally - in Brazil, India, Korea, and especially in China. There are political ramifications to China's stated policy to rein-in its overheated economy, just as there will be to the shifting political agendas of some of the other emerging-market countries.

The one problem with all the emerging economies is that they are all export driven. Sure, China has been investing internally. But politically speaking, Beijing knows that the domestic demand needed to fuel internal growth will need more time to reach a perpetuating critical mass. However, watch the country carefully: If domestic demand outpaces exports revenue, buy the country!

China is the engine of Asia. If China cools down, it will affect the entire region, as well as global commodities prices and, indeed, the entire world market.

There's a new nexus driving the world. The global confluence of politics and economics brokered the engagement of the United States and China. But who actually ends up wearing the pants in this marriage will determine where there are opportunities, and where there are struggles, all across the globe. Huge pools of capital will be shifted.

There are no bigger, faster or more profitable capital waves coming than these.

Low-Tide Interest Rates Yield Maximum Market Profits

The fixed-income asset class is arguably the most important asset class for investors. While there are plenty of bond and fixed-income securities and instruments to invest in, this asset class is crucial to watch because it is a window through which we can see the direction of interest rates. Nothing creates giant capital waves quite like interest-rate moves. If you want an early warning system to safeguard your investments, or if you're looking for new investment opportunities, become a master reader of the bond market and diviner of the direction of interest rates.

Since the stock market rally began last March, investors who bet that an increased risk appetite would mean an exodus from a massive build up in U.S. Treasury holdings got burned. If you understood the big picture and knew that the Fed and the Obama administration intended to keep interest rates at ultra-low levels at all costs, you would have participated in - and profited from - the rally in bonds.

Eventually, interest rates will start to rise. Getting the timing right could make you staggeringly wealthy - while those who don't have their eyes on the prize take it on the chin.

How will you know when rates are moving? Watch the political undercurrents. Watch tax-and-spend policies. Watch worldwide risk appetite. Watch bond spreads.

Movement in interest rates directly affects the biggest asset class of all - currencies.

Currencies and Commodities: The Best Waves to Ride

Investors who aren't playing the currency markets are missing out on the last great venue where one can start with a little money and, if managed properly, leverage it into double, triple or quadruple gains that just aren't attainable anywhere else.

Macro political decisions affect interest rates and currency relationships. Therefore, to catch the big movements in currencies, keep an eye on government-trade, spending, tax and regulatory policies. Watch what's happening between political factions in Europe. The biggest plays will be in the dollar, the euro and British pound. Right now the trades are: Long, short and double-short, respectively .

The last big asset class that investors can make a killing in is commodities. You don't have to watch them all. Watch the commodities that most affect your life. The ones to watch include oil, gasoline, natural gas, agricultural products and, of course, precious metals such as gold and silver.

What factors most affects commodities? Politics, for one thing. For instance, whether or not Beijing slows China's growth will determine the demand for most major commodities and basic materials. Indeed, whether all the world's economies will try to export their way to economic growth will determine commodity demand. After all, if global growth slows, commodities stockpiles will increase, and prices will plummet.

At the core of each of these scenarios will be series of macro political decisions that set the catalysts in motion.

No matter which way asset prices move, one fact is certain: If you divine the correct capital waves, and time your trades correctly, commodities provide a means of diversifying your investment portfolio and adding rocket fuel to your returns.

Rules for Safe Big-Wave Surfing

It's easy to take positions in macro trends and in different asset classes. There are plenty of great exchange-traded funds (ETFs) to trade if you currently don't wish to invest directly in bonds, currencies or commodities. At some point in your moneymaking career, your view on this point is likely to change, and you will make those investments directly.

As we've seen in the two years, markets go up and they go down - and sometimes very sharply. It's important to remember that, in general, when markets go down the velocity of the move is greater than it is on the way up. The simple reason for this reality is that the emotion of fear is much more powerful than that of greed. All the major asset classes can - and should - be played in both directions. If you're only playing the uptrends, you're missing out on the other half of the action.

And worse, if you're not inclined to see opportunity when markets reverse, there's a better-than-even chance that you will get stuck thinking that your sinking position will magically reverse course and resume its ascent. I call this investor trap "the tyranny of magical thinking." The bottom line is simple. If you take profits and cut your losses you will be out of the market at times. And, that gives you a clear view of trends.

The last 10 years are a wash. And stock-market investors must face the scary reality that buy-and-hold investing has failed. It has failed because the world has changed - but most investors haven't.

As the world has gotten larger, investing opportunities have grown in size, scope and speed. Huge capital flows move in and out of asset classes, markets, industries and stocks at the speed of a mouse click.

And precisely because these giant capital waves happen so often, smart investors tend to be big-wave surfers. They just need to be sure to pick the right waves to ride.

[Editor's Note: Money Morning Contributing Editor R. Shah Gilani has seen it all - which is why his columns and analyses have been read by millions.

A retired hedge-fund manager and gifted analyst, Gilani regularly readers behind Wall Street's "velvet rope" - and into the world he knows so well - exposing the pitfalls that can inoculate investors against ruinous losses even as he highlights profit opportunities that most other experts never even recognize.

With his new advisory service - The Capital Wave Forecast - Gilani shows investors the monster "capital waves" now forming, will demonstrate how to profit from every one, and will make sure to highlight the market pitfalls that all too often sweep investors away.

Take a moment to check out Gilani's capital-wave-investing strategy - and the profit opportunities that he's watching as a result.]

News and Related Story Links:

• The Capital Wave Forecast:
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• CNNMoney.com:
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• MarketWatch.com:
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• Investopedia:
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• Wikipedia:
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• Money Morning Special Investment Report:
  It's the Best Investment in North America - and It Isn't the United States
  
• Wikipedia:
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• Money Morning Special Report:
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• Money Morning News:
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• Investopedia:
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• Money Morning Special Investment Research Report:
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• Money Morning News Analysis:
  Silver's Run Quietly Gains Momentum
  
• Money Morning News Analysis:
  Iron Ore Negotiations Reach an All-Too-Familiar Impasse

Simple Supply and Demand

Coal has two primary uses - as fuel for the commercial generation of electricity and heat and for conversion into coke, which is used as both a fuel and a reducing agent in the process of smelting iron ore in a blast furnace to make steel.

Roughly 92.8% (1,041.6 million short tons) of total U.S.coal consumption (1,121.7 million short tons) was used for electricity production at 22 major coal-fired power plants in 2008, the last year for which complete figures are available. Roughly 1.9% (22.07 million short tons) was used in coking, while the remainder was used for other industrial purposes and private and institutional (e.g., hospitals and universities) power and heating plants. On the production side, U.S. coal output rose by 2.2% in 2008 to a record 1,171.5 million short tons, helping fuel a sharp increase in coal exports.

U.S. consumption totals in all sectors were down slightly in 2008 from 2007 - reflecting the relatively mild winter and the sharp economic slump - and numbers for the first three quarters of 2009 showed a continued decline, though preliminary figures for the fourth quarter and the first two months of 2010 show that trend reversing in all sectors but coking, thanks to the record-setting winter weather and a modestly resurgent economy. The continued decline in the coking sector reflects the ongoing loss of U.S. steel production to overseas competitors, most notably China.

Indeed, according to all major industry sources and the U.S. government's Energy Information Administration (EIA), China will be the driving force in the coal markets for at least the next two decades, accounting for more than half of the world's total consumption by 2025. Growth in consumption will also be far stronger in other emerging-market countries than in the developed nations.

The EIA projects growth in coal consumption in the U.S. and other nations of the Organization for Economic Cooperation and Development (OECD) will grow from 47.3 quadrillion British thermal units (Btu's) in 2010 to just 48.3 quadrillion Btu's in 2025, an increase of only 2.1%. By contrast, coal consumption in China is projected rise from 62.7 quadrillion Btu's this year to 90.1 quadrillion Btu's in 2025 - a 43.7% increase.

For those wondering why we've been describing consumption and production in quadrillion Btu's rather than the much simpler and more straightforward tonnage, it's because there are significant differences in the quality of coal, depending on where it's produced. Thus, it's more precise to talk about the energy values in coal.

Total non-OECD consumption, including China, is projected to rise by 36% from 93.3 quadrillion Btu's this year to 126.9 quadrillion Btu's in 2025. So in just 15 years, emerging nations will account for more than 72% of the world's annual coal use.

Worldwide demand for coal will rise to 175.2 quadrillion Btu's in 2025 from 140.6 quadrillion Btu's this year, an increase of 24.6%, the EIA said.

Meanwhile, the mining industry has barely managed to keep up with the increase in global demand in recent years. In 1990, total world demand was 89.2 quadrillion Btu's, while total world production was 91 quadrillion Btu's, a surplus of 1.8 quadrillion Btu's, or just over 2%. By 2006, the last year for which complete production figures are available, global demand had climbed to 127.5 quadrillion Btu's, while global output had risen to just 128.49 quadrillion Btu's - a surplus of just 0.99 quadrillion Btu's, or 0.77%.  

Given the increased worldwide restrictions on mining operations and the shrinking likelihood of new coal discoveries, it's hard to see where another 47.7 quadrillion Btu's worth of coal are going to come from, especially since projections for 2010 are already showing a potential production shortfall and depletion of existing stockpiles. (There's also no anticipated improvement longer term, since the World Coal Institute estimates there are only enough proven coal reserves to last 155 years if the rate of consumption remains unchanged.)

Investing in Coal

Unlike with many other popular commodities, individual investing in coal is generally not a simple matter of buying basic futures or forward contracts. That's because different types of coal have extreme variances in quality.

In the United States, for example, there are five primary classes of coal, each with a different Btu rating. Northern Appalachia coal, rated at 13,000 Btu per short ton, is the highest quality, while Powder River Basin coal (from Wyoming and other Rocky Mountain states) is the lowest quality, with a rating of just 8,800 Btu per short ton. Because of those quality differences, the spot prices for Northern Appalachian coal and Powder River coal at the close of trading on March 5 were $64.00 a ton and $12.70 a ton, respectively.

The other classes of U.S. coal, with March 5 spot prices, are Central Appalachia (12,500 Btu, $58.95), Illinois Basin (11,800 Btu, $41.50) and Uinta Basin (11,700 Btu, $40.00).

While the NYMEX division of the CME Group does trade one major and two minor futures contracts - Central Appalachian, or CAPP (trading symbol: QL); Western Powder River Basin, or PRB (symbol: QP); and Eastern CSX Transportation (symbol: QX) - all are fairly thinly traded and used primarily by commercial interests for hedging and supply management. Inconsistencies with the spot prices can also be high - e.g., the nearby CAPP future closed at $52.30 on March 5 compared to the spot price of $58.95.

Coal prices also tend to move separate from coal fundamentals themselves. Instead coal prices track the changes of other energy commodities, primarily crude oil and natural gas, as well as certain hedging commodities such a gold. This was illustrated quite clearly the past three years.

Through most of 2007, Northern Appalachia coal prices ran from $30 to $45 per short ton. They then skyrocketed along with oil in early 2008, peaking near $150 in October 2009, before plummeting back to just over $40 per ton in May 2009. After a couple of months of flat trading, prices again started a steady climb, reaching $64 on March 5.

So, assuming the demand will continue to grow - and oil prices will keep rising, dragging coal and gas along - how should you play the move?

Exchange-traded funds (ETFs) are among the best choices as there are at least four that take heavy positions in coal-related issues, including two that target coal specifically. All are up significantly in price since the March 2009 market bottom, but they should have ample room left to climb as the recovery gathers added steam. They are:

Market Vectors Coal (NYSE: KOL): This fund aims to track the price and yield performance of the Stowe Coal index. It normally invests at least 80% of total assets in equity securities, including American Depositary Receipts (ADRs), of U.S. and foreign companies engaged primarily in the coal industry.

PowerShares Global Coal (NYSE: PKOL): This fund attempts to mirror the NASDAQ OMX Global Coal Index. It normally invests at least 90% of assets in securities, ADRs and Global Depositary Receipts (GDRs) based on the securities in the underlying index, focusing 80% of assets on companies involved in the coal industry.

Market Vectors Steel (NYSE: SLX): Coal is a major cost factor for the companies this fund invests in since all are major consumers or producers of steel. Since steel is a major component in all sorts of infrastructure construction, the fund's holdings should benefit from new spending linked to the global economic recovery.

SPDR S&P Metals & Mining (NYSE: XME): A diversified fund that includes coal mining and processing companies among its portfolio holdings, many of which are international, meaning the fund can also benefit from currency fluctuations as well as changing prices for metals and other minerals.

For those who prefer picking individual stocks to riding along with fund managers, four companies with heavy direct involvement in the coal industry are:

Consol Energy (NYSE: CNX): This Pennsylvania-based company is involved in the mining, preparation and marketing of steam coal, primarily to power generators, and metallurgical coal to steel and coke producers. A darling of the mutual funds and institutional investors (including Carl Icahn, who had 1.36 million shares at one point), which hold 93% of the shares, CNX also has a large holding of in-ground coal reserves.  

James River Coal (Nasdaq: JRCC): After being the focus of takeover talk for more than a year before the economy collapsed, this miner and processor of industrial-grade coal pulled back from the high $40 range in 2006 to a low of $3.86 in August 2007. It then rode the oil rally to $62.14 in June 2008 before sliding all the way back to single-digit levels in late 2008. Since then, it has traded in a fairly tight range from $16 to $22, but it obviously has the potential for another large run should coal prices continue to rally.

Patriot Coal Corp. (NYSE: PCX): Patriot has reserves in both Appalachia and the Illinois Basin, operates 14 mining or processing complexes and is a major supplier of thermal coal to power companies along the upper Mississippi. The company has strong earnings ($1.49) over the past year and, though the stock has made a nice run from its lows last spring, still has a reasonable price-to-earnings (P/E) ratio of just 12.93.

Puda Coal Inc. (AMEX: PUDA): For those who like to go right to the heart of the demand, Puda is one of China's leading suppliers of metallurgical coking coal to the Chinese steel industry. It also has room left to move price-wise, unlike SinoCoking Coal and Coke Chemic (Nasdaq: SCOK), another Chinese mining and coking company, which recently shot from $3.50 a share to more than $30 after uplisting from the Bulletin Board to Nasdaq proper.

Coal prices could suffer a mild seasonal decline as winter comes to an end, but the ballooning long-term demand picture and increasing oil prices appear poised to provide support - and possibly light a new fire under coal-related stocks in the near future.   

News and Related Story Links:

• U.S. Energy Information Administration:
  Independent Statistics and Analysis - Coal
  
• U.S. Energy Information Administration:
  Coal News and Markets
  
• CME Group Official Web Site:
  Central Appalachian Coal Futures
  
• World Coal Institute:
  Official Web Site
  
• Wikipedia:
  Peak coal production
  
• Mining Industry Today News Service:
  Coal Demand News
  
• International Mining Magazine:
  China's 2010 coal demand could rise 4%-6%
  
• Mining Exploration News:
  Increased Coal Prices and Coal Demand from China Continues Until 2010
  
• Money Morning:
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• ETF Trends:
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• ETF Trends:
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• ETF Trends:
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• ETF Trends:
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"With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time," the Fed said in a statement yesterday (Tuesday).

Economic recovery has begun but at a slow pace, and companies are not likely to raise prices much before there's more job growth - and unemployment is still at an uncomfortably high level of 9.7%.

"Disinflation is going to be with us for a while," Julia Coronado, a senior U.S. economist at BNP Paribas in New York, told Bloomberg. "That's going to allow the Fed to stay on hold for a lot longer than the market is expecting."

The PPI drop followed a 1.4% January gain. The decrease was largely driven by gasoline prices, which fell 7.4% from last month after an 11.5% climb in January. Overall, energy prices fell 2.9%, and food prices rose for the second consecutive month by 0.4%.

Core producer prices - which exclude food and energy - are more closely watched by the Fed, and rose 0.1% in February, matching economists' expectations. Core costs were led higher by rising wholesale auto prices.

Producer prices were up 4.4% from February 2009, slimming January's year-over-year increase of 4.6% and falling below predictions of 4.9%. Economists say this is not elevated enough to cause inflation concerns.

"The bottom line is it looks like the price pressures are pretty moderate in terms of core producer prices right now. It doesn't suggest there is any kind of generalized inflationary pressures building up in the production pipeline," Jonathan Basile, an economist at Credit Suisse Group AG (NYSE: CS) in New York, told Reuters.

Economists in a Bloomberg survey had only predicted a slight 0.2% drop in the PPI.

The PPI is one of three measures of inflation that include the cost of imported goods - which fell by 0.3% in February - and the Consumer Price Index (CPI). The government will release CPI numbers Thursday. Predictions have it rising by 0.1%.

The PPI data and the Fed's policy meeting sentiment were just a couple pieces of this week's global news that helped rally markets Wednesday.

"Indications from the US Fed on Tuesday that interest rate increases may be some time away yet, a benign US producer price report, signs that the US financial system continues to heal with more TARP [Troubled Asset Relief Program] repayments and continued easing of sovereign debt fears in Europe this week all appear to be contributing to improved market sentiment," Colin Cieszynski, market analyst at CMC Markets, told Financial Times.

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• Money Morning:
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• Reuters:
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• Bloomberg:
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• The Federal Reserve System:
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• Financial Times:
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Steelmakers Face a "Catch 22" on Prices

Chinese steelmakers like Wuhan - China's third-largest steel maker by output - claim that price increases like the ones miners are asking for will be difficult to pass on to consumers.

"We'll either have to take a huge loss, or raise product prices for downstream users, including automakers, shipbuilders and home-appliance manufacturers," Deng said. "This may cause serious social consequences. There is no good news."

China has more than 1,000 domestic steel mills. It is the world's largest steel producer, and thus the largest consumer of iron ore. The country imported 628 million metric tons of the metal in 2009 - a 42% increase from 443.6 million tons in 2008.

After rising to a record high 570 million tons in 2009, China's steel production may exceed 600 million tons in 2010, according to the China Securities Journal.

However, those figures are winning no favors from the iron ore industry. That's because Chinese steel mills were less than generous with their contract offers when commodities prices collapsed in 2008. Chinese steelmakers used the global recession as leverage to demand a price cut of 45%-50%.

After a few rounds of bitter negotiations, the China Iron and Steel Association turned down an offer of a 33% price reduction from the world's top three iron ore producers - even though Japanese and Korean steel mills were poised to accept the price cut.

China's steelmaking contingent later signed a deal with Fortescue Metals Group Ltd., Australia's No. 3 producer, for a 35% price cut. Just 60% of the iron ore sold to China last year was done so at contract prices, and steelmakers purchased the rest on the spot market. Spot prices for iron ore tumbled 70% from 2007 to 2008.

But now prices have rebounded. Iron ore on the spot market has risen by $10-$15 a ton in the past month alone, reaching roughly $110 per ton. That's about 40% higher than a year earlier, and was double the 2009 contract price.

And with global steel demand staging a strong rebound, prices figure to stay high.

"Seaborne trade is expected to grow by over 100 million tonnes this year, which is twice the average growth rate seen during the past five years,"Goldman Sachs JBWere analyst Malcolm Southwood said in a note to clients. "Supply will inevitably catch up, but probably not until 2011. We expect supply and demand to be much more closely aligned from 2011-12 with potential for an oversupplied seaborne market from 2013-14."

No doubt it's a sellers' market and mining companies are looking to recoup last year's losses, even if that means sidelining China entirely. Vale and its Australian counterparts are reportedly willing to let China walk, and take its chances in the spot market, just as they did last year.

"As far as I am concerned, they [the Chinese negotiators] could come over to Australia if they want to talk," one executive told The Financial Times in January.

True to that sentiment, BHP and Rio are sitting on the sidelines waiting for China to come to them.

"They're not hurried," said Wuhan's Deng. "They're not hurried at all."

Meanwhile, Brazil's Vale has reportedly already abandoned its talks with China, after demanding a price increase between 80% and 100%.

"Vale of Brazil had exited the negotiation for they cannot accept the low prices proposed by Chinese steel mills," a steel producer in China's Hebei province told the National Business Daily.

Vale refuses to comment on "rumors" about iron ore negotiation.

It should be noted, however, that Chinese interests aren't the only ones worried about a stern rise in iron ore contract prices.

The European Confederation of Iron and Steel Industries (Eurofer) warned that sharp price increases could jeopardize Europe's economic recovery.

"European governments should be aware of the implications for the wider economy if these price increases become reality," Eurofer said in a statement. "Increases of this magnitude will have a significant impact on steel prices and, as such, on the whole manufacturing and construction value chain and ultimately on the European consumer. This will reduce demand for many price-sensitive products and therefore slow economic recovery or even push economies back into recession."

Neither BHP Billiton nor Rio Tinto will comment on iron ore prices or their economic impact until negotiations are completed, but both miners have called for a change to the current benchmark pricing system.

A Clash of Iron Wills

Negotiations between iron ore miners and steelmakers are dangerously close to fizzling out for the second year running - and they may be done for good.

Some miners in the past have lobbied to replace the annual benchmark system with a quarterly pricing system based on the spot market.

"For many years we have said that this market has to change, and will change," BHP Billiton Chief Executive Officer Marius Kloppers told reporters earlier this month. "We would love to sign longer term volume contracts priced on an index."

BHP has led that charge by refusing to sign new long-term deals in 2008, spelling an end to all benchmark sales by the end of the decade.

"We are assuming BHP Billiton [will] roll most of its Chinese customers onto index-linked prices," Morgan Stanley (NYSE: MS) analysts said in a recent report. "We understand [BHP] is likely to revoke contracts that have expired due to Chinese steel mills failing to sign new prices in 2009 by the drop-dead date embedded in supply contracts."

The company is "moving away from the annual benchmark price system to ... a spot market that daily sets a clearing price," the brokerage said.

However, BHP's customers are reluctant to follow suit. Some observers think that could change this year, but others are more skeptical.

"The Chinese obsession with trying to argue the iron ore price on a short-term basis from year to year rather than taking a strategic perspective to encourage the expansion of low-cost iron ore capacity has been a major contributing factor to the situation they find themselves in year after year," former BHP Billiton China CEO Clinton Dines, a 20-year veteran of the company and China who stepped down last year, told The Australian.

"The system has cost the Chinese billions," Dines added. "By being short term and bloody minded they encouraged the expansion of high-cost capacity and effectively promoted the spot market, where high-cost producers sell their iron ore. They shot themselves in the foot."

But before accepting higher contract prices or a change to the current system, Chinese steelmakers appear determined to explore one option of last resort: Appealing to China's central government.

More than 10 of the nation's top steel mills have formally petitioned Chinese Premier Wen Jiabao to make the iron ore benchmark price talks "a matter of national importance".

"The domestic steel companies can no longer bear such high quotes of iron ore and have been forced to hike steel prices to pass on the costs," an unnamed source told the China Securities Journal. "Escalating the solution of the iron ore imports issue to the national level can avoid internal friction and protect the overall interest of China's steel industry."

Australia responded this week, asking that Beijing refrain from getting involved and giving assurances that it will do the same.

"We won't be getting involved. I've made the point to China and I repeat the point, we recognize China's market economy status," Australian Trade Minister Simon Crean told reporters in Canberra. "All we ask in return is that it act in accordance with market principles, not seek to get government involved."

However, China's Commerce Ministry said yesterday (Tuesday) that it was preparing a "new policy" to support its steel industry.

"As the world's largest iron ore consumer, the interests of Chinese steel mills should be reflected in the negotiations," Commerce Ministry spokesman Yao Jian told reporters.

Yao did not specify what actions Beijing would take to support China's steel mills, but it could issue preferential tariffs on long-term contracts.

Australian Trade Minister Crean was justifiably irritated at Beijing's response.

"You can't have the government intervene to set prices for what is an internationally traded commodity," he told Australian radio. "China wanted to be recognized as a market economy and what we say is that if that's the case, we have recognized you as a market economy, act like one. Act in accordance with market principles."

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• The Australian:
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• The Australian:
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• Financial Times:
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• AFP:
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• MarketWatch:
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• MarketWatch:
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• European Confederation of Iron and Steel Industries (Eurofer):
  Official Web Site
  
• China Iron and Steel Association:
  Official Web Site
  
• Wikipedia:
  Wen Jiabao