John Felmy has been the chief economist of the American Petroleum Institute (API) for years. He’s well respected. And I appreciate his experience. But the two of us disagree more often these days.

We most recently locked horns at Malone University in Canton, Ohio, last week, where we were debating the future of oil. (Actually, when the invitation was made, I was supposed to debate Sarah Palin. But she pulled out to go on the road and pitch a book she didn’t write.)

Nonetheless, something disturbing emerged from the debate.

I still find John a pleasant enough fellow, but the mantra coming from the API, the mouthpiece of the oil industry, is wearing thin. They want us to believe that the oil market is still fine, still humming along, still providing the best energy value. You’ve heard the argument before: Gasoline is cheaper than milk or bottled water.

This time, John tried the latest API version of this sleight of hand: Whatever price you need to pay, oil is still cheap, still plentiful, still the energy of choice.

Sorry folks, the API just doesn’t get it. And what it refuses to get is becoming one of the most important factors investors in the energy sector will need to watch – carefully. This is all about supply and demand. But it’s not the traditional lecture from Econ 101.

This one is going to roll out differently.

Over the next several months, oil will begin losing its balance. As it falls off the wagon, risk will escalate. And that will require greater due diligence by investors. But as the risk increases, so will the number of opportunities. I’ll show you how to profit from them as they surface.

But first, here’s the problem with the API’s approach.

“Suspect” Figures Are Way Off

As John grudgingly admitted in our exchange, the API’s figures are becoming “suspect.” I have a less charitable view. (Unlike John, I don’t work for them.)

The API figures are way off.

They still portray a view of demand (low) and supply (high) that will not continue to square with reality. We have had lower demand for months only because of the financial crisis and the credit crunch. But this has had nothing to do with the oil market as such.

Others are catching on.

The Paris-based International Energy Agency (IEA), for example, has already admitted its supply estimates were too optimistic while its view of demand was too conservative. The IEA revisions have been paralleled in similar moves by the London Centre for Global Energy Studies (CGES), Russia’s Institute for Energy Strategy (IES), and even Washington’s usually impervious Energy Information Administration (EIA).

There’s a reason for this.

Worldwide oil demand, while sluggish, is nonetheless returning more quickly than anticipated. In addition to the usual suspects – China, India, a resurgence in the Far East – OPEC countries are retaining more of their own production to diversify their economies. Russia is facing rising domestic needs at the same time it tries to avoid a significant decline in crude production. Mexico is witnessing a meltdown in its oil sector while its domestic needs also rise. And new major markets are exploding in places like West Africa and South America.

Notice this is not happening in the United States or Europe. These countries are no longer the driving forces in the oil market. The most developed markets are not calling the shots, despite still being over-weighted in the data collected. The IEA finally got that. So did CGES, IES, and even the EIA.

But not the API.

Indeed, the paid spokesperson for the American oil industry continues to see crude oil as the main option. True, it gives lip service these days to alternative and renewable energy. Moreover, given its position as the in-house spokesman for the hydrocarbon sector as a whole, it is also praising the virtues of natural gas as the immediate choice when we transit from crude oil.

Unfortunately, the API still fails to provide an accurate picture. Perhaps in the final analysis, this happens because its clients are the oil producers.

Oil’s (Profitable) Reality

We currently have about 86 million barrels a day in worldwide crude oil demand. That still represents a figure below pre-crisis levels. However, all of the organizations mentioned above (with the exception of the API) are now estimating a rise to around 87.5 million over the next year, with increases accelerating thereafter.

Current global supply, on the other hand, will max out at 91-92 million barrels. That gives us a small cushion – just a few years – before the real fireworks start. Period.

Because new volume coming on line will barely replace declining production from older fields, we have little prospect of avoiding insufficient supply producing a spike in crude oil prices. This is not necessarily a bad development from the investor’s perspective, since a volatile market will provide profit opportunities, especially if the direction in price remains sustainable over any period of time.

The impact on other market sectors, of course, will be less positive.

The key here is to recognize the major benchmarks and triggers, along with early changes in what they tell us. These will not all be moving in the same direction as the unwinding ratchets into high gear. But we will be able to identify when they are changing and, more importantly, how to profit from them.

I’ll be discussing the strategy as it unfolds over the next several months.

I’ll show you, for example, how to spot a real oil-demand rise in the American market before it becomes apparent to everybody else. There are several approaches I will suggest as the market opens up. The best place to start is watching the leading economic indicators.

Actually, six of the 11 stats provided by the Department of Commerce are dependent upon, or reflect, changes in productivity and industrial needs. These are all also energy intensive. That means a rise in energy demand will precede the actual rise in the indicators. This is one of the early triggering mechanisms I use in my analysis and for making my estimates.

I’ll flag them for you as they emerge. And I’ll lay out how they impact the U.S. energy sector and related investments. There are quite different ways of early detection for other global markets, where the demand will be moving in more quickly.

Calls on investment alternatives will be very sensitive to changes in indicators and triggers. That means in energy, we need to stick to the trends. So stay tuned. The recommendations will follow in short order.

Just don’t expect to gain much traction from the API!

[Editor's Note: Dr. Kent Moors, now a regular contributor to Money Morning, is the executive managing partner of Risk Management Associates International LLP, a full-service global management consulting and executive training firm. He is an internationally recognized expert in global risk management, oil/natural gas policy and finance, cross-border capital flows, emerging market economic and fiscal development, political, financial and market risk assessment, as well as new techniques in energy risk management.

Dr. Moors has been an advisor to the highest levels of the U.S., Russian, Kazakh, Bahamian, Iraqi and Kurdish governments, to the governors of several U.S. states and the premiers of two Canadian provinces, a consultant to private companies, financial institutions and law firms in 25 countries and has appeared more than 1,400 times as a featured television and radio commentator in North America, Europe and Russia. He has appeared on ABC, BBC, Bloomberg TV, CBS, CNN, NBC, Russian RTV, and regularly on Fox Business Network.

Moors next columns will be written from Moscow and London, where he'll be talking to officials, company executives, traders and bankers. Russia is about to signal a major change in oil and gas development strategy, while recent events in London are signaling a new oil pricing approach.]

While American investors were busy enjoying their Thanksgiving dinners, global markets were shaken by word that Dubai asked for a payment holiday on the $59 billion it owes via its investment vehicle, Dubai World. The move, which comes as oversized bets on Persian Gulf real estate sour, was considered a default by the major rating agencies.

Last week’s “standstill” request puts at risk up to $80 billion in debt linked to the emirate. While this is small in the context of the $3 trillion in losses written down by global banks since the credit crisis began, it may very well result in the largest country debt default since Argentina in 2002.

So while Dubai is insignificant on its own, and will likely be bailed out by its larger and much wealthier neighbor and fellow United Arab Emirates member, Abu Dhabi, it ignited much larger concerns over the fiscal health of governments around the world. I discussed these concerns early last week in an in-depth discussion over rising insurance costs on government bonds.

This highlights concerns over the ability of governments to service their rapidly rising debt loads. Those on the hot seat include Greece, Japan, and much of emerging Europe. I wrote about these concerns last week when we discussed the recent rise in the cost to insure against default on public debt.

So, is this the beginning of a new crisis? The team at Capital Economics in London doesn’t believe it is: “Dubai’s current problems are a long overdue consequence of the bursting of the global property bubble rather than the start of a new financial crisis. Nonetheless, they are a timely reminder that the legacy of past excesses in heavily-indebted economies will linger for many years to come.”

In other words, imagine that the global financial system is like a patient recovering from a near fatal case of pneumonia. After being pumped with fluids and antibiotics via stimulus spending and ultra-low interest rates, the patient is on his feet again. But that doesn’t mean he isn’t vulnerable to a persistent cough and a low-grade fever.

Plus, Dubai was the country-sized equivalent of a full-tilt Miami condo flipper. The United Arab Emirates pegs its currency to the U.S. dollar, which means that it imported interest rates that were too low for its fast growing economy — resulting in a credit bubble and asset boom. Property prices have since fallen by 50% over the last 12 months. What’s worse is that efforts to diversify its economy away from fossil fuels via free-trade zones made the country extremely vulnerable to a slowdown in global trade and a decline in financial markets.

It was an extreme case of the kind of overleveraged excesses that resulted in the 2007-2008 financial crisis in the first place. The country’s investment arm spent billions on artificial islands reclaimed from the Persian Gulf in the shape of palms. It took a stake in a new $8.5 billion MGM Mirage (NYSE: MGM) hotel in Las Vegas. It invested in Canadian performance troop Cirque du Soleil. It bought stakes in Aspen ski resorts. It bought the Queen Elizabeth II ocean liner.

While the impressive rally over the past few months have brought a period of relative calm, it has merely masked the vulnerabilities that still remain. Investors were lulled into a sense of false security and Dubai’s rulers rudely awakened them. But apart from the jarring psychological effect, the risk that Dubai’s debt restructuring will result in a global “contagion” that pulls down financial markets and undermines the nascent economic recovery remains low.

Market Action

As traders returned from their holiday, they wasted no time in responding to weakness in Asia and Europe as a wave of fear spread: The Dow Jones Industrial Average lost 1.5%, the Standard & Poor’s 500 Index, the Nasdaq Composite Index lost 1.7%, the Russell 2000 lost 2.5%.

Stocks and commodities weakened, risky credit sold off, and the dollar and U.S. Treasury debt rose as investors sought safe havens. The CBOE Volatility Index or “Fear Index” was up 26.5% at one point — a jump of a magnitude that hasn’t been seen since the Lehman Bros. collapse. According to Tim Backshall at Credit Derivatives Research, credit markets had their worst day since March 5.

Intra-day losses were severe: The Dow was down 2.2% at one point. But an afternoon rally cut the losses. And over in Europe, where banks are expected to have a combined Dubai bond exposure of $40 billion according to Credit Suisse Group AG (NYSE ADR: CS) estimates, stocks climbed on Friday after deep losses on Thursday. This could be a sign that as investors learn the true nature of the Dubai situation and realize it isn’t the beginning of a new credit crisis.

For the week, the Dow lost 0.1%, the S&P 500 lost 0.4%, the Nasdaq lost 0.4%, and the Russell 2000 lost 1.3%. It was the Dow’s first weekly decline since mid-October.

Technically, the S&P 500 has struggled to overcome resistance at the 50% retracement line measured from the Oct. 07 high to the Mar. 09 low. A breakout would see a move to 1,200 for a gain of 10% where new resistance would be met. While this would be nice, my research suggests the market has lost so much momentum that such a move isn’t likely without a pause to recharge the batteries.

A breakdown here would likely see a move to the 1,000 level, for a possible decline of as much as 8% in a retest of the September low. Such a move would feel catastrophic but would be well within the bounds of a normal 10% correction in the context of a long-term bull market. This would shake off speculative excess and set the stage for a decisive move over the 1,200 level on the SPX.

Yellow Fever

Given the ferocity of gold’s advance and the pressure being exerted on the dollar, the yellow metal’s rise could last longer than most expect. But the movement is unsustainable just as the Nasdaq’s rise between 1998 and 2000 was unsustainable; just as home price appreciation in 2006 was unsustainable; or how the frenzy surrounding Dutch tulip bulbs in the 1600s was unsustainable.

The dramatic movements in gold and the dollar are being driven by a psychologically potent mix of fear and greed. Normally, these two emotions are mutually exclusive with one occurring during boom times and the other accompanying periods of panic. But now, both are encouraging people to sell the dollar and buy gold: Fear over the loss of the dollar’s purchasing power and greed as gold climbs makes it climb towards the heavens.

Remember that gold has no intrinsic value. It has no cash flows. It serves no practical purpose. It costs money to store and protect. And its value has fluctuated greatly throughout human history: Between 1980 and 1999, gold lost 71% of its value.

As for the dollar, let’s be clear: It will not collapse. And it is a long way from losing its status as the world’s main currency. This fear is increasingly widespread, but it isn’t realistic. It would result in dramatically higher interest rates and more expensive oil and other imported goods for American consumers. In addition, the U.S. government would be forced to cut spending and hike taxes as financing the deficit became more difficult. The result would be a hellish recession that makes our current affair seem like child’s play.

Exporters in Asia and the Persian Gulf understand this and aren’t keen on pushing the global economy off the cliff. Indeed, Indian Prime Minister Manmohan Singh recently said that there is no substitute for the dollar as the global reserve currency. And the economists at the ISI Group note that the real trade-weighted dollar index — which corrects for inflation and reflects the relative important of America’s trade partners — has fallen to a historical low that has held three times over the last thirty years.

So, it increasingly appears that central banks are using the IMF’s gold sale (being done to raise money to pay its bills) as a rare diversification opportunity. But it’s not a reflection of wholesale abandonment of the dollar no matter how badly the gold fanatics want to believe it.

Another possible explanation is the huge inflation many are awaiting given the massive money supply expansion over the last year. According to John Williams of Shadow Government Statistics, who reconstructs the discontinued broad M3 measure of money, the monetary base is up 129% since last August. My contacts in the hedge fund industry say that governments, central banks, and investors are pricing in inflation expectations five years out.

But this too is highly speculative: Industrial activity remains well below capacity and wage pressures should continue as the unemployment rate remains buoyant. The anecdotal evidence is also mixed. A rise in inflation-adjusted Treasury debt isn’t being matched by decreases in non-adjusted Treasury bonds.

I’ve been recommending that my subscribers play along for now, cynically following the herd and profiting from gold’s advance via our position in the StreetTracks Gold Trust (NYSE: GLD). But we will refuse to drink the Kool-Aid and will remain vigilant as we watch for signs of a reversal given that rapid, parabolic advances tend to be followed by similarly rapid, parabolic declines.

Technical analysis provides a few clues on timing. While gold has reached overbought territory on its 14-week RSI, recent history suggests multiple incursions over the 70 threshold are needed to fully exhaust bullish sentiment. So while a near-term pullback is likely, it probably won’t mark the end of the secular advance. Also, this analysis suggests gold’s bull run has another six months or so to go before pulling back for good.

Week in review

Monday: A number of comments by Federal Reserve officials encouraged traders to sell the dollar short and push stocks higher. First, St. Louis Fed president James Bullard said that he would like to keep the Fed’s direct purchase authorization for mortgage-backed securities alive past the March deadline. If implemented, Bullard’s wishes would help ensure that mortgage rates remain low and would give the housing market further times to heal. Separately, Chicago Fed President Charles Evans said that interest rates may stay near 0% until “late 2010, perhaps later” as policymakers await improvement in the job market.

These comments I’ve expressed many times in the past six months: Inflation hawks can complain all they want about U.S. money being too cheap, but the Fed is likely to keep short-term interest rates low until it has seen at least four to six months of employment growth in the United States. That won’t happen until late in the second half next year, at the earliest.

Tuesday: The government’s estimate of third-quarter economic growth was revised down to 2.8% from the original 3.5% mainly on less consumer spending, fewer exports, and a reduction in business inventories. Still, Q3 marks the first economic expansion since the slight rise in the middle of 2008. On the housing front, the latest numbers from the Case-Shiller home price index covering 20 metropolitan areas squeaked out a 0.3% gain in September — suggesting some of the wind is being taken out of the nascent housing recovery. Back in August, the index gained 1.2%. Overall, the index is up 3.5% from the low set in May as prices have returned to levels that prevailed in the autumn of 2003.

Wednesday: A heavy economic calendar. The latest weekly jobless claims number was the day’s big economic report: The measure of job loss finally fell below the 500,000 threshold for the first since October 2008. While the loss of half a million jobs a week is still terrible, history suggests a sub-500k number increases the probability of a positive monthly payroll report and a reduction in the unemployment rate.

Historically, jobless claims in excess of 500k are associated with payroll losses of 245,000. Jobless claims between 450k and 500k are associated with losses of 40,000. And finally, claims between 400k and 450k are associated with a payroll expansion of 65,000. This means we will probably see a positive payroll report within the next two months or so — providing a huge confidence boost to consumers and investors alike.

In other news, consumer spending increased 0.7% in October, beating expectations and reversing the 0.6% decline in September thanks to a 0.2% expansion in incomes. Consumer sentiment was higher than expected but still below levels reached this summer. The one blemish: Durable goods orders fell 0.6% in October, coming in below the 0.5% expansion analysts predicted and the 1% expansion in September.

Thursday: U.S. markets closed for Thanksgiving holiday. Stocks in Asia and Europe fell on Dubai debt concerns.

Friday: Black Friday kicked off the holiday shopping season. Retailers reported strong crowds. Marshal Cohen at market research firm NPD Group said the day was driven by a mix of “pent-up demand and frugal fatigue.” Let’s hope it lasts.

The Week Ahead

Monday: The Chicago Business Barometer will provide an update on manufacturing activity in the Midwest.

Tuesday: Motor vehicle sales, the Institute for Supply Management Manufacturing index, and construction spending will all be reported. Vehicle sales will be closely watched as investors gauge true consumer demand now that the affects of the government’s cash-for-clunkers scheme have dissipated. Wednesday: The ADP Employment report will provide a preview of the big employment situation report on Friday.

Thursday: Chain-store sales will tell us just how effective all those Black Friday promotions were in encouraging holiday shopping. Also, the weekly jobless claims report.

Friday: The employment situation report is expected to show a payroll decline of 100,000 and the unemployment rate unchanged at 10.2%.

[Editor’s Note: For the first time in 70 years, U.S. T-bills are paying 0% interest, while U.S stocks are continuing to rise. According to Bloomberg News, this last happened in 1938, when T-bill yields fell from 0.45% to 0.05%. Then came 1939, when stocks began a three-year slide that took the S&P down 34% after the U.S. Federal Reserve prematurely boosted borrowing costs to battle phantom inflation.

Sounds eerily like the present, doesn’t it?

When it comes to global manufacturing, Mexico is quickly emerging as the “new” China.

According to corporate consultant AlixPartners, Mexico has leapfrogged China to be ranked as the cheapest country in the world for companies looking to manufacture products for the U.S. market. India is now No. 2, followed by China and then Brazil.

In fact, Mexico’s cost advantages and has become so cheap that even Chinese companies are moving there to capitalize on the trade advantages that come from geographic proximity.

The influx of Chinese manufacturers began early in the decade, as China-based firms in the cellular telephone, television, textile and automobile sectors began to establish maquiladora operations in Mexico. By 2005, there were 20-25 Chinese manufacturers operating in such Mexican states Chihuahua, Tamaulipas and Baja.

The investments were generally small, but the operations had managed to create nearly 4,000 jobs, Enrique Castro Septien, president of the Consejo Nacional de la Industria Maquiladora de Exportacion (CNIME), told the SourceMex news portal in a 2005 interview.

China’s push into Mexico became more concentrated, with China-based automakers Zhongxing Automobile Co., First Automotive Works (in partnership with Mexican retail/media heavyweightGrupo Salinas), Geely Automobile Holdings (PINK: GELYF) and ChangAn Automobile Group Co. Ltd. (the Chinese partner of Ford Motor Co. (NYSE: F) and Suzuki Motor Corp.), allannounced plans to place automaking factories in Mexico.

Not all the plans would come to fruition. But Geely’s plan called for a three-phase project that would ultimately involve a $270 million investment and have a total annual capacity of 300,000 vehicles. ChangAn wants to churn out 50,000 vehicles a year. Both companies are taking these steps with the ultimate goal of selling cars to U.S. consumers.

Mexico’s allure as a production site that can serve the U.S. market isn’t limited to China-based suitors. U.S. companies are increasingly realizing that Mexico is a better option than China. Analysts are calling it “nearshoring” or “reverse globalization.” But the reality is this: With wages on the rise in China, ongoing worries about whipsaw energy and commodity prices, and a dollar-yuan relationship that’s destined to get much uglier before it has a chance of improving, manufacturers with an eye on the American market are increasingly realizing that Mexico trumps China in virtually every equation the producers run.

“China was like a recent graduate, hitting the job market for the first time and willing to work for next to nothing,” Mexico-manufacturing consultant German Dominguez told the Christian Science Monitor in an interview last year. But now China is experiencing “the perfect storm … it’s making Mexico – a country that had been the ugly duckling when it came to costs – look a lot better.”

The real eye opener was a 2008 speculative frenzy that sent crude oil prices up to a record level in excess of $147 a barrel – an escalation that caused shipping prices to soar. Suddenly, the labor cost advantage China enjoyed wasn’t enough to overcome the costs of shipping finished goods thousands of miles from Asia to North America. And that reality kick-started the concept of “nearshoring,” concluded an investment research report by Canadian investment bank CIBC World Markets Inc. (NYSE: CM)

“In a world of triple-digit oil prices, distance costs money,” the CIBC research analysts wrote. “And while trade liberalization and technology may have flattened the world, rising transport prices will once again make it rounder.”

Indeed, four factors are at work here.

Mexico’s “Fab Four”

• The U.S.-Mexico Connection: There’s no question that China’s role in the post-financial-crisis world economy will continue to grow in importance. But contrary to the conventional wisdom, U.S. firms still export three times as much to Mexico as they do to China. Mexico gets 75% of its foreign direct investment from the United States, and sends 85% of its exports back across U.S. borders. As China’s cost and currency advantages dissipate, the fact that the United States and Mexico are right next to one another makes it logical to keep the factories in this hemisphere – if for no other reason that to shorten the supply chain and to hold down shipping costs. This is particularly important for companies like Johnson & Johnson (NYSE: JNJ), Whirlpool Corp. (NYSE: WHR) and even the beleaguered auto parts maker Delphi Corp. (PINK: DPHIQ) which are involved in just-in-time manufacturing that requires parts be delivered only as fast as they are needed.
• The Lost Cost Advantage: A decade or more ago, in any discussion of manufactured product costs, Asia was hands-down the low-cost producer. That’s a given no more. Recent reports – including the analysis by AlixPartners – show that Asia’s production costs are 15% or 20% higher than they were just four years ago. A U.S. Bureau of Labor Statistics report from March reaches the same conclusion. Compensation costs in East Asia – a region that includes China but excludes Japan – rose from 32% of U.S. wages in 2002 to 43% in 2007, the most recent statistics available. And since wages are advancing at a rate of 8% to 9% a year, and many types of taxes are escalating, too, East Asia’s overall costs have no doubt escalated even more in the two years since the BLS figures were reported.
• The Creeping Currency Crisis: For the past few years, U.S. elected officials and corporate executives alike have groused that China keeps its currency artificially low to boost its exports, while also reducing U.S. imports. The U.S. trade deficit with China has soared, growing by $20.2 billion in August alone to reach $143 billion so far this year. The currency debate will be part of the discussion when U.S. President Barack Obama visits China starting Monday. Because China’s yuan has strengthened so much, goods made in China may not be the bargain they once were. Those currency crosscurrents aren’t a problem with the U.S. and Mexico, however. As of Monday, the dollar was down about 15% from its March 2009 high. At the same time, however, the Mexican peso had dropped 20% versus the dollar. So while the yuan was getting stronger as the dollar got cheaper, the peso was getting even cheaper versus the dollar.
• Trade Alliance Central: Everyone’s familiar with the North American Free Trade Agreement (NAFTA). But not everyone understands the impact that NAFTA has had. It isn’t just window-dressing: Mexico’s trade with the United States and Canada has tripled since NAFTA was enacted in 1994. What’s more, Mexico has 12 free-trade agreements that involve more than 40 countries – more than any other country and enough to cover more than 90% of the country’s foreign trade. Its goods can be exported – duty-free – to the United States, Canada, the European Union, most of Central and Latin America, and to Japan.

In the global scheme of things, what I am telling you here probably won’t be a game-changer when it comes to China. That country is an economic juggernaut and is a market that U.S. investors cannot afford to ignore. Given China’s emerging strength and its increasingly dominant financial position, it’s going to have its own consumer markets to service for decades to come.

Two Profit Play Candidates

From a regional standpoint, these developments all show that we’re in the earliest stages of what could be an even-closer Mexican/American relationship – enhancing the existing trade partnership in ways that benefit companies on both sides of the border (even companies that hail from other parts of the world).

In the meantime, we’ll be watching for signs of a resurgent Mexican manufacturing industry that’s ultimately driven by Chinese companies – because we know the American companies doing business with them will enjoy the fruits of their labor.

Since this is an early stage opportunity best for investors capable of stomaching some serious volatility, we’ll be watching for those Mexican companies likely to benefit from the capital that’s being newly deployed in their backyard.

Two of my favorite choices include:

• Wal Mart de Mexico SAB de CV (OTC ADR: WMMVY): Also known as “Walmex,” this retailer has all the advantages of investing in its U.S. counterpart – albeit with a couple of twists. Walmex’s third-quarter profits were up 18% and the company just started accepting bank deposits, a service that should boost store traffic. And while the U.S. retail market is highly saturated – which limits growth opportunities – there are still plenty of places to build Walmex stores south of the border. After all, somebody has to sell products to all those thousands of workers likely to be involved in the growing maquiladora sector.
• Coca-Cola FEMSA SAB de CV (NYSE ADR: KOF): Things truly do go better with Coke – especially higher wages and an improved lifestyle. According to Reuters, Mexicans now consume more Coca-Cola beverages per capita than any other nation in the world. The company just posted a 25% jump in its third-quarter net earnings, aided by a strong 21% jump in revenue. Coca-Cola FEMSA continues to experience strong growth from its Oxxo convenience stores, and strong beer sales, too. And all three product groups are logical beneficiaries of strong maquiladora development and the growing incomes and rising family wealth that will translate into higher consumer spending in the immediately surrounding areas.

[Editor's Note: Keith Fitz-Gerald is the chief investment strategist for Money Morning and The Money Map Report.]

I noticed you recently told the Japanese press that you intended to maintain a strong dollar, and that the Obama administration would bring the U.S. fiscal deficit back to a “sustainable balance.”

Tell me, don’t you feel your nose extending like Pinocchio’s when you tell these fibs to innocent Asians?

The dollar is not strong. In fact, it’s sinking to record levels of weakness, and it’s going to stay that way, for three reasons:

• First, the U.S. Federal Reserve is running a zero-interest-rate policy and has announced that it intends to continue doing so. While it does, there’s easy money to be made out of borrowing dollars and lending almost anything else – especially Russian rubles at the moment (maybe we lost the Cold War, after all!). That will actually make the dollar drop.

• Second, the Internet and all the cheap money sloshing around has made it attractive for U.S manufacturers to outsource production to emerging markets, more so than ever before. That leads to big U.S. balance-of-payments deficits. It also means emerging-market wage levels are rising fast against U.S. wage levels. Sadly, this is happening so fast that U.S. wage levels will probably have to drop - which is probably why unemployment has risen so much this time around. A weak dollar – perhaps with a little inflation – is the best way to make this adjustment without throwing everybody out of work as in the 1930s.

• Finally, the U.S. government is running huge deficits and pretty much everyone else in the United States has debt coming out the wazoo. A weak dollar – ideally mixed with a teensy, weensy bit of inflation – will make all those debts get smaller … like magic!

There are some very good reasons why the U.S. dollar is weak, and given the constraints on your policy, you’d probably like it weaker. It’s just that you can’t say so, because then foreign investors might stop buying U.S. Treasury Bonds.

Which brings me to the other point. We all know – don’t we? – that the budget deficit for the 12-month-period that ends next September will be even larger than the $1.4 trillion shortfall recorded for the 12 months that ended in September of this year.

Even though you’ve stopped bailing out banks – well, except for the odd $100 billion for Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) – there are just too many other demands on the public purse. There’s the rest of February’s stimulus, most of which actually doesn’t get spent until the 2010 fiscal year. There are little details, like the extension of the $8,000 tax credit for first-time buyers – one that’s now extended by a $6,500 tax credit for non-first-time buyers.

And still to come is the medical reform bill (which we know isn’t “deficit neutral” at all), the cost of which will kick in around 2013, just as the other budget pressures are abating. (Or not, since Congress will probably have found something else to spend money on by then).

It’s a mess, isn’t it? I mean, we’re actually talking about trillion-dollar deficits as far as the eye can see, aren’t we? Of course, Japan can’t really grumble about that, because it has public debt of almost 200% of its gross domestic product (GDP). On the other hand, Japan runs a balance-of-payments surplus and has lots of savings, so it actually owes that money to itself.

I’m not saying that it won’t be a challenge to restore American prosperity. Indeed, as the old saying goes: “If I wanted to get there, I wouldn’t start here.” At the same time, as a veteran banker who’s worked with troubled economies before, I do have a few tips to pass along:

• First and foremost, enough with the stimulus. You’re going to run into trouble soon in the bond markets, and that will prevent small business from getting the capital it needs. Cut at least $100 billion of the flaky projects out of the stimulus bill.

• If you want to encourage clean energy, put in a small-but-simple carbon tax and take away an equal amount of handouts to ethanol producers and clean-tech companies: You’ll get double the deficit cut – without having to boost your clean-energy incentive.

• Know who’s making money right now? Goldman Sachs Group Inc. (NYSE: GS) – that’s who. Unfortunately, those profits aren’t being delivered via sound capitalist practices. They instead stem from such contrivances as credit-default swaps and high-speed trading. And those are short-term rent-seeking activities – not long-term wealth-generating initiatives. Place a small Tobin tax on each trading transaction – the country needs the revenue much more than do the partners of Goldman Sachs.

• Get Fed Chairman Ben Bernanke to stop printing money. His zero-interest-rate policy is sending gold through the roof, and will cause huge trouble down the road. Interest rates need to behigher than inflation, so savers get rewarded for saving - which isn’t the case right now.

You may think those changes are “politically impossible.” We disagree. In fact, we believe there’s no time to lose. And we’d very much like to hear your reaction to our proposals. If you write to us here at Money Morning, we’ll gladly share your thoughts with our readers.

We’ll look forward to that time.

Sincerely,

Martin Hutchinson
Contributing Editor
Money Morning

105 West Monument Street
Baltimore, Maryland 21201

Massachusetts Land Court judge Keith C. Long recently ruled that foreclosure sales of two properties with securitized mortgages were invalid, a decision that ties up thousands of Massachusetts real-estate transactions.

If nothing else, this landmark court case should make one thing very clear: Securitization – the product of the finest brains of Wall Street for more than two decades – doesn’t work as advertised.

Historically, mortgage loans were made by small local institutions, which knew the borrowers personally and took the credit risk themselves.

You can see how it worked in the 1946 classic movie “It’s a Wonderful Life.” Main character George Bailey (Jimmy Stewart), as heir to a local building-and-loan company, battles the evil capitalist Henry F. Potter (Lionel Barrymore) to change the character of his local town by offering affordable housing loans to the poor but upwardly mobile.

It is an appealing model, but has one real flaw: If a local savings and loan is in financial difficulty (as was Stewart’s “Bailey Bros. Building & Loan” in 1932), it will not be able to attract deposits, and no mortgage loans will be made in that locality. With the rise of interstate banking, that problem would have been soluble – mortgage loans would be more expensive in an area if a large national bank was their only potential source, but they would still be available.

Jimmy Stewart and his building-and-loan peers were forced out of business by the inflationary surge that we saw from 1974 to 1982. That surge caused short-term interest rates to rise sharply, while long-term returns on the lender’s mortgage loans remained fixed. By 1982, the great majority of U.S. mortgage lenders had lost their capital and were insolvent. It was almost another full decade for them finally to go out of business, but the damage had been done.

The initial securitizations were done by Ginnie Mae (the Government National Mortgage Association) in 1970; the government agency had guaranteed home mortgages, and wanted a way to finance the result. Thus, when the U.S. savings-and-loan crisis began, and S&Ls actually began to fail, the securitization markets were available to pick up the slack.

It didn’t hurt that two government sponsored entities – Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) – were ready to guarantee everything in sight, and to prevent investors from worrying too hard about the underlying credit risk.

Under securitization, instead of making mortgage loans directly, mortgage bankers only “originated” them, doing whatever paperwork was thought necessary, then sold them on to a Wall Street broker, which packaged them into a shell company with other mortgages. The resultant mortgage-backed security and sold the resulting package to bond investors.

There are two major problems with securitization.

First, in modern securitization markets, nobody is really responsible for the credit risk. Instead of taking loans onto their own balance sheet, and losing money if they default, mortgage companies merely sell the loans they originate to Wall Street, pocketing a fee for doing so. Wall Street, in turn, retains very little of the resultant mortgage packages: It sells them on to investors, who can hardly expect Wall Street to be responsible for each individual mortgage.

Thus, all the parties involved in originating the transaction became salesmen. Since it was no longer necessary to have a balance sheet to originate mortgages, mortgage brokers became pure sales operations. The sales business being what it is, the more unscrupulous and aggressive the sales operation, the more business it did.

That’s how we ended up with so-called “Liar Loans.”

In newly unveiled draft legislation, the U.S. Treasury Department has proposed to reduce this problem by making securitization originators keep 5% of the resultant credit risk. This seems a sensible move, and should help matters considerably, even if it does reduce the attraction of the more-exotic securitizations.

A second problem with securitization, highlighted by the Massachusetts court decision, is that of documentation. As I can testify from experience, securitizations are by far the most tiresome of all Street transactions to document, with a non-standard securitization creating incalculable costs while taking 18-24 months to complete.

You can see why the more complex transactions were complicated: Hundreds – or even thousands – of mortgages were being bundled and sold as a bundle to maybe tens of thousands of investors.

From the comments of Judge Long, corners were cut here as everywhere else during the housing bubble that subsequently precipitated the global financial crisis. If you take the documentation seriously, foreclosures are made very difficult by securitization, because each of those 10,000 investors owns a tiny piece of, say, a $300,000 foreclosed loan – while at the same time also owning pieces of loans not in foreclosure.

If you get to the point where loans that had already been packaged are repackaged and resold, the paper trail may become completely inscrutable, in the sense that it is no longer possible to figure out who owns what.

At that point, the owners can’t foreclose, because nobody can identify them. That’s true even if the documentation was done correctly. And we now know that during the bubble, it wasn’t – the lawyers had inexperienced interns working on this stuff. You can then either ignore the fine print, allowing securitizing banks to sweep the problems under the rug, or – as Judge Long has done – insist that the precise ownership position be known.

This may be a huge blow to the entire securitization industry. If given normal human fallibility, you can’t track down the true owners of a mortgage, then the ownership of thousands of houses in default, all over the country, comes into question. Whatever solution is found will inevitably involve increased costs.

And that means that the risks of securitization just got much greater.

Is this a pity? No. You see, the move to securitization actually cost home mortgage borrowers money. The average differential between Treasury bond yields and 30-year mortgage yields in 1971-76 (before securitization really got going) was slightly more than 1%. In 2000-06, before the housing finance crash made mortgages still more expensive, it was more than 1.5%.

In other words, securitization has added 0.5% to mortgage costs since moving away from the Jimmy Stewart mortgage-market model – something free-market theory says shouldn’t happen.

As you might expect, securitization was just a way for Wall Street bankers and lawyers (don’t forget the lawyers, who made out like bandits from all the documentation) to extract additional “rents” from the rest of us. In the long run, in a free market, this should not be able to happen.

In the ongoing battle between Wall Street, the Obama administration and the public interest, it will be interesting to discover whether the United States has a true free market.

If it does, securitization should die.

With all the financial woes in the global economy, the worst thing an investor can do is to “freeze up.” With all the ups and downs in the market, it’s all too easy for investors to allow their emotions to take control. That’s when the smallest mistakes turn into the biggest mistakes.

There’s one antidote for this problem … remembering a few basic rules. Just embrace the 10 ideas that follow and you’ll be in line to make some serious money in the months ahead.

Rule Number 1: Invest on the Right Side of Major Economic Trends:That old investing adage “Don’t fight the Fed” serves as a good example here. Rising interest-rate environments make meaningful gains difficult to sustain – unless you know what to look for. Far too many investors got it wrong in the 2000-2003 and 2008-2009 periods by betting on growth stocks in a recessionary economy, and they’re still getting it wrong. Those investors are likely to get burned again should the economy slow even more, despite the government-bailout and federal-stimulus efforts. Make sure to analyze all of the other major global trends, as well – and ride the ones that are truly unstoppable. You’ll know them when you see them, because they’ll have trillions of dollars in new capital flowing directly at them – investment plays in such areas as infrastructure, inflation, energy, food, and water (both supply and purity) are great examples.

Rule Number 2: Sell Your Winners: This may seem counterintuitive, but – if you want to succeed – you must sell your winners. Rule Number 6 – thinking like a plumber to prevent losses – is only part of the success equation. To be really effective, you have to take profits, too. That way, you get more capital that you can put to work. Think of it this way – Safeway Inc. (NYSE: SWY) regularly replenishes the inventory in its

Produce Department to keep it fresh. You should do the same with the “inventory” in your portfolio because, if you let your stocks sit on the shelf too long, they’ll eventually go bad – just like fruit that’s past its expiration date.

Rule Number 3: Always Sit in an Exit Row:This rule goes hand in hand with Rule Number 2. One of the most common problems investors have is not knowing when to sell. Sometimes, they’ll let a big loss get out of control (which violates Rule Number 6) – or, worse, they’ll notch a big gain and then sit on the investment so long that it sneakily turns into a loss. The bottom line is that, up or down, you should always have planned exit pointswhen you initiate a position – and enforce them with “protective stops,“adjusting them as prices move in your favor (but never when they go against you).

Rule Number 4: Your Broker is a Salesman. So unless you know you want to buy what he has, don’t go shopping today! Wall Street is not a service business. Brokers exist for one reason and one reason only – to sell you stuff and make money . . . from your money. And the more of your money you give to them, the less you have to make more for yourself.So buy only what you want and what fits your goals and objectives – not the “stock of the day ” the broker is pushing to meet his weekly quota.

Rule Number 5: Invest for High Yields:Contrary to popular belief, rather than investing for capital gains, you should aim for the highest possible yields and the most certainty you can find. The real secret to wealth-building is compounding small gains over long periods of time. In fact, studies show that compound returns can outperform so-called “growth stocks” by as much as 22-to-1.Furthermore, dividends account for a huge percentage of total returns – varying studies have claimed anywhere from 60% to as much as 97% over time. So, don’t ignore them! 

Rule Number 6: Think Like a Plumber: Big losses – like six inches of water in your living room – are expensive and can set you back years. Professional traders – and I’m not including the risk-junkie cowboys who drove the derivatives mess to heck in a handbasket – understand this. And because they do, they focus the majority of their efforts on avoiding losses, instead of oncapturing gains. It’s counter-intuitive, but it really makes a difference. Besides, if you keep those portfolio pipes from bursting, you won’t have to worry about your assets leaking away, drip by drip.

Rule Number 7: Buy Value: Buying when the underlying value is “right” can mean the difference between pathetic single-digit gain and truly market-beating returns. It’s hard to make money when valuations – as reflected by Price/Earnings (P/E) ratios are greater than 20. More normal valuations sit in the 12 to 14 range. However, to reallymake money, you need to buy when valuations have been beaten down into the single digits – assuming, of course, that the company’s underlying value is real. Doing so puts the odds strongly in your favor and can dramatically boost returns.

Rule Number 8: Retirement is a Lifestyle Issue, Not a Monetary One: When

most people think about retirement, they think about safety. Big mistake. The single biggest problem facing us today is running out of money before we run out of life. If you’ve followed Rule Number 9, this shouldn’t be a problem. However, if you’ve thought about safety and have not invested enough, what you’re really doing is crippling your ability to earn future income – income you’re going to need in order to eat, keep a roof over your head, and provide lifelong life health care. Oh yeah, and have some fun.

Rule Number 9: Start Early and Leave Your Money Alone For as Long as Possible: This is not the same thing as “buy-and-hold” investing. Buy-and-hold is not an investing strategy, it’s a marketing gimmick – and, these days, it’s more like “hope-and-pray” investing, anyway. The world’s most successful investors – think Jim Rogers, Warren Buffett and the late Sir John Templeton, to name a few - don’t buy and hold. And I don’t believe you should, either. These experts buy and “manage,” confining themselves to stocks and strategies that meet their specific objectives. Given that one of our critical objectives is to have our money working hard for us rather than us working hard for it, the point is that you want to start as early in your life as possibleand never miss an opportunity to invest. The longer you have your money in play, the better you will be paid when you’re ready to cash out!

Rule Number 10: All Investments Contain Risks – But Not All Investments

Contain the Same Risks:Despite all my talk about avoiding losses, the simple truth is this: If you want to grow your wealth, you have to take on risk. It’s unavoidable. Every investment involves risk – the only questions are how much and under what circumstances. Remember, success is not about how much money you can make, but about how much money youkeep. As such, the true secret of wealth-building is taking risk properly.

Indeed, the late legendary U.S. Army Gen.George S. Patton Jr., once said: “There is nothing wrong with taking risks.” But he also cautioned: “That’s quite different from being rash.” I completely agree. What’s more, I think that Patton would have agreed with my belief that if you want to be successful in anything, you have to take a certain amount of risk every day. It’s just a fact of life.

Yet, most folks are unwilling to do so – or they spread themselves too thin, and over-diversify, all with the goal of “protecting” themselves. Unfortunately, by doing so, these investors actually set themselves up for failure – not because they take too muchrisk, but because they don’t concentratethe risks they do take in the right places!

What are those “right” spots? They’re the investments that can provide the potential rewards to justify the risks the investor has taken.

[Editor's Note: Keith Fitz-Gerald is the chief investment strategist for Money Morning and The Money Map Report.]

By now virtually every investor has heard the argument that the U.S. dollar is slated to lose its status as the global reserve currency. And that’s good – as far as it goes.

What’s bad is that many of these investors have yet to latch onto the fact that this could happen much sooner than many people realize and in a manner that will catch most by surprise.

Let’s take a look at the three key reasons that this shift away from the U.S. dollar happening – and sooner rather than later:

1. The Asian Region Currency Partnership: Japan, once the staunchest of U.S. allies, is leading the charge to form a regional currency partnership based on closer ties between itself, China and South Korea. Ostensibly part of the second trilateral “leader’s meeting,” that happened earlier this year, financial cooperation was front and center on the agenda (at Japan’s invitation) as a means of coping with the ongoing global financial crisis and with the subsequent resumption of worldwide financial growth. It was also key to the Association of Southeast Asian Nations (ASEAN) discussions that took place this past weekend – with the waning influence of the U.S. economy again playing a key role in the discussion amongst potential ASEAN trading block partners.

At a time when U.S. leaders are fooling only themselves by pretending this country remains the key player in the health of the worldwide economy, Japan’s newly elected Prime Minister Yukio Hatoyama didn’t mince words following the trilateral meeting when making such comments as “until now we have been too reliant on the United States” and “I would like to develop policies that focus more on Asia” to press-corps attendees.

Having spent 20 years in the region, I can’t say I’m surprised by this development. And you shouldn’t be, either. Between China, South Korea and Japan, we’re talking about 16% of the world’s gross domestic product (GDP) – a figure that’s growing almost daily, by the way.

There are obviously some significant challenges, given the cultural sensitivities that remain in the region as a result of World War II. But even those are being trumped by today’s serious global financial demands. After the three-nations met, Chinese Prime Minister Wen Jiabao noted that “we have agreed to seek common ground and shelve our differences.”

In a column written from my family home in Japan earlier this year, I noted how important it is to “read between the lines” when investors are attempting to decode English-language statements being made by officials in Japan or China. It’s not what’s actually being said – at least, not as Westerners hear it – that’s important. That’s actually been shifted a bit by the translator. You really have to go back and make an effort to see just what it was the official actually meant.

Granted, that’s not the easiest of exercises. But it does force you to really look at what’s taking place – which will usually give you a much-more accurate picture than if you just trust what’s said by the Western press.

So Wen Jiabao’s statement can be construed as it’s “time to get down to business.”

2. When “Black Gold” is No Longer Quoted in Greenbacks: Middle Eastern nations and members of the Organization of the Petroleum Exporting Countries (OPEC) finally couldn’t contain themselves any longer and leaked information a few weeks back that they’re pursuing a non-U.S. dollar trading basket as a replacement for the current U.S. dollar-traded oil markets.

We’ve been forecasting this for some time. The difference this time around is that the Middle Eastern nations are now all but openly in cahoots with China, Russia, Japan and France – all of whom the United States continues to blithely believe it can outmaneuver.

While the meetings have been held in secret, my sources in Hong Kong and the Persian Gulf region suggest that the move is imminent and that the establishment of an independent trading market is all that’s keeping us from a day in which oil prices are no longer quoted in dollars. Oil will instead trade in the combined basket using currencies from the nations I just mentioned. Led by China and potentially – although this is a big leap – tied in good measure to the yuan.

As a side note, this may at least partially explain the rise in gold prices as enlightened traders begin to hedge the dollar’s ultimate demise. This makes sense for two reasons:

• First, China uses oil in an incrementally greater proportion than the United States because it remains less energy efficient. That means that China will take in an increasingly larger percentage of world supplies.
• Second, gold is the only “currency” that is potentially liquid enough to serve as a transitional store of value until the new currency basket arrives. Pun absolutely intended.

Incidentally, you can expect Brazil and India to join the party shortly, leaving the United States even further out in the cold. And while we’re at it, my guess is that the new oil markets will be based in Shanghai, and not in New York or Chicago.

Watch, too, as the United Kingdom is dragged – kicking and screaming – to the euro because it will have no choice but to abandon the U.S. dollar.

3. U.S. Firms Are Already Adopting a China Focus: While ostensibly supporting the recovery here, major U.S. companies are already looking at what it will take to list their shares on China’s stock exchanges. Although I’ve been following this story for at least two years, it’s received almost no attention in the U.S. news media. When it does happen – and it will – this will be one of the biggest wakeup calls yet for those Western investors who refuse to acknowledge Asia’s economic ascendance.

I’m not talking about fringe companies here, either. I’m talking about stalwarts like Wal-Mart Stores Inc. (NYSE: WMT), The Coca-Cola Co. (NYSE: KO), and General Electric Co. (NYSE: GE), to name just a few. In short, companies that U.S. investors view as American as apple pie are pushing to be viewed as Asian as quickly as possible.

I originally thought this wouldn’t happen for five to seven years (which is still faster than most investors believed possible). Instead, I give this shift 12 months to 24 months – at most – before we see the first listings.

The fallout from this will be considerable. The historic financial centers of London and New York will take yet another step to the sideline as new Asian markets emerge.

To some, this will sound like scary stuff. But uncertainty breeds opportunity. And savvy investors will welcome the changes because there will be a fascinating fallout that almost no one is talking about.

The emergence of Asia as a true global financial center will make it so much easier to raise capital in that part of the world. All this new Asian capital will likely lead to a new golden age of investing – certainly in Asia, but also in the United States and Europe to the extent that companies that pursue these listings will have newfound sources of capital to buttress their balance sheets.

Not all companies will be regarded equally, however. For investors, the best choices will be those companies that can immediately use the money they raise through Chinese offerings to enhance their global operations, increase worldwide sales, and cement their relationships with sources of Asian capital.

So if there’s one key take away in all this, it’s this to paraphrase the words of American writer Ruth E. Renkel: “Don’t fear shadows – they simply mean there’s a light shining somewhere nearby.”

It looks like the U.S. housing sector has bottomed. In fact, if you’ve been thinking about buying a house, this may be the time to make your move.

Let me tell you why.

Congress and the Obama administration are considering whether to extend the $8,000 first-time-buyer tax credit for another year from Nov. 30, when it expires. With cheap money, housing may show strength in the short term, just as we’ve seen with other assets. But there is the potential for a market hiccup next year or in 2011.

When the National Association of Homebuilders released its NAHB Index for October last week, it showed a drop of one point in homebuilders’ view of the market, from 19 to 18.

The good news: The index is at double its level from last spring – when it bottomed out at nine – meaning homebuilders see an improving market.

The bad news: The index is based so that a reading of 50 is the “neutral market” view. That means there’s a long way to go, yet.

But even if Congress doesn’t opt to extend the $8,000 tax credit, 30-year mortgage rates are still down around 5.1% – close to their all-time low. But rates probably won’t remain that low for long: Building inflationary pressures and the huge U.S. budget deficit will combine to push interest rates higher.

In other words, even if housing prices are destined to drop by another 10% (except in the very worst areas, I wouldn’t expect you’d see anymore than that), you still may end up saving so much on financing costs by borrowing now that you’d be mad to wait any longer.

Housing arithmetic is always complicated but one thing I do know: 7% of $90,000 is more than 5.1% of $100,000!

The S&P/Case-Shiller composite home price index bounced nicely in July, with the 20-city index rising 1.5%, after a 1.3% jump the previous month. That’s a pretty good indication that the markets have bottomed out.

What’s more, the $8,000 credit for first-time buyers was still in force for August and September transactions (you need to close to get the credit, so deals done before Sept. 30 should squeeze under the wire). Since interest rates remained low for those months, it’s likely we’ll see further price rises then, too.

That would mirror the market in Britain, where housing prices bottomed out last spring and have risen for the six months since. Indeed, the market in London for houses priced above 5 million pounds (about $7.5 million) is apparently exceptionally strong, because of the likely level of Goldman Sachs Group Inc. (NYSE: GS) bonuses!

For those of us who aren’t about to receive a Goldman Sachs bonus, or buy a house priced above $7.5 million, the short-term outlook is still pretty good. U.S. gross domestic product (GDP) almost certainly rose during the third quarter – probably by about 3% – and is expected to rise again in the fourth quarter.

That should translate into an abatement of the flood of job losses – perhaps from the 250,000-per-month rate of the last few months to around 100,000 per month. That’s still bad, but is indicative of a recovery ahead. At that point, the outlook for the housing market will depend on what region you live in.

In Florida, California and Nevada – where prices have dropped more than 40% – there may still be a large number of foreclosures and unoccupied new buildings left over from the bubble. In those markets, therefore, the excess supply may take time to absorb.

Similarly, even with the government bailout of the automobile industry, I probably wouldn’t invest heavily in Detroit, even though prices there are lower than they were in 1995. However, in such cities as Atlanta and Dallas, prices did not rise too much in the bubble – and haven’t dropped all that much since – so the market should rest on a firm foundation and we can expect it to advance.

Beyond 2009, the prognostication is still murky. On the one hand, even a slow economic recovery should induce consumers to more seriously consider home purchases. And with inflation apparently on the upswing, the prices of those houses can be expected to increase, as well.

On the other hand, if inflation really gets a grip, the U.S. Federal Reserve will have no alternative but to raise interest rates. Housing is the most-interest-rate sensitive sector of consumer spending. So if rates rise sharply, the housing market will inevitably suffer.

As for the $8,000 credit for first-time homebuyers, it doesn’t really matter. It’s like the “Cash-for-Clunkers” program. If Congress extends it, it will prop up the housing market a bit. But if Congress doesn’t, there will be no disaster – the market will simply fall back for a few months until demand catches up with supply.

It makes only a modest short-term difference in activity, and probably only a 1% to 2% difference in the level of housing prices.

If you’ve got the money, go buy a house. You won’t find a better time to strike.

Contributing Editor
Money Morning

Two years ago, an associate of mine lost $100,000 because he didn’t listen to me. A year ago, I saved a manufacturing company from the same scam. And just last week I saved a friend of mine $300,000.

For several years now, a far-fetched but seemingly plausible investment opportunity has been wreaking havoc across the globe. In the United States alone, an estimated $10 billion has been lost in this particular gambit. The scheme is typically hidden behind such legitimate-sounding names as “Prime Bank Trading Programs,” “High-Yield Investment Programs,” or “Roll Programs.”

These are not legitimate investment opportunities. The reality is, they are outright scams. And my role as a professional investor has provided me with an up-close-and-personal vantage point from which to observe some of these con games.

Everything I am relating in this story is true. This story – along with real names, contact information and associated documents – has been forwarded to the Federal Bureau of Investigation and the U.S. Securities and Exchange Commission in an effort to catch these brazen conmen and to save unsuspecting investors from further losses.

While there are variations of this scam, once you read this article you should be able to see the set-up and con game from a thousand miles away.

And that’s as close as you ever want to get to any of this.

Raymond’s story

When the real estate market collapsed, my friend “Raymond” had several million dollars invested in the development of a couple of tracts of land in Florida. With the bank threatening foreclosure, he turned to a mortgage broker he knew. The broker, in turn, put Raymond in contact with someone she had not met. But, as the broker subsequently told me, this contact – a man we’ll call “Moss” – had been approved by her company as a source of funds for borrowers that the mortgage company wasn’t able to accommodate.

Raymond called “Moss” to discuss his predicament. Moss identified himself as an Atlanta attorney and offered to put Raymond into an “investment opportunity” that would generate huge gains. But it was only available to a select few big-time investors, Moss said.

The “No Collateral” Come-On

The first oddity about this “investment opportunity” is that it doesn’t require any collateral. Even though Raymond had a multi-million dollar piece of land that was serving as collateral for the bank loan he needed to pay off, Moss wasn’t interested in the property. What made his deal so enticing to Raymond was that Moss was offering to make Raymond twice what he owed on the bank loan – without requiring him to put up any collateral.

A variation on the “no-collateral-required” theme was evident when I steered the manufacturing company away from this same scam. In that variation, conmen offer to raise money for a worthy cause, such as a humanitarian program, or for the construction of a facility that would provide employment for a certain number of people.

But the organizers of these scams never request that part, or all, of the project being “financed” be put up as collateral. They make it sound like all they need to know is what the money is being used for. If it “fits” into one of their “programs,” you don’t need to put up any collateral.

That’s your first red flag: They don’t want collateral, only cash.

“Secret Trading Platforms”

Secret trading platforms are where giant banks and the super rich make tons of money.

In explaining the “investment opportunity” to Raymond, Moss said that it’s really pretty simple. Apparently, there are “trading platforms” out in the market, where “traders” trade “debentures,” which are described as “bonds” or “MTNs” (medium-term notes) that are issued by the big “prime” banks around the world.

Other banks and rich investors trade these instruments. You haven’t heard about these “platforms” because they’re secret, and that’s why the rich get richer and banks make so much money.

There are different programs that get traded on these platforms. But your contact will tell you that he can get you into one of these programs, so that you’ll soon be earning the same returns as the super rich.

But wait. You haven’t yet heard the best part: It’s risk-free!

I was so excited for Raymond that I decided to call Moss and hear the pitch for myself.

A Personal Pitch

What the traders do, Moss explained to me, is match buyers and sellers. The traders are the only ones who can do this. They find a seller – maybe a bank or a rich person – who wants to sell their debentures, their MTNs, or some other high-yield investments. Or maybe the seller is executing a “roll program,” where an investor or institution rolls over an investment, and must then find a buyer to take the other side of the “trade.”

But since all the trader is doing is matching buyers and sellers, there is no risk. It’s really profitable because the “spread” – the difference between what the buyer pays and what the seller sells for – are far apart. The trader keeps the difference and would share that with Raymond. How profitable are these trading platforms, I asked?

Very, very profitable, came the reply.

Said Moss: “You’ve heard of the Rockefellers – haven’t you?”

If it Sounds Too Good To be True …

We’ve all heard the old investing adage: “If it sounds too good to be true, it probably is.”

Well Moss was essentially promising Raymond a 100% return on his money – every month.

And to get started down this golden pathway, all Raymond had to do was put $300,000 into an escrow account.

On its face, that seemed to promise safety. For the funds to be released, both Raymond and Moss had to sign. So Raymond didn’t have to worry, because if he never signed a release, Moss could never get the money.

In the meantime, the escrow account would be “blocked,” so that it would be guaranteed to stay there for a year. Moss would let his “traders” use the money in the escrow account as “show money.” The traders could claim that they were “attached” to the account, meaning they could then borrow up to 10 times that amount to trade prime debentures on their platforms.

With 10-1 leverage, the traders would find “one of the smaller programs” to trade (according to the pitch, there apparently are only two or three small programs … all the other programs are for the rich guys who trade in really big blocks). And since it’s all risk-free, Raymond was told that he could expect to make back his initial investment – about $300,000 – every month.

And he might even be able to make more if the traders could find more of these pesky “small” programs to trade, Moss told Raymond.

On a Scammer’s “Do Not Call” List

I asked Moss what would happen if there weren’t any of the small programs available for Raymond to trade.

His answer was priceless.

Moss said he would have suggested this earlier, but said he’d rather see Raymond make $300,000 a month and pay off his loan than to get involved with the alternative investment. The “alternative” was for Raymond to use his $300,000 to actually “buy” a “leased instrument.”

Under this scenario, Raymond would be buying into a leased instrument that would make him part owner of a giant pool of rich investor money. And because most of the trades are big block trades, he could then participate in the big trades and make enough money in one trade to pay off the bank and make a lot more, and it would probably take about a week.

I’d heard enough. It was now my turn to ask “Moss” some questions.

Needless to say, his answers were so unbelievable, impossible, or just plain ignorant that I found myself switching between wanting to laugh and wanting to explode in anger – and struggling to control both urges.

The bottom line: He apparently didn’t like the questions I asked, and he now won’t take any more calls from me or from Raymond.

Spotting a Scammer’s “Tell”

Here’s what you need to know to avoid becoming a victim of this gambit.

First, there’s no such thing as “buying” a “leased instrument.” In fact, if you just consider it for a moment, it doesn’t even make logical sense.

Second, there’s no such thing as putting money into an escrow account so someone else can leverage it to trade against. Here’s the hint: If the trader loses money, how are they supposed to get at the “blocked” money to settle up?

Third, there’s no such thing as “risk-free” trading – period.

There’s no such thing as special programs where you can get high returns on investments because you’re going to use the money you make to build a factory to employ people or to fulfill some other philanthropic void.

There’s no such thing as a secret trading platform where prime bank debentures or any other instrument is secretly traded by global banks or the super rich.

There’s no such thing as unlicensed traders trading in some “European” or cyberspace market where they are not registered. And to imply that they are governed by the International Monetary Fund(IMF), the World Bank, or some other international body such as the International Chamber of Commerce (ICC) is just plain stupid.

Don’t be stupid.

And don’t be greedy.

There’s no such thing as making 100% per a month, or a week.

They were going to get Raymond’s money by forging his signature on the escrow agreement, by talking him into writing a check for some non-existent leased instrument, or through any one of several other pathways they could lead him down – before parting him from his money.

Don’t just take my word for it. Do an Internet search on “bank debentures trading scam” (to see the results of that search, please click here). As you’ll see, there are literally pages upon pages of information on these ugly and expensive scams. A lot of sophisticated people have been drawn in and duped. These scammers are pretty sophisticated themselves.

Epilogue: It turns out that “Moss” was once a member of the Florida bar, but is not licensed to practice law in Georgia. I followed up on his e-mail contact information, which included an address at an Atlanta law firm. I contacted the firm and found that he actually had been hired there to do some research work, but then was fired for lack of performance. The partners of the firm were obviously not happy to hear that their good name was being employed as part of a scam. But they were obviously grateful that I alerted them to the problem.

Moors is the founder and director of the Energy Policy Research Group, which conducts analyses and makes recommendations on a range of energy-related issues. He is also the president of ASIDA Inc., a worldwide advisor on the oil-and-natural-gas markets.

In an interview with Money Morning Executive Editor William Patalon III this week, Dr. Moors detailed the top current energy challenges in the global economy, and also provided investors with a look at some of the looming new technologies, as well as a future in which China is a dominant global energy player.

Some of these issues are already at work. Although oil prices remain well below the all-time record of $147 a barrel set in July 2008, crude prices have been on the march of late. Just yesterday (Wednesday), in fact, supply concerns pushed oil futures up above $81 a barrel, their highest level in more than a year.

“If you think the run up to July 2008 was a wild ride, you haven’t seen anything yet,” Dr. Moors told Money Morning. “In the next five years, investors who focus on medium- to small-sized producers and oil-field-service companies having a well-developed specialty niche will outperform the overall energy sector.”

Money Morning (Q): In an earlier discussion, you said that the successful energy investor of the future wouldn’t be a person who just goes out and invests in ExxonMobil Corp. (NYSE: XOM). Can you explain?

Dr. Kent Moors: We are entering a period of rising prices. There is still some play left in the large verticals (vertically integrated oil companies, or VIOCs) such as ExxonMobil, but the primary profits will be made with smaller, leaner exploration-and-production (E&P) outfits, field-service companies and specialized producers (unconventional gas producers - shale gas, coal bed methane, tight gas, hydrates - heavy oil and biodiesel).

(MM): How will investors have to play this future? What types of companies should they be looking for, and where should they look?

Moors: The market rapidly approaching will be more volatile with valuation often more difficult to determine than in the past, even with prices increasing. How much of the increases result from actual product margins and how much results from oil becoming a financial asset rather than just a commodity is a major concern. It requires some careful homework. The types of categories mentioned above – smaller producers, new developments in field services and technology (especially those providing ways to decrease wellhead and operational costs, increase productivity, use associated gas, treat and utilize produced water, increase efficiency per barrel … there is a long list here) as well as the specialized producers and providers of their technical needs are the main targets.

(MM): When we look at the U.S. economy, you said that investors would be stunned to discover how much of our oil is produced by small players. In that discussion, in fact, you even described the type of firm that could be the “savior” of the U.S. energy sector, and perhaps even the economy. Could you take a moment to describe that situation and explain what that means for the economy?

Moors: The United States remains one of the top five producers of crude and will shortly ramp up production of natural gas (once the current glut has moved through the system). Sixty percent of crude produced in the U.S. market is at stripper wells providing less than 10 barrels of crude a day, but more than 20 barrels of water, a major byproduct. As America enters an accelerating field maturity curve (and an intensifying decline in well debit – well production), the efficiency of production declines. Therein lies a significant area for innovation and leaner companies. And that spells greater profitability at lower entry prices. Some offshore and Alaskan National Wildlife Refuge (ANWR) production will be done at scale, but that is not where the future of U.S. production will be. It will be the result of greater profitability at existing depleting wells with the new technology rolled out (on the oil side) and unconventional gas production.

(MM): Let’s take a look at the global markets, too. China’s global shopping spree has been well chronicled. As China locks up suppliers and supplies of oil and natural gas, what are the chances there could end up being what’s almost a two-tiered market, where China has access to oil and natural gas at lower prices levels, creating a shortage of non-captive supplies and leading to Western countries having to pay much higher prices?

Moors: Price rises for Westerners will occur anyway, and not just because of China (where a rising energy bubble resulting from the recent acquisitions is a concern). The competition for available energy sources will usually result in those regions prepared to pay more, increasing the overall aggregate price for most others. China, India, a resurgent East Asia, Japan and even regions such as West Africa will occupy important positions moving forward in this regard. Also, rising demand will center in places other than OECD countries. The new oil market emerging can hardly discount the developed countries, but the primary demand spikes are going to come from elsewhere.

(MM): After some significant turmoil in recent years, you said that Russia is finally opening up to foreign investment. Will that last, and what effect will that have on global energy prices?

Moors: To offset a more rapidly declining traditional production base (primarily Western Siberia), Russia must move north of the Arctic Circle, into Eastern Siberia and out on the continental shelf. These moves are technologically sensitive and very expensive. Moscow needs the outside investment and that will remain. However, projects must be carefully structured. Foreigners cannot own 50% of “strategic fields” under new laws or anything on the shelf. This means watch out for the smaller, focused operators and oilfield service companies. They will include companies currently trading on the Alternative Investment Market (AIM) in London: The AIM and London Stock Exchange (LSE) are the sources of the new external investment phase in Russia.

(MM): From a global perspective, which markets show promise? And which ones – either because of overly restrictive investment policies, or because of the risk of nationalization – are markets to be avoided?

Moors: Many markets show promise or telegraph restraint. Let’s look at some of the more noticeably promising markets, organized by energy category:

• Conventional Oil: Sub-Saharan Africa, Brazil, Kazakhstan, Russian Eastern Siberian and Far East smaller fields.

• Conventional Natural Gas: Turkmenistan (if recent government overtures to outside investment remain genuine), Uzbekistan, Northwestern Australia (region of the Gorgon project) and New Guinea.

• Unconventional Oil: Tatarstan (Russia) for bitumen and heavy oil, Alberta for oil sands (assuming an average and multi-year sustainable crude price of $72 [USD] a barrel or above).

• Unconventional Gas: The United States for shale (especially Marcellus Shale) and coal bed methane (Powder River Basin, Wyoming, also basin into Montana – if that state reduces regulations), Poland, Turkey and Germany for shale, south central Russia and Ukraine for coal bed methane. If Baghdad and Erbil can finalize central Iraqi and regional Kurdish oil legislation – and if security is maintained – Iraq will become a major play in both oil and gas.

• TO BE AVOIDED: Iran (sanctions and buyback contract frustrations), Mexico (collapsing infrastructure and nationalization), Venezuela (significant technical shortcomings, concerns over productivity assessments, and absence of Western operators).

(MM): If an investor were to divide the energy market into short/intermediate/and long-term segments, what will be the dominant energy plays (oil, natural gas, solar, coal-bed methane, for example) in each of those three time segments? What time periods would you tack onto the short-term, intermediate-term, and long-term segments? And which energy plays will be the real winners?

Moors: To make this easier to see, let’s divide this into short-term, intermediate and long-term segments and look at the key players, issues and technologies in each category.

• Short-Term (five years out): Here we’ll see an increasing efficiency at existing oil wells; Marcellus Shale natural gas; an extension of large fields into known deeper production layers – for example, BP-led (NYSE ADR: BP) multinational plays such as the Azeri-Chyrag-Guneshli and Shah Deniz deposits offshore Azerbaijan. Other developments to watch are the huge Chevron-led (NYSE: CVX) Tengiz field in Western Kazakhstan, initiatives in the central Gulf of Mexico and all satellite fields operated by other companies.

• Intermediate-Term (five to 15 years out): All U.S. and Canadian shale plays, Wyoming, Montana, New Mexico and Russian coal bed methane, selected wind power Western U.S. and Baltic Sea region (Denmark, Germany, Poland).

• Long-Term (20 years or more): All alternative and renewable energy (by this point, crude oil will be too volatile with supply problems and natural gas from whatever source will be the main power source both for conventional applications and for new technologies – fuel cells will obtain most of their price-sensitive hydrogen from natural gas).

Moors: Here’s the bottom line. Looking forward, successful energy investors will be those who: (1) weigh volatility as well as opportunities; (2) understand the rapidly changing supply/demand balance; (3) hedge within a focused time-frame; (4) watch the development of new technology to improve production, processing or transport; and (5) have a flexible approach to the market.

(MM): Spotlighting and providing detail and in-depth analysis of the specific winners would require a much-more-detailed category breakdown than we have here. But stay tuned: Dr. Moors will delve into these topics in future issues of Money Morning.