Congress is talking about going after oil speculators in an effort to lower prices by limiting the amount of money flowing into oil contracts.

We realize that they’re upset, but they’re going about this the wrong way. What’s more, they’re demonstrating a near complete ignorance as to how financial markets actually work.

It doesn’t help that they’ve got energy analysts from some of the top firms telling them the price of oil could drop as low as $65 to $75 per barrel, bringing gas down to around $2 per gallon within 30 days of legislation that puts limits on speculation.

While we normally wouldn’t give a darn about the ignorance of elected officials, the bad news is that, judging from the solutions on the table, Congress is just crazy enough, and the vast majority of American people just angry and uninformed enough, that any legislation passed in haste could actually drive oil prices far higher rather than lower as intended.

Of course, that would create an entirely new set of profit opportunities for savvy investors in the process, but what’s a few trillion dollars of excess oil profits among friends?

Seriously.

While we applaud the fact that our leaders are angry enough about soaring fuel costs that they feel they have to do something about high oil prices, the danger is that they might actually succeed.

Here’s why.

One of the first things any licensed professional trader learns – particularly those holding the Series 3 like I did – is that in order for markets to function properly, they need a constant mix of buyers and sellers.

Together, those buyers and sellers agree on a price and make their trade. If there are more buyers than sellers, prices rise as demand outruns supply. If there are more sellers than buyers, prices fall as supply overwhelms demand. It’s a very simple equation.

When it comes to commodities such as oil, admittedly it gets a little more complicated because of geopolitical concerns and the whole peak oil argument. But not by much.

The commodities industry not only thinks about buyers and sellers, but also groups them into two segments: hedgers and speculators. The trick is that the commodities industry does not use these terms the way congress does, which is part of the flap here and, ironically, what demonstrates their naiveté.

Hedgers include companies or individuals that have commodities for sale or companies for whom the future of a given commodity presents financial risk. Examples include oil producers who may have to price their oil reserves years in advance and airline companies who are getting zapped now because they didn’t.

Speculators are typically companies and traders who assume immediate price risk in businesses that are subject to price changes. Examples include processors and refineries, as well as bankers who lend money (which is actually a financial commodity) at fixed rates.

It’s important to note that speculators are not gamblers. In contrast to gamblers who simply place bets for monetary gain, speculators trade economic goods like oil for profit based on their utility and scarceness. They also absorb risk and provide liquidity.

Not only does the presence of speculators help the markets function properly, but also they actually help keep prices down because their presence ensures that the markets are "liquid," meaning traders can get in and out of positions easily.

If speculators were taken out of the markets like some Congressional leaders are proposing, the net effect would be an artificial reduction in liquidity. And history shows beyond any shadow of a doubt that illiquid markets are more difficult to trade, tend to produce worse pricing and, when demand is increasing, far higher prices.

And then there’s the potential for hoarding and panic buying – both of which could also drive prices far higher in a real hurry.

So, the real danger is not that Congress wants to dampen future hikes, but that it may inadvertently cause price increases by eliminating one part of the equation that has historically helped hold prices down.

What about the related proposals that reference the introduction of higher margin requirements and increased financial transparency for foreign exchanges?

Again, those ideas are great in theory but each could have unintended consequences if not enacted in exquisite detail with tremendous forethought.

For instance, one of the proposals at hand includes increasing the amount of margin traders need to buy and sell oil contracts. While that could be seen as a limiting factor, the net effect is that it’s going to raise the cost of doing business for people who need the futures markets the most – big oil companies, refineries, airlines and trucking companies just to name a few.

And in the process, those businesses will pass along the new costs to already stressed consumers in the form of higher fuel taxes, fuel surcharges, and simply higher prices.

Another bill being sponsored would increase disclosure rules associated with global energy trading. While this could be great in terms of knowing who’s actively trading the markets on any given day, it could quickly drive oil markets offshore to less regulated, less transparent exchanges. The net effect of which would be that we would know less, rather than more, about who is trading what – which kind of defeats the purpose.

And that brings us to the profit opportunities.

If this plays out the way we think it’s going to, here’s what to do about it.

First, grab onto a piece of the Middle East and the so-called Frontier Markets. Many are literally awash in excess petro-profits and their markets will reflect that in the years ahead. Of course, they’re coming up a very low base so they are going to be really volatile, but we think the ride will be worth it over the long haul.

Second, follow an energy-centric "picks and shovels" strategy with an emphasis on drillers, shippers and refiners. A well-balanced blend of the three could really pay off no matter which way Congress takes things.

Third, follow the Sovereign Wealth Funds, many of which are profiting from high oil prices. These "Global Cash Barons" are investing their money around the world in businesses poised to profit from emerging consumerism and, big surprise, high oil prices. And they don’t like to lose, which is why newly established positions in China, the former Soviet Union and even Africa have all the upside in the world.

News and Related Story Links:

• MarketWatch:
  Gas could fall to $2 if Congress acts, analysts say

• Wikipedia:
  List of Securities Examinations

• Wikipedia:
  Peak Oil

• Money Morning:
  Outlook 2008: Three Ways to Profit From Sovereign Wealth Funds – the "Next Wall Street"

When U.S. Department of Energy analysts told you more than a month ago that gasoline prices would peak at about $4 a gallon around Memorial Day, we told you they were wrong. Gas prices, we said, were destined to head much, much higher.

Clearly, we were correct. Although gasoline prices have hit the $4 mark in many places, this is hardly the peak. Even though gas prices rose for 16 straight days – a streak that ended last week – oil prices have continued their surge, as well, meaning prices at the pump still haven’t caught up with oil prices.

Story continues below…

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Here’s the question many are asking now: Will Memorial Day represent the peak in gas prices (not very likely)? Or will July 4th now become the new target date for those energy prognosticators?

With investors and traders alike returning from the long holiday weekend, oil-and-gas prices will remain high on their radar screens. For now, those "low supply/high demand" naysayers seem to be winning out over the "weak dollar/speculation" conspirators and gasoline prices in excess of $4.00 a gallon are now a fait accompli.

Far in excess, in fact. Money Morning Investment Director Keith Fitz-Gerald, a longtime energy bull who first predicted triple-digit oil prices back in 2002 (a correct projection, as we know), is now predicting that oil prices will reach $225 a barrel within a just few short years.

New earnings releases this week will reveal how both discounters and high-end retailers are being impacted by both the sluggish economy and rising gas prices.  Costco Wholesale Corp. (COST), Sears Holdings Corp. (SHLD) and Tiffany & Co. (TIF) all report, though investors increasingly seem to be welcoming such profit news with a collective yawn these days. Consumer confidence and personal income/spending give investors a more accurate view of the mindset of the consumer, who, after all, accounts for as much as 70% of the U.S. economy’s gross domestic product (GDP).  Investors also get a reminder of the weak first-quarter activity, with a revised the revised release of GDP (originally reported as +0.6%); since many analysts believe a buildup in inventories pushed the number up above where it should have been, the revised statistic could be much lower – meaning that renewed talks of a U.S. recession are sure to follow.

The Federal Reserve Bank of New York will host a conference at the Colombia Business School with New York Fed President Timothy F. Geithner and Donald L. Kohn, the vice chairman of the Fed Board of Governors, pontificating on money market issues (as well as other timely topic).  Finally, with U.S. Sen. Barack Obama very close to wrapping up the Democratic presidential nomination, his policies on taxes, the economy, entitlements, drilling, globalization, and other key issues will dissected much more now than ever before in the past.

Market Matters

Memorial Day 2008 could not get here soon enough for investors (or at least for the declining numbers of consumers who still could afford to take advantage of this long holiday weekend).

After a week of obsessing over gas prices, they can analyze how those (pessimistic) travel prognostications actually panned out.  For 16 straight days, AAA reported record prices at the pumps with the recent average of $3.875/gallon getting dangerously close to the dreaded $4 per gallon mark (as we noted, that psychologically important barrier has already been eclipsed, in many places).  AAA even predicted that Americans will travel less this Memorial Day than they did last year, the first such decline since 2002.  A Deloitte & Touche LLP survey projected that 23% of folks have changed their plans because of the rising prices, with 12% of respondents canceling their vacations, altogether.  While some analysts targeted Memorial Day as the date for gas prices to peak, others are now looking at 4th of July, Labor Day, and beyond. 

In reality, the jury is still out for the energy sector altogether.  In one group, analysts say that crude prices (which actually punched through the $135 a barrel level this week) still have a ways to go.  They claim that supply will not keep up with the summer demand and point to the recent inventory levels, which have unexpectedly fallen of late. Demand in such developing nations as China continues to rise, and the devastating earthquake has only made matters worse.  Additionally, some believe that the International Energy Agency is preparing a very pessimistic report on global supply/demand issues as it conducts a thorough review of the world’s largest oil fields.

On the other hand, another group of analysts believe the declining dollar and sheer speculative pressures have more to do escalating crude prices than do actual supply concerns.  They scoff at any real rationale for prices rising $4 in one day, $9 in one week, and $16 in one month. But while some feel that the elevated prices are not economically justifiable, they cannot predict with any accuracy when this "speculative mania" will end.

According to one, "it’s a fool’s errand to try and figure out when it’s going to be over. [After all], Internet stocks took a year and a half to explode."

Some oil-industry executives even believe that the politicians are to blame and are pushing for Congress to lift the "tree-hugger" ban on domestic drilling in certain environmental regions – instead of begging "friends" in Saudi Arabia to increase production. Of course, that’s more than a bit self-serving on the part of the oil companies.

Retailers highlighted the corporate news last week. Home Depot Inc. (HD) reported a 66% decline in income, while Target Corp. (TGT) announced weaker sales, as well.  On the other hand, BJ’s Wholesale Club Inc. (BJ) reaped the benefits of shoppers traveling the discount route, and surprised investors with much-higher-than-expected profits.  Hewlett-Packard Co. (HPQ) recognized strong overseas sales, while U.S. automaker Ford Motor Co. (F) warned that its future looks bleak as drivers shy away from the gas-guzzling sport-utility vehicles and    perennially popular Ford F-150 pickup trucks that have comprised a major slice of its business in favor of more-economical cars and hybrids that are a lesser part of its business mix. Ford’s shares skidded 4.1% Friday after the company backed off its oft-repeated objective of returning to profitability in 2009.

In a broader sense on Friday, investors clearly kept on eye on high energy prices (and the damage they are causing) and the other on the clock as they prepared for the long weekend.  The pessimists ruled the day as the dreaded "I" words crept more and more into water-cooler conversations; the major indexes plummeted early and never looked back.  In fact, by shedding 145 points, or 1.2%, to close at 12,479 on Friday, the blue-chip-dominated Dow Jones Industrial Average suffered its worst two-day loss since February.  Financials led the downward spiral as investors speculated that the newfound focus on inflation means the next move in rates may be higher (see below). Right now, for investors, a long holiday weekend (at home?) may be just what the doctor (or the investors’ financial advisors) ordered.

Economically Speaking     

Inflation or recession? Recession or inflation? Suddenly the growing concern about energy-pricing pressures seems to be winning out.  The minutes from the last central bank policymaking meeting revealed that the last rate cut was a "close call," and also said that – despite the fact that labor remains "weak" and housing "bleak" – rate reductions may be a thing of the past. In fact, the benchmark Fed Funds rate futures market has priced in a 50-50 possibility that U.S. Federal Reserve Chairman Ben S. Bernanke & Co. may start raising rates in October (and almost certainly by January).

While the producer price index (PPI) climbed by a lower-than-expected 0.2% in April, the increase in "core" (excluding food and energy prices) wholesale inflation was actually twice as high as Wall Street had projected.  Additionally, some analysts point out that the recent surge in energy prices still has to be factored into the has yet to be factored into the inflation equation, meaning that the summer inflation gauges will be quite problematic.

As the Fed minutes implied, the prospects for a near-term housing rebound are indeed growing more and more bleak [Indeed, for a related story on the dour outlook for the U.S. housing market that also appears in this issue of Money Morning, please click here].

This week, the Office of Federal Housing Enterprise Oversight reported that home prices suffered their largest quarterly decline in 17 years, the worst showing on record.  The National Association of Realtors added that existing home sales dropped by 1% in April, its eighth decline in the past nine months.  (On the bright side, analysts were calling for a 1.6% decrease in sales, so the poor showing was better than expected).

Weekly Economic Calendar

News and Related Story Notes:

• Money Morning News Commentary:
  With the Energy Department’s Prediction for Gasoline Prices, the ‘Experts’ Get it Wrong Yet Again With the Energy Department’s Prediction for Gasoline Prices, the ‘Experts’ Get it Wrong Yet Again.

• Money Morning "Cashing in on Commodities" Investment Analysis Series:
  Cashing in on Commodities: What’s Driving the Oil Bull, How Much Further It Will Go, and How Investors Can Profit.

• Money Morning News Analysis:
  U.S. Housing Prices Suffer Worst Quarterly Decline on Record. 

• Money Morning Special Investment Report:
  Money Morning Boosts Oil Target Price to $225 a Barrel, Thanks to Continued Scarcity, Burgeoning Demand in China.

• Money Morning News Analysis:
  GDP Holds Steady at 0.6% in the First Quarter.

• MSNBC.com:
  Memorial Day travel hit by high fuel costs: AAA report predicts a drop for the first time since 2002.

• Money Morning News Analysis:
  Troubled Global Airline Industry Battered by Fuel Costs, Labor Problems.

• Money Morning Financial News Commentary:
  One Sure-Fire Sign That Gas Prices are Heading Higher.

• Fox Business News:
  Energy Department: Gas Prices Could Hit $4 a Gallon.

• MarketWatch.com:
  Oil closes at new record above $110 a barrel: Crude futures earlier hit new intraday high of $112.21 as inventories fall.

• Money Morning Financial Analysis:
  Three Ways to Play Money Morning’s Prediction That Oil Prices Will Reach $187 a Barrel.

• Money Morning Economic Forecasting Series:
  Outlook 2008: How to Profit When Oil Bubbles Up Above the $100 Level.

• Money Morning News Analysis:
  Goldman Sachs Follows Money Morning Prediction That Oil Prices Could Approach $200 a Barrel.

• Money Morning News Analysis:
  Oil Heads For $100 a Barrel, While Some Speculators Brace for a Correction.
• NewYorkFed.org:
  New York Fed Names Timothy F. Geithner President.

• Wikipedia:
  Donald L. Kohn.

• Money Morning "Election 2008" Series:"
  Election 2008: As Democratic Primary Hits a New Pinnacle Today, "Obamanomics" Emerges as Clear Front-Runner for Investors.

• Money Morning Analysis:
  With Oil Nearing $130, Kicking the "Oil Addiction" Looks Like the Sole U.S. Hope.

• San Jose Mercury News:
  H-P’s 2Q profit up on strong demand outside U.S.

Inflation rose in 2007 by its sharpest rate in 17 years, pushed by increased costs for energy and food, the U.S. Department of Labor reported. 

Consumer prices rose by 4.1% in 2007 – up from the 2.5% rise in 2006. Energy prices jumped 17.4% and food prices increased 4.8% last year – both the highest gains since 1990. Oil’s surging price accounted for increases in energy costs while dairy [up 13.4%] and cereal and bakery products [up 5.4%] were blamed for increased food prices. 

Increased transportation costs [up 8.3%] and medical costs [up 5.2%] were also culprits. The Labor Department’s CPI report showed inflation for the year rose at its highest pace since 1990’s 6.1% increase in prices.

However, outside of energy and food prices, inflation increased a slight 0.2% in December. For the year, core inflation (ex. food and fuel) rose 2.4%, down from 2.6% in 2006.

The Consumer Price Index (CPI) is a measure of the average change in prices over time of goods and services [food, clothing, shelter, fuel, doctor fees, drugs, etc.] purchased by households. Prices are collected in 87 urban areas across the country from about 50,000 housing units and approximately 23,000 retail establishments [department stores, supermarkets, hospitals, filling stations and other types of stores] and service establishments, the Labor Department said.

Escalating Economic Concerns

The report compounds worries from two other government economic reports issued earlier this year.

On Jan. 2, spending on residential construction fell for the 21st straight month. And on Jan. 4, the Labor Department said that unemployment rose from 4.4% last year to 5.0% and nonfarm payroll employment was relatively unchanged at 18,000 jobs added. 

Pulled together, the falling economic indicators and overall sentiment is leading many to believe the United States is heading for a recession, if its not already experiencing one.

“The U.S. economy in 2008 will be like a cat on a hot tin roof that has already used up eight of its nine lives,” Stuart G. Hoffman of PNC Financial Services Group Inc, told the Wall Street Journal.

Though U.S. Federal Reserve Chairman Ben Bernanke is becoming more frank in his economic analysis, he’s careful not to say the dreaded R-word.

“A number of factors, including higher oil prices, lower equity prices, and softening home values, seem likely to weigh on consumer spending [in 2008],” he said last week, speaking before a group from the Exchequer Club and Women in Housing and Finance in Washington. 

Analysts and investors welcomed Bernanke’s remarks. Most saw it as a sign that the Fed will lower the key interest rate by 50 basis points at the next Federal Open Market Committee meeting slated for Jan. 29 and 30. Interest rate futures are currently pricing in a 90% probability of a half-point rate cut.

“Price pressures may be a little greater than the Fed would like, but with the economy hitting the skids, inflation is not so high to stand in the way of aggressive action,” Joel L. Naroff, president and chief economist of Naroff Economic Advisors, said in a note to clients.

News and Related Links:

• United States Labor Department:

Consumer Price Index: December 2007

• Money Morning:

Money Morning’s Three-Minute Review: How Last Week’s Events Will Shape This Week’s Action

• Wall Street Journal:

Inflation Rate Worse in 17 Years

• Money Morning:

Bernanke Says Fed is Ready to Act

General Electric plans to build two power plants in Turkmenistan in an effort to help the desert nation develop solar-power facilities, Reuters reported.

The agreement was reached after talks with GE officials and Turkmen president Kurbanguly Berdymukhamedov last week in the nation’s capital, Ashgabat. 

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Despite his country’s status as Central Asia’s largest natural gas exporter, president Berdymukhamedov said Turkmenistan needs to develop alternative energy sources.

"It is incredible, but in Europe, where there are so few sunny days, they are actively working on producing solar power," Berdymukhamedov told Reuters. Meanwhile, Turkmenistan gets about 360 sunny days a year, he added.

The deal marks a huge policy leap for Turkmenistan, which has long been politically and economically isolated from Western countries and companies. Such reclusive politics were the signature of Berdymukhamedov’s predecessor, Saparmurat Niyazov, whose dictatorship ended last December after a 21-year reign.

And since Berdymukhamedov’s February election, foreign investors have been paying attention to the resource-rich country north of Iran and Afghanistan.

News and Related Story Links:

• Reuters:
  GE to build two power plants in Turkmenistan

• Wikipedia:
  Turkmenistan

Officials at solar-cell-maker LDK Solar Co. Ltd. (LDK) were apparently confused about the quality of the silicon in the firm’s inventory- just as an ex-finance official has alleged- according to an audio recording of an internal conference call obtained by The Wall Street Journal, the newspaper reported yesterday.

LDK, based in southern China’s Jiangxi province, makes the silicon solar wafers used to convert sunlight into electricity. But it depends on a mix of both new and recycled batch silicon, and that requires the company to be very specific about the source and the age of the silicon that’s in its inventory.

However, in e-mailed messages to regulators and to KPMG, Charley Situ, LDK’s former financial controller, has accused the solar-cell maker of reporting inflated figures for its silicon feedstock, The Journal reported. Specifically, Situ alleges there is a discrepancy between LDK’s reported inventory and the amount of "usable" silicon that’s actually available.

And The Journal says the recording of the Sept. 13 conference call that it obtained seems to support the contention of Situ, the ex-LDK official. In the recording, Situ and two other LDK officials- Yao Qiqiang, the vice president of accounting, and Liu Yizheng, an accounting manager- openly discussed the quality of the "feedstock" silicon with Jack Lai, LDK’s finance chief.

On the call, Situ estimates that two-thirds of the feedstock in question is older than 180 days, making it unsuitable for use producing the solar-panel wafers- something LDK should reflect by taking a write-down that will appear on its financial statements, affecting its financial position, the newspaper reported.

After finance chief Lai ask why that feedstock isn’t usable, account manager Liu explained that the inventory is leftover bits of the silicon that had already undergone testing by the production team. According to The Journal, Lai then said that "I think you should do some careful data analysis" to determine the quality of the inventory.

Yao said that "what the accounting department needs to do is a categorization of the inventory in terms of life and ways in which it was purchased…and hand it over to the technology team for a review. Let them decide whether it is usable or not," stated the newspaper report.
LDK says that Situ’s allegations are without merit, and described him as a disgruntled ex-employee who was fired. He says he resigned, the newspaper reported.

In its initial public offering on June 1, LDK raised nearly $500 million. By Sept. 26, the shares hit their all-time high of $73.95, leaving the company with a market value of $1.3 billion- nearly a three-fold increase. It paved the way for a handful of other China-based solar-power firms to go public, as well. [To read Money Morning's full report on all the China-based solar-energy firms that have gone public in the past year, please click here. The report is free of charge.]

LDK’s shares plunged $3.24 each, or 7.24%, to close at $41.51 yesterday (Thursday). Some U.S. shareholders are traveling to China to visit the company’s headquarters to assess LDK’s prospects, the newspaper reported.

News and Related Story Links:

• The Wall Street Journal:
  On Recording, LDK Officials
  Were Confused About Inventory.

• Money Morning News:
  LDK Shares Plunge Another 26% Due to Worries, Barron’s Report.

• Forbes.com:
  LDK Solar Rises.

• Money Morning:
  Fluor to Build Polysilicon Plant in China.

• ExpansionManagement.com:
  Fluor to Build Polysilicon Plant in China.

• Reuters:
  Fluor Wins $1 Billion Contract for LDK Solar Plant.

• Money Morning Investment Analysis:
  How to Profit as Surge of Solar IPOs Mark Dawn of New Industry in China.

• Money Morning News:
  IPOs Soar in Third Quarter, Fueled by Solar, Software and Finance Deals.

• Money Morning News:
  China Solar Cell Maker JA Solar to Sell $280 Million Worth of Additional Shares.

• Money Morning News Analysis:
  When Corruption is Low, Your Profits are High.

• Reuters:
  LDK Solar Shares Extend Slide, Down Almost 26%.

• Reuters:
  German Solar Firms Boost Capacity to Meet Demand.

In a story that underscores the risks investors face with emerging-markets investments, OAO Gazprom, Russia’s energy giant, is up to its old tricks and is once again threatening to cut gas supplies to the Ukraine, in an effort to extort payment, Bloomberg News reported.

It’s an issue that Money Morning has reported on extensively before.

Gazprom supplies 25% of Europe’s gas and is now threatening to curtail exports to the Ukraine over a $1.3 billion debt. The company warned the European Commission and consumers that it would take action unless the debt is settled by the end of the month. Gas supplies throughout Europe declined in a year and a half ago when Gazprom froze the Ukraine out the first time and negotiated a higher price.

And no one wants a repeat performance.

Troubles don’t end at the Ukraine either. Gazprom threatened to cut off gas supplies to Belarus in August. That dispute was resolved when Belarus paid $190 million of its $456 million debt. Threats and corresponding actions like these have made every nation in the European Union wary of Gazprom, and impelled them to seek out alternatives.

In September, the European Commission introduced a plan calling for a massive restructuring of power grids throughout the continent. The plan was designed to reduce the region’s vulnerability to massive energy companies that control the production and transmission of gas and electricity.

The Commission offered two options to proceed with a version of deregulation that it has labeled as "ownership unbundling." The first would force energy companies to sell off their transmission networks. The second would require companies to retain their respective transmission networks, but lease them to fully autonomous operators. The Commission also called for an independent EU energy agency to oversee national regulators.

The measures are clearly an attempt by the European Commission to safeguard the continent against Gazprom. Gazprom has clearly been agitated by accusations of impropriety and malfeasance. According to Bloomberg, after the commission signaled its intention to propose legislation on ownership unbundling, Gazprom Deputy Chief Executive Officer Alexander Medvedev called the plan "the most absurd idea I have ever met in the history of the world economy."

Regardless Gazprom’s power-play shenanigans have attracted the attention of the United States as well. A few months ago, Reuben Jeffery, the under-secretary at the state department for economic, energy, and agricultural affairs, traveled to Russia with the hopes of addressing some of these issues.

Jeffery commented on the failure of other nations in the region to work around Russia saying, "The objective as we talk about alternative routing systems is to create legitimate market-based competition, and to develop some redundancy in the system in the event of legitimate physical breakdown, or other political issues that might arise that might lead somebody to cut off supply."

It’s no secret just who that ‘somebody’ is.

With every price hike and subsequent threat from Gazprom, the company becomes less credible. Still, there isn’t much that Europe or the United States can do right now. Europe is heavily dependent upon Russian energy, and as the EU heads into the cold-weather months, that dependence is only going to increase. Until Europe cultivates alternative energy supplies from Africa and Central Asia, Gazprom is going to keep bullying the continent, and especially its weaker dependents, including Belarus and the Ukraine.

News and Related Story Links:

• Money Morning News:
  Belarus Assuages EU Fears; Agrees To Pay Part of Gazprom Debt.

• Money Morning News Analysis:
  EU Presses for More Energy Control.

• Bloomberg News:
  Gazprom Warns Europe of Possible Ukraine Supply Cut.

You can’t help but feel a sense of deja vu.

At least I can’t.

The last time the dollar fell this low and energy was this costly, traders were concerned about a massive recession, we were talking about a scary new economic syndrome called "stagflation," and the Major League Baseball’s Pittsburgh Pirates and Baltimore Orioles were actually perennial contenders.

It was the 1970s. The economy – then as now – was slowing as investors realized that Washington’s tough-talk and economic policies were nothing more than smoke and mirrors.

But the world has changed in the three decades that have followed. What’s different now is that we have a situation where our three largest creditors – Japan, South Korea and China – also are our largest trading partners.

And one of those trading partners – China – is extremely displeased by the weakening dollar.

In fact, all three partners are so upset that they’ve been making some very public noises about diversifying away from the greenback, or – and this is a huge deal – even dumping some of the $1.3 trillion worth of dollar-denominated debt instruments they hold.

China’s Greenback Angst

The gloom-and-doom crowd has labeled this scenario as China’s "nuclear option," because having China dump dollars on a wholesale basis would be akin to China lighting off a hydrogen bomb in the worldwide financial markets.

Come to think of it, I recall reading something in China’s press that employed the same slang term, so it’s not clear just who used it, first.

Anyway, from the way the media has reported this to date, you’d think the world was about to end.

Well, I don’t think so and when you get down to it, I really don’t think China’s "atomic saber-rattling" is much of an actual threat. In fact, I think it’s pretty benign.

For one thing, what China is supposedly saying is really nothing new, despite how the press is treating that country’s recent commentary on this issue. The truth is, China has been making noises about this for years, and so much of what’s being reported right now is really just ‘standard operating procedure,’ or S.O.P., for both U.S. and Chinese diplomats whenever they get together.

The manner in which the remarks were made is also a business-as-usual because the Chinese often use academic types to make what are essentially pending policy level announcements. That way, the official apparatchiks can remain unscathed should there be some unforeseen global backlash, which prompts a retreat or a potential loss of face.

Why There’s Bluster, Not Blasting, to Come

How this ultimately all plays out remains to be seen, and is really impossible to predict (though I doubt it will be as bad as some fear). But even if nothing comes of this, there are some things that need to be understood:

First, there is literally not another currency on the planet capable of absorbing a few hundred billion dollars. Therefore, even if China actually decides to dump the dollar, there literally isn’t any other currency that could stand in and absorb the excess capacity if China were to go shopping for alternatives to the greenback.

The European euro is at record levels and EU governments are struggling with how uncomfortably high it’s become. The Japanese yen, which would have been a good candidate in the past, has effectively been neutered by what’s left of the carry trade. Other countries are either unstable, or too small, for to be relied upon. The Middle East, Russia and Africa are hardly the poster children for stability, so they’re out too. As for the rest of the Asian Rim, those countries are too small to have meaningful places in the fiat currency arrangements relied upon by world bankers as a source of checks and balances which is why they’re not included in any of the major currency trading "pairs" in the FX markets at the present time. The bottom line: If China were to start dumping dollars, it would simultaneously put at risk every other currency it its basket in the process. It knows this. Therefore, by making such seemingly vitriolic pronouncements, what China is actually doing is to cement in place its own version of Mutually Assured Destruction – which helped keep the United States and Soviet Union out of a nuclear throw-down during the Cold War.

In doing so, China is attempting to create enough fear to make sure the world will never want to square off against it. And the Democrats who look increasingly likely to inhabit the White House next year will be fearful of enacting the punitive tariffs they’re talking so toughly about right now.

At the end of the day, China knows just how dependent they are on exports, so dumping dollars is hardly conducive to continuing those relationships, particularly since the last time I checked more than 50% of Chinese exports were headed straight for the U.S. market.

To be clear here, though, there is an element of truth to what the gloom-and-doom crowd alleges. China will continue to posture and undoubtedly will engage in short-term allocation changes designed to make clear its point. But, beyond that, nobody in Beijing is going to push the financial nuclear "button" as long as we’re all mutually engaged.

Over the long term, however, if we can no longer claim mutual engagement, then, frankly speaking, we’ll have bigger fish to fry. And currency dumping won’t even be on the radar screen.

Second, for all of China’s noise about how low the United States is letting the dollar sink, China has to share some of the blame. For that reason, I’d even go so far as to suggest that China’s threats are really a call for help.

For all its growth and prowess as an emerging world power, China’s financial markets remain remarkably primitive by world standards. What’s more, their capital markets remain woefully underdeveloped for the economic structure that’s being developed. As a result, the Chinese are actually uniquely dependent on a falling dollar to succeed over the long term.

And that brings me to my third point, which is that China is really an overvalued economy masquerading as a highly developed one. Like others before it, China will realign its interests and, at a time when the market chooses, the value associated with it will revert to longstanding norms.

What’s more, despite the fact that neither party will admit it, both the United States and China will emerge as stronger beings for having danced this financial Lambada together.

Deja vu All Over Again

Are you skeptical of my scenario?

If you are, I can’t blame you.

But, as Yankee great Yogi Berra used to say, "it’s Deja vu all over again." In other words, we’ve seen and heard this whole "currency dumping" hypothesis at least once before. If you think about it for a minute, you’ll know just what I mean.

What’s going on now is really just a replay of the 1980s, when Japan was viewed as an unstoppable juggernaut, and the Yen as the currency that would soon dominate the worldwide economy. People have apparently forgotten that Japanese businessmen were regarded as modern day samurai. Words like ruthless, cunning, and predatory were bandied about.

They’ve also forgotten that many the charges presently being levied against the Chinese now were levied against the Japanese then.

I think you know where this is going, but let me close the loop anyway.

Long story short, the Japanese waded into financial markets around the world, snatching up prime assets in nearly every country at fire-sale prices. There was a huge, emotionally driven backlash at the time when such assets as the Pebble Beach golf course and Rockefeller Center office building went up on the auction block and were snapped up by Japanese suitors. Later in the game – toward the end of Japanese hegemony – they were actually paying irresponsibly high premium prices for the assets, but that’s another story.

What’s vitally important to remember is that the Japanese Yen, as powerful as it was at the time, actually played an important role in setting the foundation for one of the longest, most profitable bull runs in history as the excess value they brought to the market was absorbed by other economies, including our own.

Will the same thing happen this time?

I don’t know for sure. But having participated in the great Japanese buying binge firsthand, I’m betting that if you follow the money, as Money Morning advocates, you’ll profit this time around, too.

You’ll also get a potential two-for-one deal at the same time that’s likely to result in higher returns, too. The reason is that by purchasing Chinese firms on the prowl as well as their intended targets in the natural-resources, financial-services and hi-tech sectors, you not only set up your investments for some healthy appreciation, but you also hedge your investment dollars from further decline by owning shares denominated in other currencies.

Of the five best-performing initial public stock offerings so far this year, three are China-based solar-energy companies.

With energy prices soaring, China is making a big move into the market for solar-energy technologies.

Initial public offerings (IPOs) of solar-energy firms have reached record levels this year, with at least half a dozen China-based alternative-energy technology companies helping to fuel that trend.

According to a recent report by New Energy Finance, solar-energy IPOs had reached $4.7 billion as of July 31, more than double the $2.2 billion recorded during the same period in 2006 and triple the $1.5 billion for 2005.

Of those six China-based solar-energy companies that went public this year, three are among the best-performing IPOs through the first nine months of this year. [For more information on these IPOs through the first three quarters of the year, please click here and check out our related story on IPO deals through the first nine months of this year].

The includes the No. 1 performer, JA Solar Holdings Co Ltd (JASO), the solar-cell maker whose shares have more than quadrupled in value since it went public on Feb. 6 at $15 a share. LDK Solar Co. Ltd. (LDK) and Yingli Green Energy Holding (YGE) – which went public a week apart in early June – ranked third and fourth, respectively.

LDK, which closed Friday at $68.90, is up 155% from its offering price. It manufactures "multi-crystalline" solar wafers, the main raw material needed to produce solar cells. LDK sells multi-crystalline wafers globally to manufacturers of photovoltaic products, including solar cells and solar modules.

Yingli, which ended the week at $26.07, is up 137% from its IPO price. Yingli is a vertically integrated photovoltaic (PV) product manufacturer in China. Through Baoding Tianwei Yingli New Energy Resources Co. Ltd. (Tianwei Yingli), the company’s principal operating subsidiary based in China, it designs, manufactures and sells PV modules, and designs, assembles, sells and installs PV systems that are connected to an electricity transmission grid. As of June 7, Yingli’s annual production capacity was 95 megawatts of poly-silicon ingots and wafers, 90 megawatts of PV cells and 100 megawatts of PV modules.

Three China-based solar-power-technology companies went public in the final two months of last year, raising $508.8 million, not including "green shoe" overallotments. Four more solar-energy-related firms went public this year, raising $1.11 billion.

What’s the attraction? Unlike many high-tech startups, solar-energy companies can become profitable very quickly, analysts say. For that reason, this surge in IPOs is an investment boom – but not a bubble.

"Solar companies, once they’re ramped up, they’re solidly profitable," Jeffries & Co. analyst Jeffrey Bencik told The Associated Press in a July interview. "This is not the Internet bubble. These companies have real products and real profits."

Soaring economic growth – primarily in China, but also in India, parts of Latin America and Eastern Europe – have sent crude oil prices soaring to record levels north of $80 a barrel, and have caused other commodities roar north, as well. And those spiraling energy and commodity prices have drawn the interest of retail investors, as well as institutional, private-equity and venture-capital investors, too.

The ultimate objective: Find the technological breakthrough that will one day enable oil, coal, and natural gas to be replaced with either alternative sources of energy, or even better with a clean, cheap, renewable fuel or energy source. As long as the prices of conventional fuels remain as high as they are now, those investments in energy alternatives will continue to increase.

In the United States alone, engineering, manufacturing and construction jobs related to the solar industry will total 30,000 by 2015, according to the report, "Solar Power Commercial Market Applications," from Energy Business Reports.

So-called "green" mutual funds – officially referred to as environmentally friendly funds – have experienced significant gains in recent months, as investors moved to profit from these same trends. The Portfolio 21 Fund (PORTX) has posted a year-to-date total return of 12.59%, is up 23.3% over the past year and has an average annual total return of 19.93% over the past five years. The Winslow Green Growth Fund (WGGFX) has done even better: It’s up 15.4% year to date, has a one-year total return of 24.23% and has generated a very lofty average annual total return of 26.76% over each of the past five years.

Morningstar rates Portfolio 21 as "above average" in terms of both risk and return, while Winslow Green is rated as a "high" risk and return fund.

Then there are the companies themselves.

LDK Solar (LDK) and Yingli Green Energy Holding (YGE) both went public in early June – LDK at $27 a share and Yingli at $11. As noted, LDK, which closed Friday at $68.90, is up 155% from its offering price. Yingli, which ended the week at $26.07, is up 137%.

The SunPower Corp. (SPWR), whose shares closed Friday at $82.82, has been a major solar energy player since late 2005. Its shares are up 192% in the past 12 months, including an advance of nearly 28% in the last three months alone.

In a research note on Thursday, Schaeffer’s Research analyst Joseph Hargett said several factors favor continued gains in the stock: The so-called "short interest" is very high – equal to 65% of the shares outstanding and available for trading – and analysts who follow the stock are somewhat bearish, with seven "buys" and six "holds." That leaves a lot of room for analyst upgrades, Hargett said.

And while he didn’t actually use the term, the scenario Hargett outlined – high short interest and lots of room for analyst upgrades in a stock that’s already performed strongly makes a rally-igniting "short-squeeze" very possible, if not likely.

There’s a reason SunPower’s shares have sizzled: Its financial performance has been extremely strong, as well. Over the past 12 months, sales have advanced at an annual rate of 227%. Revenue for the second quarter was $174.1 million, a 22% increase from the prior quarter’s revenue of $143.2 million.

The San Jose-based maker of high-efficiency solar cells, and systems, opened a new plant in the Philippines on July 30.

LDK is a leading manufacturer of multi-crystalline solar wafers, which are the principal raw material used in the production of solar cells. Net profit for the second quarter of 2007 was $99.1 million, up 35% from $73.4 million in the first quarter. This was a 716% improvement over $12.1 million in the second quarter of 2006. Gross profit was up 1,265% from a year ago, as well. Yingli Green Energy is set to release its second quarter earnings on August 15.

Both Yingli and LDK are based in China, which may have the worst pollution problem in the world. It’s estimated that the country’s pollution is responsible for the death of more than 750,000 Chinese citizens a year. The country is going through a tremendous amount of trouble to clean up its act before the 2008 Olympic games.

Because of the Olympics, China will spend $3 billion on pollution-control initiatives during this year alone.

Last year Beijing removed 15,000 old taxis and 3,000 buses from the city to try to ease pollution and traffic. Beijing officials also say they have planted nearly 200 million trees since 2002, which was the year after Beijing was named the host of the 2008 Games. And, of course, the silicon solar panels will be used to help provide power to the Olympic game venues.

Four other Chinese solar companies have gone public in the past eight months. In addition to JA Solar Holdings Co Ltd (JASO), whose shares have more than quadrupled in value since its Feb. 6 IPO at $15 a share, other U.S.-listed China-based companies involved in the solar-power sector include:

• Solarfun Power Holdings Co. Ltd (SOLF), manufacturer of both photovoltaic (PV) cells and PV modules in China.
• Trina Solar (TSL), which makes standard solar modules ranging in power output from 160 watts to 185 watts.
• Canadian Solar Inc. (CSIQ) produces and sells solar cells and module products that are have residential, commercial and even industrial uses.
• Suntech Power Holdings Co. Ltd. (STP), maker of photovoltaic cells and marketer of integration services. Its products are used to provide standalone power for street lamps, garden lamps, telecommunications relay stations, and mobile phone networks.
• And China Sunergy Co. Ltd. (CSUN), which manufactures solar cells from silicon wafers.

This is no coincidence. A mad rush to clean up the country before the Olympic games isn’t going to be enough to permanently squelch China’s pollution epidemic. If the country is going to get the problem under control it’s going to have to count on alternative energy technologies like solar power for contributions.

News and Related Story Links:

• Money Morning Special Investment Report:
  A Special Investment Report: With Crude Oil Prices Still At the Base of a Five-Year Climb, Turn Pain Into Profit.

• Money Morning News Analysis:
  China Tries to Tap the Brakes on Growth.

• Money Morning Investment Analysis:
  Alternative Energy: How Oil’s Unpredictability Is Driving Investment In Renewable Fuel Sources.

• Barron’s Tech Trader Daily:
  Solar Stocks Go Nuts On Supply Agreements; Is The Sector Overheated?

• Investors Business Daily:
  Rise Of The Solar Energy Industry Lights A Fire Under Wafer Maker.

• The Associated Press:
  LDK Solar Jumps After IPO.

• China Venture News:
  Yingli IPO Opens Down.

• Schaeffersresearch.com:
  The Casual Contrarian: Here Comes Sunpower [Video].

• Prime Newswire:
  Macy’s Launches 28-Store SunPower Solar Power Program in Westminster.

• China Analyst:
  China Solar Stocks Comparison Table (9/27/2007).

• Reuters:
  J.A. Solar: Key Developments.

• Reuters:
  Value of U.S. IPOs soar in Third Quarter, Year to Date.

Korea’s Posco Ltd., Asia’s third-largest steelmaker, has landed a $350 million contract to build the biggest blast furnace in India, Bloomberg News said Wednesday.

The furnace, a key part of the steel-making process, is for the Steel Authority of India Ltd., which is 85.84% state owned. It makes 14 million tons of steel a year – close to a third of India’s total output. The project opens up major opportunities for Posco, as India’s steel business is projected to rise at a rate of 16% each year from now until 2012.

The furnace will be 4,060 million cubic meters and have a produce of 2.7 metric tons of steel a year. It is scheduled for completion by March 2010. So far, construction has been delayed, as the land has not been fully cleared of occupants and Posco has yet to obtain a mining license.

On Wednesday, Hyundai Samho Heavy Industries Co. bought an additional 436,000 shares in Posco for $266.8 million. The transaction raised Hyundai Samho’s holding in Posco to 1.5% (1.3 million shares) of the steel maker’s total float, Hyundai Samho said in a regulatory filing. Posco has swapped stakes with several friendly investors, including Hyundai Heavy and Japan’s Nippon Steel Corp, to ward off any hostile takeover bids.

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The European Commission yesterday (Wednesday) introduced a plan calling for a massive restructuring of power grids throughout the continent.  The plan was designed to reduce the region’s vulnerability to the massive energy companies that control the production and transmission of gas and electricity.

Currently, large energy companies monopolize energy production and distribution, with little or no regulation from the EU.  These companies operate at the network, wholesale, and distribution levels, keeping competition at a distance and prices vague.

Jose Manuel Durao Barroso, president of the EC told The Associated Press that “energy is the driving force of our economy,” and added that a response is needed to “achieve greater energy security and provide abundant energy at a fair price for citizens.”

The report also pointed out that EU residents and businesses supply options and that there is too much incentive for current operators to freeze out any new competition.

The Commission offered two options to proceed with, what it called, “ownership unbundling.”  The first would force energy companies to sell off their transmission networks. The second would require companies to retain their respective transmission networks, but lease them to fully autonomous operators. The Commission also called for an independent EU energy agency to oversee national regulators.

The plan was specifically designed as a safeguard against Gazprom, the state owned Russian energy giant. Gazprom currently supplies 25% of Europe’s gas, and is aggressively seeking other European acquisitions.  It has repeatedly used supply lines as a means of political and financial gain.

Additionally, Moscow refuses to open its energy sector up to foreign investment, even though Gazprom has full access to European energy markets. This has long been a point of contention.

If the plan is put into effect, other key European energy players will no doubt suffer. France’s EdF and Germany’s Eon are among the companies that would be broken up. France and Germany oppose the measure along with six other nations.

Barroso said in Brussels that “an open and fair internal energy market is essential to ensure that the EU can rise to the challenges of climate change, increased import dependence, and global competitiveness,” The AP reported.

As it stands now, Britain, Denmark, Spain, Belgium, Finland, Romania, Sweden and the Netherlands are on his side. Though, the likelihood of the measure succeeding remains unclear.

Related Articles and Links:

• Money Morning: Belarus Assuages EU Fears; Agrees To Pay Part of Gazprom Debt.
• Money Morning: The New “Cold” War: How Russia Has Turned Its Energy Exports Into Weapons of Diplomacy.

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