Millions of investors who bought gold in the last 12 months are undoubtedly very happy at the moment – considering that the yellow metal has risen 60% since last November to a recent close of $1,138.60 an ounce on Monday.

But chances are good that many won’t be smiling when they discover just what the taxman has planned for their gains.

Unbeknownst to most investors, gold is considered a collectible not a capital asset. In plain English, this means that despite the fact that many people believe they are investing in gold, the Internal Revenue Service (IRS) believes that they are collecting it.

This is no small distinction and hurts investors because it means that gold does not qualify for the 15% maximum tax bite that most of us employ as a matter of routine when we mentally calculate profits earned on investments held for more than a year. That 15% cut for Uncle Sam is the long-term capital gains tax rate that applies to most stock or mutual fund investments.

Precious metals are a completely different story. Profits from these “investments” can be subject to a 28% maximum tax rate if held for more than 12 months. And if they are sold in less than a year, the profits count as ordinary income.

The long and the short of it “is that as a result of gold’s spectacular run-up, many investors may have a tax problem they haven’t counted on when they go to sell,” said Gary E. Ham Jr., of the Oregon-based accounting firm of Jones & Ham PC

This may be especially true for investors who have piled into such asset-backed, exchange-traded funds (ETFs) as the SPDR Gold Trust (NYSE: GLD), the iShares Silver Trust (NYSE: SLV) and the iShares COMEX Gold Trust (NYSE: IAU), for example, because precious-metals ETFs are set up as something called a “grantor trust.” According to Barron’s, ETF investors are treated as owning undivided interests in the actual metal that’s owned by the fund. Therefore, when an investor sells shares in the ETF, the tax code treats that investor as having sold a share of the metal backing the fund.

Adding insult to injury,  if the ETF sells some of its hard assets to pay expenses or management fees – as many have done recently, the resultant gains (or losses) flow directly through to investors and shareholders even if those investors don’t receive any distribution or cash whatsoever.

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And the net results can be mighty startling. For example, Doug Fabian, president of Fabian Wealth Strategies, a California-based investment advisor, noted several painful examples in an article on his firm’s Web site about the tax traps of commodity ETFs, including:

• An investor who experienced a trading loss of $741 in the United States Oil Fund LP (NYSE: USO) – with no interest received – but a K-1 tax form reporting a taxable profit of $9,136 and interest of $210.
• Another who had actual trading profits in the United States Natural Gas Fund LP (NYSE: UNG) of $1,900, with no interest received, and a K-1 reporting taxable profits of $4,319 and $120 in interest.
• An investor who had an enviable trading profit of $4,335 in the PowerShares DB Agriculture (NYSE: DBA), without receiving any interest – activity that triggered a K-1 form that reported profits of $6,963 and interest of $207.
• Finally, an investor who notched trading profits of $337 and no interest in the PowerShares DB Commodity Index Tracking Fund (NYSE: DBC) triggered a K-1 listing profits of $3,406 and interest of $195.

K-1’s, in case you are not familiar with them, are tax forms used by partnerships, corporations and ETFs to report a partner or a shareholder’s share of distributed profits and income. If you own one of the ETFs I’ve just mentioned, chances are you’ll be getting one just after the New Year to file with your taxes.

Here’s how this works.

Because the XYZ ETF does not pay income taxes itself, its profits are passed through to the actual owners – in this case, the shareholders, who must claim those profits as their own. If you own 50% of XYZ ETF, and XYZ files for a $100,000 profit in 2009, you’ll receive a K-1 for 50% of the net profits – or $50,000 – which you then will have to claim on your personal 2009 income-tax return.

By the way, conventional gold and metals stocks – gold producers are a good potential example of what we mean – are treated “normally,” so investors who have chosen to buy these more-traditional investment vehicles will escape these “unexpected” tax consequences.

If there is a moral to the story, it’s that nothing is what it seems anymore – not even gold.

[Editor's Note: Keith Fitz-Gerald is the chief investment strategist for Money Morning and The Money Map Report. Fitz-Gerald has pulled all his best thoughts together in his new book, "Fiscal Hangover: How to Profit From the New Global Economy." The reviews are excellent. Investors interested in ordering the book can save $10 off the cover price at Amazon.com. Just click here.]

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• Amazon.com:
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• “Fiscal Hangover” Book Excerpt:
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• “Fiscal Hangover” Book Excerpt:
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• Jones & Ham PC:
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• YourDictionary.com:
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• IRS.gov:
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• Fabian Wealth Strategies:
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• Yahoo!Answers:
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By Keith Fitz-Gerald
Chief Investment Strategist
Money Morning/The Money Map Report

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!

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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. Fitz-Gerald has pulled all his best thoughts together in his new book, "Fiscal Hangover: How to Profit From the New Global Economy." The reviews are excellent. Investors interested in ordering the book can save $10 off the cover price at Amazon.com. Just click here.]

News and Related Story Links:

• FiscalHangover.com:
  The Official Web Site for “Fiscal Hangover: How to Profit From the New Global Economy,” by Money Morning Chief Investment Strategist Keith Fitz-Gerald.
• Amazon.com:
  How to Order “Fiscal Hangover” With a $10 Discount From the Cover Price.
• “Fiscal Hangover” Book Excerpt:
  Where to Find Big Profits in a Post-Crash World.
• Wikipedia:
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• Investopedia:
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• Wikipedia:
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• MarketWatch.com:
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• Investopedia:
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• Money Morning News Category:
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• Investopedia:
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• CNBC Fast Money Feature:
  The Death of Buy-and-Hold Investing.
• Investopedia:
  Protective Stops.
• SirJohnTempleton.org:
  Official Web Site.
• Investopedia:
  Protective Stops.
• GeneralPatton.com:
  Biography of General George S. Patton Jr.

By Keith Fitz-Gerald
Chief Investment Strategist
Money Morning/The Money Map Report

As I write this, everyone from Wall Street to Main Street is using the word recovery in every other sentence. But what does a recovery actually look like and why should you care?

And, perhaps more importantly, how can you make back what you’ve lost in the meltdown? How long will it take? How can you speed up the process? Which sectors and business segments will lead the way? It’s tough to admit, but the U.S. economy may take years to recover – if it ever does.

Just look at Japan as an example. Its economy has still not yet recovered from the bubble it experienced nearly 20 years ago. If our government is taking many of the same actions theirs did, why would we think things are going to be different for us?

Remember, Japan is not some backwoods marketplace in the boonies – it’s the second-largest economy in the world, which means you can’t dismiss what happened there in light of what’s happening here and now. Especially when you consider Japan was an export-based economy to begin with. The United States presently derives less than 15% of its gross domestic product (GDP) from exports and fully 70% from consumer spending.

That places tremendous pressure on a group of people who are not only tapped out, but are licking their collective wounds after a 24-month financial meltdown.

Simply put, things will never be the same again.

SUVs no longer grow on trees, home-equity lines do not constitute a personal piggy bank, and derivatives are now destined for the financial trash heap.

Looking ahead, you can bet anybody who wants to buy a house will face tougher lending requirements. Credit-card debt will come home to roost and many companies that once existed on the margin will be forced to come to terms with their tricky accounting.

No siree, Bob. We believe that things will be radically different from now on. The rules of money truly have changed.

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While this sounds scary, there’s a flip side – new rules mean new opportunities. You just need to know where to look to find them.

The $300 Trillion Global Recovery

There is no question that the financial crisis has reshaped the world in ways the average investor is only just beginning to understand. But inasmuch as that’s hard to stomach, don’t forget that every crisis has produced legendary wealth for those savvy enough to capitalize on the changes it brings.

Using history as our guide, we think the current financial crisis could produce some of the largest gains ever recorded and generate as much as $300 trillion in new investment in the next few years alone.

Unfortunately, we believe that most investors, led by traditional economists, misinformed pundits, and gonzo journalists, will miss it.

Instead of looking at what’s actually happening, they’ll have their heads in the sand. Not only will they fail to see the new reality that’s unfolding right in front of their very eyes, but they’ll never set foot in the places where much of this growth is happening.

In other words, they’ll apply the same old tired theories to markets that demand different results. And that’s hardly a good or profitable mix.

What they should be doing is looking for profits where they’re being made right now!

The Biggest Economic Shift in 200 Years

It’s ironic: But at a time when economists in the United States and Europe are looking for signs that things are getting better, there’s a legion of folks in other parts of the world who are too busy managing real growth to pay attention to our problems.

They are not only watching the beginnings of this $300 trillion recovery, but actively taking steps to capitalize on it right now. They know that 60% or more of the growth they’re chasing will come from new global markets whose names most people can’t even pronounce yet. That’s double the projected growth from established markets like the United States and Japan.

You’ll be tempted to dismiss this, and I wouldn’t blame you. This isn’t for everybody – just those who understand that events thousands of miles from our own borders will set the pace for decades.

Indeed, as Figure A.1 below shows us, the move has already begun. Foreign stock markets, once regarded as fringe investments, are already outperforming our own-and have been throughout the entire financial crisis. Imagine what happens when things really get better!

Most investors have yet to understand that much of this growth is driven by China. There is not an industry or business segment on the planet that it won’t completely dominate or substantially influence in the years ahead.

This move, too, is already under way.

Even with the massive sell-off in the Chinese markets that began in late 2007, investors who placed their bets there have dramatically outperformed those who thought they were getting a better deal with the Standard & Poor’s 500 Index. Figure A.2 illustrates this in a dramatic fashion.

And if that’s not convincing enough, consider how radically the share that each

country contributes to the world’s GDP has changed in just five short years.

The United States has seen its contribution drop by 31.57%, while China and Hong Kong have increased their contributions by 217.65% and 79.17%, respectively (see Figure A.3).

Putting a Charge Into Profits

One of the simplest – yet most overlooked – indicators of all reinforces this message. We’re talking about electricity demand. In a nutshell, where electricity demand is growing, GDP growth is certain to follow.

Electricity statistics from the Department of Energy’s Energy Information Administration (EIA), say it all.

Electricity demand in the Far East is projected to exceed North American demand by 2020 – just 10 short years from now. But we believe this is a conservative forecast, and that it may actually pass North American demand by 2015 – a full five years earlier than analysts expect – which gives us even more incentive to pay attention.

The Death of the Dollar?

The U.S. dollar has been the world’s reserve currency for the last 60 years. Many people find it inconceivable that this will change. But it already has.

In 2009 alone, China initiated more than $200 billion worth of swap agreements that allow their trading partners to pay for Chinese goods and services directly, without converting into dollars or having to trade their currency openly. We think the odds are good that the actual (and closely guarded) figures may be more than double that.

So far, most of these agreements have been with smaller economies in Asia and South America, but we don’t think it will be long before Western or European countries jump on board.

The point is that while the United States struggles, China and her trading partners are taking matters into their own hands and creating a new global marketplace for currency trading that’s outside the traditional currency exchanges used by the West. It’s an end-run of epic proportions and serves as one more sign that the world’s economic center of gravity is shifting away from the West – permanently.

The Second Coming of China

While most people think the financial crisis is about the fall of Western financial markets, history will view it as critical to the second chapter of China’s remarkable rise to world economic dominance.

Unfortunately, 99% of all Westerners don’t understand that while we’re busy dealing with the fallout, China views what has happened as the mother of all opportunities . . . for them. In keeping with the Confucian concept of yin and yang, China understands that where there is darkness, there is also light. So it is doing everything it can to expand while the competition lacks the resources to act.

Considering that China has the world’s largest stockpile of cash reserves – over $2.3 trillion by some estimates – it could create the single-largest liquidity event in recorded history. Bigger than the Internet, housing bubble, and gold combined!

The Biggest Buying Opportunity of Many Lifetimes

We think this represents a buying opportunity of unprecedented magnitude.

History clearly shows that the greatest fortunes are made by those savvy enough to recognize when the rules have changed and to then invest accordingly. Which is why we want to begin investing now, when everybody is too busy looking at the right hand to notice what’s going on with the left.

It’s also critically important to understand that China (and many of the emerging markets) remains underdeveloped by Western standards. Which, in and of itself, represents another king-sized opportunity in fundamental industries like power, water, and transportation systems that we take for granted.

We’ve already explored a bunch of these in “FiscalHangover,” but there are more out there-and the list of potential investments is growing by the hour.

That’s why we invite you to grab your fair share by visiting us at http://www.fiscalhangover.com/.

We think you’ll be glad that you did.

[Editor's Note: When it comes to the new realities of the post-financial-crisis global markets, no one has a better perspective than Money Morning Chief Investment Strategist Keith Fitz-Gerald. For more than 20 years, Fitz-Gerald has made yearly sojourns to different parts of Asia, and in the process has created a cache of wisdom that few other experts can match. In recent years, Fitz-Gerald has regularly made those insights available to investors via his columns in Money Morning or its monthly affiliate, The Money Map Report.

Now Fitz-Gerald has pulled all his best thoughts together in a new book: "Fiscal Hangover: How to Profit From the New Global Economy." For investors serious about adapting to the new post-recession realities, "Fiscal Hangover" is a must-read; it even contains analyses on dozens of global companies, detailing which ones should be winners and which ones laggards.

"Fiscal Hangover" has created quite a buzz, but won't be in bookstores for several more weeks. However, Money Morning readers can obtain the book now - and at a savings of $10 off the cover price. For more information, please just click here.]

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• Amazon.com:
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• Investopedia:
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• Money Morning Special Report:
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Everything we know about classic economic theory suggests the U.S. economy should be experiencing Zimbabwe-like hyperinflation right now, thanks to the nearly $2.2 trillion the U.S. Federal Reserve has pumped into the system.

But we’re not…yet.

Classic economic theory says that money supply can be used to stimulate the economy and our central bankers seem to agree. That’s why they’ve pumped more than $1 trillion dollars into the economy, engineered countless bailout bonanzas for zombie institutions, put Detroit on life support, and delivered a bunch of financial Band-Aids to the trauma ward – all in a desperate bid to make Americans feel better about the global financial crisis.

To their way of thinking, the trillions of dollars have been a success. That’s why any meeting of the Group of Eight (G8) nations looks more like a mutual affection society with central bankers anxious to claim credit and backslap each other in congratulations for having avoided the “Great Depression II.”

But by taking the Federal balance sheet to more than $2 trillion from $928 billion 2008, they’ve created a situation that should have resulted in an epic inflationary spike to accompany the 137% increase in liabilities.

Yet that hasn’t quite happened.

Core inflation – which denotes consumer prices without food and energy costs – has actually decreased from 2.5% in 2008 to 1.5% presently. And that has many investors who have heard the siren call of the doom, gloom and boom crowd wondering if they’re worried about nothing.

So what gives?

Well, there are four reasons we haven’t yet seen hyperinflation:

• Banks are hoarding cash. Despite having received trillions of dollars in taxpayer funded bailouts and lived through a litany of shotgun weddings designed to reinvigorate the shattered lending markets, most banks are actually hoarding cash. So instead of lending money to consumers and businesses like they’re supposed to, banks have used taxpayer dollars to boost their reserves by nearly 20-fold according to the Federal Reserve. The money the bailout was supposed to make available to the system is actually not passing “Go,” but rather getting stopped by the very institutions that are supposed to be lending it out. Three-year average annualized loan growth rates were 9.6% before the crisis; now they are shrinking by 1.8%, according to Money Magazine.

• The United States exports inflation to China, which remains only too happy to continue to absorb it. What this means is that low priced products from China help keep prices down here. And this is critical to something that many in the “China-is-manipulating-their-currency” crowd fail to grasp. If China were to un-peg the yuan and let it rise by the 60% or more it’s supposedly undervalued by, we’d see jump in prices here in everything from jeans to tennis shoes, toys, medical equipment, medicines, and anything else we import in bulk from China. Chances are, the shift would not be dollar-for-dollar or even dollar-for-yuan, but there’s no doubt it would be significant. Many economists I’ve talked to privately think 25%-35% is probable. So the next time you hear a “Buy American” extremist, you might want to share this little inconvenient truth.

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Now before I get a bunch of hate mail about this, let me just say I want to “Buy American” too. I’m all for supporting our native industry and our own domestic job markets. But in today’s world, “made anywhere” is really hard to do and even harder to support. The interconnected nature of businesses and global manufacturing chains, not to mention the payment system, makes that nearly impossible. Granted, perhaps that’s part of the problem, but that’s a subject for another time. The lessons we learned in the 1930s are clear, and they must be acknowledged – protectionism only makes matters worse, no matter how we feel about it personally.

• Consumers are still cutting back. Therefore, the spending that normally helps pull demand through the system is simply not there. I don’t how things are in your neighborhood, but where I live, people are still cutting back. Indeed, data from the U.S. Department of Commerce and the Federal Reserve Board shows that consumer spending growth averaged 1.4% a year prior to the crisis and is now shrinking at a rate of 0.7%. What this means is that people have figured out that it’s more important to save money than it is to spend it. And, given that consumer spending makes up 70% or more of the U.S. economy, this is a monumental change in behavior that all but banishes the last vestiges of the “greed is good” philosophy espoused by Michael Douglas as Wall Street pirate Gordon Gekko in 1987.

• Businesses continue to cut back rather than hire new workers. Therefore, wages and wage inflation figures are lower than they would be if the economy was truly healthy and the stimulus was working. This is especially tough to stomach because it means people are still being marginalized, laid off and “part-timed” instead of being hired. And that means that most of the earnings growth we’ve seen this season has come from expense reductions rather than top line sales growth – and those are two very different things. But while this is tough, it’s also helped keep inflation lower than it would otherwise be. Prior to the financial meltdown, job growth averaged about 1% a year over the last three years whereas now it’s falling by 4.2%.

The upshot?

Any one of these factors could change at any time. And that means investors who are relying on the Fed’s version that everything is okay and that the government is managing inflation may be in for a rude awakening.

The only thing the Fed is doing is managing to manipulate is the data, and even then, not very well.

[Editor's Note: No one knows the Asian markets - or the true nature of the global capital markets - like Money Morning Chief Investment Strategist Keith Fitz-Gerald. For the last several years, Fitz-Gerald has made those insights available to investors via his daily columns in Money Morning and its monthly affiliate, The Money Map Report. Now he's making those insights available through his new book, "Fiscal Hangover: How to Profit From The New Global Economy," which can be purchased here.]

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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.

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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.”

[Editor's Note: No one knows the Asian markets - or the true nature of the global capital markets - like Money Morning Investment Director Keith Fitz-Gerald. For the last several years, Fitz-Gerald has made those insights available to investors via his daily columns in Money Morning and its monthly affiliate, The Money Map Report. In just a few weeks he'll be making those insights available through his new book, "Fiscal Hangover: How to Profit From The New Global Economy." Stay tuned for more details.]

News and Related Story Links:

• Money Morning Commentary:
  Lost In Translation: The Subtle Dealings Between China and Japan Can Lead to Powerful Profits.
• Wikipedia:
  Yukio Hatoyama.
• Organization of the Petroleum Exporting Countries:
  Official Web Site.
• Wikipedia:
  Wen Jiabao.
• Money Morning News:
  Gold Prices Soar to Record High on Report of Secret Plan to Dethrone the Dollar.

For investors who fear that the markets have soared too far too fast, the thought that some stocks may still be cheap is hard to imagine – especially when it comes to China.

Here’s one way to separate the cash from the trash.

I call it the “good-deal number,” or the “good-deal indicator.” And for a very good reason: By running this simple equation, I can determine whether a stock I’m interested in is a “good deal” – and worth buying.

Intuitively, investors know that it’s best to buy at the bottom and sell at the top. And history bears this out.

For instance, investors who bought at or near such market peaks as 1928, 1969, 1999, or 2007 tended to overpay. And they doomed themselves to sub-par returns, as a result.

On the other hand, investors who had the courage to wade in when the days were darkest – think 1932, 1942, 1982 and 2003 – were typically rewarded with above-average results. Over time, such moves can translate into life-changing wealth.

Unfortunately, reality is never that simple. Markets usually aren’t operating at peak or trough levels. And even when they are, how can an investor to tell for sure?

Nor is that the only challenge that investors have to face, Pat Dorsey, director of equity research for Morningstar Inc. (Nasdaq: MORN), wrote in a recent Money magazine column. Although investors endure a daily barrage of stock prices, Dorsey said there’s no “ticker tape” that tells us whether those prices represent actual values.

In other words, just because a stock is cheap doesn’t mean it’s a bargain.

That’s why I like my “good-deal indicator” so much. Although it can be used when the markets have reached extremes, it’s just as useful when the markets are in between extremes – as they are right now.

But best of all, it’s simple to calculate and easy to use. I can run the number in my head or on the back of a napkin – without resorting to fancy spreadsheets or computer modeling. You can develop a good feel for how a company will perform over a longer stretch – so you won’t get fooled by one or two periods of dramatic movement.

Let’s walk through a real-world example drawn from a meeting I held in China regarding a fast-growing energy-and-biofuels company that I’m studying right now.

To start, you need two key numbers: the company’s earnings per share (EPS) and its Price/Earnings (P/E) Ratio.

Since 2007, this company’s annual per-share earnings have ranged between 22 cents and 72 cents, according to MSNMoney.com. For purposes of making a reasonable, middle ground estimate, let’s say the company’s EPS number is 47 cents.

During the period in question, the company’s P/E ratio has ranged from a low of 5.0 to a high of 43. So using the same middle-ground approach, let’s call it a P/E of 24. Now we multiply the EPS of 47 cents by the P/E of 24 (0.47 x 24) and we get a rough “value per share” of $11.28. That’s roughly 1.69 times higher than the stock’s recent market price of $6.65, suggesting that this particular stock is a “good deal.” Here’s the calculation shown below:

[EPS of 47 x P/E of 24 = Estimated Value of $11.28/Market Price of $6.65 = "Good Deal Number" of 1.69.  Conclusion: Stock appears to be undervalued - and a "good deal" - at this price.]

Now for some caveats.

This company is growing rapidly and its actual current P/E ratio (as of this writing) is 11.4, which is much more conservative than our simple estimate of 24. It also tells us that the company is maturing, which suggests to me that we ought to try creating a range of values using even more conservative calculations.

Re-running the formula using a P/E of 11.4 gives us a potentially more realistic estimated value of $5.36 per share, which is slightly less than the current stock price of $6.65. Our “good deal indicator” in this example would seem to show that the company is fairly valued.

[EPS of 0.47 x P/E of 11.4 = Estimated Value of $5.36/Market Price of $6.65 = "Good Deal Number" of 0.81.  Conclusion: Stock appears to be reasonably valued at its current price.]

So what do we do now? We have one value that suggests a theoretical price that’s far higher than the current trading price. And we have a second one that gives us an estimated value that’s actually a bit less than the current stock price. It’s in the general ballpark, however.

I suggest we dig deeper. Again, we’re not trying to come up with an absolute valuation. We’re trying to develop a simple-to-calculate – but still useful – measuring stick that we can use to compare a company’s current market price with its potential value.

If we dig a little deeper, we see that the company’s current P/E (11.4) is actually lower than the industry average of 13.9 and well below the Standard & Poor’s 500 Index P/E of 32.6.

So let’s put a checkmark in the “undervalued” column.

We also know that the company has been reporting year-over-year top-line (sales) growth of 11.70%. Industry peers have actually experienced a year-over-year sales decline of 36.7%. Over a five-year period, the company we’re studying has watched its sales advance by an aggregate 127.5%. That compares very favorably with the industry’s five-year aggregate growth of 27.6%. And it is 9.7 times the average S&P 500 firm, which has experienced total growth of only 13.14%.

The upshot?

While there are conflicting good deal numbers, there’s other data suggesting that this company may be undervalued yet is experiencing sales and earnings growth above that of its peers and other investment choices. So I’m inclined to believe this stock is a good deal – even with our revised estimated value of $5.36 – but then again, I’m a conservative guy.

Before we wrap up, there’s one other point to consider – and it’s a big one. The good deal number is not a proxy for wishful thinking, nor should it be confused with an assumption that the markets will move higher.

And it’s limited to the “Buy” discipline only, which means you can’t simply plunk down your money and then just ignore (or, even worse, forget about) the stock. So make sure you have trailing stops and an exit plan in place at all times.

When it comes to investing, it pays to play it smart – even in high-growth-potential markets such as China.

[Editor's Note: If you've been thinking about investing in China, this short note could represent the wealth-building opportunity of a lifetime. When it comes to China investments, Money Morning Investment Director Keith Fitz-Gerald may well be the dean. He's lived and worked and lived in Asia for two decades - including numerous sojourns into China, where he's seen how market-focused changes are creating fortunes for the entrepreneurs who are making everything happen.

And rest-assured, Fitz-Gerald has some ideas of his own. In fact, he is scheduled to return from his most recent trip to China today (Tuesday), and figures to have much to say about where investors should be looking next.

As the editor of The New China Trader service, Fitz-Gerald can now make those market insights available to you. Fitz-Gerald has not only chronicled the many changes that have taken place in China over the past several years - in many cases, he's actually predicted them. Subscribing to The New China Trader is akin to hiring a guide to help you navigate, and profit from, a market that's perhaps the most complex in the world - and that promises to be the most profitable for decades to come.

So if you've been looking for a way to invest in China for the first time - or you've been investing there, but aren't satisfied with your results - now may be the time to act. For more information on how to sign up for Fitz-Gerald's latest on-the-ground research, please click here.]

News and Related Story Links:

• Money Morning View from China Series (2009):
  Three Ways to Profit From China’s New Anti-Corruption Regulations.
• CNNMoney.com:
  Forget stock price, focus on value.
• Investopedia:
  Price/Earnings (P/E) Ratio.
• Investopedia:
  Earnings Per Share.
• Investopedia:
  Trailing Stops

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report
Author, The Fiscal Hangover

XIAN, People’s Republic of China – During the politically charged period in the late 1980s and early 1990s – when China believed it really needed friends – a small number of Western companies ignored the controversies and refused to abandon the market.

Global investors will recognize some of the names: The Coca-Cola Co. (NYSE: KO), Johnson & Johnson (NYSE: JNJ), and ABB Ltd. (NYSE ADR: ABB). In the years since, their courage and commitment has been rewarded with hefty market shares, growing profits, and a position of trust that’s very tough for an outside firm to obtain.

These firms also have guanxi.

Loosely defined as “connections,” guanxi is actually a Chinese word that refers to the very fabric of how relationships work, and how business is conducted in this growing Asian nation. In fact, trying to better describe just how important this concept actually is, some sociologists have actually likened it to “social capital.”

While the definition itself may seem a bit hazy, one fact is crystal clear. The best relationships and biggest profits in China are built upon the trust and long-term interactions embodied by this deceptively simple term. Global investors who take the time to understand what guanxi means – and to identify the companies that actually have it – can expect to reap the biggest windfalls from their China-focused profit plays.

A Different Point of View

Talk about “connections” to a Westerner, and the odds are good you’ll get a negative reaction. In the West, a connection can come down to one person owing a second person a favor. But in China, guanxi is about increasing one’s personal standing, about getting respect and about giving it, too. It literally encapsulates every aspect of Chinese society.

Contrary to beliefs here in the West, guanxi has nothing to do with bribery or corruption – although there is admittedly a very fine line here, just as there is anywhere in the world where power, money and profits intersect.

And while some forms of guanxi can be built up immediately, as my example involving Coke, J&J and ABB demonstrates, the most powerful and profitable benefits of guanxi can take considerable periods to amass.

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The same is true for individuals, which is why most Chinese seem to spend inordinate amounts of time and money establishing, cultivating and maintaining their guanxi networks. Needless to say, once these connections are forged, they are nurtured, treasured and even guarded, for they can last a lifetime.

Guanxi starts with decency and fairness. If a company delivers their products on time – and honors its promises to the governing authorities and its workers – that firm is demonstrating “trustworthiness.” The company is reliable, dependable and can be counted on. Those qualities all enhance the firm’s guanxi.

Companies that didn’t stick with China, that seemed to pass judgment on the country and its precepts, or that tried to push a Western agenda, very rarely experienced any kind of overt or official rebuke. Instead, these companies discovered that they’d been shuffled aside. And their chance to be a real “player” in China was gone.

Guanxi’s New Role in the “New” China

Westerners who are still coming to terms with modern China will likely attribute this to what they believe is Beijing’s centralized authority. As state-operated enterprises (SOEs) decline in number, so-called “government guanxi” is losing its influence. And with good reason: The growth in entrepreneurship here has created legions of companies that are no longer dependent on state sponsorship for profits.

As China continues its emergence as a global economic superpower, even a social norm as old and established as guanxi is finding a new role. Properly constructed guanxi relationships will help global investors identify future trends, potential profit opportunities and even the players best positioned top pursue them.

In that sense, it’s a bit like the proverbial “old-boys network.” The companies with the connections will be best positioned to capitalize on the new projects, markets or potential partnerships. The companies that lack guanxi will read about the new deals in the newspaper after they’ve been finalized.

With their finely tune sense of “fair play,” it’s not surprising that many Westerners will want to cry “foul” when it comes to this aspect of guanxi. But here’s the thing: In China, connections are fair play. They’re completely legal. And it’s been that way for 5,000 years.

If anything, my experience in Asia over the last 20 years suggests that people without guanxi are the ones who should be worried.

So that begs the question: Absent traveling here three or four times a year and spending as much time as I have here in Asia over the past 20 years, how do you go about developing your own guanxi? Even better, how do you identify the companies with the powerful connections and the best profit potential?

When searching out investments, look for companies or profit opportunities that manifest the following three qualities. As we’ll explain, the presence of these three qualities makes it a near certainty that guanxi connections are present, as well. Those three things to think about are:

Consistency: Look for companies that have been in business here for a long time, and whose management teams have a strong track record. Western investors have a well-chronicled fixation on startups. And there’s a real temptation to concentrate on the newly formed companies in the potentially hottest new industries. But here’s a stunning fact: Most of China’s fastest-growing and most-profitable companies right now are the ones transitioning from a purely state-owned status. These firms either want to become private ventures outright, or to become new companies that are aligned with such major national initiatives focusing on large infrastructure projects, environmental issues and pollution control and energy. It’s no surprise that the companies with guanxi will have the best success landing business in areas the government has deemed to be so important.

Investors searching for more-aggressive, smaller companies should look for companies that have locked up special licenses, operating contracts or market franchises. These usually come about as a result of the collective guanxi of that company’s executive management team. One great example is a small, educational company that I discovered recently. It’s one of only a small group of firms granted an ultra-rare license that allows it to stream its Internet content all across China.

Patience: Here in China, executives often work for years before they are trusted enough to manage their first major deals. When I first came to Asia, a senior executive bluntly told me that he wouldn’t even begin to trust me until after we’d met at least three times. Even then, he said, that trust would be superficial, at best. When I asked why this was so, he informed me that “we Chinese see so many hotshots who come here expecting to get ahead and we only get to know them on the surface. There is no use for that.”

In his view, “we must see each other over a period of time to get to know one another.” Only then, he informed me, would our “truest character” emerge. And that would put in place the building blocks for a relationship built upon long-term trust.

It was a bit of insight that I’ve never forgotten. And neither should you.

When it comes to picking investments in China, you can’t learn everything there is to learn about a company from a “tip sheet,” or from an initial public offering (IPO) prospectus. It’s important to review management and even meet senior company officials, if possible. And if you can’t meet there in person, establish your own guanxi with someone who can.

The important thing is to learn what makes them tick over time. Just because a company is new doesn’t mean it’s the next sure thing – particularly in China.

Deliberateness: Thanks to its commitment to market reform, China has made more economic progress in the last two decades than it did in the previous 2,000 years combined. Despite the still-accelerating pace for change, however, the investors who succeed here will be those who tackle this process in a steady, measured manner.

To better understand what I mean, compare what’s happening here in China with what’s taking place in the United States. China is right now weathering the global economic storm by spending the money that it spent years saving for a rainy day. And with foreign reserves estimated at $2.3 trillion, it can rain for a long time before China’s economy gets too soaked to function.

What’s more, China’s outlays might well be better described as investments as opposed to expenditures. Beijing is spending money on expanding capacity and infrastructure that will help its economy grow for the long haul, even as it creates wealth in the near term. To a trained eye, it’s clear that the plans were put in place in a way to capitalize on the connections in business, industry, finance, and government. The country’s actions have been very deliberate. And very shrewd. Given all these considerations, the payoffs will be substantial for the country in general – as well as for investors who are shrewd enough to participate.

On the other hand, the U.S. is trying to borrow its way out of a problem that was created by debt in the first place. And it’s compounding that error by using that borrowed money to create “work” programs and to finance voter-appeasement bailouts. Neither of these actually fixes the problems at hand. Even worse, however, is that neither creates any long-term value. But both will end up sticking us with the mother of all credit card balances.

It’s no surprise to us that China is still on track for 8% economic growth. It proves that old adage that says “it’s who you know that counts.”

Especially in China.

News and Related Story Links:

• Money Morning Special Report:
  Investment Risks in China Outweighed by Growth Prospects.
• Wikipedia:
  State Run Enterprises.
• Wikipedia:
  Guanxi.
• Wikinvest:
  Initial Public Offering.

Back in mid-June, more than 75% of the investors responding to a CNNMoney poll said they were planning to buy stocks – many of them aggressively.

Of the 41,572 people polled, it now looks like those 31,179 bullish investors kept their word.

The Standard & Poor’s 500 Index has zoomed 15% since those investors were polled (and 53% from its March 9 market bottom).

Let’s face it. A 75% bullish inclination is a disproportionately high percentage. It’s way out of the norm. 

What those 31,179 bulls are telling me is … well … we’d better watch out. Statistically, the individual investor excels at making the wrong decision at precisely the worst possible time. I view this survey as yet more evidence that the “herd” may once again be heading down the wrong path.

After the collapse of Lehman Brothers Holdings Inc. (NYSE: LEHMQ) investors yanked more than $120 billion out of equity mutual funds. That’s more than the total amount of money investors poured into these funds during 2007 and 2008, a period when exuberance was at its height, according to Money magazine.

And after the S&P 500 hit its March low, most people missed the subsequent rally – 32% through June 23, when the CNNMoney poll was concluded – a run-up that could have mitigated their enormous losses.

The disturbing reality is that investors chase hot money and hang onto losers.  Most individuals have an awful sense of timing – as well as an unending tendency to act irrationally.

According to a recent Dalbar/IFA study, over-exuberant investors can lose a lot of money.  For example, the S&P 500 returned 11.81% a year on average between 1989 and 2008.  The “exuberant” gain-chaser scored 4.48% in the same time frame. Factor in inflation and the average investor gain disappears completely (See accompanying chart). You could have done better in a bank savings account!

Hope For the Best, Prepare For The Worst

That brings us back to the two most pressing questions of our time:

• What’s going to happen next?
• And what should we do about it?

Although pundits are spewing forth about an “improved” outlook for the U.S. economy, history tells us that we’re more likely to see a stock-market correction in the near term.

Over the last half a century, stock-market rallies that follow the horrific declines we’ve seen over the past 24 months are typically followed by a secondary decline of 14% to 50%.

What will happen after that is anybody’s guess. According to a study by Ned Davis Research, any secular bull market that followed a recession in the last 100 years resulted in gains in excess of 60% during an 18-month stretch. In situations where that rally was actually the catalyst for a resurgent economy, stocks averaged 110% over the next 36 months.

But we also have to remember that the bear market that started all this grew out of the worst financial crisis since the Great Depression. According to longtime investor Jeremy Grantham, the record deficits, stimulus packages and bailout packages have "reduced to guesswork" any market forecasts (as reported in CNNMoney).  That’s probably why Grantham recently warned clients: “If you feel overconfident about anything, take a cold shower and start [analyzing] again. Just be patient. In our strange markets, you usually don’t have to wait too long for something really bizarre to show up.”

Here at Money Morning, I’ve been counseling readers for more than a year to think long term. My advice is to preserve your wealth by navigating the near-term chaos. Stifle the knee-jerk urges to buy or sell.  If you succumb to the urge to follow the herd, the crowd will inevitably lead you down the wrong path. And probably at the worst possible moment.

Instead, follow these five strategies:

1. Position Your Portfolio: Develop a portfolio structure you can live with – such as the 50-40-10 allocation model we recommend in our monthly sister publication, The Money Map Report. That way you can take all sorts of economic contingencies into account, while still maintaining a steady course that emphasizes sound “safety-first” choices, portfolio stability and high income. How much stability should you be looking for? Our 50-40-10 model is typically 30% less volatile than the broader markets. But it can dramatically outperform the broader indices on the upside.

2. Limit Your Losses: Invest no more money than you can afford to lose. This sounds simple, but you’d be amazed at how many of the thousands of investors I’ve talked with through the years still don’t get it. They view themselves as “investors,” when they’ve actually become “speculators.” One Texas man I know lost half his wealth during the past two years. When I asked why he’d put so much money at risk, he shrugged and replied: “Because I could.”

Get your strategy in place then pick specific investments that keep you within the guidelines you established. Focus on global stocks with high dividend yields. And make sure you include a healthy dose of energy, technology and inflation-resistant holdings. Such stocks tend to blossom at the first signs of a real recovery – just like they have after every other documented economic downturn in history.

And finally, always make sure to manage your risk. Limit speculative positions to 2% to 5% of your overall portfolio value. That way even a total loss in one holding won’t be enough to eviscerate your portfolio.

3. Avoid Surprises: In my talks with audiences all around the world, listeners are often the most surprised to learn that successful professionals  don’t wake up with thoughts of how much money we can make each day. Instead, we think about two things from the time we get up until the time we go to bed:

• What’s the most likely thing that could cause me to lose money today?
• And how can I avoid that?

In other words, concentrate on understanding what it is that you don’t know. And then make sure to steer clear of that potential pitfall. It’s an approach that helps you make better decisions. Don’t swing for the fences and risk a strikeout each time you come to bat. Instead, make up your mind to go for much-higher-probability singles and doubles. Risk aversion should be your new mantra, especially now.

4. Risk Less – By Saving More: This is actually a neat little trick. Classic market theory holds that to generate bigger returns, you have to have to take on more risk. That’s true – as far as it goes. But here’s what that adage doesn’t address: By taking some simple steps to save more, you can actually accumulate wealth more quickly than by the increased levels of risk most investors are relying upon at the moment.

5. Don’t Let Yourself Get Whipsawed Out of the Market: Investors who prepare for only one kind of market are the most susceptible to panic selling. To them, investing is an all or nothing propostion. As we highlight in Money Morning, you’ve got to prepare for both “up” and “down” markets. And you do so with some simple hedging strategies. Hedging, after all, isn’t just for hedge funds. In fact, everyday people just like us can use them very effectively, which is why we encourage our readers to do so. You see, if you’ve prepared for “up” and “down” markets, you no longer have to actually “predict” what the markets are going to do. Then you can focus on finding quality companies with real earnings, a healthy dose of overseas sales and high income.

Once these five strategies are in place, you can turn your money loose to do the work it wants do for you. And you can sit back and enjoy beating the so-called “smart” money – practically no matter what the stock market does next.

[Editor's Note: As Money Morning Investment Director Keith Fitz-Gerald's market analysis demonstrates, success as an investor requires knowing when to act.

But it also requires knowing where to look.

Like under the Eiffel Tower.

The French Oil Ministry has confirmed there is a 40-billion-barrel reserve under that historic landmark - enough to fuel total U.S. oil demand for 5.2 years, according to the Energy Information Administration.

For more information on The Money Map Report, as well as on the oil cache beneath the Eiffel Tower, please click here.]

News and Related Story Links:

• CNNMoney.com:
  Make fear and greed work for you.
• IFA Institutional Investors:
  The Average Investor’s Return Compared to Indexes.
• GMO LLC:
  Waiting For Markets to be Silly Again (Jeremy Grantham).
• Ned Davis Research:
  Official Web Site.
• Money Morning Investment Research Report:
  Make Inefficient Markets Work For You.
• Money Morning New Market Rules Series:
  Five Wall Street Whoppers And Why You Need To Know Them.

A $15 billion deal for liquefied natural gas (LNG) involving Australia, China and global-oil heavyweight Exxon-Mobil Corp. (NYSE: XOM) has prompted many investors to worry that China may be using its global-markets muscle to “paper over” cracks in the global economy.

In reality, however, this mega-deal is a harbinger of what’s to come, and highlights the road that global investors must travel in their journey to maximize their own investment returns.

If you feel like you need a guide on that journey, just look to Australia. That country seems to be setting the pace when it comes to obtaining both a way out of the global financial crisis and an important new trading partner that could benefit their nation for years to come. What’s happening there could be a model we’d best learn from.

As we have noted repeatedly here at Money Morning, when China buys, it buys big. Most recently, China’s global resource acquisition spree has centered on Australia (after tours through Canada, Africa, the Middle East and South America).

By some accounts, the timing couldn’t be better. Following the recent arrest of four Rio Tinto PLC (NYSE ADR: RTP) employees in China last month on corporate espionage charges, the two countries needed to do something mutually beneficial to smooth over relations. For China, the acquisition is viewed as a way to save face and further its strategic interests. For Australia, this deal is a source of cash that will flow right into the government coffers and help the country rebound from the global financial crisis.

The transaction involved a place most people here have never heard of – Barrow Island. Located about 30 miles off the northwest coast of Australia, and about 80 square miles in size, Barrow sits atop a supply of natural gas – a portion of which that will now be liquefied and sent to China.

According to the terms of the deal made public recently, Australia is going to process and ship some 15 million metric tons of the fuel each year – enough for this deal to be worth roughly $15 billion over the life of the contract.

Development of the project is expected to create 6,000 jobs initially, with another 3,000 to follow. It’s also expected to yield some $6 billion for the Australian government, which – like most governments around the world – can really use the money, since it’s still struggling to come to terms with the global financial crisis.

Not surprisingly, like most deals involving China these days, this one has sparked controversy on a number of different levels.

Naturally, there are the obvious environmental issues. According to conservationists, Barrow Island is home to a number of endangered animals, which is why environmentalists are pushing for the liquefied natural gas plant to be built on the mainland.

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But Australian Environmental Minister Peter Garrett dismisses that notion. Speaking to various Australian media outlets, he’s stated that he doesn’t believe there will be “unacceptable impacts.”

As you might expect, that’s ignited a firestorm – akin to the environmental debates we’re used to seeing in this country. Australian Sen. Bob Brown, leader of the “Greens” party, groused that Canberra has put economic interests ahead of those of wildlife and the environment.

What makes this transaction important – and worthy of study – is that the deal is a window into the future. In an increasingly global economy, as mega-dollar international deal proposals become more and more commonplace, the players will have to find a way of addressing the inevitable political battles.

And that’s particularly true when one of the parties is China (as will also be the case on an increasing basis). With the LNG deal, the ink had barely tried before Australian Labor representatives were leveling charges that Canberra’s conservatives had sold out. Many, who seem to feel that a pact reached with China is tantamount to making a deal with the devil, are saying that the diplomatic cost of doing business is steamrolling the concepts of human rights and democracy. But others view such a transaction in much more pragmatic terms.

After all, they say, $6 billion is still $6 billion.

This is not a simple issue and it’s complicated by the fact that China sits on the world’s largest pile of excess reserves – more than $2.3 trillion by some estimates. And the Asian dragon is going to spend or invest that capital as it sees fit, no matter what happens with the U.S. dollar, Western budget deficits, or the global economic recovery.

And it’s not because China wants to spend this money … it’s because China has to spend that money. It’s a matter of the country’s long-term survival.

As we have said a number of times here in Money Morning, China must engage in transactions beyond its borders to ensure that it continues to have borders. Deals like this are not about world dominance. They’re aimed at avoiding “social unrest” – the two-word phrase that scares Beijing more than anything else.

This is why Chinese leaders have been so resolute in their drive to lock up supplies of raw materials and other key commodities.

For the most part, governments are caught between citizens who get uncomfortable at the thought of selling valuable national interests to a trading partner they don’t really know or understand and their own corporations, which desperately need two things to maintain their own global competitiveness: access to China’s low-cost manufacturing capacity, and market share (revenue) from what is the fastest-growing market on earth.

To be better able to deal with – and feel comfortable about – what’s transpiring in an increasingly global marketplace, Westerners need to start understanding what’s really at stake. And they need to also dispense with their own misperceptions.

Take the whole Unocal Corp. transaction of 2005. It failed because U.S. interests were appalled that a Chinese company could acquire “national interests.” Yet few took the time to understand that most of Unocal’s assets are actually located in Asia — which is why the Chinese tried to buy it.

For instance, not only did the United States slam the door in China’s face when China tried to buy Unocal Corp. Chinese National Offshore Oil Corp., or CNOOC (NYSE ADR: CEO) tried to acquire Unocal for $16 billion to $18 billion. Following a vote in the U.S. House of Representatives, the bid was referred to U.S. President George W. Bush. The reason: The deal was said to have “national security” implications. CNOOC withdrew its bid and Unocal subsequently merged with Chevron Corp. (NYSE: CVX).

Then there’s the whole human rights argument, which inevitably comes to the front of the line whenever China is involved in a deal. Detractors logically highlight the fact that China’s record doesn’t fit with our own. Yet, in doing so, they forget the West’s history. The high and mighty, history reveals, weren’t always so high and mighty. In short, we’re not perfect, either.

On one hand we espouse free markets and the premium of economic choice. So why is it that we can’t stand to have the tables turned when it comes to China’s economic freedom? The West has engaged in direct economic investment abroad for years. Shouldn’t China be allowed to do the same thing?

Then there are the concepts we’ve used to justify our own actions particularly when it comes to foreign direct investment. We’ve argued (and continue to argue) that our investments in distant locales will help spread democracy, improve human rights, nurture educational excellence and contribute to the free-market efficiencies that will allow the global economy to function much closer to peak efficiency. And we’ve used the increase in taxable revenue, local employment and even training as reasons to justify our actions and our interests.

If you adopt an objective, global perspective, and see things as China does (understanding its general objectives in the process), there is really only one conclusion a U.S.-based investor can reach: The changes under way are inevitable. Fight them, if you must, but realize it’s at your own cost, and understand the once-in-a-lifetime investment opportunities you’ll be missing.

Or embrace them and ride along – which is not only the path of least resistance: It’s also the most profitable trail to take.

News and Related Story Links:

• About.com:
  Australia, China Ink $41 Billion Natural Gas Deal.
• Money Morning News Analysis:
  China Tightens Grip on Africa’s Energy Resources with Stake in Offshore Field.
• Money Morning Analysis:
  China Continues its Commodities Binge with Brazilian Oil Deal.
• Wikipedia:
  Unocal Corp.
• Money Morning News Analysis:
  What Companies Are Profiting From China’s Commodities Crusade?
• Wikipedia:
  Peter Garrett.
• The New York Times:
  China Says Australian Is Detained in Spy Case.
• CNNMoney.com:
  China arrests 4 Rio Tinto employees.
• Wikipedia:
  Barrow Island.
• WhiteHouse.gov:
  George W. Bush.
• Wikipedia:
  Liquefied Natural Gas.
• Money Morning News Analysis:
  The Three Reasons China Will Lead the Global Rebound.
• Money Morning:
  China Landing Natural Gas Deals as Prices Plummet

If you’re looking for the next “Big Oil” play, bet on Beijing.

As we’ve been reporting for the past several years, China has been on a global commodities shopping spree, which includes locking up every source of oil that it can. The Red Dragon has cut deals in Africa, South America Russia and the Middle East – and won’t stop there. Even the mainstream news media is finally becoming aware of this crucial trend.

But here’s the thing. It’s not enough just to know that this is happening. In order to profit, an investor really needs to understand why it’s happening – and to invest accordingly. Investors who lack this insight may make the strategic misstep of betting heavily (or exclusively) on the Western heavyweights – Exxon Mobil Corp. (NYSE: XOM), BP PLC (NYSE ADR: BP) or Royal Dutch Shell (NYSE ADR: RDS.A, RDS.B) – while ignoring the oil sector’s real growth story, which is China.

Just this year alone:

• China and Russia have signed a multi-billion-dollar, intergovernmental agreement to construct an oil line from Russia that will supply oil directly to China. Actually seven agreements in one, the terms depict a deal worth trillions of dollars – including a 20-year oil contract to pump Russian oil to the Chinese market. In return, China has agreed to provide a total of $25 billion in loans to Russian oil companies Transneft and OAO Rosneft Oil Co. China even gets a cut of Rosneft’s production, as part of the deal.

• In Africa, China’s CNOOC Ltd. (NYSE ADR: CEO) and Sinopec Shanghai Petrochemical Co. (NYSE ADR: SHI) are teaming up to buy a $1.3 billion stake in Angolan offshore development rights from U.S.-based Marathon Oil Corp. (NYSE: MRO). A key point of note: Angola – historically one of Exxon’s favorite investment targets – has recently overtaken Nigeria as Africa’s biggest oil producer.

• While noting that it’s hardly a done deal, The Wall Street Journal did report earlier this month that China National Petroleum Corp. (CNPC) is interested in buying all or a part of Argentina’s YPF SA (NYSE ADR: YPF) for $14.5 billion.

• In Africa, China’s CNOOC Ltd. (NYSE ADR: CEO) and Sinopec Shanghai Petrochemical Co. (NYSE ADR: SHI) are teaming up to buy a $1.3 billion stake in Angolan offshore development rights from U.S.-based Marathon Oil Corp. (NYSE: MRO). A key point of note: Angola – historically one of Exxon’s favorite investment targets – has recently overtaken Nigeria as Africa’s biggest oil producer.

• Reports continue to circulate that CNPC will be taking the majority stake in Iraq’s Rumaila oilfield from BP. Rumaila is Iraq’s biggest oil field, producing more than a million barrels of crude oil per day.

• And China has become quite chummy with Brazil’s Petroleo Brasileiro (NYSE ADR: PBR). Petrobras is developing a huge new offshore field – one of the biggest new discoveries in decades, in fact – and any deal would include a production-supply agreement.

This flurry of deals hasn’t been a surprise to Money Morning readers. Even so, it’s worth taking a moment to look at some of the key catalysts behind many of these deals. Let’s look at the Top Three:

• Nervous Reserves: China is sitting on the world’s largest pile of cash – more than $2.3 trillion by some estimates. With an estimated 70% of that, or about $1.61 trillion, in U.S. dollars, there is no question it’s a huge source of financial firepower strength at a time when global markets are uncertain, if not downright weak. But it’s also a liability, too, in that China can’t diminish its high-concentration of greenback holdings without pushing the dollar off a cliff. So buying oil is a great way for China to diversify its reserves without kneecapping poor old Uncle Sam.

• Those Not-So-Free “Free” Markets: China has less faith in the “free” markets than the West does. Ironically, the United States and other Western powers are partly to blame for Beijing’s free-market skepticism. For instance, not only did the United States slam the door in China’s face when China tried to buy Unocal Corp. [now a part of Chevron Corp. (NYSE: CVX)]  a few years back, but when former U.S. President George W. Bush invaded Iraq, the war summarily cut off China’s ability to source oil from that Middle East member of the OPEC 12 (the Organization of the Oil Producing and Exporting Countries). Prior to the invasion, Beijing really didn’t consider the need to diversify China’s foreign-oil sources so our military action prompted their economic reaction. Now the genie’s out of the bottle.

• Peerless Perspective: China’s leaders know that they must lock up oil supplies at a time when the Western world can’t seemingly be bothered to understand that this is a zero-sum game. In other words, China views the global financial crisis as an opportunity to be exploited for economic gain and the security of its people, not as a problem to be solved. China understands the big picture, and even though we apparently painted it, the West doesn’t.  By scouring the earth for oil at a time when the West is hamstrung by the global financial crisis, not only is China able to strike more favorable deals at more favorable prices, but it’s locking up huge supplies of commodities for its own use for years, even decades, to come. In doing so – and this is the part of the equation so many experts don’t get – these resources are no longer available for our use here in the United States, which has major supply and pricing implications for this market.

Bamboozled by the Western media – which has perpetuated the “global-recession-means-lower-demand” story – it simply hasn’t dawned on most people here in the West that China doesn’t care about the major long-term impact this global buying spree will have on our economy.
Besides, this whole story thesis is flat out wrong. While the recession is definitely dampening our use of oil and gasoline, China’s oil demand is growing by more than 20% a year. And of the 8 million barrels a day that China already uses, half comes from imports. Beijing sees those as troubling statistics, which means that China:

• Absolutely must lock up as many significant external supplies oil as possible right now.

• And must accelerate its domestic exploration-and-processing efforts at warp speed.

Nor is this a static situation. China’s auto market is growing by 50% a year. It’s already the world’s largest, having passed the United States earlier this year. In fact, according to some estimates, China will have more cars on its roads in the next 20 years than all those we currently have in this country – even if you include the engine-less “restoration project” your next-door neighbor’s son has sitting under an oak tree in their back yard.

China’s never known high prices and its consumers haven’t either. So they don’t care like we do about what “price” is posted at the pump. Sure, you can argue as many Western analysts do, that China’s fuel is highly subsidized, but so what? That’s a moot point. Consumers who remember what it was like back when gasoline was 99 cents a gallon aren’t going to grouse about how it now costs $6 a gallon – these newly minted motorists will merely see gasoline as just part of the cost of having a car.

Because it understands its need for continual economic progress – as well as the role oil has to play to make that a reality – China is doing whatever it takes to guarantee future supplies, including structuring deals in ways that have caught Western companies by surprise. For instance, China’s companies are looking at how they can get a deal done by giving the other party something it actually needs. Moreover, in a move that’s as frustrating to Western leaders as it is surprising, many of these deals come with no strings attached. I suppose you could call it the “Red Dragon Option” – although Western firms would do well to embrace these as potential Harvard Business Review case studies.

After reading this overview, a U.S investor might want to conclude that China’s already got this one wrapped up and that “any resistance is futile.” But that’s not necessarily true. While China’s grown by leaps and bounds in terms of its financial sophistication when it comes to these deals, the country still lacks the relative exploration-and-production technology to go after the deep-water reserves and complicated fields where most of the still-undiscovered oil remains. Those are also the same kinds of locations where natural gas may be the better bet.

And that suggests that investments in both sectors – including deep-water drillers and companies that specialize in natural-gas liquification -may pay off for investors anxious to dine with the Red Dragon, instead of being listed as an entrée on the menu.

[Editor's Note: The global economic recovery will create an estimated $300 trillion worth of global-investing-profit opportunities. To find out how to capitalize and profit, you just need to know where to look.

And for that, you need a guide. As part of a new report, Money Morning Investment Director Keith Fitz-Gerald details "the $300 trillion global recovery that nobody's talking about" - as well as the six "lifetime" profit plays this powerful global money wave will open up to those who understand what's really playing out on the global investing stage right now.  To read this report, please click here.]

News and Related Story Links:

• Money Morning View From China Series:
  China Pursues Worldwide Growth Opportunities Caused by the Global Financial Crisis.
• CNNMoney.com:
  China: The new Big Oil.
• Money Morning Special Report:
  What Companies Are Profiting From China’s Commodities Crusade?
• Money Morning Market Commentary:
  Despite its Decline, Oil Remains a “Must-Have” Profit Play.
• Money Morning View From China Series:
  China-Russia Oil Accord a Sign of a Changing World.
• Wikipedia:
  Iraq.
• Money Morning News Analysis:
  Energy Development in Iraq Faces Political Obstacles, but Could Prove a Boon for China.
• Wikipedia:
  Organization of the Oil Producing and Exporting Countries.
• Money Morning Commentary:
  How China is Beating the United States in the Global Oil Game.
• Wikipedia:
  Rumaila Oil Field.
• Whitehouse.gov:
  George W. Bush.
• Money Morning Buy, Sell or Hold Series:
  Buy, Sell or Hold: Brazil’s Petrobras Will be Poised for Big Gains When the Economic Recovery Kicks Off in Earnest.
• Money Morning Special Report:
  The Three Reasons China Will Lead the Global Rebound.
• Money Morning News Analysis:
  CNOOC Taps Overseas Markets with Awilco Takeover.