Finance Digest for Week of August 30, 2004

WALL STREET FIRMS LOSING WEALTHY CLIENTS

The percentage of people with at least $10 million in assets to invest who used full-service brokers as their primary financial adviser fell to 30% last year from 37% in 2001, according to Spectrem Group, a Chicago-based consulting firm. Independent advisers, who sell only advice, not financial products, rose to 46% from 30%. The No 1 reason for switching advisers was a lack of trust, cited by 48% of those who changed, compared with 14% who changed because of poor investment performance. “This is a wake-up call for Wall Street, and though a lot of firms have changed their practices there’s still a long way to go,” said Tanya McDonald, 34, a director at Spectrem. “Clients are sceptical that perhaps the firm’s objectives aren’t always aligned with their own.”

THE OTHER YELLOW METAL

Over the next decade or two, energy prices are going to reach shocking levels, and the price of uranium, inextricably tied to energy, is headed up as well. I first recommended uranium companies in October 1998, when the metal was trading hands at a paltry $9.50 per pound. Since then, U3O8 has risen to $18, and I believe, due to growing global energy demand coupled with the relative costs of alternative fuel sources, it is going much, much higher.

Global electricity use is projected to increase by 66%, from 13 trillion kilowatt-hours in 1999 to 22 trillion kilowatt-hours in 2020. In North America, the growing demand for power has reached the point where the grid is increasingly vulnerable to massive failures, like that of last summer, when the lights went out on 50 million people. To meet this demand, energy has to come from somewhere. Coal and nuclear are the only feasible sources of mass energy with anything like current technology. There are many hundreds of years of cheap coal available, but the stuff is an environmental nightmare compared to nuclear (despite what the scaremongers would have you believe).

While that price of oil will certainly ebb from the current level -- maybe all the way back into the $30 per barrel range -- the days of $18 a barrel are almost certainly gone for good. While higher oil prices carry many negative consequences, for the sake of this discussion what is important is that pricey oil makes alternative forms of energy more appealing. There is a general preference for natural gas over oil and coal for power generation, because it is clean and gas-burning plants can be built relatively cheaply and quickly. Energy mavens say that by 2020, it will exceed coal use by 44%, but I doubt it. Gas will price itself out of the market before that happens.

The looming energy shortage has even become clear, however belatedly, to the U.S. Department of Energy, which recently announced incentives to encourage U.S. power companies to apply for licenses to build new nuclear plants (the first in 25 years). Canadian company Cameco, the world’s largest uranium miner, estimates that global uranium demand should average 194 million pounds per year from 2003 to 2012. Supply is running at about 135 million pounds per year, with mines contributing only 79.2 million pounds per year. In Canada and Australia, the big dogs in uranium, few new mines have come on stream, largely as a result of recently poor prices. Of course, if prices continue to rise, prospectors will redouble their efforts to find new deposits. But it typically takes up to 10 years from discovery to production for a well-sized mine. The balance of the uranium needed to keep the world’s lights on today comes from aboveground supplies, like weapons conversion, MOX/breeders and utility stockpiles.

While longer-term price forecasts are worth little -- there are just too many variables -- I will make a guess. Uranium will trade over $25 within the next 12 months and is quite capable of going to $30, $40 soon, and over $100 by the end of the decade. Uranium, after decades of being the unwanted stepchild of energy sources, is now likely to offer better percentage returns to speculators than oil, gas or any other energy alternative.

AMERICAN FIRMS ARE NOT AS HEALTHY AS YOU MIGHT SUPPOSE

Wal-Mart is nothing if not cheap, which is why this one chain alone accounts for 8% of all American retail sales. So it would be no exaggeration to say that when Wal-Mart says that its sales are sluggish, as it did on Monday August 23rd, you should take that as strong evidence that America’s indebted consumers are tightening their belts and the economy is having a rough spell. This will not be good news for corporate America if it continues. Might it be positively bad?

The very thought! American companies, as we all know, are money-making machines. Profits for those companies included in the S&P 500 index increased by 20% or more in the second quarter. They have increased by over 20% for four consecutive quarters -- only the fifth time they have managed this feat in 50 years. While markets have in general fallen this year, heady corporate profits have at least provided corporate-bond and equity markets with support at their current, still elevated, levels. Anyone who thinks that they will continue to do so might not want to read what follows.

The conventional view of corporate America is that it is in splendidly lean shape. Low interest rates and giddy profits have enabled firms to pay off debts and extend the maturity of those loans still outstanding, thus making them less vulnerable to rising interest rates. Indeed, the repair of their debt-heavy balance sheets was the main justification for the sharp contraction in the spreads of corporate bonds over Treasuries last year, and provided extra oomph to shares -- even though this process really only involved a transfer of debt from companies to individuals, who have borrowed mightily to spend and buy houses.

Too soon, perhaps -- for evidence that corporate debt has fallen in the economy as a whole is scant. The average rating of American firms from Moody’s has actually fallen over the past three years -- from the lowest investment-grade rating, Baa3, to Ba1, or junk. In contrast, the average rating of financial firms has risen over the same period. But in a time of rising interest rates, you cannot help feeling that the best years for this sector are behind it. Indeed, the sector’s annualized profits fell by $3.6 billion in the second quarter, according to recent figures. A collapse in financial-sector profits would leave something of a hole. From its peak in March 2000, the S&P excluding financials would have dropped by 50% by October 2002, its low. Since then it has risen, though it is still down by 30% from its peak.

There is, of course, no denying that companies have been raking it in lately. But if they have not been paying off debt or investing (and investment has been lackluster), what has happened to that money? An astonishing 90% of it has been paid to shareholders. But in the absence of investment and with balance sheets still heavy with debt, jam today does not necessarily mean jam tomorrow.

LIVING IN A FOOL’S PARADISE

Oil down several days in a row, the stock markets in robust shape, interest rates low, the dividends keep lobbing in your bank account, the sun is shining and the living is easy. Hold that thought -- then consider a few less palatable ones. And hope that the US economy does not fall over -- if that happens, China will find its exports piling up in warehouses, and we will find that Chinese factories do not need so many Australian mineral exports. Warren Buffett thinks the US economy is heading for a fall. This month his Berkshire Hathaway investment group lifted its foreign currency holdings to $19 billion. Buffett is betting that the US dollar will plummet.

China is doing fine now, but this week the IMF warned that the Chinese economy was at risk from a potential banking crisis. Debt is everywhere. In the week to last Monday, the US public debt reached $7.34 trillion. Nearly $7 billion was added in one week, according to the Bureau of Public Debt. At another level, 22% of people in Shanghai, Beijing and Guangdong have credit cards. The global personal debt mountain just keeps growing. But underpinning this mountain are foundations of questionable strength.

At the end of 2003, according to the Bank of International Settlements, world derivative contracts totalled more than $234 trillion. Those derivatives represent many enormous bets and nothing more. Add to this the fact that currencies, commodities, debt and stocks are heavily influenced by more than 19,000 secretive hedge funds and you start to sniff a hint of trouble waiting to happen. Bill Gross, who heads Pimco, one of the world’s biggest fixed-income managers, warned this month that because of hedge funds “the world’s economy is unstably founded on a base of cheap money used as leverage to support asset prices of dubious value.” It will take one crisis -- the US dollar, inflation, foreigners selling US Treasuries, increasing budget deficits -- to expose the flaws of the leveraged economy, Gross says.

OILING THE WHEELS OF INFLATION

It is time for a paradigm shift. Just when the consensus view has begun to focus on the buying of United States’ Treasuries by Asia to finance our country’s trade and budget deficits (to hold their currencies down), the price of oil pops up. The financial markets are now left to try and sort out what it all means and many economists are lowering their forecasts for the United States and world economic growth. We agree that in the very short run, rising oil prices act like a tax by allowing dollars to pile up as Saudi holdings of US Treasury securities. However, it is naive to stop there when it comes to economic consequences. If we trace the cycle of cash and the response by central banks, in a short period of time the world could see an increase in world spending and higher general inflation, with an increased likelihood of major currency realignment.

The problem for world economic order has been the Asian propensity to save. Instead of spending the dollars we give them, they sit tight on the cash and allow the funds to pile up as investments in US Treasuries. To a large extent, if oil prices remain high, this problem will go away. If you look at countries that produce oil you will realize they will want to spend every last oil dollar that comes in. The big immediate change is the trade balance for Asia, particularly China and Japan, which are massive importers of oil. If you think it is expensive to fill up at the gas pump in our country, think about China. Asia will be spending a lot more of their dollars on oil and a lot more of the cash will go to a country that immediately spends it. This will result in less excess dollars to buy US Treasury debt because cash will be needed to buy oil today.

When it comes to inflation, rising oil and gas prices will absolutely be a factor. Unlike housing and stock prices, energy counts in the CPI. At the same time, while rising oil prices feel like a tax to those who pay it, higher oil prices increase the incomes of countries with many needs, and their newly found cash will support higher spending. This new spending, in turn, supports rising prices. The trick for the central banks is to stay accommodative so those paying the oil tax, like American homeowners, can still borrow against their homes. We have seen this play before -- it’s known as stagflation.

We expect that the Federal Reserve and other central banks will be accommodative a few more months and only act to rein inflation in long after the inflationary process is well ingrained. Indeed, rising oil prices will give the Federal Reserve “cover” to run the inflationary policies necessary to start inflating away the massive public and private debts that have built up and can never be paid back with real value.

NATURALLY COLORED DIAMONDS HAVE ALWAYS BEEN FANCIED

For thousands of years, diamonds have held sway as symbols of beauty, wealth and power. But the overriding trait these historical diamonds had in common may come as a bit of surprise: They were all identified by, and celebrated for, their color (pink, citron, blue and canary yellow, respectively). Then, as now, naturally colored, or “fancy” diamonds, have been coveted for their rarity and individuality, and as a result, are valued much higher than top-grade, flawless white or colorless diamonds. Nationally and locally, the popularity of fancy diamonds has begun to soar during the past five years, despite the fact that fancies can cost four times the amount of standard diamonds.

For those venturing into the realm of fancy diamonds, clearly, not all carats are created alike. For every 10,000 white carats produced, there is only one colored carat. Today, a premium one-carat white diamond can fetch $25,000, but a same-sized, fancy pink can start at $100,000. Depending on its intensity and other characteristics, that figure easily could double or even triple, says Beverly Hills-based jewelry designer Alan Friedman, whose work frequently features fancy diamonds.

When making a diamond purchase, the “four C’s” always have been considered: cut, carat, clarity and color. “The most important thing about colored diamonds would be cost, which is not one of the four C’s,” says Bruce Yamron, of Yamron Jewelers in Naples, Florida.

Diamond -- actually a crystallized mineral -- is the final result of intense volcanic pressure that transforms primeval carbon, more than 100 feet below the Earth’s surface, into the light-refracting “rock” now so intrinsically associated with wedding rings, tiaras, tennis bracelets and rivière necklaces. But if boron is present during the diamond’s formation, a blue hue results in the diamond. If there is nitrogen present, it will be yellow. Iron oxide? Red. A resulting color can be so subdued that it is barely noticeable or the diamond can be so completely saturated with color that the shade is as dark as a night sky. And technically, when discussing fancies with gemologists, they are described accordingly: light, fancy, intense, vivid and deep. Local jewelers say the deeper the color, the more important the diamond.

Austalia’s Argyle Mine and its diamonds.

Western Australia’s Argyle lamproite pipe, the world’s largest producer of diamond by volume, yields brown, yellowish brown, colorless and red to pink diamonds.

Woman turns husband’s remains into diamond.

Nancy Wodziak wanted to honor her husband Richard in a special way after he died from a brain tumor last October. So, she became the first person in Florida to turn a loved one’s remains into a diamond. Wodziak received her brilliant, half-carat yellow diamond after eight months of waiting. To create the ring, the cremated remains are heated to extreme temperatures, and then the carbon is subjected to a tremendous amount of pressure. The result is a stone identical to diamonds that develop deep within the earth over millions of years. The nitrogen in the air causes the diamonds to be yellow in color. The company says yellow diamonds also occur naturally but are very rare.

UK’S BUBBLICIOUS REAL ESTATE

Did you know that between 1973 and 1998, there was no change in “real house prices in the UK (nominal prices less inflation)? And, did you also know that since 1998, real house prices in the UK have more than doubled? Let us leave aside the “UK housing bubble” disputes for a moment. Maybe it is, maybe it isn’t (although, if it looks like a duck and quacks like a duck... nah, couldn’t be.)

Recent housing data from the UK is not that encouraging. In July, the number of mortgage approvals for house purchases fell by 20%, compared to June, says the British Bankers Association. And, “in the five weeks leading up to August 14,” house prices in the Greater London fell by 4.3%, reports The BBC. So what, you may ask -- maybe the UK’s red-hot real estate is just cooling off a bit. Right?

Could be. However, these new reports do bring to mind our study, published in 2002. We plotted U.S. real estate prices against the U.S. stocks, from 1837 through 2000. The chart revealed a fascinating relationship: Historically, the real estate market lagged the stock market. If you think about it, it makes perfect sense. Prices in both the stock and the housing markets fluctuate in response to the shifts in mass psychology of stock investors and of homeowners. Yet stocks are always first to react to the changes in mass psychology. Real estate is a much slower boat -- partly because houses are less liquid than stocks, partly because stock market data is plastered everywhere these days, while the information about houses is less easy to come by.

The point is, when stocks head lower, eventually so do house prices. So we should all be looking at the FTSE as our beacon. The index has been down for four years now, after peaking back in 2000. Maybe the UK’s real estate is only now getting the message?

ARE FUND MANGERS IN “DUCK AND COVER” FROM THE STOCK MARKET?

This past weekend, a guest columnist in The New York Times argued that if “2003 was the year for investors to live dangerously, 2004 is fast becoming the year to duck and cover. That is exactly what professional money managers are starting to do.” Evidence to back up this claim comes from a recent fund manager survey, and from the percentage of cash those managers have in the stock funds they manage. The survey shows that “41 percent of global fund managers say they are ‘overweight’ in cash, meaning they are keeping a bigger portion of their portfolios in cash than they do normally.”

Mind you, these survey replies reflect the way managers perceive themselves; and we all know that perception is one thing while reality is another, to wit: “Cash now represents 4.8 percent of the average fund manager’s portfolio, the highest percentage recorded ... since just before the start of the war in Iraq.” These numbers are supposed to suggest that fund managers have made some kind of big switch into cash; and having given the impression he meant to give, the columnist asked this question: “But should individual investors follow suit?”

But in a true historical context, 4.8% is NOT an “overweight” cash position. If anything, it is close to an all-time extreme low level of cash. Cash levels in stock mutual funds (known as the Cash/Assets Ratio) have been tracked for more than 40 years. The data shows that during most of this period, it was almost unheard of for the average fund manager’s portfolio to have as little as 6% cash; instead it was common for that level to hover at 10% or greater. In fact, the level stayed above 6% from about 1976 until -- you guessed it -- the late 1990s.

Yet from there the rule has reversed itself: the average portfolio has held below 6% cash, except for a very brief time in 2001. In fact, just this past June the level fell to 4.2%, the second lowest percentage of all time. So: When fund managers increase their cash positions by 0.6% -- to the current 4.8% -- that amounts to “duck and cover”? Puhleeeze.... The truth is, the Cash/Assets Ratio and many other long-term measures clearly show that bullish sentiment still stands at extreme levels. And when the time comes for these measures to return to historic norms, the scale of the move will not be in increments of 0.6%.

13 FINANCIAL TIPS FOR COLLEGE KIDS

Few college students have learned the difference between needs and wants. The Administrative Office of the U.S. Courts reported that about 1.6 million personal bankruptcies were filed in 2003, up 7.4% from 2002, suggesting that many adults have not learned the basics of personal finance either. So it is no surprise that many kids do not know how to handle money. Their parents wanted only the best for their kids and, in most cases, provided it. But fiscal responsibility sometimes got lost between designer clothes, piano lessons and a cell phone.

Some young adults have trouble with credit cards and view the credit limit as an invitation to spend what they consider to be their money. Richard Boyum, professor emeritus of counseling and psychology at the University of Wisconsin-Eau Claire, tells the students that credit comes from the bank -- not grandma. For many, this is a revelation: Banks are in business to make money and customers have to pay interest on the balance if they miss the due date. For some students, the concept of accrued interest on debt is as foreign as compound interest on savings.

Boyum tells his students to do the math on small indulgences. Some say they only spend $20 a week on beer. Well, kids, that comes to $1,040 a year for Anheuser-Busch’s Budweiser and Adolph Coors Co.’s Coors. The total shocks most students. Boyum urges his students to keep an accurate record of expenditures.

Work can teach students discipline and the value of a buck, but study should be a kid’s primary concern when in school. Some students work just for pocket money. This is a bad idea. “I tell my students there are 168 hours in the week,” Boyum says. “There are 56 for sleep and 40 for school. That leaves 72 for other activities, including part-time jobs and socializing. Students are astonished by this and I tell them that time is their major resource.”

U.S. COMPANIES SPEED UP STOCK BUYBACK PACE

With the stock market languishing, U.S. companies are shoring up their shares by buying them back at nearly double the pace they did last year. U.S. companies this year have said they will buy back $171.5 billion in stock, according to mutual-fund research firm TrimTabs, nearly twice the $92.8 billion in repurchases announced by this time last year. Companies have not been this eager to buy back stock since 1997, when $235.7 billion of repurchases were announced.

“This is exactly the opposite of what I would have expected to see,” says Robert Willens, a tax and accounting expert at Lehman Brothers. “I’m very surprised to hear that buybacks have increased so dramatically when the tax bias to buybacks has been eliminated.” For years, the tax rate on dividends was higher than the rate on buybacks. Last year, the government brought the tax rates in line, which is why some analysts wonder why buybacks are on the rise.

Stock buybacks are a bullish signal for stock prices because they suggest that a company thinks its stock is undervalued. Buybacks also reduce a company’s outstanding stock, increasing earnings per outstanding share. But along with the benefits comes the risk for investors that corporate income growth will depend on “the share shrink”, and not company fundamentals such as revenue growth.

“EXOTIC DEBT” TRADERS TURN TO CUBA

Fidel Castro’s expectations of capitalism are not high. But even he must be galled to know that speculators are running long positions in Havana’s sovereign debt, waiting for him to die. Cuban sovereign paper is known as “hyper exotic” in default and owed by a country with a politically isolated regime. Other members of the club include Sudan and North Korea. This tiny sector of the international bond market is highly illiquid, with under $1 billion of turnover in thefirst quarter, less than 0.1% of emerging market debt activity, according to the Emerging Markets Traders Association, a US-based body. But, like distressed corporate debt, hyper-exotics can offer spectacular returns.

Vietnam is the textbook example. In the early 1990s its hard currency debt traded at 4 cents per dollar of face value. By 1996,Hanoi had come in from the political cold, having re-established US diplomatic relations and reached a preliminary agreement with the London Club of private creditors. Over this period, including repayment of past due interest, a 4 cents initial investment rose to more than 100 cents. Other politically induced bonanzas include Serbia, whose rehabilitation from international pariah status saw a 5-fold increase in its debt’s market value, and Iraq, whose bond prices have tripled since October 2002.

The search for “the next Vietnam” is focused on two countries. Largest by activity is Cuba, whose debt turned over $256 million in the first quarter. Currently priced at up to 12.5 cents, its sensitivity to US relations is high. In the year to February 1994 prices trebled to 33 cents on hopes that President Clinton would promote a Vietnam-style reconciliation.

Even political optimists need to exercise restraint. First, the perception of an asymmetric return profile is dangerous. Exotics can go close to zero as in Liberia’s case. There is the “documentation problem”, a lack of transparent legal and property rights. Also, exotic debt is a vehicle for foreign direct investment. Corporates gain privileged access by buying debt, which is then swapped it into state owned companies’ equity -- such off-market dealers can leave other investors out in the cold. Finally, there is opportunity cost. Without income, waiting decades for salvation can be more an obsession than an investment strategy. Despite these drawbacks most specialists believe exotics can deliver superior returns over a 10-year horizon.

INVESTING IN GOLD COINS

I love those gold bars you see in the movies. Stacks of 100-ounce bars are commonly the target of thieves and villains, like Goldfinger or some other greedy scoundrel. 100-ounce bars are primarily traded on the major world commodity exchanges and used by the world’s central banks when trading gold. Private investors buying less than 1,000 ounces of gold should steer clear of these bars. And I strongly recommend NEVER buying smaller gold bars, like 1 ounce or less weighted gold bars produced by private mints or refiners.

Most gold dealers, coin dealers and gold brokers do not trade the large bars and will discount a bar that large, by 5-7%. My personal experience with smaller gold bars has been consistently bad. They sell for a 3%-10% premium over the spot price, which works out to a spread of as much as 20%, which is way too big. The marketplace is dominated by bullion coins. The vast majority of rare coin and bullion dealers do 99% of their trading in coin form. It is important to make a distinction between bullion coins and numismatic coins. A bullion coin’s value is derived solely from the content of its gold and is normally sold at a small premium above the market price for gold. A numismatic coin derives its value from its rarity, historical and aesthetic qualities and can sell for up to a million dollars.

As with gold bullion bars, let me also caution you against private mint gold coins. Many refiners and private mints around the world produce 1-ounce to 1/10th-ounce gold coins and offer them for sale as “bullion” alternatives. They tout either the fact that they cost less than more commonly traded gold bullion coins produced by the governments of the United States, Canada, South Africa and Australia or that they are sold based on the uniqueness of their design. Private mints coin their gold bullion with images of everything from sporting events to Elvis Presley. You should never buy privately minted gold bullion coins. They sell originally for large premiums above the price of gold and later sell at a discount to their intrinsic gold value because they are NOT widely bought and sold by dealers, and therefore dealers will discount the coins when (or if) they buy them.

Instead, you should stick with the most commonly traded gold bullion coins in the world. Widely-traded bullion coins include the Krugerrand from South Africa, the Canadian maple leaf, Australia’s Kangaroo, Austria’s Vienna Philharmonic, the China Panda, and the American Gold Eagle -- now by far the most popular gold bullion coin in the world. Which gold bullion coin do I recommend? Hands down, the best gold bullion coin is the American Gold Eagle! It is the most liquid coin in the world. The buy/sell spread is rarely more than 7% on small amounts and as little as 5% on larger quantities.

Never buy bullion coins that have any rim nicks, scratches, abrasions, chips, or dents or those that appear to be discolored in any way. Any knowledgeable buyer will discount coins that have even the slightest damage. Steer clear of any coins that have carbon or copper spots. (If you have to use a magnifying glass to see a spot(s), it is not a problem.) Do not buy “rare date” bullion coins. A bullion coin is a bullion coin -- don’t be fooled. The least expensive way to purchase the 1-ounce coin is to specify “common date”.

Saving a few dollars with buying or selling prices versus dealing with a reputable company or person is silly. Two recommendations I always make are: 1.) Know your dealer, and 2.) Always take immediate delivery of your gold coins -- never store your gold coins in a dealer’s vault. When the gold market gets red hot, and it will, every gold dealer and precious metals brokerage firm will pay spot (most current price) for your gold coins and sell at 10% over spot. The bid/ask spread at which gold coins are traded will widen. Take your profits, and do not let the wider premiums bother you. Bottom line: Get into your gold investments now, before the market gets red hot.

BRITISH POUND NOT THE WAY TO DIVERSIFY OUT OF THE DOLLAR

London, circa August 2004 reminds me a lot of New York circa September 2001. It is the capital city of the country with the world’s strongest currency. The economy appears to be booming. The housing market is soaring. And you would have a hard time thinking of a single good reason to buy the British currency today.

Why start with the British currency when the task at hand is to talk about Asia? I have said, after all, the next great bull markets of our investment lifetime and the greatest investment story of our lifetime (the Money Migration) are taking place in Asia. But there are lots of questions to answer before investment decisions can be made. What currencies are worth owning in Asia, and how do you value a currency absolutely, instead of relatively versus other currencies? What are the underlying trends in commodity consumption in Asia, and which commodities do they support? And are there any fairly valued or, dare I say, undervalued equities in Asia worth owning -- WITHOUT a lot of risk? If not, can you still get Asia profits without the Asia risk?

But before we get to those questions, you have to roll back the videotape for a moment and ask a more basic question. As we sit here sipping our cocktails on the deck of the USS Dollar, the world stands poised on the edge of a great currency realignment. The world has too much dollar risk. With its Twin Deficits each nearing half a trillion dollars, it is hard to see the United States achieving a much sounder currency footing anytime soon. But what elase is there to buy, other than gold? First, let us look at what NOT to buy. Once you see what currencies are not likely to go higher against the dollar in the coming months, it narrows your choices (and brings us squarely back to Asia).

The British pound and the euro have both beaten the dollar soundly since midsummer 2001. Having lived in both the eurozone, in Paris, and now in London, I can report that good draft beer in Paris costs about $4, while in London it is about $6. Will my beer be getting more expensive in dollar terms this fall? For the dollar to gain ground against the euro and the pound, we would have to see an improvement in the U.S. trade deficit, which happened to roll in about $55 billion in June -- yet another record. Assume, then, that the dollar is not going to strengthen on its own merits. Does that mean it will fall? And if so, fall against what?

What would make the euro or the pound a “buy” at current levels? Things that make a currency a buy: high interest rates, a stable central bank, low inflation in domestic prices, a growing economy. Things that make a currency a “sell”: high government debt-to-GDP, low economic growth, inflation, an unstable central bank, a stagnant economy. A chart shows a British pound that has peaked and should now be sold -- certainly not bought. The Bank of England (BOE) was one of the first central banks in the world to begin its tightening cycle and put the brakes on the tide of easy money that drove everything up in price in 2003. Rising interest rates on government bonds in England made the pound a great “yield” play. It is not a coincidence that it was about November of last year that the pound began its big rally from 1.55 to 1.81. The BOE has hiked the yield on its key interest rate five times since November, and it may hike yet again. But so may the Fed, and with the slowing U.K. economy the likelihood is that the yield trade is over.

P.S. Sterling is not a currency likely to benefit from further dollar weakness. But neither is the euro. In fundamental terms, the euro is just as awful as the dollar.

THE PROTESTS IN NEW YORK CITY -- WHY NOW?

The top news event of the past few days is not taking place on Wall Street. It is happening a few subway stations down on Seventh Avenue, the famous address of Madison Square Gardens. There, at the chosen site for the 2004 GOP National Convention, more than 200,000 anti-Bush demonstrators have joined forces in a four-day long protest throughout the borough of Manhattan. From Battery Park to the Brooklyn Bridge to Broadway, the Big Apple is bracing itself for what an August 29 New York Times cover story dubbed “the largest demonstration EVER at a political convention, [in terms of numbers].”

We could fill a book with the “WHAT?” of the protests -- from radical groups on bicycles “harassing delegates” at their hotels to “Raging Grannies” in wheelchairs (85 years old and up) lampooning the Republican Party in mock sing-a-longs -- but, we are more concerned with the “WHY NOW?” of them. And the answer to that is -- because mass psychology has experienced a downturn in social mood, as confirmed by the (Elliott) wave count in stocks. Turns out, the time is just right for anger and protests. The November 2003 Elliott Wave Financial Forecast had this to say: We are moving in a “direction toward confrontation, mayhem, and the destruction of the old order -- The parallel to 1969 is palpable.”

The parallel to the anti-war riots that disrupted the 1968 Democratic Convention is also palpable. An August 30 International Herald Tribune article observes: “This was not the reception the Republicans had planned. They chose New York to evoke a moment of national unity that rallied Americans to Bush after the Sept. 11 attacks -- but instead, it opens with echoes of Chicago and the Vietnam War.”

FYI: In 1968, the Dow was two years into an eight-year long downtrend that marked the largest bear market since 1937. And we all know what the negative turn in mass social mood brought about during this time: The Turbulent (Late) Sixties.

HIGH OIL PRICES AS POLICY

At $40 per barrel oil prices are, in real terms, still below the peak, but four times higher than they were one president ago. What was everywhere known as the all-oil ticket became the oil presidency that has indeed yielded hugely high prices for oil. Why and how? There are many explanations available for why oil prices are higher than they otherwise would be. We could list taxes, restrictions on drilling, regulations making new refineries prohibitively expensive, the war on Iraq, and many other factors. Melting down all these shackles would drive the price down dramatically, so that gas would be cheaper than water.

Even so, all these interventions (apart from the Iraq War) are not new. Why the price spike now? We are talking about an oil price that is higher (again, in nominal terms) than at the height of the Nixon-Ford inflation, when we all found prices intolerably high. Prices fell all during the Reagan years, thanks to the effects of Carter’s deregulation, and during most of the Clinton years as well. In fact, prices reached good-old-days levels at the very end of the Clinton era: $11 per barrel. Gas hovered at $1 a gallon, an historic low in real terms.

In those days, some people in and out of government were very concerned about the fall in oil and gas prices. The environmentalists hated it, of course, for fear that lower prices meant more consumption and more consumption meant more industrialization, prosperity, and social happiness, which they somehow cannot stand. No, we should all pedal to work or ride mass transit or take air balloons or something. There was enough realization within the Clinton administration that such a policy would be politically devastating to keep that agenda somewhat at bay. Who else worried about low gas prices? It was four years ago last month that Richard Cheney appeared on “Meet the Press” to called for a “national energy policy”. He told Tim Russert that oil prices were “too low” and that “no one will invest” in oil wells at such prices. In retrospect, these remarks foreshadow very bad times ahead -- for consumers but not for the oil industry. The industry has not been able to gain new drilling rights, a decrease in taxes, or reduced regulations -- all of which should be supported by any free marketeer -- but the industry has obtained the next best thing: high prices for its product as well as boosted demand that comes with war.

Can you believe that prices have gone up four times in the Bush years? Between 1999 and 2003, the average household spent an additional 35% on petroleum products, an average of $500 per year more than previous years. So Cheney’s nightmare scenario of a price so low that no one will invest is not exactly an immediate threat. Not that this is a realistic scenario in the first place. So much for Cheney. What about Bush? He once said, “Cheap energy was how we had got into this mess.” Thus is Bush on the record as being for high prices and against low prices. I do not pretend to have special insight on the menacing relationship between the very powerful US oil industry, the Bush administration, and the warfare machine that protects pipelines all over the Gulf region. There is every reason to dismiss claims that a conspiracy between industry and government can dictate a certain price. Prices are set on the free market, through the forces of supply and demand, and cannot be set by anyone in particular.

But conspiracies of producers and the government can have a huge impact on controlling the variables that go into affecting the forces that impact on prices. The Clean Air regulations of 1990 added vast new costs, for example, which puts upward pressure on prices. At the same time, emptying the boondoggle called the “Strategic Petroleum Reserve” throws more supply onto the market and reduces prices (all else remaining the same). This is what the Clinton administration did, not because it wanted lower prices but because it wanted to buy votes from consumers of heating oil. Reversing this policy, the Bush administration has pumped up the SPR. The current goal of the Bush administration is to store 700 million barrels in the SPR, purchases undertaken at the highest nominal prices on record. Is this a policy driven by a government working closely with industry? We would be naïve to think otherwise.

JUNIPER NETWORKS IS A SHORT SALE CANDIDATE

Mr. Scott Kriens, the CEO of Juniper Networks (NASDAQ: JNPR), told Forbes readers that his company had never lost “cash” -- not even during the worst year of the tech crisis, 2002. While technically true, the statement omits that the cash gain occurred only because of a $72 million one-time “adjustment” to net income. It does not count the roughly $100 million in stock option awards made to employees. And it makes no mention of the company’s $120 million GAAP loss in the year.

Kriens goes on to say that his company, which, like Cisco, specializes in selling Internet technology hardware, is back to a $1 billion per year run rate. Again, this is technically true. Juniper Networks recorded $263 million in sales during the most recent quarter. But Kriens does not mention to Forbes what the company’s lawyers wisely chose to disclose to the SEC. A very large portion of the company’s revenue (37%) in the last quarter came from Juniper’s April 2004 acquisition of NetScreen Technologies -- a software company. You should keep in mind that these additional revenues came at a steep price. No, Juniper did not pay for them -- but Juniper’s shareholders sure did. NetScreen cost $3.6 BILLION in Juniper shares. Kriens’ metaphor is that, like Intel, Juniper will unseat Cisco as the dominant network hardware provider by focusing on one technology. Whether that technology is hardware or software, Kriens does not seem to know yet...

Just for reference, Cisco spends more money on R&D each quarter ($1.3 billion) than Juniper will make in sales all year. Before threatening Cisco, Kriens needs to learn how to make money. In its entire history, Juniper’s cumulative profits total about $35 million, but only if you do not include the $1 billion-plus in stock options it has granted to its own employees as a cost.

Typically, Forbes puts its magazine in subscribers’ mailboxes a week before the date on the cover. And precisely one week before the cover date (July 23), on Monday July 16, Mr. Kriens sold 1 million shares of Juniper stock, worth about $24 million dollars. While Kriens was telling people Juniper is going to be the next Intel, he was selling his own shares as fast as the market could take them up. It is another good reason to sell Juniper’s shares short.

THE FEDERAL RESERVE AND PRODUCTIVITY’S BOOM-BUST CYCLE

Alan Greenspan essentially claims that labor-productivity growth is hindering job growth. Ironically, it is the very boom-bust cycle brought on by the Federal Reserve itself that has lead to today’s productivity growth and it will be the Federal Reserve’s aggressive creation of money (out of thin air) that will eventually destroy the dollar (hyperinflation is not out of the question) and thus will correspondingly destroy productivity itself. Let us first deal with how the Federal Reserve has its hand in the productivity growth Alan Greenspan believes is resulting in poor job growth. For this I refer to the Mises Institute’s terrific book The Austrian Theory of the Trade Cycle. In a chapter written by Dr. Roger Garrison -- titled “The Austrian Theory: A Summary” -- he states the following:

“Conventionally, business cycles are marked by changes in employment and in total output. The Austrian theory suggests that the boom and bust are more meaningfully identified with intertemporal misallocations of resources within the economy’s capital structure followed by liquidation and capital restructuring. Under extreme assumptions about labor mobility, an economy could undergo policy-induced intertemporal misallocations and the subsequent reallocation with no change in total employment. Actual market processes, however, involve adjustments in both capital and labor markets that translate capital-market misallocations into labor-market fluctuations. During the artificial boom, when workers are bid away from late stages of production into earlier stages, unemployment is low; when the boom ends, workers are simply released from failing businesses, and their absorption into new or surviving firms is time-consuming.”

In a nutshell, I believe the facts and theory support the notion that, rather than productivity growth resulting in job layoffs, just the opposite is at work here. To wit, job layoffs are resulting in productivity growth. The bust phase (of the boom-bust cycle) brought on by the Federal Reserve that forced the hands of employers to lay off the least productive workers. Thus, in essence, it is Alan Greenspan’s reckless monetary policy that has brought about today’s productivity growth.

Clearly, the Federal Reserve is doing everything it can to reflate the U.S. economy to reverse the bust that it had brought upon us. In looking at this chart, is it any wonder that prices at the grocery store and the gas pump have risen so dramatically -- remember, internationally, oil is priced in dollars. Price inflation is back. However, with such an accommodative Federal Reserve, there is a distinct possibility that the dollar may soon begin to depreciate all the more rapidly -- resulting in accelerating price inflation. Should inflation become heavy -- with hyperinflation not being out of the question -- the Federal Reserve will be directly responsible for destroying labor productivity.