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Global Markets

Don’t Be A Wall Street Patsy

You want to know the truth? The truth is that Wall Street has stacked the deck against you.

That's why you need to understand how the game is played. Otherwise you'll end up a Wall Street patsy.

So, here's the truth along with some lessons that will help you play the game like a pro.

First, though, we'll need to debunk a few myths…

Let's start with the myth that the Street lowered brokerage charges for the benefit of retail investors. At one time, these fees used to be obscenely high and fixed.

But, on May 1, 1975, fixed commissions were abolished after brash upstarts like Charles Schwab and disgruntled investors decided to attack The Street's price-fixing schemes.

The negotiated commissions regime that followed lowered the cost of access to the stock market, essentially ushering in the era of the "individual investor."

The influx of these individual investors, many of whom didn't have enough money to create diversified portfolios, soon became a boon for mutual funds – which have since grown like weeds in an untended sod farm.

Wall Street Changed the Game

Since the commission business was no longer profitable, Wall Street moved its retail business to an "assets under management" model.

So instead of making money on commissions the game changed to gathering as many assets as you could into a retail investor's account and charging a fee to "manage" them; in other words, just watch them.

That's one of the reasons why Wall Street advocates a "buy and hold" strategy for retail investors. They don't want you to take those assets away from them.

It's the same thing with mutual funds.

And conveniently, if your broker puts you into mutual funds that are losers, it's not your broker's fault.

Now, it's the mutual fund manager's fault. That way the broker can't be blamed if your account loses money.

Instead, your broker can tell you, "Don't fire me, let's fire the mutual fund manager and let's find you a better fund to invest in. But, no matter what happens, we need to buy and hold and not try and time the market."

That's what retail investors are told to do over and over and over again.

But guess what? That's definitely not what Wall Street firms do.

In fact, while you're being told to buy and hold, exchange specialists, market-makers, hedge funds and every trading desk at every Wall Street bank and firm are busy trading.

Some individual investors began to see how Wall Street was really making its money and started trading themselves.

Of course, that only increased the competition for easy trades as more retail investors traded in and out of stocks.

To continue their advantage over the public, Wall Street fought to do away with the uptick rule. The rule was wiped out so traders could short sell any stock at any time.

But it's the big Wall Street players who benefit from the rule change because they can use their huge capital positions and work with each other to drive down stocks they have shorted.

Who gets hurt? The buy-and-hold retail investors who are told to buy more at lower prices are the ones who get fleeced.

And, who is selling to them?…

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Crisis in the Eurozone: The Reality of the European Downgrades

It turned out to be a ruinous Friday the 13th for Europe last week.

After the close, Standard & Poor's downgraded nine of the sovereign states in the European Union (EU).

That included dropping Austria and France to AA+ status from their formerly lofty AAA rating.

While the decision was expected, and will most likely be followed by additional downgrades from the other rating agencies such as Moody's Corp. (NYSE: MCO) and Fitch Ratings Inc., it's the knock-on effects that will have larger implications for investors around the world.

In the Wake of the European Downgrades

The first and most obvious effect was the downgrade of the European Financial Stability Facility (EFSF) that followed on Monday. In the wake of Friday's bad news, the EFSF was also dropped to a AA+ rating.

According to the S&P:

"We consider that credit enhancements that would offset what we view as the now-reduced creditworthiness of the EFSF's guarantors and securities backing the EFSF's issues are currently not in place. We have therefore lowered to 'AA+' the issuer credit rating of the EFSF, as well as the issue ratings on its long-term debt securities."

The S&P also warned more EFSF downgrades would follow if the ratings of other individual states dropped in the future.

In a warning the EFSF could fall below AA+ the S&P said:

"Conversely, if we were to conclude that sufficient offsetting credit enhancements are, in our opinion, not likely to be forthcoming, we would likely change the outlook to negative to mirror the negative outlooks of France and Austria. Under those circumstances we would expect to lower the ratings on the EFSF if we lowered the long-term sovereign credit ratings on the EFSF's 'AAA' or 'AA+' rated members to below 'AA+'."

So where do we go from here?

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Prepare for Iran's Energy Market Chaos with the United States Oil Fund LP (NYSE: USO)

Iran kicked off the New Year with aggressive messages for the Western world, setting the stage for heightened political tensions and a huge oil price push in 2012.

Oil futures finished at their highest level in eight months yesterday (Tuesday), with West Texas Intermediate crude jumping 4.2% to settle at $102.96 a barrel on the on the New York Mercantile Exchange (NYMEX).

The surge came after Iran warned a U.S. aircraft carrier to stay out of the Persian Gulf. The message fueled speculation that Iran will make good on its threat to close the Strait of Hormuz to oil tankers.

An average of 14 supertankers carrying one-sixth of the world's oil shipments every day pass through the Strait, a narrow channel which the U.S. Department of Energy calls "the world's most important oil chokepoint."

With global oil demand expected to rise to a record 89.5 million barrels per day in 2012, a major disruption to oil exports from Iran would drastically affect pricing.

Even though Iran has made such threats repeatedly over the past 20 years, tighter sanctions imposed by the United States and Europe may have pushed the country to its breaking point. Iran just concluded a 10-day military exercise intended to prove to the West that it can choke off the flow of Persian Gulf oil whenever it wants.

Now Iran is expected to trigger oil market performance similar to spring 2011, when Libya's civil war caused oil prices to spike close to $115 a barrel.

In fact, if the Iranian government made good on shutting down the Strait, oil prices would probably shoot up $20 to $30 a barrel within hours and the price of gasoline in the United States would rise by $1 a gallon.

While we can't control Iran's actions, we can control how we prepare for whatever political and economic turmoil it inflicts. That's why it's time to buy the United States Oil Fund LP (NYSE: USO).

Global Political Tensions Will Bolster US Oil Fund

Iran is trying to scare the world out of imposing more sanctions against it, which drastically limit the country's ability to conduct business.

The latest sanctions, signed into law by U.S. President Barack Obama last Saturday, will make it far more difficult for refiners to buy crude oil from Iran, the world's fourth-largest oil exporter.

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Should We Be Worried About Iran?

If the Iranian government makes good on its recent threats to stop oil shipments through the Strait of Hormuz, oil prices would shoot up $20 to $30 a barrel within hours and the price of gasoline in the United States would rise by $1 a gallon.

Such a steep spike in crude oil prices would plunge the United States and Europe back into recession, said Money Morning Global Energy Strategist Dr. Kent Moors.

Iran just concluded a 10-day military exercise intended to prove to the West that it can choke off the flow of Persian Gulf oil whenever it wants.

The world's fourth-biggest oil producer is unhappy with fresh U.S. financial sanctions that will make it harder to sell its oil, which accounts for half of the government's revenue.

"Tehran is making a renewed political point here. The message is – we can close this anytime we want to," said Moors, who has studied Iran for more than a decade. "The oil markets are essentially ignoring the likelihood at the moment, but any increase in tensions will increase risk assessment and thereby pricing."

One reason the markets haven't reacted much to Iran's latest rhetoric is that although it has threatened to close the Strait of Hormuz many times over the past 20 years, it has never followed through on the threat.

But a fresh wave of Western sanctions could hurt Iran's economy enough to make Tehran much less cautious.

The latest sanctions, signed into law by U.S. President Barack Obama on Saturday, will make it far more difficult for refiners to buy crude oil from Iran. And looming on the horizon is further action by the European Union (EU), which next month will consider an embargo of Iranian oil.

"The present United Nations, U.S. and EU sanctions have already had a significant toll," said Moors. "They have effectively prevented Iranian access to main international banking networks. Iran now has to use inefficient exchange mechanisms."

Because international oil trade is conducted in U.S. dollars, Moors said, Iran must have a convenient way to convert U.S. dollars into its home currency or other currencies it needs, such as euros.

Pushed to the Brink

The impact of the sanctions combined with internal political instability has driven Iran to turn up the volume on its rhetoric.

"Tehran has limited options remaining," Moors said, noting Iran has historically used verbal attacks on the West to distract its population from the country's problems. "The Iranian economy is seriously weakening, the political division among the ayatollahs is increasing, and unrest is rising."

Analysts worry an Iranian government that feels cornered would be more prone to dangerous risk-taking in its dealings with the West. So while totally shutting down the Strait of Hormuz isn't likely, Iran could still escalate a confrontation beyond mere talk.

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What Kim Jong Il's Death Means for the Global Economy

All eyes are on North Korea and its repressed economic system this week after the country announced early Monday that Kim Jong Il, the ruling dictator for 17 years, died Saturday. The political instability to follow Kim Jong Il's death could ripple through the global economy, weighing on confidence and growth.

Kim Jong Un, the third son of the deceased leader, will take his place. Kim Jong Un is only in his late-twenties, and has only been groomed for the role since 2008, compared to his father's 14 years of training.

While North Korea has remained economically isolated from much of the world, its military aggression, volatile relationship with South Korea and the United States, and the uncertainty surrounding Kim Jong Un's readiness to lead has put the world on alert.

"This is a tinderbox situation," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "Almost nothing is known about Kim Jong Un, this "Great Successor.' The deeper questions are the longer-term issues related to a potential power struggle within the ruling elite, given that Kim Jong Un may not have the training nor the power base from which to assume control. Now is the time to watch carefully."

That said, here's what to monitor in the global economy as North Korea rebuilds after Kim Jon Il's death.

North Korea's economic future: North Korea is a notoriously closed society and has shunned foreign investment. Kim Jong Il had started to show signs of possibly being open to economic reform. He even toured Chinese factories to learn about their rapid economic growth, and visited Russia to discuss building a gas pipeline across North Korea.

Of course, that's unlikely to change at least until the country's new leader gets established.

Still, there's hope the long-term outlook for North Korea will change since Kim Jong Un has more Western world exposure than his father, having attended school in Switzerland. That could encourage him to reach out more to other countries to help improve his impoverished nation.

"With China as its example, I am hopeful that North Korea comes out of its shell and slowly crawls to its borders to see who is willing to start a dialogue and trading with the rogue robot nation," said Money Morning Capital Waves Strategist Shah Gilani. "If it's going to be a scary and not a salutary coming out party, all bets are off; but I'm a betting man, and I'm betting North Korea will emerge from its cocoon."

South Korea's economy: South Korea faces the biggest economic disruption. The country already forecast a drastic export slowdown for 2012, with shipments growing only 7.4% next year, compared to 19.2% in 2011. The threat of North Korean instability could also slam consumer confidence, and cause the economy to grow even slower than the 3.7% gain predicted for next year.

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Those "New" E.U. Fiscal Rules Aren't
So New

Very soon we will see if the old market adage "Buy the rumor, sell the news" is true.

While rumors of Europe's impending demise were momentarily shot down by an array of silver bullets, the actual news out of Brussels of a grand bargain wasn't… exactly… honest.

Let's call the half-measures agreed to by European leaders "Brussels sprouts," because they're more like "green shoots" than a cabbage patch panacea.

The leaders agreed to agree that they needed an agreement on how to more closely integrate their fiscal and monetary interests.

Yeah, that's what they said. I say good luck with that.

Actually, they made some other moves, too.

They moved up the date for the European Stability Mechanism to get funded (yeah, right), and promised to revisit the European Financial Stability Facility's financing so they could have twin facility spigots.

And – this one's my personal favorite – they winked at having European central banks make bilateral loans up to $264 billion (€200 billion) to the International Monetary Fund so the IMF could back Europe's central banks and the European Central Bank.

You just can't make this stuff up.

Seriously, there's nothing like a crisis to consolidate your power – which is what the Northern Europeans are angling for.

But for the life of me, I can't imagine a bunch of sovereign nations subjecting themselves to forced austerity, being taxed by technocrats (who, of course, will be non-partisan, non-xenophobic, nonplussed objectivists), and dictated to as occupied territories by the machinery that ground them down in the first place… and wants to keep them there.

What… You don't get that?

Here's a newsflash for you: The "new" rules about maintaining strict debt to GDP ratios and other my-way-or-the-highway fiscal demands are not new at all.

The same metrics for fiscal discipline that were lauded last week were already in place – it's just that no one followed them.

Everybody cheated… starting with the Germans themselves.

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Latest Eurozone Debt Crisis Plan "Another Grand Illusion"

As European leaders celebrated a tentative agreement to accept tougher budgetary rules among its members, critics expressed doubts the plan would cure the two-year-old Eurozone debt crisis.

Last week's highly anticipated two-day summit resulted in 26 of the 27 European Union (EU) nations – the United Kingdom objected – agreeing to create a new treaty that would require members to keep budget deficits to within 0.5% of gross domestic product (GDP) in good economic times and within 3% of GDP in bad times.

EU governments would need to submit their budgets to a central fiscal authority, and violations would carry automatic penalties. The nations agreed to hammer out the details by March of next year.

World stock markets reacted positively, but many experts remain unconvinced that the EU has finally delivered the silver bullet needed to slay its monstrous debt crisis.

"They needed to create grand plan that's really workable and not another grand illusion," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "I'm afraid what we're getting is just another grand illusion."

In fact, last week's meeting was the fifth summit called to deal with the European debt crisis since 2009. Each has produced its share of optimistic rhetoric, but no concrete solutions.

European leaders from France, Germany, the European Central Bank (ECB) and the International Monetary Fund all hailed the summit agreement as a major step toward getting the debt crisis under control.

"This is the breakthrough to the stability union," said German Chancellor Angela Merkel at the end of the summit. "We are using the crisis as an opportunity for a renewal."

"It's a very good outcome for the euro area, very good," added ECB President Mario Draghi "It is going to be the basis for much more disciplined economic policy for euro-area members."

Fitz-Gerald said Europe's leaders mean what they say, but ultimately the latest summit will do little more than spark a brief rally in the markets.

"These government officials still don't get it," Fitz-Gerald said. "They're still not addressing the underlying problems. We'll be having this conversation again next year."

A Tough Sell

Although enforcing budgetary austerity would help prevent current debt problems from getting worse, it's unlikely the citizenry of most EU member nations will allow it to happen.

"Their proposal is preposterous," writes Brett Arends of MarketWatch, likening the EU plan to the United States allowing its largest creditors, Japan and China, control over the federal budget.

"How would you feel if you opened the paper to be told that the new Sino-Japanese "Fiscal Stability Commission' in Washington had just slashed your grandma's Social Security checks by one-third, scaled back federal highway repairs, and that it would impose a 10% national sales tax?," Arends said. "That is, after all, effectively what is being offered to the people of Greece, Italy, Spain, Portugal and Ireland."

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China Returns to Growth Mode with Major Policy Shift

The damaging global economic effects that Europe's unfolding debt crisis pose have caused a sharp reversal in China's monetary policy – one that will lead to a greater expansion of the Red Dragon's economy.

The People's Bank of China announced yesterday (Wednesday) that it would lower the percentage of deposits commercial banks must hold in reserve by 50 basis points, effective Dec. 5.

This is China's first reserve requirement cut since 2008. It drops the level to 21% for large banks and 19% for smaller institutions.

The move was unexpected from the world's second-largest economy, which has been tightening its monetary policy for more than a year.

The change underscores the country's concern that exports, its main driver of economic growth, would weaken due to lower demand from the troubled Eurozone, China's biggest consumer. However, it's also a signal that after a year of tapping the brakes on growth to curb inflation, Beijing is ready to put its foot back on the accelerator.

"This is a clear signal that Beijing has decided that the balance of risks now lies with growth, rather than inflation," Stephen Green, greater China head of research at Standard Chartered, told The Financial Times. "This is a big move, it signals China is now in loosening mode."

China's gross domestic product (GDP) in the third quarter grew by 9.1% — the slowest pace in two years and down from 9.5% in the previous three months. That's the fourth consecutive quarter of declining GDP growth.

Loosening China's Monetary Policy

China fears its best customers, Europe and the United States, will keep reducing their imports as they're burdened with weak economies. Chinese exports in October rose by 15.9%, the smallest amount in two years.

"The weakness in exports was very much in line with the global environment, especially the slowdown in Europe, and that's going to continue through to the first quarter of next year," Li Cui, an economist with the Royal Bank of Scotland, told Reuters. "I think the underlying weakness is perhaps even weaker. [M]y estimation is that the real growth could only be around 7% to 8%, adjusting for export prices."

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Europe Headed for a 'Lehman Moment'

With credit drying up across Europe we may finally see the Eurozone experience its "Lehman moment" – a replay investment banking collapse that triggered the 2008 financial crisis.

Indeed, European banks are having a harder time getting money – part of the fallout from the Eurozone debt crisis – and the resulting credit crunch could freeze business activity, cause bank runs and plunge Europe into a deep recession that would badly damage the global economy.

"The Continent is headed towards deflation if there's not enough money circulating throughout their financing and banking systems," said Money Morning Capital Waves Strategist Shah Gilani. "This all becomes self-fulfilling at some point. It's a very dangerous situation, not just for Europe, but for the whole world."

A global financial crisis would derail the struggling U.S. recovery and pinch the profits of many multinational corporations.

Fresh data this week from the European Central Bank (ECB) showed the M3 Eurozone money supply actually shrank in October by 0.6%, its steepest drop since January 2009 – the height of the Lehman Brothers crisis.

A shrinking money supply is one of the early warning signals that credit availability is drying up, making it difficult or impossible for banks, businesses, and consumers to obtain loans.

"This is very worrying," Tim Congdon from International Monetary Research told The Telegraph. "What it shows is that the implosion of the banking system on the periphery is now outweighing any growth left in the core. We are seeing the destruction of money and it is a clear warning of serious trouble over the next six months."

Signs of capital draining from European banks abound.

The bank bond market is already frozen. European banks in the third quarter were only able to sell bonds worth 15% of what they sold in the same period in the previous two years, according to Citigroup Inc. (NYSE: C).

In the past six months, U.S. money market funds have withdrawn 42% of their money from European banks. And loans to French banks have fallen 69% since the end of May, according to Fitch Ratings.

Even retail customers have started to pull their money out.

"We are starting to witness signs that corporates are withdrawing deposits from banks in Spain, Italy, France and Belgium," an analyst at Citigroup wrote in a recent report. "This is a worrying development."

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China Changing the Global Gold Market

While many investors have been distracted by the goings on in Europe, China has been making a dent in the global gold market by making it easier for investors to buy and invest in the yellow metal.

The goal: To dominate the global gold market and carve out a new role for its currency, the yuan.

China and other developing nations like India have been encouraging citizens to buy and hold physical gold, in forms ranging from jewelry and coins to bullion bars. China's aggressive promotion has pushed Chinese consumer demand for gold up 25% overall this year – much higher than the 7% global average.

World Gold Council (WGC) Far East Managing Director Albert Cheng, who predicted in March 2010 that Chinese gold demand would double by 2020, noted: "We now believe this doubling may, in fact, be achieved far sooner."

China is pushing gold because it wants the government and citizens to build financial reserves in assets stronger than the U.S. dollar, euro, and other weakening currencies. It also increases China's role in the precious metals market.

But there's another effect of this push for gold ownership: it's dislodging the dollar as the world's main reserve currency.

China's Gold Push Efforts

China's push for private gold ownership represents a major policy shift.

Chinese citizens were barred from owning physical gold under penalty of imprisonment until 2002. Since that policy was dropped and the Shanghai Gold Exchange opened, China has steadily stepped up efforts to encourage precious metal ownership.

The government now airs news programs on state-owned China Central Television describing how easy it is to buy and sell gold and silver. It also started its first gold vending machine, letting Chinese customers easily buy gold coins and bars using cash, debit cards and credit cards.

Current plans call for an additional 2,000 gold vending machines to come on line in the next two years. If they prove as successful as they did in Germany, where metals vending machines were first introduced, China's consumer gold demand will surge.

Chinese consumers turned off by the vending machines' high price mark-ups have another option – official government-operated "Mint Stores." Structured like a typical jewelry store, they feature specially minted bars in a variety of sizes. Mark-ups are minimal since each store has a Bloomberg screen tracking the current spot gold price, usually quoted in renminbi based on Shanghai trading, rather than in dollars on the London or New York market.

China also has encouraged more gold investment through new exchanges and yuan-denominated products.

The country on June 28 opened its first precious metals spot exchange. The South Rare Precious Metals Spot Exchange offers spot trading – as well as deferred and long-term electronic trades – in gold, silver, bismuth, indium and tellurium, with plans to add 13 other metal-related products. Chinese citizens can trade the metals through either direct margin accounts with the exchange, or through their banks and brokerage firms.

These efforts have increased Chinese consumers' gold interest, but it's the next development that will make China a major global player in gold trading.

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