... AeroVironment Inc. (Nasdaq: AVAV).

Death From Above

The military of tomorrow will focus more on tactical strikes and espionage than it will manpower.

That's why AeroVironment, a leading manufacturer of unmanned aerial vehicles (UAVs), or drones, is in such a good position.

AeroVironment provides 85% of the drones used by the U.S. military in Iraq and Afghanistan, and UAVs are one of the few growth areas in the Pentagon's military budget.

Since 2005 there has been a 1,200% increase in combat air patrols by UAVs. In fact, there are now more hours flown by UAVs than by its manned aircraft and more pilots are being trained to fly them than traditional fighters.

AeroVironment's Raven B drone is the most commonly used UAV in the U.S. military, and the company's newest product - the Switchblade - could be an even bigger success.

The Switchblade was developed jointly with the U.S. Air Force and can transform into a weapon if an enemy is spotted. The U.S. Army recently put in a $6 million order for Switchblade.

More importantly, UAVs and drones are starting to find work in the private sector.

The Federal Aviation Administration (FAA) is about to issue its first rules to let businesses and local law enforcement fly drones in U.S. civilian airspace without special permits. The agency has until June to open six U.S. test sites where drones will fly with other traffic.

The possibilities are endless. Police organizations, for example, could use these tools to look for escaped prisoners or lost civilians. AeroVironment has already developed a 5.5- pound mini-helicopter for law enforcement, called the Qube, which would cost about $50,000.

Big energy also has expressed interest in using drones to check on remote assets like oilrigs and pipelines.

AeroVironment's second-quarter earnings for fiscal 2012 blew away the results of the same quarter last year. Profit soared to $6.6 million, or 30 cents a share, from $262,000, or 1 cent a share. Revenue was up 26% to $80.4 million.

Analysts surveyed by Thompson Reuters predict income of 45 cents a share on revenue of $89 million for the third quarter.

The company also has huge margins. Over the trailing 12 months, gross margin are 41.4%, while operating margin are 15.9% and net margin is 10.8%.

As a result, the company has no debt and $177 million in cash, which is equivalent to about 30% of its market cap. This gives the stock a cash value of $8.15 per share.

Goldman Sachs Group Inc. (NYSE: GS) on Monday upgraded AeroVironment stock from "Neutral" to "Buy" with a price target of $38. As a result the stock is up about 7% on the week, closing yesterday (Tuesday) at $30.77.

Still, there's a 24% upside from here. Not bad for a defense company in a new era of cutbacks.

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1. Massive economic and political problems inside the country.
2. The last round of sanctions that restricted Tehran's access to international banking.
3. And the European Union's (EU) decision to boycott Iranian crude imports.

I'll explain each of these further.

First, Iran is undergoing significant economic and political problems. The rial (the Iranian currency) has inflated almost 80% against the dollar in less than a year. The government has not accounted for almost $120 billion in oil proceeds kept out of the country, resulting in a split between Iranian President Mahmoud Ahmadinejad and some of his former supporters in the Majlis (parliament). Several of the president's closest advisors are, or shortly will be, under indictment for corruption. That includes a multi-billion dollar case of banking fraud, the largest in the country's history.

Ahmadinejad is in a flat out political war with both the supreme religious leader Ayatollah Khamenei and major clerics.

Now come the sanctions, which have gotten unbearably strict.

The last round of U.S., EU and United Nations (UN) sanctions began cutting Tehran off from international banking. Since global oil sales are denominated in dollars, access to exchange and clearing banks is essential.

Germany, under pressure from Washington, closed Europäish-Iranische Handelsbank (EIH). This small bank is Hamburg-based but Iranian-owned and registered by the Bundesbank (German Central Bank). American intelligence and Treasury officials are convinced (almost certainly correctly) that EIH had been a primary means through which Tehran accessed the international exchange, acquired equipment for its nuclear program, financed arms deals, and provided subsidies to Hezbollah and Hamas.

That was followed by the end of Asian Clearing Union (ACU) services for Iranian oil sales (despite Iran being one of the ACU members). That resulted in a full-blown crisis in India, where Iranian crude imports are essential. New Delhi had no mechanism to pay for the consignments until it set up a very inefficient system of rupee accounts in Turkish banks to exchange them for rials.

Iran must now resort to inefficient and costly substitutes - such as shadowy exchanges around the Dubai Exchange and barter arrangements (especially with China) via the Singapore Exchange. Since China has a trade surplus with Iran, it can effectively finance its crude purchases with its own exports.

Finally, the EU has decided to stop importing Iranian oil. Europe is the second-largest buyer of Iranian crude after China. Iran cannot find customers to replace such a large volume in short-order. The EU must be careful not to spike the price of crude through such a policy, especially for certain member countries already having problems of their own.

Greece, for example, usually receives a third of its crude oil directly or indirectly from Iran. Spain also would be immediately impacted. There's also a range of daily swap contracts in Europe involving Iranian oil as an element. These would also be thrown out of balance resulting in a price rise.

Risk is now an exacerbating concern in the oil market. The Iranian situation is rapidly becoming a major crisis.

Q) So what's the next move? How do you see this crisis playing out over the next several months?

Moors: The crisis will probably intensify. Western intelligence agencies have already concluded Iran will get nuclear weapons at the current rate of development. The attempt now is to destabilizeIran internally - hence the latest round of sanctions. Tehran will not allow this to happen. Threateningto close the Strait of Hormuz is one response;moves to destabilize the regionwill be another. Iran is a main sponsor of both Hezbollah and Hamas and neitherof these will sit idly by and have a financiallifeline cut.

Saudi Arabia will increase its own pressure against Iran, while any genuine attempt toclose the Strait will be met with an immediate Saudi response.

Q) Finally, how can investors profit? In the past, Money Morning has advocated exchange-traded funds such as the United States Oil Fund LP (NYSE: USO) and stocks as Suncor Energy (NYSE: SU) as ways to profit from higher oil prices. Are these stocks still good investments?

The longer the crisis remains, the greater the benefit from emphasizing North American-based production.

Companies - like the Calgary-based Suncor - that are active in Canada's oil sands are one way for investors to go. According to the government of Alberta, nearly 173 billion barrels of recoverable oil rest in these tar sands, based on current production costs. This represents nearly 75% of the total North American reserves currently available. Canada is the largest supplier of oil and gas to the United States, shipping approximately 75% of its exports here each month.

Kent discusses energy-related investment opportunities in depth in his ever-popular Energy Advantage newsletter.

You can learn more about his Energy Advantage newsletter and the coming oil supply constriction by clicking here.

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Down But Not Out

Of course it's true the global economy will suffer if the European debt crisis is not contained. However, it's also true that emerging market demand will buoy oil prices and eventually push crude beyond the record levels we saw in 2008.

The International Energy Agency (IEA) said in its annual energy outlook in November that oil demand will rise 14% between 2010 and 2035, from 87 million barrels per day (bpd) in 2010 to 99 million bpd in 2035. And what's more is that the net increase in oil demand will come entirely from the transportation sector in emerging economies.

The IEA projects oil prices of $212 a barrel by 2035, as a result.

"It is hard to overstate the growing importance of China in global energy markets," says Fatih Birol, chief economist for the IEA. "The country's growing need to import fossil fuels to meet its rising domestic demand will have an increasingly large impact on international markets."

Birol says that 700 out of every 1,000 people in the United States and 500 out of every 1,000 people in Europe own cars today. In China, only 30 out of 1,000 people own cars. Birol thinks that figure could jump to 240 out of every 1,000 by 2035.

Furthermore, when Japan hit $5,000 of gross domestic product (GDP) per capita, oil demand grew at a 15% annual rate for the next 10 years, according to oil-industry consultant firm PIRA. The same is true of South Korea. However, China reached the $5,000 GDP per capita mark in 2007, and oil demand has only grown at a 7% compounded annual growth rate.

Clearly demand is far more likely to grow than shrink.

"In the last five years, worldwide consumption of oil products has grown from 3 million barrels a day to 7 million barrels," Sergio Gabrielli de Azevedo, chief executive officer of Petrobras SA (NYSE ADR: PBR), the world's third-largest oil producer, told CNBC.

"We are going to have a very tight market in 2012," he said. "At the same time, we have low interest rates, which means that by the year 2012 we are [probably] going to see prices above $100 per barrel on average, but very high volatility, because we have a lot of speculative contracts that have been traded in the market right now."

Supply Squeeze

Additionally, the supply side of the oil market is far weaker today than it's been in the past. Even though demand has eased slightly, total supply has fallen as inventories were siphoned off throughout the year.

U.S. commercial oil inventories fell for the third consecutive month in November, declining by 20.3 million barrels. And an11.8 million-barrel decline in OECD supplies in September took the inventory level below its five-year average for a third consecutive month, as well. That's the first time that's happened since 2004. Asia-Pacific inventories are declining, too.

"Falling global demand is unlikely to create large spare capacity," wrote Barclays analysts Molina and Sen.

Plus there's a wild card: Political turmoil could easily lead to an oil price spike that eclipses the one we saw last spring during the Libyan rebellion.

That would be impressive, considering Libya's revolution took oil prices from $83.13 a barrel on Feb. 15 to $113.39 a barrel on April 29. That's a 36% surge in a period of about two and a half months.

And yet, that was simply the result of political upheaval in Libya - which at the time was the world's 17-biggest oil producer. Just imagine the impact on prices of a political crisis in one of the major oil-producing nations of the Middle East.

Remember, U.S. President Barack Obama has vowed to pull all U.S. troops out of Iraq by the end of this year. That's almost certainly a relief for Iran, whose nuclear program has already aggravated tensions with the West.

An International Atomic Energy Agency (IAEA) report on Iran in November accused the country of pursuing a nuclear weapons program. This would violate United Nations sanctions and could lead to military intervention from Israel and the United States.

Iran is the world's fourth-largest oil producer, so military conflict there would lead to a spike in oil prices that dwarfs what we saw during the Libya crisis. Iran produces 3.6 million barrels of oil a day, about 5% of the world's total. By comparison, Libya produced about 1.5 million barrels of oil per day prior to its civil war, or about 2% of the world's total supply.

Iran isn't the only political risk in the region, either. Since the Arab spring many Middle-Eastern countries have ramped up social spending to dissuade rebellions of their own. Saudi Arabia alone has unveiled some $129 billion of additional expenditures in recent months.

As a result, the Organization of Petroleum Exporting Countries (OPEC) has raised by $10.00 its estimate for the underlying oil price it uses in its reference case forecast to a range of $85-$95 a barrel. This is the first tacit acknowledgment from the group that the social investment commitments of some key members will necessitate higher oil prices.

"Political unrest is certainly part of why the oil price is getting so supported despite the decline in the macro environment," Sabine Schels, senior director and global commodity strategist, Bank of America Merrill Lynch Global Research, told CNBC. "Iran is flexing its muscles in the region and we have all seen how strongly Saudi Arabia reacted."

The IEA says "consumers could face a substantial near-term rise in the oil price to $150/barrel," if energy exploration and development in the Middle East falls below $67 billion annually.

2012 Oil Price Profit Plays

The easiest way to play the looming rise in oil prices is through exchange-traded funds (ETFs).

There are several from which to choose, including: the iPath S&P GSCI Crude Oil Total Return ETF (NYSE: OIL), the PowerShares DB Oil Fund (NYSE: DBO), the SPDR S&P Oil & Gas Explorers & Producers Fund (NYSE: XOP) and the SPDR Oil & Gas Equipment & Services Fund (NYSE: XES).

Of course, there's also no shortage of companies poised to outperform the market.

China National Offshore Oil Corp. (CNOOC) (NYSE ADR: CEO) is a great way to play growing demand in China.

CNOOC is often referred to as the most "Western" of China's oil majors because it was founded with a mandate to form joint ventures with foreign companies. CNOOC is the vessel through which China is acquiring foreign expertise in the energy sector.

Last year, the company announced it would pay $1.08 billion for a 33% stake in Chesapeake Energy Corp.'s (NYSE: CHK) Eagle Ford shale acreage in Southern Texas, a deal that highlighted China's desire to develop its shale-gas extraction techniques.

"China's natural gas production has tripled in the last decade, a growth rate of 13.3%," said Douglas-Westwood's Kopits. "We project this to double in 2015 and nearly triple to 8.6 trillion cubic feet in 2020, implying 10% annual growth."

And just last month, CNOOC shelled out $2.04 billion to acquire Opti Canada Ltd. and increase its exposure to Canada's rich oil sands. Opti is CNOOC's second step into Canada's vast oil sands. In 2005, China's largest offshore oil acquired a 14% stake in MEG Energy Corp. (PINK: MEGEF), which operates an oil sands project in northern Alberta.

If you want a direct play on Canada's oil sands you might look at Suncor Energy Inc. (NYSE: SU).

Suncor boasts strong and reliable crude oil production from its oil sands operations in Canada. It also has refineries, wholly owned pipelines and specialty lubricant products. The company sells gasoline in retail locations in Canada under the Petro-Canada brand and in the United States under the Phillips 66 and Shell brands.

At a time when the many traditional Middle-Eastern oil producers are besieged by civil unrest, reliable oil production from a country as stable as Canada is especially valuable.

"Of the Canadian oil plays, I most like Suncor because of its position as the most important producer of tar sands oil," said Money Morning Global Investment Strategist Martin Hutchinson. "This is only modestly profitable at current oil prices, but if prices run up or a global crisis restricts supplies, Suncor can be expected to increase hugely in profitability."

Money Morning Global Macro Trends Specialist Jack Barnes likes Suncor, as well. And in recent "Buy, Sell or Hold" columns, he's recommended Anadarko Petroleum Corp. (NYSE: APC), EOG Resources Inc. (NYSE: EOG), and Marathon Petroleum Corp. (NYSE: MPC).

Anadarko has stakes in some of the most prolific U.S. oil fields in Texas, Colorado, Wyoming, Utah, and Pennsylvania. It's also an international leader in unconventional production, employing methods like horizontal drilling to increase productivity rates from deep wells.

EOG has shifted its focus to horizontal drilling techniques, as well, transforming itself from a leading gas drilling company to a major oil producer. Last year, the company increased its liquid production by 49%. The company just reported blowout third-quarter earnings, turning last year's loss into a $541 million profit.

And finally there's Marathon, which has a firm hold on North Dakota's Bakken oil shale formation - the largest known reserve of light sweet crude in North America.

Production from the Bakken shale is soaring. It went from a mere 3,000 barrels a day in 2005 to 225,000 in 2010, and could hit 350,000 barrels a day by 2035, according to the EIA.

All of these companies are worth a look, and paired with the aforementioned ETFs, could conjure up some very big gains in 2012.

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For instance, Nanhao Group, a Hengshui-based technology company that makes educational hardware and software, has been home to a PLA-sponsored cyber militia since 2005, according to The FT.

"All staff under 30 belong to the unit," Nanhao Vice President Bai Guolian told the paper.

Bai confirmed that its cyber militia unit was led by the local PLA command and has "regular exchanges" with it, training PLA officers. Asked whether the group would carry out cyber attacks, he said: "That has nothing to do with you."

The Nanhao cyber militia is one of thousands, The FT said.

Indeed, the PLA first made cyber security and espionage a priority in 1999 and has been collecting external talent for its operations since 2002. In addition to its cyber militias, the PLA sponsors information warfare research and hacking competitions at universities.

That has the United States and other Western countries playing catch-up.

Mission Critical

The Business Roundtable (BRT) - an association of leading U.S. companies with more than $6 trillion in collective annual revenue and employing more than 14 million workers - just last week put forth a plan to develop along with the government a more modern approach to cybersecurity.

The report, "Mission Critical: A Public-Private Strategy for Effective Cybersecurity," called for a collaborative effort by the departments of defense and homeland security, as well as the greater intelligence and diplomatic communities, to better protect businesses and national security.

"Protecting the United States from constant cybersecurity threats requires seamless, ongoing private-public sector coordination and planning," said Randall Stephenson, chairman and CEO of AT&T Inc. (NYSE: T). "Business Roundtable's plan calls for a flexible policy approach that establishes the government's critical role and encourages companies to continuously innovate and invest in advanced network technologies."

Businesses worldwide lose a staggering $221 billion a year due to data theft. Americans are affected to the tune of $54 billion.

Still, these random attacks by rogue hacking collectives pale in comparison to China's coordinated efforts to acquire intellectual property by any means necessary.

"I don't believe that there is precedent in history for such a massive and sustained intelligence effort by a government to blatantly steal commercial data and intellectual property," House Intelligence Committee Chairman Mike Rogers, R-MI, said earlier this month at a hearing on cybersecurity.

Google Inc. (Nasdaq: GOOG) in June said hackers in China tried to hack into the Gmail accounts of hundreds of journalists, Chinese activists, and U.S. government officials.

"That's just the tip of the iceberg," Rogers said. "There are more companies that have been hit that won't talk about it in the press, for fear of provoking further Chinese attacks."

Six Cybersecurity Investment Opportunities

The need for cybersecurity will only grow as attacks continue to increase in frequency and sophistication. Cybersecurity stocks make good investment candidates for precisely that reason.

Investors might consider the following five stocks:

• Symantec Corp. (Nasdaq: SYMC) - Symantec is the largest remaining publicly traded computer security firm, since McAfee was absorbed by Intel Corp. (Nasdaq: INTC). Symantec provides data protection to a wide range of clients all over the world. The company offers both direct and online sales, and has combined growth with rapid expansion via acquisitions, the most recent being a June buyout of data-management specialist Clearwell Systems Inc. Symantec earned 92 cents a share in the fiscal year ended April 1, 2011, and currently carries a price/earnings (P/E) ratio of 21. Projected earnings for this year are $1.61 per share and the average analyst price target is $22.00.

• Check Point Software Technologies Ltd. (Nasdaq: CHKP) - Israeli-headquartered Check Point specializes in developing custom software and hardware that allows companies to provide secure online financial transactions worldwide, and offers a number of other software products and security services for the global information technology (IT) sector. The company topped off six years of earnings growth with a profit of $2.13 a share in 2010, and carries a P/E of 24.

• Sourcefire Inc. (Nasdaq: FIRE) - Sourcefire provides IT security solutions for companies in healthcare, financial services, manufacturing, energy, education, retail and communications sectors worldwide. Revenue of $130.5 million in 2010 almost tripled 2007 numbers. Earnings per share rose to 53 cents from 32 cents in 2009, and analysts estimate earnings of 68 cents a share in 2011.

• SAIC Inc. (NYSE: SAI) - San Diego-based SAIC has a handle on government computer security, serving many federal government agencies and branches of the U.S. military, along with state, local and foreign governments. The company earned $1.51 a share on revenue of $11.1 billion in the fiscal year ended Jan. 31, 2011, giving it a P/E ratio of just 8.65. Analysts expect earnings to be flat to slightly higher over the next two years.

• ManTech International Corp. (Nasdaq: MANT) - Far more than just a computer training operation, Virginia-based ManTech is a highly diversified provider of security technologies for government agencies, including the Central Intelligence Agency (CIA), Federal Bureau of Investigation (FBI) and Department of Homeland Security. Operating in about 40 countries worldwide, MANT had $2.6 billion in revenue in 2010, dropping earnings of $3.43 a share to the bottom line. Earnings are expected to rise to $3.91 in the coming year. The stock has an average projected price target of $47.00, and the 84-cent dividend represents a 2.7% yield.

Of course, if you really want to profit from cybersecurity, Money Morning Private Briefing has the inside scoop on the best potential profit play in the sector. This company has had steadily rising revenue for the past five years, and is poised to make an even bigger splash going forward.

The stock was first recommended to Private Briefing subscribers on Sept. 26. and has already surged 13%. You can get access to this opportunity and many more by signing up for Private Briefing, which you can do by clicking here.

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Both Hutchinson and Barnes have made a point to warn investors about the problems pervading the U.S. banking system.

"There was a time when bank stocks actually looked like good investments," Hutchinson said in an Aug. 17 article. "But sadly, U.S. banks no longer offer the value and profit-making potential they did immediately following the financial collapse. In fact, they're actually heading for what could be a catastrophic decline."

According to Hutchinson, traditional bank lending is no longer as profitable as it once was. The lengthy recession has dampened opportunities, and corporations are building large cash reserves, reducing their need for bank financing.

Meanwhile, trading profits are on the decline, regulation is expanding, and the housing market still hasn't hit bottom.

As a result, Bank of America recently announced that it would eliminate 30,000 positions in the next two and a half years and close as many as 750 branches.

And for those reasons we continue to insist investors steer clear of bank stocks.

Said Hutchinson: "In the "too-big-to-fail' era banks may get bailed out, but shareholders don't."

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"I think we're overextended in the short term," Axel Rudolph, a technical strategist at Commerzbank AG told Bloomberg News. "I wouldn't be surprised if we were to fail around $1,900 to $1,922 and retrace a little bit for a few days or so. It's still very bullish longer term. Longer term, I think $2,000 will definitely be hit."

In the short-term, silver may be the better investment.

Silver prices rose roughly 150% between August 2010 and April 2011. But the Chicago Mercantile Exchange (CME) unilaterally raised margin requirements on silver by nearly 100% in a mere eight days this spring. That caused silver prices to plunge by 30%.

Since then, silver prices have slowly worked their way back up - and they now appear destined to hit $60 an ounce in a matter of months.

The most obvious way to play silver's potential price increase is through an exchange-traded fund (ETF) - such as the iShares Silver Trust (NYSE: SLV) - but that's certainly not the best play to make.

In fact, a far more promising opportunity was recently leaked to Money Morning Private Briefing subscribers. If you're not subscribed to Money Morning Private Briefing then you can sign up and receive our premium report on silver - which includes that pick - by clicking here.

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Indeed, developed nations' debt problems remain unresolved and the Fed's monetary policy continues to weaken the dollar, making the outlook for gold very bright.

That's good news for Newmont Mining Corp., which has 93.5 million ounces of proven and probable gold reserves. The company generated nearly $10 billion in revenue and gross profit of $6 billion in its trailing 12 months.

Newmont's stock price does not yet reflect its true value, as the company has a Price/Earnings (P/E) ratio of just 11.27. But what's even better is that Newmont is pegging its dividend payout to the price of gold.

For instance, gold settled last Friday at $1,659 an ounce, leaving the dividend at 30 cents a share. But at Monday's record high price of $1,718 an ounce, the dividend jumped to 35 cents a share. The stock currently yields about 2.2%, but you can expect that to rise, and rise quickly, as the price of gold continues to soar.

McDonald's Corp.

McDonald's Corp. is the quintessential "recession-proof" stock. It's a huge company that's very active globally. It's made a big splash in fast-growing emerging markets - particularly in Asia - and hard economic times make its affordable menu even more appealing.

The company's same-store sales increased 5.1% in July. Sales were up 5.3% in Europe, 4% in Asia, and 4.4% in the United States.

McDonald's reported a second-quarter profit of $1.41 billion, or $1.35 a share, up from $1.23 billion, or $1.13 a share, a year earlier. Revenue jumped 16% to $6.91 billion.

A strong global brand, low prices, and growing revenue were enough to land McDonald's on Goldman Sachs Group Inc.'s (NYSE: GS) prestigious "Conviction Buy" list. The firm set a $96 price target on MCD, which suggests an 11% upside to the stock's Monday closing price of $82.11.

Goldman noted it sees a total potential return of 20% for the stock when including its dividend.

McDonald's stock is up 10.5% year-to-date, compared to a nearly 10% decline for the S&P 500.

Sturm, Ruger & Co. Inc.

Finally, there's Sturm, Ruger & Co. - the firearms manufacturer that's blowing away the competition.

Sturm Ruger's net income rose 32% to $10.8 million, or 57 cents per share in the second quarter. The company also is raising its dividend and buying back shares - two hallmarks of a good company.

Ruger has raised its dividend twice lately -- most recently when the company announced earnings on July 27, 2011. The new dividend rate is now 56.8 cents per share on an annualized basis. This brings the current yield to about 2.3%.

Meanwhile, the company bought back 133,400 of its 18.9 million outstanding shares in the first half of 2011. Those purchases absorbed $2 million; another $8 million in authorized purchases remain.

Ruger's large cash stockpile made all of this possible. The company had cash and equivalents and short-term investments of $76.5 million as of July 2.

The stock is up nearly 77% in the past year, compared to the S&P 500, which is flat.


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Market Mechanics

Gilani says what happens next boils down to margin mechanics and counterparty risk.

"It's the market's ‘mechanics' that presents the greatest danger, which 98% of investors, including professionals, aren't seeing. The focus now has to be on margin mechanics," says Gilani. "More margin calls mean more pain and much, much longer recovery from wherever the markets bottom out. The next few days are super important."

Gilani says this was made evident yesterday by the downgrades of several major clearinghouses and government-related entities.

Companies downgraded to double-A-plus with a negative outlook were: Knights of Columbus, New York Life Insurance Co., Northwestern Mutual, Teachers Insurance & Annuity Association of America, and United Services Automobile Association.

Companies affirmed at AA-plus with their outlook lowered to negative were: Assured Guaranty Corp., Berkshire Hathaway Inc. (BRK.A, BRK.B), Massachusetts Mutual Life Insurance Co., Guardian and Western & Southern Financial Group Inc.

"Any panic grab for collateral, and principally I'm fearful of this happening in thederivatives marketplace, would engender counterparty fears," Gilani said. "We've seen insurance company downgrades today, so the questions are being asked: What's the real level and quality of their capital, and do they have skeletons in the closet?"

With so much risk abounding, it's important that investors not panic, but rather prepare. They can do that in a number of ways, including:

• Buying gold: Gold prices hit a record high of $1,718 an ounce in intraday trading yesterday (Monday) in response to Standard & Poor's downgrade of the U.S. credit rating, and the continuing drumbeat of dreary global economic news will keep pushing the yellow metal higher.

• Investing in high-yielding, large-cap stocks: Large multinational companies that pay juicy dividends will be less susceptible to a market downturn, and could even prove to be bargains during a rebound.

• Employ inverse funds: Exchange-traded funds like the Rydex Inverse S&P 500 fund (MUTF: RYURX) move up as the market goes down, making them a viable hedge.

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What's more is that 34% of Republicans think their party didn't compromise enough, compared to 26% who thought the GOP compromised too much.

Democrats have the opposite problem.

While 41% of Democrats felt their party gave up too much ground, just 20% said their party could have done more.

If the statistics are to be believed we now have one party that is stubborn and obstinate, and another that is weak and ineffectual.

"Unfortunately, results like these underscore what we've been telling Money Morning readers for years - that our legislators haven't got a clue, that our regulators are a sham and that Wall Street truly does rule the roost," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "What saddens me most about all this is the fact that the specific fixes are actually not that difficult to understand or implement - if we only had the political willpower to do something about a crisis that's sold Main Street down the river."

Many Money Morning readers feel the same way.

"This situation has crystallized for all to see the depth of the political agendas which are running our country under the guise of government," wrote reader Sharon S. "I think the job that President Obama and Congress have done during this developing debt-ceiling debacle could hardly be called ‘doing the job' at all. With the U.S. economy struggling to rebound I see no collaboration or cooperation from the leaders and elected officials."

Many readers also have proposed changes to the electoral process.

Some suggested introducing term limits, while others suggested docking politicians' pay.

"I would cancel all checks going to the president, his cabinet, the House, the Senate members until a debt agreement is reached," wrote M.D. "And I would not compensate the lost pay. To get paid they must produce."

Unfortunately, it's hard to imagine such a solution will ever be implemented. All we can tell you is that we here at Money Morning hear you - and we're on your side.

So keep sending your comments and questions to mailbag@moneymappress.com. And we'll do our best to help guide your investment choices in these difficult times.

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A Race Around the World

Auto sales in China, which overtook the United States as the world's largest auto market in 2009, rose 32% last year to a record 18.06 million units. However, most of those sales have gone to foreign companies. China's domestic car companies have less than 20% of the local market, with Volkswagen AG (PINK: VLKAY), Toyota Motor Corp. (NYSE ADR: TM), and others swallowing up the rest.

Chinese auto companies are looking to change that - mainly by siphoning talent and know-how away from Western competitors.

China's government already requires foreign automakers to form joint ventures with domestic companies before entering the Mainland. And over the past two years Chinese companies have been trying to attract overseas talent.

First they went to Detroit following the bankruptcies of General Motors Co. (NYSE: GM) and Chrysler looking for high-level engineers with experience. And since then the search has broadened to Germany, Japan and the United Kingdom.

Beijing Automotive Group (BAIC) in May held its first recruitment fairs in the German cities of Stuttgart, Munich, and Aachen hoping to attract engineers. Dongfeng also went to Munich in May following in the footsteps of SAIC and Geely.

"Sure there are many engineers in China. But the talent pool is fairly shallow," Bill Russo, former head of Chrysler in China, told the Financial Times. "Chinese companies are finding that there are many engineers who have been educated in the West, including overseas Chinese, who are anxious to work in such a dynamic place as China. This allows them to fill the talent gap that they are unable to fill with domestic recruiting."

More Chinese automakers are also building overseas manufacturing and research and development (R&D) plants. It costs more to build and operate these plants abroad than it would domestically. However, companies like SAIC say that it's sometimes easier than attracting talent to China.

SAIC employs more than 400 workers - including 340 design engineers - at its MG Motor UK plant in Longbridge, Birmingham. And it may soon be joined by China's third-largest carmaker, FAW Group Co.

Mike Whitby, leader of the Birmingham City Council, said he spoke with representatives who traveled with Chinese Premier Wen Jiabao on a visit to the MG Motor UK facility.

"The Chinese premier brought a delegation of powerful industrialists with him to Birmingham," Whitby told the Birmingham Mail. "I met with FAW. There's a real positivity there and we are hopeful the warm relations we have nurtured will result in a new car assembly facility here in Birmingham."

Meanwhile, Chang'an has an R&D facility in Nottingham, just north of SAIC's Birmingham plant. It also has R&D centers in Italy and Japan, and just last year became the first Chinese carmaker to establish such a facility in Detroit.

Finally, as Nissan's Ghosn pointed out, Chinese auto companies are constantly on the lookout for acquisition targets - as evidenced by Geely's acquisition of Volvo. GM's Opel unit has been on the block since a deal with Canada's Magna International was scrapped in 2009.

Regardless of the route, one Chinese car company is destined to become a global leader.

China's top five exporters from January to May of this year were: Chery Auto Co. Ltd., Chang'an, Jianghuai Vehicle Group, Great Wall Motor Co. Ltd. and Dongfeng.

Still, SAIC may have the best shot at becoming a global leader, as it remains China's largest passenger car manufacturer. The company, which operates joint ventures with both GM and Volkswagen, plans to boost annual commercial vehicle sales to about 500,000 units by 2015.

Of course, rather than try and guess which of China's car companies will finish first, it may be easier to simply invest in a company like China Yuchai International Ltd. (NYSE: CYD), which builds and sells diesel engines that are mainly distributed in China.

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But not all of that money is presently accounted for. Roughly half of it – $6.6 billion – has disappeared.

“It may have been stolen. It was vulnerable to fraud and waste and abuse,” said Stuart Bowen, U.S. special inspector-general for Iraq reconstruction. “If it were stolen, it would be one of the most significant financial crimes in history.”

The money was vulnerable to fraud and abuse because many U.S. officials didn’t have the time or resources to properly track its distribution.

Upon arriving in Iraq, the cash was stored in U.S. military bases and in the basement of one of Hussein’s former palaces. From there it was packed into gunny sacks and driven in pickup trucks to Iraqi agencies and contractors, according to the Los Angeles Times.

Bowen says Iraqi officials have been less than cooperative during the process of tracking down the lost funds. Among other things, they have not authorized the Federal Reserve to release account information to U.S. auditors, despite requests over several months.

“We will only get to the bottom of this if we get cooperation from the Iraqi government,” he said.

Meanwhile, Iraqi officials have threatened to go to court to reclaim the money. They argue that according to a 2004 legal agreement, the United States was responsible for safeguarding the liberated funds.

“Clearly Iraq has an interest in looking after its assets and protecting them,” Samir Sumaidaie, Iraq’s ambassador to the United States, told The Times.

That means U.S. taxpayers, who already have coughed up $61 billion for reconstruction and development projects in Iraq, could be on the hook for another $6.6 billion.

Members of Congress, who are under pressure to reduce U.S. debt and balancing the budget, are already bristling at the notion.

“Congress is not looking forward to having to spend billions of our money to make up for billons of their money that we can’t account for, and can’t seem to find,” U.S. Rep. Henery Waxman, D-CA, told The Times.

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However, in the 12 months through March of last year, just 505,473 new businesses started up in the United States, according to the Bureau of Labor Statistics (BLS). That's the smallest number since the BLS began tracking the data in the early 1990s.

That's not all.

Businesses with fewer than 50 employees added just 27,000 jobs in May, compared to 84,000 in April and more than 100,000 in December and January.

So it's not surprising that the national unemployment rate in April climbed for the first time in six months to 9%. And after falling as low as 8.8% in March, the unemployment rate rose even higher in May, to 9.1%. Employers added just 54,000 workers in May - the smallest number in eight months.

Much has been made of the fact that many larger businesses say they plan to increase hiring during the months ahead, but that tide is beginning to turn. Optimism among U.S. chief executive officers in the second quarter actually fell from a record high in the first quarter, according to the Business Roundtable's economic outlook index.

The index decreased to 109.9 for the April-June period from a record high 113 reading in the previous three months. The Business Roundtable is an association of executives of corporations representing a combined workforce of more than 13 million employees and almost $6 trillion in annual revenue.

But what's worse is that small businesses are even more disillusioned.

In fact, a national survey of small business owners, released yesterday (Tuesday), showed declining optimism among owners of small businesses - the third straight monthly drop. That survey was conducted by the National Federation of Independent Businesses and polled 733 small businesses across the country.

"Only the big banks and the big manufacturers are winning," the NFIB said. "Earnings trends for small business are distressingly negative and the recovery is two years old."

Indeed, the biggest reason for the pessimism among small businesses is that U.S. consumers - who have been battered by tumbling home prices, tight credit, and exorbitant gas prices - aren't spending enough. Retail sales fell 0.2% last month, the U.S. Commerce Department said yesterday.

Of course, Money Morning Contributing Editor Martin Hutchinson has another explanation. He blames the worsening job picture on Washington's faulty policies.

"Washington's fiscal stimulus - including the government dumping nearly $1 trillion into such unproductive pursuits as ‘new energy' projects and state employee labor union contracts -- has generated massive budget deficits and given banks no incentive to play its key job-creation role by lending to small businesses," said Hutchinson. "Instead, the stimulus has provided temporary jobs with the government -- and those jobs are now disappearing as Washington's money runs out."

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But while LinkedIn may be somewhat overvalued at current prices, it's more than just a bubble. It's a company that's been around for nearly a decade. And in that time it's acquired a large band of customers, raised substantial revenues, and grown into a global competitor.

So let's take a closer look at the company and its prospects.

Bubble Trouble

First, forget everything you've heard about "Tech Bubble 2.0."

No analyst or newspaper publication in the country has been able to resist comparing the lofty valuations of new-generation Internet startups such as Facebook Inc., Twitter Inc., Netflix Inc. (Nasdaq: NFLX), and LinkedIn to the dotcoms that rose to exorbitant peaks in 1999 before flaming out in 2000.

But these comparisons aren't accurate, for the simple fact that too much has changed between then and now.

A decade ago most Internet users were married to sluggish dial-up modems, phones didn't come with keyboards and Internet access, and sleek touch-screen tablets were still science fiction.

Now every Starbucks Corp. (Nasdaq: SBUX) and McDonald's Corp. (NYSE: MCD) restaurant offers WiFi, and the gap between cell phones and personal computers is rapidly narrowing.

Additionally, Web access, computer hardware, servers and other infrastructure comes much cheaper.

Most importantly, compared to the last tech bubble, relatively few Internet companies are today positioning themselves for offerings. And the companies that are currently gearing up for offerings have better business models and proven earnings.

"The companies going public now are fairly large companies, with real users, real customers, real revenues, multiple revenue sources," venture capitalist Mark Aronson told NPR.

For instance, LinkedIn has been around for eight years. The company generated $243 million in revenue in 2010 through advertising revenue and premium subscriptions. And it brought in $94 million of revenue in the first quarter of 2011, which was more than double the year-earlier total.

Of course, that's not to say some things haven't changed. U.S. Federal Reserve Chairman Ben S. Bernanke, like his predecessor, has chosen to flood the market with cheap money, inviting speculation and sky-high valuations.

But that problem is not confined to tech stocks - it extends to all sectors and asset classes.

Neither gold, nor silver, nor oil will be able to survive at current levels once the Fed is forced to confront the high levels of inflation embedded in the economy.

Still, in the short term stocks and commodities will continue to benefit from the Fed's loose monetary policy and quantitative easing programs - that is until the central bank is forced to raise interest rates.

LinkedIn Abroad

Of course, there's nothing LinkedIn can do about monetary policy. So long as there is liquidity sloshing around the markets many stocks will be overvalued.

That includes LinkedIn, which at $8.9 billion is valued at 35-times its 2010 revenue and more than 500-times last year's meager 17-cent-per-share profit.

Still, that doesn't mean LinkedIn is doomed to failure. It just means investors have to wait for a fairer price. Indeed, patience will be key for any LinkedIn investor, as the company has already said it doesn't expect to turn a profit next year.

Instead, LinkedIn will invest in technology and international growth.

It may surprise you to learn that LinkedIn actually has more overseas users than it does domestic users. Of the company's 101 million total users, 45 million are located in the United States with the remainder abroad.

LinkedIn already has existing operations in much of Europe, especially the United Kingdom. Now the company is looking to expand its presence in the Asia-Pacific region.

"According to [research firm] Comscore, from March of last year to March of this year, we grew 130% in [Asia-Pacific]," said Arvind Rajan, LinkedIn's vice president and the managing director of its Asia-Pacific unit. "We think that by having a presence here, by expanding our footprint in Asia, we'll see continued, sustained growth."

LinkedIn, whose offices in India and Australia are each just 18 months old, plans to open its Asia-Pacific headquarters in Singapore later this month, and a Japan office later this year.

"Singapore is of course smaller than the markets in India and Australia...but it increasingly moved up higher on our list because our user penetration in Singapore was so high and it's an incredibly vibrant economy," Rajan told ZDNetAsia.

LinkedIn has more than 540,000 users in Singapore, which equates to about half the professional workforce there. But that's not all. The city-state will also serve as a fulcrum for LinkedIn's Asia-Pacific business ventures.

"It's not just the Singapore market by itself, but Singapore has access to customers that have a regional responsibility," said Rajan. "So I'm not only selling to a particular company for their needs in Singapore, but their needs across the region, which makes it so exciting."

LinkedIn is particularly interested in China, where the company believes it could quickly reach 100 million working professionals.

"We hear from our members globally every day, 'When are we going to be bigger in China?' They want to do more business in China. They want to hire people in China," Rajan said at the CHINICT tech conference in Beijing last month. "We also hear from Chinese companies that they want to hire people on a global basis."

Other social media networks such as Facebook and Twitter have been blocked in China, but LinkedIn, which is more of a professional Website, has had fewer problems. However, LinkedIn was temporarily blocked in February due to an anonymous online protest call made on the site.

A greater hurdle will be the competition that's been fermenting on the Mainland. China's homegrown version of LinkedIn, a site called Ushi (Outstanding Professional), could pose a serious challenge, as could another local rival, Tianji.com.

Still, LinkedIn continues to lead in the United States, the most developed market for professional networking. It also has made significant inroads into Europe and Asia, claims to be adding 1 million members every 10 days, and more than doubled its first-quarter revenue this year.

On top of that, the company just executed the biggest Internet IPO since Google Inc. (Nasdaq: GOOG).

So if LinkedIn is a bubble, it's an awfully formidable one.

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Of course, while China may be experiencing some acute growing pains, its economy regressed the least in the wake of the global financial crisis - and it will continue to operate as the engine of global economic growth going forward, even if the United States relapses into recession.

In fact, China's GDP will rise from $11.2 trillion in 2011 to $19 trillion in 2016, while the U.S. economy will increase from $15.2 trillion to $18.8 trillion, according to the International Monetary Fund (IMF). That means in five years China will have supplanted the United States as the world's No. 1 economy.

China's share of the global economy will ascend from 14% to 18% in that time, while the United States' share will descend to 17.7%.

A Guide to China's Economy

The rise of China's economy - now the world's second largest - has been meteoric. But the time has come for the country to evolve from a source of cheap labor and manufacturing to a fully developed economic power with a consumer class that's capable of sustaining domestic growth.

China already has made some remarkable progress in rebalancing its economy. The country's trade surplus is narrowing and wages are on the rise.

The central government is targeting an increase in minimum wages of 13% a year through 2015. Additionally, Chinese Premier Wen Jiabao aims to increase per capita household income by 7% a year in real terms during that period. He's also pledged to improve the social security and healthcare systems to help low-income households and to raise the personal income tax threshold - all in an effort to give the country's 1.3 billion people more spending power.

"We will ensure that people's income increases keep pace with economic growth and people's salary growth keeps pace with the productivity rise," Wen said last month in an online chat with the Chinese public.



China's 31 provinces boosted minimum wages by an average of 24% last year, according to Yin Weimin, China's minister of human resources and social security. Meanwhile, the average monthly income for migrant workers rose 13% to $256.89 (1,690 yuan).

Six provinces have already raised minimum wages this year, with labor shortages and government mandates likely to compel the remaining 25 to follow suit.

Rising wages have directly translated to an increase in retail sales, which rose 16.3% to $657.29 billion (4.2922 trillion yuan) in the first quarter, according to the National Bureau of Statistics. Sales in March rose 17.4% from a year earlier, and edged up 1.34% from February.

"China is trying to rebalance its economy to become more consumer oriented. Wages are rising. People are earning more and will shop more, and that's good news for Chinese retailers," Andrew Sullivan, Director of Institutional Sales Trading at OSK Securities in Hong Kong, told CNBC.

Shockingly, the country that for so long has been infamous for its thriftiness has become the world's largest market for luxury goods.

As of December 2010, sales of luxury goods in China rose to $10.7 billion, or 30% of total global sales, up from $9.4 billion in 2009, according to the World Luxury Association (WLA).

Luxury brands like Coach Inc.(NYSE: COH), LVMH Moet Hennessey Louis Vuitton SA (PINK: LVMHF), Burberry Group PLC (PINK: BURBY), and Hermes International SCA (PINK: HESAF) have all benefited from China's splurging.

Coach last week reported a better-than-expected 18% increase in fiscal third-quarter profit, thanks largely to China. China revenue currently totals about $185 million and continues to increase by double-digit percentages, the company said.

Rolls Royce saw its China sales rise 600% last year, putting it above Britain as the company's second-biggest customer behind the United States.

China's luxury car sales are expected to rise to more than 909,900 units this year, up from about 727,200 last year, according to forecasts by IHS Automotive. And that number could climb to 1.6 million by 2015.

China is already the world's largest auto market, with 18 million units sold last year. That figure is expected to grow to 23 million by 2015.

As further testament to China's newfound consumer wealth, the GroupM Knowledge-Hurun Wealth Report 2011 showed the number of millionaires on the mainland is up 9.7% from a year ago. And the country has 115 billionaires according to Forbes magazine's 2011 list -- second only to the United States.

Indeed, China's domestic consumption has shown the rapid growth that has become the country's trademark. But more importantly, it's advanced the central government's goal of a more balanced economy by helping to reduce the nation's disproportionate trade surplus.

China in March posted its first trade deficit - about $1 billion - since 2004.

Strong demand for imported consumer goods and higher prices for commodities drove the value of China's imports to $152 billion in March. The value of China's imports hit a record high of more than $400 billion in the first three months of the year.

Last year, China ran a trade surplus of about $15.25 billion a month. However, 2010 also was the second consecutive year in which the trade surplus shrank, falling 6.4% from 2009 to $183.1 billion.

The State Information Center forecast China's imports to rise 20% in 2011, while exports will increase by 16%. That would trim the trade surplus by 13.2%.

China wants to double its imports by 2015, reducing the trade surplus to zero and emancipating itself from an export-reliant economy.

Potential Setbacks to China's Economy

Of course, China's rapid transformation has not gone off without a hitch. Inflation remains uncomfortably high, and there are fears of a growing bubble in the nation's red-hot property market.

The most recent consumer price index showed inflation rising at 5.4% in March, the fastest pace in three years.

China's inflation rate will likely rise above 5.5% in June, a team of economists at Bank of America-Merrill Lynch said in a report yesterday (Wednesday). However, that's likely to be the peak as Chinese policymakers are working overtime to stifle inflation at the expense of growth.

The People's Bank of China (PBOC) has raised the benchmark interest rate four times- an increase of 100 basis points - and the reserve requirement seven times since October.

"Stabilizing prices and managing inflation expectations are critical," the PBOC said in a first-quarter monetary policy report published yesterday.

Still, China's economy is overheating because capital is flowing into the mainland faster than it is flowing out. China's foreign exchange reserves, having increased by $197 billion in the first three months of the year, now exceed $3 trillion.

Indeed, huge trade surpluses and the large-scale purchases of U.S. Treasuries - which China makes to suppress the yuan's value - have resulted in a 17-fold increase in the country's reserves over the past decade.

For every dollar that goes into China's reserves, the country prints 6.5 yuan.

Furthermore, lending and money supply in the country continue to grow faster than expected.

China's top four state-owned banks dispersed $40.1 billion (260.6 billion yuan) in new loans in April, slightly higher than the $37.3 billion (242 billion yuan) issued in March, according to local financial news provider Caixin. This is despite the fact that China's biggest banks are required to keep 20% of their deposits on hand as reserves.

"What China calls ‘total social financing' - conventional bank loans and most other external sources of finance - was still 38% of GDP in the first quarter of 2011, almost as high as in 2009 when China implemented a credit-centric stimulus program," UBS AG (NYSE: UBS) economist Robert Magnus said in a column in the Financial Times. "The credit intensity of growth, or the amount of new credit generated for each unit of GDP growth, has risen from 1-1.3 before 2009 to 4.3 in 2011."

Many of the new loans are going into China's property market, which is accelerating at a dangerous pace.

The value of homes sold in the first quarter increased to $132 billion (860.7 billion yuan), the Statistics Bureau said last month, driving overall property transactions 27% higher to $157 billion (1.02 trillion yuan).

The total value of homes sold in March alone rose to $63.7 billion (414 billion yuan), which is close to the total of the first two months of this year combined. New home construction rose 20% in the first quarter to 310.2 million square meters (3.34 billion square feet), the statistics bureau said.

Overall investment in China's real estate rose 34% to $136.4 billion (885 billion yuan) in the first quarter, according to the government data.

Startlingly, these figures suggest that Beijing's attempts to cool the property market so far have been ineffective.

"While these growth rates are below ones seen in early 2010, they remain high relative to what developers are reporting and what the policy tightening would have suggested," Citigroup Inc. (NYSE: C) analysts said in a report. "We see this as a sign that the tightening probably has not yet been fully implemented at the local level."

A rising number of institutions are growing concerned about China's real estate market.

Even China Citic Bank Corp. Ltd. (OTC: CHCJY), the seventh-largest Chinese lender by assets, said yesterday that the country's property market has become too risky and it plans to cut lending to the sector.

"Citic Bank relatively clearly sees that real estate risk this year is severe," Shi Yuan, the general manager of the bank's risk management section, said on a quarterly teleconference. "We especially are paying attention to risks in the funding chain for developers. We believe as tightening continuously gets stronger, the true real estate risks will appear."

Still, it's important to remember that while bubbles may be forming - especially in the property market - the overall trend of China's growth is positive.

"Yes there are probably pockets of bubbles in China and in the real estate market, but against that backdrop you have 500 million people expected to move into Chinese cities by 2020. That means the number of people expected to move into cities is almost double the population of the United States," said Money Morning Chief Investment Strategest Keith Fitz-Gerald. "So in the context of China's explosive growth, what we're looking at are some moderate setbacks over an extended period of high growth."

China Investment Plays

Indeed, China is a growth story too compelling to pass up. However, investors should focus on parts of the Chinese economy more stable than the real estate sector.

That means playing trends like consumption.

The Claymore/Alpha Shares China Small Cap ETF (NYSE: HAO) has a large percentage of its holdings in consumer-focused firms. Consumer staples and consumer discretionary sectors represent 9.3% and 15.8%, respectively, of the fund's holdings.

You might also consider large U.S. multinationals that have a sizeable footprint in China. These companies continue to benefit from China's fast-growing consumer class and are less susceptible to potential setbacks.

McDonald's Corp. (NYSE: MCD) and Yum! Brands Inc. (NYSE: YUM) are two food operators profiting from China's growing consumerism.

Additionally, the revamped General Motors Co. (NYSE: GM) has a very strong presence in China. GM is expected to retake the crown for most global auto sales from Toyota Motor Corp. (NYSE ADR: TM), which has been devastated by the recent disasters in Japan.

The company intends to introduce more than 60 new or upgraded models for the Chinese market and aims to double sales to around 5 million units by 2015.

There's also China Yuchai International Ltd. (NYSE: CYD), which manufactures and sells diesel engines - most of which are distributed in China.

As mentioned earlier, luxury sales in China continue to rise as well. That stands to benefit luxury brands like Coach Inc. (NYSE: COH), Burberry Group PLC (PINK: BURBY), and Compagnie Finciere Richemont (PINK: CFRUY).

Finally, Money Morning's Fitz-Gerald likes the Morgan Stanley China A Shares Fund (NYSE: CAF).

"I particularly like CAF because small business ventures in China have the most to gain and most of those companies are traded only in China A shares," said Fitz-Gerald. "And CAF is the only fund that gives U.S. investors ‘direct access' to the A-shares."

CAF is one of the best ways to profit from China's shifting growth model. A recent portfolio allocation of the fund showed 28% of its holdings were in consumer goods and services, 26% were in financials and 18% were in basic materials.

CAF also holds shares in companies that make auto components and beverages, among other products, and has numerous stocks in the metals and mining sectors.

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"Higher prices at the gas pump and at the grocery store have rattled consumers," Tim Quinlan, an economist at Wells Fargo Securities LLC told Bloomberg News.

Food prices soared 3.9% last month - the biggest gain since November 1974 - according to the Labor Department's producer price index. Meanwhile, oil prices are up 11.5% from where they ended February. The average price for a gallon of regular gasoline was $3.662 yesterday (Monday), according to the AAA Daily Fuel Gauge Report. That's up from $3.493 a gallon a month ago and $2.826 this time last year.

Furthermore, higher commodities prices have raised input costs for many manufacturers and producers, which are now passing those costs onto consumers. Consumers, in turn, have cut back on spending and ramped up their bargain hunting, raising concerns that less spending will stall the economic recovery.

"Consumers' inflation expectations rose significantly in March and their income expectations soured," said Lynn Franco, director of the Conference Board's consumer research center. That "will likely impact spending decisions."

Still, not every analyst is worried. In fact, many believe that while March's data was weak, it's only natural to experience such hiccups coming out of a recession.

"The economy is still recovering from a substantial crisis. You've got some indicators pointing to faster growth but there are still areas of weakness, especially housing,"

Vassili Serebriakov, senior currency strategist at Wells Fargo told Reuters. "As far as consumer confidence, it all hangs on how long the Mideast unrest will last and how high oil prices will go. The good news is that despite all the negative news headlines, equity markets have been tremendously resilient, so that will help confidence going forward."

And, again, spiraling consumer confidence traditionally hasn't been a very good barometer of where stocks are headed.

"We've seen sluggish consumer confidence in the early 90s, and markets continued to rally higher, so there was an elongated bottoming there," said Steve Goldman, a market strategist at Weeden & Co. "So today's data is probably not going to have much (impact)."

The S&P 500 so far this month has traded mostly sideways.

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Then uranium prices would bounce back from their current level around $60 a pound to their pre-Japan crisis highs of $73 a pound. And that would just be the beginning, as higher oil prices, concerns over carbon emissions, and soaring demand for nuclear energy could drive uranium prices back up to $90, or even $140 a pound as seen in 2007.

That's precisely the scenario industry insiders have in mind.

Indeed, those closest to the situation do not believe that Japan's disaster will be the death knell for nuclear power. On the contrary, they see it as a short-term blip that will drive antsy speculators out of the market and make room for investors looking to profit from the energy of the future.

"It's going to move irregularly up. By around 2013 we'll be looking for at least $90 US per pound," Patricia Mohr of Scotiabank Group told the Business News Network. "Mostly because of a doubling of China's nuclear objectives over the coming decade."

Powering Ahead

The price of uranium oxide, the most commonly traded form of the nuclear fuel, plummeted 27% to about $50 a pound in the spot market in the days following Japan's earthquake and reactor explosion.

But since then, the spot price has rallied some 20% to more than $60 a pound - showing that many investors see uranium's dip as a buying opportunity.

And why shouldn't they?

Solar, wind, hydro, and geothermal energy are too underdeveloped to take the energy mantle away from oil and natural gas. So there is still a gaping need for an alternative energy source that doesn't carry the monetary or environmental cost of fossil fuels. And despite the catastrophe in Japan, many countries plan to expand their nuclear energy programs following a relatively brief review of safety regulations and protocol.



"It's not like the world' s major energy issues have been in any way solved by first-hand reminders of the dangers of nuclear power," Katy Payn, a Sydney, Australia-based political risk manager told Xinhua. "That danger has always been there, this is merely a wake-up call."

U.S. President Barack Obama just last week said that nuclear power would continue to play a role in U.S. energy policy.

"It's important to recognize that nuclear energy doesn't emit carbon dioxide in the atmosphere, so those of us who are concerned about climate change, we've got to recognize that nuclear power, if it's safe, can make a significant contribution to the climate change question," President Obama said last Wednesday. "We're going to incorporate those conclusions and lessons from Japan in design and the building of the next generation of plants. But we can't simply take it off the table."

And then there's China.

China is the world's largest emitter of greenhouse gases. It's also undergoing a rapid modernization that has seen millions of workers flood its cities in search of factory jobs.

China seeks to employ solar, wind and hydropower to fuel its expansion, but nuclear power remains a priority as well.

As it stands now, China has 13 working reactors with a generating capacity of 10.8 million kilowatts, and 32 reactors capable of producing 30.97 million kilowatts under construction.

The State Council said on March 16 that it would stop approving new nuclear plants "until safety and improved long-term development plans are cleared." But the country still plans to begin construction on a state-of-the-art nuclear plant this month.

The fourth generation plant will use gas for cooling instead of water.

"There are differences between the Japanese and Chinese reactors," Cui Shaozhang, deputy general manager at Huaneng Nuclear Power Development Co. told Bloomberg News. "Japan's Fukushima plant was using old technology while Chinese reactors are more advanced."

China's 12th Five-Year Plan targeted 42.9 million kilowatts of nuclear power generation capacity by 2015 and 100 million kilowatts by 2020. Concerns about a potential meltdown forced authorities to back off that target, but not in a major way.

Wei Shaofeng, deputy director of the China Electricity Council, said he believes the central government will reduce its 2020 target by just 10 million kilowatts - if it makes any adjustment all.

Meanwhile, China will be joined by other Asian countries that see nuclear power as a viable substitute for coal-fired power plants.

India, for instance, is sticking to its plan for a 13-fold increase in nuclear energy capacity by 2030.

"You can see rapid growth in nuclear installed capacity in India and China, notwithstanding the events in Fukushima," said Michael Parker, a Hong Kong-based analyst at Sanford C Bernstein & Co. "The cheapest, most easily scaled, cleanest, and most technologically mature source of electricity for these economies is nuclear."

The planned increase in atomic power would bring the Asian nations to 30% of the world's total from the current 4%, according to Sanford C Bernstein & Co.

"Asian nations will be thinking about how to meet electricity demand, which is always rising," Hiroshi Miyata, chief executive officer of Marubeni Power Development Co., a builder and operator of power stations outside Japan, told Bloomberg. "It may slow construction of nuclear plants, but investments will probably continue."

A Buying Opportunity

Indeed, the growth prospects for nuclear power remain strong, as do the prospects for its yellow cake fuel.

In fact, uranium demand will grow by 33% in the next decade to correspond with projected growth in nuclear reactor capacity, according to the World Nuclear Association.

"There's still a strong demand globally for uranium," Greg Hall, managing director of uranium exploration company Toro Energy Ltd. (PINK: TOEYF), told The Australian. "There's 440 operating reactors, there's approximately 60 under construction - even if there's a freeze for a few months on new builds... that doesn't mean a massive slowdown in the industry."

Toro isn't the only uranium miner unfazed by what's perceived as a temporary setback in the price of uranium.

Cameco Corp. (NYSE: CCJ), the world's second largest uranium mining company, is moving ahead with plans to double production to 40 million pounds a year by 2018.

"We see no reason to slow down the doubling of production," Cameco Chief Executive Officer Jerry Grandley told Reuters. "Even if there is a pause or slowdown (in the nuclear plant buildout) as expected."

Current global uranium demand is about 180 million pounds a year, while mine output stands at about 140 million pounds, according to Reuters.

"My sense is, given all those pieces, there isn't going to be much of a change in the supply and demand imbalance that we have, and in the need for new projects to come online in the next decade," said Grandley.

Still, shares of uranium producers have been hard hit in the wake of Japan's struggles. Cameco and Uranium Resources Inc. (Nasdaq: URRE) have each plunged some 25% in the past month, while shares of Uranium Energy Corp. (AMEX: UEC), an exploration-stage company, are down 28% in that time.

Many analysts say these declines are a good chance for opportunistic investors to cash in.

"With share prices falling it makes it more difficult to finance mines. But by the same token, so long as the uranium price doesn't stay down too long, it means there's great opportunities for investors to buy stocks at these levels and it's a price that I didn't think we'd see again," Warwick Grigor, executive chairman of BGF Equities, told The Australian. "The market has come off 50% since January and for anyone who can think more than one or two months ahead, then I think it's a great buying opportunity for Australian uranium companies."

Of course, it's not just Australian producers that could see a sharp bounce back.

Analysts project an average advance of 82% for the uranium companies in the Global X Uranium ETF (NYSE: URA) that have 12-month price estimates, according to data compiled by Bloomberg.

The Global X Uranium ETF is down 27% in the past four weeks.

"You're offered fundamental upside if you believe the sell-off in the uranium stocks is overdone," said Andrew Ross, partner and global equity trader at First New York Securities LLC, told Bloomberg. "The Chinese are taking a very long-term view of their energy needs and they have to incorporate some element of nuclear power into their plans. You just have to overcome the headwinds of the Japanese issues."

News and Related Story Links:

• BNN:
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• The Australian:
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• Xinhua:
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• Bloomberg:
  China, India Add Nuclear Units After Quake, Bernstein Says

• MarketWatch:
  China may revise nuclear-power target

• Reuters:
  Cameco CEO says nuclear future still sound

• Bloomberg:
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• Money Morning:
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• Money Morning:
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The central government is targeting an increase in minimum wages of 13% a year through 2015. Additionally, Chinese Premier Wen Jiabo aims to increase per capita household income by 7% a year in real terms during that period. He's also pledged to improve the social security and healthcare systems to help low-income households and raise the personal income tax threshold - all in an effort to give the country's 1.3 billion people more spending power.

But that's not all. Labor shortages have driven up wages, as well.

Dong Tao, Credit Suisse Group AG's (NYSE: CS) chief regional economist for the Asia region excluding Japan, told BusinessWeek that China is fast approaching the so-called "Lewisian turning point" - a critical moment in a developing economy when its surplus labor supply dries up, prompting hikes in wages, prices, and inflation. In China, demand for workers will outstrip supply by 2014, Tao's team calculated in a January report.

"When historians go back and describe 2010, the big story will be the massive increase in salaries that will redefine the global manufacturing model and redefine the inflation outlook for the next 10 years," said Tao.

Indeed, rising wages - while improving the quality of living for many Chinese - have accelerated inflation, both domestic and global.

Chinese inflation topped expectations at 4.9% in the year to February. Food prices alone rose 11% in February. The producer price index - a measure of inflation at the wholesale level - rose 7.2% in February, the biggest increase since October 2008.

Premier Wen places most of the blame on higher commodity prices and lax Western monetary policies, but he acknowledges that his country's rapid growth is at least partly responsible for rising prices.

"There is an inseparable connection between the pace of economic development, employment and inflation," said Wen. "When the pace of economic development is fast, there is more employment, but inflationary pressures are also bigger."

China wants to keep inflation below 4%, while maintaining an official economic growth target of 7% per year for 2011-2015. However, the government's 7.5% target for 2005-2010 was exceeded on a routine basis, and inflation will likely prove equally inextinguishable.

Manufacturers Moving Out

Higher wages have fanned inflation, but they're draining the country's gorged manufacturing base.

Indeed, Chinese workers are no longer at the bottom of Asia's pay scale. In 2009, monthly factory wages in Ho Chi Minh City, Vietnam were about $100. They were $148 in Jakarta, Indonesia and $47 in Dhaka, Bangladesh. Monthly wages in Shenzen, China by that point had reached $235. And now they're likely significantly higher.

Higher wages for Chinese laborers have directly translated to higher prices for finished products. Because China manufactures so much of the world's apparel, Chinese inflation is especially evident in higher clothing prices.

Next, Britain's second-biggest retailer, said in January that higher labor costs in China will contribute to an 8% increase in prices in the first two quarters, BusinessWeek reported. And trading group Li & Fung of Hong Kong, a top apparel supplier to Wal-Mart Stores Inc. (NYSE: WMT), says the price of Chinese exports will rise as much as 15% this year as workers earn more.

"The pressures aren't subsiding," Randal J. Konik, an equity analyst at Jefferies & Co. (NYSE: JEF) in New York, said in a research note. Konik identified luxury handbag maker Coach Inc. (NYSE: COH) and women's clothing retailer Chico's FAS Inc. (NYSE: CHS) as having "high exposure to Chinese manufacturing."

Coach in January announced a four-year plan to move the production of handbags and wallets out of China and into countries with cheaper labor. About 85% of the company's products are made in China now. But Coach plans to cut that to 50% to 60% by 2015.

Ironically, the higher wages that are driving Coach out of China have made that country the company's fastest growing market. Coach is still new to the Chinese market, but sales there rose by double digits on a percentage basis. China sales make up less than 5% of China's total business, but that's expected to rise to 10% by 2014.

Beijing is comfortable with that trade off, as China's central government aims to make domestic consumption the main driver of economic growth, rather than exports.

Trade Balance

While wages in China are on the rise, exports are on the decline.

In fact, China reported a $7.3 billion monthly trade deficit in February - its largest in seven years - as imports climbed sharply but exports lagged. Imports rose 19.4% year-over-year in February, while exports edged up just 2.4%

The February results may have been influenced by the Lunar New Year, but there also is a larger pattern developing.

Last year marked the second consecutive year that China's trade surplus shrank, falling 6.4% from 2009 to $183.1 billion. Imports rose 38.7% from the year before while exports increased 31.3%.

China's trade surplus accounted for 3% to 4% of the country's gross domestic product (GDP) in 2010, down from almost 11% in 2007.

Furthermore, the central government said in its most recent five-year plan that China aims to double its imports by 2015, reducing its trade surplus to zero.

"They believe now China's economy has gotten to the point where it can handle this kind of transformation," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "Many people continue to believe that China will live and die by its exports to the United States. Not so - exports account for only about 30% of its GDP and even less of its growth as that nation shifts to internal consumption."

Chinese domestic consumption grew at an average rate of 15% between 2001 and 2010, positioning the country as the world's second-largest importer in 2010, according to China Daily. And the State Information Center forecast China's imports to rise 20% in 2011 while exports increase by 16%. That would trim the trade surplus by 13.2%.

Cashing in on China's Consumerism

Investors should brace for China's transformation by moving away from companies that have a large manufacturing base in China and into companies that sell to its increasingly powerful consumer class.

McDonald's Corp. (NYSE: MCD) and Yum! Brands Inc. (NYSE: YUM) are two food operators profiting from China's growing consumerism.

Some luxury brands, like Coach, will also benefit - so long as they move production out of the mainland. Burberry Group PLC (PINK: BURBY) and Compagnie Finciere Richemont (PINK: CFRUY) are two luxury retailers currently growing their sales in China.

There's also the Claymore/Alpha Shares China Small Cap ETF (NYSE: HAO), which has a large percentage of its holdings in consumer-focused firms. Consumer staples and consumer discretionary sectors represent 9.3% and 15.8%, respectively, of the funds holdings.

Finally, Money Morning's Fitz-Gerald likes the Morgan Stanley China A Shares Fund (NYSE: CAF).

"I particularly like CAF because small business ventures in China have the most to gain and most of those companies are traded only in China A shares," said Fitz-Gerald. "And CAF is the only fund that gives U.S. investors ‘direct access' to the A-shares."

CAF is one of the best ways to profit from China's shifting growth model. A recent portfolio allocation of the fund showed 28% of its holdings were in consumer goods and services, 26% were in financials and 18% were in basic materials.

CAF also holds shares in companies that make auto components and beverages, among other products, and has numerous stocks in the metals and mining sectors.

News and Related Story Links:

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A Swede Turnaround Play

Sweden for a long time was an investment wasteland.

Since World War II, the Swedish economy has been characterized by its extensive and universal social benefits, which are funded by high taxes.

Financial and housing bubbles formed in the 1980s, leading to a crisis in 1990. The country's gross domestic product (GDP) declined by 5% between 1990 and 1993. And in 1992 there was a run on the krona that forced the central bank to hike interest rates as high as 500% in an unsuccessful effort to defend the currency's fixed exchange rate. Total employment fell by almost 11% during the crisis.

Yet the country appears to have learned from its checkered past, as the financial crisis of the past few years has had a relatively small impact on the Swedish economy.
In an op-ed piece that ran in The Local in January, Prime Minister Fredrik Reinfeldt and three of his ministers lauded the country's progress ahead of the World Economic Forum.

"In the wake of the crisis in the 1990s, a number of key foundation stones were laid to ensure that Sweden was on stable ground," they said. "An independent central bank, clear rules for fiscal policy and the pension reform were perhaps the most important elements. The importance of EU membership for the development of both legislation and regulatory frameworks, and ways of thinking, must not be underestimated."

The policymakers - which included ministers of finance, foreign affairs, and international development and cooperation - also acknowledged the role played by deregulation and privatization.

"Crisis-struck countries are now looking to Sweden, to learn from our example," they said. "However, it is not only the cornerstones of the economy that are arousing interest. There is also curiosity about the reform policy to get more people in work that has clearly contributed to the crisis having less of an impact than many expected."

Sweden is one of the few countries to increase its workforce during the financial crisis, adding 100,000 people. Sweden's unadjusted jobless rate was 8.2% in January, as the number of unemployed workers fell by 44,000 year-over-year to 408,000.

What's more is that the costs of the implemented stages of the in-work tax credit and other reform programs have amounted to just 2% of 2011 GDP. Indeed, Sweden's public debt totaled an estimated $42 billion in 2010 - down from $46 billion in 2007 and $52 billion in 2004 and 2005.

Sweden's debt will narrow to 37.5% of GDP in 2012, less than half the EU average of 83.3%, according to the European Commission (EC). Meanwhile, Sweden's debt office said in November that it expects national debt to shrink to 29% of GDP by the end of next year.

Sweden will post a budget surplus of $2.8 billion (18 billion kronor) this year and a $12 billion (78 billion kronor) surplus in 2012, the debt office said.

Next year's estimate includes income of $5.4 billion (35 billion kronor) from state asset sales, as the government continues to its drive towards privatization.

The Swedish government earlier this month sold about a third of its stake in Nordea Bank AB (PINK: NRBAY), the Nordic region's largest lender, recouping $3 billion (19 billion kronor).

"Proceeds from the sale will be used to reduce further the Swedish national debt so as to strengthen the stability of the Swedish economy," said Financial Markets Minister Peter Norman. The government plans to keep reducing its stake until the next election in 2014.

Prime Minister Reinfeldt earmarked Nordea for divestment back in 2006 as part of a broader strategy to sell off assets, including phone company TeliaSonera AB and mortgage lender SBAB.

Exports have been a terrific boon for the Swedish economy as well.

Swedish exports climbed 21% in December from a year earlier, as the nation posted a trade surplus every month last year except August. The country aims to double exports to about $310 billion by 2015, Trade Minister Ewa Bjoerling told Bloomberg News in an interview on Feb. 1.

"Sweden is benefiting from the diversification of their exports," Marc Chandler, the global head of currency strategy at Brown Brothers Harriman & Co. in New York told Bloomberg. "Sweden is a small, open economy that is more dynamic than most of Europe. The krona is a great story," and may appreciate to about 8.5 per euro, he said.

The krona currently trades at about 8.8 per euro.

"At the moment Sweden is a beautiful story," David Bloom, global head of foreign-exchange strategy at HSBC in London, told Bloomberg. "The growth outlook is good, exports are rising, interest rates are moving higher and the budget situation is good."

The Organization for Economic Cooperation and Development (OECD) agrees. It forecast continued strong Swedish growth of 3.9% this year and 3.4% in 2012. The organization also expects the strong growth to continue in 2012 by an additional 3.4%.

"The Swedish economy is strong like Pippi Longstocking," said OECD Secretary General José Ángel Gurría.

Perhaps even more impressive is that the World Economic Forum ranks Sweden second in the world in global competiveness - ahead of the United States and Singapore, and behind only Switzerland.

Sweden benefits from the world's most transparent and efficient public institutions and low levels of corruption, the 2010-2011 Global Competitiveness report said.

"Combined with a strong focus on education over the years (ranked 2nd for higher education and training) and the world's strongest technological adoption (ranked 1st in the technological readiness pillar), Sweden has developed a very sophisticated business culture (2nd) and is one of the world's leading innovators (ranked 5th)," the report said.

Unfortunately, there aren't many avenues available to foreign investors looking to profit from Sweden's turnaround.

LM Ericsson Telephone Co. (Nasdaq ADR: ERIC) is the only Swedish company listed on a major New York exchange. The company last month reported a 172% rise in 2010 net income, which climbed to $1.7 billion (11.2 billion kronar). The increase was the result of better performance at Sony Ericsson, fewer restructuring charges, and a 30% increase in mobile broadband subscriptions.

The iShares MSCI Sweden Index exchange-traded fund (NYSE: EWD) is another way to go. Its top holdings include Nordea Bank, Ericsson, and clothing retailer Hennes & Mauritz AB.

News and Related Story Links:

• The Local:
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Money Morning Contributing Editor Peter Krauth recommended buying silver on Sept. 1 when "white metal" was trading at about $19 an ounce. More recently, however, Krauth on Dec. 2 said silver had the potential not just to break the $30 an ounce barrier, but climb significantly higher.

"I believe we're looking at a target price for silver of $38 an ounce," said Krauth, citing the Fed's quantitative easing policy and the oft-overlooked sliver-to-gold ratio.

Gold also rose today with a surge into record territory. The "yellow metal" gained $9.50, or 0.7%, to $1,415.80 an ounce on the Comex division of the New York Mercantile Exchange (NYMEX). It earlier traded as high as $1,422.40 an ounce.
The metal last closed at a record on Nov. 9, when it settled at $1,410.10 an ounce.
[Editor's Note: Peter Krauth, a frequent contributor to Money Morning, is the editor of the Global Resource Alert, a private advisory service that focuses on precious metals, energy commodities and other natural-resource-related topics. Krauth spent two decades as a market analyst and portfolio advisor, and has covered all the commodities sectors, including gold, silver, coal, alternative energy and agriculture. He even makes his home in Canada - to be closer to the action. And several of his recent predictions have generated a genuine Internet buzz.

To find out more about commodities, or the Global Resource Alert, please click here.]

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Now, after last week's midterm elections, a more conservative Congress could further undermine the legislation.


For example, the "Volcker Rule," named after former Federal Reserve Chairman Paul Volcker, was originally designed to prohibit banks from engaging in proprietary trading. The rule was loosened to allow limited investments in hedge funds and private equity funds, but even that is too much for newly elected House Republicans.

In a letter sent to the Financial Stability Oversight Council, U.S. Rep. Spencer Bachus, R-AL, said the Volcker Rule – even its weakened state – would "impose substantial costs on the American economy and market participants" with "doubtful" benefits.

"Depending on how U.S. regulators choose to implement it, the Volcker rule may spark a mass exodus of clients from U.S. banks to banks based abroad," he said.

Regulators currently are debating exactly how the rule will be applied, with U.S. policymakers and financial firms looking on.

Meanwhile, Bachus – who is in line to replace U.S. Rep. Barney Frank, D-MA, as chairman of the House Financial Services Committee – says he is determined to address "job-killing" regulations on the derivatives market, as well.

"The derivatives provisions in Dodd-Frank alone... as they stand now they're going to take a trillion dollars out of our economy," Bachus told the Financial Times. "Think how many jobs that's going to kill."

Bachus's data comes from the International Swaps and Derivatives Association (ISDA), which lobbied feverishly – spending more than $1 million in the first six months of 2010 – against regulating the $600 trillion over-the-counter derivatives market, which had played an enormous part in exacerbating the financial crisis.

Another point of contention is the Consumer Financial Protection Bureau (CFPB), which was established to protect Americans from manipulative and predatory behavior on the part of financial firms, credit card companies, and mortgage lenders.

U.S. Rep. Scott Garrett, R-NJ, last week called on the administration to dismantle the CFPB before it's even established.

"We don't need a CFPB," said Garrett, who hopes to chair the capital markets subcommittee. "That would be a great first step for this administration if they want to start showing how they are willing to work with us, to say that, 'We recognize the failure that this doesn't do anything to address the problems so let's start unwinding that.'"

Representative Bachus didn't go as far as Garrett, but said the bureau should have its funding cut and structure overhauled.

Indeed, squeezing regulatory budgets is one of the most immediate ways House Republicans could weaken the financial reform legislation. However, not everyone is convinced Congressional threats to withhold funding will be enough to deter regulators from following through on their agreed upon mandate.

Regulators "are not about to be browbeaten into doing something just because a group of congressman threaten them," retiring U.S. Sen. Christopher Dodd told The Wall Street Journal.

A more direct approach would be for the House to author a "corrections bill" as soon as next year.

Corrections bills are typically used to fix technical errors, but the content of the Dodd-Frank bill could also become the subject of intense lobbying and political opposition.

"That corrections bill is going to look a lot different than anything Dodd and Frank would have presented," Sam Geduldig, a GOP lobbyist told The Journal.

Still, Senate Democrats, who remained in control despite a narrow majority, have warned their House colleagues not to re-fight unwinnable battles.

"I don't think that major changes will take place on Dodd-Frank," said U.S. Sen. Tim Johnson, D-S.D., who is expected to chair the Senate Banking Committee next year. "It's a matter of minor changes taking place. There is not only resistance from the Senate, but the veto is possible, too. So we should focus on realistic solutions to our problems."

No doubt, much political infighting lies ahead for the newly divided Congress, and the financial reform bill is so large and unwieldy that changes will come slowly, if at all. The real question is how the new rules will be applied as regulators and policymakers attempt to balance their own agendas in accordance with the will of the people and lobbying of financial institutions.

"The changed political landscape "will make the process more time-consuming and difficult," Sarah R Wartell, executive vice president of the Center for American Progress, told The Journal. "I'm quite certain Wall Street believes the outcome of the elections will be a net positive. But I think they'll be surprised by some of the new dynamics."

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China cut export quotas for rare earth elements by 72% for the second half of this year, capping foreign shipments at 7,976 metric tons, down from 28,417 tons for the same period in 2009.

The stiff reduction in rare earth exports was highlighted by a territorial fracas with Japan. Japanese authorities had detained the captain of a Chinese fishing boat that collided with a coast guard vessel in disputed waters. China retaliated by withholding shipments of rare earth metals destined for Japan.

Japan released the captain, but the Chinese rare earth embargo remains in place. This development has alarmed Japan, which accounts for 65% of China's rare earth exports. But what's more alarming is that the rare earth embargo appears to have been extended to the United States and Europe.

A number of industry officials in the United States and Europe told the New York Times that restrictions on China's rare mineral exports to the West went into effect on Oct. 18.

"The embargo is expanding," said one of the officials. All of The Times' sources insisted on anonymity for fear of business retaliation by Chinese authorities.

Still, it's unclear why.

"Materials are still being held up in customs and shipments are delayed," Jeff Green, president of J.A. Green & Company LLC in Washington, who represents miners and users of the elements, told Bloomberg News. "Many believe rare-earth quotas for the second half of 2010 are exhausted, leaving materials unavailable for sale."

Other industry chiefs said that China is trying to leverage its rare earth monopoly to persuade multinational companies to move their production facilities to the Mainland.

"Rare earth exports from China could fall even further, even by 30% next year," Ulrich Grillo, the chief executive of chemicals company Grillo-Werke, told The Times. "So what the Chinese are telling us, directly or indirectly, is that if we want access to their rare earth material metals we should invest in China."

However, Grillo said Western technology companies are reluctant to move production to China because they're afraid of losing their intellectual property rights.

"China needs our know-how and machines, but we need protection for our technology," he said. "We don't want these problems to turn into China bashing."

Like the situation with Japan, China's move to extinguish rare earth exports to the West coincided with a political dispute. U.S. trade officials on Oct. 15 said they would investigate whether or not China is violating World Trade Organization (WTO) rules by subsidizing its clean energy exports while limiting its imports. The probe also will determine whether or not reductions in China's rare metal export quotas and taxes qualify as illegal attempts to coerce Western technology companies into investing in China.

China invested $34.5 billion in clean energy technologies last year, according to Bloomberg New Energy Finance. The United States spent $18.6 billion.

White House spokesman Robert Gibbs responded to reports that China has clamped down on exports on Tuesday.

"We're monitoring to see whether or not what is happening on the ground is reflected in those reports," he said.

"I think we are likely to see [Chinese] President Hu [Jintao] on the trip at the G20," Gibbs added, referring to the Group of 20 meeting scheduled to take place next month in Seoul, South Korea. "If it is something that the security and economic teams think is important... certainly, we wouldn't hesitate to bring it up."

Congress is considering legislation that would provide loan guarantees for the re-establishment of rare earth mining and manufacturing in the United States, The Times reported.

Policymakers in Europe are equally dismayed by reports that China is restricting exports of rare earth metals to maximize profits boost its domestic tech companies.

"[It] hints that China is developing an industrial policy aiming at transferring as much as possible production to China," European Union trade commissioner Karel De Gucht told a high-level conference in Brussels on Tuesday. "It's obvious that we cannot continue being completely dependent on China."

An American executive at the conference said the United States and Europe should work closely together to develop their own resources.

"It is up to us to solve the problem," said Gary Litman, the U.S. Chamber of Commerce's vice president for Europe. "The U.S. has the resources and together with our EU partners we can produce anything we want."

Still, it would take years to bring rare earth metal production online in the United States.

U.S. Representative Mike Coffman, R-CO, told Bloomberg that U.S. rare-earth mining isn't likely to resume until at least late 2012 at a mine in Mountain Pass, California.

 "It's pretty frightening that there may be a gap where U.S. industry pays an extraordinary price," he said. "The administration needs to join with other countries and have a unified front to tell China this is not appropriate."

Like the United States, European authorities hope to address China's rare metal export ban at next month's G20 meeting. The German government has asked France, which will preside over that meeting, to put raw materials at the top of its agenda.

China denies that any embargos are in place, and that it is merely attempting to protect its environment.

"China will continue to supply rare earth to the world," the Commerce Ministry said last week. However, "to protect exhaustible resources and ensure sustainable development, China will continue to implement restrictions on the mining, production and export of rare earth."

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The OPEC figures are about 28 billion barrels higher than previous estimates. The added reserves would be enough to lift Iraq to No. 3 in the world - immediately above Iran, which has some 137 billion barrels of the "black gold" bubbling beneath its borders.

At $82 a barrel - roughly where oil was trading at midweek - the newfound oil would be worth about $2.3 trillion. And that may just be the beginning.

Up to 90% of Iraq remains unexplored, according to Energy Information Administration (EIA) estimates. Only 2,000 wells have been drilled in Iraq, versus approximately 1 million in the state of Texas alone. Iraq could easily have another 100 billion barrels of oil hidden within its uncharted territory.

At 2.5 million barrels per day (bpd), the country's production is considerable, but there is room for improvement. Some analysts estimate production will rise to 10 million bpd by 2020, while the Iraqi government has set a target of 12 million bpd by 2016. That would return Iraq to the ranks of the world's elite, as only Saudi Arabia and Russia are capable of producing more.

Crude oil export revenue represents around 60% of Iraq's gross domestic product (GDP) and 89% of government revenue, so a fourfold increase in production would be a significant boost to the economy. The added production could quadruple Iraq's per-capita GDP and leave the country with financial reserves in excess of $350 billion, according to Farouk Soussa, Citigroup Inc.'s (NYSE: C) chief economist for the Middle East.

The International Monetary Fund (IMF) forecast Iraq's growth at 2.6% for 2010, far lower than the 7.3% it projected in April. However, the International Monetary Fund says that economic growth will climb as high as 1.5% in 2011, as the country boosts its oil production and crude prices increase.

Higher oil prices could accelerate the rebuilding of Iraq's oil sector and have already attracted copious amounts of attention from abroad.

"International oil companies have pledged $120 billion to increase Iraq's oil production over the next five years," said Abdullah Al Ajaji, director of MerchantBridge & Co. Ltd..

Investments have also flowed into the construction sector, with international and national oil companies and the Iraqi government pledging to spend $250 billion over the next five years according to Al Ajaji.

Iraq auctioned off more proven oil reserves in the past six months of 2009 than are collectively held by the United States, Mexico, and the United Kingdom.

Royal Dutch Shell PLC (NYSE: RDS.A , RDS.B), OAO Gazprom (OTC ADR: OGZPY), Lukoil (OTC ADR: LUKOY), China National Petroleum Corp. (CNPC), and Malaysia's Petroliam Nasional Berhad (Petronas) all announced major new deals after participating in the biggest oil-field auction in history.

Lukoil and Statoil will redevelop Iraq's West Qurna-2 field, which is believed to hold more than 12 billion barrels of oil reserves, for a production fee of $1.15 per barrel. Royal Dutch Shell and Petronas will develop Majnoon, a similar-sized oil field. Additionally, the state-owned Petronas will join forces with Total SA (NYSE ADR: TOT) and CNPC on the Halfaya field, which has proven reserves of 4.1 billion barrels.

CNPC in the first licensing round in June joined British oil giant BP PLC (NYSE ADR: BP) as the first companies to win an Iraqi oil contract in more than three decades. The two oil giants signed a deal giving them the rights to Iraq's Rumaila field, one of the nation's largest 17.7 billion barrels of proven reserves.

Under terms of the 20-year contract, BP and CNPC have six years to boost the field's production to 2.85 billion barrels per day (bpd).

China, which recently surpassed Japan to become the world's second-largest economy, may have the most to gain from Iraq' resurgence. A net exporter of oil as recently as the 1990s, China's oil consumption reached 8 million bpd in 2009 - up from 4.9 million in 2001. 

The International Energy Agency (IEA) said last month that global crude demand would average 87.9 million barrels a day next year, with Chinese consumption accounting for about one-third of world growth.

The agency revised the 2010 estimate 50,000 barrels a day higher, to 86.6 million, to reflect China's accelerating industrial activity. China's implied oil demand rose 7.4% in August from a year earlier, more than twice as fast as in July.

China's crude imports rose 13% last month from a year earlier, and consumption has risen following the startup of two new refineries, with a total capacity of 260,000 bpd. August refinery output was up 7.2% from a year earlier to 34.73 million metric tons, or 8.18 million bpd, according to data from the National Statistical Bureau.

Chinese energy companies are well suited for projects in Iraq, because they have less experience and fewer business opportunities than their larger, Western counterparts. Many Western companies are shying away from Iraq because of unfavorable contract terms and security risks. But with exploration costs soaring, and many of the world's premium reserves already spoken for, China is ready and willing to invest heavily in Iraq.

The Red Dragon actually was the first country to sign an energy deal with Iraq in the post-Saddam era. CNPC in 2008 agreed to a $3 billion deal to develop the Ahdab oil field, 100 miles southeast of Baghdad.

Exxon Mobil Corp. (NYSE: XOM) and Royal Dutch Shell won the right to develop Iraq's West Qurna-1 oilfield, but by and large U.S. corporations have been virtually invisible in Iraq. 

Of the more than 40 companies to take part in the last licensing round, only seven firms present at the auction were American and only one actually entered a bid. Some industry observers had feared that the underlying goal of U.S.-led invasion of Iraq was to gain control of that Middle Eastern country's oil reserves, but so far that hasn't been the case.

"We haven't really seen U.S. companies, and that is because of intense competition," said Thamir Ghadhban, a prime ministerial adviser and former oil minister. "The issue is financial and technical and not at all political. This confirms Iraq can manage its oil policy and activities without politicization."

A senior U.S. trade official on Wedneday said that American companies can no longer afford to wait until there is "nice, neat order" before going after business deals in Iraq.

"We believe that American companies can compete with anyone in the world, but we do have to show up," said Francisco Sanchez, the U.S. undersecretary of commerce for international trade. "The time is now. I think American businesses that want to take advantage of opportunities, if they wait a year, and wait until everything is in a nice, neat order they are going to cede opportunities to businesses from other parts of the world."

Sanchez currently is leading a delegation of executives from 14 U.S.-based companies visiting Iraq.

"Opportunities to create partnerships and to engage is not a year and a half from now, or two years from now where perhaps you'll see a continued reduction in attacks or violence," he said. "If you want to really play a role here, you have to be here now."

The United States spent some $700 billion on the Iraq war and is the country's third-largest trading partner after Syria and Turkey.

News and Related Story Links:

• Money Morning:
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• Money Morning:
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• Reuters:
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• MerchantBridge & Co. Ltd:
  Official Website.