The Case For China / The Daily Reckoning

verfasst von - ELLI -, 04.02.2003, 11:25

-->The Case For China

The Daily Reckoning

Paris, France

Monday, 3 February 2003

-------------------

*** Markets make opinions...no matter what the
apparatchiks think...

*** January closes 'ingloriously'...but commodities are
shining...bulls on the rampage in the gold market...

*** Is a market rebound 24 years away? China looms
large...and more!

-------------------

When George W. Bush took the Oval office on January 20,
2001, stocks as measured by the Wilshire 5000 were valued
at $14.7 trillion.

Their value two years on? $9.9 trillion. A loss of $4.8
trillion.

Your editors note from time to time that"markets make
opinions".

Now, as if to prove our point, comes an article from some
pompous windbag named Allan Sloan, who is apparently
Newsweek's Wall Street editor, trying to pin the collapse
in the stock market on the latest fool to inhabit 16
Pennsylvania Avenue.

"The S&P 500 has fallen more in Bush's first two years,"
says Sloan in a piece about as thought-provoking as dinner
with Britney Spears,"than any other president since the
modern stock market emerged. During Hoover's first two
years, which included the Black Thursday crash in October
1929, the S&P 500 fell 29%. Not as bad as Bush's 33%."

We recall wondering...sometime after the famed"Pregnant
Chad" episode in Florida made the U.S. electoral process
the favored punch-line at dinner parties from Caracas to
Bagdad...why on earth Bush didn't ask for a recount. After
all, wasn't it obvious that the 43rd president, regardless
of his political pedigree, would have to nurse the nation's
worst debt hangover since 1929?

As Sloan points out:"Unemployment is up more than 40% (to
6% from 4.2%) since Bush took office; gigantic projected
federal-budget surpluses have turned into deficits; the
dollar has fallen sharply against the euro."

Still, Sloan cleverly calls it the"Bush Market" - as if
presidents can determine stock prices, or the shoe sizes of
their children in advance. The only good thing Sloan can
see is that interest rates are low enough to"juice"
consumer spending...meaning, we presume, he's happy the
American Consumer is still willing to buy things he doesn't
need with money that he doesn't have and hasn't thought
about paying back yet.

But it doesn't stop there. For Sloan, the worst thing that
can possibly happen now...is a tax cut."Bush is not the
first president to want to cut taxes - but he is the only
president to in at least 140 years (and probably ever) to
suggest cutting taxes as we're heading into war." As Sloan
laments,"with the economy in the dumps, tax collections
falling and federal expenditures ratcheting up, the
projected surpluses have melted away faster than your
401(k)..."

For the record, we have no problem with the man wanting to
express his beef with the President. After all, we still
pay lip service to free speech, and Bush, the fool, wanted
the job enough to send his henchmen down to Florida to take
it.

But rather than questioning the need to go to war at all or
why exactly federal expenditures are"ratcheting up," Sloan
seems to thinks all you need is a different set of wonks
calling the shots in the mosh pits of Washington's policy
think-tanks, and the market would miraculously
rebound...consumer balance sheets would dry off...and
corporations would begin posting profits again.

"Markets are pretty savvy over the long run," Sloans sums
up amazingly...to which we might agree, especially following
some rather disturbing evidence highlighted by a Bloomberg
article this morning (more below...). But Sloan's 'analysis'
of the economy - at least in this hatchet piece - is as about
as perceptive as drunk falling for a transvestite who's
forgotten to shave.


Eric, what's the latest on Wall Street?

------------

Eric Fry, reporting from New York...

- The mercury finally edged above 32 degrees here in New
York, but the frigid conditions persist on Wall Street.
Meanwhile, Mr. Capital Gains remains suspended in the
cryogenic freeze that has housed him for the last three
years. Sadly, no one has yet figured out how to bring him
back to life...

- Last week, the Dow Jones Industrial Average slipped 77
points to 8,053 and the Nasdaq pulled back by 1.6% to
1,320. Last week's losses brought January 2003 - which
started out so hopefully - to an inglorious close. The S&P
500's early 5% gain withered away, becoming a 2.7% loss by
month's end.

-"It was the second straight January in which the major
indexes lost ground," Barron's observes."Those dusty Wall
Street guidebooks hold that the direction of the market in
January foreshadows the entire year's movement...There are
better reasons to be concerned about a down year than
that."

- We can think of a few reasons right off the top of our
furrowed foreheads: stocks are still pricey; the dollar's
a basket case; the economy stinks; and investors no longer
possess neither the will nor the way to add substantially
to their stock holdings. And let's not forget the mega-
billion dollar War on Terror that our nation is waging.

-"It's likely both the Dow and the S&P will re-test their
October lows (7,286 and 776 respectively), and, failing
that test, eventually set a much lower low." That's the
unequivocal, and dire, prediction of Strategic Investments
editor, Dan Denning."If we go back to pre-bull market
levels (1995)," he says,"we'd see Dow 3,800 and S&P 450.
This is why it makes sense for you to own long-term put
options on the Dow and the S&P."...Food for thought.

- [Editor's note: Dan recently test-drove a highly
leveraged strategic play on oil service companies earlier
this week in Strategic Trader Alert. Readers following the
trade could have made 58% gains in 2 days. But he's betting
these oil service plays are just getting warmed up. You can
read about his strategy here:"No Matter What Happens In
Iraq..."
http://www.agora-inc.com/reports/STA/BelieveIt/

- While stocks put in a lackluster performance in January,
commodities shone - and especially the shiniest of
commodities. Gold rallied about $20 higher during the
month. The increasingly precious metal continues to defy
its myriad skeptics and to amaze its growing legions of
fans. But has it picked up too many fans for its own good?
Is gold's newfound popularity something that gold bulls
ought to worry about?...Maybe just a little.

- Most sentiment indicators for the gold market are
showing extreme bullish readings, which often means the
market is due for a sell-off...over the short-term at
least. (On the other hand, the sort of investor who is
buying gold to protect against a declining dollar doesn't
care one whit about the sentiment indicators).

- Item number one from the bullish sentiment files: The
"speculators" on the Comex have amassed their largest net-
long position in gold futures contracts in years. The
speculators are considered the"dumb money". So whenever
they start buying heavily, it's usually a good idea to
sell them all the gold they want."There have been only
two occasions in the past 10 years that the net long
position of Comex stocks has been at the current level
(almost 200 tonnes)," Mineweb observes."They were during
the price peaks of 1993 and 1996."

- Item II: Gold stocks have not been keeping pace lately
with the rallying gold price. About nine months ago, the
XAU Index of gold stocks touched a peak 89.0. Today the
XAU is trading 12 points lower at 77.0, even thought the
gold price is about $50 higher than it was nine months
ago. Such"negative divergences" often presage a sell-off
in the metal itself.

- Item III: Gold investment conferences have become nearly
as popular as Eminem concerts, although the two events
tend to draw different types of crowds. The recent
Vancouver Gold and Investment Show was swamped with
attendees, just like it used to be a decade ago, when
$800-gold was still a recent memory."Three months ago, we
never would have expected this kind of crowd," said the
gold show's organizer.

- Notwithstanding gold's troubling short-term indicators,
the metal's long-term prospects still gleam brightly. As
long as the Fed vows to combat deflation by dropping
dollar bills from cargo planes, gold's investment
potential is assured.

- Crude oil is another commodity that refuses to back
down. Whatever happened to all those hefty reserves of oil
we used to have? Remember when the gooey black stuff was
selling for $12 a barrel and all the"experts" would talk
about a"world awash in oil?" Evidently, the stuff's a
little harder to come by than we thought.

- Crude oil has climbed to $33.51 a barrel - up about 10%
so far this year - and U.S. crude inventories remain
relatively scarce. In addition, the American Petroleum
Institute and Energy Department reported hefty declines
last week in distillate and gasoline supplies. In other
words, oil and gasoline both have plenty of reason to
continue rallying.

- Better fill up the tank before it's too late...

[Editor's note: For a different take on what's in store
for commodities - and notably for gold and oil - see John
Myers' article"Commodity Inflation Ahead"
http://www.dailyreckoning.com/body_headline.cfm?id=2883]

------------

Back in Paris...

*** Even following a rather homely January, as a recent
Bloomberg article points out, the markets are likely to
have a long way to go before they come back to bull market
peak levels - regardless of which party is occupying the
bully pulpit. And it's not just in the U.S...

"However bad life has been since 2000," remarks writer
Matthew Lynn,"a comparison with the 3 years from 1972 to
1975 shows it could get worse. The FTSE-100 Index has about
halved since 2000. The Dow Jones Industrial Average is down
by about a third over the past three years.

"Between 1972 and 1975, stock prices in Britain, France and
Italy suffered falls of almost 80%. Stocks in the U.S. and
Germany dropped about 60%."

Adjusting for inflation, Lynn suggests,"the British market
took until May 1987 to recover in real terms, a wait of 15
years. The U.S. market took until August 1993...a wait of
21 years. The Canadian market took until October 1996, a
wait of 24 years."

That's a longer time-frame than any party hack can account
for...or even remember. But we don't doubt that will keep
Sloan and his ilk from trying.

Cheers,

Addison Wiggin
The Daily Reckoning

P.S. Bill's bound for London on the Eurostar today...but
he'll be checking back in tomorrow.


The Daily Reckoning PRESENTS: As the Great American
Consumer Economy continues to sputter, all eyes turn
toward rapidly maturing China. How will China weather the
problems besetting its financial system?"It is quite
probable that within just 10 to 20 years, China will be by
far the world's most important economy," Dr. Marc Faber
concludes below.


THE CASE FOR CHINA
By Marc Faber

The rise of China as Asia's dominant economic and
political power raises a number of issues. It is obvious
that with a population of 1.2 billion, China will be the
largest consumer in the world for most goods and services.
Already today, China has more refrigerators, mobile
phones, TVs, and motorcycles than the United States, and
it is only a matter of time before it will have huge
markets for just about any product. As a result, its
resource requirements will rise very substantially, and
Chinese purchases of oil, coffee, copper, grains, and so
on will move commodity prices dramatically.

Just consider the following. Asia, with a population of
approximately 3 billion people, consumes 19 million
barrels of oil daily. By comparison, the United States,
with a population of 285 million, consumes about 22
million barrels of oil - that is a per-capita consumption
more than 10 times that in Asia. However, consumption in
Asia is now rising rapidly. China's oil demand has doubled
over the last seven years to around 4.5 million barrels a
day.

But it is not only in the oil market that Chinese economic
growth will be felt. Take, for instance, the per-capita
consumption of food in China - which I won't compare to
food consumption in some Western countries where a large
percentage of the population suffers from obesity. If we
look at consumption of meat, milk, fish, fruits, and
poultry in China, Taiwan, and Hong Kong, it becomes
obvious that the rising standard of living in China will
lead to very meaningful increases in its purchases of
agricultural products in the years to come; sometime in
the future, it will have a similar per-capita consumption
pattern to those in Hong Kong and Taiwan.

Or compare the per-capita consumption of coffee in China
with that in Western countries. Annual per-capita
consumption of coffee in Germany amounts to 8.6 kg, in
Switzerland to 10.1 kilograms, and in Japan - where coffee
consumption has increased rapidly in the last 30 years -
to 2.3 kilograms. In China, per-capita consumption is just
0.2 kilograms. If China's per-capita consumption rose to
just 1 kilogram (a little less than in South Korea), then
China would have a total consumption of 1.2 billion
kilograms compared to a total consumption of around 70
million kilograms in Switzerland!

What I wish to emphasize here is that if standards of
living continue to rise in China, the country will have a
huge impact on the world's commodity markets and is likely
to push up commodity prices very considerably. In fact, I
regard the purchase of a basket of commodities as the
safest way to play the emergence of China as the world's
dominant economic power.

You may, of course, question my optimism about China's
growth prospects and point to the large number of problems
China is facing. These problems relate largely to its
financial system, large bad loans at state-owned banks,
underfunded pension fund liabilities, corruption, and the
growing wealth inequity between its rural and urban
populations. But I believe that, while substantial in
scope, China's problems can be dealt with.

However, I remain convinced that, sometime in the future,
China will experience a serious financial crisis, which
will then force its policymakers to deal with the bad loan
and pension fund issues. You, however, should not be
overly concerned about this financial crisis. The American
economy of the 19th century also experienced a series of
crises, and even a civil war, and yet its economy
performed admirably well between 1800 and 1900. Moreover,
all rapidly growing economies experience terrific
temporary setbacks from time to time.

But in terms of China's long-term prospects, I should like
to remind you that the U.S. economy also expanded rapidly
in the second half of the 19th century - and (this) in a
deflationary environment. This was due to several factors,
including a rapid increase in its population (rising from
37 million in 1867 to 76 million in 1900), the opening of
new territories facilitated by the railroadization of the
country, and the application of new inventions to
manufacturing, which boosted productivity dramatically.

Thus, when we compare the U.S. economy in the second half
of the 19th century to China at present, we should not
overlook the fact that, in 1850, the U.S. economy was well
behind the United Kingdom and the Continent in terms of
industrialization. Therefore, a catching-up effect came
into play.

This is evident when we compare the growth of industrial
production in the United States, Germany, and the United
Kingdom from 1875 to 1890. In the case of the United
States, industrial production grew on average by 4.9% per
annum, compared to just 1.2% for the United Kingdom and
2.5% for Germany. America's strong growth in the second
half of the 19th century was typical of an emerging
economy and is comparable to strong per-capita GDP growth
in China between 1978 and 1995, averaging more than 5% per
annum, while the world's per-capita GDP growth only
averaged 1.11% over the same period.

Moreover, by 1885, the United States, which had hardly any
industries at the beginning of the century, led the world
in manufacturing, producing 28.9% of the world's
manufactured goods, while Britain had been displaced to
second, with 26.6%, and Germany to third, with 13.9%.
Also, while the United States had produced hardly any
cotton around 1800, its plantations supplied five-sixths
of the world's cotton by 1860!

The point is simply this: if the United States could
become the world's dominant economic power by the end of
the 19th century from extremely humble beginnings, I think
that, with the acceleration of the pace of change that
allows regions that open up to industrialize in no time,
it is quite probable that within just 10 to 20 years China
will be by far the world's most important economy - no
matter how many crises it will have to deal with in the
interim.


Regards,

Marc Faber,
for the Daily Reckoning

P.S. One problem I can foresee, however, is that, because
of its size and increasing economic and military
importance, China will grow out of proportion for a
harmonious balance of power in Asia. When, in the future,
China has become Asia's largest trading partner, with
respect to both its exports and imports, it will not only
be an economic hegemon, but will also replace the United
States as Asia's most influential political power. That
such a transition will at some point lead to serious
tensions between the United States and Japan on one side
and China on the other is obvious, but the trend towards
China's dominance in Asia is well established and, in my
opinion, unstoppable.

P.P.S. At the same time, as discussed above, China is
becoming a major buyer of commodities and will become, in
due course, Asia's largest trading partner. The emergence
of China as a major buyer of commodities should support
commodity prices, and if, in the future, the global
economy should resume 1980s-like synchronized growth,
commodity prices could soar.

In fact, grain prices, after having built an extended base
since 1998, have been rising explosively since June. We
therefore still believe that commodity prices are
bottoming out and will outperform Western financial
markets in the years to come. The purchase of commodity
futures, including coffee, cotton, rubber, copper, gold,
silver, sugar, etc., is recommended.


Editor's note: Dr. Marc Faber is the editor of The Gloom,
Boom and Doom Report. Dr. Faber has been headquartered in
Hong Kong for nearly 20 years, during which time he has
specialized in Asian markets and advised major clients
seeking down and out bargains with deep hidden value -
unknown to the average investing public - with immense
upside potential. He is also a major contributor to:

Strategic Investment
http://www.agora-inc.com/reports/DRI/ProfitPlot/

The Daily Reckoning

Paris, France

Friday, 31 January 2003

---------------------

*** One lump or two? The lumpeninvestoriat takes its
lumps...big investors too...

*** Workers still ripping off the capitalists...

*** A sordid spectacle in the park! And more...

---------------------

Day after day...the market seems to be grinding down share
prices...fortunes...and reputations. Wall Street dropped
again yesterday and is now below its low-point from last
October.

The same thing is happening almost everywhere. The FTSE in
London has lost 50% of its value since its peak. The Paris
stock market is down almost 60%. And German stocks have
been whacked for nearly 70%.

Something's gotta give, we keep thinking. People cannot
keep taking losses on this scale without some important
reaction - either panic selling...or maybe panic buying.

In the meantime, we love this market. Call it mean-
spirited...call it schadenfreude...call it what you like,
but we enjoy watching Mother Nature at work. She always
seems to come up with what Emerson called"some leveling
circumstance," which redresses imbalances and corrects
undeserved success.

Poor Ted Turner, for example."Better than sex," was how
Jane Fonda's husband described corporate deal-making when
the going was good. But then he wheeled into his biggest
deal ever - a merger with AOL. The financial press loved
it. Investors loved it. It was the old Time/Warner getting
hip to the new Information Age.

Since then, Turner - AOL/TIME Warner's biggest single
shareholder - has lost almost 80% of his money. And
yesterday, a day after his company announced the biggest
loss ever - $98.7 billion - he finally walked off the job
as vice president, following president Stephen Case by only
a few weeks.

Then, there's Peter Lynch, who built his fortune and his
reputation in the stock market when the bull market was
still fresh. He retired as a fund manager well before the
peak, but encouraged the lumpeninvestoriat to get into
stocks, too. By then, the market was already beginning to
stink...and the little guys lost a lot of money. And now we
see that Lynch...still buying and hoping for a
turnaround...is losing money, too.

Eric, what's the latest news on Wall Street?

------------

Eric Fry, reporting from New York...

- The lumpeninvestoriat took a few more lumps yesterday.
The Dow tumbled 166 points to 7,945 and the Nasdaq fell
nearly 3% to 1,322. Meanwhile, gold - the once-and-again
safe-haven metal - jumped $2.30 to $369.70 an ounce.

- The days of 25% annual gains in the stock market are a
distant, and therefore, painful memory for most investors.
But for many of America's CEOs, the good ol' days never
left. That's because ever-rising CEO compensation is an
immutable law of the universe. As reliably as the sun rises
every single morning, CEO paychecks rise every single year.

- In the years of plenty, CEOs reap a hefty portion of the
bounty. And in the lean years, CEOs reap whatever they
reaped the year before, plus about 10% - leaving the
remnant for the"little people" to squabble over.

-"Faced with dismal 2002 returns, as well as the foul
smell that soaring executive compensation left in the noses
of shareholders last year, you would think chief executives
would have cleaned up their compensation acts," writes
Bloomberg's Graef Crystal disdainfully."A review I did of
2001-2002 pay changes for 31 CEOs filing early proxy
statements with the U.S. Securities and Exchange Commission
shows otherwise. For the 31 companies with 2002 revenue of
$3 billion or more, the median total return [of their
company's stock] was a negative 10.7 percent. But the
median CEO among the 31 received...a 9.3 percent increase
in total pay."

- Crystal's observation is disgusting perhaps, but hardly
surprising. (And besides, wouldn't we all like the chance
to cash an obscenely, immorally and unconscionably large
paycheck...just one time?)

-"Now we begin to see why CEO pay has gone out of sight,"
says Crystal."Because pay doesn't go down in the bad
years, it begins to lap the field every time there is a
good year." Crystal highlights a few of the folks he calls
the"Black Hats". Those are the CEOs"who combined bad
performance with big pay increases".

- For instance, take Cardinal Health's Robert Walter, whose
take-home pay soared 147% last year...even though his
company's share price fell 10.9%. And let's not forget
about Navistar International CEO John Horne, who received a
plump 146% pay hike while his company's share price slipped
25%.

- But Crystal also highlights the"White Hats." His
favorite: John Chambers, CEO of Cisco Systems. Cisco shares
fell more than 30% last year. But Chambers threw his
(white) hat into the ring alongside his long-suffering
shareholders, by slashing his salary to $1 per year and
taking no bonus at all.

-"He also returned one of his 2002 option grants to the
company," says Crystal."The net result: His total pay
dropped by 67.1%. Of all the CEOs in my review, Chambers
showed that he really gets it."

- Yes, we agree, Chambers"gets it" alright. In fact, by
our reckoning, he has gotten it already. He amassed a net
worth in the hundreds of millions of dollars, while his
company's market capitalization shriveled by hundreds of
BILLIONS of dollars...What else it there to get?...We'd
give Chambers an"A" for style, but no better than a"C"
for substance.

-"Before you start worrying about the impending Chambers
family trip to the poor farm," quipped Scott Moritz of
theStreet.com,"consider that he's still taking a 4
million-share stock option package, adding to the $77
million worth of in-the-money options he already held as of
July 27."

- Nevertheless, we applaud Chambers' gesture. The lone
dollar he'll receive this year will save Cisco $323,318,
roughly the amount he would have been paid had he kept his
original salary...and every little bit counts. Also to
Chambers' credit, even with Cisco's stock falling to a
three-year low, he hasn't been selling shares. In fact, he
donated all 126,699 shares he purchased in the past year to
charity.

- Net-net, the lumpeninvestoriat might take a few less
lumps in the future if more CEOs were to follow Chambers
recent example...Then again, Mr. Market might knock them
over the head anyway.

------------

Back in Paris...

*** Four times as many companies defaulted on their debt
last year as in 2000. The default rate 10 years ago was
only 2%, says the Financial Times. Now, it's 11%.

*** Ah, nature...we love it! Last night's entertainment
took your editor and his wife to an exclusive club in the
big park adjoining Paris, the Bois du Boulogne. It is here
where Elizabeth takes riding lessons and here where her
horse club had decided to hold its annual dinner.

Your editor is bored by animals, except in a good sauce.
But he finds humans fascinating. What is nice about a visit
to the Bois du Boulogne at night is that you see so much of
them. Driving along, a redheaded woman standing on the
right-hand curb on the right hand side opened her fur coat.
Even the SEC does not demand such full disclosure. Then, a
petite Asian woman on the same side of the road showed off
her underwear. A little further, another woman leaned into
an auto window - apparently negotiating. All we saw was her
nearly-naked derriere, reflecting the taxi's headlights
like an oversized peach at a roadside fruit market.

Of course, your editor agreed with his wife that the whole
spectacle was sordid and disgusting...


The Daily Reckoning PRESENTS: The Bush crew claim they have a
'smoking gun' - evidence that Iraq is producing weapons of
mass destruction - which they'll release next Wednesday. Why
wait? Strategic Investment's Dan Denning has a smoking gun of
his own."This war really is about oil," says Denning,"But
not in the way you might think."


THE STEVENSON MOMENT
By Dan Denning


Stevenson:"Do you, Ambassador Zorin, deny that the U.S.S.R.
has placed and is placing medium and intermediate range
missiles and sites in Cuba?"

Zorin:"I am not in an American court room, sir, and
therefore I do not wish to answer a question that is put to
me in the fashion in which a prosecutor does."

Adlai Stevenson, U.S. ambassador to the U.N.
Valerian Zorin, Soviet ambassador to the U.N.
United Nations, New York City, October 25, 1962


Moments after he spoke the above words, Adlai Stevenson
became a leading daytime drama star, at least for a few
moments. Stevenson exposed Soviet lies in front of an
international TV audience. He showed the entire world U.S.
reconnaissance photos of Russian missiles in Cuba. The world
is waiting for another"Stevenson Moment", but this time,
from U.S. Secretary of State Colin Powell. And on February
5th, it just might finally get it.

The Bush Administration will produce its"smoking gun" next
Wednesday. But why wait? Today, I'll unveil my own smoking
gun. It doesn't have anything to do with weapons of mass
destruction in Iraq. But it does directly deal with what,
deep down in his Texas heart, George W. Bush has in mind for
Iraq's 112 billion barrels of oil.

Most people think this coming war is about oil. And it is.
But not in the way you might think.

Iraq sits on the second-largest proven reserves in the world.
According to the U.S. Department of Energy, it has another
220 billion barrels of probable and possible resources. It
may be much, much larger than even this sizable number...much
of Iraq remains unexplored and undeveloped since the Gulf War
ended in 1991.

It's not as if Iraq isn't producing any oil right now.
Currently, it produces slightly less than 2 million barrels a
day. And under the terms of U.N. resolution 986, Iraq is
allowed to export around 2.2 million bpd to pay for food and
critical domestic infrastructure plans.

Yet according to Iraqi Oil Minister Amir Rashid, as of early
2002, only 24 of Iraq's 73 developed oil fields were actually
producing. Part of this is Iraq's own fault. Iraq destroyed
much of the production capacity of its southern oil fields
before advancing coalition ground forces could seize them in
the Gulf War.

All that's about to change. In a free Iraq, billions more in
reserves are likely to come online, increasing Iraqi oil
production to somewhere in the neighborhood of 5 or 6 million
bpd. But who gets rich off of this? Is it Iraq? Is it major
integrated oil companies? Is it Bush and Cheney and their
Texas Oil Mafia cronies? Is it France and Russia? The answer
tells us how to profit as investors.

First off, contrary to popular belief, an increase in Iraqi
oil production doesn't make big U.S. oil companies richer.
Rising oil production in Iraq should lead to falling oil
prices. And falling oil prices aren't generally good for big
oil profits, even on increased volume. They will lower prices
at the pump for sure. But they will not increase profits for
Texaco. In fact, if oil prices don't fall after the war with
Iraq - and I mean fall back down to around $15/barrel, the
there really IS a conspiracy.

The only companies who will profit after the war - no matter
who owns the fields - are the companies who will help make
the fields productive. I'm talking about oil service
companies. It doesn't matter if France, Russia, the U.S. Army
or a new Iraqi government owns the fields. Whoever owns them
will need the services and the equipment to make the
profitable. Enter oil service stocks.

Oil service stocks - the companies who sell the equipment and
services to make oil fields productive - were the biggest
winners in the days between the beginning of the air war in
Gulf War One and the end of the ground war. I'm forecasting a
quick gain in this sector immediately after the bullets start
to fly.

What's more, oil service stocks act a lot like traditional
resource stocks. That is, their businesses improve when the
integrated oils ramp up exploration and expansion of existing
production capacity - something that's a lock to happen in
post-Saddam Iraq.

In any case, an increase in Iraqi production seems almost
inevitable. The only question is how it will come about. If
Saddam chooses to lose gracefully, leaving oil fields intact
- or if he simply runs out of time to destroy them - existing
capacity will be expanded, and new reserves located and
developed without much hassle. Otherwise, the United States
and its allies will be faced with the black scenario of
repairing the entire destroyed infrastructure of the Iraqi
oil industry.

If Iraq does destroy its oil infrastructure preemptively - or
even if Iraq becomes a 'free' state at all - certain people
stand to lose an awful lot. These are the people for whom the
war really IS about oil.

Under the terms of U.N. resolution 986, Iraq is allowed to
export oil and use the proceeds to pay for food and critical
infrastructure, as determined by the U.N. In order to produce
its oil, Iraq is allowed to enter into contracts with foreign
firms to sell parts and equipment for its oil industry. Those
contracts must be approved by the U.N.

You can actually view the contracts on line at the U.N.
website. The site reveals that France, Russia, and China have
798, 862, and 227 contracts in various states of approval
with Iraq, respectively, although not all the contracts have
yet been approved or executed. U.S. firms have a grand total
of one contract with the Iraqi oil industry. The U.K has
eight, two of which have been nullified and six of which have
been approved.

Looking at dollar value, the picture becomes even more
interesting. Since April of 1995, over 3.3 billion barrels of
Iraqi oil valued at $62 billion have been exported under U.N.
supervision. Since 1996, about $3.6 billion of this has gone
to purchase spare parts for the Iraqi oil industry, a process
in which the U.N. acts as a broker between the Iraqi
government and foreign firms looking for business. The U.N.
estimates there are $10.8 billion worth of additional oil
industry contracts up for grabs or in the pipeline.

According to an article by Thomas W. Murphy at
www.usainreview.com,"Russia has ranked first among nations
doing business with Iraq under the oil-for-food program, with
sales exceeding $4 billion." As for France, Mr. Murphy states
that France sold $1.5 billion worth of goods to Iraq last
year, the most of any nation for the year.

The"sales", by the way, are done by letters of credit that
Iraq issues. These letters of credit draw on funds in an
escrow account established by the U.N. - funds originally
procured from Iraqi oil sales. In other words, French and
Russian business profits in Iraq are coming from Iraqi oil
money.

What's more, the potential for more French and Russian
contracts in Iraq - at least under the Hussein regime - is
staggering.

A report produced by the U.S. Department of Energy's Energy
Information Administration spells it out. Russia has a lot to
lose in a free Iraq. The DOE report states that"Russia,
which is owed several billions of dollars by Iraq for past
arms deliveries, has a strong interest in Iraqi oil
development, including a $3.5-billion, 23-year deal to
rehabilitate Iraqi oilfields, particularly the 11-15 billion
barrel West Qurna field (located west of Basra near the
Rumaila field)."

And then come the French, who've got a lot to lose too. The
DOE report states:"The largest of Iraq's oilfields slated
for post-sanctions development is Majnoon, with reserves of
12-20 billion barrels of 28o-35o API oil, and located 30
miles north of Basra on the Iranian border." French company
TotalFinaElf reportedly has signed a deal with Iraq on
development rights for Majnoon.

You can throw the Chinese and Germans on the pile, too.
Dozens of countries, in fact. The black gold rush has been
going on for twelve years, under the tight control of the
U.N. A Deutsche Bank study estimates international oil
companies have signed $50 billion in deals with Iraq. The
deals cover the development of an estimated 50 billion
barrels of reserves and an additional 4 million bbl/d of
potential production.

There are only two major countries that don't seem to be
getting in on the act...and significantly, these are the ones
applying pressure for a regime change.

The truth is, we have no idea what will happen in the coming
weeks. But using a little logic, it's not hard to figure out
that in almost any scenario, Iraqi oil production is bound to
go up. It could go up sooner, if Hussein goes quietly. Or it
could go up later, if he doesn't.

In either scenario - the restoration of destroyed facilities
or the increase in production of existing fields and the
development of dormant Iraqi reserves - oil service companies
have billions in business ahead of them.

Regards,

Dan Denning
For the Daily Reckoning

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• The Case For China / The Daily Reckoning - - ELLI -, 04.02.2003, 11:25