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The Meridian Report

A Global Perspective on Energy

www.themarkettraders.com

December 10th, 2005

If one stops for a moment to reflect on the use of weaponry over the course of history, we see that as a civilization we have indeed made tremendous strides. From hand to hand combat with sticks and stones we moved into bows and arrows. The invention of gunpowder then heralded yet another new age. Since black powder muskets in the Civil War timeframe, we have now engineered and refined our way to high velocity precision rifles. Along the way, advances in aeronautics gave us the ability to shoot at our foes from high above the ground. Advances in science then gave us the ability to exploit the power inherent in the atom. Once combined with aeronautics, we were able to drop atomic bombs from an overhead aircraft not onto an individual below but onto an entire city below. Advances in computer controlled guidance systems now see us launching so called “smart” bombs from great distances using stealth type flying crafts. But, the best is yet to come. We are about to see a radical new type of weapon unveiled on the global stage. This weapon will not rely on explosive technology or flying aircraft. This weapon will not kill enemy troops. This weapon will not see one army invading the territory of another. No, instead this weapon will simply rely on supply and demand, the basic concepts that underpin Economics 101. This new weapon will be a financial weapon. In fact this weapon will be so powerful it will be able to inflict serious harm on the financial stability of an entire adversarial nation. This weapon is the BOURSE. That’s right – the BOURSE. The dictionary defines BOURSE as follows:

BOURSE: a word of French origin meaning a stock exchange for securities trading.

If I have totally confused you, don’t run away. Keep reading and follow my argument

If you think the invasion of Iraq was about 9-11 and Al-Qaida then I urge you to think again. Cast aside all that the major television networks have programmed into your daily thinking, take a deep breath and slowly exhale. Now, think…real hard. Were any WMD’s (Weapons of Mass Destruction) ever found in Iraq? Has any connection between 9-11 and Saddam Hussein been solidly proven? The answer to both queries is a resounding NO. So why then would the US, the world’s largest economic entity, undertake an invasion of Iraq to capture and remove leader Saddam Hussein? The answer is all about economics. More specifically, Currency. That’s right, Currency. You see, Saddam Hussein had developed a very serious, very viable plan to sell Oil from his country in exchange for Euros. Had he succeeded in putting this plan into action, the damage to the stature of the US Dollar as the global reserve currency would have been un-fixable. Oil importing nations would have reduced their holdings of US Dollars and added Euros to their vaults. The damage to the US economy which is entirely predicated on US Dollar supremacy could have been quite serious indeed. So, in the immediate aftermath of 9-11, the US launched a major offensive under the rather attractive name Operation Iraqi Freedom to trounce any Oil for Euros plans once and for all. But CNN told you a different story. Over and over, night after night you were reminded that Saddam Hussein was a monster. He was sitting on a massive cache of destructive weapons that threatened your safety. He was intimately linked to Al Qaida and global terror. Carefully crafted stories by embedded reporters and film footage of US and British troops moving triumphantly towards Baghdad made the while thing seem larger than life.

Now, fast forward to December 2005. As I write this edition of the Meridian Report, there is a growing sense of deja-vu. This time, it is Iran that is causing problems. But, CNN will have you believe that Iran is causing nuclear problems by refusing to scale back its nuclear program. The real story is that by March 2006 Iran is threatening to have in place an entity called the Iranian Oil Bourse. Trading of Oil on this exchange will be denominated in – yes you guessed it – Euros. A well choreographed play from Saddam’s little black book of game day strategies. The Iranian Oil Bourse will go toe to toe and compete for global prominence with NYMEX in New York and the International Petroleum Exchange in London. Oil trading on these exchanges is done in US Dollar terms. That is why when we hear a quote given for Oil it is always basis the US Dollar. Oil is the lifeblood of the global economy, the US Dollar is the global reserve currency and Oil is quoted in US Dollar terms. A simple 1-2-3 argument.

But this simple 1-2-3 argument may be about to come under attack. A successful start-up of trading operations on this Bourse could lead to an erosion of the US Dollar. Hence this Bourse is a de facto weapon. A weapon so ferocious, that has the ability to undermine the entire US economy, and topple the US Dollar from its lofty perch. After all, why would Oil importing nations need to keep as many US Dollars in reserve if they can purchase Oil in Euros? The ramifications of a weakened US Dollar are serious. Global purchasers of US debt instruments may begin to shy away from a weaker currency in favor of Euro denominated debt instruments. This would place upward pressure on US interest rates and the serious imbalance of the US economy would be laid bare for all to see (as if we don’t already see it). After all, the US has no choice but to keep foreign investors interested in buying US debt. Management of the trade deficit and budget deficit depends on it. The housing market would surely collapse under the weight of higher interest rates. With mortgage rates now above 6% we are already seeing the signs of weakness of the housing market. Now imagine mortgage rates at 8% or even 9%. Given this scenario, it should come as little surprise that China recently moved all of a sudden to re-position its Renminbi currency away from the US Dollar and instead to a basket of global currencies. The Chinese are definitely not stupid. They have excellent relations with Iran and are well aware of the threat this new Bourse poses. Notice how the Chinese still have not told us the exact makeup of this basket? However, you can bet the Euro figures very prominently in the weighting of this basket.

With Operation Iraqi Freedom seemingly stuck in the mud and going nowhere what is the US to do? Sadly, the answer may be that there is little the US can do. The most powerful military force on the planet may be paralyzed. A simple Bourse – an exchange where Oil is bought and sold – may prove to be the ultimate weapon.

There are rumors floating about that a repeat of a 9-11 type attack is in the offing in the US. This would pave the way for the US to unilaterally launch an all out attack on Iran in the interests of protecting the world from terrorists. One of the consequences of this type of action would surely be a rapid deterioration of relations with other industrialized nations and a move by central bankers to quickly reduce US Dollar holdings. Such a move would also add more fuel to the already raging inferno of Muslim / US relations. So, not a likely strategy.

The US could try to garner support on the world stage for a group of Allies to stage an invasion of Iran to thwart further development of the Iranian nuclear program. However, given the problems with the Iraqi situation and with UK Prime Minister Tony Blair still smarting from his involvement in the Iraqi debacle, it is highly unlikely that this approach would work.

The US could simply decide to go it alone and launch a “shock and awe” attack on Iran to restore democracy and rid the world of one of the pivot points of the oft touted “axis of evil”. This no doubt would quickly degrade into mass chaos in the Middle East and global terrorism would quickly ratchet itself to new heights. While such a move would surely delight the Rumsfeld and Wolfowitz neo-conservative crowd, in all practicality an all out offensive would not be a good move.

This leaves us with the only other possibility and that is careful negotiation. But, the Iranians and for that matter all the European importing nations are in the drivers seat and really have no motivation to even come to the negotiating table. Who says Oil has to be priced in US Dollars? Who says the world needs a single reserve currency? Maybe the world needs two reserve currencies. Maybe the days of US Dollar supremacy are over. Maybe it is time for the US to change its ways. Trim the debt, scale back operations in Iraq.

The US could well be boxed in to a corner. A simple Oil Bourse in a Muslim country half-way around the world could be the straw that breaks the proverbial camel’s back. The day of financial reckoning could be at hand. We may be about to witness the next chapter in the story of the Rise and Fall of the American Empire. The Euro could be about to assume its spot as the #2 global reserve currency. As the US Dollar begins to falter under the weight of Oil being sold in Euros on the Iranian Bourse we will surely see a rise in the value of Oil Futures on Nymex. In fact we could see a rise in the value of all commodity futures that trade on the Chicago Board of Trade and the Chicago Mercantile and the New York Board of Trade. Not because these commodities are in scarce supply, but simply because it will take more units of a weakened US Dollar to buy a contract of Live Cattle or a bushel of Oats or a barrel of Oil. This will leave newly minted Fed Governor Ben Bernanke with a few inflationary conundrums of his own. Let’s hope Mr. Bernanke knows what he is doing and is up to the challenge left for him by his mentor, Easy Al.

In a recent edition of the Meridian Report I presented the case for a 4 year cycle pattern in the financial markets and noted that 2006 should produce a cyclical low and cause potentially serious harm to all those unsuspecting long term buy and hold type of investors out there. I suggested that there were a number of catalysts that could spark a market sell-off to lead us into this cycle low. I think it is fair to say we can now add the introduction of the Iranian Oil Bourse to this list of catalysts.

But here is the good news. Despite what the critics are saying, there is a lot of high octane excitement left in these energy markets. As we get closer to March 2006 and the opening of the Iranian Oil Bourse, the volatility in Oil prices and in energy stocks is sure to amplify and as we all know, volatile markets are the best for short term trading strategies. So, take your pick - energy service companies, oil and gas income trusts that trade on the Canadian markets, smaller cap up and coming producers, CBM players or the big name energy producers. These stocks will continue to provide lucrative trading opportunities in 2006. And I will do my level best to keep you all informed. Stay tuned…..

www.themarkettraders.com