Dubai in Trouble

Information about Dubai remains scarce and worst still that the government of Dubai will be on holiday until 6 December in celebration of Eid and the UAE’s National Day. The $22bn of Dubai World’s external liabilities is an amount large enough to present a significant short-term risk on global credit market. It certainly forces investing community to re-think about the strength underpinning this global recovery.

Question is that will this event be the catalyst to a new ‘sub-prime’ scale as I have been hearing repeatedly that banks in Dubai seems to be well-capitalized and do not seem large enough to badly hurt the system.

Dubai World is the emirate’s largest state-owned conglomerate and operates in diverse businesses ranging from real estate to maritime services. Nakheel is a real estate development company, owned by Dubai World and best known for its Palm project. Essentially, on Wednesday 25 November, the government of Dubai authorized the Dubai Financial Support Fund to spearhead the restructuring of Dubai World’s liabilities. The holders of Nakeel’s $3.5bn bond maturing in mid-December are facing the immediate threat of delayed payment and about two-thirds of these bonds are held by international investors. The Dubai World intends to ask all providers of financing to ‘stand still’ and extend maturities until at least May 30, 2010.

What is seriously need a re-thinking is the presumption that the government would bail out Dubai World and its companies and need to assess the viability of Middle East even if Abu Dhabi is willing to support Dubai’s economy.

We have already seen a general risk aversion move with countries with financing issues being penalized heavily. Central banks have announced they intend to buy US dollars for the first time this year and the intensity of such intention is likely to intensify. Already, the United Arab Emirates’ central bank eased credit for lenders and the MSCI Emerging Markets Index lost 3.9% in two days after news broke. The cost of protecting Dubai government notes from default more than doubled to 647 basis points in three days.

Dubai, the second biggest of seven states that make up the UAE and its state-owned companied borrowed $80 billion to fund an economy boom and this ‘butterflies’ in the stomach will continue for at least new couple of weeks, if not more, until some kind of confidence is coming back to the system.

Dubai’s trouble could trigger a wider problem. For sure, we already seeing investors traditional sought safe habour in government bonds from the stormy waters of corporate bonds, now prove to be the safer bet, after all. Dollar and Japanese Yen are the alternatives while European and especially Asian markets and commodities will take the brunt of the losses. It could be the momentary setback, but do not ignore this as Dubai World woes resonating across financial markets.

In short, this is a wake-up call and the financial crisis that we are seeing since late December 2008 is far from over.

Greece and US – what in common?

One could never understand what stands in common between these two countries. But Greece may soon like the US be faced with deciding which bad choice to make among a very small set of really bad, difficult choices.

Greece is disturbingly close to a debt compound spiral as much as we know jolly well about the US situation. Even a small increase in interest rates will have a big impact on these economies. And at some point, the bond market is not going to ‘go-along’ for the ride and there will be a limit to market tolerance.

The interest spread between 10-year Greek bonds and German bunds has jumped more than 170 basis points. Greek debt has decoupled from Italian bonds. Athens can no longer hide behind others in EMU’s soft South. Euro membership now has to work extremely hard to block every plausible way out of the crisis and this is what happens when a facile political elite signs up to a currency union for reasons of prestige or to snatch windfall gains without understanding the terms of its Faustian contract.

The newly-elected Hellenic Socialists (PASOK) of George Papandreou confesses that the budget deficit will be more than 12% of GDP this year – four times than original claim for the last lot. Communist-led shipyard workers have already clashed violently with police and some 200 anarchists were arrested in Athens and Mr Papandreau has mooted a pay freeze for state workers earning more than E2,000 a month to fight for fiscal prudence. Without drastic cuts, Greece’s public debt will rise from 99% of GDP in 2008 to 135% by 2011 – something that very dearly to Japan, indeed. In another word, Greece is testing the limit of sovereign debt as it grinds towards slump.

On top, Greece’s current account deficit hit 14.5% of GDP in 2008. In short, Greece is skating on thin ice.

On the other hand, its compatriot the United States is financing its more than trillion dollar a year borrowing with i.o.u’s on terms that seem too good to be true. That happy situation, aided by ultra low interest rates may not last much longer. Treasury officials now face a trifecta of headaches – a mountain of new debt, a balloon of short-term borrowings that come due in the months ahead and interest rates that are sure to climb back to normal as soon as the Fed decides that the emergency has passed. Treasury officials are rushing to lock in today’s low rates by exchanging short term borrowings for long term bonds. The potential for rapidly escalating interest payouts is just one of the wrenching challenges facing the US after decades of living beyond its means.

Americans now have to climb out of two deep holes as debt-loaded consumers, whose personal wealth sank along with housing and stock prices and as taxpayers, whose government debt has almost double in the last two years alone, just as costs tied to benefits from retiring baby boomers are set to explode.

The government of these two countries are on teaser rates as clever debt management strategy will not be a better match for prudent fiscal policy!

Monetary Policy in Scrutiny

Policy-making is tricky when different asset classes are sending very different signals about the economy. However, these signals are essentially a by-product of policy. US bond markets are discounting a sluggish U-shaped recovery or even a double-dip recession while risky markets are signaling a strong V-shaped recovery ahead.

I doubt risky assets to invert their course as long as the Federal Reserve commits to maintaining exceptionally low levels of the federal funds rate for an extended period. So the policy dilemma is one of having to maintain ‘exceptionally low rates’ given the still very difficult real economic conditions against the danger of an increasing disconnect between risky asset valuations and the economy, which could eventually snap back and compromise economic and financial stability in the medium term.

In the case of US, I maintain that Fed fund hikes are a story for end of 2010 or 1Q2011 and in the case of UK, as the economy failed to pull out of recession in 3Q209, a rise in interest rates is unlikely to occur before 2Q2010. The Monetary Policy Committee did move to increase the program of quantitative easing, asking the Chancellor of the Exchequer, Alistair Darling, for an extra 25 billion pound to be pumped into the economy, bringing a total amount of 200 billion pound.

The ECB, meanwhile, stayed hold at 1% in November and the ECB president Jean-Claude Trichet expressed concern over the excess volatility and strength of the US dollar. However, further rate cuts seem unnecessary as signs of economic stabilization and a deceleration of deflation have emerged. Broad money supply growth continued to decelerate and credit to real economy is contracting.

On one hand, we had seen synchronized global policy easing, but on the other hand, tightening does not need to be. Australia embarked on its rate tightening phase earlier and it raised the rates twice, in October and November by 25 basis points each. Following the footsteps of the Reserve Bank of Australia, Norges Bank (Norway’s central bank) recently increased its key policy rate by 25 basis points to 1.5%.

And in Asia, it is very likely that the central banks will be the first among emerging markets to tighten policy as capital inflows and loose policies since late 2008 are raising liquidity and asset inflation. But as good inflation is under control amid a slow recovery in domestic demand, relatively weak credit growth and an output gap, this will delay interest rate hikes in mid to late 2010, especially in the export-dependent economies and constrain aggressive tightening until domestic and external demand improve further. Until then, the central banks will fight credit and asset bubbles via liquidity absorption and regulatory and prudential measures such as in real estate. Countries that are less export dependent and have attractive asset markets like India, South Korea and Indonesia will be the first ones to hike rates and allow currency appreciation.

Tough love with China

I am not sure if conventional wisdom of asking RMB to strengthen will be benefit the US economy still holds or not. The thought that simply see the peg as China’s principal weapon in an economic struggle for global ascendancy is both incomplete and naïve. The argument that if China were to allow its currency to rise, American manufactures would regain their lost edge and both manufacturing firms and the jobs formerly associated with them would return. However, it tells the wrong story, in my view.

My point is that the abandonment of the RMB would cause severe hardship in the US. The US economy is currently on life support provided by an endless flow of debt financing from China. These purchases are the means by which China maintains the relative value of its currency against the dollar.

When China drops the peg, the immediate benefits will flow the Chinese, not the Americans. Yes, prices for Chinese goods will rise in the US – but so will prices for domestic goods. As a corollary, the Chinese will see falling prices across the board. In addition, credit will expand in china while it contracts in the US. When the RMB appreciating, it no longer needs to sell its currency reserves by buying Treasuries, then prices and interest rates in the US will rise. Americans will lose access to the consumer credit that funds their current spending, but the things they buy will also get more expensive.

The People’s Bank of China stated that it will fine-tune the exchange rate formation mechanism in connection to capital flows and the movements of major currencies. This is the first official hint that China will take global exchange rates as a benchmark for the RMB exchange rate – is a very subtle but very important change in China’s exchange rate policy. The change in short-term currency movement may not be big but this is a significant shift away from the current set up.

When domestic demand counts for a larger weight in the Chinese economy, enhancing purchasing power would outweigh the objective of maintaining export competitiveness. The recent change in thinking that happened to the Japanese Yen could happen to the RMB as well. In short, we just saw a construction step towards that direction – albeit a small step for now.

Ready for Second Stimulus?

A number of short-term indicators have moved into over-bought territory and there are reasons to suspect that the softness especially in small cap stocks, we have been seeing will continue for a week or so. Within the context of a bull-market elsewhere, the most sensible response is to step away from it and more aggressive investors may actually wish to short them.

The development of a ‘double-top’ now in the S&P 500 is going to get bears excited and a head-and-shoulders topping formation may be forming to boot will also renew their courage unless new catalysts to be found to reverse the momentum.

Last week when I was holidaying, I learned that Goldman Sach is telling its clients that the Obama administration is going to announce another major stimulus package. That would mean that the combined monetary and fiscal infusion package that is already historic in proportions might actually be kicked up a notch.

Of course, the administration would have to persuade Congress to pass the legislation at a time when conservatives are already screaming about the extreme state of the nation’s deficit. But one should not ignore the possibility that the government has gone all-in with low interest rates and fiscal stimulus and is ready to go way overboard in its attempt to get the US economy rolling again. It is after all they are well politicians with the first, second and third motivations of these people are to get re-elected!

In that context, Goldman says that we should pay attention to two developments that suggest a greater likelihood of more stimulus ahead – first, we have comments from US Senate Majority Leader Harry Reid that the Senate was likely to consider a jobs bill in early 2010 and second, President Obama announced that the White House would convene a jobs summit in December.

Goldman analysts believe that Congress will enact $250 billion in additional fiscal measures to support growth over the next three years, including $75 billion more in 2010. However, recent developments – including the $45 billion bill to help homebuyers enacted last Friday – make this assumption look conservative. The analysts say that the timetable would be similar to what we have seen in each of the past two years – policy formulated internally in December, debated publicly in January and enacted in February. But they note that it would likely take longer to create and pass due to concerns about the effectiveness about prior efforts.

If this is real as speculated, I would think that the reaction to this second package would also be positive. This could be news that kicks-off the next leg higher or at least forestalls the recent consolidation phase that seems to have gotten under way.

Mexico – The New China?

According to corporate consultant AlixPartners, Mexico has leapfrogged China to be ranked as the cheapest country in the world for companies looking to manufacture products for the U.S. market. India is now No. 2, followed by China and then Brazil.

In fact, Mexico’s cost advantages and has become so cheap that even Chinese companies are moving there to capitalize on the trade advantages that come from geographic proximity. The influx of Chinese manufacturers began early in the decade, as China-based firms in the cellular telephone, television, textile and automobile sectors began to establish maquiladora operations in Mexico. By 2005, there were 20-25 Chinese manufacturers operating in such Mexican states Chihuahua, Tamaulipas and Baja.

China’s push into Mexico became more concentrated, with China-based automakers Zhongxing Automobile Co, First Automotive Works (in partnership with Mexican retail/media heavyweight Grupo Salinas, Geely Automobile Holdings and ChangAn Automobile Group Co. Ltd. (the Chinese partner of Ford Motor Co and Suzuki Motor Corp, all announced plans to place auto-making factories in Mexico.

Not all the plans would come to fruition. But Geely’s plan called for a three-phase project that would ultimately involve a $270 million investment and have a total annual capacity of 300,000 vehicles. ChangAn wants to churn out 50,000 vehicles a year. Both companies are taking these steps with the ultimate goal of selling cars to U.S. consumers.

Mexico’s allure as a production site that can serve the U.S. market isn’t limited to China-based suitors. U.S. companies are increasingly realizing that Mexico is a better option than China. Analysts are calling it “near-shoring” or “reverse globalization.” But the reality is this: With wages on the rise in China, ongoing worries about whipsaw energy and commodity prices, and a dollar-yuan relationship that’s destined to get much uglier before it has a chance of improving, manufacturers with an eye on the American market are increasingly realizing that Mexico trumps China in virtually every equation the producers run.

Indeed, there are four factors are at work here. Firstly, the U.S.-Mexico Connection: There’s no question that China’s role in the post-financial-crisis world economy will continue to grow in importance. But contrary to the conventional wisdom, U.S. firms still export three times as much to Mexico as they do to China. Mexico gets 75% of its foreign direct investment from the United States, and sends 85% of its exports back across U.S. borders. Secondly, the Lost Cost Advantage: A decade or more ago, in any discussion of manufactured product costs, Asia was hands-down the low-cost producer. That’s a given no more. Recent reports – including the analysis by AlixPartners – show that Asia’s production costs are 15% or 20% higher than they were just four years ago. A U.S. Bureau of Labor Statistics report from March reaches the same conclusion. Thirdly, the Creeping Currency Crisis: For the past few years, U.S. elected officials and corporate executives alike have groused that China keeps its currency artificially low to boost its exports, while also reducing U.S. imports. Last but not least, Trade Alliance Central: Everyone’s familiar with the North American Free Trade Agreement (NAFTA). But not everyone understands the impact that NAFTA has had. It isn’t just window-dressing: Mexico’s trade with the United States and Canada has tripled since NAFTA was enacted in 1994. What’s more, Mexico has 12 free-trade agreements that involve more than 40 countries – more than any other country and enough to cover more than 90% of the country’s foreign trade. Its goods can be exported – duty-free – to the United States, Canada, the European Union, most of Central and Latin America, and to Japan.

Commodities Rich Australia

At the forefront, the Australian economic boom will be the nation’s huge natural gas reserves particularly the Gorgon gas field, first discovered in 1981. Developers Chevron Australia, Shell Development Australia and Mobil Australia Resources in September got their first approval to begin work on the field, which has more than 40 trillion cubic feet of gas.

The Gorgon field, Australia’s largest natural resource, is responsible for the nation’s largest trade deal ever with the world’s fastest growing economy – China. The deal is that for PetroChina Co – Asia’s largest oil and gas company to buy 2.25 million tons per year of liquefied natural gas (LNG) from Gorgon over a period of 20 years.

According to Chevron Australia managing director, Roy Krzywosinski, this project is estimated to have economic life of at least 40 years from the time of start up. It is expected to create around 10,000 indirect and direct jobs during peak construction. While Australia waits for the first Gorgon LNG to ship in 2014, it expects LNG from the $12 billion Pluto project in early 2011, just six years after the field was discovered. Production increases of this magnitude would likely see the value of LNG exports increase towards a similar share of total exports as for coal or iron ore.

Australia’s population is growing more than 2% per year with two thirds of the growth coming from immigration in the past year. Workers are likely to be in short supply, lending to strong demand for skilled migrants and therefore fast population growth, which will have flow-on effects for housing markets. This bodes well for home prices, which gained 3.7% in the third quarter and are up 6.5% on the year.

Looking at interest rate increases in Australia could serve as a sign of things to come in other Western nations, most of which have kept their key lending rates at record lows. However, I note that Australia’s 5.7% unemployment rate looks tame next to the United States’ 10.2% and the United Kingdom’s 7.9%. Even commodity-rich Canada saw its rate swing back up again to 8.6% in October.

RMB to Swap?

China has made public announcements to overhaul the global monetary system. It questions the role of the US dollar as the reserve currency. Its officials have gone on record saying they want to move the global currency peg away from the dollar in favour of currency diversification as indicated by China’s push for OPEC to price oil in a basket of currencies, including the RMB, instead of US dollar.

There has been growing transactions using the RMB in China’s neigbouring countries in recent years. Today, the RMB is informally freely convertible in almost all countries bordering China. Since July, China has allowed Hong Kong and five mainland cities to settle cross-border trade in RMB.

The push for the regionalization of RMB appears to be gathering strength ahead of the scheduled launch of the China-Asean Free Trade Area (CAFTA) on January 1, 2010. There will be zero-tariff for 90% of the products traded between China and Asean countries and substantial opening in the service trade market.

At nearly US$2.3 trillion, China holds the largest official foreign exchange reserves of any country and surpassed Japan as the largest foreign holder of US debt. The effects of devaluation is no-trivial, especially as large increases to the US money supply and the impacts on purchasing power becomes a disconcerting issue for holders of large amounts of US-denominated assets such as US government bonds and treasury bills.

And since December 2008, the PBOC has signed six different official bilateral currency swap agreements worth RMB 650 billion in total. Currency swap agreements are two-way loans between central banks. This allows for bilateral trade to occur between two countries without a requirement to covert anything into US dollars as firms importing goods from China can then pay for them with RMB borrowed from domestic banks. Other countries working towards directly exchanging their own currencies in trade transactions with China rather than using the US dollar as an intermediary include Russia, Brazil, and Thailand.

China is making a great stride that scenario of the global currency of choice for resolving international trade settlements more plausible than it was even a year ago.

Capital Control in Fashion Again?

This year, we have seen strong currency appreciation in emerging markets both because of external conditions, including high liquidity, a weak US dollar and strong risk appetite as well as domestic factors such as relatively strong fundamentals and wider interest rates differentials. As portfolio investments to emerging markets also rising, policymakers are in dilemma how to avoid losing international competitiveness while also containing asset inflation and the emergence of asset bubbles.

So far, reaction was pretty limited to either verbal intervention or reserve accumulation. Others have kept or chosen more aggressive administrative measures, including capital controls mostly targeting portfolio investments rather than FDI.

The imposition of capital controls on capital inflows as well as currency intervention tends to be ineffective in reversing the appreciating trend of the local currencies, especially if the latter are primarily driven by external factors. However, capital controls may be helpful in easing volatility and the pace of the trend itself. The risk is that capital controls are seen as punitive measures against capital markets, raise uncertainty about future policy actions, hurt the credibility of the central banks and increase the cost of external funding for local businesses.

Ultimately, the decision will be guided on how fast capital is flowing in, sterilization costs and monetary policy flexibility. Those countries where currencies and equity markets that experienced surge over the course of the year are the most likely to impose some sort of limitations on capital inflows.

On October 20, Brazil surprised investors with a 2% tax on capital inflows to both equity and bond markets. Likewise, in March 2008, Brazil used a 1.5% tax on fixed income inflows only to contain the Brazilian real’s appreciation then, which was lifted in October 2008 shortly after the Lehman collapse.

Chile is no stranger to capital controls, having imposed a 20% unremunerated reserve requirement on foreign loans from 1991-98. Chile’s foreign exchange regime is free floating and it tends to let the markets know of its intentions well in advance and their mechanisms are very transparent in length and quantity.

And in Asia-Pacific, despite a flood of portfolio investments, it still needs foreign capital to simulate investment and finance its current accounts. Most have opted to contain the currency appreciation via verbal and actual interventions, which has led to reserve growth of over US$70 billion in Q3 alone, ex-China. Based on the pace of reserve growth, and flow of hot money, this has led to an appreciation of domestic real assets, especially property. It is even clearer in the case of China, given its quasi dollar peg, which suggests inflows will persist. Tolerance for greater currency movement will be more visible for countries like South Korea, India and Indonesia with low export dependence, reliance on energy imports, and inflation risks.

Gold – Chinese?

We know gold is one of better investment options, but not all golds that will yield the same. Don’t buy another ounce of gold until you finish reading this!

In short, Chinese government has created a secret new gold investment and the last time the government did something like this, investors could have made more than 1,000% gains. China has gone crazy for gold.

In April, the government’s Foreign Exchange Agency announced the purchase of an additional 16 million ounces for state coffers. And recently, the National Geographic Magazine reported that for the first time China had surpassed the US as the buyer of gold jewelry. What has really gone unreported is that the Chinese government has created a gold investment that could dwarf the returns of gold bullion, ordinary gold stocks, and any other type of gold investment that you have heard of before.

In the late 1990s, the Chinese government created two similar investments – one to help the local insurance industry went up more than 600% in just a few years – China Life Insurance – the only company with a national license and the other one to aid the energy industry has gone up more than 100% over a similar period – China National Offshore Oil Corporation – with an exclusive right to explore, develop and produce oil with overseas partners as well PetroChina and Sinopec – another spin-off from the state-run monopoly.

And now they are doing for gold. Most investors don’t realize that China is now the world’s largest gold producer. They passed South Africa last year. China is one of the few countries in the world where known gold reserves are increasing, not shrinking. For essentially the past 50 years, no one was allowed to tough gold in China, except government and now is changing and in a hurry….

They realize gold is one of the only buy-and-hold investments in the world right now and they have nearly $2 trillion to spend, according to a recent report in The New York Times. The Ministry of Land and Resources is set to re-write the country’s mining laws, known as the Minerals and Resources Law to encourage local and foreign companies toe explore for and produce more gold.

The government has recently created the Shanghai Gold Exchange to allow anyone to trade gold on the open market. Also, that the government helped created and took nearly 50% ownership stake in a very small gold mining company as well as a new company that formed by key members of China’s National Non-Ferrous Metals Industry Corporation – a state-owned company.

RMB – Most Undervalued

G-20, the IMF, the OECD – all of the major institutions and central banks of the world are talking about the importance of repairing imbalances. Countries running large trade deficits, like the US would save more, consume less and produce more while export-driven economies like China would spend more and export less.

And again it all boils down to China. While most of China’s major economic competitors around the world have seen their currencies climb against the dollar by 20%, 30% and 40% in the last 8 months, the RMB has been virtually unchanged.

That is because China controls the value of its currency. And that creates a major advantage for China in the competition for world exports. It has long been a problem for the United States as cheap Chinese goods and cheap credit fueled a consumption binge for US consumers and a massive trade deficit. Only after the US Congress threatened to impose a tariff on Chinese imports, the RMB appreciates 17% against the dollar between 2005 and 2008. But since the financial crisis, China has returned to a peg against the greenback.

That is why while the rest of the world was in recession, China was still churning out growth and is now outperforming in the early global economic recovery.

Pressures are again rising for RMB appreciation. The recent depreciation of the RMB because of its peg to a weakening USD, the lack of restructuring in China’s growth model, rising trade protectionism, mounting capital inflows and surging FX reserves indicate that external imbalance is not repairable without price adjustment. The US-China trade negotiations will only move forward only if there is an underlying agreement for RMB to appreciate and this virtually guarantees that appreciation would resume in the near future.

I am looking for about 5-6% appreciation early next year for RMB easily and expectations for further appreciation may accelerate, but policy-makers are in no hurry given weak external environment and over-capacity in China.

Low Yield Market Dilemma

A year ago, ultra-low interest rates was supposedly meant to be a temporary measures, but it has persisted for so long now and if you are fixed-income investors, it will be a key challenge for all of us in 2010. Can we expect short-term rates to move higher anytime soon?

Long term interest rates may drift higher due to worries about US’ rapidly growing deficits and the potential for inflation down the road. But it remains quite unlikely to see short-term rates heading anytime higher soon. In fact, Fed’s most recent policy statement, they fully intend to keep rates ‘at exceptionally low levels ..for an extended period’.

It is a great dilemma for this generation and possibly the generations that come after me. Given this situation, I may have to work past my retirement age, not because I loving every minute of it. Just think, how difficult it is to cope with the triple whammy of potentially rising inflationary pressure, low yields and plus falling dollar.

I talk to a lot of people lately, but many don’t know what to do with this and many are taking on significantly more risk to make up for low yields. They are investing in higher risk stocks and other growth investments hoping to improve their cash-flow. And that is the real problem, but what choices do we have?

Do you know that in-spite of the headline-grabbing rally in stocks over the past year, government and corporate bonds have actually performed better than stocks over the past 12-months through the end of September. The key trouble is that most investors don’t own enough bonds to help stabilize their investment mix. According to a fund manager that I know quite well, investors own four times as much as in equities as in fixed income securities today.

Not all bonds or bond funds are created equal. Different types of bonds have different sensitivities to changes in interest rates and credit conditions. I note that many people make their own investment decisions rather than use an advisor. I wonder how they differentiate among the many bond funds in all different areas of the fixed income universe. After all, there are thousands of it and millions of bonds the world over to choose from today.

Now, I am slowly moving to manage my bond funds more actively, something that I never take it too seriously before. I am constantly reviewing, restructuring my portfolio to earn extra income and reduce risk, including paying more attention to emerging market bonds to protect me from falling US dollar scenario, and Treasury inflation protected securities (TIPS) with duration concentration in the shorter-to-intermediate range – 2-10 year range, indeed, which generally tend to have low or even negative correlation with stocks.

The Third Element

Battery power – a technology market that is heating up in a big way. I have seen some projections that market for rechargeable batteries is expected to zoom from $36 billion in 2008 to $51 billion in 2013. And yet, the battery market gets less attention than solar or wind power, its higher profile, but less technologically developed cousins.

Modern battery technology is the keystone of the global push to find an energy alternative for oil. In fact, a specific new category of rechargeable batteries is actually a ‘breakthrough’ technology that has the potential to replace as much as 148 billion barrels of oil over the next 50 years with a potential savings of $10.4 trillion at current prices.

What these numbers don’t tell you is that there is a big powerful catalyst at work, one that is behind the big push to develop new, rechargeable battery technologies – the electric or ‘hybrid’ car. In response to the oil price surge in 2008, US President Barack Obama promised to invest at least $150 billion on alternative energy during his term.

The technology in question: Lithium-ion.

Sometimes referred as the ‘Third Element’ – because of its No 3 position on the Periodic Table of the Elements, lithium is believed to have been one of the few elements synthesized in the ‘Big Bang’ that created the universe. Now it is a key ingredient of the new class of rechargeable batteries used to jump-start the plug-in car market.

President Obama’s American Reinvestment and Recovery Act allocates $2 billion for the development of battery systems, components and software for advanced lithium-ion batteries and for hybrid electric systems. Another $300 million will support an Alternative Fueled Vehicles Pilot Program.

Automakers have latched onto lithium-ion battery technology as the road to the future. Right now, nearly every automaker on the planet is gearing up to flood the market with some form of electric-powered car.

Daimler AG plans to roll out a hybrid version of its S-Class sedan later this year. Nissan Motor retooled a factory in Smyrna, Tenn to produce a pure electric vehicle and expect to sell as many as 50,000 units of the hybrid Altima in its first year. Meanwhile, Ford Motor is bringing out the pure electric Transit Connect commercial fleet van in 2010 and Chinese carmakers Hafei and Coda are planning to bring a mass-produced electric car to market in California in fall 2010.

Big Bet on Commodities

If you think the run up to July 2008 was a wild ride, you have not seen anything yet. In the next 5 years, investors who focus on medium-to-small sized producers and oil-field companies having a well-developed specialty niche will outperform the overall energy sector.

We are entering a period of rising prices. There is still some plays in the large verticals but the primary profits will be made with smaller, leaner exploration-and-production outfits, field-service companies and specialized producers such as shale gas, coal bed methane, tight gas, hydrates – heavy oil and biodiesel.

The market is rapidly approaching will be more volatile with valuation often more difficult to determine than in the past, even when prices increasing. It is tough to decide how much of the increases result from actual product margins and how much results from oil becoming a financial asset rather than just a commodity is major concern. It requires some careful homework.

As America enters an accelerating field maturity curve and an intensifying decline in well debit, the efficiency of production will decline. 60% of crude produced in the US market is a stripper wells, providing less than 10 barrels of crude a day but more than 20 barrels of water – a major by-product. Therein lies a significant area for innovation and leaner companies and that spells greater profitability at lower entry prices.

As such price rises for Westerners will occur anyway, not just because of China. Moving forward, China, India, a resurgent East Asia, Japan and even regions such as West Africa will occupy important positions in this regard.

To offset a more rapidly declining traditional production base, primarily Western Siberia, Russia must move north of the Arctic Circle, into Eastern Siberia and out on the continental shelf. As foreigners are not allow to own 50% of strategic fields under new laws this means watch out for the smaller, focused operators and oil field service companies.

Off the track little bit – do you know that under the Eiffel Tower – the French Oil Ministry has confirmed that there is a 40-billion-barrel reserve under the historical landmark – enough to fuel total US oil demand for 5.2 years, based on EIA estimates.