THEME: BUBBLE TROUBLE
Thanks to Steve Sewall, an article from FT points out the following:

US monetary policy has produced great distortions on the periphery of the world economy as well. The most notable example is South Africa's currency market. According to data from the Bank for International Settlements, South Africa now has the largest currency market in the developing world. Its trading volume is now equal to 24 per cent of the country's gross domestic product compared with 4 per cent for Thailand and 2 per cent for Brazil. The rand's trading volume has increased ninefold during the past decade. South Africa also has a swap market nearly three times as large as the country's GDP. The size of South Africa's currency market and swap market is a by-product of surplus global liquidity, which has been attracted by South Africa's money market yields of 8 to 9 per cent. The large interest rate differential has produced a rand carry trade - investors borrowing in dollars to invest in the rand or rand-denominated assets - that has driven the rand/dollar exchange rate from nearly R14 to the dollar in late 2001 to R6.25 in March this year. Large flows of speculative "hot" money are behind this, which means the currency will remain volatile in the future.

Low interest rates in the US and Europe have also encouraged a large carry trade in other currencies. The volume of currency trading in Australia and New Zealand is now 35 per cent of GDP compared with 27 per cent for the US and 18 per cent for Europe. As with South Africa, investors have flocked to the south Pacific in search of higher yield, turning the currencies into global casino chips, rather than a simple means of payment.

The Fed's mandate is to make monetary policy for the US economy. It has adhered to a highly stimulative policy because, until recently, US employment growth was subdued and the core inflation rate had collapsed. The central bank has not seen much risk of a liquidity bubble in the US because margin debt - money borrowed from brokers to buy shares - has remained below 2 per cent of GDP, compared with 18 per cent on the eve of the 1929 stock market crash. US banks also behaved far more prudently in the bubble economy of the late 1990s than during previous booms. They securitised their potentially bad loans and sold them to pension funds, mutual funds and insurance companies rather than keep them on their own books. As a result, America has had only 21 US bank failures since 2000, compared with nearly 500 during the early 1990s, when banks experienced large losses on property lending.

Now, the buoyancy of the US economy has encouraged the Fed's rate- setting open market committee to open the door to a possible increase in interest rates, signalling an end to America's experiment with ultra-low money market yields. It will be up to other central banks to prepare for the consequences.

David Hale is a Chicago-based economist

THEME: ENERGY CRISIS
There's been a lot of hysteria about the "energy crisis". Evidence of this is the interview with an expert on CNBC who is predicting $100/barrel of oil by the end of the decade.

Here's a quote from Donald Luskin:

And here's an even more amazing statistic. Over time, thanks to technology, we've gotten much more efficient in the way we use gasoline, oil, and energy of all kinds. In 1974, when the first oil crisis hit, it took more than 17 quadrillion BTUs of energy to produce $1 million of gross domestic product (measured in constant year-2000 dollars). Today it takes less then 10 quadrillion BTUs.

One more statistic: in 1978 the U.S. consumed more than 18 million barrels of oil every day, when annual GDP was $5 trillion. Today we use only 10% more oil every day than we did then, but GDP has more than doubled to almost $11 trillion. (Again, both figures are in constant year-2000 dollars.)

The bottom line: oil is important, but it just doesn't matter quite the same way that it used to.

THEME: CHINA SYNDROME
From Washington Post:

The China Syndrome, as it known, explains why as many as one-fifth of the bulk freighters in the world are effectively unavailable on any given day and why the cost of moving bulk freight has more than doubled in just over a year. The same ships that sit stranded outside Newcastle, or at iron ore ports in Brazil, India and western Australia, must line up again for as long as three weeks to unload at congested Chinese ports such as Qingdao and Ningbo.

The construction frenzy that is crowning China's cities with skyscrapers and laying the works for modern industry has transformed it from a minor consumer of raw materials into a country that -- according to its official statistics -- absorbed roughly half the world's cement production last year, one-third of its steel, one-fifth of its aluminum and nearly one-fourth of its copper. Last year China eclipsed Japan to become the world's second-largest importer of oil after the United States.

China's ravenous appetite also explains why shipyards in Japan and Korea, which make most of the world's freighters, have orders through at least 2007. China is building dozens of new shipyards, including the world's largest in Shanghai. Even shipyards in India, Vietnam and Indonesia are booming. Last year, global ship orders more than doubled to a record 1,600 vessels, according to Lloyd's List, an industry periodical.

But those ships won't be on the water anytime soon, meaning that the worldwide shortage is likely to continue for the foreseeable future.

"I've been in this business for over 20 years, but I've never experienced these prices," said Masafumi Yasuoka, who runs the coal and iron ore carrier division at Mitsui O.S.K. Lines of Japan, one of the world's largest bulk cargo firms. Hiring a giant freighter to run coal from Australia to Japan costs nearly $50,000 a day, up from about $20,000 in January 2003.

"We were blindsided by the sudden surge in demand," said Peter Coates, chief executive of Xstrata Coal, a primary shareholder in Port Waratah Coal Services Ltd., which owns and operates the loading terminals at Newcastle, 100 miles north of Sydney.

"How many people in the world were able to forecast the massive commodities boom in China? Suddenly, around the world, stockpiles of everything from copper to coal disappeared."

Recent weeks have brought talk of a possible slowdown in the raw materials trade as Beijing enacts measures to cool its potentially overheating economy. But even if the pace slows, those engaged in the commodity and shipping trades are generally convinced that China's impact is here to stay.

"China's got too much of an engine going to stop," said Rex Littlewood, general manager for Asia Pacific for Noble Australia, an arm of the Hong Kong-based shipping and commodities giant Noble Group, which annually ships 6 million tons of coal out of Newcastle. "When you've got 1.3 billion people, they require a lot of electricity, especially once they've got a light bulb and an air conditioner, a toaster and a rice cooker."

In April, coal was being loaded at Newcastle at an annual rate of 86 million tons, according to David Brewer, general manager of Port Waratah Coal Services -- a pace about 20 percent ahead of 2003.

Coates, the Xstrata Coal chief, calculates that if China's economy slows to 7 percent growth a year, its demand for thermal coal would still swell by about 70 million tons per year. At that rate, in less than a decade its appetite for coal would grow by an amount greater than what the United States now uses in a year.

THEME: BEARS
In sentiment, I detect a lot of sadness and despair. This is odd given that the market really is not down that much. I think the despair comes because people are not long the market, i.e. the indices. Instead, they are long the fad plays:

1. Non-dollar markets
2. Gold
3. Commodities
4. Tech
5. Leveraged carry plays (bonds, REITs, high yield)

The sadness comes from the fact that they have sold. This is the perfect environment for value players to swoop in.

Here's an extreme comment from a former bull:

Earlier this month, Merrill said its own proprietary Risk Posture Barometer has been falling since January, and chief small cap strategist Satya Pradhuman suggested then that risk appetites historically take 15 months to stabilize, on average -- in other words, it could be spring 2005 before investors feel like taking risks again.

THEME: OIL TOPPING
Sentiment indicators also tell me that oil has reached a temporary top in the $41 area. I was quite bullish on oil 3 months ago, but at these levels, its difficult to see much more progress.

Here is a typical overly bullish comment:

``I think you could see $45 oil pretty quick,'' Boone Pickens, the former Texas oilman who oversees $675 million in energy investments, said in an interview. ``There's no oil coming to us that we haven't counted on.''

THEME: INFLATION
I have been asked to do my blog by popular demand!
Please show your support with an email or two with your comments.

``The greater wall of worry here for the bond market is the Fed cycle, potential inflation risk, and the market interest-rate adjustment that's likely incomplete and obviously to higher rates,'' said Robert Podorefsky, interest-rate strategist for global derivative products at Bank of America in Boston.

Well, this comment is consensus, and well, a little too obvious.
What is going on is that the world is anchored to an environment of higher rates. This is a behavioral finance phenomena. In other words, because the bulk of active investors have lived through times of higher rates, we simply see the current period as aberrant, so we expect bonds to crash back to normal levels.

This may be flawed thinking. Whereas Americans see higher rates as normal, for over 10 years now the Japanese see low rates as normal. Their aging population and lack of population replenishment coupled with a bubble have driven JGB yields to permanently low levels.

Given that the US has similar demographic issues, I think we are going to experience the same thing.

Also, sentiment readings are as bearish on interest rates as they were in the beginning of 2003, right before a major rally in bonds.

TRADE: buy bonds, buy REITs