Flirting With Disaster

Why betting against an economic recovery is still a smart play

Markets were dallying last we checked, up a bit, but not enough to sway an opinion. The majors in the US are up on average 5% for the past month, aided, as far as we can tell, by slapdash political rhetoric, myopic investor optimism and cherry-picked data analysis. That said, a 5% gain is a good month by just about anybody's measure. So why are we so dour?

The short answer is, "we're not...we're just cautious."

In his terrific book, Fooled By Randomness: The Hidden Role of Chance in Life and in the Markets, Nassim Nicholas Taleb explores, among other things, something he calls the "zoology" of bullish and bearish sentiment. In one particular example, Taleb describes the scene in a New York office when he is asked to give his forecast on the trajectory of the market over the coming week.
Taleb answers that he thinks the market will rise. He gives it a 70% probability of doing so, a seemingly bullish outlook.

"But Nassim," interjected one of his colleagues, "you just boasted being short a very large quantity of S&P 500 futures, making a bet that the market would go down. What made you change your mind?"

"I did not change my mind," replied Taleb. "I have a lot of faith in my bet! As a matter of fact I now feel like selling even more!"

Taleb goes on to explain that, although he suspected that the market would move higher, it was preferable to short it because, "in the event of its going down, it could go down a lot."
In other words, the possible upside of going long - even though that outcome was, by his own analysis, more likely - was marginal compared to the dire consequences of what would happen in the less likely scenario that the market tanked.

"How frequent the profit is irrelevant," writes Taleb. "It is the magnitude of the outcome that counts."

US markets are, on average, up some 50% since their lows just over a year ago. That's an incredible bounce, to be sure, one for the history books. Nevertheless, the steps higher seem less and less resolute, more and more tentative. It's as if a mountain climber, after a momentous ascent, suddenly remembers that he has an acute case of acrophobia. Where to now?

The markets might well rise a little in the coming weeks, in other words, but they might also fall...a lot. We'd rather miss out on a minor advance in stocks than suffer a cataclysmic retreat. There are a slew of worrying macro-catalysts that inspire more than a little trepidation in your editor's heart. Here's one:
China and Japan, the two largest foreign holders of Treasurys, are slowly, steadily, incrementally reducing their exposure to American government debt. Now, if you were sitting on $900 billion or so of US debt - as China happens to be - and you wanted out, you couldn't simply bolt for the door. That kind of movement would spook the market, signaling a run on the dollar and decimating the value of your remaining holdings. Instead, you'd have to creep out very quietly...exactly as China and Japan appear to be doing.

Bloomberg reports: "China has been a net seller of Treasuries for three straight months, the longest such stretch since the end of 2007. Chinese officials have questioned the dollar's role as a reserve currency and recently sought assurances about the safety of US government debt as the budget deficit widens to a projected record $1.6 trillion this year."

The relationship between America and her foreign creditors is one built primarily on faith. China, Japan, Russia, Taiwan and the rest of world's dollar holders rely on the "full faith and credit" of the United States government to stand behind its currency, the world's reserve. But faith is a fickle thing. It takes a lifetime of monogamy to forge a faithful marriage...but just a single night of reckless abandon to destroy one.

The "recovery" may well deliver a few more sessions of stock market passion, in other words, but those tempted to flirt with it are advised to remember the wrath of a lover scorned.

Default, Deflation and Other Financial Curse Words

In the US, producer prices fell in February, more than expected. Core inflation was barely positive. That is not just a US trend. In Europe, price increases have fallen to the lowest level in 11 years. Japan is experiencing the biggest price drops in many years.

This sounds like a D-word to us...disinflation, almost deflation.

One report tells us that greater than 5% of Fannie Mae mortgages are 90 days in arrears - or more. Another report says it's 10%.

This too sounds like a D-word. Default.

But wait...

"Fed signals optimism over US economy," is the lead headline in today's Financial Times.

The markets responded, pushing the Dow up 47 points to a new high for this bounce...though still midway between its all-time high and its low of March 2009.

Oil rose a dollar too. So did gold. The euro edged up too...

Reading more closely, we don't see much reason for the Fed's optimism. And apparently, neither does the Fed. It is leaving its monetary stimulus program in place for an "extended period." It says inflation is likely to remain subdued "for some time."

The Great Correction (our term) destroyed nearly 8.4 million jobs (the FT's count) and wiped out $14 trillion in household wealth. And now Americans are struggling to find firm footing in an economy with fewer job openings, less credit available, and an uncertain growth outlook.

What's going on? There's a word for it. Another D-word...several of them. There's Depression. Deflation. And De-leveraging, for example.

Our old friend Porter Stansberry writes to tell us that we're wrong about household de-leveraging. The drop in credit we reported yesterday was caused by defaults...not by voluntary reductions in debt, he says.

He's right. Most of the decline in household credit, so far, comes from defaults. And maybe it is just wishful thinking on our part... hoping that Americans would willingly and eagerly improve their balance sheets. The savings rate is up...but it's not yet clear whether this marks the beginning of a major trend or not.

But whatever the cause - be it voluntary de-leveraging or involuntary de-leveraging - we think there's more of it ahead.

Here's a statistic: 21% of Iraq and Afghanistan veterans are jobless. They're mostly men. And mostly unprepared for the modern job market. After all, who wants to hire someone who knows how to drive a tank or patrol a gas station?

Ultimately, an economy gets rich by making and acquiring things people want.

Ah...we look back nostalgically at the Bubble Epoch. It was so easy to make fun of people back then. They thought they could get rich by buying things they couldn't afford with money they didn't have. Now, we're in a new era... of sorts. Now, it's the public sector that has lost its head. The feds think they can make the economy work better by buying things nobody really wants with money nobody really has.

Who really wants to guard a gas station in Baghdad? Nobody we know. Who's got the money to fund the fed's $1.8 trillion deficit? Nobody.

And think of the poor fellow who draws that sorry duty in Iraq. When he comes back to the US, what does he have on his résumé? He's good at guarding a gas station against terrorists? Not many job offers for that skill set.

So, one in five of these fellows is unemployed. And the feds try to do something about it by spending more money they don't have on more things nobody really wants.

Meanwhile...money may be getting harder to come by.... See below...

And more thoughts...

This, from Bloomberg:

China, Japan Reduced Holdings of US Treasury Debt in January

March 16 (Bloomberg) - China and Japan, the two biggest foreign holders of Treasuries, reduced their positions of US government debt in January as a measure of demand for American financial assets fell to a six- month low.

China remained the biggest owner abroad of Treasuries, even as its holdings dropped by a net $5.8 billion to $889 billion, according to Treasury Department data released yesterday in Washington. Japan cut its holdings in January by $300 million to $765.4 billion, the report showed.

China has been a net seller of Treasuries for three straight months, the longest such stretch since the end of 2007. Chinese officials have questioned the dollar's role as a reserve currency and recently sought assurances about the safety of US government debt as the budget deficit widens to a projected record $1.6 trillion this year.

"Foreign central banks stopped buying Treasuries in January," said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. "If this were to continue, if China were to stop recycling its dollars into US Treasuries, it could have dire implications for Main Street America in that mortgage rates could move higher."

"More Jains taking up santhara," reports the TIMES of India.

Santhara (also called sallekhana) is the Jain practice of voluntary and systematic fasting to death. Jain texts say it is the ultimate route to attaining Moksha and breaking free from the whirlpool of life and death...

Nearly 500 people took the road to Moksha in 2008, the paper reports. The article goes on to tell us that more women than men starve themselves to death, because they are "more strong-willed" than men.

In the past, when people took the holy vow of santhara they used to advertise it in the local papers. This would allow friends and relatives time to come over and say goodbye. Now, the government is said to be cracking down on the practice; apparently, you are no longer permitted to advertise. Now you have to die alone.

"Eunuchs want rape laws to be gender-neutral," is another headline from the Indian press. We couldn't make out the cause of the eunuchs' complaint. Rape laws are already being rewritten in a more politically correct way; the word 'rape' is to be replaced with 'sexual assault.' But the eunuchs feel they are still not getting the attention they crave. They are often "the targets of some of the worst sex crimes in India," said a spokesperson.

"Economy expected to grow four-fold by 2020." Think the headline refers to the US? Britain? France? Think again. It's the subcontinent the article talks about.

Edelweiss Capital predicts a nominal growth rate of 13% per year for India...leading to a GDP over $4 trillion in 10 years. Per capital income is expected to rise too - from $1,017 per year now to $3,213.

Imagine what these mean to business and investors. Even if you have a mediocre business you can expect your sales to triple...or quadruple...over the next 10 years.

How to Trade the BRICs with ETFs

You've heard of the BRIC countries, right? Brazil, Russia, India and China are the four top emerging markets. For various reasons, all have much better long-term prospects than most of the so-called "developed" markets.

Now there's a way you can trade the BRIC stock markets with some new leveraged ETFs — but you need to be careful.

More on this opportunity in a minute. First, let's quickly review what all the excitement is about ...

BRICs Are the Future!

I don't have to tell you that the U.S., Europe and Japan are in dismal economic condition. Getting out of the mess we're in is going to take time. Possibly a very long time.

The world isn't going to sit still and wait for us. Quite the opposite — countries that have lagged behind are catching up. The BRICs are leading the way.

Brazil dominates Latin America and is rich in natural resources. Brazil accounts for most of the world's soybean trade and about 80 percent of global orange juice production. More important, Brazil is actually energy independent — thanks to ethanol and abundant offshore oil reserves.

The BRIC nations will own the 21st Century!

Russia is reaping the reward of still-high energy prices. The former Soviet republic has the world's largest natural gas reserves and massive gold deposits. Russian cities are bustling with commercial activity

India has a huge and growing English-speaking workforce. Over the last twenty years, India's growth rates have skyrocketed. Goldman Sachs projects that India's economy will overtake France by 2020 and Japan by 2035.

China is becoming nothing less than the world's largest market for pretty much everything. The sheer scale of the growth is mind-boggling. The Chinese economy is seventy times bigger than it was in 1978. A vast industrial base is transforming the country in unimaginable ways.
You can see where this is going. The BRIC countries are exploiting our weaknesses and setting themselves up to own the 21st Century, economically speaking.

(By the way, you can read a lot more about the BRICs in my free special report. Click here to download your complimentary copy of Meet the BRICs: Economic Leaders of the Future.)

Of course, the BRIC countries aren't the only emerging markets. Each is surrounded by smaller countries and ever-growing trade relationships. You can find opportunities in places like the Next 11, too. The four BRICs are, however, the biggest emerging markets. They can't be ignored any longer.

BRIC ETFs are your ticket to these hot markets.

Trading BRICs with ETFs

Even if you've never been outside the U.S., you can still get in on the BRIC action. Today's ETF products make it easy.

One possibility is to buy ETFs that focus on each of the BRIC countries individually. Numerous ETFs cover Brazil, Russia, India or China — too many to list here, in fact.

An easier way is to get all four BRIC markets in one package. These ETFs allow you to do it all in one quick step.

SPDR S&P BRIC 40 ETF (BIK)

iShares MSCI BRIC Index Fund (BKF)

Claymore/BNY BRIC ETF (EEB)

Each of these ETFs tracks a different stock index, so the results are also slightly different. All offer a fast and easy way to get started in emerging markets investing.

If you are more experienced and/or short-term oriented, you might want to take at some new funds from Direxion. Launched just last week, these are the first leveraged and inverse BRIC ETFs:

Direxion Daily BRIC Bull 2x (BRIL)

Direxion Daily BRIC Bear 2x (BRIS)

Before you try these last two, read my articles on Inverse ETFs and Leveraged ETFs. Funds of this type are often misunderstood. Here's a hint: Pay attention to that word "Daily." Direxion put it in the names for a very good reason.

Is now the time to buy the BRICs? Maybe, maybe not. Anything can happen in the short run. But I'm confident that 20-30 years down the road, the BRICs will have shown massive growth compared to the U.S. That makes them an opportunity worth considering.

How Capital Waves Are Creating the Biggest Profit Opportunities in Today’s Markets

Back when oil was trading at a record high of $145 a barrel - and was generally expected to go higher - I concluded that the forces at play were speculative, not fundamental - driven by new institutional money looking to diversify away from too many concentrated equity bets. I argued these forces were temporary, and not entrenched, meaning that oil prices were actually headed for a fall.

The "forces" I was referring to are called "capital waves." Capital waves create some of the biggest trading opportunities in the markets today. Investors who are able to spot capital waves and identify their likely impact have a huge advantage over those who don't.

With oil, for instance, pundits were calling for new highs of $200, $250, $300 and even $500 a barrel. But behind the curtain, there was a major capital wave at play: I knew that oil was being pumped out of the ground like mad, and that shipping rates were exploding because oil was being stored in offshore, idled tankers. I knew that as little as $20 billion had been "re-allocated" out of the equity markets and into this new-asset-class investment for pension fund accounts.

As a speculative frenzy seemed to be enveloping the oil market, I called for oil prices to plummet - to more than a few looks of incredulity or outright guffaws.

When the secondary capital waves took hold, the speculative advance in oil prices first stalled - and then oil prices plunged as capital exited in another wave.

Don't feel bad if you missed this opportunity. That's the important thing to remember about capital waves - they're out there if you know where to look and how to interpret them. In fact, as good as this oil play was, I see even better opportunities ahead.

Dear Mr. Gillani, Another great, powerful and insightful article. I couldn't …

Investors too often focus on specific stock selection and watch their investments get swept away when powerful undercurrents spawn market-moving capital waves.

But finding that needle-in-the-haystack stock isn't as important as picking the right haystack.

At this critical market juncture, the easy money has already been made. Whether investors are able to hang onto recent gains and take advantage of future opportunities will be determined by where - and how quickly - giant capital pools react to financial, economic and political forces.

The new religion in investing doesn't rely on faith. If you know the sea is being parted, you don't have to walk on water.

You instead must understand how to read the ripples and invest in the waves...

Ride These Five Capital Waves

The first step to successful capital-wave investing is to understand the big picture. You can pick a stock with great promise, but if its overall industry group drifts down or is tanked by an exodus of investment capital, you're sunk.

Likewise, if you pick the right industry - and even the right stock - but the overall stock market drops, that's also bad luck.

To maximize your potential for finding winning positions, start by picking the right asset class. But also make sure that you're on the correct side of the underlying trend. If you catch the big wave, you have significantly enhanced your prospect of making money when the wave pushes all boats in front of it towards profitability.

The major asset classes where huge capital waves drive quick-and-robust profits consist of:

1.Developed-world equities.

2.Emerging-market stocks.

3.Fixed-income assets.

4.Currencies.

5.Commodities.

Profits on Our Home Shores

To really see the big picture, investors increasingly must understand political events and how they impact investment decisions and huge capital flows. Political decisions around the world affect local markets and global markets when policies impact trade relations, interest rates, currency values, taxes and regulatory matters. There are other factors, but these are the big themes to watch.

Here's what is happening around the world. And here's how to correctly position yourself in the major asset classes.

The United States is still the world's No. 1 economy and what happens here moves markets. President Barack Obama and Congress are grappling with several major political decisions. Healthcare, regulatory reform, economic stimulus and, eventually, taxation, are the major forces that will create capital waves.

The Obama administration, Congress and the U.S. Federal Reserve cannot allow interest rates to rise. They will do whatever they can to keep rates low: Otherwise, the recovery will be choked off.

Inflation is not an immediate problem. In fact, a little inflation would be an excellent tonic, and should help with asset appreciation. Also, don't get hung up on the potential ramifications of the growing U.S. deficit and escalating national debt.

The huge budgetary shortfall will hurt some investments, even as it creates huge opportunities elsewhere. But the true effects of the deficit will take more time to work their way through the U.S. economic system, meaning there are other factors that are right now more critical to consider.

With headline unemployment at almost 10% and consumers retrenching in the face of declining housing values and tight bank-lending standards, the perception of rising inflation will be offset by the need to get America going again.

Bet on low interest rates: As long as interest rates remain low, the stock market can maintain its current upward trend.

Pay careful attention to marketplace undercurrents, particularly those that are politically based. Closely follow anything that points to an end to the stimulus programs, to the market's reaction to the passage or failure of healthcare legislation, and to any real regulatory reforms that are enacted. And given the projected deficits and expected growth in U.S. debt, watch to see if any tax-law changes take place.

The trend is your friend, and right now the market trend is up. But it's a good time to be nimble, and to take profits and cut losses to give yourself the opportunity to better gauge the future direction of U.S. stocks as these major political currents play themselves out.

If you opt to remain invested in winning positions, make sure to employ protective stop-loss orders.

Ride the Tides to Global Investing Profits

The rest of the developed world is a mixed bag. Bet on Australia: As overseas economies go, it was hurt the least by the credit crisis and housing bust and has been the first to emerge. In fact, Australia is so strong that it was the first country to raise interest rates, which it never would have done if its recovery were threatened.

Canada is another strong bet. Get exposure there.

Europe is a mixed bag. The big European companies who are leaders in their respective businesses around the world are going to continue to expand and grow revenue. The governments of their home countries support and coddle the giant corporations that employ thousands and generate billions tax revenue. At this juncture, invest in the multinational leaders that are headquartered in Europe. But don't try to play any particular country.

Europe's growth prospects are inexorably tied to the euro. From a political standpoint, the European Union (EU) wants to see the euro to fall relative to the dollar and other world currencies. Why? Because, like everyone else, EU-member countries want to export their way out of recession. And a cheaper euro makes their goods and services less expensive to the rest of the world.

There's a danger, however: Europe could get too much of what it seeks.

In the face of mounting economic woes - not to mention debt that's soaring in relation to gross domestic product (GDP) - watch out for a big spike in fears that the EU could become unglued. That could cause the euro to drop too far.

This is how capital waves lead to investment opportunities. Watch the momentum of the euro: If it breaks recent support levels, it will make a great short. Put that in your currency asset-class file as a potential home-run trade.

Emerging equity markets are humming along. You should be invested internationally - in Brazil, India, Korea, and especially in China. There are political ramifications to China's stated policy to rein-in its overheated economy, just as there will be to the shifting political agendas of some of the other emerging-market countries.

The one problem with all the emerging economies is that they are all export driven. Sure, China has been investing internally. But politically speaking, Beijing knows that the domestic demand needed to fuel internal growth will need more time to reach a perpetuating critical mass. However, watch the country carefully: If domestic demand outpaces exports revenue, buy the country!

China is the engine of Asia. If China cools down, it will affect the entire region, as well as global commodities prices and, indeed, the entire world market.

There's a new nexus driving the world. The global confluence of politics and economics brokered the engagement of the United States and China. But who actually ends up wearing the pants in this marriage will determine where there are opportunities, and where there are struggles, all across the globe. Huge pools of capital will be shifted.

There are no bigger, faster or more profitable capital waves coming than these.

Low-Tide Interest Rates Yield Maximum Market Profits

The fixed-income asset class is arguably the most important asset class for investors. While there are plenty of bond and fixed-income securities and instruments to invest in, this asset class is crucial to watch because it is a window through which we can see the direction of interest rates. Nothing creates giant capital waves quite like interest-rate moves. If you want an early warning system to safeguard your investments, or if you're looking for new investment opportunities, become a master reader of the bond market and diviner of the direction of interest rates.

Since the stock market rally began last March, investors who bet that an increased risk appetite would mean an exodus from a massive build up in U.S. Treasury holdings got burned. If you understood the big picture and knew that the Fed and the Obama administration intended to keep interest rates at ultra-low levels at all costs, you would have participated in - and profited from - the rally in bonds.

Eventually, interest rates will start to rise. Getting the timing right could make you staggeringly wealthy - while those who don't have their eyes on the prize take it on the chin.

How will you know when rates are moving? Watch the political undercurrents. Watch tax-and-spend policies. Watch worldwide risk appetite. Watch bond spreads.

Movement in interest rates directly affects the biggest asset class of all - currencies.

Currencies and Commodities: The Best Waves to Ride

Investors who aren't playing the currency markets are missing out on the last great venue where one can start with a little money and, if managed properly, leverage it into double, triple or quadruple gains that just aren't attainable anywhere else.

Macro political decisions affect interest rates and currency relationships. Therefore, to catch the big movements in currencies, keep an eye on government-trade, spending, tax and regulatory policies. Watch what's happening between political factions in Europe. The biggest plays will be in the dollar, the euro and British pound. Right now the trades are: Long, short and double-short, respectively .

The last big asset class that investors can make a killing in is commodities. You don't have to watch them all. Watch the commodities that most affect your life. The ones to watch include oil, gasoline, natural gas, agricultural products and, of course, precious metals such as gold and silver.

What factors most affects commodities? Politics, for one thing. For instance, whether or not Beijing slows China's growth will determine the demand for most major commodities and basic materials. Indeed, whether all the world's economies will try to export their way to economic growth will determine commodity demand. After all, if global growth slows, commodities stockpiles will increase, and prices will plummet.

At the core of each of these scenarios will be series of macro political decisions that set the catalysts in motion.

No matter which way asset prices move, one fact is certain: If you divine the correct capital waves, and time your trades correctly, commodities provide a means of diversifying your investment portfolio and adding rocket fuel to your returns.

Rules for Safe Big-Wave Surfing

It's easy to take positions in macro trends and in different asset classes. There are plenty of great exchange-traded funds (ETFs) to trade if you currently don't wish to invest directly in bonds, currencies or commodities. At some point in your moneymaking career, your view on this point is likely to change, and you will make those investments directly.

As we've seen in the two years, markets go up and they go down - and sometimes very sharply. It's important to remember that, in general, when markets go down the velocity of the move is greater than it is on the way up. The simple reason for this reality is that the emotion of fear is much more powerful than that of greed. All the major asset classes can - and should - be played in both directions. If you're only playing the uptrends, you're missing out on the other half of the action.

And worse, if you're not inclined to see opportunity when markets reverse, there's a better-than-even chance that you will get stuck thinking that your sinking position will magically reverse course and resume its ascent. I call this investor trap "the tyranny of magical thinking." The bottom line is simple. If you take profits and cut your losses you will be out of the market at times. And, that gives you a clear view of trends.

The last 10 years are a wash. And stock-market investors must face the scary reality that buy-and-hold investing has failed. It has failed because the world has changed - but most investors haven't.

As the world has gotten larger, investing opportunities have grown in size, scope and speed. Huge capital flows move in and out of asset classes, markets, industries and stocks at the speed of a mouse click.

And precisely because these giant capital waves happen so often, smart investors tend to be big-wave surfers. They just need to be sure to pick the right waves to ride.

Are Coal Prices Ready to Burn Hot in 2010?

For most of the past 50 years, since the birth of environmental awareness, coal has been the "black sheep" of the power-production family. Now, thanks to more efficient furnaces, better exhaust-scrubbing systems and other technological advances, coal is regaining favor in the world's energy markets.

However, the biggest factor in coal's recent price surge is steadily increasing demand for the fossil fuel in power generation and steel-making process, abetted by rising costs for other types of fuel, like oil and natural gas.

The question for investors, of course, is will this rising demand continue - and how can you profit if it does?

The answer to the first part of that question is almost certainly, "yes," but solving the second part is a little trickier.

Why don't you have ANR on this list of Coal companies??…

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Simple Supply and Demand

Coal has two primary uses - as fuel for the commercial generation of electricity and heat and for conversion into coke, which is used as both a fuel and a reducing agent in the process of smelting iron ore in a blast furnace to make steel.

Roughly 92.8% (1,041.6 million short tons) of total U.S.coal consumption (1,121.7 million short tons) was used for electricity production at 22 major coal-fired power plants in 2008, the last year for which complete figures are available. Roughly 1.9% (22.07 million short tons) was used in coking, while the remainder was used for other industrial purposes and private and institutional (e.g., hospitals and universities) power and heating plants. On the production side, U.S. coal output rose by 2.2% in 2008 to a record 1,171.5 million short tons, helping fuel a sharp increase in coal exports.

U.S. consumption totals in all sectors were down slightly in 2008 from 2007 - reflecting the relatively mild winter and the sharp economic slump - and numbers for the first three quarters of 2009 showed a continued decline, though preliminary figures for the fourth quarter and the first two months of 2010 show that trend reversing in all sectors but coking, thanks to the record-setting winter weather and a modestly resurgent economy. The continued decline in the coking sector reflects the ongoing loss of U.S. steel production to overseas competitors, most notably China.

Indeed, according to all major industry sources and the U.S. government's Energy Information Administration (EIA), China will be the driving force in the coal markets for at least the next two decades, accounting for more than half of the world's total consumption by 2025. Growth in consumption will also be far stronger in other emerging-market countries than in the developed nations.

The EIA projects growth in coal consumption in the U.S. and other nations of the Organization for Economic Cooperation and Development (OECD) will grow from 47.3 quadrillion British thermal units (Btu's) in 2010 to just 48.3 quadrillion Btu's in 2025, an increase of only 2.1%. By contrast, coal consumption in China is projected rise from 62.7 quadrillion Btu's this year to 90.1 quadrillion Btu's in 2025 - a 43.7% increase.

For those wondering why we've been describing consumption and production in quadrillion Btu's rather than the much simpler and more straightforward tonnage, it's because there are significant differences in the quality of coal, depending on where it's produced. Thus, it's more precise to talk about the energy values in coal.

Total non-OECD consumption, including China, is projected to rise by 36% from 93.3 quadrillion Btu's this year to 126.9 quadrillion Btu's in 2025. So in just 15 years, emerging nations will account for more than 72% of the world's annual coal use.

Worldwide demand for coal will rise to 175.2 quadrillion Btu's in 2025 from 140.6 quadrillion Btu's this year, an increase of 24.6%, the EIA said.

Meanwhile, the mining industry has barely managed to keep up with the increase in global demand in recent years. In 1990, total world demand was 89.2 quadrillion Btu's, while total world production was 91 quadrillion Btu's, a surplus of 1.8 quadrillion Btu's, or just over 2%. By 2006, the last year for which complete production figures are available, global demand had climbed to 127.5 quadrillion Btu's, while global output had risen to just 128.49 quadrillion Btu's - a surplus of just 0.99 quadrillion Btu's, or 0.77%.

Given the increased worldwide restrictions on mining operations and the shrinking likelihood of new coal discoveries, it's hard to see where another 47.7 quadrillion Btu's worth of coal are going to come from, especially since projections for 2010 are already showing a potential production shortfall and depletion of existing stockpiles. (There's also no anticipated improvement longer term, since the World Coal Institute estimates there are only enough proven coal reserves to last 155 years if the rate of consumption remains unchanged.)

Investing in Coal

Unlike with many other popular commodities, individual investing in coal is generally not a simple matter of buying basic futures or forward contracts. That's because different types of coal have extreme variances in quality.

In the United States, for example, there are five primary classes of coal, each with a different Btu rating. Northern Appalachia coal, rated at 13,000 Btu per short ton, is the highest quality, while Powder River Basin coal (from Wyoming and other Rocky Mountain states) is the lowest quality, with a rating of just 8,800 Btu per short ton. Because of those quality differences, the spot prices for Northern Appalachian coal and Powder River coal at the close of trading on March 5 were $64.00 a ton and $12.70 a ton, respectively.

The other classes of U.S. coal, with March 5 spot prices, are Central Appalachia (12,500 Btu, $58.95), Illinois Basin (11,800 Btu, $41.50) and Uinta Basin (11,700 Btu, $40.00).

While the NYMEX division of the CME Group does trade one major and two minor futures contracts - Central Appalachian, or CAPP (trading symbol: QL); Western Powder River Basin, or PRB (symbol: QP); and Eastern CSX Transportation (symbol: QX) - all are fairly thinly traded and used primarily by commercial interests for hedging and supply management. Inconsistencies with the spot prices can also be high - e.g., the nearby CAPP future closed at $52.30 on March 5 compared to the spot price of $58.95.

Coal prices also tend to move separate from coal fundamentals themselves. Instead coal prices track the changes of other energy commodities, primarily crude oil and natural gas, as well as certain hedging commodities such a gold. This was illustrated quite clearly the past three years.

Through most of 2007, Northern Appalachia coal prices ran from $30 to $45 per short ton. They then skyrocketed along with oil in early 2008, peaking near $150 in October 2009, before plummeting back to just over $40 per ton in May 2009. After a couple of months of flat trading, prices again started a steady climb, reaching $64 on March 5.

So, assuming the demand will continue to grow - and oil prices will keep rising, dragging coal and gas along - how should you play the move?

Exchange-traded funds (ETFs) are among the best choices as there are at least four that take heavy positions in coal-related issues, including two that target coal specifically. All are up significantly in price since the March 2009 market bottom, but they should have ample room left to climb as the recovery gathers added steam. They are:

Market Vectors Coal (NYSE: KOL): This fund aims to track the price and yield performance of the Stowe Coal index. It normally invests at least 80% of total assets in equity securities, including American Depositary Receipts (ADRs), of U.S. and foreign companies engaged primarily in the coal industry.

PowerShares Global Coal (NYSE: PKOL): This fund attempts to mirror the NASDAQ OMX Global Coal Index. It normally invests at least 90% of assets in securities, ADRs and Global Depositary Receipts (GDRs) based on the securities in the underlying index, focusing 80% of assets on companies involved in the coal industry.

Market Vectors Steel (NYSE: SLX): Coal is a major cost factor for the companies this fund invests in since all are major consumers or producers of steel. Since steel is a major component in all sorts of infrastructure construction, the fund's holdings should benefit from new spending linked to the global economic recovery.

SPDR S&P Metals & Mining (NYSE: XME): A diversified fund that includes coal mining and processing companies among its portfolio holdings, many of which are international, meaning the fund can also benefit from currency fluctuations as well as changing prices for metals and other minerals.

For those who prefer picking individual stocks to riding along with fund managers, four companies with heavy direct involvement in the coal industry are:

Consol Energy (NYSE: CNX): This Pennsylvania-based company is involved in the mining, preparation and marketing of steam coal, primarily to power generators, and metallurgical coal to steel and coke producers. A darling of the mutual funds and institutional investors (including Carl Icahn, who had 1.36 million shares at one point), which hold 93% of the shares, CNX also has a large holding of in-ground coal reserves.

James River Coal (Nasdaq: JRCC): After being the focus of takeover talk for more than a year before the economy collapsed, this miner and processor of industrial-grade coal pulled back from the high $40 range in 2006 to a low of $3.86 in August 2007. It then rode the oil rally to $62.14 in June 2008 before sliding all the way back to single-digit levels in late 2008. Since then, it has traded in a fairly tight range from $16 to $22, but it obviously has the potential for another large run should coal prices continue to rally.

Patriot Coal Corp. (NYSE: PCX): Patriot has reserves in both Appalachia and the Illinois Basin, operates 14 mining or processing complexes and is a major supplier of thermal coal to power companies along the upper Mississippi. The company has strong earnings ($1.49) over the past year and, though the stock has made a nice run from its lows last spring, still has a reasonable price-to-earnings (P/E) ratio of just 12.93.

Puda Coal Inc. (AMEX: PUDA): For those who like to go right to the heart of the demand, Puda is one of China's leading suppliers of metallurgical coking coal to the Chinese steel industry. It also has room left to move price-wise, unlike SinoCoking Coal and Coke Chemic (Nasdaq: SCOK), another Chinese mining and coking company, which recently shot from $3.50 a share to more than $30 after uplisting from the Bulletin Board to Nasdaq proper.

Coal prices could suffer a mild seasonal decline as winter comes to an end, but the ballooning long-term demand picture and increasing oil prices appear poised to provide support - and possibly light a new fire under coal-related stocks in the near future.