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Todd Stein & Steven McIntyre are internationally known analysts and editors of The Texas Hedge Report, a market newsletter that highlights under and overvalued securities…

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China Dumps Dollars for Oil and Gold

Safeguarding one's access to vital natural resources such as oil and gas is crucial to nation's long-term prosperity. But telling soldiers and their families that they are fighting in part to protect against the threat of $10.00/gallon gasoline is not exactly good for morale or public relations. Protestors chanting "No blood for oil" would have a field day if the White House press secretary made an announcement such as, "Good news, the Baghdad Museum has been looted, 1,000 American troops have been killed, but we have secured 90% of Basra's oil fields."

Skeptics would tell you that part of the reason why American and NATO troops remain in Afghanistan after overthrowing the terrorist-harboring Taliban is to get a foothold in the game for Caspian Sea oil. Whether or not you believe these skeptics, it is a fact that multinational energy companies have developed a renewed interest in building gas and oil pipelines linking the Caspian region with the lucrative international market of the Arabian Sea. This activity has worried the three large powers in the Central Asian region: Iran, Russia and China. All three of these countries have indirectly (or sometimes directly) supported America's enemies over the last three years with either military or financial assistance. While Iran and Russia have long supplied America's adversaries with arms, the fact that China has stepped up its efforts in this arena marks a disturbing trend.

China, which President Bush has called a "strategic competitor", will see its demand for industrial energy more than double over the next 15 years. China's electricity demand has doubled within the last decade and is likely to quadruple by 2019. Could China's recent shenanigans in the region be a small baby step for an energy-hungry power getting restless?

As can be seen from the chart above, China was a net exporter of oil until about ten years ago. Today, China is the world's #3 consumer of oil behind the United States and Japan. Given its population and need for infrastructure, we can confidently predict that China will sooner or later overtake both nations and become the world's leading importer of oil, bringing it into conflict with the developed world.

China has already invested billions of dollars into pipeline projects in Central Asia and the Middle East and has strengthened its relationships with governments from energy-rich states. For example, China is Sudan's largest trading partner and the most important foreign investor in Sudan's oil industry. China National Petroleum Corporation has a 40% stake in the international consortium extracting oil in Sudan, and it is constructing refineries and pipelines, enabling Sudan to benefit from oil export revenue over the last five years. Recently, China deployed thousands of troops to Southern Sudan to protect its pipeline interests while Western oil companies have been withdrawing from the war-torn African nation. Sudan has been accused of using its oil revenue to purchase arms for its wars against its black African population in its Darfur region. In a classic example of realpolitik, China has threatened to veto a resolution that would consider U.N. sanctions against Sudan's oil industry if Khartoum does not stop the genocide. Could Chinese PLA troops in Sudan be a first step in China's growing expansionism throughout Eurasia?

Like Britain a century ago, the United States has greatly over-borrowed in an effort to control access to the world's energy supply and at the same keep its domestic economy firing on all cylinders. As competition for diminishing oil resources threatens U.S. dollar hegemony over world oil transactions, expect to see increased Chinese political and military presence in the Middle East. The presence of Chinese PLA troops in Sudan, in our opinion, marks the middle kingdom's entrance into the great game. China's next move could come in the form of massive dollar devaluation when they decide to unload their supply of accumulated greenbacks. China just recently released six billion of those greenbacks for its purchase of Noranda Mining - Canada's biggest mining company. Keep your eyes open for stepped-up greenback dumping by China in exchange for natural resources such as oil-bearing properties or perhaps more mines. We predict that in the near future, Saudi princes will decide to denominate some of their oil transactions in Yuan (or at least something other than dollars) and invest their profits into shares of China Mobile or PetroChina instead of Citigroup.

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