RUSSIA: WHAT WE KNOW AND DON'T KNOW

The more we know the less we seem to know about diplomacy with Russia. We know that Georgia sent troops into South Ossetia on the advice of the US before Russia invaded South Ossetia. We know that the US, France, Canada and the UK recently participated in Operation Brimstone, designed as training for a naval blockade of Iran, just before Russia placed a Naval Blockade against Georgia. We know that reliable sources say a Naval Blockade of Iran is being prepared but other reliable sources say two of the big carriers mentioned in the original reports are still in port.

This morning, sources which repeated the false reports about the USS Roosevelt and USS Iwo Jima being underway, have tried to clarify the situation. They report that a large number of ships are moving in the direction of Iran. Canada, for example, has several ships underway. The DEKAB web sight shows a picture of the USS Ronald Reagan and implies that it has joined others in the area. This is very possible as it was recently roaming the South China seas.


DEKAB continues to report that Kuwait and other Arabian nations are preparing for war. We know that an organization of Arabian states has sent diplomats from Egypt and Saudi Arabia to ask Iran to simmer down. We know that UAE has been under pressure to work more closely with the USA and that suddenly the dispute between the UAE and Iran, over three small islands, has heated up.

We know that a bill has been introduced into the US congress to authorize a Naval Blockade of Iran. We don't know that one is needed. Naval Blockades are considered acts of war, but the severe sanctions approved by the unanimous vote of the UN are either acts of war or acts to prevent war, all in the eye of the beholder. A blockade to enforce legal sanctions would be part and parcel to previous actions. We choose to believe a blockade would be done for the purpose of preventing suicide bombings and all out war while Amadenijhad chooses to believe it would be an act of war. Russia has voted for all three sets of sanctions against Iran. Iran cannot expect explicit help from Russia.

We know that Israel is for striking Iranian nuclear facilities. It is believed that Iran has more than half the uranium it needs to make a nuclear bomb. By continuing to increase and to demonstrate its long range delivery systems, Iran keeps making people nervous. Iran has stated that it has increased the distance its aircraft can fly. It claims the ability to attack Israel by air because it has the ability to refuel in air. It has continued to test long distance test rockets with the latest being a space rocket.

The Iranian air force would stand little chance against the Israeli air force and no chance against the US air force. Sneaking one nuclear bomb through to Israel is one of the few military solutions Iran has. A standard delivery van can carry a nuclear bomb sufficient to wipe out most of Israel.

We know that the USA and Russia negotiated a massive 123 Peaceful Use of Nuclear Agreement. The Congress of the USA must vote this down by late September or it will have passed all US requirements. It appears that the table has been set for serious US-Russian negotiations. The congress is not likely to let the 123 Agreement pass or approve Russia's entry into the WTO (world trade organization) while Russia occupies South Ossetia. Russia has a lot more to gain by making a deal than it has to lose.

One of the US responses to the invasion of South Ossetia was to deliver an anti-ballistic missile system to Poland. A small contingent of US troops were a part of the delivery, thus, the US now has troops stationed in a NATO nation that borders Russia to the east. Russia is no longer the big bear it once was, in the old days, the Soviet Union would not have permitted US troops to be stationed next to Russia. The paranoia of Russia is well understood in the context of 26 million Russian deaths during WWII. It is time for Russia to heal its wounds. It has recovered from the economic collapse of the Soviet Union some 19 years ago but it is no longer a "super power".

As always, economics and diplomacy are often upside down and backwards from the common perception. It appears that the current move is really a move by the west to establish stronger relations with and within former Soviet Union states and Eastern Bloc protectorates. Again, it was on the advice of American advisers that Georgia sent troops into South Ossetia. It was just a month or two ago when a US missile system was sent to the Czechs to serve as protection against Iranian missiles. Russia was not happy about the system in Czechoslovakia and it is not happy about the system in Poland. Russia is reduced to hints that it might give nuclear rockets to Syria or that it might fire nuclear weapons at Poland. These are not credible threats but negotiating tactics.

WOW! DEADLINES APPROACHING FAST!

Back on July 19, the EU and the undersecretary of the US State Department met with Iran. They gave Iran a deadline of 2 weeks to freeze production of uranium at current levels for six weeks. In exchange the UN + 1 would freeze sanctions at current levels for 6 weeks. The negotiators would have 6 weeks to make a deal before all hell breaks lose. At the end of the two week deadline, Iran refused to officially freeze, but it has attempted to keep the negotiations going while maintaining its level of production. Iran has claimed there was never a two week deadline but now it repeatedly mentions the 6 week deadline. Confusing huh?

It appears that the 2 weeks plus 6 weeks was part of an 8 week total deadline. The UN +1 are apparently prepared to tighten sanctions severely 8 weeks after July 19. And, forget about the argument that Russia might not go along with additional sanctions. The pattern of previous sanctions makes it clear that tough sanctions are passed but then only partially enforced. The negotiators have played a good game of "tit for tat". They have shown the ability to tighten hard but have been willing to let up in exchange for progress. Iran was once forced to store 30 million barrels of oil before the sanctions were eased. A lot of progress has been made. Iran has reduced its support for militants in Iraq and has reduced the production of road side bombs. Iran knows that, fully applied, the sanctions already approved would put a severe hurt on the Iranian economy.

The US Congress faces several deadlines. If the US Congress does not pass a continuing resolution by September 30, the US Government will be broke. Jim Demint, Senator from South Carolina, says he has the votes to block a continuing resolution if it includes an attachment to continue the ban on off shore drilling. Nancy and Harry are in a tough spot. Each has gone from saying there will never be a vote on drilling in this congress to saying that they are for drilling provided a bunch of other stuff is attached.

The Congress also faces a deadline on a vote to approve a 123 Agreement with India. Here again, Nancy and Harry are in a tough spot. Harry, in particular, has been holding back the development of nuclear power in the USA. India is about to round third base and to head for home. It will soon be allowed to develop its peaceful use of nuclear power with or without the USA. If the USA votes no, France, Russia, UK, South Korea, China, Australia, Canada, Japan and others will be more than happy to sell nuclear technology and fuel to India. If the USA votes yes, American companies such as GE, Shaw Industries and Westinghouse (subsidiary of Toshiba) will be allowed to compete for nuclear business in India. Can Dirty Harry win the fight to stop emission free nuclear power in India?

The 123 Agreement with Russia is probably the most important deadline. The treaty was submitted to the Congress on May 13. The congress must vote to reject within 90 days of submission. The reason it was so important for Nancy and Harry to adjourn Congress a few weeks ago was to allow them to "reconcile the count". Professional bridge players know that you sometimes have to lose a trick early in the hand in order to reconcile the count. Nancy and Harry had to move the Russian 123 Agreement deadline back by sending the Congress on vacation. The 123 Agreement with Russia includes a safe system for converting the waste stored in America into valuable nuclear fuel.

FUN, FUN, FUN

Tim Russert said that this election cycle was the most exciting he had ever seen. I know he is having great fun in heaven watching the rest of the cycle play out. McCain has all but taken a temporary lead (Obama is about to get a temporary bounce from his convention and from his nomination of a vice-presidential candidate). States which were once leaning democratic are now in McCain's camp, Missouri is now 48% for McCain and 41% for Obama. These numbers do not reflect the excellent performance of McCain at the Saddleback Church.

Colorado has moved from leaning democrat to leaning republican. In North Carolina, the history of electing a democratic governor while voting republican for president seems likely to continue. However, just a few weeks ago, NC was leaning democratic. Today, it is leaning republican and Purdue, the democratic candidate for governor, has suddenly switched from being against off shore drilling to being for off shore drilling.

The switch from extreme environmentalism to drill, drill, drill has been fun to watch. Sixty-one percent of Americans now say that Congress should hold a special session to vote on drilling. Eighty percent of Americans believe that some new off shore drilling should be allowed. McCain hold the winning positions on energy and as the correct selection as commander in chief.

MARKET IMPLICATIONS

One of the greatest investors of all time, John Templeton, said, "Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria". On a scale of 1 to 10, would you say your friends and neighbors are closer to 1 or 2 (pessimistic), 3 or 4, (skeptical), 5 or 6 (neutral), 7 or 8 (optimistic) or 9 or 10 (euphoric)? Last week, according to sentiment numbers published by more than one survey, public investors were as pessimistic as they have been since the fall of 1982. Ask them about politics and they are more depressed than ever.

The Russians have done McCain a huge favor. McCain spoke out about the Russians a month before the invasion of Georgia. When the invasion occurred, Obama basically repeated his Iranian line, that we should go have a nice talk with Russians. A large majority of Americans prefer McCain as commander in chief, which means the Obama tax increases will not pass.

The public has followed up its pessimism with actions. They have sold shares of stocks and mutual funds. Historically, at market bottoms, the public fearfully hoards cash. Not only was there record amounts of cash at the most recent bottom, but the level of cash has grown since the rally started. Even the cash does not tell the whole story. The amounts invested in large cd's at banks is shooting off the chart.

Pundits talk about the de-leveraging as only a function of reduced loan availability. Banks have tightened credit standards. Banks are also seeing the deposits needed to produce solid capital ratios.

At the start of Bull Markets, people sell into rallies; when Bull Markets are old, people buy the rallies and the dips. A lot of public buying has been concentrated on the energy markets. Now that gold and energy has turned, most investors are too numb to buy or sell anything. Gold has fallen from $1,033 to $793 but the public is in fear of inflation. Oil has fallen from $147 to $114 but the public still has heard almost nothing about the economic turn at hand, they still believe oil is on the way to $200 per barrel. The turn is here. Do you believe?

REAL ESTATE AND REAL ESTATE FINANCE

During real estate recessions mortgage companies and savings and loans get slammed in panic sell-offs. For example, MBIA traded at $14.16 in June of 1990 and at $6.60 four months latter. In recent weeks there has been a panic in real estate and real estate finance.

There is good news! 1) building has virtually ceased in saturated markets 2) many of the homeowners who are underwater will pay anyway 3) banks have already set aside massive reserves for losses 4) leverage is a double edged sword 5) the lower the price the more tempting the purchase of deeply discounted, highly leveraged assets.

In effect, near the bottom, the financial sector becomes similar to a highly pressed spring. MBIA traded at $6.60 in October of 1990 but by December of 1991 it traded at $15. A non levered investment of $1,000 in June of 1990 fell to $466 in October but that $466 had grown to $1,059 by December of 1991. Those who bought at the bottom made 2.27 times their money in only 14 months. Less than two years later, in October of 1993, the shares traded for $26; the shares jumped 400% in a little more than 3 years.

BAC (Bank of America) rode the same roller coaster. It traded at $13.60 in August of 1989, $4.90 in October of 1990, at $14.25 by March of 1993 and at $43 by July of 1998. By October of 2006 it traded at $53. Not bad but this cycle saw it fall to $1850 by July of 2008. It has already bounced to $30.59. The Washington Mutual Savings and Loan wet from $38 in September of 2007 to $4.36 in August of 2008. From its bottom in 1990, it went from $2 to $12 by September of 1993, 600%!

THE PENDULUM HAS SWUNG!

Oil rich countries have been sucking up money light giant shop-vacs. Iran's foreign currency reserves jumped from $61 Billion at the end of the 2006-7 budget year to $81 Billion at the end of the 2007-8 budget year. It's 2008 budget got off to a roaring start when oil traded at $147. The fall to $114 means less money for Iran and more for consumers. Iran's foreign reserve increases of $20 Billion in a single year came out of the pockets of consumers.

Iran has been spending money as if it has 300 billion barrels in reserve (it does, but instead of developing those reserves, it has spent billions of dollars supporting forces trying to kill Americans and to take over Israel). A recent audit by the IMF revealed that the Iranian budget will go into deficit by the time oil hits $85. A price of $75 would produce a severe crunch. It will take a long time before nuclear substitutes take large chunks of market share, but mass production of nuclear is ultimately projected to bring nuclear electricity to below 2 cents per kilowatt, the equivalent of 88 cents per gallon of gas, $30 per barrel oil.

More importantly, while Iran is enjoying budget surpluses, economic sanctions have caused the country to be "cash poor" (all the reserves in the world but nothing to spend it on). With too much money and few goods, the official inflation rate is 26%. Students, shop keepers, factory workers and members of parliament are in protest of the countries economic policies. Something has to give. The leadership is going to have to change its policies or the leadership is going to change.

To no avail, the IMF has encouraged Iran to change its monetary policy. Amadenijhad insists on lose massive spending for military goods. His policies have caused high inflation and has forced him to fight with his own cabinet. He has fired a lot of men to maintain a cabinet of yes men. His most recent appointee looked at the books and immediately made recommendations in opposition to his boss.

The USA and its European allies have said they will propose new sanctions at the next meeting of the UN Security Council in September. This is like saying to a prisoner, in two or three or four weeks I am going to stop beating you with this stick so I can start poking your eyes with a hot branding iron. Sure there might be a week or two of argument between the US and Russia about whether the new "tool" will be a branding iron or a blow torch but the beating with the stick will continue until the decision is made. While the discussions are still in progress, the poking with the branding iron will begin.

THE FORBIDDEN APPLE

The story of the forbidden apple is a very old story. The story of Adam and Eve includes the first instance of forbidden fruit.

My friend Lamar has been proven right once again. A few weeks ago, he mentioned that at the height of the sanctions against South Africa, gold bars were shipped to Canada, melted down and reformed as Canadian gold bars. South African gold was sold around the world during the height of apartheid. Lamar's point was that Iran would get around some of the sanctions. Sure enough, Amadenijhad takes great pride in displaying American forbidden Apples. Goods such as Apple iphones, Apple Macs and Apple ipods are on vendors shelves. To acquire these goods, Iran is paying black market prices at the port of Dubai, across the Persian Gulf. If someone is willing to pay double the price, it is difficult not to cheat. If you pay double for thousands of Apple iPods, a big chunk of the oil money is wasted.

Iran is flaunting a few American goods but the country is in a great economic depression. I believe only those people who have been forced to go without food have a true understanding of the words, great depression. Iranian leaders are forcing the Iranian people to pay a huge price, so the leaders can attempt to gain great power. The worst of it is that the great power they seek is a mirage.

Nuclear weapons are of no value if they cannot be used. The only exception is by those who are willing to die as martyrs. Some say that Israel still exists only because it possesses nuclear weapons (does she or doesn't she, no one knows for sure) . However, when Israel has been under great stress, it has fought back with conventional weapons. Obama, McCain, and Bush all agree that Iran must not be allowed to obtain nuclear weapons.

Only a very tiny fraction of all people are willing to commit suicide in order to kill those of another religion. The leaders of Iran have paid people to perform this act. The leaders may or may not have faith in their beliefs sufficient to include themselves in a suicide pact. Are you willing to take that chance? If so, you are willing to vote for those who would pack up and leave Iraq before a deal is made with Iran. The left either does not see or does not want to admit that the war in Iraq is a key part of the greater war against terror.

The art and science of diplomacy requires great understanding of psychology, game theory, history and military strategy. The world is a complicated place. The USA has been guilty time and time again of letting small international problems fester into major conflicts. The USA was drawn into the two World Wars after relatively minor disagreements, such as the assassination of one small country leader, turned into major confrontations.

The negotiating table has been set. Deadlines quickly approach. The safety and wealth of many nations are at stake. The options have been limited. Key players have have been set on clear paths. The correct choices are obvious. The US game of diplomacy has been well played. The odds for success are better than most people believe.

EDUCATED GUESSES

I have demonstrated my willingness to go out on limbs while holding on to only educated guesses. As a result, I have made some incredible investments of extraordinary return and I have made others of extraordinary loss. Right now, I know there is much I don't know but we have seen the beginnings of a market turn. The market turn always precedes the economic turn and we are already seeing the economic turn. The process is well underway.

I'll write another piece about the coming boom in consumer spending. Just when the majority believe the consumer is tapped out, there are signs of a great recovery. Investors must always remember not to get caught-up by what has happened or what is happening but they need to look to the future. We do not know exactly how the next couple of months will unfold but we know that pending deadlines will require action.