From The Daily Reckoning today:"--Not surprisingly, the most...

From The Daily Reckoning today:

"--Not surprisingly, the most shocking weekend on Wall Street since the Great Depression sent the Dow down over 500 points by the close. Here in Australia, the futures suggest a decline to 4,692 on the ASX/200 at the open. That would be a decline of 135 points from yesterday's close, and a 3% loss to start the day.

--Through the fog of the financial war, you can take some solace that what's going on is necessary and, in a painful way, good. That is, the financial stocks have been sitting on losses for a year, hoping to find a magic escape. This dead weight and uncertainty in the system has been bad for all stocks.

--Now, though, the financials have nowhere to run. Cut off from capital, harried by short sellers, and looking desperately to the sky for a cash air left from Helicopter Ben and Bazooka Hank, they realise now the game is up. Those that can make deals to save their own skin (like Merrill) have done so.

--The rest? Well, markets don't take prisoners.

--The action in the commodity markets is more encouraging for resource investors. Gold was up $22.50, or nearly three percent, to $787. With risk-aversion back in fashion, it should be an interesting contest between U.S. Treasury bonds and gold ETFs.

--Who will be first to occupy the ground vacated by financials? Our money would be on gold, given that the supply of gold is not growing as fast as the supply of U.S. Treasury bonds. There may be a flurry of new money marching off to war from the Fed's balance sheet. But gold is battle scared, steadier, and just plain heavier than paper.

--What's more, according to Cameron Alexander of GFMS Limited, speaking yesterday here in Sydney at the Excellence in Mining show, gold production is in the midst of what he calls a "secular decline." Not only are cash costs of production rising for gold miners (up 27% in the first half of 2008, according to GFMS), but mine production is in decline globally. Why?

--Well, gold is not like paper money or digital money. You can't just create it out of thin air. You have to find it. You have to hire people to mine it. You have to refine it.

--The costs (labour, energy, and infrastructure) are rising...and for some producers are already higher than the gold price itself. Not many businesses can stay in business for long when the cost of production exceeds the market value of the commodity. You can't make it up on volume.

--What about demand for gold? Gold's run to US$1,000 dampened demand for gold jewellery, according to Alexander. But the recent dip to $700 is already showing signs of sparking that demand. It's just too good a buying opportunity to pass up.

--Alexander also noted that the investment demand for gold is driven largely by the gold exchange traded funds. Then there is gold's role as a monetary reserve. The U.S. claims to have 79% of its official reserves in gold. Japan's central bank, by comparison, holds just 2% of its reserves in gold, and China just 1%.

--Do you think China would like to convert some of its $2 trillion in forex reserves into gold? Or, would China, through its various state intermediaries, prefer equity in resource shares listed abroad, so that is actual ownership of key strategic resources? Why not both?

--"Both" appears to be the answer suggested by Paul Glasson from KPMG, who has lived and worked in China for years. He helps Aussie firms do business with Chinese firms. His presentation yesterday was fascinating. He explained in detail how Chinese investment decisions wind their way from the Communist Party in Beijing to the stock market in Sydney.

--We mention China and gold because we think they both have huge roles to play in the coming months. It's clear by now that the American model of asset-based wealth generation through leverage, debt, securitisation, and trading is failing badly. But there is still a lot of wealth denominated in U.S. dollars to be put to the sword.

--Parties who are not interested in having their dollar-based wealth evaporate will be looking for ways to trade dollars for other assets. We're betting equity in resource companies-which again are absurdly cheap-is one way they'll do that."