In This Issue:

Surprise! Oil Prices Can Plunge As Well As Soar
Russia-Georgia Conflict Shows Oil Retreat Has Legs
The Dollar Is Rebounding By Default
We Know We've Said This Before, But "Buy The Bargains"
The Bottom Line This Week

Last week, the stock market continued to make the big swings that started several days earlier. This time, however, we were delighted to see that the pattern was skewed towards the positive. Thanks to a 332 point gain on Tuesday and another 303 point jump on Friday, the Dow and the Nasdaq ended the week up 3.6% and 4.5% respectively.

Those were very nice numbers for a five day period, especially since poor economic news –and the Russian/Georgian war- continued to dominate the headlines. However, none of it could overcome the enthusiasm investors had for the recent plunge in oil prices that brought the magic $100 level within sight. If oil gets that low we will see rejoicing on both Wall Street and on Main Street. We might even raise a glass ourselves.

Meanwhile, Mother Market is testing our resolve. After rising 49 points on Monday, stocks dropped 250 points through Wednesday. More gyrations are undoubtedly on the way.

Surprise! Oil Prices Can Plunge As Well As Soar

When oil started to drop sharply, many investors doubted that the move would go very far. Most people had come to accept the argument that the world's increasing population, and its expanding economy, could only make oil more expensive.

Long term, we think the arguments for higher priced energy are correct. However, prices depend on the delicate balance between supply and demand, which can fluctuate widely nearer term. With a high volume commodity like oil, where a gusher is produced every day, it only takes a small decrease in demand to create a flood of excess product. The market adjusts to the surplus by dropping prices, as it is doing now.

The oil bulls also forgot that markets often get ahead of themselves. Speculators pushed the price of oil to a level it probably won't reach due to market forces until late 2009 or 2010. As a result, oil was due for a rollback even if demand had not dropped.

Russia-Georgia Conflict Shows Oil Retreat Has Legs

We were given a preview to oil's most likely near-term performance when Georgia made the mistake of poking the Russian bear in the backside two weeks ago. Because Georgia has a major pipeline that carries Caspian oil to Turkey, and on to Europe, the war should have sent prices soaring. That's especially true since Russia dropped a few bombs close to the pipeline. Nevertheless, oil fell another two dollars to the $113 area.

We must conclude from oil's weakness during the Russian-Georgian conflict that its fundamentals have deteriorated significantly. It's another indication that we could see oil drop below $100 before the correction ends, although some reversals must be expected.

One caveat is in order. If the U.S. or Israel attacks Iran, oil prices will shoot back up within hours.   

The Dollar Is Rebounding By Default

Another abrupt change that analysts were not expecting is the recent upturn in the value of the U.S. dollar. As you probably know, the greenback had been on a losing streak for several years. As measured against the euro, the dollar fell from $1.06 in January 2000 to $0.63 in April of this year, a 40.6% decline. Now the greenback is up to $0.67.

At first glance, it is surprising that the dollar is getting stronger. The U.S. economy is slow, the federal debt is soaring, the credit crunch is in full swing, and housing prices are still falling.

Nevertheless, the value of the dollar is largely set by interest rates. For months, most currency traders were convinced that Europe would soon be forced to raise its interest rates to fight inflation. Then the European economy started to slow down which is taking pressure off inflation. As a result, Europe –horror of horrors- might actually lower interest rates. The bottom line is that the U.S. dollar, and dollar-based investments, became competitive again.

As with oil, however, the longer term outlook for the dollar isn't good. We continue to believe the dollar won't make a lasting rebound until the U.S. recovers from its seven year borrow-and-spend binge, and its costly aftermath. That process could take several years.

We Know We've Said This Before, But "Buy The Bargains"

When it comes to making investment recommendations we hate to sound like a broken record. On the other hand we've found that clients never get bored with making money. To that end, we will say once again that investors should use the reversals in oil prices and the dollar to pick up bargains. When the powerful forces that drove the investments in opposite directions over the past few years begin to reassert themselves, we will see the primary trends return. If you want to participate in those plays, you must take positions while most investors are bailing out of them.

The dollar is the easiest rebound to play. Nothing could be simpler than opening a foreign currency account, or buying a foreign currency CD, in a U.S bank. If your bank doesn't have them, we recommend EverBank World Markets that has many strong currencies available. www.everbank.com

Alternately, you can invest in a good foreign bond fund. The pick of the litter continues to be the T. Rowe Price International Bond Fund (RPIBX). http://finance.yahoo.com/q/pr?s=RPIBX The no-load fund seeks to provide high current income and capital appreciation by investing in bonds from France, Japan, the United Kingdom, Austria, and similar advanced countries.

As you can see from its price chart, the fund has declined 0.57% over the past 30 days, which reflects the rise in the dollar. When the dollar turns back down, the fund will rebound. We think RPIBX is an excellent hedge against the costly financial problems that are doing so much damage in the U.S.

Longer term investors should also consider the T. Rowe Price International Stock Fund (PRITX). http://finance.yahoo.com/q/pr?s=PRITX This no-load fund invests the majority of its assets in stocks of established non-US companies in both developing and developed countries. PRITX offers investors a broad position in the growth of the world economy that is still in its infancy.

In the energy industry we continue to favor exploration and development (E&D) companies. Every time we hear another politician say "drill, drill drill" we think "money, money, money." Even if the U.S. coastlines aren't opened up for energy extraction, there will be a lot of E&D elsewhere. The bottom line is clear, if the world wants more energy it will need to spend the enormous amounts of money that will be needed to find it.

There are several good E&D companies with bright futures. If you can own only one, we think it should be Transocean (RIG). http://finance.yahoo.com/q/pr?s=RIG The company specializes in finding energy in difficult areas including miles below the sea, and in festering tropical swamps. If there is any more oil to be found –and we think there is- Transocean will be a big winner.

We are also recommending Suncor Energy (SU) http://finance.yahoo.com/q/bc?s=SU&t=1y, EnCana (ECA) http://finance.yahoo.com/q/bc?s=ECA&t=1y, and Sasol (SSL) http://finance.yahoo.com/q/bc?s=SSL&t=1y All three secure energy stocks are down sharply with oil's decline because they have high production costs. The same lever will swing the other way when oil prices bounce back up. These three stocks are great long-term buys.

While you are waiting for the previous stocks to pay off, our shorter-term recommendation of Valero Energy (VLO) should keep you from getting bored. http://finance.yahoo.com/q/pr?s=VLO As we predicted in our July 24 issue, America's leading oil refiner has been caught in a pinch between rising oil costs and extreme price resistance at the pump. Now that oil costs are coming down more rapidly than gasoline prices, Valero's outlook is turning around – and so is its stock. Valero is one of the few energy plays that can gain when oil prices retreat.

Timing: In a declining market, bargain hunters should resist the impulse to make their purchases all at once. A better plan is to buy a little at a time as the situation unfolds. That way you will get at least part of your portfolio at the lowest possible prices.

The Bottom Line This Week

The oil correction is showing that it has stronger legs than most investors expected. It is impossible to know how far the price will drop, but we are only about $14 away from the psychologically-important $100 mark. We should hit it by the end of the year, and perhaps a lot earlier. Meanwhile, energy stocks are very attractive.

Similarly, the dollar's rebound could run several months. Buying foreign currencies along the way should prove to be a very profitable strategy longer term.

Until Next Week

The AIA "Advocate For Absolute Returns", a weekly publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next Thursday...