Alloy Steel expands into Indonesia

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Alloy Steel International (OTC BB: AYSI.OB) filed this 8-K today:

Quantum Leap for New Super Alloy

High demand for new Super Alloy Arcoplate products has prompted Alloy Steel International to expand their operations into Indonesia by the appointment of a company to carry out functions on its behalf and under its direction.

The first overseas engineering office, based in Jakarta, will house both marketing staff and engineering professionals.

The Indonesian capital was chosen as the hub of operations due to its proximity to the expanding South-east Asian market, the lower manufacturing costs and the availability of highly qualified technical staff.

Possible sites for the manufacturing facility are undergoing analysis regarding capital costs of construction and fit out.

The Arcoplate Super Alloy, released in July this year, can be manufactured thinner thus lighter and more durable than older white iron type products. A one inch Arcoplate Super Alloy plate can replace white iron products up to six inches thick. Successful laboratory tests and field trials have shown cost and energy savings by reducing friction, greater ease of handling, and less production shutdown time for plate replacements.

Mining clientele have indicated they will specify Arcoplate in their plant expansions, upgrades and in new mining and mineral processing applications worldwide. The new thicker sizes are in heavy demand worldwide.

The new Indonesian branch of Alloy Steel International will cater for clients extending their mining operations into Indonesia and will allow for further expansion into the Chinese, Indian and Mongolian markets.

Alloy Steel International Chairman, Mr Gene Kostecki, estimates that once the company has the facility to service the Indonesian market from a local base, demand for Arcoplate in Indonesia could exceed $10 million per annum.

There was some question on Alloy Steel's i-Hub message board about whether this is a licensing deal or not. I suspect it isn't, but I sent an e-mail to the CEO asking if he could clarify. If I hear back from him, I'll update this post accordingly.

Update: Alloy Steel International's CEO Gene Kostecki responded via e-mail saying that this was not a licensing deal. He said the company was avoiding those out of concerns about protecting its intellectual property, which he said was the company's highest priority. He said that this expansion would enable AYSI to take advantage of Indonesia's lower labor costs and proximity to markets in China and India. If I get his permission to do so, I will quote his e-mail verbatim here, but those were the key points.

Second Update: I have his permission, so here's his e-mail:

Dear David:

We are all very excited with our expansion program into South East Asia as it will give the company a great stepping stone into the entire ASEAN Market which is one of the fastest growing economies in the world.

The new government in Indonesia is fast tracking all economic development and investment in Indonesia. With Indonesia’s low labour costs and proximity to China and India it will place the company in a very competitive position to capitalize on Asian markets in this part of the world without sacrificing quality and margins, yet still being price competitive against low end products that portray themselves as wear plate.

David, we do not see the need to enter into any licensing agreements with any third party as this could potentially compromise our position in protecting our intellectual property rights in this part of the world. Protecting our intellectual property rights is the company's top priority.

Sincerely,

Gene Kostecki

Warren Buffett versus Pranab Mukherjee

Interesting juxtaposition on the front page of today's Financial Times: The paper leads with Berkshire's $27 billion buyout offer for the ~77% of Burlington Northern Santa Fe, and highlights this quote by Buffett:

It's an all-in wager on the future of the U.S.

That makes the bet seem a little riskier than it is, I think. The bet seems fairly agnostic about, say, the future of American manufacturing or exports. The railroad will make money shipping imports in from the ports or exports out to them. In any case, here's what the FT had below the fold: news that India sold dollars to buy 200 tons of gold. Excerpt:

Pranab Mukherjee, India's finance minister, said the acquisition reflected the power of an economy that laid claim to the fifth-largest global foreign reserves: "We have money to buy gold. We have enough foreign exchange reserves."

He contrasted India's strength with weakness elsewhere: "Europe collapsed and North America collapsed"

Adventures in Outsourcing.

In his book The Four Hour Work Week, Tim Ferriss extols the benefits of outsourcing and, as an example, quotes Esquire editor AJ Jacobs describing his experience working with a virtual assistant named Honey, from one of the leading Indian outsourcing firms, Brickwork:

When I open Honey's file, I have this reaction: America is f*cked. There are charts. There are section headers

[...]

If all Bangalorians are like Honey, I pity Americans about to graduate college. They're up against a hungry, polite, Excel-proficient army.

Apparently, they're not all like Honey. Here's my recent experience with this same firm. Last Thursday night, I requested a quote for a fairly simple project, the creation of a couple of spreadsheets of stock information. I got an e-mail back a few hours later, telling me they would get back to me by Sunday night with a quote. Still no word from them.

My guess is that Brickwork didn't have much bench strength, and when the inquiries came in from the readers of Ferriss's best-selling book (Brickwork's website asks if that's how you heard of them), the firm had to lower its standards in order to staff up.

Last Thursday I also contacted another Indian outsourcer Ferriss mentioned, Your Man in India. First I tried to request a quote via the "ask us" feature on the company's website, but got a server error, so I e-mailed the company instead. They referred me to their sister company, Get Friday, and someone from that company wrote back to say my request was beyond the scope of their abilities.

India is still in the running though, as I'm currently corresponding with an Indian individual about this project via Elance (in all, I received 5 proposals from India, 2 from North America, and 1 from Eastern Europe for this project).

BRIC Versus CRIB

In an op/ed in yesterday's Financial Times, Michael Hudson, an economics professor at the University of Missouri, ventriloquized the thoughts of foreign opponents of the United States, while warning of ominous consequences from the summit in Russia this week of the BRIC countries (Brazil, Russia, India, and China) ("Washington Cannot Call all the Shots"):

Many foreigners see the US as a lawless nation. How else to characterise a country that holds out a set of laws for others – on war, debt repayment and the treatment of prisoners – but ignores them itself?

[...]

It is no mystery to other countries how the US remains above the law. Foreigners see a financial system backed by American military bases encircling the globe. The IMF, World Bank, World Trade Organisation and other Washington surrogates are seen as vestiges of a lost American empire no longer able to rule by economic strength, left only with military domination. They see this hegemony cannot continue without adequate revenues and are attempting to hasten the bankruptcy of the US financial-military world order.

[...]

US officials wanted to attend Yekaterinburg as observers. They were told no. It is a word that Americans will hear much more in the future.

Mark Chandler, Global Currency Strategist at Brown Brothers Harriman, had a slightly different take on this summit recently ("Bric or Crib?"):

Brazil, Russia, India and China, now collectively known as the BRICs, will hold a summit in Russia on June 16th. Besides the Goldman Sachs invented moniker, these countries have very little in common except for the fact that they believe, to seemingly varying degrees of intensity, that they deserve greater influence in the conduct of world affairs than they currently have. And given the enormity of US power, as hard-core realists, they know any increase in their power and influence will come at the expense of America’s.

[...]

One of the most important reasons why the BRICs do not have the economic clout that they would like is frankly they don’t deserve it. Goldman-Sachs had a story (and more) to sell with its BRICs concept, but those same letters spell a real word, CRIB. The point is that the countries, outside of China, are not among the largest.

According to Bloomberg data, at the end of last year, China was the fourth largest economy ($3.2 trillion), behind the US, Japan, and Germany. This of course takes the Chinese data at face value, and given the often large gaps between energy production and reported GDP growth, as well as the amazing consistency of the pace of growth, many often cast a suspicious eye on Chinese data.

With a GDP of $1.3 trillion in 2008, Brazil was the 10th largest economy, though it is roughly half the size of France, which is the 6th largest economy. Russia and India were neck-and-neck for 11th and 12th places with each having produced about $1.2 trillion of goods and services last year. Spain’s economy is nearly 20% bigger than Russia’s and India’s, and it is the 8th largest economy. Together the BRICs account for a little more than 12% of the world’s GDP, and China alone accounts for half of that.

"Mohnish, How Are You Feeling?"

According to Mohnish Pabrai, this is what most of his investors were asking him after he lost 60% of their money last year. For his answer, see the excerpt below from his annual letter to his investors, dated January 16^th:

I did hear from a few of you in the last few weeks. While some calls and emails expressed concern over our performance numbers, the surprising thing for me was that the overwhelming majority of you were focused on asking, “Mohnish, how are you feeling?”

Well, I am actually feeling pretty good. And as Q408 unfolded, my spirits remained elevated – mainly because I remained focused on intrinsic value and was drooling over the incredible opportunity set and valuations. I was in turbo mode trying to read huge piles of 10Ks, 10Qs, annual reports, industry reports, listening to conference calls etc. – so I could pull the trigger while the prices were still incredible. And several triggers were pulled in November and December. We bought into an incredible array of assets at remarkable prices.

While it was indeed tough to watch the severe drops many of our holdings took in Q408, keeping my focus on intrinsic value, rather than fixating on the quoted market value of various positions was fundamental to staying level headed.

Pabrai isn't the only professional investor who's expressed similar sentiments when asked about his outlook recently, but I don't get this, for a couple of reasons. First, if someone asked me how I felt about the money I lost last year, "pretty good" wouldn't be my answer; "nauseous" would be -- and I just lost my own money. If I had lost 60% of the money entrusted to me by hundreds of other investors, in addition to nausea, I'd feel some remorse.

Second, it's one thing to tout the great opportunities you see in a beaten-down market, but it raises an obvious question: did you have any dry powder to take advantage of them, or have you been forced to sell your beaten-down positions to buy stocks you think are even cheaper? At least Bruce Berkowitz was candid enough to acknowledge (on a recent conference call) that that's what he's been doing, for the most part (selling cheap to buy cheaper). If that's been the case with Pabrai too (and I assume it is, considering that Pabrai has allegedly used Berkshire Hathaway stock as a "placeholder" for cash), then his zeal for current bargains ought to be tempered by some regret for not keeping more cash on hand to take advantage of them.

About the image above:

In his book The Dhando Investor: The Low Risk Value Method to High Returns, Pabrai offers the story of the end of Abhimanyu, a hero of the Hindu epic The Mahabharata, as metaphor for the difficulty of selling a stock. In an nutshell: Abhimanyu uses a technique he overheard¹ from Krishna to penetrate the spiral chakravyuh battle formation of his enemies, the Kauravas. Unfortunately, he never learned how to break out of the chakravyuh, so he has no exit strategy. He fights valiantly, one against many, and kills a number of Kauravas, but ultimately gets killed. I believe the image above², from a Geo Cities site, depicts this.


¹Please see the second comment by Ravinsu for elaboration.

²Replaced as per Ravinsu.

The FT Editors Echo Jim Rogers on India

Jim Rogers has mentioned his doubts about India as a destination for investment on various occasions (for example, in this unfortunately undated article on his website). Friday's Financial Times included a bearish editorial on India, prompted by the accounting scandal at outsourcer Satyam Computer Services ("Satyam Scandalises"). Below are a couple of excerpts from the editorial.

India is rarely as shiny as its fans insist. The $1bn fraud perpetrated by Satyam Computer Services will not only throw the $40bn software and outsourcing industry into a tailspin, it will also raise disturbing questions about the risks of doing business in India - and even the sustainability of the country's much-vaunted growth miracle.

Only a few months ago, India saw itself as relatively immune from the global credit crisis. Some officials patted themselves on the back for going slow on liberalising capital markets, crediting their prudence as yet further evidence of the country's inexorable rise. But India now has a credit crunch of its own. Exporters are hurting and threatening to lay off 10m workers. Terror attacks on Mumbai have cast into doubt the competence of the security apparatus and shaken business and consumer confidence.

[...]

In spite of its poverty, it has sold itself as a country to which Fortune 500 companies can entrust sensitive data, banks their back offices and even patients the production of medicines. Its extraordinary success in IT over the past decade was based on the trust and credibility it established with globalised companies; the Satyam scandal has now put that at risk.

Outsourcing companies, furthermore, are keen to move up the value chain; to outsource some of their own functions and even to start acquiring the western companies whose businesses they help run. These ambitions are laudable. But like India itself, whose economic success story is built on extremely rickety social and infrastructural foundations, such grand designs can also smack of hubris.

"The Arab Sole"

Whoever writes the headlines at Forbes, wrote a clever one for Tunku Varadarajan's column today about Muntader-al-Zaidi, the Arab journalist who threw his shoes at President Bush during the President's recent joint press conference in Baghdad with Iraqi Prime Minister al-Maliki, "The Arab Sole". Below is a brief excerpt from Varadarajan's column:

The Arabs, who once upon a time boasted Averroes and Avicenna, are now reduced to eulogizing a boorish act of agitprop as a heroic achievement. America gave us Martin Luther King; South Africa gave us Mandela; India gave us Gandhi; the Arab world gives us ... Muntader-al-Zaidi. A people who invented the zero are now reduced, themselves, to zero. Only a people who live under the boots of their rulers celebrate the throwing of a shoe at a guest.

A commenter on Varadarajan's column on Forbes's website objected that zero was actually invented by the Hindus. According to Scientific American's take on this question, by former Harvard professor of mathematics Robert Kaplan ("What is the origin of zero? How did we indicate nothingness before zero?"),

The first recorded zero appeared in Mesopotamia around 3 B.C. The Mayans invented it independently circa 4 A.D. It was later devised in India in the mid-fifth century, spread to Cambodia near the end of the seventh century, and into China and the Islamic countries at the end of the eighth. Zero reached western Europe in the 12th century.

The symbol changed over time as positional notation (for which zero was crucial), made its way to the Babylonian empire and from there to India, via the Greeks (in whose own culture zero made a late and only occasional appearance; the Romans had no trace of it at all). Arab merchants brought the zero they found in India to the West.

Stratfor's Outlook for the Third Quarter

Via John Mauldin, below is Stratfor's global forecast for the third quarter. Since it covers the whole world, there's a lot there. A few points that standout: Stratfor is bearish on India, bullish on Brazil, and sees peace breaking out in the Middle East. Brazil has appeared to be the most attractive of the BRIC countries to me with respect to investment, so Stratfor's take on it isn't too surprising. Its forecast for the Mideast is a little more surprising, but Stratfor believes that one reason violence has been dropping in Iraq is because of behind-the-scenes negotiations between the U.S. and Iran. Stratfor also predicts a peace treaty between Israel and Syria, possibly as early as this year.

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Quarterly Forecast: Third Quarter 2008

By George Friedman

Introduction

For the first half of 2008, Stratfor focused its attention on three features of the international system. All three remain key factors, but all have also evolved notably.

First, we anticipated an endgame between the United States and Iran over the future of Iraq. We have been surprised at just how fast U.S.-Iranian negotiations have progressed, and consequently violence has dropped to its lowest levels since the 2003 invasion (something that would be impossible without Iranian assistance). What is truly amazing is how few items necessary for a deal are not already in place. We are unlikely to have a formal "Camp David" moment, but the U.S.-Iranian understanding seems to be building quickly on the ground.

Second, Russia's efforts to rebuild its influence throughout Eurasia have been at a critical point. With the Western-backed independence of Kosovo making a mockery of Russian foreign policy, we predicted that Moscow either had to strike back or see its credibility in key former Soviet Union territories crumble. As it turned out, Russia's internal factional struggles distracted and exhausted the Kremlin. Striking back at Europe and the United States in any place that would have caused harm proved impossible, forcing the Russians to concentrate on places such as Central Asia, the Caucasus and Ukraine. In the long run, this may well prove to be the worst of all worlds, as the Europeans are convinced they beat the Russians, while the Russians are equally convinced that they have drawn a line in the sand. For the moment, however, Russia requires time to plan and flesh out its new organizational structures. That will take up the bulk of the third quarter.

Third, we forecast that high energy prices would create a flood of petrodollars that mostly would end up flowing into U.S.-dollar assets, greatly stabilizing the financial system and helping the United States shake off its economic funk. This prediction proved true in spades, and U.S. economic growth has certainly turned a corner, but two related developments have taken root. First, having oil prices increase by 40 percent in three months cannot help but have an enervating impact on economic growth, particularly in the heavily industrialized states of East Asia. Second, all that oil income is beginning to have additional impacts.

The Arab Gulf states are grossing approximately $2 billion per day, with half of that amount flowing into the coffers of Saudi Arabia. This provides the Saudis — and other Gulf Arabs — not only with tremendous wealth, but also with tremendous political power. A key trend in the third quarter will have these states using that wealth to invest, bribe and cajole their friends and enemies into following policies more to Riyadh's liking.

This money will be most politically active in two locations: Lebanon and Iraq. In both places the Saudis want to see some flavor of a peace deal. The common thread to the two issues is the Saudi fear of Iran. An Israeli-Syrian peace deal means reducing Tehran's influence within the Sunni world — specifically, the influence it holds over Damascus and Hezbollah. A U.S.-Iranian deal over Iraq means re-establishing Iraq as a buffer against Iranian expansion. In both cases, Saudi money is useful in bringing the various players to the table — most notably Damascus and the various Iraq Sunni factions — and paying them to stick to an agreement. In the case of Israel and Syria, the constellation of forces in play suggests a deal will be struck sooner rather than later.

There is one additional topic that will feature grandly in the third quarter: the Beijing Olympics. Ruling China has always been a difficult prospect, as the country is riven with urban-rural and coastal-interior splits. But while the Olympics were supposed to have been a celebration of China's "arrival" as a modern state, they are instead serving as a showcase for all the ways in which China falls short. But dealing with these issues — entrenched corruption, financial dysfunction, (unapproved) regional autonomy, unaffordable energy subsidies — is difficult for Beijing in the weeks leading up to the Olympics because, under the glare of international spotlights, it can no longer use the tried-and-true tools of an authoritarian state. The result is a string of patchwork fixes that highlight China's weaknesses, making the Asian giant vulnerable to any foreign power with an interest in demonstrating that the emperor is less than fully clothed. Not exactly the global celebration that Beijing intended when it bid for the Olympics all those years ago.

Note to readers: Our third-quarter forecast is intended to be a supplement to our annual forecast and second-quarter forecast. Within each section of this quarterly we have extracted the critical trends identified in our previous forecasts and indicated where we have been right or wrong and what is coming in the next three months. We have also examined new trends that have evolved from regional developments, independent of the earlier forecasts.

Middle East

• Regional trend: The United States has successfully forced the countries that made al Qaeda possible into the American alliance structure. It will now use that structure to clamp down on those still resisting American power. In doing so it may inadvertently trigger tensions with Israel.

In the second quarter, U.S. efforts in the Middle East received a surprising boost in the form of petrodollars. Like the United States, Saudi Arabia wants to see Iraq stable and Iran blocked from expanding its influence. High oil prices are bringing the Saudis more than a billion dollars a day in revenues, some of which they are using to push Sunnis into Iraq's governing coalition.

Syria has found a role in the tightening Arab-American alliance, but that role has taken an unexpected form: peace talks with Israel. Soon after the negotiations came into the public eye, political instability in Israel threatened to derail them, but a deal between Israel's Kadima and Labor parties now ensures that the talks will proceed even if Israeli Prime Minister Ehud Olmert is replaced toward the end of the third quarter. While Washington certainly has its reservations about an Israeli-Syrian detente, the United States is refraining from sabotaging the talks — in part because Saudi money is supporting the initiative, in part because Turkey is hosting the talks, and in part because Hezbollah will be defanged if the talks prove successful.

The third quarter could well prove to be a decisive turning point for many actors in the region. Hezbollah has no good options. It needs to find a way to scuttle the Israeli-Syrian peace talks, and an attack on Israel might be the only way it can do so — but then it risks inviting a major retaliatory attack by Israel. Iran and the United States need to seal a deal on Iraq before the U.S. elections in November, or else risk the situation remaining unresolved for years. If a U.S.-Iranian deal proves elusive, Israel needs to ensure that Iran is knocked down a few pegs before a new U.S. administration potentially restricts the Jewish state's military options. Israel can bomb Iran only with U.S. approval.

The player that will work the hardest to ensure none of these situations spins out of control is Saudi Arabia. High commodity prices are showing signs of eating into global demand, and the last thing Riyadh wants is a war-related price spike that would push many economies over the brink. So Saudi oil income will play a growing role in buying calm throughout the region.

We expect rapid progress in the region's major peace negotiations — those between Israel and Syria and those between Iran and the United States — because most of the heavy lifting has already been done. There has been a near-halt to violence in Iraq, and Israel has been preparing its public to give up the Golan Heights. We would not be surprised at all to see deals materialize in the third quarter, with Syria and Israel more likely to be successful than Iran and the United States.

In the Israel-Syria talks — assuming that they are not derailed — we expect the traditional fanfare of a peace deal, complete with public handshakes. The U.S.-Iranian negotiations, however, are unlikely to present such a tableau. Tehran and Washington seem content to dial back tensions without dropping their public hostility, for fear that their respective populations would not approve of a public burying of the hatchet.

• Regional trend: Turkey is emerging as a major regional power and in 2008 will begin to exert influence throughout its periphery — most notably in northern Iraq.

Turkey is becoming bolder on the international stage: sending troops into northern Iraq, mediating Israeli-Syrian peace talks, pushing energy projects in the Caucasus and Central Asia and making its influence felt in the Balkans. But internally, the country is paralyzed. A domestic power struggle over the nature of the state, pitting the new socially and religiously conservative elite against the established ultrasecular elite, has stalled not only local economic growth and foreign investment but also Ankara's progress toward regional player status.

We expect Turkey's court system — operated by the ultrasecularists — to dictate terms to the elected Islamist-rooted government, likely resulting in the ruling Justice and Development Party's dissolution. A verdict is expected in mid-August on a pending case that seeks to do just that, though we cannot rule out the possibility of a compromise. Toppling the government will not reverse or deflect the underlying trend of Turkey's re-emergence as a leading regional power, but it will delay it significantly.

Eurasia

• Regional trend: Should it occur over Russian objections, Kosovar independence would deliver a massive blow to Russian credibility. Thus, Kosovo will serve as the litmus test for either the return of Russian power or a surge in the West's expansion.


• Regional trend: Russia's internal power struggles will hamper Moscow's ability to pursue its international agenda.

Russia spent the bulk of its energy in the second quarter on managing the transition from Vladimir Putin the president to Vladimir Putin the prime minister. In the shuffle, Russia's restless power clans struggled for supremacy, with the conflict reverberating through some of Russia's most crucial institutions, including the Federal Security Service, Gazprom, Rosneft and the defense sector. This struggle is now over — with the battle lines ending roughly where they began — but the fighting consumed nearly all of Moscow's attention and energy for the bulk of the second quarter.

During this reorganization, the West — particularly the Europeans — did manage to force Kosovar independence over Russian objections, making a mockery of the Russian position in Europe. But Russia did not exact any retribution — or at least, not in Europe. What Russia did do was focus some of its energy on the area where its influence is strong: its immediate periphery. Belarus, Ukraine, Armenia, Azerbaijan and Georgia all witnessed a surge in Russian attention as Moscow locked down its positions in regions it feared the West was eyeing.

The result is a continuing mismatch of perceptions: the Europeans feel that their victory in Kosovo proves the Russians are more bark than bite, while the Russians feel that they have made their true red-lines clear by focusing on their near abroad. Major Eurasian conflicts have been rooted in far smaller misperceptions, but that will be a crisis for another day.

Luckily for both sides, each has other issues to occupy it for now. The Europeans have turned inward after yet another failed attempt at a constitution, and the Russians have to get their affairs in order in the third quarter before venturing outward again.

Putin has implemented major personnel reshuffles across the length and breadth of the Kremlin, with the biggest changes in the energy industry, the military and the defense-industrial complex. Additionally, Russia is a major energy exporter and a moderate food exporter, but it still struggles with inflation — doubly so now that qualitative and quantitative labor shortages are starting to bite, courtesy of Russia's deepening demographic crisis.

While Russia might be in its best posture financially, politically and militarily since the end of the Cold War, it faces a number of nagging problems that it is organizationally ill-suited to solve. Finding a way to get through these problems is not a severe challenge, but it will take time. We expect no major moves out of the Kremlin until the very end of the third quarter at the earliest. But when Russia does return, it will do so with the most money — courtesy of petrodollars — and the best leadership team it has had in 20 years.

• Regional trend: The Concert of Powers will return as the dominant organizing structure of inter-European relations.

Europe is returning to its roots. Countries are arguing over monetary policy, France is making a grab for control of Europe's Mediterranean policy, Poland is aggravating Russia, Greece is complicating Balkan policy and the United Kingdom stands aloof as ever. Any serious thoughts of pan-European integration were thrown into disarray in June when Irish voters defeated the Lisbon Treaty, the latest attempt at a European constitution.

For the third quarter, all eyes will be on France, which will hold the rotating EU presidency for the remainder of the year. Since France is one of Europe's heavyweights, its turn at the presidency would have been notable even had Ireland ratified the EU treaty — but with political integration efforts in limbo, France now has a chance to realign European structures with its own national interests. This will not take the old Gaullist form of ambitions for French superpower status. Instead, Paris will seek to wrest the economic and political leadership of Europe away from Berlin by subtly (and perhaps not-so-subtly) undermining the EU institutions that France perceives as giving Germany an advantage.

Economically, France is better poised than Germany to weather the storm of sustained high commodity prices: It has a less-industrialized economy, is an exporter of foodstuffs and has a huge capacity to generate electricity from nuclear power rather than petroleum fuels. But Paris is well-positioned politically as well. President Nicolas Sarkozy's honeymoon might be over, but Germany finds itself distracted and divided by a failing, conflicted governing coalition that is about to enter an election campaign. Germany is still the rising star of Europe, but that rise has hit a bit of a pause, and France will seize the moment to adjust Europe's direction to its own liking as much as possible.

• Regional trend: Serbian elections will end Belgrade's position in geopolitical no-man's-land — one way or the other.

Europe has seen Serbia as the litmus test of whether the Balkan region as a whole will move decisively toward the West — with each of the Balkan states eventually joining the European Union — or whether there will be a radical wild card in the center of Southeastern Europe, which could give Russia a foothold in the region.

However, we should have known better than to think that the Serbian election could generate a clear result. While Serbia enters the third quarter with its most stable government yet, it would be a mistake to label it firm enough to execute a clear break with the country's past. Undoing 18 years of contradictory policies and international isolation is simply too large a task for any government to complete in short order, much less an untested coalition containing five parties and three ethnic groups.

Nevertheless, steps toward Serbia rejoining Europe — complete with halting steps toward EU membership — appear to be in the cards for the third quarter. Vojislav Kostunica, whose power plays have often upended Serbian policy, will not be in the new government, leaving pro-Western factions with more flexibility than they have known in years. But it will take far more than three months of progress before the probabilities for success can be assessed.

Global Economy

• Regional trend: Oil prices will soften in 2008 due to the fading of geopolitical risks in key locations. The price drop, however, is contingent upon an expected weakening of geopolitical risks.

Things are going to get worse before they get better. Global crude oil prices have risen by 40 percent since the beginning of the year — and all of that took place in the second quarter — largely because of geopolitical risks that Stratfor believes will likely ease. We envision four events occurring in the third quarter that should take some of the heat out of the markets.

First, the U.S. Congress appears to be moving toward regulations intended to lessen the impact of speculation in oil trading. This will almost certainly have some unintended consequences, but will probably result in at least a minor cooling of prices.

Second, we expect a planned Nigerian energy summit to result in additional sums of oil income being funneled to the ethnic Ijaw of southern Nigeria. The Ijaw, who typically feel cut out of the oil patronage system, are responsible for most of the large attacks on oil infrastructure. A deal that enfranchises them should result in more stable Nigerian output.

Third and fourth, we expect two deals to slide into place in the Middle East: one between Iran and the United States on the future of Iraq, and another between Israel and Syria on the future of Lebanon. The Iranian-U.S. negotiations are taking place largely behind the scenes, but will impact the oil markets indirectly if they succeed in finally stabilizing Iraq. Meanwhile, Israeli-Syrian moves toward a very public peace deal should calm those parts of the oil markets that get jumpy every time they see a headline containing the words "Israel" and "Arab."

• Regional trend: Countries the world over will pull their energy sectors back from the free market in order to stave off social instability and/or maximize profit.

The primary manifestation of this forecast in the second quarter came in the form of reinforced energy subsidies, with Russia, France, Italy, India, Venezuela, Argentina and Iran being the most obvious players. Technically, such steps are not nationalizations, but they make the liberalization of energy sectors de facto impossible (no private firm wants to supply a subsidized market).

In the third quarter, we expect more dramatic steps toward direct management of energy sectors in Malaysia and China — two states in which recent efforts to lighten the subsidy burden are likely to backfire. Europe, too, will wrestle with moves to involve the state more deeply in energy questions, as high energy prices finally begin to bite hard enough to force a government response.

• Regional trend: Despite much talk to the contrary, the United States will enjoy strong economic performance. In part, this is because of the massive inflow of money into the United States from Asian and Arabian states.

While talk of recession in the United States remains par for the course, the U.S. Federal Reserve is both becoming optimistic and leaning toward interest rate increases to contain inflation. The Fed will always err on the side of triggering faster growth (and inflation with it) rather than slower growth that could lead to deflation and induce a Japanese-style depression. Add in roughly $100 billion in stimulus checks, and the United States is well past the worst that the slowdown of the latter half of 2007 presented. This does not mean that the "strong economic performance" we anticipated has materialized — but the truth so far is much more positive than the doom-and-gloom talk that dominated American media the first half of the year.

Obviously, not all things are cheery. The American property market is far from recovery — the rising inventory of unsold homes in particular is a critical factor to watch — and strong commodity prices are making the U.S. consumer take pause. Additionally, a combination of American subprime contagion and regional structural and cyclical weaknesses could trigger a European banking crisis in the third quarter. But Stratfor's primary economic concern for U.S. growth remains tied to the election cycle. Neither presidential candidate has any interest in pointing out positive aspects of the current government's economic management. And, in past elections, "It's the Economy, Stupid" has not only garnered votes, but also has had the side effect of amplifying public perceptions of the economy's problems.

• Regional trend: Inflation is on the rise on a global scale.

But while the United States is looking toward better times, the reverse could prove true elsewhere. The sheer size of combined American purchasing power means that the United States can weather high energy and commodity prices relatively well — runaway commodity inflation plus the subprime meltdown still did not push the U.S. economy into negative growth. The same cannot be said for the rest of the global system, where inflation is now pushing 5 percent.

And of course $140 a barrel oil is still $140 a barrel oil. Most countries can no longer absorb such cost increases, and Stratfor expects to see the cracks that developed in major industrialized economies in the second quarter begin to lead to fundamental breaks in the third. Barring a truly deep price drop, a great many states are beginning to have a great many problems. Between robust prices for energy and food, there is not an economy in the world that has not had to make some sort of adjustment. Stratfor divides the effects into two categories.

First, food shortages impact political stability immediately; so food prices have been — and remain — the key issue to watch. In the second quarter, the world witnessed only sporadic, minor, localized food shortages. While grain prices continue to rise, there is some light at the end of the tunnel: plantings and weather have been favorable for most crops, and most grain forecasts for harvest in the next few months are atypically large (with corn in the U.S. Midwest being the notable exception.) It is far too early to predict a price drop, but it seems safe to say that there will not be onerous supply crunches.

Second, the broader inflationary trend remains firmly in place and will disproportionately impact the heavily industrializing — and thus energy-intensive — economies of East Asia (which is hardly to say that the rest of the developing world will escape). The country facing the biggest problems will be China, which imports massive amounts of increasingly expensive commodities. Beijing will face a growing risk of widespread social unrest as these pressures take their toll on its economy, but it will be constrained from restoring order in its accustomed fashion — that is, a security crackdown — in the third quarter because of the international spotlight brought by the Olympics. Efforts to manage the problem thus far have not proven very effective, and they are complicating parallel efforts by the government to recentralize control of the energy sector.

High commodity prices — specifically high energy prices — have also had an unforeseen impact. The political power of countries raking in large numbers of petrodollars — the Arab states of the Persian Gulf now gross a combined $2 billion daily — is at its highest point in a generation. The last time these states had this amount of financial power they underwrote projects such as the Afghan mujahideen and contributed to the fall of the Soviet Union. This time around, they are concerned with Iran's involvement in Iraq and Lebanon, and are applying their riches toward pushing the Israeli-Syrian and American-Iranian peace processes forward.

East Asia

• Regional trend: The Chinese government intends for the year 2008 to be China's day in the sun, with the Olympics showcasing how advanced and stable the country has become. This requires Beijing to act preemptively to prevent anyone with an interest in marring China's image from disrupting the Olympics.

Anti-Chinese foreign activist campaigns have been neutered with a mix of visa policy and slick organizing of counterprotests, while security has been tightened ostensibly in response to the threat of domestic terrorism. But these small victories belie much larger problems that have nothing to do with the Olympics.

The Olympic Games have created an inflection point in Chinese development, disrupting the stability of Beijing's political decision-making process. On some issues, this break point has caused the government to postpone decisions beyond when they would usually have been made, while on others, decisions have been accelerated ahead of the time frame Beijing would have preferred. Reducing energy subsidies was a policy from the former group, but the attempt to delay skidded out of the government's control. Meanwhile, allowing more media access because blackouts proved no longer feasible is an example of the latter.

In short, the Olympics have forced what is normally a gently-gently decision-making process into chaotic fire-fighting mode, and rising commodity prices are forcing the entire system into the pressure cooker. All things considered, China is juggling the issues admirably, but the scope and depth of the challenges it faces guarantee tension and a continuous trickle of small crises for the next quarter (not to mention that everyone who has an interest in seeing a weaker China will use the next several weeks to nudge the country toward as many of those crises as possible).

But the Olympics are still the Olympics, the Chinese people are still very proud to be hosting them, and regional leaders fully realize that the Politburo will certainly come for them if they spoil the show. Stratfor expects this combination of nationalism and fear to see the government through the worst of the problems. Then, once the last hungover tourist steps onto the last departing plane, cracks will likely start showing, the system will start creaking, and the gloves will come off — with the acceleration of price reforms the most likely first order of business.

• Regional trend: In order to tighten its grip on an often unstable and chaotic economy and Communist Party, the Chinese Central Committee is reshuffling the bureaucracy, with an eye to creating energy, aviation and finance superministries directly under its control.

Efforts to consolidate the energy sector are proceeding, but not quickly. The central government is meeting resistance from all of the expected groups — state oil firms, local distributors and retailers, and especially regional leaders — who stand to see their influence, wealth and sources of income all subjugated to Beijing's will. With the added complications of the Olympics and global high energy prices, the central government has been forced to shuffle and reshuffle the plans several times to keep them more or less on track.

In the quarter to come, President Hu Jintao will attempt to bring all the disparate threads of the energy sector more or less under his personal control, a task that will become even more complicated once the burning incentive of the Olympics has passed and all the players take a good hard look at their bottom lines. But in many places, the push for consolidation will not rise above the level of rhetoric, given that many of Hu's key supporters are local leaders who continue to resist change on multiple issues in order to maintain their own viability and profitability. As such, Hu will likely take his campaign to provinces and regions led by people outside of his personal network — a move that will create some tensions and contradictions in the inconsistent application of central government directives across the country.

By comparison, consolidation of the aviation sector will be a cakewalk.

• Regional trend: The U.S. alliance structure in Asia is being readjusted as states feel out both bilateral and multilateral relationships in order to maximize their influence in an evolving world.

This readjustment intensified in the second quarter, with several states becoming increasingly proactive in how they manage their bilateral relations with the United States and their neighbors. As we expected, U.S. allies sought not to sever, but simply to adjust, the ties that bind.

Australia short-circuited several plans to exclude the United States from various proposed Asian clubs by proposing to create and lead its own version of the Asia-Pacific Economic Cooperation to manage the region's economic and military affairs. South Korea, despite domestic opposition, continues to put finishing touches on a free trade deal with the Americans, still vying to become the only major Asian state to land such an agreement. Taiwan's new government sought to find a middle ground that keeps its American alliance intact while allowing it to nudge closer to Beijing. And the United States took advantage of a hurricane disaster in the Philippines to demonstrate vividly that, while it might not be flying the flag in Asia as much as in times gone by, it has hardly vacated the premises. Meanwhile, one state that is by no means a U.S. ally — North Korea — saw its relations with the United States continue shifting away from crisis management toward routine bureaucracy.

This process is only in the beginning stages and will continue to intensify and accelerate in the third quarter. Bear in mind that all four of Washington's primary allies in the region — South Korea, Australia, Thailand and Taiwan — have freshman governments that are feeling their way forward. And with China's attention absorbed by the Olympics and the Americans preoccupied by the Middle East and their own election cycle, all four realize that the time to adjust their alliance relationships is now.

South Asia

• Regional trend: The Pakistani army/state will hold together even as confusion and distractions in Islamabad greatly reduce the Pakistani government's ability (and willingness) to rein in jihadists.

This has certainly proven to be the case. Pakistan's incoming coalition is fractious, inexperienced (it has been 10 years since civilians ran the government) and certainly not in the mood to rock any domestic boats. This has led Islamabad to do everything in its power to avoid unduly angering Islamist militants operating in the country's northwestern reaches. The dawning problem is that this ungoverned land is providing opportunities for militants battling NATO forces in neighboring Afghanistan to rest, recruit and rearm — re-creating precisely the sort of environment that allowed al Qaeda to operate so efficiently until Sept. 12, 2001. In response, NATO forces are beginning to target these militants regardless of the political border, critically damaging the credibility of the Pakistani government.

The third quarter will force the new government in Islamabad to decide whether it is more afraid of NATO forces or of its own militants — who now have made leaps eastward out of the tribal areas into the North-West Frontier Province (NWFP). Ultimately, we expect the government to choose to target the militants, however half-heartedly, rather than make a stand against NATO's incursions into territory that is nominally under Islamabad's writ. The government will be driven by the fear that a conflict with NATO could, at worst, destroy Pakistan or, at best, trigger a military coup — which would end the first civilian government in a decade. In the meantime, U.S. forces will escalate their overt operations in the tribal badlands and perhaps even in the NWFP, which will complicate both the security and political situation in the country.

• Regional trend: India's schizophrenic policies regarding everything from tax regimes to special economic zones to basic infrastructure are proving that the idea of "Shining India" is a myth and will lead to a waning in foreign investment.

Hopes for a "Shining" India have all but darkened, and even that assumes that there is no fallout from the deepening militant struggle in Pakistan.

With oil prices skyrocketing, India's energy subsidized economy cannot cope and state oil refiners are buckling under the pressure. This not only spells a highly uncertain political future for the ruling Congress party, but it also raises the specter of fuel shortages in an extremely riot-prone society should the government slip in managing this fuel crisis. Add in infrastructure bottlenecks and a government that is paralyzed due to rising food prices, and it is clear even to the Indian government that New Delhi's foreign direct investment (FDI) hopes are overinflated. But with inflationary pressures in the country nearing a critical point, maintaining FDI has slid well down the government's priority list.

In the third quarter, India will continue to be squeezed by economic pressure and stymied by political paralysis, both getting worse by the day. A break point is unlikely in the next three months, however. New Delhi still has enough quick fixes at its disposal to manage the impact of the commodity crisis day-to-day, but its attention is now almost fully consumed with containing domestic dissent. The political tension will continue to intensify, but with elections still more than half a year away, the situation will continue to simmer without quite boiling over.

• Regional trend: The rest of South Asia will be consumed with domestic issues.

In the rest of South Asia, domestic squabbles between governments and their opponents took place as per our predictions with one exception: Afghanistan. The advances made by the Taliban, the diversion of U.S. attention to Afghanistan because of progress in Iraq, and the rise of Pakistan's own indigenous Taliban movement has pushed Afghanistan into a world very different from the self-contained situations in Sri Lanka, Bangladesh and Nepal. In the third quarter, the decaying security situation in Pakistan will intensify Afghan militant activity, and will push NATO in general and the United States in particular to boost the involvement of their troops in southeastern Afghanistan.

Latin America

• Regional trend: Brazil is rising as the continental hegemon of South America.

Politically, financially and militarily, Brazil is truly prospering by Latin American standards. Independent of the fact that the country discovered yet more oil fields in the second quarter, Brazil certainly surged ahead of the rest of the continent by any measure.

The economic realm is where Brazil is shining brightest. It exports or is self-sufficient in many of the commodities whose prices are causing the rest of the world no end of problems — but its governance is professional and competent enough that it is, so far, managing the stress of high prices at home.

In the meantime, its primary regional competitors — Argentina and Venezuela — are struggling, falling backward in relative power as Brazil strides forward. Brazil is leveraging this growing space competently. In the second quarter, Brazil became the largest single investor in Argentina. And in the third, it will take its first shipments of liquefied natural gas, setting the stage for it to declare full energy dependence from its unreliable neighbors. And with its investment into the energy industries of those same neighbors, Brazil is laying the groundwork for controlling their energy options, not the other way around.

• New regional trend: Crises are brewing in Latin America's leftist bloc.

In the annual and second-quarter forecasts, we dealt with Argentina, Bolivia and Venezuela separately. We now weave those three trends together: The populist policies that all have adopted are coming home to roost.

Argentina's financial, political and economic stability is taking a sharp turn for the worse. Argentine President Cristina Fernandez de Kirchner's populist efforts to placate a variety of groups have consistently laid the foundations for future, greater problems. The juggling already has radically increased Argentina's debt and reduced the country's trade surplus by a quarter — despite soaring international prices for all of Argentina's exports. This shortsightedness is triggering unrest on a national level, sparking runaway inflation of the type that has made previous Argentine governments fall. It also is gutting the country's productive capacity in industries in which it was until recently a global leader, and is raising the specter of food shortages in the not-so-distant future — quite possibly before the end of the third quarter.

Meanwhile, Bolivia is slowly sinking into chaos as the divisions deepen between the poorer, populous and indigenous highlands led by President Evo Morales and the more European and richer lowlands. Morales will hold a referendum on centralizing power in the third quarter, essentially attempting to force the lowlands into economic and political submission. So long as the lowlands physically control the economy on which the government depends, however, they cannot be talked or voted or threatened into submission. When the government realizes it cannot resolve the situation through constitutional channels — and we do not expect this realization to occur in the third quarter — Bolivia will have its defining crisis. Until then, the imbalance of political and economic forces in the country will only become more skewed, making the eventual conflict that much worse.

In Venezuela, it appeared at the beginning of the year that the opposition was beginning to coalesce into a meaningful political force that could challenge President Hugo Chavez. That trend has since faded away, but Chavez's own economic and political mismanagement has more than compensated for the lack of threats to the regime. Chavez has in many ways become his own worst enemy. Rising food and commodity prices, combined with self-destructive means of dealing with them, have soured the Venezuelan population on Chavez's leadership and fractured the ruling party. Many of Chavez's attempts to rally nationalist sentiment — threatening war against Colombia, for example — have instead backfired badly.

The country's social stability has been reduced to the point where it depends on Chavez's lavish social programs. But the cost of these programs is rising faster than the country's oil income, making Venezuela unique among oil exporters as the only one getting poorer with global crude prices at historic highs. Against this backdrop, it would be logical for foreign states hostile to Chavez to take a swipe at him, or for domestic opposition to rally against him, but no one with the capability to hurt Chavez has a deep enough interest to take any dramatic steps (the same, incidentally, goes for the Argentine and Bolivian governments). In the third quarter we expect Chavez's credibility to take hits — abroad, but even more so at home — as the system's coherence begins to crumble.

The problems of all three states feed upon each other. Bolivia's secession crisis and poor economic management are reducing natural gas flows to Argentina, complicating Argentina's existing power crisis. Venezuela's political — and by some reports, military — support for Bolivia's Morales only outrages and emboldens the secessionist lowlanders there. Venezuela's financial support for Argentina not only reduces the cash Caracas has to stabilize its own system, but several billion dollars of debt linkages now tie the economic problems of one state to the other. These connected problems, mostly rooted in the three countries' populist economics, have been building for years. In the first two quarters, cracks in the facade began to show — but in the third quarter the depth of the problems will become apparent. We do not expect any catastrophic failures in the next three months, but it is time to start thinking of just that.

• New regional trend: Mexico is facing a moment of truth in the government's war against the drug cartels.

In our annual forecast, we predicted a continuing intensification (but not a resolution) of the Calderon administration's war against the country's powerful drug cartels, particularly along the Mexican-U.S. border. But in the second quarter, the cartels began carrying out high-profile assassinations of top law enforcement personnel in Mexico City itself, and this has forced the country to a decision point that will evolve the war into something new. Sustained attacks on key personnel in the halls of power are something that no state can tolerate. If they continue, it will mean that one (or a combination) of three things must happen eventually:

1. Mexico City could strike a truce with the cartels to save the central region.


2. Mexico could hurl every asset it has into the war in an effort to at least secure the country's core.


3. The cartels could strike a truce with each other and force the government away from the border and onto the defensive. In essence, this would turn Mexico into a failed state.

None of the options is easy or pretty — and none might come to pass in the third quarter — but this much is clear: the current situation is untenable.

Africa

• Regional trend: In contrast to previous years, there will be little direct involvement of the major outside — or even inside — players. The one exception will be Angola, which will enjoy a rare day in the sun as the continent's up-and-comer.

It would have been hard to hit this one any more directly: Africa simply has not seen any meaningful direct involvement from the traditional players, whether from the continent or beyond. China has made a couple of commodities deals, but little more. India and Japan each hosted Africa summits but have not pursued other engagements. The French are participating in the European Union peacekeeping force (EUFOR) in eastern Chad, but they are keeping their heads down and have not intervened between the Chadian government and opposing rebels. The United States pulled back on plans to relocate its Africa Command (AFRICOM) headquarters from Germany to Africa. Nigeria is preoccupied with managing the Niger Delta, and South Africa has engaged in very little direct activity in Zimbabwe. Even Angola, the region's up-and-comer, is currently focused on internal development. (In the second quarter, it overtook Nigeria to become Africa's leading oil-producing state.)

But if the second quarter was quiet, it will seem like a roar compared to the third.

China has the Olympics, France has the EU presidency, and the United States is in the middle of an election campaign season and has little capacity for putting pressure on its African allies over relocating AFRICOM.

Nigeria's perennial problems with internal stability will take center stage as the country's Ijaw ethnic community makes its firmest — and, if necessary, most violent — bid for a larger slice of the country's oil revenues when Nigeria's government convenes the Niger Delta Summit, expected to commence in late July.

In South Africa, the internal issues that absorbed the country's attention for the past quarter continue to beckon. President Thabo Mbeki truly is already a lame duck and has minimal room to maneuver in either domestic or international politics. A leadership transition is only a year away, and the likely next president, African National Congress chief Jacob Zuma, continues to be hounded by corruption allegations, complete with court cases. The single issue on which Mbeki can act is Zimbabwe, where growing international condemnation has provided an opening for Pretoria's more nuanced policy of engagement.

Only Angola, awash with oil revenues, will have the luxury of picking the issues it wants to address without fear of reprisal or competition. But even Angola will have internal issues to keep it busy. Parliamentary elections — the first since 1992 — will occur in the third quarter, and the government wants to add a stamp of electoral legitimacy to its list of achievements. The rest of the world, it seems, can wait for another day.