Are We Kookoo for Shorting Cocoa?

Positions: Short cocoa via the etf NIB; Long corn via the etf CORN

Conclusion: While there is currently an imbalance in supply and demand for cocoa that appears bullish for its price, we believe supply and demand will come back to more normal levels and the price of cocoa will correct.


Yesterday in the Virtual Portfolio, we added a short position in cocoa via the etn NIB.  Our position in the soft commodities also currently includes a long position in corn. 


The core fundamental thesis for shorting cocoa is related to the potential for an improving political situation in the Ivory Coast – the world’s largest producer of Cocoa – and the potential for slowing demand as global growth slows sequentially.


From a consumption perspective, both the U.S. and Europe are the large consumers of cocoa.  In fact, 16 of the 20 world’s top consumers (on a per capital basis) are European countries; by some estimates Europe consumes more than 40% of the world’s cocoa.  In aggregate, developed countries consume more than 65% of the world’s cocoa, with North America being the second largest consuming region after Europe.  In total, the world will consume somewhere on the order of 3.6 million tons in 2010.  Interestingly, while developing countries are growing demand at a slightly higher rate than developed countries, it is only marginal, as developing demand is expected to grow at under 2% this year. (This is in comparison to higher demand growth for more essential commodities such as oil, copper, etc.)


From a demand perspective, since chocolate is considered a specialty item and not a necessity, we would expect demand for it to wane in slower economic growth periods.  As we’ve noted many times, we expect both U.S. growth and global growth to slow sequentially going into 2011, which will curb consumption patterns, particularly for nonessentials such as cocoa.  As a case study of what can happen to cocoa demand in slower economic times we can look to Germany.   The demand for cocoa in Germany grew at an annual rate of -2.8% from 1990 to 2000 and then accelerated to annual growth of 0.9% for the ensuing decade.  As the economic growth patterns of German improved, so too did its demand for cocoa.


But the real story in cocoa is production.  Almost 70% of global cocoa production occurs in Africa – the top five producers globally are the Ivory Coast, Ghana, Indonesia, Nigeria, and Brazil.  The Ivory Coast, though, dominates production with approximately 45% of the world’s production occurring within her borders.   So, as the Ivory Coast goes, so too goes the price of cocoa.


Currently, things are not going well in the Ivory Coast.  As of November 14th, according to statistics from the Ivory Coast government, arrivals of cocoa crops at ports in the Ivory Coast slated for overseas transports are down almost 15% y-o-y.   This negative news, though, we believe is priced into the commodity, as it was expected that production was lagging due to new quality standards.


Prospectively, the recent Ivory Coast elections are likely a key driver of future supply growth.  The elections, which had been on hold due to political turmoil since 2005, were certified by the United Nations.  According to the UN:


“Despite some minor incidents and anomalies, it was peaceful and in line with international standards.”


In fact, more than 83% of eligible voters went to the polls.  The result of the Presidential election was that no candidate received more than 50% of the popular vote, but a runoff is scheduled for November 28th between Incumbent President Laurent Gbagbo and rival Alassane Ouattara.  It seems likely that peaceful and democratic transition of government will occur.  The implication of this is that government can begin to function at a normal level again and start to mandate, and support, a much needed modernization of the cocoa industry.  In time, this should lead to a cocoa production boom in the region.


So, are we kookoo for shorting cocoa? We don’t think so, but only time and price will tell.


Our levels on the cocoa etn, NIB, are outlined below.


Daryl G. Jones

Managing Director


Are We Kookoo for Shorting Cocoa? - nov 18 cocoa


Conclusion: Yum has seen strong sales performance lately in its China division.  The downturn in consumer confidence in the People’s Republic is worth monitoring for a view to how 4Q is trending.


Chinese consumer confidence fell for the first time in six quarters in the third quarter.  The drop is believed to be largely attributable to inflation expectations.  Pan Jiancheng, deputy-general of the National Bureau of Statistics’ monitoring center, said, “Inflation has been triggered mainly by increases in food prices which has pushed up inflation expectations, especially among low-income workers”. 


Specific to YUM, management has consistently called out consumer confidence in China as a key driver of sales.  On October 6th, from the 3Q10 earnings call transcript: “we continue to benefit from the improvement of the Chinese consumer where consumer confidence has now been positive year-over-year in the last nine months”.  During the 2Q09 earnings call, in discussing the top  line trends of -4% in China, management said, “when you look at consumer confidence, actually it’s kind of bumping along the bottom.  So that may be a reasonably good indicator of the consumer side of the equation”.  Later, during the 4Q09 earnings call, management again called out the bottoming of consumer confidence in China in the early part of 2009 and same-store sales subsequently posted strong gains in 1Q10.   Just as the inflection in consumer confidence proved to be an indicator of Yum China sales in 2009, the recent sharp downturn should also be taken into account when thinking about future quarters. 


While 4Q09 was a difficult quarter from a  top line perspective, and therefore may be easily comped by Yum in the upcoming quarter, 1Q11 will present a difficult challenge for Yum China if consumer confidence does not rebound in the interim.  Additionally, MCD announced yesterday that it has increased prices in China by between 0.5 yuan and 1 yuan to offset higher raw material costs.  YUM management stated on the most recent earnings call that it expects inflation to be a headwind in 4Q10 and 2011.  Should margins compress under rising costs, that would obviously present an additional challenge for the company.  Alternatively, following MCD’s lead and raising prices could negatively impact sales trends, particularly if consumer confidence does not rebound.


YUM – WATCH CHINA CONFIDENCE - china consumer confidence


YUM – WATCH CHINA CONFIDENCE - yum china sales


Howard Penney

Managing Director

Initial Claims Approach YTD Lows

Initial Claims Approach YTD Lows

Initial jobless claims seem to be getting better. The headline initial claims number rose 4k last week to 439k, but rolling claims fell 4k to 443k. As the following two charts show, both reported and rolling claims are knocking on the door of their YTD lows, but have yet to break through. Claims still need to be in the 375-400k range for unemployment to meaningfully improve - still well below where we are now.


Initial Claims Approach YTD Lows - 1


Initial Claims Approach YTD Lows - 2


In the table below, we chart US equity correlations with Initial Claims, the Dollar Index, and US 10Y Treasury yields on a weekly basis going back 3 months, 1 year, and 3 years.


Initial Claims Approach YTD Lows - 3


Joshua Steiner, CFA


Allison Kaptur

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Initial Claims Approach YTD Lows

Initial jobless claims seem to be getting better. The headline initial claims number rose 4k last week to 439k, but rolling claims fell 4k to 443k. As the following two charts show, both reported and rolling claims are knocking on the door of their YTD lows, but have yet to break through. Claims still need to be in the 375-400k range for unemployment to meaningfully improve - still well below where we are now.






Yield Curve Widening

The following chart shows 2-10 spread by quarter while the chart below that shows the sequential change. After falling sharply for two quarters, the 2-10 spread has stabilized thus far in 4Q.  Yesterday’s closing value of 238 bps is up from 224 bps last week.






The table below shows the stock performance of each Financial subsector over four durations. 






Joshua Steiner, CFA


Allison Kaptur

Big Week in Athletic Footwear & Apparel Sales

The athletic industry reported a solid week. Underlying trends improved across the board with apparel coming in hot last week. Here are our key takeaways: 

  • Both footwear and apparel sales improved sharply on a sequential weekly basis sparking a rebound in underlying trends. Importantly, the quality of sales acceleration is notable in the absence of promotional activity with ASPs remaining firm up low-to-mid single-digit.
  • Apparel is the key callout with Athletic Specialty sales up +31.5% on the week building on reaccelerated trends from last week. Despite facing its second easiest compare of the year (this week is the easiest), the underlying trailing 3-week on a 2yr basis rebounded sharply.
  • Footwear posted a solid week +5.9% suggesting the deceleration reported last week up +1.2% compared to +10.9% in the prior week was more likely an anomaly than trend.
  • Broad-based strength across regions with each posting double-digit gains suggesting improved underlying demand.
  • Skechers officially broke its positive sales momentum posting the first decline in year-over-year sales since June 2009 with toning trends (sales and ASPs) continuing to deteriorate.
  • Nike remains strong though the clear standouts are Under Armour with sales rebounding sharply following tough apparel compares in mid-October with sales up 45% and significant outperformance at outdoor outerwear brands Columbia up +31% and VFC (The North Face) up 59% - positive for DKS/HIBB.

Big Week in Athletic Footwear & Apparel Sales  - FW App Ind 1Yr 11 17 10


Big Week in Athletic Footwear & Apparel Sales  - FW App Ind 2Yr 11 17 10


Big Week in Athletic Footwear & Apparel Sales  - FW App FW Table 11 17 10


Big Week in Athletic Footwear & Apparel Sales  - FW App App Table 11 17 10


Casey Flavin



General Mobama

“There is, in a competitive society, nobody who can exercise even a fraction of the power which a socialist planning board would possess.”

-Friedrich Hayek


Hayek is to the Keynesians of Big Government Intervention what capitalism is to socialism. Watching some Americans beg for the scraps of a short-term socialist experiment this morning is apparently the kind of groupthink that President Obama supports:


“Through the IPO, the government will cut its stake in GM by nearly half, continuing our disciplined commitment to exit this investment while protecting the American taxpayer" –Barack Obama




Hearing our used-car salesmen of professional American politicking talk about “disciplined” investing for the American people must be some sadistic form of a joke. I, for one, will go on the record today calling this GM deal out for what it really is – socialism. General Mobama, nice trade.


Co-founder of investment banking outfit Evercore Partners, Roger Altman, loves this short-term trading of American capitalism for privileged socialist handouts. His firm was paid upwards of $46 MILLION in pre-GM bankruptcy fees and allegedly wants another $17-18 MILLION in what bankers call “success fees” for this GM deal going off with a bang this morning. Roger, nice trade.


I couldn’t make this up if I tried, but Roger met with General Mobama earlier this week to talk about his post GM deal day job. Roger likes to trade the banking-fee-cycle with time moonlighting in DC. And apparently the President of the United States liked doing this GM deal so much that he is considering Altman as Larry Summers replacement at the White House.


Wait, is Altman a banker or a politician? Sadly, when getting in tight on these socialist handout jobs, one is a prerequisite for the other. Roger Altman has an impeccable resume in old-boy network banking and politics:

  1. 1974 he became Partner at Lehman (banker)
  2. 1 he served as Assistant Secretary of the Treasury (politician)
  3. 1 he went back to Lehman and became co-head of investment banking (banker)

Oh yeah baby, that’s the change General Mobama is talking about. Let’s bring back someone who really understood Jimmy Carter and Arthur Burns style economics and let’s get this Jobless Stagflation party started.


Don’t worry, you won’t be disappointed in this storytelling. The deeper you dig into a pile of dogma the more it smells. Altman loves working at places that lever and lather themselves up with cheap moneys. After Lehman, he did LBOs at Blackstone (banker). Then, in 1993, he went back to Washington as Deputy Treasury Secretary (politician) for the only 2 years that resembled 1970’s style US Jobless Stagflation until… well… today!


No matter where you go in America this morning, this is where we are. I, for one, won’t let my son and daughter YouTube me on this day of November 18th, 2010 as one of the pretending patriots who supports socialist bailouts.


Back to the market…


Today’s pump and dump government rally should provide a fantastic opportunity to put some of our short positions back on (in the Hedgeye Portfolio we currently have 15 LONGS and 10 SHORTS). The US stock market has only had 1 UP day in the last 8. In the last 2 days the SP500 became what our Hedgeyes call immediate term TRADE oversold.


Yes, like your US government, we trade…


In terms of the Hedgeye Asset Allocation Model, in the last week, on weakness, we’ve scaled back up to 6% positions across the board (from ZERO percent at the market top on November 8th) in US Equities, International Equities and Commodities. We are long US Healthcare (XLV), Germany (EWG), Corn (CORN), and Gold (GLD). All of these positions are candidates to be sold. Our current asset allocation to Cash = 58%.


Yes, like any free market capitalist, we reserve the unalienable right to see this government sponsored casino for what it has become…


In terms of levels on the SP500, going into today’s open, from the 1178 level, we measure 2:1 upside with a significant level of immediate term TRADE resistance up at 1191. If the SP500 closes above 1191, that’s bullish. If it breaks, that’s bearish.


In the face of 1. Global Growth Slowing 2. Global Inflation Accelerating, and 3. Interconnected Risk Compounding, I don’t want a banker or a politician telling me how to manage risk. I need a transparent and accountable General who I can trust gets this game – and I guess, for now, that will have to be me.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


General Mobama - JC

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