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"The winters of my childhood were long, long seasons. We lived in three places - the school, the church and the skating rink - but our real life was on the skating rink." - Rich Carrier ("The Hockey Sweater")

Keith is back in his hometown of Thunder Bay, Ontario this week and I am in mine, Bassano, Alberta. If there is a quote that describes life growing up in a small rural Canadian town it is the one above. After I finished editing the Early Look with Brian and Keith yesterday morning and was enjoying breakfast with my parents, I was reminded of the long cold Canadian winters as I stared at the thermostat outside that was flashing -34 degrees celsius.

My hometown of Bassano is a quiet prairie outpost of 1,345 people located about 80 miles south of Calgary.  The town was incorporated in 1911 and was an agricultural center originally founded in conjunction with the building of the Bassano Dam, which was, at the time, the largest man-made dam in the world.  Yet in the last few decades agriculture has been far surpassed by the Oil and Gas industry as the life blood of the local economy.  The context of growing up within the Oil and Gas industry has given me a great foundation to do fundamental research on it.

Bassano is located above the Western Canadian Sedimentary Basin, which is one of the largest oil and gas reservoirs in the world, and a short flight from the tar sands in northern Alberta.   In total, Canada ranks second largest in terms of global proven crude oil reserves (15% of world reserves), after Saudi Arabia. The majority of these reserves are found in Alberta's tar sands – over 173 billion barrels.

While I've taken a slighly different path in life than many of my friends from Bassano (thanks to an apptitude on standardized tests and a decent slapshot) it is always a pleasure to come home.  Most of my friends from growing up now work in the Oil and Gas industry in jobs which are popularly known as "Roughnecks". These guys are the lifeblood of the industry and operate the massive CAT tractors in the Oil Sands up north, service the Oil batteries spread across the prairie in the dead of winter, and travel with their drilling crews around the country, and world, in search of the next gusher.

Most Roughnecks probably don't own a suit and will never have a seat in a boardroom. Despite their lack of "sophistication", they forget more about the energy industry in a day than most of us will ever know in a lifetime, so being back home and sharing a few Labbat's Blues at the local watering hole (there is actually only one!) gives me a great opportunity to do some real due diligence.

These conversations, along with work the Macro team has been doing on the Oil industry recently, have helped me cement a few energy related macro themes heading into 2009.

First, geopolitical power will shift in 2009 with the massive year-over-year decline in energy prices.  In particular, this is important as it relates to Russia.  We emphasized "Putin Power" repeatedly in 2008 and saw witness to it with the Russian incursion into Georgia.  With Oil in the $40/$50 range, Putin's power both domestically and abroad will be reigned in dramatically. Amplified “Putin Power” was a key global macro tail risk for the last 3 years – now it’s no longer in the tail.

Second, there is liklihood that a major oil producing nation encounters serious internal budgetary difficulties in 2009 and potentially defaults on sovereign debt.  At the top of our list of countries that may ecounter serious economic difficulties in 2009 due to this dramatic year-over-year price decline in Oil is Mexico. The combination of lower prices and production declining at -10% year-over-year (driven by the peaked Cantarell field) is concering as more than 40% of the state's budget is funded by PEMEX, the national oil company.

Finally, the long term supply constraint issue remains. While Oil has crashed for a -74% move from its manic July 11, 2008 high due to demand declines and deleveraging, longer term supply constraints are real and will likely re-emerge in late 2009 and beyond.  According to the BP Statistical Review of Energy from June 2008, world oil production in 2004 was 80.3MM barrels per day and, despite massive investment, had only grown to 81.5 barrels per day, or 1.4%, by 2007.  Because of oil’s expedited crash this year, investment will slow to a level that will only eventually exacerbate the problem.  The long term supply issues will eventually remerge  as a major investable theme. Every asset class has a price.

In the short term, we like Oil as a reflation “Trade” based on a declining U.S. dollar combined with nominal interest rates in the U.S. being as low as they have ever been, and interest rates going lower globally.  With Oil in the low $40s/high $30s per barrel, we do need much inflation to have a highly profitable “Trade” on our hands.  And if the “Trade” turns out to be profitable, maybe we'll even celebrate. Or as the well known Alberta country singer Corb Lund sings, maybe "we'll shine up our boots and head into town, scrape up twenty dollars and throw it around."

I hope you are all enjoying being home and visiting with your friends and family. (If I could only figure out how to put these fancy degrees of mine to work and beat my Mom in our nightly Jeopardy competition, I'd be really happy. . .)

Happy Holidays from Big Alberta,

Daryl G. Jones
Managing Director

Long ETFs

SPY-S&P 500 Depository Receipts – Front Month CME S&P 500 contracts opened down slightly, trading in a range of 857.1 to 861.3 before 6:30AM.

USO - U.S. OIL FUND – Front month NYMEX Light Sweet crude contracts traded as low as 38.04 before 6:30AM as surveyed refiners anticipated that today’s EIA report will show further inventory increases.

GLD -SPDR Gold Shares – Spot Gold declined 0.5% to $836 an ounce in LME trading this morning.
VYM – Vanguard High Dividend Yield- General Electric (VYM 5.2%) announced an agreement to sell their Australian mortgage lending unit including a portfolio of $2.7B  in residential mortgages. letter of warning from the FDA criticized Coca Cola’s (VYM: 2.51%) nutritional claims on the packaging for their new “Diet Coke Plus” beverage.

DIA –DIAMONDS Trust Series – Front Month CBOT DJIA contracts opened down slightly trading in a range of 8,370 to 8,417 before 6:30AM.

EWT – iShares Taiwan —Export orders declined a record 29% year-over-year in November, according to a government report released late yesterday.

EWZ – iShares Brazil —In a televised address last night, Brazilian President Luiz Inacio Lula da Silva encouraged increased consumer spending to help the national economy overcome the global slump, noting that inflation levels appear under control.

EWH –iShares Hong Kong –The Hang Seng declined 0.3% to close at 14,184.14 in a shortened holiday session today.

FXI –iShares China —The CSI 300 fell by 1.7 % to close at  1,887.07 at the close today while the yuan strengthened 0.13% to 6.8397USD.

Short ETFs

FXY – CurrencyShares Japanese Yen Trust - The yen rose to 126.50 EUR and 90.45 USD this morning


We all know that October was a bad month for the casual dining group. Same-store sales were down 6% and traffic was down 8.1%. We learned yesterday that November’s numbers, although still negative, improved sequentially from October (please see yesterday’s post titled “Casual Dining – November Was Less Bad”). On a regional basis, October’s results showed more of the same with Texas continuing to post the best numbers and Florida continuing to trail the rest of the country, according to Knapp Track data (holds true on a year-to-date basis as well). In October, Texas was the only region of the 11 (listed below in the chart) that both improved sequentially from September and did not experience a same-store sales decline (was flat). In October, the spread between the best and worst performing regions (in this case, Texas and Florida) on a comparable sales basis reached 10.1%, its highest level since January 2007 and a nearly 400 bps increase since September.

So from a regional exposure standpoint, this widening of the range of performance among regions reaffirms that it is still a positive if a company has a significant proportion of its restaurants located in Texas (PFCB, EAT’s Chili’s, TXRH and DRI are among the highest). And, on the flipside, it is less than positive if a casual dining operator/concept has a lot of geographic exposure to Florida (LongHorn Steakhouse, SNS, Capital Grille and RUTH). We will have to monitor whether casual dining trends in Texas continue to outperform, however, as DRI commented last week on its earnings call that it is seeing weakness across the country and that some of the regions that had been strong, Texas in particular, did soften up in the second quarter.

The charts attached below show casual dining restaurants’ exposure to the better and worse performing regions of the U.S. relative to the national average from a comparable sales growth perspective in September and October 2008. As of October, CPKI has the most exposure to the underperforming regions of the country, primarily as a result of it having 40% of its restaurant base located in California while 74% of SNS’s restaurants are located in the better performing parts of the country, despite its large presence in Florida. The only region of the country that moved from performing below the national same-store sales average to better than or equal to the average in October was the East and part West South Central region. If these relatively better trends hold up, CHUX will be the biggest beneficiary as 26% of its restaurants are located in this region of the country.

An Intraday Note From Your New Federal Government Bankers

“JPMorgan Chase & Co. is using the TARP funding for the purposes that the government has designated. The company is lending to consumers, small businesses, corporations, municipalities and other institutions in a disciplined and responsible manner.”

Jaime Dimon knows it, and you know it. "Investment Banking Inc.", in all of its levered manifestations, is going to go by the way of the horse and buggy whip.

From Citigroup to Morgan Stanley, what these stocks do intraday means less and less to the American Capitalists investing in The New Reality.

Upward and onward. Let the government re-regulate those who asked for it.

Keith R. McCullough
CEO & Chief Investment Officer

Early Look

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Charting Commodity Consensus: "C'mon Man!"

Commodities have crashed faster and further than the SP500 in 2008. The peak to trough decline (see chart) is a magnificent one – and now that the CRB Commodities Index is trading at 214, down -55% from its nosebleed consensus peak, I am getting bullish.

My bullishness in commodities has taken my current Asset Allocation model to 15% in Commodities today. This is the highest allocation I have ever had to commodities, and I feel pretty good about that. Buying low is what I do, and to all the bulls turned bears out there who think this chart looks like it’s time to start shorting commodities aggressively, I have to submit my favorite Monday Night Football segment one liner – “C’mon Man!”

The US$ is breaking down, and gold is breaking out. This is THE early “Re-Flation” signal associated with the most aggressive global rate cutting party in world history. Since everything “Chindia” that the bulls bought into at the June/July CRB Index highs can’t be forgotten. May I remind the newfound commodity bears of their own investment letters from only a year ago that stated, as if it were gospel, that “its global this time.” Basic commodities have a place in everyone’s portfolio, but only at a price.

Keith McCullough
Research Edge LLC

Brazilian Bulls?

One of the many thanks that I will be giving at this year’s McCullough 2008 Christmas party, is not having bought into the “Fast Money” highs of everything from Brazil to horse manure. Latin American and fertilizer stocks should never be bought at a fully loaded Park Avenue price!

Now that Brazil’s Bovespa Index has seen a -60% price cut from those manic highs to October’s lows, it’s getting very interesting. We bought more of the EWZ etf today for the same 3 reasons that we have been discussing: 1. Best country to own for Re-flation, 2. Pending Brazilian interest rate cuts, and 3. Technical support built up at the line shown below (36,582).

Buy low, sell high.

Eye on Private Equity: Don't count on a 2009 rebound

Eye on Private Equity: Don't count on a 2009 rebound

Two themes we expect to see emerging from private equity land in 2009 are continued bankruptcies of debt-laden portfolio companies, which in 2008 stands at 40 major bankruptcies and counting, and dramatic moves from these private equity owners to stave off bankruptcy. These drastic operational moves will also have many unintended consesquences as highlighted in a Bloomberg article this morning, entitled: "Feinberg Despised in Wisconsin Where Cerberus Lives Up to Name."

Feinberg's Cerebrus Capital Management owns NewPage Corporation, which recently closed a paper mill in Kimberly, Wisconsin, to ostenibly cut over head at the parent company. As a result of the closure, more than 600 jobs were lost in a town of 6,200 people. While outrage at private equity firms for downsizing is certainly not new, the comments aimed at Feinberg are particularly venomous and include, "This is a . .. extremely greedy guy who doesn't care about other human beings . . . he sold his soul to the devil . . . Feinberg has no morals."

Situations similar to this one in Kimberly, Wisconsin will only accelerate in 2009 and with them negative sentiment towards private equity firms. As this sentiment grows, Obama's ability to pass a bill forcing private equity executives to pay capital gains taxes of 35%, up from 15%, will be made easier. With continued failed deals and the outlook for lowered future compensation, the next few years are shaping up to be challening ones for the private equity world.

In addition to the points outlined above, leverage will be much less readily available for traditional leverage buyouts in 2009 than it has been in the past as investors in private equity deal debt, and investment banks that were left holding the debt, have suffered severe losses. As a result, these lenders will not be opening up their balance sheets and the credit markets for LBOs will be closed for the forseeable future, except on a very limited basis.

While it seems like Henry Kravis proclaiming that we were entering the golden age of private equity was just yesterday, and it was less than 18 months ago, that proclamation along with IPO of Blackstone marked the peak of the private equity business. In the traditional levered return sense, the priave equity business will be dead for quite some time. In its place, we will likely see an increased amount of strategic M&A. On the margin, credit markets continue to thaw, and valuations in some sectors have reached compelling levels.

In an environment where access to LBO capital tightens, and the cost of it begins to rise (over the long term; that’s what rates do after they go to zero), those liquid long cash become kings of The New Reality.

Daryl Jones
Managing Director

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