Brent Oil Sees Inflation . . . And Continued Upheaval in the Middle East

Conclusion: Brent oil broke the $100 barrier today, with little fanfare except to those European consumers who buy gasoline created from Brent.   Additionally, despite a strong couple of months for Brent, it continues to trade higher suggesting political upheaval in the Middle East may be poised to accelerate.


Globally, oil is up as much as 3% today on the back of accelerating tensions in Egypt.  As it relates to global production, Egypt is not a meaningful player.  The country produces ~650K barrels of oil per day, which is roughly in-line with its domestic consumption.  The key oil supply and demand factor relating to Egypt to focus on is related to transportation.


The Suez Canal links the Mediterranean and Red Seas and is considered to be one of the world’s chokepoints for energy.  It is estimated that more than 35,000 ships travel through the Suez Canal every year and that approximately 10 percent of those are petroleum tankers.  In recent years close to 2MM barrels per day of oil has been transported through the Canal, which is about 2.5% of the world’s daily oil consumption.


Given that the Suez Canal is located in Egypt, there is some risk that accessibility to the Canal could change with a less stable regime in place in Egypt.  Or, alternatively, as tensions escalate and are prolonged in Egypt, shipping companies may be less willing to utilize the Suez Canal.  As it relates to the last point, we have already seen global shipping companies begin to back out of Egypt.  Earlier today Danish shipping and oil conglomerate, A.P. Moller-Maersk, suspended its port terminal operations and closed its shipping offices located in Egypt.


Since the Middle East, via the Suez Canal, is a key supplier to European oil markets, it is no surprise that we are seeing, and have seen, the price of Brent Oil accelerate upwards.   As highlighted in the chart below, Brent recently surpassed $100 per barrel.  This is more than an $8 premium above West Texas Intermediate (WTI).  In effect, the demand for Brent Oil (it is sourced in Europe from the North Sea) increases with the perception that oil coming from the Middle East to Europe will be costlier to ship.


Interestingly, both Brent and WTI were at roughly $85 per barrel on December 1st, 2010.  Since early January, Brent has outpaced the price performance of WTI dramatically and correctly predicted the acceleration of popular upheaval in the Middle East.  Despite Brent being up more than $15 in the last two months, the price increase is still not abating, which suggests the issues in the Middle East may get worse before they get better.


Daryl G. Jones

Managing Director


Brent Oil Sees Inflation . . . And Continued Upheaval in the Middle East - 1

Time to Buy Brazil?

Conclusion: With the recent spike in crude oil prices, one might think Brazil is a good derivative play on the geopolitical risk in Northern Africa. Unfortunately, the math suggests otherwise and we are inclined to maintain our cautious stance on Brazilian equities.


Position: Bearish on Brazilian equities; Bullish on the Brazilian Real.


This is known: Brazil is an economy with vast natural recourses and uses those resources to profit from global demand for crude oil, sugar, corn, wheat, iron ore, and other commodities. 


This is, at times, is overlooked: Brazil is home to one of the world’s most unequal economies from an income distribution perspective. Brazil’s GINI Coefficient, which measures income distribution, is 57 – good for 11th highest in the world. That means Brazil is the 11th most unequal country in the world from a wealth dispersion standpoint – significantly more so than Egypt (34.4), Tunisia (39.8) and the United States (40.8).


We’ve been calling this out since November, but it’s worth repeating: You don’t want to be long countries where growth is slowing and inflation is accelerating – especially in poorer countries, where the citizenry is most apt to be plugged by rising food and material prices. While we didn’t necessarily predict events such as the Jasmine Revolution and Egypt’s current uprising, the tea leaves were most definitely telling us to stay out of Emerging Markets for the last 2-3 months.


Today, Brazilian equities continue to lose bids, despite the strength we’re seeing in crude oil prices (up over 3%) and commodity prices (up over 1.5%) on the day.


We are all well aware that Brazil is home to arguably the most robust consumer story in all of global macro. With record low unemployment (5.3% in Dec) and near-record low consumer loan rates (6.79%), it’s no surprise investors (including us) poured money into this story in 2010 – sending the Brazilian Consumer etf (BRAQ) up +30.3% in 2010 from its first trading day (7/8/10).


Both the price action and investor interpretation of the fundaments have reversed sharply in 2011, sending the BRAQ down over (-12%) YTD. The fundamentals themselves have been eroding for the last four to six months – particularly on the inflation front: 

  • The benchmark IPCA CPI reading accelerated in Dec to +5.91% YoY – a 25-month high;
  • Food Inflation, as captured by the same official IPCA index accelerated in Dec to +10.39% YoY – a two-year high; and
  • January is off to a “hot” start as well, with the unofficial FGV IGP-M CPI accelerating to +11.5% YoY – a 26-month high. 

Time to Buy Brazil? - 1


Ignoring the delta between the government’s reported numbers and the unofficial series (see: Egypt, Argentina, US, etc.), we see that inflation is indeed becoming the problem we anticipated a few months back. This issue is reflected in the Bovespa’s underperformance – falling (-7%) since it peaked on the 12th of January. With the exception of the now infamous EGX 30 (Egypt), that decline is tops among global equity markets over that duration. The fall leaves Brazil decidedly bearish from an intermediate-term TREND perspective.


Time to Buy Brazil? - 2


With the dollar catching no bid amid the acceleration of global geopolitical risk, we don’t see inflation as something that will quietly go away in Brazil. Brazil’s bond market agrees; yields on 10Y government securities having backed up +79bps since January 3rd. For what it’s worth, Brazilian economists see the same thing: the latest survey for full year 2011 CPI estimates came in at +4.7 YoY, up +16bps wk/wk.


Time to Buy Brazil? - 3


Unfortunately, for the poorest of Brazil’s citizenry, Brazilian policy makers have been reluctant to let the real appreciate meaningfully. Of the firm belief that the current bout with inflation is driven by rising commodity prices (see: India) the central bank is reluctant to use further rate hikes to beef up the real in an effort to combat rising inflation. Instead, Brazil continues to manufacture attempts to weaken the real, raising the reserve requirement on short dollar positions, authorizing the sovereign wealth fund to buy dollars and auctioning reverse swaps – all since January 1st.


Until Brazil’s central bank stops buying the IMF-led hype of “destabilizing fund flows” and “global capital imbalances” and realizes that inflation is priced locally and is a direct function of local monetary policy, the inflation issue will hang like a dark cloud over Brazil’s economy.


Perhaps the market is discounting this, understanding full well that Rousseff is a woman of the people and a strong advocate for Brazil’s poor. She’ll likely not let inflation get further out of control than it already is. Given this, we expect measured tightening on the horizon in the Brazilian economy, and a potential subsiding in anti real-strength policies. Perhaps the prospect of future real strength is the underlying reason Brazil’s Industrial Confidence fell in January (-1.5%) MoM. While merely a hunch at this point, we’d be remiss to ignore the interconnectedness of these risks.


If you’re still bullish on Brazilian equities, we’d recommend you buy them at an even greater discount at some point in the intermediate future. If you’re bearish, continue to watch the US dollar and how it interplays with commodity inflation. For now, the dollar is decidedly bearish-TREND, which, in turn, is bullish for global commodity prices on the margin. We don’t think we’ll see the usual benefit of these rising prices reflected in Brazilian equities until inflation subsides in Brazil – which is likely only to happen after a measured increase in hawkish monetary policy.


Darius Dale



Time to Buy Brazil? - 4

The Bounce: SP500 Levels, Refreshed

POSITION: no position in SPY


Fortunately I stayed with the risk management process and covered my short position in the SPY on Friday.


I am not surprised that we have seen the SP500 bounce from its immediate-term TRADE line of support at 1276. On Friday we obviously all knew that today would be ripe for month-end markups. After one of the most expedited 22 month rallies in US stock market history, I don’t expect the bulls to give up readily. Intermediate-term tops are processes, not points.


Friday’s move to cover doesn’t imply that I’m not bearish on US Equities anymore. It simply implies that I am waiting for a higher price to re-short them, selectively (we already re-shorted TGT this morning on strength). Friday’s moves in both volatility (VIX) and the SP500 were critical in that they arrested this almost surreal level of recent upward price momentum in US stocks.


Looking forward, here are a few important lines that I’m watching: 

  1. SP500 TRADE line resistance is now 1288
  2. VIX TREND line support is now 18.71 

If the VIX breaks down through that TREND line, I have no doubt the bulls will try to push the SP500 back toward its closing cycle-high of 1299. That said, 1299 is simply another lower-long-term closing high (think Nikkei 225 for 15 years) and when I think about this market’s long term TAIL, that’s bearish.


If the SP500 were to breakdown and close below 1276, that would be bearish too (TREND line support = 1224). In our S&P Sector model, we’ve already registered 5 of 9 Sectors breaking their immediate-term TRADE lines, respectively (XLY, XLP, XLV, XLB, and XLF). This is a bearish leading indicator.


If you covered some of your shorts on Friday, congrats. Don’t get sucked in on the long side today – this is going to be a volatile week.



Keith R. McCullough
Chief Executive Officer


The Bounce: SP500 Levels, Refreshed - 1

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January revenues up 34% YoY



It looks like January table revenues will come in at HK$17.4 billion.  After adding in an estimate for slots, total gaming revenues will fall short of our HK$18.5-19.0 billion estimate at HK$18.2, up 34% YoY.  Business slowed in the last week more than we thought in the lead up to Chinese New Year.  In terms of market share, Wynn continues to suffer from low hold and we are hearing LVS held pretty well the past week.  MPEL’s share actually grew from an already healthy clip and looks like the most interesting stock in the group.  Here are the numbers:



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