The Economic Data calendar for the week of the 28th of February through the 4th of March is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.
Conclusion: While Gaddafi, Wisconsin, and Greece continue to dominate the geopolitical risk headlines, some of Asia’s largest economies are currently dealing with uprisings of their own. Each, to varying degrees, has the potential to heat up substantially in the coming days and weeks.
Position: Short Emerging Market equities via the etf EEM.
While the conflict in MENA and the recent volatility associated with global crude oil prices appropriately garner the bulk of investor attention, that doesn’t mean geopolitical risk ceases to exist elsewhere. Given, we detail below three scenes in Asia where current uprisings have the potential to accelerate in the coming week(s):
CHINA: Cold For Now
LinkedIn Corp. has become the latest social networking site to be blocked in mainland China after a user, “Jasmine Z”, posted comments that explicitly stated Tunisia’s Jasmine Revolution should be spread throughout China. Additionally, the user set up a forum whereby others in the discussion group could post their opinions. The Chinese government’s suppression here puts China in direct contention with recently-enacted US foreign policy:
“The US will help people in oppressive internet environments get around filters, stay one step ahead of the censors, the hackers, and the thugs who beat them up or imprison them for what they say online.”
-Hillary Clinton, US Secretary of State, Feb. 2011
We doubt Washington D.C. has the political will to get in between China and its citizens; we will point out, however, that any reneging on the US’s hard stance on this topic could potentially undermine their efforts and influence in MENA negotiations.
Elsewhere in China, demonstrators continue to make a push for weekly demonstrations at 13 locations throughout the country after the initial gatherings on Feb. 20 failed to produce more protestors than police. China’s Foreign Ministry Spokesman Ma Zhaoxu had this to say regarding the demonstrations:
“It is the Chinese people’s common aspiration to safeguard social and political stability, promote social harmony, and safeguard our people’s livelihood… No one can force or sway our resolve.”
Translation: We will continue to suppress any uprising and the US/UN rhetoric will not factor into our decision.
All told, the situation remains fairly muted in China at this point, and given the recent wage increases and the potential for the next five-year plan to focus exclusively on raising broad living standards throughout the country, we don’t see this as a situation that will get out of hand.
INDIA: Warm; Poised to Heat Up?
On Feb. 3, we published a report titled, “Falling Like a BRICk: Is India the Next Egypt?”; in the report, we detailed the similarities between India’s economy and the now-falling MENA States. Furthermore, we highlighted the #1 risk that could propel Indian citizens to do their best Tunisian/Egyptian/Libyan impersonations: accelerating inflation.
We’ve been vocal about the RBI’s poor effort to adequately resolve India’s inflation issue (instead of raising rates, they spent the bulk of 4Q10 buying back gov’t bonds to increase liquidity in its banking sector). Now India is in a scenario whereby food and energy inflation is spilling over into “core” inflation as producers and retailers hike prices throughout the economy – and this is before $112 Brent crude oil gets factored into corporate decision-making.
As we’ve maintained for the past few months, high and rising food, fuel, and now “core” inflation in an economy where ~830 million people live on less than $2 per day is a sure recipe for social unrest – and now India is getting exactly what the RBI has “cooked” up. Led by the country's trade unions, thousands of workers have convened on the nation’s capital this week to protest rising food prices, low wages, and job insecurity.
And this is with +9% YoY GDP growth. Imagine what the scene would look like if Indian GDP growth slowed by 100-200bps over the next 6-9 months…
Monday (2/28) will be a critical day for the direction of social instability in India, as Finance Minister Pranab Mukherjee unveils the government’s FY12 budget. The budget is expected to be filled with food and fuel subsidies for low-income citizens, as well as guaranteed work programs for over 41 million of its poorest rural families.
The expectations for massive stimulus for the low-income segment of the Indian populace have been set; any “miss” relative to these expectations could potentially incite further unrest among Indian voters – many of which have been turning away from the ruling Congress Party in the recent polls due to corruption and unpalatable inflation, among other things.
All told, the Indian government cannot afford for the budget to miss expectations or for it to get derailed via further legislative gridlock. Opposition to the alleged graft of former Congress Party officials has stalled the legislative agenda and made the final parliament session of 2010 the least productive in 25 years!
The opposing Bharatiya Janata Party’s insistence on a parliamentary probe of the alleged graft has finally resulted in capitulation by Prime Minister Manmohan Singh, who finally agreed to the probe earlier this week, understanding just how important it is for India to get the upcoming budget bill through parliament:
“We can ill afford the situation that our parliament is not allowed to function during the critical budget session… It is in these special circumstances that our government agrees to setting up a joint parliamentary committee.”
-Indian Prime Minister Manmohan Singh, Feb. 22, 211
Special circumstances indeed... We’ll continue to monitor this situation closely, as the current demonstrations have the potential to go from “warm” to “very hot” in a heartbeat.
KOREA: Dry Ice Hot
In what is likely the wackiest news of the week, it appears South Korea is stirring the pot of its northern neighbor, attempting to incite a Jasmine Revolution-style uprising designed to overthrow the Kim regime. Its military has dropped over three million leaflets containing information regarding the pro-democracy revolts in the MENA. In addition to the leaflets, the South is also flying in rice, clothing, medicine, and working radios (with the intention of keeping them up to speed on the uprisings).
While the South Korean military declined to comment, other officials did chime in with clues as to where this may potentially be headed:
“North Korean people’s protests may also be able to bring a change to the regime… South Korea’s military and government should also be ready for any revolt inside North Korea.”
-Song Yong Sun, Member of the National Assembly’s Defense Committee
While it’s too early to tell if this latest attempt at psychological warfare will successfully incite a massive uprising in North Korea, we do believe it is of upmost importance to keep this risk on your radar. As we saw last year with the North’s sinking of the South’s naval warship Cheonan in March and its November shelling of Yeonpyeong, tensions can heat up on this peninsula in a real hurry. And perhaps more so than Libya or Egypt, any real outbreak here brings with it a great deal of global geopolitical risk, as the US and Japan remain firmly behind South Korea and China (albeit less firmly) stands behind the North.
Let us not forget that a) North and South Korea are still technically at war (and have been since 1950); and b) nuclear weapons (or merely talk of nuclear weapons) have the potential to be a factor here.
While it’s much, much too early to even assign the slightest thousandth of a percent to the probability that a nuclear conflict ensues here, we do think it’s important to keep the Korean peninsula on your screens as a place where significant geopolitical risk could erupt rather quickly.
In preparation for ISLE's FY3Q11 earnings release Monday, we’ve put together the pertinent forward looking commentary from ISLE’s FY2Q11 earnings call.
This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.
POSITION: no position in SPY
“A hard fall means a high bounce... if you're made of the right material.”
There be bulls in these parts. This bounce is made of what’s made the last 2.5 months so bullish – higher prices.
But make no mistake, these be lower-highs – both on a long-term TAIL and immediate-term TRADE basis. And while an immediate-term breakout above the 1308 line of resistance was proactively predictable, we don’t want to mistake today’s low-volume bounce for something that we should chase. A close above my refreshed immediate-term TRADE line of resistance of 1325 would change that, potentially.
Here are a few other things to think about in the immediate-term:
No one said hard falls can’t be proactively prepared for (last Friday I had 14 LONGS and 15 SHORTS). No one said you should short-and-hold after hard falls either (this Friday I have 14 LONGS and 7 SHORTS). I’m just saying that the best strategy from here is to keep managing your gross and net exposures aggressively as Big Government Intervention perpetuates price volatility.
Keith R. McCullough
Chief Executive Officer
Caesar's reported a 5.1% YoY increase in Adjusted EBITDA; however, excluding the $23.5MM property tax accrual included in the IL/IN region, Adjusted EBITDA actually declined 1.7% YoY.
HIGHLIGHTS FROM THE RELEASE
CONF CALL NOTES
Position: We are long oil via the etf OIL
Conclusion: We are long OIL in the Virtual Portfolio as price continues to confirm this position, but longer term, as history shows us, political liberalization could actually support growing production.
The price of oil is already indicating to us that the current turmoil in the Middle East will not be resolved in the short term. Since tensions heightened in Libya over the past week, the prices of most major grades of oil are up roughly $10 per barrel in just a couple of days. Today oil is flat after a volatile day of trading motivated by rumors surrounding the demise of Moammar Gadhafi.
Further to this point, we’ve outlined in a chart below the highest closing price in February going back the last 15-years. Typically, February would be a relatively slower seasonal month for demand in the United States (the world’s largest consumer) as the need for winter heating oil diminishes and summer driving season hasn’t picked up. Interestingly, while the price of oil is still more than $40 from its all time high, it is very close to highest February close of $101.78 in February 2008. This abnormal and non-seasonal price movement emphasizes the powerful price move we are seeing.
On February 16th, we called out this potential impact of popular unrest in Libya and Iran in a note that underscored our long position when we wrote:
“We are starting to see Egyptian and Tunisian type popular tensions spread to some key oil producing states, which should provide a key support under the commodity. Specifically, both Iran and Libya have seen an increase in protests. This is relevant because, based on the most recent data, Iran is the second largest producer of crude oil in OPEC, at 3.7MM barrels of oil per day, and Libya is a sizeable producer as well at 1.6MM barrels of oil per day.”
Given that Libya is less than two percent of global production and that the IEA has over 1.6BN barrels of oil in storage, clearly the current price movement is about more than Libyan disruption. Even if Libyan oil production were completely turned off, the IEA has enough oil in storage to offset that lack of production decline for a full year. Further, it is estimated that OPEC collectively has between 4 – 6MM spare barrels of daily production. So, why has oil gone parabolic over the past couple days? Simply put: oil is now trading on fear.
In effect, this is fear that popular upheaval goes well beyond Libya and into more significant producers in the Middle East (like Iran) and that the ultimate outcome is a transition in government, or armed conflict, that leads to a broad decline in oil production. An associated fear is that OPEC ultimately doesn’t have the spare capacity they claim, which could lead to a global oil supply tightening quicker than most expect. Ultimately, this fear will continue to buoy and lead the world oil markets until we have some resolution or clarity in the Middle East, which certainly does not seem imminent.
Longer term there is a scenario, which certainly isn’t consensus on a week like this, that vast liberalization and democratization in the Middle East could be positive for oil production. Russia is probably the prime example of this occurring.
In the late 1980s, Russian oil production reached a peak of production of 12.5MM barrels of production per day. Due to a decline of investment during the Soviet era, Russian oil production gradually fell thereafter and had fallen to around 6MM barrels per day by the mid-90s. The collapse of the Soviet Union combined with a privatization of the oil fields initiated a turnaround in production starting in 1999. Currently, Russia is back to near peak production levels due to privatization and subsequent modernization of her oil assets.
Iraq looks to be on a very similar path to that of Russia. Not surprisingly, with the Iraq War and the ensuing chaos following the removal of Saddam Hussein from power, Iraq oil production fell dramatically and was mired in the 1.5MM barrels per day level of production until early 2007. By then, post Saddam Hussein modernization and investment started to pay off and Iraqi oil production began to climb. In January of this year, Iraqi oil production hit a post war peak in production of ~2.6MM barrels per day and is expected to be near 3MM barrels per day by year end, a level not seen since the late 1970s. In fact, as reported late last year in the Wall Street Journal, some Iraqis believe that growth in production could be meaningful in the coming decade:
“In all, Iraq hopes the work will boost output capacity from the current 2.5 million barrels a day to 12 million barrels a day in less than a decade. That would be a feat unrivaled in the history of the modern oil era. Last month, Fatih Birol, the International Energy Agency's chief economist, called Iraq a potential "game changer" for global oil markets.”
In fact, Royal Dutch Shell, who was awarded one of the Iraqi contracts last year, recently upped its Iraqi production from the Majnoon field from 45,000 barrels per day to 70,000 barrels per day. A small change, but incremental.
No doubt this is a long tail type scenario, and a lot would have to happen for Western Oil companies to up investment in less stable regions like Iran and Libya, but both Iraq and Russia do provide some credence to the idea that production, over the longer term, could grow if the ultimately outcome is the spread of democracy and rule of law.
Daryl G. Jones
Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.