Paying The Price

This note was originally published at 8am on March 07, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“For every promise, there is a price to pay.”

-Jim Rohn


Paying The Price is what hard working Americans do every morning. They take responsibility for their families. They are accountable for their actions. They’ll also be paying for their government’s promises at the pump this morning.


If you didn’t know that The Inflation is what you get when your government promises the entire world to devalue its currency, now you know. In order to calculate the price of The Petro-Dollars look no further than the price of The Petro and the price of The Dollar.


Here’s what those two prices did last week:

  1. The Petro = UP another 6.7% week-over-week taking its 2-week move to +17.6%
  2. The US Dollar = DOWN another -1.1% week-over-week hitting new YTD lows (DOWN 8 of the last 10 weeks)

Now someone who is in the business of obfuscating the facts will tell you that the price of The Petro-Dollars raging to the upside has to do with something other than the debauchery of the dollar. Of course it does – everything that adversely affects the marketing message of Washington, DC must have to do with someone else – that’s the un-American way.


Pointing the finger at some nut-job wearing shades in Libya just makes the marketing message easier. Since speaking at the American public on economic matters has turned into a world class game of politics, we should expect nothing less. On NBC’s Meet The Press yesterday, President Obama’s newly minted Chief of Storytelling, Bill Daley, reminded the world how Washington’s finest think about risk management plainly:


“Most people don’t know what they are talking about… The President knows…”


OK. Thanks Chief.


We will un-humbly submit that, on Global Macro economic matters, US Presidents and their crony economic advisors haven’t known what they don’t know for at least a decade. That’s a long time. That’s a problem.


Back to those stubborn little critters called real-time market prices that we use to illustrate the problem, here’s what else happened in the US as a result of the US Dollar being devalued last week:

  1. CRB Commodities Index (19 components) = +3.1% week-over-week to close at a fresh weekly closing high for 2011 of 362
  2. Price Volatility (VIX Index) = flat week-over-week, holding its +22% gain above its February 18th YTD low of 15.59
  3. US Stocks (SP500) = +0.15% week-over-week to close at 1321, -1.7% lower than its YTD closing high of 1343 (also established on FEB18)

Altogether what this means is that since the US stock market stopped making higher intermediate-term highs on February 18th, the market has started to price in Slowing US Growth assumptions as US Inflation Accelerates.


For readers of our work, this shouldn’t be a new theme. Our 3 core Macro Themes at Hedgeye have been calling for Global Growth Slowing as Global Inflation Accelerates since October of 2010.


Our call on Accelerating Global Inflation’s impact on both Emerging Markets and Bonds is best captured by the #1 Economics headline on Bloomberg this morning: “Global Bond Rout Resembling 1994 As Inflation Exceeds Rates” – so, globally, people get it. The question is what will it take for US stock-centric consensus to finally get it?


Don’t fool yourself by letting some of the Fed’s Fiats fool the media most of the time, whether you look at the stock market performance divergences in US Equities or abroad, Mr. Macro Market is pricing in Global Inflation Accelerating, big time.


US S&P Sector Performance divergences for 2011 YTD:

  1. Best Sector = Energy (XLE) +14.78%
  2. Worst Sector = Consumer Staples (XLP) +0.92%

Global Equity Market Performance divergences for 2011 YTD:

  1. Best Countries = Ukraine +14.3%, Russia +13.8%, and Greece +12.2%
  2. Worst Countries = Tunisia -22.7%, Saudi Arabia -19.6%, and Dubai -17.1%

Obviously when presented with these prices on a real-time basis, the fundamental takeaways are crystal clear:

  1. Countries, Sectors, and Companies that get paid in The Petro-Dollars are getting paid by The Inflation
  2. Countries, Sectors, and Companies that don’t have pricing power are taking it in the margin
  3. Citizens are getting plugged

If this continues, the global economic risk management scenario starts to look a lot more like the 1970s than it does anything that most investors have had to wrestle with for the last 30 years. Stocks aren’t in the area code of “cheap” if inflation finds its way into margin and multiple compression.


The best way to fight this is by breaking the gigantic promise that America has made to the world – cheap moneys forever. If we start promising the world more hawkish monetary policy, the US Dollar will stop being debauched. That, in turn, will deflate The Inflation. And I’ll be the first in line to start investing more of my 49% position in Cash (versus 58% on Monday of last week). Paying the lower price works for me.


My immediate-term support and resistance levels for the SP500 are now 1315 and 1333, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Paying The Price - ab1


Paying The Price - ab2


TODAY’S S&P 500 SET-UP - March 10, 2011

As I said in yesterday’s Early Look (Under Attack), the rose-tinted view that has driven the S&P to current levels, up 4.96% year-to-date, is becoming more and more difficult to justify.  As we look at today’s set up for the S&P 500, the range is 32 points or -1.37% downside to 1302 and 1.06% upside to 1334.



  • 8:30 a.m.: Jobless claims, est. 376k, prior 386k
  • 8:30 a.m.: Trade balance, est. (-$41.5b), prior (-$40.6b)
  • 9 a.m.: Fed’s consumer advisory council hosts meeting
  • 9:45 a.m.: Bloomberg consumer confort index, prior (-39.3)
  • 10 a.m.: Freddie Mac 30-year mortgage
  • 10:30 a.m.: EIA Natural Gas storage
  • 1 p.m.: $13b 30-year bond reopening
  • 2 p.m.: Monthly budget statement   


  • NATO defense ministers scheduled to meet in Brussels today and tomorrow to discuss, possibly decide on alliance involvement in Libya 
  • Ontario Securities Commission Chairman Howard Wetston scheduled to speak in hearing to review proposed sale of TMX Group to LSE
  • Japan’s Tokyo Stock Exchange Group plans to hold merger discussions with Osaka Securities Exchange
  • Galleon Group founder Raj Rajaratnam’s insider trading trial continue.
  • President Obama is seeking to reshape federal government; plan may include folding U.S. Trade Representative’s office into Commerce Department
  • Spain’s credit rating cut one level to Aa2 by Moody’s on bank bailout costs 
  • Barclays, Deutsche Bank, JPMorgan Chase, Wells Fargo said to host lender meeting to discuss Jarden debt refinancing   


For the second day we have 5 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.  The four sectors that are positive on both TRADE and TREND are XLY, XLP, XLE and XLE.

  • One day: Dow (0.01%), S&P (0.14%), Nasdaq (0.51%), Russell 2000 (0.42%)
  • Month-to-date: Dow (0.11%), S&P (0.54%), Nasdaq (1.10%), Russell (0.27%)
  • Quarter/Year-to-date: Dow +5.49%, S&P +4.96%, Nasdaq +3.73%, Russell +4.79%
  • Sector Performance: - Materials (1.62%), Energy (0.69%), Tech (0.41%), Industrials (0.22%), Financials (0.1%), Healthcare +0.15%, Consumer Disc +0.23%, Consumer Spls +0.5%, Utilities +1.1%


  • ADVANCE/DECLINE LINE: -152 (-1710)  
  • VOLUME: NYSE 871.20 (-13.11%)
  • VIX:  20.22 +2.02% YTD PERFORMANCE: +13.92%
  • SPX PUT/CALL RATIO: 2.27 from 1.55 (+46.34%)


Treasuries were stronger yesterday on Libya concerns and a better 10-year note auction.

  • TED SPREAD: 22.23 +0.406 (1.860%)
  • 3-MONTH T-BILL YIELD: 0.10% -0.01%
  • 10-Year: 3.48 from 3.56
  • YIELD CURVE: 2.78 from 2.83


  • CRB: 360.23 -0.24% YTD: +8.24%  
  • Oil: 104.38 +0.61%; YTD: +12.09% (trading -0.30% in the AM)
  • COPPER: 421.25 -2.90%; YTD: -5.95% (trading -0.77% in the AM)  
  • GOLD: 1,429.60 +0.12%; YTD: +0.42% (trading +0.40% in the AM)  


  • Oil fell for a second day in New York after supplies surged at Cushing, Oklahoma, the delivery point for West Texas Intermediate, the U.S. benchmark grade. 
  • Gasoline inventories tumbled 5.94 million barrels to 229.2 million, the biggest decline since September 2008, according to the department. Stockpiles were forecast to drop 1.5 million barrels. Supplies of distillate fuel, a category that includes heating oil and diesel, fell 3.98 million barrels to 155.2 million, the lowest level since June. 
  • Gold and silver rose for the third time in four sessions as mounting tension in Libya and higher energy costs boosted demand for precious metals as an investment haven and an inflation hedge.
  • Copper futures fell to the lowest in more than two months on concern that demand will wane as higher energy costs slow the global economy.  Copper stockpiles monitored by the London Metal Exchange have jumped 22 percent from last year’s low on Dec. 10.
  • Arabica coffee extended a rally to the highest price since May 1997 on speculation that global supplies won’t satisfy demand.
  • The U.S. cattle herd is the smallest since 1958 as beef exports surged 19 percent in 2010 to about 2.3 billion pounds (1.04 million metric tons), according to the U.S. Department of Agriculture. Cattle prices have jumped 27 percent in the past year, fueled by a global economic recovery that is boosting meat demand in emerging economies, including China.
  • PepsiCo Inc. is raising prices for its Tropicana juice line by as much as 8% after record cold temperatures slashed this season's orange crop, the company said.


  • EURO: 1.3900 +0.06% (trading -0.40% in the AM)
  • DOLLAR: 76.721 -0.10% (trading +0.36% in the AM) 


  • FTSE 100: (0.93%); DAX (0.76%); CAC 40 (0.64%)
  • Major indices are lower as fighting continues in Libya and Moody's downgrade of Spain's sovereign debt rating one notch to Aa2 from Aa1.
  • Moody's said it expects Spain's bank restructuring will cost more than the government currently expects, "leading to a further increase in the public-debt ratio."
  • Bank of England keeps asset plan and interest rates steady.


  • Nikkei (1.47%); Hang Seng (0.82%); Shanghai Composite (1.51%)
  • Regional indices followed Wall Street and closed lower on concerns about Libya, with the situation exacerbated by disappointing macroeconomic data.
  • Japan fell on futures selling spurred by higher oil prices.  Japan was led lower by weaker exporters as the yen rose.
  • Seoul rose after the Bank of Korea raised interest rates by 25bps to 3%.
  • Property developer’s dragged Hong Kong lower.
  • Weak financials weighed on the Shanghai Composite.
  • Japan Feb domestic CGPI +1.7% y/y vs cons +1.8%. Q4 revised real annualized GDP (1.3%) vs prelim (1.1%)
  • China Feb trade balance ($7.3B) vs cons $3.9B
  • Australia down 1.43% February unemployment 5.0%, net job creation (10,100) vs cons +20K

 Howard Penney

Managing Director




Nothing unexpected. BYI reiterates opportunities for systems business.



  • Canada: BYI currently undergoing consulting process regarding slot implementation
  • $3MM upfront investment in Sightline
  • Pechanga now has 1200 iViews on their floor.
  • Last few years, operators have been focused on development and is now deleveraging/ fixing cost structure and less on gaming technology
  • Next step is to send marketing offers to mobile devices; thinks it's a big opportunity
  • iView penetrated 40% of slots connected to their system without any content
  • Average size of installs has declined as they are getting into smaller casinos with sds windows.
  • 50/50 growth in domestic/international footprint
  • Service revenues have increased from $3MM to $6MM per quarter--upgrades/add ons, etc. As they penetrate smaller casinos - which have smaller IT departments, they require more outsourcing of services.
    • Wants Software to Services revenue ratio to be 1:1
  • 386,000 units that are still not serviced by an iView. Have 160k iViews installed today vs 120k in FY08. BYI has 420k slots connected to their network. Not only can they upgrade their iViews to DM but they can also start putting apps on those units, which BYI believes is a $1BN revenue opportunity.
  • Additional opportunities include:
    • If BYI can capture 30% of their domestic competitor biz, they can add 120k slots to their system, which would equate to a $420MM opportunity.
    • If BYI can capture 50% share of the new casinos, then BYI can add 70K slots, representing a $245MM opportunity.
  • All-in, they think they have a $1.8BN addressable opportunity in systems.

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Conclusion: We remain bullish on corn for the intermediate-term TREND duration as the confluence of perpetuating inflation, spiraling demand, and supply shortage indicate that corn prices will continue to rise.


Position: Long corn via the etf CORN


We added our on and off again long position in corn yesterday via the etf CORN in the Hedgeye Virtual Portfolio. As a reminder, we have been bullish on corn on an intermediate-term TREND basis since August of last year, when we initiated our first long position at $26.27. With the US dollar making lower lows, it is necessary to point out that corn has a -0.52 correlation to the US Dollar over the last three weeks. As a food crop with inverse correlation to a sinking US Dollar, investors would be remiss not to notice that inflation is present and will persist. Corn futures are up +10.8% YTD and up +67.9% over the last twelve months.


According to the United Nations Food & Agriculture Organization, record food prices will be sustained this year due to high oil prices and smaller crops. Corn is facing a serious supply shortage in the year 2010-2011 as corn output is estimated at 814.3 million tons while corn demand will flirt with 836 million tons. Looking thoroughly at supply and demand fundamentals, we have good reason to be bullish on corn. Here’s why:


On the supply side, corn is facing a shortage as climate change and natural disasters have decreased production. Moreover, cold weather continues to delay planting in the world’s largest supplying country. The US harvest represents nearly 55% of world exports and 39% of the global corn output in the 2010-2011 year. Unfortunately, the US has a lot of uncertainty surrounding its corn output due mainly to a legitimate concern that La Nina is forecast to cause heavy rainfall in the northern US plains as well as Canadian prairies. Though La Nina is expected to strike in the US, you can bet your buck on it that this will threaten the global harvest of corn and result in tightening global supplies. It is certainly a stark reality that the US could see a third yearly deficit for corn.


Despite the potential decrease in the global supply of corn, the demand for the crop continues to trend higher. When the US Department of Agriculture reports tomorrow, we expect to see a reduction in their estimates for the world stockpile, as demand increases in part due to the recent political turmoil in North Africa and the Middle East. Rising demand is corroding US corn stocks and a recent surge in ethanol demand—due to runaway crude oil prices—isn’t quite helping. Dating back to January, the Environmental Protection Agency agreed to let refiners increase their corn-based fuel additive in gasoline from 10% up to 15% for automobiles made in 2001 or later. Ethanol continues to eat away at the US supply of corn. According to a Feb. 9th USDA estimate, approximately 43% (4.95B out of the 11.6B bushels) of corn demand in the US is for ethanol use. With rising demand and an insufficient corn supply, there is plenty reason to be bullish on corn.


CORN was added into the portfolio at $42.74. From a quantitative setup, CORN is bullish on both a TRADE and TREND duration with no upside resistance, TRADE line support at $42.16, and TREND line support at $39.02.


Daryl G. Jones

Managing Director


CRAZY FOR CORN - corn fred


SAM is trading lower today on lower-than-expected FY11 earnings guidance.


On February 4th, we outlined our reasons for being cautious on the Boston Beer Company in 2011 in a post titled “SAM – HEADING FOR A HANGOVER.”  Specifically, we cited the potential for slowing top-line trends and rising costs.  Yesterday, SAM reported 4Q10 earnings of $0.87 per share, which fell short of the street’s $0.90 per share estimate.   Revenues came in light relative to consensus estimates with FY10 depletions up 11.5%, at the low end of management’s upwardly revised guidance range of +11-13% that was provided in December.  That being said, with depletions up 12% during the quarter, top-line trends continued to be solid and gross margins increased by more than 500 bps YOY.


Looking into 2011, the top-line comparisons will be difficult but the company guided to 9% depletion growth, which is slightly improved from its prior guidance of up mid-to-high single digits provided during its 3Q10 earnings release.  SAM maintained its FY11 gross margin guidance of 54-56% and stated, “From a cost perspective, I think we indicated the biggest cost exposure we have is energy, sort of linked to freight sort of outbound primarily, little bit of inbound.  I know there have been observations of cost increases on some of the agricultural materials that we use, but we were in actual [sic] good position when we made our arrangements for our 2011 purchases so we think we’re actually covered there in the guidance that we had given previously. So, that hasn’t really changed since we last gave that guidance. And on the other packaging material items, we haven’t seen too much movement and certain nothing that it would just put as noise at least to date.”


This current margin guidance continues to assume a 1% revenue per barrel increase which may not be easily passed on to consumers in light of the continuing tough economic environment and could put pressure on the company’s 9% depletion target.  Management alluded to the tough competitive environment in its comments yesterday, saying that it in 2011, “we expect to augment our sales force and brand support levels further to address the increasing competitive activity and to grow our brands appropriately given the opportunities we see. It is possible that these decisions might result in slower earnings growth in 2011, as we may forsake some earnings in the short term in order to build our organizational capabilities and support our brands at appropriate levels.” 


Specifically, the company is going to increase its investment in its brands by $12 to $18 million in 2011.  Although management had stated its intention to increase the level of investment behind its brands in 2011 prior to yesterday, they had not quantified the magnitude of the increase.  This is important because the company widened the range of its FY11 EPS guidance yesterday to $3.45 to $3.95 from its prior guidance of $3.95, which it provided in December.  Management stated that the new guidance reflects the negative impact of rolling out its new Freshest Beer Program, which it expects to reduce EPS by $0.20-$0.30 as it will cause core shipment growth to lag depletion growth during the year.  Although this was the only explanation provided by management, a $0.30 impact would imply a full-year earnings range of $3.65-$3.95, rather than the $3.45-$3.95 range provided.


Given that the full-year margin guidance did not change, which was surprising to me, management must think that shipments could actually lag depletions more than the initial 2%+ estimate as a result of the new Freshest Beer Program and is providing a cushion on the downside or the company increased its planned level of spending behind its brands in 2011 in order to defend its share position in what it expects will be an increasingly competitive market.  If the latter reason is correct, it puts the company’s 9% depletion target at risk, particularly when you combine that more competitive market with the company’s trying to pass on a 1% price increase.  Either way, shipment growth would be negatively impacted.


Howard Penney

Managing Director

Price Volatility: VIX Levels, Refreshed

I fundamentally believe that Big Government Intervention in our markets perpetuates the opposite of what the Big Central Planners at the Fed are marketing. This is not “price stability” – this is Price Volatility. And our industry is levering up (net leverage in the hedge fund industry hit its October 2007 high this month) on it again as it accelerates. That’s scary.


Obviously there was a 2008 market crash that Bernanke didn’t see coming, but his being ignorant of the risks embedded in fueling $150/oil with a US Dollar Debauchery policy doesn’t give him a hall pass on blaming the highest levels of price volatility that our markets have ever seen on the “market.” He is the market – at least in terms of establishing the cornerstones of rate cut and QE expectations.


Since the US stock market put in another lower long-term high at 1343 on February 18th (see the red circle in the chart below), volatility (VIX) is up +32%. That’s not price stability. That shows you what happens when the easy money music stops (fund flows into US, Japanese, and Western European equity markets peaked in the same week). And unless he opts for QG3 in May/June, it will stop.


One of the hallmarks of our risk management strategy is that real-time prices rule. Currently, we are seeing the confluence of a TREND line breakout in the VIX (> 17.88) and a TRADE line breakdown in the SP500 (1319). This continues to have me thinking that the SP500 is going to continue to make a series of lower immediate-term and long-term highs on rallies.


The VIX won’t be immediate-term TRADE overbought until it tests 21.70 again on the upside.



Keith R. McCullough
Chief Executive Officer


Price Volatility: VIX Levels, Refreshed - VIX

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