Oil Price Volatility Isn’t Transitory

For those that are long of commodities, in particular oil, the last 5 trading days have been unpleasant.   Unfortunately, we are in that camp as we are long of oil in the Virtual Portfolio via the etf OIL, and are currently down -3.7% in the position.  As we noted on our morning call today, we will stick with our long oil position to a price and that price is our TREND line of support on WTI of $98.63 per barrel.  Our current levels for oil are highlighted in the chart below.


Oil Price Volatility Isn’t Transitory - 1


While price has obviously corrected, which is an important factor in our models, there has only been a marginal shift in our other key factors of geopolitics, supply / demand, and monetary policy.


As it relates to geopolitics, the significant event over the last week was the killing of al-Qaeda leader Osama bin Laden.   While the longer term implications of this event are still being analyzed, broadly across the Middle East social unrest continues to percolate and with it the intermediate future of stability in the Middle East remains largely uncertain. A few points to highlight:

  • Protests continue across Syria, which are being aggressively cracked down on by the government. U.S. Secretary of State Clinton also gave her support for EU Sanctions against Syria this week;
  • Foreign Ministers are meeting in Rome to discuss continued plans to fund Libyan rebels.  In addition, both Britain and France have expelled Libyan diplomats.  The International Criminal Court is also reputed to be in the process of issuing warrants for the arrest of Gaddafi;
  • Hundreds of thousands took to the streets in Yemen to protest against Yemeni president Saleh, who called the protesters “outlaws”; and
  • In Bahrain, four anti-government protestors were sentenced to death.

From a supply and demand perspective, the deluge of negative economic data points (employment, ISM and housing prices) from the United States continues to support what our models had already indicated, which is that growth is slowing domestically.  The United States is the largest consumer of oil globally, so as domestic growth in the United States slows, so too does its consumption of oil.  By way of a proxy, in 2009 U.S. oil consumption declined 4.9% year-over-year, while global consumption was down 1.7% year-over-year.  This highlights the potential impact of a slowing global economy on oil demand.


In terms of the direction of global growth, we continue to get mixed signals.  The market-oriented proxy of growth is the Baltic Dry Index, which implies that we are setting up for a sequential slowdown in global growth on the back of tightening global monetary policy due to inflation concerns.  In the chart below, we’ve highlighted the 1-year plot of the Baltic Dry Index, which is down 64% year-over-year and 26% year-to-date.  This is not a reassuring picture as it relates to future economic growth.


Oil Price Volatility Isn’t Transitory - 2


That said, based on our modeling, the key driver of the price of oil continues to be the price of the U.S. dollar.   Over the past three months, the correlation of the U.S. dollar to WTI is -0.89.  Dollar down equals oil up, or, as we saw this week, just the opposite with the dollar rallying against global currencies and commodities correcting sharply.  On the back of the ECB not raising rates this week and appearing incrementally dovish, the U.S. dollar rallied +2.9% versus the Euro this week from trough to peak.  Over roughly the same time frame, WTI declined -8.4%.


Oil Price Volatility Isn’t Transitory - 3


Currently, based on slowing growth and the rally in the U.S. Dollar, we are seeing a Deflation of the Inflation, but interestingly the tepid economic news could actually lead to every inflation investor’s dream . . . Quantitative Easing 3.   With continued printing of money via debt monetization, the inflation trade should continue . . . until it doesn’t.


Daryl G. Jones

Managing Director

Europe’s Eye on Inflation

Position: Long British Pound (FXB)


Conclusion: We continue to flag our concurrent call of Inflation Accelerating with Growth Slowing across global economies. The UK remains one economy mired in this trend, with elevated levels of inflation persisting and choking off growth. Today’s UK Producer Price Index for April shows an upward acceleration in Input costs to 17.6% Y/Y (versus 14.8% in March) and Output prices slowed 30bps to 5.3% Y/Y versus the previous month. In total, we continue to note that increasing input costs should weigh to the upside on output costs, and therefore continue to hamper consumer spending, confidence, and ultimately growth.  We expect UK headline inflation, currently at 4.0% in March Y/Y, to accelerate over 2011 as we expect commodity prices to remain elevated over the medium term and due to the effect of “imported inflation”, or the impact of the weakness in the GBP-EUR over the last three years to heighten inflation pressures, especially considering that the UK imports roughly 50% of its goods from the Eurozone.


With no great surprise, energy and food prices were the largest inflationary components contributing to gains in input and output prices. Input crude oil gained 37.7% in April versus the 12 months ago period, and home food materials increased 15.4%.  Output prices saw the largest gain from petroleum products (up 14.9% in April Y/Y) and food products gained 7.3%. Notably, output tobacco and alcohol prices rose 5.5% Y/Y on increased tax from the government’s budget.


Europe’s Eye on Inflation - uk1


Both the ECB and BoE held benchmark interest rates unchanged on Thursday despite existing inflationary pressures (Eurozone CPI = 2.7% in March Y/Y). While we’ll have to wait for the BoE Minutes for more insight on the bank’s thinking, we remain of the camp that a hike of 25bps is prudent.  Trichet’s language in the press conference following the announcement was measured, indicating that monetary policy is “still accommodative” in an environment where there is “upward pressure on overall inflation, mainly owning to energy and commodity prices”. The market largely interpreted these statement as “dovish” for a hike next month in that he did not reiterate such phrases as “strong vigilance” or “prepared to act in a firm and timely manner”.


We’ve seen follow-through selling of the EUR-USD after yesterday’s announcement. In reality, the EUR-USD rose very expediently to just under $1.49 this week and was clearly disconnected with underlying fundamentals. We see immediate term support in the EUR-USD around $1.44, with upside resistance at $1.47, and expect this trade to be volatile given persistent weakness in the USD (despite a bounce yesterday) and uncertainty surrounding the sovereign debt contagion across Europe's periphery. 


With the unwind of the huge correlation trade to commodities this week, notably Russia’s equity market (RTSI) fell 4.4% week-over-week and Norway’s market declined 3.4%, as Greece blew up (down 4.5% w/w) on debt restructuring fears, we continue to like Germany (via the eft EWG), due to its fiscal sobriety and continued strong fundamental performance. Year-to-date the DAX is up 8.3%, within the top 10 performing global equity markets ytd. Below we highlight our support levels for the DAX. On strength, we’d short Italy (EWI) or Spain (EWP).


Europe’s Eye on Inflation - uk2


Matthew Hedrick



Data from the BLS today a positive data point for restaurants. 


April employment data was released today by the Bureau of Labor Statistics.  As our Healthcare team pointed out this morning in their daily Healthcaster piece, the employment recovery “continues to be a barbell recovery with younger demographics, who don’t consume much healthcare, and older workers.”  The 20-24 years-of-age and the 55 years-and-higher age cohorts continue to gain while the 34-54 years-of age cohort continues to slide.  For restaurants, the recovering in employment levels among younger people is a positive for quick service restaurants, as I have written over the last number of months in these updates.  Interestingly, looking at employment trends in the full-service and limited-service sub-sectors of the food service industry also strikes a positive tone for the industry. 





I am aware that many big corporations, as the saying goes, hire at the top and fire at the bottom.  However, as long as the employment growth in the younger age cohort continues to trend in the right direction, employment will continue to be a positive driver for QSR.  The chart below also shows a sustained growth, since early 2009, in hiring by full-service restaurants.  For eating out, as a whole, it is important to pay attention to the soft employment trends in the 34-54 years-of-age bracket.  This is an important group for restaurants and the continued slide in employment levels is a negative for casual dining.





Howard Penney

Managing Director

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.52%
  • SHORT SIGNALS 78.67%


Notable news items and price action from the past twenty-fours along with our fundamental view on select names.

  • DPZ gained 10% yesterday on accelerating volume after posting better-than-expected earnings. 
  • TXRH gained 5.3% on accelerating volume.  I have a negative fundamental view of this stock and, over the past few months, the stock has underperformed many of its peers.
  • CAKE also gained on accelerating volume and my view of this stock is also negative.  This company is one that I believe is guiding below where inflation will ultimately be for their commodity basket this year.
  • CPKI reported earnings last night; EPS came in at $0.09 versus consensus of $0.06 but comparable restaurant sales came in at -2.1% versus consensus -1.4%.  2Q guidance is for EPS $0.20-0.21 and comparable restaurant sales flat-to-positive 1%.  Inflation guidance was raised from 2.5% for FY11 to 3% (which I still think is low).
  • GMCR announced the pricing of its common stock offering of an aggregate of 8,189,544 shares of its common stock at a price to the public of $71/share.
  • BWLD gained on accelerating volume. 
  • BAGL gained on accelerating volume and the company posted weaker-than-expected earnings after the close last night.
  • CBOU gained on accelerating volume and posted earnings above consensus with the benefit of a one-time tax benefit.
  • SBUX is hosting a half-price Frappuccino happy hour today.  Frappuccino Happy Hour will be held daily through Sunday, May 15.
  • SBUX featured in the “Heard on the Street” column in the Wall Street Journal yesterday.  The column detailed that SBUX is trading at 25x FY11 EPS and may be rich with coffee prices more than doubling in the last year. 




Howard Penney

Managing Director


This note was originally published at 8am on May 03, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“I feel dirty making money on the long side in this market”

-A Hedgeye Client that has been successfully making money on the long side


This quote comes from a client of hedgeye, who just happens to work for one of the largest “long only” money managers on the planet.  Why does he feel dirty?  He’s probably shares many of the same views that David Einhorn has had as he’s been covering his shorts.  The music is playing and the kids are Dirty Dancing.  The Chuck Prince of 2007 would approve. The grownups, however, do not.


David Einhorn had this to say, in the Greenlight capital Q1 Shareholder Letter: “The broad market, which shrugged off the continued escalation of commodity prices, unrest in the Middle East, a catastrophe in Japan, tightening monetary policy outside the United States and a deceleration of domestic economic growth...this quarter we were repeatedly confuzzled when we read company news announcements that we expected to cause falling stock prices, only to see them rise instead – and sometimes sharply at that.  Nonetheless, we believe that this environment is cyclical, and that it will continue this way... until it doesn’t.”   


Einhorn likens the market today to Charlie Sheen, believing that “all publicity is good publicity”.  Einhorn’s past record and thorough thought process that comes through in his writing are both impressive.  He is no Bud Fox; he understands the danger of investor psychology and groupthink.  Nevertheless, he is not confident that his firm can call the turn so he has been covering. 


Both Einhorn and the Hedgeye Client quoted at the beginning of this Early Look are thoughtful market operators that have generated alpha in different market cycles across sectors and geographies.  Clearly by the sentiments they are expressing, they are alerting us to a real problem that exists in money management at this point in equity markets.  Capital has been pumped into the system through two rounds of quantitative easing and PM’s that want to get paid will chase yield with that capital.  The stock market rally has been self-sustaining in that regard; a rising stock market does improve consumer confidence among higher income brackets.  However, the reception of all news as good news is disturbing to say the least.  As the multitude of interconnected global macro factors continue to change in real-time, the government is handcuffed with sky-high debt, zero percent interest rates, and slowing economic growth.


The pension fund community, too, has been dragged into this game of pass-the-grenade.  “Assumed” rates of return are to be hit lest the funds face a significant shortfall on their obligations.  Given the fear of inflation that has rightly taken hold, pension funds cannot look to bonds for the required 7-8% returns with interest rates at 0%.  Rather, pension fund managers are chasing yield right at the top of the cycle.  In fact, I would argue – although Keith may not agree (so this is not the official Hedgeye view) – that the cycle has already topped. 


Jobless claims have given back all of the progress that was made from January 2010 onward.  GDP slowed sequentially and sell-side expectations for GDP growth are coming back down to earth.   What’s more, Fed-sponsored inflation and price instability is the ultimate kryptonite for the economy as we head into 2H11. 


Osama bin Laden’s death is a great victory for the U.S. Military and the American people, but it is important to keep that in context from a market perspective.  Many market pendants are trying to spin this as a positive for the consumer and thus the overall market.  While it may have been yesterday, for a time, consider the day-to-day realities facing Americans.  Sky high gas prices, food costs, clothing costs, healthcare costs and declining purchasing power are a constant reminder to consumers of the fragility of the economy. 


Even if Bin Laden’s death is to have a long-lasting impact on markets, it may be a negative one if any retaliation or escalation of extremist terrorist activity causes an increase in the global risk premium and the cost of oil.  In fact, a poll conducted yesterday indicated that, of just under 10,000 respondents, 72% of people responded “No” when asked if they felt safer now that U.S. forces have killed Bin Laden.


The Dirty Dancers out there are counting their blessings that the market, perched on a precipice, is still on two feet thanks to the maintenance of the status quo.  Quantitative Easing sponsors bubbles and I believe that while earnings have been strong of late, many markets are taking on more and more of the characteristics of a bubble.  Dr. Rich Peterson uses three main parameters to describe a bubble.  First, it’s a great story.  Secondly, it has unlimited upside and finally, it is confirmed by higher prices.  An asset class that is exhibiting these characteristics is difficult to resist.  Pension fund managers and hedge fund managers alike are following market momentum as their performance targets require them to.


All the while, great stories are being told as to why the market should keep going up.  Inflation is “transitory”.  Japan’s catastrophe is not a big deal.  Oil prices are still not high enough to impact the consumer, according to some.  At the end of the day, all of these stories are supportive of higher equity prices.


How will it end?  This debate begins on the topic of debt and deficits.  Hedgeye believes that a country’s currency is a prescient indicator of its underlying economic health and we view the USD crashing as a bearish indicator, just as it was in 2008.  Warren Buffett’s recent quote on the impossibility of a U.S. debt crisis of any kind “as long as we keep issuing our notes in our own currency” is based on several obvious assumptions that neither Mr. Buffett nor anyone in the investment or bureaucratic community can be certain of.  The unexpected is unexpected for a reason.  That the political make-up of Washington D.C. will allow the federal government to continue on this road or to involve itself with the States’ debt issues remains to be seen.  


Part of the timeline of the USD Currency Crash call we’ve been making has been this literal moving target on the debt ceiling limit.  It was only three weeks ago that Secretary Geithner was doing some Dirty Dancing of his own, drawing a firm line in the sand that May 16th was the debt ceiling debate’s date with destiny.  Now, after 1Q11 GDP growth sequentially slowed and the dollar maintained its downward trajectory, Geithner has decided to join the festivities by pushing out the deadline to July 8th as of a few weeks back and now to August 2nd as of yesterday. “Extend and pretend” is a phrase that comes to mind.


In my view, the bottom line is this; there are some terrific story-tellers out there.  Whether it’s today on Osama bin Laden’s death being bullish for confidence but not for oil, that the global currency market will tolerate this crashing of the global reserve currency, or Secretary Geithner procrastinating in the hope that the market will give the dollar a bid, story-tellers abound.     


Lastly, this weekend I went shopping with my daughter for her prom dress.  After trying on at least thirty different dresses, the first twenty-nine were not good enough, she found the right one.  She has assured me that there will be no Dirty Dancing at the prom.


Function in Disaster; finish in style,


Howard Penney


DIRTY DANCING - Chart of the Day


DIRTY DANCING - Virtual Portfolio

Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.