Selling Gold, But Just Like The Terminator : We’ll Be Back

Position: We sold our position in the Gold ETF (GLD) earlier today.


Earlier today, we sold our position in the Gold ETF (GLD) for a small loss of -3.6% in the Virtual Portfolio.  Obviously, it is never enjoyable to take a loss, but, as it relates to our decision making process, it is actually pretty simple: we change our views as our factors change. 


In the instance of gold, the inverse correlation with the U.S. dollar index has recently heightened (going from +0.08 on the 30-day duration to -0.45 on the 15-day duration) and our King Dollar thesis (bullish on the U.S. dollar) has not changed.  Thus, in the shorter term it seems dollar up is likely to mean gold down, which is obviously not good for the long gold position.


The key catalyst for us with this sale was the price of gold.  As outlined in the chart below, gold broke its TREND line of support at $1,724, which, according to our quantitative models, establishes the TAIL line of $1,559 as the next key line of support.


Longer term, the key reasons to own gold are in tact.  First, inflation from fiat currencies is still, and will likely remain, a key support for the price of gold, especially as the size and scale of European sovereign debt bailout increases.  Second, and as outlined in the chart below, when real interest rates are at, or below, zero, it provides a favorable backdrop for gold as investors search for return.  (Incidentally, we don’t see a meaningfully increase in U.S. rates at least while Bernanke is at the helm.)  Finally, gold continues to be a hedge for geopolitical risk, which is only accelerating in the Middle East due to concerns over the Iranian nuclear program and uncertainty over upcoming elections in Egypt.


Selling Gold, But Just Like The Terminator : We’ll Be Back - DJ 1


Unlike other asset classes, specifically bonds, real estate and equities, the challenge with gold is that it is difficult to value.  As outlined above, it is typically used as a hedge against certain macroeconomic environments. That said, in the charts below, we took a look at gold versus WTI oil and the U.S. housing market. 


On the first metric, gold can currently purchase ~17.3 barrels of oil.  This is just above the long run average going back to 1983 of 15.7 and well off the highs of early 2009 when one ounce of gold could buy 25.7 barrels of oil.  So, on this metric, gold is basically fairly priced, at least versus the last thirty years of data.


Selling Gold, But Just Like The Terminator : We’ll Be Back - DJ 2


On the second metric relating gold and U.S. home prices, the data suggests gold may be more extended on valuation.  Currently, a hundred ounces of gold will buy 1.06 houses in the U.S. based on the current median home prices.  Almost ten years ago, a hundred ounces of gold would buys less than 0.19 of a U.S. house.  This analysis, at least over the last decade, suggests that gold is at an elevated valuation.  Longer term, going back to 1963 as highlighted in the second chart below, gold has traded higher versus U.S. home prices, so it actually remains well off its highs. 


Selling Gold, But Just Like The Terminator : We’ll Be Back - DJ 3


Selling Gold, But Just Like The Terminator : We’ll Be Back - DJ 4


The key negative fundamental data point relating to gold is on the demand side of the equation.  According to the most recent data from World Gold Council, global demand for gold was 919.8 tonnes in Q2 2011.  This was down -17% on a volume basis from Q2 2010 and down -5% sequentially from Q1 2011. While the actual volumes were down, the dollar value actually increased year-over-year by 5% and sequentially by 2.8%.  The implication for the recent demand figure is that there is some elasticity in demand and price increases.


Even if demand is more tepid at higher prices of gold, as long as interest rates in the U.S. remain near all time lows and Keynesian policies remain intact globally, the bullish TAIL position in gold should hold.


Daryl G. Jones

Director of Research









Notes below from CEO Keith McCullough


Intraday yesterday I made the 4th“Short Covering Opportunity” call I’ve made since August 4th:

  1. OVERSOLD – is as oversold does. Yesterday’s SP500 immediate-term TRADE oversold line = 1187 and this morning’s math gets me 1186, so that’s the zone. Problem with that so far is that a 10-14 point bounce can’t get us back above 1203 (TREND line resistance)
  2. ASIA – better than bad is the best way to describe how Asian stocks traded after the European and US selloff. Again, immediate-term TRADE ranges are what they are – they always get overbought/oversold. India finally arrested its recent decline, +0.75%.
  3. GOLD – I’m long and wrong Gold here and do not like it having broke its intermediate-term TREND line of $1722/oz. Gold selling off like this has a lot more to do with liquidations in the hedge fund business than anything else. Performance is not good out there.

Growth Slowing in Asia and the US combined w/ European Stagflation remains our fundamental Global Macro view on the topline.





THE HBM: JACK, YUM, CBRL, MSSR - subsector fbr





JACK: Jack In The Box reported 4Q EPS of $0.49 versus consensus $0.41.  Company same-store sales at Jack in the Box restaurants gained 5.8% in the quarter versus consensus of 2.0%.  Qdoba system same-store sales came in at 3.7% versus consensus 4.1%.  Margins continue to improve.  Guidance for 1QFY12 same store sales indicates a high level of confidence in the top line.  Same-store sales are expected to increase approximately 4 to 5% at Jack in the Box (consensus +1.5%) and 2 to 3% at Qdoba system restaurants versus consensus of 2.7%.  Below is a chart of Jack in the Box company same-store sales including management’s guidance for 1Q12.  Commodity costs for the full year FY12 are expected to be up 5% on FY11.


THE HBM: JACK, YUM, CBRL, MSSR - jack pod1



YUM: Yum! Brands’ Taco Bell has cut 105 jobs across the nation and at its Irvine headquarters, according to media reports.  30 of those jobs were open and unfilled and 75 were layoffs. Taco Bell Chief Executive Greg Creed said that the structural changes being made were necessary to compete in an increasingly competitive marketplace.





CBRL: 1QFY12 EPS was reported at $1.03 versus Bloomberg consensus $1.05.  Comparable store restaurant and retail sales were down -1.6% and -1.3%, respectively.  The press release said that there was a sequential improvement in both metrics during the quarter. Food costs are expected to be up 5.5% to 6.5% versus FY11.


THE HBM: JACK, YUM, CBRL, MSSR - cbrl pod1



MSSR: McCormick and Schmick’s and Landry’s have announced that Landry’s tender offer to acquire all of the issued and outstanding shares of common stock of MSSR at $8.75 per share has commenced.


THE HBM: JACK, YUM, CBRL, MSSR - stocks 1122



Howard Penney

Managing Director


Rory Green



PSS: Cheap w/o a Catalyst


Uninspiring fundamental results the quarter after a significant shift in strategy (i.e. aggressive store closures) is enacted is to be largely expected, but the reality is that PSS’ stock remains a waiting game for investors. We still think the break-up value is ~20%+ higher, but with the company under strategic review we need to have better confidence in a sale either in part or whole, or that a new CEO will raise the bar to take our estimates meaningfully higher. Until then, break-up value math is a simple smokescreen.


But the biggest question that we increasingly think needs to be answered is whether or not the Core Payless business deserves to exist at all. To determine a real margin of safety here, we have to evaluate the NPV assuming that it does not. 


But we all know that we can’t simply make pretend that the business goes away with a special charge or two. It would be a painful exercise of absorbing losses in the Payless in order to get to the optimal store count. The question is whether that store count is 3,500, 2,500, 1,000, 500, or zero.  We don’t think it’s zero. There are some Payless stores running at a margin well above 20%. But it’s probably not a number starting with a 3 – and perhaps not even a 2.


We don’t have the answer to this yet, and there’s no doubt that anyone that would step in as a buyer for the company would need to have done the work, or if there have been offers for PLG, then PSS will need that level of comfort for the Payless business that remains.


In looking at Q3 results, sales were mixed with domestic Payless coming in lighter than expected with comps down -4.5% along with a deceleration in International Payless offset in part by PLG wholesale coming in strong. A major point is that PLG accounted for 78% of aggregate operating profits in the quarter.


The biggest delta in the quarter is on the gross margin line coming in down -524bps reflecting the company’s new pricing strategy – offering more moderate price points. The issue here is that the strategy was implemented on legacy product purchased prior to the new strategy and intended to have a higher initial price (i.e. a great exercise in finger-pointing). We are reducing our gross margin estimates to down -325bps in Q4 as this disconnect will weigh on margins near-term and through Q1 in addition to reflecting like product cost increases of +10%.


While near-term fundamentals are mediocre at best, there is early (and we stress early) evidence to suggest the company’s new strategies are starting to show signs of progress. After a weak start in August, domestic Payless sales improved through the quarter from down high single-digits to flatish in response to the sharper pricing. While hardly a trend, it’s a trajectory worth noting. In addition, the company ramped the number of store closures by year-end to 350 from 315 of 475 over next 3-years as well as cut the associated costs (lease terminations, severance, etc.) to $25mm-$30mm reducing the high end of the range by $5mm. Taking the pain now is a positive and should accelerate the timing of a turn in profitability.


Assuming PSS continues to operate as it exists today (including store closures), we’re shaking out at $0.70 for F11 EPS and $1.14 for F12 EPS. This stock typically trades at 10-12x EPS and 5-7x EBITDA, which suggests a modest premium to where it is now. We get to a valuation of $12-$17 based on our bear case breakup analysis and can justify a valuation of the PLG business in the mid-teens to low 20s alone suggesting decent support at current levels, but we need better confidence in a sale either in part or whole, or that a new CEO will raise the bar to take our estimates meaningfully higher before we get more constructive on the name.


Below is the detailed analysis of the three potential outcomes noted above from our August 25thpost “PSS: The Decision Tree”


PSS: Cheap w/o a Catalyst - Family FW Comp Table


PSS: Cheap w/o a Catalyst - Family FW Comp Charts


PSS: Cheap w/o a Catalyst - PSS SIGMA


Our Take on Strategic Review Outcomes (from 8/25):


1) An all out sale of the company:

  • This is the least likely of the three scenarios given the disparate characteristics of two business that would ultimately attract different buyers.
  • The high fixed cost and real estate intensive nature of the domestic Payless business is best suited for a financial buyer. One with a Ron Johnson-like 7-year duration that can take control, absorb losses, and slowly but surely take the store count meaningfully.
  • Another possibility is a large property owner like a strip-mall REIT that is better equipped to utilize the company’s store base and either take out/take down the leases, or flip them to a more profitable concept. But these companies are hardly cash-rich right now.
  • Based on our breakup analysis, we get to a valuation of $3-$6 per share for the ‘core’ payless business (both domestic and international) taking debt into account and $9-$11 per share for the PLG business on our bear case assumptions. $3-6 + $9-11 = $12-$17. Using less than heroic assumptions, we can get a valuation for the PLG business in the mid-teens to low-20s alone.

2) A sale of some part of the company:

  • This is a distinct possibility, but the company is less likely to sell off PLG in its entirety as the company’s key growth engine.
  • Saucony and Sperry are the most likely candidates and both could see interest from both financial and strategic buyers.
  • Re Saucony:
    • VFC could buy it in a heartbeat. It’s small enough that they can do this side by side Timberland.
    • Adidas makes sense. They’ll do anything to get into the technical running market. They’d rather buy Asics, but if the price is right it can happen.
    • Why not Li&Fung? Li Ning? Yue Yuen? Li&Fung has stated flat out that it wants to buy brands to leverage its scale. Yue Yuen has diversified into retail. Moving into the content side of the equation would definitely leverage its manufacturing base.
    • New Balance, Asics, and Under Armour are all out.
    • Nike wouldn’t touch it with a twenty foot pole. The irony is that Nike does not do well at all in the technical running category – despite the fact that it views its birthright to be rooted in running (watch the movie ‘Without Limits’ or ‘Pre’). An interesting angle on Nike’s running share… it has about 35% share in the running space. But count the number of swooshes on the feet of the first 20 finishers of the Chicago marathon. You’ll see far fewer than 35%. Nonetheless, the factoid here is that as long as Nike THINKS it can dominate this category (which it does) it won’t buy anyone else. It’s a strategy that has paid off for shareholders, by the way.
  • Re Sperry:
    • A financial buyer is more likely. This brand is strong enough to be a stand-alone company – and even a public one.
    • On the strategic side, there’s everyone from VFC, to JNY, to the same Asian acquirers that we think are going to make their way into this market.
  • We’ve already hit on the valuations above, however in breaking out PLG further, Stride Rite and Keds are worth $1-$2 per share with Saucony and Sperry valued at $9-11 with slightly more than half of the value attributed to Saucony at $5-$6.
  • There are no structural impediments that would prohibit a carve out of PLG from happening. However, carving out a single brand within PLG would be a bit more difficult in terms of integrated back office functions. Consider the following…
    • It took the company a very very long time to integrate some of the back-end infrastructure (consolidated 2DCs and a manufacturing facility) and pulled roughly $25mm of SG&A out, but the PLG brands still operate independently to a large extent.
    • The entire PLG team still operates out of their own HQs in Lexington, MA.  
    • It wasn’t until Q2 that only some of the PLG stores were hooked into the same PeopleSoft financial systems that the core domestic Payless business uses and in a similar fashion, the retail systems that count traffic/store metrics are also still largely independent from one another.

3) No sale at all. Instead, the company names a new CEO and gets to work on closing stores:

  • Business as usual is probably the most likely outcome as the company completes its strategic review process.
  • Assuming an asset sale does not occur, who PSS hires as the new CEO will be the most important near-term catalyst. (positive or negative)
  • The board wasted no time in getting a plan in place to aggressively reduce underperforming stores, which is the most significant positive development to come out of Q2 results.
    • In total, the company expects to close approximately 475 stores (~400 Payless & ~75 Stride Rite) over the next 3-years with 300 closings by year-end with most coming after the holidays.
    • We are modeling approximately 60 store closures in Q3 and another 255 at the end of Q4.
    • With roughly $110mm in revenues associated with these stores, we expect closures to impact revenues by $5mm in Q3 and ~$15mm in Q4. The greatest hit to revenues will come in F12 (~$75mm) given the timing of closures in F11.
    • Additionally, there are $25-$35mm in costs (lease terminations, severance, etc.) associated with these closings, the bulk of which are expected to be realized in the 2H F11. Of course, the Street will strip these costs out as being non-recurring – even though they represent real cash going out the door, and PSS making up for poor decisions made in years past. Nonetheless, on an ‘adjusted’ basis, we’re likely to see far better comparision starting in 1Q12.
    • Lastly, the net benefit of these actions are expected to improve EBIT by $18-$22mm once all closures are completed. We’re modeling in an incremental $0.15 in F12 EPS as a result of these actions.


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The Macau Metro Monitor, November 22, 2011




The Macau government is expecting to rake in MOP85 billion (US$10.6 billion) in 2012 as revenue from direct taxes on gaming. Local officials say they are expecting the city’s casinos to post an average monthly gross gaming revenue of MOP20 billion for the year.  For 2012, the industry consensus is that the local casinos will post a year-on-year growth of 15 to 20%.  Estimated government expenditure for 2012 stands at MOP77.4 billion while revenue is projected to go up to a record MOP115.2 billion.



Angela Leong, Executive Director of SJM Holdings, stressed that the company had not abandoned the plan to construct the Ponte 16 theme park in the O Porto Interior area, which was announced in 2002.  She said the company could not get things done without support from the government and the public.



Total labor force was 344,000 in 3Q 2011, comprising 335,000 employed and 8,900 unemployed.  Analyzed by industry, 24.7% of the employed were engaging in Recreational, Cultural, Gaming & Other Services.


Taxi data suggests a strong October for Strip gaming volumes (ex Baccarat).  



The Nevada Taxicab Authority recently reported that October taxi trips increased 8.2% YoY.  A couple of weeks earlier, McCarran Airport reported the busiest single month for taxi traffic in the airport’s 63-year history as the taxi count was 322,322.  These two data points bode well for non-baccarat gaming volumes in October.  Of the gaming metrics—Slot Volume, Table Volume, Baccarat Volume, Total Volume ex Baccarat, and Total Volume—total volume ex Baccarat has the highest correlation with the taxi data.  This is not surprising as baccarat players are usually chauffeured to the Vegas casinos. 


The chart below shows year-on-year change for Vegas taxi trips and total volume ex Baccarat from January 2000 to Sept 2011.  Correlation was 0.65 and the t-stat was 9.7, which signals that the variable is very statistically significant.  Assuming Lady Luck is steady and baccarat doesn’t swing around too much, October could be a decent month in Vegas.


“YOU TALKIN’ TO ME” - taxi trip

Winners vs Whiners

This note was originally published at 8am on November 17, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“What is even worse is a terrifying uniformity of opinions and reasoning.”

-Siegmund Warburg


Coming out of WWII, that’s how Warburg explained the difference between his thought process and that of the American bankers he competed with (they didn’t like that). According to Niall Ferguson, “…at times Warburg could lapse into an almost blimpish anti-Americanism…” (High Financier, page 167)


I’m definitely not anti-American. In fact, at this point I think I can make the argument that I love this country as much as my own. That said, I am anti-groupthink and anti-Old Wall Street. As Warburg said, at American banks “even those who are outstandingly intelligent change their views according to the movement of the Stock Exchange.”


On that score, just fyi, the US stock market is not the US economy. A lot of people on Old Wall Street disagree with me on that – and if you can’t tell already, I really want to have this debate in the arena of American public opinion!


Strong Dollar = Strong America. Period.


That doesn’t mean that the US Dollar has to go up and the stock market down for me to be right on this. On the contrary, I think this country will only get it really right when both its currency and stock markets are going up together. That’s when the 99% get paid.


Keynesians already have their hands up in the air before the Yale-Harvard Game this weekend reading this – ‘but, but, what about exports – how do we compete with the Chinese if our currency is strong?’


Stop whining and start winning.

  1. The US Economy isn’t an export economy anymore – get over it
  2. US Consumption = 71% of US GDP - this is a service and consumption economy
  3. Strong Dollar = higher purchasing power for Americans where it matters

American winners like Ford, Microsoft, and Apple didn’t become the leaders of innovation and job creation on some cochamamy central plan for a weak currency. They did it by dealing with the globally interconnected game that they were in, and finding a way to win.


Back to the Global Macro Grind


First, let me start with what’s been winning for us here in November – our Global Macro call for King Dollar. Here’s how the Hedgeye Asset Allocation Model is positioned for this morning’s open:

  1. CASH = 52%
  2. FIXED INCOME = 24% (Long-term Treasuries, Treasury Flattener, and Corporate Bonds – TLT, FLAT, and LQD)
  3. INT’L CURRENCY = 12% (US Dollar – UUP)
  4. US EQUITIES = 6% (Utilities and Healthcare – XLU and XLV)
  5. COMMODITIES = 6% (Gold – GLD)
  6. INT’L EQUITIES = 0%

I started the week at 0% asset allocation to US Equities as I came into the week short the SP500 (SPY).


Yesterday, I did what the process told me to do: started buying Healthcare (XLV), and sold some Fixed Income exposure (which was oversized to start the week at 30%, with my max being 33% to one asset class).


By Global Macro position, here’s what I am thinking as of last price:

  1. TLT – Growth Slowing, globally, is going to continue to have an impact on US Growth Slowing. Immediate-term target for UST 10-year yields is 1.98% so that means it’s time to take my time selling some bonds and buying some stocks (see Chart of The Day).
  2. FLAT – Growth Slowing. Period. We’ve had this position on since February of 2011, so the buy-and-hold crowd can give me a golf clap for having the conviction to stay with our highest conviction idea relative to consensus in January 2011.
  3. LQD – Are Corporate balance sheets “flush with cash” – no doubt, but some of them are flush with debt too – so we want to be careful with this position as the US bankruptcy cycle accelerates (see chart of American Airlines – AMR).
  4. UUP – Domestically, we think the US Presidential cycle puts Bernanke in a box. Internationally, we think the Europeans are going to cut rates alongside most central bankers in Asia and Latin America. Strong Dollar = Strong America.
  5. XLU – next to owning the top performing major currency in November (USD), we want to continue to have exposure to American cash dividend yields. This is the highest dividend yielding S&P Sector ETF and remains in a Bullish Formation in our model.
  6. XLV – buying it right is what matters most here (yesterday was a good re-entry point), but our Healthcare Team is bullish on the intermediate-term TREND outlook for consumption oriented domestic Healthcare stocks (think dental and Strong Dollar).
  7. GLD – again, you want to buy it right and manage your risk around what looks to be a relatively predictable range ($167.21-$175.98). As long as real-interest rates on American savings accounts remain negative, Gold works for absolute return.

I know it terrifies Old Wall Street to think that we can be as bearish as we’ve been on Growth Slowing, but still find a way to make money on it on the long side. Ray Dalio has done it in both 2008 and 2011 and so have we. Winners win.


Being perma bullish or bearish isn’t a risk management process; neither is hope for the next Big Government Intervention. I think we are having a generational moment in this country where the winners can take this country’s leadership reigns back from the whiners.


That’s the long-term America I think we can all believe in.


My immediate-term support and resistance ranges for Gold, Oil, France, Germany, and the SP500 are now $1748-1808, $97.69-102.11, 3003-3089, 5802-5926, and 1224-1252, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Winners vs Whiners - Chart of the Day


Winners vs Whiners - Virtual Portfolio

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