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An Easier Solution

“At the end of this decade, in the year 1980, the United States will not be dependent on any other country for the energy we need to provide our jobs, to heat our homes, and to keep our transportation moving.”

- Richard Nixon, 1973


The current obsession in the US with energy independence is not a new one.  Richard Nixon, quoted above, embarked on “Project Independence” after the 1973 OPEC embargo led to a world oil crisis; nearly every president since has set a similar goal – none have come close to reaching it.  In 1973 the US imported 34% of its consumed petroleum; today, we import 45%.


In a speech yesterday, President Obama summarized his broad energy plan, “If we are going to control our energy future, then we’ve got to have an all-of-the-above strategy.  We’ve got to develop every source of American energy -- not just oil and gas, but wind power and solar power, nuclear power, biofuels.”


That sounds like a pretty good idea, particularly as prices at the pump have ripped to an all-time high for March, $3.76 per gallon.  As a direct result, gasoline consumption has fallen to the lowest level in over a decade, and is running 6.5% below last year’s level.


While energy independence is not an original idea, is it more realistic this time around?


It’s key to understand that the US does not have an energy crisis – it has a liquids fuel shortage.  71% of the petroleum consumed in the US is by the transportation sector; only 1% is used to generate electric power.  The US is actually abundant in its two largest power-generating sources, coal and natural gas, with the 1st and 6th largest recoverable reserves in the world, respectively.


Currently, solar and wind can only be used to generate electricity, so it is difficult to see how developing these renewable sources will lower gasoline prices or make us any more energy independent.  Further, because of issues with intermittency (the sun shines during the day, the wind blows at night, and the energy cannot be stored), low electricity conversion rates, large space requirements, and higher-than-expected operating and maintenance costs, solar and wind are simply not economic.  Even with government subsidies and private investment, the EIA estimates that solar will generate less than 1% of US electricity in 2035.  Solyndra…?  First Solar…?


Nuclear power, like solar and wind, can do very little to solve our liquids fuel shortage, as 100% of nuclear energy generated in the US is for electricity.  Regardless, there has been almost no new nuclear construction in the US in the last 30 years because of rising capital costs and risks, particularly after the nuclear disasters of the 80’s.  It is puzzling why President Obama is intent on revitalizing nuclear in the US only months after Japan’s Fukushima disaster.  And nuclear power is hardly a domestic resource – the US imports more than 80% of its required uranium.


Ethanol and biodiesel supplied 0.5% of the world’s primary energy in 2010; but increasing biofuel production comes at the cost of the world’s food and water supply.  If the US were to use its entire corn harvest to produce ethanol, it would only replace 8% of the country’s annual gasoline demand.  Cellulosic ethanol (ethanol produced from agricultural waste) has less of an impact on the world’s food, water, and fertilizer sources, though is challenged by extraction and aggregation costs as well as low energy density.


This is not a smear campaign against alternative and renewable energy sources.  With investment and time, technologies that are not currently economic, viable, or scalable one day will be, lessening our need for petroleum fuels.  The US should invest more (wisely) in energy R&D, starting with natural gas vehicles and the necessary refueling infrastructure.


But energy transitions take time.  Not years – decades, perhaps even generations.  Natural gas took 60 years from the time it was first commercially extracted (1870s) before it was 5% of the world’s primary energy market.


President Obama stated earlier this week that, “Folks are getting killed right now with gas prices.”  Touting alternative energy does nothing to fix that; neither does blaming rising oil prices on tensions in Iran, growth in China, and those pesky Wall Street speculators.  The only legitimate way to lower gasoline prices in the immediate term is the one that most of our leaders never consider: raising interest rates.


Near-zero interest rates and massive liquidity injections from the developed world’s central banks have driven investors into real assets, like oil and gold, in an effort to preserve purchasing power.  Net length among non-commercial traders in NYMEX crude oil futures and options is 333,000 contracts, nearly double the July 2008 high of 170,000 contracts when oil spiked to $145 per barrel.  In 1991, there were 3.3 dollars of money supply to every 1 barrel of oil; today there are 7.1 dollars chasing that 1 barrel.  And while the price of gasoline in dollars has increased 95% since March 2009, gasoline priced in an ounce of gold is only +7% over the same period.


Many factors influence the price of oil – supply, demand, geopolitical risk – but monetary policy is really the only one within the US’s control, and that policy cannot be any more inflationary for the price of petrol.  Recognition of such would be a refreshing dose of accountability; it would also give consumers a much-needed break at the pump.


Our immediate-term support and resistance ranges for Gold, Brent Oil, WTIC Oil, Natural Gas, US Dollar Index, and the SP500 are now $1, $123.31-126.81, $106.13-109.22, $2.21-2.39, $79.36-80.21, and 1, respectively.


Kevin Kaiser



An Easier Solution - EL chart


An Easier Solution - vp 3 8


The Macau Metro Monitor, March 8, 2012




Macau lawmaker Ng Kuok Cheong criticized the casinos and resorts for intentionally suppressing salaries to drive away local workers and employ foreign labour.  He said some local job seekers attending casinos and resorts’ recruitment fairs told him that they felt the employers were intentionally offering lower salaries than market price so that local workers would lose interest in those jobs and the companies can use up their maximum quota of imported labor. 


US Dollar strength over the past week pressured commodity prices across the board with only chicken breast prices, of the commodities we monitor, posting a significant gain.  Coffee prices continue to lead the way to the downside. 







Gas prices continue to move higher, gaining 50 bps over the last week despite Brent Crude prices declining -0.3% over the same period.  Below are some recent comments from management teams regarding the impact of gas prices on their businesses.  Clearly, given a sufficiently substantial rate of increase in gasoline prices, we will see an impact on restaurant companies’ top line trends.


WEN: Obviously, we're all watching gas prices carefully and – but consumers seem to quite honestly have digested that quite nicely.


BAGL: If employment continues to be positive, again from my perspective, I think that sort of offsets any impact that you might get – we might get on gas prices … That said, if employment tightens up or we don't see continuously positive momentum than longer-term, obviously, if we get a $5 gas price, that's one of those price points that hits overall.


CBRL: We think that given our susceptibility particularly to – in the summer travel season to potential increases in gasoline prices that it is appropriate to be suitably cautious about our third and fourth quarter traffic outlook.


DRI: Yes, I would say as we look back, we don't think the current levels, the $4 current gas prices, no longer represents sticker shock.











The USDA expects China’s corn production to drop 190 million metric tons in the year starting October 1st, down from 191.75 million metric tons the year prior.  China’s corn imports are expected to remain steady at 4MMT.




Corn prices fell 2% today as commodity funds liquidated long positions ahead of the USDA crop production release at 8:30AM on Friday.


Speaking at the Bayer CropScience Ag Issues Forum in Nashville, Tennessee recently, William Lapp, grain economist with Advanced Economic Solutions stated that three factors have driven commodity prices to record levels: strong global economic growth in agriculture led by developing economies such as China, a weakening of the US dollar since 2002, and biofuels policy for grain use in the US.  He believes that the “corn ethanol story is nearing the end” as the science lower cost cellulosic ethanol production progresses.







Concerns about a “glut” of wheat supplies overwhelming demand.  Crops in key growing regions have seen favorable growing conditions





Wheat prices fell 3% today as commodity funds liquidated long positions ahead of the USDA crop production release at 8:30AM on Friday.







China’s rate cut in its forecasted economic growth rate on Monday has heightened concerns around the outlook for the world’s biggest buyer of soybean.







The US herd remains depleted and the first steps for producers to develop a plan of action are to see how conditions are in the spring, forage growth following last year’s damaging drought, and financial and economic factors. 





A fascinating article on CattleNetwork.com discusses the bright future of China’s beef market.  According to consulting company Frost & Sullivan, China’s beef market is still in the primary development stage but it is likely to get more opportunities to grow with support from governmental policies.







Joe Sanderson, CEO of Sanderson Farms, said today that there is no chance of the supply of chicken growing this year.


Egg sets placements continue to contract at around the same rate, -5.4%, according to the Broiler Hatchery report released by the USDA today. This implies that supply will remain tight as the industry looks for more favorable business conditions before expanding production.


WEEKLY COMMODITY CHARTBOOK - egg sets wing prices





Beef: Most companies are expecting beef cost inflation to be up mid-to-high single digits versus last year


TXRH: We expect approximately 8% food inflation in 2012, primarily due to higher beef costs…on the beef side we do have fixed price – pricing arrangements in effect for over 90% of our beef costs in 2012.


CBRL: To the continued pressure on ground beef prices and other commodities partly offset by lower average dairy and produce prices, along with benefits from our supply chain initiatives, we expect cost of sales to increase 60 basis points to 80 basis points over 2011 to near 26% in 2012.


RUTH: We project 2012 beef inflation to be between 5% and 8%. We currently have purchase agreements for beef representing approximately 30% of our needs through August of 2012, which represents an approximate 7% premium compared to the prior years.


CMG:  While we're cautiously optimistic we'll see more reasonable prices in 2012 for avocados, dairy and produce, we expect these benefits will be more than offset by higher costs for our beef, chicken, rice and beans. Beef costs will be especially challenging due to protracted supply shortages, despite recent reductions in grain prices.


MCD: As we look at our guidance for 2012, we've built another mid-teens increase for beef, expecting that the dynamics in the marketplaces that we see, and are expecting, will continue.


DRI:  U.S. beef production will continue decline though over the next 24 months, placing continued upward pressure on beef prices because of the slow economic recovery hamburger and value oriented beef, cattle beef are in high demand and can be priced accordingly by the packers. At Darden we purchased mainly tenderloins and other premium steakcuts, while we expect pricing for our beef products to increase by 12% our pricing has been tempered by consumers' resistance to record higher retail prices for premium stakes and the resulting shift to value oriented cuts and as you can see beef is approximately 14% of our cost basket … We have 75% of our beef requirements contracted for fiscal 2012 and 40% of the June to December usage under contract for fiscal 2013.


SONC: One item to note is that we recently locked in our beef contract for calendar year 2012… given the potential for beef costs going even higher, which there are a lot of reports out there that speculate that could happen, that we chose to go with making this more of a known quantity here, and the idea of having a set price for the next 12 months, we feel like would be good for our business, adds some predictability to the business.



Coffee: Prices are now down -32% versus last year


PEET: We expect 2012 coffee costs to rise 12% instead of last year's 42%.


SBUX: We've taken advantage of the recent declines in the C-price to lock in more of our coffee needs for fiscal 2013. We now have six months of our fiscal 2013 requirements secured at costs moderately favorable to 2012.



Dairy: CAKE, DPZ, PZZA, TXRH and others could benefit from favorable cheese costs this year


TXRH: The volatility around that 8% estimate for food cost inflation would really be driven by produce and dairy.  Those are of the biggest components that we float around the market, and that's about 15% to 20% of our total cost of sales.


CMG: While we're cautiously optimistic we'll see more reasonable prices in 2012 for avocados, dairy and produce, we expect these benefits will be more than offset by higher costs for our beef, chicken, rice and beans.
































Chicken – Whole Breast


WEEKLY COMMODITY CHARTBOOK - chicken whole breast



Chicken Wings















Howard Penney


Managing Director






Rory Green







Triangulating Latin America

Topics discussed this week:

  • Refreshing Our View on Brazilian Equities
  • Staying Afloat In EMs Amid A Flood Of Liquidity
  • Default or Hyperinflation?: Argentina’s Tough Choice

Refreshing Our View on Brazilian Equities

Later today, Brazil’s central bank is likely to dip into historically rare territory by lowering its benchmark monetary policy rate (the Selic) to ~10%, which is only a mere 125bps above its all-time low of 8.75% (2009-10). Such a cut would be a continuation of a highly-politicized series of interest rate cuts designed to accomplish three very important political initiatives. In addition to lowering the interest burden within government expenditures, the central bank looks to:

  1. Spur Brazilian economic growth: In 2011, the Brazilian economy grew by +2.8%, which, barring 2009, is the slowest rate of Real GDP growth in Brazil since 2003. Moreover, default rates on consumer credit have risen to a 2yr high of 7.6% per the latest data, further incentivizing the central bank to maintain its trend of easing monetary policy. We are, however, starting to see some positive effects of recent monetary easing, with Brazil’s PMI indices making higher-highs since SEP; and
  2. Quash speculative capital inflows: The Brazilian real has appreciated +5.6% YTD, largely on the strength of a marked acceleration in foreign portfolio investment targeting some exposure to the G20’s highest real benchmark yield (4.3%). In just the YTD alone, Brazilian issuers have issued $19.1B in USD-denominated debt to circumvent the relative tightness of domestic monetary conditions (the proceeds of which subsequently get repatriated, boosting the currency further). That sum is on pace to overtake the record for issuance in a half-year period, which was set back in 1H11 – not coincidentally during the Federal Reserve’s second round of Quantitative Easing. Looking to Brazilian equities, R$6.1 billion have flowed into Brazil’s equity market through FEB, which is the highest JAN+FEB total ever (data going back to JAN ’08).

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To help accomplish stated goal #2, Brazil’s government recently instituted a tax on foreign financing that matures in 3yrs or less, a figure that’s as high as 6% for Brazilian exporters’ loans under advanced payment agreements within 360 days. In conjunction with the announcement, Finance Minister Guido Mantega said:


“The [Brazilian] government won’t be a passive observer in this currency war. The government will continue to take measures to prevent the real from strengthening, from hurting Brazil’s manufacturers.”


His statement echoes tightly with President Rousseff’s recent commentary (courtesy of our Portuguese-speaking Chief Compliance Officer, Moshe Silver, who regularly mines the Brazilian local press for value-added data points):

  • “There is a currency war based on an expansionary monetary policy that creates unfair conditions for competition.”
  • “Developed nations literally poured $4.7 trillion out into the world in a very adverse, very perverse, way.”
  • “Developed countries are relying on absolutely irresponsible monetary policy to compensate for the lack of room to use public spending to shore up economic growth.”
  • “Brazil needs to create tools to combat perverse policies being implemented by rich economies, such as the European Union, that are flooding the world with dollars… We need to create other tools to fight against the consequences of policies that are increasing global liquidity.”

Of course, the risk to the Brazilian economy is that policymakers overshoot their monetary easing and capital controls, which would cause them to have to dramatically reverse course on the former should another large-scale asset purchase program get implemented by the Fed or another large central bank.


While our models point to a continued benign outlook for Brazilian inflation over the intermediate-term, we’d be remiss to ignore the risk that a Qe3 would pose to Brazil and other emerging economies by, once again, stoking inflation and forcing them to tighten monetary policy. Recall that, from a price, Qe2 got us broadly bearish on EM equities and L/C fixed income (Brazil in particular) in NOV ’10.


Triangulating Latin America - BRAZIL


Given its underappreciated role in setting global food and energy prices, the USD remains our key focus and its recent stability affords Brazil additional headroom to continue easing monetary policy in support of economic growth – which is exactly what Brazilian interest rate markets have been signaling of late. Thus, from a fundamental GROWTH/INFLATION/POLICY perspective, we remain favorably disposed to Brazilian equities on an intermediate-term TREND duration.


Triangulating Latin America - 5


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Staying Afloat In EMs Amid A Flood Of Liquidity

As we mention in the previous section, the seemingly ever-growing pool of excess liquidity emanating from DM monetary policy creates systemic risk across emerging markets – particularly due to developed-world investors using easing speculation as an excuse to bid up EM assets under the tired guise of mistaking accelerating inflation for faster economic growth.


In recent Early Looks and intra-day research notes, we have been very critical of this practice, especially given that 2012 has the potential for consensus to repeat the broad mistakes of 2008 and 2011.  That said, we’re all in the business of making money at the end of the day; thus, it helps to have a strategy to properly contextualize what further dollar-debauchery could look like from here (see: intraday Qe3 speculation).


Over a short-term duration, we know that investors will chase yield shortly after an announcement is made. Using the MSCI Latin America equity index as a proxy for the region, Latin American equities rallied +18.6% from Jackson Hole ’10 to their cyclical peak in APR ‘11. The equity peak was led by Latin American L/C bond yields by nearly a full month.


Triangulating Latin America - 7


Going back to our point on accelerating inflation and inflation expectations, Latin American currencies, which appreciated vs. the dollar over that same duration due to an obvious acceleration of capital inflows, simply do not have enough juice to keep pace with higher-beta global food and energy prices. This dramatic underperformance resulted in regional inflation readings accelerating sequentially and widespread monetary policy tightening.


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Looking to the current setup, our models suggest that, with the exception of Mexico, Latin American YoY CPI readings will continue to make lower-highs – at least for the next quarter or so. This, coupled with their currencies’ relative outperformance of global energy prices and absolute outperformance of global food prices, suggests a favorable outlook for Latin American economies from a monetary policy perspective (i.e. easing speculation will continue to dominate the headline risk).


Triangulating Latin America - 10


Of course, at a point, the opposite will be the case; but as we saw in late ‘10/early ’11, it will pay to manage risk appropriately on the misguided melt-up, insomuch as it will pay to [eventually] be appropriately positioned for the fundamentally-driven melt-down in the event further Qe becomes a high-probability scenario.


Default or Hyperinflation?: Argentina’s Tough Choice

Since her election win in the fall of last year, Argentine President Cristina Fernandez de Kirchner has made a plethora of headlines with her policy intervention and aggressive regulatory changes – all designed to spur financial repression, quell capital outflows, and build FX reserves.


To say that she has been successful in achieving her goals would be largely an understatement; capital flight slowed in 4Q11 to $3.3B – down from a record pace earlier in the year – finishing 2011 at $21.5B, just shy of the 2008 record of $23.1B. The marginal increase in the supply of pesos in the economy helped to depress the rate Argentine banks must pay for 1-month peso deposits > $1M down to 13% from a cyclical peak of 22.9% in NOV. Additionally, the artificial, one-way flow of capital allowed the central bank to arrest the decline in its FX reserves, which bottomed out in DEC at $44.7B and are now at $46.8B per the latest data.


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Despite all of her aggressive maneuvers, Fernandez’ goal of rebuilding Argentine FX reserves to a level consistent with her wishes remains elusive.  Argentina, which remains one of the few countries willing to risk using their FX reserves to service external debt, needs to see “free and available” reserves (i.e. FX reserves in excess of the monetary base) substantially higher than the current $109.6M in order to meet a budgeted $5.7B payment on the country’s dollar bonds in 2012.


Triangulating Latin America - 13


As such, we, and the forex market, continue to expect additional currency devaluation in the event Argentina is unable to grow its existing stock of FX reserves the old-fashioned way (through accelerating export growth). It’s no surprise to see the Argentine peso underperform the region’s currencies in the YTD, falling -0.6% vs. a regional median gain of +5.9%.


Triangulating Latin America - 14


While a “controlled” currency devaluation is certainly no laughing matter, that is not the largest risk facing the Argentine economy at this current juncture; accelerated interventionist measures out of the Fernandez regime risk a more permanent brand of capital flight as international investors lose faith in the projected long-term returns on and of capital from investing in the country. Most disconcerting is Fernandez’ recent proposal to Congress to revoke the “free and available” clause from the 1991 Dollar-Convertibility Law, which would imply that she is seeking access to all of Argentina’s FX reserves in order to service debt.


It’s important to remember that the law was put in place after Argentine consumer prices surged +1,300% in 1990 amid rapid currency devaluation. Moreover, an assault on the country’s FX reserves, which have historically been used to shield EM currencies from aggressive sell-offs, would likely drive investors to lose confidence in the long-term sustainability of the Argentine peso, risking another episode of hyperinflation or draconian monetary tightening to ward off that outcome.


All told, investors in Argentine peso-denominated assets clearly have a vested interest in seeing Fernandez fail on her latest policy initiative. Her success could spell disaster for the Argentine economy over the long-term TAIL.


Fundamental Price Data

All % moves week-over-week unless otherwise specified.

    • Median: -0.2%
    • High: Venezuela +6.5%
    • Low: Chile -1.2%
    • Callout: Argentina down -22.5% over the LTM vs. a regional median decline of -1.5%
  • FX (vs. USD):
    • Median: -0.1%
    • High: Argentine peso +0.5%
    • Low: Brazilian real -2.7%
    • Callout: Argentine peso -7.1% over the LTM – the worst performer in the region over that duration
    • High: Mexico -1bps
    • Low: Colombia -15bps
    • Callout: Brazil -302bps over the LTM vs. Colombia +98bps
    • High: Colombia flat wk/wk
    • Low: Mexico -4bps wk/wk
    • Callout: Mexico -30bps YTD vs. Brazil -4bps
    • High: Colombia +15bps
    • Low: Mexico -3bps
    • Callout: Mexico -11bps YTD vs. Brazil +65bps
  • 5YR CDS:
    • Median: -0.4%
    • High: Venezuela +3%
    • Low: Peru -2%
    • Callout: Venezuela -27.9% over the LTM vs. a regional median gain of +21.4%
    • High: Chile +4bps
    • Low: Brazil -29bps
    • Callout: Swaps traders are pricing in -155bps of rate cuts over the NTM vs. +36bps of rate hikes in Mexico.
    • High: Chile +8bps
    • Low: Argentina -40bps
    • Callout: Colombia +202bps over the LTM vs. -142bps in Brazil
  • CORRELATION RISK: Given the widespread addiction to cheap money asset reflation, it’s no surprise to see the MSCI Latin American Equity Index’s inverse correlation to the DXY strengthen over shorter durations (from -0.43 over a 30-day study to -0.57 over a 15-day study).

Darius Dale

Senior Analyst


Foreclosure Activity Rises 28% in January

Lender Processing Services released its mortgage monitor report yesterday, showing that foreclosure activity rose dramatically in January.  Interestingly, this precedes the AG/mortgage servicer settlement, which broke in early February.  The AG/servicer settlement has dragged on now for almost a year and a half, and the complete, final agreement was still in progress at the time of the early-February media blitz.  Thus, we read this increase as a change in servicer behavior as they had more confidence in what the new standards and penalties would be. There is a degree of seasonality in foreclosures (for example, many servicers enforce a moratorium around the holidays in December), which increases the apparent MoM increase, but the spike suggests that servicers' behavior has shifted. 


Going forward, we expect that foreclosures will continue to rise from depressed October 2010 - December 2011 levels.  There are several implications to keep in mind: 

- Home prices will come under pressure - foreclosure sales are a major driver of declines in home prices, since foreclosed homes generally sell at a significant discount.  The Case-Shiller Index includes foreclosure sales in its models, as does the primary Corelogic HPI. 

- Foreclosures are correlated with higher bankruptcies.  If this relationship remains in place, then bankruptcies will also increase.  That's negative for credit card issuers, who charge off bankrupt customers as soon as they file (so these losses can hit NCO without ever spending time as delinquent balances). 














MBA Purchase Applications Rise Modestly

Last week MBA Mortgage Purchase Applications rose 2.1% to a level of 169. Today's print puts purchase applications 13% lower than a year ago. In contrast, refinance applications fell 2.0% last week. Mortgage rates rose on Thursday of last week but retreated thereafter, ending yesterday at 3.86%. 





















Joshua Steiner, CFA


Allison Kaptur


Robert Belsky


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