Gazprom Pulls the Gas Cord

The “action” finally happened. Russia’s natural gas provider, Gazprom, halted deliveries of natural gas to Ukraine yesterday, the culmination of long stand-off between the two nations (or two companies, depending on how you chose to look at it). The decision results from months of attempted negotiation over the settlement of $2.1 billion worth of debt on gas, which Ukraine received in November and December but refused to pay for.

This gas story is nothing new; in January 2006 Gazprom also turned off Ukraine’s supply. On 12/14 I wrote a weekend edition piece entitled: “Eye On The Energy Threat: Ukraine’s Geopolitical Impact”. In it I highlighted many of Ukraine’s geopolitical forces at work, including: its geographic importance as a transit country for natural gas from Russia to Europe; the country’s political orientation as it becomes more “western” and Euro-centric; and discussed Europe’s alternative energy strategies to become less reliant on Russia for its natural gas supply.

This latest shut-off was predictable. While I don’t discount that numerous political gestures are at work behind the scenes, we simply need to return to the clichéd expression, “Cash is King”, to understand the fundamentals. The fundamental for Russia right now is CASH, for she doesn’t have it. Like the rest of the world that is levered to commodities, Russia’s balance sheet doesn’t look like it did over the summer when commodities were reaching historical highs. This came to a head yesterday when Gazprom decided it was done negotiating over repayment and gas price. Russia signaled to Ukraine—which receives heavily subsidized gas from Russia to the tune of half of the European market price—that either the Ukraine is going to play ball their way or suffer the consequences.

This point may be marked as Ukraine’s struggle to transition from a socialist to capitalist state. On one hand the latest news reports from Ukraine show democratic-thinking leaders and a populous looking West. Yet on the other hand, Ukraine has a weak economy (high debt, and unstable currency, and like Russia is levered to commodities) and therefore needs Russia’s handout. The country’s lack of negotiating power is evidenced by Ukraine’s President Viktor Yushchenko attempt on December 31st to negotiate the transit price (what Gazprom pays Ukraine to ship gas through the country to Europe) from $1.70 per 1,000 cubic meters per 100 kilometers to $2. Kindly stated, Ukraine has a weak handshake and no cards to put out on the table.

Ukraine has agreed to pay $1.52 billion to Gazprom by January 11th, leaving a balance of over half a billion dollars to pay off its debt. It will be interesting to monitor this development in the next days. In the wake of the shut-off Gazprom stated it will increase supply to Europe via a line running through Belarus. Unlike in 2006, Europeans are not as worried for they have adequate inventory and alternative supplies such as liquefied natural gas. Ukraine says it has gas in storage equivalent to about 35% of annual consumption.
Let’s hope this number is accurate. Today’s weather report out of Kiev shows 13 degrees Fahrenheit and a chance of snow.
Matthew Hedrick


In their daily review of Asian newswires and economic releases, our Macau office highlighted an article from the South China Morning Post this morning, which discussed retail sales in Hong Kong. I’ve outlined a few key data points in the article below, but the summary is that retails sales were much better than expected in Hong Kong over the holiday season, which is very supportive of our decoupling thesis on Hong Kong and China.

Key highlights from the article include:
• Aeon stores with 33 Hong Kong outlets grew 9 % y-o-y in the week of December 24 – 30th.
• Sun Hung Kai Properties, Hong Kong’s largest private operator of shopping centers, said sales at its 20 shopping malls grew more than 10% y-o-y; and
• A record 420,000 shoppers visited apm, SKHP’s flagship shopping center in Kwun Tong for New Year countdown.

Based on these preliminary reports, which are more than anecdotal, both holiday sales and traffic were very strong in Hong Kong over the holidays. As we have been emphasizing over the last few months, both stock selection and country selection will be critical in 2009. While a rising tide, in terms of emerging market growth did indeed lift all boats from 2003 - 2007, in the coming 12-months differentiation will occur. And rightfully so as the economic prospects and country balance sheets are widely divergent in emerging markets, and the countries formerly known as BRICK.

We continue to be long FXI, which is the iShares FTSE/XINhua China 25 Index.

Daryl G. Jones
Managing Director

Andrew Barber


Slashing rates may help the market short term, but it won’t be enough to support growth long term

The Reserve Bank of India cut rates for the fourth time in four months as weekly inflation data continues to provide Prime Minister Singh’s government with justification to take up rates. Indian stocks rallied for a second day on the news, but trade data released yesterday suggests that the long term impact of the cuts will be minimal. Exports declined again in November by nearly 10% year-over-year, the second consecutive decline. For a country in which over a third of GDP is dependent on external trade, declining foreign demand is ominous.

In the face of increasingly grim data, the Indian recovery plan looks woefully inadequate -particularly when contrasted with China’s massive $580 billion stimulus package. The doubling of limits for foreign holdings in government debt that accompanied the rate cuts suggest that Singh’s team is already scrambling to find ways to finance the stimulus measure announced without reducing current spending on social services – a necessity if they hope to survive this year’s elections.

We bought back our IFN short on Tuesday to take a modest profit and get out of the way of a squeeze rally spurred by this rate cut, which we anticipated would arrive even if WPI came in flat. We will continue to keep our eye on the Indian market and will look to re-short into strength opportunistically.

Andrew Barber

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Add another potential trading catalyst for MGM. Due to construction issues at the Harmon Hotel, Spa and Residences, MGM may downsize the CityCenter budget. Construction on the Harmon part of CityCenter may only be suspended temporarily, but given MGM’s liquidity and covenant issues, any delay should be viewed positively by investors.

Apparently, structural problems, possibly design related, are inhibiting further construction. MGM may decide to “wrap” the building and suspend construction. We believe this could reduce the budget by several hundred million dollars. The cost “savings” combined with bond buybacks and the TI sale put MGM in a pretty good position to make it through 2009 without busting its covenants.

We still have concerns surrounding 2010 liquidity and the prolonged Las Vegas depression. However, as we wrote about in “A TALE OF TWO YEARS” on 12/26/08, the trade looks higher on MGM and the gaming sector. A CityCenter downsizing, albeit modest, adds one more near-term catalyst to the mix.

The January effect lives again!

Harmon Hotel, Spa and Residences could be delayed

How Bearish Are The Bulls?

How Bearish Are The Bulls? - asset allocation010209

“The illiterate of the 21st century will not be those who cannot read or write… but those who cannot learn, unlearn, and relearn.”
-Alvin Toffler

On New Year’s Day, one of our team’s most valuable players, Tanya Clark, sent our firm that Toffler quote as a reminder to continue to keep doing more of what we have been doing here since we started the firm in 2008. Demand from yourself to evolve. It remains the most critical aspect to a proactive risk management process. What worked yesterday does not have a birth right to work tomorrow. Be objective. Be the change you want to see every day.

Alvin Toffler is what the mass media refers to as a “futurist.” He and Ray Kurzweil are two of my favorite thought leaders in this category of my Amazon directory. While their thought process wouldn’t work if carbon copied into our daily objective (being right on markets), there are certainly components of their conclusions that are additive to how we ask THE questions here at Research Edge.

One of THE questions I have for 2009 is how bearish are the bulls? Since we have been bullish for the last month, and are now upping the ante for an “Obamerica” January squeeze, a discerning investor asked me on Wednesday who I thought the incremental “buyer” of stocks would be? Good question. If it’s not your local hedge fund mafia member who was fired and/or sent on a mission to “Chindia” for Q1, who could actually buy stocks?

The answer of course is a whole lot of people that didn’t lever themselves up to the gills with stocks at this time last year. There were plenty of winners in the 2008 game and this morning, these capitalists are fired up to get that 930AM bell rung and get this 2009 game started. We have been admiring John Paulson’s $36B hedge fund as of late – and he may be the only person I can find that was more openly bullish in December I was. The only person who was bearish at this time last year at least. Why is that? Maybe it’s because he is ALLOWED to be bullish…

After seeing the worst US stock market decline in 77 years, are the bulls allowed to be less bearish? This was the 2nd worse stock market season since 1871, and according to my old Yale economics professor’s math (Robert Shiller, who gave me a B+ by the way, and I am still bitter about that), the SP500, with dividends, recorded an annual decline of -40.3% in 1931. That was much worse than the prior 2nd place holder, 1937, which lost -30.7%. At -38.5%, the revisionist historians now get to put 2008 as the silver medalist in futility.

As interestingly, if you look under the hood of the US market in December, the returns across the major market indices were bullish! The SP500 closed the month UP +0.80% at 903; the Nasdaq was UP +2.7%; and there was a bull market in the Russell 2000, locking in a HUGE +5.6% December 2008 gain!

I know, I know… this wasn’t supposed to happen. Neither was Wednesday’s +14% intraday squeeze move in crude oil (which we sold into). But they happened… and once again, I must ask myself the same question – from commodities to stock markets, how bearish are the bulls?

The key here is that most of the bears who locked arms with me at this time last year (Roubini, Rosenberg, etc…) are still ragingly bearish. It would be really mean to kick off 2009 rhyming off all the bulls who have recently turned bearish, and I’m really going to try to be “nicer” in 2009, so I won’t go there… but the reality of it all is that I can’t, for the life of me, find anyone on the sell side who was bearish that is now bullish.  There are a lot of buy side PMs who get this, and there are 34 million online brokerage accounts in this country who get it… but consensus TV doesn’t get it yet… because no one from “Investment Banking Inc.” is allowed to get onto the You Tube, and “in their view” be bullish!

Now don’t get all horned up and charge ahead buying yourself SP Futures this morning. For the immediate term “Trade” I don’t like you buying the open. Inclusive of Wednesday’s +1.4% meltup, the SP500 has already tacked on +3.8% in the last 48 hours of trading, putting it’s “re-flation” from the November lows at +20% (which is why I made sales on Wednesday). Alongside volatility (VIX) being cut in half in the last 6 weeks, the trading range for the US market has narrowed materially. This, altogether, is bullish, but at a price. Buy low and sell high is the ole school game that’s back in town. Do not chase the pundit patrol this morning – wait.

Witness last year’s Asset Allocation “call of the year” (being in cash) or not buying into the vortex CNBC slogan of “free market capitalism is the best path to prosperity” while the US government was getting into the business of socializing corporate America’s losses… patience pays.

The bears are bearish, and the bulls aren’t bullish. Buy the SP500 on down days in the trading range that we have issued in the past few weeks – that remains 865-881. Make sales after +3-6% market moves. “Learn, unlearn, and relearn…” The future for the new American capitalist, who sees the opportunity of The New Reality, couldn’t be more bullish, at a price…

Best of luck out there in 2009,

How Bearish Are The Bulls? - etfs010209

2008 US Market Returns

Index Performance:

DJ (0.6%), SP500 +0.8%, Nasdaq +2.70%, Russell2000 +5.6%

DJ (19.1%), SP500 (22.6%), Nasdaq (24.6%), Russell2000 (26.5%)

DJ (33.8%), SP500 (38.5%), Nasdaq (40.5%), Russell2000 (34.8%)

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