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Stand Ready?

This note was originally published at 8am on June 07, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

"We must also stand ready to do even more if needed to best achieve our statutory goals of maximum employment and price stability."

–John Williams


Who is John Williams?


That’s a question that would most definitely make Atlas shrug. Not to be confused with all-American pianist and composer John Towner Williams (Star Wars, ET, Sunday Night Football, etc.), this is the lackey Williams who runs the San Francisco Fed alongside his Vice Chair of American Economic Central Planning and Economic Cycle Smoothing, Janet Yellen.


Both of these charlatans were out in full force yesterday ramping up expectations for more of what has not worked – Policies To Inflate commodity and asset prices (Qe). So, thanks to who I am sure your Founding Fathers foresaw as being the leaders of your centrally planned market life, today’s risk management question is will he (Bernanke) or will he not deliver the drugs?


Back to the Global Macro Grind..


So far, my real-time market signals are actually telling me the answer to the question is no. That doesn’t mean the market has it right this morning. But someone always knows something – and, sadly, that’s actually the game that both Bush and Obama have signed off on in this country for the last 12 years – the game within the game.


I work on the inside of the game. But I don’t have the inside information itself. I deal with some of the most sophisticated and accomplished investors in the game. I don’t deal with Washington’s academic elite and/or those with political power. My job is to boil it down to the truth and be right. In the end, from a market pricing perspective, truth trumps storytelling.


The truth is that Janet Yellen might be even worse than Ben Bernanke from a forecasting perspective. That’s saying something. She’s been on the Fed’s Board of Governors since 1994! That makes her very special. Never mind the Housing bubble, she’s overseen a hat trick of Fed sponsored bubbles: Tech, Housing, and now Commodities.


Back to what Bernanke will or will not do today…  


Bernanke, of course, is not politicized, but today’s Joint Economic Committee meeting has been completely politicized. He is supposed to be delivering an accountable explanation as to why his economic forecasts are wrong at least 2/3 of the time. Instead, Yellen is pressuring him to whisper sweet nothings about Quantitative Easing.


To review, the Fed’s Congressional mandate is twofold:

  1. Full Employment
  2. Price Stability

Instead, their perpetual Big Government Interventions in our markets are delivering:

  1. Shortened Economic Cycles
  2. Amplified Market Volatilities

Boom, bust. Boooom, bust. Then, kaboooom!


That last part is what we have been making a call on since launching our Q2 Macro Themes of Fed Fighting (The Last War) and Bernanke’s Bubbles (Commodities). Janet Yellen 3 for 3, baby – Tech, bust; Housing, bust; Commodities ka-booom!


I “stand ready” to present 35 slides today in Dallas, Texas (at The Money Show) on why Commodity Bubbles in oil and food in particular are going to continue to pop as the Fed’s broken promises continue to fail.


There is a massive movement in this country towards arresting doing more of what has not worked. And, if you all need a Canadian and his American family to stand on the front lines of this policy making war, get me a red-white-and-blue jersey (and helmet) – I’m already there.


Before I go, I’ll leave you with the real-time signals that are suggesting Bernanke may not deliver on hope today:

  1. Chinese Equities closed down -0.7% (ahead of their rate cut, which implies growth is really slowing)
  2. European Equities are up but failing at their most immediate-term TRADE lines of resistance (DAX, CAC, and IBEX)
  3. Oil prices are down
  4. Gold is down
  5. Copper is down
  6. US Dollar is barely down

The only thing that’s complicated about analyzing all of this at this point is how Bernanke is going to attempt to explain it.


Stand Ready for another Qe. This man is fighting for his political life (Romney says he will fire him). If Bernanke goes there, he’ll put his short-term political career risk ahead of the country’s long-term risk management position. Qe3 will cause Dollar Debauchery. Oil will rise again, and real (inflation adjusted) US, Chinese, and European growth will slow further.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1596-1646, $95.77-102.97, $82.11-82.65, $1.22-1.25, and 1283-1335, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Stand Ready? - Chart of the Day


Stand Ready? - Virtual Portfolio


"Our knowledge of the factors which will govern the yield of an investment some years hence is usually very slight and often negligible."

- John Maynard Keynes


That’s a quote from Chapter 12 of Keynes’ General Theory, “The State of Long-Term Expectation.”  Much of Keynes’ work was marginalized by the economists that were influential shortly after him – namely John Hicks – particularly the existence and importance of uncertainty in investment.  As a result, what is today considered Keyensian Economics is hardly the economics of Keynes (Steve Keen, 2011).  Hyman Minsky – the preeminent economist on fragility in financial markets – wrote in 1975 that, “Keynes without uncertainty is something like Hamlet without the Prince.”


This Early Look is not on Keynes – you’re welcome – but on uncertainty and oil prices.


As an energy analyst, I read a lot about oil markets.  One of the latest topics #trending on the subject is the price of oil approaching the marginal cost (MC) of production; this one always seems to get popular when oil prices drop precipitously, as it’s a go-to reason to ‘buy-de-dip,’ say the perma-bulls.


The MC of production is the change in total cost that comes from producing one additional unit of a good – a bicycle, a bushel of corn, a barrel of oil.  It is an important economic concept that determines the price of that good for a given level of demand.  On a long enough duration, the price of oil will converge around the MC because should price fall below the MC, the MC producers will not put incremental capital to work to arrest natural production declines, leading to a shortage and rising prices; and should price rise above the MC, it incentivizes production above what is demanded, leading to a surplus and falling prices.


Yes, MC matters, and yes, oil prices will track it over the long-term.  But the idea that the MC of oil production, and with it the oil price, is permanently headed higher – a popular opinion – is a fallacy.  Consensus is comfortable, and after a decade-long rise in the MC from $25/bbl in 2001 to $90/bbl in 2011 why would the next ten years be any different?  But the future is, of course, unknowable, and to deal with that inherent uncertainty “the facts of the existing situation enter, in a sense disproportionately, into the formation of our long-term expectations” (Keynes, 1937).  In other words, only after oil prices have increased 15% p.a. since 2001 does a deflating oil price seem implausible. 


In general, though, commodities – even non-renewables (fossil fuels) – do not tend to hold their real value over the long-term, proving poor investments.  New technologies, greater efficiency in extraction and production, and the substitution of one commodity for another (at one time our primary fuel was wood, then it was coal, today it is oil) drive the MC of production lower, and with it real prices.  After adjusting for inflation, major industrial commodity prices fell 80% between 1845 and 2002, though regained some of that lost ground over the last decade in a fantastic commodities bull market (The Economist, 2011).   Only gold and oil have held their value in real terms, and, indeed, oil has been a spectacular investment over the last decade, gaining 300%.  It is easy to forget, though, that the real price of oil in 2000 was no higher than it was in 1950.


We can point to a number of reasons why the MC of oil supply and the nominal price of oil have meaningfully outpaced inflation over the last decade, though easy money and China’s incredible investment boom top our list.  Others point to the decline in easily accessible oil reserves and rising social costs of Middle East nations, but we see less validity in those theses.  New technologies and greater efficiencies can counter harder-to-reach reserves; and oil exporters’ government budgets are pro-cyclical. 


In fact, most costs are pro-cyclical.  The relationship between the MC of oil production and the oil price is a classic example of mutual causality.  Is the price of oil higher because rig rates, steel pipe prices, production taxes, and labor costs are higher?  Or is it that rig rates, steel pipe prices, taxes, and wages are increasing because the oil price is?  Both occur simultaneously and as a result, the MC of oil production is just as much a moving target as the price is – not some Rock of Gibraltar level of support.


We’ve seen this movie before.  In constant dollars (year 2000) the price of US coal decreased from $31.40/short ton to $16.84/short ton between 1950 and 2003; in other words, after adjusting for inflation, coal prices have fallen more than 1% p.a. since 1950.  This trend is due to a decline in the MC, or “marked shifts in coal production to regions with high levels of productivity, the exit of less productive mines, and productivity improvements in each region resulting from improved technology, better planning and management, and improved labor relations” (Edward J. Flynn, 2000).  Those trends persist today, and the high cost coal producers are gasping for air (pull up a 5Y chart of PCX or JRCC).


And of course, we have US natural gas, which has fallen in nominal terms from $12/Mcf in 2008 to $2.50/Mcf today in a stunning display of how technology and innovation can lower the marginal cost and price of a fossil fuel.  Visions of permanently high natural gas prices prompted a build-out of LNG import facilities in the mid 2000’s.  Alan Greenspan (clearly an expert on the subject!) said in 2003 that, “high gas prices projected in the American distant futures market have made us a potential very large importer.”  With impeccable timing, Cheniere’s Sabine Pass received its first cargo of imported gas in April 2008, and now that same visionary company will spend $6.5B to export gas by 2017 (nat gas bottom?).  And this wasn’t the first time the gas bulls were fooled.  After years of rising natural gas prices in the 1970’s, four major LNG receiving terminals were constructed only to see gas prices peak in 1983 and decline for the next 15 years; three of those plants were eventually mothballed.


Is the rapid increase of the MC of oil production and oil prices any more “secular” than it was for natural gas in the 2000’s?  Will Chinese demand for commodities grow at the same pace over the next ten years as it did for the last ten?  What would sustained US dollar strength do to commodity prices, oil in particular? 


The confidence one can have in answering such questions is limited, perhaps even “negligible” (Keynes), but few in this Game accept that.  It’s funny – you don’t often hear investors or analysts say, “I don’t know,” but when consensus is proven really wrong, the all-too-common excuse is, “How could I have seen this coming?”


Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, EUR/USD, and the SP500 are now $1, $91.20-96.79, $81.21-82.02, $1.24-1.27, and 1, respectively.


Kevin Kaiser



CRUDE QUESTIONS - oil v usd 20




TODAY’S S&P 500 SET-UP – June 21, 2012

As we look at today’s set up for the S&P 500, the range is 29 points or -1.67% downside to 1333 and 0.47% upside to 1362. 












    • Down from the prior day’s trading of 2074
  • VOLUME: on 6/20 NYSE 751.15
    • Decrease versus prior day’s trading of -2.71%
  • VIX:  as of 6/20 was at 17.24
    • Decrease versus most recent day’s trading of -6.20%
    • Year-to-date decrease of -26.32%
  • SPX PUT/CALL RATIO: as of 6/20 closed at 1.90
    • Up from the day prior at 1.54 


2YR – this came up last night; we talked about it as the leading indicator for the US Fiscal Cliff; this morning, the 2yr popped above our intermediate-term TREND line of resistance of 0.30%. This will be very interesting to watch as US GDP Growth continues to slow (the denominator in deficit/GDP drives the #1 fundamental risk ratio higher). 

  • TED SPREAD: as of this morning 39
  • 3-MONTH T-BILL YIELD: as of this morning 0.08%
  • 10-Year: as of this morning 1.64
    • Decrease from prior day’s trading at 1.66
  • YIELD CURVE: as of this morning 1.34
    • Down from prior day’s trading at 1.35 

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30 am: Initial Jobless Claims, June 16, est. 383k (prior 386K)
  • 8:30 am: Continuing Claims, June 9, est. 3278k (prior 3278k)
  • 9:45 am: Bloomberg Consumer Comfort, June 17 (prior -36.4)
  • 9:45 am: Bloomberg Economic Expectations, June (prior -1)
  • 10am: Philadelphia Fed, June, est. 0.0 (prior -5.8)
  • 10am: Existing Home Sales, May, est. 4.57m (prior 4.62m)
  • 10am: House Price Index M/m, April, 0.4% (prior 1.8%)
  • 10am: Leading Indicators, May, 0.1% (prior -0.1%)
  • 10am: Freddie Mac mortgage rates
  • 10:30am: EIA natural gas change
  • 11am: Fed to purchase $4.25b-$5.25b notes in 6/30/2018-5/15/2020 range
  • 1pm: U.S. to sell $7b 30-yr TIPS (reopening) 


    • Supreme Court issues decisions today
    • CFTC holds open meeting on regulation of swaps, derivatives
    • House, Senate in session
    • Senate Banking hears from SEC Chairman Schapiro on proposals to overhaul money market mutual funds, 10am
    • House Financial Services panel holds hearing on supervision of money services businesses, 9:30am 


  • Samaras to name new Greek govt., Vassilios Rapanos, chairman of National Bank of Greece, to become finance minister
  • WTI crude oil falls below $80 for first time since Oct.
  • Spain 2014 bonds avg yield 4.706% vs 2.069% in March sale
  • Sales of previously owned U.S. homes probably fell in May
  • U.K. retail sales rose 1.4%, beating est. 1.2%
  • SEC said to depose SAC’s Cohen in insider-trading probe
  • Philip Morris cuts 2012 EPS forecast on currency swings
  • Onyx wins FDA advisory panel backing for blood-cancer drug
  • Invensys says it’s no longer in any discussions after approach by Emerson
  • BlueMountain said to help unwind JPMorgan’s losing trades
  • MSCI puts Greece on review for potential reclassification as Emerging Market
  • China manufacturing may shrink for an eighth month in June
  • EMA expected to make drug-safety/approval decisions today/tmw
  • UPS to begin offer in $6.5b TNT Express takeover tomorrow
  • New Zealand GDP rises 1.1% Q/q, fastest in five years
  • Euro-area finance ministers meet in Luxembourg to discuss financial transaction and energy taxes and the debt crisis 


    • Rite Aid (RAD) 7am, $(0.04)
    • ConAgra Foods (CAG) 7:30am, $0.50
    • CarMax (KMX) 7:35am, $0.53    



OIL – is it a bird, a plane, or demand? Or is it the Dollar? Or supply? The crash in oil (WTIC -26% from $108) is highly correlated to the USD. Currently, on a 2-mth duration, USD/WTIC = -0.94. Get the Dollar right, you get oil right. Immediate-term TRADE oversold lines for WTIC and Brent at $80.57 and $91.20. Sell all bounces. It’s a Bernanke Bubble. 

  • Founder of $125 Billion Gold ETPs Stymied on Copper: Commodities
  • Oil Drops Below $80 to Eight-Month Low on U.S. Supply, Europe
  • Commodities Slump to 19-Month Low as U.S. Growth Outlook Weakens
  • Copper Reaches One-Week Low on China Index and Fed Forecast Cut
  • Gold Drops for Third Day as Fed Opts to Extend Operation Twist
  • Sugar Falls as Rains May Ease in Top Grower Brazil; Coffee Drops
  • Corn Drops as Slowing U.S. Economic Growth May Cut Ethanol Use
  • Marcellus Gas Cuts Price Premiums to Decade Lows: Energy Markets
  • Gazprom Bond Sale Biggest Since ’09 as Yields Dip: Russia Credit
  • China Looks to Build Rare-Earths Reserves to Stabilize Prices
  • Coffee Harvest in India Seen Falling From Record on Dry Weather
  • Subsidies Boost Ambani With Record Diesel Sales: Corporate India
  • China’s Hungry Pigs Lead to Surfeit of Soy Oil: Chart of the Day
  • Crude Drops Below $80 to Eight-Month Low
  • Bauxite, Nickel-Ore Imports by China Climb to Record in May
  • Palm Oil Declines From Three-Week High on Fed’s Operation Twist
  • Chinese Seek Duty on U.S. Silicon Expanding Trade Fight: Energy















CHINA – down another -1.4% last night after another bad PMI number and ongoing #GrowthSlowing signals on the East side of the world. Germany’s PMI print of 44.7 for June reflects this global slowing; so does the long end of the UST curve. It’s only a matter of time before Equities mean revert lower.









The Hedgeye Macro Team


The Macau Metro Monitor, June 21, 2012




Macau May 2012 increased 6.76% YoY and 0.66% MoM. 




Darden reports 4QFY12 earnings on Friday the 22nd of June at 7:00 am.  The earnings call begins at 08:30 am.  We have adopted a stance of “casual dining caution” since April 20th as sales trends and underlying macro fundamentals for the casual dining group seemed to be softening.  Darden's stock has long been considered the bellwether of casual dining but, beyond our concerns about the broader group’s outlook, we believe there are additional company-specific factors working against Darden as we move into FY2013.  We believe that besides initial FY13 guidance, commentary on Olive Garden – specifically traffic trends and additional guidance on the remodel program – will be the primary focus for investors when the earnings release hits the tape. We would not be buyers of the stock ahead of earnings.


Consensus estimates for 4QFY12 have declined by roughly $0.02 over the past month but expectations for FY13 have remained unchanged, suggesting that the Street expects the company to push through the recent slowdown in sales.  Any deviation from this narrative, on the part of the company, will likely cause the stock to sell off.  Excluding one-time items that the Street may not traditionally pay for (like cutting G&A), there is still a chance the company misses $1.15 4QFY12 EPS expectations.  Overall, we believe that the company is in "investment mode", attempting to bolster its appeal to customers at all of its concepts.


Casual Dining Backdrop


Below, we show the Hedgeye Casual Dining Index versus Initial Claims (inverted) and also Darden versus Initial Claims (on the right).  The soft employment backdrop is negative for both casual dining and Darden; we expect management to allude to this during the conference call. 


DRI SHAPING UP TO DISAPPOINT - cas dining dri initial claims



3QFY12 Recap and Look Ahead


Macro: Management referred to the "choppy" environment during the earnings call on March 23rd.  At that time, according to the company, improving employment was being offset by the impact of rising gas prices.  Given that employment trends have softened since March, and gas prices peaked in early April, it will be interesting to hear which of these management weighs more heavily in its outlook for the rest of the calendar year.  In late April, CFO Branford Richmond, speaking at a conference, stated that “that’s [the broader industry] really driven … by job creation.”  We expect the tone to be negative if/when management touches on the macro environment as the employment picture has deteriorated since the most recently reported quarter.



Olive Garden: Weak traffic trends at Olive Garden are a concern for investors and will be one of the first numbers we look for when the press release hits on Friday morning.  Although promotions helped Olive Garden to narrow the Gap-to-Knapp during 3QFY12, we expect the sequentially weakening industry sales (Knapp Track) to weigh on Olive Garden trends.   


According to Consensus Metrix, the Street is anticipating Olive Garden’s 4QFY12 comps to come in at 0.48%, which would imply a two-year average trend of 0.2% versus 1.0% in 3QFY12.  While this two-year average decline would be a negative, we estimate that 0.48% would imply a sequential improvement in the Gap-to-Knapp metric: we estimate that it would imply +0.8% versus Knapp Track.  Olive Garden has underperformed Knapp for six consecutive quarters and, while the gap has been closing, we do not think that the pace at which the gap narrowed during 3QFY12 continued into 4Q. The promotions offered during 3QFY12 at Olive Garden compared very favorably to the 3QFY11 promotional offerings which performed poorly.  We think that the Street is overly optimistic in expecting 0.48% same-restaurant sales growth at Olive Garden in 4QFY12.


DRI SHAPING UP TO DISAPPOINT - olive garden gap to knapp



Red Lobster: Red Lobster posted a 6% same-restaurant sales growth number for 3QFY12, as preannounced, which benefitted by 480 basis points due to an earlier start to Lent 2012 versus 2011. According to Consensus Metrix, the Street is expecting 1.28% same-restaurant sales growth in 4QFY12 as the Lent benefit reverses.  This implies a two-year average decline in comps of 60 basis points and sequential decline, we estimate, versus Knapp Track.  During the most recent earnings call, management stated that “Red Lobster's fourth quarter same-restaurant sales will be adversely affected because of the shift forward in Lent and Lobsterfest.”


DRI SHAPING UP TO DISAPPOINT - red lobster gap to knapp



LongHorn Steakhouse: LongHorn remains a key focus for the company; the chain has been growing comps in the mid-single digit range for six consecutive quarters and new LongHorn units continue to exceed sales and earnings targets set by the company.  LongHorn is likely to continue to perform strongly.  While the chain is important for the longer-term TAIL story, we see Olive Garden and Red Lobster as being more important for the stocks near-term TRADE and intermediate term TREND price action.


DRI SHAPING UP TO DISAPPOINT - longhorn gap to knapp



A note on weather: Looking at top line trends for Darden’s restaurants versus 3QFY12, we see a risk that the street underestimates the boost that weather provided to the company during the winter months.  As we wrote on 2/22 in a post titled “WINTER WONDERLAND”, the state of Texas was heavily impacted by the adverse weather conditions for an entire week in February in 2011.  A year later, there was little-to-no snow in the Southern Region of the United States, according to data from the National Operational Hydrologic Remote Sensing Center.  According to a New York Times article of 2/4/11 titled, “Snow and Ice Paralyze Texas From Rio Grande to Oklahoma Border”, a snow storm on that morning hit much of Texas and created chaos for travelers traveling ahead of the Superbowl that Sunday.  During a conference on 4/24/12, Darden’s management team included Texas as a state that does not "traditionally see much of a weather impact", the implication being that the market there had improved its sales during 3QFY12 without any significant boost from weather, as occurred in the North East during January and February of 2012.  We think that the weather data and media reports suggest otherwise.  In light of the dramatic year-over-year change in weather conditions within Texas (a state with 148 of Darden’s 1,849 restaurants), we think that 3QFY12 comps may have been helped aided by weather more than management has implied.  





Howard Penney

Managing Director


Rory Green


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