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UA: Running Trends Bucking Bad Sentiment

Sentiment is so overwhelmingly bearish on Under Armour—including the common view that the Running footwear launch is ‘average at best.’ I won’t walk you through my thesis on UA’s approach to building this business again (check out several posts on the topic over the past few month), but I remain meaningfully more constructive – both short term and long term.

I won’t judge this launch on data from such a short time period, but we now have three weeks, which is a level that is becoming more relevant to me. A few takeaways – 1) Average price point has not budged off of $93. 2) Cross training market share has not suffered. 3) Interesting to note in the second chart that prior launches consistently made higher highs on the 1-year anniversary (counter to the view that UA launches well, but then fizzles).

Aye Carumba!: Mexican Tail Risk

In a November 11th 2008 note entitled, “Mexican Short Thesis: Oil Production”, we laid out the core tenet of our short thesis, which was based on declining national oil production in Mexico. We stated that:

“To this day, PEMEX owns and operates all of Mexican oil production and is a meaningful contributor to the Mexican economy. In 2007, Mexican oil exports contributed 10% of Mexican export revenue. PEMEX pays out over 60% of its revenue to the Mexican state in the way of royalties and taxes. In aggregate, PEMEX contributes almost 40% of the federal government’s budget. Despite record oil prices over the last few years, the Company has a substantial debt balance estimated at over $42.5BN as the vast majority of profits have gone to the government rather than to pay down debt, let alone investing in the business.

The Mexican government’s dependence on revenue from Pemex is a major issue for two reasons. First, oil is a commodity and as we have seen over the last five months the price of any commodity can change quickly. While the inherent long term value of Pemex’s reserve base does not change, the royalties and taxies paid to the government can be very volatile. Second, and more importantly, is that Pemex crude oil production has been in decline since 2004 and is down 10% ytd.”

Since then, the iShares Mexico etf, EWW, is down ~14.7% and Mexican Peso Currency Shares etf, FXM, is down 10.8%.

While the oil issue outlined above continues to be a core component of our thesis, a lunch we had yesterday with a Yale professor who in a former life was a Chief of Staff at the State Department and is a close confidante with the likes of Henry Kissinger, highlighted another key risk. We asked him what was the singles largest sleeper in terms of potential geo-political risk and his unequivocal answer was Mexico, due to the burgeoning power of the regional drug lords.

With a domestic economy that is under serious duress and a governmental income statement that is declining dramatically y-o-y, as outlined in the chart below, due to downward trending oil prices and domestic production, the drug lords have only been empowered.

In aggregate since December 2006, it is estimated that over 40,000 troops have been deployed against Mexican drug cartels. Over that time period, it is also estimated that there have been more than 8,000 fatalities associated with the drug war. News reports from south of the border over the last week suggest that the battle between Mexican drug lords and the government is turning into a veritable civil war.

In the past week, there has been a wave of street demonstrations and border crossing obstructions to protest the involvement of the military. These protests have shut down border crossings in Reynosa, Nuevo Laredo, Maramoros and Ciudad Juarez. They have also shut down part of the industrial hub Monterey.

According to the New York Times:

“Without providing evidence, the Mexican authorities say they see the hidden hand of traffickers in the splashy events, which have included men, women and children, some of whom cover their faces as they wave placards and denounce President Felipe Calderón’s decision to deploy more than 40,000 soldiers to combat a booming drug trade.”

These protests along with more brazen attacks on police and army officials highlight the growing power of these drug lords, which coincides with the declining economic power of the Mexican government due to its dependence on oil.

The emergence of a full blown civil war in Mexico is a risk that is moving from the tail into the normal distribution with every passing day.


Daryl G. Jones
Managing Director

EYE ON RUSSIA

If you’ve been following our work you know that we are bearish on Russia (forgive the pun). Russia’s stock market is down 12% this week and confirmed a new low with its close today at 549.21, 22bps below its October 24th low.

There are a few more data points out today that confirm more pain is ahead for the energy-levered economy:

-Russia’s unemployment rose to 8.1% in January, the highest since March 2005 and disposable income fell 6.7%
-January industrial output declined by 16%
-Average monthly wages fell by an annual 9.1% in January to ~$418 (the biggest drop since August 1999)

Russia forecast a 2009 contraction of 2.2% yesterday, which we believe may be a conservative estimate. We continue to follow the political gesturing from President Medvedev and PM Putin and the fluctuation in the ruble, which has depreciated 3.6% versus the dollar this week and is down 22% YTD.

Yesterday China lent Russia $25 Billion in exchange for larger supplies of crude oil. Should the Ruble continue to slide against major currencies, Russia’s debt will continue to compound. With capital investment in Russia down 15.5% in January M/M Russia can only hope for a re-flation in commodity prices. Russian leaders would be wise to get to the bottom of an apparent sinking of a Chinese merchant ship leaving the port of Nakhodka last week by their navy –violence is bad for business no matter how much the price of oil rebounds.


Matthew Hedrick
Analyst

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EYE ON INDIA: INFLATION

The SENSEX rose by 0.3% to 9,042.63 today, the first positive close this week as wholesale inflation data registered at a 13 month low of 3.92% - all but guaranteeing a rate cut when the central bank meets next.

Collapsing commodity prices may have been primarily driving inflation levels lower late last year, but with factory gate prices continuing to retreat and layoffs picking up speed the reality of sinking demand by domestic industry is here. Rate cuts, fuel subsidies and anemic stimulus proposals won’t be enough to replace external demand for India’s manufacturers products. The illiterate inhabitants of urban slums and rural farming villages (fully half the adult population of India cannot read by some estimates) now seem like the much vaunted rising consumer class that the India Bulls were flogging in research reports just 6 months ago.

We shorted IFN into today’s strength. Rate cuts and government intervention alone can’t turn this economy around, and we still do not see any sign that external demand will return soon.

Andrew Barber
Director

US Employment: The Nasty Can Indeed Break The Buck

At 627,000 this morning’s initial jobless claims came in at the same level as last week (after last week was revised up 4,000) and 18,500 above the 4 week moving average.

There are 3 important points to be made on this:

1. Context – look at this 3 year chart below, and think about it in terms of what the masses thought was improbable – its horrifying!
2. The Level – on an absolute basis this is a flat out nasty level of jobless claims – nasty enough to break the buck, for at least today!
3. The Implication – the US stock market goes up when gold and cash lose their consensus bid – watch these macro signals closely…

Have a macro point of view that allows you to keep trading this market, aggressively. That’s one of the ways to beat it.
KM

Keith R. McCullough
CEO / Chief Investment Officer

Long America, Short Gold

“Never give a sword to a man who can't dance.”
-Confucius

Chaos theorists will remind us that any complex system of consequence requires predictable patterns of behavior. Without an understanding of the deep simplicity associated with those repeatable patterns, one can surely lose his mind in trying to figure out what exactly is going on... that’s why using a global macro investment process is such a powerful weapon. Behavioral patterns repeat.

Confucius reminds us that the scariest part about this investing game is issuing swords to men who can’t dance. Women, on balance, are simply better dancers. Sorry guys. Last night, my favorite contrarian market indicators – the men of CNBC’s Fast Money – we’re at it again. God bless America for their presence in this game – without being able to take advantage of their predictable patterns of behavior, we wouldn’t be able to consistently outperform the market. These guys are consensus.

Dylan and Joey kept talking about this “long gold, short America” trade… given that I just started investing more aggressively in America over the course of the last 48 hours (and started shorting gold for the first time in forever) I found their comic relief fascinating, particularly given the timing…

Today’s markets do not trade on valuation. They trade on price. Price momentum governs predictable human behavior, and within the bounds of this interconnected global market place of interrelated factors, those behavioral patterns can be profited from.

Timing in these volatile markets is everything. When American stocks are hitting 3 months lows, and gold 7 month highs – you do not enter the game “long gold, short America” and call that a unique investment idea. I call that risk.

If you use a one factor model (price), and all you know is that you need to chase it, that’s cool – at least it’s a process. But don’t for one second think that there aren’t a world full of global macro pros out there who aren’t watching you, and waiting on you to do the perfectly predictable.

Fundamentally, I get the gold trade. I have been talking about it since 2005. Until recently, I was long gold in our Asset Allocation Portfolio, and if I get the momentum correction that I am looking for, I will cover my short position and consider it on the long side once again. This isn’t an emotional relationship – this is math.

The intermediate “Trend” in gold remains bullish, but at a price. The real support line for gold is all the way down at $824/oz. Understanding that some of the Fast Money traders who love gold up here are the same cats that loved crude oil at $140/barrel, I hope someone is at least mindful that what goes straight up can indeed come down. Support is -16% lower from where I shorted gold yesterday afternoon.

Gold is what you own as a safety currency when everything around you is in crisis. Asset classes like Gold and Cash can “re-flate” while other asset classes like stocks, bonds, real estate, etc… deflate. 

After we took a good hard look at yesterday’s intraday low in the SP500 of 782, we issued a note to our macro clients titled “Buying/Covering” (www.researchedgellc.com <http://www.researchedgellc.com> ). At 782, the US market was only 4% away from its November 20th, 2008 capitulation low. Yesterday’s lows came on much lower volatility (VIX 50 rather than VIX 80), and much lower volume. The only volume of consequence in my macro model was the audible kind – that sound of Fast Money traders chirping something about “long gold, short America”… C’mon guys… at least try to respect that there is a fiduciary aspect to this profession.

As always, putting that 782 SP500 line in context is critical. This had the SP500 down -50% from the Fast Money “buy everything Chindia” highs of 2007, and down a stiff -15.4% for 2009 to-date. Are we really investors “for the long run” here folks, or are we one factor model price chasers? My Dad, who is a firefighter, has always warned me of the psyche of those who chase his fire engines – they are not emotionally stable.

On an intermediate basis, Volatility (VIX) remains bearish. Unless the VIX can close above $53.44, I am very comfortable buying American stocks. I have not minced words and I am accountable for this call – unless we have another 6 standard deviation event, I do not think that the US stock market will penetrate that November 20th low.

What other signals in my 27 factor global macro model are signaling my conviction?

1.      The US$ is overbought anywhere north of the 88.11 line in the US Dollar Index

2.      Gold is overbought on an immediate term basis anywhere north of $983/oz

3.      The SP500 is oversold on an immediate term basis anywhere under the 790 line

4.      Other than the Russian stock market, there are NO major global equity indices that have penetrated and closed below their Oct/Nov lows

5.      China and Brazil continue to add to their YTD positive performance

6.      Credit has improved materially, particularly when it comes to global counterparty risk; the TED spread is 400 basis points lower than Oct/Nov


The inverse correlation between the US Dollar and the SP500 has been the anchor of this year’s call to remain bearishly positioned on US stocks. With the exception of one week where the US$ weakened, the US$ has been as relevant a heavyweight champion of global macro as gold has – but guess what, these factors are now very much correlated.

The US$ is trading down overseas this morning to the tune of -77 basis points. The S&P Futures are trading up +106 basis points. And looky here Joey… gold is trading down off of its 7 month highs as a result. How ironic…

Other than telling CNBC’s viewers that you love gold and hate US stocks based on a revisionist price, I have one question for Dylan and Joey… what is it exactly that you do? I know what it is that I do … and I am now Long America, Short Gold - thanking you for your predictable behavior. Sincerely,

Keith R. McCullough

Long America, Short Gold - etfs021909


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