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Black Gold: A Call Out on the Gold Oil Ratio

Over the last week, we've been scaling into a long oil and short gold position. Our quantitative models were flashing to us that gold was overbought and oil was oversold. Additionally, we are seeing many consensus indicators that support taking the opposite side of the gold trade, including Fast Money and a full-page advertisement in The Economist promoting gold as a safe haven that should be bought. The overbought nature of gold, and oversold nature of oil, is best characterized in the gold / oil ratio. This ratio measures in US dollar how many barrels of oil can be purchased with one ounce of gold.

As the charts below highlight, this ratio is at or near its all time highs. Historically, a ratio near 25 indicates an entry point to sell gold and buy oil and, conversely, a ratio of below 10 equals an opportunity to sell oil and buy gold. As of the close on Friday (2/20/2009), this ratio was at 25.0 based on light sweet crude trading at $40.03 per barrel and gold trading at 1,002.2 per ounce.

Gold and oil quite often rise in tandem due to inflationary concerns and geo-political risks. The price of oil today, and in fact its trajectory over the last six months, suggests that there is a little on the horizon in terms of major geopolitical risks. To some extent, this is a self fulfilling prophecy since when the price of oil decreases, so obviously does the power of Russia, prominent Middle Eastern nations, and Venezuela. In addition, while gold seems to be flashing inflationary concerns, few other commodities are following suit, which means either gold is early, or wrong, in this signal.

To be fair, the gold oil ratio is only one relative value factor and both oil and gold are also driven by a completely independent set of fundamental factors. That said, we reference George Santanyana's guidance: "Those who cannot learn from history are doomed to repeat its lessons." History is quite specifically telling us that the short oil, long gold trade is likely in its final innings.

Daryl G. Jones
Managing Director

Macro Catalysts: Tuesday-Thursday

Hindsight is always crystal clear. Much like last Thursday, today’s gap up open was again one that should have been sold. I sold my long position in China (CAF), and shorted Korea (EWY) into that strength. Now I am long America (SPY) and net short Asia (IFN, EWY).

Now that the Treasury, Fed and FDIC have made their official “US Banking System” statement, all the market has left to trade on is noise. And from the Slum Dog Short Sellers to the manic media, there is plenty of it.

My proactive risk management plan is moving squarely to the Tuesday-Thursday Macro calendar catalysts where whatever leadership we have left in this country’s Financial System will have an open mike to be You Tubed by both the American public and global markets at large:

1. Obama gets his shot herding cats again in speaking to Congress
2. Bernanke will attempt to calm the Senate re today’s “Banking System Statement”
3. Case/Shiller House Prices will be horrendous (lagging economic indicator)

1. Bernanke gets his shot with the House, explaining today’s “Banking System Statement” again
2. Existing Home Sales for January are released (December’s number was better than expected)
3. Earnings season for US Retailers will continue to be as bad as expected

1. Obama’s 1st Budget is release, and he’ll have another chance to herd cats/calm the country
2. New Home Sales (January) are released
3. Jaime Dimon will attempt to find credibility at JPM’s Investor Day

Importantly, the US Government’s CAP (Capital Assistance Program) will be initiated on Wednesday – so there is plenty for Bernanke to be specific about. This market wants specifics. In addition to this CAP plan, I expect Bernanke to start walking the media’s manic horses to water on what TALF (term auction lending facility) means, how much of that capital that the government has started to put to work, etc…

In between now and Thursday, America’s largest banks will continue to go through Geithner’s proposed “Stress Tests” and, all the while, the groupthink associated with a freaked out US market crowd will find their price marking another capitulation bottom. Provided that the VIX stays tucked under the bearish intermediate Trend line of 52.59, my stress levels will hopefully remain relatively low.

Keith R. McCullough
CEO & Chief Investment Officer

EYE ON THE UK: A New Banking Rescue Act

Over the weekend the UK issued the Banking Act of 2009, which allows the Bank of England, Financial Services Authority (FSA) and the Treasury to step up more quickly to rescue troubled institutions, including provisions to temporarily nationalize or sell-off stricken banks. For investors with monies tied up in injured banks, the Act calls for funds to be rapidly transferred to other banks and depositors may now access their money in a matter of days rather than weeks under previous conditions.

The Act is largely a response to the lethargic response of regulators to the collapse of Northern Rock in 2007, in which depositors made a run on the bank after it emerged that Northern Rock sought government help.

Over the weekend PM Brown met with European leaders from the Group of 20 states in Berlin to discuss the global crisis. He said that "banks must act in the long-term interests of their shareholders and therefore of the economy as a whole, not in the short-term interests of bankers." Brown rejected the Banking industry's bonus culture and signaled that Britain must return to traditional savings and mortgage banks. He voiced that loans must be made on "prudent and careful terms," while equally stressing that domestic growth would come from granting loans to first-time buyers, entrepreneurs, and individuals of middle and modest incomes.

RBS and Lloyds, both part-owned by the taxpayers, have asked the government to insure almost 500 Billion Pounds ($720 Billion) of assets as part of the Treasury's plan to spur lending, noted the Sunday Telegraph. Today RBS said it plans to cut cost by more than 1 Billion Pounds by splitting the bank into two units, including a "core" business and second division holding toxic assets. Additionally, Chancellor of the Exchequer Alistair Darling ordered Northern Rock to expand lending by 14 Billion Pounds.

These measures are the first in a series to be announced this week to revive the U.K. banking industry. RBS reports on Thursday and, alongside JPM’s Investor Day, will be our primary focus in terms of timing a catalyst on marked to market, banking regulation, transparency, etc…

Matthew Hedrick

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I have communicated three main concerns about RRGB’s business model in the last year or so. First, I thought the company was continuing to grow too fast. Second, I was concerned about the company’s increased contribution to its national advertising fund as management would never quantify the return being generated from the company’s investment. RRGB’s campaign focused only on brand-building advertising, which is never as effective as promoting products at specific price points. Additionally, the expense associated with a national T.V. advertising campaign does not seem warranted for a 400-unit restaurant company. Third, I was bothered by the company’s capital allocation decision to borrow money to buy back stock. RRGB spent $50 million in FY08 to buy back about 1.5 million shares at an average purchase prices of $33.76 while increasing its debt by nearly $70 million.

RRGB addressed all of my concerns on its earnings call last week. The company lowered its FY09 new unit growth to 13-14 new units, down from its initial guidance of 20 and cut its FY09 capital spending expectations by more than 45% from its FY08 level. Management also stated that it has not yet made any decisions about its development plans for FY10, which highlights that the company recognizes the need to be cautious in this environment (20% company-operated unit growth will no longer yield the necessary returns).

The company also announced its intention to lower its contribution to its National Advertising Fund to 0.25% of restaurant revenue in FY09, down from 1.5% in FY08, which depending on sales could result in a $11 million reduction to FY09 marketing expenses. Specifically, RRGB does not plan to run any national cable advertising. Management justified this decision, saying “In the second half of 2008 while we continued our brand building campaign on national cable TV we began to see a slowdown in incremental traffic so to help form our 2009 plan we tested both pricing and product news on TV in two markets in Q4. Based on this test and the overall results of our advertising in the second half of 2008 we concluded that in this current economic environment it would be more prudent to capitalize on the awareness gains and focus our marketing dollars on more targeted traffic driving and retention initiatives in 2009.” Although I am not sure whether the company’s advertising was ever yielding the necessary returns, I am encouraged to see that the company was evaluating the effectiveness of its marketing spend and decided to lessen its investment at this time. Going forward, the company is going to allocate more of its marketing dollars to its national online advertising and loyalty initiatives.

Regarding share repurchases, RRGB still has a $50 million authorization in place and said that it may make opportunistic purchases of common stock in FY09. The company does not, however, plan to increase its debt to execute these share repurchases. Instead, management stated that it expects to use its free cash flow to pay down outstanding debt during the year.

RRGB, like its competitors, will continue to face margin pressure in 2009 as it expects both same-store sales and traffic to remain negative. Due to the uncertainty around sales, the company decided not to provide either FY09 sales or earnings guidance. That being said, in this environment, it is encouraging to see companies that are working to manage the things they can control and RRGB seems to finally be heading in the right direction on that front.

Barney’s In Credit Penalty Box?

Credit is drying up for Barney’s. It’s on the block, but price expectations need to come down to Earth. Indirect impact on vendors is a greater consideration than a near-term hit.

Rumors are swirling in the industry that the Factors (intermediaries facilitating frictional credit between retailers and suppliers) have put Barney’s in the penalty box and stopped approving Spring orders. Unfortunately for Barney’s, this is usually a self-fulfilling prophecy in that once ‘payment issues’ are the topic du jour, it usually ends up impacting product flow and business to a greater degree.

I’m not sure if the issue here is solvency. In fact, since Istithmar (Dubai’s government-funded investment arm) bought Barney’s from JNY in 2007, it has underperformed, but remains profitable. The issue is that there is no CEO, and Istithmar is trying to sell Barney’s for a price in the vicinity of the $942mm it paid JNY in July 2007.

Guess what Istithmar… the 14x EBITDA you paid in mid-2007 before the credit crisis is a lot different from where such an asset would be priced today. You should know this -- $75 oil helped fund your mid-’07 purchase when you outbid Japan’s Fast Retailing. Not as much to bank on after a 45% slide in oil, a 2-3 point slide in margins, and weaker sales on the margin. I’d need to assume a high teens multiple no for anything close to $1bn. Sorry… no can do.

Fortunately, no vendors are overly exposed to Barney’s. Most of the companies dependent on Barney's listed in public documents (per Cap IQ) are systems and software-related. But Barney’s is an important ‘showcase’ account. For example, Timberland had a big win when it got a pair of its lux boots sold in Barney’s last year. This creates a halo effect for the brand. Saks is not exactly knocking the cover off the ball either. I don’t like seeing fewer showcase locations. If Barney’s situation gets worse, this will definitely nudge some companies into evaluating how they approach brand positioning.

An important consideration is if that Barney’s credit issues are solely because of uncertainty around its future ownership – but as a stand-alone retailer it remains a viable entity (quite possible), then this could be an opportunity for those retailers with solid balance sheets (i.e. RL) to pick up a few points of share by working with Barney’s during this period.

Slum Dog Short Seller

“Courage is being scared to death, but saddling up anyway”
-John Wayne
Short sellers can be scary, particularly if they are the kind with real capital that don’t know what they are doing. Some short sellers know exactly what they are doing – trying to scare people to death with their narrative fallacies. Don’t be scared of them – they are Slum Dogs, and you can make a career for yourself in this business picking them off.
As sad as this is to say, making stuff up is actually an investment process that some market participants use, daily. If you have no moral compass, and the SEC isn’t going to regulate your slumming tactics of fear mongering, heck … why not keep doing it? Well, as one of our clients said to me on Friday, “these raccoons all have a plan, until someone punches them in the face.”
I am a proactive risk manager and short seller, and I have had to endure these Slum Dog Short Sellers for the better part of my career. The difference between my last 10 years in this business and now, is that now I have a platform by which I can shine a flashlight on them, publicly, when they are slumming in the garbage cans of information transfer. As I wrote in Friday’s missive, “it’s time to drop the gloves.” I’m saddling up for this fight, and while I am scared of socialization, I am not scared of raccoons.
On Friday I dropped the mitts with the Slum Dogs at 1:21PM EST, and posted a real time note to our clients to “Buy SPY, with the SP500 at the 754 line.” Now call me a knucklehead hockey player or call me right – that turned out to be both the low of the day and of the year to-date. I sincerely hope that those Slum Dogs who were floating their shameless rumors and pressing their shorts in Citigroup on that line doubted the power of The New Reality.
This market needs leadership. This market needs a voice. That voice can be Chinese, Arab, or American – global markets are as interconnected as they have ever been, and collaboration amongst the uncompromised is going to get this done right.
Despite the Slum Dogs shopping their short thesis’ into the US market close, Asian markets charged higher last night, reminding us that there are new Chinese leaders in town. China was up another +2%, taking the Shanghai Stock Exchange to +26.6% for 2009 to-date. How is that short China “because they lie and make up the numbers” thesis treating you this year Mr. Slummer? Isn’t it annoying when someone who is lying like you are is crushing the short side of your P&L? Or are they lying? Inquiring and accountable minds want to know…
Asian governments also took slum lord matters into their own hands over the weekend and, with China’s leadership, established a massive $120 billion dollar Asian Currency Pool. After seeing Asian currencies hit 3-month lows last week, this proactive risk management move makes sense. Remember, China owns both her own cash and liquidity at this stage of the game of global economic power re-balancing. China is doing what she needs to do, when she needs to do it – she is controlling her own destiny, and with our being long China via the CAF closed end fund, I support her message.
In the Middle East, they rang the short squeeze sirens in the United Arab Emirates last night, taking the Slum Dog Short Sellers for a little visit up on top of one of their monstrous buildings, giving the perpetrators of storytelling a peek over the ledge. Like the Chinese, the UAE decided to take matters into their own hands and lend Dubai a cool $10 billion at a 4% rate – I bet the Pandit Bandit wouldn’t mind some of them petrodollars – no regulation strings attached! The UAE’s stock market is trading up +7.9% so far this morning – leadership matters…
Saudi Arabia’s stock market is also trading higher in the face of what looks like a bottoming process in the price of those petrodollars. I had been buying oil for the last few weeks and stating my case against the Slum Dogs that buying oil under $38/barrel gets we un-compromised American capitalists paid. Despite all of the manic media’s noise about gold last week, oil actually outperformed gold on a week over week basis. Gold was +5.6% for the week, while oil was +6.7%. This has not happened for a long time. This doesn’t fit the narrative fallacy of the Slum Dog momentum trader either – oh what is a raccoon to do when that light is shining in his face?
For the immediate term “Trade”, I am long oil and short gold. On an intermediate term basis, gold is bullish and oil is bearish – so why trade? Trading is the only means of survival in this market, and it’s also the best way to pick off the Slum lords and Slum Dogs of the land without moral compass. Is it a battle in these trading trenches? You bet your Madoff it is  - and I am signed up for it. Gold is trading down -1.5% so far this morning, and oil is up again, testing $41/barrel – game on!
My downside target for the SP500 remains a higher low versus the November 20th low of 752. I have put my money where my mouth is and taken my cash position down to 58% versus the 64% position I was carrying into Friday’s open. I have a 21% position in US Equities, and I am Long America, for a Trade. I am short gold and short the Slum Dog Short Sellers, at a price.
Best of luck out there today,


Slum Dog Short Seller - etfs022309

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