“Keep away from people who belittle your ambitions. Small people always do that, but the really great make you feel that you, too, can become great.”
The quote at the top of this note is certainly true for my experiences in life. Every time I have met someone who has truly succeeded, whatever their domain, I’ve noticed they do their best to encourage others on the path to success. In the past week, I had a very good example of this when I met Senator John McCain.
Now setting aside your political affiliation, I think it is fair to say McCain has been one of the more successful politicians of this generation. In this instance, I met him briefly in a small T.V. studio as he was going on to do a clip for CNN and I was waiting to go on for CNBC. As we waited, he wolfed down a bag of chips, hopped on and off various calls, and planned out his town hall appearance in a small Arizona town for later in the day.
So, yes, at 76 years of age and after 26 years in the Senate, McCain is still grinding. Therein lies the point of greatness and great people, they understand that the path to success is based on hard work and repetition. Investing in the public markets epitomizes this idea.
The one market that has belittled us as of late is China. Chinese equities remain one of our top long ideas, but as my colleague Darius Dale wrote in an update on the idea on Monday some of the recent economic data from China does give us pause. Specifically, industrial production, fixed asset investment and aggregate financing (a driver of money supply) were marginally below expectations and saw sequential declines.
Now to be fair, many of these economic metrics are showing year-over-year growth rates, that relative to the rest of the world, are outstanding. In the Chart of the Day, we highlight this by showing Chinese Fixed Asset Investment for the last three years. As the chart shows, in the most recent period fixed asset investment was up 21% year-over-year and remains well off its lows.
As it related to fixed asset investment in China, as the chatter out of China over night is that Shenzhen may implement a price cap at every housing project within 2013. This pressure on Chinese property stocks was then compounded by the fact that Governor Zhou of the People’s Bank of China said he is on “high alert” in regards to inflation. So the belittling point on China is that while growth remains relatively strong, the outlook for inflation and policy (the other two key factors in our country models) are more belittling to discern.
An investment asset class that has been less belittling for us to analyze recently is gold. Yesterday, my colleague Christian Drake wrote a note titled, “Gold: Anatomy of a Breakdown”. The breakdown of gold has been a key asset call on the back of our view that global growth is stabilizing. This hasn’t been a popular call as many institutional investors have been over allocated to gold based on the idea that as growth decelerates, expectations for future QE rise, the dollar depreciates and investors flock to gold as protection against further dollar debauchery.
The reality of the interplay above is that both the dollar and gold are large driven by economic data versus expectation and the view of future monetary policy. As the note emphasized:
- Gold versus Federal Reserve Balance Sheet: The correlation between Gold and the Fed’s Balance Sheet is strong across durations with an R^2 = 0.92 over the last 14 years. If you think this relationship makes common and economic sense (we do), a deceleration and unwind of policy (or the expectation for) on the back of an improving growth outlook is a decidedly bearish catalyst for gold;
- Gold vs. Dollar: Gold’s Inverse correlation to the dollar has been moderate-to-strong across durations. Gold is levered to the USD directly given that gold generally settles in dollars, and indirectly via expected inflation and policy impacts on fiat currency value. Correlations aren’t perpetual – they build and decay - but when they start to tighten alongside other relevant/corroborating factors, it’s generally worth paying attention. Gold’s 30D correlation to the dollar is currently -0.90;
- Gold - CFTC Data: Bullish Speculative positioning looks like its capitulating as net length in combined non-commercial futures & options contracts has collapsed since November. It hasn’t paid to speculate on the end of the world (again) as extremes in bullish positioning (>1STDEV) have been followed by negative subsequent price performance in gold 100% of the time over the last year. Net length is currently down ~62% from the late 2012 highs; and
- Gold ETF Flows: Gold flows to the GLD and ETFs in aggregate, have rolled over since the beginning of the year and have accelerated to the downside over the last month. For example, total Gold Holdings in the SPDR Gold Trust (GLD) are down ~114 Tonnes (-8%) from peak 2012 levels according to Bloomberg data.
The summary of the points above are that gold will go down for exactly the same reasons it went up – slow growth and loose monetary policy. So if the dollar continues to strengthen and growth continues to stabilizes, the record outflows from gold ETFs will only continue. Thus as Mark Twain wrote:
“Moralizing, I observed, then, that "all that glitters is not gold."
Our immediate-term Risk Range for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $109.02-110.78, $82.36-82.97, 93.76-96.82, 1.96-2.09%, 11.21-13.83, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on February 27, 2013 for Hedgeye subscribers.
“Not this week, thank God.”
-Dwight D. Eisenhower
That’s what the President of The United States said to one of his senior advisors “with beads of sweat on Eisenhower’s forehead during the tense debate over whether and when to intervene” in Vietnam in 1954. (Ike’s Bluff, pg 131)
As many of you know from your risk management experiences, it’s what you don’t do under pressure that often defines your performance. “Eisenhower was an expert in finding reasons for not doing things recalled Andrew Goodpaster.” (pg 130)
That’s why I study the history of great leadership. It helps me empathize with and learn from what Teddy Roosevelt called “the struggle” of other men and women when they were under pressure. It also gives me confidence in making decisions. That doesn’t always mean I’ll make the right call. It just means I’ll have known why I made it.
Back to the Global Macro Grind…
Eisenhower’s legacy is that he didn’t let the French suck US casualties into Vietnam in 1954. He also avoided playing the end of the world card (releasing the bomb) during a time when plenty of Americans had US politicians (LBJ) freaking them out about outer space.
If the world ended this morning, I am pretty sure A) I wouldn’t be writing this and B) you wouldn’t be reading anything else. So, with that in mind, and the entire manic media focused on what is so 2010-2011 (Italian Bond auctions), what happened?
- Italian Bond Auction was better than “expected”, so bond yields fell, making another lower long-term high
- Italian Equities stopped going down right at our immediate-term TRADE oversold signal of 15,511 (MIB Index)
- US Equity Futures held onto yesterday’s gains; the 2nd up day in the last 3 (+4.9% YTD)
I’m not trying to be complacent about Italy’s economic risks (just don’t be long Italy, and get over it). I’m well aware of what Eisenhower himself coined as The Domino Theory. We made this call on Europe around this time in Q1 of 2010 don’t forget. It’s 2013, and we don’t see Italy being the domino that knocks down our bull case for Asian and US Equities right now.
That could change. The plan is always changing. And when it does, I’ll be the first to let you know. But, for now, let’s focus on doing more of what we did when people were freaking out about Congress at the end of December:
- Buy Asian (China and Singapore) and US Stocks (EWS, CAF, XLF)
- Short US Treasuries (TLT)
- Short Japanese Yen (FXY)
Why buy American instead of Italian?
- US #Housing is ripping (New Home Sales shocked the bears to the upside yesterday with inventory falling, again!)
- US Employment #GrowthStabilizing (our rolling non-seasonally adjusted jobless claims model continues to be bullish)
- If you have to choose between a criminal, comedian, and Congress, I’d actually choose Congress
Yep, that’s how sad and embarrassing Italy’s #PoliticalClass has become. And neither France nor Japan are too far behind them.
So, if you are shorting Treasuries, can’t buy European or Japanese Sovereign Debt, and have to buy something else, why not Asian or American stocks? To be clear, I don’t have to buy anything. But when I do buy something, both the signal and research back it.
The last point I want to make this morning is about volatility expectations. I get the front-month VIX is different than the term-structure of volatility’s curve. Looking at expectations, across durations, will amplify my point:
- VIX (front-month) TREND resistance = 17.18, and that was only violated to the upside for ½ a day
- VIX topped on Monday at another lower long-term-high (on DEC28, 2012 the lower-high = 22.72)
- VIX was at 40 in Q1 of 2010 after we were legitimately concerned about European Dominos
As you can see in the Darius Dale’s Chart of The Day, front-month Volatility (VIX) continues to make a series of long-term lower highs as the volume of the manic media’s freak-outs make higher-highs. Think they’ll make the call on the end of the world, together?
If this is just a mini-mania of what you saw in November-December (substitute Italy for US Congress), what is it, specifically, that you have a as a catalyst that would stop the VIX from going straight back down to 12 from here?
It’s not going to 12 this week. I get that. But the VIX is probably not going back to 22.72 or 42.96 (the SEP2011 freak-out) this week either. If I see anything real developing that changes my view on this, I’ll just change my mind. I don’t have to do that yet, thank God.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST10yr, Shanghai Composite, and the SP500 are now $1552-1612, $112.55-116.12, $81.12-82.23, 91.55-94.49, 1.84-1.96%, 2204-2349, and 1486-1512, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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TODAY’S S&P 500 SET-UP – March 13, 2013
As we look at today's setup for the S&P 500, the range is 27 points or 0.93% downside to 1538 and 0.81% upside to 1565.
SECTOR AND GLOBAL PERFORMANCE
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.75 from 1.76
- VIX closed at 12.27 1 day percent change of 6.14%
MACRO DATA POINTS (Bloomberg Estimates):
- 7am: MBA Mortgage Applications, March 8 (prior 14.8%)
- 8:30am: Import Price Index M/m, Feb., est. 0.6% (prior 0.6%)
- 8:30am: Advance Retail Sales, Feb., est. 0.5% (prior 0.1%
- 8:30am: Retail Sales Less Autos, Feb., est. 0.5% (prior 0.2%)
- 8:30am: Ret Sales Ex Auto & Gas, Feb., est. 0.2% (prior 0.2%)
- 10am: Business Inventories, Jan., est. 0.5% (prior 0.1%)
- 10:30am: DOE Energy Inventories
- 11am: Fed to buy $1.25b-$1.75b notes in 2036-2043 sector
- 1pm: U.S. to sell $21b 10Y notes in re-opening
- 2pm: Monthly Budget Stmnt, Feb., est. -$205b (prior $231.7b)
- 10am: House Armed Svcs Cmte panel hearing on effect of CR, sequestration on military personnel
- 10am: House Oversight and Govt Reform Cmte hearing on increasing transparency in federal govt
- 10am: Senate Armed Svcs panel hearing on sexual assault in the military
- 10am: House Appropriations panel hears from FEMA’s Craig Fugate on Hurricane Sandy recovery
- 12pm: Congressional Progressive Caucus introduces budget plan intended to create jobs, reduce deficit
WHAT TO WATCH
- U.S. retail sales probably advanced as job market picked up
- Dell to open investor list to Southeastern amid LBO opposition
- Silver Spring Networks raises $81m pricing IPO at midpoint
- China Cosco said to weigh raising $4.3b from parent
- G4S U.S. govt unit sale has attracted potential bidders: CEO
- STMicro, Ericsson said to fail to find chip-venture buyer
- New York City appeals soda size restriction ruling
- American tax cheats picked off as Swiss adviser mails list
- Venezuelan oil spending may extend decline under Maduro: IEA
- Papal vote in 2nd day as cardinals consider non-Europeans
- Express (EXPR) 7am, $0.74
- Genivar (GNV CN) 7am, C$0.39
- Hot Topic (HOTT) 4pm, $0.27
- Orexigen (OREX) 4pm, ($0.44)
- Vera Bradley (VRA) 4:02pm, $0.57
- Men’s Wearhouse (MW) 5:30pm, $(0.05)
- Summit Midstream (SMLP) After-mkt, $0.25
- Bright Horizons (BFAM) After-mkt, N/A
- Power Corp. of Canada (POW CN) After-mkt, C$0.54
- Alacer Gold (ASR CN) After-mkt, C$0.06
- Northern Property Real Estate (NPR-U CN) C$0.52
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Central Banks Seen Buying More Gold to Help Diversify Reserves
- Stranded Hotel in Australia Emblem of Mining Bust: Commodities
- WTI Trades Near Two-Week High; IEA Trims Oil Demand Forecast
- Rebar Falls to Lowest Level This Year on Inventory, Production
- Soybeans Decline as Advancing Harvest in Brazil Boosts Shipments
- Gold Swings Near March High on Improving Data, Stimulus Outlook
- Wheat Exports From Australia May Climb as Much as 13%, CBH Says
- Palm Oil Stockpile Drawdown to Help Suport Prices, Wang Says
- Oil May Halt at $95 After Rally From Support: Technical Analysis
- Uranium Rally Falters on Japanese Nuclear Delays: Energy Markets
- OPEC Producers Said in Talks to Replace Iran Oil to India
- Marex May Boost Staff as Much as 20% for Growth in Asia and U.S.
- Paris Wheat Heads Toward Bear Market as EU Production Rebounds
- Zinc Rises on Speculation China to Further Loosen Rate Controls
The Hedgeye Macro Team
Looking Back to Look Forward
We are taking a page from our prior experience as a dedicated tobacco analyst, recalling the days when litigation threatened the domestic tobacco business at then Altria (combined international and domestic tobacco as well as Kraft Foods).
The argument was that at some point the market was applying a negative value to the domestic business and that even in a worst case scenario (a bankrupting decision against the U.S. business), the value of the other entities would be preserved on the other side of the corporate veil. Further, structural differences in the legal systems outside the United States made the export of any bankrupting litigation unlikely, preserving the multiple associated with the international assets.
We see the situation with Herbalife is broadly analogous, as the current share price reflects some material degradation of the earnings power of the business – with the US business being the most likely source of the decline. We are somewhat less secure in our belief in the case of HLF that consumer protection litigation/regulation can’t be exported outside the U.S. (versus product liability litigation in the case of the tobacco industry), but we believe that the international assets are likely far more secure than the domestic assets in the case that Pershing Square’s allegations prove to have some merit (an open issue, to be sure).
Recall that it is our belief that the Herbalife debate has become too high profile to be ignored by the powers that be – the FTC, SEC any of the State Attorneys General. We see some sort of investigation as highly likely, an event that the market will not likely treat kindly.
Consensus EBITDA estimates for 2013 EBITDA are $794 million (7.9% growth versus 2012) – of that number, we estimate that nearly $190 million in EBITDA will be generated in the United States (23.5%). It’s a bit of a chore to get to EBITDA by region and the company’s disclosures could certainly use some improvement – we agree with Pershing Square in that regard.
The company’s average forward EV/EBITDA multiple since 2007 is 7.5x – applying that multiple to the EBITDA forecast for the company ex-U.S. ($604 million) gets us to a share price of $42.50 for HLF’s business outside of the US, implying a negative value of $1.70 per share for the US business currently imbedded in the share price. At any multiple greater than 7.1x EV/EBITDA for the rest of the world, the U.S. business is “free” as currently reflected in the stock price. We think a multiple closer to 8.5x EV/EBITDA is more appropriate given peers and the growth profile.
We think replacing fear with math is always a useful exercise, and while emotions can drive stock prices beyond where the math would suggest, we think having some sort of analytical framework to look at what is currently being discounted is the best way to be right more often than not.
HEDGEYE RISK MANAGEMENT, LLC
Takeaway: Growth, $USD Strength & incremental Fed hawkishness are bearish for Gold. ETF Flows & CFTC Data are collapsing & USD correlations tightening
This note was originally published March 12, 2013 at 15:47 in Macro
On the other side of our #GrowthStabilzing theme and our bullish TREND view on the Dollar and consumption oriented equities has been a bearish view on Treasuries, Commodities, and Gold.
We’re not self-proclaimed gold experts but we’d argue the fiat currency devaluation hedge underpinning the parabolic gold trade over the last five years has been fairly discrete. In short form, the Gold bug thesis can be adequately described as:
Economic growth stagnates/decelerates further --> Expectations for further QE initiatives rise --> $USD Depreciates --> Gold rises as investors discount erosion in the currency value and prospective future inflation and seek hard asset stores of value.
Within this framework, both the dollar and Gold become a function of the interplay between reported/expected economic conditions and expectations around monetary policy. When it plays out on a global level, as it has in the wake of the Great Recession, the variable mapping gets more complex and the price action exaggerated but the idea framework is still the same.
Its also important to note strength of the growth-policy-USD/Gold connection is stage or cycle dependent. For example, in the throes of economic or market distress the correlation between the USD & Gold tends to be positive as the safe haven trade plays itself out. However, outside of crisis conditions, fundamentals (growth, interest rates, policy, etc) become the prevailing drivers and moderate-to-strong inverse correlations between Gold and the Dollar have predominated, empirically.
So, as straightforward as we think the bullish case for gold has been is as simple as we think the bearish case that has been playing out currently in gold is. If you buy into the idea that weak growth, unconventionally easy monetary policy initiatives, and investor expectations around forward policy have been the principle drivers of gold price appreciation since 2008, then a reversal in these factors – stable/accelerating growth, a cessation & eventual unwinding of easing initiatives, a strong dollar, & rising interest rates - should serve to drive a correction in Gold prices.
What does the anatomy of that correction look like?
Summarily, it looks like more of what we’ve been seeing in Gold Prices, Dollar-Gold correlations, CFTC data, and gold ETF flows over the last four months – trends we’ve seen accelerate over the last five weeks as the economic data has flashed some upside and the dollar has begun to break out.
Consider the chart below which shows physical gold outflows from the GLD (SPDR Gold Trust) vs. the dollar.
Looking across a host of relevant factors, all of the charts (unsurprisingly) reflect a similar dynamic:
Gold vs Fed Balance Sheet: The correlation between Gold and the Fed’s Balance Sheet is strong across durations with an R^2 = 0.92 over the last 14 years. If you think this relationship makes common and economic sense (we do), a deceleration and unwind of policy intitiatives (or the expectation for) on the back of an improving growth outlook is a decidedly bearish catalyst for gold.
Gold vs. Dollar: Gold’s Inverse correlation to the dollar has been moderate-to-strong across durations. Gold is levered to the USD directly given that gold generally settles in dollars, and indirectly via expected inflation & policy impacts on fiat currency value. Correlations aren’t perpetual – they build and decay - but when they start to tighten alongside other relevant/corroborating factors, it’s generally worth paying attention. Gold’s 30D correlation to the dollar is currently -0.90.
Gold - CFTC Data: Bullish Speculative positioning looks like its capitulating as net length in combined non-commercial futures & options contracts has collapsed since November. It hasn’t paid to speculate on the end of the world (again) as extremes in bullish positioning (>1STDEV) have been followed by negative subsequent price performance in gold 100% of the time over the last year. Net length is currently down ~62% from the late 2012 highs.
Gold ETF Flows: Gold flows to the GLD and ETF’s in aggregate, have rolled over since the beginning of the year and have accelerated to the downside over the last month. For example, total Gold Holdings in the SPDR Gold Trust (GLD) are down ~114 Tonnes (-8%) from peak 2012 levels according to bloomberg data.
This weekend, my brother, a sharp guy and passive retail investor, made the following rhetorical comment (paraphrased) “that jobs number was pretty good….who will be the marginal buyer of gold?”. Good Question.
The bull case for Gold was straightforward and price was reflexive on the way up. Reflexivity, by definition, works both ways and big crowds and small doorways still don't make great bedfellows.
If the growth data can continue to confirm, the USD remains in bullish formation and policy makers (Congress & the Fed) can stay out of the way, we think gold continues to hold some further downside.
In the more immediate term, equities are overbought and Gold/Treasuries oversold. From a quantitative perspective, Trade Resistance for Gold sits ~1.3% higher at $1612 with TAIL resistance up at $1681. If gold fails to recapture those lines on the bounce, and domestic housing and labor market trends remain positive, we’d be interested in playing any strength from the short side. We currently hold no position in gold in our Real-time alerts.
Christian B. Drake
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