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Gold: A Victory Lap

Takeaway: We update our bearish bias on gold with a contrarian analysis of the fundamental drivers of this asset class.

This note was originally published December 14, 2012 at 15:41 in Macro

(Editor's Note: As you can see in the published date above, we were well ahead of consensus on the collapse of Gold. That's the beauty of being #TimeStamped. We have been The Gold Bears the whole way down. For the record, Hedgeye Risk Management hereby reiterates our Short call. So, all of you knife catchers out there ... consider yourself warned. Please note the chart below highlighting the huge collapse since Hedgeye made our call. It is the only addition to this original commentary.)

Gold: A Victory Lap - Beware Bear

SUMMARY BULLETS:

  • Gold remains a crowded long for a variety of very obvious reasons – one of which could become less supportive, at the margins, on a sustainable basis.
  • In the note below, we thought we’d take a stab at how a core component of the bull case (i.e. central bank diversification) can come unwound over the long-term TAIL. It’s very important to note that we’re not positing this as the only factor driving the market price of gold; nor are we necessarily suggesting that this is a thesis to run out and short gold today with. Rather, we are offering intellectual ammunition to understand what’s likely going on behind the scenes in the event gold continues to make lower-highs over the intermediate-to-long term.
  • Sustained weakness in the JPY and EUR along with a diminished EM central bank purchases of gold (relative to investor expectations) could provide the necessary lubrication for a sustained USD rally and lower-highs in the price of gold over the long term.
  • All told, we think investors should consider reducing their allocation to this asset class. At a bare minimum, it would be prudent for gold bulls to confirm whether or not our TAIL support ($1,669) holds before increasing exposure to gold here. If $1,669 breaks, there’s no true support to the prior closing lows.

 

Gold is widely loved and probably over-owned – at both the institutional and sovereign level. Having appreciated in value for 12 consecutive years with a CAGR of 16.4%, the bull case on gold is well understood by just about every market participant.

 

This is true from traditional L/S equity hedge fund managers all the way down to retail investors, as ETF volumes have been the only thing mitigating the precipitous decline in physical gold demand. The latest data from the World Gold Council (3Q12) showed overall demand had declined -11% YoY from the all-time peak in 3Q11, with every category posting a contraction except “ETF & similar”:

 

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It’s not surprising to see demand for physical gold peaked when the price of hit an all-time peak of ~$1,900 early in the quarter.

 

Gold: A Victory Lap - 3

 

We’ll hold off on the discussion on gold supply, as we firmly believe PRICE eventually leads supply in most, if not all commodity markets. For example, if the price of gold rips to the upside, gold miners will likely follow the move by instituting aggressive E&P plans. If the gold price were to plummet, many producers will struggle to operate their mines above the cost of capital and will eventually curb production. Anything in between probably equates to a status quo level of supply growth.

 

Going back to the point we made earlier about the bull case being deeply penetrated, we thought we’d take a stab at how a core component of the bull case (i.e. central bank diversification) can come unwound over the long-term TAIL. It’s very important to note that we’re not positing this as the only factor driving the market price of gold; nor are we necessarily suggesting that this is a thesis to run out and short gold today with. Rather, we are offering intellectual ammunition to understand what’s likely going on behind the scenes in the event gold continues to make lower-highs over the intermediate-to-long term.

 

THE KNOWN-KNOWNS

Gold has ripped for over a decade as central banks increasingly diversified out of the primary world reserve currency and into other, more credible currencies, as well as other assets like SDRs and Gold.

 

Gold: A Victory Lap - 4

 

Gold: A Victory Lap - 5

 

We hold the view that credibility within the FX market is 100% relative and ever-changing. The management of foreign exchange is a 24-hour-per-day phenomenon that is consistently anchors on incremental data. Below, we focus specifically on the US because gold and other internationally traded commodities are priced in and settled in USD.

 

For 10+ years, the stream of incremental data has been a general headwind for the credibility of America’s currency, largely in the form of loose fiscal POLICY and dovish monetary POLICY. That confluence of weak POLICY has created an egregious amount of international money supply that has inflated international reserve assets across both the developed world and non-developed world. Initially, the price of gold appreciated w/o much of a shift in global central bank demand. That changed in 2004 when the confluence of the world’s reserve mangers started to accumulate gold at a rate commensurate with the rate of incremental foreign exchange accumulation. Since 2008 (not ironically when QE1 was introduced), however, they’ve been accumulating gold at a faster rate than incremental FX.

 

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Gold: A Victory Lap - 7

 

THE LESS-KNOWN KNOWNS

The first major run-up in gold (2004-2008) was occurred as DM central banks began favoring gold over incremental foreign exchange, at the margins. The second major leg up in gold prices came as EM central banks began to do the same (2008-present). This is where the real “juice” likely came from, as EM central banks have increasingly held the lion share of international reserve assets.

 

Gold: A Victory Lap - 8

 

The latter point is super intuitive, given that EM economies, on balance, have tended to be more manufacturing and export-oriented in nature (think: China). Additionally, EM central banks have likely aggressively accumulated large amounts of foreign exchange (in lieu of gold, at the margins) over the last 10+ years to resist appreciation pressure on their currencies (think: Chinese yuan and Brazilian Finance Minister Guido Mantega’s “Currency War”).

 

For reference, Switzerland has been doing exactly this (i.e. accumulating foreign exchange at a rate faster than gold) for the better part of 30 years, as the SNB has semi-perpetually combated the specter of a secular loss of competitiveness – which is a real threat given the country’s +42.9% real exchange rate appreciation over that duration. The CHF’s de-facto ceiling vs. the EUR is yet another example of the Swizz central bank being forced to accumulate incremental FX, lest the country suffer the perceived consequences of having a strong currency amid the international “race to zero” in today’s “Beggar Thy Neighbor” global economy.

 

Gold: A Victory Lap - 9

 

That brings us to our final point, which is really a question:

 

Can EM central banks ever really accumulate that much gold – especially relative to consensus expectations that they are poised to be big players in that market in perpetuity?

 

There seems to be little political will across the developing world to allow for any dramatic currency appreciation – especially with global GROWTH likely tracking in the +2-3% range for the foreseeable future. This means EM central bankers will continue to be forced to daub up large amounts of fiat currency over the long-term, absent a phase change in the global monetary POLICY landscape.

 

In light of this, it’s important to note that the People’s Bank of China (a key player in the FX reserve accumulation sphere) now views the yuan at/near an “equilibrium level” and they have been using their USD/CNY reference rate as a tool to temper appreciation pressure emanating from the market for several months now. Incremental Polices To Inflate out of DM central banks will force them to accelerate their pace of foreign exchange accumulation if they are going to resist upward pressure on CNY exchange rates from current levels.

 

What’s new across developed markets is the political will for the Europeans and the Japanese to pursue incrementally aggressive currency devaluation strategies over the intermediate-to-long term. Keep in mind that we haven’t even seen the ECB really go to town w/ unsterilized bond purchases and that the BOJ’s balance sheet is poised to expand to new heights in a variety of experimental manners under the pending LDP regime.

 

In short, we think Japan faces the risk of a currency crash (peak-to-trough decline > 20%) over the next 12-18 months. Moreover, unless Europe has been magically fixed (are the Greek and Spanish unemployment situations even “fixable”??), the EUR is likely to continue making lower-highs over the long term. In the eyes of the world’s central bankers, the perceived credibility of the JPY and EUR are likely to be materially eroded over the long term, which, on the margin, is positive for other countries’ currencies to the extent they are credible candidates for international reserve management.

 

In the aforementioned Global Macro scenario, could we see the USD grind higher against a broad basket of currencies over the intermediate-to-long term? Absolutely – especially if US fiscal POLICY starts to get hawkish on the margin (think: Fiscal Cliff). Perhaps that’s why the US Dollar Index is down less than 100bps YoY, despite the Federal Reserve kicking the ZIRP can down the road 3x in the YTD and instituting perpetual QE – twice in the last three months!

 

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If one is bearish on the US Dollar from here, we can’t even begin to fathom what their next catalyst is, given the USD’s resilience in the face of all that…

 

In the past, strong USD has been really bad for gold (early-to-mid 1980’s and late 1990’s). The most recent period of sustained USD appreciation came on the strength of the Balanced Budget Act of 1997, so it’s critically important to avoid underweighting fiscal POLICY as a factor for the market price of America’s currency. If Congress and the White House can figure out a way to resolve the Fiscal Cliff in a sustainable and effective manner (a really big “if”), we could see the US Dollar Index approach the high 80s/low 90s level over the intermediate term. That would not be good for gold.

 

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Our quantitative risk management levels for Gold are included in the chart below. If $1,669 breaks, there’s no true support to the prior closing lows. That’s something to think about as you ponder, “Who’s the incremental buyer of gold from here?” For some, that question sounds more like, “Who can I offload my gold to if and when I want to head for the exits before the crowd does?”.

 

Gold: A Victory Lap - 12

 

Gold remains a crowded long for a variety of very obvious reasons – one of which could become less supportive, at the margins, on a sustainable basis.

 

Darius Dale

Senior Analyst


MKC – QSR and Industrial Weakness Continue

 What we liked:

  • Q2 2013 EPS was in-line with consensus at $0.61
  • Consumer business segment remains strong with 3.9% revenue growth: solid emerging market performance from Russia and Poland and sustained developed market performance from the UK and France
  • Integration underway with acquisition of Wuhan Asia Pacific Condiments (WAPC), completed on May 31, 2013, to complement its portfolio and expand its geographic presence in China  
  • With the addition of WAPC, MKC increased its projected FY 2013 sales growth by 1 percentage point, and now expects to grow sales 4% to 6%, yet will take a hit on EPS (see below)
  • Positive inroads in India (currently only 5% of sales vs China at ~7%)

What we didn’t like:

  • Q2 Revenues missed consensus, $1.00B vs $1.01B, or 1.9% year-over-year vs 2.3% consensus
  • Gross Margin fell to 39.3% vs expectations of 39.8%
  • Industrial business segment remains challenged, down 1% in the quarter  
  • FY 2013 EPS guidance revised down to $3.13-3.19 versus prior $3.15-3.23
  • EPS guided lower on $4M of WAPC transaction costs and lower Industrial demand from quick service restaurants in North America and China (both markets have seen GDP forecasts guiding lower in recent weeks) and a chicken food scare
  • Flow through of a higher tax rate year-on-year and retirement benefit expenses should weigh on EPS results

Our Levels:

  • MKC is trading above its immediate term TRADE and intermediate term TREND lines from our quantitative set-up.

 

MKC – QSR and Industrial Weakness Continue - ww. mkc

 

We are cautious on the stock over the next two quarters.  MKC continues to see strong momentum in its Consumer business (mid single digit growth), whereas most CPG are running consumer sales in the 1-2% range. However, its Industrial business will continue to drag for at least the next quarter as lower demand from QSR in North America and China persists, and therefore we see headwinds in the company attaining its Q3 guidance for EPS of $0.78 (comparable to the year-ago result). Broadly, slowing global demand, particularly in the U.S. and China, should continue to weigh on a consumer that is undecided in trading up to a branded spice product.  Longer term, we like the acquisition of WAPC to drive market share (despite the competitive space), and expect tailwinds from improved demand from QSR and a chicken scare in the rear view mirror. 

 

Matthew Hedrick

Senior Analyst


Shame on Bill Gross

Takeaway: The NSA jobs data continues to improve at an accelerating year-over-year rate. The Fed needs to taper. Despite Bill Gross's protestations.

Today’s US jobless claims print (surprising to the upside - again) is the single most important economic data point this week. In particular, how it relates to rising interest rates, which have been hugging non-seasonally adjusted (NSA) rolling jobless claims like a glove over the past six months.


US Employment equals #GrowthAccelerating.

 

Shame on Bill Gross - gross

 

Contrary to what a lot of Macro Tourists may be telling you, yesterday’s Q1 GDP print isn't a forward looking economic indicator. It’s rear-view mirror. NSA rolling jobless claims is what you want to be looking at. Study it. Don’t be a Macro Tourist.

 

For the record, we haven't had bad US economic news (yet). It’s the good news that's been wreaking havoc and wrecking Gold and Bonds.

 

Incidentally, Gold continues to get clobbered. It's in full-blown correction mode. Yet the knife catchers are still out there in full force, despite their peers losing eyes, ears, and lips loading up on "precious" metals. Come on already. As I wrote earlier this week, if interest rates keep rising, gold is going to have a hangover the likes of which we’ve never seen. 

 

It's important to note that 346,000 in claims isn’t a number that ultimately matters – it’s all about the slope of the line in NSA rolling claims.

 

(Click to enlarge)

Shame on Bill Gross - steiner

 

As you can see, NSA jobs data continues to improve at an accelerating year-over-year rate. This is the case on both a 1 week and 4 week rolling-average basis. NSA jobless claims were 9.6% better than at this time last year. It’s a continuation of what we've been seeing.

 

Here’s the unfortunate rub: Fed policy hinges on employment.

 

Now, Bill Gross’ political book pushing aside (Pimco's Grand Poobah just went on record saying "...the 10-year Treasury – may be as much as 35 basis points too cheap. They belong in our opinion at 2.20% instead of 2.55%."), the Fed should be tapering right now.

 

The biggest threat to both American Purchasing Power and sustainable US economic growth remains our unelected, omnipotent Central Planners at the Federal Reserve devaluing our currency. Deal with it.

 

The other risk of course is big bond managers talking up what’s best for their own book, not their country.


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Morning Reads on Our Radar Screen

Takeaway: A quick look at stories on Hedgeye's radar screen.

Keith McCullough – CEO

(My friend) Rob Labritz's amazing shot to make it in to the PGA Championship (via PGA.com)

Yellen Betting Defies 100-Year Jinx of Fed No. 2 Never Elevated (KM note: Scary, scary option … via Bloomberg)

Brazilian protesters clash with police outside stadium (via BBC)

 

Morning Reads on Our Radar Screen - radar

 

Josh Steiner – Financials

Proposed Guidelines Could Require Banks to Raise Billions in Capital (via DealB%k)

FHFA Nominee Watt Faces Senate Skeptics at Hearing Today (via Bloomberg)

 

Jonathan Casteleyn – Financials

Biggest Pension Gap Fails to Deter Illinois Buyers: Muni Credit (via Bloomberg)

 

Brian McGough – Retail

US Boss Held Captive by Workers Leaves China (via CNBC)

 

Matt Hedrick – Macro

Europe’s Richest Person Kamprad to Move Back to Sweden (via Bloomberg)

 

Kevin Kaiser – Energy

Eclipse Resources Acquires The Oxford Oil Company in the Utica Shale (via Fiscal Insider)

 

Howard Penney – Restaurants

McDonald's Becomes #25 Most Shorted Dow Stock, Replacing JPMorgan Chase (via Forbes)

Industry reps detail health care law challenges at Congressional hearing (via National Restaurant Association)


INITIAL CLAIMS: NO IMPACT YET ON THE LABOR MARKET FROM RISING RATES

Takeaway: The labor market improved at an accelerating rate again this week on an NSA basis. Meanwhile, the yield curve has hit 217 bps.

A Steadily Widening Divergence

No real change this week vs. the trend we've been seeing over the last several weeks in claims. NSA data continues to improve at an accelerating YoY rate, on both a 1-week and 4-week rolling-average basis. NSA claims were 9.6% better than at this time last year, and, by coincidence, the 4-week moving average was also better by 9.6%. These represent sequential improvements vs. 7.7% and 9.1% YoY changes, respectively. The bottom line is that the accelerating improvement we've been seeing for the last few months continued last week. We continue to hypothesize that one contributing factor is Obamacare, which is causing high-employment, relatively low-wage industries like restaurants and hospitality to replace 3 full-time employees with 4 part-time employees to stay underneath the 30-hour ACA cutoff. We've been seeing and hearing a fair amount of anecdotal evidence in support of this idea.

 

On the seasonally-adjusted side, the data wasn't bad, but it wasn't great either. Essentially rolling SA claims went sideways again this week - a growing divergence vs. the trend in the NSA data - consistent with prior years. This trend should continue for two more months, when it peaks in August. Thereafter, we'll begin to see the reversal - SA claims data will begin to appear stronger than NSA data and the sector should be very strong in response.

 

The Data

Prior to revision, initial jobless claims fell 8k to 346k from 354k WoW, as the prior week's number was revised up by 1k to 355k.

 

The headline (unrevised) number shows claims were lower by 9k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -2.75k WoW to 346.75k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -9.6% lower YoY, which is a sequential improvement versus the previous week's YoY change of -9.1%

 

INITIAL CLAIMS: NO IMPACT YET ON THE LABOR MARKET FROM RISING RATES - 1

 

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<chart19>

 

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Yield Spreads

The 2-10 spread rose 11.8 basis points WoW to 217 bps. 2Q13TD, the 2-10 spread is averaging 169 bps, which is higher by 2 bps relative to 1Q13.

 

INITIAL CLAIMS: NO IMPACT YET ON THE LABOR MARKET FROM RISING RATES - 15

 

INITIAL CLAIMS: NO IMPACT YET ON THE LABOR MARKET FROM RISING RATES - 16

 

Joshua Steiner, CFA

Jonathan Casteleyn, CFA, CMT


Volatility (Still) Breeds Contempt

Client Talking Points

ASIA

Equities are still all over the place here. Volatility should continue to breed contempt. China was down small (-0.1%) overnight while Hong Kong was up for Day Two of a bounce (+0.5%). Since every major index in Asia is bearish TREND right now, tonight’s move in the Hang Seng will be a very important tell. Failing here? That would be a very bad thing.

EUROPE

We are already seeing European Equities fail after their 2-day no volume bounce. Say it ain't so, but the train wreck that is Greece is actually crashing again. Greece down -2.7% this morning and -29% since May 17th. #Nasty. Spain is another loser down -1% after failing at 7887 resistance (IBEX). Meanwhile, in Germany TREND resistance for the DAX remains intact at 8019.

UST 10YR

It is still all about the speed of the move (higher) on the long end of the curve. Today’s US jobless claims print is the most important (current) US economic data point of the week. Since US consensus still seems afraid of being long growth, it will be interesting to see what another positive surprise in claims would do to stocks (yields up). Of course, if claims miss, stocks could go down on that too.

Asset Allocation

CASH 65% US EQUITIES 10%
INTL EQUITIES 5% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 20%

Top Long Ideas

Company Ticker Sector Duration
HCA

Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road. 

MPEL

Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016. 

WWW

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.

Three for the Road

TWEET OF THE DAY

Bill Gross is officially talking up what's best for his own book, not his country #sad @PIMCO

@KeithMcCullough (commenting on Gross' statement earlier this morning that the 10-year Treasury may be as much as 35 basis points too cheap.)

QUOTE OF THE DAY

Every strike brings me closer to the next home run.

– Babe Ruth

STAT OF THE DAY

Worldwide arms exports are surging, up nearly 30% since 2008, according to a new report from defense analyst IHS Jane's. Weapons exports totaled $73B in 2012, up from $57B four years earlier. Total worldwide defense spending in 2012 was $1.6 trillion. 


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