Viva Deflation! Collapse of the Commodity Complex Accelerating

Takeaway: $USD strength should drive ongoing commodity deflation. The march CPI decline typified this effect.

Yesterday we hosted our 2Q13 Macro Investment Themes call ( you can access the replay info HERE).  Below is a visual review of the 1Q13 strategy playbook from the call:  In short, strong dollar driven energy and commodity deflation is bullish for domestic consumption and negative for commodity leveraged exposure (XLE, XLB, Gold, Brazil, Russia, etc).   We think this theme still has some legs in 2Q13.  


(Prices as of 4/15/13) 

Viva Deflation!  Collapse of the Commodity Complex Accelerating - 1Q13 Playbook


Yesterday’s inflation and housing data typified this dollar based flow cycle and exemplified the macro dynamics we’d like to see persist for us to stay positive on domestic consumption.  While housing starts breached the 1M threshold (note also that this morning’s mortgage applications index printed a new high & remains positive for forward housing activity), Headline CPI declined -0.2% M/M on the back of broad Food & Energy price deflation. 


With the dollar in bullish formation (Bullish across TRADE, TREND & TAIL durations) and the U.S. economic data and forward policy outlook looking okay on an absolute basis and a bit better than okay on a relative basis, we expect the strong dollar - commodity deflation relationship to extend itself further. 


Collectively, Energy and Food represent 24.26% of the CPI index and ~13.4% of personal spending (PCE).   Given the persistent and generally strong inverse correlation between the dollar and Oil/Gasoline and the fact that the commodity settles in dollars, the flow through impact to price is rather direct.  


Ag and Soft commodity prices, however, are hostage to a host of disparate influences that could predominate price trend over a given duration (think dollar strength, speculation, weather, etc).  All else equal, the impact of a strong dollar on food prices should manifest disproportionately across foodstuff categories that are pure commodity with limited branding (no branding or large private label presence) and strong industry competition.


For food categories such as protein or select dairy where these strong dollar leverage dynamics exist (branded is proportionally lower and competition is multitudinous) the impact should be more apparent as price throughout the distribution chain should tend to more accurately and rapidly reflect current input price costs.  We’re seeing some evidence of that in the March report and will continue to monitor the relevant food categories for ongoing impact.      


Viva Deflation!  Collapse of the Commodity Complex Accelerating - CPI Core vs Headline   FE Table


Households spend >$431B on gasoline and motor fuel on an annual basis which equates to approximately 3.8% and 2.7% of total household spending and GDP, respectively.  The idea that lower gas prices support other discretionary consumption is intuitively appealing and stands as perhaps the most accessible example of scalable impact – a single consumer saving $5/wk at the pump is fairly insignificant, but multiplied and annualized across a registered vehicle base of 240 million and the numbers compound to something material rather quickly.


According to FHWA and EIA data, total registered vehicles, total vehicle miles, average vehicle miles per licensed driver and average fuel economy have been relatively stable in recent years.  If we make the simplifying assumption of static totals for those metrics over the 2011-2013 period, it allows for a digestible, if imprecise, estimate of the implied impact of gas price changes on personal income and capacity for other discretionary purchasing.   In short, each $0.10 decline in gas prices from the 1Q13 average level of $3.56 implies approximately $10B in increased capacity for other discretionary purchasing.  On a year-over-year basis, the current national average gas price of $3.52 (vs. a 2Q12 average of $3.70) equates to an ~$18B annualized difference in non-fuel related spending capacity. 


Notably, given the prevailing $USD strength and the accelerating collapse pervading the commodity complex, it appears likely we break the normal seasonal pattern of sequential acceleration in fuel prices from 1Q to the typical annual peak in 2Q.   


This simplified view ignores price sensitivity of demand for gas consumption itself and the marginal propensity for other, non-fuel consumption, but it does provide a tractable framework for viewing the magnitude and direction impact of significant fuel price changes on the capacity for alternative consumer activity. 


Collectively, some measure of housing wealth effect, emergent positive real earnings growth, the resolution of tax refund delays, and a real-time tax cut via fuel and food price deflation should help to buttress consumption in the face of tax law changes and concentrated, sequestration related fiscal drag impacts over the next couple quarters.  


Viva Deflation!  Collapse of the Commodity Complex Accelerating - Fuel Consumption Table


Viva Deflation!  Collapse of the Commodity Complex Accelerating - Ave National Gas Price


Viva Deflation!  Collapse of the Commodity Complex Accelerating - Real Weekly Earnings 041713 


Viva Deflation!  Collapse of the Commodity Complex Accelerating - Housing Wealth Effect


Christian B. Drake

Senior Analyst 


Athletic Sales: Big Week For UA

Takeaway: UA's sell-through numbers continue to look good ahead of what should be a good quarter. Sustainability in FW growth is key issue/opportunity

Quick comment on weekly POS data.

Though aggregate sales trends in athletic footwear and apparel remain fairly consistent, we’re seeing some interesting movement amongst the brands – specifically UnderArmour.


UnderArmour had a monster week in both apparel and footwear – great timing given that it reports earnings on Friday. UA’s apparel sales continue to run at a 30% clip, which is very consistent despite a downtick for the category in general. But UA Footwear clocked in growth over 70% last week per NPD. That’s on top of 40-50% growth in the preceding two weeks. This is the first time we can recall UA’s market share ever being closer to 2% than 1%.


It’s been our view that UA will need to step up its SG&A dollars in the back half to achieve the kind of growth (footwear and international) that investors are paying for. If the company can hang on to the growth rate we’re currently seeing in footwear for the duration of the year, it will add about 4%-5% consolidated growth to the parent. We’ll be surprised if this is the case – especially given the fact that UA is currently going against its easiest compares of the year (they get tougher in mid-May).


Nonetheless, these numbers can’t be ignored. And with a good print coming up on Friday and excitement around UA’s analyst meeting in June, they’re coming at a good time for its multiple. The sustainability of this growth rate is officially the number one issue we’re focused on right now with UA.



UnderArmour’s Footwear Business Is Having a Great April

Athletic Sales: Big Week For UA - uachart11

Source: The NPD Group


Athletic Industry Sales: Athletic Footwear and Apparel (Trailing 3-week)

Athletic Sales: Big Week For UA - chart111

Source: SportscanINFO, ICSC, The NPD Group, and Hedgeye



Athletic Industry Sales: Athletic Footwear and Apparel

Athletic Sales: Big Week For UA - chart222

Source: SportscanINFO, ICSC, The NPD Group, and Hedgeye


Footwear Market Share By Brand

Athletic Sales: Big Week For UA - chart333

Source: The NPD Group

Tough Spot: S&P 500 Levels, Refreshed

Takeaway: Sometimes my risk management signals front-run what will become my fundamental research views. Sometimes they are head-fakes.

This note was originally published April 17, 2013 at 10:45 in Macro



The research reasons for taking down my gross long exposure into last week’s highs, and not ramping that up (yet) again here on red aren’t there. The risk management signals are. Sometimes my signals front-run what will become my research. Sometimes they are head-fakes.


That’s what makes this 1557 level a tough spot. It’s my immediate-term TRADE line – is it support (Friday and Tuesday) or is it resistance (Monday and Wednesday)? Inquiring stock market operating minds want to know (including my own). I don’t know.


Away from 1557, across my core risk management durations here are the lines that matter to me most:


  1. Immediate-term TRADE resistance = 1601
  2. Immediate-term TRADE support = 1540
  3. Intermediate-term TREND support = 1515


In other words, even if 1557 snaps, we have a big landing area of support (where I wrote a note titled “Buyem” at 1540 a few Friday’s ago). So what to do now? Just wait and watch – I think the market does a pretty good job telling us where to make the big moves.


#StrongDollar, Down Gold/Oil/Copper is a fantastic pro-growth research signal for Consumption assets. Our Q2 Global Macro Themes deck goes through the research views on that. This note is all about the risk management levels, what I am thinking right now, and why.


Tough Spot: S&P 500 Levels, Refreshed - SPX

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CAT: Why Consensus Is Coming Our Way

Takeaway: Looking for slower growth or small declines in resources-related capex is inconsistent with history and logic. That may be bad news for CAT.

CAT: Why Consensus Is Coming Our Way



Resource-related Capital Investment Cycle:  When commodities rise sharply, resources-related capital spending ramps quickly to bring on additional supply.  A subsequent flattening or decline in commodity prices can bring resource-related capital spending back to trend levels – typically not far above maintenance levels, since the industries are generally mature.  Currently, resources-related capital spending is very high following 100+ year outlier gains in many commodity prices, like iron ore, copper and gold.


CAT: Why Consensus Is Coming Our Way - 1qq



Expect Very Large Declines:  Some are looking for slower growth or small declines in resources-related capital spending.  That expectation is inconsistent with history and logic.  As the chart above shows, resources-related capital spending declined 80% over a five year period following peak orders in the late 1970s.  CAT posted very large losses in the early/mid 1980s, in part as a result of this readjustment.  As the chart below shows, a return to slow output growth levels of capital spending (approximated by depreciation and amortization) would bring a ~70% decline in capital spending at large miners.  Mining is not a growth industry.  In the long-run, capital spending should be expected to approximate DD&A.


CAT: Why Consensus Is Coming Our Way - 2qq



Resources Capital Equipment Is Where CAT Makes Money:  Approximately three-quarters of CAT’s 2012 operating income was derived from Resource Industries and Power Systems.  Both of those divisions are heavily exposed to resource-related capital spending.  Resource Industries counts sales of mining equipment to coal, copper, iron ore and gold mines as its largest end-markets.  Power Systems sells locomotives to mines and railroads, power generation systems to mines/resource companies and power plants, turbines to gas compression and energy extraction sites, and other end markets.  Picturing the impact of a 50% decline in resources-related capital spending (not at all unlikely in our view) on the operating income of CAT does not require much imagination.


CAT: Why Consensus Is Coming Our Way - 3qq



Value Traps:  CAT, Komatsu and other diversified resource-equipment suppliers are likely to look cheap on multiples for years to come.  They will go down and investors will buy them thinking they are values, only to find that results weaken yet further.  Beware the low PE in cyclicals – it is frequently a sign of a cycle peak or decline. 



To listen to the Q2 2013 Macro Themes Conference Call hosted yesterday afternoon by the Hedgeye Macro Team, led by CEO Keith McCullough, please CLICK HERE (in order to access the replay you will need your login information.) To view the presentation that accompanied the call CLICK HERE.


If you are having trouble accessing this replay or would like more information contact .




#GrowthAccelerating: After a positive growth inflection in the U.S. macro data to start the year, the key risk management consideration from here is whether domestic growth can accelerate in the face of seasonal and fiscal policy headwinds. Alongside strong dollar benefits to discretionary demand, labor market, housing, and birth trends should remain supportive of consumption over the intermediate term. 


#StrongDollar: It all starts and ends with the Buck. We see a stronger U.S. dollar deflating Bernanke's commodity bubbles which should boost U.S. consumption. In particular, we highlight a bullish set-up for the USD versus the EUR and JPY.


#EmergingOutflows: Consistent with our call for continued U.S. dollar strength and commodity deflation, we think the very early innings of the next round of emerging market crises is upon us. Sustained USD appreciation exposes EMEs to a variety of economic risks that asset allocators have not had to appropriately discount for over a decade.

Consumption Is The Name Of The Game

What drives global growth? An uptick in consumption. What drives consumption? Downward pricing pressure in commodities. Commodities have been overbought for some time but this week, they came screeching to a halt as investors around the world sold off things like corn, wheat and gold. The Consumer Discretionary SPDR (XLY) and Consumer Staples SPDR (XLP) ETFs are having a ball, up 11.8% and 11.2%, respectively, over the last six months. These ETFs will benefit from the breakdown in commodity prices which helps drive global growth. Definitely worth paying attention to.


Consumption Is The Name Of The Game - XLYXPLY



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