Passing the Torch

“To you from failing hands we throw the torch.  Be yours to hold it high.”

-Lieutenant-Colonel  John McCrae


Most of you probably haven’t played for the Montreal Canadiens, but if you had, you would know that the quote above is painted on the wall in the Canadiens locker room.  The idea is that current players are expected to live up to traditions of the past.  The line itself is taken from a poem called, “In Flanders Fields”, which was written by Dr. John McCrae in World War I.


McCrae enrolled at the age of 41 with Canadian Expeditionary Force following the outbreak of World War I.  Instead of joining the medical corps, which he had the option to do based on age and training, he instead volunteered to join a fighting unit as a gunner and medical officer and was immediately sent to the German front in Belgium.


Flanders is a region in Belgium where Germany launched the first chemical attack in the war during the second battle of Ypres.    At the conclusion of the battle, McCrae was inspired to write the poem after seeing the poppies grow on the graves of the dead at Ypres, thus the opening line of the poem, “In Flanders fields the poppies blow.” To this day, Canadians wear poppies on Remembrance Day in memory of those who died while serving in the Canadian military.


Back to the global macro grind . . .


This idea of transition from past to present is one we discussed in great detail on an expert call yesterday with Jim Rickards, the author of “Currency Wars: The Making of the Next Global Crisis”.  The focus of our discussion of transition related to the Federal Reserve. Specifically, what will happen as Chairman Bernanke’s term ends in January 2014?


On a basic level, if Bernanke moves on, whoever comes in to lead the Fed will be burdened with unwinding the most dovish monetary policy in the history of central banking, including the longest run of zero interest rate policy and a quantitative easing  program that is without parallel. Ultimately, the Fed will have to unwind the $3.4 trillion in securities on its balance sheet.  That torch is passed to you Mr. or Mrs. Next Fed Head!


One area in which we would hope to see an improvement from the next Chairman of the Federal Reserve is in economic projections.  In the Chart of the Day, we look at the U.S. GDP growth projections supplied by the Fed going back to the 2010.  Here is the skinny:

  • In 2010, the Fed’s peak GDP growth projection was 3.5%, which missed the actual number by 32%;
  • In 2011, the Fed’s peak GDP growth projection was 3.7%, which missed the actual number by 51%; and
  • In 2012, the Fed’s peak GDP growth projection was 2.7%, which missed the actual number by 19%.

If you didn’t know that economics isn’t a science, well, now you know. 


In terms of improving their internal models, we may just send the new Chairman of the Federal Reserve a Hedgeye dart board and some darts.  On a serious note, the fundamental problem with such shoddy projections is that the Federal Reserve is actually setting monetary policy based on these numbers, which currently involves purchasing $85 billion in securities monthly.  It should be no surprise then that we have market volatility.  


Speaking of central banking induced volatility, the Nikkei had a 7% intraday swing yesterday.  What was the catalyst you ask?  The Bank of Japan’s Kuroda came out midday and said that the “BOJ has announced sufficient monetary easing.”  Obviously, the markets don’t believe him.  Neither do we and therefore we are keeping our short Japanese Yen recommendation in our Best Ideas product.  We are also negative on JGBs on the recent break out above 1% on the 10-year.


No surprise, the Keynesian economic standard bearer Paul Krugman is taking the other side of our research this morning in an op-ed in the New York Times and calling, “Japan the Model”.  Like a fledgling hedge fund analyst that has to defend his position to the seasoned portfolio manager, Krugman finds the facts that best support his case.  We behavioral economists call this framing.


Interestingly, on one hand Krugman is heralding the success of Japanese monetary policy because “Japanese stocks have soared”.  Conversely though, he tells us not to worry about the recent sharp sell-off in Japanese equities when he writes:


“I’m old enough to remember Black Monday in 1987, when U.S. stocks suddenly fell more than 20 percent for no obvious reason, and the ongoing economic recovery suffered not at all.”


You can’t have your cake and eat it too Dr. Krugman!


Our ever savvy Healthcare sector head Tom Tobin offers an alternative thesis to the long decline of Japan’s economy, which is simply that over the last 50 years the population growth rate has been in steady decline.  Not surprisingly, this decline in population growth has correlated very closely with GDP growth.  That’s not our prognostication on the holy pages of the New York Times, but rather the simple math.


The fundamental problem that Keynesian economists who advocate printing to infinity and beyond have is that they can’t explain how printing leads to more jobs and higher employment.  Simply put, that is because debasing a currency doesn’t incentivize companies to invest and hire.  In fact, it does the opposite.


We are happy to continue to trade the market volatility induced by Keynesian economics, but at some point we do hope that the torch is passed on from these charlatans.


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, Weimar Nikkei, and the SP500 are now $1, $101.61-103.92, $83.24-84.29, 101.42-103.69, 1.95-2.05%, 13.11-15.73, 14,271-15,097, and 1, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Passing the Torch - xx. chart of the day


Passing the Torch - xx. VP

Big Game Hunting

This note was originally published at 8am on May 10, 2013 for Hedgeye subscribers.

“They might more than ever in the future engage in hunting beavers.”

-Samuel de Champlain


Samuel de Champlain was most definitely a big game hunter.  On a basic level, he lived from the period of 1574 – 1635, so he had to hunt big game to eat.  On a broader level, he founded the Canadian province of Quebec and was the first person to map the east coast of Canada.  Founding and mapping a large part of Canada is most certainly big game hunting.


In the investment world, this was the week of big game hunting.  Earlier in the week we had the Ira Sohn Conference, which Keith went through yesterday in the Early Look, and now we have the Salt Conference.  And if you aren’t in the hedge fund industry, you probably don’t know what I’m talking about right now!


The Ira Sohn Conference is a charitable conference at which some of the top money managers come and pitch ideas.  Meanwhile the Salt Conference is a for profit conference organized by Anthony “Gucci” Scaramucci at which money managers also talk ideas, for the monetary benefit of the organizers (and the casinos in Vegas!).   Incidentally, Gucci was the nickname bestowed upon him by President George W. Bush.  (When I met President Bush, he called me the much less creative, “Big D”.)


So, what exactly do I mean by big game hunting? Well, in this industry it is when a money manager with some sizeable funds behind him (aka ammo) comes out and pitches a unique investment idea.  More often than not the best and most controversial ideas are those on the short side.   Over time, markets go up so if you are going to pitch a short idea, you are best off doing your homework.


So this morning I’m going to take a break from the global macro grind to talk about a certain big game short idea that we are hunting.  This animal goes by the name of LINN Energy and the ticker is $LINE.  Our energy analyst Kevin Kaiser has been all over this for the past couple of months and last weekend he gained even more notoriety as his work was highlighted in Barron’s.


The indomitable Jim Cramer then attempted to provide the counter argument to Kaiser by bringing the CEO of Linn on to his nightly show, Mad Money.  And it was somewhat apropos from our perspective, as the CEO’s performance in defending himself against our short thesis was a little mad.   You can find that video here:


So what was our take on the interview? Overall, we thought Ellis' defenses were weak, which is not a surprise to us (there aren't any good ones).  No change in our view here - LNCO/LINE is still one of the best sells/shorts in the energy sector today. In the chart of the day we’ve outlined their cash funding needs and  Kaiser’s play-by-play of the Cramer interview is outlined below:


“Jim Cramer: “Are [the bankers advising LINN Energy and Berry Petroleum on the pending merger] saying that [LINE] is worth $18 like Barron’s says?”


Mark Ellis, CEO of LINN Energy: “Absolutely not, Jim.  They’ve done a complete independent analysis; we’ve had three different independent analyses done.  They are all coming in with valuations in the high 30’s to mid 40’s for the Company.  We’ve done our own valuation, it’s in the mid 40’s to as high as $60 per unit depending on how far you go into the 3P reserves.”


Hedgeye:  You are citing the fairness opinions of the bankers that are getting paid to work on the merger?  Really?  We are independent, don’t get paid banking fees from LINN or Berry, and believe that LINE is worth $5 – $18/unit.


Ellis: “Our accounting is in strict adherence to GAAP measures.”


Hedgeye:  We agree.


Ellis: “We’ve been very clear and transparent as it relates to our non-GAAP measures that we use to measure the performance of our business.  And in our most recent 8-K’s we’ve given total transparency in terms of how those measures are calculated.”


Hedgeye:  We disagree.  How LINN excludes the cash cost of put options from “distributable cash flow” by amortizing them through the unrealized loss on commodity derivatives line has neither been adequately explained nor justified (it's complex and most LINE investors don't understand it).  Further, “maintenance capex” is still very much a mystery; we are not able to calculate or estimate this number on our own.  In fact, LINN’s IR team has told us that it’s not possible with publicly available information.  This is hardly transparent.


Cramer: “[Kevin Kaiser] says that ‘LINN can’t keep production flat despite $260MM of capital expenditures, yet the amount of capital spending that is deducted from their definition of distributable cash flow was only $110MM.’  He’s saying that your free cash flow was actually negative $40MM…”


Ellis: “Jim, what you have to understand in our business is that one quarter does not make a company.  One quarter is not the appropriate measure for determining whether or not your maintaining your asset or not [sic].  You have to look at the body of the work over the course of a full year; so I think he’s taking a pretty short view of our business.”


Hedgeye:  This is a weak argument that is not supported by the data.  First off, LINN is a pretty standard E&P company – spud-to-sales times are ~30 - 60 days.  There are no significant upfront costs to be followed by a large increase in production months or years later.  Second, let’s do what Mr. Ellis suggests and look at the Company's performance over a longer duration.  LINN says that maintenance capex should be considered on an annual basis, but let’s look at the last two quarters plus the guidance for 2Q13; this is an instructive exercise because the Company did not close any material acquisitions over these three quarters, so we have three straight quarters of organic numbers.  Production averaged  800 MMcfe/d in 4Q12, 796 MMcfe/d in 1Q13, and management has guided 2Q13 production to 780 – 820 MMcfe/d.  After adjusting the 2Q13 guidance for the Panther divestiture (expected to close on 5/31/13), the midpoint of the 2Q13 guidance is 806 MMcfe/d (by our estimates).  So for three consecutive quarters LINN will have essentially no production growth, and total capex will exceed maintenance capex by $491MM.  "Distributable cash flow” over these three quarters equals $497MM.  In our view, if maintenance capex was anywhere near what it is really costing LINN to maintain production, there would be no distributable cash flow (see table below).


Ellis: "I think many of the facts were misleading.


Hedgeye: Freudian slip?”


If you want to talk to Kaiser in more detail on this name and/or subscribe to his work to get some insight on the next big animal he is going to take down, email


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1441-1479, $100.07-106.05, $82.17-83.12, 98.65-101.78, 1.77-1.88%, 12.12-14.41, and 1610-1642, respectively.


Enjoy the weekend.


Keep your head up and stick on the ice,


Daryl G. Jones

Big Game Hunter


Big Game Hunting - Chart of the Day


Big Game Hunting - Virtual Portfolio


TODAY’S S&P 500 SET-UP – May 24, 2013

As we look at today's setup for the S&P 500, the range is 23 points or 1.00% downside to 1634 and 0.39% upside to 1657.                   










  • YIELD CURVE: 1.76 from 1.79
  • VIX closed at 14.07 1 day percent change of 1.81%

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Durable Goods Orders, April, est. 1.5%
  • 8:30am: Durables Ex Trans, April, est. 0.5%
  • 8:30am: Capital Goods Orders Nondef Ex Air, April, est. 0.5%
  • 8:30am: Cap Goods Shipments Nondef Ex Air, April, est. -0.5%
  • 1pm: Baker Hughes rig count


    • House meets in pro-forma session, Senate schedule TBA
    • 8am: Natl Defense Industrial Assn, Air Force Assn, Reserve Officers Assn hold forum on nuclear, missile defense in China
    • 11am: Sec. of the Air Force Michael Donley and Air Force Chief of Staff Gen. Mark A. Welsh III hold a a media briefing on “The State of the Air Force.”


  • Google said to face new antitrust probe on display-ad market
    • Google said to consider buying Waze
    • Google loses bid to block U.S. imports of Microsoft’s Xbox
  • P&G former CEO Lafley to return, replace retiring McDonald
  • Toshiba, KKR to bid for Panasonic health-care unit: Reuters
  • China, U.S. reach agreement on audit records access: China News
  • Obama nominates 2 U.S. Senate aides as next SEC commissioners
  • 8.2 quake hits Sea of Okhotsk; Sakhalin 2 working as normal
  • German IFO business confidence rises for first time in 3 months
  • BOJ Speakers, BofA, Kerry, French Open: Wk Ahead May 25-June 1
  • U.S. markets closed Monday for Memorial Day holiday


    • Hibbett Sports (HIBB) 6:30am, $1.07
    • Foot Locker (FL) 7am, $0.88
    • Abercrombie & Fitch (ANF) 7am, $(0.05)
    • National Bank of Canada (NA CN) 7:15am, C$1.98


  • WTI Crude Heads for Biggest Weekly Decline in a Month on Supply
  • Gold Traders Most Bullish in a Month After Bernanke: Commodities
  • Soybeans Head for 4th Weekly Gain as China Demand Shrinks Stocks
  • Oil-Fixing Probe in EU Has Platts Wary Trades May Go Under Radar
  • Copper Swings Between Gains and Drops Amid Concern About Supply
  • Gold Swings as Prices Head for Weekly Gain on Stimulus Outlook
  • Cocoa Falls to One-Week Low on Ivory Coast Rains; Sugar Advances
  • Goldman Says Iron Ore Downturn Signals China’s Buyer Power
  • Yuan Gold Trade in Hong Kong Triples as Currency Gains Cut Risk
  • Grain, Cereal Correlation to Oil May Signal Easing 2H Food Costs
  • Earthquakes Raise Operational Risk for Costly LNG Terminals
  • Kingsman Cuts 2013-14 Sugar Surplus by 12% on Brazil, Russia, EU
  • Spring-Wheat Farmers Catching Up Curbs Premium: Chart of the Day
  • Aluminum Fees in Japan Said to Stall Until Abenomics Spur Demand






















The Hedgeye Macro Team












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Central Planning Circus

Client Talking Points


It's one big certified central planning circus at this point with the Nikkei down -3.5% on the lows, up +3.5% on the highs, and closing up +0.89% (that's inside my TRADE resistance line of 15,097 by a relatively wide margin). Get this: the market didn’t like it when the BOJ's Kuroda said “we have announced sufficient easing.” In other words, the market doesn’t think 50 TRILLION in incremental easing is enough! Yes ... we are still short JGBs.


Got Mining Capex Bubble (within the Bernanke Commodity Bubbles)? It's finally playing out in full (currency and stocks) in the "Land Down Under." AORDs -1.6% last night and is now bearish TRADE and TREND in our model, which is new for Aussie stocks (AUD is broken too).


It's been a really bad week for long-bond bulls. Why? Because A) Bernanke didn’t get them paid (despite trying to talk down tapering) and B) the US Economic data (jobless claims and new home sales) continued to surprise on the upside. How long can Bernanke refute economic gravity? I don’t think the market trusts him like it used to. Losing credibility is a problem folks. 2.01% and climbing on 10s.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Decent earnings visibility, stabilized market share, and aggressive share repurchases should keep a floor on the stock.  Near-term earnings, potentially big orders from Oregon and South Dakota, and news of proliferating gaming domestically could provide near term catalysts for a stock that trades at only 11x EPS.  We believe that multiple is unsustainably low – and management likely agrees given the buyback – for a company with the balance sheet and strong cash flow as IGT.  Given private equity’s interest in WMS (they lost out to SGMS) – a company similar to IGT that unlike IGT generates little free cash – we wouldn’t rule out a privatizing transaction to realize the inherent value in this company.  


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. 


With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.

Three for the Road


The LINN $LINE energy management team have been busy little beavers trying to discredit our analysis ... We aren't going away, lads.



"You cannot escape the responsibility of tomorrow by evading it today. -Abraham Lincoln


Current World Population: 7,118,612,000


The Macau Metro Monitor, May 24, 2013




James Packer's Crown Ltd has sold its 10% stake in rival casino operator Echo Entertainment Group Ltd for about 264 million Australian dollars (US$254 million).  The deal surprised the market, because it came just two weeks after Crown secured government approval to more than double its stake in Echo, which rekindled speculation that it was preparing a takeover bid for the owner of Sydney's the Star casino.


The sale diminishes the possibility of Crown launching a bid for its smaller rival by market value, but could clear the way for a takeover bid from Genting Bhd, which already holds 5.2% of Echo through affiliate companies.


Crown's investment in Echo meant that Packer would still have some exposure to Sydney's casino market, even if the government rejects his bid for a gaming floor at Barangaroo.  His decision to withdraw from Echo suggests he is confident of receiving approval for a casino license in Sydney.


A spokesman for NSW Premier Barry O'Farrell said the application process is continuing, with final bids due by June 21. A decision would subsequently be made "as soon as possible" following advice from a government advisory committee.



Yu Yio Hung, a Macau junket operator, said that he would like to see the creation of a formal blacklist of VIP gamblers who fail to repay their credit.  Yu said “I’d like to see the setting up of a database – a blacklist database – so that if a VIP customer has an unpaid balance and therefore an outstanding debt, all the junket operators will know about it so that the player cannot then borrow more money from other junket operators and go bust”.


The 27-year veteran of Macau high roller operations, runs a junket business called CCUE with rooms at MGM Macau, L’Arc, and Altira.


The Court of Second Instance rejected LVS's attempts to register “Cotai Strip CotaiExpo” and “Cotai Strip CotaiArena” as trademarks.  The Portuguese-language newspaper Jornal Tribuna de Macau quoted two judgments from the Court of Second Instance that say both the expressions ‘Cotai’ and ‘Cotai strip’ stand for a specific area of the city where gaming, hotel and entertainment activities are being developed.

The court said the expressions are too generic and fail to distinguish Las Vegas Sands from other companies that could produce or sell the same goods. The judgments do not disclose which companies are involved in the dispute.  However, Business Daily reported last week that MPEL was fighting Sands in court over the trademark “Cotai Strip CotaiTravel”.


RL: The Market Is Not Recognizing The Risk

Takeaway: Stocks don't go up when sales slow, costs increase, capex goes up materially and the stock is at 20x EPS. A textbook 'investing year.'

Conclusion: We like what RL is doing, but the near-term financial implications will not be pretty and EBIT growth trajectory and RNOA will suffer. Even though this impact will likely be temporary, investors will need to wait until near the end of this calendar year until the risk profile improves. Until then, valuation matters.



We're surprised that RL was not down more on its 4Q print. Yes, the company overdelivered -- in typical RL fashion.  But there are enough factors that are changing negatively on the margin that we think will make  RL a good candidate for multiple compression in the sloppy quarters that lie ahead in the upcoming fiscal year.


We like this company as much as we ever have. It continually reinvests in its intellectual property to elevate the retail experience and gain share -- something that has worked for RL without fail.

Case in point…we kept a little scorecard of all the times that retailers and brands mentioned the words 'omni-channel' in press releases and earnings calls this earnings season. We stopped count at 100, and no, it did not take us long to get there. This has officially become the biggest cliché buzzword since 'supply chain' made it on to the scene 15 years ago. We swear that half of the execs talking about omni-channel don't even know what it means (if there even is a universally-understood definition). They're just following the cool kids.


Ralph is one of the cool kids.  It did not discuss 'omni-channel' once on its call or press release. Why? The reality is that it has been implementing a true omni-channel strategy for much of the past five-years…at a time when no one knew what it even was. Now RL is implementing retail and e-commerce models that others will be trying to implement in another five years. Simply put, we think that RL will continue to be a winner.  


But this is one of those years where the negatives to the story are likely to outweigh the positives. Specifically…

  1. FX will be a meaningful headwind in FY14 -- especially given RL's significant exposure to Japan.  Check out the Yen's move over the past six weeks. Not good.  FX is a $75mm hit to EBIT for the year.
  2. RL's Global SAP implementation, Korean e-commerce rollout, acceleration of retail rollout -- including NY flagship. There's another $75mm hit to EBIT this year.
  3. Capex is going from $276mm last year to up to $450mm in FY14 -- that's one of the biggest capex increases we're seeing out of anyone in retail.


In fairness to RL, it has proven to be an exceptional steward of capital in the past, and we have no reason to think that will change this year.  But the reality is that the $150mm in extra costs puts RL in a hole for 13% EBIT growth. This would be ok if we could justify solid double-digit top line growth as an offset -- but the reality is that we cannot (even if partially due to FX). So we've got slowing sales, eroding margins, and a step-up in capex. Any way we cut it, we can't justify the combination of these factors leading to any form of multiple expansion.  

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