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Gas versus Oil: Flashing an Extreme

 

My colleague, and Research Edge's Asian Strategist, Andrew Barber told me the other day that he had a dream that we would one day all be driving cars powered by natural gas.  While Barber is a great analyst who has nailed China this year, he is also a man of ideas.  As of now, cars powered by natural gas are just that, an idea.  We neither have the vehicles to do this, nor the infrastructure in place to deliver the natural gas.  With all things, though, there is a price. 

 

Currently, the oil / gas ratio is suggesting that price may be near as we are at an extreme in the price differential between the two commodities.  In fact, the oil / gas ratio (the price of one barrel of oil divided by the price of one BTU of natural gas) is currently nearing 18x, which is 9-year high.

 

According to many experts, a barrel of oil contains roughly 6 BTUs of energy equivalence.  On that basis, natural gas should be trading at ~$10.80 per BTU. Based on its current price of $3.93, natural gas is trading at just 36% of energy equivalent price.  In theory, if oil stayed at its current price and natural gas reverted to its energy equivalency value, there would be ~175% upside to natural gas.  As we know, in the real world arbitrage opportunities happen for a reason and the theoretical energy equivalency value is just that, theoretical. 

 

Our competitor Dennis Gartman uses many ratios to justify his positions.  On most, we would vehemently deny that there is a fundamental underpinning (Gold versus Agriculture as an example).  With oil and natural gas, on the other hand, there is clearly some fundamental basis to consider this ratio since both oil and natural gas have an energy value that can be measured.

 

Some analysts suggest that on the industrial demand side, there is 5 - 10% overlap in oil and natural gas, which can be switched at different price levels.  While this may be accurate, the most relevant data point relates to transportation.  As the EIA reported last month in their year end natural gas review:

 

"Natural gas for vehicle fuel has increased over the past several years but remains at less than 1 percent of the total."

 

Until we see this number move meaningfully, it will be hard to argue that oil and gas are interchangeable from a usage perspective.

 

Investors who use history as a guide would suggest that either oil is over priced or natural gas is under priced.  In the short term, they could both be correct.  Longer term, the reality is more likely that we have entered an era of cheap natural gas and relatively expensive oil.  Most importantly, oil has quantifiable supply constraints and burgeoning demand from emerging economies, most specifically China, while the natural gas market is flush with supply domestically and abroad.

 

We can see this change in growth of domestic supply of both commodities. In the simple table below, we have outlined the growth in domestic oil product and gas production in 2008 and 2000 versus 1990, with 1990 as the reference year.  As we can see, on domestic basis, the market for oil has tightened dramatically.  Since 1990 oil production on an annual basis in the U.S. is down -32%, while natural gas production is up 15%.

 

Gas versus Oil: Flashing an Extreme  - change

 

While the oil / gas ratio is a relevant input for a fundamental view of the two commodities, until interchangeability becomes more prevalent between the two commodities, the history of the ratio is probably not the best guide to its future.

 

Daryl G. Jones

Managing Director

 

Gas versus Oil: Flashing an Extreme  - nymex


German Unemployment Improves on Mixed European Backdrop

 

German unemployment dropped a seasonally adjusted 10 basis points to 8.2% in May, an important call-out as unemployment is busting out across Europe.  While we're not calling a top on German unemployment, the number should provide a tailwind for German confidence.  For our fundamental view on the country see yesterday's post entitled "Germany Grinding It Out".

 

Today the European Commission released its May confidence numbers, which improved across nearly all industries.  Overall economic confidence rose to 69.3 from 67.2 in April, a six-month high. Consumer sentiment stayed flat on the previous month, while industrial, services, and retail indices improved. Only construction dipped mildly. (See the chart below).

 

In conflict with the retail sales results is Bloomberg's purchasing managers index (PMI), which recorded that retail sales for the Eurozone declined to 47.1 from 48.4 in April, based on more than 1,000 executives compiled by Markit Economics.

 

We continue to follow European data points to monitor health, yet place greater emphasis on country-specific data when considering a position as we believe auto-correlation is dead. Due to the importance of the Union as a trading partner for European countries, improvements in fundamentals and confidence will benefit the whole.

 

In Europe we're currently long Sweden via the eft EWD. We're bullish Sweden on a fundamental basis and believe that exports will benefit from a weaker Kronor versus the Euro.

 

Matthew Hedrick

Analyst

 

German Unemployment Improves on Mixed European Backdrop - euroconf


Claiming Confucius?

 

In this morning's Early Look I quoted our old friend of the fabric, Confucius. When market's trade in a proactively predictable range like this, maybe that's the only thing left to do - trade the range and philosophize...

 

The last few weeks of jobless claims data have given plenty for both perpetual bulls and perma bears to pontificate on. Last week's claims saw us shoot above the 4-week moving average, while this week's print takes us for another dive below it (see chart).

 

The New Reality is that consensus fears of the American Consumer's death were largely exaggerated. That well known phrase and a Confucius quote might give you the magic fairy dust of a Wall Street narrative fallacy.

 

Two consecutive weeks of improving jobless claims, is what it is - bullish for a market that tested the bottom end of its new trading range early this morning (886 SPX). Don't make this any more complicated than it is - trade the market and the data points that are in front of you.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Claiming Confucius? - initial


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CONSUMER COFFEE SURVEY

Big Research is a consumer centric research firm that does very detailed survey work in multiple retail categories. In the May survey of 6,000 consumers, they asked- which Fast Food Restaurant or Coffee Shop do you purchase COFFEE at most often?

 

The most recent coffee survey shows McDonald's gaining ground on both Starbucks and Dunkin Donuts. Although Starbucks is still #1 - 9.2% of consumers frequent the Starbucks most often for their coffee needs. The survey shows that McDonald's is taking more market share from Dunkin Donuts.

 

McDonald's market share has consistently grown since May of 2007, according the BIGresearch's May 2009 Consumer Intentions & Actions (CIA) Survey. With McDonald's spending upward of $100 million on its coffee campaign, it's likely that the momentum will continue.

 

According to the analysis, McDonald's coffee drinkers (those who purchase coffee most often from McDonald's) tend to be older than Starbucks drinkers with an average age of 47.7 vs. 39.2 for Starbucks drinkers. Also, 46.8% of Starbucks drinkers are in the 18-34 age range, compared to 25.8% for McDonald's.

 

More Starbucks coffee drinkers are single at 29.1% vs. 19% of McDonald's drinkers and a higher percentage hold professional/managerial jobs - 27.2% vs.15.7%. Starbucks customers are also more affluent with annual income of $67,487 vs. $55,572 for McDonald's.

Other Thoughts:
• 33.7% of McDonald's coffee drinkers are confident/very confident in the economy, vs. 30.3% of Starbucks drinkers.

 

• 72.7% of McDonald's drinkers are focusing more on needs over wants, vs. 65.7% of Starbucks drinkers.

 

• 44.2% of McDonald's drinkers are buying more store brand/generics vs. 36.2% of Starbucks drinkers.

 

• 26.4% of McDonald's drinkers feel better about their economic situation, vs. 34.4% of Starbucks drinkers.

 

• 20.8% of McDonald's drinkers are starting to spend more on discretionary items, vs. 21.4% of Starbucks drinkers.

 

CONSUMER COFFEE SURVEY - coffeemarketshare

 


THE ANATOMY OF A BAD UPGRADE

Goldman upgraded Starwood to Buy after the close yesterday.  It doesn't look like a buy to me but that is fine.  At the same time, the firm upped its price target a whopping 145% to $27.  So fundamentals must be improving, right?  Cost of capital must be falling, no?  The hotel transaction market is opening?  Asset values increasing?  Try none of the above. 

 

Instead, the upgrade is predicated on minimal supply growth and easier 2H comps.  Yet, these "catalysts" were in place 2 ½ months ago when the stock was under $10.  Now that the stock is up 145%, the supply and easy comparison drivers are suddenly important?  This smells like a sentiment upgrade to me, i.e. stock is up big, momentum guys are buying, and I want to jump on board.  Getting in front of the time when RevPAR improves (given as the catalyst for stock appreciation) is dubious when:  a) we are a long way from that happening, b) stocks have already ripped.

 

Is this the kind of research institutional investors pay the sell side for?  The fact is that the stock has made a big move, along with everything else in my space, based in part on the "less bad" thesis.  The 2nd derivative thesis can be an effective one.  The problem for HOT and lodging in general is that business hasn't gotten less bad like other sectors we follow.  Occupancy is still declining, forget about rate.  There is very good reason to believe 2010 will be worse than 2009 due to the timing of 2010 corporate rate negotiations occurring this year (when the buyer has all the power), the long tail of the group and convention business, and the deep cost cuts already implemented in 2009.

 

Besides, a recovery thesis works better when stocks are on their back, which is clearly not the case here.  Price targets based on 11-12x EV/EBITDA look very aggressive, especially when based on 2011 EBITDA.  Can you say momentum justification?  As we've written about, historical EV/EBITDA multiples are less relevant when cost of capital is escalating.  Why is an 11.5x multiple appropriate when the cost of borrowing is 300-500bps higher than the 2004-2008 period and there is so much more risk?


Deaf And Willfully Blind

"The strength of a nation derives from the integrity of the home."
-Confucius
 
President Obama should take that quote and tape it to the back of his crackberry. America's currency is on the verge of a crisis, and now so is her Treasury market.
 
If you're in the "Jimmy Timmy" camp and think that Cramerica's solution to all that ails the integrity of the US Financial System runs through CNBC and Timmy Geithner, I'm sorry to hear that. Rasmussen's latest Main Street "Timmy" poll has over 70% of Americans thinking that the YouTubed Squirrel Hunter is removed from his seat as Secretary of the Treasury by the end of 2009. That's a bullish catalyst that can't come soon enough.
 
What's the point in having Secretaries of a Treasury market that they don't manage as a priority? Even tricky Dick Cheney went on national TV last night and finally admitted what we, who aren't willfully blind, have seen for the last year - Hank The Market Tank Paulson, like Timmy, serves Investment Banking Inc. bailouts first. So... Dear American underlings who aren't part of the Wall Street Club, take your currency and savings bonds and fall in line.
 
This is so pathetic and sad that I can only call it out for what it is. The New Reality isn't about being political, it's about the US Government being willfully blind and deaf. Obama's crackberry nation of reactive said leaders can hopefully get at least a feel for this if I keep hammering on it  - no need to see or hear boys, crackberries vibrate.
 
For those who haven't noticed, the US Treasury market has gone from shaking to crashing. Not unlike that US Dollar chart that I put up in a note yesterday to our Macro subscribers titled "The Chart That No One In Obamerica Is Allowed To Talk About...", the chart of 10-year US Treasury Bonds is equally as damning. If "the strength of a nation" really does "derive from the integrity of the home", don't look to the bonds associated with a long standing American handshake for shelter. The compromised and conflicted bankers of everything Robert Rubin groupthink are still running this joint.
 
Do I sound surly this morning? Yes, these days I'm in an average mood at best when my alarm goes off at 4:01AM. I was used to sleeping in until 4:03AM, until Geithner started making me allocate an extra 90 seconds of my research time every morning trying to follow his made-up rules to this game. Hockey players can change on the fly, but this guy's proposed rules, timelines, and selective disclosures for everything from his made-up tests to the PPIF (public private investment fund of funds or whatever he use to call it) can make a Sydney Crosby pass across the neutral zone look slow!
 
The New Reality remains. American supremacy as the world's safe haven for currency and fixed income investment is under assault. American Idol season of your local insider trader hedgie who is "smart" because he "makes money" are ending, abruptly. Madoff doesn't work. The world's financial markets have voted.
 
Yesterday I said that the US Equity market was setting up to lock in another lower high, and I gave you levels. All three of those levels (SP500 934, Nasdaq 1764, and Russell 511) were not breached, and right after the US Government issued another boat load of bonds at the 5-year auction, both the US bond and stock markets fell apart.
 
This morning, I'll give you 3 more levels on those same US indices, but this time these are levels I consider critical immediate-term TRADE support:
 
1.      SP500 = 885

2.      Nasdaq = 1702

3.      Russell 2000 = 485

 
My playbook from here is crystal clear. After selling down my invested exposures aggressively in the last few weeks, I am waiting to see the confirmation of US stock market support. If you believe that real-time market prices (across asset classes and geographies) are leading indicators like I do, you get the drill. Both the US currency and bond markets are already broken. Are they leading this Canadian hockey mule to water on US stocks or not? Only time will tell...
 
The US Dollar broke my long-term TREND line of support last week. Since literally the day that I rang the sirens on this critical global macro factor, the US stock market has been down in 5 of the last 6 days.
 
The US Dollar Index long-term TREND line of $81.54 is the one that has the hair standing up on my back - Washington ignoring the alarm bell just makes this worse. If Bush was willfully blind, Obama is apparently willfully deaf.
 
The strength of this nation depends on a red, white and blue vision that people can trust. President Obama, for the third time now in a public rant, I am going to ask you on behalf of the American people who are allowed to see, do you hear me now?
 
Best of luck out there today,
KM
 

LONG ETFS

XLE - SPDR Energy- We bought Energy on 5/13 with the dollar up. We think it works higher if the Buck breaks down.  Bullish TRADE and TREND remain.

CAF - Morgan Stanley China Fund- A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.

EWD - iShares Sweden-The country issued a large stimulus package to combat its economic downturn and the central bank has effectively used interest rate cuts to manage its economy. Sweden's sovereign debt holds a strong AAA rating despite Swedish banks being primary lenders to the Baltic states. We expect Sweden to benefit from export demand as global economies heat up.

XLV - SPDR Healthcare-Healthcare looks positive from a TRADE and TREND duration. We've been on the sidelines for the last few months, but bought XLV on a down day on 5/11 to get long the safety trade.

TIP- iShares TIPS - The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%.  We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

GLD - SPDR GOLD -We bought more gold on 5/5. The inflation protection is what we're long here looking ahead 6-9 months. In the intermediate term, we like the safety trade too.
 

SHORT ETFS
 
XLU - SPDR Utilities - Utilities had an ugly day on 5/27, breaking down through the TRADE line; we remain short. As long term bond yields breakout to the upside, Utility investments are the relative yield loser.

EWJ - iShares Japan -We re-shorted the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

EWW - iShares Mexico- We're short Mexico due in part to the repercussions of the media's manic Swine flu fear.  The country's dependence on export revenues is decidedly bearish due to volatility of crude prices and when considering that the country's main oil producer, PEMEX, has substantial debt to pay down and its production capacity has declined since 2004. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.


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