“The will of man is not shattered, but softened, bent, and guided…”
-Alexis de Tocqueville
If we need a French guy to tell us what, precisely, is wrong with an un-elected US Federal Reserve whose Chairman has unlimited power over both the value of your currency and rate of return on your savings, so be it.
“… men are seldom forced by it to act, but they are constantly restrained from acting. Such a power does not destroy, but it prevents existence; it does not tyrannize, but it compresses, enervates, extinguishes, and stupefies people, till each nation is reduced to nothing better than a flock of timid and industrious animals, of which government is the shepherd.”
Isn’t it sad? But which part is the saddest? Is it the cowardice in free-market leadership, or the groupthink grounded in how much people will pander to a man that gets them paid? I don’t know anymore. I read this Tocqueville passage at a picnic table at a rest stop in Maine last night. I lit up a cigar, and I felt like I was going to puke.
Back to the Global Macro Grind…
The thought of Gold ripping and #GrowthSlowing because an un-accountable central planner doesn’t allow economic gravity to get marked-to-market makes me sick to my stomach. I run a small business in America. I have a payroll to meet and people to inspire – it gets a lot tougher when the economy slows than when it’s accelerating.
Not that anyone in Washington cares, but I’ll be fine. I started this firm during the thralls of 2008 when Bernanke thought the “shock and awe” rate cuts to 0% were going to save government from itself. So I can take a P&L punch. But if the buck keeps burning and rates keep falling, Bernanke, Obama, and “progressive” Republicans are going to knock some people right out.
I don’t agree with everything he says or thinks, but I think Mark Levin has this part of it right: “The nation has entered an age of post constitutional soft tyranny” (The Liberty Amendments, pg 4). And I’m not talking about politicized social issues or anything outside of my domain of required reading – I’m talking about the economy and markets.
How else would you describe a market that hangs on every breath of what an un-elected body @FederalReserve says and/or hints next? Forget the soft stuff – this is hard core tyranny.
So, after being the US #GrowthAccelerating bulls for the better part of the last year, how do we reposition for?
1. Down Dollar
2. Rates Falling
Whether you like the probability of these things occurring or not, it’s officially rising. But you already know that. You can see the “growth style factors” in your portfolio slowing.
Yesterday’s US stock market correction (from the all-time highs) was led by the Financials (XLF). The only S&P Sectors in our 9 Sector Model that were up on the day were the 2 slowest growth sectors – Utilities (XLU) and Consumer Staples (XLP).
What else has been working this week?
Isn’t that just great? Think about that for another few seconds – AT THE ALL-TIME HIGH IN THE US STOCK MARKET, GOLD, BONDS, and VOLATILITY WENT UP! And CNBC’s big government access ratings hit new lows.
This has never happened before… that’s why it “enervates, extinguishes, and stupefies people.”
Why has it never happened before? That’s easy. We have never been at these all-time highs before – and the Bush/Obama Bernanke legacy now has plenty of “this time is different” economic policy that history will have plenty of time to review.
Is this time really different? Is it still 2008? Or do the people in Washington who are plundering your currency for political gain look like they are living through Bernanke’s said 1936 depression?
Or is it 2013 – the year when de Tocqueville finally nails it on US monetary policy being that soft tyranny that we are all so numb to that we just allow it to exist?
2013 FACT: as US economic growth accelerated (Dollar Up, Rates Up), the bond, currency, and stock markets all had this right. That’s why Gold got tapered. On September 18th, 2013, Ben S. Bernanke restrained market forces from acting as they were.
I don’t think torching the currency, starving savers or a risk free-rate of return, and trying to arrest economic gravity ends well for Americans. That’s why I went to 58% cash yesterday and I still feel like I am going to puke.
Our immediate-term Global Macro Risk Ranges are now as follows:
UST 10yr Yield 2.47-2.60%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
We Were Mostly Right, But Too Optimistic On Restructuring
We’ve been “short” CAT for about the past year and a half, but this is the first quarter where we were not bearish enough. We had expected management to present the strong corrective measures hinted at on the 2Q 2013 call. Instead of a restructuring program, CAT management sounded a bit helpless – revenue was just dropping too fast. As the totality of the miss and lack of credible response sink in, we expect continued pressure on CAT shares. CAT’s 2014 outlook implies an earnings decline from an already weaker than expected 2013. CAT sell-siders are going to need to cut 2014 to ~$5.50 from ~$7, give or take, which will be hard for even the 13 analysts with Buys to spin as positive. CAT is not in a good way with the Street.
Troubled Industrial companies usually have a “go to” playbook. They trash a quarter or two with one-time impairment charges and accruals, boosting future earnings with a current profit hit that gets written off as one-time. Analysts may complain that those future higher earnings are just the result of previous charges, but the market usually gives a partial pass. Then that troubled company does some sort of “portfolio reshaping”, with a few small divestitures and a few large acquisitions with generous acquisition accounting. As the charges/accruals run out, they just rinse and repeat. We’ve all seen variations on this before, with some companies achieving greater success than others. It gets the management teams through the down-cycles with a bit less pain and bad press.
We had assumed CAT would adopt a version of this playbook in 3Q, finally recognizing that the market for resources-related capital equipment is going to grind lower, not turn higher. Even if CAT management truly believes that mining capital spending will come back, a series of charges would make it look like they were doing something – even if it was only protecting headline EPS. They could then do a few acquisitions (looking at you MTW – mining shovels and cranes scream synergies, right?). Acquisitions could stem the nasty revenue decline, allow CAT to stop repurchasing overvalued shares and, most importantly, give management something less gloomy to talk about.
On the earnings call, CAT oddly disavowed much of this strategy. We are “short” and even we had expected more positive news on this front.
“And in terms of physical capacity, it doesn't make any sense to close down an assembly line or get rid of machining equipment that you've put in place. So I think just from taking out physical capacity standpoint, there's just not a lot of scope to do that... But we're going to need the physical capacity.” – CAT 3Q 2013 Earnings Call
As we read that, our response is “actually, no, you are not going to need that capacity.” While we could be wrong, that expectation lies at the core of our CAT thesis and rests on pretty solid data and reasoning. Nonetheless, CAT should be telling us that it is rationalizing capacity and will take a bunch of charges – that is the playbook. It will be harder to do that convincingly with the comments above.
Why Can’t CAT Follow The Playbook?
Perhaps management is unwilling to accept an implied mea culpa on billions in bad investments in mining equipment. Action to reduce capacity or focus acquisitions elsewhere might be perceived as an admission of bad choices.
The lack of M&A is less of a surprise; the current management team’s track record on acquisitions is poor. The Board would probably be very skeptical of any proposed transaction. Given the publicity around the Siwei fraud and the BUCY purchase price allocation, transaction execution would probably not be much fun, either.
Why not ‘kitchen sink’ 3Q and then do a deal? Maybe CAT is waiting for 4Q 2013 to combine it with goodwill impairment testing. Maybe they are just responding really, really slowly – even though they responded very quickly in 2009. Maybe Kynikos’ “accounting issues”, the Siwei fraud and the huge dealer inventory problem have attracted the attention of regulators and management is distracted or wants to stop digging. Maybe senior management is about to turn over and the Board wants to leave the restructuring to the next team. The last one seems a good guess.
If the market hates uncertainty, CAT’s lack of a reasonable playbook is likely to foster continued share price weakness. We may be reading this all completely wrong, but the lack of a clear response to CAT’s challenges struck us as a key aspect of CAT’s release. What, exactly, are the longs looking forward to? Are they just going to wait for resource-related capital spending to turn up (think 2025)? As the charts below show, mining capital spending is already cyclically inflated and likely on its way lower. Please do not email that now earnings expectations are low enough – we get that every quarter. 2013 is low enough now, excluding a possible 4Q goodwill impairment charge, but 2013 is almost over. Expectations for the out years are still too high in our view.
We have held three “black book” calls and written numerous notes outlining our bear case for CAT. Our thesis has played out well so far, but all the while we had assumed that CAT would go to the playbook. While it may be interesting to see what CAT does instead, we do not see alternatives that are likely to benefit the share price anytime soon.
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In preparation for WYNN's F3Q 2013 earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.
WYNN MACAU ROOMS/SLOTS
- We are currently working on renovating the original Wynn Macau tower that's resulting in between 6% to 8% on the room base being out on any given day. Recently made some upgrades to the slot area, looking at making some possible changes to our original west casino space but nothing imminent on the casino front.
- It's about $409 million spend through the second quarter. We'll spend about $300 million more in the second half of this year, probably another $1 billion spent on that in 2014 and it will be hopefully opening still in the first half of 2016.
- Still trending on track for an early opening in January of 2016.
- With our guaranteed maximum price contract, there's a additional payment that I guess paid to the contractor, if they hit that January date. It's a pretty sizeable number, not one that we're allowed to put out but it's a big enough number where they're pretty strongly incentivized to hit their early date too.
- I've always been sort of neutral about using the word recovery. I think that Las Vegas is doing better than it did last year, but the extra capacity that came on during the recession was poorly timed.
- In Vegas we continue to outperform. Vegas is a very competitive market. And despite that, we continue to outrun all of our peers.
- We think the drivers [are] the non-casino end of the business.
MACAU AVERAGE TABLE BET
- It's going up.
- So what we have done is gone onto a policy of happier in year-end. We just did that recently. In fact we just paid.. our last dividend, we're the happier for Macau. So expect that to continue. That was HK$0.50.
PREMIUM MASS COMPETITION
- The mass market's high limit side is hypercompetitive, remains hypercompetitive, and we've just been focusing on taking care of our customers, delivering high-quality service and trying not to get into the heavy discounting promotional battle that's in the marketplace.
WYNN LAS VEGAS RENOVATION
- There's mild disruption. We're not doing heavy renovation. We're refurbishing our guest rooms. We're doing all 600 keys in our Wynn Tower, and we're just over 7 years old. They've been incredibly well received. We've taken the palette from Wynn Las Vegas Tower suites and rooms and so far the reaction has been excellent. We've done five floors so far. We'll be finished by late November.
- Everyone is aware of the liquidity issue in China. We're very cautious of how we handle our credit and collections, so we really haven't felt any effect on our business or economy here yet.
- We actually see a pick up across – besides north and also through the Guangdong province area. So, both sides are picking up.
Takeaway: Takeaway: Join us for a conference call with Guy Constant, CFO, of Brinker International.
Friday, October 25th at 11:00am EDT
We will be hosting a call with the CFO of Brinker International, Guy Constant, to discuss 2Q14 results, the outlook for the balance of the year, and the emerging role of technology in the casual dining industry.
TOPICS TO BE DISCUSSED:
- Bringing technology to the casual dining industry.
- A more detailed look at 2Q14 results.
- Why traffic trends in the casual dining industry look bleak.
Guy Constant is Executive Vice President, Chief Financial Officer and President of Global Business Development for Brinker International. In this role, he is responsible for overseeing Planning and Analysis, Mergers and Acquisitions, Investor Relations, Treasury, Tax and Accounting, Domestic Franchise Business Development, and Corporate, Chili’s and International Finance in addition to overall Development. Guy added his global responsibilities in January 2013 and is responsible for overseeing global operations.
Please email or call to learn more about the event. Attendance is limited. Please note if you are not a current client of our Restaurants research there will be a fee associated with this call.
Takeaway: Monetary policy and not perceived supply and demand is the driver of the price of gold.
As many of know, one of the most esteemed gold bugs of our generation is the venerable Eric Sprott of Sprott Asset Management in Toronto. Since 2000, he has obviously been spot on in his bullish call on gold, although this year has obviously been not quite so shiny (so to speak) for the gold bulls.
Yesterday, Sprott wrote a note to the World Gold Council effectively questioning their projections for short term supply and demand for physical gold. Admittedly, he actually raises some interesting points, in particular the idea that even though physical gold in ETFs has been in free fall this year, it appears unlikely to go much lower from current levels.
On a higher level, Sprott’s point that the available statistics on gold are misleading to the extent that they may be overstating the available supply of and thus negatively impacting the price of gold is an interesting one and worth investigating further. In the chart below, we’ve re-created Sprott’s table that was attached in his letter to the World Gold Council.
The table shows that demand for gold, according to Sprott, is clearly out stripping supply. In his analysis, Sprott nets out both Chinese and Russian domestic production from the world market, which he argues never leave the country and are consumed directly internally. He also excludes about 400 tonnes a year in technology demand, which he believes is double counted. On the flip side, Sprott excludes what the GFMS dubs “OTC investment and stock flows”, which is a name for a plug of sorts that represents the gold traded in the OTC market.
In summary, based on Sprott’s analysis there will be a deficit of supply this year of more than 780 tonnes. If he is correct, and if gold in fact trades off of supply and demand, then the sell-off in gold this year is truly because the consensus misunderstands the global supply and demand dynamics. Or, alternatively, there are other key factors driving the price of gold, which we will touch on shortly.
The counterpoint to Sprott’s case is that aggregate gold demand is down based on the World Gold Council’s numbers for the year-to-date. According to the World Gold Council, demand actually fell by 12% in Q2 2013 from Q2 1012 to 856.3 tonnes. This is just about 20% below the 5-year average quarterly demand for gold. Clearly, this is a very different story than Sprott’s numbers outline. In fact, as we show in the table below, the world gold council shows an over-supply of gold in the year-to-date.
Sprott’s full year estimates vary from the World Gold Council’s annualized numbers by 1,215 tonnes in aggregate. On a notional basis, the supply and demand difference between the two sets of estimates is $52 billion. This is a difference that is big enough to drive a very large truck through. So, who is right? Well, simply, the market seems to be saying the World Gold Council has nailed this one.
One point both groups agree on, which is very transparent data, is that the financial demand for gold via ETFs has fallen dramatically this year. Through the first two quarters of the year, the gold held by ETFs has declined by 579 tonnes.
But given the clear opacity in global supply and demand numbers for gold, we would actually posit another thesis, which is that perceived supply and demand is not the key driver of the price of gold at all and both sets of estimates are merely noise. In the chart below, we show one of the strongest correlations we’ve seen over the last five years, which is the gold price versus the Federal Reserve balance sheet.
From 2008 – 2012, this correlation was about as tight as we’ve seen in our factoring models with a r-squared of 0.90. The chart also shows that in 2013, this relationship broke down in emphatic fashion. Investors began to sell gold as economic data accelerated and in effect began front running a change in policy course from loosening to tightening.
The largest decline in demand for gold this year has come from a decline in demand from ETFs, or the financial markets. As the chart below highlights, the price of gold and value of gold in ETFs has increased in lockstep for the last decade and declined in lock step starting about a year ago with the initial correction in the price of gold leading the exit of physical gold from ETFs.
Ultimately, the true supply and demand dynamics for gold are difficult to determine, but we would argue that on some level they should likely be ignored. The best predictor of gold prices will continue to be the direction of monetary policy both in the United States. Loose monetary policy and a subsequent weak dollar, will create monetary inflation and inflate both the price of gold in real terms and lead to increased demand for gold as a store of value.
In the long term chart below, we see this relationship play out in spades going back to 1969. Consistently, a protracted increase in the value of the dollar has lead to a commensurate decline in the value of gold and vice versa. Interestingly, the recent spike we have seen in the value of gold in the last ten years coincides nicely with the advent of financial demand for gold via ETFs. But undoubtedly just as ETFs have created a multiplier on the way up, they have potential for creating a multiplier on the way down.
Daryl G. Jones
Director of Research
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